Courtesy of John Nyaradi.
Are currency controls and bank runs in our future?
As the debt crisis in Europe intensifies, more and more chatter rises around the possibility of impending currency controls and bank runs in Europe.
Bank runs are nothing new in financial history as they were recorded as early as the 16th century and in conjunction with such famous financial fiascoes as the Dutch Tulip Mania between 1634-37, the British South Sea Company Bubble in 1717 and America’s Great Depression starting in 1929.
Bank runs were a major factor in the Depression while in today’s financial crisis, we have seen bank runs surrounding Northern Rock in Europe and in current conditions in Spain.
Capital controls are designed to restrict the flow of capital to or from a country and can include measures like transaction taxes, restrictions on currency conversion and the transfer of assets and trading to or from the country. Capital controls came into being after the Bretton Woods Conference at the end of World War II and have been used at various times throughout history.
Today, with the financial crisis in Europe reaching boiling point, bank runs and capital controls become a real possibility and modern day bank runs are apparently already underway as capital leaves Spain, Greece, Italy and Europe, in general.
Recent reports indicate that 100 Billion Eurodollars have recently left Spain as residents fretted about the safety of their money and approximately 10% of Italian capital has fled the country. In Greece, reports indicate that as much as 4 Billion Euros a week are heading for safer shores.
Capital is flowing from problem countries to Germany, Switzerland and the United States, among other “safe havens” in the form of currency asset and sovereign bond purchases.
This is where capital controls come into play as countries like Greece and Italy could impose them to stop capital from leaving while countries like Germany and Switzerland could impose capital controls to stop money from coming in and forcing up the value of their currency.
Reports circulate that Switzerland is already considering restrictions on the Swiss Franc to stop the flow of Eurodollars into the Franc.
“Safe haven” country bond yields have been reaching record lows as money flows into U.S. Treasury Bonds and German Bunds with U.S. 10 year bonds at 1.58% and German 10 year bonds at 1.30%. Danish and Swedish bonds have also experienced substantial yield compression as capital apparently leaves the southern tier of Europe for northern countries.
Possible capital controls in Europe could include ATM withdrawal limits, border checks and outright control over the flow of capital around the Euro Zone.
Affected currencies include the U.S. Dollar, (NYSEARCA:UUP) up 4.5% since the start of May, which is widely seen as the safest currency in the world as the world’s largest economy stands behind it and the dollar is still the world’s reserve currency.
Other safe havens include the Swiss Franc (NYSEARCA:FXF) and U.S. Treasury Bonds (NYSEARCA:IEF)
The Eurodollar (NYSEARCA:FXE) has been in steady decline, down 5.3% since early May, good news for ProShares UltraShort Euro (NYSEARCA:EUO) which has gained approximately 10% since May 1.
Bottom line: The situation in Europe remains fluid and dangerous. With currency flight from troubled countries and an uncertain outcome for Spain and Italy, flight to safe haven currency and bonds is likely to continue and make the ongoing debt crisis more dangerous and difficult to resolve.
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