Posted by: Dirk | May 16, 2012

Corralito espanyol?

The discussion of a corralito in Spain has reached the newspapers. EL PAIS has published an article about the government renouncing the idea today. A corralito limits the amount of cash that you can withdraw from bank accounts. (Later, the corralón translated your dollar-backed pesos into free-floating peso denominated government bonds.) The discussion is part of the problems that would come with a break-up of the euro. In theory, a break-up would see national currencies reinserted. The easiest way to do this is by converting bank accounts back to, say, the nueva peseta. The nueva peseta would be worth less than the equivalent amount of euros since this is the whole point of the exercise. The currency must depreciate in order to regain competitiveness.

Therefore, if people would move their euros abroad in expectation of a corralito – which was introduced shortly before Argentina lifted the dollar peg – these euros would keep their value. Once people realize this, a bank run is what is next. Capital flows from the periphery to the core are already happening, as you can see with the bund yields trending downwards. A full capital flight would surely trigger the exit of that country, since the monetary supply would drop violently and create huge disorderly deleveraging as people struggle to pay bills and the price level collapses. The resulting deflation would be toxic for business and create a huge economic crisis – if nobody would intervene. While in Argentina it was unlikely that the US would provide help, in the euro zone that is not so sure.

The core could channel the funds that flow from periphery to core back to the periphery via the ECB and the crisis mechanisms. This has been going on for some time now, and it would stop any capital flight by lending unlimited amounts of money to those in need of funding. The LTRO probably has been set up to deal with these problems. Anyways, the corralito was a bad idea when Argentina introduced it, and the Spanish government rejected it. This should be the end of the discussion.


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