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I don't think anybody outside of Ireland will put any money in Irish banks, quite the contrary.

Have a look at it another way: zoom out to the entire eurozone. The GDP is something like 10-15 trillion €. There are big banks with liabilities in the trillion euros, but they are few. And medium banks with hundreds of billions. Overall, the liabilities amount to roughly the GDP. Governements guarantee deposits of individuals, which are only part of the liabilities (but a big part for traditional universal banks on the continent). This guarantee looks plausible on this scale: govies can pay for a bankruptcy once in a while, because it's only a liquidity issue (assets will cover the deposits, bond holders will be burned, treasuries only have to cover for the time to liquidate).

In a general downturn, it looks a bit shaky, but can still be handled by combining:

  • a little bit of printing,
  • burning select bond holders and derivative counterparties.

OK, this prevents bank runs in "most" of Europe (the UK had no decent deposit guarantee at the time of the Northern Rock debacle). A general downturn will be paid for by the community, in the form of inflation and broken bucks on some money market funds.

No significant capital flight to non-EMU money zones for domestic investors, because in these times, you can be burn by forex moves, all currencies appear shaky, so better stick to the one applying where you will retire...

(BTW, note that this new feature in the landscape means most tax-loopholes are now self-defeating: they include a terrifying forex risk and/or a counterparty risk in countries with untested guarantee systems, and of course you wouldn't get any public assistance if you sued cross-border to recoup the product of a tax scam)

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Now zoom back to Ireland. Now we have a tremendous asset bubble, in a country that has only recently acquired good living standards. This means there is no domestic accumulation of wealth an savings. The asset bubble actually is on the bank balance sheet, and the corresponding liabilities are not domestic deposits, but mostly bonds in international capital markets. EMU integration made it easy to tap these markets even for small Irish banks, and now the gov't is coming to realize that this was actually a disservice.

The Irish gov tried to prevent a run, not by Irish people, but by foreign bondholders. And that is an amount of debt that they cannot guarantee (alone), as it is bigger than GDP. Unless they get help from the rest of the EMU/ECB, the Irish treasury is going to default on this guarantee !

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Pierre

by Pierre on Wed Oct 1st, 2008 at 12:05:08 PM EST

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