On Wednesday, Fitch Ratings downgraded its credit ratings on five of Europes
biggest banks, and while that decision made headlines, its not the most
important story to come out of Europe this week. The real story, which the
mainstream media is neglecting, is about signs of an underground run on Europes
banks. Almost nobodys talking about it, but there are indications money is
already moving out of the EU faster than rats abandoning a sinking ship. Not
through the front door, mind you. There are no lines, no distraught customers
and no teller windows being boarded up not yet, anyway. For now, the run is
through the back door. Here are four things that make me think so: Italys
planned ban on cash transactions over 1,000 euros, or about $1,300. French,
Spanish and Italian banks have run out of collateral and are now pledging real
assets. Swiss officials are preparing for the end of the euro with capital
control measures. Europes CEOs are actively preparing for the end of the euro
despite governmental reassurances. Signs of a Run Lets start with Italy and
Prime Minister Mario Monti s plans to restrict cash transactions over 1,000
euros (down from the current limit of 2,500 euros, or about $3,200). Ostensibly,
the move is about reducing tax evasion by prohibiting the movement of large sums
of cash outside the official transactional system, but I think it speaks to
something far more sinister namely that the Italian government knows things are
going to get far worse than its publicly admitting. Consider: Cash is a stored
value mechanism. There isnt a lot of it because at any given time, most of it is
on deposit with banks in any country. Thats as true in Italy as it is here in
the U.S. when real interest rates are positive during healthy times. But when
real interest rates turn negative, people are likely to withdraw cash and stuff
it, quite literally, under mattresses or in coffee tins. (Real interest rates
are the official lending interest rates, as adjusted for inflation.) In such an
environment, holding cash in a bank becomes nothing more than an imputed tax and
a disincentive for deposits. Its also a significant thorn in the side of central
bankers who want to control their countrys money supply, because cash can
operate outside the system and, specifically, logjam reform efforts. The reason
is really pretty simple. If you have negative real interest rates, and cash
transactions are largely restricted or removed altogether, then the only way to
effectively use cash is to withdraw it and spend it .immediately. In other
words, by limiting cash transactions to 1,000 euros or less, Italy is putting
into place a punitive financial control fully intended to keep money moving in a
system, lest it become worthless or worse hoarded and worthless. Now lets move
on to banks. Banking Breakdown Many investors have never thought about it
before, but a bank really has only three sources of funding: Money thats
effectively lent to the bank by customers placing their assets on deposit;
Short-term money market funds; And long-term bonds or securitized products based
on long-term paper sold to bond investors. Together, the three funding sources
are like the legs on a stool lose any one of them, and the stool will topple
over. This is whats happening now. Individuals, pension funds and institutions
alike are withdrawing funds from Italian, Spanish and French banks. Money has
long since left Greece, Ireland and Portugal. The thing is, though, its not just
European money thats fleeing. Various reports from The Economist , Bloomberg ,
CNBC and others suggest that American financials may have pulled more than 40%
of their funds from all European banks and nearly two-thirds of their total
deposits away from French banks. This is drying up short-term lending capacity
and driving up interbank lending costs. At the same time, money managers the
world over are selling their European bonds. This is driving prices lower and
yields higher to the point where the cost of debt is now prohibitive (bond
prices and yields move in opposite directions). As a result, banks' new bond
issuance may be down as much as 85% over the past two years, which further
hobbles cash-hungry European banks. Finally, facing a near total loss of
short-term financing alternatives and having run out of short-term liquidity
needed to operate, a number of EU banks are reportedly having to pledge real
assets as collateral for badly needed loans. Normally, banks would use loans,
leases or receivables to accomplish the same thing. The fact that theyre now
having to throw into the mix real estate, their own property and other assets
signals extreme levels of financial stress that are far worse than whats been
disclosed publicly. Bracing for the Inevitable Swiss Finance Minister Eveline
Widmer-Schlumpf noted to the Swiss Parliament that she has a working group
examining capital controls and negative interest rates as a means of preventing
an economy-crushing Swiss franc appreciation when the euro fails. Thats not if
the euro fails, but when the Euro fails. This is an especially dire sign because
capital control measures like those the Swiss officials are considering are
inevitably the end of any failed monetary system. European CEOs and their
companies are taking matters into their own hands by actively preparing for the
destruction of the euro. Some, like German machinery maker GEA Group (PINK:
GEAGY ) are limiting the maximum funds on deposit with any single bank. Others,
like Grupo Gowex, are moving cash and deposits to Germany away from Spanish
banks (and Grupo Gowex is a Spanish company based in Madrid, so this is
especially telling). BMW plans to cut production by 30% while also tapping into
central bank reserves. According to Chief Financial Officer Friedrich Eichiner,
the company is already reducing its leasing portfolio to cope with the potential
decrease in car values that would reduce its borrowing capacity. As for what all
this means for our money, its pretty clear: Think safety first. The return of
your capital is far more important than the return on your capital at the
moment. Heres what I suggest: Buy dollars. I know theyre a bad long-term bet,
but short-term, theyre the best-looking horse in the global glue factory as long
as the euro is under pressure. Stick with what you have in place now and manage
risk with trailing stops. Confine new stock purchases to high-growth, low-debt
emerging markets rather than low-growth, high-debt developed markets. Short gold
and oil in the short-term. Both are priced in dollars, which means both will
fall as the dollar rises in conjunction with panic in the EU. Purchase inverse
funds that track the broader markets. If the euro fails, it will tank the
broader markets. Then, once it becomes clear that the world will live on, the
markets will disconnect from Europe and begin to rise again in earnest. Run the
other way if people tell you that banks are a great investment . They are
speculative at best given the number of skeletons still in the closet. This
article originally appeared on MoneyMorning .
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