Lessons from the past
WITH Greece teetering on the precipice, and Greek default not being a case of “if” but “when”, traders will be looking to pile in when the crash happens. But can you look at past financial crises to predict the future?
Geoffrey Wood is professor of economics at Cass Business School and a former special adviser on financial stability to the Bank of England. While some have drawn parallels to Argentina’s 2002 default, he points to the Argentinean panic of 1890, and the Barings crisis that it triggered, as an echo of the current Greek predicament. In 1890, Argentina went into a severe recession. In April, the government had difficulty paying its debt. Following this, the Argentinean national bank suspended interest payments on its debts. This triggered a run on the Argentine banking system and a revolution on 26 July.
Much like current worries that abound of UK banks’ over-exposure to a Greek bond tragedy, Barings Bank went into difficulties having over-lent to Argentina. Fearing a run on the bank in London following a Barings default, William Lidderdale, governor of the Bank of England, set up a consortium to guarantee Barings’ debts. Containing most of the major London banks, the consortium stumped up £17m worth of capital. On 15 November, the news of Barings’ difficulties became publicly known, but there was no run on the pound or on London banks. The event had only a small effect on the financial markets. Following the events, Barings was liquidated and refloated as a limited company. It went bust again in 1995, but that is another story.
In light of past sovereign debt crises, Wood says that the ECB, rather than throwing money into the Athenian abyss, should instead address the predicament of other Eurozone countries with exposure to Greek debt, especially Ireland, Portugal and Belgium.
ALL HANG TOGETHER
Whereas the Argentine crisis exposed other countries to the risk of contagion, in the case of the sovereign debt crisis hitting Greece and the Eurozone as a whole, the current woes are exacerbated by the European single currency experiment. “The euro is fundamentally flawed,” says Wood. Beyond the issue of lenders treating the countries within the Eurozone as being of equal risk, the current crisis highlights another glitch in the system. “The big difference between the euro and the US’s federal fiscal union is a ‘willingness to lend.’” A taxpayer in Delaware is more willing to lend to Maryland than a German to Ireland.
Traders will be interested in positioning themselves for the fallout. Sadly, no two crises are the same. “You can get some idea but the difference here is the single currency,” says Michael Hewson, market analyst at CMC Markets. “The straitjacket of the euro complicates a scenario massively, so what worked in Argentina’s case [referring to Argentina’s sovereign default in 2002] won’t work in Greece or Ireland’s case.”
Though it is difficult to predict the exact effects of Greece’s inevitable implosion, the reaction to the event will provide plenty of opportunity to trade on the volatility, and perhaps to book some profits on over-exposed banks.