The Great European Bank Run

The Financial Times recently published an article titled "Spain Reveals 100 Billion Euro Capital Flight."

Now, I know we've all become desensitized to large numbers over the last few years, but think about that: 100 billion euros. That's not chump change to any country. Not China. Not the United States. And sure as you-know-what, not Spain.

To make matters worse, the same thing is happening elsewhere across the continent. It's been reported that Italy has seen roughly 10% of its capital leave the country. And capital flight from Greece has reached 4 billion euros a week. On one day alone last month, 700 million euros were withdrawn from Greek banks.

To anyone even remotely curious, this trend raises two questions. First, why is capital fleeing Europe? And second, where's it going?

Why is capital fleeing Europe?
It's hardly an exaggeration to say that the entire world is betting against the euro.  

According to data released by the Commodity Futures Trading Commission on Friday, the number of short positions in the currency now outnumbers long positions by more than 200,000 contracts on the futures market. (For those of you wondering, that's a lot.)

Private bankers in London have reported that European clients are moving into dollar-based assets. Central banks around the world are eschewing the euro in favor of the dollar or even their own currency, according to Bank of America. And hedge funds are doing what hedge funds do -- piling on.

The reason is simple. Nobody wants to be caught with money in a European bank -- more specifically, a bank in Greece, Ireland, Italy, Spain, or Portugal -- if the monetary union disintegrates. Imagine waking up one day only to learn that the 50,000 euros in your bank account had been involuntarily converted into drachmas. Talk about coyote ugly.

It's the corollary to what Chuck Prince, the former CEO of Citigroup, said about the subprime-mortgage meltdown in 2007: "As long as the music is playing, you've got to get up and dance." Except this time, instead of dancing, everyone with euros is already grabbing a chair.

Where's the capital fleeing to?
The bet against the euro is truly the bet right now. It's not the jobs numbers in the United States. Or the fear of an economic slowdown in China. It's concern about Europe, plain and simple, that's dictating the market's unseemly gyrations.

The most immediate effect of this is in the currency markets, as investors and speculators clamor to exchange euros into something, anything, else.

It's gotten so bad for Switzerland, which never adopted the euro, that the Alpine country is thinking about imposing capital controls to stymie the tsunami-like inflow of euros. And the U.S. dollar has increased by 6.7% relative to the euro in the past three months alone.

According to the chief investment officer at a London-based investment firm: "If there is global mayhem, the U.S.  dollar will be the only credible survivor."

A less immediate, but arguably more significant, impact has been on the bond yields in countries perceived as safe.

Ask someone who's been around for a while, and they'll tell you that the current yield on the 10-year U.S. Treasury bond was previously unimaginable. I don't know which adjective best emphasizes this, but I'll go ahead and say that a 1.5% yield on the 10-year is ludicrous. And the situation is even more extreme in Germany, which recently auctioned off zero-coupon bonds.

Although this can present opportunities for companies that arbitrage interest rates -- two examples are Annaly Capital Management (NYSE: NLY  ) and its related company, Chimera Investments (NYSE: CIM  ) , which both borrow at low short-term rates and lend the same money back out at higher long-term interest rates via mortgage-backed securities -- they should also be taken for what they are: a warning signal that something serious may be on the horizon.

Foolish bottom line
Because the capital flight from the European continent may be a harbinger of worse things to come, I urge you to check out the three stocks identified in our free report: "3 American Companies Set to Dominate the World." As the title suggests, it profiles a handful of American companies that are geographically diversified enough to both survive and thrive through the European crisis. Access this free report while it's still available.

Fool contributor John Maxfield owns shares of Bank of America. The Motley Fool owns shares of Citigroup, Annaly Capital Management, and Bank of America. Motley Fool newsletter services have recommended buying shares of Annaly Capital Management. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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  • Report this Comment On June 07, 2012, at 3:06 PM, Darwood11 wrote:

    "According to the chief investment officer at a London-based investment firm: "If there is global mayhem, the U.S. dollar will be the only credible survivor.""

    Yes, and in a few years they may be talking about the Yuan exactly the same way..

    Today, because of global mistrust of the Chinese, the U.S. is considered a safe haven. It won't always be that way, I am certain.

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