Gresham’s Law in the Eurozone, Again

Tyler Cowen brought up Gresham’s Law in his NY Times column this past weekend:
IS a euro held in an Irish bank in Dublin, or in a Portuguese bank in Lisbon, as sound and secure as a euro in a German bank in Berlin? That apparently simple question holds the key to understanding why the euro zone may splinter and bring a new financial crisis. 
In Ireland, there has been a “silent bank run” on financial institutions for much of the last year. In February, for instance, Irish private sector deposits dropped at an annual rate of 9.8 percent. That’s largely because some depositors doubt the commitment of the Irish government to the euro. They fear that they will wake up one morning to frozen bank accounts, followed by the conversion of their euro deposits into a lesser-valued new Irish currency. Pre-emptively, the depositors send their money outside Ireland, where it still represents safe euros or perhaps sterling, accessible by bank transfers and A.T.M. cards.  This flight of capital reflects a centuries-old economic principle known as Gresham’s Law, sometimes expressed casually as “bad money drives out good money.” In this context, if two assets — euros inside and outside Ireland — are not equal in value in the eyes of the marketplace, sooner or later the legally fixed price parity will fall apart.

This reminded me of a Telegraph story back in June, 2008 that I blogged where it was alleged that Germans were hoarding Euro notes issued from Germany and dumping Euro notes issued from Southern Europe. I thought it was worth reposting:

In response to my posting on Gresham’s Law and reserve currency status, a reader directed me to the below article that shows not all Euros are considered equal. Apparently, Germans are hoarding German-issued Euros and dumping Southern-issued Euros en masse.

Support for Euro in Doubt as Germans Reject Latin Bloc Notes, By Ambrose Evans-Pritchard (The Telegraph) Germany’s Handelsblatt newspaper says bankers have detected a curious pattern where customers are withdrawing cash directly from branches, screening the notes to determine the origin of issue. They ask for paper from the southern states to be exchanged for German notes.

Each country prints its own notes according to its economic weight, under strict guidelines from the European Central Bank in Frankfurt. The German notes have an “X”‘ at the start of the serial numbers, showing that they come from the Bundesdruckerei in Berlin.

Italian notes have an “S” from the Instituto Poligrafico in Rome, and Spanish notes have a “V” from the Fabrica Nacional de Moneda in Madrid. The notes are entirely interchangeable and circulate freely through the eurozone and, indeed, beyond. People clearly suspect that southern notes may lose value in a crisis, or if the eurozone breaks apart… “The scurrilous idea behind this is that if the eurozone should succumb to growing divergences, then it is best to cling to most stable countries,” said the Handelsblatt.

[…]

Many [Germans] have kept a stash of D-Marks hidden in mattresses to this day. A recent IPOS poll showed that 59pc of Germany now had serious doubts about the euro.


This post originally appeared at Macro and Other Market Musings and is reproduced here with permission.

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