Monday, December 13, 2010

FT: mechanics of capital flight

A cross-border payment between banks in two countries in the euro zone automatically generates balancing credit claims between the national central banks (NCB) and the ECB. This is the mechanism that irrevocably unifies the former national currencies, converting a set of currencies whose exchange rates are merely fixed at par into a single currency. But it also allows any of the euro-zone countries to draw vast credit from the rest of the euro-zone members via the ECB in the event of capital flight that arises from fears of default on sovereign debt, of systemic risks in the banking system, or even of the breakup of the euro itself. In this dimension, it is a mechanism that entwines the capital of the ECB in a default of any of the euro sovereigns.

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