Macro DigesT: Why Cyprus has changed the paradigm

Why Cyprus has changed the paradigm

Non-Independent Investment Research

There are a number of conclusions to be drawn from last weekend's events:

1.    The economic crisis is now a full-blown political crisis in which northern and southern Europe are drifting further and further apart. The catalyst (as we have said all year) is the upcoming German election. Angela Merkel and the SPD social democratic opposition are both trailing in the polls. However, the SPD is eager to be seen as responsible and is thererfore egging Merkel on to take a tough stance. The FT has a great analysis of this today which ends with a classic quote: Solidarity in exchange for solidity will still be the national slogan. (In Germany)

2.    The levy tax is only the beginning. Remember public policy is to maximise tax revenue and this is 'easy' logistically and more 'fair' in terms of moral hazard, but more importantly as Citibankgroup's Buiter argues in FT Alphaville: (my underscores)...
First, because it paves the way for more extensive debt restructuring of excessively indebted banks as well as other private sector entities and sovereigns. Such accelerated debt restructuring is necessary for the euro area to return to sustainable growth soon – without risking a lost decade to follow the lost half decade since 2008. 
Second, the Cyprus depositors bail-in is also good news politically, as it will limit additional bail-out fatigue in Euro-area creditor countries and avoids putting the burden of bailing out investors to an even more unbearable extent on taxpayers and beneficiaries of public spending in debtor countries. 
Third, the bank creditor bail-in improves the creditworthiness of the Cypriot sovereign compared to the alternative where an additional EUR 5.8 billion worth of bank recapitalisation demands were to land on the public sector balance sheet. Other sovereigns in Europe will find their creditworthiness improved (at the same time that banks' creditworthiness is further impaired) if markets perceive a greater likelihood of unsecured bank creditor bail-ins rather than taxpayer rescues of unsecured bank creditors." 

Not to say I agree with his logic 100 percent, but Buiter has long argued that we need to create a 2-3 trillion banking fund to stop the rotting of the bank system. Of course, a levy of 20 percent or 30 percent could create that fund "outside the public finances" - and the move towards a Swedish banking rescue model, but the point remains whether in a Buiter model or not, bail-in's in the new road forward

3.    The EU has no standard model for tackling a crisis. They are taking huge risk based on political compromise. Their modus operandi is often derived  from a domestic agenda rather than the need to minimise the economic cost and more importantly, the negative consequences to growth and unemployment. The EU Commission has lost all of its power. They are mere bystanders - the Troika is now effectively a duo - the ECB and IMF, no one trusts projections from the EU after seeing the fiscal multiplier explode in their faces quarter-after-quarter. First they were three, now they are two, and soon it seems the even the IMF is having doubts.

4.    A meeting of the cardinals is imminent - all of the three points above point to an October meeting where Germany with most likely a majority government of SPD and CDU with the national slogan above in #1 will need to figure out what they want to do - do as the market consensus is betting: bail-out Europe through allowing their own debt rating to collapse or continue down the moral path of solidarity through austerity. At the end of the day investors need to understand Germany's role historically since the Middle Ages. I do recommend reading latest edition of the New Stateman called: The German Problem - this quote from the article says it all: 'One way or the other, the German question persists and will always be with us. This is because, whenever Europe and the world think they have solved it, events and the Germans change the question'

I will update on TradingFloor later today on the vote, the compromises being sought, but for now I am personally more concerned about the coming month than whether Cyprus puts the levy on 20,000 euro or 500,000 euro. In policy terms it is always what policymakers do, not what they say that is important. The week-end deal has opened a path toward a Europe-wide levy which policy maker will seek to maximise to your disfavour.

 

Med venlig hilsen  |  Best regards
Steen Jakobsen  |  Chief Economist

 

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