Where the Hell is Spring?

The end of the Cypriot incident is not really the end, of course. The only way Cyprus can thrive is by imposing capital controls, even against its fellow EMU members—something that is expressly forbidden in the Maastricht Treaty and old-fashioned, too boot. The modern world is supposed to be free of capital controls. In fact, members seeking to join the EMU have to have “free markets,” among other criteria. The only case of capital controls in recent history is Malaysia during the Asian crisis. Then the IMF disapproved, but later came to agree that countries being victimized by currency wars (Brazil) could impose controls. 

From the Cypriot point of view, the controls seem to be the death knell for its place in the world as a taxhaven and money laundry. This is what the Eurogroup wanted—for the banking sector to contract to a reasonable ratio to GDP (with Luxembourg, whose banking sector is even more bloated than Cyprus’, escaping such a judgment). Quite how capital controls are going to work is not clear. Are Cypriots cut off from the rest of the EMU financial system now? And as the WSJ says, “… lasting damage has likely been inflicted on the Cypriot economy…. Cyprus could see its economy contract by 10% or more in the years ahead, economists said.” The sustainablility of Cypriot public debt is therefore just as questionable as it was before the crisis. Moreover, as the FT reports, Swiss and UK banks are scrambling to pick up the tax haven (and presumably the money laundering) business. The Cypriots see it as hypocrisy—they are being deprived of 50% of their GDP so others can take it. But the UK and Switzerland are not EMU members. 

Therefore, if you are an EMU member and your banks get into trouble, the Eurogroup will go along with any stupid idea you may have about defaulting on deposit insurance or capital controls. If you are a bank depositor, you are now required to evaluate the solvency of your bank. Technically, a depositor is a creditor, but hardly anyone has the qualifications to judge bank solvency or capital adequacy. That’s why we have deposit insurance in the first place. Capital flight, either slow or fast, is the inevitable outcome. The ECB’s regulatory subsidiary had better get going PDQ. Net-net, the euro is at risk of a steady drip-drip-drip of outward cash flows on the loss of confidence in the only EMU institution with any power and credibility, the ECB. As we wrote last week—cui bono? Switzerland, the UK, Hong Kong, even the US. Well, maybe not the US. As we see from the tepid euro relief rally so far today, the EMU has lost the confidence of its citizens. Nobody knows how far the loss of confidence will go, or when, but a river has been crossed and the troika did itself lasting damage. 

Elsewhere, the US Congress gave itself another two-week holiday out of Washington, having passed two budgets. This looks like progress (to some). We don’t get any big data releases this week so attention turns to the Supreme Court judgment on gay marriage (along with France’s), the bankruptcy of Stockton, CA and maybe how the Feds are going to run Detroit. More dead pigs (16,000) are found in a Chinese river and commentary on pollution and environmental destruction in China is being cacophonous. And it’s still snowing, not only in the US but also the UK. Where the hell is spring?