Monday, 18 March 2013

A Cypriot Tragedy

Tragedies are usually associated with Greece - a tribute to the richness of its theatre in the 5th Century BC. Over the weekend, you could be forgiven if you changed your tastes to a Cypriot tragedy. For that's exactly what has happened - albeit in the more prosaic world of economics.
These are the facts. Cyprus is another Eurozone country in deep trouble. It needed a bailout. So far, nothing unusual. A bailout was duly announced over the weekend. It was the terms of the bailout that sent a jolt reverberating through the world of economics. The EU is bailing them by about €13 bn (chickenfeed by the standards of bailout). But the conditions of the bailout are that all bank depositors would be levied a tax of between 6.75% and 9.9%. That means on Tuesday when banks opened, all depositors would lose that amount instantaneously.
The genesis of the problem is, alas, not new. Cyprus is a very small country. In boom times, it went berserk pushing its financial industry, positioning itself as an island finance centre. That's fine, but it just went way over the top. Cypriot banks had made loans to outsiders equivalent to 8 times the country's GDP. Worse still, a lot of those was to Greece its neighbor. When Greece began to go under, Cyprus was given an almighty whack. The bailout was then a question of when, and not if.
Another actor muddling the issue is Russia.  Of the € 68 bn bank deposits which are going to get a "haircut" (the tax referred to above) , a full € 21 bn comes from Russian companies. We shall not speculate where from this close affinity of Russia came from - let us just say that the word "money laundering" comes to mind. Now the Russians will instantly lose € 2bn. Enter Vladmir Putin. He is howling against the "$%^&* Germans who are the orchestrators of the bailout.
What about Joe Public in Nicosia. Even if you had say € 100 Euros in the bank, tomorrow it is only € 93. If ever there was a recipe for street riots, this is it.
And what about nervous bank depositors in other troubled countries - say Spain or Italy. Tomorrow it might be their turn. Only an idiot will keep his money in a bank anymore if you are an European. Take it out IMMEDIATELY. Dig a hole and bury it in your backyard. Keep it under the pillow. But don't deposit it in a bank even if a gun was pointed at your head.
What a mess. The world badly needs a new economic order. Fire all economists. Go back to the basics of countries balancing their budgets. Living within their means. Curbing the excesses in the banking and finance industry ruthlessly. It will be a prolonged period of pain. But when the clouds disperse, it will be a saner and fresher world. 
This, of course, is a Utopian dream - which leader is going to tell the truth to his voters. And even if he did, which voter is going to accept it. We shall stumble along from one crisis to another.


Appu said...

For long since i have been searching for a HBR article which argued, if only EURO was not formed and each country measured on its own currency, the legislators could have been held accountable for the financial mess. In other words, the euro masked the real performance of the countries and their rulers who never got penalized in elections for their misdeeds
oh on [E]conomists and [E]conomics [with all due respects to my macro eco prof whom we all rever]
[E]conomics is a narrative discipline, and explanations are easy to fit retrospectively.
[E]conomists are evaluated on how intelligent they sound, not on a scientific measure of their knowledge of reality- Nassim Thaleb

Ramesh said...

@zeno - The problems is not the formation of the Euro, but the formation of the Euro without political union. The logic of the Euro, with political union is economically very sound - the bloc would have been bigger than the US and there are economies of scale - witness the prosperity that the European Union with free movement of goods and people has brought.

Political union in Europe is, alas, impossible given history. Hence this mess.

Isn't this a big topic in your Eco classes. Would love to hear what others - both students and profs - think.

Sriram Khé said...

He's alive, and he is blogging!!!

Hey, it appears that we were both captivated by the unfolding Cyprus story, from our own interests ... Will not repeat, therefore, the notes from my post :)

I am not sure if economic union without political union is ever feasible ... I wonder how and why the proponents of the Euro were confident that there will not be a crisis along the way ... I suspect that is always a problem with Utopian fantasies--to massively underestimate the problems ...

Just when the Euro seemed to be getting over the PIIGS problems, this one pops up. Will be interesting to see whether this sets off another chain of events.

Ultimately, it is not really a problem with economics or economists. (Not that I have too much faith in the "science" that economists peddle.) The hassle is that we operate with old models of nation-states with various aspects of the economy--including the currency, in the case of the Euro--being global. Tyler Cowen writes about this aspect in the NY Times, though from a different framework, and addresses another Utopian dream of borderless worlds with people being free to move ...

I don't think I am as pessimistic as you--Ramesh--and Appu seem to come across ... by and large, we are still experimenting how to organize ourselves. Within countries, and as a part of the whole world. Many other experiments have failed, and failed disastrously ... we can hope that the setbacks like the Euro problems will help us fine-tune the political economic model.

Prats said...

This is ridiculous. This is a recipe for disaster

Ramesh said...

@sriram - yes, alive :) And yes, our experimenting with social and economic models continues. There won't be one right answer, but hopefully we'll graduate to better models.

@Prats - Alas, ridiculous indeed.

Vinod said...

A Phoenix will rise from the ashes.Hope.

Ramesh said...

@Vinod - Well, we have to see what will rise, if anything !!!!

Ravi Rajagopalan said...

Political union in the context of a currency helps in specific cases that are really important to the economy. Some examples - Transfer of resources from richer parts to poorer parts. In India the Finance Commission sets rules for sharing tax resources. Second, ensuring that the credit of the entire economy is placed at the disposal of the needs of a specific region. In India, a badly run state like UP will always attract credit because of the sovereign rating of India. But the fact that TN is a better run state does not get it a better credit rating.

One can argue that in the case of the EU, transfer of resources very much took place. Anyone who saw the transformation of Spain and Portugal in the 1990s since the accession to the Union will attest to this. The EU does help the poorer accession countries out of budgets funded by the rich.

Also - as Ramesh has remarked, the free movement of people has significantly enhanced the quality of life in Europe and is an object lesson for the rest of the world, particularly ASEAN.

The failure lies in regulation and what I would call the implicit use of estoppel by borrowers in weaker countries. The weaker countries held out that lending to them was like lending to the EU. Borrowers invoked the estoppel and lenders swallowed the lie. The ECB did not step in then. The national banks all abdicated on regulating prudential borrowing based on need, and allowed asset bubbles to be created.

I see the way ahead as capital controls for the smaller countries. The Euro is not perfect but it will not die either. Too much of the European project is invested in it.

I also don't think political union will happen. The possibility of a BREXIT is too high, and I can assure you the Europeans will go slow on this. Greece leaving the EU is a problem, but Britain leaving is a disaster. No question for Britain as well but also for the EU.

There will be closer regulation, a more sensible view of the lender profile, a realistic assessment of risk and a more active role by the national regulator - all of which needed to be done but which was not.

So lets not blame economists.

Appu said... a much more interesting post on how it could have been done different

In our Macro, the focus was more towards the 2008 crisis with focus on US rather than the euro. prof felt the 2008 is an imp event in our lives! :)

ASEAN was another focus. Institute itself is working on too many initiatives w.r.t ASEAN

Ramesh said...

@Ravi - Yes, lending will be tightened and nations will also control their borrowing. But, I believe it won't last - when the whiff of good times comes back, irresponsible nations will restart their orgies.

Economists are not as blameless as you portray. Their failure to set sensible (and adhere to) deficit norms for example is the root cause of the problem. Even Germany broke every rule in the book in the past. And irresponsible economists like Paul Krugman perpetuate irresponsible spending. They deserve a kick too.

@Zeno - Alas, the folly of the academicians. They are always 5 years too late :)

Sriram Khé said...

Hey, let us see ...
It is about Cyprus.
About economists.
And whether economists are worth anything.

So, what if we got a economics Nobel laureate who was born and raised in Cyprus? That will be a holy trifecta, right? ;)

Here is a short interview with "Christopher Pissarides, who shared a Nobel Prize in economics in 2010 ... Pissarides was born and raised in Cyprus."

Vincy said...

Ramesh, all you have written is going over my head. all greek and cryptic :-) you said chicken feed somewhere right. I see bird brains :-) Guess it is the exam mania at home. i will come back to the utopian dream, when i am bit more saner ;-)

Ramesh said...

@sriram - Ah, be kind to your fellow humanities brethren :)

@Vincy - Ha ha. Forget Cyprus. Its too small to think about. Only the preserve of jobless bloggers such as me :)

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