2013 March 25 Monday
Cyprus Headed For Economic Depression

The creation of the European Union enabled much larger financial train wrecks than would otherwise have been possible. The banking sector in Cyprus will shrivel. Societe General economist Michala Marcussen expects the Cyprus economy to shrink another 20%. One article quotes a source that says banking makes up 45% of the Cyprus economy. So a 20% shrinkage seems too little. The surviving banks will lend much less and people will continue to find ways to get their money out of Cyprus. For example, exporters will negotiate to get paid abroad. They'll hide the size and value of their exports. Tourists will continue to be afraid to visit. So another leg of the Cyprus economy will go down.

How far down can Cyprus go? The economy of Greece has shrunk 20% since 2008 and went down 5.7% just in 4Q 2012. Another 4.5% contraction is projected for 2013. Cyprus will go thru a bigger depression than Greece because Cyprus' economy was far more distorted by large foreign deposits in its banking sector.

Cypriots need to focus on making real things that they can sell abroad.

What does this portend for Italy and Spain? Silent bank runs? Prudent people should get their money out of southern European banks.

Update: Jacques Mistral says it was actually the Cypriot president who wanted all the depositors to take a haircut. The northern Europeans who went along with this have substantially upped the risks of bank runs. What were they thinking?

First, the idea to tax every bank account whatever its amount was not a product of “German stupidity” but reflects a demand from the Cypriot president, who was willing to preserve the image of the island as a financial center; as if the confidence of dirty money could be a sustainable comparative advantage for Cyprus! The stupefying thing is that the other euro governments accepted this clause even though it was financially dangerous and certain to be rejected by the populace and its representatives.

The northern Europeans even enthused about the haircut approach and therefore made future bank runs even more likely.

In following the relief produced by the substance of the new agreement, the Dutch finance minister and chairman of the Eurogroup announced that the Cypriot treatment was great news because it showed that bank depositors may be expected to contribute to future bailout packages.

Paul Krugman thinks Cyprus should exit the Euro and do it quickly. Doing this would shorten the length of their economic depression. It is amazing how the southern Europeans are going thru economic depressions rather than exit the Euro. Will they maintain their support for the Euro as their economic downturns deepen? More economic contraction in store for Spain and Cyprus in 2013. Krugman points out that the Cyprus bailout is going to increase Cyprus sovereign debt to a level that makes default hard to avoid. So Cyprus has a sovereign debt crisis in its future as tax revenues plunge with the contracting economy.

Share |      By Randall Parker at 2013 March 25 11:28 PM 

Celtic Empire said at March 26, 2013 12:42 PM:

They should go to a gold standard and embrace Austrian economics and remain the banking/tax haven of Europe.

Whoopsie said at March 28, 2013 9:44 AM:

Cyprus politicians don't want to go off the Euro because they personally would suffer. Either the value of their own savings would be crushed by devaluation, or if they stashed their savings abroad the righteous anger of the people would damage their political careers (or even send them to prison).

Just Chillin said at March 28, 2013 11:43 AM:

The main problem not only with Cyprus, but with the European Union is that politicians are disregarding the will of the people too much. That's not a very wise thing to do. Oh wait, was I talking about America also?

Sam said at March 30, 2013 9:09 PM:

The gold standard is silly for two reasons. 1. You need an expanding money supply to match growth. Without this you get deflation. 2. The 80%-20% rule. The 20% own all the gold eventually and depress growth for everyone.
Benjamin Franklin's experiment with paper money in the early American colonies worked well where the money supply matched growth. Of course how to keep the supply matched to growth is a difficult problem. Without this you get the Zimbabwean 100 Trillion dollar bills of which I have a few.

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