We’ve discussed the Cypriot financial crisis in these pages on several occasions. Now, in his latest ‘Thoughts From The Frontline’ newsletter (link is to an Adobe Acrobat file in .PDF format), John Mauldin analyzes the background to the crisis and shows, with the help of Cypriots who lived through it, how it unfolded. Here’s an excerpt.
The most important book on the topic of the problems that have come to the fore in the last decade is clearly Rogoff’s and Reinhart’s brilliant tome, This Time Is Different, which examines 260+ financial crises over the last few centuries. While each is different in the particulars, they all have at their root too much debt and insolvent governments and/or banks. There is not some magic number that shouts, “Too much. This far and no further!” but the fundamental issue is clear.
The BANG! Moment comes, say R&R, when a wary bond market refuses to buy debt at a price that is financially sustainable for the debtor. In that moment, confidence and trust are lost.
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So what can Cyprus teach us? Many things actually. First, as Symeon said, they truly believed that “This country is different.” And for good reasons.
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Following the ruinous invasion of Cyprus by Turkey in 1974 and the deportation of Turkish Cypriots from the Greek side and vice-versa, the country recovered and grew year after year after year. The growth of the banking industry was quite pronounced in the last decade, with salaries growing apace with employment. The beginning of the end had its roots in the Greek debt crisis, because Cypriot banks had bought large amounts of Greek government debt with their massive foreign deposits. For all intents and purposes, the default on that debt bankrupted Cypriot banks. Money rapidly fled the island, and the Central Bank of Cyprus had to issue relatively massive amounts of emergency liquidity assistance (ELA) to Laiki Bank and the Bank of Cyprus.
As I wrote in January, everyone knew that Cyprus was a major problem. But Europe waited until a new Cypriot government was elected and then lowered the hammer. Partly, the problem was a matter of timing. The Irish, by contrast, were lucky that they had their banking crisis early. Spain is too big and systemically important to be allowed to become another Cyprus and has so far been spared. But Cyprus is tiny, and apparently the leaders of the EU decided to try an experiment: Let’s make the depositors rather than taxpayers pay for the risky behavior of bad banks.
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I was not the only one who was surprised. So were the Cypriots. There is still a sense of having lived through a surrealistic nightmare when you talk to them. They simply find it hard to believe that the EU would do what it did.
There’s more at the link. Essential reading if you want to know how economic catastrophe can strike without warning, even when all the warning signs were clear to see – because no-one was looking at them the right way. Could the same thing, or something similar, happen here? You bet your life it could . . . and a great many signs indicate that it’s already begun. Go read them for yourself.