This edition of Oliver’s Insights looks at the risks associated with quantitative easing, or money printing, in particular the threat of hyperinflation that many seem to be fearing. The key points are as follows:
- Concerns that quantitative easing will end in hyperinflation and economic mayhem are way overblown.
- Constrained demand for credit along with significant spare capacity suggests the risk of higher inflation is still several years away.
- However, the broader picture suggests that if the global recovery continues the risk in the years ahead will shift from disinflation and deflation to one of rising inflation.
To read this edition, click here.
Cyprus
Meanwhile, markets have shifted back to a very short term focus again with concerns about Cyprus. Here are some thoughts.
To be sure the decision to hit deposits in Cypriot banks sets a very bad precedent and violates a lesson from the 1930s that depositors should be protected. Equally the rejection of the depositor levy by Cyprus’ parliament raises the real risk that Cypriot banks will go bust resulting in even bigger losses for depositors.
Naturally investors globally are worried that this will lead one way or another to a return to the dim dark days of the Euro-zone financial crisis that we saw in 2011 and earlier last year.
There are two scenarios for Cyprus:
- First, it fails to come to an agreement with the Euro-zone regarding funding part of the bailout itself in which case it will not receive the proposed 10 billion euro in promised bailout funds and will likely see some banks collapse leading to even greater losses for depositors than would have occurred if the levy had proceeded. A sovereign default would also be likely in this scenario.
- Second, some sort of compromise involving all of the burden falling on large depositors and maybe other revenue raising measures, such as a more aggressive increase in the corporate tax rate beyond the proposed 12.5%, clearing the way for the bailout.
- The second scenario would seem a bit more likely, particularly as Cyrpriots start to contemplate the implications of a banking collapse. But there could still be much uncertainty until we even get to this point.
However, in assessing the broader implications for the Euro-zone from either the deposit tax or a potential collapse in Cypriot banks, the unique circumstances surrounding Cyprus cannot be ignored.
- At less than 0.25% of Euro-zone GDP and with a population of less than 1 million, Cyprus is literally a pimple on an elephant. Greek’s economy when it ran into trouble was 10 times bigger. Allowing Cyprus or its banks to go bust would have very little impact on the Euro-zone, providing any contagion (ie fears that the same will happen elsewhere) is contained.
- Its status as an offshore banking centre associated with money laundering and as a tax haven has led to an outsized banking sector with assets equal to 800% of Cyprus’ GDP compared to an EU average of 350%. More than 30% of its deposits come from outside the Euro-zone, particularly from Russia.
- The European Union has long sought to wind back Cyprus’ status as an offshore money centre for mainly Russian money.
- Cypriot bank recapitalisation requirements amount to a massive 80% of its GDP compared to 40% in Ireland, 27% in Greece, just 6.5% in Spain and zero in Italy.
- Its original request for a 17 billion euro bailout out would have seen its public debt to GDP ratio more than double from 86% of GDP to an unsustainable 180% of GDP from day 1.
- Reflecting all this, the rest of the Euro-zone felt that some of the burden for the bailout should be shared by large depositors in Cypriot banks, thinking Cyprus’s Government would only levy large depositors rather than ordinary Cypriots. It was the Government of Cyprus that tried to levy all depositors.
The unique nature of Cyprus’ banks and its small size indicates that it should not be seen as a precedent for other vulnerable countries in the Euro-zone. The Euro-zone has gone to extraordinary lengths via bailouts and other measures such as the ECB’s “whatever it takes” commitment to keep other countries solvent and remaining in the Euro.
Its very hard to see them letting this go to nothing because of Cyprus. Various Euro-zone officials, including German Finance Minister Wolfgang Schaeuble, have clearly stated that Cyprus’ deposit levy should not be seen as a precedent for other countries.
Given the unique circumstances of Cyprus and the efforts that have been put in place for other countries along with the fact that bank bailouts are already in place for Spain and Ireland the odds of a similar arrangement to that requested for Cyprus being forced on bank depositors in other countries is close to zero.
Of course in the very short term none of this will stop investors worrying about the implications of whatever happens in Cyprus for the Euro-zone. As a result share markets remain vulnerable to a further correction in the near term. However, as it becomes clear that Cyprus is unique and not a precedent for the rest of Europe (whether the bank levy or a collapse) investor nervousness is likely to recede.