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Jon Talton

Analysis and commentary on economic news, trends and issues, with an emphasis on Seattle and the Northwest.

March 20, 2013 at 10:46 AM

About the Cyprus canary

How horrible, fantastic, incredible it is that we should be digging trenches and trying on gas masks here because of a quarrel in a faraway country between people of whom we know nothing — Neville Chamberlain

Does the crisis in Cyprus matter? As the country has faced a bank run because the EU and IMF would impose a tax on even the poorest depositors to fund a bailout, forcing the banks to shut down, and as Cypriot lawmakers voted down the bailout, the Dow Jones Industrial Average is up today. The Republic of Cyprus has GDP of $22.5 billion, compared with more than $355 billion for Washington state. It’s a poor country dependent on tourism and services. It never should have been allowed into the eurozone because, like Greece and other southern European countries, it saw a huge influx of investment during the good times that withdrew in the Great Recession. But it’s so small, perhaps it doesn’t matter, even for the EU. Average Cypriots, not a wealthy bunch, will be ruined. The rich have taken out their money already. So one small island is economically devastated, end of story.

Unfortunately, this may not be the case. Bad loans rose this week for banks in Spain and Italy, not just with Cyprus exposure but a repeat of the “nobody trusts anybody else” mentality seen during the great panic of 2008 in America and later in Europe before the European Central Bank used its “fire hose” of liquidity.

The Prodigal Greek blogger has been following the state of play and is not optimistic for the Cypriots:

No matter what today’s outcome, Cyprus’ banking system will not be the same ever again. If Germany’s intention was to reduce the size of it – closer to the eurozone average – they managed to achieve that with a masterful stroke in just one weekend. Deposits flight combined with the sale of the Greek operations will probably leave the Cypriot banking system half the size it was on Friday night, even left with one systemic bank after restructuring. Cannot see a smooth transition period without some form of capital controls. By the time the dust settles, the Cypriot economy will sink and PIMCO’s adverse scenario will materialise. Many people did their best to make this a reality.

PIMCO, the huge money manager, has cut its exposure to the euro. “”We’ve reduced our allocations to European currency (in the last 24 hours) because it makes sense to think about this as not only a policy mistake but also a recognition that the euro is far from being a perfect reserve currency,” Saumil Parikh, a managing director, told Reuters. So maybe Cyprus will matter after all.

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