The Continuing Train Wreck of EU Governance: Cyprus Edition 2
Today the European Manufacturing index came out. I might as well just quote from the FT:
Of particular concern was that the “flash” Eurozone composite purchasing managers’ index, which fell from 47.9 in February to 46.5 in March, was aggregated before the eruption of the Cypriot banking crisis.
What is it that the ECB doesn’t get? No NGDP growth, no RGDP growth. Simples. Eventually, economies might manage to deal with endless deflation, and you can have the Japanese solution, of not quite zero RGDP growth for decades. How did it get to the point where that is the best that we can hope for is policy that is depressingly bad but not quite hopelessly destructive.
Is it so hard to understand? Ben Bernanke was a fierce critic of Japanese policy, and has managed to get the Fed to move in a reasonably positive direction, and low and behold the US economy is going from strength to strength. Who could have predicted that an appropriate monetary policy would lead to an actual recovery? Now BOJ, having for years maintained it was powerless, despite having a QE program designed to prevent deflation which did indeed move inflation to zero, has decided that twenty years of pointless misery is enough. Since it looked like Abe was going to get elected and force an explicit two percent inflation target on the BOJ, the Nikki is up from 9000 to 12,600, and is still on a charge. The markets understand monetary policy dominance. Inflation expectations in the bond market have changed quite dramatically since the BOJ first made noises about serious easing.
I am already tired of hearing about Cyprus’s run away banks. At least in the case of UK and US banking systems they could hide behind the Fig leaf of excessive leverage and risk taking. Cyprus’s banks had zero leverage. As in none. The did not even have outstanding bonds to default on. They were the safest banks imaginable. It turns out, that when you have a sector who borrows short and lends long, like any nice safe retail bank, and then your central bank decides to engineer a steep fall in nominal growth targets such that all assets and wages fall sharply, then your banking system cannot survive. WHO KNEW? I mean besides, what were the banks meant to do? Stop taking retail deposits? Haven’t we just had a big campaign about how retail banks in the UK, funded by deposits and divorced from `risky’ investment banking will be much safer.
Also, the question no one is asking, do people really imagine that if Cyprus had a smaller bank it would be avoiding the problem? No it would be having the same problem on a smaller scale.
This isn’t even the end of the pain for Cyprus, it is the beginning of the Greek death spiral. Suppose they successfully stump up the money for their bailout, well you are talking about a large fraction of the monetary base of the country leaving, either through money stumped up to the EU or capital flight. Then you get deflation, and a sharp fall in nominal wages and asset prices, which causes another Banking/sovereign debt crisis. Just wait, any minute now people will start talking about an asset price bubble in Cyprus. Oh no wait, its already happening.
The worst part of all about the Cyprus crisis, like the Greek crisis, is that the ECB could just pay. The ECB could have bought all of Greece’s debt when it was trading at pennies on the dollar and retired it as part of a sensible reflation package. The Fed has expanded its balance sheet by something in the vicinity of three trillion dollars, with a funds rate of 0.25%. That is what accommodative monetary policy looks like. The ECB has a 0.75%, and with the dubious exception of Liquidity assistance to banks via LTRO, has done exactly nothing. The entire stock of debt of all of the Eurozone countries together is about 8 trillion, so given that the EU is slightly larger, and had a slightly worse financial crisis than the US, and hence needs more monetary support, it is quite plausible that the ECB, in its normal operations of generating some demand, could have bought over half of the entire debt stock of the Eurozone. In which case it would be earning more interest every day than the total GDP of Cyprus.
Why have Eurozone governments decided that it is a bad idea for the ECB to monetize government debts at a time when it can do so for free. If the ECB announced tomorrow that it intended to hit a 5% NGDP growth target for the Eurozone and intended to do it by monetising and retiring government debt in unlimited quantities, this crisis would go away tomorrow. It would be forced to buy more in countries like Greece and Cyprus than in Germany, as NGDP is not currently distributed evenly across the continent. It would be a win for everyone. Germany could stop bailing out the south, the south could adjust wages, and Germans would get increases wages. WIN-WIN-WIN. It is literally the biggest free lunch in history, and a misguided political elite are instead imposing misery on an entire continent out of sheer incompetence.