Source: Spiegel

 

 

On Monday, our AM readings had a link to Krugman’s Hot Money Blues. There was lots of pushback against the article, which blames concentration of capital seeking to circumvent taxes and regulation as an underlying cause of nearly all financial crises:

“But the truth, hard as it may be for ideologues to accept, is that unrestricted movement of capital is looking more and more like a failed experiment . . . Since 1980, however, the roster has been impressive: Mexico, Brazil, Argentina and Chile in 1982. Sweden and Finland in 1991. Mexico again in 1995. Thailand, Malaysia, Indonesia and Korea in 1998. Argentina again in 2002. And, of course, the more recent run of disasters: Iceland, Ireland, Greece, Portugal, Spain, Italy, Cyprus.

What’s the common theme in these episodes? Runaway bankers; they played a role in a number of these crises, from Chile to Sweden to Cyprus. Best predictor of crisis is large inflows of foreign money: in all but a couple of the cases I just mentioned, the foundation for crisis was laid by a rush of foreign investors into a country, followed by a sudden rush out.” (edited & emphasis added).

Perhaps a better way to express that is a visual depiction of Cyprus’ Debt and Bank deposits, shown above. The outsize deposits relative to the nations debt or GDP) does seem like an accident waiting to happen.

There are other tax havens — Luxembourg, Switzerland, Cayman Islands, Bermuda, Singapore, Dubai, etc. — that have yet to have their crisis. This implies a full on financial crisis requires more than mere concentration of idle tax-avoiding capital. Something else must be the trigger.

 

Source:
Bailout Insights: What Cyprus Tells Us about Germany’s Character
Tyson Barker
Spiegel, March 26, 2013
http://www.spiegel.de/international/europe/the-cyprus-bailout-reveals-german-fears-of-tax-havens-a-891063.html

Category: Bailouts, Credit, Digital Media

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

27 Responses to “Best Predictor of Financial Crisis: Huge Inflows of Foreign Money”

  1. ByteMe says:

    Something else must be the trigger.

    Suddenly ignored/eliminated lending requirements allowing those banks that are flush with more money than they’ve ever seen before to gamble it away and then leave local depositors exposed along with foreign government pressure to cover those deposits?

    Just a guess. :)

  2. ldaalder says:

    The thing that I find most surprising of this chart is not the ‘huge inflow of foreign money’, but rather the unlikely size of the national deposits…

    Lukas Daalder

    ___

    BR: Congratulations! You are now a citizen of Cyprus!

  3. [...] The best financial-crisis-in-the-making indicator? Massive inflows of foreign money.  (TBP) [...]

  4. rd says:

    It is interesting that free market theory only applies to sectors that allow for concentrated wealth and quick profits.

    Many of the free market and deregulation proponents with respect to the financial sector are also leading voices for a crackdown on illegal immigration with no potential path to citizenship. But this is illogical as they are stating that financial capital should not have any boundaries while human capital should be firmly regulated within fixed national boundaries. In reality, there are significant costs to having too much or too little regulation in most sectors.

  5. AHodge says:

    really cool article, good new point for me, beyond the little tax havens, US inflows for example.
    by the way,Ireland, Malta and Luxembourg have bank assets to GDP ratio higher than the Cyprus which is (before writedowns) 800% of GDP. Luxembourg is about a 1000% ratio, or ten times its GDP.

  6. jaytrader says:

    The larger picture here is that pegged and or single currency unions are ruinous to the citizens.

    • gusgus says:

      The presence of the Euro is a secondary issue in the crisis at hand. Consider Iceland and Ireland — both are small island nations with oversized banking sectors but only Ireland had the Euro. Both suffered financial meltdowns which were ruinous to the citizens of both countries. The currency union is not the problem, rather, it’s the banking sector which has become too large. But as Barry Ritholtz noted, something else must also occur to trigger the crisis.

      If you wanted to pick on the currency union, there are (at least) two issues worth noting. First, Euro membership enabled Cyrpus’s banking system to get so large. Cypriot banks, being part of the Eurozone, were attractive to offshore money. If Cyprus had remained on its Pound, perhaps it could have avoided this crisis. But then again, Iceland remained on its Krona and it still had its banking crisis.

      The other issue, which is the one Krugman speaks of, is the recovery, and whether being on the Euro facilitates that recovery. There are good points to be made about how Iceland’s recovery has been faster than Ireland’s. But then again, Iceland’s recovery has been only marginally faster than Ireland’s.

  7. b_thunder says:

    “…a full on financial crisis requires more than mere concentration of idle tax-avoiding capital. Something else must be the trigger.” – the trigger is, as it so often is, GREED.

    Andrew Ross Sorkin wrote in
    http://dealbook.nytimes.com/2013/03/18/a-bank-levy-in-cyprus-and-why/
    when the 6.75%/9.9% levy was first proposed:

    “You would have been better off in Cyprus, even after the bailout, when your money was “confiscated.” If you had 100,000 euros in a Cypriot bank account over the last five years, where the interest rate has averaged about 5 percent, you would have about 127,600 euros today. Even after the bailout, which would require you to give up 10 percent of your deposit — 12,760 euros — you would be left with 114,840 euros. The American bank? The $100,000 you deposited at Bank of America five years ago is about $105,100, at the going rate of about 1 percent interest a year.”

    I think it’s not the money that’s sitting passively in an underground vault in Geneva or Zug trying to avoid IRS that’s the primary cause for these blow-ups. It’s the “hot” and “greedy” money seeking outsized return that’s the cause for the failures. And, as the history shows, there’s no risk-free return (unless you’re JPM-type TBTF feeding off the perpetual Bernanke’s ZIRP/QE and Eric Holder’s TBT Jail policies.)

    • WyMi says:

      ‘there’s no risk-free return (unless you’re JPM-type TBTF feeding off the perpetual Bernanke’s ZIRP/QE and Eric Holder’s TBT Jail policies.)’

      The 1980′s & 90′s saw these financiers strip the developing nations of their resources and existing wealth and stabilized the politics with friendly government reps to support their interests continuously. Those countries that took out the IMF, World bank, etc. loans are still paying taxes to pay interest on those loans to the same offshore accounts, lest they suffer currency raids by the same parties in the event they default.

      The taxpayers of more developed nations are just as easily terrorized into indentured servitude as the developing nation taxpayers were – it simply takes deeper pockets of money. Since the politicians are already in the pockets of these financiers, the pockets are as deep as … well limitless as Bernanke and Draghi have submitted.

      There doesn’t need to be a conspiracy for this to end badly. The only endgame is one in which the enslaved eventually rebel. Until then, carry on. In fact, get on with it – make the bankers declare themselves the rightful owners of all wealth. Let them die with it – so that a properly working black market can be established to replace this flawed system we now have.

  8. hue says:

    the trigger is chasing yield in a low interest environment, like risky mortgage instruments. didn’t Cyprus banks offer higher interest rates?

  9. carchamp1 says:

    Large inflows of money are the root of all financial crises. Yes, foreign inflows can impact this. My question is who is going to make the decisions on restricting foreign flows?

    We have a vast array of regulatory structures in the U.S. now which have been entirely helpless during the last few bubbles. Whether we’re talking about worthless dot-coms, housing, or oil/commodities, even when they saw what was going on have completely failed to do anything about it.

    The trigger is poor asset allocation (malinvestment). See China’s ghost cities for current example.

  10. wally says:

    The thing about Krugman is that when he makes an assertion he can always back it up with facts, figures or examples. He has been the most correct guy in economics for quite a while now.
    This particular point is really an eye-opener… or ought to be.

  11. BoKolis says:

    The difference between the two sets of nations (disaster vs. disaster-free) is that erstwhile “serfs” weren’t suckered into afforded the opportunity to live high off the hog (guess what happened in the USA). In the second set of nations, either there weren’t serfs of note, or the serfs are as they were.

    Under the theory that you always blow your first money, were the results predictable or expected?

    This time around, the free money hasn’t (yet?) been extended to/reached the serfs. So we’re good for now.

  12. papicek says:

    “Something else must be the trigger”

    Well, we know what that will look like, too (paraphrasing Simon Johnson):

    A large influx of capital, always FDI driving asset inflation (like stock indices reaching new highs, rising real estate prices and frothy housing markets), then general inflation driven by the wealth effect and wage growth as businesses seek to attract workers, sweetheart deals (crony capitalism) and explosive growth in PRIVATE sector debt to fund all this (public sector debt rises afterwards because the cost of governing rises as well and governments never have enough revenue to keep up – that FDI wouldn’t be there without tax incentives in the first place; and as the economic sector revs up, more is demanded of government, like public transportation, road construction and maintenance, energy infrastructure, etc).

    In the US, we don’t have all of those conditions in place, largely due to continuing downward pressure on wages (pdf) and the perception that businesses could easily price themselves out of business if they’re not careful.

    What did I miss?

  13. Mark A. Sadowski says:

    Let’s be clear and define “inflows of foreign money” as a current account deficit. Then it’s not clear that the size of the banking sector has anything to do with this. Here is a list of bank assets as a percent of GDP in the eurozone as of January:

    1.Luxembourg 2,170.4
    2.Malta 790.4
    3.Cyprus 706.7
    4.Ireland 706.1
    5.France 420.3
    6.Netherlands 409.2

    Eurozone as a whole 346.1

    Luxembourg and the Netherlands have huge banking sectors (and a huge amount of deposits) but both have large *ouflows* of money to other countries. France has a relatively small current account deficit.

    Let’s also be clear and define “financial crisis”. Reinhart and Rogoff deal with five varieties of economic crises: external default, domestic default, banking crises, currency crashes, and inflation outbursts.

    The following is the change in current account surplus in the European Economic Area as a percent of GDP:

    1.Latvia 31.1 (2006-09)
    2.Bulgaria 25.5 (2007-11)
    3.Estonia 19.3 (2007-09)
    4.Lithuania 18.1 (2007-09)
    5.Iceland 17.6 (2008-11)
    6.Cyprus 10.9 (2008-11)

    The four BELLs (Bulgaria, Estonia, Latvia and Lithuania) have all suffered larger current account reversals than Iceland. They were also the only countries pegged to the euro that initially had current account deficits. (Denmark is pegged but had a current account surplus.) Estonia has been a euro member since January 2011. By definition there has been no currency crash. Moreover there has been no bank crises (their banking sectors are universally small) or inflation outburst (on the contrary). With the exception of an IMF bailout for Latvia, that has since been paid back, there has been nothing hinting at a sovereign debt default.

    That’s not to say there hasn’t been a serious *economic *crisis in those countries. They have suffered easily the worst collapse in real GDP and some of the highest unemployment rates in the EEA. But there has been little that qualifies as a *financial* crisis.

  14. Frilton Miedman says:

    “This implies a full on financial crisis requires more than mere concentration of idle tax-avoiding capital. Something else must be the trigger.”

    ~~~

    Recalling this blog last year – http://www.ritholtz.com/blog/2012/04/228-trillion-derivative-exposure/

    Me thinks bond vigilantism is an easy game to play, especially if transactions happen without disclosure.

  15. badbisco363 says:

    Seems like the following are the best predictors…
    -Buying Greek/PIIGS Bonds
    -Being Small Enough To Fail
    -Needing ECB support at a time when Merkel needs to be reelected

    This was not an out of the blue crisis. The need for a bailout/restructuring has been known for months. This was simply the ECB forcing the issue so that depositor bail-ins can be introduced and used as a threat to force other periphery countries to accept the yoke of austerity

  16. S Brennan says:

    Milton Friedman, the man just keeps on giving to us…

    “Smith’s work would be reformulated by economist…Milton Friedman resulting in a recipe for a free-market economy: deregulate business and trade; restrict state intervention and FREE-FLOWING CAPITOL GENERATE WEALTH FOR ALL of those who participate in the economy.”

    - Market fundamentalism http://en.wikipedia.org/wiki/Market_fundamentalism

  17. eastman says:

    Its important to observe how the flows are invested, the quality of assets/ investment. Bermuda and Cayman Islands are British protectorates; they are simply conduits, money just flows in for the tax benefit, get the stamp and flows out. Very little is invested in Cayman Is, Bermuda apart from tourism. Dubai had its share of problems, but it also has strong friends; the rich of the region need a playground. Singapore was the early bird in the east and emerged as a financial centre under the strict supervision of Lee Kuan Yew. And the Swiss will continue to thrive on their secrecy, which no nation can afford to disturb, as it is the banker to the world’s elite.It is the Johnny-come-lately who first gets the stick.Cyprus realised that it has fair-weather friends!

  18. Frilton Miedman says:

    S Brennan, Blame F. Hayek or Ayn Rand, not so much Friedman.

    All too often, Friedman is thrown into the same basket as Hayek, they are not the same.

    Hayek was the father of Austrian economics (He was from Austria, hence the name), Austrians endorse economic Laissez-faire free-for-all , Friedman was a monetarist who didn’t completely discount the role of government in regulating fair & free trade. (Bernanke is a Friedman follower)

    An inverse example of distorting or confusing theory is the way the right constantly talks about Keynes as if he only suggested spending 100% of the time, while ignoring the fact that he called for austerity once the economy rebounded.

    Though I don’t agree with everything Friedman proposed, I think it important to give credit where it’s due, Bernanke’s Friedman roots are likely the only thing keeping us from third world economic status while the Austrian/Rand crowd in Congress have undermined any intervention they could.

    • S Brennan says:

      Bernanke, has been urging congress to enact stimulative programs [ie jobs], he has repeatedly stated that the Fed is being asked to do the job of congress. Whether Bernanke was an adherent to Friedman at one point in time is not relevant, he hasn’t been an adherent for years, the train you are looking for left the station in 2008.

      One final point, you are welcome to your opinion, but really, with a screen name of “Frilton Miedman” do you really think you have more credibility than Wikipedia? Friedman dusted off British 19th century economic theory which resulted in the loss of the empire and disgustingly, he exhumed the corpse of Smith and made him the front man for his nonsense. Every nation that has implemented Friedman’s ideas [and there were many who did before his birth] has failed miserably.

      Right now, China tariffs American auto parts at ~25% the USA tariff’s at ~2.%, guess where capitol is flowing to build auto plants? American capitol [which is the result of many generations of US Taxpayer support] should not be flowing into China and auto parts from China should not be flowing into the USA under this artificial inducement.

      This particularly so, because while the USA is playing in the Middle Eastern sandbox, paying murderous thugs to overthrow regimes that can do us little harm if they wanted to, China is at near war status with Japan which could lead to WW III. And this war is a long time in the making, after Tienanmen, the communist China diverted attention by blaming everything wrong in China on Japan…including portraying the Japanese as vermin. And yes, I know the history, but we don’t see Korea doing the same do we? A whole generation of Chinese has been raised who want war with Japan. It is a very hot cold-war in the western pacific and our policies are strengthening the aggressor. Trade, whether in goods, or investment, should always be bilateral, continually monitored, updated as facts on the ground change and to the benefit of both nations populations.

  19. denis_bda says:

    I don’t think Bermuda qualifies as its banks don’t take on massive amounts of foreign deposits.

    see the Bermuda Monetary Authority: http://www.bma.bm/publications/SitePages/Quarterly%20Banking%20Digest.aspx

    “Bermuda and Cayman Islands are British protectorates; they are simply conduits, money just flows in for the tax benefit, get the stamp and flows out. Very little is invested in Cayman Is, Bermuda apart from tourism.”

    Eastman, Bermuda has a heavy physical presence of reinsurance based companies which contribute considerably to its GDP.

    Now, that isn’t to say Bermuda will avoid a crisis of its own making

  20. Frilton Miedman says:

    S Brennan,

    I’m not disagreeing with a single thing you said regarding China trade, fiscal policy of taxation, beyond the fact that you spliced text from Wiki that to state Friedman alone is of the Austrian school when the actual statement only mentions Friedman’s name along with several more right wing economists.

    Do a search on Wiki for the differences between Hayek and Friedman, once you see it the case should be settled.

    Bernanke has been and still is a Monetarist, even though he has repeatedly suggested fiscal action is needed, the Fed actions of the last five years are right out of Friedman’s playbook.

    As I often correct others for claiming Keynes was “spend-only”, I also feel it’s important to delineate Friedman from Hayek or Rand – that were NOT the same.

    • S Brennan says:

      Were there others that shared in the idiocy of Friedman. Sure there were, did they get to run a taxpayer funded propaganda miniseries? Name me another economist [of any stripe] that was allowed to run a 12 part, one hour series broadcast in prime time [when most people only had 4 channels], over and over and over again. At least 10 times to my knowledge….all the taxpayers dime…talk about a free lunch! Talk about a world class hypocrite.

      That is why I single out Milton Friedman, nobody got 1/1000th the attention he did. If I talked about Nazism and singled out Hitler…would you take the same offense if I didn’t mention Walther Funk, Hjalmar Schacht or other too numerous to mention flunkies? Milton wanted the role, it’s time his discredited admonitions are given the spotlight he so shamelessly sought.

  21. David Merkel says:

    I don’t think Krugman is right. Most crises occur because long-dated assets are financed w/short-term liabilities. Read “The Volatility Machine” by Michael Pettis — it explains how that works for emerging markets, and small countries like Cyprus.

    Banks that keep a lot of unencumbered liquid assets around may not make a lot of money, but they rarely go broke.

  22. Frilton Miedman says:

    S Brennan, last try.

    You’re mixing up two of the three economic schools, Monetarist & Austrian.(Keynesian being the third)

    Monetarist and Austrian are not the same.

    To illustrate the point, all the recent cries about “Helicopter Ben printing money” come from Milton Friedman, who once suggested throwing money from a helicopter if that’s what it takes to prevent deflation.

    The Friedman version of a free market is NOT the same as the Austrian laissez faire version of a free market.

    I can easily pick out Friedman policies that I disagree with, but it only hurts your case if you don’t understand Friedman to begin with.

  23. Richard W. Kline says:

    The issue is less the size of non-national deposits in a nation’s banks than whether or not those funds enter the host nations real economy, whether directly or indirectly. Luxembourg, Malta, the Caymans, and such: these are tax haven drop boxes (which frankly should e put out of business). Money is cached there and then sent elsewhere by the depositors, but little enters the local economy. This has historically been the case in Switzerland, where shareholders and managers of the banks become wealthy, but where there has been little bleed over of that wealth into internal speculation.

    However, if those funds enter the real economy, disaster is highly likely. That can happen in at least three ways. One is that foreign capitl can directly invest at the depositor’s discretion and usually intent, as often in Mexico, but which happened to a degree in Cyprus also. The second is that the deposit institution can use its distorted asset base to itself invest in the local economy, such as Landsbanki did in Iceland, and as happened in Ireland. This is often non-residential property speculation, or in other high-end assets, and almost always disastrous because those ‘ deposit assets’ can go away at any time while the debts of the banking institutions remain localized. The third way is that the depositing institutions also have large _domestic_ deposit bases, who benefiting from distorted interest rates and confidence of a ‘large, safe bank’ themselves borrow against their assets for domestic investment or more accurately speculation, typically in residential property. Iceland, ireland, and Cyprus all had huge bank failures where large domestic deposit bases helped pump up the domestic economy but have been savaged when the bank went bad.

    I find it _hilarious_ that Krugman finally has the lightbult go on in his Nobel skull on this. Developmental economists were entirely aware of the ruinous nature of foreign capital inflows _in the 1960s and 1970s_, evaluating the impact of foreign aid disbursements. A great deal was published on this, all of which was completely ignored by most university economics departments, their faculty and their cirricula, who instead taught the pernicious fabulations of neoclassical economics which are, as we are now again reminded, WITHOUT ANY EMPIRICAL FOUNDATION WHATSOEVER. The damage caused by unrestrained capital flows was abundantly well known at least 50 years ago, but all the high-end carpetbaggers and their ilk have made out like bandits floating self-serving lies so no one was inclined to relate to the actual historical evidence. Reinhart and Rogoff’s study was welcome and thorough—and in no way new. But later for the facts to enter putatively educated noggins late than never . . . .