“Just when you think they’ve hit bottom, they keep digging.”


These were the words of the U.S. ambassador to Bulgaria spoken to us during the country’s staccato political ejaculations which eventually drove the country into hyperinflation in the late 1990′s.  It was on the same trip to Sophia that a senior central bank official looked us in the eye and said they would not let the government default.  The government had lost the confidence of the markets to meet its debt obligations  even though it had an independent central bank.

Bulgaria faced a choice to either default or monetize its bond maturities.  Unlike Russia who chose default over hyperinflation in 1998,  Bulgaria monetized the debt payments causing one of the worst hyperinflations in post-war history.  The economic chaos eventually resulted in a currency board FX/monetary regime.  This is a lesson to the modern monetary theorists who believe governments with independent central banks can’t default.

History shows when governments get into trouble with their local currency debt they have to make a political choice on who will take the pain.  The Russians chose to inflict the pain on David Tepper, his hedge fund buddies,  and rest of the creditors, many of whom were foreigners. Bulgaria chose the domestic population through hyperinflation.

Fast forward to Cyprus 2013 who today  rejected the depositor bail-in scheme as part of its EU bail-out.  This is a game changer.  Just when we thought Cyprus may have hit bottom, they keep digging.

We hope the government has a Plan B — i.e., Russian bail-out, etc. — as the 6-10 deposit tax will look golden to depositors if Cyprus decides to/is forced out of the Eurozone.   The EU could also cave and soften up the terms of the bailout, but wouldn’t this increase the political contagion to other countries?

If Greece, for example, sees Cyprus voting down unpalatable measures forcing a Troika retreat and softening of terms, wouldn’t they try and do the same?

The Cyprus rejection of the bail-out deal really complicates matters and significantly increases uncertainty.

How and when will they get the banks back open?    Could this be the tipping point where Germany and the rest of northern Europe’s commitment to the Euro experiment begins to falter?

Will a Plan B resemble that of Argentina’s forced conversion of confiscated bank deposits into BONEX during 1980′s?

BONEX– Government bonds issued in the  1980’s and early 1990’s. The 1989 issue was used to compensate for confiscated bank deposits. Although BONEX bonds traded as low as 20-25% of par value, they generally enjoyed a good reputation and were all paid off. Many were purchased by foreign investors at discounted value, and then used (at full value) to acquire privatized public companies.
- Argentina U.S. Embassy

The financial resources needed to solve Cyprus are so small one would think the powers that be will not let the country fall into the abyss and increase the risk of taking much of Europe with it.   In other words, Cyprus is too small to fail.

This does raise the question, however, is Cyprus, like Lehman, the problem or just the symptom of larger issues?   If not Lehman, who?  If not now, when?

Tough to currently see the path to a decent outcome now and have no idea where this is going.  Does feel like more turbulence coming.  We’ve buckled up.

video after the jump

Cyprus rejects Eurogroup’s savings levy and bailout deal

(click here if video is not observable)

The Cypriot parliament has rejected the EU/IMF bailout for the country’s banks.

Support for the deal, which would have involved a one-off charge on all deposit accounts in the country, ebbed away almost as soon as it was announced on Saturday at the Eurogroup meeting.

Before rejecting the package Cypriot MPs had already decided to exempt any savers with 20,000 euros or less in their accounts, but this was not enough to gain support.

The Eurogroup said the charge was justified because Cyprus has allowed its banking sector to mushroom, Iceland style, into a monster that is more than twice the size of the rest of the economy, and has sucked in so much foreign money, much of it Russian, that foreign deposits account for 37% of all savings in Cyprus.

The Cypriots countered by saying they have a right to build up a services sector which they accuse Germany of wanting to destroy, and that they are being targeted because of ongoing disagreements with Moscow that the EU should work out elsewhere.

The European public has not failed to notice the one big fact to emerge from this latest crisis in the Eurozone. That is, no-one’s money appears safe any more, unless its stuffed under the mattress. The implications for the EU’s already hard-pressed banking system are obvious. A collapse in confidence at this stage of the game could prove fatal for the entire European project.

Yet although the Cypriot “no” vote appears to have struck a blow for ordinary people it plunges the country into a deeper crisis, one that could have serious repercussions for the rest of Europe.

Category: Bailouts, Credit, Think Tank

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.

5 Responses to “Is Cyprus Too Small To Fail?”

  1. V says:

    Never would have predicted too small to fail, but is there any reason why Cyprus can’t protect the payments system so businesses can stay open etc, while trying to recapitalise/restructure the debt burden?

  2. Anonymous Jones says:

    “This is a lesson to the modern monetary theorists who believe governments with independent central banks can’t default.”

    I’m not an expert in MMT, but I find this statement interesting. So you are saying that the Bulgarian government (or its electorate) was put in a position in which it did not have a choice whether or not to default on debt that was issued in sovereign currency? That doesn’t seem right.

    You, of course, cannot be claiming that MMT adherents believe that governments (or electorates) with independent central banks do not have the *ability* to default on sovereign currency debt. Because the adherents are not idiots, right? They obviously know that any debt issuer anywhere always has the *choice* to default. The argument is that if the government has an independent central bank and debt is issued in sovereign currency, then the issuer is never *forced* to default. There are always other options, however unpalatable.

    Unless you have some special insight into this, I’m afraid this isn’t just a minor mistake. You seem to have casually dismissed a whole bunch of obviously thoughtful and intelligent people based on a gross misunderstanding of what they believe. That is what some people in the business refer to as a credibility-killer.

    And even if you do have some special insight into this Bulgaria situation, size and interdependence matter. A small European country bordered on all sides by trading partners that are collectively much larger brings the possibility for competitiveness and currency issues far beyond anything that the larger sovereign nations would ever face in any but the most absurd of situations. So even if you have indeed discovered a great flaw in this theory, I would parse your objection a bit more finely if I were you.

  3. rallip3 says:

    The Cyprus problem is a banking problem first; I believe that the Euro area problems show that it’s unsafe to run a bank when there are not enough risk-free assets. Surely, however if the Single Market means anything, it should mean that there is nothing foolish about a Cypriot or Luxemburg bank considering the whole of the Eurozone to be its home market.
    Also on Cyprus’ side is the observation that when Greece renegotiated its debt the ECB and IMF got an unfairly good deal compared to Cyprus’ banks. In that sense, it was not Cyprus or Athens that was deciding who took the pain from a Greek default but a group of foreign politicians hiding behind Central Bankers.
    The big paradox from Greece is that if you had a bank account you did not lose out, while those who you held a theoretically safer government bond lost unnecessarily big. In Cyprus they the same ECB and IMF are proposing a different (and perhaps more logical) outcome than in Greece. This is totally capricious and unmanageable.
    The Eurozone can only work if either all sovereign bonds are risk-free or some community-wide risk-free debt vehicle is available in sufficient size and liquidity.

  4. Lugnut says:

    I gather you feel then that Iceland would not be a valid comparison? Orfrom a different angle, why does it seem to be such an alien concept that banks w(who hold these bonds) aren’t alllowed even the hint of potential at actually having to realize a loss on an investment with inherent risk? Remember kids, the German FinMin and the other puppets wanted a 40% theft of personal depositor assets when they first started talking about this. So you think this was going to be their only bite at the apple? Fat chance, that. What happens 6 months from now, when their baseline financial situation doesnt improve markedly?

    Sure this may ‘only’ be 6-10% now, but your daft if you think thats the extent of the tax. Contrary to that a default allows them to do a total reset of obligations and debt and interest overhang. And a better long term prospect.

    Their only digging deeper if you think that the Euro is the long term victor in this story. I don’t think that book has been written yet.

  5. davebarnes says:

    late 1990s and not 1990′s
    brought to you by the Committee to Save the Apostrophe from Abuse