Is Cyprus a special case or a lesson in what happens next to indebted nations?Posted on 23 March 2013 with 2 comments from readers
Next week Cyprus should present a revised rescue plan and the S&P 500 might break its all-time high on the news. But for Cyprus life will never be the same again. Swathes of its over-sized banking sector will completely disappear along with most of the offshore deposits that made it rich.
Well-paid jobs will go and never reappear. House prices will tumble. Tourism will be the biggest earner again. The retirement savings of bigger pensioners and foreign residents will be hit by venal taxation. So much for a safe haven in the sunshine. Japanese bank Nomura thinks this will cost 15 per cent of GDP.
Of course this mess has been in the pending tray for a long time, ever since the global financial crisis and the Greek debt crisis. Lending to Greece was the act of folly that brought down the house of cards in Cyprus whose banking sector grew too large.
Wall Street is correct to ignore Cyprus in that the fall-out from its demise will be very limited outside of the island. Some Russian depositors might end up in financial trouble. Rival banking centres like Istanbul or Dubai will probably gain some of the deposits that do manage to leave the island.
But Cyprus is a reminder that debts do catch up with debtor nations. Professors Carmen and Rogoff have written a book on this called ‘This Time is Different’ because it never is different. Debts catch up with you in the end, it is just that the end may be some considerable time coming and even so long that you think it will never happen. It always does.
Who’s next then? Is it the UK about to lose its triple-A status? Will Japan’s experiment with money printing backfire? Those are the two big nations carrying the largest debt burdens.
But then the US is not so far behind. The Carmen and Rogoff study argues that whenever a nation gets beyond 90 per cent of GDP with its debt then growth slows down by one per cent. The US with its average growth of 0.6 per cent over the past four years certainly fits that model.
The US now has a $16.7 trillion total debt mountain that is 106 per cent of its $15.8 trillion economy, the largest debt burden carried by any nation in history. The Fed has more than tripled the size of its balance sheet since 2007 to $3.2 trillion.
Fed market manipulation
Fed bond purchases have kept the cost of 10-year treasuries some 0.8 to 1.2 percentage points lower than it otherwise would have been, helping the economy out of the Great Recession. But as Professors Carmen and Rogoff predicted GDP growth has remained low and almost vanished in Q4 last year.
This year the CBO projects the cost of interest on US debt will be $224 billion but that is only thanks to the Fed’s suppression of interest rates. That debt burden could easily double or treble if financial markets lost confidence in the US dollar. Yes it is the global reserve currency but a lot is hanging on that.
Push up interest rates and the US would very quickly look far more like Cyprus than would make anybody comfortable. That has always been the dangerous future consequence of playing with interest rates, the crippling recession that comes when they go back up again.
Look at the people waiting in lines to get their money out of the banks and the recession that now must come for Cyprus and the nouveau poor. Don’t ever say it is different this time and could never happen here!