Cyprus And Its Own "Grexit": A Roadmap for Greece?

Greek deputy finance minister Dimitris Mardas reassured the finance world last week that Greece would in fact meet an April 9th deadline to repay a 450 million euro IMF loan instalment on time, after comments his superior had made on television were construed by many to suggest that the country was actively considering renegading on its debt.  It did little to help already skittish investor confidence, and reignited speculation amongst many financial journalism outlets on a potential "Grexit" that is now to be expected whenever the newly installed anti-austerity government in Greece pokes its creditors in Brussels and Berlin in the eye.  But while the fracas unfolded in Athens, across the Mediterranean an unlikely and largely unheralded success story quietly wound down Monday.

in late 2012, the Cypriot government was in trouble.  Facing an over leveraged banking system exposed to (perhaps ironically) the stumbling Greek economy and an overheated real estate market, the subsequent downgrade to "junk" status of the country's debt meant that Cyprus was suddenly unable to turn to global equity markets in order to finance the stimulus and rescue packages needed to save its faltering economy.  Facing a looming default, in March of 2013 the Cypriot government agreed to a rescue package with the "troika" (the IMF, ECB, as well as the European Commission and Eurogroup representing the EU) consisting of a 10 billion euro bailout as well as strict reforms meant to forcibly instill confidence in the Cypriot banking system as well as the creditworthiness of the government.  The portion of reforms aimed at preventing a large scale exodus of money from Cyprus's banks are known as "capital controls", and were implemented in the hopes of buying more time for efforts to recapitalize the country's banking system and prevent panicked runs on the banks, which would most likely have resulted in a collapse of the system.  Initially quite strict (withdrawals from personal accounts were limited to 300 euros per day, and transfers to foreign banks were severely limited as well), the restrictions on the Cypriot euro were gradually lifted as the banks were further stabilized and confidence was slowly restored.

The measures were never popular, with leftist parties opposed to the package floating alternatives ranging from a reduction in the size of the military, a corporate income tax increase, and even outright nationalization of the banking sector.  A common theme among many opponents was resistance to what many believed amounted to EU-imposed austerity, championed by technocrats in Brussels who were only interested in preserving their economic and political union and cared little for the average Cypriot.  A blog attached to The Economist even went so far as to call the package "unfair" and "self defeating", arguing that the high political cost of such austerity preconditions for bailouts made them impractical if the EU hoped to maintain the goodwill of its constituent states.  Others worried that the implementation of such harsh measures would push Cyprus into the arms of Russia, from whom it had already received substantial financial aid.  Ultimately, it was not an easy road to recovery in Cyprus; the country's significant community of wealthy Russians who had stashed their wealth there had to be placated, and the first parliamentary vote on an assistance package failed amidst widespread protests.  And yet last month, two years removed from the bailout, a Bank of Cyprus official referred to the capital controls as "irrelevant", suggesting that the country's top economists were now confident enough in the state of the recovery that they were considering doing away with the last of the monetary restrictions first put in place two years ago, a milestone they quietly fulfilled earlier this week.

Cypriot president Nicos Anistasiades heralded that admittedly largely symbolic day as indicative of "the full restoration of confidence in our banking system and the stabilization of the economy of Cyprus."  And he's not wrong in asserting that significant progress has been made.  The flow of money within the country is now unhindered, the country has resumed borrowing (paywall) and the economy is finally expected to return to growth in 2015 after three years of recession.  While decisive action on the part of the ECB and Cypriot lawmakers no doubt played an important role in staving off a default and subsequent exit from the Eurozone, capital controls were imperative in allowing the structural issues within the economy (the banking sector's debt obligations at one point were nine times greater than the size of the Cypriot economy) to be resolved.  Despite initial public backlash, Cyprus today is in markedly better condition than Greece.  While the full extent of Greece's sovereign debt issues mean that capital controls, should they be implemented, would be in place for potentially much longer than they were in place in Cyprus, they present a more desirable alternative to the "Grexit" as a means of quarantining the country's financial troubles until a deal finally resolving the crisis is struck (or the ruling Syriza party in Greece is voted out), as opposed to continuing to simply bankroll the Greek government while subjecting it to austerity measures which are doing little to improve the long term viability of the country's economy.  But given how the Bank of England has all but thrown in the towel when it comes to Greece, it remains to see how much appetite remains amongst the EU's other core economies, especially Germany, for continued support in order to stave off a Greek default, especially given the latter's penchant for creative schemes aimed at alleviating its strict bailout conditions.  Barring a significant change in tune from the government in Athens however, its looking highly unlikely that a currency quarantine will be given a chance to help rectify the country's long running debt issues.    

Lose the Countdown: Why the talk about the "Fiscal Cliff" is overblown

One only has to look at CNBC or CNN to see these apocalyptic "Countdown to the Fiscal Cliff" timelines that pretty much distort the picture.  What should have been a simple re-adjustment of fiscal goals in light of economic conditions has suddenly turned into a giant proverbial partisan volleyball game, with the President and Democratic Senate pitted against the Republican-filled house, lobbing the ball of public opinion into the others' corner.  Last night's dramatic finish saw the Senate passed an emergency set of laws to sort of delay the fiscal cliff and soften the landing should they go over. There wasn't much anyone could do except sit close to their T.V and pray that Speaker Boehner would cut the brinkmanship and actually work towards avoiding plunging the United States into what could be a long and protracted recession, and an extended period of slow growth that could put a cap on the economy for years.  But the vital thing to keep in mind here is that this whole circus is a MANUFACTURED crisis, and really is only a a question because of the partisan bickering of both houses in the wonderful Bicameral system the United States has been blessed with.  What should have been a simple fiscal decision to stagger spending cuts and lower taxes has been hijacked by ideology and a certain pledge named after the always charming Grover Norquist.    

To understand the Fiscal cliff one must roughly understand the economy.  A rough but easy way to look at it would be to visualize the economy as a bucket, with taps injecting water, or economic activity into the economy, and drains, leaking economic activity out of it.  The "injections" would basically include investments, exports, consumer spending and the golden ticket in our case, government spending.  On the flip side, there's savings, imports, and the other key word, taxes.  In biology they teach you about an ecosystem's "carrying capacity", or just how much a population it can hold.  Well the economy works in a similar way.  There's an equilibrium where economic growth is sustainable and that is where fiscal and monetary policy combined come together to strive for this equilibrium.  The "Fiscal Cliff"  has the potential to be a destabilizing force in the economy because now government injections in the economy because what it would've done was hiked taxes, "draining" more economic activity, and lowered government "injections" into the economy moving the economy below the desired equilibrium.  But in economics everything is related, and  this would have the effect of curtailing business investment as profits are squeezed which would spin-off into other business sectors that rely on corporate investment which would cause layoffs reducing consumer spending as purchasing power declines, etc.  As you can see, the ripple effect could have serious effect on the economy that Ben Bernanke and the Fed would be pretty much useless to try and stop, considering the huge balance sheet it's accumulated through previous stimulus measures.

So things seem pretty dire judging from the economics of it all, and as a result CNN wouldn't be too far off the money with that countdown to the cliff would they?  Nope.  Congress had the option, not to mention the time to deal with this all the way back since they, characteristically like the 112th Congress, they agreed to raise the debt ceiling in yet another 11th hour deal.  And keeping with the indicators, Congress did not disappoint.  They had about a year and a half to talk about an important issue that would effect possibly millions of Americans.  Instead they resorted to a policy of brinkmanship, confrontational showdowns and concocted dumb rules they ended up breaking anyways like the unrealistic "Boehner Rule".  Not to mention making pledges that then held them hostage to the whims of one very partisan group, something that runs against the very nature of democracy itself.  Those countdowns served no purpose other than to panic political pundits and the general public, and maybe expose just how gridlocked Congress is.

At midnight when the ball dropped in Times Square there wasn't a magic switch that went off that all of a sudden plunged the United States into a recession and wiped out trillions of dollars from the global economy.  Only when businesses and people would be forced into paying more taxes and the government tap squeaked shut would we have seen any substantial real reaction.  That would've given Congress about a month to hammer out a deal. The important thing to note is that they should not have needed a month, as this was something that could have been solved by the time the Republican caucuses were taking place.  Things that had been politicized heavily such as a tax hike on the top 2% and defense and medicare spending held up negotiations and negotiations are still ongoing as the relatively over hyped sequesters, which don't cut spending but decrease projected increases in spending and find savings through "inefficiencies".  The deficit is still projected to increase by a large amount, although this is a good start.  It's been more than a decade since America has seen a surplus, and years of fiscal irresponsibility and financial imprudence have taken their toll on the country.  Of course markets may have dropped should Congress have failed to reach an agreement by the time markets had opened on the 2nd, but that's controlled by two of the worst  human emotions:  Fear and Greed.  The stock market cannot be used as a barometer of the health of the economy immediately following an event of mass economic hysteria.  Last night the Nasdaq Futures index was up around 400 points, an indicator of the bull market that took hold today.  And yet the American and global economy are not in much of a safer position now than they were 72 hours ago.  So CNN, lose the hysterical pundits and doomsday clocks, because sure catastrophe is fully possible, but this isn't the Dark Knight Rises.  There's no nuclear bomb sitting in the back of a truck with a timer saying when it's going to go off.