What to look for in the Cyprus deal
1. Output on the island could easily decline by 25% or more, and I don’t think that will involve much subsequent mean-reversion. There will be a deflationary shock, an uncertainty shock, an “austerity shock,” a credit contraction shock, and a few other negative shocks as well. The Cypriot government will not be fiscally well situated to support the safety net or automatic stabilizers.
2. It’s never a good sign when a deal is structured so that no one has to vote on it. (Correction: various European legislatures may be voting on it, but no one in Cyprus.)
3. The deal itself still doesn’t cough up all the money, but rather relies on subsequent tax increases and privatizations to come up with at least another billion euros. Believe it or not, the numbers don’t add up.
4. “This was not a good weekend for Russian billionaires.”
5. I wonder if the two main banks even have the money they claim they do. Who tells the truth going into a deal like this?
6. Capital controls in Iceland are expected to remain in place at least through 2015, which would make seven years (and counting). That is a better run country with lots of fish and aluminum smelting. You can expect the same or longer from Cyprus, and that’s assuming this deal can last that long, which I doubt.
7. ELA assistance is now, all the more obviously, contingent rather than certain. Who would keep their money in the “good bank” which is being folded into Bank of Cyprus? Why would anyone do this? Given a shrinking economy, surely this bank cannot afford to pay very much to retain deposits, since rates of return on domestic assets will be negative and capital controls will limit or prevent investments in foreign assets.
8. The capital controls will have to be strict. What will the price of a Cypriot euro be, relative to a German euro? 50%? I call this Cyprus leaving the euro but keeping the word “euro” to save face. And yet they fail to reap most of the advantages of leaving the euro, such as having an independent monetary policy.
9. Given that the nation is uh…corrupt, and the account holders are very often money launderers (duh), how effectively will those capital controls be enforced? Won’t the banks end up drained, one way or another? Of course remittances will need to be sent abroad to purchase “essential services,” right? Who picks up the tab for the total collapse of all the banks? Won’t the euros that are left depart Cyprus altogether?
10. Next up may be Slovenia…
Addendum: A summary of the deal is here. And here are some very good comments. Here are more details on capital controls.