I have taken a bit of a break from the macro diary, and from serious analysis in general, over the past week or so. One needs focus to do analysis, and my focus has been lacking. It is nice to be away from the fray for a while, but it also feels good to get back to it.
My period of absence has coincided with some interesting decisions in Europe, culminating in a new deal for Cyprus on Monday night. What is one to make of this new deal? In summary, it wipes out equity and debt holders in some banks, and also hits holders of uninsured deposits, in the natural order. An earlier deal imposed losses on insured depositors as well, and it appears that this earlier deal was an attempt by the new Cypriot government to minimise the hit to the offshore depositors who are the basis of Cyprus’s offshore-finance economy (it reminded me of the first bailout of Ireland, to which I objected that a well-understood instrument with a well-understood default procedure — that is, government debt — had been replaced with a new instrument — European loans — for which the rules were not clear; in the Cypriot case, all the rules were put in play by the tax on insured deposits; perhaps smart-alec bureaucrats imagine themselves so clever that they need take no account of precedent or history). A revolt by the Cypriot parliament put paid to the earlier deal and precipitated the new one.
The first, obvious thought is that, because a depositor write-off is now part of the toolkit of European bailouts, countries that appear to be getting closer to a bailout should see an acceleration of capital outflows and thus an exacerbation of the problem. Previously, thanks to Mr. Draghi, countries that appeared to be getting closer to a bailout were also getting closer to OMT, which provided an automatic stabiliser that meant a bailout could become unnecessary. It is possible, in other words, that the Cypriot resolution could undo much of the good work done by the ECB last year. Whether it will in fact do so will depend on whether markets really believe that Cyprus is a special case. They might do so — after all, with its enormous banking sector (relative to GDP) and penchant for dodgy Russian clients, Cyprus is an unusual case — or they might not. Perhaps the things to watch for initial signs are the deposits of Spanish and Italian banks and the development of Target2 balances.
Why has the ECB (which threatened to cut off ELA on Monday if no deal was reached) allowed this to happen? I see three ways of looking at the question. First, from the point of view of internal politics: some members of the ECB committee were never keen on OMT, and their voices have carried weight in the latest crisis. I am not sure where to go with that idea. Second, treating the ECB as a single actor with coherent objectives: the revealed preference of the ECB has been for crises to develop in order 1) to force governments into fiscal consolidation and 2) to make its implicit threats to allow some kind of disaster (which are not actually credible) seem credible. Third, there has been a strong thread of incomprehension running through the various “solutions” to European crisis over the past couple of years, and it is still there in the latest decision: in this case, it is the self-fulfilling nature of financial crises and the circular nature of their solutions (make a commitment to do something so effective that you never have to do it) that policy-makers appear not to have understood.
Another thought is that the latest deal illustrates something that I have said many times: once politicians are in power, they face strong incentives to co-operate with the Troika. Perhaps Mr. Anastasiades might have taken his country out of the euro, as he threatened; perhaps, indeed, that would have been good for Cyprus; but he must have known that his political career was unlikely to survive such a move (any more than Eduardo Duhalde’s survived Argentina’s devaluation of 2001, sensible though it was).
Everybody is talking about Cyprus’s capital controls, which, as I understand it, have not yet actually been imposed. These controls seem to be more about controlling flows of capital domestically — that is, between banks — than internationally, although one imagines that international capital controls are also likely to be imposed if domestic controls do not prevent large outflows. There is some philosophical discussion about whether a country that has imposed temporary capital controls is still part of a single currency, which seems to me to be more a matter of definition than reality; the best answer is: mostly.
Mr. Dudley has said that the greatest danger to US growth in 2013 is fiscal policy, which he expects to detract 1.75% from the rate of growth. He mentioned unemployment, the employment to population ratio and the hiring rate as being good indicators of the health of the labour market.
Dubai’s trade with Iran was down by a third in 2012 compared with 2011, according to recently-released annual figures. This is evidence that the sanctions regime is really hurting Iran. Dubai’s traders have reportedly tried quite hard to continue trading with Iran (the relationship is important for both countries) but in spite of that trade has been severely hampered.