Early Readouts From The Cyprus Experiment
“The no bail-out principle means that everyone should face the consequences of their own actions.”
--Jens Weidmann, president of the Bundesbank
The Year Ahead 2018
The world’s leading thinkers and policymakers examine what’s come apart in the past year, and anticipate what will define the year ahead.
Thank goodness for Cyprus. We don’t want to perform economic experiments using the entire population of Europe: what if it went wrong? But tiny, powerless Cyprus is a perfect laboratory for testing theories such as the “no bail-out” principle.
Europe plans to implement the “no bail-out” principle on a continental scale in a couple of years. From then on, eurozone governments and banks will be allowed to default on their liabilities. Wonderful. But luckily, Europe can play with the Cypriot economy for a while before it rolls out the policy for everyone else.
Here is the Cyprus experiment: What are the economic consequences of a banking collapse unmediated by external forces? (This is the same game that Hoover played in the early thirties, but it’s a good idea to rerun these exercises every eighty years or so. People have short memories, on both sides of the Atlantic.)
The Cypriot experiment just occurred this spring, and it takes time for the experiment to play out. It will take a full year for us to have definitive data, but we are already starting to get some early telemetry. My data sources are the Bank of Cyprus, the ECB and TradingEconomics.
Bank deposits have fallen from 70 billion to 50 billion, a decline of 30%. I can only imagine that the money supply has declined by a similar proportion. As we know from the quantity theory, a big decline in M usually results in a big decline in output. RGDP is declining at a 5% annual rate, but I expect that to accelerate. Industrial production is declining at a 17% annual rate, which is more like it. Unemployment is 17% and rising. The twin deficits (budget and current account) are both running at 6% of GDP (uh-oh!). Prices are declining, as we would expect.
So there you have it. The economy is in free-fall. Isn’t this a fun experiment? Just imagine if we could do this to all of Europe.