Friday, March 22, 2013

TMM thoughts on Cyprotoxins

- The EU group is suffering from the weak leadership of the Dutch Finance Minister. The pasting he received in the EU Parliament yesterday was fully justified. He even apologised for not getting it right & said it was for us to decide if they were incompetent! TMM answer with a firm "YES!".

- This lack of leadership within EU policymaking has led to an impasse: The recent Eurogroup statements barely disguise the complete lack of agreement as "German Economics" espoused by an election driven Schaeuble, with its determination to force internal devaluations on the periphery, going unopposed.

- German Pressure is compromising ECB freedoms to do its job. The ECB has announced that it will not provide ELA to insolvent banks and will turn off the tap on Monday without a bailout. First, the ECB/ELA *can* lend to insolvent banks and has done so in the past (Anglo Irish). Second, and more importantly, the ECB is shirking its core responsibility of lender of last resort.

- Is Draghi happy with having his mandate hamstrung? TMM severely doubt it and wonder if his silence hides deeper ire that is too dangerous to publicise.

- Precedent-setting, no matter what they claim - calls into question whether the OMT can be employed in large enough scale to prevent EUR exit risk premia arising in peripheral market.

- Imposing depositor haircuts across the board (again, let's not kid ourselves: Barclays Nicosia is hardly a bankrupt bank) has de facto devalued the Euro in Nicosia. It is now worth just 0.92 Berlin Euros. This, in TMM's view, is a catastrophic policy error for Europe.

- Cyprus solution has broken THE MOST IMPORTANT FUNDAMENTAL PILLAR that supports EMU: A Euro in Berlin is both worth the *SAME* as a Euro in Nicosia, and entirely fungible. This reminds us of the similar breakdown the Federal Reserve System in the 1930s where Bills of the NY Fed were discounted elsewhere.

- Similarly, the ECB's attempt to force Cyprus to adopt capital controls is a hugely misguided endeavour, for it *too* violates this fundamental premise

- The Target 2 system was designed to prevent Balance of Payments crises between member states, not for the purpose of economic war. ECB threats to cut the Cypriot Central Bank off from its window (don't buy the ECB/German rhetoric: it's the Cypriot Central Bank that is being cut off here, not the domestic banks, given it intermediates the Target 2 balance & ELA facility to the domestic banks), & similarly the possibility of Cyprus defaulting on its Target 2 balances have turned a payments system designed to prevent crisis into the economic equivalent of a Nuclear strike. Political interference (and TMM would include the German contingent of the ECB here) should never have been allowed to interfere with this system.

- By just announcing that deposits could be haircut, the Troika have unleashed very powerful forces that will inevitably result in the deposit base of Cyprus' banks evaporating via capital flight. This, by definition, will cause a collapse in the money supply & a deep recession.

- TMM's men on the ground in Cyprus report that today, the economy has, unsurprisingly, primarily become a "cash only" economy.

- Imposing limits on cash withdrawals, online payments etc simply results in *a collapse of the velocity of money*. The economic effect is likely to be the same as if the money supply collapsed via deposit flight.  MV = PQ = GDP. Cyprus's economy is being hit by an unforced policy error of the type usually seen in chaotic EM crises.

- The policy of limiting cash withdrawals was tried in December 2001 in Argentina - known as the Corralito. It failed spectacularly - within a couple of weeks. Riots eventually forced the President to flee as economic transactions became virtually impossible. Default & devaluation quickly followed.

  - Cyprus is thus in the early stages of experiencing what it would do were it to leave the Euro: (i) a household liquidity crisis, (ii) a paralysed financial system, (iii) a collapse in monetary velocity, (iv) a large loss of national wealth, (v) capital controls, (vi) shortages of imported basic goods [trade credit for Cyprus now non-existent],  and (vii) an exceptionally deep recession.

- The "Alternative" that the Cypriot government (with the encouragement of the ECB) is to impose Capital Controls & deposit withdrawal limits. Under Article 63 of the Treaty, these are illegal. There is, of course, a clause that allows governments to do this with a "macro prudential" remit. However, TMM totally call "horse sh1t" on the idea that such measures are "prudential", and given that they have been made up in a very short amount of time before properly thinking them through, imagine that a Court may well agree that an injunction be imposed until policy has been properly considered, instead of rushing into potentially damaging actions.

- TMM are opinion that imposing capital controls drastically increases the probability of Cyprus exiting the Euro.

- This state of affairs, TMM believe, is entirely unsustainable. Given the drastic recession that is about to occur, government debt will blow out again, requiring a further bailout in 6months. Germany has declared that there will be no more money. Cyprus would then have to leave the Euro *anyway*.

-  TMM used to have a German boss many years ago who once described German foreign policy as such : "You throw in a hand grenade, wait for the dust to settle and walk straight through. Don't even bother counting the bodies". They appear to be sticking to their rule book. But then, what else would you expect from Germany?

- TMM think that  the Rest of World is numbed to Euroblx and is happy using the "just muddle through" model to trade on, having been severely roasted last year expecting the opposite.

- TMM think this creates a more dangerous environment for markets as complacency levels with respect to Europe are at levels not seen for some time.


  1. Hi awesome TMM,

    Where can I learn more about: "the similar breakdown the Federal Reserve System in the 1930s where Bills of the NY Fed were discounted elsewhere." ?

    (not 200 pages papers but a few pages article/report on this thing)

    Thank you very much,

  2. A short history of the 1930s Bank Holiday in the US and FDR's Fireside Chat.

    US bank Holiday 1930s

  3. The time has come for the powers that be to introduce Weighted Instrument Guarantees (or Wigs) to force markets to price risk properly.

    Haircuts (actual and prospective) seem to have failed. Wigs (particularly the threat of having to wear silly ones) offer a better chance of success.

  4. At his point Cyprus is sure to get all the onus of staying inside the Euro and none of the bonus of walking away... The only reason why the polticians in charge there have not yet decided to do just that is that, whoever decides to take this road is commiting political suicide as the short term chaos will be awful. I believe an exit will occur, but only as a "consumated fact". Just like in Argentina...

  5. Calling the Eurogroup's recent proposal for Cyprus a "colossal mistake", Greek MEP Nikos Chountis today asked recently appointed President of the Eurogroup Jeroen Dijsselbloem "whether the Eurogroup is merely incompetent, or do you simply have hidden motives?"

    "I am afraid that Mr Schäuble made clear what seems to be a separate set of motives. He made clear why Germany chose this destructive solution, saying that 'anyone who invests his money in countries with lower taxes takes the risk when these banks become unsustainable'. In other words what he said was 'bring your money to our banks, they face no such dangers" in what was an open call for investors to leave Cyprus and choose more stable financial institutions, like German ones."

    "The second unmentionable objective that Schäuble did not make clear is the offer of financial breaks to countries like Cyprus and Greece in exchange for the acquisition by extortionate terms of the gas and energy resources of these countries."

  6. The parallel with Argentina 2001 is a good one. LB was there and remembers the street protests, shortages of currency and the payments in patacones (a sort of scrip/"bond" that the local governments used to make their payroll). In the aftermath of the deep deflationary episode, there were two years of extreme poverty for the poor and some breakdown of law and order.

    In both cases the proximal cause of the disaster is an inelastic exchange mechanism - a currency peg, Argentina's peso having been pegged to the USD some years earlier, as well as the usual emerging market problem of hot money flows chasing high interest rates. Of course a massive devaluation of the peso was the end result.

  7. Agree with TMM that the importance of Cyprus is being under-estimated. People are just not thinking this through.

    Most people are thinking Cyprus is a mini-Greece ("small island, small economy, doesn't matter"), and ignoring the fact that this is a signifier of things to come. Put simply, something is going to happen next week that hasn't happened in a while. Some people are going to lose money, and more importantly, some large institutions are going to take write-downs.

    OK, so let's say some Russian bank takes a write-down. Who cares? EURUSD might even rally at first, having decided not to print money to solve the Cyprus issue.

    This analysis neglects several things we know about the way the banking system works. First of all, that Russian bank is leveraged, and we don't know by how much. So a 1% loss of their capital might have severe liquidity or even solvency effects.

    The peer group of this bank is likely to shun them as a counter-party and also to reduce risk. {This is what happened with US banks holding bad MBS and CDO paper}. The result of this is likely to be the Russian and other European banks buying USD and JPY. We also don't know whether Russia has an effective plan to backstop a bank failure.

    A large risk-off FX move always unwinds carry trades, and we are likely to see weakness in other emerging markets as a consequence of a general decline in confidence.

  8. Here is a good summary of the complacency over Europe, concluding with "shorting the Euro hasn't worked in the past", and including the "impact is likely to felt in (Russia)" which presumably doesn't matter.

    Euro Rising Despite Cyprus Turmoil

    Frightening when you have people who don't even remember it was something that happened in Russia that brought down LTCM.....

  9. C Says
    I suspect we have more than a little conditioning going on here.How many times have people sold off ,or gone short etc etc in the face of past issues since 2009 and how mnay times have they had last minute 'deals' bury their positions?
    I suspect this has even fed through now to the latest 'sell-side' mantra that buy and hold is the ony thing that works;you can't time the markets;doing less is doing more (oh yes Barry?). What I am saying is we are hearing a great deal of guff which actually just shows how prior behaviour is now shaping current responses. I could point even to more recet popularity in say Investment Trusts that had been out of favour ,but now hey they smooth the volatility and keep you in game so pop your money in.

    Current behaviour in the face of risk is really just showing how it has been shaped in the last couple of years where 'normal' markets in many ways simply ceased to exist.

  10. Buy and hold is the market reverting to its mean behaviour.

    Its always been encouraged to do so until the fraud of it all is exposed. Just like a ponzi scheme.

  11. Indeed. Recency bias in play.

    "I can hardly remember the last time I lost money in this market". "It doesn't matter what I buy, it makes money". "The Fed has my back, and the ECB, and the BoJ. I can't lose".

    In fact punters are becoming dangerously over-confident that "Look, I am so smart, I can put my d*ck in a blender and use it to stir drinks without getting injured".

    True, as long as it isn't plugged in at the time.

  12. And now, the ultimate "kick the man while he's down" moment... I can't believe the Troika has increased its demands by nearly 1bn. I am speechless.

  13. Cypriot banking sector obit was written the day the depositors were touched.

    While I dont see this spreading (yet), there is incredible fragility now. At the first sign of problems, we will see _rapid_ escalation.

    Gamma-shorting macro-tourists should beware.

  14. Anon @ 7.27

    Where did you see this ?


  15. Eddie,
    Reported in the media (couple) that the troika needed a furtehr Euro 900m to make good the additional damage that they believed had taken place over the interim since the initial offer was tabled and then rejected.

  16. As always, great commentary. I have a small objection on the impact of deposits haircut on domestic demand. Especially given that the deposits that will be hurt are the ones above 100k, I would argue that demand wouldn't be affected much (at least not as a direct result of that). This is parked wealth that was not really meant to be spent in Cyprus anyway, or not anytime soon (with the few expections of course in case someone was about to buy a house with that money etc. but in general it wouldn't be the case).

  17. "Ireland to remove bank deposit guarantee from end-March"

    "The removal of the guarantee will not impact the vast majority of bank customers because deposits over 100,000 euros are covered by a separate guarantee which has been in operation in Ireland since 1995
    The Eligible Liabilities Guarantee (ELG) scheme guaranteed deposits over 100,000 euros in case banks got into trouble"

    With confidence running so high this well-timed move should not be a problem at all.

  18. Thanks Anon 2.45 for the link. Really enjoying the reading :)

  19. Theta,

    100+ bln banking sector that may be cut to 1/2 or 1/3 its size. Those 60-70 billion generate a lot of fees, supporting a lot of Cypriot employment from bankers, laywers, accountants to restaurants, shop-owners etc. So even if its foreign wealth getting hurt, there is a reason why the Cypriot President was reluctant to push all the burden on the wealthy. It will badly damage the Cyprus economy. Its folly to think this is just a problem for the foreigners and ordinary Cypriots coming out okay.

  20. Anonymous 2.45, TMM;
    I read the FED Report but I see no mention about the "Bills of the NY Fed were discounted elsewhere" :'(