Cyprus has finally killed myth that EMU is benign

The punishment regime imposed on Cyprus is a trick against everybody involved in this squalid saga, against the Cypriot people and the German people, against savers and creditors. All are being deceived.

By Ambrose Evans-Pritchard

7:55PM GMT 27 Mar 2013

Cypriot students shout slogans as they stand at an entrance of the presidential palace in capital Nicosia, on Tuesday, March 26, 2013.
If Cyprus tries to claw back competitiveness with an 'internal devaluation', it will drive unemployment to Greek levels (27pc) and cause the economy to contract so fast that the debt ratio explodes Photo: AP

Capital controls have shattered the monetary unity of EMU. A Cypriot euro is no longer a core euro. We wait to hear the first stories of shops across Europe refusing to accept euro notes issued by Cyprus, with a G in the serial number.

The curbs are draconian. There will be a forced rollover of debt. Cheques may not be cashed. Basic cross-border trade is severely curtailed. Credit card use abroad will be limited to €5,000 (£4,200) a month. “We wonder how such capital controls could eventually be lifted with no obvious cure of the underlying problem,” said Credit Suisse.

The complicity of EU authorities in the original plan to violate insured bank savingshalted only by the revolt of the Cypriot parliamentleaves the suspicion that they will steal anybody’s money if leaders of the creditor states think it is in their immediate interest to do so. Monetary union has become a danger to property.

One can only smile at the denunciations of Eurogroup chief Jeroen Dijsselbloem for letting slip that the Cypriot package is a template for future EMU rescues, with further haircuts for “uninsured deposit holders”.
That is not the script. Cyprus is supposed to be a special case. Yet the “Dijssel Bomb” merely confirms that the creditor powers – the people who run EMU at the moment – will impose just such a policy on the rest of Club Med if push ever comes to shove. At the same time, the German bloc is lying to its own people about the real costs of holding the euro together. The accord pretends to shield the taxpayers of EMU creditor states from future losses. By seizing €5.8bn from savings accounts, it has reduced the headline figure on the EU-IMF Troika rescue to €10bn.

This is legerdemain. They have simply switched the cost of the new credit line for Cyprus to the European Central Bank. The ECB will have to offset the slow-motion bank run in Cyprus with its Emergency Liquidity Assistance (ELA), and this is likely to be a big chunk of the remaining €68bn in deposits after what has happened over the past two weeks.

Much of this will show up on the balance sheet of the Bundesbank and its peers through the ECB’s Target2 payment nexus. The money will leak out of Cyprus unless the Troika tries to encircle the island with razor wire.

“In saving €5.8bn in bail-out money, the other euro area countries will likely be on the hook for four to five times more in contingent liabilities. But, of course, the former represents real money that gives politicians a headache; the latter is monopoly central bank money,” said Marchel Alexandrovich, from Jefferies.

Chancellor Angela Merkel will do anything before the elections in September to disguise the true cost of the EMU project. It has been clear since August 2012 that she is willing let the ECB carry out bail-outs by stealth, as the lesser of evils. Such action is invisible to the German public. It does not require a vote in the Bundestag. It circumvents democracy.

Mrs Merkel can get away with this, provided Cyprus does not leave EMU and default on the Bundesbank’s Target2 claims, yet that may well happen.

“I wouldn’t be surprised to see a 20pc fall in real GDP,” said Nobel economist Paul Krugman.

Cyprus should leave the euro. Staying in means an incredibly severe depression.”

Nobody knows what is going to happen. The economy could go into a free fall,” said Dimitris Drakopoulos, from Nomura.

The country has just lost its core industry, a banking system with assets equal to eight times GDP, and has little to replace it with. Cyprus cannot hope to claw its way back to viability with a tourist boom because EMU membership has made it shockingly expensive.

Turkey, Croatia or Egypt are all much cheaper. Manufacturing is just 7pc of GDP. The IMF says the labour cost index has risen even faster than in Greece, Spain or Italy since the late 1990s.

What saved Iceland from mass unemployment after its banks blew up – or saved Sweden and Finland in the early 1990s – was a currency devaluation that brought industries back from the dead. Iceland’s krona has fallen low enough to make it worthwhile growing tomatoes for sale in greenhouses near the Arctic Circle.

If Cyprus tries to claw back competitiveness with an “internal devaluation”, it will drive unemployment to Greek levels (27pc) and cause the economy to contract so fast that the debt ratio explodes.

The IMF’s Christine Lagarde has given her blessing to the Troika deal, claiming that the package will restore Cyprus to full health, with public debt below 100pc of GDP by 2020.

Yet the Fund has already been through this charade in Greece, and her own staff discredited the doctrine behind EMU crisis measures. It has shown that the “fiscal multiplier” is three times higher than thought for the Club Med bloc. Austerity beyond the therapeutic dose is self-defeating.

Some in Nicosia cling to the hope that Cyprus can carry on as a financial gateway for Russians and Kazakhs, as if nothing has happened. RBS says the Russians will pull what remains of their money out of Cyprus “as soon as the capital controls are lifted”.

The willingness of the Cypriot authorities last week to seize money from anybody in any bank in Cyprus – even healthy banks – was an act of state madness. We will find out over time whether this epic blunder has destroyed confidence in the country as a financial centre, or whether parts of the financial and legal services sector can rebound.

Yet surely there is no going back to the old model, even though the final package restricts the losses to the two banks that are actually in trouble. Savers above €100,000 at Laiki will lose 80pc of their money, if they get anything back. Those at the Bank of Cyprus will lose 40pc.

Thousands of small firms trying to hang on face seizure of their operating funds. One Cypriot told me that the €400,000 trading account of his father at Laiki had just been frozen, leaving him unable to pay an Egyptian firm for a consignment of shoes.

The Cyprus debacle has taught us yet again that EMU has gone off the rails, is a danger to stability, and should be dismantled before it destroys Europe’s post-War order.

Whether it marks a watershed moment in the crisis is another matter. Italy, Spain, France and Portugal have their own crises, moving to their own rhythm.

The denouement will arrive when the democracies of southern Europe conclude that recovery is a false promise and that the only way to end mass unemployment is to break free of EMU’s contractionary regime.

It will be decided by Italy, not Cyprus.


March 27, 2013, 7:58 p.m. ET

Laffer and Moore: The Red-State Path to Prosperity

Blue states with high taxes are struggling to compete for businesses and workers.


You can tell a lot about prosperity in America by observing the places people are moving to and where they are packing up and moving from. New Census Bureau data on metropolitan areas indicate that the South and the Sunbelt regions continue to grow, while the Northeast and Midwest continue to shrink.

Among the 10 fastest-growing metro areas last year were Raleigh, Austin, Las Vegas, Orlando, Charlotte, Phoenix, Houston, San Antonio and Dallas. All of these are in low-tax, business-friendly red states. Blue-state areas such as Cleveland, Detroit, Buffalo, Providence and Rochester were among the biggest population losers.

This migration isn't accidental. Workers and business owners are responding to clear economic incentives. Red states in the Southeast and Sunbelt are following the Reagan model by reducing tax rates and easing regulations. They also offer right-to-work laws as an enticement for businesses to come and set up shop. Meanwhile, the blue states of the Northeast, joined by California, Minnesota and Illinois, are implementing the Obama model of raising taxes on businesses and the wealthy to fund government "investments" and union power.

The contrast sets up a wonderful natural laboratory to test rival economic ideas.

Consider the South. We predict that within a decade five or six states in Dixie could entirely eliminate their income taxes. This would mean that the region stretching from Florida through Texas and Louisiana could become a vast state income-tax free zone.

Three of these statesFlorida, Texas and Tennessee—already impose no income tax. Louisiana and North Carolina, both with bold Republican governors and legislatures, are moving quickly ahead with plans to eliminate theirs. Just to the west, Kansas and Oklahoma are also devising plans to replace their income taxes with more growth-friendly expanded sales taxes and energy extraction taxes. Utah, while not a Southern state, leads the tax-cutting pack under Republican Gov. Gary Herbert.

Much of this is the result of GOP victories in the 2010 and 2012 elections. Today 10 of the 12 governors in the Southern states are Republican, and in nine of those states the Republicans control both chambers of the legislature.

Meanwhile, the Northeast is bluer than ever. Consider Massachusetts, where only four of the 40 state senators and just 29 of the 160 House members are Republicans. In the past two elections, the GOP was crushed in Connecticut, New York, Rhode Island and Illinois. And in 2012, Democrats gained a supermajority in both houses of the California legislature for the first time since 1883. Not surprisingly, California, Illinois, New York, Oregon, Minnesota, Hawaii, Connecticut, Maryland and Massachusetts have all raised income taxes in recent years.

But it isn't just higher taxes that make these so-called progressive states less attractive to business. Red states Texas, Oklahoma, Wyoming, West Virginia, Montana and North Dakota (and a few blue states like Ohio and Pennsylvania) are getting rich from oil and gas drilling.

Meanwhile, bluer-than-blue New York has extended its moratorium on the technological advance behind the boom, hydraulic fracturing, citing overblown environmental hazards, and Vermont has outlawed it altogether. California's regulations prohibit nearly all new drilling of any kind.

Moreover, the entire Northeast and West Coast is anti-right-to-work, meaning that workers employed in unionized workplaces may be required to join the union and pay dues that might go toward political causes they disagree with. Most of these blue states also have super-minimum wage laws that price low-income workers out of the job market.

All the empirical evidence shows that raising a state's tax burden weakens its tax base. Still, too many blue-state lawmakers believe that a primary purpose of government is to redistribute income from rich to poor, even if those policies make everyone, including the poor, less well off. The obsession with "fairness" puts growth secondary.

Meanwhile, in the South, watch for a zero-income-tax domino effect. Georgia can hardly sustain a 6% income tax if businesses can skip across the border into neighboring states like Florida, Tennessee or South Carolina. Oklahoma Gov. Mary Fallin has told her legislature that the Sooner State will face high economic hurdles in the future if it is an income-tax sandwich between Texas and Kansas. 

Last year, Tennessee Gov. Bill Haslam signed into law legislation repealing the state gift tax and phasing out the state estate tax. Next on the docket? Repealing the state's tax on "unearned income"—income from sources other than wages such as rent and investments.

Increasingly, under Republican leadership, the pro-growth movement is spreading north. Over the past two years, Michigan and Indiana passed right-to-work legislation, and the latter phased out its estate tax. Ohio Gov. John Kasich turned a $6 billion deficit into a budget surplus with no tax increases. Wisconsin Gov. Scott Walker made a number of positive budget and collective-bargaining reforms and wants tax cuts this year. Kansas Gov. Sam Brownback signed into law legislation slashing the state's highest personal income-tax rate to 4.9% from 6.45%, and says his ultimate goal is to eliminate the income tax.

In short, red states of the South and other areas of the country are moving forward with pro-growth tax reform, while California and the blue states of the Northeast are doubling down on Obamanomics and European progressivism. Who will come out on top? Our money is on the red states and those wisely following their lead.

Mr. Laffer is chairman of Laffer Associates. Mr. Moore is a member of the Journal's editorial board.


Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved


Updated March 26, 2013, 10:39 p.m. ET

European Regulators to Charge Banks Over Derivatives


BRUSSELS European antitrust authorities are moving soon to bring a case against some of the world's largest banks alleging collusion in the $27 trillion market for credit derivatives, people familiar with the investigation said.

The probe by the European Commission involves 16 financial groups. It focuses on whether they sought to stifle competition from exchanges in the market for credit-default swaps, which pay out when a country or a company defaults on its debts.

If the European regulators press ahead with their administrative case and win, some or all of the banks could face fines.

Also under investigation is Markit Group, a credit derivatives data provider that is partly owned by the dealers, and ICE Clear Europe, a unit of IntercontinentalExchange Inc. ICE +1.85% Markit and ICE declined to comment.

The commission said Tuesday it also had "preliminary indications" a derivatives trade body, the International Swaps and Derivatives Association, might have been part of an alleged effort to limit access to the credit-derivatives market.


ISDA said it "is aware that it has been made subject to these proceedings" and is "confident that it has acted properly at all times and has not infringed EU competition rules."

Markit and ISDA are likely to be part of the commission's case, a person familiar with the investigation said.

The probe is part of U.S. and European efforts to bring more competition to the opaque markets for CDS. The contracts came under fire during the 2008 financial turmoil and, more recently, the European debt crisis. Critics complained that some investors used them to speculate on the health of a country or company, not just as insurance against defaults.

The U.S. Department of Justice has launched a probe into the possibility of anticompetitive activity in credit-derivatives trading and clearing, and in information services industries supporting the activities. That probe is ongoing, a DOJ spokesman said, declining to elaborate.

Among those the European Commission probe has focused on are such industry giants as J.P. Morgan Chase JPM -0.69%& Co., Goldman Sachs Group Inc. GS -0.08%and Deutsche Bank AG, DBK.XE -0.23%the commission has said.

Others potentially involved, it has said, are Bank of America BAC -0.49%Corp, Citigroup Inc., C -0.34%Barclays BARC.LN +1.13%PLC, BNP Paribas SA, BNP.FR +0.93%Commerzbank AG, CBK.XE +0.79%Credit Suisse Group, CSGN.VX -1.74% HSBC Holdings HSBA.LN +0.70%PLC, Morgan Stanley, MS -1.59%Royal Bank of Scotland Group RBS.LN -0.58%PLC, UBS AG, Wells Fargo WFC -0.03%& Co., Credit Agricole SA ACA.FR +2.39%and Société Générale GLE.FR +0.61%SA.

The banks either declined to comment or didn't immediately reply to requests for comment.
The European Commission, the European Union's executive arm, said in 2011 it was investigating whether there was a coordinated effort among banks to prevent exchanges from getting a piece of the CDS market.

Unlike other financial instruments, these are traded privately between two parties, away from regulated exchanges where prices are displayedmeaning that customers aren't able to see whether they are getting the best prices.

The probe is part of a push by European officials to wrest control of the market from a relative handful of global derivatives dealers and move swaps trading onto exchanges, where pricing is more transparent.

The U.S. Dodd-Frank law and new EU legislation both called for derivatives, with some exceptions, to be traded on exchanges.

Officials hope that moving trading onto exchanges would help regulators monitor risks in the market and help prevent a repeat of the 2008 credit debacle.

A reshaping of credit-derivatives markets, and a move to open futures exchanges, poses a threat to profits dealers have long made in that market by dominating it. Profits for financial institutions that act as the intermediaries could shrink because of a smaller spread between bid and ask prices.

European regulators in April 2011 began looking into whether a number of investment banks had used Markit Group, the leading provider of financial information in the CDS market, to block the development of certain CDS trading platforms.

The commission said it was looking at whether dealers were providing raw swaps data only to Markit. The banks at the time either declined to comment or didn't respond to requests for comment.

Markit runs auctions to determine the price at which CDS holders can settle when a default occurs, but it does so on behalf of ISDA, which owns the intellectual property on the swaps auctions.

European authorities are looking into whether ISDA refused to allow exchanges to license CDS auction data that would be necessary to determine the payout on an exchange-traded CDS contract, according to two people familiar with the probe.

According to a person familiar with the matter, the commission's investigation of CDS trading is at a more advanced stage than another probe it is conducting—into whether banks colluded in the fixing of the Libor and Euribor benchmark lending rates.

Under EU rules, the European Commission's antitrust department first sends a so-called "statement of objections" laying out the charges. Companies are given a chance to respond to any charges levied.

If the commission decides to sanction a company, it can fine a firm up to 10% of its annual global revenue, though penalties that big are rare.

Regulators also take into consideration the market impact a violation has had, as well as its duration.

Companies that cooperate with a probe can be dealt with more leniently than others.