What If Cyprus Left The Euro

Tyler Durden's picture

As we recently discussed, many euroskeptics are pushing Cypriot lawmakers to default, devalue, and decouple from the Euro - understanding that the short-term pain of such a move will lead to much more sustainable gains afterwards. But BofAML raises the question of what damage (and required response) would occur in the remainder of the European Union should Cyprus leave (or be pushed ). Unlike some EU leaders suggestions, BofAML suggests the contagion and growth impacts could last a decade; but it is the policy reaction of the ECB that is most crucial to understand and how it may rapidly lead to a German decision on debt mutualization (or not) that should be most concerning.


Via BofAML,

alternative scenario: Cyprus defaults, exits, confidence is shaken


In this scenario, the possibility of a country exiting the Eurozone could revive contagion risks, only to be mitigated by much more forceful policy reactions. We would see such a scenario materialising if negotiations failed, leading to a default on private and then public debt in Cyprus. In that scenario, when banks reopened, deposit flights would kill bank solvency and the ECB would veto ELA.


As a result, banks would default and since the sovereign is not in a position to nationalise the banks and cover the deposit insurance, it would be likely to default as well. This would probably be followed by a strong policy response from the ECB. In that case, to contain a potential run on the peripheral banks, the ECB would have to use more of its unconventional tools: first, more LTRO, together with rate cuts and possibly further collateral loosening to cheapen the price of liquidity as much as possible; second, possibly bond buying if there was a sell-off of periphery bond countries.


To contain the run on sovereigns, the ECB would have to proceed with extensive bond buying. OMT is a tool designed for countries with temporary liquidity, which might not be perfectly suited for a rapid deterioration of several countries’ bond markets that would reflect contagion. Against that backdrop, the ECB could be forced to intervene directly, though we believe such purchases could not take place (for more than a couple of days and by a limited amount such as the SMP) without the implicit support of core countries. Given the contentious nature of sovereign bond purchases and fiscal transfers in the eurozone, for markets to be fully convinced, in our view, the agreement by core countries would then have to be followed by a political process endorsing the debt mutualisation by the ECB together with a transfer of sovereignty at the euro level.


What does this mean for economic performance?


In a Cypriot exit scenario, we would expect a significant uncertainty shock but not as severe as that caused by the Lehman collapse, given that the economic cycle and leverage has changed markedly. First, given economies’ positions in the cycle, the current level of inventories is much lower (Chart 2).



Second, financial integration and leverage has diminished. Overall, the shock would be more contained geographically and in magnitude, in our view, but would still be sizeable and only contained thanks to large policy response. In our view, consumption and investment would be particularly affected, albeit much less than in the Lehman episode, as investment is far from fully recovered across most euro-area countries (Chart 3).



However, we would expect a similar contraction in exports – because roughly half of Eurozone countries’ exports are directed to their euro partners.


Although putting a number to such an uncertain outcome is complicated, we use recent research (see Box 1.3 of the World Economic Outlook of October 2012) to provide some guidance. According to this research, a one standard deviation increase in uncertainty is associated with a decline in output growth of between 0.4ppt and 1.25ppt. Assuming the uncertainty shock resembles that of Q4 2011 this would imply a headwind to our 2013 forecast of -0.5% of between -1% and -2.5%. In other words, we would expect a GDP contraction of between 1.5% and 3%, that is, a middle point below 2%.


What about the long run under this scenario? The special treatment of deposits and the imposition of semi-capital control has the implicit effect of underlining the fragmentation between the North and the South. Once again, the lack of respect for capital structure when designing programmes leads to the perception that restructuring in the Eurozone rests on arbitrary decisions, which clearly damages investment cases in the euro area, particularly in countries with pending deleveraging.


Conclusion: endangering Eurozone trend growth


The eurozone crisis has permanently damaged the euro area’s growth potential, unless economic reforms can boost investment and productivity again. In the absence of a considerable boost to economic policy, but assuming a standard recovery, Europe’s large countries trend growth would be lower at c.1.3% in 2015-20. But in our previous work we had assumed as a central scenario that the investment growth rate returns to its pre-crisis level by 2020.


In other words, the underlining of fragmentation that would come with a Cypriot exit would bring us closer to our scenario of much slower investment growth in 2015-20. In this situation trend growth in the four main economies in the Eurozone would be cut by an average of 1%, bringing France and Spain to a growth rate of 0.4%, Germany to 0.0%, and Italy to -0.6% on average during 2015-20.

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Gunga's picture

Whistling past the graveyard.

toys for tits's picture

I just read that now the Troika is demanding that the south free all its slaves.

flacon's picture

Here's my email to my "dyed-in-the-wool intellectual Keynesian" brother who is a graduate from Princeton Univeristy. What do you think? Will he ever talk to me again? 




From: ====
Sent: Saturday, March 23, 2013 19:20
To: '=====
Subject: RE: Why Austrians believe in hyperinflation.



As much as the establishment pseudo-intellectual economists despise bit-coin, (and I don’t trust it as much as I do my gold coins, but I respect it entirely as a free-market entity that is beyond the control (for the moment) of menacing “do-gooders”), it is however very real and very much in use as a mechanism of the free market to counter the fascist/communist/totalitarian nature of the end goal of pompous, arrogant, anti-human and pro fake-science (with their self-congratulatory awards and meaningless paper certificates from so-called “accredited academic institutions” which should be teaching higher science but which (in the field of economics anyway) have reverted to entirely discredited “witch-doctor economics”) Keynesianism – and that alone is reason enough to pay some respect to it.


How The Only Market That Is Open Reacted To Today's News & Rumors




Joe moneybags's picture

I'm trying to think of some topic that you didn't cover in that incredibly long opening sentence.

Nope, I think you got it all.

flacon's picture

If you've been reading ZeroHedge for any amount of time then I'm sure you are used to the verbose and insulting-to-the-establishment use of opening sentences which some times do run on but which contain more truth than a dozen dissertations from most accredited university Ph. D. graduates in the field of pseudo-economics.


If not then I'm pretty sure it's shocking to you. :)

flacon's picture

It's my verbose way of saying: "Hi-five" to Joe moneybags

Freddie's picture

Dude - your brother is a Princeton grad and a Keynesian stooge?    You could have just sent him a short and concise email that would have delivered the message.  It would have been very ZH too.

F**k Paul Krugman!  

flacon's picture

I already tried that. And I already tried the Krugman is Keynes reincarnated. Nothing seems to work. 


Maybe I should bleed his ankles and rid him of the bad juu-juu... 

Assetman's picture

Keynes would roll over in his grave with the mere suggestion as such.

Bendromeda Strain's picture

They buried him on top of a little boy to prevent that...

WmMcK's picture

Aspiring to the style of Tyler.

Kirk2NCC1701's picture

I gave him a +1 for a nice run-on sentence.

What do you think, Mr Spock. Spock, Spock!? Where's that bloody Vulcan?

Grimbert's picture

"As much as the establishment pseudo-intellectual economists despise bit-coin, (and I don’t trust it as much as I do my gold coins, but I respect it entirely as a free-market entity that is beyond the control (for the moment) of menacing “do-gooders”), it is however very real and very much in use as a mechanism of the free market to counter the fascist/communist/totalitarian nature of the end goal of pompous, arrogant, anti-human and pro fake-science (with their self-congratulatory awards and meaningless paper certificates from so-called “accredited academic institutions” which should be teaching higher science but which (in the field of economics anyway) have reverted to entirely discredited “witch-doctor economics”) Keynesianism – and that alone is reason enough to pay some respect to it."


I want to read this but this is only one sentence. No man can be expected to take this in from the beginning to the end. I will have forgotten the beginning when I reach the end. So I will reread the first half to remember it. Then I will just be annoyed and not remember any of it then write what I have just written.

Assetman's picture


Will you dub that in Japanese?

Rogue Trooper's picture

Yes he will speak to you again.  It will be around the time that the riots start getting worse and their is a crowd of folks now gathering 'on his street' waving their, now useless, SNAP cards and holding various colorful placards, chains, baseball bats and wearing bike helmets.  "Bro" subsequently calls you in absolute panic demanding you come around to his place right now to rescue him and family with those evil assault weapons.

... at the time you will need to make that choice yourself.

ATM's picture

Lament of the psuedo-intellectual leftist:

"I didn't think it would get this bad."

Roandavid's picture

I think I might have just simply gone with, "I love you because you're my brother, even though you're also a moron,"

Schmuck Raker's picture

Wow, this isn't good:

"...70 per cent of the island's account holders have applied to withdraw all their money if, and when, the banks ever open their doors again..."


[from BC6's link (above)]

nmewn's picture

And this new addition to the lexicon..."debt mutualization."

What the hell does that even mean?

Is Germany gonna take a credit down grade to "equalize" EU debt across the individual countries comprising the euro spectrum?

The socialized emperor is as naked as a jay bird...lol.


Ahhh, here it is...debt mutualization.


It is as I thought...more central planning by people only concerned with managing debt.


formadesika3's picture

Debt Mutualization.

Here's a simple example that should help to clarify things (I like to teach by example :-)

You cosign for a loan to get MDB's Herbalife distributorship offf to a good start :-\

When he can't make the payments and skips town in the middle of the night, you start getting phone calls...

nmewn's picture

That would be about right...lol.

I mean look at what we're talking about here. All these euro-countries (culturally) have been around for centuries. We're not talking about Burma suddenly discovering the light bulb exists.

I say either quit lending them debts they will never pay back or just give it to them as charity for the basket cases they are and quit extorting interest from them under the guise of statist compassion.

lewy14's picture

Option three: encumber their sovereignty. Basically take them over, without firing a shot.

Look, when the "bond market" pukes up a trillion or so in Club Med bonds and the ECB buys them, then the ECB will effectively become the bond market.

The Treasuries and legislatures of all the supposedly "sovereign nations" of the southern EU will become completely subservient to the troika. They will not be able to formulate their own policy - or even really elect their own (unscreened) leaders.

See, e.g. what the ECB did to Berlusconi a while back by not intervening in the Italian bond market for a couple weeks. Gonzo. Aaand they get Monti.

A crisis which requires large scale OMT will result in devolved sovereignty instantly, de-factor, without any messy treaties, referenda, votes, or other democratic bullshit. The troika will be free to do what it likes.

I think they're begging to be thrown in that briar patch.

They just need a good crisis. They won't let it go to waste.

nmewn's picture

Quite so.

But I would say they have willingly given over their sovereignty already. Thats what bonds are. Governments (properly run) shouldn't be in the habit of indebtedness as a device to run its day to day affairs.

It should be taxing to fund its operations or cutting back its operations to match the taxes collected. The function of how much to tax is in the process of elections. Tax too much and the people open black markets or rebel.

They believe they have gotten around certain laws of finance & governance by cozying up to creditors but they have not. Historically, the people wake up one day (in a country they no longer recognize) and look for retribution...even if they themselves allowed it or begged for it.  

So, I wouldn't want to be a foreigner, government worker, politician or banker in one of those nations when the day arrives.

lostintheflood's picture

...70 per cent of the island's account holders have applied to withdraw all their money if, and when, the banks ever open their doors again...


gotta wonder why it's not 100%

Tango in the Blight's picture

The other 30% already took their money out.

notbot's picture

Should be titled "When Cyprus leaves the euro"

machineh's picture

"When Merkeljackals attack"

Lore's picture

That article about the situation on the ground in Cyprus is telling.  Everybody is filling their boots with gold. I would bet that a lot of agencies are doing the same covertly.  

Breakup seems to be baked into the cake.  Big banks have turned subject nations into gardens for harvesting debt, and seem genuinely surprised that the citizenry objects. JUST WAIT.

bank guy in Brussels's picture

They are missing that if Cyprus blows out all the Southern countries start to blow out

Greece shortly after, then Italy, then Spain and Portugal and France

Bring it on

machineh's picture

Probably Argentina is going to default first, next month, when a U.S. court in New York rules that it must pay holdouts.

Cyprus is the new Argentina: the first euro-corralito!

Kirk2NCC1701's picture

I think someone commented on this before, but why didn't Iceland have to pony up? No assets worth coveting?

Freddie's picture

Argentina is sort of a special case. I hate the banksters but the leftist PEronist scum and their unions have been looting and driving Argentina into the dirt for 60+ years.   The politicians are scum and the populace sort of get the govt they deserve. 

Argentina is a lot like Greece except Argentina has loads of resources especially lots of food production.

tom a taxpayer's picture

Fook BofAML! Who gives a flying fook what these BofAML muthafuchas think that were up to their eyeballs in the U.S. finnacial crisis and should be in prison doing 40 years to life!

Telemakhos's picture

I think you missed the third paragraph in BoA/ML's hariolation: the ECB freaks, goes Bernanke on the PIIGS bond markets buying everything in sight on Germany's dime, and then the Euro area ratifies a full-on political union to justify this to the "taxpayers" or "voters" or whatever you call the equipment of manufacturing consensus over there, becoming in effect the USofE, comprising a number of provinces/states that once were called "Germany" or "France," back in the barbaric times of nation-state democracy, henceforth to be known as "nationalist bigotry."

In other words, they throw Cyprus overboard to keep all the other rats from jumping ship long enough to make sure that they all stay in the same boat for good.

morning's picture

Good luck with that. In Portugal even salary cuts are deemed unconstitutional. It would take 40 years or the Wehrmacht to enforce otherwise.

Telemakhos's picture

I'm tempted to reply that local constitutions will be worthless scraps of paper, once the EU achieves true political union (supremacy/sovereignty) and becomes a true nation state (all while decrying the evils of nationalism). But, really, I'm not sure it matters. The Portuguese might well not see any nominal salary cuts under total Unification; without borders and competing sovereign/banking interests, there isn't any obstacle to the EU being able to achieve a steady pay for Portugal. It's just paper fiat; a unified EU would be sufficiently too-big-to-fail that they could keep shuffling around accounts to make magic promises like no-(nominal)-salary-cuts work for a few years, until the can needs to get kicked a bit further.

TBT or not TBT's picture

Yeah, first the Germans would need to have some kids to man a wehrmacht, and the lack thereof is also the source of their economic decline.

morning's picture

Portugal first, please. I have a 42 year old bet to collect.

chubbyjjfong's picture

Who takes the hit for the derivatives? 

toys for tits's picture

Probably some other EZ country just like Cyprus took the hit for Greek bonds.

Dominoes anyone?

butchee's picture

Maybe the ISDA just deletes a few spreadsheets with a wink and a nod from the BIS?

CunnyFunt's picture

For all this talk of "growth", the black market will take the lion's share.

falak pema's picture

sleeping beauty europe; wake me up in twenty years! 

WmMcK's picture

Rip slept for 20.  Beauty for 100.  Europe may not ever awake again.

TBT or not TBT's picture

It may not look real European, as they've chosen demographic disappearance.