Guest Post: 3 Types of Contagion And What They Mean For The Global Economy

Tyler Durden's picture

Submitted by F.F. Wiley of Cyniconomics blog,

In one of a few early hints that Europe might surprise the world with its Cyprus bailout, on February 10th the Financial Times leaked the content of a secret EU memo. It reported that bank depositor haircuts were among three options being considered to reduce bailout costs. And the memo also warned ominously that “such drastic action could restart contagion in eurozone financial markets.”

Clearly, policymakers decided to take their chances. And now we’re living through the contagion that the memo’s authors predicted. But what exactly does that mean? Sure, we can see volatility in asset prices, but how long will it last? Some pundits say it’ll blow over like a late afternoon shower on an otherwise sunny day. I disagree.

I’ll suggest there’s more to it than rising market volatility and that we should take a closer look at the meaning of contagion. I’ll argue there are three different types at work today: vanilla contagion, latent contagion and stealth contagion. And when you add up the three effects, Cyprus will have a bigger global impact than many expect.

Vanilla contagion

This is the term I’ll use for a rapid transmission of volatility from one region to another – what most people simply call contagion. We’ve seen vanilla contagion in financial markets since the announcement of the first bailout agreement on March 16th. We’ve also seen it in reports of bank customers in the European periphery rethinking their loyalties. Both effects should continue for awhile, especially as EU officials have warned uninsured depositors that their assets aren’t protected in government bailouts. This is by far the most significant development of the past two weeks. And it’ll play out slowly, since it takes depositors time to find a new home for their assets once they’ve decided their banks are too risky.

On the other hand, the optimistic case is that flight capital in the periphery has already “flown” during the past several years of repeated crises. Remaining bank deposits should be stickier than they were before Europe realized the euro isn’t such a huge success. Moreover, most people take a wait-and-see attitude to events that aren’t happening right on their doorsteps. And as long as the news doesn’t get worse, they just keep waiting. That’s not to say things won’t get worse for those with the misfortune of living in Cyprus – they’ll get much worse. But the bad news for Cypriots should gradually lose its shock value for those living elsewhere.

Latent contagion.

This is the contagion that occurs because people who are waiting-and-seeing aren’t quite forgetting. When the next crisis does come to their doorsteps, they’ll quickly remember what happened to the Cypriots. And the flight to safety will occur much faster than it would have without the new precedent set by the latest bailout. Think of it this way: If vanilla contagion is the extra lock you purchased after learning of a rash of burglaries in your neighborhood, latent contagion is the fact that you’re now jumping out of bed much more quickly when you hear a noise in the middle of the night.

In my opinion, latent contagion will prove more damaging in this instance than vanilla contagion. After all, Cyprus is pretty tiny. If the various crises in the rest of Europe were fully resolved, then it wouldn’t receive much attention. It’s because the crises in Europe are alive and kicking that Cyprus has so much meaning. The bailout gives us information about what could happen when banks (or governments) in other countries are once again short of cash.

Latent contagion is already appearing this week with the Italians’ continued failure to form a new government. It’s not especially comforting that Italy is in the middle of a political crisis just as the EU rewrites its rules of engagement in the aftermath of Cyprus.

Stealth contagion

The third type of contagion is one that no-one seems to be talking about. To understand it, imagine that people waiting-and-seeing just keep on waiting and never take action. Then there’s no contagion, right? Well, actually that’s wrong. It’s wrong because contagion doesn’t just work by causing people to take certain actions; it also works by causing them to refrain from certain actions. Like lending, for example. Tightening lending standards are a key piece of the vicious circle that’s currently in place in Europe. Have a look at the chart below, which shows past results of the ECB’s bank lending standards survey, and then I’ll come back to stealth contagion in just a moment.

Cyprus 1

In a recession, this survey is like a quarterly and economic version of Groundhog’s Day. If it shows lending standards are still tightening, then expect “winter” to continue, because it’s folly to think economies will recover. Economies rise and fall with the rise and fall of credit, and if bankers tell you credit expansion isn’t happening, then economic expansion isn’t happening either. It’s really that simple. This is arguably the best leading indicator of all, even though it’s rarely noticed. For those optimistic forecasters who keep expecting a recovery and getting it wrong, their errors are probably best explained by not giving enough weight to lending standards.

Getting back to stealth contagion, this occurs when people reduce their risk-taking activities. It has nothing to do with either buying an extra lock or being jumpy at night after learning of those burglaries I mentioned earlier. Think of it as a developer shelving his plans to build a high-end apartment complex because of the increase in local crime. And in the case of stealth contagion from Cyprus, bankers are the ones to watch. Bankers in the peripheral economies realize their deposit base is becoming less secure, even if they haven’t seen a significant rise in withdrawals. They’re doing the same calculations as the rest of us and concluding that risks are higher than they were before.

So how significant is the stealth contagion effect? We’ll have a pretty good answer to that on April 24th. That’s the next release date for the lending standards survey. The ECB began to solicit responses in mid-March and will continue to do this through the early part of April, which means the survey should partly reflect the public mood as the Cyprus bailout has unfolded. And I predict it’ll tell us to expect more winter, but don’t just take my word for it. Mark your calendar for April 24th and plan to go straight to the ECB’s website. We may learn that the least talked about of the three contagion types is also the most significant.

Lastly, here’s an article posted by Zerohedge and sourced from JP Morgan that lists other indicators that might foreshadow a change in lending standards. In a nutshell, other indicators to watch include excess cash in the Euro banking system (available daily), peripheral bank debt issuance (available weekly), Target 2 balances (monthly) and balance sheets of monetary financial institutions (also monthly).

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DJ Happy Ending's picture

Contagion is for pussies. Gold and lead, bitchez

wee-weed up's picture

Vanilla... Latent... Stealth...

All you need to know is that eventually we're going to have Conflagration Contagion!

ZerOhead's picture

There's also a fourth kind of contagion... I call it MORAL contagion.

It's the kind of contagion that occurs when bank depositors realize that they have been lending to virtually unindictable crooks who use their own money against both them and society at large through creating inflation, misallocation of capital (through incompetence or corrupt practices), and outright fraud/ theft.

And they will simply take their money out.

The heads of the sheeple are beginning to rise... the endless chewing is ceasing... and their eyes are beginning to open wide.

imbrbing's picture

"The heads of the sheeple are beginning to rise... the endless chewing is ceasing... and their eyes are beginning to open wide."

How true. I was outside having a smoke with a buddy at work here and we overheard a group of three other guys next to us talking

about civil war in the future. We chuckled a bit and said pretty much what you stated here.

Sketch's picture

At this point, gold is easier to get than lead...

TrumpXVI's picture

Isn't that the freakin' truth.

Glad I stocked up while I had the chance (but one never has too much!).

ZerOhead's picture

let me turn some of that gold into lead for you my friend... I have the Sadim touch.

Xanadu_doo's picture


kaiserhoff's picture

A swing..., and a miss.

Formula driven, Hen's magazine stuff.

TrustWho's picture

The fourth contangion is Political Contagion in Italy. In the next election, if EU elite allow another election, the Italians will tell Brussels and Germany to go to hell along with the EURO. Same in Greece and Spain....if Barcelona doesn't leave prior to Spanish election.

All commentaries are missing this point...probably because no one wants to be say it first! 

disabledvet's picture

"and the Pope kisses the feet of total strangers." this is no "mere" man of courage but a man who dispenses it. When I hear of this to say it moves me is an understatement. I do not need to ask "where is our God" when I hear of this...and hopefully this is true of France and Italy as well. I agree with the sentiment stated above...but what is being presented to us is a fait acoompli...and while obviously we recoil at it economic?!!!..."realisms" we need not look long to see "there is more here than meets the eye." Socrates taught us to understand the difference between "the shadows on the wall" and the people projecting the image. All I can say is "I'm trying" and so are the people here.

falak pema's picture

I think we all agree that the Euro conundrum comes apart in Italy for reasons beyond financial which is at the core of this poltical construct on one leg. The Euro cannot be continent wide if it  does not respond to the socio-politcal needs of the south which don't have the north's paradigm to withstand the global debt storm. 

Its better to save the politcal union by sacrficing even temporarily the broken monetary one. 

But this needs to see more pain for it to "make"in total solidity, fiscal, banking and monetary across EZ, or to "brake".

The "make" option is now too late by the looks of it as the bank insolvency and illiquidity is now beyond ECB reach.

Monedas's picture

Latent Vanilla Stealth Contagion:  When your white partner doesn't tell you he's HIV positive !

gwar5's picture

Looks like a risky Hail Mary from the banks to try to scare people into increasing money velocity. If it doesn't work it just weakens the banks more, ensuring the next crises.

disabledvet's picture


diana_in_spain's picture

i cant see the image that you put on the front page, can you resend it larger please? I like to see cartoons on fridays.

bank guy in Brussels's picture

That's quite true for ZeroHedge, we need to see the big version of the pics with the articles, not just some sorry-ass tiny thumbnail

Especially when hot babes are in the image


Funny, for the first time on my ZeroHedge ads - which are usually girls in eyeglasses, telling me I can make money trading, in four different languages ...

Now I have an ad ... for mattresses! Young couple kissing, and then a Dutch language ad for a mattress ... tho nothing explicit about the money-or-gold-hiding pocket

Pimp Juice's picture

Sarchasm: the gulf between a sarcastic poster and a naive reader.

Eurochasm: the gulf between the credibility of the Euro elite and us.

Quinvarius's picture

Most people need to see the Outbreak Monkey or Zombies before they take action.

ebworthen's picture

The head of the Orthodox Church there has blocked expropriation of church assets as it is forbidden in the Cyprus Constitution.

Not that bankers obey laws or constitutions, but if they steal the money anyway Cypriots will be left with a clear indication that they have no rights and that all laws mean absolutely nothing.

Imagine if you as a parishioner had given weekly to the church to benefit the downtrodden but now all your contributions were instead going to fatten the coffers of an already rich banker via salary and/or bonuses.

Bad enough that the bankers are stealing depositor savings, but now they are robbing the collection boxes at church's as well!

Robin Hood!  Where art thou!?!?

alien-IQ's picture

I suspect that the next time there is so much as "talk" of a European bank needing a bailout, that will be enough to cause a preemptive bank run that will magnify whatever damage may be looming by orders of magnitude.

This recent Cyprus raping of depositors is going to train many people to keep their finger on the "get your money out of dodge" trigger. And they will pull that trigger at the first even slight sign of potential trouble.

The Navigator's picture

Man, I don't know how big the writing on the wall has to be - If I was anywhere in Europe, I would have pulled my cash like 2 weeks ago.

This thing is gonna spread like a wildfire and there'll be no time to thiink about pulling the trigger.

alien-IQ's picture

Well, here's a bit of writing on American walls:


The 15-page FDIC-BOE document is called “Resolving Globally Active, Systemically Important, Financial Institutions.”  It begins by explaining that the 2008 banking crisis has made it clear that some other way besides taxpayer bailouts is needed to maintain “financial stability.” Evidently anticipating that the next financial collapse will be on a grander scale than either the taxpayers or Congress is willing to underwrite, the authors state:

An efficient path for returning the sound operations of the G-SIFI to the private sector would be provided by exchanging or converting a sufficient amount of the unsecured debt from the original creditors of the failed company [meaning the depositors] into equity [or stock]. In the U.S., the new equity would become capital in one or more newly formed operating entities. In the U.K., the same approach could be used, or the equity could be used to recapitalize the failing financial company itself—thus, the highest layer of surviving bailed-in creditors would become the owners of the resolved firm. In either country, the new equity holders would take on the corresponding risk of being shareholders in a financial institution.


You can read the full article here:

It Can Happen Here: The Confiscation Scheme Planned for US and UK Depositors

not a twin's picture

gimme a break, alien, are you the author?  This is written by an MMTer who thinks you can print your way to prosperity - print cash and hand it out, she says.  What does that have to do with contagion?   Or sensible thought?

alien-IQ's picture

The aspect of this that I was pointing out was the 15 page FDIC/BOE paper that outlines a method of dealing with the next financial crisis. That method is in fact the same method that we just saw deployed in Cyprus. Hence: It can happen here.

If you are so offended by the beliefs of the messenger to offhandedly disregard the message, then there's little that I can say or do about that. If you will only accept information from people who do not offend your sensibilities, then you are not really seeking information, you are merely seeking confirmation.

Monedas's picture

That was one of the nicest, most thoughtful fuck yous I've ever heard .... I'm not agreeing nor disagreeing .... just admiring the civility of it all !

not a twin's picture

You're right, I suffer from confirmation bias.  But happily.  If I wrote four articles explaining why the world is flat, would you read my fifth to overcome your own confirmation bias?  (We all have one.)

q99x2's picture

It's high time those with disabilities pick up their crutches get in their wheelchairs and march on Washington to demand more benefits--even the ones that are disabled. 

americanspirit's picture

There is a fifth type of contagion - terminal decline. Generally affects empires - political, financial, religious, etc. It causes unrelenting suffering, and the only outcome is the death and dissolution of the system.

GOSPLAN HERO's picture

Thirty silver coins ...

Monedas's picture

After all this co-tangent contagion works its wonder .... the system implodes .... and we ponder what was the acceptable stash .... in order to re-capitalize .... in the new world order .... it may become apparent .... that a modest leather pouch .... about the size of a ball sack .... with a rawhide drawstring .... containing about 30 junk silver quarters .... was enough .... to comfortably begin anew .... then my dog farted .... and I woke up ?

ivana's picture

It seems that still few understand cyprus etc criminal acts are done on purpose. After carefully evaluationg all possible consequences. Economy is going down the drain and that's been know for some time now since it was made clear that existing criminal financial system will not be fixed or at least changed. Please look cyprus move from angle of central banker who :

  • wants to expropriate any valuable colateral at lowest price possible while
  • distributing money to those who obey and their friends reinforcing slavery
  • wants this criminal system to last as long as possible
  • wants to prolong fiat controls as long as possible
  • does not want hyperinflation
  • does not want to launch PMs
  • satisfying main players like Germany and UK at same time
  • killing perifery which is considered like shity province
  • sending message to Italy
  • scaring savers and investors from EU periphery to core/north banks reinforcing their position

Banksters and politicians do not give a shit about and "growth" and "contagion" bla bla bla . They care about power, control, expropriating assets, brownnosing, suckingin etc etc.

If you consider cyprus move in light of above bullets - you will see it matches well. And that's direction we are going to. Down the drain

ivana's picture

forgot to mention - those are times when politicians & banksters pull out some brend new sociopat bastard nobody herd before to speak for them. Like this garbage with complicated surname

Dr. Sandi's picture

In reality, we have bail-ins built into the US banking system.

Consider what happens when one large black swan is sucked into the engine of the economy and a lot of banks fail at once. The FDIC is there. Or is it?

If the FDIC, which is almost insolvent right now, doesn't get any more fake money to make good on multiple bank failures, depositors will take a haircut that will look like day one at boot camp.

The only difference between banking in Cyprus and the US right now is that we still believe the government (FDIC) will step in to make us whole. But should the government say, "No, the taxpayers must not be burdened this time", then there will be no visible difference between the Cypriot bank system and the US bank system other than scale.

Son of Loki's picture

Most people have no clue what's happening and don't even know where Cyprus is. I showed some of the ZH Cyprus articles to my boss (who is a pretty bright guy or he wouldn't be the boss of our comapny). He was shocked. Since I showed him the articles he has been going to the bank and withdrawing several thou a day and hiding it I guess in the company vault of in shoe boxes at home......he has also increased his PMs holdings.

These are some of the micro-effects of Cyprus. If you multiply his reaction by 1000's you can have a serious global problem.

Nu Yawks hottest club is's picture

Debt expanded until loan originators were getting tramps (hobos if you're in the US) to sign up for credit.

What happens when lending standards are reduced to the level where every penny one earns is going on debt repayment ?

New growth needs to come from knowledge, not by doubling-down on a bullshit argument that growth and new debt are synonomous.

deus x machina's picture

Our fuckin government signed off without reading the bailout terminology for T.A.R.P.  and now the banker ass wipes are untouchable!  they can fuck us up, down and sideways without recourse.  just bend over.