Eurozone Calvinball

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And no, you don't get a toaster

Headwinds.  That's what economic analysts called the Sequester's effect on the American economy.  The US economy appears to be consolidating its gains and beginning what could represent a real, accelerating recovery.  The only real threat to that are 'headwinds'.

Taking 85 billion dollars out of the economy in a sudden and altogether ham-handed fashion is definitely a headwind.  Logic, history and basic macroeconomics tell us that we should be shoveling coal on the fire, borrowing at virtually no cost to drive the recovery at least until unemployment falls to around 6% and inflation tops 3%.  Reducing spending at this point, people who don't have an ideological or political ax to grind agree, is risking the best chance we have at improving the biggest challenge to American economic stability - long term unemployment and the precipitous fall in labor force participation.

Of course the Republicans in Congress represent a Headwind all by themselves.  Although it isn't polite for the media to say it, there is no doubt to any more-than-casual observer that the Republican party has made a political calculation to keep the US economy mired in recession to whatever extent they can, in order to then try to blame the despised Obama for the electorate's economic miseries.  Taken together, these headwinds don't appear to be capable of derailing the recovery, although they will by definition reduce the robustness of the rebound and make the entire economic environment that much more fragile and vulnerable to external shocks.

Which brings us, this weekend, to Cyprus.  Cyprus is an international banking hub, used extensively by Russian mobsters and Eastern European criminals as a safe place to stash and launder their large piles of ill-gotten cash.  As a result, the Cypriot banking sector is very large compared to the rest of the Cypriot economy.  And now, that banking sector needs a bail-out.

Up until now, the one key premise underlying all the Eurozone economic interventions, by the ECB, the Bundesbank and even the IMF, was that in every bailout the banks creditors - in banking, that means the depositors and investors - would be kept whole.  Nobody was going to have to take a haircut.  That way, people, corporations and investment funds would be willing to continue to put money into even troubled Eurozone banks, knowing those funds were not at risk.

But the Germans are increasingly tired of funding the less robust of the Eurozone economies, and there is a moral sense at the ECB that the Russian mob shouldn't be the beneficiaries of their largess, so in an abrupt and unexpected reversal, the bailout includes an across-the-board haircut for depositors.  A one-time levy of 9.9% will be extracted from all deposits over €100,000.  That isn't actually all that surprising, because of the German resistance to bailing out Russian criminals.  But it doesn't stop there - there will also be a one-time levy on everyone else of 6.75%.  That means even the poorest bricklayer and fisherman will be asked to take a haircut in order that the banks holding their money get a bailout.  Tellingly, those banks' bondholders will not see their returns impacted - many of them are investors in Germany and Greece, and the central banks will protect their profits over the savings of individual Cypriot citizens.  No one should find this at all surprising.

The Bundesbank and the ECB like this solution - so the bankers in Italy, Spain and especially Greece are now looking over their shoulder. The genie is out of the bottle, and the big question is why would anyone leave big deposits in troubled banks now that, for the first time, depositor and investor haircuts are a reality?  As I write this, it's Sunday evening in Western Europe.  In Greece, Italy and Ireland in particular, people have to make a decision - either to have confidence that "it can't happen here" or to play it safe and withdraw their money from the local banking system.  If tomorrow morning sees lines of panicked depositors, we could see large capital shifts through the week and a full-on financial crisis by the weekend.

Headwinds...
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