By Alexander Apostolides on December 20, 2013

Introducing a new Author: Haris on Bullshit Jobs

One of the more intuitive articles on labor markets i have read lately deals with  Bullshit Jobs that was recently in the Economist.

The article pays importance to the magnitude and significance written of the work of  anthropologist David Graeber article of the same name.

In it Graeber presents the economic argument of increasing industrial productivity of the 1930s whereby it was thought that technology would linearly substitute most menial jobs with the far more capable machinery so totally that a new system of economics would need to be enacted; one where laborers work less hours and gain more leisure and money in order for the system to not collapse.

Clearly this favorable scenario didn't materialize. But why? Well the author argues that what happened was a global surge in bureaucratic administrative structures because increasing globalization has occurred. This required a lot more white collar workers constantly slaving in their cubicles to get all the different regulatory and organisational frameworks for every single product --> And many of them just create work with no meaning for others down the line i.e. a bullshit job. 

The economist actually thinks that the technology available for companies is depressing the volume of workers needed which would, possibly, trickle down to the hordes of younger white collar men expecting to get a foot in the labor market emulating their baby boomer fathers and mothers. So maybe bullshit jobs are saving us from a worse existence - mass unemployment.

By Haris

By Alexander Apostolides on December 19, 2013

Looking Ahead: Cyprus in 2014

Cyprus has the habit of grabbing international attention in a global way, only to then be marginalised as a footnote when the immediate crisis seems to have abated. This has been historically true in issues of communal violence and the Annan plan, in what we Cypriots call “the original Cyprus problem”. Sadly for Cyprus, this is also seems to hold true in regards to its financial crisis.

After the March 2013 bailout and the partial bail-in of uninsured deposits in some Cypriot banks, the international attention has moved away from the island. Yet despite the lack of interest internationally, troubles that need international cooperation for resolution remain. Unless more attention is given by the international community in 2014, both the Cyprus problem and the financial crisis are in danger of becoming intractable impediments against Cypriot recovery.

The negotiations of the Cyprus question seem to have hit a snag even before they began. Despite a resurgence of optimism during the summer over a possible breakthrough confidence building measures, which could have included the return of the abandoned city of Varosha and the partial lifting of trade and flight embargoes, the mood has significantly soured since. This breakdown is mostly due to Turkish Cypriot community leader Dervis Eroglu rejecting the use of binding phraseology on sovereignty and nationality in the communique that would launch the new round of negotiations, and the reluctance of the Greek Cypriot government in being bound to a tight deadline for talks that might lead to the strengthening of calls for “normalization” of the EU relationship with the unrecognized TRNC.  The actual timeframe before major elections in capitals that matter is tightening, and thus unless a common communique is agreed upon soon the opportunity to conclude negotiations in 2014 might be lost.

The government of Cyprus has requested that the EU adopt a far more active role in the negotiation process: its aim was not to undermine the role of the United Nations in leading the efforts for a settlement, but to introduce the EU as a neutral arbitrator where basic premises of the European acquis communitaire are threatened. Proposals and solution plans in the past have ignored the non-compatibility with the basic laws and regulations of the EU, and thus the Republic of Cyprus suggested empowering the EU’s role in the negotiations in order to unlock thorny issues in 2014. It must be said that looking at it from Cyprus it seems the EU is currently reluctant to take on this more active role. Despite the aura of pessimism around the possibility of starting negotiations, the Republic of Cyprus has established working groups on six major issues to support the negotiator in the upcoming negotiations.

The ruling system in Cyprus is supremely centred on the President, currently Nicos Anastasiades, who is elected directly by the electorate; thus one must feel great sympathy for the President that has to manage the Cyprus problem while the nation is in the grip of its worst financial crisis. The Cypriot financial crisis is particularly severe due to the delay of taking action from the previous president, Demetris Christofias: Cyprus refused to capitulate to market sentiment for a long time after Greece, Ireland, Portugal and Spain concluded bailout negotiations. The added delay magnified Cypriot banking problems, compounding the problems of Laiki and Bank of Cyprus from non-performing loans in Greece and the severe losses that they were inflicted due to the haircut, or PSI, of Greek government bonds.
The bail-in of the uninsured depositors of Laiki Bank and its merger with Bank of Cyprus (whose uninsured depositors were also partially bailed-in) is generally understood as being a badly botched affair, despite European protestations to the contrary. 

The Cyprus financial system is still in the emergency room: capital controls are still in place and there is an excessive reliance on the European Central Bank’s Emergency Liquidity Assistance (ELA) due to the decision to sell the assets of all Cypriot banks in Greece.  The poor return of this sale resulted in Bank of Cyprus having to pledge its own assets for ELA that Laiki provided to its branches in Greece, leading to a precarious liquidity situation for the new, hugely systemic, Bank of Cyprus.  The financial system cannot recover in Cyprus unless the ECB allows for the ELA to be replaced by more long-term finance; however there seems to be a lack of interest for such accommodation in this stage. Trust cannot be regained in the Cypriot banking system in 2014 if the bank that holds more than 50 percent of loans and deposits is severely exposed to ELA obligations.

Most analysts seem to be optimistic about Cyprus due to the better than expected 2013 results, were GDP is expected to fall  -5.5 to -6.5 percent rather than the expected -8.7 percent of the troika estimate in March. The October business survey also showed a slight increase in sentiment that seems to back up the optimistic view.  Yet, economists remain very pessimistic: the latest projections by the University of Cyprus indicate a -8 percent decline in 2014. The lack of liquidity will result in banks making an intense effort to recover assets in 2014, leading to a much more severe recession than predicted by the memorandum. In the upcoming year the efforts to recover value from non-performing loans will lead to intense political pressure to exclude groups. 

Already a law that would require a reduction of business loan interest rates has passed but its implementation is delayed through legal processes by the President as the “request” of the troika. However the very high levels of debt of companies and households in Cyprus will result in very severe reduction on consumption in 2014 as well as a possible new risk to the banking system through a dramatic increase of non-performing loans. 
* Alexander Apostolides is an economic historian at the European University Cyprus. For his analysis of economics and politics in Cyprus and Malta visit:
- See more at:

By Alexander Apostolides on May 03, 2013

How to make sense of the Cyprus bailout and its crisis: An article and analysis aggregator

Latest Update: 19th September 2013

I have been far too quiet while the whole world shifted its attention to the Island of Cyprus. Although this was the change for this blog to shine, my direct and indirect involvement in what has happened in Cyprus since the 15th of March has kept me far too busy to post. This is mostly English articles with some Greek ones. Please paste in the comments section other good articles in English, Greek and even better in other languages.

Below is an attempt to provide articles and sources relating to the Cypriot situation, for people to use as they see fit. I do not intend to keep updating it. So if you find this post a long time after it was written, I suggest look for newer articles and sources.

All this work let to the paper which I wrote here: as it is a work in progress, please use the comment section to correct mistakes. 

Section 1: Documents

A special mention should go to from putting together a list of official documents, relating to the Cyprus bailout, many of  whom are given both in their draft and in their final form in order to allow you to compare. Bravo to whoever is behind that effort.

Troika Memorandum documents and Bail-out amount controversy

Bank Related Documents

Projections on the future of the Cyprus economy

Analysis on the situation of Cyprus:

Pre 15th of March 

Between 15th and 25th of March

Post 25th of March

Current Suggetions for the future of Cyprus

  • Common Call of Cyprus Chamber of Commerce and Cyprus Chamber of Industry of the necessary steps forward 
  • Karl Whelan at Forbes outlining the alternations to the  Bailout the Cyprus government now needs

Articles in the Economist on Cyprus

Cyprus and "CyExit" - Why quitting the Euro is a bad idea only for Cyprus

Multimedia on the Cyprus Crisis

On Cyprus and Wealth of Households controversy

By Michalis Zaouras on April 19, 2013

Banks bail-in a template or not?

EU officials and Member States' representatives (national governments) have been discussing whether a bail-in approach to banks resolution is a template or not. I provide below some evidence that it might be a template after all. In 06/06/2012 the Bank recovery and resolution proposal is clearly suggesting a shift of EU's policy from bail-out to bail-in. To cite:

"What resolution tools will be needed?

(iv) bail in creditors (mechanism to cancel or reduce the liabilities of a failing bank, or to convert debt to equity, as a means of restoring the institution's capital position)."

The proposal also suggest the protection of secured depositors. See below for reference:

Interestingly, the proposal does not exclude a bail-out approach but rather allows a bail-in within a European context. Worryingly, a bail-out can be used in order to safeguard the big banks from failing (too big to fail) in the context of systematic risk while a bail-in approach can be used for smaller non-systematic banks. The problem with such an approach is how you define a big bank (or systematic). Consider the case of Cyprus, Laike-Marfin is definitely a small bank (and non-systematic) in the European context and as a result it can be bailed-in. However, this bank is "big" within Cyprus therefore generating systematic risks within Cyprus (but potentially not within EU). As a result, someone would expect big banks in large economies within EU to be bailed-out while "small" banks in small economies to be bailed-in. So is this a step forward for EU integration or not?

Please note though that the above analysis is based on a proposal. This has not been put as a directive (not yet at least), which means that it is not legalized as a template. Therefore, it is not a template (yet) but it is included in the proposal of Monetary and Fiscal Integration of the EU (and seen as a necessary tool).

Most interestingly I have found an EU discussion paper that proposes the bail-in approach (see below for reference) and suggests that this idea should be tested first. Guess where they have tested the bail-in approach? Hmm... wait a minute I know, Cyprus!

Finally, the above documents suggest that political parties (which take part in the EU Parliament) and the Government  of Cyprus (participating in the initiatives for Monetary and Fiscal Integration) were (or should have been) aware of what the bail-in and bank resolution within that context corresponds to. Therefore, I believe that the blaming game currently taking place in Cyprus is just ridiculous (everyone is responsible, maybe some of them to a lesser degree) and unproductive.  Most importantly, the root of the problem was not how we handled the crisis (though it has amplified the crisis) but rather the failure of the banking sector and the banks overexposure to risky assets.

By Michalis Zaouras on April 18, 2013

A new currency is born in Cyprus (or at least this is what is promised)!!!

What happened? Nicosia municipalities are planning to start a program where products and services can be exchanged for To.M.'s (an exchange vehicle). The owners of To.M. units can "cash them out" by buying other goods or services offered by individuals and companies within the exchange program.

Ring any bell? It should; this is the definition of paper money (mean of exchange)...

Why has this happened? Two reasons; lack of liquidity (businesses cannot use their bank accounts to buy supplies and as a result they are desperate for a mean of exchange - >To.M.). Furthermore, the threat of Cyprus leaving the Euro makes the business and individuals less willing to make payments in Euro (if Cyprus pound is introduced then one Euro will worth more than the pound so people are keeping their Euros under their "pillows"), adding to the liquidity problem.

See link below for reference (unfortunately is written in Greek though)

By Michalis Zaouras on April 12, 2013

Short - Medium Run solutions for Cyprus Economy (some first thoughts)

Unfortunately, in the last month we have seen something unprecedented happening in Cyprus; financial institutions melt down within a couple days. The immediate consequences have started to appear (internal and external capital controls, drop in consumption… ). Economists, media and politicians, up to now, have been consumed on analysing alternative scenarios (exit of Eurozone or not) and more recently consumed into a blaming game for the situation that we are up to. However, we have neglected to draw a plan on what economic model we should follow from now on (with exception today’s announcement by president Anastasiades). Therefore, I believe that an open dialogue on the future of the Cyprus Economy (which industries should we “help” to be developed) is of immense importance. Having that in mind, I have decided to put on paper some first thoughts on short – medium run solutions for the Cypriot economy.

First of all, without a good functioning of the financial institutions then one can not find a way out of the crisis. Therefore, I believe that we should approach foreign banks (Barclays, Societe Generale, City Bank, Gazprombank…) and propose acquisition of Cypriot owned branches (unfortunately this will come with a huge cost since these banks will not be willing to take such an investment without a large discount on the value of those assets). This will guarantee (I hope) that some of the financial institutions in Cyprus are healthy and those institutions will be able to gain the trust of the public (new banks created without the threat of recapitalization). As a result, these banks will be able to attract and finance international and local investments (this can be agreed with the government of Cyprus in order to increase the benefits of those banks and increase the attractiveness of such an investment). Having found a solution that stabilizes the financial sector we should draw plans on the economic model we should follow. Below I list some options.

1. Shipping;
Cyprus has been successful to attract offshore companies active on the shipping industry. We can privatize our ports (in Limassol and Larnaca) conditional on investment on updating and expanding the infrastructure. We should provide incentives to increase the hub operations in our ports. However, it requires some research to be done in order to pin-point what additional services, public and/or private, are required for Cyprus to become a major shipping center. This solution can have immediate effects (increase the hub operations) as well as medium effect to the Cyprus economy (investments on ports’ infrastructure).

2. Tourism;
We are currently faced with capacity constraints with respect to the number of tourists that we can attract (we cannot built new hotels within 2 months). Therefore, at the short run we should focus on how to expand the tourism period; casinos, academic conferences are some options. In the medium run we should provide incentives on quality updates in order to increase the “value of money”.

3. Financial services - Consultancy;
This sector can cope without financial institutions (a firm that specializes in fx trading can still trade through other European banks – not located in Cyprus), in Cyprus at least. A short –run negative effect is in place, since most probably some of their capital has been wiped out from Laike and BoC deposits hair-cut, but I feel confident that it will be revived (a mergers-acquisitions spiral might-should be facilitated by the Cypriot authorities).

4. Agriculture
I feel that due to the lack of the ability to invest on economies of scales this is not a promising sector (we cannot compete with other agriculture oriented countries). However, there is a market for genetically modified agricultural products (even though I am not really fond of this idea). Through proper legislation we might be able to attract some investment on a small scale testing ground for the development of these products (R &D). This will benefit both the agriculture sector but also R & D (high skilled - research jobs might be generated).

5. Internet services;
We do have the labor force (skilled-educated) to attract internet companies. Probably a serious research will be required to investigate how we can attract some of those companies (Malta can be an example I think).

6. Gas reserves;
I will not say much of this, there is a current (huge) discussion on whether we should presell some of our exploitation rights. However, I am a bit concern with the potential economic dangers (which no one is talking about). Cyprus has high seismic activity and this might increase the likelihood of an accident on a deep water gas production (not certain though, I am aware of the oil spill accident at the Gulf of Mexico). Shouldn't we start discussing on safety issues (and dangers) as well?

Please note, I am certain that there might be more alternative solutions which are more than welcome to discuss. Finally, notice that the above options can be used irrespective on our decision of a Euro exit or not (probably with the exception of Financial services - Consultancy).

By Michalis Zaouras on April 10, 2013

Cyprus Sells gold reserves valued at 400mn Euro

The recent announcement is very worrying. What are the implications? Without gold reserves there is no possibility of a Euro exit neither the threat of it. It also increases the control of the ECB to the Central Bank of Cyprus since an important tool to increase money supply within the country is foregone (and tackle future liquidity issues). As a consequence I believe that any negotiation (bargaining) power, through a potential Euro exit, that Cyprus officials have on future demands of Troika has gone as well. Can we do any worse?

By Alexander Apostolides on March 31, 2013

By Alexander Apostolides on March 22, 2013

My first shot of Cyprus if it leave the Euro. Disaster for Cyprus!

Loads of people fail to distinguish that a currency union is not the same as the gold standard or other similar deals when you have a currency. We do not have a currency, we do not even have a domestic economy. This is why:

By Alexander Apostolides on March 21, 2013

Η καταστροφή στο Sedan και ο πόλεμος για την τιμή των όπλων: Πως η βουλή μας έφτασε στο χείλος του γκρεμού

Το 1870 η Γάλλια, ενοχλημένη από την εξευτελιστική στάση του Πρώσου Βασιλιά έναντι του Γάλλου πρέσβη, κήρυξε πόλεμο. Η απόφαση της Γαλλίας ήταν περισσότερο για εσωτερική κατανάλωση. Ο αυτοκράτορας Ναπολέοντας ο τρίτος, που δεν ήταν δημοφιλής λόγω της κακής οικονομικής κατάστασης της χώρας, ένιωσε πίεση από τις διαδηλώσεις υπέρ της αποκατάστασης της υπερηφάνειας του γαλλικού έθνους, και θεώρησε ότι θα αποκαθιστούσε το κύρος του προς τους Γάλλους με την κήρυξη του πολέμου. Οι στρατιωτικοί, που γνώριζαν την αληθινή ανισσόροποια δυνάμεων εναντίων της Γαλλίας, μάταια προσπαθούσαν να τον μεταπείσουν. Το διπλωματικό σώμα ήταν επίσης ανήσυχο, αφού διαφαινόταν ότι η στάση της Γαλλίας δεν είχε στήριξη από άλλες σημαντικές Ευρωπαϊκές δυνάμεις, ενώ η Πρωσία είχε κηρύξει στρατιωτική συμμαχία με αλλά Γερμανικά κρατίδια. Ο κόσμος της Γαλλίας δεν γνώριζε την πραγματικότητα. Ο αυτοκράτορας όμως, αν και ήξερε τα προβλήματα που αντιμετώπισε η Γαλλία, δεν ήθελε να δεχτεί επίκριση από τον κόσμο του και κήρυξε πόλεμο.

Το αποτέλεσμα ήταν καταστροφικό για την Γάλλια και το παγκόσμιο. Τα Γαλλικά στρατεύματα ηττηθήκαν και περικυκλώθηκαν στο φρούριο του Sedan. Η πτώση του Sedan είχε τεράστιες συνέπειες. Ακολούθησαν αλλεπάλληλα δείνα για την χώρα – επαναστάσεις, εισβολή, εξευτελιστικοί οικονομικοί οροί και αποζημίωση προς την Πρωσία. Η Πρωσία ενοποίησε την Γερμάνια κάτω από το βασιλικό της θρόνο, αλλάζοντας την ισορροπία δυνάμεων τις Ευρώπης, και έτσι θέτοντας την βάση για τους δυο παγκοσμίους πολέμους που ακολούθησαν.

Βλέποντας την απόφαση της κυπριακής βουλής να καταψηφίζει το μόνο σχέδιο σωτηρίας της Κύπρου κάτω από την πίεση του λαϊκού αναβρασμού μου θύμισε την Γαλλία του 1870. Το σίγουρο είναι ότι το αίσθημα ταπείνωσης είναι δικαιολογημένο: το Eurogroup ζήτησε από την Κύπρο να ανευρεθεί το ποσό του 5.8 δισεκατομμυρίων ευρώ, αγνοώντας το γεγονός ότι ο τραπεζικός μας τομέας είναι σε κρίση κυρίως λόγω την απόφασης του Eurogroup να κουρέψει το Ελληνικό κυβερνητικό χρέος. Όμως το αίσθημα ταπείνωσης θα έπρεπε να περάσει σε μια δεύτερη μοίρα μπροστά στην ανάγκη επιβίωσης της χώρας και την εξυγίανση του κυπριακού τραπεζικού συστήματος.

Το τραπεζικό μας σύστημα είναι υπό κατάρρευση, λόγω των κακών χειρισμών της Κύπρου και του Eurogroup. Κακώς υπήρχε η διοχέτευση ρευστότητας προς μια τράπεζα που όλοι γνώριζαν ότι έπρεπε να κλείσει. Αυτή η διοχέτευση ρευστότητας ήταν και ο μοχλός πίεσης που δεν άφησε περιθώρια διαπραγμάτευσης στην κυβέρνηση της Κύπρου. Κακώς δεν υπήρχε η διεκπεραίωση του πόνου που θα πρέπει να υποστεί η Κύπρος προς τους επενδυτές κυβερνητικών ομολόγων. Κακώς αποφασίστηκε το κούρεμα των μικροκαταθετών. Όμως αυτή τη στιγμή η βουλή αποφάσισε ότι η δικαιολογημένη αγανάκτηση του κόσμου είναι πιο σημαντική από την οικονομική επιβίωση της χώρας. Η βουλή συμπεριφέρθηκε σαν τον Ναπολέοντα του 1870. Αν και γνώριζε ότι τέτοια απόφαση φέρνει την Κύπρο στο χείλος μιας άτακτης χρεωκοπίας, η βουλή προτίμησε την ευθυνόφοβη πολιτική εσωτερικής κατανάλωσης.

Το κόστος μιας άτακτης χρεωκοπίας θα είναι δυσβάστακτο. Δεν έχουμε δικό μας νόμισμα και η οικονομία μας είναι απόλυτα συνδεδεμένη με αυτή της Ευρώπης. Σαν αποτέλεσμα η χρεωκοπία και η έξοδος από το ευρώ θα προκαλέσει μια σειρά από βίαιες αλλαγές και στρεβλώσεις. Το κούρεμα των καταθέσεων σε τέτοια περίπτωση θα είναι της τάξης του 50%, και η υποτίμηση του νέου νομίσματος θα αυξήσει την τιμή πρώτον υλών (π.χ. βενζίνης) κατά 30% με 100%. Ο πληθωρισμός θα καταστρέψει την μεσαία τάξη, και το εισόδημα της χώρας θα έχει πληγεί ανεπανόρθωτα, χωρίς να υπάρξει αύξηση των εξαγωγών, αφού η ανταγωνιστικότητα που θα παρείχε μια υποβάθμιση του νέου νομίσματος θα πληγωνόταν από την αύξηση της τιμής της βενζίνης. Τώρα είναι η ώρα για την βουλή να πάρει τις ευθύνες της σοβαρά και να προστατέψει την Κύπρο από τα χειρότερα.  

By Euronomist on March 20, 2013

A Plan to Save Cyprus

After considering the current situation in Cyprus we have can up with the following plan. It was written by Euronomist, but Apostolides comments are seen  in brackets:

Instead of haircutting the depositors, use their funds as loans, i.e. hold them for 3-5 years until the economy starts growing again (if the natural gas investment starts earlier then we are looking at 2-3 years tops). During that time the deposits will receive interest (lower than the given market rate) which depositors will be able to use freely. Our understanding is that most of the domestic money is in the form of term deposits; having the amount sitting at the bank or utilized by the government will make no difference to ordinary citizens. In this way, those who have taken out loans on existing deposits will not be gravely affected and in addition this would allow citizens to proceed with their everyday occupations.(Apostolides: people must know that if we leave the Euro this is what will happen, and at much worse rates and conditions that what is described here. In Argentina the Corralon forced deposits into peso denominated bonds.  )

Next, depositors will receive bank shares at the rate of 1.5 share per 1 euro held by the government. (Apostolides: the real sticking point is IMF, but you have the ECB as an ally who want to put this to bed quickly) Banks should be recapitalized by the state, although the shares should be made out in the names of the depositors whose deposits have been used (ordinary shares rather than preferred since preferred is debt which does not assist too much in capital adequacy ratios). Through this, the banks' equity will be increased, meaning that the capital adequacy ratios targets will be fulfilled. The ECB will have no reason to shut the ELA, especially since the amount needed to recapitalise the banks will be much less after such a deal. As banks' share capital represents only the face value of the shares, the money given to the banks may be used two-fold:

1. Bring liquidity to the market thus boosting the economy
2. Rolling-over government debt, which will be decreased given that the deficit is expected to be less than 3% this year. (Apostolides: The deficit will now balloon to over 5%, but the difference in financing can be made up by restructuring all government debt). If the interest rate on the government debt is reduced to 1-2% (or less) and a long maturity is used, although the burden will be increased the interest payments will be significantly lower. Let us not forget that the current Russian loan has been issued with a 4,5% interest rate and it is highly unlikely that any new agreement will mean a lower rate. Lowering the interest rate by half will mean an additional reduction to the government budget.

If the government wishes, it can also give the depositors the rights to long-term bonds, with their rates dependent on the natural gas revenues.

Imposting capital constraints on transfers to foreign banks and withdrawals will be suitable as a mechanism to avoid bank runs from foreign investors. No solution can occur without imposing severe capital control regulations. In case anyone has not heard, these regulations are in fact legal in the European Union. We cannot emphasize it more: with no capital controls there is no solution for the island.

What we would propose is no cash withdrawals larger than 3,000-4,000 euros and not being able to transfer more than 5% (or 5,000 whichever is larger) of an account balance outside Cyprus unless it is payment of invoice (although the invoices should be carefully studied). Transfers between domestic banks and check issuance for deposit may take be issued for any account.

In addition, there should be a restructuring of bank loans, increasing their duration while simultaneously decreasing both the lending as well as the deposits interest rate. This will allow for lower installments over a longer time-frame which will mean that NPL's will be reduced significantly, both increasing bank profits and the capital adequacy ratios.

Although there have been some talks about leaving the euro, we are largely unsure of the consequences of a Eurozone exit (which will not be a controlled one). However, we commit to study the subject with more detail and come back with an answer.

P.S. Gas-linked bonds may be used as sweeteners only. Otherwise it would be mere speculation.

-Alexander Apostolides

By Alexander Apostolides on March 16, 2013

What are governments defaults and how they are managed? Could Cyprus do it?

I have been asked to explain on how government defaults take place.
Government defaults are very unpredictable events, and so they are hard for economics to predict or model.

I think only history can be a very rough guide: Defaults that work go something like this (based on 1932 Greece or 1931 UK). I define a good default one that lead to recovery of GDP within 18 months. 

a) You stop paying international creditors (so the 1.3 bn in june becomes less threatening). You put capital controls and close borders for 2 days. You convert all deposits to new currency and notes and coins in banks (do not even need to print currency - you an stamp all euros).

 b) The hard part: You need to Balance your current account (imports/ exports) and your government account (the hardest as deficit will be 0 - but you have no interest payments). Both of these will be a rude shock to GDP, much harder and ruder than any bailout/austerity package. But some argue it is a one shot game, rather than a prolonged period of austerity. 

However it is interesting to note that all Eurozone countries eliminated a large part of their currency reserves when joining the Euro (they became Euros). Thus you would need to start from the beggining, maybe keeping a current account surplus.

 c) A mixture of inflation and growth will ensure - the key is you do not know how much of each before the default! 

Inflation will arise: I do think inflation will be bad, and you will have fuel shortage as well. After some time J curve effect will make your exports very competitive. However it is important to remember that inflation transfers income from to those who own supermarkets to those who shop there. All the big Greek families with famous names became super rich when the exit from the gold standard took place. It is also true that inflation destroys the middle class. In that case savings will be hurt, perhaps far more than the 6.75% that were now subjected by the memorandum. Some argue however, than you can stop this cycle of inflation by correctly issuing your currency - ending fiat currency and only backing it on assets. 

d) The new currency needs to be backed on something: I would back it on the assets of the troubled banks and not have fiat circulation i.e. all circulation of pounds will equal the assets of the banks and the government. If you did that today those assets should be more than Euros in circulation. This should not reduce the money supply. If this process is done correctly (see UK in 1931) you might stabilize and your new currency will trade to around 30% below euro. 

Even so that does mean 30% increase in fuel prices however, making all domestic production more expensive. Thus the export increase effect perhaps muted. I disagree with the analysis that a country like Cyprus does not seek to gain with a devaluation: although the effect could be negative or positive, it is clear that at least three sectors will become competitive:
1) the tourism sector will be very competitive to tourists holding Euros 
2) The universities / education sector will offer a 40% cheaper tuition/accommodation costs than UK 
3) the existing business services will be able to take on back office outsourcing work from their UK and European organizations, as the cost of a chartered accountant will be much lower.

This default is not a panacea. It is harsh and wrong decisions can make it much more painful.
The first is that there are  Common problems/mistakes on defaults: 

1) Governments wait too long to leave to default. It becomes obvious to all and subject to speculation and hoarding of currency. Leaving sooner is better. This is something that politicians seem to resist. The UK only left the gold standard quickly when the central governor had a nervous breakdown, creating a lack of communication. In short government never leave a currency union (or other for of currency link) early enough

 2) Governments usually print money rather than balance the books. Austerity before hand makes governments not balance their books, with large problems of inflation arising. This is because common sense macroeconomic stability is not followed after a default as people want a break from austerity 

3) Litigation can stop a re-entry into the markets. As Argentina has discovered a default without the agreement of all creditors can stop your economy coming back in the international arena. This is the case in Cyprus which has British law bonds, although experts thing that this just makes renegotiation of bond difficult but not impossible 

First memorandum deal makes a second memorandum almost a certainty.

First memorandum deal makes a second memorandum almost a certainty.

It took a while to get around the news this morning. The main issue is the immediate haircutting of all deposits of all Cypriot banks (although oddly Greek depositors are excluded!). What does that mean for the economy of Cyprus:

A) Macroeconomic Instability

The news this morning initiated what looked like a bank run: the Eurogroup must not have known that the Co-op societies are open on Saturday, and people patiently waited in queue to remove their deposits only to be turned away. This made everything worse: we seem to have a bank run, which I think the government promise of this being a “one-off” raid on personal deposits will not stem.

How bad is the bank run? According to government sources, the last two months saw 11 billion euros was removed from the Cypriot deposit system within the last few weeks. This week is not going to be any better. I am assuming that at best there will just be an additional 11 billion loss of deposits for the banking system this following months. This means that banks will need liquidity assistance; as a result the Emergency Liquidity Assistance (ELA) of the ECB is bound to continue.  

What is the effect of this loss of deposits? Let remember the Axiom of economics that links the monetary economy with the real economy:
Ms*V= P*Q
or Money supply times velocity equals price times quantity (P*Q is also called nominal GDP).

The removal of deposits led to a reduction of the money supply. As a result there is a brutal negative shock to the money supply, coupled with reduction of velocity as companies and individuals with loans that are attached to deposits battle it out with the banks. As prices in Cyprus are relatively stable then it means that quantity (output) will decline. This makes the scenario for a recession of -2.4% very unlikely (my prediction is -5% GDP). As the recession will be worse than predicted, then neither the government revenue/expenditure stream we agreed on the troika, nor the PIMCO report on the banks’ capitalisation needs, will be accurate. As a result we need a larger bailout à A second bailout is coming

  1. B)  mortal blow for Cyprus as international financial centre?

If one agrees with my logic of a second bailout then we need to think what that means for Cyprus’ position as an international financial centre.

Some foreign depositors woke up with the news that they have lost money in the unthinkable way. Clever depositors might have thought they were safe by reducing their accounts to several accounts of 100,000 euro tranches, the limit guaranteed by deposit insurance, or by moving them to the better run banks. However these did not help them; they woke up to hear a 6.75% haircut on their deposits under 100,000, which includes all financial institutions, even banks that avoided the mess and were run efficiently.

The confidence to the banking sector is shaken. Quickly as the negative shock ripples through the economy there will be a realisation that a second bailout will be needed. The local and foreign depositor will ask himself “Is this the last time there will be a deposit haircut or will
my deposits be affected in a second bailout?”
No one can answer that question with any credibility anymore. After all, the President of Cyprus had committed while being a presidential candidate to never accept a deposit haircut. No one knows what the Europeans will ask next time. Thinking backwards the depositor will not be lured or committed to stay in Cyprus, regardless of the competitiveness of the Cypriot business services sector, which is one of the best in the world.

    C)  The moral of the story is that politics need to listen to basic economic principles
The basis of any successful capitalist economy is the protection of the right of personal property. This decision to punish all savers equally across all banks, regardless of the bank’s solvency, violates this principle. Note that depositors under 100,000 were insured against losses even if the banks failed, but are now forced to bear the brunt of the banking recapitalization. Thus the majority of depositors and shareholders of the two major banks actually had an incentive to let the two major bank fail, as they would not have their deposits haircutted.

This matters: when the right of personal property is violated the whole capitalist system, or institutions, that underlie the correct running of an economy, are threatened. And when such basic principles are disturbed, neither does the IMD, the Eurogroup of the EU commission can estimate the repercussions for Little Cyprus, but also for the Eurozone as a whole. 

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By Alexander Apostolides on March 13, 2013

My Second Interview with “Inside Outside“, for the Istanbul based community radio Açık Radyo

As I said before I like when Ekrem Eddy Guzeldere interviews people: he lets the person talk and really listens to the answers. He interviewed me after the Cypriot election and I am still very hopeful  about how things will turn out, but that was before the negotiations started. Things look tougher now but i am still optimistic, especially for Cyprus peace negotiations. 

By Alexander Apostolides on March 06, 2013

Efficient Taxation 101: The locust tax of Cyprus

A revolution, like the one that affected Egypt, usually leads to a collapse of the basic functions of the state. This is not surprising: as revenues collapse, the state will focus to maintaining the very basic economic functions, such as keeping Cairo ticking. The countryside will come second: people are mainly in the cities, and they are the ones that can "make or break" the new, post revolutionary regime. The Jacobins understood that well during the French revolution: they managed to takeover the revolutionary government by tapping into the anger of the Parisians, and maintained it their power by keeping Paris as happy as possible.

The effects of the neglect of rural Egypt are materialising in scary, biblical ways. Locust swarms are now making their way through Egypt, re-energised due to the neglect of the past two years, as the revolution reduced the ability of the government to react. Locusts are very dangerous to crops, but especially if they reach the critical mass of swarms: when Locusts swarm, there is really no way to stop their march as they raze all flora in their way. With no flora remaining, fauna is also decimated, causing severe environmental damage over large areas. Swarms change locusts both in how they behave but also in how they look, blackening them while making them very aggressive and mobile. Spraying them with pesticide will only knock out thousands at a time, yet millions are relentlessly pushing forwards towards new land in order to feed. Even with modern technology, locusts, when swarming, are near impossible to stop.

Many people might not know this but Cyprus was traditionally part of the locust migration and swarming problem, with millions of locusts consuming vast amounts of carobs and grain. It seems that the phenomenon was seen as most problematic (perhaps because people thought they could stop it) during the 18th and 19th century. Although the phenomenon is in part a response to the environmental conditions (see the National Geographic article linked above), correct prevention can reduce the possibility of swarming occurring in the first place.

It was quickly found out back then Locust swarms can be prevented by capturing the eggs of the locusts in specially made traps. The trigger to swarm arises from overpopulation of swarms due to high rainfall: thus by keeping the population in check through the collections of eggs, the possibility of swarming was reduced. The Ottoman administration of the island introduced sporadic egg capturing campaigns that were successful;  however the problem would re-occur after the campaigns would wind down.

The new British Administration of Cyprus decided to do something about it. It introduced the Locust Prevention Tax of 1881 (Law 12). It aimed to raise revenue in order to create a systematic,  year-on-year effort to destroy the locust prior to swarming. The history of this tax can be seen here.

The law aimed to correct a problem of negative externalities in agricultural production:  all persons were negatively affected by the swarming, and yet none was willing to pay more than his private benefit in order to eliminate it. In these situations the government has a very positive role to play in raising the revenue to act and eliminate the negative costs of swarming, thus creating a better market outcome.

The tax was ingeniously planned. Firstly the revenue was placed in an escrow account, completely separate from normal government revenue. This guaranteed that an amount was always available: locust prevention would not be sacrificed in order for other, more popular or immediate government projects. This was done on purpose, as the failure of the Ottomans to control the locust on Cyprus indicated that people (and officials) were willing to divert funds to prevention during and after a swarming event, but quickly diverted resources to other areas after the immediate threat passed, allowing the locust time to recover and regroup. By keeping the locust account separate, the government ensured that investment in prevention was ongoing, allowing for funds to attack the locust exactly when it was the weakest, further reducing the ability of the animals to swarm and become destructive.

Secondly the law was careful in should carry the burden. The Locust tax, collected 1% of agricultural  production, 0.1% of the value of property (since at the time a lot of property were trees and land, directly affected by swarming) and a smaller tax on flocks of sheep and goats. As a result all who would loose out by swarms had to pay, and each paid relative to the possible damage he or she would have if the locusts swarmed. That is why flocks were taxed less: although a swarm would cause losses to a flock by reducing the pasture, their cost would be less than the cost of a person who owned an orchard.

Note that the law has cyclical and non-cyclical elements, providing both flexibility and stability. Output is cyclical to GDP and thus the burden would not overwhelm farmers when their output was low (as they were charged 1% of output). At the same time property and flocks are stock concepts, allowing for stable revenue collection, which is less variable than output. Thus there was a basic amount of tax collected that would not vary much (based on taxing those who owned wealth and stock), and this was topped up according to the economic growth of agricultural sector (by directly taxing output).

The effect of the tax was immediately clear. As the locust was brought under check, the cost of prevention fell rapidly, allowing for a healthy surplus in the escrow account. Rather than stop the tax and have the issue of raising revenue if a future locust swarm issue resurfaced, the government kept the law and separate account, and passed a new law that allowed it to spend the revenues (or earmark future revenues) of the tax on infrastructure projects. The pier in Larnaca and other projects that allowed for the opening of markets were undertaken by the revenue collected by this tax. The prevention of locusts remained a priority, but the fund also allowed government to spend on long term projects based on a predicted revenue stream. It is no surprise that one of the few foreign loans that the British administration was able to procure was based on earmarked revenues of this tax, as the creditors felt safer knowing their interest would not be repaid by the general government revenue: as a result the locust tax enabled the largest infrastructure project to date, the construction of Famagusta harbour and the railway to connect it to Nicosia.

By 1926 the abolition of the Tithe brought the tax to abeyance. The funds in the separate account were depleted, and sure enough the Locust returned in 1948, forcing the government to spend £20,000 on DDT and other highly hazardous chemicals in order to try and counter it. The liberal use of such dangerous chemicals has a huge cost to Cypriot wildlife, which was decimated and has never recovered.

What are the lessons that this tax can provide? Taxation can and should be used to correct market failures (in the case failure to prevent Locust swarming) where the private cost is lower that the social cost to society.    Yet such revenue needs to be protected and not allowed to be put in general government revenue, where short term needs will trump long term development issues. Thus I am all for a tax that would collect revenue for the future infrastructure costs of establishing a local and exported gas network, provided it is kept out of general government revenue.

Secondly, all good taxes need to balance revenue flexibility with revenue stability. A tax that is too flexible (such as VAT) will not be able to sustain government expenditure if the economy suffers a severe recession; likewise a tax that is too rigid (such as property tax) will be far too onerous to the taxpayer when his income contracts. The fact that the above tax combined tax flexibility/stability with varying the burden on the taxpayer according to possible future loss due to locusts was a brilliant idea. Each taxpayer contributed relative to the possible loss he would suffer if locust swarms occurred and  thus prevention was shared not equally but according to who had more to loose, making the tax more bearable.

By Alexander Apostolides on February 20, 2013

My letter to the Wall Street Journal

To the Editor,
The Wall Street Journal

Dear Madam/Sir,
Your article "Europe's Least Essential Bailout: Cyprus is an ideal testing ground for forcing loses on all bank creditors (18th of February, 2013)" seems to be making a valid argument but only because it is missing two key ingredients: Facts and Data.

Cyprus has requested 17bn euro bailout from the "Troika" of IMF, ECB and EU, and that is enough to secure the viability of its banks and the borrowing needs of the state without any need of creditor or depositor losses. However your article suggests instead  in "bailing-in" depositors that hold an amount above the insured 100,000 euros; yet this will require "Troika" support of 35 billion euros.

This is because no nations' deposit insurance scheme (and this includes the US FDIC) could honour its commitments to depositors if the largest two banks in an economy fail. As a result if Cyprus is forced to "bail-in" its depositors it only has two options:
1) Request a bailout of 35billion euro (currently the amount of deposits that are guaranteed) from the  "Troika", thus condemning Cyprus in having an unsustainable debt, forcing "Troika" into accepting looses on the amount borrowed.
2) Print its own currency to cover the shortfall of the deposit guarantee scheme (forbidden by Eurozone agreements) and introduce Capital controls (forbidden by the European Single Market Agreement). Unlike Iceland, which is not a member of the European Union, a decision to introduce capital controls by Cyprus will mean at least a temporary withdrawal from the EU, as controls of capital are forbidden under  the EU acquis. Since Cyprus is still an integral nation state with veto powers in key European Union decisions, this decision could condemn any progress in  EU wide issues, such as the future EU budget.

Thus if one ignores the data that  a "bailing-in" will cost the official sector lender twice as much, and the facts that Cyprus is a member of the Eurozone and the European Union, the argument proposed by your article might appear valid. Thankfully we here in Cyprus are working towards a solution that would ignore neither the real facts or the data of our situation.
Dr. Alexander Apostolides
Lecturer in Economic History
European University Cyprus

By Alexander Apostolides on February 18, 2013

A run-off in the Cyprus presidential elections: My presentation of what the Cypriot President needs to do

Last week i was asked by a Swiss Forex bank to make an online presentation about the Cypriot elections. I countered saying that the issue should be in what the new president needs to do in the first 100 days of being in office. Now we are into a second round of elections, making the 100days prediction accurate (if we had one round, the president would have 106 days to solve our immediate problems).

I enjoyed the on-line experience. Watch me loose it 1/2 times as background sounds from my office distracted my thought process. Also despite being conntected to the University network, the line was laggy. It is amazing that Cyprus thinks we need investments in roads, when really we need better ports and better optic cables linking us to cheaper and higher on-line speeds.


By Alexander Apostolides on January 31, 2013

Excellent Paper and Workshop "Eurozone Debt Crisis:The options now, with Special Reference to Cyprus"

Back in December I was lucky enough to meet Mitu Gulati, Professor of Law, Duke University, in Geneva. We both quickly concurred that the fiscal needs of Cyprus was in the agenda of all in Europe and beyond, and we decided to have a workshop about it in Nicosia. Lee C Buchheit, partner at Cleary, Gottlieb, Steen & Hamilton LLP, by far the most experienced sovereign debt reconstruction lawyer agreed to attend, and we decided to add a view from the ground by asking Fiona Mullen of Sapienta Economics to review the situation from Cyprus.

Lawyers are used to problem-solving and need to give their clients options: economists far too often retreat in the theoretical field when faced with a real world dilemma. Originally the plan was to present to excellent evaluation of the Eurozone debt crisis which was written by Lee C Buchheit and Mitu Gulati ("The Eurozone   debt crisis- the options now"  which in very simple language puts forth the possibilities of how the overall Eurozone debt issue will play out.

Yet thanks to Mitu Gulati's and Lee C Buchheit's incredible work-rate, they managed to make a working paper on the issue that was most on the mind of those who are considering restructuring of Cypriot debt: the issue of holdouts.

Mitu Gulati and Lee C Buchheit are intensely aware that in practical terms the Greek restructuring had a limited number of holdouts due to the fact that 93% of the Greek debt was under domestic law, and hence legal instruments could be retroactively integrated in the law to force the holdouts to settle. Yet  Cyprus, as well as other EU countries,  would face a significant holdout problem if they ever restructure their debt, even by mildly extending the maturity of the loan. This is because about half of the Cypriot debt was issued under English law, and because of that the  investors have the ability to to holdout and demand to be paid in full and on time.

"The Problem of Holdout Creditors in Eurozone Debt Restructurings" spells out the problem; the authors offer an alteration of the Europe-wide ESM treaty that would reduce the bargaining power of the creditors, which has been noted by the Financial Times as a possible future issue to be addressed by the Eurozone member countries.   My personal thought is that the Cypriot presidency, which took charge in the latter half of 2012 when the ESM was still not fully fleshed out, missed a historic opportunity to attach such a condition to the treaty. This would have helped Cyprus but also all other  Eurozone nations struggling with their debt. Rather than chase the issues that were important for the Cypriot presidency in 2012, we chased the issues other presidencies seemed to have placed on the wayside. This is a minor error by the Republic when faced by another, more basic error: the fact that Cypriot government debt was issued without hiring lawyers to represent the republic. The  decision of the Republic of Cyprus not to hire lawyers when issuing debt led to very inflexible contracts: in order to save some thousands of Euros in lawyer fees, the Republic now faces  investor intransigence and the possibility of paying out billions of Euros that it can not afford.

The Workshop "Eurozone Debt Crisis:The options now, with Special Reference to Cyprus" took place on the 30th of January at the European University Cyprus and it was an unqualified success. Both English speaking and Greek speaking Cypriot media took up the concerns expressed by the three panellists (and echoed by myself, who acted as the moderator).

First up was Fiona Mullen of Sapianta Economics who in her presentation (you can access it here) outlined the current issues of Cyprus:
1) The republic is 2 to 3 bn Euro away from being able to call its debt "sustainable" and hence qualify for IMF assistance
2) There  is a need to repay bondholders 1.4 bn euros in the 3rd of June, and the Republic does not have it.

Fiona argues that a mix and match of policies could bring the debt down to the IMF number of 120% debt to GDP ratio that is aimed by the IMF, and considers the idea of a very modest restructuring of the debt by extending the debt maturity by five years as one of the best options to alleviate the austerity of the adjustment period. Fiona is too polite to point out that that 2/3 Bn missing is because Mr Stavrakis (the then finance minister) decided to borrow short term rather than more expensive long term borrowing (that would have forced him to launch austerity or taxation increases). As a result over 34% of National debt is expiring in 2013 due to Mr Stavrakis' bet that the economic situation of Cyprus would have changed by the better this year. His lost bet doomed Cyprus: the amount we need to pay to bondholders that hold maturing debt is now the difference between being accepted as having a sustainable debt level by the IMF or not receiving a bailout. When the government rails against privatisation of semi-government companies, it is very ironic as its actions back in the period 2008-2010 ensured that some privatisation will be necessary.

Next, Mitu Gulati and Lee Buchheit divided their time on two issues:
1) The possibility of extending debt maturity in Cyprus: They pointed out that contrary to most shallow analysis, the Cypriot foreign debt contracts do have enough legal basis for Cyprus to go to court and expect a possibly favourable result (see the presentation here).
2) General Eurozone issues: Lee C Buchheit pointed out that the issue of Cyprus and the decisions if the EU taxpayer or the investor or depositors pay the price is now out of Cypriot hands.
The Eurozone has to decide not only in how to help countries which need bailouts, but also whether they want the debt liability to be the sole concern of the European taxpayer. Lee C Buchheit pointed out that out of the first Greek Bailout, approximately 75% of the bailout amount went to investors who were paid out in full, and the resulting political  backlash led to a very severe haircutting of the remaining private investors. He suggests a more outright approach  from the beginning as to who is going to bear the costs should be addressed at an Eurozone-wide level.

The discussion largely centred around Cyprus and what it could do. The general agreement seemed to be that if required, the pushing back of maturity of the existing debt seemed like the most sensible option. This re-profiling of the debt, rather than a haircut of the interest or of the principal could solve many issues:

  • The  reduction of the net present value of government debt owned by Cypriot bank would be relatively small, reducing the contagion to the local banking system. 
  • Thanks to the way contracts were written, even in the English law bonds there is enough of a difference of interpretation to ensure that the Republic has a chance in surviving litigation, thus changing the incentives of holdouts to accept the extension of the maturity.  
  • But the June deadline is very tight: in order to do the above the new president has to run and start the procedure of debt re-profiling, or at least convince the Eurozone partners to provide the amount needed to pay the June investors in full.
 I would like to thank the Speakers (Lee Buchheit, Fiona Mullen and Mitu Gulati), and especially Lee Buchheit and Mitu Gulati who took time out of  their busy schedule to fly to Cyprus, and to all who attended. The active participation of the audience made this a very lively event. Now we all await the new government of Cyprus in February, and how it will react in front of the tough options that it faces.

Alexander Apostolides
Lecturer, Economic History
European University Cyprus