Bloomberg News

Cyprus Crisis Solved in Great Depression Laws: Cutting Research

March 27, 2013

The federal holiday that President Franklin Roosevelt declared for American banks in March 1933 may hold lessons for the euro area of 2013 amid the banking crisis in Cyprus.

In looking to the Great Depression, Nomura Holdings Inc. (8604) economists and strategists said that big crises can spring from small events. In the U.S., numerous reports show it was a 1933 Valentine’s Day bank holiday in one state, Michigan, that sparked a nationwide bank run. As with Cyprus, what counts is the ability of policy makers to maintain confidence elsewhere no matter what happens.

“Euro area policy makers might believe that Cyprus is not systemic,” said Nomura. “History shows that is exactly the opposite when depositors are involved.”

Nomura’s Jacques Cailloux, Dimitris Drakopoulos and Jens Nordvig outlined the parallels of 80 years ago in a March 25 report written after Cyprus secured a 10 billion euro ($12.8 billion) aid package. The country’s banks were closed March 16 to prevent collapse and reopened today with capital controls in place.

The U.S. experience was also instructive in that the Federal Reserve was given power to create an emergency currency that created the expectation policy makers would guarantee all bank deposits. The equivalent in the euro area would be for the European Central Bank to match deposit withdrawal with cash. That “is very hard to see” given collateral rules, the report said.

In a separate report, released March 19, Russell Napier, a strategist at CLSA Ltd., said an historical parallel might be the citizens of the Soviet Union or the American colonies who “eventually reject the sacrifice of political rights necessary to support the system.”

Cypriots were angered by a March 16 bailout program in which all bank deposits would be taxed. The ultimate deal protected those with accounts holding less than 100,000 euros.

“When the history books are written, the Brussels-imposed sequestration in Cyprus will be seen as the tipping point when the citizens of the euro system realized that the socio- political sacrifice needed to sustain a single currency was just too great,” said Napier.

* * *

Income inequality is becoming an increasing issue for Federal Reserve officials and may prove to be an important factor in monetary policy, according to Credit Suisse Group AG. (CSGN)

Citing speeches by policy makers including Vice Chairman Janet Yellen and Governors Sarah Bloom Raskin and Elizabeth Duke, New York-based economists Neal Soss and Dana Saporta said in a March 24 report that officials are concerned income disparity undermines the ability of the economy to grow sustainably and efficiently.

Raskin has noted the U.S. poverty rate now stands at 15 percent, higher than the three-decade average of 13.4 percent, while Duke says new households face tight credit conditions. Yellen says hourly compensation has barely kept pace with the cost of living over the last three years.

By contrast, Soss and Saporta said the collective finances of American households appear to have improved since the 2009 recession. Debt-service burdens are the lowest in 30 years and record low borrowing costs have helped households extend financially.

The challenge is that the Fed has limited means to address inequality, they said. Chairman Ben S. Bernanke has said the best way the Fed can help is to spur hiring.

That suggests to the Credit Suisse economists that inequality probably will to play a role in the data used to justify continuing easy monetary policy.

* * *

China’s economic data may be reliable after all.

So says a study published March 25 by the Federal Reserve Bank of San Francisco. It challenges those who have questioned whether China slowed more in 2012 than gross domestic product figures indicate.

The veracity of China’s output and industrial production figures is backed up by other measures of economic activity. That’s a sign the official growth rate of 7.8 percent last year, the weakest in 13 years, was valid.

The report combined data such as electricity production, rail cargo shipments, construction of new floor space, air passenger volumes and measures of trade reported outside of China. The results were consistent with last year’s slowdown and the pickup in growth that began in the fourth quarter.

“These models suggest that Chinese growth has been in the ballpark of what official data have reported,” wrote economists John Fernald, Israel Malkin and Mark Spiegel.

A caveat is that the report doesn’t provide evidence on the long-term accuracy of China’s GDP statistics, so if they are consistently over-reported the Fed bank’s statistical relationships would be skewed by the persistent bias.

* * *

South Korea’s private consumption growth rate has lagged behind the pace of economic expansion since the global financial crisis due to slow wage increases and worsening terms of trade, according to an economist at the Bank of Korea.

The widening gap between rich and poor contributed to the limited consumption: High-income earners were reluctant to spend more on non-necessities amid persistent uncertainty over the global economic outlook, Nah Seung Ho said in a March 24 study.

In addition, increases in household debt that exceed income growth have capped private spending, while an aging population and an increase in self-employment restrains gains in incomes, the report said.

Sluggish private spending increases the economy’s vulnerability to changes in global economic conditions while sapping corporate investment, the report said. Nah studied 40 big economies and found the lower the ratio of domestic demand to gross domestic product, the higher the correlation with global economic changes.

The latest developments on South Korea’s household income and consumption may worsen the economy’s structural weakness, hampering sustainable growth, the economist said. As of 2011, South Korean consumers spent 99.2 percent of their disposable income, leading to lower savings rates and higher demand for borrowings, a potential threat to the financial system.

To contact the reporters on this story: Simon Kennedy in London at skennedy4@bloomberg.net Eunkyung Seo in Seoul at eseo3@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net


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