Eurozone at risk of almost “endless depression” in wake of settlement imposed on Cypriot banks says Invesco’s John Greenwood

9th April 2013


The EU-imposed Cyprus banking settlement could set off a chain of events that risks an almost endless depression for the eurozone, Invesco chief economist John Greenwood has warned.

The nature of the bail-in could see Eurozone banks becoming ever more conservative in their leading strategies leading to deleveraging, and under the current euro-orthdoxy, more austerity risking almost endless depression.

Greenwood says the banking restructure imposed on Cyprus will push it into a depression while the knock on effect on Europe’ banks brings the danger of turning the Eurozone into another Japan.

This is despite Cyprus banking system being smaller as a ratio of GDP than Luxembourg and the fact that it was an EU write down of Greek debt that pitched the country into trouble.

In his quarterly outlook, he writes: “At least two aspects of the Cyprus crisis are worrying for the long term outlook. First, the initial problems of Cypriot banks were caused by having to take 80 per cent write-downs on Greek government debt when the Troika demanded a bond exchange to lower the value of Greek government debt outstanding. Cyprus has a smaller banking system relative to its GDP than Luxemburg, yet it is being compelled to ditch its successful international banking business in order to conform to a euro-area business-model for banking. If this restructuring is forced through, then Cyprus will follow Greece, Ireland and Spain into depression.”

Greenwood says the nature of the settlement is bad news for the Eurozone banking sector.

“The nature of the Cypriot settlement, a 10 billion euro loan from the Troika worth 55 per cent of Cyprus’s GDP, is bad news for the eurozone banking sector in the short term. Under the “bail-in” scheme, shareholders, bondholders and uninsured depositors of Cyprus’s second largest bank, Laiki, will lose almost everything, while the remaining insured  deposits and “good assets” will be folded into Bank of Cyprus, the largest bank, which itself will be recapitalised with funds from uninsured depositors, equity shareholders and bondholders. This marks the first time, following 503 billion euros of taxpayer-funded rescue schemes for other peripherals that the EU authorities have “bailed-in” other creditors.”

Greenwood now fears extended deleveraging with a long term danger of endless depression.

The  implications are clear: future eurozone banking problems will have to be solved by funding from creditors, not taxpayers. This implies euro-area banks will have to be much more conservative in their funding, leading to extended deleveraging.

“In view of this outcome, it is clear that the euro-area orthodoxy implies further austerity and almost endless depression. To achieve the necessary structural adjustments in the euro-area economies the austerity programs enforced by the Troika are likely to need to continue much longer than had been planned. This means that the prospects for GDP recovery in the eurozone in 2013 or 2014 are diminishing by the month.

“My forecast is for real GDP growth of -0.2 per cent (compared with an estimated -0.5 per cent in 2012). In short, there will be no meaningful recovery in 2013, and there is a risk of  the downturn extending into 2014. Inflation, too, should remain subdued at 1.7 per cent, held down by low money and credit growth, high rates of unemployment and spare capacity, with some deflation in the periphery. The longer term danger is a “Japanization” of Europe as growth stalls and deflation takes hold.”


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