What an interesting week. Monday brought a wave of righteous indignation over the thought of a haircut for Cypriot depositors, on Friday everyone is cheering the idea that deposits over E100k are going to gets ‘faced’ for 40%. The Cyprus story is far from over, but there are some lessons so far:
- European leaders have shown their hand. They are more than willing to stiff depositors when pushed to the wall.
- The deposit level of +/- E100k has been reinforced at the benchmark for haircuts.
- All Deposits < E100k in European banks are safe.
- All Deposits > E100k are unsafe.
- One would have to be oblivious to these facts (or a complete idiot) to have greater than E100k in an EU bank deposit.
- European Money Centers are at risk.
One consequence of being a money center is that there has to be huge foreign liabilities. Looking at what is owed to external creditors provides some information on what I call the Money Center Debt Syndrome (MCDS). The following numbers on External Debt come from the CIA (Link). The numbers are external debt owing to other countries, minus external debt of other countries held. (The CIA presents all numbers in dollars.) The numbers are only the liabilities, there are foreign assets held against these liabilities. I want to focus on just the debt side of this picture.
The two biggest money centers in Europe are Zurich and London. The MCDS is very obvious:
Switzerland – External Debt = $2.2T. External Debt to GDP = 210%
UK – External Debt = $9.8T. External Debt to GDP = 400%
Again, there are real assets behind most of this debt, so these ratios are not really as scary as they appear. In addition, these money centers are outside of the Euro Zone. I don’t think there is an issue with these. Now consider Germany, a country with a large GDP and a relatively small function as a money center:
Germany – External Debt = $5.6T. External Debt to GDP = 150%
Italy/Spain are not money centers at. As a result, they do not suffer from MCDS:
Italy – External Debt = $2.5T. External Debt to GDP = 110%
Spain – External Debt = $1.4T. External Debt to GDP = 93%
The following are 2011 numbers for Cyprus:
Cyprus – External Debt = $106B. External Debt to GDP = 440%
Clearly there was a red flag with external debt/GDP in Cyprus two years ago. The ratio was higher than all the other EU countries. It was higher than Switzerland. Cyprus was an accident waiting to happen.
Now to the point of this article; consider the ratio for this European money center:
Luxemburg – External Debt = $2.2T. External debt to GDP = 3,700%
Yes, yes, I know. Luxemburg is different than Cyprus. Luxemburg is just a booking center, there are assets behind all of this debt. But at the same time, this looks like a very unstable situation.
I end with where I started, only an idiot would leave more than E100k in a Luxemburg bank (any EU bank for the foreseeable future). I believe that the deposits that are behind Luxemburg’s external debt are measured in the trillions, the vast majority of those deposits exceed E100k. It would not take much for this situation to slide out of control.
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