Have politicians had a mental blackout?

There’s a real risk of energy shortages in Britain, yet still the political class is obsessed with cutting fossil fuel use

by Rob Lyons 

‘Britain faces gas supply crisis as storage runs dry’, warned Reuters last week. Unseasonably cold weather has meant that demand for gas has shot up just as it should be going down with the arrival of spring. Just to add a little spice to the warnings, tens of thousands of homes were left without power as blizzards knocked out power lines in Northern Ireland and Scotland. A taste of things to come?

As it goes, the claim that gas supplies could run out by 8 April is very much a worst-case scenario. There is normally plenty of supply, from a combination of the North Sea, Europe and shipments of liquefied gas coming from countries further afield, particularly Qatar. Nonetheless, it is daft that a modern, highly developed economy like the UK should even be discussing such things. That we are is the product of years of inertia in central government and an obsession with self-imposed greenhouse-gas emissions targets.

So perversely, just as a set of circumstances was emerging that showed how close to the wind the UK is sailing on energy security, Britain has been closing power stations. For example, on Friday, Didcot A power station in Oxfordshire was disconnected from the National Grid after 43 years. The 2,000-megawatt plant got the chop because it burns coal. Older coal plants are being phased out under EU regulations. Indeed, according to Alistair Buchanan, the boss of energy regulator Ofgem, 10 per cent of the UK’s electricity generating capacity is due to be switched off this month.

Buchanan notes the speed at which plant closures will now kick in: ‘If you can imagine a ride on a rollercoaster at a fairground, then this winter, we are at the top of the circuit and we head downhill – fast. Within three years, we will see the reserve margin of generation fall from about 14 per cent to less than five per cent. That is uncomfortably tight.’ In fact, some of those coal plants are closing ahead of schedule because their remaining operating hours have been used up quickly to take advantage of low coal prices. At a time when complaints about domestic energy costs are getting louder and louder, we are turning our back on the cheapest form of power available.

We’ve known for quite some time that there was the potential for a major shortfall in energy supplies. Coal and nuclear stations have been shutting but alternatives have fallen short. Wind is expensive to build and intermittent in operation. At some of the coldest periods of the year, wind supply can fall to nearly zero. Renewable UK celebrated the fact that wind produced a record proportion of UK electricity in 2012 - but it was still just 5.5 per cent of the total. New nuclear stations should be being built now, but years of political indecision mean that not a single new plant has actually got agreement yet. Even now, suppliers are haggling with government over guaranteed prices, though planning permission for Hinkley Point C - a new station on the site of two older nuclear reactors - has at least been approved. Nonetheless, it will still take eight to 10 years to build the plant.

In Instanbul: The Rise & Fall of Society

Since the State thrives on what it expropriates the general decline in production which it induces by its avarice foretells its own doom

by Chris Mayer

It’s Istanbul, not Constantinople, as the song goes. In this history is an omen for any powerful state (read: the U.S.). A somewhat obscure essayist knew all about it back in 1959. His little book deserves wider circulation. Below, we’ll take a look.

Constantinople was once the seat of a vast, rich empire. The successor to Rome, it ruled over a land that stretched from the Caucasus to the Adriatic, from the Danube to the Sahara. The Dark Ages were dark only if you ignore the flourishing civilization on the Bosporus.

Historian Merle Severy writes: “Medieval visitors from the rural West, where Rome had shrunk to a cow town, were struck dumb by this resplendent metropolis.” There were half a million people here. Its harbors full of ships, “its markets filled with silks, spices, furs, precious stones, perfumed woods, carved ivory, gold and silver and enameled jewelry.”

This civilization lasted for a thousand years.

Actually, it lasted for 1,123 years and 18 days after Constantine the Great made the city his new Christian Rome. On May 29, 1453, Constantinople fell to the Turks.

Renamed Istanbul, the city would serve as the seat of yet another great empire, the Ottoman. And this one would last nearly five centuries. In the 16th and 17th centuries, the Ottoman Empire was perhaps the most powerful state on Earth. It was on one heck of a roll. After Constantinople, the Ottomans took Athens in 1458. Then it was on to Tabriz (1514), Damascus (1516), Cairo (1517), Belgrade (1521), Rhodes (1522), Baghdad (1534), Buda (1541), Tripoli (1551) and Cyprus (1571).

They almost took Vienna. The powers of Western Europe drew the line in the sand there. Interesting to think what would’ve happened if the Turks took Vienna. All of Western Europe would be at their feet. If they had succeeded, perhaps the majority of Europeans would be answering the call to prayer, echoing from the minarets of cathedrals-turned-mosques…

Yet the Ottoman Empire, too, would crumble. It was constantly at war. By one historian’s reckoning, the longest period of peace was just 24 years in nearly six centuries of reign.

In 1923, with the founding of the Republic of Turkey, Ankara became the seat of government. As historian John Freely notes: “For the first time in 16 centuries, the ancient city on the Golden Horn was no longer reigning over a world empire with only the presence of the monuments to remind one of its imperial past.”

It is not hard to think of the U.S. in the context of these great powers.

*** Enter Chodorov

One of the books I had tucked in my bag that I read while in Turkey was Frank Chodorov’sThe Rise & Fall of Society. This is a slender 168-page book by a great, if somewhat forgotten, essayist and editor. It gives a tightly reasoned answer to the question “Why do societies rise and fall?”

Chodorov’s thesis is that “every collapse of which we have sufficient evidence was preceded by the same course of events.”

The course of events goes like this: “The State, in its insatiable lust for power, increasingly intensified its encroachments on the economy of the nation…” and finally gets to the point where the economy can no longer support the state at the level it is accustomed to. Society can’t meet the strain, so “society collapsed and drew the State down with it.”

The pattern is always the same, regardless of size or ideology. The state can grow only by taking. “Since the State thrives on what it expropriates,” Chodorov writes, “the general decline in production which it induces by its avarice foretells its own doom.”

Chodorov bases much of his thesis on what he calls “the law of parsimony.” In essence, it is simply that people try to get the most satisfaction with the least amount of effort. It is a natural law of human behavior.

Anatomy of the Bank Run

Fractional reserve banks, being inherently insolvent, are uninsurable

[This article is featured in chapter 79 of Making Economic Sense by Murray Rothbard and originally appeared in the September, 1985 edition of The Free Market]

by Murray N. Rothbard
It was a scene familiar to any nostalgia buff: all-night lines waiting for the banks (first in Ohio, then in Maryland) to open; pompous but mendacious assurances by the bankers that all is well and that the people should go home; a stubborn insistence by depositors to get their money out; and the consequent closing of the banks by government, while at the same time the banks were permitted to stay in existence and collect the debts due them by their borrowers.

In other words, instead of government protecting private property and enforcing voluntary contracts, it deliberately violated the property of the depositors by barring them from retrieving their own money from the banks.

All this was, of course, a replay of the early 1930s: the last era of massive runs on banks. On the surface the weakness was the fact that the failed banks were insured by private or state deposit insurance agencies, whereas the banks that easily withstood the storm were insured by the federal government (FDIC for commercial banks; FSLIC for savings and loan banks).

But why? What is the magic elixir possessed by the federal government that neither private firms nor states can muster? The defenders of the private insurance agencies noted that they were technically in better financial shape than FSLIC or FDIC, since they had greater reserves per deposit dollar insured. How is it that private firms, so far superior to government in all other operations, should be so defective in this one area? Is there something unique about money that requires federal control?

Why Cyprus 2013 is worse than the KreditAnstalt (1931) and Argentina 2001 crises

The Cyprus 2013, like any other event, can be thought in political and economic terms

by Martin Sibileau 

Political analysis: Two dimensions

Politically, I can see two dimensions. The first dimension belongs to the geopolitical history of the region, with the addition of the recently discovered natural gas reserves. The historical relevance goes as far back as 1853, the year the Crimean War began. The Crimean War took place in the adjacent Black Sea, but the political interest was the same: To avoid the expansion of Russia into the Mediterranean. The relevance of this episode was the break-up of the balance of power established after the Napoleonic Wars, with the Congress of Vienna, in 1815. From then on, a whole new series of unexpected events would lead to a weaker France, a stronger Prussia, new alliances and a final resolution sixty years later: World War I.  It is within this same framework that I see Cyprus 2013 as a very relevant political event: Should Russia eventually obtain a bailout of Cyprus (as I write, this does not seem likely) against a pledge on the natural gas reserves or a naval base, a new balance of power will have been drafted in the region, with Israel as the biggest loser.

The second political dimension refers to a point I made exactly a year ago, precisely inspired in the KreditAnstalt event of 1931. In an article titled: “On gold, stocks, financial repression and the KreditAnstalt of 1931” I wrote:

“(The KreditAnstalt event) was triggered because France, a public sector creditor,introduced a political condition to Austria, in exchange for a bailout of the KreditAnstalt. Today, like in 1931, in the Euro zone, the public sector is increasingly the creditor of the public sector. In 1931, England and France were creditors of Austria and demanded conditions that no private investor would have demanded.

Private investors live and die by their profits and losses. Politicians live and die by the votes they get. Private investors worry about the sustainability and capital structure of the borrower, the collateralization and the funding profile of their credits. Politicians worry about the sustainability of their power. It’s a fact and we must learn to live with it.

In 2012, Greece and increasingly other peripheral EU countries owe to other governments, the IMF and the European Central Bank. Private investors have been wiped out and will not return any moment soon. We fear that just like in 1931, when the next bailout is due either for Greece again or Portugal or Spain, political conditions will be demanded that no private investor in his/her right mind would ever have demanded.

Think of it... What in the world had the customs union between Austria and Germany in 1931 had to do with the capitalization ratio of the KreditAnstalt??? Nothing! Yet, millions and millions of people worldwide were condemned to misery in only a matter of days as their savings evaporated! Ladies and gentlemen, welcome to the world of fiat currencies! You have been warned! If months from now you read in the papers that the EU Council irresponsibly demands strange things from a peripheral country in need of a bailout, remember the KreditAnstalt. Remember 1931.

Europe's Cyprus Crisis Has a Familiar Look

When will we learn?

By Peter Coy 

To most of the world, the banking crisis that broke out in Cyprus in mid-March was as abrupt and unexpected as an outbreak of Ebola. For Cypriots, it wasn’t sudden at all. Many opportunities to steer the country in a better direction came along over the years but were missed or never tried. Now the misbegotten decision by European finance ministers to tax the accounts of ordinary depositors to help pay for a bailout of the country’s biggest banks has become a source of continentwide embarrassment.

The bailout mess roiling the capital of Nicosia and the financial hub of Limassol has plenty of only-in-Cyprus color: Russian oligarchs doing biznes in the sunny Mediterranean, a simmering conflict with Turkey, a former president who was educated in Soviet-era Moscow. Underneath the details, though, is a frustratingly familiar pattern. A small country cleans up its act and joins the international financial community. Money pours in from abroad. The cash is spent or lent unwisely under the noses of inattentive or ineffectual regulators. When losses mount, the money flows out as quickly as it came in. In the end, it’s the little guys who lose the most.

Only five years ago, Cyprus seemed to be in a sweet spot. The country had teetered on the edge since a war in 1974 that left the northern third of the island under Turkish control. For years it also had shaky government finances and a reputation as a haven for foreign money launderers and tax evaders. But successive governments worked hard to lose those bad habits as the price for admission to the European club. Cyprus balanced its budget (for two years, anyway). And it tightened banking regulations so successfully that today it’s in better compliance with the 36-nation Financial Action Task Force’s rules on money laundering than Germany, France, or the Netherlands.

Cyprus was the richest of the 10 countries that joined the European Union in 2004. Just four years later it dropped its currency, the pound, in favor of the euro. There was a brief episode of capital flight after the Lehman Brothers failure in 2008, but it was soon reversed.

For a time, being inside the EU and the euro zone benefited both Cyprus and foreigners eager to invest there. It made the country—whose population of 800,000 or so is no bigger than that of Jacksonville, Fla.—more attractive as a place to do business. It particularly lured wealthy Russians, who appreciated the country’s strong protection of property rights beyond Moscow’s reach and its 10 percent corporate income tax rate (Europe’s lowest), not to mention the balmy weather and a shared Orthodox faith. The storefronts of Limassol are plastered with signs in Cyrillic. Roman Abramovich, the oligarch whose properties include London’s Chelsea Football Club, operates Evraz (EVR), his steel, mining, and vanadium business, through a limited liability company called Lanebrook in downtown Nicosia. There’s no evidence to support German parliamentarians’ allegations that Cyprus is a haven for tax evaders. In January even Russian tax authorities gave Cyprus a clean bill of health.

When Do We Call It A Solvency Crisis?

Don't pop the champagne corks yet

by Michael Pettis

I got back last week from a two-day trip to London, where I spoke at an interesting event organized by the Carnegie Endowment. The attendees were for the most part senior bankers and investors, and I got the impression that several, though maybe not all, shared with me a certain amount of surprise that European bond markets were up this year. We were even a little shocked that the buoyant markets were being interpreted as suggesting that the worst of the European crisis was behind us. The euro, the market seems to be telling us, has been saved, and peripheral Europe is widely seen as being out of the woods.

I cannot name any of the attendees at the Carnegie event because it was off the record, but one of them who seemed most strongly to share my skepticism is a very senior and experienced banker whose name is likely to be recognized by anyone in the industry. After I finished explaining why I thought the euro crisis was far from over, and that I still expected that absent a serious effort from Germany to boost domestic spending – an effort likely to leave the country with rapidly rising debt – at least one or more countries would eventually be forced off the currency, he told the group that he hadn’t made as gloomy a presentation only because he considered it impolitic to sound as pessimistic as I did.

Neither of us, in other words, (and few in the meeting) felt that the recent market enthusiasm was justified. Never mind that the Spanish economy, to return to the country I know best, contracted again in the fourth quarter of last year, that it is expected to contract again this year, that unemployment is still rising, and that the ruling party is involved in yet another scandal that has driven its popularity down to 20%. Never mind that young Spaniards are emigrating (20,000 a month net), that the real estate market continues to drop, that businesses are still disinvesting and popular anger is extraordinarily high. The ECB, it seems, is willing to pump as much liquidity into the markets as it needs, so rising debt levels, greater political fragmentation, and a worsening economy somehow don’t really matter. This crisis continues to be just a liquidity crisis as far as policymakers are concerned – and not caused by problems in the “real” economy – and the solution of course to a liquidity crisis is more liquidity.

Forget Spain and Italy. It’s France that’s Greece-ifying before our very eyes

The French Economy is Going Down the Drain

By Gwynn Guilford 

France has so far dodged the “problem child” reputations that Spain and Italy have earned. But it looks like that will be increasingly hard to keep up. Data today on France’s business output hinted not just that its economy is decaying—but that it’s doing so rapidly.

Markit’s preliminary March purchasing managers’ index—which measures monthly changes in private-sector output—came in at 42.1 (pdf), down from 43.1 in February. (Anything lower than 50 reflects a drop in output.) That’s the fastest slowdown in business activity France has seen since March 2009. And Jack Kennedy, economist at Markit, says this likely augurs a larger crumbling of the French economy.

“My take is it’s really a continuation of the sharp weakening pattern we’ve seen in recent months—so very much a trend rather than a blip,” Kennedy tells Quartz. “Most of the anecdotal feedback from the survey panel points to a general lack of confidence and clients reining in spending accordingly.”

To frame it in another horrifying perspective, the PMI of the euro zone’s second-largest economy was lower than that of Spain and Italy—and almost down to Greek levels (video), as Reuters’ Jamie McGeever explains.

What’s most worrying is when you look at how France’s data stacked up against the euro zone’s as a whole, which were also published today. While the euro zone’s PMI (blue line) and its GDP growth (orange line) have moved pretty closely in sync, France’s PMI has become unhinged in the last couple of years. And that’s bad because, as PMI reflects business confidence, it’s typically a leading indicator of GDP growth:

One of the biggest sources of concern: France’s service sector, which contributes something like four-fifths of France’s GDP. Even as the pace of decline for France’s manufacturing output slowed, the services PMI hit 41.9, indicating the steepest drop since February 2009.

“Notably in the latest survey we saw service sector future expectations plunging to [their] lowest since [December 2008,] in the wake of the Lehman collapse which really underlines the scale of the worries at the moment,” says Markit’s Kennedy, adding that that “in turn seems to be feeding back into lower activity.”

But even if PMI continues to fall, the chart above shows that France’s GDP has proven fairly resilient—especially compared with the euro zone’s trend. So things should be okay, right?

Probably not. Kennedy chalks this ”puzzling” gap in GDP and PMI up to the difficulty in accurately measuring service-sector output in the official data. The recent blindsiding slump in French industrial production may show official data finally falling back in line with PMI, he says.

That means that the gap you see in the above chart could be about to close. GDP growth for the first quarter of this year could come in surprisingly low. If so the country’s chances for a near-term recovery are receding faster than its leaders may be willing to admit. 

JPMorgan On The Inevitability Of Europe-Wide Capital Controls

EU's Ponzi in imminent danger

With the Cypriot government still 'undecided' about what to 'take' and the European leaders very much 'decided' about what to 'give', the fact of the matter is, as JPMorgan explains in this excellent summary of the state of affairs in Europe, that because ELA funding facility is limited by the availability of collateral (and the haircuts applied to those by the central bank), and cutting the Cypriot banking system completely from ELA access is equivalent to cutting it from the Eurosystem making an exit from the euro a matter of time. This makes it inevitable that capital controls and a capital freeze will be imposed, in their view, but it is not only bank deposits that are at risk. A broader retrenchment in funding markets is possible given the confusion and inconsistency last weekend's decision created for investors relative to previous policy decisions. Add to this the move by Spain, which announced this week a tax or bank levy (probably 0.2%) to be imposed on bank deposits, without details on which deposits will be affected or timing, and the chance of sparking much broader deposit outflows across the union are rising quickly.

By JPMorgan,

Capital Control Risks

What was widely viewed as an ill-conceived Cyprus deal last weekend renewed fears of a re-escalation of the euro debt crisis. The original proposal to hit insured depositors below €100k caused a bank run and set a new precedent in the course of the Euro area debt crisis, with potential negative consequences for bank deposits not only in Cyprus but also in other peripheral countries. Once again, as it happened with the Greek crisis last May, the Cyprus crisis exposes the fragmentation of the deposit guarantee schemes in the Euro area and its inconsistency with a monetary union.

Even if the original deal is eventually revised and the guarantee for depositors with less than €100k is respected, the damage from the original proposal will be difficult to undo, in our view.

Cypriot banks are relying on ECB’s Emergency Liquidity Assistance (ELA) to avert a collapse once they open next week. ELA reflects collateralized borrowing from the national central bank rather than the ECB directly, not only at a more punitive interest rate relative to refi rate but more importantly with much larger collateral haircuts. The ECB is still on the hook under ELA because the national central bank borrows these funds from the ECB, i.e. it generates a liability against the Eurosystem. The ECB’s provision of liquidity via ELA is admittedly not a given but it will be provided to Cypriot banks for as long as Cyprus is looking to finalize its revised bailout plan, the so called Plan B.

Although the ECB always states that it provides liquidity to only solvent and well-capitalized institutions, past experience with Irish and Greek banks and even with Cypriot banks shows that the ECB has tolerated long periods of liquidity provision to undercapitalized institutions. Greece is the most characteristic case. Greek banks had access to ELA even when the bank recapitalization was pending between April and December 2012. And Greek banks had access to ELA in-between the two Greek elections when it was not even clear whether Greece would stay in the euro. Cutting the Cypriot banking system completely from ELA access is equivalent to cutting it from the Eurosystem making an exit from the euro a matter of time. This is a political decision rather than a decision that the ECB can take alone. This would effectively cut the Central Bank of Cyprus off from TARGET2 and force it along with the Cypriot government to eventually issue its own money.

But even assuming that a new deal is agreed between Cyprus and the Eurogroup and ELA continues for the Cypriot banking system after Monday, this does not mean that this ELA is unlimited. ELA is limited by the availability of collateral and the haircuts that the central bank applies to this collateral. The Greek case is the most characteristic example of how punitive haircuts on ELA collateral can be. As of the end of January Greek banks used €122bn of collateral to borrow €31bn via ELA, i.e. an implied haircut of 75%. In contrast, they borrowed €76bn via normal ECB operations posting collateral of €97bn, i.e. the implied haircut on their normal ECB borrowing was 22%. The higher haircut on ELA collateral i.e. is mostly the result of the lower quality of this collateral, typically credit claims, vs. that accepted in normal ECB operations, typically securities. But it perhaps also reflects the higher riskiness the ECB sees with its counterparty, i.e. the national central bank and eventually the sovereign, when a country's banking system has to resort to ELA.

The economics of bubbles, in Cyprus and here at home

If something can’t go on, it won’t

By Conrad Black

Thursday’s federal budget was a commendable effort that plausibly forecasts a modest surplus in two years, along with a federal debt level that amounts to 28% of GDP (barely a quarter of where the corresponding U.S. figure will be). My own view is that the government should further stabilize the country’s finances by raising the sales tax on elective spending and cut the income tax (in a way that also serves to discourage income-tax increases by the provinces). But since the federal fiscal policy generally has been sensible since the Mulroney years, a steady-on course is not a bad thing — especially as the world around us hobbles toward the finish line in the 80-year devaluation of money.

An examination of the writing of a British 18th Century author such as Dr. Johnson, and a writer from 100 years later, such as Charles Dickens, reveals that there was no increase in that time in the cost of a loaf of bread or the rental of a simple but respectable residential room in London. There were soaring economic bubbles and bone-cracking depressions, and prices followed supply and demand, but the essential currency value was constant. Unfortunately, that would change: There was no way to pay for the appalling hecatomb of the First World War, where almost the whole populations of all the Great Powers except the United States and Japan were at total war for over four years, except to increase the money supply by printing more of it.

In the Roaring Twenties, the New York stock market, especially, was a bubble, fed by the fraudulent notion that permanent growth was assured, and based largely on borrowings secured, in circular fashion, by the stock that was acquired with the borrowed funds. As soon as the market turned, it came down hard. Forced sales of the pledged stocks accelerated and broadened the plunge. Eventually, governments inflated the currencies by flooding the private sector with borrowed money.

The profusion of new, unearned money generates increased demand and starts to push prices and wages higher, but in currency of deteriorating value. This practice has stalked and haunted the world ever since.

This is essentially the trade-off that our civilization has made: Destitution will be spared all but a few people, but savings, investment, and the quest for security will be an endless treadmill on which he who earns and tries to accumulate wealth is in a constant race with the deterioration in the buying power of the currency in which he measures his wealth. Meanwhile, most useful, durable assets, such as homes and fine arts, given some astuteness on the part of the acquirer, increase in value, though they endure severe fluctuations in marketability, according to changing tastes and economic conditions.

Let us be under no illusions about the implications of these trends. Even a Cézanne painting of a bowl of fruit costs 200 times what it did 50 years ago. And, at the risk of seeming an unutterable philistine, great artist though Cezanne was, his bowl of fruit was not a better depiction than the real thing, which with a comparable bowl could be replenished with fresh fruit from the local super market, at today’s prices, for 200,000 years for less than what the Cézanne canvas would cost.

In other important news

Lockheed Martin Moves Closer to Affordable Water Desalination

Lockheed Martin has been awarded a patent for Perforene™ material, a molecular filtration solution designed to meet the growing global demand for potable water. 

The Perforene material works by removing sodium, chlorine and other ions from sea water and other sources.

“Access to clean drinking water is going to become more critical as the global population continues to grow, and we believe that this simple and affordable solution will be a game-changer for the industry,” said Dr. Ray O. Johnson, senior vice president and chief technology officer of Lockheed Martin. “The Perforene filtration solution is just one example of Lockheed Martin’s efforts to apply some of the advanced materials that we have developed for our core markets, including aircraft and spacecraft, to global environmental and economic challenges.” 

The Perforene membrane was developed by placing holes that are one nanometer or less in a graphene membrane. These holes are small enough to trap the ions while dramatically improving the flow-through of water molecules, reducing clogging and pressure on the membrane. 

At only one atom thick, graphene is both strong and durable, making it more effective at sea water desalination at a fraction of the cost of industry-standard reverse osmosis systems.  

In addition to desalination, the Perforene membrane can be tailored to other applications, including capturing minerals, through the selection of the size of hole placed in the material to filter or capture a specific size particle of interest. Lockheed Martin has also been developing processes that will allow the material to be produced at scale.

The company is currently seeking commercialization partners.

The patent was awarded by the United States Patent and Trademark Office.

Yet another prescription for a far greater disaster

Mario Draghi’s Opiate of the Markets

By Luigi Zingales

From the standpoint of European stability, the Italian elections could not have delivered a worse outcome. Italy’s parliament is divided among three mutually incompatible political forces, with none strong enough to rule alone. Worse, one of these forces, which won 25% of the vote, is an anti-euro populist party, while another, a Euro-skeptic group led by former Prime Minister Silvio Berlusconi, received close to 30% support, giving anti-euro parties a clear majority.

Despite these scary results, the interest-rate spread for Italian government bonds relative to German bunds has increased by only 40 basis points since the election. In July 2012, when a pro-European, austerity-minded government was running the country, with the well-respected economist Mario Monti in charge, the spread reached 536 basis points. Today, with no government and little chance that a decent one will be formed soon, the spread sits at 314 points. So, are markets bullish about Italy, or have they lost their ability to assess risk?

A recent survey of international investors conducted by Morgan Stanley suggests that they are not bullish. Forty-six percent of the respondents said that the most likely outcome for Italy is an interim administration and new elections. And they regard this outcome as the worst-case scenario, one that implies a delay of any further economic measures, deep policy uncertainty, and the risk of an even less favorable electoral outcome.

The survey also clearly indicated why the interest-rate spread for Italian government bonds is not much wider: the perceived backstop provided by the European Central Bank. Although investors believe that the backstop is unlikely to be used, its mere presence dissuades them from betting against Italy. In other words, the “outright monetary transactions” (OMT) scheme announced by ECB President Mario Draghi last July has served as the proverbial “bazooka” – a gun so powerful that it does not need to be used.

Big Russian money out of Cyprus

Still, crisis endangers flows

By Polina Devitt and Katya Golubkova

If Russian oligarchs still have money in Cyprus, where a lot of them base their businesses, they aren't letting on.

"You must be out of your mind!" snapped tycoon Igor Zyuzin, main owner of New York-listed coal-to-steel group Mechel , as he dismissed a suggestion this week that the financial meltdown in Cyprus posed a risk to his interests.

His response is typical across the oligarch class of major corporations and super-rich individuals, reflecting the assessment of officials and bankers on the Mediterranean island who say the bulk of the billions of euros of Russian money in Cyprus comes from smaller firms and middle-class savers.

The collapse of an economy 75 times smaller than its own may not have much impact in Russia, though the crisis has strained relations with the European Union, raised questions on Russian influence over Cypriot politicians and highlighted geopolitical competition for new offshore gas fields. But some would suffer.

As much as losses likely to be sustained on deposits held in Cypriot banks, pain for the Russian economy could come from a disruption in money flows between Russians which pass through the island - transfers that dwarf Cyprus's own national income. 

Light regulation and taxes, cultural ties through Orthodox Christianity and the weather have long attracted the capital and savings of Russians - many keen to keep their wealth out of the sight of often predatory bureaucrats at home.

Yet precisely because investors can hide their wealth behind nominee structures - often held in the name of a local lawyer - it is difficult to say just how much Russian money is tied up on the Mediterranean island. Or how much has already left.

Where it is going is also unclear, though a possible rise in Russian deposits in fellow EU member Latvia, a former Soviet republic that hopes to enter the euro zone next year, has raised concerns of displacing instability northward.

Cyprus Lifts the Curtain

The Cyprus Plan Was Too Transparent To Survive In A World Dependent On Deceit

By Peter Schiff

This week financial analysts, economists, politicians, and bank depositors from around the world were outraged that European leaders, more specifically the Germans, currently calling many of the shots in Brussels and Frankfurt, could be so politically reckless, economically ignorant, and emotionally callous as to violate the sanctity of bank deposits in order to fund a bailout of Cyprus. The chorus of condemnation may have been the deciding factor in giving the Cypriot parliament the confidence to unanimously vote down the measures in hopes that Berlin will cave or Russia will swoop in with a bailout.

The decision to inflict pain on both large and small depositors was almost universally described as a historic blunder. But the mistake was to do so in a manner that was not camouflaged by financial smoke and mirrors. In truth, rank and file depositors have been paying, and will continue to pay, for all manner of bailouts and stimulus. Whether it's through lower interest payments on deposits, inflation, higher taxes, higher borrowing costs, or the accumulation of unsustainable sovereign debt, Cypriots will bear the burden of past profligacy. But the new plan for Cyprus was far too transparent, simple, and direct to survive in a world dependent on deceit and obfuscation. It was dead on arrival.

All over the world, most notably in the United States, Britain and Japan, central bankers are actively pursuing inflation targets of two to three percent. But isn't inflation, which allows governments to pay off debt through the creation of new money that transfers purchasing power from savers to borrowers, just a deposit tax in disguise? (Read more about Japan's plan to do just that). British citizens of all means have been living with such a three percent stealth tax for the past three years, and it is expected to stay that high for at least two more years. Yet a one-time tax of 6.75% in Cyprus is seen as the ultimate act of betrayal?  

Many are lamenting that Cyprus' membership in the EU prevents it from devaluing its own currency to get out of the jam. How would such a course be morally superior? Taking actual losses on deposits is no different than taking losses through devaluation and inflation. Both result in the loss of purchasing power. Asking for a depositor haircut at least deals with the problem honestly and immediately. Although it's not quite as honest, devaluation can also be effective.

The same dynamic holds true with bailout funds. Suppose the EU were to come through with more funds? All that means is that Cypriots will have to pay more in future debt and interest repayments. In so doing they would saddle future generations with a burden that they had no hand in creating. How is that fair?   

And it's not as if depositors at Cypriot banks, many of whom are reported to be Russian citizens seeking tax havens, were not complicit in the risk taking. Bloomberg reports that over the past five years euro deposits at Cyprus banks returned more than 24 percent cumulatively, almost double the returns on comparable German accounts. The banks were able to offer such returns because they were exposed to riskier assets (i.e. Greek government bonds). What's so wrong with asking those who took greater risks to earn higher returns to give something back when their decisions go bad?

Cyprus : Designed for Failure

What are the alternatives?

by Thorsten Beck

The Cypriot banking system is insolvent; it needs a large capital injection. As in several other peripheral states of the Eurozone, Cyprus cannot resolve the crisis alone. Given an already high debt-to-GDP ratio and an oversized banking system, recapitalising the banks via sovereign debt would produce unsustainable sovereign-debt levels and, ultimately, sovereign default. In short, Cyprus’s banks are too big to fail, and too big to save.

This is why Cyprus negotiated a rescue package with the Troika – ECB, European Commission and IMF. The ‘bailout’ agreement (in quotation marks, as it is not quite sure who is supposed to be bailed out here, certainly not Cypriot taxpayers and their children, to be burdened with debt for a long time) is still in the making and might even fall through. The damage, however, has already been done. There has been a complete loss of confidence, not only in the Cypriot banking system but also in the crisis-management capacity of the Eurozone.

The Saturday morning hangover

The decision taken in the early hours of last Saturday caused indignation and rejection across Europe, and rightly so. While imposing market discipline is a useful aim, and long overdue after four years of bailouts at the expense of taxpayers and future generations, the way it was originally to be imposed in the case of Cyprus has been more than counter-productive.

Economists and practitioners alike point to a couple of common principles in bank resolution. One is respect for creditor ranking:

·         Equity holders take a hit before junior debt holders;

·         Junior debt holders take a hit before senior creditors and uninsured depositors.

·         Insured depositors should take a hit last.

Such a creditor ranking is based not only on legal rules, but also on the idea that claims should be priced according to their risk and expected repayment in case of failure.

The ‘bailout’ deal with Cyprus foresees, however, a tax on deposits, originally imposed on all deposits even those covered by the EU-wide deposit insurance. Put differently, insured depositors suffer a haircut, while uninsured depositors still maintain a large share of their claims. This seems a violation of the creditor ranking, in spirit if not in the letter of the law.

In order to not violate the promise of deposit insurance of up to 100,000 euros, what the agreement calls a tax is effectively an insurance co-payment. There is nothing to be said against co-insurance, which can improve market discipline, but introducing it ex-post constitutes a clear violation of trust. And if it walks like a duck and it quacks like a duck, let’s call it a duck! This is not a tax, but an ex-post insurance co-payment and loss-sharing arrangement.

But there is more. Imposing losses on depositors is to be done in order to reduce the risk of sovereign over-indebtedness and thus guarantee repayment of current sovereign-bond holders. Imposing losses on insured bank depositors to thus guarantee repayments to sovereign-bond holders violates another political priority of putting (certainly more sophisticated) bond holders above (mostly less sophisticated) holders of small deposits.

Finally, imposing a tax on depositors of all banks, independent of the financial situation of each bank, further undermines market discipline. Yes, it seems an easier option, requiring less administrative effort, but it sends the message that investors do not have to price investments properly as the haircut is the same across banks. And it increases herding trends towards aggressive risk-taking.

Addressing the problem at its core

The Cypriot economy is in crisis, for many reasons. But the insolvency of the banking system is at the core of the current crisis, and should therefore be the focus of the resolution. The literature on resolving bank crises has pointed to several important lessons. On is that losses should be recognised early on, allocated and then managed. While the flow solution, i.e. re-establishing solvency of the banking system through retained earnings or future government earnings, seems attractive as it avoids immediate pain, it comes at high risks.

For Earth Hour, let’s celebrate electricity as a ‘gift of the gods’

The difference between the Dark Ages and the present

By mark perry

“On the evening of March 23, 1.3 billion people will go without light for the rest of the night—just like every other night of the year. With no access to electricity, darkness after sunset is a constant reality for these people. See the video above from Bjorn Lomborg’s environmental think tank - the Copenhagen Consensus Center - with a different message for this Saturday’s Earth Hour.”

According to the WUWT blog, the picture below shows a satellite view at night of North Korea, the winner for Earth Hour in every year since 2003. Odds favor them to be the winner again this year. Earth Hour has been such a stunning success in North Korea, that it’s “always Earth Hour there”, according to Alan Caruba, who comments that “electricity is truly a gift of the gods. It is the difference between the Dark Ages and the present age.”

How Do You Say “Quagmire” in French?

Embers of War: The Fall of an Empire and the Making of America’s Vietnam

President Lyndon Johnson in Vietnam with Gen. Westmoreland and South Vietnam's Lt. Gen. Nguyen Van Thieu and Prime Minister Nguyen Cao Ky

By LEON HADAR

Graham Greene’s novel The Quiet American—adapted into films in 1958 and 2002—was inspired by the author’s experiences as a war correspondent in French Indochina in the early 1950s, in particular by his conversations with American aid worker Lee Hochstetter while the two were driving back to Saigon from a tour to Ben Tre province in the countryside in October 1951.

As the Swedish-born historian and Cornell University professor Fredrik Logevall recounts in Embers of War, during their ride to the city Hochstetter, who had served as the public-affairs director for the U.S. Economic Aid Mission in Saigon, lectured Greene about the need for a “Third Force” in French-ruled Vietnam, one not beholden either to the French colonialists or to their main adversaries, the guerilla forces led by Ho Chi Minh.

Ho’s fighters—the Viet Minh, a nationalist and communist movement—operated from Hanoi in the north of the country and were resisting French attempts to re-establish control over Indochina after the end of Japanese occupation in 1945, part of a wider strategy of restoring the French empire in Southeast Asia and elsewhere.

But as Hochstetter explained to Greene, French efforts to defeat the Viet Minh militarily while denying the non-communist Vietnamese real independence were doomed to fail. The Vietnamese fighting on the side of the French against Ho had to be convinced that they were advancing the cause of democracy for their own country, the young American aid worker insisted. “The only way to make them so convinced was to build up a genuine nationalist force that was neither pro-Communist nor obligated to France and that could rally the public to its side,” writes Logevall.

In The Quiet American—set in 1952, and which Greene started writing that year in his hotel room in Saigon—the character of Alden Pyle was modeled after Hochstetter (and not, as some have speculated, after the legendary Cold War-era counterinsurgency strategist Edward Lansdale). Pyle’s views are described to the novel’s protagonist, a British war correspondent named Thomas Fowler (based on Greene himself), as follows: “There was always a Third Force to be found free from Communism and the taint of colonialism—national democracy, he called it; you only had to find a leader and keep him safe from the old colonial powers.”