After the Cyprus deal – Schroders suggests eight lessons for investors

27th March 2013

Robert Farago, head of asset allocation at Schroders Private Bank has compiled a list of the eight lessons for investors to learn from Cyprus. It’s one of the best summaries of the situation and the implications we have read.

1) In an imperfect, seventeen-country currency union, no country is too small to matter. Cyprus is a country of just over one  million people at the very periphery of the euro  area. The enormous size of its banking sector  relative to the underlying economy means that if it were outside the euro area it would likely have followed the path of the Icelandic bust. Instead, Europe and the IMF were impelled  to step in with additional support rather  than risk the loss of a single member of the  currency union.

2) The markets continue to have faith in Mario Draghi’s statement of last summer that the European Central Bank will do “whatever it takes” to keep the currency intact. Prices of European stocks and peripheral euro area bonds have so far been barely impacted by this crisis.

3) Investors should expect the  unexpected in the form of rule changes from overly indebted governments. While ultimately rejected, the fact that anyone in authority could have proposed a tax on small depositors is shocking.

4) Capital controls will likely top the list of rule changes for any country heading into a crisis from now on. The attack on bank depositors in Cyprus will clearly increase the risk of a bank run in the next country  that runs into trouble.

5) The event is a reminder that financial crises and government debt crises are intrinsically interlinked. The financial crisis of 2008 saw governments around the world step in to prop up ailing banking systems. Now we see a government forced to tap bank deposits to fill the holes in its own balance sheet. While the Cypriot tax on depositors is for now a one off, banks in the UK and elsewhere have been forced to increase their holdings of government bonds in the name of prudent capital management.

6) Gold remains the obvious safe haven when money itself is under threat. The amount of gold held in exchange traded funds had been shrinking this year as investor confidence in the rebound in the US economy grew.

7) A Euro area banking union remains some way off. Yet this is the necessary next step towards a stronger currency union. It was clearly politically unacceptable for German taxpayers to support the Cypriot banking sector, where a fifth of deposits come from Russia. Yet a true banking union would not allow the authorities to be selective about which country’s banks they wish to support.

8) Finally, investors should not dismiss the Cypriot’s appeal to Russia for help as a one off. The current crisis has parallels with the late nineteenth century. Back then, a small number of London-based merchant banks formed a closely-knit group that dominated lending to the developing world. When a borrower ran into trouble, they cooperated to ensure they achieved the best possible outcome for the lenders. However, as the number of problem loans multiplied, eventually a bank would break ranks. They negotiated a bilateral arrangement that protected their own interests ahead of their peers. It would not be without precedent, therefore, if Cyprus had reached a financing deal with Russia using their gas fields as collateral.

13 thoughts on “After the Cyprus deal – Schroders suggests eight lessons for investors”

  1. Anonymous says:

    Hi Shaun,

    China’s economy is outgrowing it’s administration. There is a limit to how rich you can become by manufacturing cheap substitutable items.To invest serious money in R&D and/or modern robotics needs a transparent legal system with property rights the investors can trust. A murky legal system with questionable support for property rights is a driver of middle class immigration and so is pollution.

    While China is struggling, I expect US manufacturing to perform better. Decent administration encourages and rewards innovation. High value manufacturing is more profitable and quality is easier to control onshore. Boeing has a good civil airline order book. US military hardware is not offshored for security reasons. Australia has increased it’s JSF order by an extra 58 planes. Finland is also evaluating the JSF. Poland wants US bases and troops on Polish soil. I suspect the US military – politician – lobbyist – military industrial complex link will help swing Polish (and maybe Baltic, Visegrad) military purchasing decisions towards US hardware. Many countries bordering Russia are fearfully re-evaluating their military spending.

    1. dutch says:

      ‘In China, “protected by law” has a much different meaning, however. Ordinary citizens take the phrase to mean that the Chinese government guarantees bank deposits.

      Yet the guarantee is only implicit, and when the China Banking Association, a trade group, issued a statement on Wednesday that “there is no risk of bankruptcy,” it was not telling the truth. In fact, regulators have let banks fail in the past. The famous failure is Hainan Development Bank, closed in 1998.

      Moreover, Beijing officials, well before Wednesday, have been preparing the public for more failures. In
      November, Fang Xinghai, a bureau director of the Communist Party’s
      Central Leading Group for Financial and Economic Affairs, said that the
      possibility of bank runs or bankruptcies in 2014 was “very high.”’

      1. Anonymous says:

        Hi Dutch

        From the marvellous Yes Minister on official statements.

        James Hacker: No, but it’s never been officially denied. First rule in politics: never believe anything until it’s officially denied.

        It comes up just before the 22 minute mark here.

    2. Anonymous says:

      Hi ExpatInBG

      I think that the UK has a small share of J-35 production although I suspect that current fears about Russian expansionism may only keep the program as forecast. Otherwise there would have been cuts. But I guess the military industrial complex is smiling right now..

      However some nations are planning major changes. From AFP at the end of March.

      “Lithuania and Latvia say they will increase defence spending by 2020 to NATO’s recommended two percent of gross domestic product, from the current level of one percent of GDP.”

      I do hope that nice Mr.Putin will wait….

      1. Anonymous says:

        There is also Baltic energy security talk about building an LPG import terminal and a new reactor at Visaginas.

        Many wars are decided by economic factors. Russia is big enough to bully divided and unprepared European nations, but a united NATO is just too big to beat conventionally. If Putin does manage to embarrass Obama Jimmy Carter style, I’d expect the next POTUS to be a bellicose republican. Putin may succeed in destabilising or occupying Ukraine, but it’s likely to be a Pyrrhic victory that unites NATO and alerts them who they are dealing with. The USA has proved itself capable of facing down nuclear brinkmanship.

        The 1970s oil embargo eventually led to an oil glut which proved bad for the USSR. Energy supply brinkmanship will cause Europe to find alternate energy sources.

        The ruble is already weak and I’ve heard rumours that international money transfers from Russia are taking over 10 days. I really wish that Putin could call off the paramilitarys and let the diplomats settle matters peacefully – that’s the best result for civilians everywhere.

  2. Noo 2 Economics says:

    Hi Shaun – not much interest today. The answer is an economics version of indigestion. Expect GDP to pick up (slightly) from Summer/early Autumn.

    China has reached a crossroads, carrying on subcontract manufacturing is no longer the answer. It’s got to start migrating to more R & D and service industries. Theres no reason why Government companies can’t undertake this work if private enterprise is fearful of losing intellectual property rights. Whether it can make the transition we will not know for 5 – 10 years.

  3. dutch says:

    ‘China’s Income Inequality Surpasses U.S., Posing Risk for Xi’

    ‘The income gap between the rich and poor in China has surpassed that of the U.S. and is among the widest in the world’

    hattip HPC.

  4. Paul C says:

    China has to slow, because it was statistically impossible to grow in a compound manner as they were doing. Pollution is causing a natural break too, with old and young people’s health at serious risk a biological brake is coming into play. I’ve been selling my solution to the city of Xi’an and they can’t quite bring themselves to buy it yet but things will get worse before they get better so has got legs I reckon.

    They have some industrial hangovers and mass consumerism in country is probably one of the few ways out. Some of the financial stories are over-hyped, of course there is a lot of state and oligopolistic finance controls but do not under-estimate their innovation in financial products. We in the west think we lead the world with our 1980’s deregulation and license to print money for banker and governments.

    The Chinese are wise to our London money market manipulation and fraudulent PPI and over-charging fiascos. At present perhaps they are little better but watch as they unleash a wave of consumer financial solutions. When was the last time you stood-up following a shared meal with colleagues, reached forward and “waved” your smart phone to achieve and even split of cash and instant bank payments from every diner directly to the restaurant?

    There has been mis-reporting of instability of small local banks, suggestions by western media of “runs” on those banks. In some cases those “old” banks were only offering 0.5-1% interest rates (sound familiar?) and deregulation has allowed some virtual banks to offer introductory interest rates of 8%. If you have your savings in a rickety local bank where you queued to get your cash and an alternative came up that gave you 8%, would you move your money about? Pity I can’t see that happening in the UK, now why is that?

    Paul C

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  6. Jim M. says:

    hi Forbin (and hi Shaun)

    I must confess, I had to google “salad shooter” to tease out the full meaning of your comment.

    It is gratifying, is it not, to see the huge leaps forward we have made in kitchen essentials in my lifetime. Surely the day of the knife is almost over? I can remember a time when we had to rely on one of these to do… erm… whatever it is these things do.

    Can’t stop… busy daytime tv schedule to attend to. A man’s gotta keep up with what’s going on, y’know!

  7. Anonymous says:

    Hi Forbin

    The trouble is from a Chinese perspective how much money can be made out of such products where there is always another low-cost competitor around the corner. Maybe the return to a type of competitive devaluation strategy is a confession of that..

    Meanwhile speaking of the impact of 1 billion Chinese.

    It is a funny old world as I had to confess I had thought of chopsticks as being renewable and green….

  8. forbin says:

    when I saw just the top of the picture with


    I immediatley thought of Wallace & Grommits solution to the Bankers ! ( a la madam guillotine ! )


  9. Anonymous says:

    Hi JimM

    If it helps I had never heard of a salad shooter either! As to knives well the link about chopstick use leading to deforestation in China may mean the humble knife and fork gets a boost…

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