The Causes of Economic Crisis

This week's story is Cyprus- another European periphery country in economic crisis, requiring a bailout from the ECB or someone.  Natually this caused my right wingnut email correspondent to fire off a missive about Cyprus's fiscal profligacy and the Doom that awaits the US if we don't solve our deficit problem.



But why did Cyprus's banking industry implode?  Should we blame it on liberal government spending?

No.

OK, I admit it, I knew nothing about Cyprus.  Now I know next-to-nothing about Cyprus.  But I'm reading up online a little.  And the story isn't complicated- it's nearly the same as the Irish story and the Iceland story, with a few twists.  Banking sectors become incredibly large, investing lots of leveraged money poorly (in this case, I guess they invested in Greek government bonds- OOPS!).  In Cyprus, they had lots of money to invest because they were a banking haven where wealthy Russians could go to avoid taxes. (In Ireland and Iceland, the banks attracted investors from Germany and UK especially).  In all three places, the banks were about to go bust, and so the government had to step in, but the numbers were too massive for such small countries to fund the bailouts, so they were screwed.

But where does government incompetence and overspending come in?  Sorry, wingnuts, it doesn't.  Yes, yes, that story plays in Greece, and it plays to a lesser extent in Italy, but not here.  Not in Spain and Ireland, which were running budget surpluses before 2008.

 

When you're a hammer, everything looks like a nail.  For people who have decided that government deficits will be the death of us all, every problem can be explained by deficits if the shoehorn is flexible enough.  But when a country goes in the tank because the banking industry fails, where does the blame actually lie?  With the banking industry!  And with the governments' failure to adequately regulate the industry.  That's the real message.

 

I guess my critics will say I'm just a regulation-guy hammer, so regulation is the answer to everything.  But at least my argument follows a logical progression from problem back to cause.

 

And there's another reason that Cyprus is totally screwed: they don't print their own money, so they can't devalue, they can't increase the money supply, they can't cause inflation to rise.  The European monetary system is controlled by Germany, and is run for the benefit of the German economy and nobody else.