Will Cyprus start the dominos falling?

Greece didn't drop the Euro but there's a new threat to the common currency -- Cyprus. The country with a tiny economy (one about the size of Scranton, Pennsylvania) may abandon the Euro, thanks to the uproar caused by the "Troika's" (the European Central Bank, the European Union and the IMF) plan to force depositors to fork over a percentage of their fully guaranteed bank deposits to help finance the rescue of the country's banks.

The proposal, which isn't prospering, would have had savers take a haircut to pay bond holders 100 cents on the dollar. If implemented, it would toss aside the hitherto sacrosanct principle that a government guarantee of bank deposits is a hell or high water guarantee.

If ever there was an incentive to move money out of the banks of weaker countries (like Cyprus, Greece, Spain, Italy, etc.) into the banks of strong ones (like Germany), this is it. What a recipe for capital flight and for a death spiral for weak banks!

The problem is that there's still no other solution and Cyprus faces a March 25 deadline. Stay tuned for the result of the frantic negotiations that will undoubtedly be occurring over the weekend.

Quantitative easing: not without risk...

In his testimony before the Senate Banking Committee several week ago, Fed Chairman Ben Bernanke said as clearly as central bankers ever say anything that the Fed will NOT tighten monetary policy in the near future. He recognized that the Fed’s policy experiments carry risks but he deemed them manageable or worth taking. 

There are three broad risks associated with the Fed’s QE programs. One is the inflation risk, which the Fed is confident it can manage. The Governors believe the Fed has the tools to tighten monetary policy when necessary. In any case, inflation is not a problem now and inflationary expectations are low.

A less obvious risk is to the federal budget. The Fed earns interest on the assets it has purchased. Between 2009 and 2012, the Fed sent the Treasury on the order of US$290 billion, roughly triple its pre-QE remittances. When the Fed implements an “exit strategy” from its QE program, the interest earned and, consequently, the remittances to the Treasury will fall. Mr. Bernanke expects that even after the exit, the Fed’s remittances to the Treasury will be above pre-crisis levels. A recovering economy, a pre-condition of the exit, generates higher tax revenue, which would more than compensate for the decline in Fed remittances.

A third risk is to financial stability. With US interest rates so low and liquidity flooding the system, portfolio managers may “reach for yield” by taking on riskier credits, greater leverage or lengthening their exposure. The extraordinary inflow of portfolio investment directed to Mexico over the last three years exemplifies how low interest rates and ample liquidity in the US can affect other economies. Mr. Bernanke recognizes that investors may pile on risk in the search for higher returns but believes the benefits of stronger growth and job creation in the US justify the risk. 

The cost-benefit analysis for this last risk -- to financial stability -- may be different for the US and the recipients of massive portfolio inflows, like Mexico. Yes, Mexico will benefit from a stronger US economy. But, the vulnerability to the movements of foreign investment in fixed income obligations and equities is much greater for Mexico than for the US. Time will tell...

At work on immigration reform...

After the votes were counted in the US last November, immigration reform became a hot issue in Washington. That one of the top items on Mexico's agenda in the bilateral relationship is center stage in American politics has everything to do with American politics.

The "Group of 8" (four Republican and four Democratic Senators) are thrashing out a legislative proposal that stands a chance of passage. According to today's Washington Post, the "8" are discussing redistributing visas: fewer family members would receive priority so that more visas could go to qualified workers. The Migration Policy Institute says that about 65% of legal immigrants are admitted for family reasons. Only 14% of legal immigrants are admitted for employment.

The discussion is centering on who should qualify as "family" for visa purposes. Presently, spouses and minor children have first priority. Unmarried children older than 21 are next, followed by married adult children and siblings. An idea being floated is to eliminate the latter two categories, which would free up about 90,000 visas a year. Those visas could go instead to qualified workers. Married adult children and siblings could still apply for a visa but they would need other qualifications (such as highly technical skills) to get a green card.