Cyprus

by Jerry O’Driscoll

Think Markets
April 1, 2013

Cyprus is the latest country to succumb to the financial rot in the European Union. Once a banking center, its citizens now cannot pay for their own imports. Exporters are demanding cash only for goods sent to Cypriote businesses. Credit has dried up. Businesses are closing because they have no goods to sell.

The economic crises in the various countries have fallen into two types. In the first type, highly indebted governments experienced fiscal crises and could no longer service their debts. Banks had lent to these governments and their condition was impaired by the value of the government bonds falling. The economies went into recession, which was aggravated by higher taxes and enhanced collection of taxes. Greece is the poster child for a financial and economic crisis begat by a fiscal crisis.

In some countries, the country’s banks engaged in imprudent lending to private firms – typically property developers and overextended homeowners. The banks became insolvent as the loans soured. Credit was curtailed and the economy went into recession. Then government revenue fell and a fiscal crisis ensued. A highly indebted private sector and irresponsible banking sector caused a fiscal crisis. Ireland and Spain exemplify this type of crisis.

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