The EU Crosses the Rubicon

This weekend, the government of Greek Cyprus — under pressure from the European Union — negotiated a bailout that had as one of its provisions an assessment on the capital of those with deposits in the banks on Cyprus. Those with under 100,000 Euros in their accounts are slated to receive a 6.6% haircut while those with more than 100,000 Euros in their accounts will be docked 9.9%.

Whether the government can secure the approval of the Cypriot legislature for this unprecedented move remains unclear. There is talk of lowering the tax on deposits under 100,000 Euros to 3% and of raising the tax on larger deposits to 12.5%. But while the difference no doubt matters to ordinary Cypriots, whose savings are modest, and to the Russian oligarchs who have parked huge sums in the Cypriot banks, when viewed from a larger perspective, it matters not one whit. Indeed, at this point, it does not even matter whether the Cypriot government backs off from this plan altogether.

Banks are fiduciary institutions. The rely on trust; and, if there is a breach of trust, they are cooked. Individuals deposit money in banks instead of stuffing it in their mattresses because they believe that it will be safe there. Once they realize or even suspect that the money they put in the bank is anything but safe, they will take what is left of their money and run — and the bank will collapse. And Cyprus is not Las Vegas. What happens in Cyprus cannot possibly stay in Cyprus.

The Greeks will draw their own conclusions, as will the Spanish and the Italians and perhaps even the Irish and the French. No one who lives in a country that is in financial trouble and that may need emergency help from the European Union will entrust his loose change to a bank in his own country. The Euros is his mattress will retain their full value; those which he entrusts to the bank may, at least in part, be confiscated. All of this ought to be a boon to the Swiss.

It would be hard to imagine what one could do to turn an ongoing crisis into a total catastrophe that would be more effective than the terms imposed by the European Union on Cyprus. That such a move is in contemplation is an indication of the degree to which the authorities in Brussels and Nicosia are in the grips of desperation.

Greek Cyprus got into in trouble in large part because of those Russian deposits. The banks there had a great deal more money than they knew what to do with on the island, and so they loaned money to their less than creditworthy cousins in the republic of Greece. Now they have obligations that they cannot pay, and so they have turned to Brussels.

Had Greek Cyprus not joined the Euro, this problem would be relatively easy to solve. The government could simply devalue the currency and give the Cypriot banks’ Russian depositors a haircut in this time-honored fashion. That is what was done with considerable regularity in places such as Greece and Italy before they joined the Euro; and, if the Cypriots could do it now, it would have this virtue. The haircut imposed on their own citizens would — initially, at least — be less onerous. Abroad, the savings of the Cypriots would buy them less, to be sure. But, at home, for a while, it would buy them what it had before. Moreover, what the Cypriots produced at home would be more competitive in the world market — since its purchase would set the buyer back less — and as a tourist destination the island would be more attractive, since accommodations and food would for foreigners be cheaper than it had been. For a time, there might even be a boom.

I am not suggesting that devaluation is a joy nor that its long-term consequences are salutary. It isn’t a joy, and the consequences are not good. Inflation is apt to erupt, and inflation can all too easily become habitual. But a devaluation of the currency would not lead to a complete collapse of credit, which this tax on savings might well achieve.

Credit, you need to keep in mind, is what makes the world go round. Modern economies do not operate on cash. They operate on credit — which is to say, they rely on the very trust against which the European Union and the Greek Cypriot government have launched a devastating attack.

All of this ought to be enough to persuade Barack Obama to seriously tackle the United States’ deficit spending. But it won’t be. About our welfare, he doesn’t give a damn. if we were to reach the tipping point and there were another financial crisis, he would welcome it as yet another opportunity to impose his will on the hapless Republicans and advance his agenda. The motto for this administration should be Rahm Emanuel’s infamous dictum: “You should never let a crisis go to waste.”

  1. Steve MacDonald

    When I first read the initial reports this morning (I live in Asia), I wondered if this could be the Archduke Ferdinand moment, or the Black Swan that sets the economic model “reconfiguration” going. It is after all, EU imposed outright theft of citizen assets and renders meaningless the EU deposit guarantee system. It does away with the niceties of the Ireland, Spanish and other solutions that at least disguise the citizenry subsidy of the banks – this is the direct deal.  

    I reached out to a bunch of Europeans while they slept, asking for their and others reactions to this development. I suspect there will be little at first but will grow during the week.  Can’t wait to get their feedback. 

  2. Paul A. Rahe
    C
    Steve MacDonald: When I first read the initial reports this morning (I live in Asia), I wondered if this could be the Archduke Ferdinand moment, or the Black Swan that sets the economic model “reconfiguration” going. It is after all, EU imposed outright theft of citizen assets and renders meaningless the EU deposit guarantee system. It does away with the niceties of the Ireland, Spanish and other solutions that at least disguise the citizenry subsidy of the banks – this is the direct deal.  

    I reached out to a bunch of Europeans while they slept, asking for their and others reactions to this development. I suspect there will be little at first but will grow during the week.  Can’t wait to get their feedback.  · 2 hours ago

    Write a post and pass what they say on to us!

  3. Joseph Eagar

    I guess if the U.S. monetary union survived the depressions of the late 19th and early 20th centuries, the eurozone could survive this.  Of course, the dollar has the advantage of being issued by a single national government, in a country that restricts fiscal deficits at the provincial level.

    The key to a successful monetary union is breaking the link between the union’s banking system and the financial health of the individual sovereign states.  The Europeans understand this, but with elections in Germany approaching they can’t do anything about it.

  4. Paul A. Rahe
    C
    Joseph Eagar: I guess if the U.S. monetary union survived the depressions of the late 19th and early 20th centuries, the eurozone could survive this.  Of course, the dollar has the advantage of being issued by a single national government, in a country that restricts fiscal deficits at the provincial level.

     · 50 minutes ago

    In theory, we restrict fiscal deficits at the provincial (i.e., state) level. But do we do so in reality? California? Illinois? New York?

  5. Barbara Kidder
    Paul A. Rahe

    Joseph Eagar: I guess if the U.S. monetary union survived the depressions of the late 19th and early 20th centuries, the eurozone could survive this.  Of course, the dollar has the advantage of being issued by a single national government, in a country that restricts fiscal deficits at the provincial level.

     · 50 minutes ago

    In theory, we restrict fiscal deficits at the provincial (i.e., state) level. But do we do so in reality? California? Illinois? New York? · 22 minutes ago

    Please write a post to illustrate this point!

    We need a ‘tract’ (much like religious sects use) to show the unholy alliance between the unions and the Democratic Party, with examples tailored for each one of these states.

     The analogy that comes to mind is that of a pack of hyenas bringing down a water buffalo (an illustration of which should be on the front of the brochure)!

  6. Aaron Miller

    Have we already forgotten when our own government stole from GM stockholders in a similar manner? Americans kept investing despite that breach of trust, presumably because they didn’t like the alternatives. They doggedly continued to trust.

    Even if theft from a bank is worse, why expect different results now?

  7. Aaron Miller

    Y’all might also consider a more extreme example of government theft: the Venezuelan government’s seizure of oil companies. What effects did that have on the Venezuelan market? Whatever the effects, one thing is clear: Venezuelans pushed on for their own interests — the market adapted to a new, terrible norm.

  8. Paul A. Rahe
    C
    Aaron Miller: Have we already forgotten when our own government stole from GM stockholders in a similar manner? Americans kept investing despite that breach of trust, presumably because they didn’t like the alternatives. They doggedly continued to trust.

    Even if theft from a bank is worse, why expect different results now? · 47 minutes ago

    There are alternatives to banking in Cyprus, Greece, and Italy.

    Actually, no one stole anything from GM stockholders. It was the bondholders who suffered theft. But, yes, people still buy bonds — albeit, I suspect, with a bit more care. I would not want to own the bonds of a company in trouble if it had a unionized work force — not in the age of Obama.

  9. Richard Fulmer

    And if you have to create a crisis…

  10. Jeff

    It’s also important to note that the modern money system, being an extension of the modern central banking system, is based on credit too. Since every creditor has a debtor, we could also say that the system is based on debt.

    Currency is backed by the taxing power of the government to pay debts. Thus, the central banking system creates powerful incentives for governments to increase taxes and debt.

    Central banks set the interest rate, manipulating the price of money. This creates incentives for malinvestments that create and gluts in incalculable ways throughout the economy. The real estate bubble was only the most visible manifestation of the malinvestment problem.

    Debt, tax increases to service debt, twisted and warped capital investment. Welcome to the 21st Keynesian century.

    The corrective to all this is of course freedom. Eliminate legal tender laws. Simply allow everyone accept or decline whatever currency they wish for each and any exchange.

  11. Scott R

    That “9.9%” is precious. Thank God it’s not 10%!

  12. Matthew Gilley

    Hold fast to your 401(k).

  13. Freesmith

    Does anyone wonder how corporate profits can be up in a stagnant economy? Could it be ZIR and QE?

    Can artificially restrained interest rates lead to wealth creation in anything but paper assets?

    Did you know that total consumer debt is higher today in the US than it was before the 2008 crash? Credit card debt is lower, but not total indebtedness.

    Seeing more of those “no interest, no money down” pitches on TV for cars and appliances lately?

    Consider the American college student: today, he graduates with the equivalent of a mortgage, but no house. Which kind of puts him out of the housing market, don’t you think?

    Single-family home prices are inching up, not surprisingly in a period of decreased supply. But maybe you’ve seen the increase in bank-owned rental residential properties now on the market? They were formerly called “single-family homes.”

  14. John Murdoch
    Barbara Kidder:

    Meanwhile, back in the U.S. we read of “sinkholes” in Florida and Pennsylvania….

    Sinkholes in Pennsylvania have far more to do with broken water mains in communities built on limestone than the strength or weakness of the nation’s finances.

    Sinkholes hereabouts are a nuisance–but they’re a fact of life. The area between Bethlehem and Portland, Pennsylvania is one giant mass of limestone–which is why the Portland cement industry developed here.

    The sinkhole in Bethlehem Township opened because of a water main break; but we see sinkholes happen when any kind of change in the water table disrupts the underground. The most exciting happened a few years back, when Hercules shut down a quarry (and thus stopped pumping out the water) outside of Stockertown. The change in the water table opened a sinkhole that undermined two bridges on a nearby highway–causing the northbound side of the highway to drop 12″ in a matter of a minute or two. Fortunately it happened on a Sunday morning, and the local state police barracks was a half-mile away–so nobody was hurt. But both bridges had to be replaced.

  15. John Murdoch
    Steve MacDonald: …I wondered if this could be the Archduke Ferdinand moment….

    I wondered exactly the same thing. Some questions that I think will tell us how this plays out:

    1a. Friends and family: When Cypriots rushed to ATM machines, they reportedly discovered that the banks had already seized the 6.6% “contribution.” Which means the banks knew in advance–they had to execute a bunch of transactions immediately after the chose of business on Friday. Who knew in advance, and got their money out?

    1b. Political ramifications of “Friends and Family”: When the F&F list becomes public, how violent will the mob response be? Will we see government/banking officials trying to flee the country?

    2. Russian fatcats: By all accounts, Cypriot banks are stuffed with cash from Russian high-rollers–they’re the ones taking the 9.9% “haircut.” (And the ones prevented from using EFT to get their money out of Cyprus.) Are they influential Russians (i.e. with political ties to Putin)? Or are they out-of-favor Russians trying to hide cash from Russian tax authorities? 

    3. Thus, will Vladimir Putin and the Russian government view this as an attack on Mother Russia?

  16. Barbara Kidder
    John Murdoch

    Barbara Kidder:

    Meanwhile, back in the U.S. we read of “sinkholes” in Florida and Pennsylvania….

    Sinkholes in Pennsylvania have far more to do with broken water mains in communities built on limestone than the strength or weakness of the nation’s finances. · 12 minutes ago

     Sorry that my obtuse metaphor was meant to point out the hidden dangers here at home!

  17. John Murdoch

    More questions:

    3a. Or will Putin and the Russian government snicker at the beating the tax cheats are taking by investing in Cypriot banks?

    3b. If 3a is true (or…not), did the EU consult with the Russian government beforehand?

    4. What is happening to bank liquidity in Greece, Italy, Ireland, Portugal, and Spain?

    5. Remember that “Cyprus” is really Greek Cyprus. There’s a Turkish Cyprus, too, on that same island–and Turkey is not part of the EU, or the Euro zone. What role/mischief can/might/will Turkey play as a result?

    6. What American financial institutions have exposure to European banking? If this prompts a run on Euro-zone banks, the Fed should publish a list of American banks with significant deposits in the Euro-zone, and keep that list–and it’s daily changes–publicly visible.

    The instability of banks in the Mediterranean has little to do with deficit spending in the U.S.–or California and Illinois. Apples and oranges. Long term deficits are a very different thing from immediate term liquidity.

  18. John Murdoch

    The problem with immediate term liquidity (put another way, “what the [CofC violation] do you mean I can’t get my money out of my [CofC violation] account?!?!? I’ll [CofC violation] [CofC violation] somebody!!!”) is that it provokes panic, and rage.

    The question instantly becomes, rage against whom?

    If this is cast as rage against the impersonal, unknowable European Union, the crowd might be stymied. If this is cast as rage against the Germans, who are facing an election and an electorate that is bitterly opposed to bailing out the rest of Europe, the crowd might very well get violent. And do things like sack the German embassy, burn German cars, etc.

    In other words, this could get really ugly. And if there is even a rumor that it will happen in Greece (30% unemployment?) Spain (25% unemployment, and over 50% among young people?) or elsewhere, it will become multi-national ugly.

  19. John Murdoch

    The funny thing is, the impact on the U.S. will be positive. The U.S. is the de facto safe haven that cash will fly to–the price of T-bills and interest rates on deposits will plummet. The dollar is soaring in value this morning, and will likely only continue upward, particularly against the Euro.

    That, in turn, means that the U.S. government (and the financially wobbly states like California, Illinois, and New York) will likely benefit from even lower interest rates for years–maybe even decades–to come.

    Crazy as it may sound, this is pretty good news for the Obama administration. They’ll be fools to smirk–but U.S. government securities will be the beneficiaries of all of that cash fleeing the Euro zone.

  20. CuriousKevmo
    Matthew Gilley: Hold fast to your 401(k). · 12 hours ago

    how?

    I’m not being a smart a** when I ask that, it’s a legitimate concern for me.  Like I suspect most people reading this post, I’ve sacrificed a bit to save 10+% of my income over the years to acquire a nest egg to cover me in my twilight years — especially since the conventional wisdom since I came of age was that Social Security wouldn’t be there.  But now, it would seem I was a sucker, either through confiscation or the running of the printing presses, my savings will be worthless and I’ll be working until the day I die.

    I’d love to figure out how best to insulate myself from this mess, but I’m a software geek, not a financial guru.

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