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.”