Pandora’s
Box: The Cyprus
Story
Well here
we are again, with yet another European country in financial distress and the
‘troika’ (European Commission, ECB, and the IMF) riding to the rescue. After a
brief hiatus the ‘bailout bandwagon’ gets back on the road, and this time it’s
Cyprus’s turn to go cap in hand to prevent it defaulting.
So how did
Cyprus,
a tiny country best known as a fantastic holiday destination, become the centre
of a financial firestorm with far-reaching implications?
Its fate
was effectively sealed when it joined the euro in 2008. Although it wasn’t in
great financial shape at the time of joining, the imbalances in its financial
system ballooned once it was effectively backed by the Euro rather than the
Cypriot pound.
Over the
five year period since joining, its bank assets have doubled, reaching an
incredible eight times GDP and completely skewing the risk profile of the
country. Money flooded in (much of it from the Russian mafia) attracted by low
taxes, a relaxed attitude to banking regulations and the implied guarantee of
euro membership. As a result of this flood of money, Cyprus became a major centre for
tax evasion and money laundering. Awash in money, much of it ended up invested
in Greek corporate and government debt, and when the Greeks effectively
defaulted, this money went up in smoke and a Cypriot default became inevitable.
Now we
know how the situation developed, let’s look at how the rescue deal was struck
and why its ripples will spread much further than the Mediterranean.
The original deal from the troika was to lend
10bn euros on the proviso that the Cypriots find the remaining 5.8bn euros by
imposing a levy on bank deposits, part of which entailed depositors with 100,000
euros or less taking a 6.75% haircut.
Seeing
that this would affect almost every voter in the country, create a huge
political storm, and probably result in them being thrown out of office, the
politicians did exactly what we would expect them to do, voted in their own
self-interest and refused the deal.
After much
wailing and gnashing of teeth a new proposal was made, ring-fencing those
deposits below 100,000 euros, but placing a higher burden on wealthier
depositors, and being the only politically tenable solution, was accepted.
Over this
period the entire banking system was shutdown to prevent a mass flight of
capital, although it is now becoming clear that certain overseas branches of
the Cypriot banks remained open for withdrawals and that large sums were indeed
spirited out of reach of the Cypriot authorities.
It would be very interesting to discover who
those people were that made these withdrawals, I would place a small wager that
it includes politicians and high ranking government officials but I’m just an
old cynic.
The net
result of this is that it is still unclear as to the amount of haircut these
large depositors will have to take, with some of the latest estimates as high
as 80%.
So with
peoples’ assets being taken, businesses going bust (1 in 3 has already gone
bust) and an inability to get your assets out of the country due to capital
controls, it is not hard to see the potential for civil unrest.
It is
clear to see from all this that life for Cypriots is tough and will get a whole
lot tougher in the months ahead. But
however tragic for those caught up in the mess why does it have wider
implications?
The answer to that lies in the initial plan proposed by the
troika.
The big question
every depositor must ask themselves is ‘How safe is my money?’ and the answer (for
deposits within the euro zone) was pretty safe, because the Eurozone Banking
Deposit Guarantee Scheme provided protection up to a value of 100,000 euros.
However,
the initial scheme proposed by the troika included a levy on all depositors
irrespective of the amount deposited. The fact it was rejected is irrelevant,
it still shows that the troika think that when needs must, peoples bank
deposits are fair game. This undermines the very basis of confidence in the
euro-zone banking system and changes the dynamic of where to hold your
investments.
The
significance of the troika’s initial proposal was reinforced by the comments
from the man that brokered the deal, Eurogroup chief Jeroen Dijsselbloem who
said that the Cypriot package is a
template for future EMU rescues, with further haircuts for “uninsured deposit
holders”. Once the effects of his comments sunk in, financial markets
started to react, and in spite of a later ‘clarification’ of its meaning, the
damage had been done.
The
bottom line in all this is that the Euro project was flawed from the start. It
was sold to the citizens of Europe as a financial amalgamation that would
enable all the countries that participated to grow their economies and flourish,
and although that certainly was a positive by-product, the main reason was to
cement relationships between the major European countries (both financially and
politically) so completely, that there would never again be another European
war.
Unfortunately,
because it was driven by politicians with an agenda rather than people that
understand financial markets, major mistakes were made, including the decision
not to amalgamate all the countries debts into one, creating a single Eurobond
market.
These
mistakes sowed the seed for the disaster that we now face.
Because
it is still politically motivated, European authorities will continue on the
same course, stating categorically that something won’t happen, until of course
it does, forced to make harder and more unpalatable choices, as the process
grinds on to its inevitable conclusion.
It is for
this reason that we are seeing currency flows out of the euro and into the US
dollar, a trickle that will become a flood as the euro crisis intensifies and
big money starts looking for a safe haven.
Small money can find a home in ‘tangibles’
like housing, land, antiques or gold, outside the financial system. But big
money doesn’t have that luxury, and can only be parked within the system,
making the ‘least worst’ the best option, and for the foreseeable future that
will be US dollars.
However, in
a few years time, when the US
becomes the ‘last man standing’ it will face its own financial Armageddon.
The real
tragedy in all this is that as a result of the design flaws in the original
concept, and the troika’s rigid adherence to a political ideology, it will
likely foster the exact sentiments that the entire Euro project was designed to
eradicate, with harmonious relationships and a sense of unity, replaced by
distrust, anger and a move towards nationalism.
I think
this is a seminal moment in the history of the Euro zone.
