Cyprus and money
Commentary and weekly watch by Doug Noland
Last week was one of high-stakes drama for the euro zone. It started with Cyprus’s leaders and European officials agreeing to a ”bail in” whereby bank depositors would be ”taxed” to help pay for the cost of bailing out Cyprus’ troubled banking sector.
Apparently, outflows from Cypriot banks had recently accelerated and the available supply of emergency ECB liquidity had about been exhausted. The European Union would contribute 10 billion euros (US$13 billion) to the bailout, with Cypriot depositors on the hook for 5.8 billion euros. The levy (”haircuts”) on deposits below the 100,000 threshold unleashed a firestorm of condemnation heard around the globe.
There actually seemed a bit of histrionics on the prospect of small depositors taking a 6.75% hit. Yes, these deposits were insured. But, as German Finance Minister Wolfgang Schaeuble noted, deposit insurance is only as good as the solvency of the sovereign. Are the Germans expected to back all euro zone deposit insurance? Still, with Mario Draghi’s European Central Bank market backstop in place, the worry that depositors (and investors/speculators) around Europe would suddenly fear for the safety of their deposits (or bonds) was farfetched.
At the same time, the Cyprus situation is as intriguing as it is potentially troubling. This Eastern Mediterranean Sea island has a population of only about a million and a tiny little economy. It didn’t become part of the euro until 2008. It’s a nice tourist spot, but mainly it’s distinguished by its bloated banking sector. Regrettably, bank assets doubled over the past five years, ballooning to a precarious eight times gross domestic product. Its low corporate tax rate, loose banking regulations and euro zone membership propelled Cyprus into a major hub for tax evasion and money laundering. As money came flooding in, much of it from Russia, too much of it found its way to high-yield Greek corporate lending and government bonds.
I wonder if European officials appreciated at the time that euro membership would greatly increase the allure of Cyprus’ questionable ”banking” arrangements. Here Cyprus, you and your friends enjoy your new euro printing press! We’ll count on you to regulate yourself, as we don’t even want to contemplate what we know you all are up to.
On Tuesday, the Cypriot parliament brazenly rejected the bailout agreement negotiated over the previous weekend between Cyprus’s new president and the ”troika” (European Commission, ECB and International Monetary Fund). To cheers from Cypriot citizens and others (notably left-wing Greek politicians), the Cyprus’ parliament became the first governmental body to spurn EU bailout terms.
After the vote, Cyprus’ finance minister jumped on a flight to Russia, while street protesters pointed blame directly at German Chancellor Angela Merkel and the German government. In a Mediterranean region where ”austerity” and German political influence have become such hot-button issues, there was palpable enthusiasm that someone was finally going to call Germany’s bluff.
At least the Cypriots acted as if they had a strong hand to play, as they fought to safeguard their little financial empire. They appeared confident in their close ties with Russia, and the Russians did lend Cyprus US$2.5 billion a year ago. Cyprus does have a strategically important location (and naval port), along with supposedly large untapped natural gas deposits. Protesters drew Hitler mustaches on Merkel photos, while politicians were determined to publicly snub euro zone officials. They were surely emboldened by tough talk from the likes of Russian President Vladimir Putin and Prime Minister Dmitry Medvedev.
By week’s end, however, the Cypriots were left empty-handed by the Russians…………..