It was with shock over the weekend that many in Cyprus learnt of a plan to impose on them a tax on savers deposits as part of the price for a eurozone bailout. This is wrong on so many levels one scarcely knows where to start.
First of all there is the principle of it all. The IMF/Germans are proposing that those Cypriot’s who were careful and prudent with their money by saving for a rainy day should be subjected to collective punishment, not for their own crimes, but the reckless spending of others. Its the equivalent of arguing that drivers who happened to be sharing the road as another driver was caught speeding should be given points on their license instead of the guy who was speeding.
As Robert Peston points out this plan violates two of the important principles that have underlined the Eurozones bailout policy. Firstly that the deposits of ordinary savers would be protected at all costs. Secondly, that it is international lenders who should bare the brunt of any losses in the event of, as the Irish put it a hair cut. This is only fair, as ordinary savers cannot afford to take such losses, but international banks and the bond market can. Plus its the job of the banks to properly assess the loans they have going out the door and make sure they are not lending money recklessly.
As one Economists put it you couldn’t come up with a better way to undermine confidence in the eurozone if you tried. For it isn’t just for moral issues that these principles have been applied but to offset the very real danger of avoiding the sort of bank run that brought down Northern Rock and the Icelandic banks in 2007.
The danger is the Cypriot government will fail to get this bill passed before the banks reopen in Cyprus. There is only so long the government can keep them closed without bringing the entire economy to a halt and creating dangerous uncertainty (as if there wasn’t enough of that on the Island already!). There’s also the risk of someone getting a judge to agree this proposal might be illegal and getting an injunction to stop it being implemented.
Obviously it is very probable that if the banks open with this sort of speculation going on, the bulk of Cypriots will show up at 9am at their local branch and withdraw all their money. Banks only ever hold a small fraction of deposits in ready cash (as George Bailey in its a wonderful life correctly points out the bank doesn’t have you’re money, its in Bill’s house and Jill’s flower shops, etc.). thus it would only take a small number of such withdrawals (noting its the bigger deposit holders who will have the incentive to be first in the queue) to destabilise even a healthy bank.
Even if by some miracle, the Cypriot government gets this bill passed it may not stem the rot. Bank runs have a habit of taking on a life of their own. Many of those who queued outside Northern Rock, or who began withdrawing money from Irish banks had actually little to fear, as even if the bank when bankrupt, they’d still likely get back the bulk of their cash (of course it could take many months for that to happen!). However, inevitably many concluded a bird in the hand is worth two in the bush.
Thus the second risk is that even if the bill gets successfully passed, many ordinary savers, not just in Cyprus but in other Eurozone countries also, will conclude their money is no longer safe in a euro bank account and withdraw it. And again it would only take a small queue outside a few branches in Nicosia or Athens to have other passers by worried that a bank run is in progress (and thus their money is no longer safe) and also join the queue until you have a full scale series of bank runs in progress across the Eurozone. And as we learnt in the 1920’s, once a bank run starts, stopping it is very difficult…and expensive (as we Irish learnt the hard way with Anglo Irish Bank!)
Furthermore, the very fact that the Germans agreed or even pushed for this ridiculous deal is also troubling. This seems to have been driven by rumours in German tabloids that most of the money in Cypriot banks came from the Russian mafia (actually, while a sizeable amount of Russian money is in Cypriot banks, the bulk of the cash in the banks comes from ordinary Cypriot savers…or British pensioners!, Russian money is probably at between 10-20% in all probability).
Naturally this will only pour fuel on the fire of public anger. Any such tax will be labelled a German Tax by Cypriots, and will provide very useful ammunition to euroskeptic and far right parties. If it weren’t for the flap in the UK regarding press regulation, no doubt the Daily Mail would be running headlines about Merkel picking the pockets of British pensioners. Perhaps sensing their miscalculation the Germans have spend the last 24 hrs back pedalling more furiously than Lance Armstrong.
As I’ve been saying from the beginning of this crisis much of this eurozone crisis is as much a crisis of leadership (or lack thereof) and cooperation than anything intrinsically wrong with the EU economy itself. A fact clearly highlighted by this situation where it appears that the economic policy of the EU in Cyprus is being set by Der Spiegel and a bunch of Supermarket tabloids in Germany.