I have been slow to write about the Eurozone crisis of the moment, Cyprus, for one important reason – I didn’t understand it. I read about how the big banks became under-capitalized and as the central government contemplated default like so many other European nations and thought it was about the same as we’ve seen repeated in far too many nations. Then, it got weird. What was so hard to understand? It was the way the European Central Bank (ECB) put the hammer down that pretty much forced a run on Cypriot banks and guaranteed a major depression. Was there something in this that I missed? Or was the ECB really that unbelievably stupid?
After looking this over for a while, I have come to a very frightening conclusion – the ECB really was that stupid, and more. This isn’t about Cyprus anymore, it’s about how the ECB is unworthy of any faith at all. If that scares the Hell out of you, welcome to the club. I certainly didn’t want to come to this conclusion, but here it is. It all starts, like everything Euro, with Greece …
Cyprus has fared very well through the economic crisis because it set itself up as a Eurozone member with a key difference – it’s a tax haven with a tendency to look the other way if necessary. On this resource-poor island still divided by a Turkish occupation the major industry became banking on the fringes of the developed world. Deposits in Cypriot banks were about 8 time the total GDP of the island, much of it from Russia (and often considered sketchy). About 20% of the economy comes from being something like the Caymans of the Mediterranean.
But with the winding down of the Greek crisis, a major problem developed. Greece has been Cyprus’ only real friend through the generations-long crisis with Turkey, and Cypriot banks have invested heavily in Greek debt as a result. So when Greek bonds were refinanced with a 70% default last year (and anyone who calls this a “haircut” should not be listened to) it hit Cyprus hard. Their banks were suddenly undercapitalized and their own bonds came under attack.
Enter the ECB to save the day! Only the ECB didn’t bother to come in with the hundreds of billions of Euros that they promised to Italy or Spain – no, on the €15.8B needed to shore things up, the ECB said they would give €10B and Cyprus would have to come up with the other €5.8B. The difference was pocket change to the ECB, but it wasn’t coming. And on top of it, they insisted that Cyprus “tax” their largest asset – bank accounts – more or less seizing whatever they needed to make up the balance.
Think about this for a moment – if you are sure that the government is about to seize 10-30% of the money you have in the bank, there is one thing you can do and that is to remove all the money you can from the bank immediately. It’s called a “panic” and any sensible banker would do anything to prevent it, especially given that the immediate problem was that banks were under-capitalized to start with.
The Cypriot Parliament refused without a single vote in favor for one very good reason – it spelled the end of the banking system on which they rely. But it was too late and the damage was done. Cypriot banks were closed for 2 weeks while it was sorted out, meaning that people had zero access to their money and couldn’t buy food, pay rent, or anything. The banks opened with strict controls on what could be taken out last Thursday. The lack of a major riot is a testimony to the patience of the dear people of Cyprus.
If this wasn’t stupid enough, consider that while banks were closed in Cyprus their branches abroad, such as in London, stayed open. That Russian money parked safely in a Euro denominated semi-blind account? Oh, you can bet that as much of that fled as possible – but this hasn’t been tallied yet.
But it gets even worse. As part of the currency controls in place to prevent banks from bleeding further, there are limits on how much can be transferred from Cyprus to the rest of Euroland. The island has been made into a junior partner of the Eurozone.
Think about this for a while. While the tax on all bank accounts didn’t go through, access to the money is severely limited and something horrible was nearly forced on them. If you were an ordinary Cypriot, where is about the last place you would put your money right now? What if you were a Russian?
A bad situation was made much, much worse by a very stupid decision compounded daily by even more stupid decisions. And the basic promise of the Euro, that all members were equal, has been violated. What happens when it becomes convenient to isolate Italy or Spain? Or, for that matter, France?
Banks in the entire Eurozone are now suspect and can expect foreign investors, as well as locals, to be much more careful, making capital even harder to raise. In essence, the Euro has already stopped existing as we once knew it. It’s hard to see how it survives this series of insanely boneheaded moves by the ECB.
That’s what I’ve come to understand, at least.