The nice thing about being a member of the European Union is that you always get a second chance.
If you vote one way, and the Europeans don’t like it, they’ll give you another chance to vote the ‘right’ way.
Of course, this does rather undermine local democracy somewhat. But that’s all part of the price of being one big happy European family. Didn’t you realise that?
Anyway, now it’s the turn of Cyprus to go back to the drawing board. Having ditched its original plan to tax savings to secure a bailout, the Cypriots have been told to come up with a new deal.
Or else…
How Cyprus Ended Up Here
A quick recap of the Cyprus story so far.
Cyprus needs a bailout. It needs €17bn. But the ‘troika’ (Europe’s big bailout committee) is only willing to lend it €10bn, because they knowCyprus could never pay back the whole €17bn. Even €10bn will be a push, but we can at least pretend it’s feasible.
So Cyprus needed to raise the extra from somewhere else fast. That’s where the bright idea of taxing bank deposits came from. Everyone with less than €100,000 in the bank was set to lose 6.75%. More than that would be taxed at 9.9%.
Great idea. Except of course that it tore up pretty much every unwritten rule about bank deposit security, and was an open invitation to bank runs across the eurozone.
As the queues formed in front of the cash machines, Cypriot politicians had a rapid rethink. They rejected the bailout deal out of hand, without a single pro-vote.
That left everyone floundering around. The Russians don’t seem willing to help much, despite the Kremlin’s outrage and all the money they’re said to have on the island. And if the Russians aren’t willing to pay, that leaves two options: Cyprus leaves the eurozone, or the bailout deal is renegotiated.
No one really wants Cyprus to leave the eurozone. As Die Zelt editor Josef Joffe notes in the FT, Cyprus itself is just ‘a tiny sliver of the EU economy’.
But given the backdrop, if it leaves the euro now, you could see ‘millions of panicked savers start a run on their banks from Lisbon to Athens’. That in turn would unleash ‘a broad-scale attack by the markets. Auf Wiedersehen, euro.’
Cypriot citizens also realise full well that returning to the Cypriot pound would be a lot more damaging to their savings than even a 10% ‘haircut’. Any new currency would plunge in value against the euro – that might be good for the tourist industry, but the resulting social unrest probably wouldn’t be.
So quitting the euro isn’t an easy option. But as far as Germany is concerned, neither is giving Cyprus a no-strings attached handout. If it does that, everyone from Greece to Italy will want one. As Joffe puts it, Germany will be left ‘bleeding for the greater good forever’.
So it’s back to the drawing board for Cyprus. The European Central Bank (ECB) has threatened – once again – to pull the plug on Cyprus’s banks if it doesn’t come up with a plan.
At the moment, the European Central Bank emergency funding is the only thing keeping those banks open. So a deposit tax would be the least of savers’ worries if that happens.
What this Means for Markets
So what’s likely to happen? And what does it all mean for your money?
In terms of the actual outcome, this is too close to call. It’s very hard to work out exactly what’s going on in policymakers’ minds.
A cynic might argue that this is just a cleverly-played, high-stakes negotiating game. You present everyone involved – the public, the troika, other politicians – with an utterly outrageous opening deal. And it doesn’t get much more outrageous than saying you’re going to take money that people thought was insured against loss.
As a result, whatever you end up with seems moderate by comparison. Chastened by the prospect of how bad things could have been, everyone involved walks away poorer, but feeling they’ve been let off the hook somehow.
But given the risks involved, it’s hard to believe this was deliberate. Regardless of what deal is reached, serious damage has been done to the banking system.
Why would anyone in Cyprus keep a significant amount of money in the bank now? They’ve seen how vulnerable the system is. When the banks re-open, a lot of people will be keen to get all their money out. Even if some sort of control is imposed to prevent that – as seems likely – it could get very messy.
It also damages faith in the rest of the European system, even at the margins. For example, if I’m travelling in Europe, I rarely bother getting hold of euros before I go. I just assume I’ll be able to get some from a cash machine when I land in the airport. I’ll not be doing that for the foreseeable future.
And for anyone assuming that a deal will get done because it ‘has’ to: it’s worth remembering that there was a point last year when almost all of us thought that Greece was going to walk out of the euro.
If Europe wants a test case to see just how to cope with a euro exit, Cyprus is the place to do it.
So far, markets are taking this in their stride. The euro has fallen, but no one is pricing in another Lehman Brothers. If Cyprus does leave the euro, you can expect more panic. But even then, I’d bet there are a lot of people ready to ‘buy the dips’ on this one.
The more important aspect of Cyprus is what it says about what happens when governments and banking systems go bust. In short, no one’s money is safe, and there are no risk-free havens.
John Stepek
Contributing Editor, Money Morning
Publisher’s Note: This article originally appeared in MoneyWeek
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