Economics, Foreign and Defense Policy, Europe and Russia, International economy

Europe’s Cyprus blunder

Image Credit: Shutterstock

Image Credit: Shutterstock

European policymakers work in strange and mysterious ways. Over the past year, they bent many rules and threw literally hundreds of billions of Euros at Greece to prevent that country from exiting the Euro. They did so for fear that a Greek exit might cause contagion to other countries in the European periphery. And then over this last weekend, they chose to spook financial markets and risk the very contagion that they sought to avoid in the Greek case, by demanding that as part of its bailout package Cyprus imposes a tax on bank deposits.

The only way that Europe’s seemingly irrational policy prescription for Cyprus can be explained is that it was the result of a political compromise. In anticipation of German elections scheduled for September 2013, Mrs. Merkel, the German Chancellor, had to assure her electorate that German taxpayer money would not be effectively used to bailout the Russian oligarchs who have large deposits at the Cypriot banks. She did so by demanding that at least EUR5.8 billion in Cyprus’ bailout package came from a tax on bank deposits. For his part, Mr. Anastasiades, the new Cypriot president, fearful of unduly antagonizing the Russians, felt that he could not have all of the tax on depositors fall on the large depositors. For this reason he agreed to tax small depositors as well.

Whatever the reasons for the decision to have Cyprus tax small depositors, it sets a dreadful precedent for the rest of Europe. No longer can depositors in Italy, Portugal, and Spain feel secure that their deposits are safe from confiscation in the event of the need for an IMF-EU bailout package. This must be expected to accelerate capital flight from these countries to safer havens both within and outside of Europe. And such capital flight will only complicate the European crisis down the road.

It might also be noted that the Cypriot debacle is not occurring in isolation. Rather it is occurring at a time that Italy is in the midst of a serious and prolonged political stalemate, Spain and Portugal are plunging ever deeper into recession, and Greece is already missing its IMF revised tax revenue targets. Anyone who still thinks that the Euro crisis is over is simply not paying attention.

6 thoughts on “Europe’s Cyprus blunder

    • “fraudulent fractional reserve lending”

      Fractional reserve lending is not, in itself, fraudulent. It provides a useful flexibility in money supply but, yes, it can be very risky without adequate safeguards.

      Necessary safeguards are: high enough reserve requirement to incentivize bank investors to demand caution in lending; limitation on deposit insurance, to make depositors prudently spread their capital; most importantly, with the first two conditions satisfied, the understanding that if the bankers screw up, the bank will go bankrupt and bank investors will take the loss.

      • When turn $100 in deposits into $900 of loans that is fraud. So is the use of money that you can create out of thin air as you rob savers of purchasing power.

        Why do you think that we are having a global banking and sovereign debt crisis? Such things are not possible under a hard money system that limits the creation of credit.

        • It’s not fraud unless their is deception (look up the word).

          You can claim it’s immoral, unethical, or bad economics, but it’s not fraud when the banks are not deceiving anyone about what they are doing. (Ignorance on the part of the public is not the same as deception on the part of the bank.)

  1. The EU-inspired “tax” confiscation of bank deposits in Cyprus is not only foolish policy, but a glaring inequity as well. Whatever its intentions, the policy punishes savers while imposing no sacrifice on improvident people who spend everything (possibly including proceeds of bank loans that have now gone bad) and save nothing, or on canny folk who save elsewhere or via other mechanisms (real estate, artwork, coins buried in the back yard, bonds, etc.). If placating the Germans’ (understandable) desire to see some Cyriot skin in the game is indeed an objective in the national interest, then the funds were better secured by a broad-based tax that would be less economically inefficient and less destructive of public confidence in good governance.

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