Introduction by Brianroy:
On March 22, 2013, Stratfor's George Friedman was interviewed regarding the developing handling of the Cypriot Private Account Bank raids:
The Crisis in Cyprus (Agenda) is republished with permission of Stratfor.
My prior post on this is from just over a week ago at: http://www.brianroysinput.blogspot.com/2013/03/cypriot-private-bank-account-raids.html
and this issue is only, is still less than two weeks old in the major news cycles. What is of interest, is that there is an absolute determination by the European Governments to DIRECTLY rob from the people from right out of their bank accounts, rather than to be bothered with the issuance and processes of legalizing new taxes. Now here is George Friedman to give us a more updated insight into the action with some newer developments.
Europe's Disturbing Precedent in the
Cyprus Bailout
March 26, 2013
| 0900 GMT
By George Friedman Founder and Chairman of Stratfor
http://www.stratfor.com/weekly/europes-disturbing-precedent-cyprus-bailout">Europe's
Disturbing Precedent in the Cyprus Bailout
is republished with
permission of Stratfor.
The European
economic crisis has taken different forms in different places, and Cyprus is
the latest country to face the prospect of financial ruin. Overextended banks
in Cyprus are teetering on the brink of failure for issuing loans they cannot
repay, which has prompted the tiny Mediterranean country, a member of the
European Union, to turn to Brussels for help. Late Sunday, the European Union
and Cypriot president announced new terms for a bailout that would provide the
infusion of cash necessary to prevent bankruptcies in Cyprus' banking sector
and, more important, prevent a banking panic from spreading to the rest of
Europe.
What makes this
crisis different from the previous bailouts for Greece, Ireland or elsewhere
are the conditions Brussels has attached for its assistance. Due to
circumstances unique to Cyprus, namely the questionable origin of a large chunk
of the deposits in its now-stricken banking sector and that sector's small size
relative to the overall European economy, the European Union, led by Germany,
has taken a harder line with the country. Cyprus has few sources of capital
besides its capacity as a banking shelter, so Brussels required that the
country raise part of the necessary funds from its own banking sector --
possibly by seizing money from certain bank deposits and putting it toward the
bailout fund. The proposal has not yet been approved, but if enacted it would
undermine a formerly sacred principle of banking in most industrial nations --
the security of deposits -- setting a new and possibly destabilizing precedent
in Europe.
Cyprus' Dilemma
For years
before the crisis, Cyprus promoted itself as an offshore financial center by
creating a tax structure and banking rules that made depositing money in the
country attractive to foreigners. As a result, Cyprus' financial sector grew to
dwarf the rest of the Cypriot economy, accounting for about eight times the
country's annual gross domestic product and employing a substantial portion of
the nation's work force. A side effect of this strategy, however, was that if
the financial sector experienced problems, the rest of the domestic economy
would not be big enough to stabilize the banks without outside help.
Europe's
economic crisis spawned precisely those sorts of problems for the Cypriot
banking sector. This was not just a concern for Cyprus, though. Even though
Cyprus' banking sector is tiny relative to the rest of Europe's, one Cypriot
bank defaulting on what it owed other banks could put the whole European
banking system in question, and the last thing the European Union needs now is
a crisis of confidence in its banks.
The Cypriots
were facing chaos if their banks failed because the insurance system was
insufficient to cover the claims of depositors. For its part, the European Union
could not risk the financial contagion. But Brussels could not simply bail out
the entire banking system, both because of the precedent it would set and
because the political support for a total bailout wasn't there. This was
particularly the case for Germany, which would carry much of the financial
burden and is preparing for elections in September 2013 before an electorate
that is increasingly hostile to bailouts.
Even though the
German public may oppose the bailouts, it benefits immensely from what those
bailouts preserve. As I have pointed out many times, Germany is heavily
dependent on exports and the European Union is critical to those exports as a
free trade zone. Although Germany also imports a great deal from the rest of
the bloc, a break in the free trade zone would be catastrophic for the German
economy. If all imports were cut along with exports, Germany would still be
devastated because what it produces and exports and what it imports are very
different things. Germany could not absorb all its production and would
experience massive unemployment.
Currently,
Germany's unemployment rate is below 6 percent while Spain's is above 25
percent. An exploding financial crisis would cut into consumption, which would
particularly hurt an export-dependent country like Germany. Berlin's posture
through much of the European economic crisis has been to pretend it is about to
stop providing assistance to other countries, but the fact is that doing so
would inflict pain on Germany, too. Germany will make its threats and its
voters will be upset, but in the end, the country would not be enjoying high
employment if the crisis got out of hand. So the German game is to constantly
threaten to let someone sink, while in the end doing whatever has to be done.
Cyprus was a
place where Germany could show its willingness to get tough but didn't carry
any of the risks that would arise in pushing a country such as Spain too hard,
for example. Cyprus' economy was small enough and its problems unique enough
that the rest of Europe could dismiss any measures taken against the country as
a one-off. Here was a case where the German position appears enormously more
powerful than usual. And in isolation, this is true -- if we ignore the
question of what conclusion the rest of Europe, and the world, draws from the
treatment of Cyprus.
A Firmer Line
Under German
guidance, the European Union made an extraordinary demand on the Cypriots. It
demanded that a tax be placed on deposits in the country's two largest banks.
The tax would be about 10 percent and would, under the initial terms, be
applied to all accounts, regardless of their size. This was an unprecedented
solution. Since the global financial crisis of the 1920s, all advanced
industrial countries -- and many others -- had been operating on a fundamental
principle that deposits in banks were utterly secure. They were not regarded as
bonds paying certain interest, whose value would disappear if the bank failed.
Deposits were regarded as riskless placements of money, with the risk covered
by deposit insurance for smaller deposits, but in practical terms, guaranteed
by the national wealth.
This guarantee
meant that individual savings would be safe and that working capital parked by
corporations in a bank was safe as well. The alternative was not only
uncertainty, but also people hoarding cash and preventing it from entering the
financial system. It was necessary to have a secure place to put money so that
it was available for lending. The runs on banks in the 1920s and 1930s drove
home the need for total security for deposits.
Brussels
demanded that the bailout for Cypriot banks be partly paid for by depositors in
those banks. That demand essentially violated the social contract on the
sanctity of bank deposits and did so in a country that was a member of the
European Union -- one of the world's major economic blocs. Proponents of the
measure pointed out that many of the depositors were not Cypriot nationals but
rather foreigners, many of whom were Russian. Moreover, it was suggested that
the only reason for a Russian to be putting money in a Cypriot bank was to get
it out of Russia, and the only motive for that had to be nefarious. It followed
that the confiscation was not targeted against ordinary people but against
shady Russians.
There is no
question that there are shady Russians putting money into Cyprus. But ordinary
Cypriots had their money in the same banks and so did many Cypriot and foreign
companies, including European companies, who were doing business in Cyprus and
need money for payroll and so on. The proposal might look like an attempt to
seize Russian money, but it would pinch the bank accounts of all Cypriots as
well as a sizable amount of legitimate Russian money. Confiscating 10 percent
of all deposits could devastate individuals and the overall economy and likely
would prompt companies operating in Cyprus to move their cash elsewhere. The
measure would have been devastating and the Cypriot parliament rejected it.
Another deal, the one currently up for
approval, tried to mitigate the problem but still broke the social contract.
Accounts smaller than 100,000 euros (about $128,000) would not be touched.
However, accounts larger than 100,000 euros would be taxed at an uncertain
rate, currently estimated at 20 percent, while bondholders would lose up to 40
percent. These numbers
will likely shift again, but assuming they are close to the final figures,
depositors putting money into banks beyond this amount are at risk depending on
the financial condition of the bank.
The impact on
Cyprus is more than Russian mafia money being taxed. All corporations doing
business in Cyprus could have 20 percent of their operating cash seized.
Regardless of precisely how the Cypriot banking system is restructured, the
fact is that the European Union demanded that Cyprus seize portions of bank
accounts from large depositors. From a business' perspective, 100,000 euros is
not all that much when you are running a supermarket or a car dealership or a
construction company, but this arbitrary level could easily be raised in the
future and the mere existence of the measure will make attracting investment more
difficult.
A New Precedent
The more
significant development was the fact that the European Union has now made it
official policy, under certain circumstances, to encourage member states to
seize depositors' assets to pay for the stabilization of financial
institutions. To put it simply, if you are a business, the safety of your money
in a bank depends on the bank's financial condition and the political
considerations of the European Union. What had been a haven -- no risk and
minimal returns -- now has minimal returns and unknown risks. Brussels'
emphasis that this was mostly Russian money is not assuring, either. More than
just Russian money stands to be taken for the bailout fund if the new policy is
approved. Moreover, the point of the global banking system is that money is
safe wherever it is deposited. Europe has other money centers, like Luxembourg,
where the financial system outstrips gross domestic product. There are no
problems there right now, but as we have learned, the European Union is an uncertain
place. If Russian deposits can be seized in Nicosia, why not American deposits
in Luxembourg?
This was why it
was so important to emphasize the potentially criminal nature of the Russian
deposits and to downplay the effect on ordinary law-abiding Cypriots. Brussels
has worked very hard to make the Cyprus case seem unique and non-replicable:
Cyprus is small and its banking system attracted criminals, so the principle
that deposits in banks are secure doesn't necessarily apply there. Another way
to look at it is that an EU member, like some other members of the bloc, could
not guarantee the solvency of its banks so Brussels forced the country to seize
deposits in order to receive help stabilizing the system. Viewed that way, the
European Union has established a new option for itself in dealing with
depositors in troubled banks, and that principle now applies to all of Europe,
particularly to those countries with financial institutions potentially facing
similar problems.
The question,
of course, is whether foreign depositors in European banks will accept that
Cyprus was one of a kind. If they decide that it isn't obvious, then foreign
corporations -- and even European corporations -- could start pulling at least
part of their cash out of European banks and putting it elsewhere. They can
minimize the amount of cash on hand in Europe by shifting to non-European banks
and transferring as needed. Those withdrawals, if they occur, could create a
massive liquidity crisis in Europe. At the very least, every reasonable CFO
will now assume that the risk in Europe has risen and that an eye needs to be
kept on the financial health of institutions where they have deposits. In
Europe, depositing money in a bank is no longer a no-brainer.
Now we must ask
ourselves why the Germans would have created this risk. One answer is that they
were confident they could convince depositors that Cyprus was one of a kind and
not to be repeated. The other answer was that they had no choice. The first
explanation was undermined March 25, when Eurogroup President Jeroen
Dijsselbloem said that the model used in Cyprus could be used in future bank
bailouts. Locked in by an electorate that does not fully understand Germany's
vulnerability, the German government decided it had to take a hard line on
Cyprus regardless of risk. Or Germany may be preparing a new strategy for the
management of the European financial crisis. The banking system in Europe is
too big to salvage if it comes to a serious crisis. Any solution will involve
the loss of depositors' money. Contemplating that concept could lead to a run
on banks that would trigger the crisis Europe fears. Solving a crisis and
guaranteeing depositors may be seen as having impossible consequences. Setting
the precedent in Cyprus has the advantage of not appearing to be a precedent.
It's not clear
what the Germans or the EU negotiators are thinking, and all these theories are
speculative. What is certain is that an EU country, facing a crisis in its
financial system, is now weighing whether to pay for that crisis by seizing
depositors' money. And with that, the Europeans have broken a barrier that has
been in place since the 1930s. They didn't do that casually and they didn't do
that because they wanted to. But they did it.
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