The response to the bank failures in Cyprus has ostensibly been about cracking down on money laundering, but the action being taken will take down the country's economy with it.
Cross posted from Pruning Shears.
The economic crisis in Cyprus began with a depressingly familiar story: bank gambles on risky debt, loses its bet, goes bust and needs a bailout. It very quickly took what was to me1 a bewildering turn: Instead of a central bank
cranking up the money printing machines until smoke billowed from them creating sufficient reserves to keep the banks going, the so-called troika of the European Commission, the International Monetary Fund, and the European Central Bank had another idea: take money from individual depositors.
This seemed like an astoundingly stupid idea. It was wrong on matters of simple equity. Those who were innocent of any wrongdoing or incompetence should not have been on the hook for remediation. But it was also wrong for a much more practical reason: raiding customers' deposits would utterly destroy confidence in the entire country's banking system. No one would ever trust a Cypriot bank again; only those forced to use them would do so. Which, since banking is (was) the largest industry in the country, meant that Cyprus' economy would be wrecked.
As all this unfolded I really had trouble wrapping my mind around the relative equanimity with which it was being received. Paul Krugman even referred to the seizing of assets as a haircut. Now, just to be clear: I'm an economics layman and Paul Krugman is a Nobel Laureate in it. He has probably forgotten more about economics than I will ever know.
But my understanding of a haircut is that it refers to the reduction in value of a security; bonds are the most common examples I've seen. Are bank deposits used as collateral or otherwise treated as investments? Sure - by the institution receiving them, but not by the depositors themselves. At the very least, describing what's happening in Cyprus as a haircut seems to require a somewhat, um, flexible understanding of the concept.
There has been a certain kind of distasteful resignation in the financial reporting on this, as though everyone recognizes it's a bad situation but unfortunately this is the best way out of it.2 And I read those reports and analyses almost with incredulity. This is going to destroy an entire country's economy and cause an unfathomable amount of misery for its citizens. Don't any of the major players know that?
A couple weeks in I got my answer: Of course they did. Destroying the country's banks was by design. In a remarkably candid analysis Tyson Barker led with this:
The architects of the euro had one primary strategic goal. It was, to play on Lord Ismay's famous quip about NATO, to keep the Americans out, the Germans in and the Mediterranean states downLater in the article Barker casually refers to the nation's banking sector being halved.3 With finance and real estate representing a quarter of the country's entire economy, this is a ruinous development. It does not occur in a vacuum either. Tourism represents another quarter of its economy, and because of the chaos it too is taking a huge hit. In other words, half the Cyprus economy just got whacked.
The remaining half is on the fault line of this quake, too. As Karl Denninger noted, many businesses will be crippled:
There were branches of the Cypriot banks that were open in London during the time that they were closed in Cyprus. So if you were Russian that have great deal of money in these banks, or you were some kind of other off-shore person, who had money in these banks and you had some cash, you get on the plane, go to London and then you take all your money out. While the small business person in Cyprus who has his money there and needs to make payroll has his stolen.In other words, this across-the-board seizure of money isn't (or isn't just) going after obscenely wealthy foreigners who have stashed their loot in Cypriot banks under sketchy circumstances. Local businesses that kept their operating funds at local banks are now seeing those funds disappear too. So even if, for example, the external factors causing the nosedive in tourism get resolved, there will be a far less attractive industry to cater to foreigners on holiday. No wonder the forecast for the country is bleak.
Such brutal tactics were not necessary. Even assuming that Germany (which appears to be setting the direction for the troika) is sincerely on the warpath against tax evasion, its efforts closer to home have been far more diplomatic and targeted. Barker describes German efforts to nab tax evaders in Liechtenstein and Switzerland through a process he delicately refers to as "shadowy data acquisition." Why not use that same kind of surgical approach to Cyprus? Taking a wrecking ball to the banking sector just supports the thesis that it's about keeping the Mediterranean states down.
Barker's theory was substantially reinforced last weekend when the New York Times reported: "A key demand of a recent bailout deal announced for Cyprus was that the nation drastically shrink its role as a financial center and, many in Germany suspect, a haven for money laundering."
It may well be that Germany is going after money laundering as its primary goal, but it is using remarkably crude means to achieve that end. Since there will be such blindingly obvious and disastrous consequences, it seems only fair to say that it is also ultimately responsible for the human effects of it. Some in the troika appear to know as much and already sound defensive about it:
French Finance Minister Pierre Moscovici rejected charges that the EU had brought Cypriots to their knees, saying it was the island's offshore business model that had failed.Both those things can be true though: It can be true that Cyprus was a casino economy on the brink of bankruptcy and that the troika's remedy will cause needless suffering throughout the nation.
"To all those who say that we are strangling an entire people ... Cyprus is a casino economy that was on the brink of bankruptcy," he told Canal Plus television.
Towards the end of last year Tim Pat Coogan released a book that sparked a debate over Ireland's suffering between 1845 and 1852. I hadn't known this, but even the name of that period is controversial. It is commonly known as the Great Famine, but many in Ireland now reject that term. The traditional understanding is that catastrophic crop failures led to mass starvation.
But many refer to it as the Great Hunger due to the belief that the crop failure (which did actually occur) was not destined to kill so many people; rather, it was British policy that took a grim circumstance and made it horrifying. Coogan calls it genocide. Others, trying to be more charitable towards Britain, put it down to Ireland being "the unfortunate test case for a new Victorian zeal for free market principles, self-help, and ideas about nation-building."4
Looking back a century and a half later, the verdict is damning either way. Whether by design or as a direct and easily foreseeable consequence of a kind of free market idolatry, those responsible are now thought to have unleashed a monstrous evil and are judged accordingly. What is happening to Cyprus now won't cause the starvation of a million people, but the hardship it will inflict is nothing to shrug off, either. And everyone can see it coming.
2. Another curiosity: Isn't anyone bothered by the nice, round numbers for everything? I jokingly referred to it as the Base 10 Bailout: €10b to banks, deposits over €100k seized, €100 ATM limit. Everything can be expressed as a power of 10. Does this sound like the result of a team of experts auditing the situation and at least estimating the numbers?
3. I had trouble parsing Barker's language here:
With its banking sector halved, the country faces a difficult if not impossible challenge to re-establish its status as a financial oasis. The high-risk political economy that fueled the tiny island-nation since 1974 has ended.What is the high-risk political economy he refers to? In a crisis brought about by high risk banking practices, why mention political ones in passing and not fill it in with a little detail? And what does 1974 have to do with it? To me it smacks of conservatives blaming the 2008 financial crisis on the 1977 Community Reinvestment Act. In other words: find a scapegoat to fit the ideological narrative, even if it means implausibly reaching back decades.
4. In the Economist article, author Y.F. also writes: "Poverty was considered a moral failure." Laissez faire capitalists seem prone to such theological zeal in their ostensibly rational worldviews, which may explain why religious fundamentalists and free enterprise evangelists seem to end up in right wing coalitions with each other.