The EU has thrown Cyprus to the wolves

John Lennon’s best line in a lifetime of song-writing was “life is what happens when you’re busy making other plans”. I had planned today to write about the excellent Atlantic Monthly The Economy Summit 2013 conference I spoke at in Washington on Wednesday, where it seemed that senior figures in the US were finally starting to realise that private debt, not public, was the main game in a debt-deflation.

Then “I read the news today, oh boy”. I woke at 4am on Sunday to the news that the EU has confiscated 10 per cent of depositors' funds in its 'bailout' of Cyprus, in a move that will raise around €6 billion. Lennon didn’t go far enough. It seems political suicide is also what happens when you’re busy making other plans.

Now, Cyprus is racing to prevent a possible meltdown of its financial sector with parliamentary negotiations that aim to reach a compromise which will enable the bailout to pass, as its two largest banks are rapidly running out of money.

If there was one lesson that I thought the world had learnt from the Great Depression, it was the need to guarantee depositors’ funds. So much for that fantasy. Now the EU has shown that its obsession with austerity has gone so far that even this historical wisdom has been abandoned. Not only are depositors’ funds not guaranteed, they are being lost even in banks that have not (yet) failed.

Many banks are likely to fail however, if depositors come to believe – as this action gives them every right to believe – that their savings are not safe in banks. The public’s first response will be to no longer trust the digital ones and zeros in their bank statements, and to demand their funds in cold, hard cash. The only way to do this is to front up at the bank, present it with a withdrawal equivalent to the deposit balance, and wait for the teller to count out the notes.

The public will be waiting a while: the cash currently simply doesn’t exist. Currency constitutes only a tiny percentage of the aggregate money supply – whether defined as that found in bank at-call cheque and savings accounts (M2), or including term deposits and other not-at-call accounts (M3). If everyone wants it, then only one in twenty will get it, if Europe’s figures are at all comparable to America’s (see figure 1). That’s why a collapse in confidence in deposits is called a bank run: only those who run first to the bank get their money.

Figure 1: Currency is only a fraction of the money supply


Graph for The EU has thrown Cyprus to the wolves

Only Cypriots – and Russians, who apparently put substantial funds in Cyprus, probably in search of either a safe haven or high returns (that’s one trivia question I don’t know the answer to) – have an immediate motivation to demand cash, but they won’t be able to, thanks to a 'bank holiday' in Cyprus on Monday, and withdrawal restrictions from Tuesday on. But what about depositors in the other Mediterranean states – in fact, anywhere other than Germany? I can’t imagine them not queuing at their banks on Monday, and in large numbers.

With the inability of individuals to freely withdraw funds will come a political credit crunch. Commerce relies upon the easy transfer of funds from buyer to seller. Companies can’t have these restrictions imposed on their accounts without causing commerce to grind to a halt, but surely their suppliers – particularly tradesmen and small businesses – are going to demand cash payments in future. What happens when companies start demanding cash from their banks, rather than relying upon e-commerce?

What will happen to e-commerce after this? Would you trust the swipe of a card for a cappuccino now, or would you demand coin – even if they were euro coins? And what on earth will money markets make of this? What will a euro be worth on Monday morning?

Goldbugs will rejoice, I am sure – here comes the currency apocalypse they have eagerly anticipated. The Bitcoin community is going to rejoice as well – theirs is one form of e-commerce that is likely to prosper after this insane act. The great attraction of Bitcoin is that it is the creature of no state, and therefore it can’t be confiscated by one.

There will be political demands for the return to national currencies: better the national state you can control than the supra-national state that controls yours. I can’t think of any other act that could do more to bring the euro to an end than the news that a country has had 10 per cent of its deposits confiscated, because that nation was foolish enough to cede the right to issue its own currency to the European Union a decade ago.

This will also surely stir the Russian Bear. I have no idea which Russians have funds that are now being used to bailout European banks, but I doubt that Vladimir Putin will take kindly to this effective seizure of Russian assets. Putin certainly has to act: his strongman image in Russia would be in tatters if he does not.

What might his comeback be – turning off Russian gas supplies to Europe perhaps, until Russian depositors are repaid? And probably in dollars rather than euros? What then in Europe, if strongman tactics force compensation for Russians, but none is forthcoming for Cypriots?

The most ominous political portent lies in the legitimacy this will bestow on the Far Right. This betrayal of the people of Cyprus by its politicians and bureaucrats will be seized upon by the fascist (and leftist) parties throughout Europe. The centrist parties whose politicians and bureaucrats have insisted on depositors contributing to a bank bailout to appease German voters have just thrown the centre away.

Gawd knows what the long-term consequences will be, but if I had to identify one single act that could lead to a rerun of the political chaos of the 1930s in Europe today, this would be it. I began this post with John Lennon. Maybe the story will end with the resurrection of Vladimir Ilyich Lenin. But in the interim I expect that the Right – and most immediately, Golden Dawn in Greece – will make the most political capital out of Brussels’s incredible folly.

I’ve written this quite literally 'up in the air' – flying from Washington to Los Angeles – wondering what else will have occurred by the time I touch down. Surely there will be further reaction by Cypriots and demonstrations elsewhere in Europe by both Left and Right. These might cause some backdown by the idiot bureaucrats and politicians who forged this plan, but even then it will be too late: the damage to the credibility of the euro and the entire European banking system will already have been done.

Monday is going to be a very interesting day in Europe. And Tuesday in Cyprus? I would not like to be a bank teller on that day.

Steve Keen is professor of economics and finance at the University of Western Sydney and author of Debunking Economics and the blog Debtwatch. His Minsky Kickstarter page is here.

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Great article, but more importantly I'd like to congratulate Steve Keen on his appearance at the conference last Wednesday with his question on stability drawing the following response from
Paul Volcker: "There is no central bank that I know of that has ever exhibited the capacity for that kind of fine-tuning.And if they lose sight of the basic role of a central bank is to maintain price stability,stability generally--- the game will sooner or later be lost....this hubris that somehow we have the tools that can manage in a very defined way little increases or decreases in the inflation rate to manage the real economy is nonsense.Did I say that strongly enough?"

I've some sympathy for the EU. Economies like Cyprus have been ridiculously managed. Feckless populist governments inflating living standards with cheap borrowings. Dodgy banking regulation, and in the case of Cyprus a banking system that's been Russian mafia-friendly. What a stinking mess. The EU must address these basic issues. It can't just dole out "recovery-money". And there must be pain.

But better for Cyprus if the EU had enforced a Swedish solution (guarantee deposits, nationalise the banks, wipe shareholders and management, give bondholders a haircut). Since the GFC, no one has had the guts to apply that. The banks and their managements have been left in place, and pumped full of free money by goverments hugely increasing their own debts. No change even in the outrageous bonus culture, which drove the toxic banking practices in the first place. No serious lessons have been learned. It's PAP - a pain-avoidance-plan.

Fascinating comment from Volcker (via Nordstrom above). Surely he's saying that Bernanke is on the wrong path. Ben's trying to manipulate the economy to an arbitrary unemployment level as he "controls the recovery", which is exactly what Volcker says is not the Fed's job. Bernanke is bypassing real capital with his own counterfeit. I don't know what you call this, but it's not Capitalism. More like "Counterfeit Capital - ism". It's a big experiment. Time will tell who's right.

Europe is becoming a joke. Decades of fiscal irresponsibility is finally coming home to roost. The politicians can tinker and delay the inevitable but they need to address the problem.

The only two solutions I see are complete fiscal and political integration or the abandonment of the common currency.

Both will address the problem, the first by spreading the pain and the second by devaluation of individual currencies forcing countries to behave, at least a little.

Of course money laundering in Lichtenstein, Switzerland, Luxembourg, the City of London or anywhere else in Europe, Mexican drug money by the big US banks etc, all that is not happening, yes ... or maybe this is a way to get at the Russians.
What will Putin do ?

Steve,
Mark has made this point above already but the annecdotal reason so much Russian money is in Cypriot banks is because it belongs to the Russian mafia. It is not the life savings of poor Russian folk 'looking for a safe haven' (Cyprus!). In other words the Russian mafia is laundering money through Cypriot banks. Don't expect the EU to provide bailout funds to a country that allows that without some serious stick being wielded. And I don't think even Vladimir Putin would have the hide to complain about Russian mafia money being confiscated. You are way off-base on this one.

But this sweeping and destructive generalisation is exactly the appalling policy practiced by Eurozone governments for the last five years! Cypriots are remarkable people according to Karl - they have no savings whatever in any bank in the country in which they live. It must surely be a deeply inadequate Russian mafiosi who only has €100,000?

It is a measure of the abysmal and appalling degeneration of Eurozone policy-making that no effort whatever is made to do anything about the money-laundering; on the contrary, it is welcome to continue, albeit with a one-off commission.

Hmm Welch and Richards, have basically got it rite, and i certainly agree that Europe is a basket case , they have run the joint from Brussels and have wollowed in their own self importance, well!, all i can say is they can now wallow in their own effluent.
Of course the Greeks have this socalled cash economy that dodges paying tax and they probably are getting their just deserts with this 10% tax on their bank accounts, , but what about the few that have paid their tax, ha bad luck, and not only that what does it do for the trust we put in our banks??? makes one wonder what will happen next??
VERN

That's not even a problem. That's complete DISASTER. And not only for Cyprus and EU, but for whole western banking system. "The benefit of the deposit levy is that ... a significant proportion of it is paid by non-residents" !!!!!! Legendary trader Jim Sinclair told King World News we have just witnessed one of the most important events in history and it will have a major impact on the gold market. Below Sinclair, who’s father was business partners with legendary trader Jesse Livermore, had to say in this extraordinary and exclusive KWN interview: “The wire reports on the Cyprus situation are working overtime to try to make the case that 80% of the deposits belong to the people of Cyprus, and only 20% of the deposits belong to the Russians. That’s absolutely false. After 1985, when the ‘Robber Barrons’ of Russia took over the general economics of Russia, that was the transformation from the KGB to private business. The primary place for exported Russian funds was Cyprus. Now, there is one leader in the world that would be very dangerous to challenge, and that is Putin of Russia…. “What’s just happened is the IMF has backed up, lauded, supported, and publicized, as if it were a victory, the taking of 10% of what really turns out to be 80% of Russian ‘black money.’ Russian ‘black money’ is KGB money, now in business. The leader of Russia (Putin) was a former KGB official. Who’s money do you think they have taken? This is the biggest mistake the IMF could possibly have ever made.” Eric King: “Jim, it’s unimaginable to me, but, incredibly, just ten days ago you warned that you don’t want to anger Russian leader Putin because he and Russia will punish the West in the gold market. Can you talk about how this is going to impact the gold market beginning on Monday?”

Isn't this a storm in a tea cup...and while you're there....can we have our old conversation structure back ( or is that forever gone?)

This is exactly the point "If there was one lesson that I thought the world had learnt from the Great Depression, it was the need to guarantee depositors’ funds. So much for that fantasy. Now the EU has shown that its obsession with austerity has gone so far that even this historical wisdom has been abandoned. Not only are depositors’ funds not guaranteed, they are being lost even in banks that have not (yet) failed."
But this time it's MUCH worse then just to betray own public what bankers did so far. They saying in Russia "never cut the branch on which you sit" or "never byte the hand that feeds you" !!!
But bankers care only about their own money, not Cyprus.
Unfortunately for bankers, rushing to steal others money they shoot themselves not just in a foot this time, but about 1 meter higher !!!

@Karl
then why not snip non-Cypriot accounts. If the account holder can prove Cypriot residency or legitimate (business or otherwise) use, then fine. Otherwise, assume the worst.

Orson Wells described the suicide of the scorpion crossing the river on the frog's back.
To make an analogy the “taxocrates” are the scorpions and the banks the frogs, ultimately economics is resource development, then we don't have to worry about M1 M2 ...M7 or scorpions, we just find frogs everywhere to cross rivers.
There is a lot of truth expained in simple terms in this article, I would enjoy more frequent short articles in this style from Steve, then I will be able to understand the other style as well, which undoubtly is also interesting.

At least they are being honest about confiscating savers' money. This is unlike other places (like the US), where confiscation is done by dishonest, slimy, obfuscated means. It's called "inflation".

Yep, inflation and its partner in crime, devaluation. Both erode savings and reduce debt. The difference is, the numbers don't change in your savings account.

Yes Steve, exactly. "if I had to identify one single act that could lead to a rerun of the political chaos of the 1930s in Europe today, this would be it". But much worse, not only Europe, whole western banking system.

I bet Wayne Swan thought for a moment about the Cyprus action this morning and said.

"You can do that?"

No, I bet he said, "Can I do that".

Huge cycle of every 100 years big WR. But this time it is different. This time it's run in finance. Currency manipulation is very important tool in battle field. All type of crap used to camouflage real intention - currency devaluation. Looks like all this so called 'solution' of Cyprus problem is just German way to camouflage desperately needed euro devaluation. We don't have reasons to think that Germans more stupid then Japanese, do we ?! Mr. Bernanke better start to warm up his helicopter engine. As for all global 'public', tight your belt one notch further !!!

Well done Steve.
Surely there has to be an alternative agenda here. Who has shorted European bank stocks? Who has bought big holdings in gold? Or are the people behind these moves become more sophisticated and have massively bought up futures in American armaments manufacturers when they were cheap?
Why doesn't anyone in authority in the EU understand moral hazard risk?

I heard Wayne Duck say "suffering catfish, why didn't I think of that!".

Brent, please read my comments and Sinclair comments, above. There's answer to your qstn "Who has shorted European bank stocks? Who has bought big holdings in gold? ". Bankers made huge mistake: they destroyed the most important thing in fractional money system, TRUST, trust of public in safeness of money in bank accounts. Especially bad, trust of rich foreigners. Check HSI -478, N225 -264 !!!!!! When trust in safeness of money in bank accounts destroyed it will be impossible to run QEs (money printing). It will bring hyperinflation. That will be the tool for Putin & others to punish western bankers

Why so timid? If this happens, Cyprus is wrecking it's off-shore money laundering business - the mobile money will move elsewhere. So why not just confiscate the contents of all foriegner accounts? A barrage of noisy holier-than-thou "outrage" about the Cypriot Government taking action against international criminals should provide the political fig leaf - and the locals can keep their cash. If you are going to hit the nuclear button, you may as well go all the way and strike a heroic pose while at it. Politicians these days, useless, even at politics.

Looks like politicians really useless. They still have not realized what they have done !!! "Cyprus' finance minister, Michael Sarris, tells CNBC why he defends the controversial tax on bank deposits."

Listened Michael Sarris, Cyprus fin minister. He is saying that 10% robbery of savers sort of not bad thing. He also tries to persuade foreigners that this robbery only for once. Those russians should be not worried, Cyprus gvmnt promises it will never happend again !!! Sort of, you know us, we always keep our word. Circus left the town, but clowns still here !!!

Latest discussion. Cyprus gvmnt wonna change amnt of robbery. Deposits below 100k will be robbed by 3%, but deposits above 100k euro could be robbed by ... drams please ... 12.5% !!!!! As Cyprus fin minister said: no worries, it will be only once, just trust our word - we always keep it.

Jim Sinclair’s Commentary

The funds withdrawn in Cyprus by depositors via the use of ATM machines this weekend already had 10% deducted from the cash balance in the account by the banks.
The ATM use was a "run on the system" and not a trick to avoid the 10% confiscation.
Could, and would are two different things. Maybe a call from Russia has had an impact on Cyprus’ leadership.
Revenge can be a bitch when it is Russian style. LaGarde has made the mistake of her career. Central banks everywhere have put $4 trillion into the system to save it from the effects of the OTC derivative meltdown and the flushing of Lehman. $10 billion is about to blow that all up.
The greatest conspiracy in history may well end up being stupidity and hubris. It might be Europe’s consideration of Russian money as too Russian to care about.
The Fed will be swapping the hell out of the dollar from 11pm tonight forward.

Mr Keane would you like to simply what is happening globally??? Between globalisation and the EU is it possible that all this if good for big busines multinationals the more concentrated the market the more monopoly or captured the market becomes and if it goes wrong the taxpayer of whatever country is expected to bail the bankers and business out???

So what is new?
Except of course an 'as usual' cultural 'trainsmash' Greek-Cypriot lack of subtilty!
Having a grab at a piece of the middle class's bank savings accounts isn't the smartest option when the 'international bank executives larceny best practise book of instructions' is consulted - is it? But then again there isn't a lot of accumulation fund superannuation in Cyprus to rort - is there?
When Australian's superannuation balances were 'got at' via negative returns (mine included) in 2008, 2009,2010 it was never made public into whose pockets the double entry 'credits', which balanced the other side of the ledger 'debits' (the losses we endured) - went ?
It is of course the same pockets as to where this Cyprus savings bank deposits grab is destined, when one tracks the monies concerned, via a plethora of deliberately cloudy deviations, to its final resting place!
After watching 4 Corners last night I am starting to think that our politicians are as culpable and 'bent' as the Wall Street crooks!