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Cyprus Crisis II: Canary in the Global Financial Coalmine?


It’s now been more than a week since the Cyprus banking crisis erupted, and patterns are beginning to appear for the Eurozone and greater global financial system that are of some interest.

As predicted by this writer in a commentary on the Cyprus crisis earlier in April, the condition in Cyprus continues to worsen by the day. What was initially estimated to cost 7 billion Euros to Cyprus in order to obtain an additional 10 billion euro bailout by the European ‘Troika’ (i.e. Euro Commission, IMF, and ESM fund), rose last week to a 13 billion Euros cost to Cyprus. 'Cost’ means the government of Cyprus must raise taxes, increase spending cuts, and accelerate the sell off of government assets.

But that's not all. Since the Cyprus crisis represents not just a government debt crisis but clearly, first and foremost, a banking crisis, the additional cost required by the ‘Troika’ is to make depositors in Cyprus’s two main banks pay for the bailout in part as well—in the form of an expropriation of their savings deposits.

The Cyprus situation therefore represents a strategic shift by big Euro bankers, by their executive committee the Troika, and by Euro government policymakers in general. It is a recognition that prior policy solutions, of austerity fiscal policies and liquidity injection monetary policies, will likely not prove sufficient in the event of another banking crisis elsewhere in Europe to keep the Euro banking system afloat. Confiscation of depositors’ savings are therefore now projected to serve as a ‘third way' to pay for Troika engineered banking bail outs.

When the Cyprus crisis first erupted, Eurozone financial minister, Djisselboem, let the cat out of the bag by letting it slip in a public comment to the press that confiscation of part of Cyprus depositors savings (called ‘bail ins’) now represented the ‘template’, as he put it, for future euro bank bailouts. He quickly back-tracked, however, since to publicly admit such was to encourage an old-fashioned retail ‘run on the banks’, not only in Cyprus but potentially in the Eurozone periphery of Spain, Portugal, Ireland, Greece, and even Italy—not to mention in the latest banking instability event now emerging in Slovenia.

 

The Troika therefore quickly clarified Djisselboem’s statement, and amended its initial position that all Cyprus depositors’ savings would have to contribute in part to pay for bailouts, adopting the position that only depositors with 100,000 euros or more in the bank of Cyprus would have to pay.

At last count, as of last week estimates were that only depositors with 100,000 or more Euros ($130,000) in the remaining Bank of Cyprus could expect a ‘haircut’–up to 60% of their deposit balances.

But that was a week ago, at the beginning of April. By mid-April the situation has no doubt deteriorated further. That means the cost of bailout continues to rise daily, before the ink has even dried on the 23 billion Euro bailout deal. That in turn means the 60% confiscation of depositors with more than 100,000 Euros will have to be further raised, the Troika will have to provide more than 10 billion euros bailout, or that the exemption of savers with deposits less than 100,000 euros will eventually have to start paying something as well.

The situation in Cyprus in terms of both government and bank bailouts will inevitably grow worse. Why? Because the real economy will now continue to grow worse. Austerity will mean even less government revenue collection and thus even greater government debt cost. More Troika bailout funding will increase that debt cost still further. The parallel on-going bank crisis in Cyprus will also grow worse, as depositors withdraw as much money as quickly as possible from the Cyprus bank and start hoarding it and/or find ways to move it out of the country, notwithstanding recent controls imposed on withdrawals and capital flight.

To put it in economist jargon, money supply in the system will collapse despite the Troika bailout, as money demand and money hoarding escalate and money velocity plummets. Bank lending to business will dry up. Further layoffs will occur. Unemployment will rapidly reach depression levels in excess of 20%, and tax revenues correspondingly fall even further. With depression, prices will collapse. Debt and deflation will lead to more business and consumer defaults.

In a futile attempt to stem the collapse of money and the economy in the private sector, the Cyprus government in early April initially instituted draconian controls on bank deposit withdrawals and money transfer from the country. The government has recently announced these initial limits and controls are now being tightened further, and extended to the end of May. Limits and controls on withdrawals of deposits and money transfer will remain for quite some time. That means a two tier Euro system, with Euros in Cyprus worth far less than Euros elsewhere.

Over the next six weeks the situation in Cyprus will deteriorate significantly. By this summer, the cost of the Cyprus bailout could rise to 30 billion, from the current 23 billion total. The Troika will have to add more bailout, the Cyprus government introduce even more draconian austerity measures, and depositors will have to pay even more—or some combination of all the above.

Elsewhere in Europe, calls are consequently rising for the EU to provide additional funds to Cyprus out of the Eurozone’s ‘structural fund’, i.e. its long term infrastructure spending assistance fund available to Eurozone members, as an emergency solution. But such funding assistance will amount to ‘too little too late’ to make a difference to the downward spiral that will continue to hit Cyprus over the coming months. Moreover, if and when structured funds are made available to Cyprus, much could simply be hoarded by lenders and investors, given the dire economic situation in Cyprus, and therefore have little positive effect.

Last week the Euro financial ministers met in Dublin, in part to deal with the Cyprus situation and in part to address continuing debt problems elsewhere in the periphery as well as weakening of banks in the Euro 'core' economies. They quickly agreed in the midst of last week’s worsening events in Cyprus to extend terms of bailout payments by Portugal, Ireland and Spain for several more years. Absence the Cyprus events, the Euro financial ministers would no doubt have been tougher with Portugal and the others, requiring them to introduce even more austerity measures in exchange for extending the debt payment schedules. That they didn’t take that hard line is an indication they recognize the banking situation throughout the Eurozone is continuing to deteriorate.

On the agenda in Dublin as well was the question of establishing a true banking union in the Eurozone and broader EU. Little was accomplished on that question, however. Unlike the US central bank, the Federal Reserve, or the Bank of England or Bank of Japan, the European Central Bank, ECB, is not a true central bank. It can only engage in central bank money injection and bail out of individual banks in trouble if all the financial ministers of the Eurozone countries (i.e. their respective central banks) agree to allow the ECB to do so. Thus, unlike the US, UK, or Japan, the ECB cannot engage in a massive liquidity injection in the form of ‘Quantitative Easing’, or QE, as a means to engineer bank bailouts. The Eurozone in part must therefore lean more toward confiscating depositors’ savings in the banks in trouble as a solution.

Last summer 2012, ECB head, Mario Draghi, promised to move forward on a banking union and the first step toward such a union, the establishment of the ECB as a true ‘banking supervisor’ of private sector banks. That temporarily quelled last year’s Euro banking crisis. But it was apparently mostly just talk and mere talk can only last so long. As was made clear from the recent Dublin meeting of Euro financial ministers, the Eurozone has made little to no progress toward even granting the ECB ‘banking supervisor’ powers—i.e. a necessary precondition to becoming a true central bank. Nor is that likely to happen before the next German national elections in September 2013, or even after. Germany will continue to thwart and oppose the ECB assuming central bank-like supervision powers or becoming a true central bank capable of independently introdcuing massive QE injections. Germany in its present position can far better call the shots on the entire Eurozone economy. Giving authority to a true ECB central bank would only dilute its present authority and role. So don't expect any real changes in the Eurozone, Mario Draghi's pronouncements notwithstanding.

All that likely means that the Euro banking system in general will continue to drift toward more instability. Watch for Slovenia as the next crisis center. And behind the scenes, investors throughout the Eurozone’s periphery are no doubt looking at Cyprus and preparing to move their money out of their own national banks in Spain, Portugal, and elsewhere in anticipation of likely ‘depositors’ confiscations’ should a banking crisis erupt in their respective countries. That money will most likely flow into Germany, New York, or even Tokyo.

Meanwhile, elsewhere globally the US, the UK, and now Japan continue their headlong rush toward ever more quantitative easing, QE—that is liquidity injection to banks, shadow banks, and wealthy private investors—by printing money.

The US has led the way with multi-trillions of QE, continuing at the rate of $80 billion a month with no end in sight. The Bank of Japan has just announced its equivalent, even larger than the US QE, per its GDP, and soon the Bank of England will announce another round of QE when its new chair, Mark Carney, comes on board this summer. Outside Europe, capitalists are clearly rolling the dice on QE as the solution.

It is becoming increasingly clear in fact that global policy makers and capitalists are moving toward a general policy mix of ever more QE combined with continuing fiscal austerity. But austerity is clearly causing problems and is a drag on economic recovery. QE is also having a net negative effect on real economic growth and financial instability, contrary to its announced intent, as will be explained in a subsequent article by this writer.

Without the option of a true QE, the Eurozone has had to rely more on austerity. In contrast to Europe, the US has relied more on QE and is only now moving toward more fiscal austerity after putting that on hold during the 2012 election year. The UK has introduced austerity and a moderate QE policy, neither of which has prevented it from descending into recession again. Japan initially did nothing, neither QE or austerity, but is now betting heavily on a massive QE policy that has begun to roil financial markets globally and intensify an emerging ‘currency war’ via QE-driven competitive currency devaluations.

So all are major capitalist sectors globally are converging toward ‘Austerity + QE’ as the policy solution. But neither QE or Austerity will resurrect the global economy as it drifts toward slower growth, more recessions, and more banking instability in the months ahead.

A growing focus on confiscating depositors savings will therefore become more of an option by all over the longer run. Not just in Cyprus. Not even just in the Europe. But in the US as well. Confidential memos recently released show plans by the US FDIC and the Bank of England in a meeting last December 2012 open to the idea of confiscating depositors' savings as yet another means by which to bail out banks in the event of another banking crisis.

But more on the contradictions of QE, ‘Austerity American Style’, and bank savings confiscations in a follow up to this article. 

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