Monday, March 18, 2013

Cyprus Bailout

The recent news that Cyprus would be taxing 10% of every savings account in domestic banks has sparked major backlash, as well as a negative ripple effect through the global markets. But there's more than an unprecedented tax that makes the Cyprus situation unique. And it's worth taking a look at just why this tax is being placed on the people of Cyprus.

So, like many other small EU nations, Cyprus took advantage of the protection and stability of the Eurozone to borrow large amounts of money, driving themselves into debt. Like other countries that have done this (Greece is the best example), Cyprus was abruptly cut off when the recession hit back in 2007/08.

The thing that sets Cyprus apart is its banking system. First of all, the banks can make almost no money on bonds, so they focus a lot more on savings. Because of that, the Cyprus banks have very loose regulations to help attract big investors. This has led Cyprus to become a major tax haven for foreign Oligarchs, specifically Russians. Many wealthy Russians use the Cyprus banking system to keep their savings free from higher domestic taxes. The EU struggles with banking because different nations have different laws and regulations, creating pockets where investment and savings grow while others shrink. The Cyprus banks used all that foreign money to invest and keep themselves afloat, at least until the crisis.

Now, Cyprus is asking for a bailout for its banks. In other nations, the EU (really, Germany, but it's essentially the same thing) has demanded steep austerity measures to offset the influx of cash to bail out the government. But it's not just the governments that are asking for bailouts, its the banks. In Cyprus, the banks are demanding a bailout from the Cyprus government who, in turn, is asking for the money from their creditors.

The problem, though, is that the EU is not about to bail out a bunch of wealthy foreigners, especially not Russians. They are loathe to pour European Union money into a banking system that is used by wealthy non-EU tax cheats. So, the creditors gave Cyprus the ultimatum: charge the savings accounts to help with the bailout cost, or say goodbye to the Eurozone.

It's an interesting calamity. Cyprus is a relatively small country, like Greece, and both have been threatened with EU ostracization. Both have relatively small economies, and both have borrowed huge sums of money to help improve and maintain a high standard of living for their citizens. But Cyprus has been given what appears to be a no-win situation. Either they steal 10% of their citizens' money, or they are kicked out of the Eurozone. You can imagine why Cyprus faced a near-run on the banks, stopped only when the government ordered all the banks closed until Thursday, likely when the 10% tax will be incurred.

But wait, there are some limits on that tax. For one thing, it won't touch anyone with less than $100K. Second, it's worth noting what the alternative appears to be: the end of the Euro in Cyprus. What will everyone's money be worth when it has to be converted into domestic currency? Not only that, forget about Eurozone trade, Eurozone politics and "borderless" diplomacy, easy Eurozone protection and support, and so on.

Like I said, the EU has essentially put Cyprus in a situation they cannot possibly work out without serious damage to their credibility, economy, or both. The EU, and especially Germany, has got to stop demanding blood sacrfices for every penny they kick to these developing nations. Places like Greece and Cyprus can't keep up with the rest of the Eurozone economy, so they have to borrow. Then, the big banks in Germany and the other lending nations call in these debts, and demand austerity for them. Those small countries don't have much of a budget to slash, so every little bit hurts. This leads to layoffs, depressed economies, and more borrowing to keep things running, which demands more austerity to keep the cycle going.

I'm not saying the major powers of the European Union should just give away this money, and I can understand their reluctance to bail out the Cyprus banks. But they have to see now that austerity helps no one and hurts everyone, and that continuing to hold small countries to impossible standards, to the point of forcing complete chaos in their economy and banking system (not to mention global implications) is unwise, unfair, unjustified, and downright stupid. If they expect to get their money back from a country that has to steal the wealth of its citizens (by their own direction, mind you), and demanding spending cuts, they have no concept of basic economics and investment returns. That money has to be put to use, it can't be shackled to austerity cuts.

So, that's basically the Cyprus story. It will be interesting to see how this plays out, and how the rest of the Eurozone responds to whatever Cyprus ends up doing. Seeing as how they've closed their banks until later in the week, they seem to be leaning toward tax. Or, they are attempting to prevent a run and buy themselves enough time to fashion a new deal with their lenders. I wish them well. Any deal would be better than what they've been handed now.

By the way, the reason there aren't more links in this is because so few new agencies are reporting on it, at least beyond the fact that it is happening. Let's hope this gets more attention.


samp said...

Very scary situation to say the least. When country begins steal it's citizens money the world is beginning to come apart. I certainly hope that the U.S. administration does not get any ideas to follow this "model"for getting new revenue sources as it seems they have with Greece, Spain, Italy and all the other countries going bankrupt in the EU. Interesting to see how this plays out as you say.

Chain-thinker said...

I don't think the US has to worry about this any time soon. Our economy is too big and too productive. If we are talking new sources of revenue, what would you suggest? Personally I like the idea of a 1% tax on every trade that is done on Wall Street. Just 1%. That would be tacked on to all of those micro trades conducted by computers at hundreds of times a second. Each of those trades makes only a few cents, and the tax would generate fractions of that each time, but those trades can generate money in the trillions of dollars over a year. 1% of $1 trillion is $10 billion. Imagine that revenue stream. You could fund nearly the entire government on that. And that's just one idea. No, Samp, I don't think we have to worry about Cyprus solutions for a long time...

samp said...

As you may have guessed, I was kidding sort of. The 1% tax on wall street trades is good idea. However, it will go nowhere as wall streeters "run" the country. I think closing some loopholes, but not the mortgage interest deduction as that would hurt the housing market I believe. There are a zillion places where cuts could be made. There simply is no political will. Require U.S.companies regardless of where they do business to pay U.S.taxes. But I really feel not much is going to get done until the "entitlements" are addressed. So, until there are some reasonable adjustments to those we're not going to solve anything long term. Entitlements could be adjusted as long as it is prospective and not retroactive. Frankly I hate the word entitlement; those who have Medicare paid into the system all their working lives; also SS. Howe about those on Medicaid? Also, I have never been able understand giving tax returns, which means that you paid more than you owed, to those who have paid no taxes. Where's the logic in that? Businesses like GE making something like $5B in profit paying NO taxes...first things first. ALL of congress has to be replaced. Senators like our great Senator Leahy, having been in DC for over 30 years, are the problem. Term limits will never get done, but not a bad idea. What is about the only thing not cut in DC? That's right congressional pay....