Cyprus- Drink Your Orange Juice and Like It, Comrade

There’s a Cyprus fiscal surplus deficit
(with apologies to Ogden Nash)

JR Max Wheel

19 March 2013

Oh dear, if there was any doubt about the competence of EZ leaders to achieve sensible restructuring of economies, the Cyprus “solution” has really taken matters to a new low by imposing a tax on depositors and it hardly matters, in one sense whether depositors are Russian oligarchs or ordinary citizens. The reversal of the normal rules of creditor priority is a major mistake, making a Cyprus bank run almost a certainty and putting a large hole in the pan-European bank deposit scheme. Of course, it matters to the ordinary Cypriot deposit holder, who is not the culpable party here and for them this half-baked idea is a real disaster, but it also makes for uncomfortable viewing in other larger indebted Southern European countries, where although it is less likely, a bank run would mark the end of the Euro experiment.

It is argued that Cyprus is special, because of its disproportionately large banking sector to the island’s GDP. This situation has been built up over years as the banks have encouraged flows of kleptocrat monies from all over, but especially Russia, with not too many questions asked. It is also  a home to “place in the sun” retirees, who have also joined the party, and not to mention the importance of NATO armed forces conveniently using the island as a permanent “aircraft carrier” in the Eastern Mediterranean.

The FT points out the delicious irony that Cypriot banks are almost entirely non-reliant on the wholesale markets and largely deposit-funded, the holy grail of banking supervisors worldwide. This is another idea that has taken a hefty knock on the head, if your banking system is reliant for its deposits on large amounts held by foreign citizens and roughly seven- to eight  times the size of your economy, which explains warning shots from the Kremlin about continuing with the terms of its € 2.5bn. loan, to assist the Cypriot economy. To paraphrase Ogden Nash- Drink your orange juice and like it, Comrade. Your deposit, your problem, or is it? Bail-ins are seen by some wilful economists as being a favourable move, that might be so if you had wiped out equity and bondholders first, but not innocent citizens or do economists not recognize such a social contract?

It is easy to see this situation unfolding as most Cypriot banks were impacted by the Greek debt situation and it should have been obvious that this was fast coming down the tracks to Cyprus. Even moving funds to non-Cypriot foreign banks has not made any difference to the savings grab.

The argument is that there is no alternative to a savings grab because there is nothing else of the size of the banking sector to grab. No significant senior of junior debt to seize or large equity holdings anywhere near sufficient to meet the size of the bailout needed, approx €16bn.  Even the French have stated that there is no way the Cypriot economy can manage to repay a bailout of more than €10bn.

This situation is extreme in Cyprus, but not unique and the same tired arguments play through over and again- there is no lasting solution to the problem until you remove its cause, this is the currency itself. Cyprus cannot afford to be in a strong currency club and there has to be flexibility brought into the Euro mechanism.  Equally, all the deficit countries need a LT solution to the debt hangover, not a series of weak fixes imposed by the ECB or Brussels. This means radically stretching the maturities of monies owed to allow a gradual recovery, a total recapitalisation of the banks and exiting the currency club that neither should have joined, or be permitted to join, in the first place. One might well ask why there was not a focus on the amount of klepto-deposits poured into the Cyprus banks.

It is utterly laughable that M. Juncker, the Prime Minister of Luxembourg, another mini-State with an outsize banking sector, is now warning of the dangers of contagion- he has every reason to worry, having been at the heart of EZ restructure efforts until very recently. But then like so many EZ leaders, he will find it impossible to admit the dreary history of mistakes that led to the founding of this ill-fated currency and the truly colossal damage it is wreaking across the Eurozone.