That’s, essentially what the profligate government of Cyprus did. They robbed the bank, or to be more direct, they robbed the individual accounts of everyone who had anything worth taking. Why? Well, as renowned bank-robber Willie Sutton famously said, “That’s where the money is.”
Tiny little Cyprus has been very much in the news lately and the thing is that while the island nation went broke and needed a bailout from the European Union it may be a microcosm of the same problem that many countries that have overspent could confront. Washington Post columnist Charles Krauthammer warned that while the Cyprus bailout may appear to involve a “trivial” amount of money, it could set the stage for wide‑reaching consequences. In fact he compared the situation in Cyprus to the 1914 assassination of Austrian Archduke Franz Ferdinand, which began the dramatic spiral towards World War I. It could have a ripple effect the way Sarajevo did in 1914. Little things can develop into big things. But the bailout is “only” $13 billon. Krauthammer opined that, “What is surprising is how the European Union decided to get really tough, because this is a relatively trivial amount of money.” And they decided that the bailouts are really going to get out of hand. From now on they are going to make people pay, really pay, and they mean they are going to make the governments pay and they are going to make the depositors pay, which is always a way to get the money.
The original plan for Cyprus by the European Union called for a tax on depositors’ money. Of course, it wasn’t really a tax it was essentially taking the money of depositors; ten percent was proposed, and giving the depositors, in effect, stock for an equity position in the Island so that creditors could be paid first and depositors would get their money back last.
Looking at Cyprus in isolation, the amount of money is small; it is only a $13 billion bailout. Apple has about $50 billion cash on hand, which means that Apple could take a quarter of its current holdings and purchase the Island and turn it into a silicon campus.
As The Wall Street Journal noted, “Nothing is ever simple with a euro‑bailout, and the Cyprus fiasco is proving that again.” The tiny island disaster became the first euro‑zone country to impose capital controls since the single European currency was introduced. This spared Cyprus from immediate economic collapse, but the curbs are a worrying precedent. Limitations on cashing checks, redeeming time deposits, and paying with credit and debit cards will keep the banks liquid and payments moving. It is, of course, the depositors who will be providing the liquidity and keeping the payments moving. They may not be so liquid or able to keep their own payments moving, but Willie Sutton never worried about the depositors and neither, evidently, is Cyprus.
More troubling, however, is the Cypriot government’s control on cross‑border capital flows. Cypriot depositors won’t be able to make electronic transactions between Cyprus and foreign countries, and no one will be able to obtain more than €3,000 out of Cyprus in cash. All of this helps avert an immediate freeze‑up of the domestic economy. But the trouble comes once money is allowed to move freely again. At that point, even insured depositors will reconsider whether they wouldn’t rather keep their savings somewhere else.
Capital controls tend to be much easier to impose than to lift. No politician would prefer to suffer painful consequences today if they can be delayed until next month. Iceland still has capital controls five years after its crisis.
Cyprus is facing a run on its banks, not on its currency. That alone means capital control in this case shouldn’t have gone beyond what’s necessary to stabilize the financial system. All of this could reinforce a broader confidence crisis if depositors are convinced elsewhere in Europe that they too might someday face strictures on capital movement. The euro zone is entering risky territory.
Another interesting thing to note is that money in Cyprus has been laundered into Russia, not out of it. Cyprus has been valuable to Russia because it offers democratic stability, a British legal system and a history of predictable justice. Cyprus is a refuge that makes Russians willing to reinvest in Russia, to the tune of $50 billion since the Soviet Union fell.
Last week, it was reported in The Wall Street Journal that, “A multicolored stack of shipping containers stuffed with goods intended for Cypriot stores towered over this nation’s largest seaport a monument to the country’s financial paralysis. In more normal times, thousands of tons of cargo speed through the Cypriot ports every week feeding Cyprus’ import hungry economy. But with the country’s banking system on life support, the cargo in that network is shuddered to a halt. “This is the artery of the economy and now nothing can move through here because no one’s sure they’ll get paid,” one of the dockworkers said, as a huge crane moved another steel container into the holding area.
Cash‑starved businesses across Cyprus are counting the costs of the prolonged bank shutdown and of new capital controls aimed at keeping funds in the country. Unable to pay suppliers, many stores have opted to close until things improve. While banks reopened ‑ allowing cash to return to the economy from depositors who can withdraw up to €300 a day ‑ it isn’t clear how long it will take before funds and credit again flow freely through Cyprus’ banks.
Perishable goods such as fruit and vegetables are running low. Cypriots have begun to stockpile essentials, such as baby formula, tinned food and olive oil. Almost everyone is trying to hoard cash. The head of Cyprus’ Small Business Confederation said that, “The market right now is a time bomb ready to explode.” “The full costs,” he said, “will become apparent only in the days and weeks ahead. Then businessmen will realize how big their losses are.” Central Bank of Cyprus is appointing an independent “valuer” for the commercial lender, and all or part of the 22.50 percent haircut that is being imposed on their depositors may be converted into shares within 90 days of that process being completed. The so‑called bail‑in won’t apply to the Bank of Cyprus account holders whose debts to the lender bring their net balance below the 100,000‑euro threshold, according to the statement of The Central Bank. Holders of accounts at other banks on the Mediterranean island aren’t being touched.
In the meantime, small groups of account holders, mostly retirees, pressed to enter banks as they formally reopened last Thursday. Police and private security guards limited entry to only a few people at a time. Some depositors searched all day for a cash machine that would dispense the €300 daily maximum permitted under new capital‑flight laws. Cypriot President Nicos Anastasiades ordered the creation of a three‑member committee to investigate the roots of the economic malaise engulfing the island. Although some have called for the head of The Central Bank to be fired, he said he had no intention of resigning.
Meanwhile, if Cyprus should need further assistance from the EU bankers or the IMF, it may have to mortgage its substantial future gas revenues from the recent finds in the tiny island nation’s territorial waters, something Cyprus has fought hard to avoid.
The long and the short of all this is that the story has a familiar feel to it. Running up huge debt that cannot be repaid has seriously hobbled Cyprus. It affects every European country and while no such damage is yet possible in the United States, the Cyprus story resonates as an example of what happens when a country ignores its debt.
We all know the United States has a debt bomb and although it has not yet exploded, the Administration in the United States shows no serious sign of restraining spending. In fact, the President of the United States has said, “We do not have a debt problem. We don’t have a spending problem.” We would like to know what kind of a problem we have with nearly $17 trillion of debt and a so-called sequester that results in a $15 billion spending increase over the last fiscal year. The Cyprus problem could be an important lesson, but it is one we fear will not be heeded on this side of the Atlantic.