Monday, March 18, 2013

The Implications of the Cyprus Decision

Over the weekend, Cyprus announced that it would be taxing bank deposits in return for a 10 billion euro rescue package from the European Central Bank.  For deposits up to 100,000 euros, the tax would run at 6.75%.  Deposits over 100,000 euros would be taxed at 9.9%.

This is the first time in the euro crisis that bank depositors - and not bond holders  - are being hit. Although the euro zone leaders were initially targeting the reported $18 billion of Russian and other Mafia money on deposit in Cyprus, the fact that the new tax would also be imposed on ordinary citizens has understandably created anger and the possibility of a bank run.

It was just announced that the parliament of Cyprus has delayed voting on the measure (largely because it was unlikely to pass).

Here's what the New York Times reported this morning:

By size, Cyprus’s economy represents not even half a percent of the combined output of the 17 euro zone countries. Yet the impact of this weekend’s decision by European leaders to impose across-the-board losses on bank depositors — from the richest Russian oligarchs, who have increasingly deposited their money in Cyprus’s banks, to the poorest Cypriot pensioners — in return for 10 billion euros, or $13 billion, in bailout money could not be more far-reaching...

But it is one thing to wipe out bond investors and quite another to force a loss on bank depositors, including Cypriot savers who had their deposits insured and, like people all over the world, had the impression that a government-backed savings account was inviolable.

We have seen a growing anger among the European electorate that the wealthy have largely escaped paying the consequences for the recent crisis. Both the U.K. and Switzerland have passed measures attempting to cap banker pay, for example, and now this measure aimed at hitting large depositors.

A wealth tax in this country seems unlikely.  However, a couple of years ago economists Carmen Reinhart and Belen Sbrancia wrote a piece that suggested that confiscation of at least a portion of deposit savings was not without historic precedent.  Here's what Paul Murphy wrote yesterday on the Financial Times Alphaville blog:

A couple of years back, when Carmen Reinhart and Belen Sbrancia updated the concept whereby governments might deal with a problematic mountain of debt by confiscating the savings of their subjects, the discussion was all about the subtle, sleight of hand solutions that might be employed.

Artificially cheap rates of interest might be forced on the embattled sovereign’s debt, local banks might be obliged to buy mis-priced government paper, exchange controls may be erected, and so on. Ordinary people, it seemed, could be financially repressed without realising they were in fact the victims.

There was no discussion back then of outright expropriation or a “tax”, as insured (and uninsured) depositors at Cypriot banks are now being forced to bear.

Although Cyprus is obviously a tiny part of the world's economy, the result of this latest move bears watching.