In times past we had Jean-Claude Juncker. The prime minister of Luxembourg. He was the head of the Eurogroup of finance ministers when the bail-outs of Greece, Ireland, Portugal and Spain’s banks were agreed on. The very mention of his name, at the time, could evoke an almost spitting rage, except that to actually spit on his name seemed to create a sizzling noise as if the very fires of hell were making it so.
Those deals, we all so despised, now we can almost hear him sing “I am the very model of a finance General” (with due apology to Gilbert and Sullivan). How times have changed. What then seemed the actions of a mad man, now seem the actions of a sage.
The intended design of last week’s bail out to rescue Cyprus has backfired so badly this week, that there is now every chance the island may pop from the single currency like a squeezed orange pip from between the fingers. Whilst Bank shares have tumbled across Southern Europe, the Bond markets have been an ocean of calm. Even if this ignominious exit can now be avoided, this complete balls up has done a serious wrecking job on the Island, its banking system, its economy and fractured interests beyond its shores.
In case we need reminding. The deal criteria given on the 16th was for those under €100,000 balance to pay as well as those uninsured deposits over €100,000 at a rate of 9.9%.
This threshold of €100,000 alienated one of the most influential bodies in Cyprus today, that of Russia. By also attempting a raid on the sub €100,000 band the EU managed to also alienate the very people of Cyprus. Even when these terms were watered down to exempt those with balances under €20,000 not one single MP voted in favour. Are you surprised? Apparently those powers that be in the EU actually were. This is how far they have become removed from reality.
The Finance Minister then jumped on the next available flight to Moscow to see if Russia could stump up some cash, but to date this has yielded no result.
Cypriot cash machines are working overtime and were being refilled as the banks are not going to reopen until after March 26th. I say after, rather than on March 26th as there is every likelihood that some may never reopen.
However this pans out, it is now odds on that a bank run will occur. The local community is most probably going to withdraw every cent they can, stuff it in anywhere the banks, or any other institution cannot get their sticky fingers on it.
So how did this all happen? The core of the problem lays in the size compared to GDP. The amount is actually quite small, some €17 billion. However, this is pretty much the size of the Cypriot economy. A bail out of this size would take the public debt to around 150% of GDP. Quite unsustainable. Furthermore, over €10 billion of this is needed to recapitalise the banks, especially the two top banks who together have assets some 4 times the size of the Cyprus GDP.
I mentioned some time back about the island’s banks being pretty much awash with Russian moolah and also mentioned that the Germans were spitting venom over any bail out required because of this.
The prime Minister of Cyprus has been in the job less than a month. His acceptance speech, full of bravado, stated clearly that under no circumstances would bank depositors suffer any kind of haircut in their accounts. Notwithstanding his empty words that this ‘tax’ was different, in fact it is exactly what he promised would not happen.
Who was behind this levy? The finger has to point to Germany, The Central European bank (lapdog of Germany) and the IMF. They refused point blank to cough up more than €10 billion. The difference was a simple €7 billion. Privatisation will provide around€1.5 billion and the rest had to come from somewhere. Deposits in Cypriot banks as at the end of January were reported at €68 billion. You do the maths. Add to this mix the small fact that of the reported €68 billion, Russian deposits are estimated at €21 billion. As I mentioned some weeks ago, the largest investor in Russia has been Cyprus (with Russian money). Nearly one third of all Cypriot bank deposits last year and around one quarter of total lending to Russia shows the size of the situation. No wonder Russia was the first place Cyprus went in 2011 when the markets pulled stumps on them.
However, the alacrity with which the creditor countries seemed to agree to all this doesn’t bear close scrutiny. So far there has been no bank run in an EU country, including those taking very large bail outs. So one wonders why the smaller balance holders were to be hit, which of course has had something of a huge domino effect on the banking insurance scheme. The prime Minister, in a fit of I do not know what, imagined that the intellectual impact of 9.9% would be far better than 10%. He forgot this message would be delivered to people who live and die by money, and figures. They know, as well as anyone, that the actual difference is 1/100th. The total estimated deposits over €100,000 are €38 billion, so this would raise €3.8 odd billion. Deposits sub €100,000 would have to bear the balance of the burden, some €2 billion.
It all started to go pear shaped when it became apparent that this was never going to happen. Germany has dug in and is refusing to budge. So the Cypriots have turned, once more, to Russia.
There is serious poker being played here. The recent discovery of a gas field has given Cyprus a lifeline. Putin, having bared his teeth over the situation now has to show he can protect Russian interests abroad. It is likely he would bargain very hard for (1) an extension on the present €2.5 billion loan and (2) any further moolah.
On the other hand, Germany really does not want to see an increased Russian influence in the Mediterranean. So in turn, Germany will be trying to find a way to stop Russia from making this play, as it would also kick the can down the road and increase the dependency on Russia.
So what may happen? Well the two most obvious results will be (a) Germany remains firm and there is no breaking the impasse. Cyprus is ejected from the Euro and the ramifications of that momentous decision are played out. The peril in which this places the euro Zone cannot be underestimated. Yes, some might say Cyprus is tiny and the shock waves wont amount to much, but they may well. The fears of last year when the Euro slid so badly would rear once more and this would bring all the related problems of imported inflation etc with it.
(b) The more likely is that some kind of fudge will be resolved. The Russians getting a piece and the ECB picking up more. The balance still being thrust upon the Cypriot people.
However, the damage is already done, and what damage it is. The forecasts for Cyprus were a 3.5% contraction this year. I imagine this looks very rosy right now. I would suggest nearer 5% or even 6% contraction. This will then be followed by a further slide a la Greece (the economy of which has contracted by some 20%+ over the past 5 years). Furthermore, it is highly unlikely that the original projection of a 100% debt to GDP ration by 2020 would be achieved. This then casts the people of the island into pretty much a generation of depression with all the social problems inherent in this.
Beyond the island, weak banks in other economies around the med and elsewhere will have seen all this unravelling before their eyes, so will their deposit holders. Whilst a bank run is unlikely, it may restart the slide in deposits that occurred 2009 and 2012 when those deposits slumped by some 30% with Greece at nearly 40%. This, in turn will slow any recovery.
Lastly, and maybe most importantly, it is now obvious to any watchers that the politics of the euro zone outweigh any other needs. And, dear reader, in this last sentence is the core of the weakness of this whole crazy unified currency.
Due to current economic conditions the light at the end of the tunnel has been turned off