In economics, everybody is in the same boat. Everybody has an oar, rowing in a different direction. Everybody’s oar is a different size. Oh, and there’s a wind. And strong currents. And the odd waterfall.
So it is in Cyprus this morning, as people rise to the knowledge that some of their savings are about to be taken to bail out their sinking banks. I feel sorry for the people of Cyprus, which include a large number of British service personnel. But the big danger is that this bailout (or rather, “bail-in”) will do just the opposite of what it intends: plunge Europe back into financial crisis. This is how…
So what just happened?
In a nutshell, Cypriot banks went bankrupt because they lent money to Greece – eight times the value of everything made in Cyprus in a year – and Greece couldn’t pay it back. They weren’t alone. Britain’s banks also lent way too much money in the 90’s and 00’s. A few of them also went bankrupt – the government effectively bought chunks of Royal Bank of Scotland, HBOS and Lloyds TSB in 2008.
Cyprus (and the British government) could just let its banks fail, but by doing so people who lent a failed bank money would lose it. Who lends money to banks….? Other banks, who then become too afraid to lend to anybody else, stalling the economy. That’s what we call a “credit crunch”. Obviously, the Cypriot government can’t (or at least shouldn’t) let that happen.
The only option is to ask for help from places with money – the European Central Bank, International Monetary Fund and European Union. They have to make a deal which will involve these organisations giving them the money they need in exchange for a plan to sort out their debt. Greece has done this before, as has Ireland, Portugal and Spain. But this is different. This time, the ECB, IMF and EU (acronym hell) spied rich Russians, who have a habit of saving money in Cypriot banks. This time, everyone with money in a bank account in Cyprus will have to help pay for their banks’ mistakes: 6.75 per cent of all deposits under €100,000 (£87,000) and 9.9 per cent for those above €100,000.
Understandably, Cypriots are unimpressed.
Is Britain next?
Yes and no. First off, don’t panic – whether or not you’re an austerity fan, Britain’s government is dealing with its debt and the banks are more or less out of trouble for the time being. Your bank accounts will not be raided.
But…anyone remember Northern Rock? In 2008 the bank got into trouble and everyone rushed to withdraw their money because they feared they would lose it, just making the problem worse. This was a key moment starting a general loss of economic confidence. Investors (rich people), stopped giving their money to companies and banks. It spooked banks, who stopped lending so much (including to each other), which meant that people couldn’t buy homes, for example. The vicious spiral got us where we are today – a spluttering economy and lacklustre recovery.
Cyprus is like Northern Rock. If you knew that a percentage of your savings would be taken away from you, what would you do? Withdraw it! That’s exactly what the people of Cyprus are trying to do, and the government has forced the banks to stay closed until at least Tuesday. But if Cypriot savers can be made to stump the bill for their banks’ mistakes, why not, say the Portuguese? Or the Italians, Irish, Greeks or Spanish, none of which are out of economic danger yet. If people in those countries think they could be next, they’ll take out their money and banks won’t be able to pay their debts. Banks won’t lend and investors (rich people, again) won’t invest as evidence from Asia shows. This kind of Europe-wide calamity may not occur at once, and Cyprus is an unusual case, but the erosion on confidence is inevitable and the impact on Britain certain.
Bottom line: Cyprus could be the start of the next financial crisis.
UPDATE (20 March 2013): Spare change, anyone?
It’s not over yet. The Cypriot parliament yesterday voted unanimously (19 people abstained) against the plan to take money from savers in the country, which means that somehow it needs to find €5.8bn (£5bn) from somewhere else. It also means that the third smallest Eurozone country just stuck two fingers up to all the rest, setting a precedent that could undermine the ability of the other countries in the Eurozone to enforce bailout conditions. Why is this important? Well if investors (yes, rich people) don’t believe that the ECB can do “whatever it takes” to save the Euro (because countries won’t listen to them), then they’ll spend less than a miser in prison, further throttling the global economy.
In an attempt to plug the money gap, the Cypriot finance minister flew all the way to Moscow today to try to persuade the Russians to help out. After all, rich Russians account for around $31bn (€24bn / £20.5bn) of all deposits in Cypriot banks. Maybe Putin will cough up. Maybe not. Maybe a certain Russian energy company thought that rights to explore gas fields of Cyprus’s coastline might be worth a bit….say….€5.8bn?
Keep an eye on this one.