On Saturday the 16th of March, the European Union and the government of Cyprus (that is, the internationally recognised state which covers the southern half of the island) quietly agreed the terms for a €10,000,000,000 bail-out for the debt-laden island. Quietly, that is, for the rest of the world. The people of Cyprus are outraged at the most draconian austerity plans ever seen in peacetime history. For it is not only the traditional pattern of regressive tax rises, public sector layoffs, and undemocratic privatisation that the islanders will be forced to accept, but an unprecedented direct levy on all savings held in Cypriot banks.
Within hours, EU officials (notably, not the Cypriot government itself) announced that the first €100,000 of deposits held by individual has been taxed at 6.75%, rising to 9.9% on savings above that level. Though this has raised €6,000,000,000 for the Cypriot government, the indirect costs this precedent will have dwarf any ‘benefit’. Within minutes, queues were forming at bank counters and ATMs, despite the futility of withdrawing cash from accounts in attempting to avoid the tax- as with all emergency moves like these, all means of avoiding it are blocked. In this case, banks were told to pay out no more than the 90.1% net balance of people’s accounts. Nevertheless, the queues continued to grow.
Cyprus has just raised the equivalent of one-quarter of its GDP, and this will be valuable in meeting its liabilities to foreign investors. Unfortunately this means that any country in the EU which is having financial problems is likely to face a run on its banks, caused initially by fears of a tax but then becoming self-sustaining, even if there was a chance of avoiding emergency assistance. The world has just witnessed a tragic and short-sighted undermining of confidence in the safety of retail savings.
Some on the radical left have commented that, though taxing pensioners on their modest care home fund is appalling, the principle of a one-time levy on the assets of the super-rich should be welcomed. To quote Peter Mannion (the cynical Cabinet minister from the popular satire The Thick of It), it is a “political merengue: sweet, but without much real world substance”. Trust that money in the bank is as safe as cash in the hand is crucial to supporting the bread and butter finance which keeps the global economy functioning.
The implications of this levy will not appear to be a significant problem today, but it is only a matter of time until they come back to haunt Europe. And this has only happened for the sake of a fraction of a percentage of the region’s annual economic output. Unfortunately, it is too late for us to negotiate a fairer deal for Cyprus. The logic of the austerity measures has become so complex as to become self-contradictory: in order to avoid a default on Cypriot government bonds, which would damage investor confidence, an effectual “default” on Cypriot savings has taken place… which will ultimately damage general investor confidence.
Simply allowing Cyprus to default on, say, 50% of its debts followed by an EU-funded loan to any pension funds or banks affected would have been a more productive path for European officials to follow. This is particularly true when one considers how small the Cypriot national debt is compared to the European economy- Spain or Italy might be another story. The effects of those who have agreed to take a risk on their capital (by lending to a government) actually enduring a loss on some of that capital would be less severe than rendering savings banks unsafe investments. How can it be that investors have come to expect fair returns on gilts, and yet expect the losses to be paid by the general population who have received no such benefit?
BY: Jack Darrant