The lessons we can learn from Cyprus

Debt is slowing down nations within the G7, while Russia has freedom to operate


So a deposit in a European bank is not safe after all. The decision by the eurozone authorities to make people with bank accounts in Cyprus lose part of their deposits crosses a line in the sand. Legally, the levy on the deposits may be classed as a wealth tax and, accordingly, the façade is maintained that bank accounts in Europe are guaranteed up to €100,000 (or £85,000 in the UK). But, in practice, we now know they are not – and that will have profound consequences far beyond the shores of Cyprus itself.

This is a story at three levels. First, it is one about people: how will Europeans react to this shock? Second, it is one about Europe: if the core, led by Germany, imposes such terms on a small Mediterranean state, what might it do when confronted by demands from Spain and Italy? And third, it is one about global power: if it is true that the Russian authorities are willing to bail Cyprus out – and we will have to see about that – then this will be a stark reminder of how power is shifting towards the BRICs.

People first. We don’t yet know the details of the bailout but we do know that some depositors will lose some money. British service and government personnel will be compensated by our own Government and we are told that the UK branches of Cypriot banks are ring-fenced. But, as far as one can see, everyone else is liable to lose some money. We all know the reasons why the deal was structured in this way. A lot of non-nationals, including many Russians, have bank accounts there and it would be difficult for German politicians to explain to voters that their funds were being used to bail out foreigners. There is also the half-hinted suggestion that a lot of the foreign deposits in Cypriot banks are there to avoid tax or worse.

But if we can understand the reasons, we can also see the consequences. This does not mean that any Briton with a bank account in Spain or Italy should take their money out tomorrow. Nor does it mean that all Spaniards and Italians should open an account in Switzerland or Germany either. But it does mean that there is a non-negligible chance that people with assets in banks in other financially weak European countries will face a similar levy, not now but in a couple of years’ time or whenever. Many people will conclude that it is silly to take the risk and will take their money out while they can.

That is, after all, what many European companies with cross-border activities are doing. For example, if they have a business in Spain, every night they sweep the accounts of their local subsidiary and transfer the money out of the country. The accounts of the European Central Bank show how money has flooded from south to north, with a peak last summer. Recently, the pace has subsided and some funds have started to flow back. Expect that modest return of confidence to be reversed again – and that the eurozone authorities should have allowed this to happen shows how little they understand about people and their savings.

The costs of leaving the eurozone, in the short-term at least, are larger than the costs of remaining in

That leads to the second story: what this tells us about the eurozone. While the German taxpayer is prepared to underwrite other countries’ continued membership of the eurozone, the euro will survive intact. The costs of leaving the eurozone, in the short-term at least, are larger than the costs of remaining in. So money is doled out, the country is “rescued”, but the terms are harsh, for the country is required to cut public spending, increase taxes, recapitalise its banking system, bring in market reforms and so on. You can have a debate as to whether the terms have been too harsh or just too ill-constructed but the results have been, at best, disappointing. The poster-boy, Ireland, is starting to be able to borrow again from the commercial markets and so is on the way to leaving life-support, but at a cost of five consecutive years of the economy shrinking. That is success. If you want to see failure, look at Greece.

At every bailout there has been German resistance, for the understandable reason that the German taxpayer is the largest single guarantor of the deal. But only now has German pressure been so suddenly and starkly imposed. There was an outline deal last week that did not hit bank deposits. Germany baulked and insisted on tougher terms. It may well be that Germany did not want the bank levy imposed on balances of less than €100,000. The German Finance Minister, Wolfgang Schäuble, said yesterday that he and the IMF had been in favour of “respecting a deposit guarantee for accounts up to €100,000” and that it was the Cypriot government, the European Commission and the ECB that had decided on the levy terms.

But the harsh truth is that if Germany is close to its political limits over the terms it demands of a tiny economy, equivalent to 0.2 per cent of eurozone GDP, the country’s willingness to support potential future bailouts of Spain and Italy must be in question. To say that is not to attack Germany. It is simply that it has its red lines, just like any other country, and we have seen them this weekend in a particularly clear form.

And the global shift in power? It would have been perfectly possible for Germany to ease up on Cyprus. It chose not to. Russia, by contrast, rushed forward with its chequebook. Or maybe not, for I don’t think we should take too seriously any offer by the Russian authorities, or its national energy company Gazprom, until something firm is on the table. What we do know is that if Russia did want to bail out Cyprus it could do so without blinking, for Russia has the lowest overall debt-to-GDP ratio of any large economy in the world.

And there’s the rub. Our world, the G7, is slow-growing and heavily in debt. Add together all the debt in Britain – personal debt, company debt, public debt and so on – and it is more than four times GDP. Even in Germany, it is two-and-a-half times. But in Russia, total debt is only three-quarters of GDP. China, India and Brazil all have debts of less than one-and-a-half times. So the BRICs have freedom that we don’t have – a freedom to invest, a freedom to deploy their power. And, as we can see with Russia’s swagger over Cyprus, they know it.

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