Crossing the Rubicon – IX

 

Queen

The Queen

Another One Bites the Dust

(And another one gone, another one bites the dust)

A bank rescue is being attempted in Cyprus by the European Union, the IMF, the ECB and the Cypriot Government. The full tab is expected to be of 17Bn euros of which the EU wants bank depositors to contribute with 5.8Bn. The first sentence takes care of the what, when, where and by whom, while the second is a pretty condensed version of the how. Five of the six questions people ask (or should ask) when they want to know about something. This leaves us with the trickiest one: the why. And the honest answer to that is I do not know and can only speculate about it.

The situation in Cyprus was well known and the can had been kick down the road like with everything else. Some 10Bln euros had already been transferred to Cypriot banks to help keeping them afloat. Now more money is needed and, in popular opinion, Germany said “nein” although in reality it said “we and our European partners will not pay the full amount”. In a world where property is no longer a sacred institution saying that you are willing to pay part of the mess not only does not earn gratitude from the debtor, it actually instigates accusations that the crisis is your fault from those who need the money.

This in part happens because the money in question does not belong to the donor either, it is being exacted (or more likely it will be in the future) from that country’s taxpayers. The receivers of that money do not understand why someone who does not own that money is holding back a fraction of it when their necessity for that money is absolutely clear to the donor (and a lot less to the taxpayer who usually unknowingly is paying the bill). But Cypriot leaders don’t want to pick up the tab themselves even when it is not their money either. So, despite not being their money, every politician would rather have other politicians’ constituencies paying for the bill rather than its own. There is, after all, some amount of accountability, although a lot less than what would be desirable. This explains why Churchill famously stated that democracy is the worst form of government with the exception of every other one.

Friends Will be Friends

(The other half run away, taking all the cash and leaving you the lumber)

Yet all democracies are not created equal (in fact, around the world, almost every single country is ruled by democracy. A triumph of the form, but less so of the substance) so the amount of pain you can inflict on your taxpayers is more limited in some countries than in others. In Germany people pay a lot of taxes, an indication that, perhaps, Germans are willing to pay for a lot without accountability. Not so fast. Germans are willing to pay a lot of taxes for things a vast majority of the country believes necessary, and although the collective guilt-complex over the war makes them prone to pay for a lot of things they shouldn’t, saving Cyprus banks, where apparently Russian oligarchs evade taxes, is not one of them. More so when there has been in the past a silent animosity between Germany and Russia (and a lot of bad blood for what the former did during the war but also for what the later did after the war was over).

An indication that the Government of Cyprus feels a little less accountable is that, after the suggestion that they should only tax accounts above 100,000 euros (an indication that Europe is not going after the Cypriots but aims further Northeast?) the Government said they would tax all accounts (albeit at different rates). Yet, as much as, in paper, Cypriot rulers are unwilling to live without the benefits of Russian money, in practice they are finding it hard to approve a law that will openly take money from their voters. Clearly the worst form of government with the exception of every other one.

So, Europe will not commit to saving Cyprus although the bill is a lot smaller than some paid previously (not in relative terms though), Cyprus wants to let the Russians of the hook but do not call their taxpayer to cover for the difference and to make things weirder, the Russian Government, instead of being pleased with all those mean tax evaders getting divine punishment, is not happy about it (it makes us wonder how close to the government the owners of that money are). This is a classical three-way standout very much like that one between the Good, the Bad and the Ugly (no intended pun on which is which) that can only be solved by two of them shooting in the same direction. Although the possibility they all shoot each other is very real.

One Vision

(One voice, one hope, one real decision)

I believe a word must be said in defence of the Russian oligarchs, since nobody else will (at least for free). Wherever people say that money came from, as far as we know it is theirs, and the banks in Cyprus failed to perform the first task of a safe-house which is the safekeeping of the thing that was delivered. Spanish late scholastics warned those who were happy to deliver their money to bankers against interest of being fools as the only way the banker could do this was by investing their money away. In a sense, those apparently-holders-of-Russian-passports should have thought about it twice before depositing their money in Cyprus. But, I’m afraid bank deposits are treated like loans everywhere so it all comes down to due diligence about where the bank themselves invest that money.

As it stands the Cypriot banks were prudent enough to invest in long term government bonds (mainly their own and Greek) making a nice spread on the yield curve with no risk. That’s what they thought at least. Of all possible investments, government bonds seem the safest to banks mainly because states can confiscate wealth almost at will and money itself, in a fiat world, is created mostly out of it. Govies can usually be converted into money at the smallest of discounts. Bear in mind that, if government bonds lose their value, since money is created out of them, so will currency, thus a government default through depreciation of currency will be, to a large extent, pass onto the depositor by the bank. The bond will not default nominally although the interest it bears and the returned principal become less appealing, but so will the money deposited. The problem was the Greek and Cypriot government do not issue their own currency so their bonds can lose value while the deposits used to buy them don’t. When the European Union forced the otherwise inevitable default of Greek bonds into private bond holders, banks in Cyprus went bust, their assets taking a large cut while their liabilities remained the same. And now someone has to give in.

Is This the World We Created?

(What did we do it for? Is this the world we invaded against the law? )

In the old days when a bank declared insolvency, the first to lose their investment were the shareholders, then debt holders and finally depositors. Nowadays everything is political and it really depends on whims more or less backed by supposedly impartial economic calculations. It seems the plan is to give depositors shares in the banks to prevent them from withdrawing the remaining deposits, but, in a perfect world, this should only be done after current equity and bonds are wiped out. Anyway the plan seems rather weak. Why would someone refrain from taking their money from Cypriot banks because they would be given in return shares of a broken institution? You have to convince them the situation will be solved in a satisfactory way, that is, that their shares are worth more than the money they lose (and even then bear in mind that the perceived risk is not the same). A partial cut on deposits to keep a bank afloat doesn’t work because the very next day it opens its doors people will demand the rest of it and, even if there is no fractional reserve, the bank does not hold enough liquid assets to pay everybody. Apparently the government is looking for a source of revenue from which to pay depositors, and rumours say the revenues of natural gas extraction will be used for this purpose. The more attractive the compensation is, the less likely the complete implosion of the banking system will be. This of course means the government will be left with less revenue to press other outstanding matters, namely their own debt. Cyprus taxpayers will after all be called to pay. But the whole financial crisis is an exercise of pushing liabilities into the more or less distant future, and that is the main reason why it will never go away.

Bohemian Rhapsody

(Is this real life? Is this fantasy? Caught in a landslide, no escape from reality, open your eyes!)

For the time being the crisis in Cyprus is a small matter and it does not necessarily follow that will become a huge one. For the moment markets work under the impression that all this can be kept within the boundaries of the Mediterranean Island. But all big things start small: it was the assassination of the a future crowned head that spark what came to be the Great  War in 1914 and bond markets early that Summer did not anticipate it. I’m not saying this is the beginning of something big, but a lot of Pandora boxes are on the verge of being opened. Firstly, banks perform two basic services: credit and deposits. The first is already being diverted into public debt. If the second can be transferred into the government by decree then there isn’t much use for banks, except perhaps as another arm of the state, but confidence, already at minimum levels, will only deteriorate further.  And without confidence, exchange and with it, civilization as we know it, cannot last. Secondly, Germany and Russia are moving towards a state of open hostility and could open a lot of old wounds. Finally, the whole monetary system based on transforming debt into money proves itself, once again, unsustainable. The first two are possible grim outcomes, but the last one is a certainty, the question is not if but when. I believe Voltaire said “paper money eventually returns to its intrinsic value – zero”. Albeit there is no such thing as intrinsic value and paper money does start by being worth something, he is absolutely right as to where it will end when created at will. And all we have to do is sit and watch what will the next forced redistribution of contracting wealth will be…this evening. Stay tuned!

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