~ Frederic Sautet ~
Some depositors at Cyprus’ largest bank may lose a lot of
money (e.g. see article in FT). Those with deposits above €100,000 could lose 37.5 percent in tax (cash
converted into bank shares), and on top of that another 22.5 percent to
replenish the bank’s reserves (a “special fund”). Basically “big depositors” are “asked” to pay
for (at least part of) Cyprus’ bailout (the rest will be paid by other
taxpayers in the EU).
I cannot think of a faster way to completely destroy a banking
system than to expropriate its depositors. This is the kind of policies one
would expect from a banana republic, not from a political system that rests on
the rule of law. But this is the point: the EU does not
respect the principles upon which a free society is based. The more a
government uses the tools of expropriation, the more it creates the conditions
of its future demise. Big depositors will not come back to Cyprus once all this is over.
And restricting capital flows, as it is the case now, worsens the situation in the long run.
As many commentators have said, the Cyprus problem, like
that of Italy, France, Greece, Portugal, and Spain is one of public finance. As
the EU moved from a free trade zone to a political system after the ratification
of the Maastricht Treaty in 1992, it also (among many other things) progressively
collectivized the risks associated with public spending. Until the euro came
along, countries with bad public policies would simply devaluate their currencies.
The French government, for instance, devaluated the franc twice (in 1981 and
1982) under Mitterrand’s presidency and in 1983 the Deutsche mark and the
florin were reevaluated against all the other European currencies. Under this
system the consequences of bad public policies are internalized to a large
extent. The euro changed that. Bad policies are now either kept in check at the
country level because no currency devaluation is possible (that’s the positive
scenario), or the consequences of bad policies are born by the entire system. This,
of course, is only if EU authorities want to keep the euro zone intact,
otherwise they could simply let Greece and Cyprus out of the euro zone, but
this would be to admit the failure of their grandiose currency plan. This is
why the European Central Bank is resorting to Stalinist methods to make sure
the government in Cyprus does what the EU wants it to do.
Now that EU governments have decided to collectivize the
risks attached to public spending, it’s hard to see what will stop the next
crisis from happening. The EU had already become a system of redistribution
from rich to poor (e.g. the CAP), now everyone knows that it is a system of
collectivization of the risks attached to public spending, deficit, and debt.
The risk attached to Cyprus bonds are now collectivized; they are not just Cyprus’
problem. Unless the fundamental principles upon which the EU rests change, it will
eventually collapse as collectivized risks are probably too big an incentive
for many countries in the EU (principally the FIGS countries: France, Italy,
Greece, and Spain and the PIGS: Portugal, etc. I can’t find an acronym that
would work for all five of them…).
The EU today is a case in point of “market-destroying”
federalism. As Barry Weingast pointed out in a series of great papers on
federalism (The Economic Role of Political Institutions, Federalism as a
Commitment to Preserving Market Incentives), the institutions of federalism lead
to political competition and the weeding out of bad policies (it is “market
preserving”). But if this mechanism is attenuated through transfers from the federal
state to lower jurisdictions, the incentives to maintain one’s fiscal house in
order disappear. Ultimately the entire system collapses as a result of
collectivized risks. This has been slowly happening in the United States
throughout the 20th century, but it is taking place at an even
bigger level in the EU because the EU is a hybrid federal system. This is why
many want to centralize political and policy powers in the EU so as to make the
place more like the US (a European banking union would be a first step in that
direction according to the defenders of greater centralization).
It is likely, however, that greater centralization would fail
because at the end of the day, EU institutions are not geared towards
market-preserving federalism. The dominant thinking is one of indicative
planning, regulation, and neo-mercantilism. In my opinion, the only course of
action to save the EU would be to return to the original free-trade zone agreement
of the 1950s and 60s. Trade zones enable political competition, which leads to virtuous
outcomes such as lower taxes and lower public spending. Moreover, free trade zones
with freely competing currencies, even if they remain government produced (one
could adopt the Deutsche mark anywhere in the zone for instance), would bring
vast positive benefits to Europeans. This would imply a complete reversal of
policies, which shows how far we are from solving the problems in Europe. Ultimately, of course, governments should get out of money production, but that’s maybe for
another century.
ADDENDUM (4/3): for a much more acurate analysis of the monetary and banking situation, read Jerry O'Driscoll's excellent post on Cyprus in ThinkMarkets.
