Another Greek Debt Default?

Three years have passed since Greece simply nullified part of its debt. In the last quarter of 2011 the Greek government owed its creditors 356 billion euros; in the first quarter of 2012 that debt had been reduced to 281 billion euros, a reduction of 75 billion euros, or 21 percent. The banks that owned Greek treasury bonds were strong-armed by the EU and the ECB into accepting the debt write-down; ironically, that only added insult to injury as banks in, e.g., Cyprus started having serious problems as a result of precisely that same write-down.

As some of you may recall, a bit over a year after the Greek government unilaterally decided to keep some of the property lenders had allowed them to use – in other words wrote down their own debt – banks in Cyprus began having problems. Having invested heavily in Greek treasury bonds they had to take a disproportionately impactful loss on their lending to Athens. As a direct result the EU-ECB-IMF troika began twisting another arm: that of the Cypriot government. They wanted the government in Nicosia to order the banks in Cyprus to replenish their balance sheets with – yes – money confiscated from their customers.

That little episode of assault on private property is also known as the Cyprus Bank Heist.

Both these events, which exemplify reckless disrespect for private property and business contracts, make Bernie Madoff look like a Sunday school prankster. Unlike Madoff, government is established to protect life, liberty and property. But in both Greece and Cyprus government has voided property rights simply because it is the most convenient way at the time for government to fund its operations.

In other words, to protect the welfare state at any cost.

There were many of us who thought that Europe’s governments had learned a lesson from the massive protests against both the Greek debt write-down and the Cyprus Bank Heist. Sadly, that is not the case. Benjamin Fox, one of the best writers at EU Observer, has the story:

With fewer than three weeks to go until elections which seem ever more likely to see the left-wing Syriza party form the next Greek government, the debt debate has returned to the centre of European politics. Syriza’s promises to call an end to the Brussels-mandated budgetary austerity policies … are not new … But what is potentially groundbreaking is Syriza’s proposal to convene a European Debt Conference, modelled on the London Agreement on German External Debts in 1953 which wrote off around 60 percent of West Germany’s debts following the Second World War

Apparently, Syriza does not think twice about the actual consequences of their proposal. If it was carried out, it would have the same kind of effects on Europe’s banks as the last debt write-down. While there are no immediately reliable sources on how much of the Greek government debt is owned by financial corporations, we can get an indirect image from other euro-zone countries in a similar situation. In Spain, e.g., banks owned 54.3 percent of all government debt in 2013; in Italy the share was 55.6 percent while 41.2 percent of the French government were in the hands of financial corporations.

Adding up actual debt for these three countries, both total and the share owned by banks, gives us a financial-corporation share of almost exactly 50 percent. Using this number as a proxy for Greece, we can assume that banks own 160 billion of 320 billion euros worth of Greek government debt.

A Greek debt write-down according to the Syriza proposal would, if it cut evenly across the total debt, force banks to lose 86 billion euros. And this is under the assumption that, unlike the last write-down, banks are treated on the same footing as everyone else. Back then banks had to assume a bigger shock than other creditors.

The 2012 write-down was worth a total of 75 billion euros.

Has Syriza even taken into account that families, saving up for retirement, own treasury bonds? In Italy they own as much as ten percent of all government debt, a share that would equal 32 billion euros in Greece. But even if that number is five percent – 16bn euros – and you ask them to give up 60 percent of it, the impact on remaining private wealth in Greece would be devastating.

To make matters worse, Syriza does not confine their confiscatory dreams to their own tentative jurisdiction. Benjamin Fox explains that Syriza hopes that a write-down in Greece…

would lead to a huge write-down of government debt for … other southern European countries. The idea was initially mooted by Syriza leader Alexis Tsipras in 2012 when the left-wing coalition finished second in the last Greek elections. Roundly dismissed as fantasy for almost all the two years since then, the proposal is at the heart of the party’s campaign manifesto and Syriza insists it won’t back down if it wins the election.

In the three countries mentioned earlier, Italy, Spain and Greece, banks own a total of 2.47 trillion euros worth of debt. A 60-percent write-down of that equals 1.58 trillion euros. Compare that, again, to the total Greek write-down of three years ago of 75 billion euros.

In Italy alone households own 215 billion euros in government debt. Is the socialist cadre leading Syriza ready to rob them of 89 billion euros just to improve their government’s balance sheets? That would be 1,500 euros for every man, woman and child in Italy. Obviously, all of them do not own government debt, but the more concentrated the ownership is the bigger the impact will be on their economic decisions.

This is, for all it is worth, an idea of galaxy-class irresponsibility. If it ever became the law of the land in Europe it would set off a financial earthquake far beyond what the continent experienced in 2009. And I keep repeating this: all of this is under the assumption that banks will not be discriminated against – an assumption that is not likely to survive all the way to a deal of this kind. Europe’s socialists have a tendency to despise banks and consider them unfair, even illegitimate institutions. It is possible that Syriza, at least as far as Greece is concerned, would force banks to eat the entire write-down loss.

But is this really worth all the drama? After all, the Greek election is three weeks out. Benjamin Fox notes that “Syriza is so close to taking power that the proposal deserves to be taken seriously.”

This debt write-down is part of a broader plan that Syriza has put in place for the entire European Union. To work at the EU level the plan would have to be more complex and involve a series of transactions involving the European Central Bank that, frankly, amount to little more than macro-financial accounting trickery. At the end of the day, those who have lent money to Europe’s governments would make losses worth trillions of euros.

As things look today it is not very possible that Syriza would have it their way across the EU. But it is almost certain that they will go ahead and do it in Greece. What the ramifications would be for the Greek economy is difficult to predict at this point – suffice it to say that the storm waves on the financial ocean that is the euro zone will rise again, and rise high, if Syriza wins on January 25.

When Is Government Big Enough?

Welcome to Year of the Lord 2014. (Forget that “Current Era” crap – we are on God’s calendar for a reason!)

A lot is at stake this year. For us here in America we have upcoming midterm elections in November. Republicans have the momentum and it is not impossible that they take the Senate. The Democrats are panicking over what the Obama presidency is doing to their party; they have already suffered costly losses in state legislatures and gubernatorial offices.

We will also see an emerging field of presidential candidates for 2016. There are already some interesting Republicans lurking behind the curtains. New Jersey Governor Chris Christie is often suggested as an early front runner. Senator Ted Cruz has won many informal polls recently, and let’s not forget Senator Rand Paul, a much more realistic libertarian politician than his firebrand father.

To make matters even more interesting, there could actually be some respectable candidates on the Democrat side as well, such as New York Governor Andrew Cuomo (though he might hold off until he’s done two terms).

We also have to get really serious about our budget deficit. Fortunately, Compact for America – I am on their advisory council – is making progress with a good, realistic proposal for a constitutional amendment to bring about a budget balance.

Overall, the outlook for the United States is moderately optimistic. That includes the economy, which is not exactly steaming ahead, but definitely crawling forward faster than the European economy. The fact of the matter is that Europe, or at least the European Union, is in much bigger trouble than the United States. Yes, our interest rates on such indicators as the ten-year Treasury bond may be a bit higher than, e.g., France, but unemployment, GDP growth, taxes and welfare spending are all moving in the wrong direction in the EU.

To make matters worse for Europe, the current crisis, which I have described as a state of industrial poverty, is far from over. In fact, it may very well make a big turn for the worse, a fact that very few people speak openly about. We find a notable exception in one of the world’s few remaining respectable journalists, namely Ambrose Evans-Pritchard at The Telegraph, who does not mince his words when discussing the mounting debt crisis in the industrialized world:

Much of the Western world will require defaults, a savings tax and higher inflation to clear the way for recovery as debt levels reach a 200-year high, according to a new report by the International Monetary Fund. The IMF working paper said debt burdens in developed nations have become extreme by any historical measure and will require a wave of haircuts, either negotiated 1930s-style write-offs or the standard mix of measures used by the IMF in its “toolkit” for emerging market blow-ups. “The size of the problem suggests that restructurings will be needed, for example, in the periphery of Europe, far beyond anything discussed in public to this point,” said the paper, by Harvard professors Carmen Reinhart and Kenneth Rogoff.

Some telling examples of what we are talking about:

  • The EU, with 28 member states, had a gross government debt of 86.8 percent of GDP in the second quarter of 2013, up from 84.8 percent in Q2 2012;
  • The 17-member euro zone’s debt ratios were 93.4 percent in Q2 2013 and 89.9 percent in Q2 2012;
  • Greece: 169.1 percent, up from 149.2;
  • Spain: 92.3, up from 77.6;
  • France: 93.5, up from 90.8;
  • Italy: 133.3, up from 125.6;
  • The Netherlands: 73.9, up from 68.4.

Very few EU member states show a falling debt ratio, and when they do, the decline is marginal compared to the rise in other countries.

There is an implicit premise in the IMF report about the relation between the private sector and government. Before we get to it, let’s hear more from Evans-Pritchard:

The [IMF] paper said policy elites in the West are still clinging to the illusion that rich countries are different from poorer regions and can therefore chip away at their debts with a blend of austerity cuts, growth, and tinkering (“forbearance”). The presumption is that advanced economies “do not resort to such gimmicks” such as debt restructuring and repression, which would “give up hard-earned credibility” and throw the economy into a “vicious circle”. But the paper says this mantra borders on “collective amnesia” of European and US history, and is built on “overly optimistic” assumptions that risk doing far more damage to credibility in the end.

Very important indeed. Remember the Greek partial debt default? Not to mention the Cypriot Bank Heist when the government of Cyprus confiscated private savings deposits to pay for a bank bailout. Both these measures are now part of the legislative toolkit as the governments of the EU continue to fight their hopeless fight against the debt.

In reality, this fight is about something else than the debt itself. It is about the very heart and soul of the European economy. If the EU chooses to deal with its current crisis the way the IMF hints at, then it will automatically put government above the private sector. The measures proposed will save government at the expense of the private sector. This is the implicit premise in the IMF report, one that Evans-Pritchard does not address. However, as we return to his column we get some hints of how this premise would inform actual policy:

While use of debt pooling in the eurozone can reduce the need for restructuring or defaults, it comes at the cost of higher burdens for northern taxpayers. This could drag the EMU core states into a recession and aggravate their own debt and ageing crises. The clear implication of the IMF paper is that Germany and the creditor core would do better to bite the bullet on big write-offs immediately rather than buying time with creeping debt mutualisation. The paper says the Western debt burden is now so big that rich states will need same tonic of debt haircuts, higher inflation and financial repression – defined as an “opaque tax on savers” – as used in countless IMF rescues for emerging markets.

Aside the implied acknowledgement that the private sector will have to give in order for Europe’s welfare states to take, this paragraph is an effective IMF acknowledgement that Europe is now in a state of long-term economic stagnation.

The two issues actually connect. If there was any prospect of strong economic growth in the EU, there would not be any need to push for practically authoritarian measures to “save” governments from their own debts. Yet the IMF report cleverly opens for precisely that, namely debt defaults on a much wider scale than happened in Greece, as well as inflation and widespread use of so called “financial repression”:

Most advanced states wrote off debt in the 1930s, though in different ways. … Financial repression can take many forms, including capital controls, interest rate caps or the force-feeding of government debt to captive pension funds and insurance companies. Some of these methods are already in use but not yet on the scale seen in the late 1940s and early 1950s as countries resorted to every trick to tackle their war debts. The policy is essentially a confiscation of savings, partly achieved by pushing up inflation while rigging the system to stop markets taking evasive action.

We hear more and more about inflation as a “solution” to the debt crisis. This is disturbing, especially since when the inflation genie is out of the bottle, he is mighty reluctant to get back in there again. While it is difficult for politicians to cause inflation, it is not impossible, and if they are delusional enough to believe that they can turn off the inflation faucet just as easily as they can turn it on, they are going to use it.

Again, inflation is but one of the measures that politicians would resort to in order to save the welfare state from its own debt. The measures to save the welfare state would by necessity tax the private sector in every way possible, thus forcing voluntary economic activity – the heart and soul of a free society – to take the back seat while coercive economic activity – the welfare state – lives on unperturbed by the weight of its own debt.

The comparison to World War II debt is an egregious way to elevate the welfare-state crisis above the responsibility of statist politicians who built and nurtured it. World War II was an exceptional, disastrous event. The current debt crisis was not caused by a disaster. It was caused by deliberate, long-term political action to take one man’s money and time and give to someone else, for no other reason than that the recipient was considered “entitled”.

Through the build-up of the welfare state, government spending ran amok, demanding far more money than taxpayers could afford, over a long period of time. I explain this in detail in my forthcoming book Industrial Poverty; the short story is that Europe’s welfare states allowed entitlement spending to creep up above tax revenues, little by little, until the combined effect of taxes, entitlements and work discouragement had pushed back the private sector to where it was structurally unable to pay for the welfare state.

At this point it was only a matter of time before the debt that the welfare state brought about would explode. The financial crisis came along and helped the debt balloon inflate – notably the financial crisis was aggravated by banks’ exposure to deteriorating government debt!

This means two things. First, it is high time to stop imposing more regulations on the private sector. The more governments regulate the private sector, the more hindrances they put in place for the only engine that can pull Europe out of its crisis. Secondly, there is no way out of the debt crisis unless we are willing to say farewell to the welfare state. Its entitlement systems and its taxes will continue to weigh down the private sector for as long as the welfare state exists. The same crawling debt crisis that exploded in 2008-09 will begin again as soon as governments all over Europe stop their austerity measures.

At the same time, austerity has only made a bad crisis worse. The design of austerity measures used thus far is clearly to save the welfare state and make it fit within a tighter economy. Yet the burden of entitlement programs has not eased – on the contrary, it has increased. For every new austerity measure that has increased taxes and cut government spending, the economic crisis has worsened, thus giving rise to the need for even more austerity.

Europe must break this vicious circle, and the only way to do this is to abandon the desperate hunt for the balanced budget. Instead, Europe’s political leadership must focus on structurally phasing out the welfare state. They must privatize health care, income security and education – and cut taxes proportionately to their structural spending cuts. They must let the private sector take over what government has failed at delivering, both in terms of producing services and in terms of funding those services. Permanent spending cuts coupled with well designed tax cuts.

Only then can Europe see growth and prosperity again. If they do not choose this path, but instead stick to the old recipe of keeping the welfare state and trying to starve it into a stagnant economy, they will perpetuate their debt crisis.

That, in turn, means static or even declining private-sector activity while more and more people will clamor to the welfare state’s entitlement programs just to be able to make ends meet every month. Government will continue to grow, both in absolute and in relative terms. That growth will continue ad infinitum, until there is nothing but a planned, Sovieticized economy left.

Europe does not need that. Europe needs massive doses of economic freedom.


Cyprus Looks beyond Austerity

While Europe in general remains stuck in a structural recession, there are signs of hope on the horizon. Some political leaders are beginning to think outside the box to find a way out of the economic wasteland created by the austerity hurricane.

One of these new promising leaders is Finance Minister Georgiades of Cyprus. In a recent speech he pledge allegiance to austerity – a political must for a European – but his ambitions actually go beyond that. From Cyprus Mail:

The [Cyprus] government aims to reduce state spending by 10 per cent in 2014, and reduce the public deficit without imposing new taxes, Finance Minister Harris Georgiades told an audience of overseas Cypriots yesterday. Speaking at the 17th annual conference of Greek and Cypriot organisations abroad, Georgiades said this amounted to savings of around €700 million. The aim is to reduce the public deficit to around €500m next year and ensure a primary surplus by 2016, a step closer towards Cyprus returning to international markets for capital. He assured overseas Cypriots that the government’s policy focused on curbing spending, not imposing new taxes, adding: “We will secure taxation stability.”

Before we get to the good news in what Georgiades has in mind, let us first get a little bit of a background. The Cypriot government debt increased rapidly during the first four years of the crisis, from 48.9 percent of GDP in 2008 to 84.2 percent in 2012. One reason was that the nation’s banks were in struggling after having invested heavily in Greek treasury bonds. Partly as a result of the losses the Cypriot banks took on its loans to the Greek government, in the spring of this year the Cypriot government was strong-armed by the EU-ECB-IMF troika into stealing deposits from customers of the country’s banks. The Cyprus Bank Heist was sold as a rescue plan for the entire banking industry. In reality, there was never a need for that egregious an assault on private property rights, especially not when it came to helping the Cypriot government avoid yet more debt. The banks were, simply put, never in as bad of a situation as the EU-ECB-IMF troika suggested.

Back to Cyprus Mail:

“We lived beyond our means” both in the public and private sector, he told the audience. The Cypriot state was spending more than it earned, and not on development projects, creating continual deficits and a growing debt, said the minister. At the same time, banks were lending money beyond the means of the real economy, with the money directed towards consumption. “In just three years from 2005 to 2007, private lending doubled.”

Again, this sounds more like politically mandated rhetoric than anything else. From 2005 to 2009 private consumption in Cyprus grew by an average of 3.9 percent per year, adjusted for inflation. That is a healthy rate, though not exceptional. Poland experienced 4.1 percent consumption growth during that same period. Other countries saw even higher growth rates, such as Romania (5.8 percent per year), Slovakia (5.0) or Serbia (4.6). It is worth noticing that all these countries are emerging European economies, which during the years after 2000 reaped the harvests of deregulation and still having a relatively limited government. It is hardly surprising that Cyprus would be in the same group.

In other words, whatever consumption boom that generous bank lending could have led to, it did not cause any exceptional growth in private consumption. The prime minister’s point is therefore a moot one unless he can specify what the lending went to, if it created a mortgage crisis, etc.

The problem is if the Cypriot government now resorts to sustained austerity measures. It is understandable that they try to focus entirely on spending cuts: there are suggestions in current public policy literature that austerity packages with at least two-to-one spending cuts are much more successful than packages with more tax hikes in them. However, the evidence that such suggestions rest on is shaky in some cases and in other cases very limited in policy application. Overall, the current experience from Greece, Spain, Italy and Portugal (as well as Sweden in the ’90s) is that austerity in general is actually quite bad for the private sector.

This is not an argument for keeping big government. It is an argument for doing away with it entirely, not trying to save it by means of austerity.

And now for the good news. Attached to his pledge to austerity, Finance Minister Georgiades, according to the Cyprus Mail, made promises to match spending cuts with tax cuts down the road. This is a first on the European scene since the austerity assault began:

Once government got a grip on public finances and reduced expenditures it would also lower the tax burden, he said. The government also planned to make significant structural changes, referring to the new social welfare policy, new healthcare plan and “ambitious” reform of the public sector. Regarding Cyprus’ battered banking sector, the minister argued that it was stabilising day by day.

If the Cypriots do indeed move beyond mere austerity, there is a brighter tomorrow on the horizon for them. Let’s keep an eye on them and see what they come up with.

Banks Hurt By Troubled Welfare States

I am working on a third installment about the G20 governments’ solemn vow to not leave any business, any product or any market unregulated. While that one is progressing, it is time to yet again say:

Never bark at the big dog. The big dog is always right.

Today Ambrose Evans-Pritchard of the Daily Telegraph has this to say about Europe’s troubled banks and even more troubled welfare-state governments:

Anybody with serious banking exposure to any EMU state on the front line of Europe’s macro-economic crisis now knows what to expect. The deal reached by EMU finance ministers on the use of the bail-out fund (ESM) to recapitalise distressed banks makes clear who will in fact suffer the real losses: first shareholders, then bondholders and then deposit holders above €100,000. They stand to lose almost everything, as we saw with Laiki in Cyprus.

See I told you so. I have said all along that this will spread, and not just to other European countries. This is going to become a big problem for the banks in any country that adopts the Cyprus Bank Heist confiscation scheme. It is very likely going to change the very way that banks provide services for wealthy customers.

But there is more to this. I have also pointed out on numerous occasions that the banks are liable for losing customers’ money on wild-brained real estate speculation, but I have also explained that if there had not been a welfare-state crisis at the same time, the banks would have prevailed without requiring bailouts and restructuring help. With Evans-Pritchard, this point is now slowly beginning to make its way out in the public:

Officials from the European Central Bank and the European Commission warned during the Cyprus crisis that it would be dangerous to set such a precedent, fearing contagion. The Portuguese were openly alarmed. So has that risk of contagion since dissipated? One should have thought quite the opposite, given the yield spike in Portugal, Spain, Italy et al since the Bernanke Fed dropped its taper bomb this week.

He is right. Nothing has changed in terms of the depressed economic activity in Europe’s more troubled welfare states. Then we get to the marriage-made-in-hell kind of relationship between banks and governments in Europe, and a reminder of how the decision to raid bank customers’ accounts fits into the picture:

The states that are already in trouble will have to carry most of the burden of recapitalising banks, pushing them over the edge into actual insolvency. They will have to come up with the money needed to raise capital ratios to 4.5pc of assets. Then come the private haircuts, which of course risk devastation for the host country, and the collapse of investor confidence.

There is one more angle to this. Europe’s banks bought massive amounts of government bonds during the decade leading up to the current crisis. While in 2009 EU governments committed 700 billion euros for bank recapitalization and restructuring programs, in that same year, according to Eurostat, financial institutions owned more than one trillion euros worth of treasury bonds issued by Ireland, Spain, Italy and Portugal.

These are, as we know, some of the most troubled welfare states in Europe – frankly, some of the most troubled in the world. And we are not even counting Greece here. In theory, therefore, if banks had refrained from buying any bonds from troubled welfare states they would not be in such a bad need of tax money to bail them out. Or, better yet: if the welfare states would have bought back the bonds they sold to the banks, the banks would have been solidly recapitalized and could have reinvested their money in bonds from more reliable countries.

Again: without the welfare state, Europe and its banks would have been in far better shape than they are now. As for America, the welfare state stands right in the middle of a fork in the road. Either we try to save it and follow Europe into the dungeon of industrial poverty; or we structurally reform away the welfare state, restore economic freedom and resume our pursuit of endless prosperity.

Cyprus Bank Heist Did Not Help

The rule of law is a cornerstone of Western Civilization. The rule of law means that government protects the life, liberty and property of its citizens.

Another cornerstone of Western Civilization is accountable government. It goes hand in hand with the rule of law, such that the protection of life, liberty and property is executed with the consent of the governed.

The two remaining cornerstones of Western Civilization are individual and economic freedom. A necessary (but not sufficient) condition for economic freedom is the protection of private property.

Remember the Cyprus Bank Heist? If you had money there, I am sure you won’t forget it for as long as you live. Under the auspices of wanting to save the nation’s banks and rid them of allegedly widespread money laundering, the Cypriot government and the European Union seized up to 40 percent of people’s bank deposits. On May 25, though, I reported that the portion about money laundering was a complete fabrication: a whopping 0.000049 percent of all bank transactions in 2008-2012 were possibly illegitimate.

That is a rate of compliance with the law that maybe Mother Teresa can match. If government can seize private property – yours or others’ – because you violate a law once for every 20,344 things you do every day, then there would be no private property left in this world.

The Cyprus Bank Heist was a floodgate of authoritarianism, opened to unleash hitherto not-seen government powers against private citizens. Even the creatively constitutional Russian government was astounded and compared the entire scheme to actions taken by Communist thugs in the old Soviet Union.

Needless to say, this assault on one of the cornerstones of a free, civilized society has had decisively negative influence on the banking industry in Europe, with shrinking deposits and lost faith in the safety and security of what people still have in their savings accounts.

To make matters worse, soon after the heist we learned that this was not a one-time, one-country deal. On the contrary, other governments followed Cyprus with pledges or laws to allow the same confiscatory scheme to be applied within their jurisdictions. The Canadian government, e.g., announced in its federal budget bill this spring that it wanted the authority to save what it called “systemically important” banks by permitting those banks to “convert liabilities into assets”, i.e., take people’s bank deposits.

It is bad enough that we have a widespread tax system in all Western countries, allowing governments to seize property on a regular basis. At least in terms of taxation there is a sense of stability and predictability that allows people some foresight and opportunity to plan their economic activities based on the confiscatory scheme. But bank deposit confiscation is an entirely new instrument for governments to grab people’s money. It is unpredictable in time – the Cyprus Bank Heist happened after the banks suddenly closed and refused to open for days – and it is arbitrary in size. Even after the Cypriot government ordered the banks closed (how they could do that is another interesting question) there was still a great deal of uncertainty and debate among the Eurotarians who made this happen as to exactly how much of people’s money they were going to take.

All in all, the Cyprus Bank Heist dealt a serious blow to one of the cornerstones of the Western world. But perhaps it would be possible to repair the damage if there was some kind of economic logic to all this? Maybe, if the confiscation saved Cyprus from some kind of cataclysmic macroeconomic event, it would make sense?

As an economist by training and unstoppable habit I cannot find any such event, even remotely conceivable, that would justify what the Cypriot government and their Eurotarian co-conspirators did. Perhaps if I kept looking I’d find that justification, but I doubt it would be worth it, especially since the Cyprus Mail reports that nothing good came out of the Cyprus Bank Heist:

Rating agency Fitch on Monday cut Cyprus’ rating further into junk and warned more cuts could be on the way as an EU/IMF rescue programme could fail. The agency cut Cyprus’ long-term foreign currency issuer default rating to B-minus from B with a negative outlook due to the country’s elevated economic uncertainty.

One of the motivating factors behind the Cyprus Bank Heist was to remove a critical threat to the country’s economy, namely a bank collapse. If the confiscation was so necessary, then why did it not even make a dent in the downward spiral of the Cypriot economy?

Cyprus Mail again:

“Cyprus has no flexibility to deal with domestic or external shocks and there is a high risk of the (EU/IMF) program going off track, with financing buffers potentially insufficient to absorb material fiscal and economic slippage,” Fitch said in a statement. The local currency issuer default rating (IDR) was cut to `CCC` from `B`. … The downgrade of the foreign currency IDR to `B-` reflects the elevated uncertainty around the outlook for the Cypriot economy due to the high implementation risks on the agreed programme and the restructuring of the banking industry.

And listen to this:

Fitch acknowledges that the programme improves the immediate position of the sovereign from both a liquidity and solvency perspective, however, it notes that Cyprus has no flexibility to deal with domestic or external shocks and there is a high risk of the programme going off track, with financing buffers potentially insufficient to absorb material fiscal and economic slippage.

In plain English: the Cyprus Bank Heist provided a one-time replenishment of bank balance sheets but did not change anything at all in the rest of the economy. The Cypriot GDP is still forecast to shrink by 1.7 percent this year and 0.7 percent next year – and that’s on a good day. Youth unemployment was 27.8 percent last year, up from nine percent in 2008. And the banks’ balance sheets are still full of junkyard-grade treasury bonds from Greece – and Cyprus.

Government debt was 54 percent of GDP in 2008 and is now, according to Cyprus Mail…

likely to peak higher than the 126 per cent of GDP by 2015 assumed under the programme, reflecting Fitch`s view a deeper recession in the later years of the programme is possible and that there is little sign at this stage of the potential for Cyprus to transform its economy successfully away from sectors associated with the shrinking financial sector.

So the financial sector is shrinking, huh? What a confounding surprise. The one industry that had given the Cypriot economy a real boost is now bruised, battered and shattered by authoritarian government intervention.

There is little doubt that the real purpose behind the Cyprus Bank Heist was to politically “legitimize” an entirely new form of taxation. By starting off in a small country, wrongfully vilified as the home of rampant tax evasion and money laundering, the EU was able to get the precedent it needed for the future. Never mind that they left an entire nation’s economy in even worse shape than before. Never mind that they dealt a serious blow to the faith in the rule of law in the EU.

All that mattered was that the Eurotarians in Brussels could expand their power.

There is no other conclusion to draw from this than that the EU is indeed a threat to democracy, freedom and the very essence of what Western Civilization represents. The sooner it is dissolved, the better.

The Lie behind the Cyprus Bank Heist

Remember the Cyprus Bank Heist? The troika formed by the European Union, the European Central Bank and the International Monetary Fund strong-armed the Cypriot government into seizing parts of people’s bank deposits. One of the arguments for this was that Cyprus was a haven for shady banking, most of which allegedly coming out of Russia. As late as May 17, the Wall Street Journal reported:

There are plenty of reasons why Cyprus’s bailout took so long and came with such tough terms. But one is very clear: Cyprus’s reputation as a site for money laundering and tax avoidance made its rescuers loath to prop up its bulging banks.

By stirring up these sentiments, the EU-ECB-IMF troika was able to push the Cypriot government into an unprecedented assault on private property. The only problem is that  the talk about money laundering was mixed with generous portions of hot air. Cyprus Mail reports:

Cyprus yesterday accused the troika of distorting information in a document purportedly summarising the island’s status vis a vis anti-money laundering (AML) measures by “drawing inferences” where none existed in the original reports. … Yesterday the Central Bank of Cyprus (CBC) said the summary did not give a synopsis of the main findings “but rather a description of the perceived weaknesses of the system, drawing inferences where none exist in the original reports.”

How about that – “drawing inferences where none exist”! In short: building a castle on clouds.

“The lack of consultation with the authors of the reports and the failure to refer to any of the positive aspects mentioned therein, has resulted in erroneous and distorted conclusions in the media, especially the international press,” the CBC said in a statement. “A summary of the reports cannot be considered balanced if it omits to mention that  they reveal a number of strengths both in the Cypriot AML framework and in the effective implementation of customer due diligence by Cypriot banks.”

So why has the Troika omitted this from their report summary? Well, here is one clue:

An independent audit of Cyprus’ implementation of AML measures was set as a precondition for an international bailout. Cyprus initially resisted the idea, arguing it had already been cleared in a prior assessment by [EU money laundering agency] Moneyval. The government later backed down and agreed to a fresh review, one by Moneyval and a parallel one by private auditor Deloitte. The summary said that between 2008 and 2010, Cypriot banks reported not a single suspicious transaction under anti-money laundering regulations, and flagged only one in 2011 and “a few” in 2012.

The report on money laundering sampled 590,000 transactions and found a full 29 – twenty nine – that could be deemed suspicious. In other words, 0.000049 percent of all bank transactions could possibly be illegitimate.

That is a legal compliance rate that would make any government agency in Europe or the United States green with envy. I doubt that a single employee of the EU-ECB-IMF troika can prove that only 0.000049 of their daily activities violate some law.

Among the positive aspects the CBC listed as being absent from the troika summary was the fact that Deloitte also said Cyprus had a stricter legal framework beyond normal EU standards. “In the audit for compliance with the CDD (customer due diligence) requirements of the Cyprus legal framework, it is worthy of note that these requirements are more detailed, and to a certain extent prescriptive, than in many other jurisdictions, including other EU Member States that similarly have implemented the requirements of the Third Money Laundering Directive,” the CBC quoted Deloitte as saying. Cyprus also had a solid level of compliance on CDD across the sector and displayed strong compliance in the identification of customers, it said.

Long story short: Cyprus was not a haven for illicit banking. It was simply a low-tax jurisdiction that attracted more investments because of that than banks in larger, higher-taxed countries. For two reasons the Troika decided to use Cyprus as a vehicle for their outrageous scheme to seize people’s bank deposits:

1. Its low taxes were a sore spot for tax-greedy governments elsewhere in the EU, including over-bloated welfare states in north and central Europe. They wanted an opportunity to crush the economy of a “tax haven” and set an example so as to prevent others from breaking the tax-to-the-max ranks.

2. Cypriot banks had invested heavily in Greek treasury bonds. When the Greek government and the Troika forced the creditors of the Greek government to forgive a good part of their loans – prosaically referred to as a debt “haircut” – banks in Cyprus were among the hardest hit. Since the Cypriot government, like every other government in the EU, wanted to prevent its banks from failing as a result of bad investments in bad treasury bonds, they had to consider a bailout scheme. The Troika took the chance to blackmail the Cypriot government into being the first to steal money from bank customers, using unfounded accusations of shady banking practices to twist the arm of the Cypriot government.

The impression that Cyprus was singled out for reasons unrelated to the unfounded accusations of money laundering is reinforced by a concluding statement from the Cypriot government:

Echoing the [Central Bank of Cyprus] CBC, a statement from the finance ministry said the nature and depth of the assessments done on Cyprus were “unique and have never been carried out in any other jurisdiction”. “The outcome of the assessments … indicates a solid level of compliance across the sector,” the ministry said.

In other words, all the other countries that have passed, or are considering passing, deposit confiscation schemes as part of a legal way to “save” their banks have done so based on a false premise, namely that the Cypriot Bank Heist was legitimately motivated by bad banking practices.

Will this make any legislators in Europe or Canada rethink their support for this kind of authoritarian assault on property rights? Probably not. What reasons would those legislators have to reverse the growth of government power?

ECB Guarantee Did Not Save Spain

By now, everyone around the world has probably heard that Spain is de facto in fiscal default – i.e., bankrupt. The IMF, whose report Fiscal Monitor number 1301 presented the numbers showing that Spain is practically in default, does not offer an explicit analysis of the default scenario itself, but it gives a very illuminating background to the proliferating economic tragedy in Europe.

I will do an analysis of the Fiscal Monitor report later; for now, let’s return to Spain and the notable fact that the country has gone into effective bankruptcy despite the commitment by the European Central Bank to buy up every euro’s worth of Spanish treasury bonds. This commitment meant two things:

  1. owners of Spanish bonds would always be able to sell them, thus putting a mild downward pressure on the interest rate; and
  2. the Spanish government would be able to finance its own debt in perpetuity – all it would have to do would be to issue more debt, i.e., to ask the ECB to print more money.

This is a slight simplification, as the Spanish government would still have to meet certain fiscal criteria, such as continued austerity. But at the same time, if a central bank issues a guarantee to buy all bonds that its government issues in order to bring down the interest rate on those bonds, you cannot condition your promise on fiscal austerity. As soon as the government must take fiscal steps to maintain the central bank’s purchasing guarantee, the guarantee loses its inherent value. It is no longer worth any more than the bonds it is supposed to guarantee.

In other words, meaningless.

Assuming that the ECB does not make meaningless promises, the Spanish de facto default is all the more remarkable – and comes with serious warnings to everyone with money in Spain: get out or face a Cypriot Bank Heist seizure of your assets.

Here is what Jeremy Warner said in the Daily Telegraph a couple of days ago:

Next year, the [Spanish] deficit is expected to be 6.9 per cent [of GDP], the year after 6.6 per cent, and so on with very little further progress thereafter. Remember, all these projections are made on the basis of everything we know about policy so far, so they take account of the latest package of austerity measures announced by the Spanish Government.

Which means that we can expect an increase in the deficit ratio in the future, as forecasters often forget to incorporate the negative effects of austerity on GDP.

The situation looks even worse on a cyclically adjusted basis. What is sometimes called the “structural deficit”, or the bit of government borrowing that doesn’t go away even after the economy returns to growth (if indeed it ever does), actually deteriorates from an expected 4.2 per cent of GDP this year to 5.7 per cent in 2018.

This is important, because it shows that there is a structural change going on in the Spanish economy. People are paying permanently higher taxes and get permanently less back from government for that money. The private sector has been permanently diminished and an entire generation of young Spaniards has been sentenced to a life on welfare.

By 2018, Spain has far and away the worst structural deficit of any advanced economy, including other such well known fiscal basket cases as the UK and the US. So what happens when you carry on borrowing at that sort of rate, year in, year out? Your overall indebtedness rockets, of course, and that’s what’s going to happen to Spain, where general government gross debt is forecast to rise from 84.1 per cent of GDP last year to 110.6 per cent in 2018. No other advanced economy has such a dramatically worsening outlook.

But Greece did, and they ended up losing one quarter of the GDP.

Unfortunately, Jeremy Warner does not see the damage done by austerity:

And the tragedy of it all is that Spain is actually making relatively good progress in addressing the “primary balance”, that’s the deficit before debt servicing costs.

The “progress” consists of increasing taxes and reducing spending in an entirely static fashion. There is no analysis behind the austerity efforts of the long-term effects they will have on the economy. For example, the increase in the value-added tax that was enacted last year reduced the ability of consumers to spend on other items. This reduced private consumption and forced lay-offs in retail and other consumer-oriented industries. The laid off workers went from being taxpayers to being full-time entitlement consumers. As they did they reduced the tax base and cut tax revenues for the government in the future.

This point aside, Warner explains well the bankruptcy side of the issue:

What’s projected to occur is essentially what happens in all bankruptcies. Eventually you have to borrow more just to pay the interest on your existing debt. The fiscal compact requires eurozone countries to reduce their deficits to 3 per cent by the end of this year, though Spain among others was recently granted an extension. But on these numbers, there is no chance ever of achieving this target without further austerity measures … it seems doubtful an economy where unemployment is already above 25 per cent could take any more. … All this leads to the conclusion that a big Spanish debt restructuring is inevitable.

Debt restructuring, of course, being the same as bankruptcy. In a matter of speaking, Greece did a “bankruptcy light” when they unilaterally wrote down their debt. In the case of Spain it would probably mean a much bigger debt writedown than in Greece.

Back to Warner:

Spanish sovereign bond yields have fallen sharply since announcement of the European Central Bank’s “outright monetary transactions” programme. … But in the end, no amount of liquidity can cover up for an underlying problem with solvency. Europe said that Greece was the first and last such restructuring, but then there was Cyprus.

And toward the end Warner issues a fair warning about a repetition of the Cyprus Bank Heist:

Confiscation of deposits looks all too possible. I don’t advise getting your money out lightly. Indeed, such advise is generally thought grossly irresponsible, for it risks inducing a self reinforcing panic. Yet looking at the IMF projections, it’s the only rational thing to do.

Spain is the fourth largest euro-area economy, with ten percent of the euro zone GDP. If we add Greece, Cyprus and an all-but-certain Portuguese de facto bankruptcy, we would now have 14 percent of the euro area economy declared practically insolvent.  As Jeremy Warner so well explains, the point where this bankruptcy becomes a fact is one where the macroeconomy in a country is permanently unable to bear the burden of government.

This means that 14 percent of the euro-zone economy will be at a point where it is acutely unable to fund the welfare state.

What conclusions will Europe’s elected officials draw from that? It remains to be seen, though it is not far fetched to assume that no one will be ready, willing or courageous enough to remove the welfare state.

That is too bad, because it means – again – that Europe is stuck in a permanent state of industrial poverty. Hopefully, America’s elected officials will watch, learn and do the right thing.

The Assault on Property and Prosperity

As the world is now beginning to realize, the Cyprus Bank Heist was not a one-time, exceptional measure to save banks, never to be applied again. On the contrary, as I explained earlier this week the idea of confiscating bank deposits to save banks is catching on internationally.

This is a frightening perspective on the issue, because it means that we, the Western civilization, is about to turn our backs on one of the most important cornerstones of our prosperity: the property rights contract between banks and their clients.

There is no doubt that more governments are going to apply the Cyprus Bank Heist model to their own jurisdictions. You would think that this was bad enough – but it is not. Today we can report that the Cyprus Bank Heist model is soon going to expand into other assets than bank deposits.

More on that in a moment. First, let us note that the Eurotarians who govern the EU are temporarily in damage-control mode. Mario Draghi, the president of the European Central Bank, is trying to blow cute little smoke screens to draw people’s attention away from the devastating consequences of the Cyprus Bank Heist. EU Observer reports:

European Central Bank chief Mario Draghi on Thursday (4 April) admitted that an initial plan to tax small savers in Cyprus was “not smart”, but stressed that the island is “no template” for others.

Really… Every finance minister in the euro zone has endorsed it. Finland, Ireland and Estonia have vowed to use it themselves. The Canadian parliament will soon consider a bill that would legalize confiscation of deposits in “systemically important” banks. New Zealand is allegedly considering a similar law. Et cetera.

No, the Cyprus Bank Heist was “no template” at all. Not at all.

Back to the EU Observer works hard to draw people’s attention to small details instead of the big, freedom-shattering principled questions that the Cyprus Bank Heist give rise to:

Draghi said that the ECB had not been the source of the original (and subsequently rejected) idea to impose a tax on small savers, but did agree to it as part of an overall deal on 15 March. “That was not smart, to say the least, and it was quickly corrected the day after in the Eurogroup conference call,” Draghi said during a press conference in Frankfurt after the monthly meeting of the ECB governing council.

Draghi’s strategy is to get people bogged down in some kind of nonsensical debate over who should lose the most. Once people talk about technical details they have de facto accepted the architecture itself.

Draghi’s support for the Cyprus Bank Heist as a template for the future is revealed later in the EU Observer article:

“A bail-in by itself is not a problem, it’s the lack of rules known to all parties which can make a bail-in a disorderly event, and the lack of capital buffers. Absence of rules give this impression of ad-hoc-ary in these cases,” Draghi said. The quicker eurozone-wide rules are in place on how to deal with failing banks and who picks up the bill, the better, he indicated. “We would like these rules not in 2018-2019 as it’s foreseen, but way, way earlier – in 2015.” “It is very urgent that we have in place a European framework for resolution, restructuring and recapitalisation of the banking systems. These are the lessons I would draw from the Cyprus event,” he said.

So first you create an “event” – a government seizes private bank deposits – then you say that the lesson from the event is that we must do it again.

Why do I come to think about the staged Polish invasion of Nazi Germany just prior to September 1, 1939? Hmm…

But regardless of what hot air Mario Draghi is producing, others have already grabbed the torch and carried it to new places where they can set private property rights on fire. First off is the CEO of Unicredit, a large, international bank. From Goldcore.com:

The CEO of Unicredit Federico Ghizzoni said yesterday that it is “acceptable to confiscate savings to save banks.” He said that the savings which are not guaranteed by any protection or insurance could be used in the future to contribute to the rescue of banks who fail and that uninsured deposits could be used in future bank failures provided global policy makers agree on a common approach. He called for “a common solution in Europe” saying that the “EU should pass laws identical and shared in different member states”. Indeed he went a step further and called for a global coordination of deposit confiscations to rescue failing banks.

So what do you think will happen when all depositors have depositors’ insurance? Exactly! There will be a new clause added to some existing law that voids that insurance under “exceptional circumstances” such as when the government needs to seize your assets to save a bank – or a government with unsustainable deficits.

If we add Mr Ghizzoni’s words to the Canadian bill to make it legal for banks to “turn liabilities into assets”, and hold them up against the background of the European chorus of praise for the bank heist model, we get a clear, chilling and very dangerous picture of how this destruction of private property rights is going to spread to every corner of the world.

And once it has conquered all free nations, it will start spreading to other assets as well. Also from Goldcore.com:

An interesting development in the precious metals market is the largest Dutch bank, ABN Amro, has said that they will no longer be providing physical delivery of precious metals including gold, silver, platinum, and palladium bullion coins and bars. ABN AMRO, one of the largest banks in Europe announced in a letter to clients that it would no longer allow clients to take delivery of their metal and instead will pay account holders in a paper currency equivalent to the current spot value of the precious metal. Thus, instead of legally owning a risk free, physical asset (a bullion bar or a bullion coin), the bank’s clients are now unsecured creditors and are now exposed to the bank and the financial system – somewhat defeating the purpose of owning precious metals. The move highlights the importance of owning physical bullion either in your possession (be that be in a safe or vault in a house, in the attic, under the floorboards or elsewhere in your possession) or in a secure vault in a country that is stable and respects property rights.

Indeed it does. But it also highlights a new turn in how the global banking system is trying to prevent people from escaping the next Cyprus Bank Heist.

If you don’t want to keep your money in a regular bank account, but instead own something that we cannot physically take from you – then we are going to make sure we can physically take it from you anyway.

It is shocking to watch the spreading of the bank heist model. It is even more shocking when you realize that this is actually an assault on the oldest, currently existing form of private property right. The entire, modern banking system stands and falls with the banks honoring this property right. This very same banking system has done an enormous amount of good for all countries who have embraced the pillars of Western Civilization – among them economic freedom – and helped create prosperity and wealth of proportions previously unknown to man. Private banking, honoring property rights, has been instrumental in allowing desperately poor nations to lift themselves to a Western-style standard of living.

And now – what is this going to lead to? What will come of this, when the accumulation of wealth has been reduced to a form of fodder for banks and governments?

Are we watching the beginning of the end of free-market capitalism as we know it?

So far, no Cyprus Bank Heist legislation has been introduced here in the United States. Let us pray that it won’t happen. But if that happens, or if it becomes de facto law through some kind of international treaty, then… well, where do we stand then?

Canada Eyes Bank-Deposit Grab

After the Cyprus Bank Heist where the government took as much as 40 percent of large-balance bank accounts above 100,000 euros, three other EU member states have vowed to use the same method for confiscating bank deposits from private citizens. The finance ministers of EU’s member states stand firmly behind this confiscation scheme, which means that it could easily become common practice in Europe to steal people’s bank deposits to save troubled banks – or, as some politicians have said, for “similar” crises.

 The big, unanswered question is of course what those similar crises would be. A common argument among Europe’s leading politicians is that regular taxation no longer works: they have effectively maxed out their ability to take people’s incomes, to charge a value added tax on their spending and to seize some of their equity through property taxes. Therefore they simply have to come up with new ways to get their hands on people’s money.

An even more urgent question, though, is why this reckless form of confiscation is now spreading beyond Europe. The Dollar Vigilante reports:

Rest easy, Canadians, for your bank accounts are going to be made as safe as those bank accounts in Cyprus. Just take a look at the Canadian government’s budget plan for 2013, particularly pages 144 and 145 of Economic Action Plan 2013. There the Canadian government promises to use Canadian deposits to save “systematicaly important” banks…

Why – why – would the Canadian government want to do this? Were we not told during the opening of the Great Recession that the Canadian banks were solid and shielded from the ramifications of the U.S. mortgage crisis? Why would the federal government in Canada all of a sudden feel it necessary to give itself the right to confiscate people’s deposits?

Let’s see what they actually say in their 2013 budget plan:

The Government proposes to implement a “bail-in” regime for systemically important banks. This regime will be designed to ensure that, in the unlikely event that a systemically important bank depletes its capital, the bank can be recapitalized and returned to viability through the very rapid conversion of certain bank liabilities into regulatory capital. This will reduce risks for taxpayers. The Government will consult stakeholders on how best to implement a bail-in regime in Canada.

What does this mean in plain English? Well,

1. Should this budget plan pass into law, the federal Canadian government will give “systemically important” banks the authority to take bank customers’ money and turn them into the bank’s own money. This is what is meant by “conversion of liabilities into regulatory capital”. It is the exact same thing as if you owe the bank $10,000 on a car loan and you could somehow make the bank owe you that money instead.

2. Some banks are deemed “systemically important” without a clear definition of the term. This means that the government has pre-selected a group of banks that will be given the government’s go-ahead to seize customers’ money – uh, I mean… convert liabilities into assets. Since there is no workable definition of “systemically important” and since it is only this loosely identified group of banks that will be allowed to do this, it is very difficult for bank customers to know where to go with their money. If (when) this new deposit confiscation scheme comes to the United States, the equivalent of a systemically un-important bank would be your local credit union.

3. Again – and I cannot stress this enough – it is remarkable that the Canadian government feels the need to include this scheme in its latest budget plan. Sure, the Canadian economy is slowing down, with a growth outlook that is more pessimistic than for the U.S. economy, but are Canadian banks really in such a bad shape that a recession would hurl them into insolvency?

As for the last point, The Dollar Vigilante adds a confounding observation:

Also, due to recent legislative reform, Canadian securities held by those with domicile in Canada can no longer be traded in accounts held in other parts of the world. Non-Canadian banks have been sending letters to their Canadian customers to inform them that they must sell or transfer any Canadian securities held in their accounts by an April 5 deadline. Canadians can’t even transact with an offshore broker who isn’t registered in their specific PROVINCE.

Effectively, this means that Canadians have to take their money home and put it in a Canadian bank. Preferably a “systemically important” one, we assume. But why would the Canadian government force its citizens to do this?

There are of course regular tax reasons: with more banking going on at home there are more transactions to be taxes. Canada, unlike the United States, has a territorial tax system which means that the federal government can only tax economic activity within its geographic jurisdiction. By de facto forcing people to bring offshore assets home they effectively eliminate the shortcomings of a territorial tax system.

Nevertheless, one cannot help but wonder if there is more than meets the eye when a government first forces people to bring offshore banking home and then allows large banks to grab customers’ money in the event of a crisis.

Let me add a few words on the confiscation idea itself. Ever since modern banking was invented in northern Italy in the late Middle Ages, the contract between the bank and the customer has been a sacred one. Few institutions have safeguarded private property rights with such vigilance as banks. No doubt, there have been bank collapses and failures throughout history, and people have lost their bank deposits. But that has been because the bank speculated – took risks – with its customers’ money.

Basically, it was not until the 20th century that governments started regulating banking on a large scale. And slowly but inevitably, with regulations came bail-outs, where governments vowed to use other people’s – taxpayers’ – money to save banks that over-indulged in risk taking.

After governments removed the annihilation risks for banks in general, and for “systemically important” banks in particular, by means of tax-funded bail-outs, the banks no longer had to worry as much about their risk exposure. Add to this the fact that over the past 10-15 years banks have bought loads of treasury bonds issued by welfare states all over Europe. Together with the bail-out pledge from governments, the massive investments in treasury bonds presented banks with an iron-clad investment strategy. They could easily maintain or even increase their investments at the high-risk end of their portfolios.

Now that governments have effectively eliminated common-sense, market-based banking and also maxed out what they can take from taxpayers, then rather than getting out of the banking industry, our politicians are willing to destroy one of the world’s oldest property-rights institutions.

To be succinct – this is not good. And there is a lot more to be said about it. Stay tuned.

See I Told You So: Get Out of Europe!

Never bark at the big dog. The big dog is always right.

To begin with, I have said all the way that the European crisis is a welfare-state crisis, not a financial crisis. The blow to the banks from the financial-market problems of 2008 would never have caused the ripple effects it did, had it not been for the fact that banks in Europe had invested so heavily in government treasury bonds.

The banks thought – for obvious reasons – that those bonds were the safest investment they could make, that large investments in treasury bonds would provide them with a rock-solid low-risk platform for their portfolio management. But then the welfare states in Europe kept on spending on their entitlements, despite the fact that scores of taxpayers were either unemployed or earning fractions of what they would in a strong economy. They started having problems paying their creditors – i.e., the banks.

Low-risk treasury bonds became high-risk assets. Bank portfolios were totally upset, leaving them with much more of mid-to-high risk assets than was healthy for them.

Today the British news site The Commentator confirms my analysis, using Cyprus as an example:

When the European Union (with German money) mounted its most recent bailout of Greece, one of the conditions was a 75 percent write down of Greek government debt. For the Cypriot banks, which had made loans to the Greek government totalling 160 percent of Cyprus’s GDP, this was disastrous.

I was also right about the true purpose behind the Cyprus bank heist. Yesterday I explained that the plan to confiscate bank deposits was not going to be a one-time  exceptional event, but was instead intended to set a new precedent for future bank-deposit confiscation raids:

Again, the two-fold goal of the Cyprus bank heist is to secure the euro zone as it is and to cause a long-term depreciation of the euro. In order to accomplish the latter, the Eurotarians have to create a certain, calculated level of capital flight from the euro zone. There are several ways to do this, but the instrument they have chosen – seizing bank deposits above a certain level – is devious enough to work. However, to cause a “right-sized” exodus you cannot limit the scheme to one country. You need others to follow.

British daily newspaper The Guardian has a story that confirms my analysis:

Fears that bank accounts could be raided in any future eurozone bailouts spooked markets on Monday, as Cypriots prepared for their banks to reopen for the first time in over a week on Thursday following a deal to secure a €10bn lifeline. Markets took fright after the head of the group of eurozone finance ministers indicated that the Cyprus rescue could be a template for similar situations.

And then the question is: what is a similar situation? Again, the Cyprus bank heist was not about taking deposits from individuals to rescue the banks where they had their money. The purpose was instead to take depositors’ money to give to government, which then used it to prop up ailing and failing banks.

The difference may seem like a technicality, but it is not. The fact that government is the middle man is crucial: it is right there that you find the precedent in this confiscation scheme. Government took money from large-balance accounts because it did not have enough cash for very important expenditures. Next time the very important expenditure does not have to be a bank, or even a financial institution. It could just as well be an urgently needed but financially strapped income-security system (Americans, think TANF or even Social Security).

The purpose behind the Cyprus bank heist was not primarily to save the banks – that could have been handled in a much different way by, e.g., the ECB printing another five billion euros – but instead to establish that government can raid the bank accounts of private citizens under the auspices of some kind of fiscal emergency.

It is not far-fetched to guess that many governments in small EU member states are now salivating over the opportunity to raid the bank accounts of their own wealthy citizens. The fact that the Cypriot government appears to be ready to take 40 percent above 100,000 euros makes this an even more attractive “revenue tool” for Europe’s cash-strapped welfare states.

It is this realization that is now setting in on investors all across the euro zone. The Guardian again:

[All] markets erased their early gains to close down on the day. The FTSE 100 index lost 0.2% and the German stock market fell 0.5%. Bank shares fell across Europe while the euro, which had nudged up through $1.30 initially, fell back to below $1.29. US markets, which had largely shrugged off the Cypriot problem, were also lower, with the Dow Jones Industrial Average down over 70 points, 0.5%.

The decline in Dow Jones is temporary, while the decline in Europe is the beginning of a permanent downward adjustment. Again: one of the ideas behind the Cyprus bank heist is to start a process that stokes fear in financial investors, resulting in a moderate outflow of funds from the euro zone. This will in turn cause a depreciation of the euro.

Germany needs this downward adjustment to compensate its export industries for the ridiculous shift to a much more expensive system for producing power.

Yes, politics can be that cynical. It is a risky strategy, but so is any high-end manipulation of the course of events, either in politics or in the economy.

In fact, if the Cyprus bank heist was repeated in a couple of more countries, it would give the desired financial outflow the boost that German leaders are calculating with.

And they may get exactly what they want. The Guardian again:

Malta’s finance minister wrote an article in the Malta Times expressing concern about what would happen if it encounters similar problems in the eurozone.

But this ill-intended, well-hatched plan also puts on full display the arrogance with which Europe’s political elite runs its new kingdom. They are either oblivious to, or dismissive of, the severity of the crisis that Europe has been stuck with for the better part of four years. This crisis only seems to get deeper and more entrenched for every move that this political elite makes. Der Spiegel has a good analysis:

It has been only four weeks since German Chancellor Angela Merkel had nothing but nice things to say about her “very esteemed” counterpart in Cyprus. In a telegram to newly elected President Nicos Anastasiades, she “warmly” congratulated him on his election victory and wrote that she looked forward to their “close and trusting cooperation.” That was then, as Merkel conceded last Friday in a speech to the parliamentary group of her center-right Christian Democratic Union (CDU) at the Reichstag in Berlin.

I could say something funny here about the fact that the German parliament is once again referred to as Reichstag – something about how it is easier to rule a continent by means of a common currency than by means of a common army. But let’s leave that aside. Back to Der Spiegel:

Although her intent was not to set an example, she said, Germany also would not “give in.” She added that there would be “no special treatment” for Cyprus. And over the weekend, she lived up to her word. … Since Cypriot parliament rejected the initial bailout plan, one crisis meeting followed the next in Berlin, Frankfurt and Brussels as concepts were presented, revised, rejected and resubmitted. In the end, the European Central Bank (ECB) imposed an ultimatum on the country. The message from ECB President Mario Draghi was that either Cyprus agree to the bailout conditions or it could be the first member of the euro zone to declare a national bankruptcy.

The technical meaning  of that would be that Cyprus would have left the euro zone, reinstated its national currency and re-denominated all its debt in that new currency. Most analysts would contend that such a move would have led to a drastic depreciation which in turn would have caused foreign investors in Cypriot treasury bonds, as well as in private banks, to lose money.

However, there is a real possibility that the opposite would have happened: with Cyprus out of the euro zone the country could de facto have reinforced its position as a low-tax jurisdiction with high respect for bank privacy. That would have led to a new inflow of foreign money, and eventually the little nation could actually have come out more prosperous.

Now they are facing the exact opposite scenario, as Der Spiegel explains:

In the end, Nicosia agreed. The country’s oversized banking industry is to be radically downscaled, one of its biggest banks, Laiki, is going to be dissolved and those holding accounts there will see volumes over the €100,000 insured limit potentially vanish. A worsening economy will almost certainly be the result.

Not to mention the ramifications for the entire euro zone:

Smoldering and flaring for the last three years, the euro crisis has reached a new stage. For the first time, a parliament rebelled against the requirements of international creditors, and for the first time euro-zone taskmasters tried to take a slice of the savings of ordinary citizens, prompting people throughout the continent to wonder whether their money is still safe. The unprecedented showdown led many in Europe to speculate over the national character of the Cypriots, and wonder: Are they especially jaded, desperate or simply nuts? Finding the right answer was the perplexing task for leaders in Brussels, Paris and Berlin. How far can one bend to demands from a teetering country like Cyprus without losing one’s credibility?

Actually, the real question is: how far can the European political elite bend their member states before they start breaking apart – or breaking away from the common currency, and perhaps even the euro zone? The jury is still out on that question, but there is no doubt that the political elite that runs Europe completely lacks understanding of the art of government. They have eradicated hundreds of billions of euros worth of GDP in several EU member states, just to preserve their precious union and at the same time gradually centralize control over fiscal policy. They completely dismiss the will of voters, either as expressed in elections, in a referendum or in the form of parliamentary representation. Cyprus is only the latest example, and certainly won’t be the last.

They are Europe’s authoritarian leaders and deserve to be called Eurotarians. They rule with very little regard for the half-a-billion people whose tax money they live off. they use instruments of power, such as austerity policies, to close the ranks of member states and if necessary oppress public opinion.

These instruments of power have thus far allowed the elite to win and become seemingly stronger. But at the same time, each new victory they score erodes the very pillars upon which they build their power. Der Spiegel makes a good point on this:

But a monetary union, at its core, is not held together by budget figures or austerity programs, nor by the statements of finance ministers and the heads of central banks, no matter how well-received they are in the markets. The most important glue holding together a monetary union is the mutual confidence of its members, and that has declined drastically in recent months. While many in the north question the willingness of politicians in Rome and Athens to bring about reform, citizens in the south are increasingly furious over the austerity diktats from Berlin, Brussels and Frankfurt. There are predetermined breaking points all across the continent, but they are more apparent in Cyprus than anyplace else. … the debacle over the debt-ridden island nation is more than just another financial crisis along Europe’s southeastern edge. It is emblematic of the entire monetary union. If the euro zone collapses, it will be because of both its economic contradictions and its members’ inability to reach agreement.

In other words, the attempts at keeping the euro zone together, by means of austerity and anti-democratic thuggery, have created a backlash that will combine a persistent economic crisis with an accelerating democratic crisis. These two are now merging into a perfect storm of uncertainty, unemployment and deprivation. Italy offers a great example, as illustrated by this story from Corriere della Sera:

Time is running out for Italian industry. Business is in a “desperate” condition with companies “very close to the end”. This umpteenth warning came from Confindustria chair Giorgio Squinzi during talks with the mandated prime minister, Pier Luigi Bersani, in which Mr Squinzi appealed for a swift return to “a stable government”. Given the three million Italians out of work, with a spike of almost 40% for young people, Mr Squinzi pointed out that the employment issue “is becoming a tragedy”. Confindustria had no option but to be “extremely concerned about Italy’s real economy”, warned Mr Squinzi. The Confindustria leader said “intervention is needed with absolute priority”, starting with payment of the public sector’s outstanding debts to businesses and implementing what he described as a no-holds-barred “shock treatment” for the first hundred days of government.

In the recent election Italian voters responded negatively to the bone-crushing austerity measures forced upon the nation by the EU and the ECB. Their response created a stalemate in negotiations for a new prime minister and parliamentary majority, which in turn has led to a standstill in legislative activity. There is no identifiable course of fiscal policy, which means uncertainty as to taxes and government spending. (This includes the macroeconomically small but microeconomically important problem of government contractors not getting paid.)

This uncertainty, ultimately brought about by the relentless pressure from the EU and the ECB, is making life increasingly desperate for Italy’s businesses and citizens. The private sector’s faith in, and respect for, a parliamentary government will at some point start eroding. Once that process gains critical mass they will either leave the country in order to invest elsewhere…

…or support political forces that are much more hostile toward the EU than what we have seen thus far in Italy. We got a foretaste of what that means in the Greek election last summer.

It would be an exaggeration to say that the common currency and the European project of unity are unraveling. That said, though, there is no doubt that Europe is inching closer to the point where both the EU and the currency union start falling apart. The institutional uncertainty of the continent has increased, while the reasons to invest there have weakened significantly.

Therefore, I will say it again: If you have any investments in the euro zone, get the money out ASAP.