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.
I am a strong supporter of the United States armed forces, which are the world’s most powerful force for liberty. But war and other armed conflicts are costly in more ways than one; there is a much more efficient way to break down tyranny.
The world’s largest authoritarian regime, China, is slowly but steadily reforming in the right direction. The underlying force moving China in the right direction is, plainly, economic freedom. When people are free to own property, be entrepreneurial, build wealth and pursue a lifestyle above what a state-run economy can provide, they will eventually demand political freedom as well. The Chinese leaders know this, but they also know that political freedom can be destructive if introduced before a country is ready for it. They wisely and fearfully look at what happened in Russia after the collapse of the Soviet Union, where political freedom preceded economic freedom – and economic freedom was introduced haphazardly.
But the benefits of economic freedom are not just limited to authoritarian nations. Other countries where government plays a destructively large role can also benefit substantially from a new dose of economic freedom. As I explain in my new book Industrial Poverty, Europe is going backwards as an economy because of persistent efforts by the political leadership to preserve the welfare state and all its big spending programs – not to mention its high taxes.
Economic freedom comes in many forms: deregulation, termination of spending programs, tax cuts… and free trade between sovereign nations. Often, free trade can be an inroad for economic freedom to open up heavily regulated economies. In Europe’s case, free trade with more regions of the world could give some entrepreneurs opportunity to thrive when the domestic economy is holding them back.
Therefore, it would be good if the EU could ratify its pending free trade agreements with the United States and Canada. Unfortunately, it does not look like that is about to happen, at least any time soon. And the reason is a section of the trade agreements that protects private investments under certain conditions. The EU Observer reports:
Provisions allowing companies to sue governments to protect their investments must be taken out of an EU-Canada trade agreement (Ceta), German chancellor Angela Merkel’s coalition partners have said. Speaking in the Bundestag on Thursday (25 September), Sigmar Gabriel, who leads the centre-left SPD, noted that “the chapter regarding investment protection is not approvable,” adding that “the last word hasn’t been spoken yet”.
So what is this investment protection that the European left is so passionately opposed to? Here is how the Office of the United States Trade Representative explains it:
[The U.S. government] seek to ensure that Americans investing abroad are provided the same kinds of basic legal protections that we provide in the United States to both Americans and foreigners doing business within our borders. One element we use to achieve that goal is investor-state dispute settlement (ISDS). ISDS creates a fair and transparent process, grounded in established legal principles, for resolving individual investment disputes between investors and states. … Over the last 50 years, nearly 3,200 trade and investment agreements among 180 countries have included investment provisions, and the vast majority of these agreements have included some form of ISDS. The United States entered its first bilateral investment treaty (BIT) in 1982, and is party to 50 agreements currently in force with ISDS provisions.
Another point made by the U.S. Trade Representative is that the ISDS does not allow any government regulations at all. As anyone even remotely familiar with the United States economy would know, that is absolutely false. We have our own (un-)fair share of regulations. All that the ISDS does is protect private investors from arbitrary, authoritarian government intrusions into the realm of free enterprise.
The European interpretation of ISDS is a bit less forthright. The EU Observer again:
celebrations are likely to be muted now that the [Canada-EU trade] agreement, which is widely seen as a trial run for the ongoing trade talks with the US, faces a number of obstacles before it is ratified. The mechanism, known as investor state dispute settlement (ISDS), allows companies to take legal action against governments if their decisions risk undermining their investments. Critics of ISDS claim that investor claims can prevent governments from passing legislation in fields such as environmental and social protection, enabling corporations to claim potentially unlimited damages in “arbitration panels” if their profits are adversely affected by new regulations.
The part about “unlimited damages” is patently absurd. It would require a forecast for the investment in question that credibly predicts endless profits. But you do not need to study finance or economics to realize that such forecasts simply do not exist. That would require something called “perfect foresight”, an ability of economic agents to predict the world with absolute certainty.
But as the EU Observer reports, reason and good analysis do not prevent leftist hardliners from acting according to their beliefs:
Deputies from the centre-left Socialist and Democrat group and the Liberals have indicated that ISDS would have to be left out in order for them to support Ceta, while the Green and far-left GUE factions have already come out against the treaty. … In a statement on Thursday, the European trades union congress (ETUC) said that it would not support Ceta if ISDS remained part of the agreement. The ETUC also called on officials to include a list of sectors that would not be liberalised by the agreement and for Canada to sign up to the International Labour Organisation Conventions.
The EU Commission appears to be determined to complete the trade agreement with Canada. However, the left-bound winds in the EU Parliament are a guarantee for a protracted battle. This is unfortunate, since the EU is in dire need of strengthening its economy. In lieu of advancements for economic freedom inside the EU, a couple of trans-Altantic free-trade agreements would be of great help.
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.
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.
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?
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.
I usually do not spend more than at the most two articles on the same subject, but the plan to seize bank deposits in Cyprus is such a pivotal moment in Europe’s political and economic crisis that it merits one last piece. In fact, this story from Reuters puts an important perspective on the crisis, a perspective that hints at what the true, long-term impact of this disastrous plan could actually turn out to be:
Cyprus pleaded for a new loan from Russia on Wednesday to avert a financial meltdown, after the island’s parliament rejected the terms of a bailout from the EU, raising the risk of default and a bank crash. Cypriot Finance Minister Michael Sarris said he had not reached a deal at a first meeting with his Russian counterpart Anton Siluanov in Moscow, but talks there would continue. Russia’s finance ministry said Nicosia had sought a further 5 billion euros, on top of a five-year extension and lower interest on an existing 2.5 billion euro loan. Cyprus is seeking Moscow’s help after parliament voted down the euro zone’s plan for a 10 billion euro bailout on Tuesday.
There are two reasons why they are turning to Moscow for help. Russians own 23 percent of all bank deposits in Cyprus, and most of their deposits are quite large. This benefits both parties: the Cypriots have been able to built a little bit of an offshore banking industry, which in turn has helped elevate the nation’s notoriously poor per-capita income scores; the Russians, in turn, get a quick and easy entryway into the EU, where they can buy upscale vacation homes and in general live a lavish lifestyle.
The second reason for the Cypriot government to turn to Russia is that the leaders in Moscow don’t give a fly’s fart about austerity. The people in the nation of Cyprus are of Greek descent – the island is technically divided with the north-east part being a deplorably poor Turkish province – and they know very well what the EU has done to Greece. They do not want the same treatment.
Closer financial ties between Nicosia and Moscow is, of course, not exactly what the Eurocrats in Brussels would want. Reuters again:
The European Central Bank’s chief negotiator on Cyprus, Joerg Asmussen, said the ECB would have to pull the plug on Cypriot banks unless the country took a bailout quickly. “We can provide emergency liquidity only to solvent banks and… the solvency of Cypriot banks cannot be assumed if an aid program is not agreed on soon, which would allow for a quick recapitalization of the banking sector,” Asmussen told German weekly Die Zeit in an interview conducted on Tuesday evening.
What he really meant to say is that the solvency of the banks can only be guaranteed if the government takes eight percent or so of what people have deposited into the banks. That is, after all, what the EU-ECB bank grab plan says. In other words, drain the banks for some of the money they can use to issue loans and make money, and the banks will be better off.
Makes perfect sense. Eurocrat sense.
As does this hollow threat from another European politician, as reported by Reuters:
Austrian Chancellor Werner Faymann said he could not rule out Cyprus leaving the euro zone, although he hoped its leaders would find a solution for it to stay.
Complete nonsense. The EU and the ECB have wreaked havoc with their destructive austerity policies on country after country to keep the euro zone together. They have hurled Greece into a full-fledged depression and pushed its parliament to the brink of fascism just so they could make sure the Greeks were not going to give up on the euro. They have turned middle-class Spaniards into food scavengers to guarantee that Madrid would not re-introduce the peseta. They have effectively neutralized parliamentary democracy in Italy and reduced Portugal to a whirlpool of social turmoil – all in the name of the common currency.
There is no chance that they will kick Cyprus out of the euro for going to Russia for loans. The Eurocracy may be arrogant enough to ignore the will of the European voter when it comes to fiscal policy, but they are smart enough to know that the euro is unpopular even among national leaders in Europe, and if they allow one country to slip out of the euro zone – for whatever reason – it will open for more countries to follow.
That is not to say that the EU won’t try to punish Cyprus. But they really do not have that many ways of doing it. The EU is a burden on most countries, though Cyprus is one of the net takers of EU funds. In theory, the EU could reduce or terminate parts of the grants they hand out to Nicosia. In practice, though, that would be politically very dangerous, as it would spark stronger anti-EU sentiments in many countries. National leaders would in all likelihood voice their strong opposition, especially the British government which is being pressured by a surging UKIP to sever ties with Brussels.
What we do know, though, is that there will be some kind of reaction from Brussels, and that it will probably be of the knee-jerk type. Reuters reminds us that:
The EU has a track record of pressing smaller countries to vote again until they achieve the desired outcome.
The difference is that no other country has had such comparatively convenient access to alternative credit as Cyprus has.
We won’t know the full fallout of the bank-grab scheme for some time. But there is no doubt that this story will have consequences for the entire European Union, not just the euro zone. And it will be worth following.
The decision to start confiscating bank deposits in Cyprus was not something that Europe’s political leadership came up with on a whim. It’s been long in the making, part of a carefully laid-out plan.
Those who believe that Cyprus was only the start appear to be right.
More on that in a moment. First, let us put this decision in its proper context. The leaders of the EU and the ECB – and the finance ministers of the euro zone – were all in on this deposit confiscation deal, and the idea very likely saw the light of day in the EU leadership. This is important, because it helps us understand whether or not this is indeed something that the EU will implement in more countries than just Cyprus.
The Eurocrats within the EU and the ECB have been trampling on the people of Europe for several years now. They have gotten high on their own political arrogance after having forced Greece into submission and years of bone-crushing austerity. They have put country after country under their authoritarian policies, apparently believing that they could continue to rule Europe at their own discretion.
If you can eradicate one quarter of the GDP in Greece and still subject tens of millions of other Europeans to the same anti-democratic, fiscally torturous policies, then why should the confiscation of people’s bank deposits present you with any more than minor white noise of protests?
The problem for the Eurocrats is that this might have been the worst possible thing to do at the worst possible point in time. It is one thing to tax people to death on their income, and to put heavy weights of value-added taxes on their spending. It is an entirely different thing to start going after what people have managed to set aside for themselves and their families – out of money that government has already taxed both one or two times.
A savings account is one of the few remaining sources of personal pride that citizens in Europe’s fiscally oppressive welfare states have left. Not to mention the fact that for many millions of middle-class families all over Europe, the money they have in the bank is a critical life line in tough economic times. Since these are tough economic times, they really do need to be able to rely on those savings.
Add to this that welfare state after welfare state in Europe has begun defaulting on their spending promises, cutting down on entitlements of all kinds, from unemployment benefits to college tuition assistance to subsidies for pharmaceutical products – and we have a full, sharp and chilling picture of why the Cypriot bank-deposit confiscation comes at exactly the wrong time.
Precisely because this looks small compared to years of austerity, at least from the viewpoint of someone up in the EU ivory tower, I highly doubt that the Eurocrats understand the depth of fear that their plan to seize bank deposits has stoked in Europe’s middle class. I also doubt that they will realize what the political fallout from this will be. If anything could cause the EU to unravel, it would be a widespread application of this kind of organized theft of people’s property.
However, we might never get that far. While the people’s will is little more than the irritating sound of a mosquito in the ears of the Eurocracy, the reaction on the financial markets might actually cause them to rethink their plan, or at least limit its application to one country. Consider this good analysis from Stefan Kaiser at Der Spiegel:
The shock waves of the Cyprus bailout deal hit financial markets on Monday, as anger spread over a one-time levy on bank deposits on the small island at the fringe of the euro zone. This marks the first time since the start of the European sovereign debt crisis that average savers are being forced to help rescue a country’s finances alongside taxpayers, investors and private creditors.
And this after years of higher taxes and government spending cuts that, each time they were introduced, were sold to the public as “the” solution to the current crisis. And just like each round of austerity proved to be just a prelude to the next one, people in Europe now have good reasons to ask themselves where this bank-deposit confiscation scheme will strike next.
According to Kaiser and Der Spiegel, investors on the financial markets have already made up their mind:
Financial markets reacted nervously, as share prices of banks across Europe dropped. Monday’s biggest losers were financial institutions in countries hardest hit by the debt crisis, like Spain’s Bankia, whose stock temporarily slipped by more than 8 percent. Deutsche Bank was also not immune, losing 4 percent of its stock price. Investors appeared to be fleeing to assets perceived to be safer, like German bonds or gold.
Then Der Spiegel reveals the true depth of support among Europe’s political leadership for the confiscation scheme:
It looks as if the deal struck by euro-zone finance ministers in Brussels over the weekend is already in doubt as a result of massive uncertainty among the public and on the finance markets. Several news agencies have reported that the terms of the deal were to be renegotiated on Monday. Proposals include lowering the levy on bank deposits below €100,000 ($129,000) to 3 percent from 6.75 percent, and potentially increasing the forced contributions of deposits above €500,000 to 12.5 or 15 percent, up from 9.9 percent.
In other words: all the finance ministers of the euro zone were in on this deal. This means that the plan to seize bank deposits has been in the making for quite some time. It is therefore not a desperate measure aimed at simply saving Cyprus, but something that will become a regular part of the European policy tool box for grabbing more money whenever government needs it.
This, in turn, means that the Eurocracy has been planning to do this for a long time – and as we know by now, whenever the Eurocracy decides to do something, they will stick with it regardless of the consequences. You don’t need to look further than to Greece where the persistence of the Eurocracy to force austerity down the throat of the Greek people has now cost that nation one quarter of its GDP.
That tells us quite a bit of what they are willing to do in terms of trampling on public protests in order to get their will; if they can basically transform an EU member state into a complete economic wasteland and throw half of all the young in that country into unemployment and economic despair, then why would they worry when their plans to seize bank deposits draws flak in the media?
Their determination to stay the course is put on full display in how they are considering a re-arrangement of the confiscation rates. By suggesting to take more from large deposits and less from small deposits they are playing the same despicable class-warfare tones as the left always uses when it wants to go after private property.
Then Stefan Kaiser at Der Spiegel reminds us that there is actually a precedent to this deposit confiscation:
In the case of Greece’s second loan program in 2011, private investors were called on to take part for the first time. German Chancellor Angela Merkel insisted that such action would remain unique to that program.
This was when the Greek government declared that it would write down what it owed them. Backed by the EU, the ECB and the IMF they basically unilaterally seized a portion of the money people had lent them by buying their treasury bonds.
It was, in some way, possible for them to get away with that scheme since the bond buyers had technically deposited their money with the government. The Cypriot bank-deposit confiscation plan is different in that those who have the deposits have given their money to another private entity, a bank. Even with the Greek debt writedown in mind you would expect private-to-private transactions to be safer.
Not so, alas, which explains why this is becoming such a toxic political issue. In fact, it is becoming so toxic that the leaders in Europe who concocted the scheme are now trying to pass the blame to someone else. From the EU Observer:
German finance minister Wolfgang Schaeuble and European Central Bank board member Joerg Asmussen during parallel events in Berlin on Monday (18 March) tried to blame each other for an unprecedented eurozone bailout deal demanding small savers in Cyprus to take losses on their bank deposits. “The levy on deposits under €100,000 was not an invention of the German government,” Schaeuble said during a conference on taxation. He insisted that the “configuration” he and the International Monetary Fund were defending was to tax only deposits above €100,000 – to a much higher rate than what was finally agreed. “The figures we have come up with are at the lower limit. If another configuration was chosen, touching only deposits above €100,000, the result would have been different and we would not have had these problems,” Schaeuble said.
The last statement is startling. Apparently, Mr. Schäuble seems to believe that all he and the Eurocracy need in order to get away with their deposit confiscation is a little bit of class-warfare rhetoric.
But his statement also reveals the utter contempt that he and others in Europe’s power-hungry political elite have acquired for the rule of law. This contempt is extremely dangerous, because it opens the floodgates of completely unabridged government power. It is very easy to transition from today’s policy paradigm where private property rights are worth defending only insofar as they produce taxable economic activity, to a paradigm where property rights are not even given such scant recognition.
America can learn a lot from this moment in Europe’s downward spiral. One lesson is that when a welfare state finally plunges into a deep crisis, no rules apply anymore. When government has brought the private sector to its knees in its desperate attempt to save the welfare state, then the distance between the welfare state and the totalitarian state will be so short that no one can see the difference anymore.
It is rather telling that the Cypriot bank-deposit confiscation idea surfaces in Europe, at this time. The Eurocracy is no doubt getting desperate when it comes to saving their super-state project with it common currency and its welfare state. No one should doubt that the confiscation idea was conceived in closed, anonymous, tainted-window offices at the heart of the EU power machine.
More on that in a moment. First, let’s listen to a voice on what this totally game-changing deposit confiscation can lead to for the Cypriot economy. From EUBusiness.com:
Russians are preparing to withdraw billions of euros from Cyprus and the island will plunge into a recession lasting for decades due to the onerous terms of a EU bailout, economists warned on Monday. “The Russians are already indicating they want to withdraw their money. Why should they stay? They will go somewhere where they can be protected; we can’t protect them,” economist Simeon Matsi told AFP. “We have indications that billions (of euros) will be withdrawn, we already know of about three billion that is ready to move. They are already asking lawyers to draw up documents to withdraw money.”
It’s ironic. Wealthy Russians make tons of money in an economy where protection of property right is precarious. They then take their money to Europe, the birthplace of the ironclad definition of property rights – only to see their property be subjected to an unprecedented confiscation campaign from government.
As a condition for a desperately-needed 10-billion-euro ($13 billion) bailout for Cyprus, fellow eurozone countries and international creditors Saturday imposed a levy on all deposits in the island’s banks. Deposits of more than 100,000 euros will be hit with a 9.9 percent charge, while under that threshold the levy drops to 6.75 percent. The controversial tax is seen hitting Russian pockets hard, with experts estimating that Russian deposits in Cypriot banks amount to at least 15.4 billion euros ($20 billion) of the estimated 67 billion euros of deposits held by Cyprus banks.
If the EU could apply the 9.9 percent confiscation to all the 67 billion euros, they would only get two thirds of the money they are after. If the Russians withdraw their money before the confiscation kicks in, they only collect a bit more than half of what they are after. And that is under the assumption that there are no other major withdrawals, an assumption that is obviously unrealistic.
Talk about creating a bank run… but the long-term consequences for the Cypriot economy are far more ominous:
Economist Castas Apostolides said the Cypriot government went unprepared into negotiations with the eurogroup. “We should have called Europe’s bluff,” he said. “A bank haircut on deposits is unacceptable; they should have walked out because without a business sector there is no Cyprus economy,” Apostolides said. “Cyprus will be unable to exit recession for the next 20 years. Our children will pay for this mistake.”
Indeed. One of the most important pillars of economic freedom is the credit system. It allows for a functional separation of property rights and rights of use, without destroying or eroding the status of the former. A credit system can only function if people feel that their property – their bank deposits – are always protected. If bank deposits are not protected, there will be no money for the banking system to lend. If they have no money to lend, there will be no credit available for small businesses to grow.
But even larger businesses can start feeling uneasy. They often bank internally – set up their own internal credit system for funding investments – but they, too, need to have their money deposited somewhere. Unless they own their own bank they need to expose themselves to the same world as the rest of us. When government can arbitrarily come up with a reason to confiscate ten percent of your deposits, even large corporations are going to get nervous.
Once that uneasiness sets in, people and corporations with large assets will start comparing risks on a broader scale. One immediate question is: are your bank deposits safe in other EU member states? The EU Business again:
An analysis by IHS Global Insight said there was a “potential for contagion from the move to impact bank sectors in other troubled economies on the periphery of the eurozone.” “A mass of withdrawals from eurozone periphery banks could heat up the debt crisis once again after the international financial community had decided that lending to countries such as Spain and Italy would not require the extremely high risk premia it had earlier demanded,” it said. “The financial markets’ immediate bad reaction to the part funding of the Cypriot rescue by taxing bank depositors has highlighted the concerns that it could be opening a nasty can of worms.” UBS Investment Bank managing director Reinhard Cluse said the deal “raises the obvious question whether the depositor bail-in in Cyprus is a ‘one-off’ or whether it will eventually be repeated elsewhere in the future”.
Let us not forget that the reduction of the risk premiums for investments in Spanish and Italian treasury bonds happened only after the European Central Bank had promised to buy an unlimited amount of their treasury bonds. In other words, the ECB did precisely what it is not allowed to do according to the EU constitution, namely bail out countries with unmanageable government debts.
The ECB allowed itself to break the constitution – and the EU accepted it – to achieve a political goal, namely to save the common currency and the Spanish and Italian welfare states. In other words, the respect for the rule of law is already rather scant in the hallways of European power. It is therefore not very surprising that this bank-deposit confiscation idea was concocted in those very same hallways. Euractiv reports:
Cypriot President Nicos Anastasiades said yesterday (17 March) he had no choice but to accept a painful tax on the country’s bank deposits in return for international aid, saying the alternative was bankruptcy.
For government, mind you.
In a nationally televised address, the president called it the least painful option under the circumstances before going on to accuse eurozone finance ministers of forcing Cyprus into this deal, Euronews reported. Breaking with previous EU practice that depositors’ savings are sacrosanct, Cyprus and international lenders agreed at the weekend that savers in the island’s outsized banking system would take a hit in return for the offer of €10 billion in aid. … The news stunned Cypriots and caused a run on bank machines, most of which were depleted within hours. Electronic transfers were halted. Outside Cyprus, the move unnerved depositors in the eurozone’s weaker economies and investors fearing a precedent that could reignite market turmoil.
There you go. Once the Eurocrats have gotten away with doing this to one country, they will most certainly do it elsewhere. They have done it with austerity, and they have already set a precedent for not caring too much about the rule of law.
It is easy for the Eurocrats to concoct all these power-grab schemes. It is a lot harder for the nationally elected officials to deal with the wrath of the people – as Greek and Italian voters have shown. When it comes time to confiscate people’s bank deposits, things get even more tense, which explains why, according to Euractiv, the Cypriot president is making a desperate promise:
Anastasiades promised those savers they would be compensated by being given shares in banks guaranteed by future natural gas revenues. Cyprus is expecting the results of an offshore appraisal drilling this year to confirm the island is sitting on vast amounts of natural gas worth billions.
And if that is not the case? If the reserves are not “vast”? Let’s not forget that the global-market price of natural gas has dropped significantly over the past year, as new resources have come on line, primarily in North America. And more is to come. By the time the Cypriot report is done it could turn out that only a fraction of the reserves is commercially viable.
At that point, what will the Cypriot government do? Can it even survive such a crisis, on top of a massive bank run?
Ultimately, the bank customers in Cyprus are just another cluster of victims of the reckless European attempt at saving what cannot be saved: the European welfare state. Let’s not forget that this entire thing did not start with a financial crisis, but with government deficits. The financial trouble in 2007-2008 would have been contained if it was not for the fact that banks over the previous decade had invested profusely in treasury bonds. The philosophy was that such assets would offset the rising risks elsewhere.
When governments like Greece, Portugal and Spain started having serious debt problems the low-risk end of bank balance sheets basically evaporated.
Bottom line: had the governments of Europe not borrowed so much money to save their unsustainable welfare states, the banks would have been able to handle the crisis on their own.
One of the perennial, unanswered questions in this world is: when is government big enough for a leftist? All we hear from people of left-leaning political convictions is that government must grow bigger. American liberals continuously call for new entitlements – the latest being the ridiculous universal child care program funded by money borrowed from China – but even in notoriously welfare-statist Scandinavia the left continues to demand more government. In Sweden, e.g., the incumbent prime minister and his cabinet (nominally “center-right”) are forcing local governments to raise taxes to record levels. The social democrats, in turn, want to significantly expand government spending and raise payroll taxes. And this in the country that has been notorious for world-record high taxes for almost half a century now.
Add to this the trend of higher taxes sweeping across the EU, and there should be no doubt that the left harbors a totally insatiable desire for more government, regardless of how big government already is.
You would think that the debacle of socialism toward the end of the 20th century had left big enough footprints in the history books for anyone to see and be deterred. Not so. Socialism is still alive and kicking and has even seen a resurrection over the past decade. The international socialist movement, which fell into disarray and a deep identity crisis after the fall of the Berlin Wall, got its act together again in 2001 when muslim terrorists committed the atrocities of 9/11 here in America. Suddenly, the old, deeply rooted anti-Americanism that had driven the global left during the Cold War was jolted back to life.
The resurrection of the global left accelerated in 2003 when they aligned themselves with Saddam Hussein to defend his tyranny against a multinational coalition. From there, the global left reignited its hatred for economic freedom and capitalism, a hatred that was partly inspired by the seemingly successful implementation of socialism in Venezuela. Socialists all over the world merrily turned a blind eye to facts such as out-of-control inflation at 30-35 percent per year, the virtual destruction of property rights when the military seized everything from farms to oil production facilities, the complete pull-out of foreign investors, food shortage, power shortage (in a country that exports oil) and rampant crime.
To the global left, the very existence of Venezuela gave them hope – hope that their warped view of the world was still somehow valid.
Sadly, the political virus of socialism is not contained to Venezuela. In Ecuador, president Correa has been copying “bolivarian” socialism since he took office in 2009. Reinvigorated by another election victory, Correa now sets out to make his destruction of the country “irreversible”. From the Buenos Aires Herald:
Ecuadorean President Rafael Correa said his party likely won three-quarters of the seats in Congress in last weekend’s election and vowed today to “steamroll” through reforms that will make his socialist model irreversible. The 49-year-old economist was re-elected on Sunday with 57 percent of votes, some 34 percentage points more than the runner-up. During his six years in office he has won broad support with high spending on infrastructure and social welfare.
There is another side to his “success” story. We will get to it in a moment. For now, let’s listen to what the Buenos Aires Herald has to say:
“This is going to be a legislative steamroller to serve the interests of the Ecuadorean people. … In democracy, the winners rule, but the losers have to be respected,” he told foreign reporters at the presidential palace.
The left always reduces democracy to a matter of election results. Or, as it has more aptly been called: the tyranny of the majority. In the socialist paradigm, majority votes are unabridged mandates, which explains why the left so adamantly uses its election victories to “transform” the countries they rule. Look at what Franklin D Roosevelt and his Democrat cohort in Congress did to America during the 1930s; go back and see what happened to France after Francois Mitterand was elected president in 1981 – or just glance at the arrogance of the current French president and his socialist majority in the National Assembly.
And these are mild examples by historic comparison.
The Herald again, where the Ecuadorean president takes his hubris to the next level:
“We’re overwhelmed with the amount of support from people. … We’re going to deepen the citizen’s revolution, build a new homeland and make it irreversible.” … [Correa] also promised to press ahead with socialist reforms to empower the low-income majority and dismantle what he called an elitist system that controlled the state and neglected the poor.
Alright, let’s stop there for a second and take a look at the other side of the story. Here is what the Heritage Foundation has to say about Ecuador in its annual report Index of Economic Freedom:
Ecuador’s economic freedom score is 46.9, making its economy the 159th freest in the 2013 Index. Its overall score is 1.4 points lower than last year, with substantial declines in the control of government spending and investment freedom offsetting improvements in labor freedom and freedom from corruption. Ecuador is ranked 26th out of 29 countries in the South and Central America/Caribbean region, and its overall score is far below world and regional averages. Once considered moderately free, Ecuador has slid significantly in the rankings and continues for a fourth year as a “repressed” economy. The reach of government continues to expand to economic sectors beyond the petroleum industry, and pervasive corruption continues to weaken property rights. The private sector has been marginalized by a restrictive entrepreneurial environment. Ecuador’s underdeveloped financial sector, often subjected to state-directed allocation of credit, limits access to financing and adds costs for entrepreneurs. The overall investment climate has become increasingly risky because of the repressive political environment. The restrictive trade regime is reducing competition and eroding productivity. By controlling flows of trade and investment, the government has been forcing closer economic and commercial ties with Venezuela and China.
As Bloomberg.com reports, this unrelenting decline in economic freedom is taking its toll:
Ecuador’s economy, South America’s seventh biggest, is growing at its weakest pace since 2010 as lower oil prices and limited financing options after a 2008 default crimped government spending and cooled domestic demand. Gross domestic product expanded 4.7 percent in the third quarter from the previous year and 1.5 percent from the prior quarter, the central bank said today in a report on its website. The bank revised down figures for second-quarter growth to 4.6 percent from a previously reported 5.2 percent, the lowest yearly reading since the third quarter of 2010.
These growth figures may seem strong, but they are driven entirely by a government that is not only growing its spending, but doing it while critically dependent on oil-export revenues:
Ecuador’s government, which depends on oil sales for about 44 percent of its revenue, used public spending to boost growth in 2012, Economic Policy Minister Jeannette Sanchez said yesterday. As oil prices fell last year, revenues declined, which limits the amount the government can spend to stimulate the economy, said Capital Markets economist Michael Henderson. “Under Correa you’ve basically seen government spending driving growth,” Henderson, who forecasts 4 percent annual growth in 2012 and 2.5 percent in 2013, said Jan. 2 in a telephone interview from London. “You’re going to see domestic demand slow further and pretty much we expect that to translate into a halving of growth rates from 2012 to 2013.”
It would be a valid point that this expansion of government spending should pull the economy into a higher growth gear. However, for that to happen, the economy must meet three conditions: it must have a healthy entrepreneurial environment; it must have a well-working credit market and a free banking system; and the spending that government engages in must be of such a kind that it actually generates productive economic activity.
The first condition is essentially the same as rock-solid protection of property rights. If a country’s property rights system is weak, no one will risk his investments even if he sees the potential to make some money. As the Heritage Foundation said, Ecuador has not exactly excelled in its protection of property rights.
The second condition is also not met by the Ecuadorian economy. The Correa government has been very heavy-handed in regulating the banking sector, which has stifled access to credit and made it more difficult to finance expansion of private businesses. As a result, it is difficult if not impossible for the private sector to take advantage of any sign of growing economic activity, including government spending on, e.g., infrastructure.
The third condition is rarely discussed in the literature on the role of government spending. If government pours more money into entitlement programs, then there will be no substantial multiplier effect at all for the private sector to capitalize on. Entitlements, especially in the form of work-free income, discourage productive activity such as participation in the work force. At the same time, there is no discernible increase in consumer spending, as the recipients of those entitlements are at the very bottom of the income scale.
A good part of the Correa government’s spending has been on entitlements – though it is still somewhat difficult to determine the exact figures – which leads to the conclusion that a government-driven expansion of the economy falls flat to the ground beyond the dollars the government spends.
The Bloomberg report also indicates that there is a looming budget deficit crisis in Ecuador, which means that Correa will soon face the same problems that Hugo Chavez had to deal with in Venezuela. Chavez chose to print money (partly through so called sterilization of the exchange rate) which ultimately set off an inflationare bonfire in the Venezuelan economy. Will Correa follow in his footsteps? To do so he would have to introduce a national currency; so far he has conveniently been riding on the coat tails of the U.S. dollar.
Would he be willing to drop the dollar as the nation’s currency? Let’s return to the Buenos Aires Herald to see if they can give us a clue:
Among the bills Correa has pledged to push are a plan to distribute idle land among the poor, and a media law to regulate content in newspapers and TV networks – which could stoke an ongoing confrontation with opposition media. “We’ll ask for the same things that we asked for before this resounding victory: for the media to be decent, ethical, to inform instead of manipulate, to communicate instead of getting involved in politics,” the president said. In the past, Correa has called journalists “dogs” and “hired assassins,” and has filed lawsuits against reporters and media owners who he says are determined to undermine his government. He is also expected to pass a new mining law to ease investment terms that could pave the way for the development of some large and mid-sized projects that would let Ecuador diversify its economy away from a dependence on oil exports.
So the freedom of press is in grave danger, and Correa presses on with more government spending despite a decline in oil revenues. So far the Chinese have been generous with loans to cover his budget deficit, but unless Correa is going to put all his country’s oil reserves in Chinese hands he will sooner or later come to the point where Beijing imposes a credit ceiling on him. At that point, he will either have to abandon his socialist agenda – or introduce a national currency.
Once the national currency is there, he can basically create whatever commando economy he wants. That would only accelerate his nation’s plunge into the despair and deprivation that always follows in the footsteps of arrogant socialist revolutionaries.
If the Ecuadorian people cannot be saved from the inevitable, at least let’s hope that Correa’s failure will stand as a stark reminder to the world – just like Venezuela does today – that socialism is never, ever a free meal.