The Financial Situation in Cyprus and the End of the Euro

Over the last few weeks, I’ve watched in horror as the financial situation in Cyprus goes from bad to worse.

Cyprus banks have now reopened after a 12-day “bank holiday.” But, depositors can’t simply close their accounts and move their funds elsewhere. In exchange for a €10 billion bailout from the European Central Bank, Cyprus has imposed restrictions on withdrawals to prevent capital flight. Bank customers can withdraw no more than €1,000 daily from their accounts. That’s for insured deposits under €100,000. Larger depositors with accounts over €100,000 stand to lose as much as 60% of their assets. What’s worse, those depositors who went to the trouble of choosing a safe, highly-liquid bank in Cyprus in which to invest face the same losses and withdrawal restrictions as the larger commercial banks that needed a bailout.

The bottom line is that euro deposits in Cyprus banks are worth less than euro deposits anywhere else. I can’t think of a scenario more likely to instill distrust in banks throughout the euro-zone. That’s because bank account holders in other financially troubled EU countries, especially Greece, Spain, Italy, and Portugal, rightly consider the Cyprus example as a template for their own country’s banks. And, they’re frantically withdrawing euros from their accounts to get under the €100,000 deposit insurance maximum.

That’s not to imply that “deposit insurance” is actually, well, insurance. The European Central Bank doesn’t actually have the cash to back up these deposit guarantees. Only by borrowing money – or creating it out of thin air – can the ECB protect smaller depositors from losses. The original deal offered Cyprus bank depositors implicitly recognized this fact. That proposal, which the Cyprus Parliament rejected March 20, would have confiscated 6.75% of accounts holding between €20,000 and €100,000, and 9.9% of accounts over €100,000.

There are several lessons to be learned here:

  1. Politicians lie. Only a few weeks ago, politicians in Cyprus promised that deposits in local banks would be backed 100% and that euro-zone taxpayers would finance any bailout. Obviously, that turned out not to be true.
    The swift win the race. Those depositors who got their funds out of Cyprus banks before the bailout get to keep 100% of their capital. Those who delayed face losses up to 60%.
  2. Cash is king. While the value of the euro has slumped in recent weeks, anyone with euros in cash form, rather than in an account, is far better off than with euros in a bank account.
  3. The euro is doomed. Eventually, the euro experiment will end and countries using the euro as their currency will begin using their own respective national currencies once again. Revaluation of these euros to national currencies will be at relatively high levels in countries with relatively healthy economies in northern Europe. Southern European economies won’t fare nearly as well.
  4. It’s a great time to consider investments outside the banking system. Ultimately, precious metals, real estate, cash, or anything else tangible will fare much better than deposits in banks whose deposits are backed only with fiat money.

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