Article / 01 April 2013 at 12:51 GMT

Blame the Euro, not Cyprus

co-founder & CEO / Saxo Bank A/S

The real problem is not Cyprus, it is the Euro.

After a few disturbing weeks, I would like to wrap up my comments on Cyprus and, hopefully, turn to other issues going forward. It is astonishing that a EUR 10 billion bailout can keep the world spellbound for so long. But then again, while the amount is not staggering, some of the implications are mind-blowing.

That a small economy can be destroyed over a weekend is in itself very scary. But Cyprus's fate was basically sealed when the Troika revealed its first version of the bailout package. That the final outcome turned out to become even worse should not surprise anyone following the Euro zone's past efforts at saving its project. There is no coherent line, no apparent co-ordination of statements and the grand plans bear the impression of having been scribbled on a napkin long after bedtime. The results are accordingly: poor.

So did Cyprus do terrible things that made it deserve this gruesome fate? Actually not. Cyprus had respectable numbers both for growth, public debt and finances - certainly compared with many other countries in the region. Cyprus succesfully built a strong financial services sector, as the island has little industry or agriculture to live from. Cyprus has a well-functioning, English-speaking workforce and has based itself on British law. So all in all, not a bad place to do business. It made the most of what they had to offer.

The one thing that went wrong for Cyprus was its bankers expecting that Euro zone politicians could be trusted to pay back their loans. Investing heavily in Greek paper is not unusual for a country so intimately related to Greece - and not much different from what other banks do with their own national (in this case quasi-national) sovereign debt.

From my own talks in the past with high-ranking officials in the Cyprus banking sector, it was quite clear that not insignificant political pressure was placed on at least those banks operating in Greece to buy the local bonds.  The risks of this concentration were clearly underestimated, but basically, there was a reliance on the Euro zone to support any country getting into serious trouble, including Greece. If you remember back just a few years, most people actually believed this was an inherent part of the Euro deal, otherwise there would not have been such a massive convergence in bond yields.

So I don’t think you can absolve the Cypriot banking sector from blame altogether, but all the troubles could only have been built into the system with the Euro zone dynamics in place. Otherwise, fewer foreign investors would have placed money in Cyprus, the risk dynamics of a free-floating Drachma sovereign bond market would have prohibited such exposures and would have led to a much faster mark-to-market based risk adjustment. Greece itself would probably not have had to default, but would instead have relied on competitive devaluations as the country always did in the past.

Now, instead, the problems grew much bigger than free capitalistic markets would ever have allowed. Now, therefore, we have capital controls and withdrawal restrictions and de facto wealth taxes inside the Euro zone, meaning that the concept of THE EUR can hardly be said to exist in the same format any more. There are at least two different EUR: the restricted one in Nicosia and the so far unrestricted one in the rest of the Euro zone. Totally different dynamics and, I believe, the start of multiple versions of the EUR in the future. Similar measures are likely to be used in similar situations and already now, people are discussing where the crisis will hit next. Slovenia? Malta? Other, much bigger problem, countries?

The Financial Times reminded us the other day of Friedrich Hayek's chilling warning about capital controls:

“Nothing would at first seem to affect private life less than state control of the dealings in foreign exchange, and most people will regard its introduction with complete indifference. Yet the experience of most Continental countries has taught thoughtful people to regard this step as the decisive advance on the path to totalitarianism and the suppression of individual liberty. It is, in fact, the complete delivery of the individual to the tyranny of the state, the final suppression of all means of escape – not merely for the rich but for everybody.” (The Road to Serfdom, 1944).

Beware of the new tools that have been introduced. Capital controls was one. What looked a lot like a broader wealth tax was another.

I strongly believe that we have witnessed a game changer in the past few weeks. I think anything and everything can and must now be expected as the Euro crisis worsens and the Euro steamroller moves from one country bailout to the next.

There are very few limits to what you can do to people in the modern interpretation of democracy. A version where only majority rule is required, but where there is no longer a respect for personal negative rights – as we know them from the American Constitution.

The easiest target will always be wealthy people, or even just working people and savers who did the right thing all their lives. As the bloated welfare states begin to collapse under their irresponsible promises, their crumbling value systems and their unsustainable demographics, it will be easy to convince more than 50 percent of voters that confiscating and stealing other people's money is OK for the greater good. Boston Consulting Group calculated that 28 percent of ALL private wealth is needed to meet just existing debts – not future obligations , mind you – and the money can only come from one place… Your pockets. Beware.

A lot of things have gone wrong over the past few years, but the seeds were planted many years ago. In the form of pressure for more people having the “right” to own their properties, even if they did not fulfill the traditional mortgage criteria – hence subprime. In the form of enormous “entitlements” to not just poor, but also middle-class people in the welfare states – hence ballooning deficits and debt. In the form of a Euro, a grand, political project with no practical foundation – hence crisis after crisis, with the dominoes stretching far into the distance.

For sure, a lot of financial institutions took advantage of the hands they were dealt. They are not without guilt and responsibility for the current mess. But the real problems lie not in people trying to take advantage of whatever conditions they operate under. The real problem lies in the framework that is created by politicians, preventing free markets to deal with excesses in the way capitalism always does. Solving crises and exposing poor business models are part of capitalism, and it is not always pretty – but it is a damn sight more efficient and quicker than trying to desperately salvage what is already doomed. And it will never allow problems to grow to the magnitude that we are now facing.

Cyprus is a very good example of this. The problem is not Cyprus. The problem is the Euro.  



Mickette Mickette
No, put the blame on the Greek Cypriot political class.
benlouro benlouro
Totally agree. Can you think (and write) some strategies to put some money "aside" this mess?Imagine for example you were a "Spanish saver". thanks in advance
Jean-michel Ortega Jean-michel Ortega
Malta would it be the next bailout? The Euro Group is increasingly fragile and unique currency. because it seems inevitable in the long term, because too many countries are about unsustainable debt and breath!
Germany eventually it will come out of the Euro?
Sorry Lars, but the Cypriots themsleves carry the largest portion of the blame. The Laiki Group bankrupted itself on semi-criminal lending policies right under the nose of the Cyprus Central Bank. The 'responsible persons' were either asleep at the wheel, paid to look the other way or plain criminal. Northern european taxpayers should not have to pay for this alone! This is the reintroduction of moral hazard on the national level. Of course, its brutally unfair to the depositors, but the alternative is default.
MedievalAstrology MedievalAstrology
I agree with every sentence, this is absolutely correct in my view. The sad fact for me is that there are so few liberal democrats writing about this openly. We have a deficiency in basic democratic values, and only statism and EU-officials controlling from above on the one hand, and collectivist movements like 5star / Grillo on the other hand. As someone who values personal freedom and self-responsibility against every form of state authority it is quite easy to see that this Cyprus event has left a very bad taste.

Apart from Hayek´s book, which should be read in every school in my opinion, a good classic read is L. Mises `s " On Bureaucracy ".

To put the blame somewhere like e.g Laiki Bank is oblivious to the fact that the ECB has actually kept these banks going for months, although the ownership of worthless Greek bonds ( after the haircut ) and thus the true state of Cypriot banks should have been well known.
@MedievaAstrology "the ECB has actually kept these banks going for months" I think you mean that the ECB has kept Cyprus going for the past months. Make no mistake, ECB support for the state was no vindication for the corrupt banking and lax oversight which went on in Cyprus. It was systemic support until the EU and Cyprus reached a bail-out 'agreement'.
michalism michalism
hear hear


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