Let me first (try to) give you a justification for the seizure of bank deposits in Cyprus.
Everybody who knows any thing about Cyprus also knows that the domestic banks were a parking lot for Russian hot money. I wrote about this back in 2011 (Link). There are a gazillion other articles saying the same thing.
That being the case, the seizure of some of the black Russian money as part of a bailout for Cyprus is not really a surprise. With dirty money flowing in, the stupid banks in Cyprus used the deposits to buy crappy assets like the sovereign bonds of Greece. To a significant extent, the hot money caused the problem – and therefore the E5.8b ($7.5b) hit to depositors is justified.
The folks in Berlin, Brussels and Paris all understood that Cyprus was a Russian front. To bailout Cyprus is one thing, but to bail out Russian Oligarchs is quite another. What else could the Euro Deciders do?
I struggle to come up with a valid comparison for what has happened in Cyprus. Think what the backlash would be if somehow the FDIC/Federal Reserve were forced to step in to bailout an entity that was a depository for the Mexican drug lords. If faced with a similar situation, America would do the same as the EU. Screw the hot money crowd.
And now the other side. This is a huge development, a potential game changer. If the seizure of accounts had happened in Greece (or the other PIGS) the European Monetary Union, as we know it today, would not exist. The EU would have imploded within months. This outcome would have resulted in some form of Euro break up, and a return to national currencies. That scenario has broad global implications.
The decision to clip depositors was not taken lightly. The ECB, and all the other Finance ministers contributed to the decision to take the depositors money. While making that decision, they had to have considered the consequences. Certainly there was recognition that this was an unprecedented step, and that it was extraordinarily hostile to bank depositors.
How are markets going to react to this? Will people care if some Russian money was stolen? Will they conclude that this was a unique event, and the depositors in Italy, Spain and France will never face the same losses that depositors in Cyprus have realized?
Given the significance of what has happened it would be logical to assume that a huge safe-haven trade could be the market’s response. If the Cyprus seizure had happened a year ago, the market would have reacted with:
- The Euro trades cheap against all crosses.
- The Yen strengthens against the Euro and the dollar.
-European bond spreads widen. Money moves to Germany, while Spanish and Italian bonds get crushed.
-The EURCHF comes under attack. The Swiss national Bank floor of 1.2000 is tested, and the SNB is forced to intervene to maintain the peg.
-US bonds trade rich.
-Money moves to the UK (where banks are ‘safe’) and Sterling strengthens.
-Money moves to gold, and other PMs.
-Stocks would take a beating globally.
While all of those things might have happened a year ago, I’m not sure that is the case today. As of Friday, the markets hated gold/PMs, Sterling, the Yen against everything (including the Euro), the EURCHF, US bonds and everyone loved stocks.
Is it possible that everything that was in the market on Friday is going to be reversed? I would think not, but these are very unusual circumstances. Nothing like the seizure of depositor’s money has ever happened before, so we are on uncharted ground.
Given the fact that the EU deciders were well aware of the potential consequences to financial stability within the EU, I wonder if some additional “market friendly” steps might be in the offing. (There must be a plan ‘B” in place – that or the guys pulling the strings are idiots.)
Because of the Russian money angle, the step to seize deposits might be glossed over. On the other hand, there is a great risk that what has happened is a turning point in modern finance. I’m not aware of any precedent for what has occurred. I say again, if this had happened in any other country in Europe – the monetary union would be dead within months. That possibility still exists, even though it was just crooked Russian money that was stolen. We shall see the market’s reaction in a matter of hours – I can’t wait.