The True Worth of a Government Guarantee about your Bank Deposits

The European Union has 27 member states. Virtually all of them have had economic problems. In virtually all the economies, the economic problems were caused by over spending. Nations in effect bribed the voters with gifts of large pensions and large social security payments which the nations could not afford. Those gifts would be paid for by future generations unless the future amounts of the bribes were curtailed, and thus “austerity” became the solution for most of the economies.

But not all of the economies got into economic difficulty by making large bribes. Certainly Italy, France, Greece, Spain and Portugal did, but certainly Cyprus did not. It got into difficulties by investing its depositors money in Greece and in particular the Cypriot banks lent money to the Greek banks that proceeded to lose the money lent.

Greece’s solution imposed by the European Union on this small nation of eleven and a half millions was to cut out the bribes otherwise known as austerity. Then the European Union’s Central Bank would lend Greece enough money to get buy, provided that no more bribes were made.

Cyprus, where the population was not bribed (at least to the extent of the other EU nations, including the United Kingdom) had not caused its own crisis except to the extent that investing in the banks of a neighbouring country that speaks the same language can be considered blameworthy.

However Cyprus is a small nation of less than eight hundred thousand people. There are large numbers of people who have retired and settled in Cyprus. Some have come from the original colonial master, the United Kingdom, and others have come from Russia, a co religionist. It is easier to impose a drastic solution on a small nation than it is to impose one on a larger nation.

In the case of Cyprus the EU’s “bailout” was not so much a bailout using the EU’s money but more of a bailout using the money deposited in banks in Cyprus. If you have less than €100,000 in the bank 6.75% of it will be removed by way of tax. If you have more than that, 9.9% will be removed by way of tax. In return you will get some shares in the bank, such shares almost certainly being worthless.

Many complain that this amounts to confiscation. It does, of course, but only to the extent that all tax is confiscation. The banks have been closed and electronic transfers are not permitted until after the tax is taken on Tuesday.

Clearly, this solution would not have been imposed on a large nation, at least not imposed openly. We should remember that inflation is in effect a tax on bank deposits. In the past few years in the United Kingdom if you have money deposited in a bank it has eroded in value by at least 2% a year, compound, after giving credit for any interest you have received.

The amount that the levy will raise is only €5.8 billion, but that in the context of the economy of Cyprus is a large amount, although in the context of the United Kingdom would barely keep the BBC going for one year. The levy will damage confidence, with many depositors failing to trust banks and no doubt there will be an increase in the cash economy. The amount being lent by international banks, which imposed the condition of the seizure of depositors’ funds, is not quite double the amount being seized from depositors.

The irony which people seemed to have failed to spot in all this, is that like the UK government, the Government of Cyprus guarantees bank deposits up to a certain amount which in the case of Cyprus is €100,000.

There is probably nothing wrong with a one off tax; it will likely happen in other places in future as governments look to solve the problems in banking that they have created. What this crisis shows is that bank depositors cannot trust governments. The purpose of a government guarantee that so much of your money will be safe if you deposit it in a bank is to prevent a run on banks, who by their system of fractional lending cannot repay the depositors if all of them ask for their money back at the same time. Indeed they could not repay 10% of the depositors if 10% of the depositors asked for their money back at the same time.

By taxing depositors of less than €100,000 at the behest of the European Union supported by the International Monetary Fund, the EU and the IMF are showing us all just how valueless a state guarantee of the money you keep in the bank is.

Although this tax on deposits has been promised to be a one off tax, the confidence of savers will have been shattered and no doubt many will withdraw cash from the bank, either keeping it in their mattress or else sending it abroad to a foreign bank, if they can find one that they will trust.

One Response

  1. I think you’re being too generous here. Confiscation by tax or by inflation happens over time and (in the case of taxation) is usually subject to some form of democratic process. The Cyprus levy came swiftly and suddenly and that’s what makes it different.

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