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Cyprus: Big Lie of the Financial Crisis Finally Explodes

19/03/2013 13:18 GMT | Updated 18/05/2013 10:12 BST

"Protect the small savers" - that has been the mantra of policy wonks and politicians dealing with bank failures since the Great Depression 80 years ago.

Fifteen years ago, for instance, the Asian Crisis saw the IMF and US Treasury fight to "keep the depositors whole" in bid to defend the region's new-found stability and consumer markets. And five years ago today (to the very day, in fact) customers of Bear Stearns barely noticed the change when it collapsed into the warm, taxpayer-funded embrace of J.P.Morgan for just $2 per share.

But this rule finally got broken Saturday morning. To get a bail-out from the rest of Europe, the government in Cyprus agreed a 9.9% levy on anyone with €100,000 in a Cypriot bank. Most amazing, small savers are no longer sacred. They are being hit for 6.75% on deposits below €100,000.

The FT calls this a stupid idea whose time had come. Paul Krugman writing in the New York Times says "it's as if the Europeans are holding up a neon sign, written in Greek and Italian, saying 'time to stage a run on your banks!'... " Lots of people note that Russian mafia money, a huge part of Cypriot banking, will see a 10% levy as just a cost of doing business. President Putin is still furious though, especially as the Kremlin is about to renegotiate its own loans to Cyprus directly.

Big picture, Cyprus accounts for just 0.5% of the 17-nation eurozone economy. Although equal to one third of GDP, the levy will raise perhaps €5.8billion, just $7.5billion. Yet the Eurogroup's action has already seen stock markets sink, along with the Euro. The gold price in Euros jumped 2.3% at the start of Asian trade overnight. Dollar gold prices jumped above $1600 per ounce for the first time this month.

Terrified savers emptied Cyprus's cash machines, of course. But the government had already blocked electronic transfers over the weekend, and besides - money equal to the levy was frozen immediately, according to Jörg Asmussen of the European Central Bank.

Yesterday was a pre-planned Bank Holiday in Cyprus (Clean or 'Ash' Monday, no fooling), but so parliament can vote either to approve or dismiss this 'tax' before the banks re-open, emergency holidays may be used until Friday, according to press reports. The vote has already been pushed back to today. Parliament may yet alter the terms (the prime minister is apparently offering to cut the tax on smaller savers to 3%). But either way, the big lie behind the financial crisis so far - that bank savings are safe - has finally blown up.

Putting cash on deposit makes you a creditor. And in financial crises, the creditor always pays in the end (borrowers can't; they don't have any money). Whether through inflation, default or a 'levy', savers are sure to suffer in the end. Holding a little physical gold exposes you to price movements. But it gets a chunk of your savings away from the myth of bank-account security.

Three notes:

  • This is a "bail-in" by depositors. They will get shares in the bank equal to the value of their levy - effectively replaying the "preferentes" scandal which hit Spanish savers;
  • The price of silver has quickly come back down. It barely touched $29.20 per ounce at the Asian opening, and is now unchanged from last week's finish. Because yet again, people have opted to buy gold when the SHTF;
  • The gold price in Sterling is unmoved. Because, bizarrely, the Pound is seen as a "safe haven" - a view only reinforced by the British government vowing yesterday to make good the loss of any UK armed forces personnel stationed on the island. That could look very expensive if the bail-out now fails, and the banks go under completely. But such risks never stopped UK governments promising the unpromisable before.