Cyprus Forces Politics Back Into Banking and Bailouts

Willie Sutton, America's infamous bank robber, said "Go where the money is...and go there often." European finance ministers have just asked for 5.8 billion euros from Cypriots' bank accounts as a condition of the 10-billion euro bailout. The big question is whether this is a one-time raid, or whether the finance ministers will be raiding European depositors' accounts on a regular basis.

Europe has been papering over its insolvency problems with repeated monetary infusions from the European Central Bank. Mario Dragi has said that he will do "whatever it takes" to preserve the euro. Yet every thinking person knows that the ECB is just buying time, hoping that Europe will recover. So far, no recovery in sight.

Ultimately, there are three ways to pay off the eurozone's insolvent loans if Germany is unwilling to foot the bill. Banks and other financial institutions can absorb the losses from their bad loans, and some will go under. The depositors can be asked to take a haircut on their savings. Or, taxpayers can pony up through higher taxes to bail out the banks.

Now that the European ministers have picked Cyprus's small depositors to foot the bill, savers in other countries are no doubt thinking that they might be next in line. Out with the banks, in with stuffing assets in mattresses. Hence the drop in the euro on Monday to its lowest level this year, ending at $1.29.

This is the environment in which Europeans are waking up and deciding that perhaps gold is the best bet after all. Not surprisingly, the price of gold rose on Monday.

The damage is not just to Cypriots, both rich and poor, but to the financial systems of other countries whose depositors are likely to withdraw funds from banks in preparation for a similar initiative. A run on the banks, or even a gradual withdrawal of funds as trust dwindles, throws sand in the wheels of commerce.

Spain, Greece, Ireland, and Portugal have already received bailouts. Will the finance ministers request a tax from depositors in these countries also? Or, will they pick on other countries that might need a bailout in the future? How about Italy, currently without a government, or France, perhaps next in line?

The European ministers' decision to tax Cypriots' bank deposits follows a series of bad economic news in the euro area. Just this month Eurostat, the keeper of Europe's statistics, made the following gloomy announcements:

The unemployment rate in the eurozone rose to 11.9 percent in January, up from 11.8 percent the prior month. The contrast between the Teutonic north and the Mediterranean south could not have been starker, with rates of 5 percent in Germany and Austria compared with 27 percent in Greece, 26 percent in Spain, and 18 percent in Portugal.

Employment declined in the fourth quarter of 2012 by three tenths of a percent from the third quarter. Employment has been steadily declining since the second quarter of 2011.

GDP in the eurozone in the fourth quarter of 2012 declined by six tenths of a percentage point compared with the third quarter. The only growth was in the former Soviet satellites, Poland, Romania, Slovakia, Lithuania, Estonia and Latvia. Portugal and Cyprus suffered the largest declines.

Industrial production declined by four tenths of a percent in January 2013 compared with December 2012, led by Finland, Norway, and Luxembourg.

The European finance ministers' demand to Cyprus means that Europeans will shift their savings from financial institutions based in Europe. This can only be bad news for European banks and the broader European economy, which is in no condition to take another hit. Europeans hold checking and savings accounts in banks because they value those services. But financial services are global, and can be provided elsewhere.

American Enterprise Institute fellow Desmond Lachman, just back from a trip to Europe, told me that German politics is the only explanation for Europeans' treatment of Cyprus. Germans need to be reassured before the elections next September that their funds are not being used to bail out the Russian oligarchs who have substantial sums in Cypriot banks. Otherwise, Chancellor Angela Merkel will lose the election.

It is hard to think of anything worse happening to the euro zone banking system than what the European ministers have done to Cyprus. The burden of the tax will be felt not just by the Cypriots, but by the banks themselves and ultimately Europe as Europeans remove their money to safer locations.

That's one reason that American stock markets fell by half a percent or less on Monday, and that markets in Japan and Hong Kong were recovering in Tuesday trading. America and Japan have their own sets of problems, but with new European bank raids they could benefit from an inflow of European cash.