If you ever doubted that we lived in an interdependent world, the traffic chaos in south Dublin last Friday will reinforce just how fragile the ecosystem we inhabit is. Running up one rat-run after another to avoid the escalating traffic, it struck me just how similar the flows in the economic and financial world are to the flows in traffic.
One small change in the real world of rain and traffic can cause enormous ramifications all around the city. Last Friday, the torrential rain – unusual but hardly unheard of in Ireland – caused flooding, closing the N11 and revealed to all just how dependent we are on each other.
People like me, who were only collecting children two miles away from their house, got caught up in a jam which had its origin about five miles away on a main road that had no obvious connection to the blocked-up, suburban road on which I sat, motionless. But once the traffic stopped outside Enniskerry, the resulting chaos spread, revealing how we are all dependent on a smooth flow of traffic, and how an event in one part of the system can have enormous ramifications in another part.
Consider the similarities between the movement of traffic on the roads, and the movement of cash and credit in an economy. When credit is flowing and people are spending, and basing that spending on the notion that there will be no credit jams, broken ATM machines or bank runs, the system works fairly well.
You pay me, or indicate that your account will be debited, and I trust you and the bank to deliver the cash into my account in a few days. Similarly, when you deposit money in a bank, you fully expect that money to be there when you want it. When you open a savings account, it never strikes you that you are lending the money to the bank.
Expressions like ‘safe-keeping’ and ‘nest-egg’ come to mind when you put money in a savings account. Who thinks that, when you set aside money (or when you sell an asset like a house and put the proceeds into the bank, rather than speculate on bank shares or blow the money on fancy stuff), you are being anything other than prudent?
This is why the eventual deal being forced on Cyprus is so dangerous, because going after savers to pay for the greed and stupidity of the bankers, regulators and, of course, the EU itself – which created and oversaw the monster that is the Cypriot banking system – breaks the essence of trust between saver and bank.
Over the last few days, I have heard all sorts of people – particularly academic economists (who tend not to be the most entrepreneurial people in the world) – suggest that savers ‘lend’ money to the banks. Yes, let’s repeat that: ‘lend’ money to the bank. Is that what you think you are doing when you open a savings account? I defy you to find the word ‘lend’ in any bank literature or advertising about opening a savings account. You won’t find it, because it doesn’t exist.
In the main, savers put money in the bank for safekeeping. This is why savers are different. They are not ‘legitimate targets’ to go after in a bankruptcy. They should be regarded as a special case – no matter how big the deposits. Imagine you just sold your house – which you regarded as your pension – in Cyprus, and put the cash in the bank, only to be told you are to be punished for prudence.
Depositors are a different type of bank creditor to any other sort. In an insolvency situation, they ought to be regarded as ‘trust creditors’ or ‘creditors in trust’. They deposit their money because they trust the system. They are not ‘investors’ in the traditional sense like shareholders or bondholders. They trust the system to look after their savings and, as such, they need to be protected. If you actively break that trust, as the EU wants to do, you do so at your peril.
Of course, the peril or risk here is that depositors in other countries with still-unresolved banking crises, such as Spain, will see the Cypriot deposits being looted, think “we’re next” and take their money out of the banks.
This deposit flight is the bank-run – which is the very outcome that the authorities are most keen to avoid.
Why is Cyprus a special case? After all, every eurozone crisis has been labelled a special case by the EU up to now, so why believe that this is the last one? And what if ‘next time’, in the next country, the €100,000 threshold is €60,000, and the levy is even higher?
The reason there is likely to be a ‘next time’ is because, now that deposits have been targeted, people all over Europe are realising that the banks actually don’t have all your savings in their vaults, safe and sound. They have lent your money out and, when you look for it, they need to find it elsewhere to plug the deficit.
When economists blithely say that depositors are creditors who need to pay in the same way as taxpayers are asked to plug a deficit, they forget the role of psychology in finance and economics.
As they say, there are two things certain in life: death and taxes; we mightn’t like taxes, but we are used to them. Therefore, the reaction to higher income taxes is not that dramatic because we know what tax rises look and feel like.
Taxing savings is different. It breaks the rules and it causes panic. This is why, no matter what happens tomorrow, there will probably be a run on the Cypriot banks when they open. If you were Cypriot, what would you do the minute the banks open? Would you take the word of people who said that your savings would be safe, only then to turn around and indicate your savings could be confiscated because you had saved in the first place?
Once people lose trust in banks, they hoard money. Once they hoard money, credit stops flowing and, once credit stops flowing, the system, like the traffic system, clogs up. People in one part of the economy who mightn’t have been directly affected by the deposit confiscation are affected because credit dries up and the system gets stuck.
Credit needs to flow again, but this demands that trust in the system is recovered. However, trust, once it is abused, takes a long time to come back, not just in Cyprus – but all over the eurozone.