Sunday, 24 March 2013

After Cyprus, Who's Next

So far, Russia has turned down any offer to get involved in bailing out Cyprus. That could be because Cyprus has not been prepared to offer Russia the things in return it requires, such as control over the gas reserves, and a warm water port, or at least not at a price Russia feels it has to pay given the situation. In response, the EU and IMF have toughened their stance to an extent that it looks like Cyprus may be forced out of the Eurozone, because the changed conditions mean that any bail-out is likely to be insufficient to deal with the now bigger problem. Already, Cyprus is talking about 20% levies on deposits over €100,000, but also the introduction of capital controls to prevent large scale capital flight, if and when its banks do open. Capital controls themselves breach EU rules, which insist upon the free movement of Capital and Labour, though their introduction was mooted last year in response to the potential capital flight from Spain, Italy and Portugal.

A lot of the coverage of events in Cyprus, and the complaints raised by other EU states are hypocritical. Cyprus is not, after all the only EU country that is host to large amounts of Russian money. The London property market has been massively inflated upon a sea of Russian money, much of it of dubious origin. The events surrounding the death of Boris Berezovsky today are just one aspect of that. But, there are lots of other property developments in London that have forced up property prices on similar grounds. For example, their have been numerous property developments that have occurred with no real intention of providing immediate shelter for anyone, but instead have been investment vehicles for foreign money, that is happy to simply allow the property to remain empty, while the owners benefit from rising prices, whilst paying no Council Tax even.

Britain is particularly hypocritical in its criticisms over the use of Cyprus as a tax haven given its role in that regard. Places like the Isle of Man, and the Channel Islands only survive, because they are even bigger tax havens than Cyprus. There can be little doubt that the same Russian money that went into Cyprus, that goes into London property, will also be tucked away in places like the Isle of Man, and the Channel Isles. These purpose built tax havens created by Britain, so that its rich can conveniently shelter their funds away from the tax man, have the benefit of paying no tax to Britain, elect their own Parliaments to keep those benefits in tact, and yet have all the benefits that British residents have to pay for, such as defence against attack, and so on.

Even less than Cyprus do these tiny British enclaves of tax exiles, have anything they can rely on other than the inflow of funds from the rich. If the Russians and other global rent seekers, decide that after Cyprus, their funds are not particularly safe anywhere in Europe, these tax havens could also see massive outflows. Given that many of the banks that operate there are themselves branches of British banks, that could have a significant effect on them. No doubt, they too, will then be looking to the British taxpayers once again to bail-them out. Its time that Britain ended the charade with these tax havens. Either they are part of the British State or they are not. They should be asked to either be governed by the British Parliament, pay British taxes and so on, or else separate themselves entirely. That would mean them having to pay for their own defence, their own health service and so on.

But, for Europe there is a much bigger problem. Much has been said about the fact that the deposits of the Cypriot banks amounted to 8 times its GDP. But, of course, Cyprus' GDP is tiny. Its less than the annual income of a large company like Apple. Apple, with its $140 billion of cash sitting on its Balance Sheet, could have bailed out Cyprus 20 times over! A country with a much bigger GDP, and with a much bigger proportion of deposits to its GDP is – Luxembourg. In 2011, according to this IMF document,

Luxembourg’s financial sector is exceptionally large and globally interconnected (Table 1). It represents about one-fourth of Luxembourg’s GDP, one-third of its tax revenues, and 12.5 percent of its labour force. It comprises the banking industry, with total assets surpassing 20 times GDP; the investment fund industry, with assets under management equivalent to around 50 times GDP; and the insurance industry, with an aggregate balance sheet of about four times GDP. Luxembourg’s international financial centre has strong
linkages with France, Germany, Italy, the Kingdom of the Netherlands, the United Kingdom, and the United States (Box 1), and is driven by private banking and investment fund activities (Figures 1 and 2). Its monetary and financial institutions (MFIs) intermediate about 16 percent of total cross-border exposures among Euro area MFIs.1”

Cyprus' GDP is $22.5 billion, whereas Luxembourg's GDP is $55 billion, which means the total exposure is that much greater in Luxembourg than in Cyprus. But, the problem for Luxembourg is that much greater, because of the interconnectivity of its financial system with that of the rest of Europe.

According to the IMF,

Luxembourg’s banks are mostly foreign-owned and net providers of liquidity to their parent groups. The banking sector accounts for about 28 percent of total financial sector assets. As of June 2010, there were 149 banks operating in Luxembourg. However,
most banks and 90 percent of total bank assets are foreign-owned. The majority of these groups operate through both subsidiaries and branches in Luxembourg, which provides flexibility to accommodate clients’ needs for financial services and to optimize funding operations with parent groups. Indeed, reflecting the liquidity generated by treasury
management for institutional customers, as well as private banking and custody activities, the local banking system is a net provider of liquidity to parent banks (“upstreaming”). Overall, interbank positions represent about half of bank assets and liabilities (compared to an average of about 28 percent in the euro area), two thirds of these interbank positions are cross-border exposures, and intra-group exposures account for about 40 percent of total bank assets.”


Luxembourg is the world’s second largest centre for investment funds after the United States. Investment funds domiciled and marketed in Luxembourg account for about 70 percent of its total financial sector assets, and about 30 percent of total assets under management by European funds. Fund sponsors mainly originate from Europe and the United States. Funds domiciled in Luxembourg are generally managed from other international financial centers. Fund shares are distributed in other European countries through an extensive use of the European passport, as well as to investors worldwide (particularly Asia). MMFs represent a fifth of Luxembourg’s investment funds and more than 25 percent of total European MMF assets under management.”

The tiny Northern Rock was the canary in the coal mine.
In other words, Luxembourg represents a much bigger threat to European, and therefore, global financial security than Cyprus ever could. But, the measures undertaken in Cyprus, in particular the expropriation of Cypriot bank funds, and the reneging on the Bank Deposit Guarantee, must now mean that this foreign money must be removing itself from Luxembourg as fast as it can! All eyes are currently on Cyprus, and from there to Spain and Italy, but the real focus should be on these other tiny economies, where contagion is likely to spread to first, but which represent a much bigger systemic threat than does Cyprus.

Many more could be asking the same question - "Where is my money?"
That is not to say that if you have money in Spain, Italy, Greece, Portugal, or Ireland you shouldn't be getting it out as soon as you can find some alternative safe home for it. A rush for the doors in Luxembourg, the Channel Isles, Isle of Man, and other small states like Malta, will crush their banks and their economies even more severely than in Cyprus, but because those banks are largely foreign owned, and tightly enmeshed in the European, and global banking system, the ramifications will send shock waves around the globe, and the first banks to get swamped by the tsunami will be in those weaker economies like Spain, Italy, Portugal, Greece and Ireland. Far better to move to higher ground well in advance of any potential flood than to wait until its lapping your ankles.

But, Britain would not escape such a situation. Nigel Farage has called on the government to give a public statement saying that the existing Bank Deposit Guarantee will not be infringed, and Government Ministers have come out to say that of course there is no chance that they would renege upon it. Well, given that the EU and IMF called for it to be scrapped in Cyprus, we now know how much such government backed guarantees are worth! In fact, of course, the British Government is already imposing such expropriation on British savers via Financial Repression.

On the one hand, money printing by the Bank of England is crushing the value of the pound, thereby pushing up inflation. On the other hand, that same money printing means that savers are able to get nothing in interest on their savings. With inflation at real levels way over 3%, and after tax interest rates at around 1%, British savers have already had around 10% of their bank deposits taken from them over the last 3 or 4 years. Those that have been encouraged to save for a lifetime in a pension fund now find that this same money printing means that the annuity they can get on their pension pot is virtually worthless. Given that the British Government has already been filching money from savers in this way, there can be little doubt that if push comes to shove, and they need to save the necks of their friends in the banks, they will take even more arbitrary action to do so.

Apparently, sellers of safes are doing good business at the moment. But, as the Foreign Office pointed out in recommending that British tourists take plenty of Euros with them to Cyprus, beware of thieves. There again deciding exactly who the thieves are now, is not that clear.

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