The dramatic recent events in Cyprus have highlighted the fundamental weakness
in the European banking system and the extreme fragility of fractional reserve
banking. Cypriot banks invested heavily in Greek sovereign debt, and last
summer's Greek debt restructuring resulted in losses equivalent to more than
25 percent of Cyprus' GDP. These banks then took their bad investments to
the government, demanding a bailout from an already beleaguered Cypriot treasury.
The government of Cyprus then turned to the European Union (EU) for a bailout.
The terms insisted upon by the troika (European Commission, European Central
Bank, International Monetary Fund) before funding the bailout were nothing
short of highway robbery. While bank depositors have traditionally been protected
in the event of bankruptcy or liquidation, the troika insisted that all bank
depositors pay a tax of between 6.75 and 10 percent of their total deposits
to help fund the bailout.
While one can sympathize with EU taxpayers not wanting to fund yet another
bailout of a poorly-managed banking system, forcing the Cypriot people to
pay for the foolish risks taken by their government and bankers is also criminal.
In their desire to punish a "tax haven" catering supposedly to Russian oligarchs,
the EU elites ensured that ordinary citizens would suffer just as much as
foreign depositors. Imagine the reaction if in September 2008, the US government
had financed its $700 billion bank bailout by directly looting American taxpayers'
bank accounts!
While the Cypriot parliament rejected that first proposal, they will have
no say in the final proposal delivered by the EU and IMF: deposits over 100,000
euros are likely to see losses of at least 40 percent and possibly as much
as 80 percent. "Temporary" capital controls that were supposed to last for
days will now last at least a month and might remain in effect for years.
Especially affected have been the elderly, who were unable to use ATMs or
to transfer money electronically. Despite the fact that ATMs severely limited
the size of withdrawals during the two week-long bank closure, reports indicated
that account holders who had access to Cypriot bank branches in London and
Athens were able to withdraw most of their funds, leading to speculation that
there would be no money available when banks finally opened up again. In other
words, the supposed Russian oligarch money may well be already gone.
Remember that under a fractional reserve banking system only a small percentage
of deposits is kept on hand for dispersal to depositors. The rest of the money
is loaned out. Not only are many of the loans made by these banks going bad,
but the reserve requirement in Euro-system countries is only one percent!
If just one euro out of every hundred is withdrawn from banks, the bank reserves
would be completely exhausted and the whole system would collapse. Is it any
wonder, then, that the EU fears a major bank run and has shipped billions
of euros to Cyprus?
The elites in the EU and IMF failed to learn their lesson from the popular
backlash to these tax proposals, and have openly talked about using Cyprus
as a template for future bank bailouts. This raises the prospect of raids
on bank accounts, pension funds, and any investments the government can get
its hands on. In other words, no one's money is safe in any financial institution
in Europe. Bank runs are now a certainty in future crises, as the people realize
that they do not really own the money in their accounts. How long before bureaucrat
and banker try that here?
Unfortunately, all of this is the predictable result of a fiat paper money
system combined with fractional reserve banking. When governments and banks
collude to monopolize the monetary system so that they can create money out
of thin air, the result is a business cycle that wreaks havoc on the economy.
Pyramiding more and more loans on top of a tiny base of money will create
an economic house of cards just waiting to collapse. The situation in Cyprus
should be both a lesson and a warning to the United States. We need to end
the Federal Reserve, stay away from propping up the euro, and return to a
sound monetary system.