What the panic in Cyprus means for your money

Having rejected a controversial bail-out plan that involved taxing savers, it’s back to the drawing board for Cyprus. John Stepek looks at what this means for the markets, and for your money.

The nice thing about being a member of the European Union is that you always get a second chance.

If you vote one way, and the Europeans don't like it, they'll tell you; they'll give you another chance to vote the right' way.

Of course, this does rather undermine local democracy somewhat. But that's all part of the price of being one big happy European family. Didn't you realise that?

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Anyway, now it's the turn of Cyprus to go back to the drawing board. Having ditched its original plan to tax savings to secure a bail-out, the Cypriots have been told to come up with a new deal by Monday.

Or else

How Cyprus ended up here

A quick recap of the Cyprus story so far.

Cyprus needs a bail-out. It needs €17bn. But the troika' (Europe's big bail-out committee) is only willing to lend it €10bn, because they know Cyprus could never pay back the whole €17bn. Even €10bn will be a push, but we can at least pretend it's feasible.

So Cyprus needed to raise the extra from somewhere else fast. That's where the bright idea of taxing bank deposits came from. Everyone with less than €100,000 in the bank was set to lose 6.75%. More than that would be taxed at 9.9%.

Great idea. Except of course that it tore up pretty much every unwritten rule about bank deposit security, and was an open invitation to bank runs across the eurozone.

As the queues formed in front of the cash machines, Cypriot politicians had a rapid rethink. They rejected the bail-out deal out of hand, without a single pro-vote.

That left everyone floundering around. The Russians don't seem willing to help much, despite the Kremlin's outrage and all the money they're said to have on the island. And if the Russians aren't willing to pay, that leaves two options: Cyprus leaves the eurozone, or the bail-out deal is renegotiated.

No one really wants Cyprus to leave the eurozone. As Die Zelt editor Josef Joffe notes in the FT this morning, Cyprus itself is just "a tiny sliver of the EU economy".

But given the backdrop, if it leaves the euro now, you could see "millions of panicked savers start a run on their banks from Lisbon to Athens". That in turn would unleash "a broad-scale attack by the markets. Auf Wiedersehen, euro."

Cypriot citizens also realise full well that returning to the Cypriot pound would be a lot more damaging to their savings than even a 10% haircut'. Any new currency would plunge in value against the euro - that might be good for the tourist industry, but the resulting social unrest probably wouldn't be.

So quitting the euro isn't an easy option. But as far as Germany is concerned, neither is giving Cyprus a no-strings attached handout. If it does that, everyone from Greece to Italy will want one. As Joffe puts it, Germany will be left "bleeding for the greater good forever".

So it's back to the drawing board for Cyprus. The European Central Bank (ECB) has threatened - once again - to pull the plug on Cyprus's banks on Monday if it doesn't come up with a plan.

At the moment, ECB emergency funding is the only thing keeping those banks open. So a deposit tax would be the least of savers' worries if that happens.

What this means for markets

So what's likely to happen? And what does it all mean for your money?

In terms of the actual outcome, this is too close to call. It's very hard to work out exactly what's going on in policymakers' minds.

A cynic might argue that this is just a cleverly-played, high-stakes negotiating game. You present everyone involved - the public, the troika, other politicians - with an utterly outrageous opening deal. And it doesn't get much more outrageous than saying you're going to take money that people thought was insured against loss.

As a result, whatever you end up with seems moderate by comparison. Chastened by the prospect of how bad things could have been, everyone involved walks away poorer, but feeling they've been let off the hook somehow.

But given the risks involved, it's hard to believe this was deliberate. Regardless of what deal is reached, serious damage has been done to the banking system.

Why would anyone in Cyprus keep a significant amount of money in the bank now? They've seen how vulnerable the system is. When the banks re-open, a lot of people will be keen to get all their money out. Even if some sort of control is imposed to prevent that - as seems likely - it could get very messy.

It also damages faith in the rest of the European system, even at the margins. For example, if I'm travelling in Europe, I rarely bother getting hold of euros before I go. I just assume I'll be able to get some from a cash machine when I land in the airport. I'll not be doing that for the foreseeable future.

And for anyone assuming that a deal will get done because it has' to: it's worth remembering that there was a point last year when almost all of us thought that Greece was going to walk out of the euro.

If Europe wants a test case to see just how to cope with a euro exit, Cyprus is the place to do it.

The bottom line: stick to your plan

So far, markets are taking this in their stride. The euro has fallen, but no one is pricing in another Lehman Brothers. If Cyprus does leave the euro, you can expect more panic. But even then, I'd bet there are a lot of people ready to buy the dips' on this one.

Obviously, I wouldn't hold any big short-term spread bets over the weekend, as you never know what's going to happen. These things tend to go right to the deadline.

But I wouldn't make any big changes to your investment plans on the basis of Cyprus. Stick to what you're doing: drip-feeding money into cheap stocks, diversifying out of sterling, and keeping a bit of cash to hand to capitalise on any opportunities.

The more important aspect of Cyprus is what it says about what happens when governments and banking systems go bust. In short, no one's money is safe, and there are no risk-free havens.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.