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Brian Tora: Cyprus bailout follows path of least resistance

Brian Tora MM blog side

While I do not consider myself a particularly political person, whether spelt with a small or a large P, my involvement with my local constituency means I do have some interesting discussions with politicians from time to time. One such took place last week with a member of the European Parliament. Unsurprisingly, the topic of the Cyprus bail-out came up.

It was his opinion that final outcomes depended on the flexibility of the electorate. Angela Merkel was likely to feel that, with elections due this September, asking the German taxpayer to shell out yet again without some form of contribution from the offending (in their eyes) nation was a non-starter. And Wolfgang Schaeuble, her finance minister, had secured a deal that their electorate would accept. The opinion of the Cypriot people appeared irrelevant.

Let’s face it, the concept of the European Union is a political experiment. The trials and tribulations of the past few years surely demonstrate that the original plan is unworkable. Without closer financial and political ties, a single European currency has no future.

The fact that the shots are being called by Germany simply reflects the fact that they are the biggest nation, with the largest economy and the deepest pockets.

Make no mistake, Germany has profited hugely from the single currency. With the euro a weaker currency than the Deutschmark would have been, German exporters have benefited significantly.

Ironically, the bank lending that has brought many southern European countries (which apparently are known by the Germans as “Die Oliven”, or the olive growers) has been made possible by German bank support and has helped finance the purchase of German goods.

As for poor old Cyprus, the flood of money into this offshore banking regime created a bubble that has certainly ended in tears. Much of the surplus cash went into Greece, so Wolfgang Schaeuble’s contention that their business model was bust sounds all too reasonable. He was quick to point out that Luxembourg was not similarly exposed, but euro weakness suggests many believe we have reached a tipping point in European rescue plans.

And we have. The issue appears to be that future bailouts will see investors shouldering the bulk of the cost in place of taxpayers.

The taxpayers are the electorate, after all, with investors being mainly institutions, even if they really end up representing you and I – and we all have a vote, too.

In the case of Cyprus, bond investors, shareholders and depositors are all sharing the cost. Unfortunately, the system being applied is unlikely to be fair, so innocent bystanders will be swept up in the coming maelstrom.

But since the only alternative seems to be allowing Cyprus to go bust, with an inevitable exit from the euro, perhaps this is the best option, at least for the wider Europe.

It has become clear that the potential collateral damage from the departure of even a small economy like Cyprus demands holding it all together. We have to hope that the electorate in nations like Cyprus see it that way as well.

At least the seizure of a proportion of bank deposits is no longer being presented as a tax.

Even so, this new approach must have consequences for investors. At the very least, the attractions of a bombed-out banking sector have receded further.

We may not have the exposure in this country, but even here banks are being told to boost their reserves as a protection against future problems, which now look more, not less, likely. And the euro may continue to suffer which, ironically, will help rather than hinder. This remains a situation to watch carefully.

Brian Tora is an associate with investment managers JM Finn & Co

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