All eyes are on the Cypriot parliament. Will they, or won’t they approve the deal that takes a cut from all deposits, including small ones, in order to get the bail-out and prevent disorderly default of Laiki Bank (followed by politically unspeakable other mess).
Signs of panic emerge, and commentators saying this threatens confidence in the EU-wide banking system, retirement systems, etc.
It will undoubtedly lead to volatility. Telling people they can’t trust the system (in this case the deposit guarantees) is dangerous. But it is a system that fed them for decades at the expense of the next generation: Not telling them would be far worse.
It’s a bit like not telling a patient he needs a heart bypass. But how did we contract heart disease in the first place? Europe has been at the forefront of developing several high arts of fiscal politics:
(1) sustaining a government spending at or around 50% of GDP. (Note, this implies a total tax burden of around the same level, give or take net new borrowing. Keynes, is often, conveniently, and falsely blamed for this, for he agreed in a personal letter with Colin Clark that 25% was the maximum tolerable level before all kinds of negative consequences and inefficiencies would be set in motion).
(2) creating various forms of “fiscal illusion”, a concept pioneered by Puviani in 1903. Essentially, it says government isn’t trying to optimize what citizens pay or get. It’s trying to optimize what citizens think they pay and think they get.
(3) spending above one’s means at the expense of future generations. We are not just talking about the difference between spending and tax take which makes up net new borrowing. Far worse are the unfunded future promises, which make even the national debt something of a beautifully crafted fiscal illusion. In the European Union, the National Centre for Policy Analysis estimates the total-liabilities-to-GDP ratio at 434%, far in excess of debt-to-GDP ratios. The difference are the un-funded future promises.
(4) Having fewer and fewer children while still restricting immigration. According to the UN population division, the European Union would need about 40x more immigration than it has in order to keep the dependency ratio (and therefore the fiscal balance) intact
The ECB, having triggered the current tussle with its correct refusal to provide further emergency liquidity to Laiki, has done us a favour, for it has triggered a process where certain facts become more clearly visible for all:
- Someone has to pay for the un-funded spending in the past and the un-funded promises of the future. It can be creditors (through default or restructuring), it can be depositors (through emergency measures like in Cyprus), or both (through inflation and taxes).
- People will have to save for their own first layer of social safety net. The public safety net will either shrink in an orderly fashion, or disappear in a disorderly one, and will in no case cover more than an absolute minimum. The numbers don’t allow it.
- Money isn’t a safe store of value right now. It’s a promise by the government, and promises can be broken.
Compare the “shock” that is being administered to Cypriot savers to the shock of being told you need to have open-heart surgery: You will forever curse the day you were told, but what is the alternative to being told? To continue to live under the fiscal illusion that the economic heart disease isn’t there.
Fiscal and social promises are only as good as the money that backs them. The above-mentioned trends in Europe, government-promises just aren’t “money-good” any more. They can’t be. And since defaults on explicit government debt will continue to be avoided at all costs, it has to be other promises that will be broken: Un-funded social programs, health care programs, and the value of fiat money.
It is questionable that the strategy in Cyprus was the right one, but the underlying message should be heeded anyway.
Pity the Cypriots for having found out this weekend. It’s never nice when you are told. The best we can do is realize that a similar epiphany will hit us all rather soon. And adjust your lifestyle and your investment asset allocation accordingly.