In recent weeks, a financial, banking-monetary and political crisis erupted on the small Mediterranean island country of Cyprus. Here I am interested in examining only one aspect of this complex crisis, the banking and monetary aspect.
The Cyprus banking crisis was largely caused by the fact that Cypriot banks invested heavily in Greek government bonds. Government bonds appeared to be a safe investment in a period of crisis-depression. But then these bonds fell sharply in value due to Greece’s partial default in 2012—the so-called “haircut” that the holders of Greek government bonds were forced to take in order to avoid a full-scale default. The Cyprus banking and financial crisis is therefore an extension of the Greek crisis. However, in Cyprus the banking crisis went one stage beyond what has occurred so far in either the U.S. or Europe.
The European Union, the European Central Bank and the IMF imposed an agreement on Cyprus that involved massive losses for the owners of large bank deposits, over 100,000 euros. Mass protests by workers in Cyprus forced the European Union and the European Central Bank to retreat from their original plans to have small depositors take losses as well.
Since the late 19th century, central banks, like the Bank of England, have gone out of their way when they wind up the affairs of failing banks to do so in ways that preserve the currency value of bank deposits for their owners. The officials charged with regulating the banks prefer instead to wipe out the stockholders and sometimes the bondholders.
Why are the central banks and other governmental regulatory organs—like the U.S. Federal Deposit Insurance Agency, which was created under the New Deal in hopes of avoiding bank runs in the United States—so eager to preserve the value of bank deposits, even at the expense of bank stockholders and bondholders?
The reason is that if the owners of deposits fear that they could lose their money, they will attempt to convert their deposits into hard cash all at once, causing a run on the banks. Under the present monetary system, “hard cash” is state-created legal-tender token money. Whenever depositors of a bank en mass attempt to convert their bank deposits into cash, the reserves of the banks are drained. Unless the “run” is quickly halted, the bank fails.
A bank facing a run in a last-ditch attempt to avoid failure calls in all loans it possibly can, sells off its assets such as government bonds in order to raise cash to meet its depositors’ demands, and halts additional loans to preserve cash. Therefore, if there is a general run on the banks, the result is a drying up of loan money capital, creating a massive contraction in demand. This causes commodities to pile up unsold in warehouses, which results in a sharp contraction of production and employment. Soaring unemployment can then lead to a severe social crisis.
This is exactly the situation that now confronts the people of Cyprus. University of Cyprus political scientist Antonis Ellinas, according to Menelaos Hadjicostis of CNBC and AP, “predicted that unemployment, currently at 15 percent, will ‘probably go through the roof’ over the next few years.” With official unemployment in Cyprus already at a Depression-level 15 percent, what will the unemployment rate be “when it goes through the roof”? Throughout the Eurozone as a whole, official unemployment now stands at 12 percent.