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Cyprus: 'Monetary unions die because of bank runs'
The European authorities have increased the risk of a break-up in the euro with the raid on deposits in Cyprus, warns Paul Donovan of UBS.
Paul Donovan (pictured), senior economist at UBS, the Swiss bank, is well known for his ascerbic daily podcasts on financial markets. Here we publish the transcript of his comment on the dangers posed by the bailout of Cyprus.
Politicians fail to see the bigger picture
'The economists of UBS have been emphatic that the euro will not break up. The costs of break up are horrendous, not just economically but also socially and politically. The benefits of a breakup are few if any.
'Hitherto the euro area has lurched from crisis to crisis without increasing the risk of a break in any of its solutions.
'The terms over the bailout of Cyrpus over the weekend have increased the risk of breakup of the euro. We still do not see the euro breaking up and the increase in the risk is still very small.
'The politicians in the euro area seem not to have properly comprehended the bigger picture. Either that or there’s some kind of dramatic alternative gesture that they’re going to unveil.
'The terms of the bailout are well known but the critical issue is what is characterised officially as a wealth tax and effectively a raid on all bank deposits in Cyprus.
'The euro in a Cypriot bank is not worth the same as a euro in a German, a French or even a Greek bank right now because depending on the size of the deposit, a tax, which means a haircut of 6.75% or 9.99% will be levied.
'The very great risk is that if there is even a hint of a wobble in the banking system elsewhere in the euro area depositors will fear that similar rules will apply.
'Even a 10% chance of losing 10% of one’s bank deposit is likely to create a panic.
'While Cyprus might be characterised as a special case there have been so many special cases across the euro that political reassurances in this regard will not have much worth.
'Why would one risk holding a bank deposit in a banking system even with insurance and guarantees if one thinks the banking system is vulnerable?
'There are two critical points to emphasise.
'First, every peacetime monetary union break-up of the 20th century was characterised first by depositor flight and bank runs.
'Monetary unions die because of bank runs.
'That phrase should be whispered in to the ear of every European finance minister every day, three times a day until the fact becomes lodged in their brains.
'Second, people dislike losing money more than they like making it. That is to say the anger at being denied 100 euros one is owed is less than the anger one feels at having 100 euros one already owns subsequently taken away.
'This is why the fear of a bank deposit raid causes a disproportionate effect on investors.'
To hear today's podcast by Paul Donovan go to the UBS website and follow the link.
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