I am not the sharpest knife in the drawer when it comes to understanding economics. In fact, I often ignore information because I don't want to take time to understand how it all fits together or the ramifications of some of the monetary policies. I found this article which came today as the S&A Digest Master Series e-letter, easy to understand and enlightening.
What a Wicked World! By Bill Bonner, Diary of a Rogue Economist
Cyprus made a deal with its European overlords. It will crucify its savers. Deposits of over 100,000 euros will get a 40% haircut.
What does this tell us?
Governments will do whatever they need to do to stay in business.
The island nation's rescue sets precedents for the eurozone that may stick in the memory of depositors and bondholders alike as investors debate who will next fall victim to the debt crisis. Under the terms of the agreement struck yesterday in Brussels, senior Cypriot bank bondholders will take losses and uninsured depositors will be largely wiped out.
The message that stakeholders of all stripes can be coerced into helping a cash-strapped nation may make investors more skittish. The risk is that bank runs and bond market sell-offs become more likely the moment a country applies for a new rescue, said economists and academics from Nicosia to New York.
"We now have a new type of rule and everyone within the eurozone has to sit down and see what that implies for their own finances," Nobel laureate Christopher Pissarides, an advisor to the Cypriot government, told The Pulse on Bloomberg Television.
What does it mean for your finances, dear reader?
Probably nothing in the short run. The Dow didn't care about Cyprus yesterday. It went up 111 points anyway. Gold dropped back below the $1,600-per-ounce mark.
But in the long run, all governments get themselves into Cyprus-like messes. And all governments have one overriding concern: to remain in power.
Everything Falls Apart
Governments are nothing more than instruments used by insiders to take advantage of the outsiders.
Those who control the government (insiders) use its police power for their own purposes. That does not mean that they can get away with anything they want. Ultimately, they depend on the sheep-like complacence and credulity of the masses to maintain their authority.
Modern democracies, for example, hold periodic ballots to give the masses the impression they are in control. And sometimes voters "throw the bums out." Usually, though, the insiders have the voters under control.
They do so by buying the support of important groups – with tax breaks, social programs, contracts, and jobs – giving them enough to keep them in line.
But the insiders risk losing everything if they run out of money. Without money, they can't buy votes. They can't continue to divert resources to themselves. And they can't afford their phony programs and claptrap redistribution systems, either.
In short, without access to money, everything falls apart. So a government, such as Cyprus', will do anything – including stabbing its major industries in the back – to keep the cash flowing. Cyprus is a tax haven and a money center. Clipping bank accounts is ruinous for its business. But if that's what it takes to stay in business, that's what the Cypriot insiders will do.
A Tax on Savers
Is Britain different? France? America? No. They are all on the same course. And all are dominated by insiders (even though the insider group can be large and amorphous) who will stop at nothing to remain in power.
Will they try to cut their liabilities by inflating the currency? Yes. Will they impose heavy taxes to protect their credit? Yes. Will they stiff savers? Definitely. They are already doing it. Artificially low interest rates are, in effect, an unlegislated tax on savers.
How much is that tax?
Ah! At the present rate, savers get next to nothing on their deposits, and the official rate of consumer price inflation (CPI) is about 2%. This makes the effective tax rate – or the negative interest rate – about 2%.
But if you calculate the CPI the way the Bureau of Labor Statistics did when Jimmy Carter was president, the rate of consumer price increases is more like 10%. This puts the annual "tax" on savers closer to 10%.
So go ahead. Put your money in a bank. Let your interest payments accumulate. Ten years from now, you will have less than half of what you have today.
You might as well have left your money in the Bank of Cyprus…
Editor's note: As we've said many times… we think Bill's e-letter, Diary of a Rogue Economist, is a must-read. If you would like to read more of Bill's essays, you can sign up for his free e-letter here.