Assume that ordinary Cypriots had to pay some sort of tax on their savings, even those with less than €100,000 in the bank. If I were a Cypriot facing this situation, how would I react?
I would first pull out as much cash as possible, as quickly as possible. It makes no sense to endure a tax, if you can avoid it, after all. And as they say, you don't want to be the last sucker out when there's a bank run, which brings me to the next point.
That savers are being taxed, should be enough warning of what's to come at the end of a bank run. Even if the Central Bank of Cyprus guaranteed your bank deposits up to a certain level, the fact of the matter is, the CBC cannot say "no" to the European Central Bank and the IMF, if push comes to shove and the CBC runs out of money: That guarantee may be unilaterally come with a further haircut, so to speak. I'm not taking any risk of additional haircuts: Even after getting my savings taxed, I'm going to pull out the rest of what remains.
Forget putting my money into any Eurozone bank; they're all at risk of having their deposits taxed if things get worse and the troika get desperate. But I don't particularly like the idea of keeping all my money in the mattress.
Any earnings I get will be invested into either foreign bonds such as TIPS, or I will lend it out directly to people who wish to borrow from me. Just think about it for a moment: If I invest in TIPS and the US grows while the rest of the EU collapses or remains stagnant, I'm actually benefitting like crazy, even as my country -- Cyprus -- is failing! If I find out that there is an off-the-books bank that I can get in on, that pays even minimal interest, I'm in. In other words, shadow banking system.
Granted, these actions will further erode the financial condition of Cyprus, but I'm not going to allow the EU (especially that Merkel) to determine my livelihood. As such, if it results in Cyprus leaving the Euro currency behind, that's fine by me. The UK seems to do okay (aside from its nutty, self-induced austerity policies) by being half in and half out of the EU, so why can't Cyprus? Knowing that my money is already stashed in overseas investments, I have less fear of the transition away from the Euro currency, after all.
End of thought experiment. Conclusion: taxing savers is counter-productive.
Update: Well there we go. Yet again there is proof that we have an abundance of very intelligent, creative people in this world (and if only we had wide open discussions to vet the best ideas!). Felix Salmon covers this brilliant solution: instead of taxing savings, the money needed to secure a bailout comes from pushing deposits over €100,000 into long-term bonds, then roll bonds about to mature, back into these same long-term bonds. It prevents a bank run but also avoids the need to pay out bondholders in the near-term.
It's an eloquent solution -- I love it!
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