March 20, 2013 | By Scott Minerd
#Cyprus has the potential to create a dramatic setback in European crisis and could even become a "Lehman Event" for Europe!
European policymakers have opened a Pandora’s box by attempting to levy a deposit tax in Cyprus. The proposed action amounts to a haircut, or worse, a wealth confiscation by the European Union (EU). The range and magnitude of the deposit tax make this action unprecedented in this crisis, and perhaps the history of major developed economies. One potential consequence is the spread of the perception that no deposits in the European periphery are safe, even if insured.
Contagion risk of bank runs and capital flight in larger economies like Spain and Italy has been significantly elevated, and this is likely to affect global markets in a dramatic way for an extended period. Worst case scenario is that the recent developments in Cyprus may prove to be Europe’s Lehman moment. Even if they do not, though, the EU has crossed a line that should never have been crossed.
Capital flow activity will determine whether the crisis in Cyprus will spill into other peripheral countries. Since Mario Draghi promised to defend the euro in July last year, deposit flows in Greece, Ireland, Portugal, and Spain have stabilized. A failure to reach an agreement on the resolution of the Cyprus crisis by policymakers could trigger a renewed deposit outflow in peripheral nations, which could have severe consequences for the eurozone as a whole. Close monitoring of bank deposit flows in the eurozone, therefore, is warranted in the coming weeks and months.
Source: ECB, Guggenheim Investments. Data as of 12/31/2012. *Note: Data excludes deposits from monetary financial institutions and general government. Data rebased to 100 at the start of 2009.
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