Risks in Europe have once again flared up, this time from the tiny island of Cyprus. European Union (EU) leaders granted Cyprus a bailout over the weekend. But in an unprecedented step they required a one-time tax on checking and savings accounts held by citizens and businesses in Cyprus in return for the bailout.
As jaw-dropping at the headlines were, as usual there is more than meets the eye …
In order to understand why EU leaders made these demands, it’s important to first realize that Cyprus is a very popular tax haven for European, and particularly Russian, investors and corporations. Nearly one-third of all deposits in Cyprus are controlled by Cyprus-based, Russian-owned banks.
What’s more, last year €120 billion from Russia was “invested” in Cyprus, and nearly €130 billion was transferred from Cyprus back to Russia. This is nearly seven times Cyprus’ GDP, which is only about €17 billion. Cyprus has very lax financial control laws, and as a result many believe it is the money laundering capital of Europe (which those figures just mentioned would support).
EU politicians couldn’t ask their constituents to back another bailout, this time to tax dodgers and Russian corporations. So they were hesitant to provide the same sort of assistance that was given to Ireland, Portugal, Greece, and Spain.
|Anger in Cyprus could ripple through Europe and shake up Wall Street.|
Cyprus Is Small Potatoes, But …
This has reignited concerns about Europe, and rightly so. Over the weekend I read dozens of headlines regarding the potential fall out, and at this point it remains anyone’s guess.
As in the past, the major concern isn’t really Cyprus (its economy is smaller than Vermont’s), it’s contagion in the euro zone, which could damage Wall Street’s rally. Theoretically speaking, Spanish, Portuguese, Greek, and Irish depositors could get nervous and pull their money from local banks and deposit it in the UK or Germany, causing a bank run and potentially another financial crisis.
That’s a remote possibility. But obviously it’s a situation we have to monitor. Trying to gauge what’s happening by reading the headlines can be maddening — but luckily there is one indicator that gives instant and accurate analysis of the level of contagion in the euro zone: Spanish 10-year bond yields.
Although Spain has nothing to do with Cyprus, Spain is largely seen as being the most at-risk European country. So if contagion from Cyprus spreads, it’ll attack Spanish bonds first, as markets get more and more nervous about the need for another bailout. Ten-year Spanish yields, therefore, are the key metric to watch in the euro zone.
Monitoring those yields on a daily basis is relatively easy on sites like Bloomberg.
If you see Spanish 10-year yields start moving substantially higher (towards 6 percent) over the coming weeks, it’ll be a sure signal that contagion is spreading, and a sign to get more defensive with your investments.
Investing in the global-economic environment we live in today is always a challenge. And while you can’t predict where the next crisis will come from, it is important to know which key indicators to monitor, to tell you when the crisis is escalating.