The real trouble with Cyprus

During the 1998 Asian currency crisis, a desperate finance minister whose currency had come under sudden attack in the world markets called the IMF for advice. But it was after 5pm Washington time and the IMF officials had gone home.  The security guard told him he would have to make up his own mind.

The IMF may not have been there when they were needed them - at least outside Washington office hours - - but they were always able to help some of the most unpleasant third world dictators, including Mobutu, Moi, Samuel Doe, the Argentine junta, Marcos and Pinochet - all regarded as useful to the USA in the Cold War. Of the $26 billion of foreign aid flowing to the Philippine government under his regime, Ferdinand Marcos managed to salt away $10 billion into secret foreign accounts.  Worse, the whole of the $4.4 billion bailout to Russia in 1998 disappeared within days, siphoned out of the economy through secret offshore bank accounts in Cyprus.

Here is part of the problem of tax havens.  The drug lords, black marketeers and mafiosi use the offshore centres to launder their ill-gotten gains. Cyprus alone handles about $2.5 billion a year from the Russian black economy. 

The trouble with the Cyprus bail-out is that the authorities know that Cyprus is a tax haven.  Tax havens are an invention of the British government incidentally – though Cyprus is one of the less reputable ones that takes the hot money and sends it to the more reputable ones like the Bahamas, which then send it to Jersey and thence to the City of London, and so on .... 

That is an explanation for the unprecedented demand for all those with bank accounts to pay ten per cent: they know some of the money is hot.

But two aspects of this whole business rather stick in the throat.

First, if finance ministers are finally concerned about tax havens, why on earth do they not tackle these problems more directly – close the loopholes for the tax avoiders and evaders rather than hitting everyone with the bill (as if we don’t all pay for tax havens in one way or another)?

Second, the great tragedy of tax havens is that they ruin the people who live there.  Jersey has more than 600 banks but nobody can afford property there.  Their agriculture is in a state of collapse because nobody can afford to work there if they are not in financial services. 

This is because of the version of a Casino Effect (I coined the term).  Gambling money tends to drive out everything else, because it is so profitable.  In this same way, the City of London is slowly impoverishing the UK – but so slowly that we don’t notice.  In tax havens, the same process happens much faster.

And so it is that the people of Cyprus have to suffer not once but over and over again.

Tax haven status is tolerated because of lobbying by the tiny elite that benefit, but also because governments – and the UK government particularly – believe that small island states are not economically viable.

The idea of bottom-up economics, where small economies and neighbourhoods can drag themselves up using their own resources, is only just emerging.  Because it is a slower but more effective means of economic development, it is a key idea in the battle against tax havens and money-laundering.

Find out more in my book Money Matters.