I was reviewing World War I history with my son yesterday.

The global-scale conflict started with the assassination of Archduke Franz Ferdinand, heir to the Austro-Hungarian throne, on June 28, 1914.  This event set in motion a series of diplomatic incidents that led inexorably to the outbreak of war in Europe within a few weeks.

Then I began contemplating the possible repercussions of the Cyprus bank bailout, and asked my San Diego compatriot and economics expert W.C. Varones for his opinion on its impact on the world economy.  He says:

The new deal in Cyprus is fairer to insured depositors, but just having floated the idea of deposit confiscation will do permanent damage to faith in the financial system.  Cyprus will be a wreck when the banks open and Societe Generale, a major French bank, is already calling for a depression there.  And anyone with money over the insured limit in Spain, Greece, Portugal, or Italy would be crazy not to pull it out now.  Heck, I’d be nervous about money even under the insured limit.

To underscore his thoughts, Varones offers a piece from the Economist with the following quote from Jeroen Dijsselbloem, the Dutch finance minister and head of the “Eurogroup” of euro-zone finance ministers:

A rescue programme agreed for Cyprus on Monday represents a new template for resolving euro zone banking problems and other countries may have to restructure their banking sectors…

This new template will surely have rich Spaniards, wealthy Italians, and other EU citizens considering their options, in terms of moving money in excess of deposit guarantee limits elsewhere.

The reminded me of a scene from a “South Park” episode that seems most apt.

In fact, Tyler Durden of Zero hedge notes that Cyprus serves as a reminder that a bank deposit is not risk-free (hat-tip Ed Driscoll).

  1. A deposit in a bank is not a riskless form of saving.We may not see eye to eye with the FT’s Martin Wolf on many aspects of modern economics and central banking in particular, but he described banks well last week:
  2. Banks are not vaults. They are thinly capitalised asset managers that make a promise– to return depositors’ money on demand and at par– that cannot always be kept without the assistance of a solvent state.”
  3. When states become insolvent, the piper must ultimately be paid. Fatal, embarrassing insolvency is not a problem that can be perpetually or painlessly deferred.

Cyprus matters..because the inept handling of its crisis last week threw one facet of modern banking into sharp relief: if a deposit guarantee is seen to be fraudulent or sufficiently fragile to be easily smashed by politicians, then confidence in banks, and in unbacked paper currency itself, will be vulnerable to an unpredictable run.

Frankly, a run on Cypriot banks seems inevitable, which is why they are now closed until Thursday  — giving the regular people time to embrace the levy and understand all the awesome goodness in the new bailout plan.

What is the impact here? As Professor Jacobson noted, the American stock markets fell in response.  And I would like to note that Varones was one of the first to opine that our government’s manipulation of interest rates has led to something resembling confiscation in this country already.

Finally, the Russians cannot be pleased that the accounts of their citizens were trimmed more severely by this solution.  The following statement from Dimitry Afanasiev, chairman of a law firm in Moscow, brings to mind another famous global war:

“These people thought their savings were safe in the EU and now they are caught in the pincers of the German blitzkrieg, with Cyprus unable and Russia unwilling to protect them,” he said.

I suspect, like the1914 assassination in Sarajevo, its going to take the world a few weeks to process the consequences of the Cyprus plans.