Broken Cyprus Bows to Its New Eurozone Masters
”For a small, open economy like Cyprus, euro adoption provides protection from international financial turmoil.”
European Central Bank President Jean-Claude Trichet, welcoming Cyprus into the European single currency in 2008.
Cyprus has agreed to a ten billion euro ($13bn) deal with eurozone and IMF leaders to bail out its banks, and to prevent the Mediterranean island nation from exiting the European single currency. However, Cypriots can be forgiven for not taking to the streets to wave flags and honk their car horns. They’re finding out just what the “protection” afforded by the euro looks like, and it’s more akin to the kind offered by ski mask-wearing heavies in certain parts of New Jersey than the financial security Monsieur Trichet promised.
Under the terms of the deal, the country’s second-largest bank will be shut down, and its largest bank will be restructured. Depositors with more than €100,000 ($130,000) in either bank will face losses in the vicinity of 40 percent. In a bid to prevent a run on the island’s other banks and to stop money from fleeing the country, capital controls have been imposed -- guaranteeing that there will still be capital flight once the restrictions are lifted.
The effect on the Cypriot economy will be catastrophic. Businesses serving the banking sector will begin to fail immediately, and others will follow. Property values will plummet and unemployment will soar as the country is plunged into recession.
We’ve been here before of course, with Greece (twice), Spain, Portugal, and Ireland. And compared to those crises, the Cyprus installment of the eurozone drama has been brief, and the amounts of money involved relatively small. But while Cyprus should not, on the face of it, pose much of a threat to the euro project -- it accounts for less than one third of one percent of the eurozone economy -- the manner in which the crisis has been handled may make this the most damaging episode yet in the single currency’s turbulent history.
In past bailouts, the inevitable “haircut” was imposed mostly on bank bondholders, but because most of the assets of Cypriot banks are in the form of deposits, it was decided that depositors would have to take a substantial hit. An initial bailout proposal caused uproar last week when it emerged that insured depositors would face losses; under EU law, bank deposits up to €100,000 are guaranteed, but because that guarantee only applies in the event of a bank failure and the banks had not at that point failed, the savings were considered fair game.
That deal was rejected by the Cypriot parliament, and while the savings of insured depositors will not be raided under the terms of the new agreement, an alarming precedent has been set with the imposition of a levy on uninsured deposits. Eurozone leaders have let it be known that from now on they will target the savings of private individuals rather than inflicting losses solely on institutional bondholders such as other banks and pension funds.
Investors in Greece, Spain, and elsewhere have been thinking that if the eurozone can do this to savers in Cyprus, they can do it to them when their country needs another bailout (“when” is more likely than “if”). And that fear was brewing even before the chairman of the eurozone declared that the Cyprus deal would indeed be a "template" for future bailouts. As the euro and European markets fell, officials frantically attempted to row back from his statement amid fears of bank runs across southern Europe.
The imposition of capital controls also sets a dangerous precedent for the eurozone, and will further spur savers to start moving their money out of banks in Europe’s weakest economies. Far from marking an end to the eurozone crisis, the harsh treatment meted out to Cyprus runs the risk of reigniting it on an unprecedented scale.
A third new precedent is the seizing of money from large numbers of investors from outside the eurozone -- specifically Russians, who are thought to have around €25 billion ($32 billion) in Cypriot banks. Wealthy Russians have been stashing their money in Cyprus since the breakup of the Soviet Union, attracted by high interest rates, low taxes, and light regulation.
In a bid to justify the raid on deposits, eurozone officials and politicians in Germany, which as the eurozone’s most powerful economy effectively underwrites the single currency, have been muttering about Cyprus being a tax haven and dropping hints about money laundering. Yet such accusations are moot given that large parts of its banking sector are about to be wiped out. And whatever Cypriot banks have been up to, they were doing it back in 2004 when the country was allowed to join the European Union, and when it joined the euro four years later. Political considerations trumped economic ones then, as they always have in the drive towards “ever-closer union”; several countries have been admitted to the euro despite failing to meet the requisite economic benchmarks.
It’s understandable that Germany, which is ultimately on the hook for the bailouts provided to Cyprus and other countries, is reluctant to be seen as bailing out Russian tycoons, particularly with elections due in September. But the roughly six billion euros ($7.5bn) that Germany is insisting must come from depositors is pocket change next to the hundreds of billions spent on bailing out other countries, and an awfully small sum over which to risk the entire eurozone.
The euro was the pet project of Europe's rich northern countries, in particular Germany and France, with the poorer southern nations brought along for the ride. The north needed markets for its exports, and the south was seduced by the promise of cheap and apparently limitless credit guaranteed by its economic betters, which fueled both property booms and growing entitlement states. Underpinning the whole enterprise was the dream of a European superstate to rival the U.S.
When things started to go wrong following the credit crunch of 2008, the southern countries found themselves trapped, unable to devalue their way back to competitiveness while they remained in the euro, but unwilling to leave for fear of the consequences. One after another, they've been forced to submit to punishing austerity and economic stagnation imposed by their new masters: EU and eurozone bureaucrats, and northern politicians.
But a revolt is brewing. Tapping into a growing sense that ordinary people have been betrayed by a political class that's both incompetent and out of touch, anti-euro and populist parties have been gaining ground across the south, most recently in the Italian elections. If just one country finds the courage to leave the euro, there could be a stampede for the exit. (A “euroskeptic” party has even been launched in Germany, albeit with a very different motive: its supporters are tired of picking up the tab for what they view as profligate southerners.)
The future of the eurozone is far from guaranteed, and the inept and cynical way in which its political and financial elites have dealt with Cyprus may yet have an impact on the continent out of proportion to its tiny size.