After Cyprus, eurozone risks transmission failure and running out of road

?????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????The Eurogroup’s decision on Friday to impose a one-off tax on depositors in Cyprus may mark a turning point in the euro crisis. Only, the single currency’s decision makers might soon realize that in taking this particular turn, they also ran out of road.

Under pressure from several members of the eurozone – Germany in particular, if reports are accurate – the new Nicosia government agreed that deposits above 100,000 euros would be taxed 9.9 percent and those under 100,000 at a rate of 6.75 percent.

This is an unprecedented decision for a eurozone country. It is also one whose potential consequences reach much further than an island in the eastern Mediterranean. It threatens to cause the transmission system between the economic and financial sectors on one side and the political and social on the other to seize up. Without this, the euro cannot be propelled forward. It cannot function.

The choice to tax depositors has prompted an intense economic debate about whether it was the correct policy or not. Both sides have put forward points worth considering. Those arguing against the decision have pointed, for instance, to the risk of contagion in other eurozone countries that are facing economic problems. Those who defend the Eurogroup’s stance say depositors in Cyprus earned high interest, which gave them profits over the last few years and carried a bigger risk.

Setting these arguments aside, the eurozone ignores at its peril the fact that these decisions do not happen in an economic or financial vacuum. They have political and social consequences that cannot be ignored if the single currency is to have a future. One need only look at the political changes that have taken place in Greece, Ireland, Portugal, Spain, Italy and elsewhere to realize that the euro area is running out of leaders who have the backing needed to implement the decisions being taken.

Cypriot President Nicos Anastasiades, elected just last month, has to clarify to his people why he is adopting a bank deposit tax when he told voters a few weeks ago that he was absolutely opposed to it. Even before Anastasiades had returned from Brussels, his political opponents were demanding a referendum on the deposit tax. Some were even calling for new elections or an exit from the euro.

Anastasiades also has to explain to Cypriots why small-time depositors have to pay a similar levy to the one some eurozone countries supposedly demanded so alleged Russian oligarchs would be forced to pay for bailing out the island’s banking system. Furthermore, he has to inform them why the Cypriot government’s pledge to guarantee deposits up to 100,000 euros – supposedly even in the most extreme circumstances – is not even worth the paper it was written on.

The implications for people’s trust in their government and financial system are obvious. It would be remiss to think that this wariness will be contained just to Cyprus. While many will be watching next week for signs of financial contagion from the Cypriot decision in other parts of the eurozone, with Spaniards or Italians possibly withdrawing savings from their banks, there is a more insidious infection that could spread.

Cypriots will be given equity in their banks in return for the tax but what value will this have when they no longer have faith in the banking system? Cypriots will be told that the deposit tax will stave off further measures but they only have to look to Greece or Portugal to see that promises of no more taxes or cuts have little value. They will be told that there was no alternative but then they will hear about pressure from other single currency members and concerns about the upcoming German elections.

And, all the time, citizens in other troubled eurozone countries will watch and grow warier. They will interpret the policies advocated by the stronger members as punitive for the weaker. They will consider the hypocrisy of leaders who cry foul about money laundering in Cyprus but turn a blind eye if it is happening in Lichtenstein, Switzerland, Luxembourg, the City of London or anywhere else in Europe. They will realize that their government’s promises carry no value when measured against the ideas, motives or obsessions of the single currency’s big players.

This is the point at which the political and social sectors will experience a complete disconnect from the economic and financial. Restoring the connection will be an immense task.

Then, these same citizens will begin to ask themselves where their interests lie, what’s in the euro for them and whether other options would be better. And, as they are mulling over these thoughts, they will look to other parts of Europe and see people like them but also analysts and policy makers wondering what all the fuss is about. They will hear others who have not had to suffer any hardship or financial losses wonder why there is such a negative reaction to wages being slashed, taxes being hiked or deposits being taxed.

This is the point at which the links within the eurozone will begin to pop apart, when citizens will turn to Beppe Grillo-style solutions, to nationalists, extremists or to anyone who promises a different path.

This is the point at which the vehicle stops functioning and the road ends.

Nick Malkoutzis

11 responses to “After Cyprus, eurozone risks transmission failure and running out of road

  1. Nikos Patiniotakis

    It is really interesting the decision of the Eurozone. It seems that will bring the discussion on the efficiency of Euro 2 to 3 years back. Supposedly we should be in the moment that the European leaders should be reflecting on the learnings of austerity measures taken in Irland, Greece, Portugal and in less extend Italy but instead they delivered a decision that will spark greater problems. Is it because they had in mind the particularities of Cyprus economy and the fact that indeed foreign capitals (Russian) are in the island? Even if so how they calculate the collateral damage? A couple of weeks ago in the epicenter of the discussion was how to drive growth and how to fight unemployment. It ll be worth to hear how a measure like that will help in this direction.

  2. @Nikos
    Well, 4 years into the crisis we are still waiting for even ONE measure that will drive growth. That applies to every debtor country. As yet there has not been one measure produced internally and not one measure from the EU. Apart from slashing wages to less than half of EU poverty standards to “compete” for “investment” from international corporations…but even they don’t seem interested.

    • Ha! You can forget about growth: the issue here is the risk that the Troika is prepared to take with the entire Euro banking system. Following the typical “moralising” that has come out of hypocritical northern Europe in recent years, the Germans (and allegedly the IMF) could not support the large deposits held by Russian citizens in Cypriot banks — “for political reasons”. This puts the internal politics of Germany (although Christ only knows why the IMF supported this stupidity) above the interests of the eurozone and implicitly of the future of Europe.

      Another possible explanation — of a more devious nature — is that this is an intentional non-rescue of Cyprus, which will lead to near-collapse of the country. Given the prospects of massive energy reserves of the small island, this would then allow Germany to manipulate the energy exploitation for their own commercial gain. (This is similar to the US reason for invading Iraq.)

      In either case, it shows conclusively that Germany is unfit to govern Europe. It is time for European politicians to grow either balls or backbone (preferably both) and put an end to the nonsense. If this means ending the current regime of the European Union, then so be it. We cannot carry on with the financial terrorism that is destroying people’s lives and countries’ economies. The end may be in sight anyway, if there is a consequent run on the banks in Spain and other southern countries: the euro cannot survive a collapse of banks across the region.

  3. everygoodboydeservesfavour

    Totally agree with you xenos, yet another ham-fisted approach by the Euroburghers to impose their will, this time for moral reasons supposedly, since Russian (dirty) Euros are not European (dirty) Euros hiding in Switzerland, London et al. It really is all such a squalid game. Surely, a number of countries must now serious question the value of the Eurozone. The UK ,Sweden and Denmark seem to get by outside the group OK. Italy could leave and not unduly suffer, with its large population and diversified economy. That then would surely be the catalyst for others to follow, return to their national currencies, devalue and rebuild their battered economies. Even default/restructure (over a much longer term), similar to Iceland. The Euro has now definitely been proved to have failed in its implementation, if not in idea. I forsee many years of austerity and penury on this current path.

    • The paradox for Greece is that autonomous exit from the euro would clearly be a disaster; Greece would just be perceived as a catastrophic mess, unsuitable for investment and with a government/state that could not be trusted with anything. On the other hand, a collapse of the entire eurozone would be the least costly way to reinvent the drachma (and all the dubious money-printing, moderate inflation and delayed bill payments associated with it). At least, with a collapse of the entire region’s currency, Greece would not be singled out as either irresponsible or a risky place for FDI.

  4. everygoodboydeservesfavour

    Xenos, you’re right of course. So where will flashpoint occur first, Italy or Spain? (The others are too small and insignificant to matter.)

    • The Spanish banks are the most vulnerable, so this is the most likely flashpoint. Of course, it is quite possible that nothing will happen: we shall see.

      • I cannot forsee a collapse of the Euro it would affect the world economy, the currency would be supported until a program was set in place. The worst scenario would be the wealthy EU countries band together with Germany forming one currency and leave the rest of us in the Euro. I see above you consider that in this way Greece would benefit as it wouldn’t be singled out as risky. This is one point I can’t agree with you on, Greece has always and will always be risky. Why invest in Greece when there will be Italy, Spain, etc., far more stable and property investment would definitely put Spain ahead. The poorer ex satelite countries that are more inclined to accept low standards of living would, encourage investment which frankly Greece has never considered. Greece is too divided politically and has too many extremists, again a problem throughout her history.

  5. There are larger issues at play in Cyprus.

    After partitiion, the foreign presence of the English was joined by UN peacekeepers and NATO/ US (Israel). It gradually morphed into spy central looking east, with bases. With the Lebanese war, lebanese fortunes and businesses moved offshore to Cyprus and this began Cyprus’ development into a offshore banking and business centre. The forced migration south of newly penniless cypriot greeks from the north were gradually absorbed into the cypriot economy through these new developments. The russians arrived during the Putin era, and much of the russian money is government, especially KGB funds, probably invested in Cyprus’ core political business, this time looking west. Meanwhile Cyprus became a popular tourist and retirement destination.

    The discovery of hydrocarbons in Cypriot waters tipped the balance. Which of course the EU is eager to secure – while keeping out GAZPROM.

    So Cyprus is indeed a “special case” but Russian black money is a side issue. The EU played its hand last Friday, and Putin / GAZPROM are allegedly making a counter offer this weekend. It will be interesting to see which way the Cypriots jump.

  6. Eleni the EU was insisting months ago that Russia contributed to the bail out as like you rightly say they have apart from black money in off shore accounts, legal deposits from Russia. I’m sure if the EU was so eager to secure they would have been more lenient, and one wonders if this wasn’t a ploy by the EU to push Russia into the equation. There does seem to be conflicting reports, some suggest that the EU favoured only deposits over the 100,000 should have deductions exchanged for bank guarantees, as Cypriots feared loss of their big investors if too high deductions in that sector were agreed. The problem there in Cyprus is that many consider it better to tax now rather than borrow more funds which will make it difficult to repay. Personally I think the low bank deposits under 100,000 should not have been taxed, but no interest should have been paid for the year. Higher taxes on deposits above 100,000. Total bank interest paid over five years was approx 25% they are not losing their capital and they will receive bonds.The risk is of course that they will move their funds, however, Russians have invested heavily in Cyprus and as you rightly say GAZPROM is more than interested in the deposits there. I still think Cypriots should be careful as they are a minnow in the EU, we hear from the media that the exit of Cyprus from the EUro would damage the Euro, if so it would be short term, but Cypriots would suffer.

  7. interesting article in the WSJ:
    Is Bitter Medicine for Cyprus a Cure for the Euro Zone?


    The euro zone’s decision to force Cyprus to impose losses on bank depositors as a condition of its €10 billion ($13 billion) bailout has inevitably provoked a furious reaction in some quarters.

    There have been claims it marks a turning point in the crisis, the moment at which the euro zone implicitly confirmed that a euro in a peripheral euro-zone bank account isn’t worth the same as a euro in a core country bank account. And that this paves the way for the currency bloc’s eventual collapse.

    But could the Cypriot bailout mark a turning point of a different sort: the moment when the euro area took a decisive step toward its ultimate recovery?

    It is certainly plausible.

    The deal marks a victory for the German approach to tackling the euro crisis. By breaking the final taboo and inflicting losses on depositors—even those with less than €100,000 who believed they were protected by a state guarantee—the euro zone has sent a powerful signal.

    The message is that the burden of tackling unsustainable debts will fall on a country’s own creditors rather than be passed on to other members.

    Of course, that is tough on those who must bear the losses. But the euro zone’s previous approach of trying to shield creditors from losses via endless bailouts was making the region’s debt problems worse. Meanwhile, the austerity needed to service those debts was crushing any hopes of a recovery.

    A crisis response based on restructuring debts—whether those of governments or banks—is ultimately more likely to restore sovereign and bank balance sheets to a sustainable position. Indeed, it goes some way toward breaking the toxic link between sovereigns and banks that lies at the heart of the crisis.

    At least that is the theory. The risk is that the threat of private-sector debt restructurings will lead to contagion in the form of bank runs and the loss of market access for weak sovereigns and banks. But these risks may be overstated.

    After all, the European Central Bank is now a credible backstop to solvent governments and sovereigns. Any contagion to insolvent borrowers should accelerate the process of debt restructurings, so that they are swiftly restored to a sustainable footing.

    Citigroup C +0.22% reckons there is a great deal of euro-zone debt that will eventually need to be restructured, although it is unlikely that further raids on uninsured deposits will be necessary. Cyprus was unique in that it didn’t have significant quantities of sovereign and bank debt that could be easily restructured.

    Of course, further debt restructuring means further market volatility.

    A common bank resolution mechanism and a related fund would help create a more orderly process.

    But for investors willing to look through the immediate uncertainty, the Cyprus bailout may mark the moment when the euro zone finally decided to stop adding to its debt burden and find ways to cut the debt instead.

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