Your World Today: Cyprus bailout plan renews euro zone fears
by Timothy J.A. Passmore
Mar 22, 2013 | 437 views | 0 0 comments | 4 4 recommendations | email to a friend | print
At one point in time, few would have entertained the idea that a small Mediterranean island with a population of little more than 1 million could affect the global economic landscape. But as the glaring weaknesses of Europe’s single currency have been exposed in the last several years, it now comes as little shock that Cyprus could throw the entire currency enterprise back into a firestorm of controversy and crisis.

Last week, Cyprus became the latest in a growing list of euro zone countries forced to request a bailout to prevent complete economic collapse. With its mounting experience in rescuing failing economies, one might expect the EU to have learned to handle such situations more effectively. Certainly, having rescued countries like Spain and Portugal, a plan to stabilize the comparatively small economy of Cyprus should come with little difficulty.

Yet this assumption has been debunked with the plan proposed this week, reminding the world of the ever-present ineptitude of the European Union in dealing with its seemingly endless problems. In particular, the Cyprus plan has caused significant controversy with its initial plan to collect money from banks in a one-time levy placed on citizens’ savings. Needless to say, the Cypriot people are not too happy.

Cyprus had a burgeoning economy in the years prior to the 2008 global crisis, but since then things have taken a turn for the worse. In particular, Cyprus made a large number of loans to Greece (which has since seen its own financial collapse), a hard hit to holders of Greek bonds.

Facing its own impending crisis, Cyprus’s banks have been weakened, the nation’s credit ratings downgraded and its ability to borrow money from other countries virtually erased.

Unlike Greece, Cyprus does not owe such huge debts to other countries, and subsequently doesn’t have a large pool of bond holders from whom they can fund part of the 10 billion euro bailout. Instead, the Cypriot finance ministry and euro zone leaders suggested the levy on bank holdings.

The initial plan proposed an across-the-board levy of 6.75 percent on all citizens’ savings. This was naturally met with uproar by Cypriots, who inevitably went to withdraw their savings from the banks in order to avoid the levy, a sight not seen since the 2007 bank run of Northern Rock in the UK. When banks were then closed until further notice, the citizens of Cyprus took to the streets in protest.

Realizing that punishing citizens was perhaps not the best-conceived plan, the finance ministry revised the terms of the bailout to exclude those with savings below 20,000 euros, yet even this plan did not appeal to the parliament which on Tuesday voted overwhelmingly to squash the proposal.

The Cypriot government now finds itself in a worrying position, requiring an alternative plan quickly. Global stocks have already tumbled at the news of the failed bailout plan, and other options are proving limited.

Default on its debt would be the worst-case scenario, almost certainly leading to removal from the single currency. The reason this is a possibility is that the government is unable to bail out its own banks (as some countries have done), and Cyprus would lose emergency funding from the European Central Bank without a bailout deal. Failing to come to an agreement would therefore leave Cyprus with little option other than massive default.

On the one hand, Cyprus would create much fewer shock waves than other countries by doing this, with its relatively small economy and smaller debt obligations. However, no country has left the euro yet, as close as some have come, and with no precedent or clear mechanism for doing so, the entire stability of the euro, and with it the global economy, would be very vulnerable.

Alternatively, Cyprus may eventually agree to a levy after all, which will not appease the citizens, and will certainly raise fears in other euro countries of a similar plan should Cyprus require a bailout. Runs on banks across Europe will create panic and disorder of incalculable proportions.

There may yet be a surprise role for Russia in all of this. Russia tends to keep its nose out of most things European, yet there are huge amounts of Russian money held in accounts in Cypriot banks. Some EU countries (Germany in particular), would happily see the Russian millionaires take a hit instead of European bond holders, a sentiment many believe pushed for the levy in the first place.

In order to protect its own citizens’ savings and investments, it is quite possible the Russian government will offer Cyprus a loan with more favorable terms than the EU bailout. A Russian rescue would certainly be the latest bizarre twist in the euro crisis that has persisted for too long.

I have long argued that the euro was an ill-conceived plan from its inception. The Cyprus bailout may be the latest instance of “rearranging the deck chairs on the Titanic,” with failure all but inevitable given the woes of recent years.