Cyprus paying price of eurozone hegemoney

The deposit tax debacle in Cyprus is rich in historical resonance, as well as showing that, frankly, as Leigh Phillips has suggested on EUobserver.com, Europe is run by the Three Stooges.

In 1571, at the height of the Venetian-Ottoman War, the defenders of Famagusta stood staunchly against the Ottomans. On surrendering, the leader was, despite promises of safe passage, skinned alive. Now we see that, despite promises to “do whatever it takes”, the ECB has supported skinning Cypriot deposits.

Europe seems unable to work in a sensible manner, and is devolving into a crisis junkie. Again we see a meeting at 3am making decisions that, in a fog of fatigue, may have seemed sensible but, on waking, perhaps less so. The historical ironies pile up. Cyprus is a small nation, far away.

In 1939, a hegemonic Germany called the president of the independent rump of Czechoslovakia to a meeting. Emil Hácha thought the meeting was going to be bad, but was subjected to a grilling and a haranguing that resulted in his collapse, and the death of his country.

While not suggesting that anyone is going to invade the 60% of Cyprus not under occupation, the reports of the Eurogroup meeting are nauseating. A hegemonic Germany, its allies, and the silent acquiescence of the rest of Europe, placed unreasonable demands on a small country.

A century ago, nobody really wanted a pan-European war (at least, not in 1914) and yet Europe found itself at war through a combination of poor diplomacy, overreaction to minor events, and a rigid adherence to plans laid in different times. We may yet, although I do not think so, see Cyprus leaving the euro — we have learned nothing in a century.

The genie is now out of the bottle with regard to depositors. Just this week, and under the radar, Spain introduced a deposit tax. Yes, it will be small (for now) and yes it will be paid by the banks (of course they won’t pass it onto the customers... of course) but there it is. Commerzbank have pondered a deposit tax for Italy. Deposits, including guaranteed deposits, are now in the firing line and we should all be wary and aware of that.

There are good arguments for bailing in creditors of failing banks, depositors included at some stages. What there is not a good reason for is crashing an entire economy or for destroying fundamental trust. Even with capital controls, Cyprus is in for a massive crash. =

I suspect the majority of the adjustment will come on the level of national income. Even with capital controls in place — and in passing we might wonder how exactly we can build a union built on free movement of goods, capital and people with capital controls — who now will trust Cypriot banks?

The proposal now on the table is to save guaranteed deposits and move unguaranteed (those over €100k) into a bad bank where they might end up getting only 40-50%. There will also be a sovereign solidarity fund and some gas bonds. While few will grieve for oligarchs losing money lets sit back.

Companies, charities, people with money saved prudently and legally, anyone who is in the middle of a transactions chain with cash at the moment, will also be cut. This will hit prudent Cypriots and Cypriot SMEs hard. It might well hit some oligarchs, but they will have their money stored in yachts in Monaco and Belgravian mansions, not on deposit in Laki bank. The Russians that will be hit are those middle-class savers who have done well from the last two decades and who saved that money in Cyprus to reduce the chance of expropriation. Some mafiosi will be cut, but are we now adopting collective punishment?

Cyprus has been sacrificed on bad grounds. Its banks are overly large (although not as large as some other EU countries as a percentage of GDP) and the business model was flawed. But they were holed below the waterline by Greek bond cuts and the collapse of the Greek economy.

They asked repeatedly over the last nine months for assistance, and when it came it was too late and flawed. The unwillingness of the Europeans to consider flexibility in how to deal, not with a bank, but a banking system that was imploding, was dogmatism at its worst. There are alternative plans out there that will deflate the Cypriot banking sector without crashing the economy. But none seem to satisfy what is increasingly looking like a teutonic desire for exemplary punishment “die andere zu ermutigen” (to encourage others), as it were. Every time a proposal emerges for sensible enhancement of the crisis management capacity of the eurozone, so too will some obscure German to explain why the voters in lower Thuringia won’t like it.

Germany is not the eurozone and it’s time that this was made clear by the others. Either they pull their weight, and yes, that may mean some costs somewhere down the line, or the eurozone staggers on at best with a lost generation, at worst towards a breakup that will cost Germany anyhow.

Brian Lucey is professor of finance at Trinity College Dublin