Analysing the latest acute episode of the euro crisis, Cyprus, on March 26th is a bit like writing a match report at halftime: you’re bound to get much of the story right, but if you try to predict the final outcome, you may very well miss – by an inch or by a mile. And as it happens, this particular crisis episode is very much at halftime: after intense negotiations and some extraordinarily clumsy backing and forthing by the Eurogroup and the Cypriot authorities, a deal has finally been brokered that involves a 10€ billion emergency loan, differential treatment of the various banks, austerity (as always), a bail-in of the holders of bonds and deposits over 100,000€ (the big novelty) and no penalty on holders of deposits under that amount (albeit after an announcement to the contrary with indelible consequences, more on which below). However, the banks in Cyprus remain closed to the public as I write, with strict restrictions on movements and withdrawals in place, and no one really knows what will happen once depositors are once again allowed to access their money. My own guess, taking into account the rationality of bank runs and the stage that has been set by the political handling of this crisis, is that the Cypriot banking system may well come crumbling down in a matter of days – and it’s anyone’s guess what that could unleash. We shall soon find out, however, so rather than play the role of Cassandra here, I shall instead dwell on some of the lessons that, even at halftime, we can already draw from the Cypriot crisis – and there are some interesting ones to be drawn.
1. It ain’t over till it’s over. By now, there have probably been a hundred different speeches claiming that the worst of the euro crisis is behind us. In some instances, this has been based on wishful thinking regarding the imaginary virtuous properties of the fiscal compact and structural reform (read: permanent austerity, labour market deregulation and privatisation). In other cases, it has been supported by the peripheral countries’ ‘return’ to the bond markets (really due to the OMT) or the reduction in their current account deficits (mostly a consequence of recession). For all this magical thinking, however, the fact of the matter remains that the eurozone as a whole is in recession and looks set to plunge even deeper; the number of countries that have had to resort to emergency loans has by now reached a handful (Greece, Portugal, Ireland, Spain and Cyprus); the social and economic situation is dire across the eurozone periphery and catastrophic in the hardest-hit countries; and the question in many people’s minds is which country will be next, with several candidates in line. So really, it’s far from over.
2. Every unhappy eurozone member is unhappy in its own way. Each troubled eurozone country has its own set of specific troubles, including the unraveling of massively bloated financial systems, busted housing bubbles, distorted specialisation patterns, loss of international competitiveness, or various combinations of the above. Make no mistake about it, however: there is one common cause underlying all of these epiphenomena, and that cause is an ultimately flawed monetary union without a sovereign to back it.
3. All creditors are equal, but some creditors are more equal than others. Throughout the Eurozone crisis, creditors (typically bondholders) have by and large been treated as sacrosanct. The argument has always been that default or suspension of debt/interest repayment is really not an option, because once you scare investors away, it’s well-nigh impossible to regain their trust. In the Portuguese case, for example, this is used to justify paying out 10 billion euros in interest on public debt in 2013 (more or less equivalent to total public spending on health), even as the economy collapses for lack of domestic demand and even as it is increasingly obvious that a default, or at least major haircut, isinevitable further down the road (public debt amounting to 120% of GDP, with an implicit average interest rate of 5%-6% and absent inflation, can never be repaid by the government of a shrinking economy). Now, what the Cyprus banking crisis has shown is that creditors are not so sacrosanct after all, and it’s alright to scare them away if most of those creditors are not financial institutions from the European core – particularly if there’s a fair chance that these creditors might be scared away from Cyprus and onto Luxembourg or the Netherlands. Indeed, taking into account how all the Cyprus-bashing as an offshore haven for Russian mobsters and oligarchs fails to recall the amount of money laundering that takes place in Luxembourg, the Isle of Man, the Netherlands – and even Germany, for that matter –, one might add that all offshore havens are equal, but some are more equal than others.
4. Once the cat is out of the bag, you probably won’t be able to catch it. The Cypriot banking crisis has been quite extraordinary not only because this is the first time that creditors are called upon to suffer losses as a pre-condition for a bail-out, but also, and especially, because the initial plan involved overriding the EU-wide insurance on deposits under 100,000€ by levying a 6,7% penalty on those deposits. This figure was subsequently reduced to 3%, and then dropped altogether, but by then the cat had already been let out of the bag: depositors in Cyprus, across the Eurozone periphery and in fact across the Eurozone as a whole now know that, under certain circumstances, the European authorities are willing to sacrifice small depositors. Now that’s what I call a sure way of triggering some major bank runs across the Eurozone. But then again, let me not play Cassandra here.