Crisis in Cyprus: The Eurocrush of a Small Country

I was actually surprised that the Euro, Europe's monetary experiment at unity survived passed September 2012. At the earlier part of 2012, the Euro was beset by problems spurned by the insolvent Greek economy, the teetering Spanish and Italian economies not to mention the sovereign rescues of Portugal, Ireland, Greece and on a partial manner, the financial lifeline extended to the Spanish banking system.

And then came Cyprus, which was on the brink of bankruptcy following the massive losses of its two largest banks, which have invested heavily, apparently without financial basis, on Greek bonds, which as we know now, are practically in the doldrums. The Cypriot banking system is roughly twice the size of the 18 billion USD Cypriot economy, which is supported by its tourist and banking sectors. Russia is reported to have massive deposits in Cyprus, attracted by its low 10% corporate tax rate, which is half that of other European countries. The troika, composed of the ECB, the IMF and the European Commission is said to have arm-twisted the Cypriots into finding a way to raise EUR 5 billion in order to receive a cash infusion of EUR 10 billion to save Cyprus' banking sector, essentially its economy. The now infamous decision to tax the deposits to achieve such that was widely derided by economists across the world and most especially by the ordinary Cypriot depositor. Such plan was eventually rejected by the Cypriot parliament. However, the damage has been done, and until now the banks in Cyprus are still closed, and when it does open sometime this week, a possible bank run will not be an impossibility. A possibility that the Cypriot government can delay by limiting daily withdrawals, but such will only delay the inevitable, the eventually collapse of trust in the Cypriot banking system.

The original bailout plan suggested by the troika was to tax all deposits, this was in turn changed to protect deposits of less than EUR 100,000 but imposing a tax of between 20-25% on larger deposits. As of now, the Cypriot government is still hammering out new strategies of coming up with the required money without stealing from depositors.

We are still waiting how the Cypriot government will actually solve this problem, and frankly, even if they come up with a moderately reasonable solution for the matter, investors the world over will have been scarred by the experience of the last two weeks and will take necessary precautions from then on. This could put a dampen on the euro as a viable currency. Indeed, some pundits have already sounded the death knell for the euro, predicting for example that before or by the year 2020, the Euro may have to be extinct. This view was articulated by none other than Jim O'Neill, a Goldman Sachs economist. O'Neill asserts that by 2020, Germany will be exporting twice as much to China as to France, essentially making the euro useless and irrelevant. Indeed, the euro was suggested by France to dampen the overwhelming power of the German economy which, incidentally, was wholly embraced by Germany as it made its exports to other eurozone countries more competitive than it otherwise would have been without the euro. It cannot be denied that if there was ever a country in Europe who has substantially benefited form the adoption of the euro, it would undoubtedly be Germany. As always, Germany continues to have export surpluses with the rest of the eurozone, making its exports virtually cheap and affordable, not to mention of good quality and craftmanship. This was because of the euro, which made Germany actually export more since the euro made German products cheap than if the Deustchmarks were used.

The euro conundrum then is - with the impending problematic financial situation that Cyprus is in - will the euro even be worth its benefits? Cyprus will be a petridish for this eventuality. Whatever happens in Cyprus will forever determine the fundamental viability and raison d'etre of the euro itself and may herald, as O'Neill predicts, an earlier than expected EUROCALYPSE.