Cyprus and European amateurs
As is now typical for Eurozone crises, an agreement on Cyprus was finally reached in the early hours of Monday – just hours before a self-imposed deadline. The agreement drastically shrinks the Cypriot banking sector and imposes capital controls on the Mediterranean island and may well induce a deep and prolonged recession.
Moreover, even though the initial decision ten days ago to tax all bank deposits was vetoed by the Cypriot parliament, the issue leaves a nasty aftertaste. Despite being scratched from the final agreement, it could have far-reaching consequences.
Debating the initial decision with many colleagues in research and the Chief Investment Office, I often heard the argument that the original tax levy on the deposits of the Cypriot banks “was morally the right thing to do.” Cyprus has an overblown banking sector (roughly six times its GDP). Moreover, according to media reports, money of questionable Russian origin is deposited there. So why should German or Dutch taxpayers bail out such a “grubby” offshore financial center?
Not being an expert on ethics, I don’t want to enter this debate. It might indeed have been the right decision from a moral standpoint. But it was also economically not well thought through and legally questionable. It reopened the Pandora’s box of possible bank runs in the European periphery, which Europe worked all of 2012 to contain, going so far last September as to announce its intention to construct a banking union. In fact on Monday 18 March after the original decision, both Chancellor Angela Merkel and President François Hollande had to make official statements to reassure their respective populations that this wouldn’t happen in Germany or France.
Nonetheless, the French regional newspaper Sud Ouest published a poll a week later showing that over 40% of the French thought their savings were not safe anymore. Over the next couple of months the so-called TARGET2 balance, mirroring the capital flows (flights) between the European periphery and Northern Europe will have to be monitored again closely.
The original decision was also legally questionable because it stereotyped Russian money and by extension all the money in Cypriot banks as inevitably of dubious origin. With no court decision or even official enquiry this looks completely arbitrary. Angering and at the same time allowing Russia to push some pawns in the Eastern Mediterranean at a time when its closest regional ally, Syria, is destabilized by a civil war could be another unintended consequence of the crisis.
One can explain the initial summit decision with the understanding that there will be general elections in Germany this fall, before which German Chancellor Merkel cannot show any signs of perceived weakness. This doesn’t bode well for the next two summits scheduled in May and June.