Yves here. The longer you look at the Cyprus “rescue,” the worse it looks. As you can learn from our compendium in today’s Links, the Cypriot economy is already reeling. It’s straining under the extended bank holiday, which is scheduled to end Thursday. Moreover, the impact of losses radiating from number two bank Laiki are already propagating through the island. Businesses that had accounts and will suffer losses are reducing operations or closing and firing staff. Those firms are also canceling or cutting orders with customers, who in turn close or fire staff. Officials are now warning that losses on uninsured deposits in Laiki could reach 80%. It will be more like 100% by the time the dust settles. Paul Krugman argues that Cyprus would have been better off leaving the Eurozone, so it could depreciate its currency and boost its tourism and other businesses. While its Euro-denominated debt is a big offset, Cyprus is going to continue to be subject to the austerian predilections of the Eurozone, and we can see how well that is working out in Greece. A break, though more painful initially, might have been better in the long run.
And that’s before we get to the wider ramifications. Whether Germany understands it or not, it has delivered a fatal blow to the Euro project. How long it continues is anyone’s guess, but the Balkanization of the financial system that the Eurocrats have set in motion means they won’t be able to go the US/Japan zombification route.
By Yanis Varoufakis, Professor of Economics at the University of Athens. Cross posted from his blog
There are some good features of the Cyprus deal and, of course, some bad aspects. However, its repercussions for the Eurozone as a whole are exceptionally ugly and will, I submit, mark a turning point for Europe; a point at which Europe took a nasty turn toward a set of mutually disagreeable outcomes.
• Unlike the Eurogroup’s original decision, deposit insurance for accounts up to €100 thousand will be respected. The reversal of the decision to ‘tax’ insured depositors constitutes a last minute restoration of common sense.
• Marfin-Laiki Bank’s bond and shareholders will be wiped out – as they ought to. The original Eurogroup decision to let them off the hook (especially the bond holders) while haircutting depositors (including those whose deposits were guaranteed by the state) would have been an indefensible re-ordering of a failed banking system’s creditors.
• The new deal treats different banks differently, as it ought to. The earlier Eurogroup decision imposed blanket haircuts on all accounts irrespectively of the bank’s bottom line. At least now uninsured deposits will be haircut in proportion to the size of the bank’s black hole, thus restoring a degree of private responsibility on the part of depositors viz. their choice of banker.
• By forcing losses on uninsured depositors and the banks’ bondholders, taxpayers have to bear a smaller burden of the bailout loans; and this is, ceteris paribus, a good thing.
• The Memorandum of Understanding has not been written up yet and, thus, the deal is utterly incomplete. In particular, we have no idea what degree and type of austerity will be imposed upon a collapsing social economy. Given the troika’s track record, it is almost certain that yet again they will elect an austerian package bound to crush the weaker Cypriots with ever-increasing verve.
• The effect of the complete wipe out of the foreign depositors will have a devastating effect not just on the banking sector but also on the hotel and tourist industry. As a Russian commentator noted: “Now that the Russians’ deposits have been all but confiscated, who will stay in the €500 per night five star hotel rooms on the island? Mrs Merkel?” It is highly doubtful that the troika will factor in the deflationary effects of this aspect in their fiscal consolidation and debt sustainability plans.
• The transfer of €9 billion of ELA money from winding down of Marfin-Laiki to the Bank of Cyprus – it flies in the face of basic banking resolution principles, reflecting the ECB’s Taliban-like defence of what it considers to be its ‘realm’.
• Capital controls have been touted, even though it is not clear how they will be implemented, creating a second-tier euro: Cypriot euros that are no longer exportable (nb. Imagine Vermont dollars that cannot be taken out of Vermont: a logical travesty within a currency union)
And the Extremely Ugly
Setting aside the Cyprus drama and the tragedy awaiting its people, the repercussions of the past week’s shenanigans for the Eurozone as a whole are exceptionally ugly. As I wrote the other day, in one short week Europe has managed to put in jeopardy the sacrosanct concept of state guaranteed deposit insurance (even if, in the end, they took this threat back), to bring back into question the integrity of the Euro-area and to sacrifice the European Union’s single market principle according to which capital controls are inadmissible.
However, the ugliest dimension that the new deal has introduced is the effective end of any hopes of a genuine Eurozone-wide banking union. Mr Dijsselbloem, the new Eurogroup head who seems terribly keen to be more amenable to German thinking than his predecessor, Mr Yuncker ever was, said so in no uncertain terms when rejoicing that the Cyprus deal paves the ground for new bailout arrangements such that the European Union “…will never need to even consider direct recapitalisation” of failing banks. This constitutes the death knell of both the direct recapitalisation agreement reached last in the EU’s June 2012 summit and, naturally, of any meaningful banking union. The message is thus clear: Each to his or her own! All plans to use the ESM in order to de-couple the banking from the public debt crisis are off the table.
The combination of (a) the denial of the need to effect public debt consolidation, (b) the derailing of a meaningful banking union and (c) the heavy-handedness with which Cyprus was treated over the past week, spell a new, uglier, state of affairs in Europe. Up to now, supporters of austerity and of the German approach to the Eurozone Crisis in the deficit countries (including France) have argued that we need to go along with Berlin and Frankfurt so as to inspire sufficient confidence in those who control the purse strings (in our willingness to ‘do our homework’) before they can yield to the inevitable eurobonds, to the logic of a banking union, to whatever it takes to bring about greater political and economic union.
Alas, the Cyprus deal reveals how wrong this view was: Even though peoples throughout the periphery (in Ireland, in Portugal, even in Greece and Italy) have, however grumpily, bowed their heads to severe austerity and the removal of labour protection laws, the powers that be in Berlin and Frankfurt are shifting away from unifying moves, adopting increasingly authoritarian, divisive policies that are pushing the Eurozone in precisely the opposite direction to that dictated by political and economic sustainability.
In short, while the bailing in of inane Cypriot bankers and risk-taking depositors is to be welcome, I would not be at all surprised if the Cyprus week-long episode does not register in history’s annals as a major turning point; as the moment in history when Europe moved beyond the pale.