Cyprus's Big Bluff

The Cyprus banking crisis presents, in microcosm, everything that is perverse about the European leaders’ response to the continuing financial collapse. And bravo to the Cypriot Parliament for rejecting the EU’s insane demand to condition a bank bailout on a large tax on small depositors.

If this crisis threatens to spread to other nations, it’s a good object lesson. Here is the punch line of this column: It's time for Europe’s small nations, who are getting slammed into permanent depression by the arrogance of Berlin and Brussels, to think about abandoning the euro. At least the threat would strengthen their bargaining position, and if they actually quit the euro, the result could hardly be worse than their permanent sentence to debtors’ prison. More on that in a moment.

The back story: Cyprus, with just over a million people, is not a poor country. Its per capita GDP is actually above the European Union average. Cyprus has only used the euro since 2008.

Once Cyprus was in the Eurozone, like the banks of Ireland and Iceland before them, the two main Cypriot banks got cute. They offered above-market interest rates to suck in lots of deposits, mainly, as it turned out, from Russians. Then, to pay the high interest, they made speculative investments. You can guess the rest.

When the Cyprus government turned to the EU and the European Central Bank for a bailout, the idiots in charge came up with a scheme requiring ordinary depositors to pay for the sins of the bankers. (Imagine if the Fed had done that when it bailed out Wall Street.)

Though the details are much more complex in the austerity schemes imposed on Greece, Spain, Portugal, and Ireland, the basic story is the same. The big guys get greedy and the little guys pay the price. This time, the double standard was even more naked than usual.

The Cyprus government went along, but after massive protests by ordinary citizens, the Parliament failed to approve the tax. So, what now?

The Cypriots tried to do a deal with the Russians, offering to sell them rights of offshore natural gas deposits, in exchange for a bailout by Moscow. But that doesn’t seem to be going forward. So now, the Cypriots, inadvertently, have the power of the weak. If they refuse to cave, their European masters may soften the terms.

Or not. The German government, in particular, is dug in. Fiscal sinners must pay dearly. For now, there’s a bank holiday, withdrawals are strictly limited, and the economy is grinding to a halt.

Interestingly, however, the ECB has not suspended advances to Cypriot banks, which would cause a total collapse with wider repercussions. So what’s really occurring is a high-stakes game of chicken.

Enough is enough, I’d say. These policies of no-mercy have pushed all of Europe into prolonged depression. Unemployment rates in Greece and Spain are upwards of 25 percent. Among the young, they approach 50 percent.

Britain, which doesn’t use the Euro, volunteered for austerity. The more they cut spending and raise taxes, the more the economy shrinks and the worse the ratio of debt to GDP gets—because GDP keeps shrinking as a consequence of the austerity.

This is not rocket science, folks—austerity doesn’t work.

But, austerity elsewhere is good for Germany, because it pulls in capital and leaves Germany with the Continent’s lowest interest rates, and because the euro is an undervalued currency where Germany is concerned, which is good for German exports.

It’s time for the peripheral European countries—Greece, Spain, Portugal, Ireland, and now Cyprus—to push back. Only a unified threat to quit the euro might get the attention of Brussels and Berlin.

What would happen if one or more countries actually reverted to their own currencies? Financial elites around the world say that would be catastrophic, but for Europe’s small nations, the catastrophe is now.

If Cyprus or Greece or Spain or Portugal (or better yet, all of them en bloc) decided to quit the euro and revert to drachmas and pesetas, they would need to block bank accounts, impose currency and capital controls, and default on some of all of their foreign debts, which would be re-denominated in the new local currency. There would be lawsuits up the gazork, but the IMF and ECB would have to step in to limit the broader damage even if they disapproved.

It would not be pretty, but it has been done before. In fact, in the past century, some 69 countries have abandoned currencies. It happened after the break-up of the Soviet Union. It happened after World War II. In fact, withdrawal of the Hitler-era Reichsmark in favor of the post 1948 Deutschmark was accompanied by massive debt relief for Germany. (How about that, Ms. Merkel?)

After a relative brief period of worse economic pain, these small nations would emerge with far greater freedom of action over their own economic destiny. They would have currencies that were a lot cheaper internationally, which would be good for exports and for tourism. In the short run, they would have to finance most of their capital needs internally, but foreign capital would soon return. It always does—especially once economies start growing again. And freed from artificial austerity burdens, these nations could resume growth.

The Germans, of course, would have fits. Because Germany enjoys the greatest advantage from the mismanaged euro and would suffer a relative loss if the Eurozone shrank and some debts to German banks were written off. But what are the Germans going to do—invade? Happily, the allies after World War II insisted on a very small German army.

Even if these nations did not end up actually quitting the euro, a credible threat might get the elite in charge to soften the terms of austerity.

In his poem, “I Sing of Olaf Glad and Big,” an ode to an abused conscientious objector who refused to be cowed by psychological torture and beatings, E.E. Cummings wrote:

Olaf (upon what were once knees)

does almost ceaselessly repeat

"there is some shit I will not eat."

That’s not a bad credo for the small, peripheral, suffering nations of Europe.

Comments

I think the EU and IMF wanted Cyprus to honor the deposit insurance and not charge bank depositors on the first 100,000 euros. They wanted Cyprus to pay much of the bailout without borrowing money, this would lead to a levy of over 15% on the Russian tax evaders that use Cyprus. Clearly the government officials in Cyprus prefer those Russians to their own people. The EU only wanted Cyprus to pay the cost without borrowing money, with a tax of some sort.

Hi Bob
Nice to see The American Prospect still in business - some time ago I read that there were problems with that.

To "Cyprus's Big Bluff" I agree with you on "austerity is not the answer", I take some issue though with several items:
- "But what are the Germans going to do—invade? Happily, the allies after World War II insisted on a very small German army."
When is this bashing ever going end ??? Its been 58 years since Germany was destroyed, thanks to a crazy dictator who took power this month 70 years ago. You want my grandchildren - or yours - to keep blaming Germans for all the shit in Europe. And you know quite well which country has been doing the "invading" recently - and good for Germany that it didn't follow that shit! Re rearming Germany, that was done at the insistence of the US/NATO. We have downsized in a major way since then.

In my mind and that of many people much more knowledgeable than I, the real issue is that we have a single currency and a single market but not a single policy. That of course allowed the Cypriots to balloon their banks which are basically beyond help. The fact that everyone now is playing hardball on the scale of things is just a minor issue.
Another basic problem is that everyone who signed up for the Euro agreed to certain terms: 3% max deficit, and a limit on total debt. Some countries - Greece and others - cheated on that to get into the Euro zone. Would you kick Mississippi or any of the other low ranking states out of the dollar zone ? I don't think so.

Austerity is needed in some places, these are just some of the outrageous examples:
- a specially created bloated Greek bureaucracy to sell Olympic Airlines planes - after years of NOT trying - in the end for scrap.
- Sicily has no forests but more government foresters than the rest of Italy combined.

The major share of the EU structure funds did go to these med countries and they benefited from that a great deal, their current problems are then results of their governments not reigning in the voracious appetites of almost all segments of their respective societies.

Another point: Germany's exports are good, not because of currency issues but because we make products that people and businesses want, how else can one explain that despite the Euro going from a low of about 80 US Cents for one Euro to now about 1.30 US Dollar for one Euro and Germany's exports to outside the Euro Zone still grew every year.

We do need a spending program to invest in infra structure in the Med Euro countries, but with better controls on the bloated governments, a program that will allow their people to be more productive and to have a chance in this global world.

Still Love You

Ek

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