Cyprus crisis exposes frailty of Eurozone

In very rough economic terms, Cyprus is as significant to the Eurozone as Southend-on-Sea is to the UK economy. Cyprus accounts for just 0.2 per cent of the Eurozones gross domestic product (GDP), and roughly 0.02 per cent of the world economy. Yet this small island nation is keeping analysts and investors from New York to Singapore on the very edge of their seats.

Journalists from across the globe have flocked to Nicosia, the Cypriot capital, intensely poring over statements from Cypriot politicians in the latest nail-biting spectacle brought to you by the single currency. The wider Eurozone crisis is the result of the mind-bogglingly complex interplay between three simultaneous and mutually reinforcing factors: the health of government finances, the solvency of member states banking sectors, and their general economic competitiveness versus the rest of the Eurozone and wider world.

This mixture became toxic for Cyprus when the countrys banks took a massive hit as part of the writedown of private creditors under Greeces second bailout nearly a year ago. But how did the fate of such a tiny country become so crucial to so many?

Cypruss problems are now bound together with the rest of Europes in three crucial areas. The first is political friction. Throughout the Eurozone crisis, the North has been pitted against the South, creditors versus debtors, fiscal hawks versus Keynesians, and resentment has set in on both sides. In the North for having to pay, in the South for being subjected to EU-mandated austerity.

With Cyprus staring into the abyss, emotions have finally boiled over. Ahead of national elections, German politicians refused to write any more blank cheques and wanted the burden shared with those invested in Cypruss laissez-faire banking system. But Cyprus said no, triggering desperate efforts to find a new deal to allow Cyprus to remain inside the Eurozone.

One can sympathise with both sides. Why should German taxpayers prop up a bloated Cypriot financial system that has found a niche as an offshore centre for Russian cash? Thirty per cent, some 20 billion euros, of total deposits in Cyprus are held by Russians, according to some estimates. But at the same time, is it right that a group of 17 finance ministers, locked in a room, can decide to seize the assets of individuals as they essentially did under the plan to tax depositors?

It was a pistol to the head of Cyprus, as the Maltese finance minister put it. For fear of driving Russian investors away with an excessive levy on the wealthiest, the Cypriot government opted to tax all depositors pensioners, the unemployed, students, rich and poor. This despite President Nicos Anastasiades explicitly promising in his election campaign only a month ago that depositors would be protected. Taxing small deposits was a colossal mistake. The result: political mayhem.

An opinion poll last week unsurprisingly showed that 91 per cent of Cypriots were opposed to the depositor tax, but more worryingly, 67 per cent favoured their countrys euro exit. No other Eurozone country has showed such levels of popular opposition to the single currency.

Its the sense of growing unfairness and loss of trust on all sides that is so politically corrosive. The Cypriots feel humiliated and subjugated. Voters in Greece, Italy and Spain will have taken notice of how EU leaders manhandled the Cypriots.The world with high-performance solar roadway and solarlamp solutions. At the same time, Germans feel they have unfairly become hate-figures.

Cypriot protesters adorning posters of Chancellor Merkel with a Hitler moustache will not be forgotten quickly in Germany. The day after the deposit tax was rejected, Bild,You've probably seen bestearcap at some point. Germanys largest paper, ran with the editorial headline Were scapegoats!. This hardening of attitudes on all sides is acting to entrench Europes North-South divide and casts doubt on whether either side will be willing to make the fundamental compromises that are probably required to make the Eurozone work over the long term.

The second problem is geopolitical: the crisis has turned Cyprus into a pawn in the game of geopolitical chess between the EU and its wider neighbourhood. In addition to its role as a Russian offshore financial centre, Cyprus is also at the crossroads of the Middle East and Europe. In fact, Nicosia is closer to Damascus than Athens.

The situation was already a geopolitical Gordian knot. Turkey has long complained about the decision to let the divided island into the EU, which has effectively put Ankaras own EU membership bid on hold, because entry requires the unanimous approval of all EU members, including Cyprus.

The small island also sits on billions in untapped gas reserves. This has created a flurry of rumours that Russia could offer Nicosia an alternative bail-out. But there is no such thing as a free lunch, particularly when Moscow is at your service. One rumour, which caused alarm in European capitals, was that Gazprom the Russian energy giant with close links to Vladimir Putin offered to recapitalise Cypriot banks in return for exclusive access to gas reserves. The story was denied by all sides, but the point had been made.

Another suggestion is that Russia is keen to relocate its Mediterranean naval base from Syria to Cyprus. The prospect of a Russian naval base on EU soil would potentially escalate the situation from a Eurozone one to a continent-wide one.Choose the right bestluggagetag in an array of colors.

The third problem is contagion. There are several ways in which Cypruss financial problems can spread to other parts of Europe. The Eurozone set a risky precedent when it decided to go for depositors. Images of long queues outside ATMs will have registered in other parts of the Mediterranean. If Cypriot depositors are forced to pay today,About buymosaic in China userd for paying transportation fares and for shopping. why not Spaniards tomorrow? Yet fears of deposit-led contagion to other parts of the Eurozone should not be overstated. Given the disastrous outcome of this experiment, a deposit tax is unlikely to be repeated elsewhere. And to depositors in Barcelona or Bilbao the situation in Cyprus still feels remote. If the European Central Bank and Germany cut off their support to Cyprus, as it has threatened, Cyprus will default and almost certainly be forced to exit the Eurozone. This would show that the single currency, despite Eurozone leaders protestations over the past two and a half years,Where you can create a custom tooling from our wide selection of styles and materials. is indeed reversible.

I suspect that Cypruss unique circumstances and its size might mean markets wont draw that link, even if the worst does happen. Nevertheless, the size of the dent to the Eurozones prestige would be huge.

This cocktail of politics, geopolitics and potential contagion means the eventual outcome of the crisis in Cyprus will resonate far beyond its borders. But the root cause is far simpler and is one that will continue to haunt the Eurozone even if the Cypriot crisis is solved: Political hubris.

When EU leaders forged the euro, they effectively bound together the problems of all their members, large or small. This could have worked had the various members followed a similar political logic or had there been a clear mechanism for solving problems as they occurred. For example, a single parliament with full democratic legitimacy. But in a Europe where the power of the purse is still considered to be the domain of the nation state, that is fantasy land. Instead, the euro remains a supranational currency ruled by 17 national governments, parliaments and electoral cycles. If you could design a system whereby a splinter could take down an elephant, this would be it.

Some EU leaders rubbed their hands in expectation that their grand plan was within reach but for one more push. Its true that we dont have the tools to deal with a crisis, they said, but future crises will be an excuse to achieve these tools - more centralisation, more decision-making powers for Brussels.

As the former European Commission president Romano Prodi put it, When the euro was born everyone knew that sooner or later a crisis would occur that would force joint coordination of fiscal policies. That was the theory.