Implications of Europe's Stumble in Cyprus

Cyprus has, for the first time, demonstrated there is in fact a limit to what northern European countries will do to preserve the illusion that Euro land can remain a cohesive and equal entity.
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Forget everything you've ever heard from the European Union policy elite about the sanctity of the Euro and forget ECB President Mario Draghi's statement last July about doing "whatever it takes" to save the Euro. This week's actions by the "Euro Elite" have clearly demonstrated that neither is true. The fault lines between northern and southern Europe -- previously obscured by well camouflaged 'Euro rhetoric' -- are as clear as day now. Bailout fatigue has reached a peak, and through their proposed 'solution' in Cyprus, northern European creditor nations have now effectively thrown southern Europe under a bus. EMU 'solidarity' has finally been revealed for what it really is -- little more than hot air.

I've been saying for some time that it was just a matter of time until the Euro creditor nations (and their taxpayers, of course) woke up and realized that they simply cannot continue to throw their money into a black hole. Cyprus has, for the first time, demonstrated there is in fact a limit to what northern European countries will do to preserve the illusion that Euro land can remain a cohesive and equal entity. Since 2008, Euro land has been anything but cohesive and equal, but the Euro policy makers have done everything in their power to preserve the notion that the EU will continue to function as it has since it was created.

Apart from creating a 'trust gap' between European creditor and debtor nations, the effective attempted expropriation of bank deposits in Cyprus, and the failure of creditor nations to imagine the broader consequences, have created a gap in confidence about the future. Until now, country after country in Europe has been bailed out while waving a flag of equality. Cyprus has demonstrated that this is no longer the case, and that circumstances, size, and perceived importance really do matter in the end.

It is not yet clear whether the fact that 42 percent of Cyprus's bank deposits are foreign-held (with 57% of this being Russian money ) was the driving force behind the decision to forcefully expropriate up to 10% of depositors' bank holdings, but if so, it is a poorly thought out proposition. No one will want to do business in Cyprus in the future, nor will anyone want to put their money in Cypriot banks going forward. The very idea that this approach to resolving the Cypriot debt crisis would be taken instead of increasing corporate or other taxes, for example, is troublesome, to say the least, and represents a watershed in stupefying Euro policy making.

Equally mystifying is the fact that the Euro closed even yesterday, implying that the markets believe that even in spite of this display of short-sightedness, Euro policy makers will 'do whatever it takes' to see the Euro and EU through. With no realistic short-term prospect of meaningful growth in Euro land this year and probably next as well, the markets themselves appear to be living in a dream world, where kicking the can down the road is gospel, and economic, fiscal and political sobriety and realism are anathema.

The truth is that Euro land has run out of steam, in virtually every sense of the word. It is tapped out of blank checks and has run out of political capital. German and other credit nation tax payers have said they have had enough, and their politicians are no longer willing to bet the farm on propping up neighboring countries who have failed to live up to their financial and budgetary obligations to the EU in the past, and are now not in a position to do so even if they wanted to.

The end game here is not pretty at all. It may soon be the case that the bank runs Europe had hoped to avoid may become common, that civil disobedience and political violence may rise as the erosion of the middle class spirals further downward, that European voters may demand a new political and economic reality, and that the whole house of cards that we today call the EU may indeed come crashing down. Euro policy makers have certainly contributed to the possibility of such an outcome by their actions to date in Cyprus. The EU and the Euro remain an experiment filled with uncertainty.

Daniel Wagner is CEO of Country Risk Solutions, a cross-border risk advisory firm based in Connecticut, and author of the book "Managing Country Risk".

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