“Now don’t mistake me. I'm not advising cruelty or brutality with no
purpose. My point is that cruelty with
purpose is no cruelty – it’s efficiency.
Then a man will never disobey once he’s watched his mate’s backbone laid
bare”. (Mutiny on the Bounty, 1962)
Until last week, Cyprus’travails looked like those
of El Tite Socarras, who had been put out of the smuggling business by an
overactive Colombian Navy. By Sunday,
Captain Bligh of the Royal Navy came to mind.
The weekend negotiations with the European
authorities and the IMF were bruising for Cyprus, and its economic future is
uncertain. That goes for the eurozone too.
On the positive side, the debt restructuring focused
on the banks in trouble, mainly Laiki, and reverted to financial orthodoxy:
insured deposits would be protected, recapitalization (of Bank of Cyprus) would
involve a debt-to-equity process where losses would be assumed by shareholders,
bondholders and uninsured depositors, in that order. Laiki would be split into a good bank and a
bad bank, with the former being merged into Bank of Cyprus.
Less positive was the assumption of the ECB funding
of Laiki by BOC and the lack of estimates as to the extent of the losses
uninsured depositors would suffer in both banks. Laiki’s will likely lose most of their money
while BOC’s may lose anywhere between 20% and 50%.
Very negative was the evisceration of the Cypriot
economy. Post crisis, its main industry,
offshore banking and financial services, has been destroyed. And it is pretty clear that this was done on
purpose. Yes, the Cypriot banking sector
was hypertrophied, but isn’t Luxembourg in the same situation? Or Switzerland? And while it was prudent to reduce its size,
did this have to be achieved overnight?
While it was legal to force uninsured depositors to take losses
after junior creditors and shareholders have been wiped out, in the case of Cyprus it smacked of retribution, and of example setting
Captain Bligh-style. After all, while
the Cyprus restructuring rolled on, Spain announced that the recapitalization
of Bankia - which called for wiping out common shareholders, haircuts of 43% for holders of preferred shares and of 15%-40%
for subordinated bondholders - would leave all
depositors unscathed.
Indeed, the public flogging of Cyprus at the mast was
so harsh that no country which might fear a similar fate in the future raised
its voice in defense of the island. The
eurozone lives for another day, but the atmosphere on board ship is now more Bounty than Club Med.
Understandably, no country wants to quit the euro
now for fear of suffering a rapid financial meltdown. But what is the price for continued
membership?
The elaborate Euro charter, institutional design and numerous
Brussels staff have been superseded by German directives; that is
understandable since Germany is asked to bankroll everybody else, but is that
really the European project that members had in mind? For that matter, did Germany expect to be
besieged with demands for money by its fellow Europeans when it co-founded the
eurozone?
With no way to devalue their currencies, Eurozone
members experiencing financial difficulties are forced to rely solely on cost
cuts, which are politically difficult to enact and socially destabilizing. A more palatable solution would be a reliance
on some currency devaluation, some inflation and some fiscal/cost adjustment. This has been the way most countries,
from the Latin Americans in the 1980s to Russia in the 1990s, overcame their crises.
Mired in economic stagnation and hampered by a
banking system which remains undercapitalized, Europe is gradually tackling its
debt problems but is doing so on an ad hoc basis and in an increasingly
destabilizing way: massive financial resources of the Union are being used up, and distressed
countries are required to make adjustments which are deeper and faster than
would otherwise be advisable.
Finally, it remains to be seen if smaller countries
can attain and maintain the same degree of productivity as the best in class while abiding by
the same EU rules: could Singapore be what it is if it were a eurozone and EU member?
For the time being, Cyprus is in the eurozone, but I
wonder: longer term, wouldn’t it be better off leaving it, reverting to the
lira and setting up an off-shore dollar banking zone?
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