With Cyprus Saved, The Eurozone Remains Intact, But Problems Remain

Cyprus is in trouble, and everyone, at least in the European Union, is arguing about it. Thankfully, European Union leaders in Brussels agreed yesterday to a new bailout package, preventing Cyprus from being the first country to leave the chronically precarious Eurozone.

The deal, which forewent the highly controversial strategy to dip into ordinary bank deposits, will see bondholders and depositors in the biggest Cypriot banks take forced losses. The Bank of Cyprus will be restructured, and the second largest, the Laiki Bank, will be split into two – a ‘good’ bank with the strongest assets and a ‘bad’ bank with the most undesirable liabilities. As frightening as it is, all this hasty financial surgery will put Cyprus into shape, qualifying it for a €10 billion bailout from the Troika: The IMF, the European Commission, and the European Central Bank.

It’s all a sad story, really, because for the thirty-plus years before the global financial crisis, the island nation has seen significant economic growth. With a GDP per capita reaching $30,000, it is one of the most prosperous countries in the Mediterranean, and is ranked 23rd in the world for quality of life. Now bank accounts are effectively frozen, and even small cash withdrawals are being controlled. Wages are being held and businesses are facing severe problems paying their suppliers. The economy has seized up. Professor Hari Tsoukas told Sky News that,”Unemployment is likely to at least double from 14% to at least 25% and possibly up to 30%. Not so long ago it was just 5%.”

Paul Murphy from FT Alphaville and Paul Krugman from The New York Times urged Cyprus to “Just pop the red pill, please,” stressing that Cyprus needs to face reality and choose between being Russia’s shady tax haven and assimilating properly into the EU, rebuilding its economy on something more sustainable than its banking sector.

Let’s put this into perspective. At one million people, the entire population of Cyprus is smaller than that of the city of Brussels. The latest figures from 2011 put the country’s nominal GDP at $24.9 billion. It barely counts for 0.2% of the total GDP of the European Union, which happens to be the largest economy in the world at $17.2 trillion. Greece might be pulling Cyprus into the depths, but, as always, the rest of the European Union will, albeit unenthusiastically, extend their hand.

There is something to be said about all the commotion Europe kicks up when one of its peripheral economies flounder. It has never given up on a member nation. The political and cultural costs of letting the European project disintegrate would be truly devastating, and the financial costs of any foreseeable Eurozone bailout package could ever outweigh them.

This is what we saw with Greece. When the crisis hit its 11.3 million citizens, it had only 3% of the Eurozone population, and an even smaller share of its GDP. Its first bailout package in 2010 consisted of €110 billion, and Ireland’s 2010 package amounted to €85 billion. With a population of 4.6 million, Ireland had an even smaller proportion of the Eurozone population. Ireland also only accounted for barely 1.5% of the Eurozone economy. The European Central Bank came to the rescue every time, with plenty of strings attached, of course.

The media, reporting from the angle of economic uncertainty, will send markets into turmoil. Investors and depositors across Europe, especially in teetering Italy and Spain, will look to Cyprus for indications on how their bailouts might fare down the road. That’s what people forget, that the European Union can’t afford not to bailout its member countries. You can count on it.

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