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The ECB is threatening the nuclear option in Cyprus. What then?


 

PARIS – What happens if Cyprus’ banks collapse? If its government goes broke? If it leaves the euro?

The European Union, the International Monetary Fund, the European Central Bank and the country’s leaders are trying to find a deal to secure a 10 billion euro ($13 billion) loan for Cyprus and stave off a failure of its banking system. The Cypriot parliament has already rejected one deal, which would have taxed all bank deposits in the country. The ECB has now put a ticking timer on this drama by declaring it would cut off emergency support to Cyprus’ banks on Monday if no deal is found.

That’s the worst case.

Even if a deal is found, the messy decision-making over the past week will have shaken confidence in Cyprus and the euro currency union itself. Here’s what’s at stake.

CYPRUS

The consequences for Cyprus itself could be so rough that many analysts think some kind of deal will be struck. If not:

The only thing keeping Cyprus’ banks afloat right now are short-term loans from the Cypriot central bank with the blessing of the ECB. The banks need this special funding because they can’t borrow normally. They don’t have good enough collateral to receive normal loans from the ECB, and others are reluctant to lend to them for fear of not getting their money back. The emergency lending program isn’t publicly declared, but analysts say the Cypriot central bank has already handed out around 9 billion euros ($11.6 billion).

If the ECB pulls the plug, the Cypriot banks would probably not be able to open their doors, or would very quickly collapse because they wouldn’t be able to satisfy the likely rush of customers pulling their money out. Then the banking system enters a sort of twilight zone — with the banks closed, there can be no real run on the banks, but salaries won’t be paid, mortgage payments won’t go through, electricity bills will linger.

After the banks, the next logical step is that the government goes bankrupt, either as it tries to shore up the banking system or because it is on the hook for insuring all deposits under 100,000 euros ($130,000).

The resulting disaster cannot be predicted clearly — and shouldn’t be underestimated. The road could lead to an utter breakdown not just of the economy, but of the country’s social fabric. Some economists say that as euros become scarce, Cyprus may have to issue some sort of IOUs for people to buy basic necessities. That could lead to hyperinflation, in which the prices of goods double and triple regularly. The country might have to prevent cash from leaving its borders. People may turn to barter. Commerce will slow or in grind to a halt.

The country could leave the euro, and no one really knows what happens then. It’s such a terrifying possibility for Cyprus and Europe, that some analysts think the EU will step in at some point to prevent it from happening, even if most of the damage to Cyprus is already done.

It’s such a terrifying possibility for Cyprus and Europe that some analysts think the EU will step in at some point to prevent it from happening, even if most of the damage to Cyprus is already done.

“The euro area doesn’t want a failed state in Cyprus,” said Jacob Kirkegaard, senior fellow at the Peterson Institute for International Economics in Washington. “Once the disaster happens, I would actually imagine that the euro area would be relatively lenient with respect to engaging in a new program.”

Even if Cyprus avoids the nightmare scenario, it is facing a long road back. The measures it ends up enacting to secure the loan could hurt growth — especially as it may have to raise taxes, doing away with one of the things that was most attractive for businesses setting up in Cyprus. And the mere threat of confiscating a part of bank deposits could ruin faith in Cyprus as a centre of international banking — destroying its largest industry.

Some argue that investors who put their money in Cyprus have been paid for this kind of risk — through high interest rates and low tax rates. Even if they aren’t scared away, any deal with international lenders will demand that the country severely shrink its banking sector anyway.

EUROZONE

Cyprus’ economy is a tiny fraction of the eurozone’s — just 0.2 per cent — but its banking sector is heavily connected to Greece and any collapse could have a disastrous effect on that already stricken nation. European officials would have to move quickly to insulate Greece. How well Greece is protected will largely determine how much impact a Cypriot banking system collapse will affect the eurozone.

That’s if Cyprus manages to stay in the euro. If it leaves, the consequences are hard to predict. Some think it could raise fears other countries, such as Greece, might leave. That would cause those countries’ borrowing costs on the bond markets to rise, making it harder for them to finance deficits and potentially requiring them to seek bailouts. If fears worsened, investors and savers could pull their money out of these countries, threatening their banking sectors.

For now, the Cyprus crisis is not spreading market panic to other indebted countries such as Italy or Spain. That’s because the ECB has pledged to do “whatever it takes” to save the euro, including buying the government bonds of troubled countries to keep their borrowing rates down. The backstop has done much to contain the eurozone crisis since last summer.

But even if Cyprus finds a deal by Monday, the impact of its crisis may be felt across Europe for a while to come. The mere fact that Cyprus considered confiscating bank deposits below the insured limit of 100,000 euros may have unsettled account holders in other financially troubled eurozone countries. The question is, whether depositors will be quicker to run for the ATM in a future crisis now that the insurance promise has been revealed as less than sacrosanct.

RUSSIA

The possibility that bank deposits might be taxed has particularly angered Russia, whose citizens hold as much as 20 billion euros ($26 billion) in Cypriot banks. Russian President Vladimir Putin called it “unjust, unprofessional and dangerous.” Still, middle-class Russians don’t have their money in Cyprus, so the effects will be limited to a class that can largely afford to shoulder the burden. They may move their money elsewhere, but Russian officials do not expect them to bring the money back home.

On the other hand, Russian banks, which have about $40 billion worth of loans to Cyprus-based companies on their books, stand to lose significant amounts if Cyprus’ banking system breaks down and money isn’t allowed to leave the country. The cost to could rise to almost 2 per cent of Russia’s gross domestic product.

GLOBAL MARKETS

For the moment, global markets appear largely unconcerned about Cyprus.

This could be because Cyprus is tiny. It could be because they are confident an 11th hour deal is assured. Or that there’s so much cash floating around markets after several rounds of monetary easing by the U.S. Federal Reserve and other central banks that investors are impervious to a potential banking collapse in just one small country.

Since Cyprus has a highly connected, international banking system, if it collapses, companies around the world will suffer. They will lose their savings and fail to be paid on outstanding contracts. But the entire banking sector is relatively small, so the direct effects from a collapse in Cyprus shouldn’t be dramatic around the world.

The global impact depends largely on the effect on how the eurozone is affected. If European leaders contain the damage to Cyprus, the world probably shrugs. If Cyprus exits the euro or its banking collapse roils Greece or Spanish savers start demanding their money back, then the world will sit up and take notice. Taken as a whole, the EU is the world’s largest economy. When it falters, everyone does.

___

McHugh contributed from Frankfurt, Germany. Associated Press writer Nataliya Vasilyeva contributed from Moscow.


 
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The ECB is threatening the nuclear option in Cyprus. What then?

  1. Cyprus will be another fine example in the long list of failed communist societies. The two main parties battle each other for who can go as radically left-wing as possible, with absolutely no thought to finance or economics. Almost every economic sector is dominated by the government. What isn’t is British owned, and the only reason any business is viable on the island is because the taxes are moronically low. So the communists borrow more money to finance their lavish spending promises. And then they panic when they realize people actually expect them to be able to pay back that money at some point.

    It’s theater of the absurd. They’ll simply be absorbed as a part of Greece in the future, crisis will be averted, and people and businesses will start to leave the island. It’s become a fashionable place for middle-aged and retired socialists from the EU who thought they could bask in the excesses of a socialist society that was somehow protected from the realities of every other country on the planet. And now we’re seeing how that works out.

      • Um, who am I “shilling” for, exactly? That link you provided explicitly states that Cyprus has the lowest corporate tax rates in the EU. Their government is a communist government. Their government is now requiring a bailout (they’re bankrupt).

        They survived for the last decade by being a tax haven for Russians, because of this Russian money now accounts for 1/3 of all deposits in the country. The banking sector is now worth 5x the countries entire economy. That money will now be evacuated at an incredible speed.

        So I fail to see how anything I stated above was false, they’re simply facts. Just because you don’t like them, doesn’t make them any less true. In fact, most rational people could see this coming from a mile away. When any government refuses to watch it’s spending and refuses to repay creditors, eventually the money simply dries up. It’s not rocket science.

        The worst part about the situation is that they could have implemented austerity measures and increased taxes to alleviate the situation, but like good Communists, they refused. And now when it’s all said and done there will be zero private investment in Cyprus and internationally they’ll be regarded as a bunch of clowns.

        • Ricki-Ticki-Troll……Con/Libertarian.

          Funny, you’ve now discovered that everything you said about Cyprus in the first place….was wrong. Still is, mostly

          I doubt you even know where Cyprus is.

          • You don’t have a clue, do you? What exactly did I get wrong? Nothing. You can’t even point to a single instance where I was wrong. Get life, you’re breaking the internet with your ignorance.

          • See, this is why nobody talks to you Rick…..you simply lie and practice projection.

            I tried Rick….I really did. But you’re now on the ditz list…straight to trash.

            Ciao

          • You can’t even back up your idiotic threats. You’re the worst troll of them all. You should seek medical help for your issues.

          • Like I said kiddo, I’m not interested in your lies and games….Ciao.

          • So much for that “straight to trash” lie of yours, eh? I’ll happily let you make yourself look like an idiot here all day long. With people like you in the party, it’s no wonder the Liberals are a distant third! LOL

          • LOL First of all I have to set it to do that….and you’re not so important that I rush. I work for a living, and I’m busy tonight.

            And ….regarding your lies….I’m not a Liberal. Never have been. And you know that. Not an economist either. You know that too.

            You lie like a rug. It’s in your DNA.

            Now piss off.

          • I know that you’re not an economist, but you’ve claimed that’s your profession on many, many occasions. So sure, call me a liar. Tell me you have “work” to do (what kind of work would that be, if your not an economist today?)

          • No, I never have. It’s just one more example of your constant Con lying.

            Now then…..Flush.

          • Hahahaha. Right. You never claimed to be an economist? You repeated that lie over and over again for years! Whatever, I’ll give you a couple of weeks to figure out how to black-list me from Disqus. Loser.

  2. Societies throughout history have annulled their debts and survived. How? Because at the time, the investor classes actually had to live with the risk. If you lent to a government or king and that king said, “Yeah, you remember that deal we had about me paying you back? Sorry.. can’t afford it.” You, as an investor, went “Crap” and had to figure out some other way to survive. Rome was the first civilization that mobilized the government to protect the investor class. They went to war to collect the debts the investors made because the investors had become government. (A useful thing about democracy.. it allows the people who control the resources to take power without requiring the actual support of the people beyond a single day of the election cycle.) They then used government (aka, citizen funded) force to ensure that their investors (aka, themselves) did not have to suffer the results of making bad investments.. and we’ve continued that way ever since.

    We’re finally getting to the point where the amount of bad debt is simply greater than the entirety of “worth” that our global civilization can provide — it is becoming physically impossible for all of the debt to be repaid, but repayment of debt is the lynchpin of how our civilization runs these days.

    Those two things are going to collide, and at the end of the day, physical reality always wins, but it doesn’t care how brutal things get while it’s doing so.

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