Confusion and suspicion after Europe's new crisis

The wild rise to a Cyprus 'solution' has left European bank depositors fearful, cross-country resentment boiling and faith in policymaker competence completely destroyed.

Watching the ALP’s strange attempts to solve its leadership crisis last week, it appeared that Coalition strategists could not have written a better script. There is only one consolation for Labor: When it comes to self-destruction, nothing beats the European Union.

The EU’s circus around the Cyprus bailout makes Labor appear like a disciplined combat formation. For anyone wanting to risk a continent-wide bank run, undermine economic confidence and create international tensions, the EU has just provided a new benchmark. What should have been a small problem for a tiny economy on the outskirts of Europe was allowed to become a disaster for the whole continent.

To add insult to injury, the chairman of the eurozone, Dutch finance minister Jeroen Dijsselbloem, even hailed the Cyprus bailout as a template for future crises. Apparently he wasn’t joking and was entirely sober when he made these remarks. Which, incidentally, makes you wonder what they are smoking in the Netherlands these days.

To all other observers, however, following the European Union’s botched crisis management was akin to watching train wreck in slow motion. For seasoned economists and central bankers, the Cyprus show was fascinating. Yet at the same time, the sheer incompetence of everyone involved in it was mind-boggling and painful to witness.

It was difficult not to feel embarrassed for one’s European colleagues. They effectively ignored every rule on how to deal with economic crises, beginning with the most important one: Never make bank clients nervous about their deposits.

It need not have come to this. Cyprus’ problems had been known for months if not years: Its oversized banking sector, built on capital from dubious sources had suffered during the Greek crisis. The political complications were also clear: The German government was not willing to jeopardise its re-election for the sake of bailing out Russian oligarchs in Cyprus. And the Cypriot government’s position was even more foreseeable: they were unprepared to change their business model which was, essentially, to be a European financial gateway for Russian investors.

Despite the apparent incompatibility of all these propositions, there would have been enough time to find a compromise which would have contained the problem to where it belonged: in Cyprus.

In fact, if the European Union had paid closer attention to the smallest eurozone member state, it could have taken steps to prevent the crisis in the first place. But it did not tackle Cyprus’ lax stance on money-laundering. Arguably, Cyprus should have never joined the euro in the first place.

Instead, the European Union turned a predictable problem in tiny Cyprus into an uncontrollable crisis for all of Europe. By threatening to confiscate deposits of ordinary savers, the eurozone’s finance ministers demonstrated how far they are willing to go in their efforts to ‘save’ the euro.

By openly declaring this a precedent now, it has sent a strong signal to anyone holding money in a eurozone bank: “Your money is no longer safe.” Thank you, Mr Dijsselbloem.

Despite the seeming solution to the Cyprus question, the damage is done after Europe’s days of chaos. And the damage is twofold.

First there is the psychological damage. If there had been any confidence left in the competence of eurozone policymakers, it is now comprehensively destroyed. Second, there is the political fallout. For anyone still believing in the fairy tale of pan-European solidarity and the peace-making capabilities of monetary union, Cyprus should rob you of any such illusions.

The psychological damage is best exemplified by German reactions to the Cyprus deal. Chancellor Merkel was desperate to avoid a debate about German taxpayers rescuing Russian billionaires. In doing so, she has inadvertently made Germans worry about the safety of their own deposits. Broadsheet newspapers are running articles seriously discussing how much German bank customers can still trust their banks. If being tough on Cyprus was meant to help Merkel win the next election, it may have badly misfired. The Germans are more critical of the euro than ever – and they are unlikely to trust their government’s assurances less than before the Cyprus disaster.

The political repercussions of the EU’s unprofessional dealing with the situation in Cyprus are also apparent. You may not harbour the greatest sympathy towards Russian president Vladimir Putin, but it’s hard not to feel pity for him. One moment he is bullied into providing billions towards a bailout, which he refused; then his country is vilified as the root of Cyprus’ problems; finally he is supposed to provide some cash in return for vague promises of gas exploration rights in Cyprus. By all accounts, European diplomacy has seen finer hours than this.

What’s even worse than their dealings with Russia was that the agony over Cyprus intensified divisions within the so-called European 'Union'. It was basically a repeat of previous bailouts. Whether it was a rescue operation for Greece, Ireland, Portugal or Spain, in each case it looked like a confrontation between a German-led bloc and the poorer rest of Europe.

Cyprus was no exception. After a week of acrimony, the Germans are now seen as neo-colonial dictators in Cyprus, while in Germany the Cypriots are regarded as a bunch of half-criminal bankrupts. There is no shortage of reproaches, insults and hatred on either side. The euro, which was officially meant to promote peace and understanding, is achieving the precise opposite. Instead of bringing countries such as Cyprus and Germany closer together, it only serves to remind them of how different they are.

Whether the deal for Cyprus will be successful or not – if it survives the reopening of the country’s banks this Thursday – its long-term legacy is nasty. It has made Europeans more cautious about their deposits. It has underlined to international investors that the euro crisis is not over. And it has further estranged EU members from each other.

That all of this was triggered by tiny Cyprus is ironic. While we were all waiting for post-election Italy to blow up, of Hollande’s France to go bust, it was Cyprus that brought the euro crisis to a new high.

It was almost as bizarre as Simon Crean pushing for a reinstatement of Kevin Rudd.

Dr Oliver Marc Hartwich is executive director of The New Zealand Initiative.