The Euro: The beginning of the end?
Over the past few years the Eurozone has been full of problems. Ireland and Greece have both needed international bailouts to keep them afloat, each time creating weeks of uncertainty. Amongst other things, each bailout led to debates as to whether each country would end up leaving the Euro, or in more extravagant predictions, some thought that it might even be the end for the whole of the single currency. Each time however, the situation was mostly resolved without either of the scenarios happening, as both countries stayed in the single currency. Now, the crisis has spread to Cyprus, who has also had a botched bank bailout of their own finalised in recent days. It was inevitable that there would be talk of Cyprus leaving the single currency, but unlike the other countries, this might well be different.
Cyprus has been experiencing difficulty for many months, but the first time most people became aware of the real problem was two weeks ago, when the banks closed in order to prevent a bank run. Discussions began and the leaders agreed on a depositor haircut for everyone, even if they had deposits below the guarantee limit of €100,000 that was put in place by the Eurozone after the 2008 crisis. It’s common practice that bondholders and bank shareholders would the first to lose out, but in this case the “rescue plan” hit the ordinary person more than expected. Days later, this decision was reversed after public outcry, leading to the country splitting the bad banks in two, keeping the good assets and guaranteed depositors safe, while the savers with over €100,000 are going to have to take an unknown haircut, possibly exceeding 40% once the true scale of the bad assets is known. With this agreed, the banks are going to reopen and people are beginning to look to the future.
Capital controls have been introduced, with the aim of avoiding a catastrophic mass exodus of capital from the country. This is of course needed, because otherwise the moment the banks reopen almost everybody would be redrawing their money. Without the capital controls, the banks would quickly become insolvent regardless of any recapitalisation that the Eurozone could provide. Almost no amount of capital would be sufficient if the Russians; who hold around €20 billion of the €80 billion country’s total deposits; immediately withdrew all of their money as soon as the banks opened. However, this situation never happened in other troubled Eurozone countries, with capital controls avoided until now. However, now that they are imposed, it practically creates a new currency as far as the markets are concerned, threatening the whole idea of a single market.
Basically, Cypriot euros turn almost into a national currency, rather than part of wider monetary union, where people can freely move money around. People won’t be able to get their Euros out of Cyprus, rending them useless to anybody not in Cyprus. When one of the main concepts of a monetary union is broken, it’s time to start thinking about other options. In this case, it means a return of the Cypriot pound, with Cyprus officially leaving the single currency. Despite problems in other countries, they never really publicly explored the idea.
Over the past few weeks we’ve seen the power of public pressure; forcing a renegotiation of the bank bailout; and I believe that this could be the difference that leads to the country leaving the single currency. This is because recent polls have suggested that a majority of the public want to leave the Euro, which despite all of the issues, never happened in Ireland or Greece. Life in Cyprus will no doubt get a lot worse over the next few months, with experts predicting a deep recession, with a 10% fall in GDP this year alone. No doubt this will lead to more pressure put on the government and growing discontent which means that they could be the first country to seriously consider leaving the Euro.
This discontent could also spread to other countries, notably Portugal, Ireland, Greece and Spain who are still in serious trouble. The past few weeks would have proved to savers, especially wealthy individuals and investors that they cannot safely keep their money in these countries. As a result, they’ll pull their money into Germany or the UK, creating more inequality in the Eurozone as the weak struggle even more while the stronger countries thrive. As the future prospects get worse, we could see these countries considering a return to their own currencies as well.
Overall, many lessons have been learnt from this crisis in Cyprus. Yet again we’ve seen Eurozone leaders squabble and prove that they are unable to solve any serious problem. Germany has a severe conflict of interest, with voters not wanting to support anymore bailouts but still wanting to keep the Euro together. This will continue to create problems and could hit a crisis point in 2014 after the German elections, resulting in questions in the future of the Euro. We might look back in a few years at this botched bailout as the beginning of the end, as Cyprus leaves due to growing public discontent.