Events in Cyprus this week have been an unpleasant reminder that the eurozone crisis is still bubbling beneath the surface.
Cyprus may account for only 0.2% of the eurozone economy but it is nevertheless still capable of bringing the entire project down with it. Surely this will be looked back on as the prime example of how not to organise a bank bail-out. Late last night newly elected President Nicos Anastasiades was attempting to ram a second agreement through the island's reluctant Parliament but whatever the outcome the Cypriot economy has been badly damaged.
It is not now clear who thought it was a clever idea to make up part of the 5.8 billion euro hole in the required 17bn euro rescue by "bailing in" the country's insured depositors, including hundreds of British ex-pats. If this is what being "rescued" by the European Central Bank looks like, every depositor in every vulnerable bank in every weak economy in Europe will soon be transferring their precious savings to their mattresses, fatally undermining the European currency.
Admittedly, Cyprus is in a particularly awkward spot. Its banking system is collapsing, having been allowed to swell to eight times the size of the country's economy largely on the back of huge deposits by Russians, who use the island as a tax haven. (The banking system has become reliant on these often shady depositors rather than conventional bond holders.) Secondly, with elections coming up in the autumn, German Chancellor Angela Merkel has no intention of being seen as a soft touch.
Nevertheless, it is in everyone's interests that the Cypriot banks are not left to implode. Most of all, this would be disastrous for Cypriots, many of whom lost everything in the 1974 war and could now lose everything again. To prevent a run on the island's two largest banks, capital controls, including restrictions on daily withdrawals and non-cash transactions, are essential. This also may limit the threat of contagion, especially in Italy and Portugal.
The euro may not be a great success but the cost of abandoning it would be higher than sticking with it. Ultimately this crisis is a reminder that monetary union without a proper banking union, including an element of sovereign debt mutualisation, is a lost cause.
For Cyprus it is a lesson that exploiting its newly discovered gas reserves and developing its travel and tourism sector (preferably on the basis of a reunified island) is a better basis for their economy than banking.
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