Is Cyprus All That It Seems?

What is these days?  We’re hearing that the Western world’s financial system is about to implode because of Cyprus, that no one’s bank savings are safe because of Cyprus, that the EU will fall because of Cyprus, and that Merkel is the devil because of Cyprus. Okay, I’m exaggerating—Germany’s Prime Minister was vilified long before Cyprus.

For those of you locked in your room for the past couple of weeks playing the latest version of “Call of Duty,” let me take some time, as Fagan sang in Oliver, “reviewing the situation.”

Ron Moody as Fagan

Cyprus is an eastern Mediterranean island about one and one-half times the size of the U.S. state of Delaware, with a total population of a bit more than a million.  Since 1974 it’s been divided into a Turkish occupied north and the Greek-speaking Republic of Cyprus to the south.  It is the south that’s a member of the EU, not a NATO member, on the Euro, the subject of current financial concern, and what I’m referring to as “Cyprus” in this post.

Divided Cyprus

It was no secret that after the breakup of the Soviet Union Cyprus became the place of choice for many former Soviets looking for a safe haven in which to bank their money, and that there’s broad speculation over the sources of those depositors’ funds and the uses to which they’ve been put [think Cold War thriller scenarios]. 

But Cyprus gladly accepted its new-found windfall (its banks grew to hold eight times the nation’s gross domestic product (GDP)) and the influx of Russian millionaires—and billionaires—buying up many of the island’s most expensive residential properties.

The Cyprus economy cruised along quite nicely, doing relatively well even during the early years of the worldwide recession.  Then came the Greek bond crisis, and the bottom fell out for Cypriot banks. They were heavily—some say disproportionately or even speculatively— invested in Greek government debt.  The Cypriot government nationalized one bank to avoid its collapse and borrowed heavily to support its system, including loans from Russia, some at less than prevailing interest rates but with maturity dates just a few years away.

None of that, though, was enough, and in order to save its banking system Cyprus needed an infusion of 16 billion euros, roughly equivalent to its GDP.  Enter the Troika (IMF, European Central Bank and EU) offering to loan 10 billion euros if the Cypriot government came up with an additional 5.8 billion euros and agreed to other terms intended to stabilize its banking system and (hopefully) hasten its return to fiscal health. 

What sent prophets of doom to the ramparts was the proposal put forth by the newly elected Cypriot President (in consultation with the Troika) for raising that additional 5.8 billion: Impose a one time “tax” on depositors’ accounts—9.9% on bank accounts above 100,000 euros and 6.75% on the smaller ones. 

All hell broke loose, with screaming demonstrations, runs on ATM machines (the banks were and remain closed), and the Cypriot Parliament ultimately and unanimously voting down the proposal.

The question is, “Now what?” Either Cyprus doesn’t get the money it needs or it does.  If it doesn’t, the country’s banks fail, with inevitable widespread pain to many.  Just how far and deep that pain will spread is a matter of economists’ speculation—a notoriously inaccurate conjurers’ device.

 

All I can say is we shall see, but it seems hard to imagine that in light of the many unique factors surrounding the Cyprus crisis that the world will plunge into a “Great Depression” or the European Union will fall.  And that’s not just because of the relatively small size of the Cyprus economy.  In fact, some wags say that if Cyprus refuses to accept the Troika’s terms, its small size makes it a “manageable” example to other struggling EU nations of what will happen to your country if you refuse to be “realistic.”

Frankly, it appears that many of those “unique factors” are what led to the incendiary bank account “tax” proposal in the first place.  For example: Many of the largest account holders are foreigners, mainly Russian, so the “tax” was seen as a way of bringing substantial funds into the Cypriot economy from foreigners, rather than taking it all from Cypriots though such means such as reducing pensions; foreign investors, mainly Russians, have long known of the precarious situation facing Cyprus’ banks yet chose to keep their money there; and Cyprus bank accounts paid 5% interest (three to four times what U.S. banks paid) and in post-Madoff times anyone expecting that sort of out of whack interest return had to realize there was a gamble involved, and losing less than 10% was not that bad a haircut under the circumstances.

The big miscalculation was “taxing” the small account holders (rather than taking a bit more from the larger accounts to come up with the 5.8 billion) who believed the government had promised to protect accounts of up to 100,000 euros.  It was a PR disaster, even though at the time it certainly must have seemed a brilliant solution to some Cypriot politicians.  After all, during the last parliamentary election in neighboring Greece one party leader advocated imposing such a “tax” on every bank account in excess of 20,000 euros as a means for getting Greece out of its mess, and his party garnered the second most votes. 

Bottom line: It wasn’t a smart move.  BUT at least one behind the scene’s player has carefully positioned itself to take advantage of the unfolding situation.

For Russia it looks to be a win-win situation.  If the Troika gives Cyrus the money on terms acceptable to the Cypriot people, other EU countries in need (Greece, Spain, Portugal, Italy, Ireland, and to be continued) will likely stiffen resistance to the popularly unpopular conditions of their Troika loans…drawing out the “euro crisis.”

If the Troika doesn’t deliver and Cyprus crashes, it gives credence to Russia’s message for the former Soviet Satellites now part of the EU or wishing to be (something Putin has never forgiven the West for encouraging) that they cannot trust the West to be there when they need them most.

But no matter what the Troika does, Russia now has a far better shot at getting a piece of something it really wants: Cyprus’ recently discovered, vast offshore natural gas deposits.  That discovery put Cyprus in conflict with Turkey, into an alliance with Israel, and in future competition with Europe’s primary supplier of natural gas, Russia’s Gazprom.  A financially strapped Cyprus, owing billions to Russia, and needing billions more to develop its gas reserves, this week sent its Finance and Energy ministers to Moscow—and the Church of Cyprus announced its willingness to post its wealth as collateral. 

What sort of bargain do you think the Russians will drive?  To some extent it depends on whether the Troika or Cyprus blinks first.  And, of course, how belligerent Turkey is prepared to become.  But either way the Russians undoubtedly see themselves as winners.  After all, let’s not forget that much of what happened to Cyprus in the past was the result of Cold War concerns by the West over the island’s potential alliance with the Soviets.  Now it’s only the Russians.  And they are coming.

[Update:  As of late Friday Cyprus still had no fixed plan, but looks to be making deal with the Troika that puts no tax on small accounts but a whooping 22-25% hit on accounts above 100,000 Euros.  Russia’s position: Sorry, no help now, let’s first see what kind of deal you can make with the Troika, then we’ll talk. The dance continues.]

 

If that sort of modern day Russian intrigue seems fitting for a novel, you’ll find more on September 3rd when MYKONOS AFTER MIDNIGHT is released by Poisoned Pen Press.

Jeff—Saturday