Cyprus demonstrates fundamental instability of Euro Zone

Posted: March 27, 2013 in Uncategorized

For all intents and purposes, the Cyprus drama is over, at least the public part of it that anyone in the U.S. will pay attention to. After a lot of arm twisting, Germany got its way and Cyprus will dismantle its second largest bank, put capital controls into place and watch it’s economy descend into a deep, wrenching depression.

All this is the result of the austerity that Germany is determined to enforce on it’s weaker neighbors; Cyprus, unfortunately for it’s citizens, is just the latest victim and an example to the rest of the periphery of what might happen if more bailouts are required elsewhere. Frankly, what happened with Cyprus is an example of the worst bullying tendencies of Germany. Condemning Cypriots to an economic depression is just incidental to the Germans, as long as they can avoid inflation and keep their economy humming along.

This Financial Times article gives a taste of what the economic fallout has already been for Cypriots; unfortunately much worse is yet to come as Paul Krugman notes in his New York Times blog. The Irish, Greeks, Spanish and Portuguese are already intimately familiar with the economic prison of austerity: sky-high unemployment and drastic benefit, pension and social services cuts that don’t actually even improve the situation, just make it worse. It’s an ugly Catch-22.

Krugman suggests that Cyprus get it over with and leave the Euro Zone, pronto. That would cause a lot of economic pain, but get it over with faster, whereas staying in the Euro Zone would prolong that pain for years. I’m a proponent of his approach, I suggested much the same for Greece a while back. I think even calling German’s bluff would have gotten all of the peripheral countries better deals even if they didn’t actually end up leaving the Euro Zone because Germany knows full well that exits from the Zone will wreak economic havoc in the EU and the global economy.

Another facet of the Cyprus crisis is the Russian angle. Mohamed El-Erian of PIMCO writes that the EU should be more worried about Russia weighing in and bailing out Cyprus if it is pushed too far than it apparently is. I believe the EU leaders are fully cognizant of the implications as far as Russia goes of the Cyprus deal, at least in how it is a slap in the face to Russia’s oligarchs, who will lose millions of dollars. Germany may very well have a blind spot in not appreciating the fact that Cyprus would fall into Russia’s arms if it left the Euro Zone because they believe that Cyprus won’t leave and they’ve been right so far in that none of their austerity whipping boys (the peripheral countries) have been willing to exit.

All this being said, my point remains that the Euro Zone is still fundamentally unstable. While the cracks have been papered over with a lot of money from the European Central Bank, the can keeps being kicked down the road. The EU is no closer to economic and political unity than it was when this crisis began.

So it behooves all of us to realize that the European situation is a major geopolitical risk to global economic stability and to act accordingly. By that I mean investors should be aware that markets could tank at any time due to continued problems in Europe, so a diversified portfolio with a healthy dose of cash is a good idea, as the next European crisis could easily trigger another recession or another global financial crisis.

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