Cyprus Augurs End of Euro

Why is Cyprus so important? Because it marks the end of the euro as we know it. This from today's excellent offering from Liz Alderman and Landon Thomas Jr., "With or Without Bailout, Cypriots Lose Trust in Banks":

“For the first time, we have capital controls in the euro zone,” said Nicolas Véron, a senior fellow at Bruegel, a policy research group in Brussels, and a visiting fellow at the Peterson Institute for International Economics in Washington. “The next time there is a crisis somewhere else in the world, people will think of what happened in Cyprus and will try to get their money out much faster. These are the new rules of the game.”

My interest in and concern with Cyprus is what happens to markets once the realization sinks in that the eurozone is starting to disintegrate. Yesterday, after Eurogroup head Jeroen Dijsselbloem said that Cyprus would be a model going forward, European markets dropped. This from Alderman and Thomas:

Stocks were down broadly in Europe on Monday, after the head of the Eurogroup, Jeroen Dijsselbloem, suggested that the idea of skimming savers’ accounts to bail out banks could be considered a “template” for other countries. The borrowing costs of the financially shaky Spain and Italy surged upward as the markets digested the Cyprus news — and the broader implications for the euro currency union.

Dijsselbloem later disavowed this statement, saying that Cyprus was a one-off, and in this he was supported by officials from the ECB (for more, check out the story this morning by Liz Alderman and David Jolly, "Head of Cyprus's Biggest Bank Resigns"). But even if it's not true, and bail-ins are not the new normal, the impression created by the Cyprus bailout negotiations is one of chaos. As the New York Times sums up in an editorial this morning:

Though it is better than the initial plan, the new agreement does not inspire much hope. It represents the latest in a series of slapdash and last-minute European efforts to prevent financial Armageddon in one country or another. Many analysts have noted that this deal leaves the government of Cyprus with an impossibly high debt burden, about 140 percent of its gross domestic product, and will impose many years of hardship and pain on its people and its economy.

For Spain, Italy and other troubled euro zone countries, Cyprus is an unnerving example. Individuals and businesses in those countries will probably split up their savings into smaller accounts or move some of their money to another country. If a lot of depositors withdraw cash from the weakest banks in those countries, Europe could have another crisis on its hands. 

The way to prevent financial catastrophes like this is to impose strong centralized regulations on all banks and recapitalize or restructure weakened ones. Most important, the policy makers need to scrap austerity programs that are making it nearly impossible for the European economy and financial system to recover.

Suffering is certainly ahead for Cypriots as they go the way of Greece and Portugal and Ireland and Spain. The question is whether that pain finds its way to our shores. A scenario that has to be contemplated is one where U.S. markets react negatively as the eurozone's disintegration accelerates. We are not flush with economic health in this country; we cannot sustain another significant market drop. Yesterday at work I saw a Reuter's headline online, "Student loan write-offs hit $3 billion in first two months of year" -- up 36% from the same period last year. More people are going back to school. Why? Because there is nothing else to do. There is not enough work.