Lessons from Cyprus: Euro Crisis Poses Grave Dangers to EU Unity

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Cyprus has been saved. But the euro zone may ultimately be the biggest loser. The tough negotiations clearly demonstrated that Europe's north and south no longer understand each other -- and the political differences could soon become more dangerous than the currency crisis. By SPIEGEL Staff

It has been only four weeks since German Chancellor Angela Merkel had nothing but nice things to say about her "very esteemed" counterpart in Cyprus. In a telegram to newly elected President Nicos Anastasiades, she "warmly" congratulated him on his election victory and wrote that she looked forward to their "close and trusting cooperation."

That was then, as Merkel conceded last Friday in a speech to the parliamentary group of her center-right Christian Democratic Union (CDU) at the Reichstag in Berlin. Although her intent was not to set an example, she said, Germany also would not "give in." She added that there would be "no special treatment" for Cyprus. And over the weekend, she lived up to her word.

The island republic in the eastern Mediterranean is about as economically significant as the German city-state of Bremen, and yet the attention of citizens and politicians alike was focused on the debt-ridden country on the continent's periphery last week and through the weekend. Since Cypriot parliament rejected the initial bailout plan, one crisis meeting followed the next in Berlin, Frankfurt and Brussels as concepts were presented, revised, rejected and resubmitted. In the end, the European Central Bank (ECB) imposed an ultimatum on the country. The message from ECB President Mario Draghi was that either Cyprus agree to the bailout conditions or it could be the first member of the euro zone to declare a national bankruptcy.

In the end, Nicosia agreed. The country's oversized banking industry is to be radically downscaled, one of its biggest banks, Laiki, is going to be dissolved and those holding accounts there will see volumes over the €100,000 insured limit potentially vanish. A worsening economy will almost certainly be the result. The deal came just a day before the ECB ultimatum -- a cessation of emergency liquidity for the country's banks -- was set to become reality, a move that would have resulted in a messy crash of the country's financial system.

Smoldering and Flaring

Despite the deal, Cyprus was making preparations for the reopening of banks this week. Financial institutions there have reportedly hired extra security in preparation for an onslaught of furious customers. For the last several days, they experienced what it's like for a country to literally run out of money. Many service stations only accepted cash, and some kiosk owners closed up shop when they ran out of cash to make change. Bank machines over the weekend were only giving out €100 per day, per customer.

Smoldering and flaring for the last three years, the euro crisis has reached a new stage. For the first time, a parliament rebelled against the requirements of international creditors, and for the first time euro-zone taskmasters tried to take a slice of the savings of ordinary citizens, prompting people throughout the continent to wonder whether their money is still safe. The unprecedented showdown led many in Europe to speculate over the national character of the Cypriots, and wonder: Are they especially jaded, desperate or simply nuts?

Finding the right answer was the perplexing task for leaders in Brussels, Paris and Berlin. How far can one bend to demands from a teetering country like Cyprus without losing one's credibility? At what point does a debt-ridden country endanger the entire financial system, and how can allowing it to go bankrupt still be the right approach? Finally, how does one rescue a country that doesn't want to be rescued?

It was a matter of risk and confidence, of European solidarity and of Merkel's crisis management. In recent months, the chancellor seemed to have stopped the impending collapse of the common currency with her recipe of aid in return for reforms. Investors had calmed down, capital was flowing back into Southern European economies and in recent weeks German Finance Minister Wolfgang Schäuble (CDU) seemed as relaxed as the markets.

But a monetary union, at its core, is not held together by budget figures or austerity programs, nor by the statements of finance ministers and the heads of central banks, no matter how well-received they are in the markets. The most important glue holding together a monetary union is the mutual confidence of its members, and that has declined drastically in recent months. While many in the north question the willingness of politicians in Rome and Athens to bring about reform, citizens in the south are increasingly furious over the austerity diktats from Berlin, Brussels and Frankfurt.

Different Planets

There are predetermined breaking points all across the continent, but they are more apparent in Cyprus than anyplace else. Lawmakers in Berlin see the small country as a haven for the illegal money of wealthy Russians that urgently needs to be shut down. In contrast, island residents see themselves as the innocent victims of a ruthless bailout policy. Cypriots and other Europeans spent nine months in Brussels hammering out a solution to the crisis, but all the while it seemed as if they were living on different planets.

Seen in this light, the debacle over the debt-ridden island nation is more than just another financial crisis along Europe's southeastern edge. It is emblematic of the entire monetary union. If the euro zone collapses, it will be because of both its economic contradictions and its members' inability to reach agreement. Last week, European politicians involved in the bailout were calling Cyprus a "special case." And perhaps it is. But there was a very real danger that the crisis on the island could have ultimately become the straw that broke the euro's back -- a back which is still fragile indeed.

Depending, of course, on whom you listen to. Klaus Regling, head of the euro bailout fund European Stability Mechanism (ESM), has been giving presentations around the globe for months. Last Monday, he stood on a small stage at the Friedrich Ebert Foundation in Berlin, exuding indefatigable optimism. The euro zone is on a difficult path, Regling admitted, but "relevant data shows that the strategy is working."

Those in the audience were shaking their heads in disbelief, but the 62-year-old allowed the facts to speak for themselves. His slides showed colorful graphs indicating how much debt-ridden euro-zone member states had cut spending in recent years. Both Italy and Spain have packages of cuts and tax increases worth dozens of billions of euros in recent years.

Long-Overdue Reforms

Thanks to an aggressive consolidation strategy, many of the hardest hit countries have managed to drastically reduce their budget deficits. Greece, for example, has managed to reduce its deficit by almost 10 percentage points relative to gross domestic product within three years, a record among the world's developed countries. Were Germany to have done the same, some €250 billion in federal, state and municipal spending would have had to have been cut.

In addition to the austerity measures, governments across the Continent have tackled long-overdue reforms. Portugal eased access to previously protected professions and eliminated some holidays and vacation days. Spain relaxed protections against employee termination. In Greece, the government reduced the minimum wage by almost a quarter, and by a third for younger workers. The government in Rome raised the retirement age.

Even more importantly, these policies produced the desired results. Throughout Southern Europe, citizens have purchased fewer imported goods and exports have risen. Current account deficits in Southern European countries have declined to just a few percent of their GDPs. These countries are even exporting more goods now than they were before the crisis began.

"To be honest, I sometimes don't understand why this progress is often not noticed in Germany," says Regling.

The problem is that while Europe has become more economically harmonized, it is drifting apart politically. The reforms have made the southern part of the continent more competitive, but people are not necessarily benefiting from these economic successes. On the contrary, unemployment remains at record high levels, and poverty is on the rise. At the most recent EU summit, outgoing Italian Prime Minister Mario Monti spoke of a "time lag."

Monti knows what he's talking about. After all, that time lag explains why he was unceremoniously voted out of office a month ago. Monti claims that, even though he explained his policies at length, anti-European forces won the Italian elections.

Yet people are turning away from Europe in almost all countries that have suffered economic upheaval recently. Anti-austerity protests are increasing again in Greece, even though the government hasn't even implemented certain reforms yet. Social conflict is likewise on the increase in Spain, where half of all young people are now unemployed and the government of Prime Minister Mariano Rajoy is under fire because of a corruption scandal. In France, President François Hollande has seen his popularity drop to a new low -- to the point that he has been overtaken in the polls by Marine Le Pen, head of the far-right National Front.

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1. Eurozone won
Kofi 03/25/2013
The Eurozone made clear that rogue states cannot game the rules. Brussels is no oriental bazar.
2. Two euro's.
yiannaki 03/25/2013
Please do give the South of Europe a Seuro they can devaluate. And when they don't need that anymore (evidence based) they can have the Neuro again. Don't try to press oil out of water.
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