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.
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.
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.
Deep-Seated Mistrust across Euro Zone
The anti-European mood in the south, in turn, has spurned the euro-skeptics in the north. Many Germans, Finns and Dutch long felt that Mediterranean countries were incapable of economic reform. As proof, they can now point to Italy's election winners, Beppe Grillo and Silvio Berlusconi, both of whom are publicly contemplating a withdrawal from the common currency.
There is deep-seated mistrust in all of Europe, but the suspicions run particularly deep between the Germans and the Cypriots. For months, the euro-zone leaders sought a solution for the debt-ridden country, but in the end the country still lacked €5.8 billion of the €7 billion it was supposed to contribute to its own bailout.
One of the primary hurdles is the Cypriot conviction that they are more victims of the crisis than they are perpetrators. After all, the main reason their largest banks are in trouble is that Europe ordered a debt haircut for Greek government bonds, many of which were held by Cypriot banks.
Now they feel like laboratory rats, say the Cypriots. They are convinced that the kind of bank account levy conceived of for depositors in Cyprus would never have been attempted on any other euro-zone member state. The prevailing feeling is that because Cyprus is small and weak, Europe felt it could get away with it.
The Cypriots were quick to assign blame. A cartoon in the Cypriot daily O Phileleftheros portrayed Merkel, Schäuble and International Monetary Fund (IMF) President Christine Lagarde as Huns with their swords drawn. A journalist with the same paper referred to as "fascist" Schäuble's characterization of the Cypriot business model as "no longer sustainable."
The German finance minister has become a symbol of the almost insurmountable differences between the Mediterranean country and Germany. "Unfortunately, the mutual perception of our countries is totally distorted," complains a Cypriot diplomat who lived in Germany for a long time. "Nowadays the German public only associates us with money laundering, the Russian mafia and oligarchs."
Victims or Perpetrators?
No Cypriot disputes that the island is a safe haven for foreign capital from around the world. They are convinced, however, that their country's business model differs only slightly from those of other financial centers like Ireland, Luxembourg and Great Britain. Island residents find it outrageous that Schäuble views Cyprus's low-tax model as a failure while a number of German companies profit from precisely that model. For instance, of the 80 foreign shipping companies in the port city of Limassol, 36 are German and only three are Russian.
"Many see Cyprus as nothing but a problem island that is bringing down the euro zone," says Andreas Athinodorou, who runs a tax and corporate consulting business in Nicosia. Last Wednesday, Athinodorou received more than 200 emails from concerned investors who "wanted to know whether their money is still safe with us, and yes, I was able to reassure them," he says. The "Cypriot business model," with the lowest corporate tax rate in the EU, will remain in place for now, says Athinodorou.
But that is precisely what Germany wanted to prevent. Berlin sees the Cypriots not as innocent victims but as being largely responsible for their current predicament. It is, after all, true that Cypriot banks lured billions into the country with low taxes, attractive interest rates and lax regulation -- and much of that money came from dubious sources. Cyprus was known for the fact that no one wanted to know exactly where the money had come from.
Late last year, a report by the BND, Germany's foreign intelligence agency, attracted attention when it portrayed Cyprus as a hub for money laundering. Wealthy Russians in particular were attracted to the favorable conditions and invested billions in Cyprus, often circumventing the Russian tax collector. According to the BND, 80 Russia oligarchs have sheltered their money on the island.
But citizens of other countries, especially Great Britain, also value Cypriot discretion. There is about €70 billion deposited in savings accounts with Cypriot banks. More than half of that, €39 billion, is in accounts with balances in excess of €100,000. European leaders were anxious to trim the island's banking sector to tolerable levels as quickly as possible. But Nicosia was keen to keep its financial industry intact.
Rigidity in Berlin
That desire goes a long way toward explaining President Anastasiades' stubbornness during the negotiations. To protect his banks and their major foreign investors, he initially opposed the Euro Group's plan to introduce a mandatory levy on savings deposits to bridge the funding gap. Ultimately, he acquiesced, but insisted that small deposits also be levied, only to claim afterwards that the hardliners from Germany had supported the inclusion of ordinary savers. In fact, it was Anastasiades who had insisted that large investors be protected as much as possible.
European leaders were astonished when, last Tuesday, not a single member of the Cypriot parliament voted in favor of the bailout package that included the one-time levy on deposits: 6.75 percent for accounts worth between €20,000 and 100,000, and 9.9 percent for those above that level.
Veteran European politicians also attribute the failure of the deal to the rigid position of the German government. "Other countries also have legitimate interests, which isn't sufficiently appreciated in Germany," says Luxembourg Foreign Minister Jean Asselborn. "We also accept that Germany sells a disproportionate number of weapons. In return, Berlin could show a little more understanding for the special situation of smaller countries."
Meanwhile, Berlin rejects all blame for the debacle, saying that those who don't want to be rescued simply cannot be helped. The ESM and the IMF cannot contribute more than the proposed €10 billion in bailout loans, says Berlin, arguing that this is the only way to achieve a debt level of 100 percent of GDP by 2020, as the IMF requires.
For this reason, the troika and the German Finance Ministry also discarded the Cypriots' proposed solution last week, which was to establish a bailout fund, using government and church property as collateral, which could then issue bonds independently. But critics unanimously agreed that the construct would simply amount to Cyprus taking on additional debt. "The proposal is worthless," sources associated with the troika said bluntly.
The Haves and the Have Nots
Instead, the ECB stepped in last Thursday, acting with unprecedented severity in giving a member state an ultimatum. Had Cyprus not submitted to the EU bailout program, the ECB would have cut off funding on Tuesday. To reinforce the threat, the ECB promptly froze its liquidity aid at the current level of €11.4 billion.
Even Southern European countries, normally in favor of generosity, agreed with the hard-line position. And the threat worked, with the Cypriot parliament and other leaders working tirelessly to come up with a deal.
Still, the real loser in the Mediterranean game of poker was the euro zone. Once again, leaders have demonstrated their inability to balance the interests of the currency union "haves" with those of the "have nots." Depositors, for their part, learned that legal protections on their savings accounts are not as concrete as they thought. And international financial markets learned that the term "systemically relevant" is extremely relative.
German Chancellor Merkel has likewise not emerged unscathed. In much of Europe, her image is that of an overbearing, heartless know-it-all who cares little for the suffering of average people. And at home, voters were likewise less than impressed. In the most recent public opinion polls, her Christian Democrats have lost two percentage points of support.
BY SVEN BÖLL, CHRISTIAN REIERMANN, MICHAEL SAUGA, CHRISTOPH SCHULT, ANNE SEITH and DANIEL STEINVORTH