There has always been a Cyprus problem. It is a small island which has been ruled by many colonial powers for much of its recorded history. The French, Venetians, the Ottomans and the British all colonised Cyprus and exploited its people. Cyprus achieved independence despite the fierce opposition by many British in 1960; the colonial system of divide and rule drove a political rift between the Greeks and the Turks who lived in the island and after fighting in 1974 the island split into two sectors. Reunification of the island had until now been the Cyprus problem but today there is a new Cyprus problem, without the old problem having been solved.
Cyprus looked for ways to build its economy. It is poor in natural resources (despite the fact that the island was named for the copper once mined there) but rich in human resources. After the “big bang” liberalised banking Cyprus decided to exploit its best resources, its people, and set itself up as an offshore banking centre.
In doing so it copied the practices of many small nations such as Luxembourg, Gibraltar, the Channel Islands, the Isle of Man, Liechtenstein, Andorra, and many Caribbean Islands, such as the Caymans, the British Virgin Islands and the Turks and Caicos. It attracted investment into the island and with a liberal tax regime became a centre for people wishing to protect their savings from high and often confiscatory taxes or for people wishing to protect their wealth from simple confiscation.
When the financial crisis hot, Cyprus was in good shape except for one thing; its Cypriot banks bought bonds issued by the Greek banks and when the Greek banks were “bailed out” one of the terms of being bailed out was that its banks’ bondholders would have the proverbial haircut. That inevitably had a disastrous impact on the Cypriot banks and created the new Cyprus problem of today.
However, even though other nations’ banks had been bailed out when it came to Cyprus the rules changed. The key reason for the change was that Germany is due to hold elections in September and the German politicians did not feel that they could justify to their voters to lend the relatively very small amounts of money that Cyprus needed for its bailout. Germany seemed to take the view that Cyprus should be punished for being an offshore banking centre. That would strike the right chord amongst the Germany voters who felt that Germany savings should not support a tax dodging profligate nations who assisted money launderers, such as they characterised Cyprus.
There is a good reason why Germany should support the bailout of Cyprus. It is Germany’s own interest. The harsh terms imposed upon those who have deposited funds in Cypriot banks are unprecedented within the European Union. This will shake confidence in the single currency, the Euro, and I expect that there are likely to be runs on banks in other Eurozone nations.
Germany has been the greatest beneficiary of the single currency. The euro works to help keep the price of German goods low, especially when those goods are exported. If there had been no single currency far fewer German goods would have been capable of being afforded by many outside Germany.
Germany claims that the business model of Cyprus as an offshore banking centre is incompatible with membership of the European Union. Of course it does not apply this to Luxembourg, which has a larger offshore banking business per capital, equivalent to ten times its GDP, compared with Cyprus which is eight times its GDP. One by one the small nations that managed to achieve prosperity through offshore banking are being picked off and their business models caused to fail. There is a prejudice that offshore banking is a centre for money laundering with implications of criminality. That is often a prejudice rather than reality. No doubt money laundering happens everywhere- it was only nine months ago that HSBC were fined nearly $2 billion (which would have been about half of what Cyprus needed to raise for its bail out) for money laundering yet HSBC prospers in Germany. Much of what is written about Cyprus and money laundering is simple prejudice.
These are the prejudices that will cause problems for the people for Cyprus for many years to come. The politicians of the European Union have chosen a short term political gain and have almost certainly created a long term problem, not just for Cyprus but also for the whole of the Eurozone. Politicians find it hard to give due weight to the long term and prefer a short term view because, above all, politicians desire to be re-elected, even if that re-election means hardship and misery to the inhabitants of a small island a long way away.
Increasingly the world is shrinking. The smaller it gets in economic terms the less viable small nations become. At one time small nations were regularly invaded by larger nations who captured their land and often enslaved their peoples. In the civilised Europe of today nations no longer invade each other with armies. It is more profitable to wage economic war through banks, single currencies and devices controlled by large nations.