Financial markets haven’t freaked out over Cyprus. That doesn’t mean we’re in the clear.

March 18, 2013

First the good news: Financial markets have been relatively stable Monday, not really panicking over international authorities’ decision to force losses on those with deposits in Cyprus’s banks.

Borrowing costs for Spain and Italy have risen only about 6/100 of a percent, the German stock markets are down about 1 percent, and the value of the euro currency is down only about 0.9 percent against the dollar. Those are all signs of an adverse market reaction to the weekend’s news — but not evidence that a broader run on Europe is underway.

But the bad news is this: We learned over the weekend that European authorities still haven’t learned something fundamental, namely, that with every decision they make, economic actors across the world will extrapolate and draw conclusions about what they will do in the future and act accordingly.


Will Cyrpus be the new Deauville? (Petros Karadjias/AP)

The modest declines in financial markets Monday are a sign that global investors are betting that the losses being forced upon Cypriot bank deposits will be a one-off situation, and not form a precedent for future aid to banks in Greece, Spain, Portugal and beyond. There is indeed plenty that is unique about Cyprus compared to other Eurozone countries— not just its tiny size (only 1.1 million people) and location closer to the Middle East than Western Europe — but also a high proportion of bank deposits that are Russian wealth of dubious provenance.  (Already the diplomatic tension between Russia and European leaders has heated up).

After outcry from the people of Cyprus and anyone who cares about financial markets and worries about the implications of a government suddenly seizing a chunk of the money people kept in supposedly safe bank accounts, the terms of the rescue deal were being renegotiated Monday. The most likely outcome is a new deal that protects Cypriots’ deposits up to 100,000 euros, though details were murky Monday.

The whole experience, though, gives flashbacks of one of the least impressive moments of the Eurozone crisis, one summed up in a single word: Deauville.

Mention that seaside town in France to anyone who was involved in dealing with the European crisis, and there is a good chance they will smack their forehead. On Oct. 19, 2010, at a time that the panic around European nations’ debt had seemed to be in remission, French President Nicolas Sarkozy and German Chancellor Angela Merkel, at a conference in Deauville devoted to national security issues, went for a sunset stroll on the boardwalk overlooking the English Channel.

They agreed between themselves on the next steps forward, including that any future bailouts of European nations would include “private sector involvement.” Translation: That the owners of bonds would take losses.

The rest is history. It took a few days for markets to digest the news from Deauville, but eventually it became clear that bonds issued by Ireland, Portugal and Spain were riskier than investors had thought previously. The sell-off became self-fulfilling, and just a month later Ireland needed a formal bailout package. By the time the Germans and French realized the hazards of this path, it was too late.

Here’s what the recent events have in common with Deauville. The international negotiators, including at the International Monetary Fund, European Central Bank and European Commission, are right that they have principle on their side. It is unfair for the rest of the world to come to the rescue of Cyprus at a time when the Russian oligarchs who have used the country’s banking system to squirrel away money pay nothing. But sometimes it’s better to have a policy that is unfair than one that is destructive. Europe has spent the past three years trying to persuade global investors and ordinary citizens that their money is safe in European banks. They had finally succeeded in the last several months. But the punitive approach to depositors in Cyprus throws that success into new question.

In other words, future policymakers, looking back, may smack their heads at the mention of Cyprus the way they now do at the word “Deauville.”

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Sarah Kliff · March 18, 2013