Confused by all the talk of Cyprus? Don’t be. Here’s the situation in three sentences: The country’s banks were using Russian deposits to buy Greek bonds. The Greek bonds went bad, and the Cypriot banks lost a bundle. They now need a bailout from their euro zone partners, but it’s tough to convince German taxpayers to pony up if they think the money is really going to Russian oligarchs.

But here’s the bigger question: Why are we talking about Cyprus at all?

Cyprus is tiny. It has fewer people than Philadelphia. It has a smaller economy than Vermont. It has no nukes. It is not a country that typically commands global headlines.

But in 2008, exhibiting epically bad timing, Cyprus joined the euro zone. So now its problems are the euro zone’s problems. And as we’ve discovered in recent years, the euro zone’s problems are the world’s problems.

In 2011 and 2012, markets seemed in almost constant turmoil over the very survival of the currency union -- and their turmoil, in turn, actually threatened the survival of the currency union, as the market became unwilling to lend Italy, Greece, Portugal and Ireland the money needed to fund their governments. Investors have since calmed down. But the relative financial calm masks a very dangerous political and human situation.

Beppe Grillo, the comedian-cum-politician who got the most votes in the last election in Italy. (Guiseppe Cacase -- AFP/Getty)

In Spain, unemployment is at 26 percent, and youth unemployment is above 50 percent. The same is true in Greece. In Italy, an anti-euro zone comedian won more votes than the leaders of either major party, and with no one commanding sufficient support to form a government, it looks like the deadlock will require a redo election. As of press time, public outrage had scotched Cyprus’s initial idea of paying for its bailout with a broad bank tax, and the country is now scrambling to come up with a new source of funds before the Monday deadline set by the euro zone.

“My view is that what you’re seeing already is the politics coming unstuck in a lot of places in Europe,” says Desmond Lachman, a resident fellow at the American Enterprise Institute, a Washington think tank. “Greece is the worst example. The extreme left and right has 45 percent of the vote now.”

In 2011, the euro-zone’s crises were driven by fearful markets. On any given morning, people would awaken to find that interest rates on Spanish bonds had soared. Today, the crises are driven by volatile politics, and that makes them all the more dangerous. The European Central Bank can deal with a bond-market crisis. It can’t deal with a popular revolt.

“I don’t understand how you can extend this for many more years,” Lachman says. “The gameplan is they apply this fiscal austerity in 2013, 2014 and 2015. And my problem with all this is I don’t see how, if you’ve got significant fiscal austerity at a time when banks are cutting credit and Germany is slowing down and, in Spain, the housing bubble is bursting, I don’t see how this recession ends. And if you don’t have hope? The politicians keep selling the idea that this will hurt a bit but in six months time we’ll see the green shoots. If you don’t see them, you’re just inviting a political mess.”

If you want to fear for the euro, this is the reason to do it. A half dozen countries have unemployment in the 15 to 25 percent range, with youth unemployment in the 30 to 60 percent range. Politics isn’t stable amidst that sort of pain -- particularly when there’s a perception that some of the pain is being forced upon the country by richer, wealthier outsiders.

That’s what’s happening now. Christopher Pissarides, a Cypriot economist, won the Nobel prize in economics in 2010. But in an interview with BusinessWeek, his fury at the more powerful countries in the euro zone was sparklingly clear. “Small countries, be warned when joining the euro zone,” he said. “You could be bullied any time by your big brothers if it suits their political objectives.”

And that, again, is the view from Cyprus’s Nobel-prize-in-economics contingent. The man on the street, it’s safe to say, is even angrier.

A demonstrator kicks a riot policeman in Athens. (AP)

As austerity continues to squeeze these economies over the next couple of years, the political pressure to do something, anything, to recapture national pride and rediscover some measure of hope will build. And once it finds expression -- if it finds expression -- the chain reaction could be catastrophic for the euro zone.

That’s the other reason a tiny Island like Cyprus matters. It shows the euro zone’s tendency toward contagion. Cyprus’s banks fell because they’d invested in Greek debt -- so no Greek problem, no Cypriot problem. The initial idea to pay for Cyprus’s bailout would’ve included levying a 6.6 percent fee on all bank accounts under 100,000 euros.

That was taken, in many quarters, as a violation of the euro-zone’s young deposit insurance scheme. It raised the possibility that investors in Italy or Spain would wonder about the need to move their money, too. After all, if deposit insurance doesn’t protect you from the euro zone simply removing money from your bank account, what good is it, really?

But what killed the idea wasn’t its underlying economic flaws. It was political outrage in Cyprus. So far, these eruptions against the bailout conditions set by the richer members of the euro zone have always proved manageable. But there’s been a number of close calls, and of late, the political situation in many of these countries is deteriorating.

If a country like Greece or Spain were to see a political reaction that made remaining in the euro impossible, it would immediately spark a run on the other teetering countries, making it more likely they’d have to leave, too. That’s how you get to actual dissolution.

Jacob Funk Kirkegaard, a senior fellow at the Peterson Institute for International Economics, thinks all this is a bit overblown. “The euro is a prison, or a Hotel California,” he says. “Once you’re in, you can’t get out. The costs of leaving are just cataclysmic. They’re so high no one will do it. Greece shows that.”

And thus far, Kirkegaard had been proven right. Elections have produced a lot of anti-euro zone rhetoric, but not a lot of anti-euro zone behavior. “A lot of people have been predicting the 1930s scenario, where the economic hardship we’re seeing will lead to political extremism, and then lead to the undoing of entire area,” he says. “I take some solace in the elections we’ve actually had. Yes, you’ve kicked out incumbent governments in almost every case, but the government that comes in and replaces it is pretty much the same.”

The question is whether they’ll remain so. It is hard to be confident in a currency union that must fret over the decisions of Cyprus.

Further reading:

- Everything you need to know about the Cyprus bailout, in one FAQ.

- My interview with Desmond Lachman.