It looks like the latest euro zone crisis has been brought under control, at least for now - though markets continue to be worried about the events in tiny Cyprus. The nature of the euro zone means that such crises, caused by a uniform currency coexisting with far from sufficiently uniform banking regulations and a lack of co-ordination in fiscal policy, may continue to recur. People are already wondering whether Slovenia, with a banking network snowed under with bad debts to profligate local corporations, is next. Each euro zone country that has gone into crisis has had slightly different circumstances, and each has faced a differing solution. But the case of Cyprus - and, more particularly, how the European authorities have chosen to address it - breaks some new ground.
Cyprus, a relatively small island just south of Greece, had developed a reputation as an offshore banking centre, particularly loved by rich Russians. Billions of euros have been deposited into Cyprus' banks over the past years as Russia's economy thrived on supernormal profits from energy sales. The first plan to bail out Cyprus - which had bank deposits totalling a startling 800 per cent of its gross domestic product (GDP) - had unwisely chosen to tax all depositors in order to recapitalise the banking system. This was, of course, asking for a run on the banks, but Cyprus' political leaders were terrified that the country would otherwise lose its status as a haven for foreign funds.
Fortunately, saner politics prevailed, and the European Union's plan to instead tax deposits over euro 100,000 was approved and capital controls imposed to prevent the Russians from simply taking their big deposits out of the banking system. When the banks open in Nicosia on Thursday, for the first time in two weeks, those controls' effectiveness will be put to the test. But the more crucial step is the taxing of bigger depositors and the wiping out of bondholders' value - although it is accompanied by a loan from the International Monetary Fund and the euro zone, which will leave Cyprus deep in debt.
Dutch Finance Minister Jeroen Dijsselbloem, who chairs the group of euro zone finance ministers overseeing the crisis, openly said that Europe intended to start "pushing back the risks" on to private investors. If you put your money in a fragile offshore banking system to evade taxes, he seemed to be saying, you can no longer expect that those who do pay taxes will be on the hook to pay you back if the system goes belly up. Bondholders and depositors will no longer be protected from crises, as they were when Ireland stepped in to nationalise its banking system's debt. This has caused fresh and detailed scrutiny from the markets of the banking systems of Malta and Luxembourg, as well, to ensure that the Cyprus disease isn't catching.
Cyprus will suffer for its hubris in developing a financial sector vastly disproportionate to its real economy and its national ability to control aggregate sectoral risk. By some estimates, its economy will shrink 20-30 per cent, and the usual political tensions over the distribution of these GDP losses will be seen. However, banking havens and those who invest in them have been put on notice: even if international financial regulation is still a dream, offshore money is not invisible to the ripples of crisis, however invisible it may be to the taxman.