Big Trouble in Little Cyprus

eyeball monster

Small Cyprus May Trigger Big Trouble in Europe.

Angela Merkel’s Cypriot Headache — The American Magazine.

One of my favorite cult films is Big Trouble in Little China, an action-fantasy movie starring Kurt Russell as truck driver Jack Burton.

Jack gets dragged into a battle between good and evil in a secret temple in L.A.’s Little China while he searches for his truck. After he believes that he has vanquished the last monster, the little eyeball creature above appears, and Jack exclaims incredulously , “Oh no, what the hell is that?”

This is Merkel’s Cyprus situation in a nutshell. Just as she thinks Greece is put to bed and won’t be a bother prior to  elections in the fall, the Cyprus crisis takes a turn for the worse. I can just imagine Angie looking at Wolfie and screaming, “Oh no, what the hell is that?”

That is the tiny island nation of Cyprus needing German money so that it avoids a Cyprexit. The adoption of the euro caused imbalances in every country. In Spain, the euro fed a real estate and credit bubble. Greece experienced a sovereign debt bubble. In Cyprus, the adoption of the euro fueled the expansion of banks to eight times GDP with the increase in deposits being loaned to Greece and Cypriots. We know what is happening to all of that money loaned to Greece. In Cyprus, Cypriots borrowed money to buy real estate creating a bubble that has burst.

Cyprus is now experiencing the consequences of burst bubbles with which we have grown so familiar over the past few years with decreasing GDP, increasing unemployment, large current account deficits and widening budget deficits:

cyprus-gdp-growth-annual cyprus-government-budget cyprus-current-account-to-gdp cyprus-unemployment-rate

Cyprus is a small country, so the amount it needs is a rounding error in the eurocrisis, a mere €17.5bn. You would think it would be easy to just cut the check and preserve the euro. However, if you have been paying attention to the Eurocrisis, you know that months of brinkmanship are required to push through any deal.

The problem here is that most of the money deposited in Cypriot banks is from Russian oligarchs seeking to avoid taxes and launder ill-gotten gains. The EU wants to be seen as being tough on tax evasion and money laundering, so it is insisting on harsh reforms for the Cypriot banking system.

Cyprus denies any wrongdoing, so we have reached an impasse. Ultimately, no country can be allowed to bring the euro down, so the Germans will whip out the checkbook. Until then, it should be a wild ride.

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