The conventional wisdom is that financial troubles in Cyprus have little bearing on the health of American banks and the U.S. financial system. That view may prove optimistic if problems in Cyprus spread to its neighbors.
The Mediterranean nation’s attempt to resolve its financial crisis on the backs of bank depositors has spooked global financial markets, worried neighbors and angered Russia, and rescue plans were altered after a public outcry.
How the resolution of problems in Cyprus plays out in coming days might have big consequences for Europe and the global financial system. Here are some answers to questions about how:
Q: Cyprus is a small island with a lot of bank deposits from Russians and other foreigners. Why should Americans care?
A: One of the deeper issues in Cyprus, as it was in nearby Greece, is whether and how a country exits the euro, the common currency used by 17 countries.
Q: How are they held captive by the euro?
A: Countries that run into financial troubles usually devalue their currency to make their exports cheaper and draw foreign investment. But one country cannot devalue the euro.
“Cyprus is sustaining all of the cost associated with leaving the European Union and none of the benefits,” said Phil Suttle, the chief economist of the Institute of International Finance, a trade association for global financiers started during the debt crisis of the 1980s.
The benefit of leaving the EU would be devaluing the currency. The costs include confiscated bank deposits, controls on removal of capital from banks or the country, scaring off investment, and very tough austerity programs that thwart near-term growth.
Q: What would happen if Cyprus exits the euro?
A: “Cyprus would be the canary in the coal mine,” said Scott Anderson, senior vice president and chief economist for San Francisco-based Bank of the West and a former Europe analyst.
If nothing else, an exit by Cyprus might signal bigger things to come. Larger troubled European economies, such as Spain and Italy, would likely attract more European rescue funds amid deteriorating finances. Smaller ones such as Portugal and Greece, which face tremendous citizen opposition to tough austerity programs, might be tempted to exit, too. It might begin an unraveling that proves hard to stop and carries global consequences if investors begin to doubt the future of one of the world’s three reserve currencies.
Q: Is the Cyprus mess harming American companies?
A: There’s little U.S. investment in Cyprus. But the actions against bank deposits are a wake-up call to U.S. multinational corporations. The levy on bank deposits will make treasurers of global American companies think twice about where they bank their foreign earnings and in what currency.
Dutch Finance Minister Jeroen Dijsselbloem also gave them plenty to think about. He heads a group of eurozone finance chiefs, and he said this week that Cyprus was a template for future actions. He touted having bank investors and depositors pay to save banks, and his words may trigger movement of investors’ money from weak banks to stronger ones in coming weeks, deepening the banking crisis.
The financial crisis hurts U.S. companies in Europe in other ways. U.S. automakers Chevrolet, Ford and General Motors saw respective European monthly sales declines in February of 38 percent, 20.8 percent and 20.1 percent, according to the European Automobile Manufacturers’ Association.
The EU as a whole posted a 0.5 percent contraction for the full year in 2012, and it shrank by 2.3 percent in the fourth quarter when compared with the three previous months. Almost all forecasters predict another year of contraction for Europe in 2013, and troubled countries are increasingly worse off.
More than a month after parliamentary elections in which a bloc led by a comedian topped the vote-getters, Italy still has no prime minister. Spain’s and Portugal’s deficits are widening despite austerity measures. In fact, Spain’s central bank this week forecast 27 percent unemployment for this year, and after 18 months of contraction it still sees no return to growth before late 2014.
Solutions for Europe’s problems still seem far off.