In the past eight months before Cyprus erupted people have frequently reminded me, often with a smirk, of a forecast I made in late November 2011. On these pages, I declared that eurozone leaders had 10 days to save the euro. I made an ultimately similar, though less dramatic, prediction in 2006 when I wrote that Romano Prodi’s administration offered Italy’s last chance to achieve a sustainable position in the eurozone.
Mr Prodi’s administration did not deliver. The 10 days in 2011 passed without action. It is 2013, the euro is still there, Italy is still in it – and I am still making forecasts. Undeterred, I will double down today. A eurozone that compromises countries as diverse as Germany and Cyprus is not sustainable, even if the EU and Cyprus manage to find a last-minute compromise. An operational banking union that comprises supervision, resolution and deposit insurance would have been a minimally sufficient condition to make a divergent monetary work against the odds. It would have solved the problems of the Cypriot banks for sure. But the eurozone does not have such a banking union. It will not have such a banking union in five years. Germany rejects it flat out on the grounds that it is too expensive for the German taxpayer. Ironically, Cyprus would also reject it as it would kill the country’s business model as an offshore centre for foreign deposits. Whatever banking union will ultimately emerge in the long run will be irrelevant to this crisis.
What happened in Cyprus last week is not a deep cause of anything. But it is a perfect illustration of the eurozone’s collective action problem. This latest escalation began with the dangerous agreement to bail-in insured depositors. Eurozone officials are as legally literate as they are economically illiterate. Their ever so brilliant idea was not to haircut insured deposits of under €100,000, but simply to tax them. They did not realise that if they take away the promise inherent in deposit insurance, they are in default, and in danger of starting a bank run.