Letter from Cyprus

The warm breeze of spring is finally embracing Cyprus. So far, 2012 has been unusually wet and cool. For most of the year, Cyprus is brown and semi-arid but this year the grass is green and the fairways at the hilltop golf course at Tsada are as spongy and verdant as they’ve ever been.

When I first visited Cyprus in July 2008 it was in the grips of a severe drought. The land looked barren and the dams so depleted the government was buying tanker loads of fresh water from far away Greece. Now the dams are full to overflowing, creeks are gurgling to the sea and drought couldn’t be further from the most pessimistic of minds.

Now, those minds, and even the minds of the optimists, are focussed elsewhere. Their anxious gaze is towards Greece and the fate of its embattled economy.

Cyprus is an undeserving victim of the Greek tragedy. After all, very little of its trade is with Greece and outside of the financial sector, Cyprus is much more dependent on the rest of Europe and Russia. But the Greek Cypriots – that’s 80 percent of the population – have a natural and obvious affinity with what they like to call their motherland. Greek flags proliferate all over southern Cyprus and their national anthem is the same as Greece’s.

So it’s hardly surprising that Cypriot banks have over the years bought Greek government bonds and have lent heavily to Greek companies and individuals. Their exposure to Greece is said to be around 26 billion euros. To put that into perspective, the total GDP of Cyprus is something like 20 billion euros. Of that money, 5 billion euros was in Greek government bonds but the banks have now lost about three quarters of that. So the government has had to start bailing them out.

The nightmare for Cyprus is that Greece leaves the euro. If that happens, then the value of all those loans will at least halve, if not worse. Overall, the Cypriot banks could lose about 5 billion euros on top of what they’ve lost already. And if that happens, the Cypriot government will have to get support from the European Union or it too would follow Greece into bankruptcy and out of the euro. That support from the EU would come with conditions such as lower wages, public sector sackings and cuts to pensions and health services.

Poor little Cyprus. Since the war in 1974, they’ve painstakingly rebuilt their economy and run their budgets with Costello-like proficiency. But like a swimmer stranded near a sinking ship, they are being sucked under – or will be if Greece leaves the euro.

Now Cyprus is small compared to Spain or Italy. Contagion to Cyprus can be managed by the EU but the bigger countries are another matter. The simple point is, this can’t be allowed to happen. Germany in particular has a great responsibility to stem the tide, to stop the euro sliding into a catastrophe.

I’ve always said the euro is the triumph of politics over economics. It is about European integration, not economic management. Economically speaking, the 16 euro-economies don’t have enough in common to justify a single currency. Their trade patterns are diverse, for a start. Spain’s trade and investment is in Latin America. Germany is more global. Countries like Austria and Finland feed off the might of the German economy. Greece is about shipping and tourism. The Netherlands is a global entrepôt. And so on. They’re all different.

They’re also at different stages of development, have different fiscal policies and priorities. Now, the euro makes no economic sense. It is a political tool to draw Europe ever closer together. Therefore it comes with a price. The richest, most successful economies in the eurozone have to pay that price.

Germany knows about the triumph of politics over economics. The reunification of Germany cost the former West Germany about $2 trillion. Now they’re going to have to put their hands in their pockets again and guarantee the loans of Greece and other weak eurozone countries like Spain and Portugal.

None of the options is going to win votes. Bailing out the Greeks and their non-performing, profligate colleagues will be resented by German voters. It will cost them money and they don’t think it’s fair that their hard earned earnings should support irresponsible spendthrifts. So that will cost Angela Merkel precious votes in the lead up to next year’s federal elections.

Not bailing them out will cause enormous hardship to millions in at least Greece. Already, over the last four years Greece’s GDP has shrunk by about 20 percent. If they’re not bailed out by the Germans then it will simply collapse.

This situation is summed up with an old German proverb that Chancellor Merkel may be familiar with: ‘Better an end with horror than horror without end.’