From a European perspective, the list of broken taboos and assumptions continues to grow. It includes:
1. EU sovereign debt cannot be restructured: broken by the Greek PSI.
2. Senior bank debt-holders cannot be bailed in: broken several times with respect to banks in Denmark, Ireland and now two Cypriot banks.
3. Depositors are sacrosanct: broken by Cyprus – deposits greater than the formal guarantee (EUR100k) in the two biggest banks, with EUR4.2bn of uninsured deposits in Laiki Bank set for a large haircut of unknown size, and Bank of Cyprus deposits set for a haircut of around 35% according to several news reports (eg, Economist, Reuters).
4. Depositors should not be punitively taxed: broken by the Cypriot government and implicitly endorsed by the EU, but vetoed by the Cypriot parliament.
5. If capital controls are applied in the euro area, it is ‘game over’: broken by Cyprus – banks were shut for nearly two weeks; draconian controls of uncertain duration have been imposed.
6. Discussion of a euro exit is ‘off limits’: already it is apparent that euro exit was discussed with respect to Greece during H1 12; this topic again re-emerged last weekend with respect to Cyprus.
7. The EU can rely on the IMF to be sympathetic in providing financing without haircuts, even for countries with high public debt: from the Greek and now the Cypriot experience, the Fund is evidently evaluating new programmes more critically, particularly when debt/GDP ratios rise above 100%.
Cyprus can also be considered “the exception that proves the rule”. The euro’s core founding principles, based on the Maastricht Treaty’s “irrevocable” fixing of currency rates, and of the free movement of capital, have been violated. The euro will never be the same again; its preservation now depends urgently upon economic recovery. Without the delivery of economic growth, unemployment will rise to yet higher post-war record levels, and the widespread and growing disillusionment felt by EU citizens towards their economic regime will threaten to spill over into more explicit questioning of the euro’s suitability.