Colin Chapman: The clock is ticking for a solution to Europe's latest crisis: broken banks in Cyprus, a small divided island outpost of the EU strategically located off the coast of Lebanon and Syria. Once the stuff of spy novels, Cyprus now has politicians, bankers and bureaucrats scratching their heads and trying to find 5.8 billion euros — that's just under $7.5 billion — to secure a European rescue package of about $13 billion. The deadline is Monday. The banks are closed until Tuesday, but worried Cypriots have been at the ATMs pulling out what cash they can. Welcome to Agenda. I'm Colin Chapman, and with me is George Friedman, Stratfor's founder. George, how does Cyprus differ from other bailouts like Greece and elsewhere in Europe?
George Friedman: It differs in a fundamental sense and that it has a great deal of Russian money there. It has been a bank center — tried to become a banking center to replace the Swiss, Liechtenstein and so on — tried to become that and did become that, and the Russians have used their banking system for quite a while. One of the important things about Cyprus is that it has substantial oil and gas reserves offshore. And, for example, the Israelis have been involved in developing some of them. It's very close to the Levant, it's very close to Lebanon, it's very close to Greece, it's close to Israel. It's close to many things, but in and of itself, it's not going to tilt the direction in which the EU goes.
However, what has been created here is a massive crisis in this small country. And that seems to be the major product of the European Union these days: massive crises. This one is in many ways unprecedented, because one of the solutions the government felt it was forced to undertake — which is literally seizing a percentage of bank accounts indiscriminately. And that's not been done before — I mean, the seizure of property in order to manage financial shortfalls, sovereign debt problems, and so on to balance, control the banking system — that hasn't been done yet in Europe. And this is an extreme level that may be one off. But one thing we've learned with the European crisis is the things which were unthinkable before not only become thinkable but at a certain point become general. And this really is a question of whether or not this is going to become a standard tool.
Colin: Cyprus' finance minister went to Moscow, and it seemed at one stage that the Russians might come in and bail them out. After all, Russian companies have a reported 25 billion euros on deposit in Nicosia's banks, which is more than the country's GDP. But the Russians were unconvinced. All it did was to queue up Premier Dmitri Medvedev to fire an icy blast at the EU for incompetence and for treating Cypriots with the same disdain the former Soviet Union had shown toward small savers.
George: Well, I mean, you can measure the EU when the Russians are criticizing your managerial competence. It's fairly impressive. But look, I mean, a lot of the money that is in Cyprus came from Russia. But a great deal of that really came illegally or informally. And the idea that they're going to save the Cypriot banks in order to protect the people who have taken money out of Russia and deposited it in Cyprus — was a little farfetched. The Russians looked at this in terms of what it would cost, and I think although they had some interest in saving Cyprus — partly for political reasons, to show their muscle, partly because they've historically been interested in Cyprus as both a listening post and a foothold in the Middle East. For all of these reasons they simply decided they couldn't afford it, that it wasn't very attractive, and that gives you some idea of how serious banking crisis was.
Colin: And as we speak, the European Central Bank is saying you've got a couple of days to accept our terms, or no deal. Which would mean two of the biggest banks would fall over because Cyprus can't take over their debts — that would run to 145 percent of GDP. Meanwhile, the Cyprus government has offered to protect depositors up to 100,000 euros. Those with more pay a tax. This is clearly aimed at the big Russian depositors, many of whom are using lightly regulated Cyprus as a place to launder money — a point conceded by Medvedev.
George: Well if you're the European Union, and you want to demonstrate something you've not demonstrated before — the will to impose extraordinarily painful sanctions — Cyprus is the place to do it. Because what ever happens in Cyprus really isn't going to change the equation in the European Union. If they choose to default, the assumption is that no one will follow them for that. If they're forced to default, it is simply too small a place to play. From the Russian point of view, they're just not that interested in what happens in Cyprus. So this is where the European Union has decided to take a stand because it couldn't afford to take a stand in Spain or Italy or anywhere else.
Now the question really becomes — and this what gets frightening for the Europeans — is assume that the Cypriots either default — say basically, "Look, we're not going to take this, we're better off going ahead without confiscating money and just starting over and being frozen out of money markets — well the only thing that we're being frozen out of is cash to save the banks, we don't see any of that anyway. Let's go this way." Or they'll go ahead and do it. Either way this is going to scare the daylights out of the Greeks, the Spaniards, the Italians. Because once you have this precedent set, of this sort of demand, they'll be waiting for when the demand of this sort will come to them, if it will. So if the European Union is going to be that harsh with Cyprus, who else will it be that harsh with? And this is the problem, really, for this entire maneuver. Which is the last thing that the Europeans or the Germans want is defaults in Greece or Italy or Spain. They don't want people walking away from their debts. They're trying not to impose overwhelming sanctions that would cause that even though already the pain that's being caused in countries with 25 percent unemployment is enormous. So the Europeans are playing, I think, with a bit of fire here. I think they know it. But on the other hand, they're afraid that if they don't take a stand somewhere they will have no credibility whatsoever. On the other hand, beating up on Cyprus is hardly going to give them a sense of authority and power.
Colin: And I suppose, just to conclude, Angela Merkel, the German chancellor, has to stick with this. She has an election coming, and any softening of this bailout and opinion would turn against her.
George: Well the problem is that Germany has an unemployment rate below 6 percent. Spain has an unemployment rate that's 26 percent. The Germans are terrified that that unemployment rate will spread to them. Which could happen if you have a slowdown in Europe, which you have — which could happen if the free trade zone broke down, which is not yet happening but may. So when you look at it from the German point of view, the election is always a concern, but there are real fears. The question for the Germans is how do you protect the German economy from everything that's happening in Europe? And it really doesn't involve, at this point, financial issues alone, because as you impose austerity you decrease the amount that these countries can purchase. That decreases your German exports. It's a very nasty cycle. So almost inevitably, if this recession throughout Europe continues, the question is going to be — and Germany's having one too — when does the German unemployment rate soar? And that, of course, is going to be a game changer for politics in Germany and therefore for Europe.
Colin: Stratfor's Founder and Chairman George Friedman, ending Agenda. You can follow the developments on Monday on our website at stratfor.com, for this issue may be with us for some time yet. Thanks for being with us. See you next time.