New Cracks Appear in the Eurozone From One Small Source

For the past few months, the eurozone financial crisis has significantly subsided, at least on the surface. However, because of the fragility within the eurozone, it won’t take much for a new financial crisis to be sparked.

There are new questions arising about the future of the eurozone, and these begin not with the giant nations of that union, but with tiny Cyprus.

Finance ministers from the eurozone countries are hotly debating much-needed bailout funds for the tiny island of Cyprus. One organization missing from these talks in Brussels is the International Monetary Fund (IMF).

As it stands, funds from the 700-billion-euro European Stability Mechanism (ESM) can only be dispersed if the IMF agrees to the cash payments. However, the IMF is disagreeing with some European nations as to the viability of Cyprus being able to pay back its debt under the current restructuring agreements. (Source: Pauly, C., et al., “Troika Travails: Split Emerges Over Cyprus Bailout Package,” Der Spiegel, January 21, 2013.)

Clearly, the financial crisis within the eurozone is not over if a nation like Cyprus is expected to have its debt load at 140% of its gross domestic product (GDP) by 2014—a clearly unsustainable level. This is the conclusion that the IMF has determined, and it is demanding that creditors of the banks within Cyprus incur a haircut in their principal or a decrease in their total claims.

Another serious worry for eurozone members is that Cyprus has a reputation of money laundering. With the financial crisis still a worry for many, especially the super-rich, having funds in accounts across the eurozone is clearly a problem. All citizens need to pay their fair share, and if one island nation is holding billions in assets hidden from the other eurozone members, this needs to be addressed.

While Cyprus is a tiny nation, this disagreement on how best to deal with the nation’s financial crisis is a great example of the inability of eurozone member nations and organizations to work together to come up with solid long-term solutions.

If the eurozone members in the IMF can’t agree on the bailout to avert a financial crisis in a small country like Cyprus, there’s not much hope or optimism for the much greater problems of their larger members.

While many investors have begun piling into eurozone investments, believing the worst of the financial crisis is over, this small split in views on how to handle Cyprus is indicative of possibly much larger problems to come.

The problem with so many eurozone members having interconnected ties across different countries is that it raises the issue of conflicts of interest. To avert a financial crisis, is it better to increase austerity at the price of local citizens while bailing out international investors? Or should creditors take some of the losses for their poor investments?

Similar questions continue to arise, and no end is in sight. The problem with the eurozone is that actions tend to only come because of a financial crisis. Very little progress is made when times are tranquil. But a financial crisis forces all eurozone members to focus on trying to solve some of the bigger problems.

The eurozone’s recent quiet environment is not due to the implementation of a long-term solution that will prevent any financial crisis down the road; it is simply buying time for member countries to enact the type of structural reforms necessary.

If the eurozone members do not take advantage of this lull in activity and simply waste time, the next financial crisis will be even worse.

Unfortunately, the only predictable outcome I can see for the future is that eurozone members will continue bickering.

investmentcontrarians