Cyprus- Bailing out Economic Bubble

Paul Krugman summarizes the origins of Cyprus' problems in (here): the banking system, a housing bubble and an overvaluation. He says that it was as “if Cyprus has managed to combine in one place everything that has gone wrong elsewhere”. One could add policymaking to it.

I’m from a country that had (and has) “creative” policymakers. We’ve seen a lot here. Especially during hyperinflation-years. But, what I see emerging from a small island can put all the wrong Brazilian attempts behind. It just scares me.

The way out found by Cypriot policymakers was to tax deposits to help pay the bills. I’m not kidding. They’ve decided to impose a suddenly loss of wealth in country lacking competitiveness (the overvaluation issue), whose problems emerged from the banking system, though it still depends on financial services, while housing prices are correcting the distortions brought by a housing bubble. But there’s more. It is a country that does NOT have monetary policy to fight recession and whose government finances are problematic.

If it wasn’t enough, it brings the fear of a banking run. A banking holiday was instituted to contain the damage. Well, good policies would be a better way for containing the damage. Furthermore, it raises problems outside of the island. Cyprus participates in a monetary arrangement called Euro zone.

The Cypriot policy brings uncertainty to what could happen in other problematic countries. The possibility of a banking run in Cyprus, or the mere thought that something similar could be done in another country, could trigger the end of the time brought by Mario Draghi’s whatever it takes.  

The problems in the Euro Zone were far from being resolved, but at least markets were calm enough to provide European policymakers time to waste. I wonder what’s coming.