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Cyprus Points to Euro Folly

In a report discussing the Cyprus situation published early on Thursday, Credit Suisse's European Economics Team said "we expect real GDP to decline by more than 20% in the next couple of years, rendering many assumptions of the bail-out obsolete. Cypriot unemployment is likely to rise above 20%."

If the economy in Cyprus tanks to that extent, the assumptions underlying the recapitalization of its banks will be in doubt. The country's banking sector may need another large cash infusion down the line.

If Cyprus had its own currency, the country at least could take measures similar to some of the ones taken by the Federal Reserve in the U.S., on a much smaller scale, to limit economic damage.

After securing the European bailout and the "bail-in" by the large depositors, Cyprus reopened its banks on Thursday, with a limit on withdrawals to 300 euro per day, while allowing people leaving the country only to take up to 3,000 euro in cash, in any currency. The government of Cyprus also announced that "Businesses will be able to carry out transactions up to €5.000 per day, per account and pay staff salaries. Payments and or transfers outside the Republic, via debit and or credit and or prepaid cards are permitted up to €5.000 per month, per person in each credit institution."

Those are very strict capital controls, and will no doubt severely curtail economic activity in Cyprus. Just imagine how difficult it will be for some businesses to operate, when they can only make transactions of up to 5,000 euro per day.

Germans Set Stage for Saying No

European officials are hoping the Cyprus deal will resolve the country's banking crisis, and that the "bail-in" will be a unique event. However, with much larger banking crises in Italy, Spain and Portugal still unresolved, the euro area may be headed for many more complicated bank resolution scenarios.

And political leaders of the European countries with the strongest economies, especially Germany, have to take their own citizens' views into account. There's a limit on how much wealth can be transferred south.

The Deutsche Bundesbank on March 21 published the results of a study on the distribution of wealth in Germany and found at the end of 2010, the average (mean) German household had net household wealth of about 195,200 euro, and that the median German household had net wealth of roughly 51,400 euro.
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