Back in the day, in the 1500s and earlier, when Europe’s crowned heads got their financial butts in a crack, one of their favorite devices to raise a bunch of money without calling it a “tax” was the involuntary “loan,” which of course was typically never paid back.  Henry VIII, if my memory on the subject serves, was rather a fan of the method, since for all his absolutist yearnings he still had a Parliament that was very conscious of its control over taxation (itself a power wrested from Edward III in the course of his pouring money down the rat hole of the Hundred Years War).  Later on, in the early 1600s, when Charles I was falling out with Parliament, he attempted to use the ancient levy of “ship money” to raise general revenue.  It didn’t work for him.  Even later, in the 1860s, when Wilhelm I wanted to raise the length of conscripted service in the Prussian army from two years to three, the Landtag balked at raising the money for it.  A constitutional crisis threatened and in desperation Wilhelm summoned a previously-obscure Prussian Junker to Berlin.  Otto von Bismarck was Johnny-on-the-spot and got down to business, with results as known.

But O! what Henry, Charles, Wilhelm, and the rest of them could have done if only they’d thought up a single currency — call it the “Euro,” perhaps — and a continent-wide central bank, and a raft of bureaucrats to administer the whole show.  They all could have lived far above their means and then handed the bill to their neighbors.  They could agree to a “bail-out package” that makes the levy of ship money look like pocket change.  They could agree to deals which cut their troublesome parliaments, Landtag, and the like out of the picture.

Just like is happening in Cyprus, right now.  Cyprus, in addition to being the site of one of the Western world’s most ancient cultures — and most intriguing, with its as-yet undeciphered linear script and its cataclysmic destruction — as well as a bone fought over since the dawn of history — the Ottoman sultan’s flaying alive the commanders of captured garrisons was neither the first nor the last barbarity played out — is almost a self-parody of a nasty, corrupt little hell-hole of a country that is run more as an off-balance-sheet investment of international criminal circles than anything else.  Its banking and finance sector especially, we are told, has battened on money-laundering Russian kleptocrats and their ilk.  In one respect, however, it also resembles its other Mediterranean neighbors:  For years it’s been living beyond its means and now the piper must be paid.

And so once more the world gets a front-row seat as you have, on one side, the compulsive addict/alcoholic who demands that the rest of Europe cover not only his accumulated bar tab, but also negotiate a special all-day happy hour price for his continued tippling, which he adamantly refuses to cut back, and on the other side a bunch of deep pockets who can’t decide if they’re the Temperance League, a methadone clinic, a personal life coach, a bartender, AA, or some combination of all five.

There is this difference, though:  If Cyprus went bust and left the Euro, no one would really notice the difference one way or the other.  I mean, the total bail-out numbers being bandied about are in the €15 billion range, which is a rounding error in Spain, Italy, and Greece.  As one might expect, this point of distinction expresses itself, among other ways, in the conduct of the bargaining process, and the degree to which the Golden Rule (i.e., the man with the gold makes the rules) is applied.  In Greece and Italy there’s been a great deal of back-and-forth, and extensions of deadlines, and re-negotiations of terms, and so forth.  Cyprus is getting a whacking great dose of “Shut, they explained.”  Specifically, they’re having to come up with roughly a third of the cost of the total bail-out package, in cash, and do that from their own economy.  Five billion Euros might be a rounding error in Greece, but in Cyprus that’s a pretty big nut.

The original package contemplated a levy on all bank accounts (even the insured bank accounts), ranging from around 6.6% for smaller depositors to a figure just under 10% for the Russian kleptocrats.  That deal got shot out of the saddle by the Cypriot parliament.  The next idea floated was to nationalize the retirement funds of government employees into a “solidarity fund” that was to be secured by gas concessions to be granted; additional money was to come from the Cypriot Orthodox church’s assets.  That idea went nowhere as well.  Mind you, the banks are closed right now and have been for some days.  The country’s ATMs are letting people pull out as little as €100 per day, and the lines are getting longer by the hour.  After the “solidarity fund” notion tanked, the discussion turned back to a variant of the original deal, with some significant modifications.

On the sidelines is Vladimir Putin, whose kleptocrat buddies have over €24 billion on deposit in Cypriot banks, and have made a further €31 billion in loans to companies based (nominally cough! cough!>) in Cyprus.  In considering those numbers one must bear in mind that a good chunk of it represents money laundering and asset-hiding, and that the people doing it are Putin’s friends, political supporters, and very possibly undisclosed business partners.  So Vlad has has Gazprom, the slush fund piggy bank national hydrocarbon giant offer to restructure Cyprus’s debt in exchange for that seven trillion cubic feet of natural gas.  If not he’s toying with his options, including dumping some sizable portion of Russia’s Euro-denominated foreign reserves (wonder what that would do to the calculations of the savants in Brussels?).

I’m not sure whether I see it as a proxy fight between Germany and Russia, as this article does.  Nor do I necessarily fault Merkel for respectfully declining to use German taxpayers’ money to bail out Russian criminal enterprises.  But there’s no denying what’s going to happen when the banks open back up.  Everyone who can — including the small depositors — is going to bust a gut to put his money anywhere other than a Cypriot bank.  Lopping off a chunk of some people’s deposits is to let a horse out that cannot be re-stabled.  The Cypriots may be running a banana republic without the bananas, but they’re not stupid; they know that once you go down that road it’s just a question of time before some government does come after their money, or their retirement accounts.

Now the EU weenies and the Cypriot government have reached a deal.  It goes back to the original notion of a decapitation haircut for depositors and bondholders.  There are some differences.  Most importantly, deposits less than €100,000 are to remain untouched; they will, however, get a new banker: the Bank of Cyprus, the country’s largest bank.  Deposits above that sum are looking at a levy of up to 40% (although over at ZeroHedge they’re not buying that 40% limit for a moment), and being stuck at Laiki Bank, which will be wound up.  The whole deal has been structured so that it’s technically not a tax on the big depositors; were it otherwise the deal would have to be passed on by the Cypriot parliament.  Gentle Reader is invited to speculate on what is the likelihood that those folks, most of whom can be presumed to be directly or indirectly on the Russian payroll, and who’ve already rejected the much milder 9-odd percent levy, would approve a deal that essentially takes their party boat out over the continental shelf and blows scuttling charges all up and down its keel.

I haven’t seen anything on whether capital controls are also part of the deal but seriously, aren’t they almost inevitable?  I mean, why would a Cypriot small business owner continue to deposit his money at home when under EU rules he can dump it into a Deutsche Bank account in Frankfurt?  After the terms of the Greek bail-out began to take shape, billions of Euros left that country, large sums of it being transferred by senior politicians.  So let’s see where that leaves Joe Cypriot.  If you save your money by putting it in a bank account at home, you have no idea whether in the dead of night the government is going to lock down your bank and take as much of your account as pleases them for that night.  If you save for your retirement by putting your money into the Cypriot equivalent of a 401(k) or 403(b), your retirement nest egg might or might not be nationalized.  If you earn — on the books — more than bare subsistence, you have no place to put your money other than a fruit jar buried out back.  Since most if not all of your fellow-citizens will be able to figure the game out just as well as you, your local banker is going to be starved of depositors and thus liquidity, and so good luck on getting that bank loan to start/expand a business, or even earn a halfway decent return on what you do dare deposit.  If you’re a business looking to expand or invest overseas, exactly what positive incentive do you now have to consider, even for a fleeting, drunken moment, putting your money into Cyprus?

What is all that going to do to the Cypriot economy in the long term?  Well, for starts it’s going to drive a healthy part of it underground.  What the government can’t see it can’t expropriate and can’t tax.  Secondly it’s going to shrink the size even of that partially-underground economy.  Just about every history of the Scottish and English border marches ascribes its grinding, unending poverty to the structural uncertainty of limited land tenure, endemic public and private violence, and general inability to have any reasonable assurance that the fruits of today’s labor would not go up in smoke — quite literally — tomorrow.  Cyprus and the EU have just recreated that world, which James I in Britain crushed at the outset of the 17th Century, in a modern European island paradise.  True enough, the Russian criminal element will take a beating, but they’ll get theirs back from the skin of the patient, ever-oppressed narod of that unfortunate land.  But the true victims of all this are going to be exactly those small depositors in Cyprus who might, given enough generations, have made something of their homeland.  When economies collapse the already poor have nothing left to lose and the upper echelons have the ability to weather the storm.  It’s the middles who are destroyed.  Germany in the 1920s and 30s got to experience where that train takes you.  Will we see something like that in Cyprus?  Will Russia step into the shambles and set up shop?  Just a couple hundred miles from Syria, and less than 100 from the Turkish coast?  How’s that likely to work out?

Update [26 Mar 13]:  And sure enough, the Powers That Be are already wistfully wondering whether the Cyprus bail-out might become a template for future Eurozone bail-outs.  Immediate push-back, of course, arises, with the spokesman for the EU internal market commissioner emphasizing (a) that Cyprus is plainly (got that? plainly) a one-off case that cannot serve in any fashion as a precedent for any future situations, and (b) we need to figure out a way that taxpayers don’t keep getting stuck with the bill.  OK, as long as we’re clear about that.

The Luxemburg foreign minister is also quoted in the linked article.  He’s upset that Germany’s finance minister observed that Cyprus needs to alter its “business model.”  He objects to that expression, implying as it does that Cyprus (and other tiny European countries, such as . . . Luxemburg) has whored itself out as a haven for tax evasion and shady financial dealings.  The foreign minister accuses Germany, France, and Great Britain of seeking “hegemony” in the international finance markets.  It’s “un-European” for the big players to suggest that outfits like Cyprus ought to limit their financial sectors to ahem> legitimate financial business, and not serve the Putins of the world.  It bothers him that Germany is leading the charge in suggesting that those who benefit from playing in the shadows of places like Cyprus need to pony up when it’s time to bail out their benefactors.

Stand by to stand by, as we used to say in the navy.

Update [28 Mar 13]:  Well, here’s one for can’t-put-it-back-in-the-horse:  The EU internal markets minister is proposing to introduce a bill that will explicitly permit larger depositors (those above €100,000) to get shorn in the bank liquidation and/or bail-out process.  That didn’t take long.  So much for the Luxemburgers’ pronouncements that Cyprus is just obviously a one-off, no-precedent-here situation.