Little Island, Big Problem

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Byline: Steve H. Hanke

The financial crisis in Cyprus has global ramifications.

Who's going to bail out Cyprus: Brussels or Moscow? That's the multibillion-dollar question. In mid-March, the European Union and the International Monetary Fund proposed a rescue package for the tiny island--to the tune of roughly $20.5 billion. But this bailout proposal was different: $13 billion in aid being offered was conditional upon Cyprus raising the remaining $7.5 billion through a hefty one-time tax on its bank depositors. Not surprisingly, the Cypriots, among others, were not pleased with this idea. And on March 19, to Brussels's surprise, the Cypriot Parliament overwhelmingly rejected the bailout package. Officials are now scrambling to arrive at a solution before March 26, when Cypriot banks are scheduled to reopen.

To some, the Cyprus crisis may seem like much ado about nothing--surely a tiny country of under a million people couldn't possibly destabilize an institution as large and established as the European Union, right?

Wrong. For starters, Cyprus's banking system is actually quite large--more than eight times larger than the Cypriot economy itself. What's more, if Cyprus does end up partially financing a bailout using depositors' money, it would set a dangerous precedent and could shatter confidence in an already-fragile European banking system. And if Cyprus's banks do go bust, it would send shock waves through the markets.

Still, questions linger: why is this crisis happening now? And why did the EU prescribe such a bitter pill for the Cypriot depositors? If we look at who those depositors actually are, a clearer picture begins to emerge. The first thing to note is that European depositors' money began to flow out of Cyprus's banks back in 2010, and by now, most European depositors have already left. …