Cyprus is teetering on the verge of bankruptcy…

Cyprus is teetering on the verge of bankruptcy. This once again highlights the fragility of the eurozone and the safety of European banking deposits, particularly those in countries with sovereign debt problems. By most accounts, Cyprus is tiny and hardly worth mentioning here. Its $30 billion of GDP (gross domestic product) represents about 0.2% of the eurozone’s total GDP, or about one-tenth the size of Maryland’s GDP. The island’s total banking assets stand at around $160 billion but that’s still less than 10% of the assets held by Bank of America. To avoid bankruptcy, Cyprus needs about $13 billion, a figure that’s dwarfed by the ~$220 billion doled out to Greece in 2010 and 2012.

Given the relatively tiny sum of funding, why are global investors closely watching Cyprus? The original bailout package proposed on March 16th included something very unusual-a stunning 10% tax on depositors to cover about 60% of the rescue. Apparently this was aimed at pleasing German voters and stripping Cyprus of its status as an offshore banking haven. Although that proposal was shot down, it does raise a question: If Cyprus can try to confiscate deposits, what’s to prevent the same from happening in the other countries with sovereign debt problems (e.g. Portugal, Ireland, Italy, Greece, and Spain)? That prospect, although distant, could scare depositors possibly spurring a bank run in those countries. Clearly, this question was on the top of investors’ minds when global markets opened last Monday. Luckily, however, depositors across Europe handled the Cyprus crisis in stride. For example, gold, which is typically viewed as a currency of last resort, finished up just 1% for the week. Meanwhile, the Euro fell less than 1% compared to the US dollar.

The bigger concern lies in the fate of the eurozone. Should Cyprus fail to reach an agreement on a bailout, there’s a remote chance it could exit the eurozone, perhaps setting a precedent for others to follow. That would be a big game changer, and clearly the last thing European leaders want to see, considering the painstaking efforts and large bailouts since 2010 to hold the zone together. For this reason, we think it’s likely both sides will ultimately reach a compromise.