Living within our means: lessons from Cyprus

There is an old saying that it only takes one shot to start a war.

While technically correct, this ignores the build-up - a failure of diplomacy, increasing tensions, months or years of military escalation and a collapse of trust in the opposing government or military force - that ultimately leads to that first shot.

There is a parallel with the European sovereign debt crisis where one event in recent days could turn out to be the tipping point.

The debt crisis has taken years to develop as governments in Greece, Italy, Spain, Ireland and Portugal, among others, have steadily accumulated ever increasing levels of debt.

By consistently spending more than they derive from taxation income, false community expectations about the role of government have been created, which will be ever more difficult to wind back.

A failure of political leadership led to inaction until faced with imminent collapse.

This has led to a series of bailouts in the EU funded by the wealthier member nations.

However, the failure of massive bailouts to stabilise the situation has led to growing resentment among taxpayers in Germany, France and other European nations who have been footing the bill.

In turn that resentment has contributed to the controversial policy of austerity, championed by Germany, which imposes strict spending controls on governments in receipt of bailout funds.

Political turmoil was inevitable in those nations struggling under the weight of government debt.

There have been instances of strong leadership that ensured genuine efforts were made to meet the terms of the bailouts.

This would have ensured relative stability, despite significant angst and opposition to the policy of austerity.

However, all that changed last week when it was revealed that the terms of the proposed bailout of Cyprus included a tax of 9.9% on bank deposits of more than €100,00 and 6.75% on bank deposits of less than that amount.

Like the proverbial first shot, this announcement caused a collapse in trust and confidence that risks spreading to the European banking system.

A vote in the Cyprus parliament comprehensively rejected the terms of the bailout, which has plunged the small nation into further turmoil.

The damage this has inflicted on confidence throughout the Eurozone is potentially enormous.

Russian investors have been hit particularly hard as they have historically used Cypriot banks as an offshore financial hub, with more than €30 billion invested out of the total €70 billion held in Cypriot bank accounts.

President Vladimir Putin described the proposal as “unfair, unprofessional and dangerous”.

There are reports of Russian investors notifying banks in Cyprus of their intention to withdraw billions of euros.

Banks on the island have been and remain closed to prevent spooked locals withdrawing their savings en masse.

The citizens of Cyprus could not have anticipated this development for it is common practice throughout the EU for bank deposits of up to €100,000 to be guaranteed by the government.

There is a danger that confidence in the banking system has been shattered in other parts of Europe, even if the Cyprus proposal is not implemented.

Whether this act triggers a further crisis remains to be seen.

The lesson for Australia is clear – governments must learn to live within their means and public finances must remain on a sustainable footing at all times.

One of the great failings of the Gillard Government is its inability to curb spending.

From zero government debt to gross debt nearing $300 billion, the government has no plans to repay it.

The Gillard Government will be remembered as the most profligate and wasteful custodian of the Federal Treasury in Australian history.

This has made our nation more vulnerable to any shocks that could potentially come from a worsening of the European debt crisis.

The burden of paying down Labor debt will once more fall on the shoulders of a future Coalition government.