Beaches and Banks: A three hour flight south from Moscow, Cyprus offered Russians a pleasant place to do their offshore banking. Photo: Cyprus Tourism Organization

Russia suffered a major defeat last week.
And no one noticed.
But the setback was so striking that President Vladimir Putin picked up the phone at 4 am on Thursday and ordered a surprise drill of 30 Russian Navy ships in the Black Sea.
The political goal was to flood Russian TV news with images of pretend naval heroics in the Black Sea. Ideally, this would distract attention from Russia’s real defeat in the neighboring Mediterranean Sea.
China has Hong Kong, an offshore island where British-style law guarantees property rights.
Similarly, Russia has Cyprus – British-style law, low taxes, and membership in the European Union. The formula was so successful that tiny Cyprus became the largest foreign investor in Russia.
Last week, when the financial merry go round stopped, currency controls froze as much as $30 billion in Russian deposits on the island.
Now, more accurately, Russia had Cyprus.

In face of the Cyprus debacle, President Putin ordered 30 ships of the Russian Navy’s Black Sea fleet to sea for maneuvers. Here the missile cruiser Peter the Great on an earlier exercise. Photo: Presidential Press and Information Office

The European bailout, designed in Brussels and Berlin, essentially ends Cyprus’ role as the premier offshore financial center for Russia. With currency controls now locking up billions of deposits, Russians’ number one goal in Cyprus today is get their money out of the island.
No wonder President Putin ordered the ships to sea – and ordered his officials to shut up about Cyprus.
Diversions, coincidental or otherwise, can be useful in politics.
President Ronald Reagan invaded the Caribbean island of Grenada two days after truck bombs killed 299 American and French soldiers in Beirut. Images of the American victory over Communist Caribbean forces quickly displaced those of the 220 dead U.S. Marines.
In Russia today, the loss of Cyprus highlights in stark detail the Kremlin’s real lack of influence over Europe.

Cyprus’ membership in the European Union and in the Euro currency zone gave Russian a false sense of security. Photo: EUCyprus

In Putin’s early years, he formed friendships with Germany’s Schroeder, Italy’s Berlusconi, and France’s Chirac. But in real democracies, the figures at the top change. Of the G-8 of 2000, only Putin survives, marching into a third term that is to stretch to 2018.
Handicapped by a personality based diplomacy, Putin had no powerful friend to call last week in Europe to block the EU’s strangling of the Cyprus offshore banking system.
As the crisis unfolded, Dmitry Afanasiev, a Moscow lawyer, wrote an essay in the newspaper Vedemosti urging the Kremlin to act. The essay seemed designed to drum up business with Russians planning to sue to get their money out of Cyprus banks. But Afanasiev let slip one interesting truism: “Russia has only one friend left in the EU, Cyprus, and that friend could be lost.”
That is a pretty depressing testament to the efficacy of Russian diplomacy.
While we Americans think that the Kremlin only picks on us, the Europeans have been stewing in silence in recent years.

Raising the comfort level for many Russians, the Greek population of Cyprus overwhelmingly follow the Orthodox branch of Christianity, as attested by this church in Platres, Cyprus. Photo: Cyprus Tourism Organization

The Kremlin’s clear use of oil and gas deliveries as a political cudgel has scared Europeans into building terminals to receive natural gas from the Persian Gulf, into interconnecting gas pipelines and into developing shale gas and oil resources.
Russia’s spreading anti-gay legislation offends many Western Europeans, fueling anti-Kremlin rallies. Watch how President Putin’s visit to Amsterdam goes off on April 8.
And the Kremlin’s relentless crackdown on civil society alienates democratic Europe. Recent police raids on German political party foundations in Moscow and St. Petersburg prompted front page articles in Germany – just when the Kremlin needed someone to call in Berlin.
Realpolitik strategists may say “goodwill” does not carry weight in international relations. But, as Putin might recall from his days in the 1960s as a self-described “punk” on the streets of Leningrad: what goes around comes around.
Increasingly at odds with the West, Putin’s Kremlin is defaulting to the mentality of Russia’s 1880s Emperor, Alexander III, who said: “Russia has only two friends: its Army and its Navy.”
The Cyprus case not only illustrates how estranged the Kremlin has become from Europe. It also illustrates how the Kremlin’s rhetoric often masks a lack of action.
President Putin’s spokesman criticized the bailout plan as “unfair, unprofessional and dangerous.”
Prime Minister Dmitry Medvedev accused the EU of acting “like an elephant in a China shop”. He warned the continued currency controls “could even bury the whole banking sector of Cyprus. It will cease to exist.”

Russians fly South to enjoy the sun and the warmth of Cyprus, here on Agia Napa beach. Photo: Cyprus Tourism Organization

The warning signals on Cyprus were crystal clear over 18 months ago.
With Cypriot banks heavily invested in Greek government bonds, Cyprus looked less like a Mediterranean Hong Kong and more like a southern extension of Greece. But the Kremlin missed the window to be proactive.
The Kremlin had another reason to change the subject when Cyprus came up. In recent months, Putin has launched a highly public anti-corruption campaign. One element is the ‘de-offshorization” or curbing the Russian practice of parking money outside the country for safekeeping.
A Cyprus bailout does not fit into this narrative. On one hand, Cyprus drew deposits that were undoubtedly the fruit of corruption. On the other, Cyprus drew deposits from Russians seeking protection from corruption. Bailing out an offshore tax haven for Russian oligarchs will not boost Putin’s popularity rating at home.

Spring in Moscow. Snow fell on March 31, the Sunday celebrated in the West as Easter. Photo: James Brooke

But, if the Kremlin had been more nimble and decisive, it could have pulled off bold coups.
With $460 billion in foreign currency reserves, the Kremlin could have crafted a bailout tied to Gazprom’s development of Cyprus’ offshore gas reserves. With Syria’s civil war threatening the future of Russia’s only naval base in the Mediterranean, at Tartus, Syria, the Kremlin could have told Cyprus to add a naval base to the deal.
Instead, the Kremlin seems to have fallen for one of the oldest tricks in the political book – bamboozled by the leader of a small country who fluently speaks the language of the big country.
In the Cyprus case, the soothing words came from Demetris Christofias, Cyprus president from 2008 until Feb. 28 – five weeks ago. A leader of Cyprus’ Communist party, AKEL, Christofias studied history for five years in the Soviet Union in the 1970s. In his meetings as president with Kremlin leaders, Christofias may have said nice things, in Russian. But clearly, he had a, um, fuzzy understanding of finance.

Sunset for Cyprus as an offshore banking center for Russians? Tourists will always come to escape the cold and enjoy the vistas, such as this sunset at Larnaka. Photo: Cyprus Tourism Organization

So Cyprus became a Russia-friendly island in recent years: a Russian-speaking president who loved Moscow, a people who shared Russia’s Christian Orthodox faith, the security of the Euro zone, lawyers and accountants with impressive British accents, and all those nice Russian-speaking waiters and real estate agents.
Unfortunately, few Russians bothered to read the fine print. Or, if they did, take it seriously. As in most European Union countries, bank deposits in Cyprus are insured for the first 100,000 Euros, about $130,000.
If you parked $10 million in Cyprus last month, you are now painfully aware that insurance does not cover $9,870,000. And what remains after the bank reorganizations may be locked up for years.
All the missile cruisers and mine sweepers churning the waters of the Black Sea are not going to reverse Russia’s loss of Cyprus in the Mediterranean.