Cyprus is going to be the new “poster economy” for the damage poor governance and an economy-“saving” bailout can do — forecasts of the carnage now range from 15% to 25% over the next two years as the economy contracts rapidly into a deep recession from the ending of offshore financial services (the only growth industry in the past 30 years), rising unemployment and no spending from consumers shellshocked by the attempt to seize some of their savings in the first bailout offer nearly two weeks ago.

Cyprus’ future reminds of stories from the US side in the Vietnam War, where the military said it had to level the village to save it. What we have seen in the Cyprus bailout in the past fortnight is yet another example of how Europe struggles to confront and then resolve its problems.

In every eurozone crisis the EU, the European Central Bank and the IMF all do just enough to resolve the current problem via a bailout or policy change, but never do enough to make sure all future problems can be more easily tackled. Nothing more can be done because the political will isn’t there (read: Germany isn’t interested). Much of the eurozone have long memories of German marching tours of their countries in 1870, 1914 and the biggest of all, 1939-45. Those memories linger and hold back what the euro is demanding — a fiscal and banking union.

And along comes tiny Cyprus as the 2013 crisis (or a warm-up), and suddenly all those old verities established in the previous bailouts have been blown out of the water. It was too small to worry about, but its problems were so outsized (too many foreign bank deposits) that bailing out and resolving Cyprus’ crisis has taken the eurozone to where it doesn’t want to go — where the convertibility of the currency across the borders of all 17 member countries will no longer be as free as demanded in the various treaties. Capital controls in Cyprus to prevent a crippling flood of money out of the country and the collapse of the economy have driven a worrying wedge into the zone from the weak southern periphery. It could prove fatal in years to come.

There is every chance Cyprus will witness an eruption of non-euro-based payment and settlement systems in coming years because no one trusts banks, no one has much cash, and a shortage of euros force people to look elsewhere for income and value. Estimates are firming that big depositors in Cyprus banks of over 100,000 euros face losing 40% of their holdings in the revamp, an incredible loss, which could spread to the UK, where several Cyprus bank branches are located.

Once that starts happening regularly, the euro goes from being the sole currency of Cyprus to one of several. Such a situation already exists in countries such as Russia (ruble and greenback) and Argentina (peso and greenback), but not in an area of 17 countries united financially and by one currency. If it happens, it will be a slow but steady development for as long as Cyprus is cut off from the rest of Europe and people have a fear of banks.

It’s even worse broad terms: Cyprus now faces a future as bleak as any country has faced in recent times — more miserable than Greece, tougher than anything Argentina faced a decade ago, or Russia after its default in 1998. Cyprus has just 860,000 people and accounts for only 0.2% per cent of eurozone GDP ($US23.25 billion in 2012). Growth is sliding, down 1% in the final quarter of last year and 3% over all of 2012, one of the largest falls in the eurozone. Some early estimates suggest the economy will contract by a massive 15% this year, and a further 5% in 2015 to be 20% or more than $US4.6 billion smaller at the end of next year than at the end of 2012. If that happens, the country will resemble a wasteland with high unemployment, low levels of activity and a shrinking currency base.

Laki and Bank of Cyprus, the two main banks, have a total of 10 billion euros or around $US12.9 billion in what’s called Emergency Liquidity Assistance from the European Central Bank. That assistance will have to be maintained for an indefinite period because without it, the country’s financial system will evaporate. Throw in other debts, and Cyprus has no equity in itself. It owes more than its worth to its rescuers and no real way of generating enough income before 2020 to pay down that debt. According to the rescuers (especially the IMF), Cyprus is expected to get its debt back to 100% of GDP by 2020. If the economy continues to contract for much of that time, debt reduction will be much harder.

And on top of these huge debts, the Cyprus government borrowed 2.5 billion euros from Russia two years ago, and that debt remains on the books. So total known debt from this trio of Russia, ELA and bailout loans already exceeds GDP at around 29 billion euros, and the economy will contract by an estimated 15% this year or more (or more than 3.5 billion euros). The damage is going to be enormous and Cyprus will have no chance whatsoever in repaying these loans without a further bailout.

After the banks reopen, everyone will be watching to see if there is a run from worried small investors. Once the capital controls are in place, Cyprus will become financially isolated from the rest of Europe (and the economic isolation will grow over time). It will be a fraught few weeks. As noted financial blogger Frances Coppola wrote at the weekend:

“From Tuesday, Cyprus becomes a black hole in the Eurozone: any money that goes into it stays there, and no money can leave … From a safe distance, it will appear frozen in time, a small cash-based economy, isolated from the rest of the EU. While inside, invisible to all except those who actually go there — or live there — its social fabric is torn apart as its economy collapses.”

And London-based Gary Jenkins of Swordfish Research was quoted on a blog at The Guardian website as saying:

“The economy is crushed for the next god knows how many years. As soon as people can take their money out the banks, they will take it out. Confidence has disappeared. Who’s going to want to do business with Cypriot corporates right now?”