It’s an unfamiliar feeling these days, travelling to a country with capital controls – or the threat of them slamming down any moment. You bring more cash than usual because the ATMs don’t all work, but you can’t take too much or you might not be allowed to take the remainder back home. The feeling’s even odder when the country in question is in the euro area.
I’m writing this from on board a flight to Cyprus, filled with an odd combination of locals, tourists and journalists talking about bank haircuts and capital controls. There is, dare I say it, a palpable air of excitement. No-one is quite sure what we will witness over the next few days – and for good reason.
The Eurozone is once more on the brink. It’s deeply reminiscent of last summer, when Europe contemplated chucking Greece off the edge. Around that time I asked one of the continent’s senior policymakers (someone not prone to hyperbole) what would happen in Athens. He looked me straight in my face and said: “Put it this way: if you’ve got any money in Greece, get it out. Now.”
Of course, the brinksmanship came to an end when, in that famous London speech, European Central Bank President Mario Draghi vowed to do “whatever it takes” to save the single currency. The Europeans realised that to toss Greece aside could feasibly take down the entire single currency. The rest is history: the ECB unveiled its Outright Monetary Transactions (OMT) programme, markets gradually calmed down and, notwithstanding continued pain on the periphery, the crisis died down.
Until now. This weekend, once again, Europe is looking off that cliff-edge, contemplating the economic collapse and, possibly, the euro exit, of one of its members. In 48 hours we shall know just how serious it is this time around. And that slightly apprehensive sense of excitement on board is reinforced by the knowledge that nothing like this has happened for generations
There hasn’t been a system-wide closure of banks in a European nation since the 1930s. Even the collapse of Credit Anstalt – the event that triggered the European Great Depression – took down Austria’s system for only two days. Rarely has economic policy been quite so confidence-sappingly shambolic. There are few examples – save for Argentina at the turn of the millennium – of a country having to resort to a cash economy because of the collapse of the banking system.
And then there are the capital controls. This weekend the Cypriot Parliament passed a bill enabling it to impose controls over a quite disturbing range of transactions: limiting the amount of cash coming in and out of the country, restraining electronic transfers and potentially even forcibly converting instant access bank accounts into time-limited ones. To say that Europe hasn’t seen anything like this in a generation is to understate the significance of this: the free movement of capital is a fundamental element of the European Union. I’m not talking merely about a Treaty of Rome aspiration, or the inconvenience of not being able to leave the country after a holiday with all one’s cash – the ability for money to flow between different parts of the Eurozone is a fundamental element of the entire monetary edifice.
Don’t take it from me, take it from David Marsh, who put it this way in his monumental history of the single currency, The Euro:
“The… liberalism of an integrated European financial market is one of the essential conditions within the Euro area required to provide the economic flexibility and financial lubrication to offset the rigidity of permanently fixed exchange rates.”
If capital controls get put properly in place, it’s the end of this monetary system as we know it – at the very least it’s probably the end of Cyprus’s place within it. A euro within Cyprus will suddenly be worth significantly less than a euro in Germany or, for that matter, Greece. Or to put it in more economic, and slightly more doomsday terms, consider this: there’s a pretty fundamental rule in economic policy that nation states must choose two (but not three) of the following: independent monetary policy (in other words the power to set your own interest rates), a fixed exchange rate and free movement of capital. Economists call this the “impossible trinity” or trilemma, because you can never have all three at any one time. If Cyprus is to abandon the free movement of capital, the next economically-logical step is for it to have its own independent monetary policy, in other words to leave the single currency.
Which begs the question, why has Cyprus readied these controls? The primary and most obvious motive is that it fears a sudden and enormous outflow of money from its financial system when the banks final reopen. Simon Ward of Henderson reckons the instant capital flight could be around €15bn, which is about three quarters the size of the Cypriot economy; it would be far greater were it not for the fact that many bank accounts and investments do not permit instant access. Capital controls would at least force some of this money to remain in the country – if unwillingly. Of course, it would also obliterate the economy’s reputation as a place to invest for decades, but one has to presume that by this stage the Cypriots feel they have nothing left to lose.
Which brings one to the secondary motivation: brinksmanship. The imposition of capital controls would be an enormous one-fingered salute to the eurocrats in Brussels, who know full-well that measures of that kind would bring Cyprus one giant leap closer to leaving the single currency. It’s no coincidence that this law was passed well before the Cypriot President’s flight up to Brussels for the make-or-break summit tonight: it’s intended as a sign that if the Europeans aren’t prepared to help, it is prepared to countenance the alternatives.
Unfortunately for Cyprus, its hand looks decidedly weak. For one thing, the talks between the Finance Minister Michalis Sarris and the Russian authorities over a possibly supplementary bail-out to add to the €2.5bn one from earlier in the crisis have, predictably, fallen through. There will be no white knight coming to its rescue. Neither have the markets helped: a plunge in stock market indices or a spike in other nations’ bond yields over the past week might have given Brussels cause to think twice. As it is, investors have simply shrugged their shoulders at this forsaken island.
Their rationale is, in the first order, quite sensible. Cyprus is tiny. The population of the Greek half of the island is, at 800,000, slightly smaller than Liverpool. The entire island has fewer people than Glasgow. The country’s gross domestic product of around €20bn is less than a couple of percentage points the size of France. Even the overblown banking system is, en masse, equivalent to a medium-sized German bank.
Plus, as far as many Europeans are concerned, letting go of Cyprus might provide a useful reminder to the rest of the euro periphery of what they could expect in the event of departure: financial chaos, economic ignominy and a lengthy period of self-imposed (rather than Brussels/Berlin-determined) austerity.
If you think you’ve heard this all before, you’re not wrong: it was precisely what some eurocrats were saying last summer, shortly before Europe turned back from the abyss. So it might be part-bluster. After all, saving Cyprus would cost a fraction of what it cost to bail out Greece.
But then, set against that, it is a German election year. Cyprus made the mistake of turning itself into an offshore laundry for dirty Russian money. Teaching it (and Moscow) a lesson would go down pretty well in Berlin. Hence the European Central Bank’s deadline of Monday for the country to come up with a deal, before it switches off the financial life-support of liquidity from Frankfurt.
So that’s where we are today. No-one knows how this episode of brinksmanship will end. The fudge of a deal is slowly baking in the Nicosia sun. One of the two main Cypriot banks will be restructured (for which read nationalised); high-end deposits in the other one will be taxed punitively. It’s a lot like the deal the IMF suggested before someone (President Anistasiades allegedly, although he denies it) proposed taxing all depositors, not just the wealthy ones.
The main difference is that the Cypriot people have had their economy taken away from them. They are the great victims: both to their Government, for turning their state into a satellite Russian financing hub, and to the Nicosia/EC/IMF nexus which has destroyed their financial system in one short week. Cyprus was not in anything like the state Greece’s economy was before this crisis: a smart bail-out deal could have had it back on the road to health before too long. Even if their savings are not taxed, after this mess it’s hard to see why any Cypriot will put faith in the Government or the banks for generations to come.
Which is why we’re all here today. To see what happens when a nation state is cruelly mistreated by those who claimed to have its best interests at heart.