Do Capital Controls Mean Cyprus Has Already Left the Eurozone?

Cyprus is in a struggle to save itself, at least the European definition of “save itself,” and remain a Eurozone member.  But will Cyrpus even use the same euro as the rest of Europe when all is said and done?

After all, banks remain closed in Cyprus, which means a euro in a Cypriot bank has very little value.  If you can’t spend it, is it really a euro?  And even when banks reopen, it is assumed that capital controls will be imposed to prevent euros from leaving the island.  So a French euro will be able to purchase goods and services in Germany, but a Cypriot euro will not. It seems then that a Cypriot euro is unambiguously worth less than a French euro.

Thus, there will be two Euros in circulation (if not already).  This is the thesis of blogger Guntrum B. Wolff (ht Ed Harrison):

The most important characteristic of a monetary union is the ability to move money without any restrictions from any bank to any other bank in the entire currency area. If this is restricted, the value of a euro in a Cypriot bank becomes significantly inferior to the value of a euro in any other bank in the euro area. Effectively, it means that a Cypriot euro is not a euro anymore. By agreeing to this measure, the ECB has de-facto introduced a new currency in Cyprus.

I think this might be right.  If I can spend my dollar in Oregon but not in California, it is really the same dollar?  I think not.

Is this how the Eurozone experiment will end?  Not with a formal “exit,” but with a return to banking dominated by national boundaries and enforced by capital controls?  No longer a true common currency, but a dozen currencies sharing the same name, each with a different value?

There will be another banking crisis in Europe (just as a bank will fail in some US state) and depositors are now aware that they are fair game in any crisis response, so capital flight will intensify at an earlier stage in the crisis.  As may have been noted, European policymakers find rapid crisis resolution to be something of a challenge, thus accelerated capital flight will necessitate a more rapid imposition of capital controls in the future – and with each round of capital controls, a new sub-euro will be born.

Bottom Line:  Europe’s response to the Cyprus situation will have long-lasting impacts on the Eurozone experiment itself, none of the good.  Indeed, the imposition of capital controls should lead one to wonder if the “solution” to Cyprus is effectively an exit from the Eurozone is everything but name.  And don’t forget that the crisis also threatens to destabilize the region geopolitcally.  I don’t think that “disaster” is too strong a word in this case.

This piece is cross-posted from Tim Duy’s Fed Watch with permission.

3 Responses to "Do Capital Controls Mean Cyprus Has Already Left the Eurozone?"

  1. WV bill   March 26, 2013 at 6:51 am

    a virtual euro, a euro ghost? My grandapa had $45,000 dollars in a US bank in 1929, they
    became "ghost dollars" only a memory of wealth, not exchangable for anything but imaginary goods. to bad he didn't keep real bills under his mattress, or better yet gold coin which would be worth $4,500,000 today

  2. T Warr   March 29, 2013 at 9:54 pm

    But having accepted the Eurogroup's bail-out, and still being saddled with the Euro, there will be a long, long period of austerity. The capital controls put in place were initially supposed to last a week. Now it has been announced they will be in place a month. In reality. the controls will be in place until there is political change. Being a democratic country, the people will grow weary of the austerity, and vote themselves into power a government that promises to reject the EU's demands. Then they will end up in the same place they find themselves today. The only viable choice it to dump the Euro.