So here it is: yes, Cyprus should leave the euro. Now.
The reason is straightforward: staying in the euro means an incredibly severe depression, which will last for many years while Cyprus tries to build a new export sector. Leaving the euro, and letting the new currency fall sharply, would greatly accelerate that rebuilding.
If you look at Cyprus’s trade profile, you see just how much damage the country is about to sustain. This is a highly open economy with just two major exports, banking services and tourism — and one of them just disappeared. This would lead to a severe slump on its own. On top of that, the troika is demanding major new austerity, even though the country supposedly has rough primary (non-interest) budget balance. I wouldn’t be surprised to see a 20 percent fall in real GDP.
What’s the path forward? Cyprus needs to have a tourist boom, plus a rapid growth of other exports — my guess would be agriculture as a driver, although I don’t know much about it. The obvious way to get there is through a large devaluation; yes, in the end this probably does come down to cheap deals that attract lots of British package tours.
Getting to the same point by cutting nominal wages would take much longer and inflict much more human and economic damage.
But is it even possible to leave the euro? The Eichengreen point — that even a hint of exit would cause panicked capital flight and bank runs — is now moot: the banks are closed, and capital is controlled. So if I were dictator, I’d just extend the bank holiday long enough to prepare for the new currency.
OK, what about the bank notes? I’m no kind of expert in such matters, but I’ve heard suggestions to the effect that it might be possible to rush debit cards into circulation, so that business could resume without having to wait for someone to run the printing presses. The government might also be able to issue temporary scrip, IOUs that don’t look like proper bank notes, as a transitional measure.
Yes, it all sounds kind of desperate and improvised. But desperation is appropriate! Otherwise, we’re talking about Greek-level austerity or worse in an economy whose fundamentals, thanks to the implosion of offshore banking, are much worse than Greece’s ever were.
My guess is that none of this will happen, at least not right away, that the country’s leadership will fear the leap into the unknown that would come from euro exit despite the obvious horror of trying to stay in. But as I said, I think euro exit is now the right thing to do.
Karl Whelan faz hoje, em Has Cyrpus already left the euro?, uma pergunta óbvia: por que não recapitalizar os bancos cipriotas através do Mecanismo Europeu de Estabilidade e abdicar dos potencialmente corrosivos controlos de capitais?
Some of the coverage of today’s events in Cyprus has been drawing the conclusion that the plan to restructure Cyprus’s banks is going well because there has been no “bank run”. However, the only reason there isn’t a massive bank run in Cyprus today is the imposition of severe capital controls (full details here).
The controls have frozen accounts over €100,000 in Cyprus’s main banks and have limited cash withdrawals to €300. The large deposit withdrawals that really destroy a bank are not possible. And most ordinary people in Cyprus know full well there is no point in queuing up to withdraw all their money because such withdrawals are not allowed. Hence, no bank run.
As it is, it is hard to see how the capital controls can be lifted without a complete reworking of Cyprus’s agreement with the EU. Depositors with over €100,000 still do not know how much they are going to get back, while those with under €100,000 may still feel worried that their turn to take a hit may come around again. The likely collapse of the economy may trigger a sovereign default which would further hit the banks and further increase creditor losses.
The capital controls could be lifted if the ECB allowed the Central Bank of Cyprus to provide unlimited amounts of Emergency Liquidity Assistance to facilitate massive deposit flight. However, neither the ECB nor the Central Bank of Cyprus are likely to be interested in doing this. The ECB are very touchy about allowing ELA and worry a lot about how to end such programs. The Central Bank of Cyprus are aware that they are supposed to take the credit risk associated with ELA lending which differs from regular Eurosystem lending in which the risks are shared among participating central banks.
For these reasons, the capital controls are likely to remain in place. As long as they do, Cyprus is a member of the euro in name only.
As long as Cyprus is a member of the euro in name only, the question will remain as to whether it can ever return to being a normal member of the euro or whether it will be better off to set up its own currency.
One way to ease a return to Cypriot euros being equal to euros elsewhere is for Europe’s leaders to reverse course on Cyprus. This would involve ESM taking over the Cypriot banks and putting in enough money to ensure these banks are well-capitalised and safe beyond question. Since this outcome seems unlikely, Cyprus’s euro membership seems to hang in the balance. The fear that capital controls are coming to their country will also be influencing behavior in other euro area countries in the coming weeks.
Ler também The bahamian dollar and the cypriot euro, por Matt Yglesias.
Karl Whelan explica tem duas óptimas peças na Forbes a explicar o que se passou na reunião do Eurogrupo e quais as consequências que a decisão cipriota poderá ter para o resto da Europa. Cyprus depositor tax: genius plan or the end of the euro? e Cyprys deposit levy: no panic yet but scary long term consequences.
Second, the decision to apply the levy to people with deposits under €100,000, who were covered by a deposit insurance scheme, has severely undermined the credibility of these schemes throughout Europe. The ongoing delays in passing the legislation to introduce the levy indicate the possibility that this part of the levy could be rolled back with the full burden falling on uninsured deposits.
Hopefully, this reversal will occur because the current design of the scheme is unnecessarily unfair. But the fact that this element was part of the original proposal will have damaged the reputation of deposit insurance schemes across Europe. (And this at a time when the European Commission has been working to harmonize and improve deposit guarantee schemes.)
Third, once this tool has been used once, there is likely to be external pressure for it to be used again when other European banks get into trouble, an event that is as sure to happen as night following day.
In fact, once the dust settles in Cyprus, those who are less well off in other countries may come around to the viewpoint that levies on uninsured deposits are a fairer way to deal with failing banks than sticking all of their debts on taxpayers. Depositors in Spain may not feel today that their money is currently in danger. However, given the full extent of unrealized bad debts in Europe, it is hard to see why anyone should rule out depositor levies being imposed elsewhere in the future.
A final observation for now: How foolish must Ireland’s citizens be feeling today? After being reassured time and again that all depositors and senior bond creditors of the now-defunct Anglo Irish Bank must be saved in the name of European financial stability, now they find out that Europe’s leaders now believe hair-cutting depositors is fine and fair and doesn’t cause contagion. The moral grounds for a retrospective compensation deal for Ireland have increased substantially with this new development.