Cyprus Temporary Capital Controls Likely To Last a Long Time

Cyprus' capital controls, only to last for one week, will now be in effect for at least a month. This from a story today by Andrew Higgins and Liz Alderman, "Long Lines as Banks Reopen in Cyprus After Freeze":

Not since the introduction of the euro in January 1999 has a European country blocked bank depositors from having full access to their own cash. Under European Union treaties, such restrictions are normally forbidden. But the European Commission, the union’s administrative arm, issued a statement Thursday morning that the Cyprus controls were legal — though urging that they be rescinded as soon as possible. Originally, the controls were to be in place for one week. But on Thursday, the Cypriot foreign minister, Ioannis Kasoulides, said that restrictions on financial transactions would not be lifted for a month.

A naked capitalism cross post from VoxEU today by Jon Danielsson, Director of the ESRC funded Systemic Risk Centre, London School of Economics, argues that the example of Iceland proves that temporary capital controls should, for all intents, be considered permanent:

Another European country was forced to implement `temporary’ capital controls in its crisis – Iceland, as discussed here on Vox (Danielsson and Arnason 2011). 

The Icelandic government, its central bank and the IMF considered the controls necessary because so many foreigners, and the occasional wealthy Icelander, had lost faith in the economy and only wanted to take their money out. While such individuals were considered misguided, their exit would have had disastrous consequences. Hence it was thought necessary to `temporarily’ prevent capital outflows. 

The authorities said at the time the controls would be temporary and limited in scope – lasting a few weeks or, at worst, a month or two. Half a decade later, the capital controls are still in place and getting more and more restrictive. 

This was the second time Iceland had implemented `temporary’ capital controls. The first time it did so, in the 1930s, led to the controls being in place until 1993. This is in line with the historical evidence; once capital controls are imposed, they are really hard to abolish, and a temporary arrangement usually ends up being permanent.

Reporting from Nicosia, Landon Thomas Jr. says the prevailing wisdom appears to be holding. Cyprus is a one-off and will not spread:

“People have lost all their money,” screamed a young financier Wednesday night, as he knocked back drink after drink at a local nightclub — which, despite the earsplitting din of Greek rap music, was half empty. “To me, that feels like war.” 

But on a global scale, investors have refused to panic, other than unloading the risky bonds of second-tier banks in Spain and Italy. 

And while the bond yields of Italian government debt have spiked in recent days, a signal of investor wariness, and the euro has traded down against the dollar, the view, for now, is that even though Europe’s handling of the crisis has been a mess, broader contagion has largely been avoided. 

“This does not worry us at all — Cyprus is just not systemic,” said a senior executive at a large sovereign wealth fund based in the Middle East, who was not authorized to speak publicly. 

Even Cypriot government bonds that are due to reach maturity this June are holding up fairly well, trading at 88 cents, not far from their recent high of 94 cents earlier this week, though a 12 percent discount from their face value.

But Floyd Norris in a High & Low Finance column that appears side by side with Thomas' piece sees signs of a spreading instability:

The fact the hot money stayed even after it became clear the Cypriot banks were in trouble — in large part because of all the Greek bonds they owned — is a testament to the false security the euro provided even after the Greek crisis erupted. That security has faded, at least a little. The cost of credit-default swaps on European banks has been rising since Cyprus got into trouble, suggesting the market thinks bank defaults have grown more likely. That cost continued to rise after the latest plan was announced. It does not help that European leaders seem unable to decide whether the Cypriot deal would set a precedent if banks in other countries get into trouble. It does, whatever they say, or at least it could. 

A few months ago, Europe was supposed to be on the way to a banking union, an arrangement that it was hoped would prevent what has now happened in Cyprus. What happens to those plans will be an indication of whether Europe can continue to hold the euro zone together. 

It may help that Cyprus is so insignificant. Its economy is about one-tenth the size of Ireland’s, which itself is among the smaller economies in the euro zone. It is even smaller than Vermont’s, which is smaller than that of any other state. We can only shudder at what might happen if banks in a big euro zone country got into a lot of trouble.

The next small eurozone country headed to the troika for a bailout, according to naked capitalism's Yves Smith, is Slovenia.