By Fiona Mullen, Director of Sapienta Economics
As I write this I do not know when the banks will open again. And from the rapidly changing policies of the past 48 hours it is clear that there is a big debate going on about capital controls and how to handle them.
Here I shall examine the arguments for and against.
I must attribute many of these points to the twitter-brainstorming economists, mainly academics, who I trust (I do still trust) will come out as the clear heroes of this crisis, as well as other academics at the University of Cyprus.
There are many twitter superheroes of the Cyprus crisis. But for crisis management brainstorming, the first three names that come to mind are Alex Apostolides of European University Cyprus (@alexapostolides), Faisal Islam, Economic editor of Channel 4 news (@faisalislam) and Hugo Dixon, “editor at large” of Reuters (@hugodixon).
And just in case you think that Cyprus has lost all its friends, if you have a Twitter account, go to #Cyprusheroes. There are many of out there them and my drumbeat of thanks has a long way to go.
The argument of principle
The argument in favour of opening some or all of the banks as soon as possible and allowing full free capital has two elements, one of principle and one of psychology.
The one of principle is that capital controls breach of the European Union treaties.
Article 26(2) of the Treaty on European Union states: “The internal market shall comprise an area without internal frontiers in which the free movement of goods, persons, services and capital is ensured in accordance with the provisions of the Treaties.”
So imposing capital controls is a breach of this article.
But then there is Article 27, which reads as follows.
“When drawing up its proposals with a view to achieving the objectives set out in Article 26, the Commission shall take into account the extent of the effort that certain economies showing differences in development will have to sustain for the establishment of the internal market and it may propose appropriate provisions.
If these provisions take the form of derogations, they must be of a temporary nature and must cause the least possible disturbance to the functioning of the internal market.”
This is EU-speak for imposing capital controls.
The key phrases here are: “may propose appropriate provisions”, “temporary” and “least possible disturbance”.
So they are allowed, but only for short periods and in extreme circumstances.
We are already in extreme circumstances, so we have already passed that test.
And with the banks closed, we have already imposed de facto capital controls so we have already breached Article 26.
The matter of psychology
Now let’s deal with the matter of psychology.
The argument in favour of opening the banks and allowing full free movement of capital is that confidence has already been dealt a blow by the closure of the banks. Open them again, but with strict conditions on the export of capital, and you are sending a signal that all is still not well in the financial system.
If we had endless Emergency Liquidity Assistance (ELA) from the European Central Bank (ECB) then that might be the sensible thing to do. But it is not completely clear that we do. Here’s why.
The Eurogroup statement on Monday said this: “The Governing Council of the ECB will provide liquidity to the BoC in line with applicable rules.”
As Apostolides noted, if “in line with applicable rules” means that the rules on acceptable collateral remain strictly the same as before, then we do not have any more eligible capital left and effectively the ECB has switched off the taps.
The only cash left in Cyprus is what is still in the banks and under the mattress.
The ECB has been accused of playing politics this week. I suspect that, along with the March 25th deadline for switching off the taps issued last week, the historians will use the “applicable rules” statement as evidence of the same.
Even while I write this, there is disagreement from the experts on twitter about whether or not the ECB will provide unlimited assistance or not.
As long as the ECB remains equivocal about it, we have to move on the assumption that they will not provide more and therefore we have to impose capital controls.
What do we do next?
The next step is how to control the inevitable outflow.
Given the chance, all of the old “offshore” money will go in 24 hours and we will only be left with the “domestic” currency in circulation. This could cripple the banks.
So assuming that there is no unlimited ELA, we have only one choice: let the offshore leave, but let it leave “siga siga”, a little at a time, so that we do not have an immediate cash crunch.
There are many ideas for how to do this, which I won’t go into here.
I just live in hope that the idea from Alex survives.
It is an honourable way to do it, and would send the right message to the people of Europe about how welcoming the Cypriots really are.
Follow Fiona on Twitter: @FionaMullenCY