Any other measure which the Finance Minister or the Governor of Cyprus Central Bank see necessary for reasons of public order and safety













Imagine you live in a prosperous country, with a lovely climate, beautiful beaches, blue seas. But there's something funny about this country. It doesn't have a functioning banking system.You can put money into your bank, but you can't get it out again. At least you can, through ATMs, but only in very small amounts.If you have money on deposit, you can't take the money out and close the account. And if it's a time deposit, when it reaches the end of its life, you can't have the money to spend. You have to roll it over into a new deposit.You can't cash a cheque in a high street bank. You can't pay bills in a high street bank, either. And no high street bank is lending any money, so if you want a loan, forget it. In fact high street banks are not much use.Your employer pays you in cash, because there are no electronic payments. Which is just as well, really, because you need cash. There are no automated payments such as direct debits, so you pay all your household bills in cash. Credit and debit cards are no longer accepted anywhere, so you buy all your shopping and petrol for your car with cash. You can't make phone or internet purchases.If you have more than one account, you can't transfer money between your accounts. If only one of your accounts has ATM access, once that account is empty, you are stuck with no money.You can't go on holiday abroad because you can't take any money out of the country. Your employer won't send you abroad on business, either, because you might not come back.....All the local shopkeepers will only accept cash, not cheques. That's because they have to pay suppliers in cash, and once you put money in a bank, you can't get it out again.....But all small businesses are having a very hard time. Shops are closing, businesses going bust, people losing their jobs. You're not sure how much longer you will keep yours. You've taken a pay cut already, even though it means you struggle to pay your mortgage.It would really help if lots of tourists would visit your beautiful sunny country. But the place is deserted. Tourists are unwilling to come here now....it's very cheap, but they can only bring cash with them and whatever they bring must stay here - and if they run out of cash they can't get any more.This is Cyprus. Or rather, it will be - next week. When full capital controls are imposed. When Cyprus is ring-fenced from the Euro area and its membership of the European Union is effectively suspended.I am not being dramatic. The above is a description of the effects of the capital control bill forced through the Cypriot parliament this weekend. From Tuesday, Cyprus becomes a black hole in the Eurozone: any money that goes into it stays there, and no money can leave......From a safe distance, it will appear frozen in time, a small cash-based economy, isolated from the rest of the EU. While inside, invisible to all except those who actually go there - or live there - its social fabric is torn apart as its economy collapses. Note the final clause in the capital control bill:So as people's livelihoods are destroyed and their standard of living crashes, other measures may be introduced to ensure that they can't take matters into their own hands.The IMF acknowledged in a paper a few months ago that capital controls can be helpful in crisis-hit economies. In Cyprus's case, the immediate need for capital controls is to choke off bank runs when the banks reopen after the extended bank holiday. The trouble is that bank runs are not necessarily acute. As we have seen in other countries, notably Greece and Spain, bank runs can be silent and extended. Even in Cyprus, deposit flight started some time before the attempted depositor haircut last week that forced closure of the banks. It is difficult to see how, with a wrecked financial system and collapsing economy, capital controls can be lifted at all without setting off bank runs. As things are set to get much worse, probably including bank failure and sovereign default in the not too distant future, capital controls are likely to remain in place for a long time. Despite the IMF's insistence that capital controls should be short-term, recent use of them has been anything but: Iceland has now had "temporary" capital controls for five years , and Argentina for ten (although that is probably for political reasons). Dismantling capital controls is not easy.But the Cyprus capital controls differ fundamentally from those imposed in the Iceland banking crisis . Iceland is a sovereign state with its own currency. Cyprus is a member of a currency union - the Euro. And capital controls make a complete nonsense of currency union.Once full capital controls are imposed, a Euro in Cyprus will no longer be the same as a Euro anywhere else in the Euro area. It cannot leave the island. The Cyprus Euro will in effect be a new domestic currency. The imposition of capital controls in Cyprus is therefore the end of the single currency in its present form. As this image shows, the single currency will have a bit missing - a bleeding chunk torn from its edge:Yes, the Eurogroup will claim that it is "business as usual" in the Euro area. Draghi will continue to claim that the Euro is "irreversible". Eurostat will continue to produce statistics for E17 and E27 including Cyprus. But the reality will be that the Euro will be broken in two. There will be the Cyprus Euro, and the "mainland" Euro (if we can call it that).One of the interesting effects of capital controls is that the Cyprus Euro would be likely to depreciate against the mainland Euro - afloating exchange rate. This might help to protect the Cypriot economy from the worst of the coming economic collapse. The ECB would of course enforce convertibility at par for any Euros that did manage to get in or out of the island, but as this traffic should be small, the purchasing power of the Cypriot Euro within Cyprus itself would be far more important. Cyprus would in effect have gained control of its own currency without the costs and risks of redenomination.But this is not as good as it sounds. There would be likely to be serious shortages of Euros in Cyprus once capital controls were in place. Currently the Cypriot central bank cannot print Euros : the Euros in circulation in Cyprus are printed in France and the Netherlands on behalf of the Cypriot central bank and transported to Cyprus. These Euros are printed in accordance with the ECB's rules, which operate strict proportionality in relation to the size of the economy and overall Euro area money supply, but Cyprus's need for cash will be much greater when there are no alternative methods of payment. I can't see the ECB being particularly keen on expanding the physical money supply in Cyprus because of Cypriot capital controls.Because of this, I would expect to see alternative currencies starting to circulate in the Republic of Cyprus. The obvious candidates are sterling, because of the large UK expatriate community and military presence; and Turkish lira, because of the presence of the (unrecognised) Northern Republic on the island of Cyprus.*And because of the ban on electronic transactions in Euros, I would not be surprised to see e-currencies and mobile money becoming popular: they would be an effective way of avoiding capital controls. It is unclear exactly how the Government and central bank would respond to this, but remember that final clause in the capital controls bill: is a ban on private use and holdings of alternative currencies beyond the bounds of possibility? Or would they simply accept (gratefully) that use of alternative currencies relieves the pressure on the Cyprus Euro, enabling more economic activity than would otherwise be possible? Much depends, I suspect, on the pressure on public finances caused by the now inevitable economic collapse . Declining tax take might encourage a desperate government to enforce use of the Euro, despite shortages, to help ensure that taxes can be collected. Using alternative currencies is of course a standard way of avoiding tax. Personally I think this would be a mistake: repressing alternative currencies would depress economic activity and slow down recovery. But as the Troika would be overseeing Cyprus's public finances and enforcing the agreed austerity measures (and probably harsher ones too, once the debt/GDP ratio started to rise due to economic collapse), counterproductive repression of alternative currencies to increase short-term tax take seems likely.The fact that the ECB will still control the purse strings, and the Troika will still oversee public finances, may eventually make the shortage of Euros and the lack of control of monetary policy intolerable. If this were to happen, then Cyprus should formally break free. The fact that it cannot print Euros means that it would then have to redenominate, probably into Cyprus pounds at one-to-one par value with the Cyprus Euro. This is not a step to be undertaken lightly, though: it would mean that Cyprus's public debt would then be denominated in a foreign currency. Some form of currency peg, perhaps to sterling, would in my view be necessary to prevent collapse of the new currency and disorderly debt default. I'm not at all sure this route should be followed yet. It may be that the fragmentation of the Euro caused by capital controls will give Cyprus sufficient protection to enable it to recover from this awful mess - if the Troika's hamfistedness doesn't scupper the whole thing anyway.So the nature of the Euro will be fundamentally changed by Cyprus's capital controls. The single currency will exist in name only: the reality will be fragmentation. But it is not just the single currency that will be compromised. The isolation of Cyprus is clearly in breach of the founding principles of the European Union. It is unclear whether the capital controls are legal: Article 63 says they are not, but Article 65 1b and 2 suggests they may be. I leave that to the lawyers: I am more interested in the principles. The European Union was founded on "four freedoms" : free movement of goods, free movement of services, free movement of capital and free movement of people. Capital controls are direct prevention of free movement of capital. In fact it is worse than that, because strict capital controls also severely curtail free movement of goods and services and free movement of people - the other founding principles. Will other countries want to trade with Cyprus, if it is difficult to get money out of the island? How can anything other than subsistence-level trade within the island operate, if payments can only be made in cash? How can people move in and out of Cyprus, if they can't take any money with them? Indeed, how can any of these freedoms be said to operate in a country with capital controls as tight as those now signed into law in Cyprus? In effect, Cyprus is no longer a full member of the European Union.And this sets a dangerous precedent. The Troika's mishandling of the Greek crisis and the ensuing contagion to Cyprus has fundamentally weakened the European project. If it can bully one state into imposing capital controls in clear breach of the principles of the European Union, and in so doing destroy the integrity of the single currency, then it can do it to others. And this is on top of the damage already caused by the disastrous attempt to impose losses on small depositors in Cyprus, and the imposition of highly damaging "deficit reduction" programmes against the will of the people in a number of states including Cyprus. The Troika has already demonstrated that it will sacrifice democracy in the cause of the European project. But now it shows that it will sacrifice the very principles of that project to maintain the sham of unity. How much longer before the whole thing unravels? Cyprus, capital controls - The Prodigal Greek (Yiannis Mouzakis) Capital controls in Cyprus: the end of Target2? - Guntram Wolff, Bruegel Cyprus: The operation was a success, shame the patient died - Pawel Morski Sowing the wind - Coppola Comment The liberalization and management of capital flows - IMF The Icelandic financial crisis - Wikipedia Internal market - Wikipedia TMM Thoughts on Cyprotoxins - Macro Man Analysis: "Lex Cyprus" will set precedents for closer EU union - Paul Taylor (Reuters) Will Germany turn Europe into Latin America? - Christopher T. Mahoneyand once again, a strong plug for FT Alphaville's excellent Cyprus Coverage "Broken Euro" image courtesy of George Mitakides* Turkey has already expressed an interest in reopening negotiations with a view to achieving recognition of the Northern Republic, apparently in return for allowing the Cypriot government to exploit the natural resources in the southern part of the island and offshore waters. This is an interesting and rather disturbing development: at present the Republic of Cyprus appears to be ignoring Turkey's offer (and associated warning), but that may change if the EU freezes them out and they are faced with economic collapse.