Bloomberg View: The Perils of Capital Controls

Life under permanent, temporary capital controls

Bloomberg View: The Perils of Capital Controls
Customers queue outside a Bank of Cyprus branch in Nicosia ahead of its opening for the first time in two weeks on March 28
Photograph by Simon Dawson/Bloomberg

Picture not being able to cash a check, transfer money electronically, or withdraw more than $385 a day from your bank. Or imagine being searched by airport gendarmes making sure you aren’t taking more than $3,800 of your own money out of the country.

These are the indignities Cypriots must endure after the country’s $13 billion bank rescue. For the first time in the history of the single currency, a euro country is imposing capital controls, even for transfers within the union. It’s as if California barred residents from moving their savings to banks in Oregon.

The unfortunate rule of thumb on capital controls is that they are easy to impose, difficult to enforce, and almost impossible to lift. Iceland, whose banks ran into similar trouble as Cyprus’s, adopted emergency controls in 2008. They’re still in place.

At first, Cypriot officials pledged that the controls would last about a week but quickly revised that to about a month. Hardly anyone believes that time frame. The minute Cyprus lifts its controls, money will fly to safer havens.

In imposing capital controls, Cyprus has detached itself from Europe’s monetary union. A euro deposited in a bank in Cyprus is no longer worth the same as one deposited in France or Germany. It can’t be easily withdrawn, spent, or converted, and is therefore a second-class euro. The consequences are going to be harsh, with some economists now warning of Greek-like shrinkage of Cyprus’s gross domestic product. As long as capital controls are in force, no one is going to buy Cypriot government or corporate debt or make direct investments in Cypriot businesses.

It’s too late to suggest that Cyprus should have been more prudent. It isn’t too late, though, to warn other countries away from the practices that caused this debacle. The biggest lesson is obvious but worth stating clearly: Don’t let your banks get too big to save.

Both Iceland and Cyprus buckled under the weight of an overblown banking sector. Iceland’s was 10 times the size of its economy; Cyprus’s was eight times, bloated by deposits that came mostly from Russians avoiding taxes. Flush with about $20 billion from Russians, Cypriot banks put much of that money to work in Greek government bonds. When those bonds were written down because of the 2011 Greek debt restructuring, the three largest publicly traded Cypriot banks lost €6.5 billion ($8.35 billion), sealing their fate.

The euro area shouldn’t kid itself: Cyprus’s capital controls, while needed to avert a banking meltdown, are a break from the principle that a euro is a euro, no matter which of the 17 currency-union countries you live, work, or travel in. If depositors in other countries start worrying that their money may one day be similarly trapped in their domestic banking systems, then the whole single-currency project will be in jeopardy.

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