Greece Tries to Defy History of Capital Controls Doomed to Fail

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Greek Banks Close, Capital Controls Imposed

When a nation is fast running out of cash, it often tries to stop the hemorrhaging by clamping down on how much money can leave its borders.

Unfortunately for Greece, history suggests it hardly ever works. The country, teetering on the edge of economic ruin after refusing the demands of its creditors and euro-area officials on a debt agreement, joined on Monday a long list of embattled governments that turned to capital controls.

While dozens of countries from Mexico to Iceland and Thailand have imposed such measures since World War I to boost revenue, prop up currencies and hold down interest rates, the International Monetary Fund found that only those few with sound economies and strong institutions succeeded in slowing capital flight. That poses a challenge for Greece, which is facing a default and an exit from the 19-nation currency bloc after aid talks with creditors broke down and the European Central Bank froze its financial safety net for lenders.

“With Greece, a lot of money has already left the country and they’re sort of shutting the gate after the horse has left the barn,” Michael Klein, a professor of international economic affairs at Tufts University’s Fletcher School, said from Dallas prior to Greece’s announcement. With countries in crisis, “there are issues of how effective they can be.”

The more likely scenario is that cash stops coming in as overseas investors shun countries where returns can’t be repatriated, according to last year’s IMF study, which looked at 37 cases from 1995 to 2010.


At the same time, outflows may persist as locals keep trying to get their money out any way they can, according to Marcio Garcia, a professor of economics at Pontifical Catholic University of Rio de Janeiro.

Putting limits on the flow of capital has become an increasingly common stop-gap measure for governments in turmoil.

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Countries including Thailand, Malaysia and Indonesia imposed limits on outflows during the Asian financial crisis that began in 1997 as worries over developing-world finances caused investors to pull money out of emerging markets.

More recently, Iceland implemented capital controls in

2008. The krona stabilized shortly after and the IMF said the measures gave the nation the breathing room it needed the to get back on track. This month, Iceland unveiled plans to lift those restrictions.

Bank Exodus

Greece, which fell back into a recession in March, issued a decree imposing capital controls and shutting banks at almost 3 a.m. on Monday in Athens. Banks will be closed until at least July 6, and there will be a daily cash withdrawal limit of 60 euros ($66). Bank transfers or payments abroad will be banned.

The move comes after the most recent round of negotiations over aid between Prime Minister Alexis Tsipras, European Union finance officials and the IMF broke down, with Tsipras pledging to put creditors’ demands to a referendum July 5.

An existing bailout agreement expires on June 30, the day Greece is due to make a payment to the IMF.

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That’s left investors preparing for the worst.

Yields on Greece’s benchmark 10-year notes have more than doubled in the past year and are now approaching 15 percent. Those on its two-year debt are close to 40 percent.

The ASE Index of Greek equities, which didn’t trade on Monday after Greece shuttered its stock market, has tumbled 35 percent as bank stocks led the plummet. National Bank of Greece, the biggest lender by assets, has lost about 55 percent of its market value over that span.

‘Failure Epitomized’

The euro dropped as much as 1.9 percent on Monday, while volatility for the currency rose by the most since 2008.

Greece’s decision comes just two years after Cyprus, another euro-bloc member, restricted money transfers following its own banking crisis. Yet in Cyprus’s case, the capital controls were backed by international financial support.

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The move, which included capping withdrawals to 300 euros a day, restricting overseas transfers and terminating time deposits, lasted two years and let Cyprus implement reforms its political leaders agreed were badly needed, said Gabriel Sterne, the head of global macro research at Oxford Economics.

“The key point is that Cyprus’s were part of a cruel solution, while Greece’s would be part of a failure to agree on any sensible solution,” Sterne said in an e-mail. “Capital controls in Greece are failure epitomized.”

Greece’s predicament more closely resembles the disarray that precipitated Argentina’s economic collapse in early 2002, according to Athanasios Orphanides, who served as governor of Cyprus’s central bank until 2012.

Argentina Model

While defaulting on $95 billion of debt, Argentina froze bank deposits, seized retirement savings, and banned overseas transfers to protect its decade-long currency peg to the dollar and the nation’s banking system.

The measures, which sparked violence that killed at least 27 people, eroded confidence in the government and deepened one of the worst economic crises in modern history, according to Barclays Plc. Argentina ended up abandoning its currency peg and converted dollar-denominated deposits into pesos, which effectively slashed people’s savings by more than two-thirds.

Just like the South American nation before it dropped its peg, Greece doesn’t have the money it needs to spend and lacks the ability to print euros -- making capital controls all but useless, said Orphanides, now a professor at Massachusetts Institute of Technology’s Sloan School of Management.

Tough Decisions

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That suggests euro-area leaders, including German Chancellor Angela Merkel, face some tough decisions over what they’re willing to do to keep Greece in euro.

And if there’s a “disorderly unraveling” from the euro, Greek savers could wake up one morning to see their deposits denominated in drachmas -- similar to what occurred in Argentina, Barclays said in June 3 report.

Capital controls “would solve nothing,” Orphanides said. “European governments have to make up their minds. Either they force Greece out of the euro or they lighten the debt burden the government faces to help the country stay in the euro.”

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