Friday, March 22, 2013

Europe's Newest Currency: The Nonconvertible Euro

“Today the Cypriot parliament will vote on capital controls allowing authorities to restrict noncash transactions, curtail check cashing, limit withdrawals and to even convert current accounts into fixed-term deposits when banks reopen on Tuesday... There have also been discussions over eurozone-enforced controls on Cyprus, including freezes on savings and a requirement that all bank transfers are approved by a central bank, Handelsblatt reported today.”
---today’s Telegraph

The Cyprus resolution that is being cobbled together this weekend would involve a haircut on uninsured deposits and banking sector consolidation in exchange for the troika’s recapitalization of what’s left of the banking system. This would permit the ECB to continue to fund the remaining Cypriot banks, allowing them to continue to function in euro without have to redenominate. Cyprus would not default on its government debt and would remain in the eurozone.

There would also presumably be a new austerity package for the government involving the usual “impossible” and “unthinkable” reforms. In theory, the government and legislature will capitulate completely to the troika’s entire list of demands.

This plan is supposed to put the Cypriot crisis to bed for the medium-term.

In addition to the haircutting of uninsured deposits, it appears that remaining uninsured (and insured?) deposits while remaining “whole” will not be unfrozen and will be not be convertible into real euros. As the Telegraph reports above, the Cypriot euro will remain subject to currency restrictions including even the possibility of forced conversion into longer-term instruments.

Cyprus will have a nonconvertible currency for some period of time until something even worse happens: redenomination back into pounds. There will be a powerful incentive for capital flight before that happens.

As any Argentine or Venezuelan will tell you, when you can’t wire your money to Miami, you fill your suitcase and fly it there. Will Cyprus try to prevent the physical movement of large quantities of cash from Cyprus to anywhere else (Israel, Lebanon, or even Northern Cyprus, which is literally across the street)? Perhaps Cypriots will try to exchange euro notes in Cyprus for convertible rubles in Russia. The Argentines and Venezuelans will need to establish a school in Limassol for “Living With A Nonconvertible Currency”.

Will a parallel currency market develop for Cyprus euros at a discount to convertible euros abroad? I presume that that will happen. Business must go on, and payments must be made. We should also see the underinvoicing of exports and the overinvoicing of imports, as is normal for blocked currencies.

And where will rich Cypriots want to park their money? My guess would be as far from the EU as possible, such as Dubai. Their natural depository is London, but that might not be safe from their government’s clutches. Similarly, it will be safer to keep cash in anonymous safe-deposit boxes, rather than in bank accounts which can be more easily identified and confiscated.

Of course, the development of the Cypriot currency system is monumentally unimportant to the rest of us. But it may serve as a wake-up call to Greeks, Portuguese and other residents of Club Med who are relying on Europe’s promise that depository confiscation and/or currency controls will never happen there. They know those promises mean nothing. The holders of Club Med government bonds know that they can be defaulted upon (Greece), and the holders of Club Med bank deposits know that they can be frozen and/or haircut. Soon they may learn that a euro can go from being convertible to being nonconvertible to being another currency altogether. Ask any Latin American.

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