When Your Country is Just a Rounding Error

The most difficult part of having a single currency for a body of highly differentiated economies with profoundly differing values and cultural attitudes is the inability to let local currencies inflate or deflate (rise and fall in relative value) in reaction to local “issues.” We’re used to seeing “banana republics” have massive daily (if not hourly) inflation based on populist overspending, and internal pay scales and export values vary accordingly. But what happens when you put a de facto “banana republic” into the same currency mix as a Teutonic manufacturing and banking superpower? When they both share the same currency and one economy tanks while the other soars, how do you adjust?

So far, as the European Union has grappled with the ultra-rich stable Germany (and her immediate Teutonic affiliated nations) holding up the values of the entire Eurozone, even as Spain, Portugal, Greece, Italy, Cyprus, etc. are mired in massive unemployment and staggering government debt. The EU has bailed out these economies through austerity measures that have made local unemployment seeming rise to toxic levels. Effectively, they are cutting salaries and services as the only seeming alternative they have since these nations share the same currency. Floating currency values just are not possible within the Eurozone.

But wait; there is one more tool in that financial chest, one that is rarely deployed and very seldom fully understood: capital controls. As much as the 17 member nations that share the euro have struggled to remain as a single, integrated economy… not breaking up and devolving into the multiple currencies that existed before… that unitary economy may be breaking up anyway.

And tiny little Cyprus, an island nation with a $23 billion GDP (less than Bill and Melinda Gate’s net worth) and a rounding error in the $9.5 trillion aggregate Eurozone GDP, may be where the unraveling has already begun. The damage is being inflicted by these “capital controls” – basically restrictions on removing or moving capital from one jurisdiction or purpose to another.

Euros deposited in a Cyprus bank, absent a specific permit or regulation to the contrary, cannot be transferred to another EU nation to buy assets or pay debts. So a Cypriot euro is clearly not the same as a French euro, even though the currency and the underlying notes are precisely the same. “‘A Cyprus euro is a second-class euro,’ said Mr. [Marios] Loucaides, the managing director of the Cyprus Trading Corporation…  Capital controls, once a tool used frequently by governments in times of crisis, have become extremely rare in Europe, though they are not unknown. Iceland, which is not a member of the European Union and uses its own currency, imposed them in 2008 after its three main banks imploded.” New York Times, July 9^th.

Many are asking if in fact these capital controls have already effectively pushed Cyprus out of the Eurozone into a de facto separate currency. “President Nicos Anastasiades of Cyprus certainly thinks so. ‘Actually, we are already out of the euro zone,’ he said, citing restrictions on the movement of euros from Cyprus as evidence that his country’s money now has a different status and value from that in France, Germany and the 14 other European Union nations that use the currency… ‘It is a peculiar situation,’ Mr. Anastasiades said in an interview.

“The rules of the European Union, enshrined in the 1992 Maastricht Treaty, ban restrictions on the movement of capital, but the measures by Cyprus have been endorsed by the European Central Bank and the union’s executive arm, the European Commission, as essential to prevent money from fleeing the country. While the European Central Bank declined to comment on the Cyprus situation, officials in Brussels say they remain firmly committed to maintaining the euro as a single currency.

“Nevertheless, many financial experts say Cyprus has, in effect, made a ‘silent, hidden exit’ from the euro, said Guntram B. Wolff, the director of Bruegel, a Brussels research group. Despite a softening of restrictions, he added, ‘the euro in Cyprus is still not the same as a euro in Frankfurt.’ … The rigid capital controls introduced in March have been steadily relaxed, but they still snarl businesses and ordinary Cypriots in a web of red tape.” NY Times. If the euro is not sustainable among the Eurozone members, and if too many European banks are anything but stable yet, is the entire “single economy” concept of the European Union doomed and simply waiting out its remaining time… or is there hope? Time will tell, but the little cracks in the wall seem increasingly like evidence of deeper structural defects.

I’m Peter Dekom, and these little cracks, combined with increasing signs in instability in China’s growth patterns, may put a serious damper on our own growth and recovery aspirations.