Has Cyprus Left the Eurozone? Let the Market Tell Us!

Since Cyprus announced two weeks ago that it would be confiscating money from all deposits to put up its contribution for a Eurozone bailout, the EU has been back in crisis mode.  Naturally, banks in Cyprus have been shut down to prevent bank runs, and capital is now locked inside the country…so is Cyprus out of the European Monetary Union? This is the question posed by Tim Duy, to which the answer seems to be yes:

After all, banks remain closed in Cyprus, which means a euro in a Cypriot bank has very little value.  If you can’t spend it, is it really a euro?  And even when banks reopen, it is assumed that capital controls will be imposed to prevent euros from leaving the island.  So a French euro will be able to purchase goods and services in Germany, but a Cypriot euro will not. It seems then that a Cypriot euro is unambiguously worth less than a French euro.

Duy wrote a few days ago, and since then little has changed except to become worse for Cyprus.  It seems too small to really disrupt the Eurozone – but at the same time, it seems fairly clear that Cyprus is in for a very rough go of it.  Capital controls imposed immediately after the announcement proved to be ineffective, and money has been fleeing the country via backdoors ever since the deposit tax was announced.  Furthermore, banks were initially to reopen today, but the deadline was pushed back to at least Thursday.

If I were a Cypriot, I would be working as hard as possible to get my deposits, insured or uninsured, out of the banks and out of the country.  It’s the clearly rational move here – suggesting that bank runs and collapse of all the banks is inevitable.  Aside from Russian millionaires, most of the large depositors are Cypriot businesses, who use their deposits for little things like payroll and accounts payable/receivable, meaning that a prolonged bank closure will put them all out of business even without the government taking all their money.  Currently the figure being floated is a whopping 40% of uninsured deposits, which would destroy most businesses even without the bank closure.  Anecdotal reports suggest immediate and massive deflation as all the money has been suddenly sucked out of the economy.

But…if Cyprus has left the Eurozone, then the value of the Cypriot euro (“Cyeuro”) is now floating! I propose an experiment to judge the likelihood of permanent departure. If capital controls are likely to be temporary, you should see a flood of Europeans with suitcases of dollars landing at Nicosia.  They will be exchanging cash for checks written on (temporarily frozen) accounts in Cypriot banks at a large discount to par – Cypriots will give up anything for liquidity right now.  The entrepreneurs will just have to wait for capital controls to be lifted, and they’ll have made enormous profits.  If capital controls are likely to be permanent, then the discount to par will be much greater because of the perceived likelihood of confiscation, forced conversion to Cypriot drachmas/rubles/whatever, and being locked in Cyprus.

The euro/Cyeuro spread should give us a clear signal as to the fiscal straits of the Cyprus economy.  Not to mention being a great business opportunity if you happen to be a shady European with suitcases full of dollars.


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