Why Cyprus must leave the euro

By Felix Salmon
April 10, 2013

Megan Greene has a great column on Cyprus and the euro today. In short, there are costs and benefits to leaving the euro — but the costs are going to be borne anyway, which means that at the margin, devaluation is likely to be good for the country.

Among the greatest costs of any euro-area exit would be bank defaults on their liabilities, capital controls and a sovereign default. Cyprus has already experienced the first two and will most likely see the latter in the next year or two if it stays in the euro area.

So if Cyprus is going to incur some of the worst costs of abandoning the euro anyhow, it might as well print its own currency and benefit from a devaluation and the immediate boost in competitiveness that would follow.

This is perfectly logical. But — you knew there was going to be a but — there are two big complications.

Firstly, leaving the euro is an expensive proposition, and Cyprus doesn’t have any money: it’s already selling off its gold reserves to help recapitalize its banks. Cyprus would be insolvent, with massive new debts to the ECB; it would also have massive liquidity problems, with no obvious way of paying for the enormous quantities of foreign imports all island nations require. As a result, there’s only one way for Cyprus to exit and devalue without risking power cuts, food shortages, and general chaos: it would need to borrow even more money than it has done already. Which is not going to be easy, given that the rest of the world has made it very clear that it’s pretty much maxed out, in terms of loans to Cyprus.

How could Cyprus persuade the EU and the IMF to lend it the extra money it would need for a semi-orderly devaluation? Threatening default wouldn’t work, since it’s basically impossible for Cyprus to devalue without defaulting. Alternatively it could threaten to run into the arms of Russia, but that would be a very high-risk strategy indeed.

And then there’s the other big complication: while a Cypriot exit would probably be good for Cyprus, it would be very bad for the rest of the eurozone, since it would be a clear precedent showing that exiting the euro is possible after all. The result would be further capital flight from the eurozone periphery towards the center, and a general feeling that the multi-year project of trying to remove tail risk from the euro had failed spectacularly. There’s no way that any country leaving the euro could possibly be good for the rest of the currency union — even if that country were as small as Cyprus.

Greene’s conclusion, then, is absolutely right: if the troika won’t help Cyprus exit the euro — and there’s absolutely no indication that it will — then “Cypriots really are stuck”. The government would have no recourse, at that point. Individual citizens, on the other hand, could still take advantage of the relatively free labor mobility within the EU, and move to another European country where prospects are brighter.

Is that likely? Even within countries, people in poorer areas (the north of England, the south of Italy, the east of Germany) rarely move en masse to richer areas with greater potential; big movements between countries are rarer still. But the bigger the osmotic gradient between two economies, the greater the flow of human resources into the wealthier nation. And Cyprus has more than its fair share of the most mobile population in Europe: relatively young and well-educated people with good language skills. If their future is brighter in the UK than it is in Cyprus, they’ll move there.

Cyprus can implement capital controls, but it can’t implement emigration controls. Even if it does leave the euro, a lot of its most talented professionals will leave; if it doesn’t, and falls instead into what Greene calls “an endless spiral of austerity and recession”, the brain drain will make Latvia’s look modest. The cost of joining the euro, for Cyprus, will be no less than a hollowing out of its population, along with its economic and demographic future. Let’s hope that it manages to find a way to exit, somehow.


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Well Cyprus is, in fact, already out of the Euro since Cyprus Euros are “disabled” and “crippled” by the restrictions put on their use. Euros were and are intended to be used anywhere in the Euro zone and to be free to go from one Euro country to the next. None of this is true re the Cyprus Euro that isn’t anything but a Cyprus currency with a wrong name on it.

Posted by Chris08 | Report as abusive

All of the arguments above also, incidentally, explain why it was impossible for Russia, Belarus, Ukraine, Armenia, Uzbekistan and Tajikistan, inter alia, to give up the Soviet ruble.

Posted by johnhhaskell | Report as abusive

I think the article misses two huge… possibly the largest two reasons that Cyprus can’t leave the Euro.

#1 they still have massive amounts of (now captive) slim shady offshore deposits in their still bloated banking system. If you look out a year or even two years the Cypriot banking system will still likely be a larger % of the economy than the financial system is in the United States. Most digital music is still downloaded illegally despite cheap and easy alternatives… Why is that… because the odds of getting caught are miniscule. It’s the same with offshore tax avoidance. If you’re a medium sized fish you’ll probably never see the inside of a net and even if you do get pinched you might have to pay 3 years worth of back taxes but a good lawyer will keep you on the right side of the bars. The capital controls and inertia will keep more money on the island than you would expect.

The other reason is legitimate tourism. I think right now the papers and websites of Europe are probably filled with the equivalent of 4 star beach front hotels for 99$/night. That’s worth a bunch of money year in year out.

Posted by y2kurtus | Report as abusive

It is true that people rarely move en masse. But the movement of people from Poland et al to the UK on the accession of Eastern European nations really was a mass movement.

Besides, a large number of Cypriots have relatives in the UK already. That makes any move much easier.

Posted by Urban_Guerilla | Report as abusive

How about a kickstarter project?

Posted by samadamsthedog | Report as abusive

In the end, Cyprus will exit, redenominate, default AND effectively repudiate its debts to the troika including Target2.

Posted by nixonfan | Report as abusive

Why wouldn’t they redenominate their debts to the ECB along with everything else, if not just immediately repudiate them as nixonfan wrote? The whole point is that those are debts that cannot be repaid.

Posted by MattJ | Report as abusive

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