Hugo Dixon

Imposing capital controls would be a historic mistake for Cyprus and the euro zone – even worse than the crass idea of taxing uninsured deposits. Non-cash transactions would be limited, while withdrawals from cash machines would be rationed.

This would be equivalent to Argentina’s “corralito”, which lasted a year in 2001/2002. If capital controls are imposed, it will be almost impossible to lift them because people will stampede for the exits once they are removed. But such heavy-handed rationing of limited cash would clobber an economy which is already heading for a slump.

Some people will say that Cyprus has already endured a week of capital controls because of the extended bank holiday since last weekend’s botched bailout. But officially imposed indefinite capital controls – blessed by the euro zone and the International Monetary Fund – would be far worse.

They would also be a terrible precedent. Savers in Italy, Spain, Greece and other vulnerable euro zone countries might worry that they would be next and rush to remove cash from their banking systems. If that led to capital controls being imposed in these much bigger economies, the euro zone might then be staring at the end of its single currency.

The least-bad solution is for the European Central Bank to offer to supply unlimited liquidity to the Cypriot banks and fund a run. Some of the money would never return. But, after a few weeks when the people realised that the cash really wasn’t running out, some deposits would return. For the ECB to do this within its rules, the banks must be properly recapitalised and have sufficient collateral.

Cyprus will pay dearly for its sins. The Mediterranean island has committed many follies over the years – and is still making mistakes.

The Cypriots seem congenitally inclined to overestimate their negotiating position. In recent years, their first big folly was to reject in 2004 the United Nations plan for uniting their island. That irritated their European Union partners, meant that Cyprus still has a weak strategic position vis-à-vis Turkey and leaves a jagged scar across the island.

The last Communist government was also criminal in its failure to act as the crisis in Greece threatened to swamp Cyprus. If it had been willing to restructure the banks, the Cypriot economy would now be in a lot better shape. It was also much easier to do a deal with Germany then than now, when Angela Merkel is only months away from an election.

The Cypriots have an expression: eninboro allo. It means: I cannot take any more of it.

There was jubilation last night outside the small Mediterranean island’s parliament when every single MP either voted against a plan to tax depositors or abstained. The message was that people of Cyprus had had enough and weren’t going to let the big bullies, led by Germany, boss them around.

The plan to tax insured deposits was a dreadful mistake – I have described it as legalised bank robbery. But the deposit tax was part of an unpalatable but available 10 billion euro bailout, agreed with the euro zone. That plan A is now at risk. As Cypriots contemplate possible plan Bs, their jubilation may start to fade: all of them are also dreadful.

One knee-jerk reaction to Italy’s shock election was to worry about contagion to Spain. As Rome’s bond yields shot up last Tuesday, Madrid’s were dragged up in sympathy. These are the two troubled big beasts of the euro zone periphery and an explosion in either of them could destroy the single currency.

But Spain, where I spent part of last week, probably won’t catch Italian flu. True, the risk of Madrid being thrown off its reform path has risen since Italy’s inconclusive election. But Prime Minister Mariano Rajoy doesn’t have to face the voters for nearly three years. What’s more, the Italian vote may make euro zone policymakers less keen on austerity and so give Spain a better chance of returning to growth.

Indeed, investors have already started having second thoughts. By Friday, Madrid’s 10-year bond yield had fallen back to 5.1 percent from 5.4 percent on Tuesday. The spread between Spanish and Italian yields has shrunk to 0.3 percentage points. There’s even a chance that Madrid could enjoy lower borrowing costs than Rome in the coming weeks if Italy’s political paralysis shows no sign of resolution.

Can the Italians be serious? That is likely to be the reaction of financial markets and the country’s euro zone partners as they ponder a disastrous election result, which could reignite the euro crisis. More than half of those who voted chose one of two comedians: Beppe Grillo, who really is a stand-up comic; and Silvio Berlusconi, who drove Italy to the edge of the abyss when he was last prime minister in 2011. Both are anti-euro populists.

This comedy could easily end in tragedy. The inconclusive result has echoes of last year’s first Greek election – except that Italy is bigger and more strategic. The country faces political paralysis, while its economy is shrinking and its debt is rising. The European Commission forecast last week that GDP would fall a further 1 percent this year after last’s year 2.2 percent drop. Debt, meanwhile, would reach 128 percent of GDP by the end of this year.

The euro crisis went into remission after the European Central Bank’s president Mario Draghi promised last summer to do “whatever it takes” to preserve the single currency. But, if Italy proves ungovernable during this critical time, even the ECB’s safety net may not work.

When euro zone governments agreed last year to give the European Central Bank the power to supervise its banks, that looked like another victory for its president Mario Draghi. It is more like a poisoned chalice.

The ECB will certainly get a chunk of extra power. But it will also be blamed when banks run into trouble, as they inevitably will. Draghi himself is experiencing this first hand following the scandal at Monte dei Paschi di Siena (MPS), which has had to be rescued by the Italian state. He has been lambasted for failing to supervise the country’s third largest bank properly when he ran the Bank of Italy – although the criticism seems overdone and has often been fuelled by his political opponents back in Rome.

The potential reputational risks for the ECB from banking snarl-ups on its watch are probably even bigger than they are for national central banks. This is because it doesn’t yet have the full set of tools to do the job properly. Moreover, a huge amount is at stake since the ECB is the euro zone’s most credible institution. If its reputation gets tarnished because of perceived supervisory failures, that could rub off on its ability to conduct monetary policy or manage crises effectively.

David Cameron is planning a keynote speech on Britain’s relationship with the EU later this month. Here is what the UK prime minister should say.
 
 The euro crisis is forcing euro zone nations to rethink how they wish to run their currency union. It is also forcing European Union countries that don’t use the single currency, such as Britain, to rethink their relationship with Europe.

We have three main options: quit the EU; move to the edge as the euro zone pushes towards closer union; and seek to stay at the heart of Europe and influence its development in a way that promotes our interests.

There are members of my own Conservative party who would like Britain to quit. There are others who would like us to move to the periphery. But I am determined to make sure that we stay at the centre.

Who is Europe’s most powerful man? If one phrased the question as who is Europe’s most powerful person, the answer might well be Angela Merkel. But the deliberate use of the masculine excludes Germany’s chancellor, leaving the field open to Mario Draghi.

This answer can, of course, be disputed. How can one compare power in economics with power in, say, religion? Is it possible to rank the technocratic European Central Bank boss on the same scale, for example, as the Pope?

The best place to start is with an attempt to understand what power is. Bertrand Russell, the British philosopher, said it was the production of intended effects. By contrast, Steven Lukes, one of the top contemporary power theorists, said in an interview last week that power is the capacity to make a difference in a manner that is significant.

Conventional wisdom has it that the euro zone needs a banking union to solve its crisis. This is wrong. Not only are there alternatives to an integrated regulatory structure for the zone’s 6,000 banks; centralisation will undermine national sovereignty.

“Create a banking union” became a rallying cry earlier in the year when it looked like the euro was going to explode. Advocates of a single banking authority said it would break the “doom loop” which tied troubled banks to troubled governments. European Union governments will this week continue their attempt to agree on a single supervisor, the first stage of a banking union.

There are two parts to the doom loop: when banks go bust, their governments bail them out, adding to their own debts; and when governments become over-indebted, the nation’s banks are usually big lenders, so the banks get sucked into the sovereign debt vortex.

The battle against Grexit – Greece’s exit from the euro – is far from won. Assume Athens is promised its next 44 billion euro tranche of bailout cash and some further debt relief when euro zone finance ministers reconvene on Nov. 26. Even then, the banks will still be hobbled, while another round of austerity is in the works and vested interests are rife.

It will be hard to restore confidence and, without that, there won’t be a return to growth. Meanwhile, without growth, Antonis Samaras’ fragile coalition government will fall. Alexis Tsipras’ radical left SYRIZA movement would then probably take over – plunging the country into a new hot phase of the crisis. What’s more, if investors and consumers fear such a scenario, they won’t start spending – making a continuation of the slump self-fulfilling.

Samaras, who became as prime minister in June, has been better than many feared. His strategy has been to do everything demanded of Greece by the “Troika” – the European Commission, the European Central Bank and the International Monetary Fund – with the aim of changing the perception that Athens cannot be trusted.