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.