COLUMN: “Cyprus euro” a boon to US dollar: James Saft

March 27, 2013

March 27 (Reuters) – One clear winner from Cyprus’S
imposition of capital controls is the U.S. dollar, which stands
to benefit from public and private flows after another round of
damage to the euro’s reserve currency status.

The euro fell to its lowest against the U.S. dollar in four
months on Wednesday, falling below $1.28 after Cyprus moved to
limit the flow of money out of the country in the aftermath of a
bank bailout which singed foreign bank lenders and depositors
alike. The dollar was just below its 52 week high against a
trade-weighted basket of currencies, indicating that its
strength was broad-based.

Following a bailout package that includes a substantial hit
to uninsured deposits, many of them Russian, Cyprus imposed a
limit of 300 euros per day on account withdrawals and set a
limit of 5000 euros per month on credit and debit cards used

This should surprise absolutely no-one. Whacking depositors
was probably the right thing to do, but it is a policy with
substantial costs, and not just to Cyprus.

The introduction of capital controls actually will mark the
effective debut of a new currency, the “Cyprus euro.” As a euro
held in Cyprus is no longer a unit of value with free movement,
it will no longer be worth as much as a euro held in France or
under a mattress in Moscow.

That in itself is a blow to the euro’s status as an
international reserve currency which has already been damaged by
the terms imposed on foreign depositors and the ongoing risks to
the euro project itself.

Since its conception, one of the hopes for the euro was that
it would develop into a reserve currency to rival the U.S.
dollar. Reserve currencies are those held in reserves by
governments and institutions and they also tend to be used for
pricing and exchange of commodities, as the dollar is for oil.

Reserve managers, and the private parties who follow in
their footsteps, look for stable stores of value which are
easily convertible in highly liquid markets. That is simply less
true of the euro than a month ago, and will be still less true
tomorrow when Cyprus banks reopen in what may prove to be a long
era of capital controls.


Moody’s Investors Service estimates that Russian companies
and individuals have, or had, at least $30 billion in Cyprus
banks, while some $135 billion is estimated to have flown from
Russia to the island between 2007 and 2011.

Many Russian companies priced goods and services in euros
and transacted much of their business through Cyprus-based
accounts. That phenomenon, of people using a currency when they
don’t strictly have to, is what happens when a currency becomes
a reserve currency. While the euro won’t stop being used
internationally, far from it, there are now new risks and
restrictions which will tend to retard its use.

In fact, we were already seeing this, according to the
latest IMF data, based on the third quarter of 2012 which showed
the euro’s share of global reserve holdings falling to 24.1
percent, down from 24.9 percent at the end of 2011. This move
away from the euro was particularly marked among emerging market
central banks, which cut their holdings on a valuation-based
level to the lowest since late 2002, according to estimates from

Given that Japan is about to embark on a still more radical
round of easing to try and create inflation and stoke economic
growth, the attractions of the U.S. and the dollar are markedly
stronger than they were six months or a year ago.

Of course, being a reserve currency is not all good. A
weakening euro, whatever the reason, is precisely what the
continent needs to help to ease the pain of trying to adjust the
weaker economies without recourse to separate official exchange

The flip side is that the larger you are as a reserve
currency the cheaper it becomes to borrow, a cost that will make
supporting current levels of debt in the euro zone marginally
more difficult.

Add to this all the real risk that the “Cyprus euro”
eventually is replaced by the Cyprus pound if the country leaves
the currency union and we have yet another reason for reserve
managers to shave their exposure.

That process won’t be quick. The euro’s share of reserves
grew by about 50 percent in the decade to 2009, but with global
currency reserves of more than $10 trillion, the dollar will get
substantial help for a long time.

At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at and find more columns at)

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