Reader Asks "Where's the Money?"

Reader Robert at Americans for Limited Government asks an interesting question.

Robert writes ...

Hello Mish

We are led to believe that taxing Cypriot deposits in the amount of 5.8 billion euros will make the banks solvent. I have a question: Why the need for capital controls after "recapitalization"? How can deposits be used for taxation but not withdrawals?

Robert

With the European Central Bank threatening to pull the plug on Monday by denying further liquidity support, and showing absolutely no sign of blinking, Cypriots have little choice in the matter. The present plan is only slightly more palatable than the last. The two most problematic banks are to be restructured, with uninsured creditors taking a 40 per cent hair cut. That gets the Cypriot authorities some of the way towards the €5.8bn they need, or is that €6.7bn? Reports suggest the beastly Troika has upped the ante. In any case, the balance, whatever it might be, is going to come from "taxing" uninsured deposits above €100,000 in other banks in the way originally proposed.

However, the perhaps more widely significant part of the proposal is the planned application of capital controls. This is of course entirely necessary to prevent a further run on the banks the moment they open their doors on Monday. Many Russian depositors are threatening to remove their spoils if they are subjected to any kind of a haircut. This would quickly render these organisations essentially insolvent regardless of the recapitalisations. Almost no amount of capital is sufficient for a bank which has lost the confidence of its depositors.

Yet the point is that if capital controls are introduced, it basically makes Cypriot euros into a national currency, rather than part of wider monetary union. The capital controls will severely limit your ability to get your euros out of Cyprus, rending them essentially worthless in the wider eurozone. It would be a bit like telling Scots they can't spend their UK pounds in England. Monetary union is many things, but above all it is about free movement of money and a uniform value wherever it is spent. When these functions are disabled, then you cease to be part of a single currency.