Tuesday 26 March 2013

Euro gleich Mark or Euro gleich Euro?

In the Germany of the pre-hyperinflation era, the Reichsbank creed was a Mark is worth Mark whether paper or gold, in Berlin or Munich. This creed was also enshrined in the Euro when the new currency was adopted by the 17 European countries. To make sure that that was the case one of the fundamental principles of the Euro project was the free movement of capital and goods.
This was the case till last week when Cyprus was forced to liquidate one bank and break up another. The Cypriot government passed a law giving powers to the governor of the Bank of Cyprus Mr Panicos Demetriadis to stop the panic. 

This is an extremely worrying development and in my view completely against the interest of the Euro-project and Cyprus. It is absolutely the wrong decision especially now that Cyprus has yielded on the entire Troika demands to restructure and clean their banking sector. Cyprus should refrain from imposing any capital controls that create a Euro of different value in Cyprus from that of Germany. A Euro is worth a Euro whether in Nicosia or Berlin. I am surprised that the ECB accepted such a blatant violation of the fundamental principles of the EU.
The Eurogroup made a gross mistake when it asked for insured deposits to be haircut and the ECB bears a lot of responsibility in not refusing to accept such a solution. The ECB should not make another mistake by accepting capital controls.

The ECB’s primary responsibility is price stability and financial stability. The Cypriot banks following the Sunday’s decisions to convert depositor to equity would have more than enough capital to be solvent. Any outflow of money would pose a liquidity shortage in the Cypriot banks and not a solvency issue. The solvency issue has been addressed.
Taking this into account the ECB should extend their liquidity to Cyprus either through the normal MRO or through the ELA of the bank of Cyprus. Any shortage of printed notes can easily be fixed by borrowing from other central banks in the same way the Bank of Greece borrowed tens of billions of printed notes from other banks.
This would restore faith both in the Euro and in the Cypriot banking system. There may be a spike in the outflow of funds in the first few days but as confidence is restored this would subside and possibly reversed. Cypriots and other Europeans would have faith that the cash in their pocket is worth what the ECB says it is worth.
It would also help the Cypriots believe that Europe is there not to punish them but help them in their hour of need.
The ECB should act now and support the Banking Cyprus banking system. It is in the interest of Europe and the ECB. A Euro is a Euro everywhere and should not be seen as a Mark.