What Now?

Tuesday, the legislature of Cyprus unanimously voted down the aid package agreed to on Friday.

This could be a good thing: the whole explicit taking of government guaranteed deposits is a Pandora’s box no one should have peeked into.

But, we’re not back to the situation of last Friday either.

• Last Friday, there was a credible threat that a bank or banks would go bankrupt and close its doors. That would mean that some depositors would lose a big chunk of their wealth permanently, and a bit more temporarily as the bankruptcy was worked out.
• Over the weekend, the plan was for everyone to lose some of their money permanently.
• Now, the lack of plan, means that everyone will lose all of their wealth temporarily. Is that better? It now appears that the banks will not open before next Tuesday.

And, keep in mind that, like all legislators, voting against an unpopular proposal in public doesn’t mean that they aren’t still working towards the same or a similar plan in private.

What are the new developments? Well …

• The UK stations a lot of troops in Cyprus, and they are already flying in cash. BTW: there are UN peacekeepers in Cyprus too — no doubt cash will be flown in for them as well.
• Russia’s largest natural gas company, Gazprom, is offering to bail out the government in exchange for drilling concessions. The Russians are known for driving hard bargains.
• More broadly, Russia is willing to offer more aid, but only if Cyprus starts divulging the names of Russian nationals with big deposits in Cyprus. That sounds like thugs angling to hit other thugs.
• International markets in Cypriot assets have not crashed (much). This suggests that investors already anticipated, and had marked down prices, in anticipation of nonsense (like that which has taken place). This is bad news for Cyprus and good news for you and me.
• International risk managers are starting to decline counterparty offers with Cypriot connections.
• There is talk of capital controls.

Ah … capital controls. What exactly does that mean? The capital here is financial capital: basically, accounting entries in Euros on bank statements (remember, the banks are closed, so the only money now is the cash in people’s hands). Capital controls means that, first, no one will be allowed to transfer those Euros to a financial institution outside the country — those transactions won’t be hard, they’ll be considered a criminal activity. Second, you do permit some capital movement by forcing (or allowing) people to buy brand new bonds with their Euros. But those bonds will only be available within Cyprus, so to get your money out of Cyprus you’ll need to sell your bond to someone who … probably already has one. Good luck with that, but it is possible.

In the end, capital controls will mean that everyone loses a chunk of their wealth. It probably also means that Cyprus eventually leaves the Eurozone, and goes back to issuing its own currency. This will probably make the Mexican experience of 1994-5 look easy.

Lastly, you may have some fun with the “game” at Crooked Timber.