According to analysts at Macropolis, the Greek banking system lost € 24.6 billion in deposits between December 2014 and the end of February 2015. The money has tended to ebb and flow in line with the tension in the talks between the Greek government and its creditors. On balance, however, the flow has exceeded the ebb and so the Greek banking system is now weaker on the liability side than it has been since 2012. Such a trend cannot continue indefinitely. And, as one-time chairman of the Council of Economic Advisors Herbert Stein once quipped, if something cannot go on forever, it will stop.
This threat of a run on Greek deposits has fuelled speculation about whether the Greek government will have to impose capital controls to stabilize the banks before they become insolvent. Hans-Werner Sinn has been making the case for Greek capital controls since early February. Eurogroup President Jeroen Dijsselbloem added his support in a widely quoted interview on 17 March. And since then rumors have been swirling that the European Commission is looking at the legal requirements to make the temporary imposition of controls on Greek banks consistent with Greece’s requirements under the internal market. With the Orthodox Easter weekend immediately on the heels of a difficult €450 million repayment to the International Monetary Fund (IMF), the time for imposing capital controls may be ripe.
From a technical point of view, the argument is sound. Capital controls would reduce pressure on bank funding requirements and so buy time for politicians to negotiate their way out of the crisis. Of course to be effective, it would help if policymakers could impose the capital controls before they are widely debated (and particularly before they are announced). Moreover, most of the large accounts have already been emptied and the small accounts that remain would not be overly inconvenienced by restrictions on withdrawals; the result would simply be to discourage small depositors from taking the money out overnight and hiding it under the mattress.
From a wider political point of view, however, the decision to rely on capital controls to stabilize the Greek banking system should raise important questions about the functioning of the internal market. Greece would not be the first country to break with the free movement of capital in Europe; it would be the third, behind Iceland and Cyprus. The imposition of controls was not a permanent feature for either small island nation. The big Icelandic banks are getting ready to go back into global financial markets and the government of Cyprus has announced Monday that it will lift remaining restrictions. Nevertheless, the process of stabilization took far longer than either country originally envisaged. Given the damage already wrought to the Greek financial system, the situation there might be worse.
The question is whether there is a superior alternative. Ironically, that is what European integration was supposed to offer. To see why, it is necessary to take a little historical detour. In doing so, I will crib from Eric Helleiner’s 1994 book called States and the Reemergence of Global Finance. What Helleiner argues is that European governments entered into the Bretton Woods system at the end of the Second World War with a strong commitment to the use of capital controls as a means of preserving national policy autonomy. This was a framework that the United States tolerated but never wholeheartedly.
Once the U.S. government saw advantages in liberalizing international capital flows and encouraging financial market integration, it was quick to change tack leaving the Europeans with little choice but to respond. They built the European Monetary System, completed the internal market, embraced capital market liberalization, and launched the single currency in order to maximize their global competitiveness.
This is where Helleiner’s argument stops and the implications become important. European policymakers accepted the logic of their interdependence and so sought to maximize their autonomy within that constraint. They got more efficient financial markets with a lower cost of borrowing but they also faced the risk of transnational financial crises and large lender-of-last-resort requirements. These are the implications that the Eurogroup acknowledged in the June 2012 Euro Area summit when they launched the debate about banking union and that European Central Bank President Mario Draghi underwrote when he promised the next month to do ‘whatever it takes’ to safeguard the euro.
Now European policymakers are winding back the clock. The imposition of capital controls in Cyprus was the first step. Two years ago Dijsselbloem heralded those negotiations as setting the model for the future. He quickly retracted his words in the face of market pressure, but the experience of Greece suggests he was not wrong in his assessment. A colleague of mine in the Italian Foreign Ministry said to me recently that we need a clear commitment to do ‘whatever it takes’ politically to safeguard Europe and not just the euro. The problem is that it is unclear what kind of Europe politicians want to have.
NB: This posting was edited and published originally on Euroinsight. This version is the unedited pre-production copy. Many thanks to Silvia Amaro for her permission to reproduce the essay here. The title of the posting is borrowed from Lucas Tsoukalis’ 2005 book. The question remains as pertinent today as it did then.Follow @Erik_Jones_SAIS