Capital controls — how Greece could stay in the Eurozone even without a deal

As negotiations between Greece and other Eurozone member states — most of all Germany — continue, there’s growing speculation that Greece will be forced to leave the Eurozone. And if no deal is reached it might. But there is another policy the country can adopt that is in many ways politically and legally more likely: capital controls.

That’s finance jargon for legal restrictions on the ability to move money across national borders. Capital controls are in place in a lot of countries, ranging from China to Argentina. But they are rarely seen in the richest countries, and the idea of imposing capital controls on a country that is in a currency union is a little paradoxical. But capital controls are already in place in the small Eurozone state of Cyprus, and they could provide a solution — or at least a “solution” — to the Greco-German standoff that doesn’t involve Greece leaving the Eurozone.

Greece has a lot of problems. But its specific problem right now is that for Greek banks to keep functioning, they need to be backstopped by the European Central Bank. At the same time, the Greek government is deeply in debt to a bunch of other Eurozone countries as a result of a debt bailout it received years ago. Under the terms of that bailout, Greece needs to abide by a policy of fiscal austerity and also commit itself to various privatizations and labor market deregulations. A new government came to power in Greece in January promising to reverse all that, but they have not succeeded in convincing Germany to let them.

The ECB has made it pretty clear that it won’t keep supporting Greek banks if Greece can’t reach a deal with its Eurozone creditors. And if the ECB pulls its support, the entire Greek banking system would collapse.

There is one way to save the banking system in that scenario: the Greek government could start issuing a new currency of its own and use that currency to support its banks outside the ECB’s purview. That, of course, would mean leaving the Eurozone.

One big problem with leaving the Eurozone (“Grexit” they call it) is that there’s no legal mechanism through which it can be done. That doesn’t mean it’s impossible, but it does mean it would be quite chaotic. For one thing, the Greek economy relies on contracts that are written in terms of euros, which would all have to be revisited in light of an exit.

Another, potentially more cooperative way forward is capital controls. Greece could impose severe legal restrictions on Greek people’s ability to shift their euros out of the country, leaving them with no alternative but to trust the Greek banking system. That, combined perhaps with some limited support from the ECB, could keep Greek banks running even in the absence of a deal.

Greek people and companies would still be able to fulfill the terms of old euro-denominated contracts without entering into a legal grey zone, and European visitors to Greece could keep spending their euros.

A clear precedent for this exists in Cyrpus, where a 2013 banking and fiscal crisis was resolved with the use of capital controls, among other things.

Cyprus still uses the euro as its currency, but as you can read on their central bank’s websites there are tons of legal restrictions on what a Cypriot can do with his euros. Cypriot euros are semi-trapped inside Cyprus, whereas as Belgian euro can fly all around the eurozone or even be traded for dollars. Consequently, in practical terms a Cypriot euro is less valuable than a Belgian (or Finnish or Irish or Portugese or German) euro. This raises some metaphysical questions as to whether Cyprus really has the same currency as the rest of the Eurozone — after all, lots of currencies are called dollars but that doesn’t make them US dollars — but officially the capital controls are only “temporary” and Cyprus is a member of the club.

You could imagine something similar happening in Greece. Cyprus’ temporary controls are still in place with no end in site, and Greece might languish in capital control land for a long time. But unlike an official exit from the Eurozone, a capital control scenario wouldn’t be irreversible. The Syriza government could collapse, and the Eurozone could hold out the promise of reversing the capital controls if a new coalition comes to power and returns to the bargaining table.