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Capital Controls Loom in Greece

Macduff Everton | Ironica | Getty Images

It looks increasingly likely that Greece will have to implement controls to prevent capital flight and a banking collapse. To my mind, the only real question is when this will occur.

The widespread talk about Greece possibly leaving the euro zone is likely to trigger withdrawal of bank deposits and other financial assets, by those who fear they might be redenominated into a drachma that would be worth far less than the euro.

Foreigners have around 46.7 billion in deposits in major financial institutions in Greece. According to the latest data, there were around 1.3 billion of euros belonging to non-Greek euro-zone residents as of March 2012. In addition, there were deposits of 45.4 billion euros belonging to non-euro-zone residents.

Corporations and households of Greece had around 153 billion euros on deposit in Greece as of March 2012. By far the largest portion of that—nearly 140 billion—is owned by Greek households. Forty-nine billion of that is in savings deposits, which could easily be withdrawn. Another 84 billion is in time deposits, many of which may include penalties for early withdrawal.

Much of these deposits will likely flee Greece in the next days and weeks, if controls are not put in place. Even residents concerned about meeting payments due in the new currency—such as tax assessments—would be better off converting into a new currency after a euro-exit than before.

Even controls on expatriating funds may be inadequate. Most ATMs across Europe allow withdrawals of up to 300 euros per day. A paper by London’s Capital Economics Limited calculated that if every working-age Greek withdrew the maximum amount, the Greek financial system would lose 2.3 billion euros per day. At that rate, every single deposit of Greek households would be gone within 61 days. (In reality, the Greek banks would run out of euro notes long before that.)

So the controls put in place in advance of an exit from the euro would have to include not only limits on moving funds abroad, but limiting withdrawals from ATMs and possibly declaring a bank holiday.

Such controls could face challenges under European Union rules. After all, the free flow of goods, people and capital across member borders is one of the core principles of the EU. But it appears as if an early look into the possibilities of controls found that they could be permissible in extreme circumstances:

Ambrose Evans-Pritchard explained two years ago in the Telegraph:

… such options were studied earlier this decade, just in case. This document is sitting in a drawer at the Directorate of Economic and Monetary Affairs in Brussels.

It was written by a small cellule of EU officials in 2003 or 2004 (If I remember correctly) under prodding from Paris. It explores the legal basis for measures to stabilise the euro and EMU.

After combing through the EU treaties and court judgments, it concluded that Brussels may impose "quantitative restrictions" on capital inflows.

Free movement of capital in the EU is not an "absolute freedom" and could be limited in an emergency.

"Should extremely disturbing capital movements endanger the operation of economic and monetary union, Article 59 EC (Maastricht) provides for the possibility to adopt restrictive measures for a period not exceeding six months," it says.

It would be renewable every six months. Any decision would be taken by EU finance ministers under qualified majority voting, so no country could veto it.

The document was shown to me by one of the authors at the time. Part of it was later included in a published report, but nobody noticed — except Bernard Connolly, former currency chief at the Commission and later global strategist at Banque AIG. He always suspected that the EU experiment would end in capital controls.

The imposition of capital controls under Article 59 would require the approval of the European Commission. It strikes me as likely that the Commission would grant its approval in order to prevent a complete meltdown of Greece’s banking system.

The tricky question is whether the capital controls would have to be extended even further. After all, if Greece were to leave the euro and depreciate its currency, it would have a competitive advantage over countries like Spain, Italy, Ireland and Portugal. They would then be tempted to exit the euro. Even if such plans go nowhere, knowledge of these incentives could lead to a run on their banks. To prevent those runs, wider capital controls might be necessary.

But if Europe becomes a land where capital cannot move freely, is it still the European Union?

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