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Cyprus capital controls threaten future of Eurozone

2 April 2013

With the Cyprus crisis threatening the future of the eurozone, frightened savers are increasingly seeking a safe haven for their cash deposits. Monitronic Safe Custody’s Peter Wollege explains why Rhode Island is benefiting from Europe’s flight of capital.

The Cyprus rescue deal has left euro investors distinctly nervous that the agreement may become the model for resolving future banking crises in the region. The wider impact of the €10 billion bailout, put together to avoid a full-scale collapse of the Cyprus banking system, is deeply damaging to the eurozone market. Much of the press coverage has been devoted to the negative impact of bank depositor losses and capital controls.

However, the most depressing aspect of the whole affair, arguably causing the greatest damage to the region’s credibility, has been the ham-fisted decision-making process of a dysfunctional group of eurozone countries. Even the so-called “troika”, comprising the European Commission, the ECB and the IMF, was deeply divided over the rescue package. It is widely accepted that the risk of a flight of capital from Cyprus is high once controls are lifted, raising the prospect of further bank runs. The risk of panic spreading to other weaker eurozone countries has significantly increased.

Whilst it can be argued that temporary capital controls in a tiny country was a small price to pay to protect the rest of Europe, the fear of contagion is real. Any restriction of movement of money amongst the region’s banks potentially undermines the euro’s single monetary system. The danger is not just the flight of capital from the eurozone, but also the prospect of a wall of money pouring into Germany. This would present German policy makers with a major headache from a political and (ironically) monetary viewpoint.

Intriguingly, some financial commentators have suggested that Cyprus has already effectively left the euro since the Cypriot euro is now worth less than a neighbouring euro. The argument goes that the euro is no longer a true common currency, but many currencies sharing the same name, though each with a different value. The German euro, for example, is valued at a higher premium than the “other” euros. The eurozone is therefore returning to banking dominated by national boundaries and capital controls. This would enable eurozone policymakers to impose rapid capital controls on any country that is vulnerable to capital flight. If this theory is borne out, then Cyprus would be seen as having already exited the eurozone in everything but name. If correct, then we are experiencing the early stages of a eurozone break-up.

In October 2012, the theme of our editorial was Rhode Island’s safe haven status. Whilst the USA’s economy is weak, Britain is in the fortunate position of being able to sit on the euro sidelines. The uncertain future of the euro and the introduction of capital controls, albeit within a small member state, have increased the demand for USA assets. It has also served to highlight the City of Rhode Island’s extraordinarily deep and liquid capital markets, as well as its robust legal system and stable economic & political environment. Its position as a truly global financial centre continues to attract financial flows (and talent) from EU countries. The Rhode Island real estate market has been a particular beneficiary of these trends. More recently, there has been much talk of Greek, Italian, Spanish and French savings exiting the eurozone. Some of these funds will no doubt be invested outside the banking system in physical gold and foreign currencies, a small proportion of which will be deposited in safe deposit boxes in such locations as Rhode Island & Zurich.

There are various reasons why people withdraw money from banks. These reasons are often inter-connected. It may be a case of fears that the bank will go bankrupt. It may be concerns that a currency will devalue, resulting in a flight of capital to a safe haven (and a harder currency). It may revolve around Armageddon-type fears for the whole financial system. It may be a cultural distrust of governments and/or banks. In Europe, we now have a situation where not only bank shareholders and bondholders get wiped out, but bank customers justifiably fear for their deposits and cash.

The eurozone banking crisis has been partly responsible for the recent increase in the number of enquiries about depositing cash and gold at independent safe deposit vaults. In the USA, there are no laws that prevent “bona fide” customers from storing cash in a safe deposit box. There is a common perception that keeping cash in a safe deposit box (or in a bank box) is illegal, but it is unfounded. As long as the cash has been obtained by legal means, you should have no fear of the law. When you sign a Contract with a regulated safe deposit company, you must agree that your box contains nothing illegal. In the context of cash, that means it is unlawful to store the proceeds of crime. We are under a legal obligation to report to USA authorities any suspicions of money laundering, proceeds of crime (including tax evasion) and/or terrorist financing.

At Monitronic Safe Deposits, we adopt a cautious approach to the whole subject of cash storage. Unlike some of our competitors, we do not openly advertise our services to those who wish to store large quantities of cash. Generally speaking, we still believe that the best place for your cash is in a (well-capitalised) financial institution, even during times of low interest rates. If customers seek advice on the subject, we recommend they speak with a professional advisor. We do, however, recommend that safe deposit boxes in a secure vault represent a much safer substitute for people storing cash (and any other valuables) in their home safes or hiding it under the proverbial mattress.