Should Cyprus leave the euro?

Krugman argued yes and I am inclined to agree.  From fortheisland, here is a case for no:

All of Cyprus’ physical inputs are imported. Everything; from feed to steel and from fertilizers to computers. Raw materials are imported. Intermediary goods are imported. Capital goods also imported.

This is an island economy with a GDP smaller than Vermont and a population 200.000 short of a million. So, when I say, “imported”, I mean “close to 100%”.  While the primary surplus that Krugman mentions is a 2013 projection unlikely to materialize (again), the trade deficit spikes with GDP growth and declines rapidly with recessions. This is not unusual, and Krugman would say that it reflects FDI flows as well. But a closer look reflects the extreme dependence on imported factors of production.

This changes the entire picture and makes one wonder about the level of inflation under a new currency, as well of the impact that this would have. All of the obvious concerns about a nascent currency borne out of crisis are suddenly multiplied into a nightmare.

In fact, as if all of this weren’t enough, note that Cyprus is also 100% dependent on energy imports. Gas prices have been rising at a dizzying pace in the last two years, although from a lower starting point than in most other countries. Electricity is another issue –prices accurately reflect how profoundly reckless Cyprus has been in managing its infrastructure: We managed to blow up our main electricity plant by storing munitions outdoors, nearby. Ever been in Cyprus in the Summer?

Krugman notes that Cyprus has two main exports- tourism and banking services. And, he is right in saying that banking was wiped out overnight, at least as export. On the other hand, the main question about tourism isn’t so much whether a devaluation will help the industry; of course it will.

The question, though, is more basic than that: After the glorious 1980s, can the industry be revived? One wonders, after the sun-sea-and-sex tourist wave 30 years ago, what the prospects are for Cypriot tourism. With a few bright and special exceptions, the industry has been in a steady wane since the early 1990s.

Barkley Rosser makes some similar points.  If I’m not convinced, it’s because I don’t see how the current regime of “Cypriot euro with capital controls” will boost either tourism or enable significant imports.  Nonetheless, at the very least, you can take these paragraphs as a further indication of just how much trouble Cyprus is in.

For the pointer I thank Dries de Smet.


The problem with cyprus tourism is it just drunk brits and dirty Russians.

And if you want Russian whores, go to Dubai. So I don't see frustrated Arabs as a replacement.

Here's an idea -- merge with Greece!

Yeah, they tried that. Suffice to say it didn't quite work out.

Merge with Turkey!

I suppose you're joking about Greece, but isn't there the real possibility of Turkey taking advantage of all the chaos to make a political/military move into southern Cyprus? And under the current circumstances, Cyprus and the Eurogroup might not object. What a way to exit the Euro, amirite? Eurogroup gets rid of the troublesome little backwater, washes its fiscal hands, and allows the lesson to sink in to the rest of the periphery.

Don't the Turks have enough (separatist-related) to worry about with the Kurds etc.?

At present, the Turkish government is working on a peace solution with the Kurds (Abdullah_Öcalan, who has already publicly called for a historic ceasefire)

I agree with Krugman on this one.

Devaluing the Cypriot currency in this awful moment is like having your airbag inflate when you crash your car: it's not a perfect situation, and it's not meant to be. It's just better than the alternative.

Well, I see the point but cap controls are to be (presumably and hopefully) a short term relief until BoC dust settles. Cyprus FinMin is not expecting to renew it after the 4 working days expire, and hopefully they won't. ECB liquidity support -promised rather explicitly would also buy time for BoC restructuring. In the meantime, lots of indications showing that most of the demand for cash in BoC is intended to go to other banks inside the Cy banking system- allowing a slow asset stripping.

So the option is not Cyprus in the euro and with cap controls, but simply in the euro.

Not saying it's a nice option, either, but it's much better to be squeezed by your currency, than to be blown up by it.

So how are you and yours doing in any event? How difficult were the last couple of weeks for you personally? (You may have mentioned it on your blog, but most of it is in Greek, which I, and I fear most MR commenters as well can't read.)

Is it even theoretically possible for residents of such a poor country to maintain a high standard of living? Are we not facing either a continental welfare system, or allowing destitution in such unfortunate areas?

Is it even theoretically possible for residents of such a poor country to maintain a high standard of living?

This is the big question for me. Assuming Cyprus was mostly a banking economy with a small, waning tourism sector, how can they survive without the Banking part? The argument that they will suffer a major shock during a currency devaluation seems logical, but on the other hand how are they going to survive without a currency devaluation.

They import nearly all raw and intermediate goods, which means they must export high end goods. Can they do so currently with a much smaller Banking industry? If not they must either a) find a high end good replacement (possibly tourism) or b) reduce the net import of raw and intermediate goods.

I agree with Krugman, but has anybody else detected what I see Krugman doing a lot (and other economists): advocate a position that is unlikely to be adopted, that is contrary to the official position? That way he can say "I told you policy X would fail" (if it fails; if not, the matter is quietly dropped). Case in point: he criticizes Japan for not doing enough stimulus in the last 10+ years, though they did stimulate. Good enough is never enough for Krugman, and nobody but him seems to get it right. That's not science, that's charlatanism, because it's untestable. Lots of economists do this BTW.

What a terrible idea!
All their debts are still in Euros. Leaving the Euro will give them their own currency which will devalue before you can finish your coffee, quadrupling or so their foreign debt. (Unless you are suggesting that in addition to leaving the Euro they also renege on their 10 billion loan from the EU? Maybe they should leave the EU as well and become part of the African Union?)
Did you consider this or am I totally mistaken?

All their debts are still in Euros. Leaving the Euro will give them their own currency which will devalue before you can finish your coffee, quadrupling or so their foreign debt.

What's the difference in not being able to repay the debt in Euros and not being able to repay the debt in Cypriot pounds?

A agree with _fotheisland_: "So the option is not Cyprus in the euro and with cap controls, but simply in the euro".

Hopefully, capital controls do not have to stay for years in Cyprus, unlike in Iceland. Cyprus is a member of a currency union with the union’s banking sector much larger than that of Cyprus. Therefore, the union’s central bank can relatively simply deal with a run on Cypriot banks as ECB can substitute all fleeing deposits with its own liquidity without causing devaluation of euro. In Iceland, this was not an option. After all, being a member of a large currency union has certain advantages…

Well if you import everything, and all you currently export is offshore banking services and tourism, and now your offshore banking industry is toast and your tourist industry is in decline...then it seems to me that the question of "what currency should we have?" is window dressing as far as your standard of living, at least in the near term.

Perhaps the real question should be "what is the best currency for attracting the investment necessary to develop the offshore gas fields and related infrastructure?" to which I highly doubt the answer would be "Cypriot euro with capital controls." Maybe they should leave the euro and adopt the pound or dollar, that would be hilarious.

How about the ruble?

Since there is nothing to lose no matter what happens, perhaps there are other things that Cypriots could do than these two alternatives. Surely there are some. Sell their military grade ports to the highest bidder? I'm certain Russia, Iran, maybe China would have some interest. Maybe foment the Greek Turkish conflict again. It isn't that long ago that Canadian peacekeepers were there. It doesn't even have to be so overt or official. How about a center for contraband and piracy in the Med? Since the Greeks defaulting on a bunch of debt caused this problem, why not take one of their islands?

What could happen? Germans send their military? A stern talking to by Kerry?

Wouldn't it be rather amusing if the European project of integration ended up being the cause of the next conflagration?

"Wouldn’t it be rather amusing if the European project of integration ended up being the cause of the next conflagration?"

Martin Feldstein said something along this line back when the euro got going. He observed that the real point of the euro was to draw the countries that adopted it closer together politically, but that the practical effect would likely be just the opposite.

Selling those gets you a lot of money in the near-term, but it doesn't get you jobs or dependable revenues to your budget in the long-term, meaning it's not a viable economic development plan. Banking accounts, in one way or another, I read somewhere, can't find the link, for 70,000 jobs. That's insane. That's as much as my native Romania in boom times, with 25 times the population.

" We managed to blow up our main electricity plant by storing munitions outdoors, nearby. " That'll larn you: next time the US Navy invites you to look after some stuff for them, just say "no".

By the by, if Cyprus can't possibly survive outside the Euro, how did it previously survive outside the Euro?

Being leased to the British Empire?

Then becoming a British crown colony?

But there was a spell of several decades between independence and submission to the Eurozone, surely?

"This is an island economy with a GDP smaller than Vermont and a population 200.000 short of a million."

I was young,

How bad was it when Orange County went bankrupt? Why is this different?

It's different because Orange County's economy was almost certainly much more diversified. This is more similar to Detroit.

The rest of the state of California kept paving their roads, paying for their schools, and policing their neighborhoods. The old people still got their Medicare and Social Security. People feel free to come and go out of the county.

Europe has none of this, the whole problem.

Cyprus leaving the EU will mean they lose the gigantic leverage they have over Turkey. As it stands, they can prevent the Turks from ever much is that worth in terms of GDP?

No one said anything about Cyprus leaving the EU. We're talking about Cyprus leaving the Euro- Currency. Turkey also has clear guide lines of what they must do to join the EU and that is come to a solution with Cyprus of which they have been negligent to do.

They can't leave the EZ without leaving the EU, unless the treaties are changed. For the treaties to change there must be unanimous consent from all the members, which includes at least a few that would be unwilling to offer the concession.

Whatever the economics, the politics of the situation mean that it's very dangerous for Cyprus to go it alone. Firstly, is it even an independent country? Turkey, remember, controls about 1/3 of the island (even though the whole island theoretically joined the EU in 2004, the EU "acquis" only applies to the Greek-controlled park). This apart, Cyprus, unlike Iceland, is in a part of the Mediterranean which is contested over by several countries in the region.

Btw, LOVED the comments about drunk Brits and dirty Russians. Always rewarding to read such intelligent, well-constructed thoughts. Keep it up!

As a dirty Brit who won't be getting drunk until at least 2PM, I agree that such stereotypes are demeaning and insensitive.

I have been doing extensive research on the topic of the Cyprus Economy since this whole thing surfaced. Cyprus leaving the Euro would be the absolute worst thing to happen at this time. Taking the Euro away from Cyprus would be like taking water from a man dying of thirst. This article does not adress the Natural Gas discovered off of the south coast of Cyprus in 2010 that is predicted to be worth around $400 Billion and have enough natural gas to energize Europe for 50 years. This in itself completely discounts your argument. A $10 Billion bailout seems insignificant in compared to $400 Billion.

Cyprus also does not import everything, up there with tourism they have a very successful produce and agriculture industry. Despite the islands small size and GDP in terms of europe, it plays an important role for it's strategic location. Times are tough right now in Cyprus but I truly believe that it is only for the short term and just brace yourself when shit hits the fan in the US.

According to Wiki, the estimated natural gas reserves are around 200 billion cubic meters.

Europe consumes about 500 billion cubic meters per year. So that's enough natural gas for 6 months not 50 years. And it's certainly not worth $400 billion.

The aphrodite gas field is just one block out of the 12 blocks in the exclusive economic zone of Cyprus.

The French company TOTAL was granted hydrocarbon exploration licence in Cyprus EEZ blocks 10 and 11. Contracts were also signed on January 24 with the ENI/KOGAS consortium for hydrocarbons exploration in blocks 2, 3 and 9 within Cyprus EEZ.

Conclusion: natural gas reserves will be worth much more than $400 billion

Come on now, you know better than to use wiki-pedia.

Its estimated 50 - 60 tfc of Natural gas and about 1.7 billion barrels of crude.

It sucks for Cypriots right now but this bail out will hopefully prevent the need of future ones.

How will this gas be exported from Cyprus. By pipeline or by LNG ships?

Natural gas is unlike petroleum, which is cheap to transport over water. As a rule of the thumb, the process to convert natural gas to the liquid form that is necessary to transport by ship costs approximately $3 a 1,000 cubic feet.

If the Cypriots can build some kind of underwater pipeline then they can probably export the gas. But if they have to convert it to LNG then it will be at a substantial cost disadvantage to existing producers on the European continent like Russia and to new producers coming on stream like the Ukraine.

Shit kind of already hit the fan back in 2008. We're just fine, thanks.


The top export from Cyprus is refined petroleum products, for which they need to import the crude. This already signals their future reliance on natural gas expors, although if the prices on that continue to fall, that may not be as great as it looks now. Their ag exports are not all that substantial, with scattered light manufacturing more important, notably textiles and pharmaceuticals.

Yeah, well too bad the Cypriot bankers didn't take all those billions in deposits and invest them in natural gas extraction instead of loaning them to their cousins on the mainland. In any event, the solution is apparently quite simple: Cyprus can discharge its debts by selling mineral rights in its territorial waters. If they have $400B of natural gas just sitting out there, they obviously don't need anybody else's money.

What's the point of leaving the Euro?

A reduction of all prices and wages will accomplish exactly the same thing as a devalued currency in the short term, while keeping a stable currency for the long term.

In general, there is never any reason to leave any stable currency, unless you are moving to a significantly stabler one (e.g. creation of the Eurozone).

Also, there is no "Cypriot euro", there is just "euro deposited in current Cypriot banks"; Cypriot citizens can just open accounts in local branches of foreign banks for large amounts, and keep small amounts in ECB-issued banknotes, which are as good as any other.

In other words, it's just some failed banks, not sure why this is a big deal other than the wealth transfer from depositors in Cyprus to whoever received funds from Greek sovereign bonds and didn't pay back.

Yes, Cyprus should leave the Euro in order to allow it to rapidly reduce real wages. (Funny how Krugman doesn't explicitly call out that aspect, even though it is the key recovery mechanism of a devaluation.) What I find inexplicable is his claim that this will allow Cyprus to avoid "Greek-level austerity or worse". Cyprus is going to have "Greek-level austerity or worse" whether it leaves the Euro or not. If you measure austerity as budget balance, Cyrpus is going to have to zero its deficit because no one is going to lend it money. If you measure austerity as a fall in government spending, Cyrpus is going to have to slash government spending because there is no way it can raise taxes fast enough to make up for the degree to which its GDP is going to fall as the offshore banking industry collapses. To summarize: the reason to leave the Euro is to speed the recovery by quickly slashing real wages, not to avoid the inevitabile short-term austerity.

How long would it take to get economic growth by reducing nominal wages and prices in Euros?

For those who did not read the link that Tyler made to my post on econospeak and the comments there, let me make a few points.

One is that I am not saying that Cyprus should not leave the euro. The case for them doing so is quite strong, and Krugman largely makes it. What I was looking at were reasons why they might do so beyond the obvious sheer difficulty of doing so and the strong "wanting to be part of Europe" effect.

So, I pointed out the issue of a sharp near term decline in living standards for all of the population in the short run due to their heavy reliance on imports. I discussed the cases of Argentina and Iceland, both of which experienced such sharp declines, although these were followed by turnarounds in growth and rising employment, more rapidly in Argentina, more slowly in Iceland, with those relative gains being somewhat more concentrated on the parts of the population that are either gaining jobs or avoiding losing jobs.

The other aspect of this is the time horizon one, more emphasized in one of my comments. I think that aside from the widespread nature of that short run pain is the matter of hyperbolic discounting, that lots of people very highly value very near term events. So the prospect of a very sharp near term collapse of living standards for the whole population is taken very seriously, even if this will be offset quite soon thereafter. This is an argument about why the Cypriots may be reluctant to leave the euro, not an argument about why they should or should not do so. To the extent that this hyperbolic discounting is in some sense "irrational," they should perhaps be more reasonably discounting their justifiable fears of near term pain and focus more on the likely later gains.

Oh, and if they exit, worrying about their euro-denominated debts will not be an issue. Like Argentina and Iceland, they will simply default and have to live with the consequences of that in terms of limits on their future abilityi to borrow.

Oooops! In second paragraph line 1, should read "reasons why they mght NOT do so,..."

I live in the Eurozone and wish I didn't have to. HOPEFULLY this madness will be over soon and national currencies will be reintroduced.

Cyprus leaving the Euro would almost certainly result in a small short term gain for their most important real industry, tourism as prices in Euros would fall. but I suspect that their tourism industry is already at capacity. Longer term I think it would not be in their long term interests, they need to attract more investment in the tourism industry to replace the lost banking activity. They won't be able to do that unless they can show a stable investment climate, which changing currencies every few years is not a good example.

A few other points, Cyprus is a beautiful developed country, with very good infrastructure, well educated and mostly English speaking population, that are cosmopolitan not xenophobic. There are few restrictions on foreigners investing and the people of Cyprus can easily move to other parts of Europe. Their police and judiciary are pretty clean, and they have democratic institutions. So they will be fine, unless they go autarktic or seriously change one of these elements. Their monetary system is not the reason they are rich, and changing their monetary system will not make them poor or rich. It will be a minor effect at best. Trying to pay off the debts that their bureaucrats have incurred on their behalf will make them significantly poorer, but the good news is that that is not remotely possible, either democratically or fiscally. So we can be sure that the matter will either be fudged by the ECB or the debts repudiated, neither of which will have any effect on the real ec

Sorry, sent by accident before I was finished.

I was saying that the Cyprus government debt would only have real effects if they actually tried to repay it.

Finally, can everyone shut up about the gas resources. They are speculative and years away from development. They are not by any means reserves, the technical definition of reserves means they have been properly appraised and a gas sales contract is in place.

I'm puzzled; surely the more trade a country does the more effective a currency devaluation will be. A country that doesn't trade won't see any impact from a currency devaluation.
Isn't this an argument FOR leaving the Euro, not against?

Should Cyprus leave the euro?

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