In allowing Cyprus to impose capital controls, the EU violates one of its founding principles – the free flow of money (and goods) to help unite nations.
For more than six decades, the world has admired Europe as it shed past tendencies for war by binding many nations into a pact based on the free flow of money, people, and goods. A common market, even a common currency, has indeed curbed aggressive nationalism.
This grand experiment, however, has just violated one of its core principles. The latest financial rescue by the European Union of a member, Cyprus, includes a curb on the free flow of money into and from the island. This step would be similar to a rescue of Detroit by Washington that requires residents not to take dollars outside city limits or to bring any in. The effect would be to have two, walled-off currencies.
By going along with capital controls to help keep Cyprus in the eurozone, both the EU and the International Monetary Fund (IMF) send a signal to other troubled economies in Europe that their citizens may not be able to trust that their money can be freely transferred to the most productive investments within the 17-nation eurozone. Yet such a basic freedom is the cornerstone for market discipline, economic efficiency, competitive innovation – and Europe’s future as a model for ensuring peace.
Capital controls are a blunt instrument for any government to use. They are most often employed because of bad economic policy, such as in Argentina, or when a country tries to control many aspects of its economy, such as in China. Small nations with weak financial systems try to curb money flows to prevent bubbles in certain markets – or prevent a market collapse if investors flee. But the result of such curbs hurts their economies in the long run.
The EU knows it stepped over a line with the Cyprus rescue package (which includes a hefty tax on large-scale depositors in Cypriot banks).