A cautionary tale of what happens when a country like Greece closes its banks

The Greek government shut all banks in the country on June 29 after the European Central Bank capped emergency funding to the lenders.

Cash withdrawals from ATMs are now limited to €60 a day (about US$67) for Greek citizens. Foreigners who can find an ATM with cash are exempt from the limit, but cash-poor tourists are finding it very hard to find ATMs with money.

More importantly, Greece has made the first step down the road to capital controls by prohibiting the transfer of money to destinations outside Greece unless approved by the Ministry of Finance.

No one knows what the impact will be on Greece and the rest of the world. However, history can shed some light on the situation. Before joining the euro, the Greek government had previously implemented strict capital controls and foreign transaction limitations. My personal experience suggests these temporary measures will hurt the economy in the long term.

What do countries gain by currency controls?

I visited Greece in the mid-1980s, a time when the country had very strict currency controls. It was illegal to exchange foreign money in the country except at a bank.

Countries often implement these kinds of policies because it gives them a chance to impose a hidden tax on all foreign exchange transactions. The tax is hidden because the official rate is very different from the free market rate.

Argentina is a country where the official, or “blanco dollar,” rate is very different than the black market, or “blue dollar,” rate.

For example, today going to a bank and exchanging one US dollar will get you about 9,000 pesos at the “blanco dollar” official exchange rate. However, the “blue dollar” rate is about 13,500 pesos, which gets you 50% more for your money. If exchanging US$20 at the official rate gets enough money for dinner in Argentina, using the “blue” rate will get enough money for lunch plus dinner.

Other reasons why countries implement controls are found in a very readable overview of the topic published by the Federal Reserve Bank of St Louis (see table 1 here).

My experience with Greece currency controls

I arrived in Greece in the mid-1980s for a 10-day trip and exchanged US dollars without a problem into Greek drachmas, the currency prior to the euro.

I had a wonderful time seeing famous ruins such as the Parthenon, cycling through picturesque towns and eating great food. My last day in Greece was in the middle of the week. I was staying in Athens and had already purchased a boat ticket to another country. I woke up, paid my hotel bill — which emptied my wallet of Greek drachmas — and planned on stopping by a bank to get some money to pay for laundering the clothes I had dropped off two days earlier at a nearby cleaners and then heading down to the port for a leisurely lunch before departure.

I was surprised to find the streets empty, many shops closed and not a single bank open, all in the middle of the week. It was May 1, International Workers’ Day, which is commonly called May Day. The streets were soon filled with tens of thousands of Greeks marching and chanting slogans.

Luckily, the cleaners that had my neatly pressed clothes was still open. However, while I had lots of US dollars, and even an American Express credit card, I had no Greek money. The owner explained to me that if she took dollars in payment, she could be arrested for violating the currency controls. She took pity on me and gave my clothes back cleaned for free and even handed me a subway token to get me down to the port.

I was rich man who could not legally pay my debt. To this day I am confused on the right thing to do. Paying her in dollars was a crime. Not paying her was stealing. Before leaving the shop I surreptitiously slipped roughly how much I owed in US dollars under a vase near the cash register when the shop owner wasn’t looking. Hopefully, the currency police didn’t catch her.

Currency controls made it difficult for me to spend money and greatly dampened my desire to visit Greece again. The important question Greek politicians face is whether implementing currency controls will help save Greece’s banks.

Economists have not reached a unified consensus on the answer. Some research suggests controls are economically good, some research finds it economically bad and some finds it not important. The business press, however, often cheers the removal of currency controls, with examples like Bloomberg attributing the economic resurgence of Poland to policy changes, such as the elimination of capital and currency controls.

My opinion is that implementing currency controls now will stifle tourism, which makes up directly and indirectly about 16% of the Greek total gross domestic product (GDP). It will also not help weak Greek banks very much, because people have lost faith that they can access their savings.

Reducing tourism and not rebuilding people’s faith in Greek banks ensures Greece’s economic revival will take even longer after the debt crisis is finally resolved. Capital controls look to me like a short-term bandage that only allows a long-term wound to get more seriously infected.