Krugman's Advice to Cyprus: 'Leave the Euro. Now.'

Asked to put aside the obstacles of political reality or feasibility and simply offer his unadulterated advice to the nation of Cyprus, Nobel-winning economist Paul Krugman spoke bluntly and plainly by agreeing to say what he would do if it was up to him.

"Cyprus should leave the euro. Now," Krugman said on Tuesday.

As the banks in Cyprus remain closed and public opposition to the bailout deal being orchestrated grows, Krugman explained why he (and many others) support the idea of an exit.

"The reason is straightforward," He continued. "Staying in the euro means an incredibly severe depression, which will last for many years while Cyprus tries to build a new export sector. Leaving the euro, and letting the new currency fall sharply, would greatly accelerate that rebuilding."

The exit plan itself would be murky, admits Krugman--acknowledging "it all sounds kind of desperate and improvised"--but such actions would be appropriate given the situation.

"We're talking about Greek-level austerity or worse in an economy whose fundamentals, thanks to the implosion of offshore banking, are much worse than Greece's ever were," he said.

And Krugman's not alone in his assessment. As the crises unfolded last week, economist Robert Kuttner, writing at the American Prospect, suggested that Cyprus (and other countries as well) should also leave the Eurozone--or at least make serious threats to do so--as a way to put pressure on the Troika (the EU, ECB, and the IMF) to bend in the severity of their demands.

Kuttner wrote:

It's time for the peripheral European countries--Greece, Spain, Portugal, Ireland, and now Cyprus--to push back. Only a unified threat to quit the euro might get the attention of Brussels and Berlin.

What would happen if one or more countries actually reverted to their own currencies? Financial elites around the world say that would be catastrophic, but for Europe's small nations, the catastrophe is now.

If Cyprus or Greece or Spain or Portugal (or better yet, all of them en bloc) decided to quit the euro and revert to drachmas and pesetas, they would need to block bank accounts, impose currency and capital controls, and default on some of all of their foreign debts, which would be re-denominated in the new local currency. There would be lawsuits up the gazork, but the IMF and ECB would have to step in to limit the broader damage even if they disapproved.

However, based on comments by Cyprus leaders, Krugman's advice (as he well understands) is not likely to be followed.

''An exit from the eurozone, which could also mean an exit from the European Union, would be disastrous both politically and economically,'' said Cypriot Finance Minister Michalis Sarris on Tuesday. ''It is a hypothesis we do not even wish to contemplate."

But as the global financial community responds to the realities of the Cyprus situation, some market analysts are saying that Cyprus will not have to "exit" the Eurozoneas it appears likely the Euro in many ways will simply evaporate from Cyprus.

"Cyprus is effectively no longer a full member of the eurozone," declared an analysis from Morgan Stanley on Wednesday morning.

As the Digital Journalreports:

The EU bailout deal ensures Cyprus remains a member of the eurozone, avoiding a disorderly default and return to the Cypriot pound. However, its banking sector has been decimated and its reputation as a safe refuge for foreign deposits destroyed. Capital flight will bolster and benefit banks in northern Europe, notably Luxembourg and Germany. The rift between northern EU members and the Mediterranean nations grows.

Cypriots face an uncertain future with inevitable job losses and business closures, while waiting to hear the terms of German dictated austerity they must now knuckle under.

As Cypriot banks remain closed and bank officials attempt to make sense of the restrictions which capital controls will place on funds when banks reopen, the flaws of a single eurozone currency are exposed.

And reporting from public protests in the capital of Nicosia on Tuesday, Reutersadds:

"They've just got rid of all our dreams, everything we've worked for, everything we've achieved up until now, what our parents have achieved," said one student, named Thomas.

Outside the central bank, about 200 employees of the country's biggest commercial lender, the Bank of Cyprus, demanded the resignation of the central bank governor, Panicos Demetriades, chanting "Hands off Cyprus" and "Disgrace".

Dimos Dimosthenous, who has worked at the Bank of Cyprus for over 30 years, said: "The bank is being driven to closure.

"That will be the end. Our jobs, our rights, our welfare funds will be lost and Cyprus will be destroyed."

_________________________________