Gil’s Musings

Cyprus’ Banking Industry

Recent headlines have focused on the seemingly financially insignificant country of Cyprus. The reason this has become a topic worthy of discussion is that Cyprus’ primary industry is banking; and possibly questionable banking at that. Cyprus is rumored to have one of the most lax set of rules on money laundering on the planet. It’s no wonder then that the country’s banks have become a hotbed for apparent illicit deposit schemes of the Russian mob.

Cypriot leadership recently floated the idea of a one-time “tax” (sic Confiscation) on bank deposits. This was roughly 10% for large deposits (over $135,000) and 7% for smaller deposits. Under protest, parliament has revoked that plan. This was for the country to “right itself” financially. European leaders are learning the hard way that “thinking out-loud” is probably not a good idea when all ears are listening. But the concept is eye-opening. Surely, it gives one a glimpse into the mindset of desperation.

Bankrobbery of the Cypriot People

What it also does is to call into question the promises of all government institutions, and to call into question the validity of government backed deposits in general. The climb just got steeper for Greece and Spain. Credibility is important in games of trust. Claims that Cyprus is unique will get the laugh they deserve. This is all rather clownish, except it’s not funny. The backlash over showing those cards at the table has been as one might expect. It’s sort of like waking up in the morning to have your spouse share the good news that they decided not to stab you in the arm last night with the knife they had taken to bed. How reassuring. I think I would sleep with one eye open and on the couch, while I looked for an apartment. The same will happen in Cyprus. Parliament has decided not to pursue the idea, since it was met with protest, both domestically and internationally. However, with that cat out of the bag, the money will leave at the first opportunity now, and the banking system will collapse without intervention.

This event changes the trajectory of Europe’s recovery. Segment had recently purchased an international component in our ETF strategy for the first time since we exited that position in 2007. We avoided the slide in 2008, but missed the snap-back since. We were hoping to catch the continuing recovery, but it seems still early for that now. We sold our EAFE position yesterday, essentially even.

This financial shiver caused by Cyprus should result in growing deposits in the US as foreign investors seek the least bad choice. This should put additional downward pressure on US interest rates as foreigners buy Treasury Bonds and drive prices higher. Gold should be both helped and hurt. It will be helped to the extent foreigners will buy gold as a safe haven. It will be hurt to the extent that some buyers will choose US dollars instead.

There is a lesson in all of this for US leadership. Despite the US having the distinct advantage in the ability to print more of the world’s reserve currency, we are running down a similar path. The endgame of expanding large and growing deficits is insolvency, no matter the flowery rhetoric from Paul Krugman. Printing more money is confiscation by another means: purchasing power. Inflation would result if not for the bleak US employment picture.

Europe is not alone in dealing with its repercussions to socialism. Argentina is also on the fast track to disaster. We are witnessing a slow motion train wreck one frame at a time. We would all be wise to pay attention, and to recognize that the wheels are still coming off, not being put back on as the politicians would have us believe.

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