EU to test a financial nuke in Cyprus

European leaders obviously decided to make a nuclear test in financial system to demonstrate the consequences of not making the needed austerity reforms. Cyprus is the ideal range for this as the economy is very small and even enormous fluctuations there cannot harm the rest of EU. Cyprus is much smaller even than Greece, that itself is considered small enough for experiments. Anyway Cyprus is even better, because much of the money lost will be from outside EU. Cyprus is an offshore zone.

Anyway this nuclear financial bomb is still nuclear and can provoke a chain-reaction that to blow other countries, and even to destroy the whole European Union.

The protection of small depositors is the milestone of all banking system today. To prevent mass withdrawing of money that could bankrupt any bank, the governments have implemented deposit protection systems (like FDIC). This way the depositor is sure that his money is granted, no one can take it, and even if the bank goes default the government will repay the money to the owners. This guarantee helped the financial system to develop to the current high level, that allowed the economy to rise.

The “bank run” is the nightmare of banks. Every depositor can at any time request his money back. But as the money is not in the bank, it cannot repay it if too much depositors at one and the same time do this. In this case, even if the bank is in a perfect condition and has no problematic assets, it will anyway go bankrupt, because it cannot collect back the credits immediately to repay the depositors. There is a joke, that a fly and a bank are crushed with one and the same weapon – a newspaper :)

The confidence is the base of the banks. With no confidence, there will be no deposits, everyone will keep the money home or in a safe and all the financial system that relies on this money will vaporize.
That is exactly the problem with the chain reaction. Financially the harm could be insulated to Cyprus. But the fear of the precedent will go globally. And shatter even stable banks by the influence of the mass deposit withdrawing. Even if any bank does not go to default, the money in it may decrease and the business will go down. This will affect also the economy that will have less credits and higher interest rates.

The danger is biggest in other troubled countries that are using bailout money or are close to request a help. No depositor can be sure of its money that could at any moment be “taxed” and de facto nationalized.

In EU the deposit protection was at least for any deposit of up to 100 000 Euros ($130 000). There has never been a possibility of stepping back from it. Now sacrificing some of Cyprus depositors this illusion is going away.

There are also some other aspects of the “deposit-tax”. The money for it, in fact does not exist in the banks. It doesn’t matter if angry depositors or the government will withdraw the money. In both cases, the banks have no money. They have credit assets and a small sum as cash. Withdrawing 6,75% (9,9% for above 100 000 euros) will remain the banks with no liquidity. It is not clear even if all the banks have a liquidity of 6,75% of deposit base. So mathematically the tax can be imposed but in real money it cannot be paid immediately. The banks will have to wait for credit-borrowers to return their debts so have the money to pay the government.

Theoretically the banks can open each a government account and formally deposit the money there. But this must happen in a way in every bank is opened a special bank account. The regular way of collecting the tax in an account in one bank will simply decapitalize the rest of the banks. Unless this bank is obliged immediately to credit the rest with the same sum, these banks will simply be extracted from money.

So technically nationalizing almost 7% of the deposits is not an easy job.

In addition to this, much other money will be immediately withdrawn by angry depositors and it is not clear from where the banks will find cash to pay them.

But there are some more problems. Even the assets of the Cyprus banks are not good ones. These banks fell down due to the Greece debt crisis when much of the Greek debt was erased. As big investors in Greek debt, the Cyprus banks simply have lost much of their assets. So now they have no even a theoretical option to collect any money, at least from a big share of their assets.

Generally the events in Cyprus are absolutely expected. They are just a part of the inevitable and unavoidable crash of the current paper-money system, based on high credit, artificially low interest rates and increasing political intervention. Bank runs are inevitable. Government debts are increasing. Central banks are printing money. The common people confidence is vaporizing. It is inevitable and predictable people to turn initially to cash, and then - even to gold and real assets, when they recognize the paper money is granted by the same governments that are nationalizing their deposits.

The crash of the welfare state, based on financial magic is closing. Cyprus is may be planned to be a lesson for all governments that reject to make spending cuts and balance their budgets. If happened so this may become a part of the curing process. But as we see from up to now practice, most of the policies are bringing not exactly the expected effect. So my prognosis is we are seeing not a well-managed lesson, but a bad managed panic-inspirer and a logic step of the evolution to the general financial apocalypse. The politicians are saving the system for already 5 years, and every year the problems become bigger and the price requested is higher. But that has always been the same – in all mankind history. Every time the market is banned and the bureaucracy is crowned, the result is a total catastrophe. So my advice is the same – buy gold…

March 18th 2013

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