Archive - Mar 2013

Until this weekend's Cyprus black swan, the biggest red flag facing the market was the threat of persistent Chinese inflation, manifesting itself in very sticky and upward rising home (and many other) prices. In fact, quite recently the new Chinese leadership encouraged "bold" and aggressive steps to tame real estate inflation and instituting fresh curbs on house appreciation "speculation", which is a natural byproduct in a nation that has an underdeveloped and untrusted capital market - unlike in the US where the S&P absorbs all the Fed's reserves (with no money multiplier impact) keeping inflation elsewhere largely tame. It is this inflation that has kept the PBOC not only on the global "reflation" sidelines, but forced it to withdraw liquidity with several record repos in the days following the Chinese new year. It is also the downstream effects of this inflation that has pushed the Chinese stock market red for the year. So just how much of an issue is the soaring Chinese real estate market as global liquidity makes its way to triplexes in Shanghai? The chart below explains it all.

At this point a question is in order: while in Cyprus, and soon probably elsewhere, the government will openly confiscate deposits to fund insolvent banking systems, in the US excess deposits are used by the prop desks of banks like JPMorgan to inflate risk assets, corner a bond market (IG9), and to generally create a wealth effect... for the 1%.

Yi Gang, Vice Governor of the People's Bank of China (PBOC), recently made the headlines with his comments on Chinese gold reserves. On Wednesday, Mr. Yi stated that China's gold reserves remain static at 1,054 tonnes, and suggested that a sizeable increase in those reserves would be unlikely in the future. "We need to take into account both the stability of the market and gold prices," Mr. Yi stated, adding that as the world's largest gold producer and importer, China produces about 400 tonnes of gold annually, and imports an additional 500 to 600 tonnes of gold every year. "Compared with China's 3.3-trillion-U.S.-dollar foreign exchange reserves, the size of the gold market is too small," Yi said, rejecting speculation that China would further diversify its foreign reserve investments into the precious metal. "If the Chinese government were to buy too much gold, gold prices would surge, a scenario that will hurt Chinese consumers ... We can only invest about 1-2 percent of the foreign exchange reserves into gold because the market is too small," Yi stated.

The Cyprus bailout package tax on bank deposits is a deeply dangerous policy that creates a new situation, more perilous than ever. It is a radical change that potentially undermines a perfectly reasonable deposit guarantee and the euro itself. Historians will one day explore the dark political motives behind this move. Meanwhile, we can only hope that the bad equilibrium that has just been created will not be chosen by anguished depositors in Spain and Italy. The really worrisome scenario is that the Cypriot bailout becomes euro-systemic – in which case the collapse of the Cypriot economy will be a sideshow. This will happen when and if depositors in troubled countries, say Italy or Spain, take notice of how fellow depositors were treated in Cyprus. All the ingredients of a self-fulfilling crisis are now in place: It will be individually rational to withdraw deposits from local banks to avoid the remote probability of a confiscatory tax. As depositors learn what others do and proceed to withdraw funds, a bank run will occur. The banking system will collapse, requiring a Cyprus-style programme that will tax whatever is left in deposits, thus justifying the withdrawals. This would probably be the end of the euro.

While hope appears to still be alive that the Cypriot government will hand over their natural resources to wealthy Russia (or Gazpromia) and all depositors (Russians and Cypriots alike will be saved), we suspect there is a much bigger threat from Russia that has not been discussed. As Monument Securities' Marc Ostwald notes "there's a 50/50 chance Cypriot bailout fails because of the 'massive danger' a large amount of Russian cash flees Cyprus following deposit tax plans." Russia has ~$60 billion exposure to Cyprus, including loans to companies registered in the country and after the haircut 90% of Russian deposits will still be free to leave the country if the levy is approved.

Just a reminder: this time won't be different.

Cyprus is now old news: local (and Russian... and UK... and European) depositors will see anywhere between 3% and 13% (or more) of their deposits, depending on what the "fair" threshold of a "lot" of money is determined to be in the first revision to the deposit tax levy, confiscated and in return they will get "equity" in broke banks, and maybe some gas-linked bonds. That much we know. The question then becomes: what would "Cyprus" look like if it took place in the US? Below, courtesy of William Banzai, is one artist's impression...

Deposit Insurance at a bank, any bank in Europe, is now meaningless. A bond indenture, any clause, any paragraph, any promise or assurance; now meaningless. The notion of private property, land, cash, house; now meaningless. The European Union will take what they want as they deem it necessary and the IMF will follow along. The question has been asked, during the last few days, why the bond holders of Cyprus were not tagged along with the bank deposits. We can answer the question. Virtually all of the Cyprus sovereign debt is governed under British law and so the EU did not pursue this course. Greece came first. Lesson one and "shame on you." Cyprus comes second and now "shame on me." What will come next? What will you tell your partners or your shareholders when they say, "You should have known." You will have no excuse!

Can't get enough of Cyprus? Then here is yet another post-post-mortem from Goldman's Jernej Omahen, once more trying to put some very silvery lining on this particular mushroom cloud, and providing some useful facts in the process. "As part of its rescue package, Cyprus introduced a one-off tax on deposits. This “tax” can be viewed as both (1) a depositor bail-in, and/or (2) a wealth tax. Cyprus aims to capture €5.8 bn of tax revenue in this way, which compares to the total bailout package of €10 bn. In absolute terms, the amounts are low; regardless, the market focus on potential read-across will be high, in our view. The tax on depositors is setting a precedent, which is likely to have an impact beyond the immediate term, in our view. Resilience of, in particular, retail deposits was an important element of stability during crisis peaks (e.g., Spain). Post the Cyprus precedent, however, it is reasonable to expect that the deposit volatility in stressed sovereigns could rise, for two reasons: firstly, perceived risk of deposit bail-in will have increased; secondly (independent of failing bank issues), perceiving savings as a potential tax-base – for wealth taxes – is new."

• Cypriot Bank Levy Is ‘Ominous’ for Bondholders, Barclays Says (BBG)
• Euro, Stocks Drops; Gold, German Bonds Rally on Cyprus (BBG)
• Total chaos:Cyprus tries to rework divisive bank tax (Reuters)
• More total chaos: Cyprus Prepares New Deposit-Tax Proposal (WSJ)
• Euro Slides Most in 14 Months on Cyprus Turmoil; Yen Strengthens (BBG)
• Osborne to admit fresh blow to debt target (FT)
• Even the Finns are giving up: Finnish Government May Relinquish Deficit Target to Boost Growth (BBG)
• Moody’s Sees Defaults as PBOC Warns on Local Risks (BBG)
• Australia Faces ‘Massive Hit’ to Government Revenue, Swan Says (BBG)
• Inside a Warier Fed, Watch the New Guy (Hilsenrath)
• Obama to Tap Perez for Labor Secretary (WSJ) - and with that the "minorities" quota is full
• Finally, this should be good: BuzzFeed to Launch Business Section (WSJ)

Moments ago we got news that the same kind of "depositor repression" aka wealth tax just implemented in Cyprus over the weekend, may spread to other stability and deposit havens. Such as Switzerland. Just before 7 am Eastern, the SNB's Moder, who is an alternative board member, said on the wires that the SNB will not exclude negative interest rates, which followed earlier comments from the IMF that the SNB should have negative rates if there is a renewed surge in the Swissie, and a plunge in the EURCHF, as has happened as the Euro has tumbled. Sure enough, the EURCHF soared on news that even Europe's last remaining deposit bastion is about to be impaired, because all negative rates are is an ongoing deposit confiscation, instead of a one-time "levy" as per Cyprus.

As expected, it is all about Cyprus this morning, and overnight, and just as naturally it wouldn't be a centrally-planned market without the generic BTFD overnight ramp attempt, which we got from the EURUSD, as the pair rose from sub 1.29 to 1.2973, which also pushed the US futures up to nearly fill half the overnight gap lower. Citi explained this, observing the "EUR/USD squeezed higher on reports Cyprus bailout terms may be eased, CitiFX Wire says", but it did add that "selling was likely to materialize; flow has 60% bias in favor of downside, Seeing heavy net selling, mainly from leveraged funds." Naturally, the market does what it does best - clutches at straws, although not even this centrally-planned market could ignore news that today's Cyprus parliament vote has been cancelled, that banks will likely remain closed tomorrow, and that a vote may not happen until Friday, which likely means the bank holiday is about to stretch to one week, and possibly much longer as Cyprus is terrified to open its banks to the fury of scrambling "bank-runners." Things started to get interesting following another RIA report citing finance minister Siluanov, that Russia may reconsider its role in the Cyprus rescue following the bank tax. Siluanov added that bank tax breaks the plan for joint steps on Cyprus and that the decision was made without Russia.

An update on Cyprus and what else the week has in store.

The root of the problem is the manufacture of counterfeit credit. Examples of counterfeit credit include Greek government bonds... Depositors are paid the lowest interest rate of all, and in return are promised to be made whole, even if it means every other class in the capital structure is utterly wiped out. In Cyprus, they were not. This reckless and politically-expedient decision has consequences.