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Cyprus Collapse Triggers Unintended Consequences

Monetary Metals's picture




 

Some people believe that by imposing losses on investors and reducing the Cyprus banking system liabilities, the European powers have addressed the problems in Cyprus (if harshly). Others think that it was just an unjust tax on depositors. I have written about the sequence of events. Cyprus banks borrowed money and bought Greek government bonds. Greece defaulted, imposing big losses on bondholders.  Cyprus banks postponed marking down their losses. Now, they have to mark those losses and admit that they are insolvent. This triggered a run on the banks. Now, finally, shareholders, bondholders, and depositors are taking their losses. The government of Cyprus and the “Troika” did not provide enough money to pay everyone.

Within Cyprus, there is now uncertainty about remaining deposits, capital controls, and the solvency of the Cyprus government itself. Elsewhere, the focus turns to other countries (e.g. Slovenia) where markets are becoming jittery that the same thing could happen.

The first question is, can one still buy gold in Cyprus? I predict that if it’s still possible to buy gold right now, it may not be for long. I corresponded with Panos Kostopoulos of AMP Gold Bullion Merchants Ltd. in Nicosia. First, he said:

“Immediately after the Cyprus presidential elections [Feb 24], I strongly recommended to Cypriots to buy gold, in order to protect their hard-earned money (taking in consideration wide spreading rumors for the deposits "haircut", already at the time). Unfortunately, not a single person was convinced to do so. It is obviously needless to mention that I received orders for over 15kg within one day after the haircut was officially announced.”

It is interesting that Cypriots were not proactive, either in buying gold or in transferring Euros to banks outside Cyprus. It’s hard to believe that people will continue to be so naive in the next flare-up of the ongoing crisis.

Regarding whether they sell gold in Cyprus, Mr. Kostopoulos said:

“Our bullion is always kept OUT of Cyprus. We can either import it to Cyprus and sell it, or we can sell to our potential clients Gold warehouse receipts, with which they can go and collect their gold from our collaborators-dealers in Germany, Holland or Belgium. So, the answer to your question if we can sell gold in Cyprus at the moment is YES. However, nowadays, who will pay us in cash (daily withdrawal limit is 300 Euros per person)? Should we receive payment in our Bank account, we would need to apply to the Central Bank for permission to transfer funds out of the country, in order to pay for our scrap suppliers in Greece, so that we would replace our stock and keep our cycle of business going. The approval would take some bureaucracy hassle and at least 48hours, so, since our normal cycle of business is delayed, we are concluding transactions only with selected existing clients, for amounts not exceeding 20,000 Euros, and at a substantially higher premium than before, or than in the rest of the world [3.5% vs. 0.5%].”

Mr. Kostopoulos confirms that gold is not typically being brought into Cyprus. It is also important to note that Cypriots must pay using Euros outside the country, or cash. If they don’t have either, then most cannot get gold (those few who can will only get a limited quantity, and are subject to permission and delays at the central bank, and higher costs).

He was not optimistic that capital controls will be lifted soon.

Shareholders in the banks have taken total losses, though stock market losses do not generally cause a systemic crisis. Bondholders were also wiped out, and this is more serious because bonds are held in the portfolios of insurers, pension funds, and annuities. The Cyprus bond default could also bring down banks in other countries, if they used leverage to buy Cypriot bonds. The most serious impact is that depositors lost deposits over €100,000.

In sharing my thoughts, I take the risk of being wrong. It is not possible to predict the market reaction even in calm times, much less a sea change in volatile and dangerous times such as now. Below is my analysis, logic, and educated guesses about how events may play out over the short to intermediate term.

Cypriots who were formerly wealthy are now impoverished. Businesses may be unable to pay their landlords, suppliers, and payroll. Consumers, who now feel less wealthy, will cut back their spending. Unemployment is likely to spike (it was 14.7% in January).

It is questionable if Cyprus can fund its existing welfare state, much less grow the rolls—especially with a declining tax base. The Cyprus government bond itself currently has a Caa3 rating by Moodys (i.e. speculative, high risk). Can the Cyprus government now sell more bonds to pay maturing bonds plus fund its operations? If not, then many people, including the newly jobless, could be forced to leave the island.

A mass exodus would put downward pressure on real estate prices and on rents. This will impact much of the remaining banking system asset base, leading to further losses for depositors. The system based on borrow-to-consume has probably reached its terminus in Cyprus.

Cypriots face a dilemma. Without capital controls, people would quickly drain the banks of whatever remaining liquid assets they have, and then the banks would collapse utterly. With capital controls, they cause a whole new set of problems (if they can even successfully keep the capital in the country).

Will they offer a special exception to businesses that import products? Cyprus imports food, fuel, raw materials, and machinery1. If they don’t allow importers to send money offshore, it is hard to imagine how these businesses could continue to buy the products that Cypriots need, leading to immediate and desperate shortages. If they do, then it would seem to be a great hole through which massive capital outflows could pour, circumventing the capital controls.

Let’s assume that Cyprus somehow manages to enact rules that differentiate between permissible importing and illicit attempts to send Euros out of the country. There is still their trade deficit, which means capital is leaving unless it is offset by either foreign investment in Cyprus or additional bond selling by the government. Is either of these likely? Can the Cyprus government sustain borrowing at the current market rate, even if the market would bid on its bonds at all?

Capital controls are “necessary” if one accepts that any part of the coercive regime of irredeemable paper money with a government bond as “risk free” asset. But there is a profound and subtle (for now) unintended consequence. Euros in Cyprus are not the same as Euros out of Cyprus. A spread is forced open between what I shall dub “Cypros” and Euros.

To see this, imagine that you had a bank account at a bank in Germany. Someone in Cyprus says he would like to trade Cypros for Euros. He invites you to open an account in Bank of Cyprus and he has opened an account in Germany. He will transfer 10,000 Cypros to your account in Cyprus and in return you will transfer Euros to him in Germany. How many Euros would you bid to buy his 10,000 Cypros?

Less than €10,000.

Why? Unless you planned to go to Cyprus on holiday, holding a balance at Bank of Cyprus does you no good. This is the least of your problems. There are two other risks to your Cypro deposit.

One is that the Bank of Cyprus could collapse. Especially if Cypriots find ways to bypass capital controls, and probably even if not, the bank could default on its deposits. The Cyprus government does not appear to be in a position to provide bailouts—not even the “deposit insurance” promised up to 100,000 Cypros. The European Central Bank and the IMF may have made their best and final offer and could very well leave the depositors of Bank of Cyprus to their fate. There is no way to know today.

The second risk is that Cyprus could formally abandon the Euro. It would be the logical next step, after implicitly switching to Cypros. There is little question that the value of the Cypro would plummet following such an announcement.

Now consider the Cypriot with the 10,000 Cypros. Does he have any reason not to want to trade them for Euros in a German bank? When one side has many good reasons to be reluctant to buy, and the other side has a clear and compelling reason to sell, the price is bound to fall. I would bet an ounce of fine gold against a soggy dollar bill that this spread has already opened up, even if it is not yet reported in the news. Once this genie is out of the bottle, it will be impossible to put it back in, short of a blank check from the European powers.

Let’s look at something else, another unintended consequence, that is probably not well understood. Each cash note circulating in Europe was created by one or another national central bank. I understand from my German friends that paper Euros have a series designation imprinted on them. For instance, “X” means Germany and “G” means Cyprus. It would seem to be the basic operation of Gresham’s Law that people would prefer to hold “X” notes and spend or trade “G” notes away. This is because a bank note is the liability of the issuing bank. With the risk that a Euro note, even if it is currently circulating in France, could be defaulted by the Cyprus central bank or officially redenominated in Cypros, why should people prefer to keep it? Just as the silver coins in widespread circulation in the U.S. in 1965 were pulled for private hoards and only base metal coins were in circulation thereafter, the same phenomenon could occur in reverse with “G” euro bills.

This is a very dangerous development.  Let’s go back to my first question. Is gold still bidding on the Cypro? Aside from some possible inertia, desire to satisfy loyal customers, and remaining inventory, the big picture is that there is an irreparable fissure in the Euro. Due to national and banking system insolvency, the Cypro has split off. While the Euro is irredeemable, the debtors supporting it are still paying the interest.

Will anyone be willing to exchange gold for a Cypro bank deposit locked under capital controls, with risk of default, and no near-term prospect to get it off the island? There is no rational reason why they should. Only so long as the central bank allows bullion dealers to export Cypros at par can gold be imported for sale in Cyprus.

The government may not have realized it yet, but once Cypriots have gold, then they have escaped the prison of the Cypro. They can find ways to get the gold off the island, perhaps by boarding a boat and carrying it in their pockets. The flows out of their banks will, sooner or later, lead them to prohibit buying gold as a way around capital controls.

However, once gold is no longer available, then the final coup de grâce will come quickly. There is an interesting asymmetry. While gold owners no longer desire to get Cypros, holders of Cypros will still desire to get gold. When they cannot buy gold in a direct exchange, what will they do?

They will buy anything that can be readily exchanged for gold. Will Cyprus ban the export of commodities? If not, then holders of Cypros will buy oil, petrol, wheat, and other liquid commodities. They will sell it to those who can pay gold. This constant buying pressure on commodities and other goods will drive up their prices in terms of Cypros. It will send the goods offshore, depriving Cypriots of the ability to consume them.

Mechanically this is simpler than it sounds. Off the island, there is a Euro price for gold and a Euro price for crude oil, say €1244 per ounce and €82 per barrel. If one could exchange an ounce of gold for 16 barrels of crude, it would be a good deal (not including costs such as shipping, and taxes). While this window remains open, it will provide a way for foresighted Cypriots to exchange their Cypros for good gold. Under these market conditions, any Cypriot who can exchange Cypros for 16 barrels of crude can get an ounce of gold.

The window will not remain open for long. This is because the Cypro prices of commodities will rise relentlessly and exponentially. As they are becoming scarcer, and thus Cypriots will be watching the purchasing power of their Cypros falling, the Cypro-to-commodity-to-gold trade will be fueled even more, driving up the prices of commodities further. In the end, the Cypro will be repudiated.

People will call this “hyperinflation”. It will have nothing to do with the quantity of money. Cyprus may or may not be printing Cypros. We would guess they will not, as this is not allowed. While they still pretend that they are still using the Euro, and still deny that they have transitioned to the Cypro, they will have to obey the European rules.

In this scenario, I do not see how Cyprus can fix the problem simply by declaring a new currency. The root of the problem is that the assets backing the bank deposits, and ultimately the Cypro, were proven to be worthless. Bank deposits are the liability of the banks; if the banks’ assets are worthless, then so are their liabilities—i.e. the deposits. As the Cyprus central bank is also insolvent, its liabilities such as the Cyprus “G” Euros are worthless.

Cyprus could try to move to a new currency, and start from scratch. The bad liabilities would be written off, and thus there would be few assets. I assume that this would not be acceptable to the voters who would be rendered penniless. Voters today seem to prefer to have something from nothing, like a cargo cult. They want new paper currency and new bank deposits that “work”. Cyprus can issue such new liabilities. What they cannot do is declare by fiat that the banks’ worthless assets (such as Greek government bonds) shall have market value again.

Cyprus is caught between a rock and a hard place. Cypriot voters would not agree to be 100% wiped out in the name of moving to a better currency. The reality is that the Cypriot banks are nearly 100% wiped out.

Meanwhile, outside Cyprus, pressures are building on other marginal countries and their insolvent banking systems.

The best way to understand what’s happening in the dollar and euro credit markets is to watch the gold basis. Monetary Metals publishes The Last Contango: Gold Basis Report weekly (free registration required).

 

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Mon, 04/01/2013 - 11:39 | 3396008 Lordflin
Lordflin's picture

So what are the chances we will get out of 2013 without a major war?

Mon, 04/01/2013 - 13:30 | 3396457 FeralSerf
FeralSerf's picture

Besides the Drug War, the War on Terror and the War on the Middle Class?

Mon, 04/01/2013 - 12:39 | 3396233 kito
kito's picture

there already is a war going on....for your mind.........................

Mon, 04/01/2013 - 10:41 | 3395757 NEOSERF
NEOSERF's picture

Saw it in Greece and will be accelerated in Cyprus, no outside companies are going to risk non-payment for shipments of food, energy, drugs etc...and even if 5% of Portuguese, Spaniards, Italians and Greeks start moving deposits out of banks this spring, the Arab Spring may come to Europe.

Mon, 04/01/2013 - 10:41 | 3395755 NEOSERF
NEOSERF's picture

Saw it in Greece and will be accelerated in Cyprus, no outside companies are going to risk non-payment for shipments of food, energy, drugs etc...and even if 5% of Italians, Portuguese, Spaniards and Greeks start moving deposits out of banks this spring, the Arab Spring may come to Europe.

Mon, 04/01/2013 - 10:24 | 3395702 NoDebt
NoDebt's picture

So they killed the real economy to save the banks.  Ya know, one of these days the real economy will matter again.  I'm not holding my breath, though.

Mon, 04/01/2013 - 11:30 | 3395972 NotApplicable
NotApplicable's picture

They don't care, as they hold title to everything, including thousands of armed forces to ensure their rule.

Mon, 04/01/2013 - 10:17 | 3395684 Mototard at Large
Mototard at Large's picture

Derivatives?  Unintended consquences may come from this direction as well.

Derivatives are financial weapons of mass destruction which could unwind during a crisis. Here is a simple explanation of what they are and why they can be both good and dangerous. It is written in plain language by ex-central bankers for a non-specialist audience. With the current “difficulties” in Cyprus about to spread, it will be curious to see if derivatives raise their ugly heads again. Who knows how much exposure the TBTF banks have once things unwind a bit?    http://tinyurl.com/blhtc3q

Mon, 04/01/2013 - 09:58 | 3395649 rsnoble
rsnoble's picture

Looks like they'll be moving to the new currencty regardless.  With the same fucking morons in charge no doubt.  In other words the same slave masters with a brand new shiny piece of ponzi fucking shit to last another hundred fucking years. 

Mon, 04/01/2013 - 09:30 | 3395566 Son of Loki
Son of Loki's picture

"unintended consequences" is correct. i wonder how many companies cut off shipping to Cyprus now? My friend used to ship his stuff all over the world but now has longer and longer "Do Not Ship" list and Cyprus is added to it he said. If their credit is bad how to they import 'stuff' like food? Who wants to ship to them when they may not be paid?

Mon, 04/01/2013 - 11:27 | 3395965 NotApplicable
NotApplicable's picture

Bullshit!

Only an idiot would believe these consequences are uninteneded.

But hey, you and the author can go right ahead and continue to pave the path for the banksters to steal everything due to their "incompetence" and see just where you end up.

All people occupy their positions of power for a REASON. The ability to CON YOU.

Now this isn't to call them all evil masterminds, but rather, loyalists to the cause that empowers them, a.k.a., tools of the true powers that be. You just noted how Cyprus is DEAD, yet you label the cause manslaughter, rather than first degree murder.

Why is it you choose to serve the elite so?

Mon, 04/01/2013 - 13:26 | 3396435 OccupyTVstations
OccupyTVstations's picture

They've been using the incompetence excuse for everything. My favorite was when Rumsfeld said the reason NORAD couldn't find the hijacked planes was because the radars were pointed outward! No joke, not April fools.... at the 9ll commission the Sec of Defense actually claimed NORAD's defense radar is directional (as if we've never seen a weather forecast), located on the coasts and pointed towards Russia.

I cannot comprehend how they got away with that most ridiculous excuse. It must be that fluoride in the water, prozac, zoloft, etc is really freakin powerful.

Mon, 04/01/2013 - 13:58 | 3396552 OccupyTVstations
OccupyTVstations's picture

I guess the 'incompetence' would be Rumsfeld, Gen Myers, the 9ll commission and every reporter and anchor in every major media outlet not knowing how Radar works.

Now this isn't to call them all evil masterminds, but rather

useful idiots.

 

 

Mon, 04/01/2013 - 09:22 | 3395543 q99x2
q99x2's picture

Import from cousin Vinnie for twice the value and pocket the other half in Italy.

Mon, 04/01/2013 - 09:16 | 3395523 one-in-nine
one-in-nine's picture

In light of how Europe has treated Cyprus in this debacle, the Cypriots may let the Russians in and show their middle finger to NATO regardless of NATO/Europe's better offer. They were burned here and will remember who lit the match.

Mon, 04/01/2013 - 09:20 | 3395541 Sandmann
Sandmann's picture

NATO does NOT have a base on Cyprus, BRITAIN does. It is a SOVEREIGN BASE of 98 sq. miles. It is BRITISH like GITMO is US not NATO

Mon, 04/01/2013 - 09:04 | 3395492 pashley1411
pashley1411's picture

And where else in Europe have the banks been forced to buy government bonds, not even of their own country?   Hmmm, everywhere.   US too.

Mon, 04/01/2013 - 08:07 | 3395411 goose3
goose3's picture

That...was brilliant.  Makes me want to talk to my local dealer and see what Silver Eagles are going for this morning.

Mon, 04/01/2013 - 09:21 | 3395391 CheapBastard
CheapBastard's picture

Yes, it seems they did not learn from Asians who hold the yellow metal  in case of emergency. The tenth ounce coins were used freely to fascilitate many escapes over there during and after the Vietnam War.  How about the Jews escaping from Hitler during WWII. Gold was their passage to freedom in many cases.

History is a good teacher many times. I would have thought the Europeans knew some of these lessons.

Mon, 04/01/2013 - 09:47 | 3395622 tango
tango's picture

People post as if Cyprus was a great repository of economic knowledge.   It's always been part of the Europe that in the current era survived by a simple, cheap lifestyle, self-reliance and lots of tourists.  The Cypriot people are notoriious for bad governments (the lastest being a Russian Stooge who went all in for investment bankers).  They've fought a civil war for decades and were foolish to attempt a match with Germany and the Netherlands.  The tragedy of Cypriots - and Greeks - is that they contributed to their own demise by trying to get something for nothing (and yes, I know we are doing exactly the same thing).  

Mon, 04/01/2013 - 11:55 | 3396077 taraxias
taraxias's picture

Are you pulling this shit out of your ass?

Yes, I did junk you for talking like you are an authority about something you know nothing about.

Mon, 04/01/2013 - 09:25 | 3395558 q99x2
q99x2's picture

I've got my exit metal ready but in a globalist's world I don't think it is enough to get me to Mars.

Mon, 04/01/2013 - 07:47 | 3395386 mt paul
mt paul's picture

get a few big tug boats

tow Cyprus up there by Iceland

 

tha grave yard of IMF killed economies

Mon, 04/01/2013 - 07:38 | 3395375 eddiebe
eddiebe's picture

A sobering article. My condolences Cypriots! The EU really fucked up here, and it really does seem like something has changed in the Western world, certainly in Europe. My take-away is: Start hoarding cash and keep stacking PM.'s. 

I'm also looking for reports in some news venue that shows bank withdraws, especially in Europe, since this Cyprus debacle was released to the press.

Mon, 04/01/2013 - 08:01 | 3395406 silvermail
silvermail's picture

Right now, we have an unprecedented suppression of the gold price. Why? Because they drive us like rams in paper assets. They closed for rams opportunity to go into gold and silver. They have put in the way of sheep economic barrier via “Low price”.
Therefore, a rams can only go in fiat paper or the stock market paper. Only in the paper.

What happened in Cyprus, there was not a spontaneous decision. It was a carefully planned operation by the IMF and the ECB. This operation is not over. For the success of this operation, it was necessary to suppress the price of gold and silver. Without such price suppression, the whole operation to slaughter rams for meat, not could be successful.
If they had not put down in this period the price of gold and silver, most rams would go away in a safe place – in gold and silver.

But in this case they can not be robbed. For this reason, the price of gold and silver should be very low right now.

Mon, 04/01/2013 - 07:55 | 3395400 sunnydays
sunnydays's picture

It is just so sad to know that only 5 years ago, they had a strong currency and was the healthest country and banks in the European area.  They then joined the Euro and had to buy Greek bonds.   They were taken down fast.  It almost seems as if it was planned.   Those people have lost everything due to banks and their greed and their gambling.   Yet they didn't gamble before the Euro.   

I hope they go Iceland. 

 

Mon, 04/01/2013 - 09:37 | 3395591 tango
tango's picture

Cyprus may have been doing well before the EU but only because of Greek aid and especially, the busy tourist trade. Cyprus has always been primarily a travelt locale.   By population, it was the most visited nation in the EU and a huge percentage of income and jobs derived from tourism.  Then the welfare state began looking for funds and they turned to...investment banking, particularly under the "leadership" of communist Christofias (talk about intellectual dishonesty).  They discovered that they could not compete with the likes of Holland, Finland and Germany so here's where we are.  

 

Mon, 04/01/2013 - 10:43 | 3395760 DosZap
DosZap's picture

Simple as it gets to be= The LOVE of money is the root of ALL evil.

Esp when you use your own citizens money.

These SOB's need to be HUNG.

 

Mon, 04/01/2013 - 07:33 | 3395373 apberusdisvet
apberusdisvet's picture

It will be interesting to see who will recapitalize this country; Russia, the IMF, even China?

Don't overlook the strategic military value of Cypress.

Mon, 04/01/2013 - 08:12 | 3395416 NoWayJose
NoWayJose's picture

Agreed. How valuable to Russia would a naval base on Cyprus be? Or how valuable to NATO would blocking a Russian naval base be?

Mon, 04/01/2013 - 11:36 | 3396001 NotApplicable
NotApplicable's picture

Why focus on those abstract, two-bit players? I'd say the question is "which way creates WWIII in a manner to our liking?"

As always, the considerations are future command and control, along with flow of wealth. Anything less is just the manufacture of one of numerous casus belli, setting the stage for the "outbreak of hostilities."

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