Gold, Cyprus & Europe: Security. Bankruptcy & Pregnancy
Only when the tide goes out do you discover who's been swimming naked. -- Warren Buffett
Goldwatcher co-author Frank Holmes recently published this analysis titled In Gold Not Cyprus We Trust.
His comment ends with this chart:
Click to enlarge
In this article address the recent developments that have brought gold back on asset allocation agendas as investors seek security and protection from capital controls, currency and systemic risks.
Cyprus & Europe - Bankruptcy & Pregnancy
You can't be a little bit bankrupt. Yet we have known for a long time that some of Cyprus's banks were de facto bankrupt and, somehow, they escaped formal bankruptcy until now.
It's also a fact of life that you can't be a little bit pregnant. Such an incontrovertible fact that the analogy has resonance for other improbable situations such as inconsistencies in the structure of the European Union that include:
- Sovereign states that are no longer altogether sovereign working in an association that is neither a political federation or a fiscal union;
- Supporting a euro currency for a eurozone that exists like another Europe within Europe;
- A European Central Bank that is not supported by a banking union between its member states; and
- Financial markets that expect any European Union member state in financial difficulties will get bailed out even though European Treaties prohibit sovereign bail outs.
While the financial tide was flowing in Europe's inconsistencies weren't seen as life threatening or even dangerous. But, now with the tide out, it's been revealed who has been caught swimming naked and the spotlight is on Cyprus and Europe.
Cyprus blames its adverse turn of fortune on losses sustained in the pseudo Greek default imposed by the Troika when it was restructuring Greece's debts and, apart from the substantial financial losses incurred as a result of the enforced write downs, Cyprus also lost access to capital markets and these loses were certainly damaging. But Cyprus's banking edifice was an accident waiting to happen and the tide would have gone out for Cyprus anyway. The banking edifice was built on foundations of tax evasion and money laundering.
Last weekend Europe eventually recognised the only realistic solution for Cyprus would be to deal with bankrupt banks, depositors, bondholders and creditors according to law - a solution anticipated in a Goldwatcher comment Let Cyprus's Bankrupt Banks Go Bust filed last Saturday before the decisive European Union meeting commenced.
A Financial Times editorial 'Europe Gets Real - Not Before Time' published yesterday was sub titled 'The Right Plan for Cyprus After Dreadful Errors' addresses the agreements in principle reached with Europe and notes:
'Europe has arrived at the best available remedy ... but not without first trying every other option and nearly letting a tiny peripheral economy shatter the monetary union ... Few in Cyprus may agree, but the island state has got the best deal it was entitled to expect ... Even proportionately small losses are unaffordable for the state to make good ... 'A metastasised banking system sucked in more funds than it could usefully deploy at home ... But the choice to hitch the economy to offshore banking was made with the complicity of leaders and the acquiescence of a population content to live beyond its means...'Other countries made clear that their (Europe's) taxpayers would not pay for a model Cyprus itself cannot afford with loans it could never pay back'
'... The perception of Cypriots and others that Europe "forced" the island to ruin depositors only testifies to abysmally bad communication by the rest of the currency union ...... The banking meltdown will worsen a contraction some forecast at 25 per cent. But no other package of policies would be better than this - Cyprus must chart a new economic course, probably by accelerating natural gas exploitation. Restructuring holds the best prospect for quickly re-establishing a functioning banking system. Most worryingly, hopes of the euro navigating the debt crisis successfully were hit badly by its leaders' breathtaking amateurishness in the Cyprus case.'
Protecting assets for Cypriots
Cyprus owns valuable offshore gas deposits. If local politicians had a free hand the deposits would probably have been handed over to Russian or other associates by now but, as a result of the support committed byEurope, the offshore wealth is likely to remain owned by Cypriots - and 'believe me' as Mario Draghi would say, the Cypriots will need it.
Cyprus's sovereign credit rating is already down to one point above junk and its vulnerable banks have already been further downgraded. In this Bloomberg interview conducted this afternoon with Bridget Gandy, Fitch's head of European credit ratings, information is given on where Cyprus banks ratings stand now and why Europe must proceed rapidly and implement a banking union that can independently guarantee deposit insurance.
Capital controls: A Tipping Point?
Following the imposition of capital controls restricting access to Cyprus bank accounts today we have another inconsistency that makes the euro also look a little bit pregnant. Capital controls are theoretically impossible in a currency union. The currency of each member state must have the same value everywhere. That's how the gold standard worked and, if standards mean anything, a Cyprus euro must be worth the same as a German euro and it isn't anymore. Further, Cyprus's capital controls will remain at least until after all bank restructurings have run their course. At a guess that will take between six months and a year.
Will the bail out of Cyprus and imposition of currency controls be the tipping point that ends Europe's phantom pregnancy and, with it, any sense of security we might still have in our fiduciary paper money currencies? If you read some articles and comments published today you will find warnings that not only has the end come for Europe, but it has come for life as we know it on the planet. But, unless the crisis spreads, risks are low for the time being.
Europe has agreed to lend Cyprus ten billion euros and, with debt reductions that will flow from bankruptcy or restructuring proceedings, there will be enough funding for a small island with a population of only a million people to recover. And, even if is it's not enough and Cyprus abandons the euro, consequences outside Cyprus could be managed. However the economist Megan Green hit the nail on the head today with her comment Bond-buying can't mitigate a run on the banks.
"If the crisis spreads and we have runs on banks by nervous depositors in Spain, France or Italy the consequences will be unthinkable. And, in Italy, we have Beppe Grillo and his 5 Star movement totally opposed to the euro (and almost everything else.) And, in my opinion, that's why gold is back on the agenda for asset allocators."
A series of current Goldwatcher articles on Italy is accessible on The Goldwatcher website