I Rest My Case

March 28, 2013

"Instead of just letting shareholders in entities such as General Motors taking direct hits, they should also let depositors take a percentage hit on their savings as well. If losses are not flushed out of the system then no lasting improvement can be expected. Telling people that their savings are safe and guaranteed but then lumping bank losses and failures onto the public purse is a circuitous subterfuge that breathes life into a monster rather than slaying it."

On Printed and Borrowed Money

September 5, 2009

I wrote the above words almost 4 years ago and they remained in suspended animation until this last week when Cyprus came apart at the seams. There was no joy in seeing what I proposed actually taking place. The timing and the manner were totally inept.

As a result of the "deal" they could not refuse, (literally) everyone including junior and senior bondholders, shareholders and depositors took a bath.

In the words of Eurogroup head Jeroen Dijsselbloem:

"What we've done last night is what I call pushing back the risks.

If there is a risk in a bank, our first question should be 'Okay, what are you in the bank going to do about that? What can you do to recapitalize yourself?'.

If the bank can't do it, then we'll talk to the shareholders and the bondholders, we'll ask them to contribute in recapitalizing the bank, and if necessary the uninsured deposit holders."

The suffering is at its beginning and to date has claimed shareholders, depositors and bondholders. It has also claimed democracy and property rights as its victims. The suffering of the Cypriot people is at its inception. The hit to its disproportionately large banking system will have ongoing ripple effects.

Economic activity will shrink automatically due to uncertainty. Then the loss of jobs in the banking sector will add to these woes which will also entail salary cuts. As the economy shrinks the wage and employment levels in the rest of the economy will also falter and the government will be forced to reduce expenditures by cutting away at many useless public sector positions out of necessity if not common sense. All this will further shrink property values which in turn will further adversely affect the securities held by banks for lending.

Thus the whole exercise will in many respects be as damaging as the Greek experience where property values have become so damaged that banks (in my view) might be operating but in reality are insolvent.

Ask any Greek and he will tell you that property values have fallen by at least 50%. Despite that level of fall, there are still very few sales taking place.

There is of course the threat and the fear that the Cyprus solution may be pursued in various other jurisdictions and this to my way of thinking may be inevitable given that governments everywhere are out of both ideas and ammunition in dealing with the current economic malaise.

In fact I can almost guarantee that in some shape or form there will be a repeat of the Cyprus solution at some point in time. But there is something deeper and more sinister than some nations going off the rails.

Why?

Imagine you found a bottle with a label proclaiming it to be the wonder cure for all ailments. Without questioning the claims on the bottle you start to take the recommended dosage religiously. For a while you start to feel stronger and happier but then something happens and you take a turn for the worse.

You start to suspect the contents of the bottle as being the culprit and when the lab sends back the results you are confronted with a disturbing truth. The potion was nothing more than snake oil mixed with steroids and the recommended dosage was in fact an overdose which took you over the edge.

A fiat monetary system when combined with fractional reserve banking, is the equivalent of mixing snake oil with steroids. Leverage, which is the equivalent of oversubscribing the dose, only makes matters worse.

Cyprus, in other words, is just a symptom rather than the cause of what has transpired in recent days.

Inevitably, the Euro experiment will end in an expensive and acrimonious divorce because while marriage between two people is a challenge, polygamy becomes hell when the husband on the one hand is an authoritarian and miserly German and the wives on the other hand are spendthrifts.

My dear readers, the world is bankrupt but more importantly, the system itself is ideologically and logistically bankrupt and unless it changes, all infusions of debt masquerading as capital will simply go to waste and make matters worse.

The further complicating factor is that men like Jeroen Dijsselbloem are incapable of leading the system out of the wilderness. When SNS Reaal which was the fourth largest bank and insurance group in Netherlands, was heading south, it was under his direction that it was bailed out. These are not the actions of an enlightened European but instead of a pedestrian politician. Brussels effectively wasted a crisis by dealing with Cyprus in the way it did.

And now that the Cypriot banks have lost their credibility, the vultures of Europe have descended on the tiny island state trying to coax the large depositors to transfer what is left to their banks.

Yes dear readers, we truly have a unified Europe with an umbilical cord made of paper which lacks any nutrients.

My advice to Europeans is to get the hell out of the Euro if they want to preserve capital. Instead, be a citizen of the world by holding gold and silver. No visa is required in any jurisdiction for these true currencies to be admitted and accepted.

Unless Europe comes up with a Marshall Plan for Cyprus, we will see a disaster of epic proportions unfolding in Cyprus and all this for the sake of a lousy 6 billion in paper confetti.

Will your country be next or the one after? It is now only a question of which order the same events will unfold everywhere.

Sydney Australia

A single ounce of gold (about 28 grams) can be stretched into a gold thread 5 miles (8 kilometers) long.