Cyprus, stocks and platinum

Cyprus lawmakers this week rejected a controversial euro bailout package, which would have set a dangerous precedent by taxing ordinary bank depositors to pay part of the bill. How will it affect the stock market? Will it make platinum any less appealing – especially relative to gold? Let’s take a look.

The genie has been let out of the bottle. The fact that a democratic government could propose such a plan is a game changer. Ordinary people everywhere now know that putting their savings into insured bank accounts is no longer a guarantee of a good night’s sleep. When governments are in desperate financial straits they will not hesitate to plunder the accounts of ordinary savers and investors. And that make gold all the more attractive.

At issue was a plan for a one-time tax of 6.75% on bank deposits of less than €100,000 even though deposits are guaranteed (insured) up to that amount in Cyprus and in most other European countries.  In addition, the government wanted to levy a 9.9% tax on Cyprus bank accounts with more than €100,000 many of which contain Russian money. Russian banks and businesses have been flooding Cyprus for years taking advantage of low taxes and loose regulations, setting the laundering dial on the fast spin cycle. This decision would have penalized small depositors who are not responsible for the bubble and would have let off the hook the bankers, shareholders and bondholders who supposedly assumed the risks. Worried investors everywhere finally got the point that gold is one of the few safe havens and gold went up $22.80 (1.43%) this week. On Tuesday, for the first time since Feb. 6, gold was added to the trust for the SPDR Gold Shares ETF (GLD).

Cyprus, like Iceland before it, has an outsized banking sector eight times the size of its economy, which indicates that money flows into its banks without any connection to the local economy. (In other words, possibly some tax evasion and a bit of money laundering.) Just for comparison, U.K. banks are only three times larger than the British economy and London is considered to be a global financial center. Cyprus banks were heavily damaged by exposure to Greece and now Cyprus' entire banking system needs to be capitalized.

Even by just having considered shaving the top of bank deposits, a psychological Rubicon has been crossed raising some serious questions and issues.

The first is why bother having a deposit guarantee if governments can expropriate your deposits? Even though policy makers claimed this would be a one-time event, how can one be sure? If this were to happen in Cyprus, could it not happen anywhere else in the Eurozone, Greece, Spain, etc.?  Already there is a similar proposal being considered in New Zealand. Without credible deposit insurance it’s every person for himself, all bets are off and it’s a matter of how fast you can queue up to withdraw your money. With such low interest rates paid on deposits, isn’t it safer to stuff the money into the mattress or under the floorboard? And if that’s the case, instead of paper money, which loses value, wouldn’t it be smarter to hold gold? Without the public’s trust in the banking system the economy cannot function.

Cyprus is a small country of less than a million people. It joined the Eurozone on Jan. 1, 2008. That decision, to forgo sovereignty of its own currency, sealed its fate. Even though Cyprus backed down from the plan to tax deposits, just bringing it up as a possibility, might have killed its status as an offshore tax haven. But that’s what got it into trouble in the first place.

No one knows what will happen next, but none of the options is pretty. Cyprus debt-to-GDP ratio pushed to 127% in the third quarter of 2012.  Only Greece (at 153%) has a higher level. It is politically difficult to persuade German taxpayers to finance a bailout of an off-shore money heaven for shady deposits, and can you blame them?

So either Russia will come to the rescue with a fat check, or EU officials will relent when faced with the prospect of a Cypriot exit from the Eurozone. Another possibility might be that the Cypriots tax the big accounts and spare the small, mostly local savers. Cyprus has no central bank to prop up its banks like a non-Eurozone country does. So the last option is for Cyprus to exit the Eurozone and to start printing its own currency.

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