The news that the bailout of the Cyprus banking system released after the markets closed on Friday will carry with it confiscation of up to 10% of Cypriot bank deposits will be yet another important moment in this phase in monetary history. By refusing to allow bondholders to bear even a modicum of responsibility for the eurozone banking tragedy, the Troika have pushed through a barrier that once breached will not be repaired any time soon, if ever. The effect will be positive for both the U.S. dollar in the short term and gold in the long run.
During the Great Depression, loss of faith in the banking system had become so complete that nothing short of deposit guarantees would bring money out from underneath mattresses. I agree with those that cite the creation of the FDIC as the watershed moment in that era. Only after the government backed bank deposits could there be a positive credit growth cycle. This is not an endorsement of that process, just an observation of its effect.
Fast forward to today and we see the exact opposite scenario playing out in Cyprus. I guess for Cypriots the current version of the plan to steal their bank deposits is far more benign than what the Germans were asking for originally - 40% of all deposits versus the 10% that is in the current proposal. And even though the EU is reaching new levels of venality with their constantly shifting the terms of the theft to see which trial balloon will float the longest, the main point is that like food scares, once trust in one's money or bank is gone, it won't be coming back any time soon.
In addition, the FDIC in the U.S. stands like a paper wall in a Japanese home between depositors and any real banking stress in the U.S. Because, when push comes to shove it will be the depositors who will lose either in a similar wealth tax on a previously protected form of savings, the swapping of pension/401K assets for Treasury bonds or good old taxation via mass inflation.
The instability created by this will have ripple effects well beyond Cyprus. There are rumblings that Italy is going to be offered the same deal, or worse, though I can't imagine that would go over at all given the outcome of the latest elections. One almost gets the sense that this bailout in Cyprus is a response to the Italian situation, with the EU and IMF attempting to exert as much control over the situation as possible because the actual threat of a eurozone breakup is, in reality, remote.
In the same way that the commodity markets in the U.S. have not been the same since MF Global -- with traders leaving the market and volumes in the precious metals pits falling steadily as it became clear that those markets are less about price discovery than they are about price management --the breach of trust between depositor and banker will never be regained.
Personally, I despise the eurozone and everything that it portends. But my opinion of it as a political and economic monstrosity is irrelevant. This is a project that has been 60 years in the making; carefully planned, laid out and executed. To me, then, the most useful analysis of this turn of events in Cyprus involves considering it as euro-positive even though that seems counter-intuitive.
While this truly may be one of the biggest poker bets of all-time it is very likely that it will work out to the Troika's advantage while ultimately pitting them against Russia and savers across the eurozone.
The positive about this is that the Cyprus situation has been dealt with and if the Cypriot parliament votes in favor of it over current schizoid public opinion - 71% being against the deal but 62% wanting to stay in the euro - then everything will work out to their advantage. Cyprus will be effectively fixed and at little cost to the ECB.
And this will be positive for gold as the inherent trust between the banking system and savers in Europe will have been broken. Absent a coherent deposit insurance program, a portion of the money that will flow out of European banks on fear of confiscation will flow into the precious metals. Rising gold is also bullish for the euro as it will further improve the ECB's balance sheet along with that of the rest of the BRICS who will come in to take the price higher as needed.
Sure, the U.S. dollar and U.S. Treasury bonds will see a bid from this. The immediate reaction was a jump in bond future prices and the yen on safe-haven buying. The gold market is simply not big enough to soak up the money that will flow out of European banks but at the same time, this fear trade will not result in a simultaneous hammering of the gold price.
Even if the uncertainty over Cyprus accepting these conditions lingers for a couple of weeks, last year's eurozone-breakup-fear trade happened against a backdrop of the Federal Reserve actively tightening the monetary base. This year we are in the exact opposite environment. We are starting from a different place. U.S. bond yields have been rising for months and looked very weak coming into this news. gold isn't coming off of a $275 rally in two months like it was last February. Quite the opposite has been occurring. The only common denominator is rising equity prices.
So we will see some savings flow into gold, at a minimum supporting the current price range. Now, if there is a response to this by Russian or Chinese interests in the futures markets then I would be expecting $1700 gold very quickly on a short-squeeze thanks to a near biblical hedge fund short position. Once the euro is past the uncertainty over Cyprus, it will be free to begin rising versus the dollar, which is being actively debased by the Fed, helping gold climb the wall of worry.
Remember, activation of the OMT will result in sterilized QE of some form or another. The ECB will resist adding anymore to its balance sheet for as long as it can -- and certainly through the German elections. The Fed, on the other hand, is expanding its balance sheet by at least $85 billion per month. Remove eurozone fear even a little and the exchange rate will stabilize.
Banking -- especially that of the fractional reserve variety -- is ultimately a confidence game. And any loss of that confidence will quickly turn into a panic. There are a lot of people in Europe right now reconsidering the definition of what a safe haven is for their money.