Playing Cyprus: The Stupid Burn

 |  Includes: FXE, QQQ, SPY
by: Dana Blankenhorn

The move by European Union bankers to demand a 10% haircut on Cyprus depositors in order to maintain loans to the country is seen by many as a turning point.

But which way will it turn?

I can certainly understand and sympathize with those predicting death, destruction, and other terrible things as a result of this. It is, by far, the dumbest idea I have seen central policymakers try to impose in many years. Investors agree, and are hammering the main Euro ETF (NYSEARCA:FXE) as well as that of nearby Greece (NYSEARCA:GREK).

I get why they went after Cyprus. There are lots of Russians with money who have moved there. So don't tax you and don't tax me, tax that man behind the tree. If Russian money controls Cyprus' banking system, then go after it.

It should be noted that this is a situation unique to Cyprus. Bankers aren't trying to protect old loans, giving new ones to paper things over. This is all new money. Essentially, Cyprus offered a down payment on the loans in the form of money mainly held by rich Russians.

But countries are not companies. You can make a company pay up-front to get a new loan, often in the form of stock or even preferred shares. Companies have been squeezed in this way since J.P. Morgan was in knee britches.

When you try to do this with countries, trouble always follows. The examples being trotted by the Euro-bears are all valid. You can't really foreclose on a sovereign state, or on its people. All you can do is inflict maximum pain and, in the end, take what you can get, as was done with Greece, which now suffers from 1930s conditions, which could indeed lead to a 1930s loss of confidence in democracy and free markets.

When you can't write off bad loans, you are always playing with fire.

The good news is that this truth may be dawning on Europe's bankers. There are indications this may not happen.

We've seen this play out time-after-time throughout Europe's crisis. The center decides to do something stupid, the markets go haywire, then an accommodation is made and, if you got in at the height of the panic, you made money. This was true with Greek debt, with Italian debt, and with Spanish debt.

It will be true with Cyprus as well. Those who keep predicting utter disaster, like Bo Peng at TheStreet, need to understand that Armageddon can usually be prevented, and almost always is, even at a price.

The current crisis may also be an invitation for U.S. markets to go through that long-overdue correction. The next quarter will see federal austerity impose a 2.5% annualized downdraft on GDP, according to GS Global Research, and it's hard to see the private economy making up for all of that. Even a stellar 3% gain in the private economy would mean a final GDP rise of just 0.5% - still feel bullish?

That said, the deepest problem with the stock market today has much in common with what's wrong with Cyprus. Too much of the market is held by too-few people. The top 1% own 40% of the market, the next 9% own another 40%, and 80% of Americans aren't in the market at all. This is similar to Russian dominance of the Cyprus banking sector.

When wealth isn't spread widely, it becomes a target. We're seeing this in Cyprus today, and U.S. stock wealth needs to broaden if it won't happen here. Since broadening won't happen here in the near term, it won't represent any pain for the vast majority of people if you and I feel some pain.

So we will. Expect falls in the major averages, reflected in major ETFs like SPY and QQQ, over the next three months. The folks in financial news will panic, and so will some people here, but if you're smart, if you don't panic, there will be huge opportunities.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.