On 15 March 2013, Cyprus said it would impose a levy of 6.75% on deposits of less than 100,000 euros and 9.9% above that. The measure will raise 5.8 billion euros ($7.5 billion), which implies that we have about 68 billion euro ($85 billion) in deposits in the Cypriot banks. What this means is that each depositor in a Cypriot bank will get a haircut on their savings. This event is actually a very important one in history as it marks the first time that depositors actually lose their money, despite the presence of a deposit insurance. Of course, you can't have deposit insurance without a bailout of the banking system by the IMF. But to have this bailout, depositors need to have a cut (imposed by the IMF). It's sort of a paradox: "from now on deposit insurance is not insured anymore".
Many people think that their deposits are safe when they put their cash in the bank, but they either lose it to inflation or in this case lose it to the government. The result is that investors lose confidence in the banking system and will go to assets like precious metals which don't have counterparty risk.
There is a belief that Cyprus is too small of a country to have any significant impact on the markets, but I'll show with some figures that investors should be cautious about this misconception.
First of all Cyprus has a very large banking system. Its banking system is 7 times its GDP. With a GDP of $26 billion, its banking system is $182 billion, which is exactly equal to the tax-payer funded bailout of AIG. So we're not talking about small numbers.
Second, we need to consider who these depositors are. We are not only talking about the deposits of individual investors. Also companies, which have deposits in Cypriot banks will lose money. Around 40% of the $85 billion in deposits are from foreigners and 30% of the $85 billion of deposits are from Russian companies. This implicitly means that 80% of the foreign money is from Russians. What this tax really does is target these Russian companies. They could lose up to $3 billion and this could put many companies on the brink of collapse. On a side note, Britons are also affected by this levy, but to a lesser extent (3%). All of this is true if the numbers are actually correct. Jim Sinclair said in an interview with King World News that the numbers could be much bigger:
Sinclair: "If people believe that $13 billion is the total of this bailout, they are out of their minds. $130 billion is not the true total of even the Russian deposits in Cyprus banks. One important Russian businessman, in his various business enterprises, would have $100 billion on deposit himself. 10% of all deposits in Cyprus could be $500 billion or more because Cyprus is the banking entity for Russia, not Switzerland or Grand Cayman.
Third, we haven't seen the effect just yet because the banks are closed until next Tuesday. If the banks open again, we could see a bank run due to panic. At this moment we already see riots on the streets in Cyprus. What we need to note here is that the liquid reserves to bank assets ratio of Cypriot banks is only 3%. This ratio measures how liquid the banking system is. A low liquidity means that the country's banking system is more vulnerable to a financial crisis, especially when banks lose depositors during a bank run. When bank reserves get depleted in this scenario, we get a freeze of credit and loans.
And finally, we could have a ripple effect. As you know, Cyprus is part of the EU and the IMF is the mastermind of this implementation. If the IMF can impose this on Cyprus, it can impose this on every European country. The amount is 10% now, but it could also be 20%. I even heard numbers as large as 40%. According to Zerohedge, the IMF and the EU were originally demanding a 40% wealth tax on bank account holders in Cyprus. I think we haven't seen the last of this.
The key thing to remember is, your money is not safe in a bank and certainly not in the banking system in the form of derivatives. I would sell the financial sector (NYSEARCA:XLF), as that sector had a nice run already and I would put that money into physical gold (NYSEARCA:PHYS), as physical gold is the only asset that doesn't have counterparty risk. To give an idea about the bullish movement in gold I want to point out that the gold price in euro terms jumped more than 1000 euro/kg in just 2 days.
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.