Through The Looking Glass

Includes: CIU, LQD, VCIT
by: Kyle Spencer

On Friday, I predicted that a

massive bank restructuring

combined with massive capital controls was in the cards for Cyprus, singling out Laiki ("Popular") Bank in particular for demolition. This assessment turned out to be correct

on Sunday night

, when Cyprus finally caved to the Troika's demands.

The new deal puts the onus of the "bail-in" squarely on the shoulders of the Russian oligarchs. It includes:

  • Shutting down Cyprus' second largest bank and inflicting heavy losses on uninsured depositors (above €100,000),
  • Winding down Laiki Bank, also known as Laiki, and shifting deposits below €100,000 to the Bank of Cyprus to create a "good bank."
  • Deposits above €100,000 will be frozen and used to resolve debts, and Laiki will be shuttered.

Amateur Hour

Remember, this 11th hour bailout of Cyprus didn't happen overnight. Brussels had 8 months of lead time on Cyprus, with the shambolic results you see: foreign state actors (i.e. Russia) being propositioned like any John in the red light district of Hollywood, and bank heist that would have been executed more effectively by Monty Python.

With this deal, Cyprus has effectively committed economic suicide, and President Nicos Anastasiades's political career is over before it began. We can also expect mass outflows of large deposits from Europe starting on Monday into American, Chinese, and Singaporean banks, as the well-to-do start to wake up to the fact that they are being put on the hook for the failed policies of Brussels.

Perpetual Crisis

In a broader sense, Europe is replicating the mistakes of the American states under the Articles of the Confederation: Brussels cannot force its member states to obey its decrees, tax directly, automatically transfer wealth from rich members to poor members, raise a European army, or establish federal courts. The European Project therefore cannot survive long downturns in the markets without acerbating the problem.

Despite what the technocrats may tell themselves, there is no realistic way to circumvent this state of perpetual crisis, as it is exists primarily as a consequence of the fragility of the European "Articles" system, rather than as a cause.

This has led to some counter-intuitive and even perverse results: Capital controls have been implemented in a system designed to facilitate the free flow of capital. The euro itself, which was billed as bringing prosperity is strangling economic recovery in the Southern states.

More troubling is the prospect of individual states reaching out to other non-European state actors (i.e. Russia). In fact, such a system so flawed that it seems destined to fall into the hands of "strong men." I would argue that the markets are far too short sighted in this regard. Would Stalin have failed to exploit such disunity?

Through The Looking Glass

The international markets are predictably euphoric about the "salvation" of Cyprus. However, the European Press doesn't appear to be buying it. The Irish Independent calls it "shocking." The Dutch think Cyprus should have left the EU for their own good. Moody's is going to declare Cyprus in default no matter what.

Moreover, the Cypriot banking system is now virtually guaranteed to crash anyway: Would you put your hard earned money in the Bank of Cyprus after this? Would anyone, with capital controls now being put into effect? Remember, Cyprus is now joining the august company of international luminaries like Mexico, Brazil, Argentina, Chile..and yes, Greece.

In a rational world, one would expect such a shoddy state of affairs to result in a sell-off. However, we are no longer in the "rational world." In the Looking Glass World of the PIIGS, Up is down, Black is White, and every headline with the word "deal" in it - no matter how shoddy, self-destructive or ill-conceived - drives equities higher and gold lower.

Short-term traders should therefore consider going long on investment grade bond ETFs that are directly exposed to Europe, including iShares iBoxx $ Investment Grade Corporate Bond (NYSEARCA:LQD), the Vanguard Intermediate-Term Corporate Bond Index (NASDAQ:VCIT) and the iShares Barclays Intermediate Credit Bond (NYSEARCA:CIU).

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.