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By Amine Bouchentouf

Cyprus, a small island country on the eastern coast of the Mediterranean Sea, has been caught in the limelight of the international media as the latest victim of the eurozone crisis. What began as an attempt to stabilize the country's troubled banks has turned into a debate about the very existence and reliability of the global banking system. Cyprus, while representing less than 1% of the European Union's GDP, is nonetheless an integral part of this union -- so much so that Cyprus is now taking front and center stage in discussions about the eurozone's future and how the union will deal with its member countries that require imminent assistance.

Home to about 1 million people, Cyprus has a banking system multiple times larger than its GDP. This is because Cypriot banks lent large amounts of money to both Greek businesses and individuals during pre-crisis times. As the situation in Greece deteriorated economically, Cyprus' loans that had any exposure to the Greek economy soon became worthless -- so much so that the Cypriot banking system is literally on the verge of collapse. Without external intervention, banks in Cyprus are facing a classic run on the bank.

Faced with this troubling situation, Cypriot lawmakers quickly turned to traditional institutions for help: the European Central Bank (ECB), the European Commission (EC), and the International Monetary Fund (IMF). These three institutions, known as "the troika," have played a role in stabilizing other economies within the European Union ever since the crisis began. They notably played a role in helping Greece, Spain and Italy go through very difficult period. While the EU is nowhere near out of the woods, these have been the main institutions that have been able to provide assistance in the past. Therefore, it made total sense to decision makers in Cyprus to turn to them for help.

Yes, but With Strings Attached

Not wanting to be seen as a lender of last resort with no strings attached, the troika decided to take a hard line with Cyprus. The troika, led primarily by Germany, told Cyprus it would provide a 10 billion euro lifeline to the country's banking system. However, the country had to help pay for this bailout by taxing regular bank checking and savings accounts. As soon as word spread that people's bank accounts would be taxed, riots and demonstrations spread around the island country.

As of the writing of this column, the different stakeholders in the Cyprus banking crisis came to a resolution that seems to have averted a full-scale banking meltdown. However, when you look closely into the details of the deal, you see that unsecured bank account holders at Cyprus' second-biggest bank will be completely wiped out. While politicians might be patting themselves on the back, they have set a dangerous precedent -- that people with bank accounts are at risk of losing their money in the face of this banking crisis. This only serves to drive the point home that paper currencies are becoming increasingly risky, especially when compared to the reliability of gold.

The initial proposal saw bank accounts with less than 100,000 euro deposits subject to a one-time tax of 6.75%, and those with more than 100,000 euros taxed at a one-time rate of 9.99%. The politicians anticipated their tiered taxing system, which penalized wealthier borrowers, would help less affluent holders (the majority) accept the measure. However, no politician anticipated the firestorm that erupted once ordinary citizens learned the government planned to touch their bank accounts.

Implications for Paper Money and Gold

The real implications of this tax proposal have been overlooked by almost every mainstream media article that has covered this issue. Many commentators have pointed out how Cyprus got itself in this situation -- which is similar to how Greece, Italy, Spain, and other countries ended up here in the first place. But the real issue is much more serious than has been written about. At stake here is the very confidence in the global financial system that individuals and businesses have, and if that is gone, then it may very well be the end of paper money as we know it.

The Cypriot tax incident has raised the global financial stakes to a whole new level. Now the question is whether individuals and businesses feel confident in keeping their hard-earned assets -- represented by paper currencies -- within the world's banks. Once you lose confidence in whether your wealth is safe and secure, it's only natural to look for alternative ways to preserve and store that wealth.

As soon as regular Cypriots heard that the government was going to essentially confiscate part of their money in order to pay for a government bailout, the first reaction was to withdraw as much money as possible from the banks. Within hours, ATMs all over the country ran out of paper currencies, which represents a run on the bank. While Cyprus is a small chain in the global banking system, the confidence that bonds its banks with its depositors is global in nature. If Americans, Brits, Saudis, Chinese or Japanese all lose confidence in their banks, then it is the end of the banking system as we know it. And all it took for Cypriots to lose confidence in their banks was one declaration from the government.

In this environment where confidence in paper currencies is declining, many individuals are turning to alternative assets to preserve and secure their wealth -- and at the top of that list is gold. As soon as Cyprus proposed a tax on bank accounts, gold brokers all over Europe reported a spike in inquiries and transactions coming out of Cyprus. As the ultimate store of value, gold can be fully trusted by ordinary citizens and investors alike to preserve their wealth. In times of financial crises like we've experienced recently and will most likely experience in the near future, gold remains the go-to asset in times of stress.

Paper currencies are losing their value slowly but surely. There's inflation, then there's government printing more and more paper to get out of insurmountable debts, and now there is outright confiscation of paper money stored in bank accounts. If there's anything that the Cyprus situation teaches us, it's that paper currency cannot be relied on in the long run -- in this environment, gold presents itself as the ultimate store of value.

Disclosure: The author doesn't have any positions in the stocks mentioned.

Source: The Commodity Investor: Gold's Value Shines Through Cyprus Bank Deposit Seizures