The Cyprus Threat

Includes: GLD, IAU, PHYS
by: Paul Nathan

We all woke up to a new crisis in the Eurozone this week. This time it was out of Cyprus. This tiny, almost insignificant country has put itself in a position of having to raise money to refinance debt. So they, with the consent of the IMF and others, decided to impose a bank-deposit tax. They decreed that they could go into the banks and confiscate a certain percentage of the depositor's savings. This is what the Founding Fathers called "legal plunder."

Gold shot up and markets around the world sold off. My take on the Cyprus move is that the problem is much different than any other so far in the ongoing euro crisis. It is not a liquidity crisis as was the case in years past, since the ECB can now act as a lender of last resort and replace any money withdrawn by depositors via a bank run. And it's not a solvency threat since the banks can be back-stopped by the Central Bank. And it's not a contagion threat since Cyprus can be ring-fenced and any contagion prevented.

So, on a technical level, the threat is smaller than any before. This is perhaps why gold and gold stocks retreated after their quick spike up.

But on a legal level, the threat is greater than ever before. A legal precedent is being set. The precedent is that no one's money is safe from governments. If push comes to shove, it will be the individual that will get pushed around, and it will be the governments that will do the pushing.

The fact that the IMF, ECB and US Treasury all sanctioned and/or refused to condemn this move is of grave concern: it condones the abandonment of private contracts and the rule of law.

Even the guise of a vote will not allay the fears of savers and investors trying to preserve their wealth. The fact that governments put to a vote the proposition that any majority can take money from any minority, only confirms the abandonment of the rule of law. Switching the minority groups the governments take from, is simply a shell game that eventually the average citizen will catch on to. Eventually all will find themselves being part of some minority or another.

The danger here is that other governments around the world may be tempted to use the Cyprus model or some variation thereof to raise money. So far there has been no opposition from the IMF, ECB or US Treasury. On the contrary, the US Treasury released a statement on the Cyprus move saying that it is important that the parties act in a "fair and responsible manner." This implies that the confiscation of a depositor's money is up for negotiation. It need only be confiscated "fairly and responsibly." Does that sound like a government that vigorously protects the property of individuals?

So far markets have reacted cautiously. But if individuals become fearful of their governments, as well as suspicious of the validity of contracts, they may decide to begin pulling their money away from the banking system and other official government institutions - they may begin to transfer from government money to commodity money which they can hold in their possession. The result would be the demise of the fiat system, since the fiat system is built on confidence and trust. Lose that, and you lose not only the monetary system between nations but the medium of exchange that supports worldwide trade.

This is what is at stake when governments start breaking promises at will. Cyprus began taking the first step toward that end, and the IMF, ECB and the US refused to condemn it. This is the real worry. As I write this, it is being reported that the Cyprus Parliament has voted to rescind the deposit tax. But you cannot un-ring a bell. A government attempted to blatantly confiscate individual wealth, and the leading international governments and institutions of the world offered no resistance.

Whatever happens, we have one more reason to hold gold. Gold is something that can be held in one's own possession, not others. It is not a promise that can be broken, it is a diverse way to hold wealth, and it is an unofficial way to hold it. Given the new Cyprus attempt to resolve its problems at the expense of innocent victims, it is no wonder that gold moved quickly above 1,600.

Gold has held its lows and has been slowly turning up. As we move toward Thursday and the reopening of banks in Cyprus, watch gold as a measure of confidence or fear in what amounts to a growing desperation for governments to find cash.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in GLD, SDS over 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.