Political analysis: Two dimensions
Politically, I can see two dimensions. The first dimension belongs to the
geopolitical history of the region, with the addition of the recently
discovered natural gas reserves. The historical relevance goes as far back as
1853, the year the Crimean War began. The Crimean War took place in the
adjacent Black Sea, but the political interest was the same: To avoid the
expansion of Russia into the Mediterranean. The relevance of this episode was
the break-up of the balance of power established after the Napoleonic Wars,
with the Congress of Vienna, in 1815. From then on, a whole new series of
unexpected events would lead to a weaker France, a stronger Prussia, new
alliances and a final resolution sixty years later: World War I. It is
within this same framework that I see Cyprus 2013 as a very relevant political
event: Should Russia eventually obtain a bailout of Cyprus (as I write, this
does not seem likely) against a pledge on the natural gas reserves or a naval
base, a new balance of power will have been drafted in the region, with Israel
as the biggest loser.
The second political dimension refers to a point I made exactly a year ago,
precisely inspired in the KreditAnstalt event of 1931. In an article titled: “On gold, stocks,
financial repression and the KreditAnstalt of 1931” I wrote:
“(The KreditAnstalt event) was triggered because France, a public sector creditor,introduced a political condition to Austria, in exchange for a bailout of the KreditAnstalt. Today, like in 1931, in the Euro zone, the public sector is increasingly the creditor of the public sector. In 1931, England and France were creditors of Austria and demanded conditions that no private investor would have demanded.
Private investors live and die by their profits and losses. Politicians live and die by the votes they get. Private investors worry about the sustainability and capital structure of the borrower, the collateralization and the funding profile of their credits. Politicians worry about the sustainability of their power. It’s a fact and we must learn to live with it.
In 2012, Greece and increasingly other peripheral EU countries owe to other governments, the IMF and the European Central Bank. Private investors have been wiped out and will not return any moment soon. We fear that just like in 1931, when the next bailout is due either for Greece again or Portugal or Spain, political conditions will be demanded that no private investor in his/her right mind would ever have demanded.
Think of it... What in the world had the customs union between Austria and Germany in 1931 had to do with the capitalization ratio of the KreditAnstalt??? Nothing! Yet, millions and millions of people worldwide were condemned to misery in only a matter of days as their savings evaporated! Ladies and gentlemen, welcome to the world of fiat currencies! You have been warned! If months from now you read in the papers that the EU Council irresponsibly demands strange things from a peripheral country in need of a bailout, remember the KreditAnstalt. Remember 1931.
Please, understand that this is not a tail risk. The tail risk is precisely the opposite. The real tail risk here is that when the next bailout comes due, politicians think like private investors and give priority to economic rather than political considerations. That’s the tail risk! If such a crisis occurred, the media will speak of increased correlations and tell you that everything is actually fine on this side of the Atlantic. But if you read us, you will know that all that led to such a situation was perfectly foreseeable and nothing is really fine on this side of the Atlantic either. You will have remembered 1931…”
At this point, I think all is said and I have nothing else to add. My
worries a year ago are proving too correct.
Economic analysis: Confiscation and two broken
promises
Cyprus 2013 is worse than the KreditAnstalt and Argentina 2001 crises
because it has an element of confiscation and two broken promises that were absent
in the latter.
Confiscation
Neither in 1931 or in 2001 were the depositors in Austria or Argentina
subject to an explicit and arbitrary confiscation of their savings by their
fellow representatives, meeting at a Parliament. This is a totally new element
of violence in the drama. Back in 1931 and in 2001, depositors simply run
against their banks for price discovery: to discover the true value of holding
US dollar bills –physical- vs. their respective fiat currencies (shillings and
pesos). That was all what these exercises (i.e. runs) were about. The
governments did not intervene to distort the final discovery. In the ‘30s,
through contagion to the US, such discovery allowed depositors to realize that
their US dollars were worth a lot less than 1/20.67th of an
ounce of gold. In the 21st century, the final act of the same
game will see holders of fiat gold realizing that there is a premium for
physical gold.
Both in 1931 and 2001, governments intervened only to slow down the process
of price discovery. But could not change the outcome of the same. In the case
of Argentina, with a credit multiplier for US dollars of 1/0.3 (30% was the
reserve ratio), the US dollar ended trading at 3 pesos by 2003. Nobody should
have been surprised in Argentina therefore, that the peso lost 2/3rds of its
value vs. the US dollar. The devaluation was not a confiscation. Depositors did
not bail out their banks or the government. Depositors simply suffer a market
priced transfer of wealth that benefited those who held physical US dollars.
And neither the banks nor the government had physical US dollars. That’s why
they both went bankrupt.
In Cyprus 2013, depositors have no clue as to what the final recovery of
their capital will be. The expected losses have no connection with a public
credit multiplier (In Argentina everyone and their grandmothers knew that as of
March 1995, by regulation of the central bank, for every three fiat US dollars
circulating there was only 1 real US dollar as backup). In Cyprus, the
final recovery is being “debated” at this moment by members of Parliament and
is consulted to powers outside the country, in Brussels, in Berlin, in
Washington DC and in Moscow. This is far worse. This will bring an element of
social conflict, of resentment, that will not be easy to appease.
Broken Promise no. 1: The promise of a banking union
During 2012, real efforts were made by policy makers to convince the public
that the Euro zone was shifting towards a banking union first, as the stepping
stone to a political union. The cornerstone of that promise was the role of the
European Central Bank as lender of last resort. It had to be an unanimous
promise; a promise to every jurisdiction. For all practical purposes, it should
matter very little what the GDP or population of a member of the union is. In
fact, if the European Central Bank can not come up with the EUR5.8BN package
that is claimed to be minimally needed to kick the Cypriot can down the
road….what can we expect when this problem gets to Italy, which doesn’t even
have a government to negotiate with yet???
In 1931, the promise of international support for Austria was only
implicit. In 2001, the promise of a lender of last resort was explicitly absent
in Argentina. Nobody in either Austria or Argentina had never expected
anything. Nobody was promised anything. Nobody was let down. This is not the
case in 2013.
Broken Promise no. 2: The promise that deposits below EUR100,000 are
guaranteed
Perhaps I missed something here, but as far as I know, I never saw Mario
Draghi calling for a press conference to say: “Dear depositors of Euros in the
Euro zone: As long as this central bank I preside exists, regardless of
geography or political circumstance, any deposit up to EUR100M is guaranteed by
my institution”. If I missed such message, please, accept my apologies and be
kind enough to send me the link to watch it online (I cut my cable tv
subscription last year, in the interest my kids’ education).
The promised EUR100M deposit guarantee has not been openly defended in
Cyprus 2013. To my knowledge, there was never such a promise either in 1931 or
in 2001. Therefore, Cypriot depositors were left in the cold far worse than
their counterparts in Austria or Argentina, whose expectations had never been
high.
Final thoughts
If you look at the case of Argentina 2001, you will realize that it was a
pretty clean bet. In Argentina, the reserve ratio on US dollars was known: 30%.
We all knew that the USD deposits had been loaned out to the government and
that the government faced a significant probability of default. Banks however
offered depositors of US dollars a 20% p.a. interest rate. Therefore, an
Argentine depositor was faced with a clean bet: Earn 20% p.a. vs. the
probability of losing 2/3rds of capital. If you thought that the probability of
default of the Argentine government was beyond four years, you would play the
bet with a chance of winning it.
What are depositors of Euros faced with today? Anything but a clean bet!
They don’t know what the expected loss on their capital will be, because it
will be decided over a weekend by politicians who don’t even represent
them. They don’t really know where their deposits went to and they also
ignore what jurisdiction they really belong to. Finally, depositors are paid
mere basis points for their trust in the system vs. the 20% p.a. Argentina
offered in 2001 (thanks to the zero-interest rate policies of the 21st century).
In light of all this, I can only conclude that anyone still having an unsecured
deposit in a Euro zone bank should get his/her head examined!
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