Lessons From The Cyprus Bank Heist

Cyprus bank depositors have been royally fleeced. The largest bank, the Bank of Cyprus, has converted 37.5 per cent of deposits over 100,000 euros into shares in this bankrupt bank while keeping back another 22.5 per cent for possible conversion into stock in the future. The final 30 per cent will be frozen and held as a deposit.

“What had already been stolen has been stolen,” are the well-chosen words of Russian Prime Minister Dmitri Medvedev. This is a seminal moment in the history of modern banking in Europe. Larger depositors everywhere must be wondering if their money is safe in any bank.

The only modern parallel is Lehman Brothers whose failure was supposed to cleanse a damaged system and instead ended up creating the worst systemic banking crisis in living memory. Lehman shareholders and bondholders lost their shirts, so have depositors in the Bank of Cyprus.

Should they have known better? True the bank paid high interest rates that ought to have sounded alarm bells about where that money was going. Still Greek debt denominated in euros carried a sovereign guarantee and should have been safe.

But a bank deposit also ought to be secure. This is not a loan or an equity investment, although that is what deposits in the Bank of Cyprus have become. So what are the implications for the banking system?

First, there will be a flight to quality among the banks. The top banks will gain deposits and the weaker banks lose them. That could be a self-fulfilling doomsday scenario for some banks in Greece, Spain and Italy. And a gain for banks in Germany, Austria and the Netherlands, though if that comes at the cost of a systemic banking crisis they will not be winners either.

Secondly, owners of capital are going to increasingly want non-banking products outside of the banking system. Gold is an excellent saving product with no third party between you and your money, unless you keep it in a bank vault.

Even then confiscation is far less likely than from a bank deposit. Nobody usually knows the content of your safe deposit box while any clerk with a computer can see how much you have in the bank (and refuse to pay it to you).

Is this one reason why the gold price mini-crash in April — very clearly deliberately orchestrated by the central banks to mask the Bank of Japan’s massive new money printing programme — brought such a strong surge in retail gold buying?

The investing public is aghast at what has happened in Cyprus. It is all very well to argue that Cyprus is an exception. But then who saw it coming there, apart from the hundred or so top customers who were tipped off in advance and got their money out? By extension you can see what this means.

Depositors anywhere could have their money stolen at some point. Do you want to find yourself in that position? Holding cash is supposed to be the most secure and neutral investment position, at least in the short term. Is that no longer the case?

Fear and greed drive markets and the Cyprus affair has created a new fear among bank depositors that will help to drive the price of gold up and up. It is fear of the conventional banking system as a place to put money that will cause a flow of money into the precious metals, along with the bond market crash that just has to follow as investors decide to get their money out of the conventional banking system.

Gold is a protection against an Armageddon scenario in the global banking system. Those who don’t take up this insurance policy may one day soon wake up to a realisation that like the depositors of the Bank of Cyprus they have nothing left of their savings.

Cyprus always did look a bit of a dodgy proposition and now we know just how dodgy!