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You Can’t Insure Against a Tax

cyprus_map

If you ask most Americans, my guess is that they would not be able to find Cyprus on a map. Russians, however, have deposited a whole bunch of money in this tiny Mediterranean island (see the map above to give you a feel for where it is and its size in relation to Europe/Asia/Africa).

Why is this important? Over the weekend, it was announced that Cyprus had received a bailout from the European Union, and one of the conditions was that a special “tax” was being levied on bank depositors to offset the cost of bailing out their banks. Bank depositors in Cyprus have a 100,000 Euro deposit insurance guarantee, much like the US FDIC coverage. So, in spite of having a fully insured deposit under 100,000 Euros, depositors will have 6.75% of their deposit deducted from their account and handed over to the government. Depositors over 100,000 Euros will see 9.9% of their deposit turned over to the government.

In a strange turn of events, bondholders in those banks (in otherwords, the creditors of the banks who generally would be next in line after the stockholders to lose money when corporations fail) will be made whole and not lose anything.

Banks in Cyprus are closed through Thursday at which time it wouldn’t surprise me to see a massive exodus of deposits (particularly the Russian deposits which make up the bulk of the Cypriot bank deposit base) and a liquidity crisis as the next issue.

If you remember, when Lehman Brothers failed in 2008 and kicked off the stock market crash, a liquidity crisis was the proximate cause. Cyprus is just 0.02% of European Union GDP, so it is very small – however its banking system is 13 times greater than its GDP (I can’t find a source for this other than an interview I listened to earlier today – don’t place reliance in that number but rather in the fact that the banking system was a lot bigger than the country itself).

Last night, the Dow Jones Industrial Average futures were down 200 points, but as I write this, we are down 3 points. Volume, today, is lower than recent trading sessions, and in general for most of the increase in prices recently volume has been well below normal.

So what is going on? The stock market continues to be strong in price despite being weak in participation – that is not a situation that is durable and I wouldn’t expect it to last.

sp-500-trading-range

The graph above shows you the secular bear market we have been navigating since 2000. The S&P 500 is roughly 10 points from an all-time high, or 0.63%, and it has been trying to break through that upper resistance level for several days. Readers of this blog know that I have been very cautious and have been selling stocks into this year’s strength. BUT, the question is what will send the market into correction mode?

So far, investors have shrugged off this event and are focused on the wonders of Fed monetary policy keeping stock prices moving ahead. That will work until something happens to spook people into selling, much like last summer, sending the market down 10% to 15% – a healthy consolidation that shakes out those with short-term horizons but allows those with cash on-hand (like us) to buy solid companies at cheaper prices.

What seems most insane about this whole situation in Cyprus is that the EU officials are publicly stating that this is a one-time event and that it won’t be repeated. If you were a depositor in a Cypriot or Greek or Portuguese or Spanish or Italian bank, would you believe that? Or, would you want to move your deposit to a German or Swiss bank where the risk of confiscation, or “tax” as its being called, is less. I know what I’d do – buy a Rosetta Stone and learn to sprechen sie Deutsche pretty darn quick. Obviously I am not alone in this assumption as yields on both German and Swiss debt have turned negative (meaning people are willing to lose money on a 2-year bond just to avoid bigger potential losses in other investments).

And, we have to ask: if it can happen in Europe, can it happen in the USA? (ignoring the obvious that it already did happen in the USA during FDR’s first 100 days when physical gold was confiscated by the US government)…

We normally don’t listen to rap here on the blog, but given today’s topic, I couldn’t resist something from the early 90’s:


Click Here for Today\'s Video on YouTube

For those of you who don’t like rap (that generally includes me) here is a story from Russia about the Cyprus situation:

Mark