The Law of Liabilities — Falling Interest Rate will Increase your Liability
The West has long abandon the laws of accounting that would clearly show the harmful effects of rising and falling interest rates associated with irredeemable fiat currency. For example the city of San Jose has suddenly discovered that has more than five times the liability stated in the account books:
The solvency of San Jose’s city council pensions was reported last year by CalPERS to be 72% funded and had a stated liability of $976,000, based on the agency’s assumption that the pension plan investments would earn 7.5% percent for each of the next 30 years. But CalPERS told the city council to exit the pension plan would cost between $5 million to $5.7 million, approximately 584% more than the liability CalPERS had been annually reporting to the city. It seems CalPERS’ expected return of 7.5% per year is only for participants that stay in the plan. CalPERS hammers participants when they want to check-out of the plan by whacking their future estimated return down to the U.S. government bond yield, which is 2.4% right now.
—CalPERS is Hotel California, Chriss Street 2013
I have nothing positive to say about CalPERS but in this case they are not the one to blame, actually by asking for the high liquidation value for the liabilities of the city they are finally applying the Law of Liabilities:
The Law of Liabilities. It asserts that a liability must be carried in the balance sheet at its value at maturity, or at liquidation value, whichever is higher. Since liquidation would have to take place at the current rate of interest, in a falling interest-rate environment the liabilities of all firms are rising. This spells a great danger to the national economy, one that has been completely disregarded by the economists’ profession, as it also has by the accountants’ profession.
—IS OUR ACCOUNTING SYSTEM FLAWED? by Antal E. Fekete 2008 [my emphasis]
This law is disregarded by all pension funds in the country except of course when it is time to pay then the real books are opened and the real value is demanded. All companies and cities with pension liabilities are benefiting from disregarding the law of liabilities, even so many have huge pension fund deficits.
Ever since the dollar was made irredeemable the Federal Reserve has been able to manipulate interest rate. First during the depression and the second World War the Fed was able to hold interest rates below market value. After WWII the Bretton Wood accord anchored the dollar to gold and interest rate somewhat stabilized, since 1968 the interest rate, has been on a wild ride swinging from record lows to record highs back to record lows. Since the laws of accounting described by Prof. Fekete—I highly recommend the article quoted above—were ignored the wild swings of the rate caused mayhem and destruction as capital evaporated without trace.
See also:
- Of Thrift and Gold, you can only save in gold.
- Farewell my Savings, savings in dollars are not safe.
- Liquidating the Debt of the United States, numerical example of the effect of interest rate on debt liquidation.
Humorous Population Videos
Population decline over the whole West (2011 estimate)
The above map is a cropped version of a Wikipedia map showing population growth. The whole West (with a capital ‘w’) is declining. Countries that do not welcome immigrants are losing population, while countries that encourage immigration are barely growing with a rate less than 1%. The ongoing economic crisis has slowed and even reversed the immigration stream resulting in reversals in countries that were dependent on them for growth.
Although the number of native Spaniards grew in 2012 by some 10,000 – it only minimally offset the overall fall of nearly 216,000 among registered foreign residents.
The figures show that the ongoing economic crisis has reversed the country’s rapid population growth in the decade before the financial crisis erupted in 2008.
—Spain’s population shrinks as immigrants flee economic crisis, BBC 22 April 2013
Percentage of the population over 65 in 2010 for each country
Population decline causes population aging, this is a mathematical fact. Increase in life expectancy does and will not cause aging, society will age when fertility rates drop below replacement. The less children are added the higher the percentage of old people.
If the West is failing to reproduce itself to propagate, i.e. it is dying, then why should any country listen to Western propaganda about population, family planning, the role of women in society, even their views on abortion and homosexuality?
Would you go to Bangladesh to learn about flood control, or to China to learn about earthquake-resistant building codes or to Japan to study how they re-started their economy after a national credit bubble or to Argentina to observe how they tamed a runaway inflation or to the US to document their success in fighting childhood obesity? Why then should anyone listen to the West about population, families, women, children, health, immigration or anything at all for that matter.
Here are three humorous videos about population from the Population Research Institute, I do not agree with all views or even all the statements in these videos.
See also:
- Demographic Genocide, economic decline not growth is the reason behind European demographic decline.
- Look on my Works ye Mighty, and despair!, the wealth and might of the West is a relic of a past age when excess population spread over the world like locust.
Think about the Intrinsic Value of Gold
No need for daily polish, gold will keep its shine even after centuries.
“If you think about the intrinsic value of gold, there’s not a lot,” Guy Debelle, assistant governor at Australia’s central bank, which owns 79.9 tons, said at a business lunch in Canberra today. “Gold often has a high price because people believe that other people believe that it’s worth a lot. When you describe other markets like that, the word ‘bubble’ gets thrown about.”
—Gold Drop Splits Central Banks as Sri Lanka Sees Opportunity, Bloomberg April 16, 2013
I wanted to write this post each time I hear someone dismissing gold as useless or without real value. Such claims have come from functionaries like Bernanke, obnoxious financial creatures like Buffet, but surprisingly also from people promoting silver with its 10,000 uses. The only reason gold is not used in industry is its high value otherwise it has a number of very useful properties:
Besides its widespread monetary and symbolic functions, gold has many practical uses in dentistry, electronics, and other fields. Its high malleability, ductility, resistance to corrosion and most other chemical reactions, and conductivity of electricity led to many uses of gold, including electric wiring, colored-glass production and gold leafing.
-Gold, Wikipedia
A super car uses gold foil as a heat shield in the exhaust compartment.
For an excellent rundown of gold’s uses:
If you are going to spend billions of dollars on a vehicle that when launched will travel on a voyage where the possibility of lubrication, maintenance and repair is absolutely zero, then building it with extremely dependable materials is essential. This is exactly why gold is used in hundreds of ways in every space vehicle that NASA launches.
—The Many Uses of Gold, geology.com
Gold is an excellent metal with numerous usages, thus an intrinsic value. Some lies are so stupid that there is really little to be said to counter them. Never since archaeological history started has gold become worthless, fiat currencies on the other hand have all declined to zero. Even at $1300 per ounce the Australian dollar has lost 97% of its value against gold since 1967, so much for thinking from Australia.
See also:
- The Difference between Past and Future Labour, you can only be paid in gold.
- Of Thrift and Gold, you can only save in gold.
- How to Invest in Dollars, you can only earn gold.
- Australian dollar, from Wikipedia.
Dude, Where’s My Hyperinflation?
In Shattered! posted July 4 of 2008 I wrote based on a single graph:
From the red line we concluded that US banks are insolvent, from the blue we concluded that the Fed (Federal Reserve) has assumed their liabilities. The result will be a terminal decline of the dollar (to zero) causing hyperinflation.
In September of 2008 Lehman Brothers went bankrupt and the US banking system needed a $750 billion government bailout and trillions of monetary easing from the Fed. I made three predictions from a single graph with only two lines, two of them came true a couple of months later while the third has not come true in the following four and a half years. In this post I will explain why the the third part have been delayed. This is how the graph looks today:
Total Borrowings of from the Federal Reserve and Non-Borrowed Reserves of Depository Institutions
(source: St. Louis Fed)
The third line is the sum of the total borrowings and non-borrowed reserves and is identical to the Reserve Balances series. The banks’ problems started actually in November 2007, five months before Bear Sterns faced bankruptcy. As the non-borrowed reserves declined the Fed lent equal amounts to hold the reserve balance steady. The money lent out by the Fed was not created out of thin air, this lending was financed by selling short term treasuries to the market and lending the cash to the banks:
Treasury securities held by the Federal Reserve (Red: mature within a year. Blue: mature in longer than a year)
(source: St. Louis Fed)
Short term treasuries were in great demand as banks stopped lending to each other and sought refuge in government securities. When Lehman collapsed the Fed started to print money and doubled the monetary base in a very short period. The effect on the non-borrowed reserves was immediate, they started to climb up while borrowing from the Fed declined. By lowering the interest rate and printing money the Fed was recapitalizing the banks.
The reserves kept on growing and growing, for the first time in history the banks deposited significant amounts of their assets with the Fed rather than lend it out to risky counter-parties; the banks today hold 40 times the reserves they had in 2007 with the Fed. Slowly all the borrowing from the Fed was paid off by the the start of 2013 (see graph above).
Now we can answer the question: Where is the hyperinflation? Why all the printed dollars did not have a bigger effect on the value of the dollar?
Monetary Base minus Excess Reserves of Depository Institutions
(source: St. Louis Fed)
The red line in the graph above is the monetary base, we can see clearly how from September 2008 it has been expanded by several multiples. The blue line is the monetary base minus the excess reserves that the banks hold with the Fed, that line has only increased by about 50% since September 2008. Most of the dollars created are not circulating in the economy and multiplying ten to twenty times as usual.
When I revisited the graph of the reserves in Track Record I noted : “The high reserves are like a huge body of water behind a dam and the economy is the little village at the foot of the dam.”
Note on the nature of Hyperinflation
You can not show a person that which he does not recognize. Inflation has been universally described as a phenomenon difficult to understand, hyperinflation is inflation on the a very large scale and scale is the important word here. I have broached this subject before, I wrote in Beware the Boom!: “Just like physics inflation is relative, it depends on the lifetime of the transaction. Infrastructure and multi-decade projects have already been in a hyperinflation situation for decades now.”
Instead of assigning arbitrary numbers to define hyperinflation—in Wikipedia you might find it defined as 50% inflation per month—it should be defined by terms that are independent of scale. In hydrodynamics turbulence is defined by a dimensionless number, because the phenomenon appears in the smallest pipes as well as the most thunderous waterfall while mighty rivers flow serenely.
I do not have a better definition for hyperinflation, although I suspect the growth of the monetary base and real interest rates play a role in it, I only know that a natural phenomenon can not be defined by arbitrary levels for certain timescales. When hyperinflation arrives there will be no wheelbarrows of cash or people using hundred dollar notes to light a fire, but their savings will be wiped out nonetheless and businesses will fail as their capital disappear; by then it would be too late to discuss definitions.
See also:
- The Printing Press is a Harsh Mistress, once a central banker starts printing he can never stops.
- Dark Pools of Future Inflation, more dollars lurking in the shadows.
- Twisted all the Way to Zero, today nothing remains of the Fed’s short term treasuries.
The Losses of the Falkland War Today
The Present
In 1982 the Royal Navy lost 2 destroyers, 2 frigates and 1 Amphibious assault ship. In my previous post on the subject, Old Britannia Fades Away, I included a graph showing the decline in number of ships in the Royal Navy.
Different types of Royal Navy warships since 1980
To measure the losses of the Falklands War on the Royal navy of today I compared the percentage of ships lost per class. For the starting numbers I used the graph above, the latest numbers I obtained from Wikipedia (see List of active Royal Navy ships which has accurate number of March 2013). The result is the following table:
Royal Navy’s Falklands War losses compared to current strength
A similar result today would cost the Royal Navy a third of its destroyers, a third of its Amphibious assault ship and about a seventh of its frigates. The Royal Navy also lost 10 fighters out of a total of 42 aircraft; today it has no aircraft carriers although two have been ordered and are being built. The Royal Air Force have four (4) Eurofighter Typhoon stationed on the Falklands in RAF Mount Pleasant, an airbase built after the war. Taking out one of the Eurofighters would equal the losses of the war on relative bases.
The Future
If I may wildly speculate then I expect the following developments in the future: The UK will not build the second Queen Elizabeth carrier. The UK has ordered the F-35B (the vertical landing and take off variant) instead of the F-35C (the carrier variant) for its future aircraft, this change could have serious consequences as it appears that the F-35B will either be delayed or completely scrapped. This will render the new carrier unable to launch fixed wing aircrafts because it is not equipped with catapults and arresting gear.
Not only the British armed forces budget is being severely cut, but the politicians demand wildly diverse missions from their armed forces: from counter-insurgency in Afghanistan to anti-piracy in the Indian Ocean and of course they are supposed to defend far flung overseas territories like the Falklands.
The Navy has no working aircraft carrier and its surface fleet is based on six destroyers and 13 frigates. Gen Richards said he was particularly worried about the size of the fleet and suggested that a shortage of ships meant resources were being allotted to the wrong tasks.
“One of my biggest concerns is the number of frigates and destroyers the Navy has,” he said. Gen Richards cited the Navy’s Operation Atalanta to counter piracy in the Indian Ocean. A lack of ships has forced admirals to use the most advanced warships for relatively simple operations, the general said.
“You get to this ridiculous situation where in Operation Atalanta off the Somali coast, we have £1 billion destroyers trying to sort out pirates in a little dhow with RPGs [rocket-propelled grenades] costing $50, with an outboard motor [costing] $100,” he said. “That can’t be good. We’ve got to sort it out.”
—Defence chief General Sir David Richards attacks Armed Forces cuts, The Telegraph 14 Nov 2012
Argentina cut its military budget right after the war and has kept it small relative to its GDP. Since the war Argentina has been governed by a neo-liberal regime during the 1990′s that ruined the economy and caused the currency to fall by 80% in 2001, that was followed by a false export-driven boom. Since 2008 the economy is struggling again, the economics of Argentina today do not support any military buildup.
Despite Argentina’s present economic situation change can and does happen, it was only a hundred years ago that the Royal Navy was the world’s largest and strongest navy and yet today it is a third rate navy with less frigates than Turkey. Once Argentina gets its economy sorted and growing, which can happen as fast as the economy of the UK crashing, it will set itself the following goal: reclaiming the Falkland islands by any means including military force; national pride is one thing but oil reserves are another thing altogether.
Military expenditure as percentage of GDP
Once Argentina’s economy is reconstituted the military will put a plan for reclaiming the islands and all budget increases will be spent according to the plan, a targeted military buildup in Argentina while the UK armed forces are cut down and spread thin.
See also:
- The Falklanders Invite Genocide to their Homes
- Debt and War, 300 years of British public debt.
Notes on the Bank of Cyprus Settlement
Under the arrangement, depositors in Bank of Cyprus will receive shares in the lender worth 37.5pc of any savings over €100,000, while the rest may never be paid back, according to a statement from the Cypriot central bank.
Of the 62.5pc of uninsured deposits not converted to bank shares, about 40pc will continue to accrue interest but will not be repaid unless the bank does well, while the final 22.5pc will cease to attract interest.
—Cypriot authorities confirm raid on big depositors, The Telegraph 29 Mar 2013
People seem to be writing lots of nonsense about Cyprus, clearly the ignorance about how banks work is not stopping a lot of people from commenting. People are still using words like ‘levy’, ‘tax’ and the most nonsensical ‘bail-in’; the sequel to the misleading bailout.
For the Bank of Cyprus it seems that the shareholders and junior bondholders will be wiped out. I am not sure about senior bondholders, but they will either be wiped out or their securities converted to perpetuals, which I will discuss below.
As to the depositors of the Bank of Cyprus who have more than the guarantee limit the following will apply to the money above the limit, some people are confused about this because the tax applied to the whole amount if it was above the limit. For any amount above the limit: 22.5% will wiped out, 40% converted to perpetuals and the rest converted to equity—the last is mistakenly described as “receive shares.”
I am not sure why any amount had to be wiped out, unless this is to cover debt that had to be written-off or even debt to Laiki bank. I believe all the depositors money should have been converted to equity unless it is because of the conditions of the deal with the troika or debt that had to be written off .
As to perpetuals they were actually the norm when the currency’s value was linked to gold; states didn’t issue bonds that expired because they will only roll the debt over at a similar rate, so they sold perpetual bonds that pay interest yearly and the state was under no obligation to buy them. When the link to gold was severed and the interest rate started to oscillate and inflation became a constant investors demanded that the state buy the bonds at face value. Today no one would buy a perpetual from a state no matter how high their ratings or the interest they offer.
A deposit is a loan to the bank, I hope everyone realize this by now, only the lender (depositor) can demand the payment of the debt at any moment. What they are going to do is to convert this to a perpetual bond that pays interest. I am sure they are going to issue securities and create a market for them so people who need money can sell them, I am also sure that vulture funds from Germany, the Netherlands, etc, are going to swoop to Cyprus and buy such securities for a fraction of their face value.
The last part, the conversion to equity, is the part least understood by commentators with people wondering how they are going to “price” the shares. They seem to be under the impression that the depositors are to be given existing shares, but all current shares have been wiped and there is no more shares outstanding (I believe this to be true, although I am still to see official documentation about this step). Let us assume that the total that will be converted to equity is €10 billion and that they decided to issue 10 billion shares, then they will issue €1 shares and give them to the depositors. There is no problem in pricing the shares because it is just a question of how many you want to issue. The real question is how the market will price those same shares, when the people try to sell them off. Again I think vultures will descend and take them for a fraction of their face value.
People are becoming hysterical about schemes to unwind failed banks being published in New Zealand and Canada, that is nonsense. These are schemes to quickly and systematically resolve a failed bank in the correct way, i.e. without a bailout from the taxpayer. Read my post on the Nonsense about the Open Bank Resolution in New Zealand.
See also:
- How to Honour your Financial Obligations, UK perpetual debt from WWI.
- Highway Robbery in Cyprus, from the start I thought depositors in the failed banks should pay.
- Bagehot on Money a 5-part series discussing Bagehot’s book on how capital markets developed historically.
- Recapitalizing Banks with a Debt/Equity Swap by Nathan Lewis.
“Generate your own capital through savings” — Shoaib Sultan Khan
In my post Micro-Usury Shows its Ugly Face I pinpointed the mistake at the center of the micro-credit model: “Historically finance was spread by providing saving accounts and not credit.” That is a deadly mistake by itself but actually the situation is even worse than this, all the successful examples of micro-credit touted for propaganda (and they are very adapt at using the media) are what I like to characterize as: NEP men.
NEP, or the New Economic Policy, was implemented in the Soviet Union to help rebuild the country after the ruins of WWI, the civil war and the Polish war; the policy resulted in the emergence of middlemen who would facilitate the trade between the hungry workers in the cities and the farmers eager to get finished goods after years of war. The middlemen bought cheap from both ends of the trade and sold dear, pocketing the profits.
When a woman buys a mobile phone with the help of loan from a micro-credit institution then sells calls to her follow villagers she makes money, but not because she invested in the village and helped raise the productivity of the land producing more wealth. This lady is a middleman between the phone company and the villagers, getting a cut just because she has capital. The villagers usually use the phone to call a relative who works in the city or overseas (contrary to propaganda), the money they pay is usually from that same relative.
Another example I saw this week on the news is an Indian woman opening a shop in a village of 20,000 people which did not contain a single bank, that is a mark of shame on the government of India, but what exactly did that shop add to the village? Consumer products and one rich household. Spending on consumer products—bought with money remitted by relatives working far away or the little surplus that the villagers produce—prevents the villagers from accumulating capital to invest and raise their productivity.
I have already pointed to the solution: saving. I suggested that poor countries need basically two things a stable currency (i.e. gold-backed currency) and a postal bank to encourage saving and channel capital to productive investment. To my surprise I read an article putting saving as the center of a plan to develop poor rural communities:
‘In every village I went to,’ he replied, ‘I was very blunt and would tell them that I have not come to listen to your problems nor your needs because I don’t have the resources to do anything about these. But I have come with the conviction that you have potential and we would like to unleash that. So I offered them a development partnership, which entailed their having to do something first before the programme can do anything. I told them that individually I would not be able to help and could only help if they got organised. And that organisation has to be in the common interest of the group.
‘My second condition to them was: you have to identify one of your own men or women as the activist who will lead the organisation. No outsider can do that. My third condition was saving. Since capital is power, you must generate your own capital through savings. However poor, you must save something – even one rupee a week.’
—Escaping Pakistan’s poverty trap, The Telegraph
The article has very interesting information and I would recommend reading it in full, despite the idiotic point of view.
One very interesting part was how women entered the market and developed their independent business (described as “the lives of these women have become purposeful” as if the lives of their mothers had no purpose because they were not part of the market economy) this in contrast to Grameen Bank’s frontal attack on the traditional social structures regardless of the socio-economics conditions.
Women enter the market when the conditions are right, any political structure that try to hold them back will undergo huge internal pressure and will do so at its own peril and vice versa; there is no need for a dramatic rescue from outside actors funded with Scandinavian money trying to remould rural South-East Asia in its own image.
The truth of micro-credit is that it is supported because it helps in breaking the traditional structures and sucking more people into the devouring mouth of the market economy. The market economy is a step on the path of human development and every society should go through it, but I believe people should enter this dangerous territory armed with the power of their own savings, as Shoaib Sultan Khan express it: “Since capital is power, you must generate your own capital through savings.“
See also:
- Micro Credit is Usury
- Shoaib Sultan Khan, Wikipedia article.
What US Bombers Flying over Korea means to the North Koreans
The B-52 flights come amid spiking tensions between North Korea and the United States after the U.N. Security Council voted to impose tougher sanctions on North Korea following its latest nuclear test last month.
In a slew of angry rhetoric in response to the U.N. vote, North Korea has threatened to carry out a pre-emptive nuclear attack on the United States and South Korea and said it was nullifying the armistice agreement that stopped the Korean War in 1953.
Reacting to the U.S. flights, a spokesman for the North Korean foreign ministry described them as an “unpardonable provocation,” the state news agency reported.
—U.S. flies B-52s over South Korea, CNN.com 20 March 2013
For the last week the North Korean have increased the rhetoric and threats of war. I do not want to discuss the politics of Korea, but while the media constantly characterize the North Koreans as mad or irrational we should keep in our mind the history of that country:
On 12 August 1950, the USAF dropped 625 tons of bombs on North Korea; two weeks later, the daily tonnage increased to some 800 tons. U.S. warplanes dropped more napalm and bombs on North Korea than they did during the whole Pacific campaign of World War II.
As a result, almost every substantial building in North Korea was destroyed. The war’s highest-ranking American POW, US Major General William F. Dean, reported that most of the North Korean cities and villages he saw were either rubble or snow-covered wastelands.
—Bombing North Korea, Wikipedia [my emphasis]
See also:
Twisted all the Way to Zero
About 18 months ago I published in Will the Fed ever Get Paid Back: Operation Twist in Two Simple Graphs two graphs to show the percentage of all treasury securities held by the Federal Reserve that would mature in less than a year. The percentage was above 50% before the financial crisis started and had, by the date of that post, declined to less than 10%. At the conclusion I wrote the following:
Extending the average maturity of the treasuries today means that while investors roll over their bills at higher rates, as the dollar starts to lose the remaining one percent of value it still has, the Fed will be stuck with long dated treasuries. A positive feedback loop descending all the way to zero dollar value.
Today, 18 months later, the Fed does not hold a single treasury security that would mature before 20 March 2014.
U.S. Treasury securities held by the Federal Reserve (blue: maturing within a year. red: maturing in longer than a year)
The big financial players seem to have dumped treasuries maturing in more than a year on the Fed’s balance sheet, while gladly keeping the zero-rate short duration treasuries to themselves. As inflation and rates go up the Fed will be stuck with long duration paper issued at the lowest rate in three decades, with every doubling of the interest rate the value of this paper will half.
If you want to make your own graphs you can use this FRED graph to get you started.
See also:
- Fed Holdings: Short vs. Long Term Securties, first look at this issue
Farewell my Savings
When the news about Cyprus broke last week this blog was one of the first to outright condemn the proposed measures as robbery (see Highway Robbery in Cyprus). Afterwards almost the whole internet joined in condemning the proposed measures. One thing I left from my coverage of the fast-paced development in Cyprus was the fact that this proposed overt levy has been carried out in many countries covertly.
S&P 500 Index, real and relative to gold (published two years ago)
This blog’s history in covering inflation and its effect on savers is very long indeed. On the other hand many who spoke against the Cyprus levy have actually supported money printing by the major central banks or at least have not spoken out against effect on savers. The UK newspaper The Telegraph is one of the few major newspaper to consistently draw attention to the negative effects of quantitative easing, i.e. money printing, on savers and pensioners. They take advantage of what happened in Cyprus to raise the issue and draw parallels:
When the Cypriot government proposed taking a slice of people’s savings, there was outrage, but its error was to admit doing it. In Britain, QE is having precisely the same effect. Government policies are crushing savers – average rates have fallen by a third since Funding for Lending began eight months ago. Banks don’t need money from the public when they can get it far cheaper from the Government. And lower interest rates have skimmed an additional £200 billion from our collective pension funds, according to industry estimates. This is how “monetary activism” works: low interest rates transfer wealth from savers to borrowers. And government, of course, is the hungriest borrower of all.
—Britain’s fortunes rest on the Bank’s great money-printing machine, The Telegraph 21 March 2013 [my emphasis]
The Bank of England’s malfeasance hits the workers too as their wages lag behind the inflation rate. The reality is that there was boom that benefited almost everyone and so it is expected that people will have to pay in some way or another for the bust. The problem is that the most affected are the working class, those who have no assets and depend entirely on their income, then those who although have to work do have some assets in the form of property and pensions. The rich were first affected by the lack of profits and income growth, but this has since passed and their incomes are rising again. The perverseness of money printing is that a very small minority of the richest people who benefited the most from the boom have actually become even richer reaping huge profits during the bust.
Here is the point of this discussion. The continued drive by the Fed’s monetary policies to artificially suppress interest rates to create a negative interest rate environment for savers is a defacto “tax” on savings as shown in the chart below.
While the individuals in Cyprus have been faced with an outright extraction of capital from their accounts – U.S. savers have had their savings negatively impacted much more surreptitiously.
Between 1815 and 1914 the UK was a creditor nation with capital flowing from London to all the corners of the globe. The pound was as good as gold and the attitude was in everything favorable to creditors, to the point of invading countries that default on their debts to British bondholders. This changed dramatically after the WWI when the Bank of England supported the government’s need to borrow at low interest by monetizing debt. After the war an attempt to re-peg the pound to gold at the pre-war rate failed and the pound became an irredeemable fiat currency. After WWII the UK became clearly a debtor country and the pound has since lost more than 99% of its original value.
Lost value against gold between 1900 and 2012 (published a year ago)
The United State’s commitment to creditors was never as strong as that of the UK. The country’s revolution was partially financed by printing money, it’s civil war was financed by printing money and during its industrial boom there were many calls to devaluation to ease the burden of debt. The popular democratic system of the US meant there was always the danger of a populist gaining power if the debtor class grew large enough. When the US entered WWI they financed it in the only way they know how to finance wars, i.e. with money printing. The Great Depression brought fourth the populist who devalued the currency and then WWII was again financed with money printing.
When the dollar was linked to gold in the post-war settlement the link was not as strong as the link that existed between the pound and gold. The dollar was not redeemable and the citizens were still prohibited from owning large amounts of gold. As the table above shows in the last hundred years the dollar has lost a little less than 99% of its value against gold and this trend will continue as long as the money printing does.
See also:
Nonsense about the Open Bank Resolution in New Zealand
Russia Today published a story yesterday, New Zealand considers Cyprus-style banking failure solution, about the Open Bank Resolution, a policy being implemented by the Reserve Bank of New Zealand to deal with failing banks. The news story was completely nonsensical carrying a politically-driven quote by a member of the the opposition. The story claimed that this is the same as what is happening in Cyprus, sadly many have carried and repeated this claim (especially on Twitter). This is complete and utter nonsense.
Here is how the OBR process works according to a Consultation Paper published on the RBNZ website:
5. The OBR process and pre-positioning requirements
(1) OBR is an option that provides the ability to allocate losses to creditors of the failed bank without causing unnecessary disruption to the payments system and bank customers’ access to liquidity. As a general principle, first losses are allocated to and borne by shareholders followed by holders of subordinated debt. Claims of subordinated creditors and other capital providers will be fully frozen and will not be available for payment unless the senior creditors were paid in full.
This only applies to failed banks and just like FDIC insured banks payment is done by seniority: senior creditors (including depositors) first, shareholders last. When a FDIC insured bank fails they usually close it on Friday after working hours and try to have business transferred by Monday morning so people can continue banking with no problem. If you have money in a FDIC insured bank that exceeds the insurance limit and the assets of the failed bank does not cover the liabilities you are going to lose money, the only difference in New Zealand is that there is no deposit guarantees (which I think is a good thing) but since every bank has to hold part of its assets in government bonds this functions as a sort of government guarantee.
What happened in Cyprus is totally different: in Cyprus they levied all accounts even those covered by insurance in all banks because one single bank was facing collapse. Shareholders and bondholders were left intact.
The levy in Cyprus is clearly wrong, but as I wrote in Highway Robbery in Cyprus:
The banks who hold large part of their assets in state debt would be wiped out. First their equity holders would be wiped out, then the bond holders, then the uninsured depositors. The insured depositors, those with less than €100,000 in the bank, should not lose anything.
How mush would the uninsured depositors lose? I don’t know, but whatever it is it would be the result of trusting their money to the banks of Cyprus and not due to decision to make them pay made by finance ministers in Brussels.
That is exactly what the OBR is designed to do, unfortunately many people are under the impression that no one should lose any money when banks collapse; that is just as wrong as the decision to levy a tax on all bank account holders in Cyprus.
See also:
- Open Bank Resolution policy – Q&A, RBNZ website.
- A primer on Open Bank Resolution, RBNZ website.
Euro Apocalypse: Bank Statistics in Cyprus and Malta
In this post I will compare the aggregate balance sheet of all Monetary Financial Institutions (definition according to ECB) in Cyprus and Malta. I will use the following documents:
- Aggregated balance sheet All MFI Euro area
- Aggregated balance sheet All MFI Cyprus
- Aggregated balance sheet All MFI Malta
First some background: Cyprus is Euro area member state with 1 million people and GDP of $24 billion. Malta is a Euro area member state with 450 thousand people and a GDP of $9 billion. The Euro area has a population of 333 million people and a GDP of €9.5 trillion.
Now lets look at the MFI’s data:
- Total assets: Cyprus €126.4 billion. Malta €53.4 billion. Euro area €32.8 trillion.
- Total assets as a percentage of GDP: Cyprus 683%. Malta 774%. Euro area 345%.
- Debt securities as a percentage of liabilities: Cyprus 1.3%. Malta 0.75%. Euro area 14.7%.
- External liabilities as a percentage of liabilities: Cyprus 27.5%. Malta 41.2%. Euro area 10.6%.
If a levy on depositors in Cyprus was possible because Cyprus is small, then Malta is smaller. If the banking sector of Cyprus was too big for the small island, then that of Malta is even bigger compared to the smaller Malta. If Cypriot banks had little senior bonds and thus a loss by depositors was inevitable (which doesn’t explain why the bondholders were exempt) then Maltese banks have even less bonds. Finally if Cypriot banks had a big external liabilities, then Maltese banks have even bigger external liabilities.
The breakdown of Malta’s banks Cross-border positions reveals €13.5 billion deposits by non EU residents, that is a quarter of their total liabilities.
Greek and Cypriot banks had no major problems, but they held big positions in Greek government bonds. When the Greek government could no longer pay its debts it forced a haircut on its bond holders, mainly Greek and Cypriot banks. The bailout that Greece received included the recapitalization of its banks, but no help was extended to Cypriot banks. Cyprus had no major problems in paying its debt, but the Cypriot banks needed recapitalization or they would fail. The bailout that Cyprus is going to receive for the recapitalization of its banks is conditional upon a levy on depositors.
Today Malta has neither sovereign debt crisis nor a banking crisis, but if offshore depositors, especially those from outside the EU, start pulling their money then the banks of Malta might need a bailout from the government. With an over-sized banking sector Malta will not be able to recapitalize its banks without help from the Euro area members; they will surely demand a one-off levy on depositors.
See also:
Euro Apocalypse: And then there was Malta
The following graph is taken from The Banking System in Cyprus (2011) by Constantinos Stephanou:
Evolution of Banking System Size for Selected Countries (2001-09)
The top three countries were Ireland, Cyprus and Malta. Of those three two have needed a bailout and a bank recapitalization.
According to the Malta Financial Services Authority Analysis of the Banking Sector in Malta (2010)—the latest available on their website—there are 25 credit institution licensed in a nation of 450,000 person. According to the analysis Capital requirements ratio at 2009 was 57%, although it is important to note that this ratio is the “percentage of the aggregate banks’ total own funds to their total risk-weighted assets” and Euro area government bonds are weighted as zero, artificially inflating the ratio. Clearly after the Greek haircut weighing Euro government bonds as zero is exposed as foolish.
The report shows the banks having €49.5 billion in assets and €26.1 billion in deposits. Of total liabilities, which include deposits, only about €11 billion is from Malta; Turkey is slightly less and the rest is from other European countries. Only about €9 billion of their total assets are in Malta. According to an article from last year out of the biggest six banks banks in Malta only one has local equity majority control.
The Maltese banking system is like a tight-rope performer with foreign liabilities on one side balanced by foreign assets on the other. If foreigners start taking their deposits out of Malta, as a consequences of the Cypriot levy, then they will have to start selling their assets. Both Cyprus and Malta seem to have gone down the same road of providing a European Euro area environment that welcomed funds from overseas (and outside the EU) to inflate their financial sector and reaped profits in the good times. Now the times have changed and trust in the Euro and the institutions behind it is shaken to the core.
Euro Apocalypse: Cyprus Watch
The President of Cyprus is the head of state and the head of government of the Republic of Cyprus. The current president, Nicos Anastasiades, was elected on 24 February 2013, less than a month ago. He obtained 45.46% of the vote in the first round and 57.48% in the second (see the Wikipedia article Cypriot presidential election, 2013 for full details). Anastasiades belongs to the Democratic Rally party, similar to the parties of Angela Merkel of Germany, Antonis Samaras of Greece and Mariano Rajoy of Spain (see Wikipedia article European People’s Party).
An extraordinary cabinet meeting will be held this weekend at the Presidential Palace on the return of President of the Republic Nicos Anastasiades from Brussels, following the political agreement on the bailout package for the Cyprus economy.
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Meanwhile, the House of Representatives is also expected to convene this Weekend or Monday the latest to discuss and vote on the draft bills which the Government will table and they are necessary for the implementation of the agreed bailout programme.
—Cabinet to meet, inCyprus
The opposition parties will surely make a lot of noise:
AKEL leader Andros Kyprianou described Cyprus’ treatment by the troika as “vindictive and neo-colonial,” adding that his party would discuss proposing the island’s exit from the eurozone.
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Socialists EDEK slammed the EU for “burying the principle of community solidarity” and the government for its “unconditional surrender” to the absurd and outrageous demands.
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Government partners DIKO were cautious in their approach, saying they needed to be briefed on the decision before taking a stance.
—Parties furious over Eurogroup decision, Cyprus Mail 16 March 2013
The finance minister will miss the show, because on Monday he is leaving to Russia:
Cypriot finance minister Sarris will travel to Moscow for meetings on Monday to try to pin down the new loan terms.
—Incredulity at decision gives way to fury, Kathimerini English Edition 16 March 2013
It will be surely an awkward meeting:
Cyprus secured the €2.5 billion loan at a 4.5 per cent interest rate in 2011 to plug its finances after becoming shut out of international markets. The loan matures in 2016, but Cyprus hopes to get it extend the deadline to 2020.
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One way is to secure a Russian contribution, and another solution mentioned by officials is the possibility of Russia buying a majority stake in Popular Bank, which along with the Bank of Cyprus needs to be bailed out.Russia also has a motive to protect its depositors who hold an estimated €25 billion in Cyprus’ banks, a third of the deposits in their entirety, Clerides said.
He added that when Iceland refused to bail out British depositors when its banks collapsed 2008, the UK was forced to bail out its depositors. “Just as Cyprus has an obligation towards its public, so does Russia towards its citizens,” Clerides said.
—Where will Russia fit in bailout jigsaw? Cyprus Mail 16 March 2013
Russia suffered badly in 1998 for defaulting on its international debt and has since paid all debts as it recognize the danger to its sovereignty. Why would the Russians want to “buy” stakes in insolvent banks? By Tuesday these banks are going to face a bank run.
Clerides statement about the UK bailout of depositors is highly deceptive, those were depositors in British branches of Icelandic banks. The UK allowed the Icelandic banks to open branches (subsidiary?) in the UK, British savers didn’t move their money overseas and expect a bailout from their government.
Here is the latest details about the measures to be taken (parliament still have to vote on them):
Here are the outlines of the financial package:
- Nicosia will impose a 9.9 per cent one-off levy on deposits above €100,000 in Cypriot banks and a tax of 6.75 percent on smaller deposits from March 19. The levy will generate €5.8 billion.
Depositors will be compensated by equity in the banks.
There will also be a tax on interest that the deposits generate.
- Cyprus has agreed to increase its nominal corporate tax rate by 2.5 percentage points to 12.5 per cent, which could bring in up to €200 million a year.
- The International Monetary Fund is expected to contribute to the rescue package, but the amount is still to be determined.
- Russia will likely help finance the programme by extending a 2.5 billion euro loan already made to Cyprus by five years to 2021 and reducing the interest rate, which is now at 4.5 per cent.
- Cyprus may be required to privatise the Cypriot telecoms company, the electricity company and the ports authority.
- Cyprus will have to downsize its banking sector, reducing it to the EU average by 2018. The size of the banking sector in Cyprus is more than eight times the size of the economy, compared to around 3.5 times in the EU.
—Savers forced to bear costs in Cyprus bailout, Cyprus Mail 16 March 2013
The UK ruled Cyprus for 82 years (1878-1960) and still holds sovereignty over two military bases (see the Wikipedia article Akrotiri and Dhekelia). About 30,000 Greek and Turkish Cypriots joined the Cyprus Regiment during WWII to fight with the British. In 2001 the UK Census recorded 77,673 Cypriot-born people residing in the UK, the National Federation of Cypriots in the UK claims to represent more than 300,000 people of Cypriot ancestry (see the Wikipedia article British Cypriots).
Tens of thousands of Britons live in Cyprus, including many retirees who have taken advantage of lucrative tax breaks.
Figures from the European Central Bank (ECB) show that British citizens have about €2bn on deposit in Cypriot banks, more than any other country in the European Union apart from Greece.
—British savers face £170m Cyprus bailout bill, The Sunday Times 17 March 2013
British savers flocked to Icelandic banks because they offered “lucrative” interest rates. Again opportunities that sound too good to be true turn out to be false. British retirees who left the UK to the south of Spain, Cyprus and even North Africa discover everyday that the age of globalization is a mirage and the reality is much different than the brochure.
