Cyprus – severely wounded with euro exit the likely ultimate outcome

So, the banks in Cyprus finally reopened today at 10.00 UK time, freshly filled with newly minted ECB euros and transported in armored trucks overnight (to keep the rioting masses at bay!) as the Cypriot authorities were concerned with what could happen when the banks reopen. The British company G4S (they obviously know nothing about the Olympics fisaco…) will in fact provide 200 men to help police ensure the safety of banks and the people of Cyprus.

There are fears that even with the various capital controls imposed by the authorities that money could disappear from the banks in just a few hours due to fear-led huge withdrawals – who can blame them? Cyprus actually has a record amount of money deposited per inhabitant. With just 860,000 people, total deposits amount to €68 billion, which averages €79,000 per person although that is skewed by very large deposits from a number of Russians – a very bad move on their part given the haircut’s they are taking now!

After failed negotiations with the EU and a veto on the initial plan A, which sought to confiscate 6.75% of deposits under €100,000 and 9.90% on deposits over that amount, Cyprus leant on Russia in asking for help – to no avail in the end however. Ultimately, in an 11th hour deal in the late hours of last Sunday, her politicans reached a deal with the EU under which the main Laiki Bank will be dismantled and its assets sold. Depositors  with in excess of 100,000 euros initially take a cut of 40% on deposits over €100,000 whilst deposits below this figure will be honored in full albeit in staged withdrawals per the capital controls. The tight capital controls include a maximum daily cash withdrawal of €300, no cheque’s, a limit of €5,000 credit card spending per month outside Cyprus and no one can leave Cyprus with more than €1,000 in his pockets!

Even though cash will not be withdrawn all at the same time, we’re certain that here people will try to get as much as possible out of the banks and the country – certainly the larger depositers near the 100,000 euro threshold. At the same time, if you were a business, would you accept payments other than with cash? So cash will be more valuable than any other means of payment and the economy will most likely struggle in the short terms. We expect the financial system to almost freeze and the country ultimately be pushed to a situation under which it not only needs but actually wants to leave the Euro – just look at the zombie state of Greece as a consequence of remaining in the euro… Cyprus is a much more palatable exit.

How will Cypriot businesses survive without liquidity? How will new projects get financing. Will the ECB provide it? Temporarily, yes, but we doubt they will continue to finance if they see money wholesale leaving the banks. What could be a small and contained problem may become a huge blow in the Eurozone. Messing with deposits changes rules. It was previously sacrosanct and we think the repurcussions of this will be far reaching.

If deposits aren’t safe anymore and Governments may take your money, especially in peripheral European countries – what fait can citizens of Greece and Portugal for example have in the integrity of their banking systems and the implicit trust in making a deposit? This is what may be the slow burn that accelerates once more the euro crisis for the 3rd summer in a row.

Cash has in fact already started leaving those peripheral countries in the form of reduced demand for sovereign debt as we have seen in Italy yesterday for example. Yields are rising again, having surpassed 5% in Spain on 10-year debt, and hitting 12% in Greece, while the German government can continue raise money at a miserable 1.32% rate. This is the consequence of the new deposit measures. Money flows from periphery to the centre. This new “bail-in” way of solving EU problems is the most dangerous route so far within the region and one that will help the fragile European economy sink again in our opinion.

With unemployment rates around 20% and GDP heading south, how can you sell the idea the Euro is the best place to remain for the peripheral countries? You just can’t, and as a consequence of this, euro-skepticism is rising as never did.

The Euro is losing once more against all the majors today. After hitting 1.37 against the dollar, the Euro is now trading around 1.28 and threatening to go even lower. In fact, it is our opinion the common currency is trading much above what it should be – realistically against the Pound it should be 1.30-1.35. The matter is not only an economic issue but also political one. If mining in some African countries is seen as a risky business due to political instability, depositing money in Europe is also a risk, so why not look elsewhere? With banks charging to keep your money unsafe, it is time to buy a good mattress with a safe vault under it.