A Historically Unique Event

We keep watching what is happening in Cyprus with morbid fascination. As a reminder, the unhappy island was the first major “haircut” victim in Europe. Its bankers, who had flagrantly over-traded their capital and won prizes for running “the best banks in Europe” along the way, erroneously believed the repeated promises of assorted EU commissars that Greece would never – never! – be allowed to go bankrupt. Consequently they stuffed their balance sheets to the gills with supposedly risk-free Greek government bonds, only to eventually see them get “haircut” twice in a row.


Laiki-Bank_People-smDesperate depositors queuing in front of Laiki Bank, the second largest Cypriot bank,

which was eventually wound up

 Photo credit: Yorgos Karahalis / Reuters


With their capital thus depleted, the banks became dependent on “ELA” funding from the ECB in order to pay depositors who wished to withdraw their money. So as to avoid a panic, the Cypriot government and the EU lied for months to the customers of these banks, assuring them that their deposits were perfectly safe. This inter alia gave the friends and families of well-connected politicians and oligarchs (including close family members of the then president of Cyprus) the opportunity to get all their money out before the curtain came down.

Citizens of Cyprus would have done well to inform themselves about the fraudulent nature of fractional reserve banking. Many might perhaps have been able to avoid what happened next: they were expropriated overnight in an act of confiscatory deflation.

Note here that we are not saying bank depositors should not bear risks, nor are we saying that they should be bailed out by taxpayers. In fact, we cannot offer an alternative to what happened, except perhaps to state that if any bank-related bailouts are implemented (such as the ongoing ECB QE program), depositors should ideally be first in line to partake of the central bank’s largesse. We mainly want to point to the fact that depositors were lied to about these risks all along, which vastly reduced their chances to save their hard-earned money while it was still possible to do so.

We have kept a close eye on the stock market of Cyprus, and lo and behold, it made a new all time low in late 2015:


1-CyprusThe Cyprus stock market has declined by 99.986% – of every 100 euro invested at the peak, a mere 0.014 euro are left. In other words, 100 euro have been transformed into just 1.4 cents – click to enlarge.


In order to fully grasp the extent of this devastation, consider the following: had you bought the market after it had declined by 90%, you would quickly have lost another 90%. Had you bought after it had declined by 90% twice, you would just as quickly have lost almost another 90%. So since 2007, this market has seen three consecutive declines of 90%. As far as we know this is unparalleled. If there had been a stock market in the Roman Empire, it might have done something similar around AD 400 – AD 500.


Boom, Bust and the Money Supply

As we have frequently pointed out, euro-area wide money supply is growing at an astonishing pace thanks to the ECB printing money 24/7 of late. The most recent annual change rate of the narrow money supply M1, which is the aggregate that most closely resembles money TMS (true money supply) stands at around 14% (a few items are missing from this measure to make it fully comparable to TMS, such as deposits owned by non-residents. However, adding them would probably have little effect on the rate of change).


2-Euro area TMSEuro area M1 (demand deposits and currency) – roughly equal to TMS. Thank God the central bank provides such admirable “stability” (as indicated by the line in blue, which looks a bit like the EKG of a heart attack victim). Since 2012 money supply growth has gone “parabolic”. This isn’t going to end well – click to enlarge.


However, this aggregate statistic actually masks the extremely uneven distribution of money supply growth across the euro area. For instance, Germany’s money supply has increased by approximately 125% since 2008. Countries that have been hit by severe banking and economic crises – particularly Greece and Cyprus, in both of which the commercial banking system has essentially collapsed – have seen their money supply nosedive in the same span.

In order to illustrate this, we have charted the amount of deposit money extant in the Cypriot banking system since 2008. After the initial crisis in 2008, Cyprus “benefited” from the inflationary push the ECB implemented in 2009-2010 in the form of LTROs. When these LTROs began to be paid back and euro area-wide money supply growth screeched to a halt in 2011, the Greek and Cypriot crises not surprisingly went into overdrive. All the losses that had been masked by monetary inflation up to that point suddenly became obvious.

After the decision in favor of a depositor haircut in Cyprus had been made, the country’s deposit money supply collapsed by about 44% over the ensuing two years, with the bulk of the decline occurring in 2012. Since then, it has essentially flat-lined:


3-Cyprus, deposit moneyDeposit money in the banking system of Cyprus: total (in red), the portion owned solely by residents in black. Total deposit money is still down more than 40% from the 2011 peak – click to enlarge.


However, prior to the bust, the money supply of Cyprus was growing immensely – which explains the unhealthy artificial boom that ruined the island’s economy. The responsibility for this is equally shared between the country’s reckless banks and their new “lender of last resort”, the ECB. The central planners had suppressed interest rates to a level they thought appropriate for Germany, which was long held to be Europe’s “sick man”. These rates were however highly inappropriate for Europe’s periphery.


4-cyprus-money-supply-m1Cyprus, M1 during the boom years – going gangbusters – click to enlarge.


In case you’re wondering: M1 is no longer reported separately by the Central Bank of Cyprus, so we had to make do with piecing together extant deposit money as a reasonable proxy for the Cypriot money supply.


Cyprus Shows us Why the Fiat Money System is Doomed

This brings us to our point: what this inter alia shows us, is how strongly asset prices depend on monetary inflation. The stock market of Cyprus rose nearly six-fold from 2003 to 2007 – exactly the time when money supply growth started to go “parabolic”. This was not the result of business getting “six times better” in any sense. It was simply a reflection of money printing.

Now consider what a roughly 44% decline in the money supply has led to: a 99.986% collapse in stocks prices. Given that stock prices can be used as a proxy for the trend in asset prices in general, a lot of the collateral backing loans in Cyprus is likely worth far less than the outstanding debt it supposedly covers. Indeed, house prices in Cyprus have declined with nary an interruption since 2008 as well (recently a small bounce could be detected) – albeit to a far smaller extent than stocks. Still, the housing bubble that was a notable feature of the boom years has essentially been wiped out as well.


5-cyprus-housing-indexCyprus house price index: declining for almost seven years, which has wiped out nearly all the price gains made in the “parabolic” stage of the bubble – click to enlarge.


In fact, the events in Cyprus, Greece and more recently Puerto Rico reveal a harsh truth: nearly all the socialist regulatory welfare/warfare states of the West are in reality bankrupt. The only thing holding up the charade is the fact that central banks are able to create nigh unlimited amounts of money from thin air. As soon as a country or a self-governing region no longer enjoys a central bank backstop, it is game over.

This leaves only very little by way of choices. Look again at the chart of the euro area money supply above, or a recent chart of US money TMS-2. What would happen if these money supply measures were to deflate, or merely stop growing?

Just as in Cyprus, asset prices would decline to reflect such a deflation – and these price declines would have to be expected to be very pronounced, given the extent of monetary inflation that has already occurred and the degree to which asset prices have been disproportionately affected. Stocks are titles to capital, and these price distortions have also affected capital goods.

This would in turn lower the value of much of the collateral supporting outstanding bank loans. The monetary system would likely suffer a deflationary implosion. This wouldn’t be a bad thing per se, even though it would be quite disruptive. After all, the existing real capital would continue to exist. Not a single factory would cease to exist if the money supply somehow declined. Only prices would change, and ownership of real capital would in many cases change as well.

Moreover, the essential insolvency of the system, including the insolvency of the governments running today’s welfare/warfare states would be revealed, and a lot of unproductive and wasteful activity would cease by necessity. Unfortunately, just as has happened in Cyprus, many innocent and hitherto prudent bystanders would become victims of this economic disruption as well.

Our guess is that the powers-that-be simply won’t let that happen, so they will be “forced” to take option two: they will keep inflating, and very likely at an ever more accelerating pace. In the end this will be even more destructive, although it will keep buying time for a while, just as it has since 2008.

Government and central bank officials will naturally choose the “buying time” option, hoping that the really big problems won’t materialize on their watch, but rather on that of their successors. In that sense, Ben Bernanke has timed his exit from the Fed exceedingly well.



The modern debt money system has a limited life span and it cannot stand still. The problem is that with every iteration of the boom-bust cycle, more real wealth is destroyed and more obstacles to the creation of real wealth are erected.

Hapless governments desperately try to squeeze blood out of a turnip by taxing and regulating the private sector to death, while central banks keep promoting monetary inflation. At some point the limit to this game will be reached – and the longer it takes to get to that point, the more devastating the eventual denouement will be.

We don’t see it as our task to offer a solution – with respect to that, we can only reiterate that a return to an unhampered free market system is the only way out, painful as it may initially prove to be. We know however that modern-day governments will simply not go down this path, as it would involve a vast loss of power for them.

All we can do is point out the risks, so that people can at least prepare on an individual level. A major lesson everybody should take to heart from the Cyprus experience is this: when the next crisis strikes, do not believe any of the promises uttered by government or central bank officials. You will be lied to in the critical moments, and you could stand to lose a lot if you believe the lies.

You don’t have to take our word for it: just ask anyone in Greece or Cyprus what they got for believing their deposits were safe.


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2 Responses to “Revisiting the Greatest Crash in History”

  • rodney:

    You don’t have to take our word for it: just ask anyone in Greece or Cyprus what they got for believing their deposits were safe.

    You forgot to mention that EU citizens can now expect to lose their deposits without anyone lying to them: the EU “Bank Recovery and Resolution Directive” is officially being implemented, bail-ins and all, from 1st January, 2016, i.e. a few days ago. Deposits are last in line for a bail-in, but banks have such little reserves and capital nowadays that you can expect the worst.

    This is now the law of the land and it is in full force and operation. No need for lying, they just take them

    Gentlemen, if you live in Europe, it is now your responsibility to perform some due dilligence on banks and to diversify your deposits. Especially if you live in peripheral Europe, do not think twice before diversifying some of your deposits in either German or Swiss Banks.

  • Kreditanstalt:

    “Hapless governments desperately try to squeeze blood out of a turnip by taxing and regulating the private sector to death, while central banks keep promoting monetary inflation. At some point the limit to this game will be reached – and the longer it takes to get to that point, the more devastating the eventual denouement will be.”

    Of course…such an outcome is a “lead pipe cinch”, as they used to say back in, I think, the 1920s.

    Unfortunately, I think most pundits and observers missing something: these things move like glaciers. Exceedingly slowly. And they don’t affect an entire economy or population evenly: things change at the margin, and move towards the centre.

    As we are seeing, some economic actors suffer more than others. Some jurisdictions. Some entities. Some jobs, some incomes, some business models. So people, obsessed with short-term statistics, miss the epochal OVERALL decline in the standard of living. The disappearance of breadwinner jobs and that stubborn and (to the mainstream) inexplicable statistic “those not in the labour force” are dismissed or footnoted, but not taken as the harbingers of permanent social change that they are.


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