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.
Desperate 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:
The 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).
Euro 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:
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.
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.
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.
Charts by bigcharts, ECB, tradingeconomics, acting-man.com
It is that time of the year again – our semi-annual funding drive begins today. Give us a little hand in offsetting the costs of running this blog, as advertising revenue alone is insufficient. You can help us reach our modest funding goal by donating either via paypal or bitcoin. Those of you who have made a ton of money based on some of the things we have said in these pages (we actually made a few good calls lately!), please feel free to up your donations accordingly (we are sorry if you have followed one of our bad calls. This is of course your own fault). Other than that, we can only repeat that donations to this site are apt to secure many benefits. These range from sound sleep, to children including you in their songs, to the potential of obtaining privileges in the afterlife (the latter cannot be guaranteed, but it seems highly likely). As always, we are greatly honored by your readership and hope that our special mixture of entertainment and education is adding a little value to your life!
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
2 Responses to “Revisiting the Greatest Crash in History”
Most read in the last 20 days:
- Gold Price Skyrockets in India after Currency Ban – Part III
When Money Dies In part-I of the dispatch we talked about what happened during the first two days after Indian Prime Minister, Narendra Modi banned Rs 500 and Rs 1000 banknotes, comprising of 88% of the monetary value of cash in circulation. In part-II, we talked about the scenes, chaos, desperation, and massive loss of productive capacity that this ban had led to over the next few days. Indian prime minister Narendra Modi – another finger-wagger, as can be seen in this...
- Gold Price Skyrockets in India after Currency Ban – Part II
Chaos in the Wake of the Ban Here is a link to Part 1, about what happened in the first two days after India's government made Rs 500 (~$7.50) and Rs 1,000 (~$15) banknotes illegal. They can now only be converted to Rs 100 (~$1.50) or lower denomination notes, at bank branches or post offices. Banks were closed the first day after the decision. What follows is the crux of what has happened over the subsequent four days. India's prime minister Nahendra Modi, author of the...
- Gold Price Skyrockets in India after Currency Ban – Part IV
A Market Gripped by Fear The Indian Prime Minister announced on 8th November 2016 that Rs 500 and Rs 1,000 banknotes would no longer be legal tender. Linked are Part-I, Part-II and Part-III updates on the rapidly encroaching police state. The economic and social mess that Modi has created is unprecedented. It will go down in history as an epitome of naivety and arrogance due to Modi’s self-centered desire to increase tax-collection at any cost. Indian jewelry...
- A Note on Gold and India – What is Driving the Gold Price?
Hidden Motives It is well-known that India's government wants to coerce its population into “modernizing” its financial behavior and abandoning its traditions. The recent ban on large-denomination banknotes was not only meant to fight corruption. Obviously, this very bad Indian has way too much cash. Just look at him, he looks suspicious! Photo via thenewsminute.com In fact, as our friend Jayant Bhandari has pointed out, fresh avenues for corruption ...
- Will Trump Do What Reagan Couldn’t?
Depravity and Degeneration BALTIMORE – Finally, it’s over. We were both delighted and appalled by the news. A smile spread over our face... and our steps lightened... as we looked ahead to four years without Hillary Clinton’s know-it-all mug in the news. Praise be! This mug will be largely missing from the airwaves and the intertubes in coming years. And your caption scribbler PT won't have to look for a fall-out shelter! We thank the Lord and the American public for...
- India's Currency Debacle – An Interview with Jayant Bhandari
A Major Crisis Last week Jayant Bhandari related the story of the overnight ban of certain banknotes in India under cover of “stamping out corruption” (see Gold Price Skyrockets In India after Currency Ban Part 1 and Part 2 for the details). Banned 500 rupee banknotes The problem is inter alia that the sudden ban of these banknotes has hit the Indian economy quite hard, given that 97% of all transactions in the country are cash-based. Not only that, it has...
- Inflation Expectations Rise Sharply
Mini-Panic Over Inflation After Trump's Election Victory We have witnessed truly astonishing short term market conniptions following the Donald Trump's election victory. In this post we want to focus on one aspect that seems to be exercising people quite a bit at present, namely the recent surge in inflation expectations reflected in the markets. Will we have to get those WIN buttons out again? A 1970s “whip inflation now” button. The only thing that was actually needed...
- Will the Swamp Swallow Trump?
Permanently Skewed TRUMP HOTEL, New York – Trump’s rambling army – professionals, amateurs, camp followers, and profiteers – is marching south, down the I-95 corridor. There, on the banks of the Potomac, it will fight its next big battle. Lieutenants in Trump's army: Bannon, Flynn & Sessions Photo credit: Drew Angerer / AFP Here at the Diary, we do not like to get involved in politics. But this is a special time in the history of our planet – a...
- There Are Two Types of Credit — One of Them Leads to Booms and Busts
Stumped by the Bust In the slump of a cycle, businesses that were thriving begin to experience difficulties or go under. They do so not because of firm-specific entrepreneurial errors but rather in tandem with whole sectors of the economy. People who were wealthy yesterday have become poor today. Factories that were busy yesterday are shut down today, and workers are out of jobs. What has caused the bust? The modern-day economic orthodoxy continues to be unable to provide...
- All Aboard! Trump’s Express Train to the Future
Free Money! BALTIMORE – Last week, the Dow punched up above 19,000 – a new all-time record. And on Monday, the Dow, the S&P 500, the Nasdaq, and the small-cap Russell 2000 each hit new all-time highs. The last time that happened was on the last day of December 1999. Ironically, two events that were almost universally expected to trigger large stock market declines were followed by quite rapid and strong gains. Would the market have fallen if Hillary Clinton had won...
- Gold Bull Market Remains Intact – Long Term Fundamentals Outweigh Short Term Market Gyrations
A Strong First Half of the Year, Followed by Another Retreat In early 2016 gold had a big bull run. The precious metal rose close to 25% this year, pushed higher in a summer rally that peaked on July 10th. Gold experienced a bumpy ride over the remainder of the summer though, as investors became increasingly concerned about a potential rate hike by the Federal Reserve. Uncertainty returned to gold market and has intensified further since then. Initially, gold rallied sharply...
- Too Early for “Inflation Bets”?
The Trump Trade After 35 years of waiting... so many false signals... so often deceived... so often disappointed... bond bears gathered on rooftops as though awaiting the Second Coming. Many times, investors have said to themselves, “This is it! This is the end of the Great Bull Market in Bonds!” The long bond's long cycle – red rectangles indicate when the post 1980 bull market was held to be “over” or “over for sure” or “100% over”, etc. We have...