Gold – AMP Predicts : The IMF Won’t Bailout Cyprus Account Holders – i.e. Russia

Gold

GC : NASDAQ : US$1,611.70
If Cyprus is Europe’s Lehman moment; Why isn’t gold higher?

The proposal to impose a levy on Cypriot bank depositors as a condition of the latest euro zone bailout package has elicited a bearish reaction across risk assets and put a bid under gold – up through the US$1,600 level for the first time in several weeks.

Credit Suisse does not believe the Cyprus bailout is likely to  morph into an existential crisis for the euro zone. Credit Suisse also does not expect any major announcements to emerge from this week’s Federal Open Market Committee (FOMC) meeting and do not expect the pace of stimulus to change – maintain the $85 billion monthly asset purchase pace for now. It is possible, however, that further comments about the Fed’s exit strategy from QE might be forthcoming.

Note that the FOMC’s Summary of Economic Projections will be updated and point out that recent U.S. data have tended to be stronger than expected. Gold, Credit Suisse thinks, will be vulnerable to renewed selling if the FOMC meaningfully changes its U.S. outlook for the better. Results of this week’s meeting will be released in three stages.

The FOMC policy statement will hit the wires today at about 12:30pm EDT. This will be followed by updated FOMC economic and fed funds rate projections at 2:00. Fed Chairman Bernanke will then hold a press briefing at 2:15. Is everyone getting bullish on the U.S. dollar?

Cyprus’s Four Options to Avoid

Banking Collapse

The only thing worse than Cyprus accepting the rotten bailout program that European policy makers agreed on late last week was Cyprus rejecting it. Yesterday, the parliament voted decisively against the terms of the bailout, with 36 members opposing it, the ruling party abstaining and not a single vote in favor.

Policy makers will have to come up with a new plan, and they had better hope the European Central Bank buys them enough time to do so before Cyprus’s financial system melts down.

A bank holiday was declared at least until tomorrow to prevent panicked savers from withdrawing their deposits from banks when they learned over the weekend that a levy may be imposed on deposits as part of a bailout program.

If depositors were worried about losing their savings before, they should be even more worried now. Last week, the ECB threatened to cut off emergency liquidity assistance to Cyprus’s two main banks in the absence of a bailout program. This would result in the immediate collapse of both banks, and they would default on their debt and most, if not all, of the 30 billion euros ($39 billion) in deposits they hold.

Faced with a bank run and the collapse of its largest financial institutions, Cyprus would only be able to rescue its banks and its economy by printing money and leaving the euro.

Capital Controls

Luckily, this needn’t happen. A much more likely outcome is that the ECB will first impose capital controls. The euro area is founded on the principle of freedom of goods, labor and capital, but Article 65 of the Treaty on the Functioning of the European Union stipulates that capital controls are allowed when “justified on grounds of public policy or public security.” We have already seen capital controls this week in Cyprus, with the bank holiday and transfers frozen.

Once banks reopen — scheduled for tomorrow but probably postponed until next week — we can expect deposit flight from Cypriot banks. A bank run is no problem as long as the ECB continues to finance it by plugging the gap with continued emergency liquidity assistance. After parliament’s rejection of the bailout deal, the ECB announced yesterday that it would offer Cyprus liquidity within “existing rules,” a strong indication that it will back down from its earlier threat to take the punch bowl away and shut down emergency funding to banks.

Capital controls and the ECB’s emergency financing can buy time for Cyprus, but the tiny island will still need at least 17 billion euros in bailout funding. So far, the 10 billion euros that the International Monetary Fund, the European Union and the ECB offered in the original deal are still on the table, but Cyprus needs to find an additional 7 billion euros. There are four potential sources.

The best option would be for the government to accept that wealthy Russian depositors have already been well and truly scared off from Cypriot banks, given developments over the past few days, and impose a big enough levy on uninsured deposits to avoid having to tax insured deposits. The government remains stubbornly protective of the country’s status as a tax haven, so this option seems unlikely, though not impossible.

Cyprus could try to piece together 7 billion euros from other sources. The nation could force losses on unsecured senior bank bondholders, but for the two biggest banks this would generate less than 200 million euros in savings. Yesterday, Mario Mavrides, a member of parliament, admitted the government was considering raiding pension funds, as was done in Ireland to help finance its bailout program. This would bring in less than 500 million euros.

Gas Reserves

Cyprus could also discount the net present value of future revenue from gas reserves lying off its coast. These reserves are notoriously difficult to value, and delays in establishing the infrastructure to capture and transfer them are inevitable.

A third option would be for Cyprus to go back to the troika of lenders — the IMF, ECB and EU — for more money. It would probably reject such a request for the same reason it originally did: A 17 billion-euro bailout would cause Cyprus’s public debt burden to balloon to unsustainable levels, even more so now because gross domestic product is set to contract further, given deposit and capital flight.

The final option is for Cyprus to negotiate aid from Russia. Finance Minister Michael Sarris traveled to Moscow yesterday to meet with President Vladimir Putin. A plain vanilla loan from Russia could cause the troika to withdraw their support for Cyprus for the same reason the troika won’t offer the extra funds themselves: It would make Cyprus’ debt unsustainable. Russia could offer money in exchange for rights. There has been speculation that OAO Gazprom (GAZP) may offer to recapitalize Cyprus’s banks in exchange for ownership of gas fields and factories near and on the island. The EU has opposed Russia increasing its foothold in the region, but having botched the original bailout deal so appallingly, euro-area policy makers may have lost their right to have an opinion on this.

Cyprus’s path forward is highly uncertain, and even though the island is tiny, it stands to set an important precedent in the euro area. This goes not only for how policy makers structure the bailout, but also for how Cyprus responds to it. The government has surprised investors by being the first to stand up to the troika of lenders by rejecting the proposed bailout. I doubt it will be the last.

(Megan Greene is a Bloomberg View columnist and chief economist at Maverick Intelligence. She is also a senior fellow at the Atlantic Council. Follow her on Twitter at @economistmeg. The opinions expressed are her own.)

To contact the writer of this article: Megan Greene Megan Greene – the chief economist at Maverick Intelligence

Cyprus Is Right to Make the

Russians Pay

The Cypriot government’s plan to levy a 9.9-percent tax on uninsured deposits has met with a vitriolic response in Russia and the U.K., whose citizens and companies have favored Cyprus as an offshore haven for their money. Russian Prime Minister Dmitri Medvedev deemed the move “confiscatory.” Billionaire Mikhail Prokhorov went so far as to call it an assault on “the foundations of Western civilization, the sanctity of private property.”

Actually, in the recent history of Western civilization, it’s common practice for uninsured depositors to suffer losses when a bank goes bust. In cases where the government must get involved, forcing losses on such creditors — who, after all, should have known they were taking a risk — is necessary to protect insured depositors and minimize the cost of that protection to taxpayers.

In the U.S., for example, the Federal Deposit Insurance Corp. frequently imposes losses when it steps in to take over insolvent banks. From 2007 through 2011, uninsured depositors at 32 banks suffered an average haircut of 67 percent, according to a recent paper by two FDIC economists. European countries, too, have bailed-in uninsured depositors. In 2011, for example, state administrators in Denmark forced depositors to share losses when they took over the insolvent Amagerbanken A/S.

As the editors of Bloomberg View have written, the disastrous part of Cyprus’s plan is the imposition of losses on insured deposits — that is, on balances of less than 100,000 euros. The breach of trust could lead people to question the value of insurance throughout the euro area. It’s also patently unfair. Insured depositors presumably accepted a lower interest rate in return for safety. Other creditors, by contrast, knowingly entrusted their money to banks with junk ratings.

It would be well within reason, and within historical precedent, for Cyprus to raise its full 5.8-billion-euro share of its bailout package by imposing much steeper losses on uninsured depositors and bondholders. Concerns that the move could destroy the island nation’s reputation as an offshore haven are misplaced. The damage is already done: Foreign depositors will start pulling cash as soon as the banks reopen. If the government doesn’t do the right thing now, the money will be gone.