The First Crack In The Bond Market Is A Fact

This article is the result of an interview with Bob Moriarty (editor and founder of and reflects his thoughts on the Cypriot case.

There are two main issues in the Cypriot banking crisis. The first one is related to the general principle of loans: it is axiomatic that all loans get paid either by the borrower or by the lender. This is the fundamental relationship that anyone has with the bank. When you deposit money into the bank, in your mind it is your money. In the bank’s mind, and from a legal point of view, it is a loan to the bank. If the bank makes foolish investments and loses money [including (y)ours], someone has to pay it.

“Cyprus made us clear that our money on the bank is not our money, it is the bank’s money.”

In the case of Cyprus, the losses of the banks were first attributed to the shareholders, then the bondholders, finally the people who had loaned money to the bank. Which foolish investments did the Cypriot banks make? Simple, they were in Greek bonds. As we all know Greek bonds have lost 90% of their value (despite sky high interest rates). Here it gets really interesting. The shareholders and the bondholders of insolvent banks never lost a cent because governments have bailed them out. For the very first time now, they have been wiped out. That is a catastrophic moment for the banking system. Bank A loans money to bank B in the form of a bond, bank B loans money to bank A in the form of a bond. That is the keystone of the whole banking system. It is a zero sum game until one of the counterparties is not able to meet its obligations. It’s no longer an interest rate risk, it is now a counter-party risk.

In Cyprus, for the very first time counterparties have been wiped out. Once this gets rolling, it is able to start an avalanche. When people will look back to history there will be two moments that mark the big financial and banking collapse. The first one is late June of 2007 when two Bear Stearns hedge funds collapsed. The second one will be March of 2013 when Cypriot banks closed in an unprecedented bank holiday, and for the first time counterparties have been wiped out. It is almost a sure thing that the latter will cause a cascading effect because all banks are linked to each other via bonds. As the banking system has become so complex lately (to the extent that it is almost not possible to understand it anymore), the cascade will hit pretty hard and fast.

There could be bank runs in other countries because Cyprus has shown the world that money at the bank is at risk. But that is not the key risk we are facing. The main risk is the unsecured money. In the US there is $10.9 trillion of debt which is insured by an FDAC fund of $32 billion. This is ludicrous. The insolvency of the whole debt based system is the main risk right now. That means that for every $100 on deposit under FDIC insurance, only $.30 is there to back it in case of a bank failure.

“There is more debt in the world than there are assets to pay, so somebody has to pay for the debts.”

We are back at June 2007

After 2008, the banks have accumulated more debt. Going back to the first point (all loans get paid, either by the borrower either by the lender) it implies that someone will turn up for this excessive debt. The day of reckoning can be delayed, but it cannot be avoided.

When Bear Stearns hedge funds went under, because of subprime mortgages, nobody could pretend that there was no problem. Similarly, the bankruptcy in Cyprus is the first crack and maybe the most important one. Nobody can ignore the debt problem as from now on. In that respect, Japan is a story that is much worse. Governments have a vested interest in lying to the public. For the public to understand, they need to look at all the information that is laying out there. The highest level piece of information is that there are $648 trillion dollars in derivatives out there in a $64 trillion dollar global economy. What does it tell you? Take a moment to reflect this.

Precious metals as the primary means of protection

All banks in the Western world are bankrupt, which implies that someone is going to lose a lot of money. That is the fundamental case for gold. Precious metals are the only assets that have no corresponding liability. One of the functions of gold and silver is to act as an insurance policy against financial irresponsibility.

Based on plain logic we can expect additional bank failures, capital controls and more losses by bank depositors. It is up to anyone to chose to keep money in the bank, or keep it in precious metals which is the primary store of value that has no counterparty risk.

We are taught to believe by the 6 hour news that there is a cause and effect relationship between events (for instance a war, a bank run, etc) and (in this case) the price of gold. That is not true.

“For me, being a prudent investor who is concerned about protecting my his assets, it does not matter if the price of gold stands at $1,800 an ounce or $1,500 an ounce. The fundamental value that gold offers me remains the same, I only welcome a lower price to accumulate more of it.”

In closing, it should be clear by now that holding your gold or silver in a vault in your bank is as safe as holding money on a deposit account.

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