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02 April 2013

Cyprus Crisis - Lessons for the U.S.

The Euro has essentially been split in two. There is the Cyprus Euro and the Everywhere Else Euro. Currency trapped in Cypriot banks is subject to capitol controls and export restrictions. While there are some aspects unique to Cyprus, there are important lessons to be learned and warnings to be heeded.

The latest estimates of the amount of “haircut” depositors will be subject to now range from 60 to 100%. Money held in-hand is still worth approximately the same as before the crisis unfolded. Money trapped in Cyprus banks is now worth 40 to 0% of what it was before the crisis. It is important to realize there isn’t really paper money in the banks. Deposits are simply accounting entries, because the Euro is a fractional reserve currency. 

- Just like the U.S. dollar.

 U.S. Bank Deposits vs. Currency

This chart plots total U.S. deposits and circulating currency[1]. At current levels, if the U.S. were to go through a similar crisis as Cyprus, non-cash dollars would lose 88%. In plain English, for every $1000 you had in the bank you would receive $120.Of course the U.S. government could take the non-Cyprus route and devalue the dollar instead, in which case you would get back the entire $1000 but it would only be worth $120. You lose either way. 

This is difficult for many people to grasp, but keep in mind, the 9.2 trillion dollars in deposits doesn't really exist! 

In both cases, capital controls would certainly include a restriction on the transfer of precious metals and possibly forced confiscation. Don’t believe for a second that it couldn’t happen because it already has; in 1933[2].


This is one of the fundamental problems I have with main-stream economists and financial advisers. They invariable advise keeping assets in non-cash, non-good forms. The value of the dollar only has value because people think it has. It isn’t backed by gold or any other real asset, and it no longer is even backed by the classic ability of the government to tax. The world knows there will never be tax rates in the U.S. high enough to cover spending, and the world also has seen the U.S. government’s adamant refusal to balance the budget. There are also concerted efforts worldwide to destroy the dollar by removing its status as the worlds reserve currency. Most recently Australia agreed with China to trade directly in each others currencies, thereby bypassing the dollar. Russia, Brazil, India, Iran and others have also moved away from trading in dollars.

[1] Federal Reserve Statistical Release, H.6, March 28, 2013

[2] Executive Order 6102 Requiring Gold Coin, Gold Bullion and Gold Certificates to Be Delivered to the Government April 5, 1933