Why governments, politicians and businessmen hate gold

gold
Yesterday Switzerland voted on whether its central bank should be holding more gold as a proportion of its total assets. Gold currently makes up for around 7% of the total assets of Swiss National Bank, the country’s central bank.
The proposal dubbed as “Save Our Swiss Gold” had called for increasing the central bank’s holding of gold to 20% of its total assets. It was more or less rejected unanimously with
nearly 78% of the voters having voted against it.
This proposal was backed by the right-wing Swiss People’s Party and came out of the concern that the Swiss National Bank had sold too much of its gold in the years gone by.
Interestingly, Switzerland was on a gold standard till 1999 and was the last country to leave it. In a gold standard the paper money issued by the central bank is backed by a certain amount of gold held in the vaults of the central bank.
What this means is that the central bank and the government cannot issue an unlimited amount of paper money. The total amount of paper money that can be issued is a function of the total amount of gold that the central bank holds in its vaults.
In April 1933, when the Great Depression was on in the United States, the Federal Reserve of the United States had around $2.7 billion in gold reserves, which formed around 25 percent of the monetary gold reserves of the world. At the same time, the ratio of paper money to gold was at a healthy 45 percent, more than the decreed 35–40 percent. (Source: J.W. Angell, “Gold, Banks and the New Deal,”
Political Science Quarterly 49, 4(1934): pp 481–505)
That’s how the gold standard worked.
Getting back to the Swiss vote on gold, other than the Swiss People’s Party, the other parties as well as businessmen were opposed to it. As
the Wall Street Journal reports “The initiative was widely criticized by Switzerland’s political and business communities.”
This isn’t anything new. The politicians over the last 100 years have not liked the gold standard because it limits their ability to create money out of thin air. And as far as businessmen are concerned they usually tend to go with what the politicians are saying.
As Raghuram Rajan and Luigi Zingales write in
Saving Capitalism from the Capitalists: “The First World War and the Great Depression created great dislocation and unemployment… Workers, many of whom had become politically aware in the trenches of World War I, organized to demand for some form of protection against economic adversity. But the reaction really set in during the Great Depression, when they were joined in country after country by others who had lost out—farmers, investors, war veterans, the elderly.”
The politicians could not do much about it given that most of the world was on the gold standard. And given this, they could not print money and flood the financial system with it. “The gold standard … imposed tight budgetary discipline on governments, which made it difficult for them to intervene much in economic affairs… Politicians had to respond, but such a large demand for protection could not be satisfied within the tight constraints imposed by the gold standard. Hence, the world abandoned the straitjacket of the gold standard… With their ability to turn on or turn off finance, governments obtained extraordinary power,” write Rajan and Zingales.
This explains why governments hate gold.
In 2012, I had the pleasure of speaking to the financial historian Russell Napier. And he made a very interesting point about the rise of democracy and paper money having gone hand in hand. As he put it: “The history of the paper currency system, or the fiat currency system is really the history of democracy… Within the metal currency, there was very limited ability for elected governments to manipulate that currency.”
Napier further pointed out that most people don’t have savings. As he explained: “And I know this is why people with savings and people with money like the gold standard. They like it because it reduces the ability of politicians to play around with the quantity of money. But we have to remember that most people don’t have savings. They don’t have capital. And that’s why we got the paper currency in the first place. It was to allow the democracies. Democracy will always turn toward paper currency and unless you see the destruction of democracy in the developed world, and I do not see that, we will stay with paper currencies and not return to metallic currencies or metallic based currencies.”
With paper currencies around, politicians (even honest ones) feel that they have the ability to bring an economy out of a recession, by getting their central banks to print money and flood the financial system with it, so as to maintain low interest rates.
At low interest rates the hope is that people will borrow and spend more. In a gold standard all this wouldn’t have been possible. But that as we have seen over the last few years has led to other problems.
Having said that, the fundamental problem with paper money, that it can be created out of thin air, remains. Or as Ben Bernanke, the former Chairman of the Federal Reserve of United States, put it in 2002: “The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.”
This is what the US government has done with the help of its central bank, the Federal Reserve, over the last few years, largely during the years in which Bernanke was the Chairman.
As on September 17, 2008, two days after the investment bank Lehman Brothers went bust, and the financial crisis well and truly started, the Federal Reserve held US government treasury bonds worth $479.8 billion. Since then, the number
has jumped up to $2.46 trillion. Where did the Fed get the money to buy these bonds? It simply printed it. And then it bought bonds to pump that money into the financial system.
In fact, it also printed money to buy bonds other than treasury bonds as well. This was done so as to flood the financial system with money, in the hope of keeping interest rates low, in order to get people to borrow and spend again, and hopefully create economic growth.
While that has happened to a limited extent, financial institutions have borrowed this money at low interest rates and invested this money in large parts of the world chasing returns.
The Fed decided to stop printing money towards the end of October 2014. But now it needs to keep telling the financial markets that it won’t go about withdrawing the trillions of dollars that it has printed and pumped into the financial system, any time soon. We need to see what happens when it decides to start withdrawing all the money it has printed and pumped into the financial system.
To conclude, it is worth remembering what economist Stephen D. King writes in 
When the Money Runs Out “A central banker who jumps into bed with a finance minister too often ends up with a nasty dose of hyperinflation.”

The article appeared originally on www.equitymaster.com on Dec 1, 2014

‘The choice is between democracy and the gold standard’

vivek 2Author Vivek Kaul tells Sanjitha Rao Chaini that his book ‘Easy Money’ is an outcome of how money and the financial system have evolved over a very long period of time.

Why this book? How did the idea of writing this book come to you? 

The book was essentially an evolution of the writing that I do to make a living. I first started writing on the financial crisis after the investment bank Lehman Brothers went bust. The idea was to explain to the readers what is happening in the world. The Indian media (or even the world media) at that point of time had turned into a jargon spewing monster. Terms like sub-prime, securitization, Alt-A, CDOs etc were being bandied around. So, I started writing a series of pieces explaining these terms and the impact they were having on the world at large.

Over a period of time I came to the realization that what is happening now is not just because of things that have happened over the last few years or even decades. It is an outcome of how money and the financial system have evolved over a very long period of time. It has all come together to cause the current financial crisis. Easy Money was an outcome of that realization.

What kind of research did you put into this book?

The research has been extensive. Even before I decided to write the book I had read some 75-80 books on money and the financial system as they had evolved. As I wrote, I read a lot of research papers and historical documents that were written over the past 300 years. These research papers were a storehouse of information. Interestingly, with the advent of the internet a lot of historical material is available at the click of a button. What also helped was the fact that websites like Infibeam.com source second hand books, which are not easily available otherwise, from the United States. I don’t think I would have managed to write the book that I have, 10 years back, sitting in Mumbai. I would have probably managed to do if I had access to a library at a good American university.

You write… “as we have seen throughout history money printing has never ended well. But the same mistake continues to be made.” Why do you think that we haven’t learnt the lesson?

I wish I had an answer for that. I can only make a guess. In every era people who make economic decisions feel that “this time it’s different”. The tragedy is that it is never really different. And hence, the lessons are never really learnt. The same mistakes are made. Money printing never ends well that is a something that the world refuses to learn.

Do you think we would have been better off in any way if we had stuck to the gold standard as a store of value of money?

When I started writing Easy Money , in late 2011, I thought that the gold standard is the answer. During the process of writing the book that idea evolved. The thing with the gold standard is that it limits the amount of money that can be put into the financial system. Ultimately, it becomes a function of the amount of gold being dug up from the earth and that is what makes it work as well. But this is something that no politician is comfortable with. And politicians are essential for democracy.

In fact, I spoke to Russell Napier, a financial historian who works for CLSA, sometime in 2012. And he made a very important point which changed my thinking on the gold standard. “The history of the paper currency system or the fiat currency system is really the history of democracy,” he told me during the conversation. “Within the metal currency there was very limited ability for the elected governments to manipulate that currency. And I know this is why people with savings and people with money like the gold standard. They like it because it reduces the ability of politicians to play around with the quantity of money. But we have to remember that most people don’t have savings. They don’t have capital. And that’s why we got the paper currency in the first place. It was to allow the democracies. Democracy will always turn towards paper currency and unless you see the destruction of democracy in the developed world and I do not see that we will stay with paper currencies and not return to metallic currencies or metallic based currencies,” he added.

So, in a way, the choice is between democracy and the gold standard. In fact, the era of the classical gold standard which started in the 1870s and survived till around the time of the First World War, was an era of limited democracy even in most of what is now known as the developed world.

There are contrary views on usage of bitcoins. Recently RBI even said it has no plans to regulate Bitcoins. Do you see a hard-landing for bitcoins? Do you think that central bankers will be able to regulate, and if not, what are the concerns?

That is a very difficult question to answer. One school of thought is that the Federal Reserve regularly lends out its gold to bullion banks, so that they can short-sell it and ensure that the price of gold does not rise beyond a point. Whether they will be able to crack the bitcoin system as well, in the days to come, I really don’t know.

How can policymakers make use of this book?

Policy makers don’t need any books. They do what they feel like doing. Given that, I don’t think this book or any book can be of much help to them. As the German philosopher Georg Hegel once said “What experience and history teach is this —that nations and governments have never learned anything from history, or acted on principles deduced from it.” And why should this time be any different?

What are you reading at the moment?

I have this habit of reading multiple books at the same time. So I read a few pages, drop that book and move onto something else. This loop keeps repeating. Right now I am reading Alan S Blinder’s After the Music Stopped. Blinder is a professor of economics at the Princeton University. He was also the vice chairman of the Federal Reserve of United States, between 1994 and 1996, under Alan Greenspan. His book is by far the best book I have read on the current the financial crisis. Excellent research presented in very simple English.

I am also reading The Bankers’ New Clothes by Anant Admati and Martin Hellwig. The fundamental point they make in their book is that if we need to make the financial system safer, banks need to have much more capital on their books than they currently have. This is one of the points I make in Easy Money as well. As Walter Bagehot, the great editor of The Economist once said more than 100 years back, “the main source of profitableness of established banking is the smallness of requisite capital.” This is something that needs to be set right.
As far as fiction goes I am currently reading a Swedish thriller titled Never Screw Up by Jens Lapidus. It is a sequel to a book which was also titled Easy Money. Ruskin Bond’s Tales of Fosterganj has just arrived and that is what I am looking forward to reading next weekend.

E-books or paper format ?

Paper totally. And there is a practical reason for it. I keep making notes on the edges (horrible habit some might say) as I read. This is a great help when one wants to write something and needs to revisit a book. You don’t have to bang your head against the wall at that point of time, thinking, where did I read that? So this ‘bad’ habit ensures that research and reading happen at the same time.

When and where do you write? And what’s the hardest thing about being a writer? 

Living in Mumbai means that one really does not have much choice about where to write. Also, having worked in extremely noisy newspaper offices, I can write almost anywhere. The place doesn’t really matter, as long as I have a computer and an internet connection.

Most of my writing happens between 11AM to 5PM. Having said that, some of my best writing has happened post midnight. The one time I hate writing is early in the morning between 7 to 10 AM.
I recently finished reading this book titled The Infatuations by the Spanish author Javier Marias. In this book Marias writes “You have to be slightly abnormal to sit down and work on something without being told to.” That is the toughest thing about being a writer. It needs a lot of self discipline and self motivation, knowing fully well that the money you make from your writing will most likely never compensate you for the opportunity cost that comes with it.

What next?

Easy Money is a trilogy. The first book ends around the time of the First World War. The second book starts from there and goes on till the time of the dot-com bubble burst. The third one deals with the current financial crisis. I have just finished the final edit of the second book, which should be out very soon. In about a week’s time I will get back to the third book. I had last looked at it in January 2013. So to give the readers a complete perspective the third book needs to be updated because a lot has happened in the last one year.

The interview originally appeared in the Business World

Why the Federal Reserve will be back to full money printing soon

helicash Vivek Kaul 
The Federal Reserve of United States led by Chairman Ben Bernanke has decided to start tapering or go slow on its money printing operations in the days to come.
Currently the Fed prints $85 billion every month. Of this $40 billion are used to buy mortgage backed securities and $45 billion are used to buy American government bonds. Come January and the Fed will ‘taper’ these purchases by $5 billion each. It will buy mortgage backed securities worth $35 billion and $40 billion worth American government bonds, every month. The American central bank hopes to end money printing to buy bonds by sometime late next year.
The Federal Reserve started its third round of money printing(technically referred to as Quantitative Easing(QE)- 3) in September 2012. The idea, as before, was to print money and pump it into the financial system, by buying bonds. This would ensure that there would be enough money going around in the financial system, thus keeping interest rates low and encouraging people to borrow and spend money.
This spending would help businesses and in turn lead to economic growth. With businesses doing well, they would recruit more and thus the job market would improve. Higher spending would also hopefully lead to some inflation. And some inflation would ensure that people buy things now rather than postpone their consumption.
Unlike the previous rounds of money printing, the Federal Reserve had kept QE 3 more open ended. As the Federal Open Market Comittee(FOMC) of the Fed had said in a statement issued on September 13, 2012 “ If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.”
Now what did this mean in simple English? Neil Irwin translates the above statement in 
The Alchemists – Inside the Secret World of Central Bankers “We’ll keep pushing money into the system until the job market really starts to improve or inflation starts to become a problem. And we will act on whatever scale we need until we achieve that goal. We’re not going to take the foot off the gas, that is, until some time after the car has reached cruising speed. Markets had been eagerly speculating about the possibility of QE3. Instead, they got something bigger: QE infinity.”
In a statement issued on December 13, 2012, it further clarified that it was targeting an unemployment level of 6.5%, in a period of one to two years. And the hint was that once the level is achieved, the Federal Reserve would start going slow on money printing.
The unemployment rate for November 2013 came in at 7% as employers added nearly 203,000 workers during the course of the month. This is the lowest the unemployment level has been for a while, after achieving a high of 10% in October 2009. The Federal Reserve’s forecast for 2014 is that the rate of unemployment would be anywhere between 6.3 to 6.6%. Given this, it was about time that the Federal Reserve started to go slow on money printing.
History has shown us that continued money printing over a period of time inevitably leads to high inflation and the destruction of the financial system. Hence, going slow on money printing “seems” like a sensible thing to do. But there are several twists in the tail.
The unemployment rate of 7% in November 2013, does not take into account Americans who have dropped out of the workforce, because they could not find a job for a substantial period of time. It also does not take into account people who are working part time even though they have the education and experience to work full time.
Once these factors are taken into account the rate of unemployment shoots up to 13.2%. The labour participation ratio has been shrinking since the start of the finanical crisis. In 2007, 66% of Americans had a job or were looking for one. The number has since shrunk to around 63%. To cut a long story short, all is not well on the employment front.
What about inflation? The measure of inflation that the Federal Reserve likes to look at is the core personal consumption expenditure (CPE). The CPE has been constantly falling since the beginning of 2013. At the beginning of the year it stood at 2%. Since then the number has constantly been falling and for October 2013 stood at 1.11%, having fallen from 1.22% a month earlier. This is well below the Federal Reserve’s target level of 2%. In 2014, the Federal Reserve expects this to be around 1.4-1.6%. And only in 2015 does the Fed expect it touch the target of 2%.
The point is that the Federal Reserve hasn’t been able to create inflation even after all the money that it has printed over the last few years, to keep interest rates low. A possible explanation for this could be the fact that the disposable income has been falling leading to a section of people spending less, and hence, lower inflation. As Gary Dorsch, editor of Global Money Trends newsletter points out in his latest newsletter “For Middle America, real disposable income has declined. The Median household income fell to $51,404 in Feb ‘13, or -5.6% lower than in June ‘09, the month the recovery technically began. The average income of the poorest 20% of households fell -8% to levels last seen in the Reagan era.”
Given this, instead of the inflation going up, it has been falling. The benign inflation might very well be on its way to become a dangerous deflation, feels CLSA strategist Russell Napier.
Deflation is the opposite of inflation, a scenario where prices of goods and services start to fall. And since prices are falling, people postpone their consumption in the hope of getting a better deal at a lower price. This has a huge impact on businesses and hence, the broader economy, with economic growth slowing down.
Deflation also kills stock markets. As Napier wrote in a recent note “Inflation has fallen to 1.1% in the USA and 0.7% in the Eurozone and we are now perilously close to deflation…Investors are cheering the direct impact of QE on their equity valuations, but ignoring its failure to produce sufficient nominal-GDP growth to reduce debt…When US inflation fell below 1% in 1998, 2001-02 and 2008-09, equity investors saw major losses. If a similar deflation shock hits us now, those losses will be exacerbated, since the available monetary responses are much more limited than they were in the past…
We are on the eve of a deflationary shock which will likely reduce equity valuations from very high to very low levels.”
Albert Edwards of Societe Generale in a research note dated December 11, 2013, provides further information on why all is not well with the US economy. As he writes “So far, S&P 500 companies have issued negative guidance 103 times and positive guidance only 9 times. The resulting 11.4 negative to positive guidance ratio is the most negative on record by a wide marginThe highest N/P ratio prior to this quarter was Q1 2001, at 6.8…The margin cycle is turning down, profit forecasts over the next few weeks will be eviscerated. To me, this is consistent with recession.”
What these numbers tell us is that all is not well with the American economy. Over the last few years it has become very clear that the only tool that central banks have had to tackle low growth is to print more money.
Given this, it is more than likely that the Federal Reserve will go back to printing as much as it is currently doing or even more, in the days to come. The FOMC has kept this option open. As it said in a statement “However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchase.”
In simple English, what this means is that if the need be we will go back to doing what we were. As The Economist magazine puts it “It is entirely possible that the tapering decision will prove premature. The Fed terminated two previous rounds of QE, only to restart them when the economy faltered and deflation fears flared. The FOMC’s forecasts have repeatedly proved too optimistic. Two years ago it thought GDP would grow 3.2% in 2013; a year ago, that had dropped to 2.6%, and it now looks to come in around 2.2%..”
We haven’t seen the end of the era of easy money as yet. There is more to come.
The article originally appeared on www.firstpost.com on December 19, 2013.

(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Cyprus’ financial repression: when people bail out govts

keynes_395
Vivek Kaul 

John Maynard Keynes (pictured above) was a rare economist whose books sold well even among the common public. The only exception to this was his magnum opus, The General Theory of Employment, Interest and Money, which was published towards the end of 1936.
In this book Keynes discussed the paradox of thrift or saving. What Keynes said was that when it comes to thrift or saving, the economics of the individual differed from the economics of the system as a whole. An individual saving more by cutting down on expenditure made tremendous sense. But when a society as a whole starts to save more then there is a problem. This is primarily because what is expenditure for one person is income for someone else. Hence when expenditures start to go down, incomes start to go down, which leads to a further reduction in expenditure and so the cycle continues. In this way the aggregate demand of a society as a whole falls which slows down economic growth.
This Keynes felt went a long way in explaining the real cause behind The Great Depression which started sometime in 1929. After the stock market crash in late October 1929, people’s perception of the future changed and this led them to cutting down on their expenditure, which slowed down different economies all over the world.
As per Keynes, the way out of this situation was for someone to spend more. The best way out was the government spending more money, and becoming the “
spender of the last resort”. Also it did not matter if the government ended up running a fiscal deficit doing so. Fiscal deficit is the difference between what the government earns and what it spends.
What Keynes said in the General Theory was largely ignored initially. Gradually what Keynes had suggested started playing out on its own in different parts of the world.
Adolf Hitler had put 100,000 construction workers for the construction of Autobahn, a nationally coordinated motorway system in Germany, which was supposed to have no speed limits. Hitler first came to power in 1934. By 1936, the Germany economy was chugging along nicely having recovered from the devastating slump and unemployment
. Italy and Japan had also worked along similar lines.
Very soon Britain would end up doing what Keynes had been recommending. The rise of Hitler led to a situation where Britain had to build massive defence capabilities in a very short period of time. The Prime Minister Neville Chamberlain was in no position to raise taxes to finance the defence expenditure. What he did was instead borrow money from the public and by the time the Second World War started in 1939, the British fiscal deficit was already projected to be around £1billion or around 25% of the national income. The deficit spending which started to happen even before the Second World War started led to the British economy booming.
This evidence left very little doubt in the minds of politicians, budding economists and people around the world that the economy worked like Keynes said it did. Keynesianism became the economic philosophy of the world.
Lest we come to the conclusion that Keynes was an advocate of government’s running fiscal deficits all the time, it needs to be clarified that his stated position was far from that. What Keynes believed in was that on an average the government budget should be balanced. This meant that during years of prosperity the governments should run budget surpluses. But when the environment was recessionary and things were not looking good, governments should spend more than what they earn and even run a fiscal deficit.
The politicians over the decades just took one part of Keynes’ argument and ran with it. The belief in running deficits in bad times became permanently etched in their minds. In the meanwhile they forgot that Keynes had also wanted them to run surpluses during good times. So they ran deficits even in good times. The expenditure of the government was always more than its income.
Thus, governments all over the world have run fiscal deficits over the years. This has been largely financed by borrowing money. With all this borrowing governments, at least in the developed world, have ended up with huge debts to repay. What has added to the trouble is the financial crisis which started in late 2008. In the aftermath of the crisis, governments have gone back to Keynes and increased their expenditure considerably in the hope of reviving their moribund economies.
In fact the increase in expenditure has been so huge that its not been possible to meet all of it through borrowing money. So several governments have got their respective central banks to buy the bonds they issue in order to finance their fiscal deficit. Central banks buy these bonds by simply printing money.
All this money printing has led to the Federal Reserve of United States expanding its balance sheet by 220% since early 2008. The Bank of England has done even better at 350%. The European Central Bank(ECB) has expanded its balance sheet by around 98%. The ECB is the central bank of the seventeen countries which use the euro as their currency. Countries using the euro as their currency are in total referred to as the euro zone.
The ECB and the euro zone have been rather subdued in their money printing operations. In fact, when one of the member countries Cyprus was given a bailout of € 10 billion (or around $13billion), a couple of days back, it was asked to partly finance the deal by seizing deposits of over €100,000 in its second largest bank, the Laiki Bank. This move is expected to generate €4.2 billion. The remaining money is expected to come from privatisation and tax increases, over a period of time.
It would have been simpler to just print and handover the money to Cyprus, rather than seizing deposits and creating insecurities in the minds of depositors all over the Euro Zone.
Spain, another member of the Euro Zone, seems to be working along similar lines. L
oans given to real estate developers and construction companies by Spanish banks amount to nearly $700 billion, or nearly 50 percent of the Spain’s current GDP of nearly $1.4 trillion. With homes lying unsold developers are in no position to repay. And hence Spanish banks are in big trouble.
The government is not bailing out the Spanish banks totally by handing them freshly printed money or by pumping in borrowed money, as has been the case globally, over the last few years. It has asked the shareholders and bondholders of the five nationalised banks in the country, to share the cost of restructuring.
The modus operandi being resorted to in Cyprus and Spain can be termed as an extreme form of financial repression. Russell Napier, a consultant with CLSA, defines this term as “There is a thing called financial repression which is effectively forcing people to lend money to the…government.” In case of Cyprus and Spain the government has simply decided to seize the money from the depositors/shareholders/bondholders in order to fund itself. If the government had not done so, it would have had to borrow more money and increase its already burgeoning level of debt.
In effect the citizens of these countries are bailing out the governments. In case of Cyprus this may not be totally true, given that it is widely held that a significant portion of deposit holders with more than 
€100,000 in the Cyprian bank accounts are held by Russians laundering their black money.
But the broader point is that governments in the Euro Zone are coming around to the idea of financial repression where citizens of these countries will effectively bailout their troubled governments and banks.
Financing expenditure by money printing which has been the trend in other parts of the world hasn’t caught on as much in continental Europe. There are historical reasons for the same which go back to Germany and the way it was in the aftermath of the First World War.
The government was printing huge amounts of money to meet its expenditure. And this in turn led to very high inflation or hyperinflation as it is called, as this new money chased the same amount of goods and services. A kilo of butter cost ended up costing 250 billion marks and a kilo of bacon 180 billion marks. Interest rates as high as 22% per day were deemed to be legally fair.
Inflation in Germany at its peak touched a 1000 million %. This led to people losing faith in the politicians of the day, which in turn led to the rise of Adolf Hitler, the Second World War and the division of Germany.
Due to this historical reason, Germany has never come around to the idea of printing money to finance expenditure. And this to some extent has kept the total Euro Zone in control(given that Germany is the biggest economy in the zone) when it comes to printing money at the same rate as other governments in the world are. It has also led to the current policy of financial repression where the savings of the citizens of the country are forcefully being used to finance its government and rescue its banks.
The question is will the United States get around to the idea of financial repression and force its citizens to finance the government by either forcing them to buy bonds issued by the government or by simply seizing their savings, as is happening in Europe.
Currently the United States seems happy printing money to meet its expenditure. The trouble with printing too much money is that one day it does lead to inflation as more and more money chases the same number of goods, leading to higher prices. But that inflation is still to be seen.
As Nicholas NassimTaleb puts it in 
Anti Fragile “central banks can print money; they print print and print with no effect (and claim the “safety” of such a measure), then, “unexpectedly,” the printing causes a jump in inflation.”
It is when this inflation appears that the United States is likely to resort to financial repression and force its citizens to fund the government. As Russell Napier of CLSA told this writer in an interview I am sure that if the Federal Reserve sees inflation climbing to anywhere near 10% it would go to the government and say that we cannot continue to print money to buy these treasuries and we need to force financial institutions and people to buy these treasuries.” Treasuries are the bonds that the American government sells to finance its fiscal deficit.
“May you live in interesting times,” goes the old Chinese curse. These surely are interesting times.
The article originally appeared on www.firstpost.com on March 27,2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)

 
 
 

Question after Cyprus: Will govts loot depositors again?

A woman walks out of a branch of Laiki Bank in Nicosia
Vivek Kaul 
So why is the world worried about the Cyprus? A country of less than a million people, which accounts for just 0.2% of the euro zone economy. Euro Zone is a term used in reference to the seventeen countries that have adopted the euro as their currency.
The answer lies in the fact that what is happening in Cyprus might just play itself out in other parts of continental Europe, sooner rather than later. Allow me to explain.
Cyprus has been given a bailout amounting to € 10 billion (or around $13billion) by the International Monetary Fund and the European Union. As The New York Times reports “The money is supposed to help the country cope with the severe recession by financing government programs and refinancing debt held by private investors.”
Hence, a part of the bailout money will be used to repay government debt that is maturing. Governments all over the world typically spend more than they earn. The difference is made up for by borrowing. The Cyprian government has been no different on this account. An estimate made by Satyajit Das, a derivatives expert and the author of 
Extreme Money, in a note titled The Cyprus File suggests that the country might require around €7-8billion “for general government operations including debt servicing”.
But there is a twist in this tale. In return for the bailout IMF and the European Union want Cyprus to make its share of sacrifice as well. The Popular Bank of Cyprus (better known as the Laiki Bank), the second largest bank in the country, will shut down operations. Deposits of up to € 100,000 will be protected. These deposits will be shifted to the Bank of Cyprus, the largest bank in the country.
Deposits greater than € 100,000 will be frozen, seized by the government and used to partly pay for the deal. This move is expected to generate €4.2 billion. The remaining money is expected to come from privatisation and tax increases.
As The Huffington Post writes “The country of about 800,000 people has a banking sector eight times larger than its gross domestic product, with nearly a third of the roughly 68 billion euros in the country’s banks believed to be held by Russians.” Hence, it is widely believed that most deposits of greater than € 100,000 in Cyprian banks are held by Russians. And the move to seize these deposits thus cannot impact the local population.
This move is line with the German belief that any bailout money shouldn’t be rescuing the Russians, who are not a part of the European Union. “Germany wants to prevent any bailout fund flowing to Russian depositors, such as oligarchs or organised criminals who have used Cypriot banks to launder money. Carsten Schneider, a SPD politician, spoke gleefully about burning “
Russian black money,”” writes Das.
It need not be said that this move will have a big impact on the Cyprian economy given that the country has evolved into an offshore banking centre over the years. The move to seize deposits will keep foreign money way from Cyprus and thus impact incomes as well as jobs.
The New York Times DealBook writes “Exotix, the brokerage firm, is predicting a 10 percent slump in gross domestic product this year followed by 8 percent next year and a total 23 percent decline before nadir is reached. Using Okun’s Law, which translates every one percentage point fall in G.D.P. (gross domestic product) to half a percentage point increase in unemployment, such a depression would push the unemployment rate up 11.5 percentage points, taking it to about 26 percent.”
But then that is not something that the world at large is worried about. The world at large is worried about the fact “what if”what has happened in Cyprus starts to happen in other parts of Europe?
The modus operandi being resorted to in Cyprus can be termed as an extreme form of financial repression. Russell Napier, a consultant with CLSA, defines this term as “
There is a thing called financial repression which is effectively forcing people to lend money to the…government.” In case of Cyprus the government has simply decided to seize the money from the depositors in order to fund itself, albeit under outside pressure. 
The question is will this become a model for other parts of the European Union where banks and governments are in trouble. Take the case of Spain, a country which forms 12% of the total GDP of the European Union. L
oans given to real estate developers and construction companies by Spanish banks amount to nearly $700 billion, or nearly 50 percent of the Spain’s current GDP of nearly $1.4 trillion. With homes lying unsold developers are in no position to repay. Spain built nearly 30 percent of all the homes in the EU since 2000. The country has as many unsold homes as the United States of America which is many times bigger than Spain.
And Spain’s biggest three banks have assets worth $2.7trillion, which is two times Spain’s GDP. Estimates suggest that troubled Spanish banks are supposed to require anywhere between €75 billion and €100 billion to continue operating. This is many times the size of the crisis in Cyprus which is currently being dealt with.
The fear is “what if” a Cyprus like plan is implemented in Spain, or other countries in Europe, like Greece, Portugal, Ireland or Italy, for that matter, where both governments as well as banks are in trouble. “For Spain, Italy and other troubled euro zone countries, Cyprus is an unnerving example. Individuals and businesses in those countries will probably split up their savings into smaller accounts or move some of their money to another country. If a lot of depositors withdraw cash from the weakest banks in those countries, Europe could have another crisis on its hands,” 
The New York Times points out.
Given this there can be several repercussions in the future. “The Cyprus package highlights the increasing reluctance of countries like Germany, Finland and the Netherlands to support weaker Euro-Zone members,” writes Das. The German public has never been in great favour of bailing out the weaker countries. But their politicians have been going against this till now simply because they did not want to be seen responsible for the failure of the euro as a currency. Hence, they have cleared bailout packages for countries like Ireland, Greece etc in the past. Nevertheless that may not continue to happen given that Parliamentary elections are due in September later this year. So deposit holders in other countries which are likely to get bailout packages in the future maybe asked to share a part of the burden or even fully finance themselves.
This becomes clear with the statement made by Jeroen Dijsselbloem, the Dutch finance minister who heads the Eurogroup of euro-zone finance ministers “when failing banks need rescuing, euro-zone officials would turn to the bank’s shareholders, bondholders and uninsured depositors to contribute to their recapitalization.”
“He also said that Cyprus was a template for handling the region’s other debt-strapped countries,” reports 
Reuters. In the Euro Zone deposits above €100,000 are uninsured.
Given this likely possibility, even a hint of financial trouble will lead to people withdrawing their deposits. As Steve Forbes writes in The Forbes “After this, all it will take is just a hint of a financial crisis to send Spaniards, Italians, the French and others scurrying to ATMs and banks to pull out their cash.” Even the most well capitalised bank cannot hold onto a sustained bank run beyond a point.
It could also mean that people would look at parking their money outside the banking system.
“Even in the absence of a disaster individuals and companies will be looking to park at least a portion of their money outside the banking system,” writes Forbes. Does that imply more money flowing into gold, or simply more money under the pillow? That time will tell.
Also this could lead to more rescues and further bailouts in the days to come. As Das writes “If depositors withdraw funds in significant size and capital flight accelerates, then the European Central Bank, national central banks and governments will have intervene, funding affected banks and potentially restricting withdrawals, electronic funds transfers and imposing cross-border capital controls.” And this can’t be a good sign for the world economy.
The question being asked in Cyprus as The Forbes magazine puts it is “
if something goes wrong again, what’s stopping the government from dipping back into their deposits?” To deal with this government has closed the banks until Thursday morning, in order to stop people from withdrawing money. Also the two largest banks in the country, the Bank of Cyprus and the Laiki Bank have imposed a daily withdrawal limit of €100 (or $130).
It will be interesting to see how the situation plays out once the banks open. Will depositors make a run for their deposits? Or will they continue to keep their money in banks? That might very well decide how the rest of the Europe behaves in the days to come.

Watch this space.
This article originally appeared on www.firstpost.com on March 26, 2013.

(Vivek Kaul is a writer. He tweets @kaul_vivek)