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Deposits swap the ownership of your funds for a paper obligation from the bank!! Welcome counter–party risk!Gijsbert Groenewegen What dealt a fatal blow to Cyprus was the impediment to borrowing because of a credit downgrade to BB+, which made the Cypriot bonds unacceptable as collateral to the ECB, and certainly not viable on the public markets. As a result the banks were insolvent and had to be rescued through the confiscation of depositors funds. Well I believe that downgrades of sovereign paper for all countries in the EU will be ongoing for many more years with all its consequences, as we are witnessing with the periphery countries and Cyprus in specific. As mentioned before we have passed the tipping point and thus there won’t be any sustainability of improvements or traction of economic forces despite the increasingly massive QEs. It feels like all the circumstances for a historic selloff are starting to get in place. Only when all circumstances are in place a historic value destruction will occur, I refer to Joseph Schumpeter’s “Creative Destruction”! All pensions and savings of people will be obliterated when the equity and bond markets implode. Therefore be very aware in which assets you invest your capital and where you safeguard it. As mentioned before it is no longer about the return on your money (next to that bond yields are at all time lows and therefore no competition for gold or silver!!) but the return of your money! And we know by now how safe banks are. Let me give you a taste of how reliable and safe banks are and the counter party risk they represent! The largest Dutch bank, ABN AMRO, defaults on physical gold deliveries to customers!! A couple of days ago, an important milestone was reached in the precious metals market as one of the largest banks in Europe, ABN AMRO, defaulted on their gold delivery contracts, and informed their customers there was no physical gold “available” for delivery. What does that tell you about the physical shortages in the market and manipulation of the gold market, do you need any other evidence!! Goldman just brought out a forecast that targeted a gold price of $1,300/oz!? ABN AMRO issued a letter to their gold contract customers of failure of delivery, and that instead the bank will pay account holders in a paper currency equivalent to the current spot value of the metal. Voila counter party risk. If you have a piece of paper you don’t have anything, “if you don’t hold it, you don’t own it”. It is all about physical possession. ABN AMRO, the biggest Dutch bank, has informed it clients that they will no longer be able (?) to take physical deliveries of the gold they have bought through ABN. Instead they are offered money at the current market rate for gold. Basically, instead of owning a risk free, physical asset (a gold bar or a gold coin), the bank’s clients now own an obligation from, a monetary claim on ABN AMRO. Although Cyprus jumps to mind I don’t think that ABN AMRO’s credit risk is a real issue at this moment. The bank is 100% owned by the state, though as we know states also go bankrupt. This story is much more significant in terms of why there is such a discrepancy between the paper and physical price of gold (see my latest article about backwardation). Over the past two months, there has been a concerted action by several institutions to bring down the price of gold and silver, even as other central banks from countries such as Russia, Iran, and China continue to accumulate the physical metal in large quantities at now “subsidized” prices. But as stated in my previous article, in the end the physical will win from the paper despite the fact that the paper market is roughly 100x bigger than the physical market. For general information the London gold market is the physical market whilst the NY market is the paper market, where most of the manipulation takes place. You have a big paper problem if people don’t sell their gold despite much lower prices because ultimately the shorts have to buy their contracts back!!!! Especially if delivery is requested through the futures and if the Comex has to call a force majeure and pays in cash because there is not enough physical gold to meet the delivery requests people should pay attention! In terms of silver it looks like JP Morgan has another “Whale” in the closet because investors keep scooping up physical silver hence why delivery times are increasing. Anyway the market is definitely tightening, look at delivery times are doing and look at “Force Majeures a la ABN AMRO”. What is happening to the meaning of certain well-anchored concepts following the Cyprus affair? What is the definition of “to save”: to rescue from loss; to keep safe, intact, or unhurt; safeguard; preserve, to keep from being lost. Well ask the Cypriots if they still think that this is true! We are undermining the fundamentals on which the financial system is based: the sanctity of ownership. When politicians and (central) bankers believe they can steal your savings in order to clean up the mess they created there is something terribly wrong! Financial institutions have a special task in economies and therefore should act much more prudent with other people’s money. Are they? The Troika that sanctioned the confiscation of course also supervises deposit accounts in the other European countries! So don’t exclude anything! What is the definition of a safe? A safety box, located inside a bank or home, which is used to store valuables for safekeeping. In general a safe deposit box is rented from a banking institution that can be accessed with keys, pin numbers or some other security pass. Valuables such as documents and jewelry are placed inside and customers rely on the security of the bank building to protect those valuables for which they pay a fee. Contents of a safe deposit box are not insured in the same way bank deposits are. The Federal Deposit Insurance Corporation insures cash deposits up to a certain limit, but due to the fact that there is no way to verify the contents of a safe deposit box, banks will not insure their contents. Though what is the guarantee of the FDIC worth when all banks fall over and the country is bankrupt? Goodbye deposit guarantee! Next to that you won’t be able to have access to a safety box in the bank when the bank is closed! And if your safety box contains gold it could be confiscated. So why keep a deposit or safety box at the bank? What is the definition of property/ownership rights: The ultimate and exclusive right conferred by a lawful claim or title, and subject to certain restrictions, to enjoy, occupy, possess, rent, sell, use, give away, or even destroy an item of property. Anyway as described here above that sanctity of an ultimate and exclusive right is being challenged by the Cyprus situation and could have far reaching consequences in case of other bank or sovereign defaults. Basically the trust in the financial system has been put on a slippery slope. Politicians and banks, the creators of money, can’t be trusted any longer (we knew this already for a long time) to safeguard and protect your money! Anyway the banks have become the thieves! So what does that tell you about the storage value function of money that basically is a derivative of the trust in the financial system? What is the definition of confiscation: The word stems from the Latin confiscatio ‘joining to the fiscus, i.e. transfer to the treasury’ it is a legal seizure without compensation by a government or other public authority. Confiscation is often applied in function of fighting crime, the rationale being that the criminal must be denied the fruits of their fault, while the crime itself is rather punished in some other, independent way, such as physical punishments or even a concurring fine. In airports, potentially dangerous items (such as hazardous chemicals, weapons, and sharp objects) are usually confiscated at inspections. Other items, such as certain food, may also be confiscated, depending on importation laws. Another form of asset forfeiture is also roadside forfeiture during a vehicle stop. Completely out of line in my point of view. The offense doesn’t justify the punishment at all. If anything, because of its overwhelming powers, a government should show even more restraint than any other party. Anyway lets figure out what exactly the crime is that has been committed by the depositors or holders of physical gold “justifying” confiscation. Confiscation of gold in 1933 by Franklin D. Roosevelt by Executive Order 6102. On April 5, 1933, during the Great Depression, President Franklin D. Roosevelt signed Executive Order 6102 “forbidding the hoarding of gold coins, gold bullion, and gold certificates within the continental United States”. Roosevelt based his executive order on the 1933 Emergency Banking Relief Act, which gave the president power to curb gold hoarding in any “declared national emergency”. The order was rationalized on the grounds that hard times had caused “hoarding” of gold, stalling economic growth and making the depression worse. This is reverse psychology in my point of view, you mess up and then you blame people that acted correctly in order to preserve their capital. The order criminalized the possession of monetary gold by any individual, partnership, association or corporation. Americans were forced to surrender their gold in exchange for U.S. paper currency. So people that had been frugal and saved had to pay for the mistakes of people that were irresponsible, reckless and wasteful. The people that surrendered their gold later discovered that not only would they never get their gold back, but those paper dollars would be devalued far below the intrinsic value of the confiscated gold (“L’histoire se repete?”). By the way most citizens who owned large amounts of gold had it transferred to countries such as Switzerland. But as we know the Swiss don’t want to do any business with Americans any longer! The price of gold from the Treasury for international transactions was after the confiscation raised from $20.67 to $35 an ounce ($587 in 2010 dollars) resulting in an immediate loss for everyone who had been forced to surrender their gold (how much can you trust the Government?). The resulting profit that the government realized funded the Exchange Stabilization Fund established by the Gold Reserve Act in 1934. This price remained in effect until August 15, 1971, when President Richard Nixon announced that the United States would no longer convert dollars to gold at a fixed value (the French were exchanging all their dollars for gold), thus abandoning the gold standard for foreign exchange. The private ownership of gold certificates was already legalized in 1964, the certificates could be openly owned by collectors but were not redeemable in gold. The limitation on gold ownership in the U.S. was repealed after President Gerald Ford signed a bill to “permit (!) United States citizens to purchase, hold, sell, or otherwise deal with gold in the United States or abroad” which went into effect December 31, 1974. Anyway as mentioned before watch out for history to repeat itself! The fact that the US government tells you your accounts are safe, or they won’t touch your gold, is meaningless because they already took your gold in 1933! They have a precedent and they will not hesitate to act. They will make an announcement on a Sunday night and on Monday morning your gold, and your accounts, will be cleaned out. Obama could also confiscate gold on the basis of Executive Powers! According to some people President Obama has the power of the executive power to order the confiscation of gold issuing executive orders without having to consult congress. Under the radical Foreign Account Tax Compliance Act (FATCA) the IRS has the power to force foreign bankers to act as their spies on U.S. clients or suffer a 30% tax on their U.S. sources if they refuse. This is blatant extraterritorial jurisdiction; it is the “legal ability” of a government to exercise authority beyond its normal boundaries. And thus there is nothing to stop the IRS from using FATCA to impose restrictions on foreign gold purchases by Americans! Boundaries are no longer boundaries! The flipside of the coin is that we today live in a world that is more international than ever before and if “the US prices itself out of the market” people will find other countries to live, and get that citizenship, where the Government takes responsibility for its actions and doesn’t punish its citizens instead of the real culprits. The “bail-in” confiscation model used in Cyprus seems to be based on an agreement that was the result of a bank bail-out model that was drafted by a sub-committee of the BIS (Bank for International Settlement, the central bank of central banks) and was subsequently endorsed at the G20 Cannes summit in 2011. The Preamble specifically states: The objective of an effective resolution regime is to make feasible the resolution of financial institutions without severe systemic disruption and without exposing taxpayers to losses, while protecting vital economic functions through mechanisms which make it possible for shareholders and unsecured and uninsured creditors to absorb losses in a manner that respects the hierarchy of claims in liquidation. Basically G20 members are ensuring that they can legally override the rights of creditors, including uninsured depositors, and make them, the people that basically fund the bank, pay for losses incurred as a result of bad decisions of the management team of the banks! Don’t you love to be a banker? You give yourself a great bonus and if you make big mistakes you get bought out either by the Government (taxpayers) or by the creditors (deposit holders). In general there are three broad classes of deposit to consider:
The BIS proposals being applied throughout the G20 allow for different treatment for these deposit classes in a bank rescue. The government or its agency is going to have to pay out for insured deposits anyway (if they still have the funds). Wholesale deposits, which are not the focus of the BIS proposal, are unlikely to be touched except in the case of very small bank failures, because of the risks spreading to other banks and financial institutions. This leaves the full burden of depositor contributions to a bank rescue falling on the shoulders of uninsured non-monetary and financial institutions. In other words any deposit in excess of the insured amount owned by individuals, companies, trusts, pension funds and other savings vehicles, and any segregated client accounts operated by a business, lawyers and brokers acting as agents for its customers are likely to be raided where there is a risk of bank failure. Goodbye banking system! Why would you deposit funds with a bank when the funds can be taken from you indiscriminately, you hardly get any interest and the banks rip you off for “their services” anyway! Because all the banks are interconnected or interdependent, as Mohammed El-Erian calls it, no bank accounts are safe when the ripple effect starts to have its effect. Non-financial S&P 500 companies that have in excess of $1.5trn of cash on their balance sheet have to ask themselves what will happen to that cash when the banks fall over!! They might win the battle but ultimately lose the war. It is clear to me who are culpable and have committed the real crimes in the confiscation model: the bankers and the politicians and they are the ones that should face very severe repercussions for mismanagement, they want the goodies so they should also get the baddies!! The deposit holders and taxpayers shouldn’t be punished through confiscation or higher taxes, it is like punishing the victim. In my point of view these situations whereby the real culprits get away occur more and more frequently because nobody is being held responsible any longer and that is why we end up in the situation we are in. It is astounding to me that there hasn’t been a much larger backlash in Cyprus considering the pain that has been suffered by the deposit holders. It is almost like people are indifferent, apathetic towards their situation. A deposit swaps your ownership rights for an obligation from the bank activating counter party risk! What is the definition of a bank deposit: Money placed into a banking institution for safekeeping. The deposit holder has the right to withdraw any deposited funds, as set forth in the terms and conditions of the account. Though the “deposit” itself becomes a liability owed by the bank to the depositor. In other words when you deposit your money in your bank account, it isn’t legally yours any longer, you will get an obligation from the bank for repayment of the deposited funds in return. You are swapping your ownership rights for a paper obligation of the bank! I think most investors worldwide are of the belief that when you deposit your money in a bank, that the banks simply safe keeps your money. Very few realize that depositing your money basically means you have “lent” the bank your money and have thus become an unsecured creditor of the bank. You have become a creditor of the bank like the bank’s bondholders! Welcome to the counter party risk of the Ponzi scheme of Ponzi schemes of the banks! I am saying this of course in light of the fact that the banks are operating under the so-called fractional reserve banking system, which “allows” them to keep only a fraction (say 10%) of the deposited funds in cash in case of cash calls. In other words they don’t have to keep your money in sufficient availability, as directed and approved by the central banks, because they need to make money with your funds to pay you interest and because the special money creating role they fulfill in the economy. But basically bankers are playing “Russian” roulette with your money. Something the Cyprus affair has clearly illustrated. And by the way is it not also ironic that Madoff made a comment that the banks were aware and in on the Ponzi scheme of him! Did you know that a deposit holder becomes a creditor of the bank? The banking terms “deposit” and “withdrawal” obscure the economic substance and legal essence of transactions in a deposit account. From a legal and financial accounting standpoint, the term “deposit” is used by the banking industry in financial statements to describe the liability owed by the bank to its depositor. Great deceptive marketing and fooling of deposit holders in my point of view. Ask yourself if you knew this, I didn’t and so didn’t many other people I asked! When people will become really aware of this they will probably get a different view of how “safe” banks are! Ask MF Global shareholders or investors who won’t get their gold from ABN AMRO! By the way have you heard lately from Corzine? Or is he just hiding hoping people will forget? General unsecured creditors of the MF Global holding company are expected to collect between 14.7 cents and 34 cents on the dollar of what they are owed, according to court documents, because their so-called “segregated accounts” were plundered. There are a lot of laws but there is very little justice! What does that tell you about credibility of the legal system and how well it will protect you. It all fits in with my perception that we are at the latest stages of an era. The deposit holders “surrender” legal title of their ownership to the bank and deposits will be shown as an asset of the bank. Deposits allow the fractional reserve banking system to create money. If the deposit holders wouldn’t “surrender” legal title of their ownership and the banks wouldn’t assume ownership of the deposits the banks probably could never, from a legal point of view, apply the fractional reserve banking system whereby it only keeps a fraction of the deposited moneys using the remainder to invest or lend to other parties. By transferring the ownership of deposits from one party to another, banks can avoid using physical cash as a method of payment, because only a small part of all the money in circulation is done through cash transactions. For example, if a bank in the United States makes a loan to a customer by depositing the loan proceeds in that customer’s checking account, the bank typically records this event by debiting an asset account on the bank’s books (called loans receivable or some similar name) and credits the deposit liability or checking account of the customer on the bank’s books. From an economic standpoint, the bank has essentially created economic money by crediting an account. The customer’s checking account balance has no dollar bills in it, as a demand deposit account is simply a liability owed by the bank to its customer. In this way, commercial banks are allowed to increase the money supply (without printing currency, or legal tender). And because as mentioned only a fraction of the outstanding accounts demand to be paid in cash the banks can operate this way whereby they only “cover” a fraction of their outstanding obligations in cash. This is how Ponzi banks are being created and hence why the deposit guarantee system was created to give deposit holders the “assurance” that their money is “safe”. That assurance of course only works in incidental cases and not in systemic cases. How can a levy be imposed on bank account holders when they are legally the assets of the bank? In other words the moment you deposit money into a deposit account you swap real money for a paper obligation to return money. And thus you now incurred counter party risk, because instead of having the real thing, money in your possession, you swapped it for a piece of paper that states the obligation of the bank to repay you the nominal amount you have deposited. But what if the banks fail or go bankrupt or suddenly gets levied a certain percentage charge on its uninsured bank accounts (Cyprus)!! Are they your deposited funds or are they the bank assets? And thus if they are the bank assets, as is legally determined, how does that affect their obligation to repay the nominal amount that the banks are obliged to repay? Does this represent a “force majeure” that the banks obligation to pay you your deposited funds back has just been reduced by the percentage charge on the assets of the bank? From a legal point of view that isn’t right in my opinion! Deposit holders have a claim towards the bank in my point of view. And when the assets get levied, taxed or a haircut in the first instance it is a problem of the banks and not a problem of the deposit holders in my opinion. Although when you get to this point legal claims will probably sort very little effect and it will be a choice between survival or bankruptcy. Go and sue a bankrupt institution! But it stipulates again my opinion that the bankers should really be held responsible because they are responsible for peoples livelihoods (deposits) and as long as they are allowed to get away with their irresponsible behavior they will. Anyway considering the fact that the Dutch Minister of Finance Mr Dijsselbloem spoke of “the template” it would be prudent to assume that “the institution of ownership” is no longer holy. And that next to the shareholders and bondholders the pillars of the banking system, the savers/deposit holders, are exposed to all kinds of unduly measures. So be prepared at which banks you deposit your money! Don’t forget that as mentioned here above all banks are interconnected and that when the domino stones start to fall over nothing is safe any longer. It is always what you don’t know that is going to hit you; we don’t know what the interbank obligations are. The banks don’t show those! There is too much shadow-banking going on. I only have to refer to the $50bn liability of Lehman that was swapped from NY to London and back in order to polish the accounts! It is clear that when you swap ownership for an obligation to repay you that you incur counter party risk. Counter party risk is described as the risk to each party of a contract that the counterparty will not live up to its contractual obligations. An obligation is the act by binding oneself through a legal or moral tie, it is a course of action that someone is required to take, whether legal or moral. As a result of the transformation from possession of the title of ownership to getting an obligation for repayment of the deposited amount from the bank you go from having an asset (without counter party risk) to getting an obligation from a third party, the bank (with counter party risk). In other words you have encountered counter party risk because when the bank goes bankrupt, or needs a bail-in or has any other reason why it can’t repay you your deposit its obligation is not worth the paper it is written on. See also the earlier mentioned failing of the ABN AMRO bank’s obligation to deliver the physical gold to its clients! A paper obligation is no guarantee of delivery of your assets. And the piece of paper in itself doesn’t have any value to compensate you for the loss of the assets you were promised. And thus every paper promise embodies counter party risk; a piece of paper without the follow up is worth zilch! And with the ongoing downgrades of countries debt ratings everything is possible. Counter party risk also applies to currencies when they are undermined. This concept ultimately also applies to money and currency. If the monetary authorities and central banks can’t back up the value of the currency because of their financial and monetary mismanagement the currency at one stage will not represent the purchasing power any longer that it used to have when the economy was strong and the Debt/GDP ratio was healthy. In this case your counter party are the monetary authorities of the country and the counter party risk is the way they handle the economy and the state’s finances and thus the subsequent strength of the currency. The Government has the obligation to ensure that money keep its value, its purchasing value, the amount of goods people can buy with their money. But the moment the currency loses its purchasing power the obligation of the government to guarantee the real value of money will have failed and the citizens will endure counter party risk. This will affect the citizen’s livelihoods in the most fundamental form; their standard of living will deteriorate as we are clearly witnessing today. In general you don’t have this problem with a gold backed system because the money supply is pegged to a certain amount of gold. Look at substance and profit from artificially low prices. Therefore going forward people should next be looking at the economic fundamentals of a currency (economic strength, Debt/GDP ratio, health of the banking system) look at the amount of gold a country has in its forex reserves and which is duly accounted for (unlike the US gold reserves which haven’t been audited for a long time) and look in addition at the richness in agricultural and industrial commodities a country has. But foremost consider the ultimate currency that can’t be manipulated, gold and silver. At this moment gold and silver are being kept artificially low because of the paper manipulation of the prices but the physical will prevail. Use the opportunity! ### Apr 11, 2013 |
