Lessons from Brussels: Trust in gold but not politicians

After the troika of EU, ECB and IMF found a compromise with Cyprus to avoid a bankruptcy, which was approved by eurozone finance ministers in early Monday morning hours, gold pared part of the gains made the week before. It was a typical reaction as the worst case could be evaded. However, it was not a smart move.

The bailout plan now excludes that deposits below the guaranteed sum 100,000 euro will be partly expropriated. However, bank deposits above this sum will still be confiscated. This has not been the case in Ireland or Spain, where the banking system had been bailed out without depositors being robbed by the troika. And as pointed out last week, the banking crisis in Cyprus was not the result of banks lending recklessly to a booming real-estate sector. The solvency crisis in Cyprus was the collateral damage of the default of Greece on its government debt held by private investors, which was also enforced by the troika.

Dutch finance minister and Eurogroup chairman Jeroen Dijsselbloem stated on Monday afternoon that the solution enforced by the troika and eurozone finance ministers would be a blue print for further banking sector bailouts in the eurozone. While he later paddled back, he already had let the cat out of the bag. Also an initiative of a member of the European parliament points to the same direction. Saver be aware, if in trouble the government will steal your money!

So far, there has been no contagion in other southern European countries and even the situation remained relatively calm in Cyprus after banks re-opened on Thursday. However, in Cyprus, this is only due to massive capital controls, which violate the spirit of the Lisbon treaty and are only allowed in cases of emergency. But as mistakes made by politicians are often the root-cause of a crisis and then politicians decide again on the imposition of capital controls, investors can not rely on the freedom of moving capital from one place to the other.

The financial system of the eurozone was never a single market as it is the case in the US. However, with the launch of the single currency, a process of more integration started. Until the financial crisis broke out, a successful process of integration within the eurzone took place. Rates of lending from banks converged to only small spreads. Thus, the monetary policy of the ECB acting upon the maxim of one size fits all had the same impact throughout the single currency area. But this all changed after the financial crisis of 2008, and the management of the debt crisis by the Eurogroup finance ministers made the situation worse.

ECB president Draghi was successful in calming the situation down last summer, when he gave his pledge that the ECB would do everything within its mandate to secure the euro. The capital flight within the eurozone not only came to a stop but reversed as some investors repatriated funds again to domestic banks. The balances of the Target system, which reflected the flight into the safe haven of German Bunds, declined again albeit still being far above pre-crisis levels. With the solution to solve the banking crisis in Cyprus, dictated by the jurists Mrs. Lagard and Mr. Schaeuble, this trend is likely to reverse again, once the capital controls in Cyprus are fully lifted.

For investors, the Cyprus crisis management adds another dimension to risk management. Investments in financial institutions should be held not only with several legally separated entities in one country, but also spread over various countries within the eurozone. But in the case of a crisis bigger than the one in Cyprus, even that might not be sufficient. Deposits would also have to be held outside the eurozone. It is an old wisdom that gold can not go bankrupt. Thus, due to the political risk in the eurozone, gold is definitively an asset, which should be part of a diversified portfolio. And to avoid any confiscation, it is best held in secure vaults outside of the eurzone.