Bank Leverage, Fractional Reserve Banking and Central Banks - the US vs. Europe

The gold standard put a check on governmental plans for easy money. It was impossible to indulge in credit expansion and yet cling to the gold parity permanently fixed by law. Governments had to choose between the gold standard and their — in the long run disastrous — policy of credit expansion. The gold standard did not collapse. The governments destroyed it. It was incompatible with etatism as was free trade. The various governments went off the gold standard because they were eager to make domestic prices and wages rise above the world market level, and because they wanted to stimulate exports and to hinder imports. Ludwig von Mises

If the situation in Cyprus has accomplished one thing, it has raised the issue of fractional reserve banking.  Moreover, it appears that governments, the Troika and central banksters everywhere have shed the false benevolence of statist theft as they now clearly and resoundingly assert that  YES, they fully intend to steal the deposits of ordinary folks to save and subsidize failed banks and banksters.  The plundering masks have finally come off.

This is truly EPIC.

However, what is confounding and confusing is why European banks are in so much trouble yet US banks are proclaimed healthy, at least by comparison to European banks.  This phenomena has a lot to do with leverage.

Leverage increases when bank assets grow at a faster rate than equity capital, such as common stock, which acts as a cushion against losses.  Allbusiness.com 

In other words, banks don't gamble with their own capital, they use the money of depositors.  Anybody who deposits money in a bank is giving the bank permission to gamble with their money however they want - there are ZERO restrictions on the banks and banks effectively become casinos.  Such is the fatal flaw of fractional reserve banking, here.

Zero Hedge zoomed in on the issue of bank leverage.

Guess Who’s Even More Leveraged Than the European Banks?

The US banking system as a whole is leveraged at 13-to-1. While this is not horrible relative to Europe’s banking system (more on this in a moment), these levels still mean that an 8% drop in asset values wipes out ALL equity.

Then you have Europe’s banking system, which is leveraged at 26-to-1. Anecdotally, this is borderline Lehman Brothers (30 to 1). At these levels, even a 4% drop in asset prices wipes out ALL equity.

Japan’s banks are leveraged at 23 to 1. France’s are 26 to 1. Germany is 32 to 1.

You get the idea.

However, worse than any of these the US Federal Reserve. With $2.8 trillion in assets and only $52 billion in capital, the Fed is leveraged at 53 to 1. Yes, 53 to 1.

The only reason US banks have some semblance of sane leverage ratios is because the Federal Reserve created a ton of "out of thin air fiat money" to recapitalize US banks and they did it by largely buying bad assets that included $1.3 trillion in bad mortgage paper.

Of course the next logical question is:  why didn't the European Troika just do what the Federal Reserve did?  Moreover, printing money out of thin air doesn't solve the myriad of problems associated with the scourges of fractional reserve banking but for some reason the Troika has opted to take a different path than the US.  It's entirely possible that European banks were always way more leveraged than US banks and that printing was a nuclear option that would immediately result in inflation on steroids, Weimar Republic style, here.

While many who try and follow Austrian economics do indeed scratch their heads in bewilderment over the fact that the US has managed to escape the stone cold reality check that is descending upon Europe, one of the most fascinating and enlightening explanations came from the Ludwig von Mises Institute that actually argued in favor of the Euro in that it was a rudimentary form of a disciplined free market currency despite its vast and numerous flaws.

An Austrian Defense of the Euro

The Euro as a "Proxy" for the Gold Standard (or Why Champions of Free Enterprise and the Free Market Should Support the Euro While the Only Alternative Is a Return to Monetary Nationalism)....

The introduction of the euro in 1999 and its culmination beginning in 2002 meant the disappearance of monetary nationalism and flexible exchange rates in most of continental Europe. Later we will consider the errors committed by the European Central Bank (ECB). Now what interests us is to note that the different member states of the monetary union completely relinquished and lost their monetary autonomy, that is, the possibility of manipulating their local currency by placing it at the service of the political needs of the moment. In this sense, at least with respect to the countries in the eurozone, the euro began to act and continues to act very much like the gold standard did in its day. Thus, we must view the euro as a clear, true, even if imperfect, step toward the gold standard.

Moreover, the arrival of the Great Recession of 2008 has even further revealed to everyone the disciplinary nature of the euro: for the first time, the countries of the monetary union have had to face a deep economic recession without monetary-policy autonomy. Up until the adoption of the euro, when a crisis hit, governments and central banks invariably acted in the same way: they injected all the necessary liquidity, allowed the local currency to float downward and depreciated it, and indefinitely postponed the painful structural reforms that where needed and that involve economic liberalization, deregulation, increased flexibility in prices and markets (especially the labor market), a reduction in public spending, and the withdrawal and dismantling of union power and the welfare state. With the euro, despite all the errors, weaknesses, and concessions we will discuss later, this type of irresponsible behavior and forward escape has no longer been possible.

It it possible that Europe and the Euro are well ahead of America in addressing its monetary problems? It's hardly likely that the EU anticipated or welcomed the situation of collapsing banks and it's doubtful that the EU bureaucrats have any goal except to hold the economic, political and monetary union together, whatever the cost.

Meanwhile, the Federal Reserve continues to purr along oblivious to its own fatal flaws as the political class in the District of Crime (DC) grows even more arrogant and smug, as if America is somehow exempt from the problems that plague the rest of the world and the mountain of debt created by fiat monetary systems.

When reality finally strikes America, it will be far more painful and devastating than anything the profoundly suffering southern Europeans are experiencing.

Cyprus: Where Big Oil, Big Money and Geopolitics Collide

The island nation of Cyprus is garnering big global headlines as the government seems determined to plunder the bank accounts of its citizens to guarantee debt service payments on a $13 billion Troika loan to bailout bankster.  To understand Cyprus, you have to start with having a grasp of geo-politics and the history of Cyprus.  The sordid and lurid details of Russian oligarchs using Cyprus banks for laundering money from their nefarious activities is indeed firing up imaginations because the Cypriot people, and people everywhere, are suddenly shocked and appalled that ordinary people are now forcibly being required to bailout Russian mobsters.  Forget that the entire global financial system is itself a well organized crime syndicate.

Cyprus is an island nation and the 3rd largest Mediterranean island after Sicily and Sardinia (both under Italian sovereignty) and according to the CIA Factbook is .6 the size of Connecticut.  With 1.1 million folks occupying the island, Cyprus has a long and fascinating history of being a pawn on the Muslim-Christian chessboard as battles waged for theocratic and empirical control of the Mediterranean.

Somebody made the astute observation:  If goods don't cross borders then armies definitely will.  It's always been true, though rarely practiced in human history.  The Venetians acquired vast wealth and prosperity through trade and they even traded significantly with the Muslim world.  Consequently, the Venetians were wisely obsessed with trade, protecting their trade routes, avoiding war and negotiating peace with anybody to preserve trade.

Cyprus has always been a Greek majority, Greek speaking island and became part of the Orthodox Byzantine Empire in the 4th century.  It's close proximity to Turkey (less than 50 miles from the Turkish mainland) made it an attractive conquest for the now defunct Ottoman Empire.  Cyprus was deemed critical to Venetian trade and the Venetian Republic, here, and the Venetians invaded Cyprus in 1489.  Relations between east and western Christianity were never good as Roman Catholics under the rule of Rome locked horns with Orthodox Christians under the rule of Constantinople.  Constantinople fell to the Muslim Turks in 1453 under the Ottomans who embarked on a massive geographic military expansion of conquest and plunder.

In 1570, the Ottomans invaded Cyprus, quickly conquered most of the island, including the capitol city of Nicosia, but the heavily fortified city of Famagusta was held by the Venetians and only fell after a long seige.   The heroic defender of Famagusta was Marco Antonio Bragadin, here.  When Bragadin surrendered after being promised safe passage out of Cyprus, the Muslim Turks literally flayed him alive and carted the spectacle of a human being being skinned alive through the streets as a warning that such was the fate of anybody who defied the Muslims.

The horror of Bragadin's fate spread rapidly throughout a shocked Christian world.  That's when the Christian West decided to stop the Ottomans.  The Venetians had been paying the Ottomans a huge amount of money in annual tribute.  They were furious at the betrayal and conquest of Cyprus.  Several Italian states and other western Christian nations quickly assembled a navy which was not a problem for the seafaring Venetians.  The goal was to wipe out the Ottoman navy which it accomplished at the legendary sea battle of Lepanto, here and here.

The 1570 defeat of the Ottoman Navy was largely symbolic.  However, it did slow down Ottoman expansion but the Ottomans managed to keep Cyprus until 1878 when it ceded control of Cyprus to the British.  Ottoman power was approaching its zenith but that changed in 1683 when Ottoman armies were decisively defeated at the gates of Vienna.   After Lepanto (1570) and the Christian defeat of Islamic expansion at Vienna (1683), the Christian world ceased to fear the Ottomans who had so terrified the western Christian world for hundreds of years, starting with the defeat of the Serbs in 1389 and the Muslim conquest of Constantinople in 1453.  Revolts against Islamic rule started to accelerate and they accelerated on two fronts, from the Orthodox east and the Papal west.

1736 Russo/Austrian-Turkish War
1768 Russo-Turkish War
1770 Revolt in Peloponnese
1787 Russo/Austrian-Turkish War
1804 First Serbian uprising
1815 Second Serbian uprising
1821 Greek War of Independence
1877 Russo-Turkish War
1912 First Balkan War
1913 First Second Balkan War

By 1878, 300 hundred years of Ottoman rule over Cyprus was ending.  The Suez Canal opened in 1869, the Ottoman Empire was literally in shambles and the Ottomans ceded control of Cyprus to the British.

The Greek Cypriots welcomes British rule over Ottoman rule but there was always a Greek Cypriot movement called 'enosis' that yearned to unite with Greece under the Greek flag.  It wasn't long before the Greek Cypriots started revolting against the British.  After significant agitation for sovereignty, Cyprus finally shed British rule in 1960 and became the Cyprus Republic.  That resulted in a low level civil war between the minority Muslim Cypriots and the majority Greek Cypriots who were further conspiring to unite under the Greek flag.  The Muslim Turks and the Greek Christians may have shared an island but they really didn't co-exist together.  The Muslims occupied the northern part of the island while the Greek Christians occupied the larger southern portion.  Greece itself was internally a mess as various players sought power and Greece was politically unstable while waging various revolutions that included a military dictatorship.

The president of Cyprus post 1960 independence was Archbishop Makarios, a firebrand cleric, a communist sympathizer and a hardliner Greek unity advocate.  Makarios did wage a successful guerilla war against the British.  By 1964, not only was the Cold War in full bloom, the world had just survived the Cuban Missile Crisis.  Britain and the US used Cyprus as a military base for spying on the Soviets and other communist nations.  In fact, Cyprus was strategically very significant to the US and Britain as a military base.  Although Greece and Turkey are mortal enemies, they both joined NATO in 1952.  Orthodox Christians are always on the side of Orthodox Russia, the Orthodox Balkans and Orthodox Greece.  Makarios refused to be a puppet of the US and Britain and he was convinced that the US and Britain favored Turkey over Greece.  A BBC timeline on Greece from 1924-2012 is here.

In 1964 the US and Britain got the UN to send 'peacekeeping' troops to Cyprus.  They've been there nearly 50 year.  As Cyprus continued to heat up, The Turkish military invaded Cyprus in 1974 and some even believe that the CIA engineered a coup to kill Makarios who managed to escape.  Makarios died in 1977, he left no memoirs and all that is left is an interview he granted to Italian journalist Oriana Fallaci who died in 2006; the 1974 interview is here.

In 1983, the Turkish Cypriots declared their independence from Cyprus and named itself the Turkish Republic of Northern Cyprus.  However, only Turkey has recognized the sovereignty of the TRNC.   While it is indeed a tragedy that the Muslim Turks and Christian Greeks can't live together in peace and prosperity, it's not an unusual situation when you are dealing with folks with festering wounds spanning hundreds of years.  Cyprus remains a divided nation - 2 languages (Turkish and Greek), 2 religions (Islam and Christianity) and two entirely different cultures.

Although many view Archbishop Makarios as a radical Greek nationalist, he was very much a product of the times.  As it turns out, Makarios wasn't so crazy in his assertion that the US and Britain were backing Turkey.  The Raw Story published a piece on 2007 based on the disclosure of 700 pages of highly classified CIA documents known as the 'Family Jewels'.

New documents link Kissinger to two 1970s coups

Release of CIA's Family Jewels provides insight into political juggernaut and Bush Administration adviser

Former Secretary of State Henry Kissinger pushed for the 1974 Turkish invasion of Cyprus and allowed arms to be moved to Ankara for an attack on that island in reaction to a coup sponsored by the Greek junta, according to documents and intelligence officers with close knowledge of the event.

Nearly 700 pages of highly classified Central Intelligence Agency reports from the 1970's, known collectively as the "Family Jewels," are slated for public release today.....

Some Greek Cypriots believed then, and still believe, that the invasion was a deliberate plot on the part of Britain and the US to maintain their influence on the island, which was particularly important as a listening post in the Eastern Mediterranean in the wake of the October 1973 War between Israel, Egypt, Jordan and Syria.

According to columnist Christopher Hitchens, author of the book The Trial of Henry Kissinger, "At the time, many Greeks believed that the significant thing was that [Prime Minister Bulent] Ecevit had been a pupil of Kissinger's at Harvard."

Several intelligence sources, who wished to remain anonymous to maintain the security of their identity, confirmed to RAW STORY that Kissinger both pushed for the Turkish invasion of Cyprus and allowed arms to be moved to Ankara.

Cyprus was admitted to the EU in 2004 and adopted the Euro as its currency in 2008.

Fast forward to today as the Cyprus banking crisis explodes and the Troika (EC, ECB and the IMF) demand that the Cyprus government literally steal bank deposits to guarantee a $13 billion bankster bailout loan.  It's no secret that Cyprus banks have been the choice of Russian oligarchs and their nefarious money laundering schemes.  So who is being bailed out and why?  It's clear that a bailout of bondholders is the motivating factor behind the Troika bailout but the greater question is this:  WHY would the Troika be so foolishly suicidal as to risk banks runs and accelerate spreading economic calamity for a puny nation like Cyprus that only comprises .2% of the EU's GDP?

That the Cyprus depositors are being plundered is clear.  The WHY is not so clear.  Although the financial pundits are yapping endlessly about the situation in Cyprus, most are stuck on 'yap' with very little substance, except for Reggie Middleton who runs the Boombustblog.com and is published at Zero Hedge.

What Is The Value Of The Gas Assets That Cyprus Pledged To It's Bank Depositors?

Following yesterday'shighly analytical rant on Cypriotic bank nonsense, I present an interesting analysis on the value of the gas assets pledged to those who's bank accounts may be clipped by the Cypriotic government/ECB. For those who don't know, the proposal was to compensate those who were subject to the tax/levy on their bank accounts with bonds linked to the output of Cyprus natural gas mines. Of course, the first question anyone should ask is "Why not simply pledge the gas assets directly to the ECB vs stealing from the bank depositors?" I think we can all ascertain the answer to that question. I was tweeted an analyst by Anthony Alfidi wherein he delved into the fundamental value of the exchange. I would like to reproduce a portion of it here. The balance can be found on his site.

Cyprus Bank Deposit Levy and Natural Gas Bonds

Cyprus' president has pledged to cover the value of its imminent savings deposit levy with an equivalent value of natural gas bonds. It's hard to say whether Cypriot savers should take this promise seriously without some analysis of its viability.
Let's use the European bailout sum for Cyprus of US$13B as a proxy for the amount of savings about to be confiscated from Cyprus' resident depositors. I need a proxy because I have no idea how much the government of Cyprus will actually collect from this levy. The natural gas revenue needed to back the bonds that would make savers whole would likely come from the Aphrodite field. Title to this field is unclear; Turkey has made a competing claim for the sovereign right to control drilling.

This is the likely answer to the quetion above. If the ownership and rights to the mine are in question, then it is essentially an encumbered asset. As such, how is it Cyprus's to pledge to anybody? May I add that Turkey actually has a functional military, and Cyprus has???

There is currently no pipeline from Cyprus to either Turkey or Crete which could deliver the gas to market; that would cost US$1B to build and Cyprus has no money. Building a $10B LNG terminal is ten times as unlikely, because Cyprus is still broke. The energy supermajor that ends up building it will get the lion's share of the revenue from the gas field as compensation for its costs and will have to deal with the likelihood of being shut out of other projects in Turkey.

Again, exactly how will this gas asset be monetized? I have not verified the facts and calculations behind this article, but if they ring true, then it appears that Cyprus is pledging the option of future development to a gas asset that it MIGHT own in exchange for actual cash in terms of what is being offered to bank depositors. So, the most valuable asset possible (actual cash denominated in a major currency) is being exchanged for an option on an undeveloped asset whose ownership and right to pledge/transfer is undetermined. Does this sound like a good deal to you? And we haven't even started to glean the actual fundamental value yet?

The lack of drilling and delivery infrastructure means that no Aphrodite gas will go to Europe until 2018 at the earliest. A lot can happen with the price of natural gas in five years. The wide availability of shale gas in the U.S. will keep the price down in North America. Europe's need for gas is met mainly by Russia, and Gazprom can adjust its rates at will to pressure Russia's neighbors.

And such pressure is guaranteed if Russian citizens are to lose the 2 billion or so euros to the Cyprus bailout levy that is being bandied around.

Apparently, the Aphrodite gas field is loaded with gas and oil as Turkey makes a probably futile attempt to claim those resources, here.

'Noble Energy received the concession to explore block 12 in October 2008.[6] In August 2011, Noble entered into a production-sharing agreement with the Cypriot government regarding the block's commercial development.[7] Sources in Cyprus indicated in mid-September that Noble had commenced exploratory drilling of the block.[8]

Cyprus demarcated its maritime border with Egypt in 2003, and with Lebanon in 2007.[9] Cyprus and Israel demarcated their maritime border in 2010.[10] Turkey, which does not recognize the border agreements of Cyprus with its neighbors,[11] threatened to mobilize its naval forces in the event that Cyprus would proceed with plans to begin drilling at Block 12.[12] Cyprus' drilling efforts have the support of the United States, European Union and United Nations, and on September 19, 2011 drilling in Block 12 began without any incidents being reported.[13] The development of oil and gas resources in the Cypriot Exclusive Economic Zone (EEZ) abide to the UN Convention of the Law of the Seas (UNCLOS) which the Republic of Cyprus ratified in 1988.[14]

According to Noble Energy, a total gross unrisked deep oil potential is 3.7 billion barrels (590×106 m3). The field has a gross mean average of 7 trillion cubic feet (200 billion cubic metres) of natural gas with an estimated gross resource range of 5–8 trillion cubic feet...

Who is Noble Energy?  It's headquartered in Houston, TX and its Wikipedia history is here.  The Board of Directors, here, includes alumni of Goldman Sachs, Merrill Lynch and energy executives.

Meanwhile, the giant state owned Russian oil company, Gazprom, has offered to bailout the Cyprus banks in exchange for exclusive exploration rights.

Gazprom’s audacious offer to bail out Cyprus in return for its natural gas

Talk about buying low and selling high. Gazprom, Russia’s state-owned oil company, reportedly offered to bail out Cyprus’s troubled financial sector in exchange for exploration rights to the country’s natural gas.

Cyprus is holding a bank holiday until Thursday as it works to finalize a deal with European leaders that would rescue the country, but the tentative agreement includes a controversial provision taxing bank depositors, one that even conservative German newspapers think is a bad idea.

Hence Gazprom sweeping in with its “friendlier” rescue offer. It’s not clear if they wanted to take over the entire bailout, which would cost roughly €16 billion, or merely the depositor bail-in of €5.8 billion, but either way they’d be getting a pretty rock-solid deal: The gas reserves could be worth as much as €300 billion, though it would likely take about seven years of development to start exporting gas and collecting revenue, not to mention fears of competing claims on the reserves from Turkey.

Cyprus rejected the offer, preferring to refine the fiscal program it is negotiating with the European Central Bank, European finance ministers, and the International Monetary Fund, which will likely include some concessions from the Russian government, which made an emergency loan to the country last year.

The irony here is that one of the reasons Cyprus’ bailout is so unpleasant is that it acts as an off-shore financial center for Russia, whose residents and corporations have as much as US$19 billion in the country’s banks and stand to lose about US$2 billion if the depositor tax goes through. A significant motivation for the deposit tax was to make sure that foreigners taking advantage of Cyprus’ bank secrecy laws and low taxes would take part of the hit. A partnership with Gazprom, in exchange for exploration rights, would have further solidified the island’s status as a Russian client.

The Cyprus government is trying to use its gas reserves to keep people from pulling their money out of the country, offering to compensate depositors with securities linked to the reserves. While the long time-horizon on returns from those securities might be scant comfort to private investors who fear losing money they keep on the island nation, the ability of the Cypriot public sector to manage those reserves in the long-term is one the country’s bigger advantages in digging itself out of its fiscal hole.

A Texas oil company, a Russian oil company, Russian oligarchs, banksters, big oil, and Turkish claims to the oil/gas patch all combine for very intriguing geopolitics. All of which makes what is happening in Cyprus even more repugnant - with so much BIG money vested in Cyprus energy resources, why stiff the ordinary Cypriot depositors?

Is the Cold War about to reappear and heat up into a HOT war as US/EU interests clash with Russian and Turkish interests?  The Turks and the Russians hate each other but the US has always been committed to advancing the US/British Empire and that almost always requires squashing Russia.  But Russia isn't broke and bankrupt like the US and the EU.  It's rolling in energy wealth as well as other natural resource wealth.  Russia has been stockpiling gold for years.

Currency Wars Escalate: Russia Stockpiling Gold

Of course, all the vultures are circling the fiat monetary corpses and even before they keeled over and officially croaked but croak they will.   The smart money recognizes a walking corpse when it sees one.  How long can the EU and the Euro last before the whole failed experiment in fiat money propelled statism finally implodes?  How long can the US continue to spend, print and borrow?

Meanwhile, the world is waiting and watching......

Cyprus?  They've got something that the stooges who lord over the planet want very badly.  At the end of the day, it's always about money and resources.