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“The banking crisis in Cyprus is worsening, Eric.  The banks there remain shut as the Cypriot politicians scramble for a solution to bailout that country's banks.  The banks were supposed to re-open this past Tuesday after a 3-day weekend from a national holiday.  Then they were supposed to open today, but they remain shut.  Now the authorities say they will open on Tuesday.  But who knows?  They could remain closed for days or even weeks, given their dire financial condition.

In fact, the EU authorities say that the Cypriot banks are insolvent....

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“In other words, the liabilities of these banks, which are mainly the money it owes to depositors, are far greater than the value of the banks' assets, even after accounting for bank equity and any reserves.  This insolvency of course did not happen overnight.  It has been going on for months - actually years and took a turn for the worse when Greece fell over because the banks in these two countries are so closely interlinked.  One has to ask why this insolvency was allowed to happen?

The answer isn't pretty.  Cypriot politicians and the bankers themselves conspired with the European Central Bank, with the blessing of EU politicians, Brussels eurocrats and IMF bureaucrats, to try to sweep under the rug the reality of the situation.  I guess they were hoping that by pretending that all was well, the problem would go away - or someone else in the future could deal with it when they were no longer in office.

Cynics of this practice are often criticized by central bank apologists for calling this policy one of "extend and pretend", but it is an accurate description.  The ECB and IMF extend loans to keep the banks liquid and then pretend all is well while hoping things improve.  But they rarely do.  Bad assets like defaulted loans have little or no value, which creates a black-hole on the asset side of bank balance sheets.  When that black-hole is greater than bank capital and reserves - as is the case with Cypriot banks - a bank is effectively bust.  

Papering over these bad assets does not make them good again; it simply hides them and thereby disguises the fact that bank assets are less than bank liabilities, i.e., the money the bank owes depositors.  So kicking the can down the road is never a solution because reality always hits eventually, and right now it is hitting Cyprus like a tsunami.  To put it bluntly, Eric, its banks are busted.  But we are just starting to see the knock-on effect from this bank holiday.

For example, merchants in Cyprus have moved to a cash-only basis.  They no longer accept credit or debit cards because they do not know when - or if - they will ever get paid by their bank.  Then, consider everyone who can't access their money. 

In addition to all of the people who have money deposited in these banks which they can't access, there are also thousands of international companies that are shut-off from their money.  They cannot make the payments they planned to settle bills, nor receive any money that they were expecting.  There is going to be a severe impact on economic activity, not only in Cyprus itself, but wherever these international companies operate.

In this respect, this situation in Cyprus reminds me of the Herstatt Bank failure in 1974 which turned into an international crisis, even though it was just a medium-sized bank in what was then West Germany.  Herstatt went bankrupt and shut its doors before paying out $200 million that was owed to many companies and banks around the world.  That was a lot of money back then after adjusting for inflation and the size of the global economy four decades ago. 

When these companies and banks didn't get their money, a daisy-chain of defaults and near-defaults spiraled out of control for months.  One casualty was a New York bank called Franklin National, which was up to that time the largest bank failure in US history. 

Franklin National failed about two months after Herstatt collapsed, which highlights an important point that I cannot stress enough.  The fallout from this banking collapse in Cyprus is likely to last for weeks, maybe even months.  What's more, just like Herstatt's collapse had an impact far beyond the borders of West Germany, so too will this failure of the Cypriot banks.  This interlinking of the financial system is the nature of banking today and one of the financial system's greatest vulnerabilities. 

When one bank goes bust, others inevitably follow.  It is just a matter of “when”, not “if”.  And the when depends on how long the authorities pursue their “extend and pretend” policy, which in the case of Cyprus is not much longer.  The ECB said after Monday it will no longer make loans to provide Cypriot banks with liquidity.  Thus, Cypriot authorities have to come up with an estimated €6 - €10 billion by Monday to plug the black-hole on the asset side of the aggregate balance sheet of Cypriot banks. 

Can they do it?  We'll have to wait and see.  There are a number of proposals on the table.  Right now they are begging hat-in-hand for some kind of deal from Russia.  They are also proposing stealing what is in private pension plans, like Argentina did.  Ireland and Spain, in effect, did the same thing by taking the good assets in those plans and replacing them with their own debt, which of course is essentially junk-rated.  As I mentioned when we spoke on Monday, the rule of law is being eroded everywhere.  Private property is under threat.

The fallout from the Cyprus banking collapse cannot be predicted.  We just have to wait and watch to see how things unfold.  But clearly, the best way to do that is to watch while sitting with the safety provided by your physical gold and silver - your money outside of the banking system.  Because they are money outside the banking system, you do not have counterparty risk.  These tangible assets that you own and store safely are not based on any bank's - or politician's - promise.”

© 2013 by King World News®. All Rights Reserved. This material may not be published, broadcast, rewritten, or redistributed.  However, linking directly to the blog page is permitted and encouraged.

The interviews with Gerald Celente, Michael Pento, Nigel Farage, Eric Sprott, Dr. Paul Craig Roberts, Egon von Greyerz, Rob Arnott, James Turk, Jim Sinclair and Andrew Maguire are available now.  Also, be sure to listen to the other recent KWN interviews which included Marc Faber, Felix Zulauf and Art Cashin by CLICKING HERE.

Eric King

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