In an unexpected twist, the small island nation of Cyprus has cast a shadow over Europe, stirring emotions reminiscent of a frosty December. For a fleeting moment, the Cypriot legislature boldly rejected the EU, ECB, and IMF’s so-called “stability levy,” igniting hopes for a significant shift in the financial landscape. We were poised on the brink of witnessing a seismic collapse within the banking sector.
It seemed the potential loss of deposits could warrant sacrificing an entire country’s banking institutions, ushering in a much-needed lesson on sound banking practices for generations to come. Future Cypriots might inherit a resilient financial system grounded in reality rather than a fragile array of paper promises.
Regrettably, such aspirations were short-lived. As it turns out, the politicians had alternative, less prudent strategies in mind. Reports indicate one potential route involved deepening financial ties with Russia, while another, labeled “Plan B,” proposed nationalizing pension funds, issuing emergency bonds linked to future natural gas revenues, and revising the stability levy to primarily target wealthier citizens.
In essence, the proposed solutions revolve around debt, appropriation, and targeting the wealthy. An authentic banking crisis could have ultimately served the interests of the average depositor better. While individual savings would be obliterated, those responsible for the current predicament—bankers and politicians—could finally see the consequences of their actions.
Feeding the Financial Beast
Meanwhile, across the Atlantic, Federal Reserve Chairman Ben Bernanke reaffirmed his commitment to support the financial system until the unemployment rate dips to 6.5 percent or until a truly disastrous event unfolds. Here are some key excerpts from Wednesday’s FOMC statement:
“To support a stronger economic recovery and ensure that inflation aligns with its dual mandate, the Committee has decided to continue purchasing additional agency mortgage-backed securities at a rate of $40 billion monthly and longer-term Treasury securities at a pace of $45 billion per month.
“To promote sustained progress toward maximum employment and price stability, the Committee expects to maintain a highly accommodative monetary policy for a considerable time after the asset purchase program concludes and the economic recovery strengthens.
“In particular, the Committee decided to keep the target for the federal funds rate at 0 to 0.25 percent and currently anticipates this exceptionally low range will remain appropriate as long as the unemployment rate exceeds 6.5 percent, inflation is projected to be no more than half a percentage point above the Committee’s 2 percent longer-run goal, and long-term inflation expectations remain well anchored.”
From our viewpoint, the creation of $85 billion monthly from thin air to sustain the mortgage and government debt markets will likely yield negative consequences. Nonetheless, Wall Street reacted positively, pushing the Dow up by 55 points.
Dark Clouds Looming Ahead
Indeed, history teaches us to seize favorable moments while they last. For the stock market, the sun has seldom shone so brightly since the fall of 2007. Speculators are utilizing unprecedented levels of margin debt to purchase stocks.
Unquestionably, the Federal Reserve’s objective is to encourage stock investments. Current policies render obtaining returns from Treasuries or CDs nearly impossible. As a result, stocks stand out as the sole option.
The Fed believes that inflating the stock market will create a perception of wealth among consumers. This sense of prosperity will spur spending, potentially igniting a genuine economic boom. Buoyed by consumer purchases, businesses would begin hiring, unemployment would decrease, and the overall outlook would appear bright.
But is that—a dark cloud from Cyprus—on the horizon, threatening to disrupt the Fed’s optimistic vision?
Perhaps it will merely be a light rain, nurturing the markets to grow and bear even greater fruits. Or, it could herald a storm that sweeps across Europe and beyond.
Just imagine the potential outcomes.
Sincerely,
MN Gordon
for Economic Prism