Is the Latest Ultimatum in Cyprus About to Derail the Eurozone?

You probably know the story by now.

Following riots in the streets and a run on local banks, Cypriot lawmakers voted down a key element of the European Central Bank's (ECB) bailout proposal that would have required the country to impose a one-time 9.9% tax on bank deposits of more than 100,000 euros and a 6.75% tax on bank deposits under that amount.

I can understand why people took to the street - the "tax" was little more than organized robbery under the guise of keeping that country afloat.

Why should you care about what happens in Cyprus?...

Cyprus is not Las Vegas. What happens in Cyprus cannot possibly stay in Cyprus. The world's financial markets are too interlinked. Ultimately, it is a move intended to keep the euro afloat at any cost.

The Desperation Behind the Cyprus Bailout

In this case, three banks control 60% of the country's 150 billion euros in total banking assets, at a time when Cypriot bank assets exceed 835% of the country's 2011 national income, according to the IMF.

Those same three banks - Bank of Cyprus, Laiki Bank and Hellenic Bank -- lent heavily to other failed economies throughout Europe such as Greece, where loans to the troubled Mediterranean country all by itself amounted to 1.6x the entire Cypriot GDP.

Now they need to find 5.8 billion euros to bail the mess out.

Eurozone politicians and bankers are anxious to have the world believe this is a carefully measured negotiation. In reality it's a move that reeks of desperation no matter what they call it - a tax, a levy, or even a bailout.

Why I think so is pretty simple.

Banks are fiduciary institutions. They rely almost entirely on trust and confidence. If there is a breach of trust - for any reason - the banks are cooked.

Individuals deposit money in banks instead of stuffing it in their mattresses because they believe that their money will be safe there. Once they realize, or even suspect, that the money they put in the bank is anything but safe, they will take whatever's left and run - and the bank will collapse in spite of the "bailout."

Because the Cypriot banks are linked to investments and deposits throughout Europe, what's happening there highlights something I've talked about since this crisis began - the euro is a "house of cards," and should one country -- no matter how small -- decide to leave the European Union, the entire shootin' match comes tumbling down.

Anxious to prevent a run and complete chaos, the government has ordered the banks to stay closed until Tuesday in the wake of the ECB's latest ultimatum. That's the date the EU has set for Cyprus to get its affairs in order and prevent a financial collapse -- not to mention a messy exit from the euro.

The psychology is very interesting to me because this saga highlights the split between Europe's "haves" and "have nots." After years of bailouts, the northern nations have had it with paying for the fiscal mistakes of their southern partners. The two-speed economy I wrote to you about several years ago seems to be a de facto truth now.

Now you'd think they could just figure a way out of this mess, but that's extremely unlikely because this crisis is happening at a time when socialist leanings are overwhelming the need for fiscal reform. There's a leadership vacuum across Europe (and in the United States) that's preventing politicians from telling people the truth -- which is that they are going to have to make tough, unpopular decisions to resolve this mess.

It's made far worse by the fact that central bankers are repeating errors that are well documented in the historical record, not the least of which is thinking they can print more money to solve everybody's problems.

The Key Takeaways for Investors

I expect the ECB and IMF to resist additional losses so they will inject, print, inflate, bamboozle and con their way through increasingly creative stimulus packages - the EU's ultimatum is a smokescreen for the bigger picture and the bigger players.

So don't sell prematurely. The last place you want to be is on the sidelines if a deal is reached at the 11th hour.

If it isn't, that's not necessarily a bad thing. A little financial honesty would do Europe good at this point in the scheme of things. But absolutely make sure you have trailing stops in place as we head into the weekend. That way you can harvest gainers and protect your capital at the same time if things do get bumpy next week.

No matter what happens come Monday, I expect renewed interest in gold...but after a short-term decline. This will catch a lot of people who are expecting an immediate run by surprise. The key to this lull is the false sense of relief that will accompany any newly injected "liquidity" no matter how convoluted any "solution" actually is.

Bear in mind that nothing in the underlying markets has changed. Whether Cyprus is a part of Europe or not has no bearing on the euro. It's a wreck now and it will be a wreck come Monday.

Traders know this, which is why the really big move here will be to the U.S. dollar and, to a lesser degree, the Japanese yen. The former is because it's the best-looking horse in the glue factory, while the latter is simply because it's a force of habit for traders looking to go "risk-off."

This favors U.S. equities at the moment, and is a renewed opportunity to short the yen if it rallies. Japan still has the worst demographics on the planet, and longer term that's a negative, not a positive. As for the euro, there really aren't a lot of reasons to buy it. In fact, I'd be a net seller.

Second, get ready to pounce.

If Cyprus does derail the Eurozone, we're going to see everything from ABB Ltd. (NYSE:ABB) to Nestle SA (VTX: NESN) put on sale.

And you don't want to walk by the bargain basement bin when it happens this time around any more than you did in March 2009...right before the markets "melted up."

As for how this situation may play out, Hollywood couldn't come up with a more subtle story of international intrigue.

Both Russia and China have long angled for ports and energy rights in the region. Even if the IMF and ECB do come forward with some sort of liquidity arrangement, expect one or both nations to wind up with enhanced interests in the region. I think some mix of deep water ports, more extended lending arrangements, and newly acquired rights to energy reserves and drilling in the region are distinct possibilities.

The EU's political leaders and Washington's strategists will go apoplectic, because a Russian or Chinese presence in the middle of the EU is not something they want to see.

But there's nothing they can do about it. Fresh lending in exchange for prize assets is the ultimate discipline in capitalism.

If you're out of money, creditors take prize assets. That's just the way it works. It's a reflection of the ultimate Golden Rule - you know the one - he who has the gold makes the rules.

Right now, it looks like the European Union is coming up empty.

[Editor's Note: Keith Fitz-Gerald's Strike Force is designed to take advantage of the wild volatility that's a hallmark of today's stock market... And it is on fire!

In 2012 alone his readers closed out 16 double- and triple-digit gains, including a whopping 200% gain on one of the most lucrative energy deals of the year.

And now until midnight tonight, you can get immediate full access to his Strike Force model portfolio for just $99. But that's only a small part of this story. The same deal includes a "test drive" all of our premium services but one. That's $27,500 in research, for just $99! You can go here for the details]

Related Articles and News: