Irish lesson - post scriptum

In an article "Irish lesson" published on this blog on 14 August 2010, the author argued that the UK credit rating will be cut by the rating agencies, despite (or rather because) of the government savings, public spending cuts and austerity measures.

Recently a credit rating agency, Moody's, has confirmed such an intention.

The so-called "financial markets" have become so transparent, conspicuous and predictable in their rather crude ripping off strategy of the taxpayers that it defies belief. It adds insult to injury: this is exactly like a burglar sending an advance notice to his victims and then robbing their homes in front of their eyes.

We are getting poorer

Let us look at the current economic figures as reported tonight by the BBC (interest rates given are per annum):

On the "costs" side: the Consumer Price Index is currently running at 3.1%. The Retail Price Index, which reflects the real increase in costs of living, is currently running at 4.8%.

On the "income" side: the wage rise is currently running at 2%. The Bank of England interest rate is currently 0.5% and it is difficult get anything above that on the savings.

Our savings are eroded by a staggering 4.3% a year. Shockingly it is more than Halifax standard variable rate which is at 3.5% a year. However those with mortgages are not that lucky since, typically, they have to earn their living. Their wage is shrinking by 2.8% a year. This is offset to some degree by depreciation of the loan value if an interest of the mortgage is below the rate of inflation (using Halifax rate it is 1.3%). These figures are striking: we are all ripped off, savers or mortgage payers alike. The economy remains in a morbid state.

What does the above tell us? We, the taxpayers, are getting poorer. With trillions of pounds circulating in the economy the difference between "costs" and "income" is substantial. And growing (in an exponential way, i.e. very fast indeed). So on the whole we are getting much poorer. It is clear that this is a process, executed in a rather clandestine way, of inflating out the current liquidity crisis since the effective interest rate (interest rate minus inflation) is negative. This is the way we are paying for the largest heist in history. It begs a question why neither politicians nor mainstream media discuss this aspect of the current economic situation.

Irish lesson

The UK government was warned in the article “Prime Minister, sort out this mess, please” about the risk that by making all the savings and cuts, without taking adequate protective steps, it is is “inviting” the “financial markets” to downgrade the UK rating. I.e. the saving and cuts are very likely to be perceived by the “markets” as the government's increased capacity to borrow short term by the amount of those cuts and savings. Hence it will be able to pay more in interests to the “financial markets”. There seems to be a little doubt that the “financial markets” are not going to miss such opportunity to get even more money from the taxpayers. “Financial markets” have a very short term strategies. Practically it is all about to the next bonus, a Madame Pompadour view of the world: “aprés nous le déluge”. As it seems the credit rating agencies do not play a role of objective judge of credit worthiness but are merely tools for making money by the “financial markets” players.

After the article “Prime Minister, sort out this mess, please” was published this is precisely what happened to Ireland. On 19 July 2010 The Irish Times announced having made massive spending savings, cuts and implemented austerity measures, Ireland rating was downgraded. The same strategy of the “financial markets” can reasonably be expected towards Britain. This is how the "financial markets" work these days. Indeed they are already half way there, i.e. the government announced saving and cuts without taking adequate protective measures. And the reasons for the UK downgrade will not be important: they will always be found.

Heading towards global Zimbabwe?

On 9 August 2010, BBC Newsnight reported that $1 trillion stimulus package was not sufficient v, "the recovery is losing momentum" and that quantitative easing (QE) is now expected to follow, to stimulate the economy.

In her report, a BBC Newsnight journalist, Ms Naga Munchetty, gave an explanation what QE was. Her account was absolutely consistent with the foundation premise of this blog, and the analysis based on it. The current crisis was caused by the financial institutions that constructed a giant pyramid scheme (by lending with loan to deposit ratio greater than 100%, thereby generating in a run away manner a massive and uncontrollable money multiplier).

Ms Munchetty said: "Quantitative easing is likened by some economists to pouring liquid down the black hole in the dark." This black hole is nothing mysterious. In fact it is the amount of money needed to reduce the current massive level of money multiplier to an acceptable level. Smaller money multiplier means higher financial liquidity as one dollar of real cash has a smaller number of dollars of liabilities to serve. Historically, when economy functioned properly, it used to be in 5 - 8 region. In simpler terms, this is printing money to support the financial pyramid so it does not run out of cash. Had Albanian gangesters been allowed to do the same in 1997, their pyramids would not have collapsed either. However they did not have a clout of the modern days' financiers to convince Albanian government that this was the "right" way forward.

Ms Munchetty continued: "It's hard to tell how deep the hole is, or when you are close to filling it up." This precisely refers to the fact that we do not know the current level of money multiplier. (As it has been proved on this blog this is a direct result of a lending with loan to deposit ratio greater 100%: it is its characteristics. It is a loss of control of money multiplier resulting from lending with loan to deposit ratio greater than 100%.)

The filling in"holes of confidence", i.e. restoring confidence between banks, companies in the commercial world, mentioned by Ms Munchetty is simply a reduction of money multiplier to an acceptable level. It is also clear why banks are not lending: they hold off to QE money as it reduces the money multiplier, which any lending whatsoever would have increased (even with a minimal loan to deposit ratio).

However, contrary to what Ms Munchetty's suggested, "what happens next" once the black hole of liquidity is filled up is completely predictable. Once money multiplier reaches acceptable level, the banks will start lending again. It is their business and in fact they are urged to do so by politicians and business people. At that point the QE money, trillions of dollars will find its way to the market and will get multiplied. Even if the banks lend with a very low loan to deposit ratio of 50%, this money will be doubled. If they use a conservative 80%, a much more realistic scenario, the money will be multiplied by 5. I.e. every trillion of dollars in circulation will very quickly create a demand for 5 trillion worth of products and services in the current low inflation economy. To economists who "do not know": this means, surprise, surprise raise in inflation at an instant. Now you have been warned.

Any suggestion - supposedly by some economists - that printing money will result in economic growth, as Ms Munchetty also mentioned, defies belief and rational thinking. If that was possible any country would grow its economy by printing money. We all would be rich without doing much work (apart from running the printing presses). Presently Zimbabwe would have led the world as the most successful economy. It is simply amazing what some bewildered or dishonest economic pundits come up with trying to avoid the central issue of this crisis: the financial system has been a massive pyramid scheme with all its fraudulent characteristics.

"Hier liegt der Hund begraben"

In Britain, the politicians are putting pressure on the banks to start lending. The public pressure and the media are also adding to it. It has been going like that, on and off, for some months, well over a year. Yet the banks whose primary business is to generate income by lending money are not doing so. Why something that was banks "raison d'être" and "modus operandi" for hundreds of years until the outbreak of the current financial crisis in September 2008, became so problematic. Is it not bizarre?

The public perception of the banks is that they are nasty. That it is all down to greedy irresponsible bankers that act against the national interest. Whilst it looks like a reasonable assessment of the state of the banking, it does not explain the root cause. If the banks had had money they would have lent it: this is the business they know very well for centuries and it is very profitable.

The crux of the matter is that by creating a massive pyramid scheme the banks pumped out the massive amounts of cash from mainstream banking to shadow financial institutions, hedge funds, offshore, SIV, etc. The money multiplier (in a simplified way called the leverage) is far too big to allow for further meaningful lending. The money put by taxpayers rescued the system but it was not enough to fill the liquidity hole sufficiently enough so as to reduce money multiplier to manageable level. In fact the government does not know what the size of liquidity hole is. In fact, due to the nature of the OTC market and off balance sheet practices, it appears that it is impossible to assess it but strong indications are (e.g. figures by the Banks of International Settlements in basel) it is massive: globally hundreds of trillions or even quadrillions of dollars. Many times over the world's GDP. Any lending, even very conservative, increases money multiplier still further.

The banks are caught in a "damn if you do, damn if you don't" situation. If they start lending as politicians and the public expect, they will deteriorate still very fragile liquidity situation, with a high risk of another massive credit crunch. If they don't, the economy recovery is very seriously impeded which also has a very serious impact upon the financial markets liquidity. "Hier liegt der Hund begraben."

No politicians' appeals are going to change any of that. They are, in fact, quite populist and rather incompetent. Or maybe bankers are expected impossible, to create a pretext to get them by the throat and sort them out? Politicians becoming more clever than bankers? "Exitus acta probat." Banks do not lend because they cannot. The solution is a reduction of money multiplier: "Prime Minister, sort out this mess, please".