If you are new to this blog, you are invited to read first “The Largest Heist in History” which was accepted as evidence and published by the British Parliament, House of Commons, Treasury Committee.

"It is typically characterised by strong, compelling, logic. I loosely use the term 'pyramid selling' to describe the activities of the City but you explain in crystal clear terms why this is so." commented Dr Vincent Cable MP to the author.

This blog demonstrates that:

- the financial system was turned into a pyramid scheme in a technical, legal sense (not just proverbial);

- the current crisis was easily predictable (without any benefit of hindsight) by any competent financier, i.e. with rudimentary knowledge of mathematics, hence avoidable.

It is up to readers to draw their own conclusions. Whether this crisis is a result of a conspiracy to defraud taxpayers, or a massive negligence, or it is just a misfortune, or maybe a Swedish count, Axel Oxenstierna, was right when he said to his son in the 17th century: "Do you not know, my son, with how little wisdom the world is governed?".

Friday, 18 November 2011

Budget. What budget?

It is not that long ago when the Chancellor of the Exchequer (the British Finance Minister), Gordon Brown, was preaching the virtues of a balanced budget. In fact this was a commonly accepted wisdom: in a period covering up and down ("boom and bust") of economic cycles governments should balance their budgets. They should have neither surplus nor be in debt. There was a debate how it can be achieved. One approach was that a surplus produced during good times is saved and then used in bad times. The government is never in debt and any surplus is kept as a reserve for bad times. The opposite approach is that during bad times the government gets into debt which is then paid back during good times. The practical solution would be somewhere in between. Precisely where, can be the subject of pragmatic arguments and philosophical debates. What had never been put into question was the entire concept as it clearly makes sense.

After the outbreak of the current financial crisis when governments had spent massive amounts of monies to subsidise the collapsing financial industry, the concept of the balanced budget remains forgotten. Now the real issue is the maximum level of debt governments can sustain in servicing it. In practice it means that governments would remain in maximum permanent debt paying maximum amounts in interest and service payments to the financial industry. And whenever the capacity of repayment appears the debt will be increased, rather than repaid, so the maximum level of permanent interest and service payments to the banks is maintained. Such increase of debt can be achieved through various mechanisms like additional bank's bailout or a downgrade in the credit rating. This is a classic strategy that loan sharks use against their victims: this is how the financial industry - with politicians as conduits - treats the taxpayers now.

This current level of governments debt is a direct result of banks' bailouts. These bailouts broke the traditional economic cycle of "boom and bust". Indeed Gordon Brown's claim that "boom and bust" in the UK was abolished seems correct. But not in a way that Mr Brown would have hoped: the UK ended up in a state of permanent, or at least very long term, "bust" state. When the British government rescued banks to the tune of £65 billion (of direct costs) in 2008 it was not just about £65 billion, a massive amount of cash as it was. These £65 billion ended up in banks coffers filling up the liquidity hole which was created by the banks running a giant pyramid scheme. Banks did not start lending and it was obvious that they could not have started doing so. So £65 billion did not end up in real economy but in the banking system securing interbanking transactions against toxic waste which were generated by the pyramid process. Needless to say these £65 billion generously helped to fund the financiers remuneration.

This £65 billion debt is not just a normal government debt as it would have been if this money had been spent in the economy through tax cuts or public spending. If the banking system was relatively healthy (i.e. did not require rescuing and was not such a pyramid as it is) and the government borrowed additional £65 billion, to fund tax cuts or to spend on public investment programme to stimulate the economy, then through the healthy banking system credit creation cycle this £65 billion would have been multiplied seven to ten fold. Therefore the debt directly generated to rescue the banks in the UK in real economic terms cannot be considered as additional £65 billions on the government balance sheet but as £455 billion to £650 billion lost opportunity costs of the real economy.

Bailouts, such as one in the UK, happened in the US and the entire eurozone. It is economic value is not in hundreds of billions of euros or dollars, but in serious trillions. And it keeps growing. The financial system which was turned into a classic case of a pyramid scheme (in legal and technical terms) and which the governments decided to support, is killing off the real economy. The idea of a balanced budget is unlikely to come back soon.


  1. And so?
    Like so what.
    The bankers who are now known psychopaths will continue to pull stunts like this
    They know we will never remove their heads, never set fire to their children, never disembowel their wives
    No rule by anyone who is not a psychopath is pure madness!
    If we cannot kill them, as is Gods command, we should decapitate their children, set fire to their wives!
    It is only a free market until I am under threat, you will be the sacrifice that restores the freedom to me DO AS I SAY OR I WILL SACK YOU!

  2. If you are going to waste your money on something this Christmas, make it the head of a banker

  3. Greg -
    I like your blog & agree with much of it , but one conviction you hold bothers me. The idea that banks are reserve constrained ( lending wise) - that bank reserves are neccessary to fund lending - appears to me, as a matter of simple observation, to be mistaken.

    (See the quote below)

    Wondered if you'd care to comment ?


    Over forty years ago, the then Senior Vice-President of the New York Federal Reserve, Alan Holmes, pointed out that this perspective in which the aggregate level of debt does not matter, and banks are mere intermediaries between savers and lenders, was erroneous. He argued that the view “that the banking system only expands loans after the [Federal Reserve] System (or market factors) have put reserves in the banking system” was based on “a naive assumption”. Instead, he argued,

    ‘In the real world, banks extend credit, creating deposits in the process, and look for the reserves later. The question then becomes one of whether and how the Federal Reserve will accommodate the demand for reserves. In the very short run, the Federal Reserve has little or no choice about accommodating that demand; over time, its influence can obviously be felt.’ (Holmes 1969, p. 73; emphasis added)...

    This experience-based judgment was subsequently confirmed by empirical research by the Post Keynesian economist Basil Moore (Basil J. Moore, 1979, 1988, 2001, 1983), and even by the founders of Real Business Cycle theory (Finn E. Kydland and Edward C. Prescott, 1990). This led to the development of the model of “endogenous money”, in which a loan is regarded not a transfer of spending power from a saver to a lender, but a creation of spending power for the borrower by the bank ab initio. This modern Post Keynesian theory in fact rediscovered an argument first put by Schumpeter, that banks create money simply by an accounting operation: a loan extended to a borrower creates both debt and spending power “out of nothing”:

  4. Hi chaingangcharlie, thanks for the nice words. But I do not feel I am specialist on running monetary and fiscal policy in broad economic terms. What I am a specialist is risk analysis of specific situations. For example I am not defending a fractional reserve banking on my blog. Depending how it is put into practice it has its risks. I am minded to accepted that these are manageable risk provided honest and competent people deal with it (and this provision creates additional risk, but this is life).

    What I am proving on my blog is that the current financial system degenerated into a fraud. It is a pyramid scheme (constructed through the system which I called a depleting reserve banking). As such the risks of pyramids schemes are unmanageable, pyramids have to collapse (and that's why they are illegal).

    Have a look here: http://gregpytel.blogspot.com/2011/10/its-pyramid-indeed.html (together with links there)

    I think you should find it of some use

    Best, Greg

  5. Hi Greg,

    Thanks for the reply, & I will certainly check the links.

    I am not a specialist in anything remotely relevant, but Steve Keen ( whose article I quoted above) couldn't be more in agreement with you that bank lending over the past 20 (?) years or so has been basically a Ponzi Scheme. ( Incidentally Keen was one of the very few economists who predicted the great crash of 2008 ).
    His point re fractional reserve banking is that we don't actually practise it, and that what we DO practice is just so much * worse.*

    At least in classical FR banking, loans are to *some* extent limited by available deposits. In the system that we ( de facto) have , there are really *no* limits on lending whatever. Banks 1) make whatever loans they feel are good bets, and then 2) go begging the cenral bank for reserves to cover the loans later. As the article says "In the very short run, the Federal Reserve has little or no choice about accommodating that demand" , though in the long run they can whack up interest rates to choke off the demand.

    For what purpose have banks been wildly lending these past N years ? Investment in sound long term business propositions ? Or consumption (!) & asset price bubbles ? ( OK we lend you M million for some cool buy to let speculation..) .

    All is obviously fine ( or better ) till enough people start to scratch their heads & 'take profits' , and at that point the whole disastrous Ponzi Scheme falls over, a la 2008.

    Strange to be in a position where FR banking looks downright *conservative* compared to what we have.


  6. Hi CGC,

    "Strange to be in a position where FR banking looks downright *conservative* compared to what we have. "

    It is impossible to put better:-) I think I put this on my comment banner.

    Best, Greg