The ECB decided to subsidise private banks

Italy has to roll over 306.9 billion in Eurobonds in 2012. The interest rate it has to pay is around 7% and is highly unlikely to be any lower. There were concerns that Italy would not be able to refinance its debt on the markets. The European Central Bank (ECB) was not willing to step in directly but it had a trick up its sleeve and decided instead to lend nearly 500 billion Euros on 1% annual interest to the private banks on 3-year loans. The banks will buy Italian bonds and will cash a massive interest rate differential (4%, 5%, 6%). This differential would have only made sense if lending to private banks were significantly less risky than lending directly to Italy by buying its bonds. But this is not the case: if Italy defaults on over 300 billion Eurobonds, the private banks will also default on their debt to the ECB and quite likely will collapse altogether. It is that simple. And who is backstopping the ECB if this catastrophe happens? The European taxpayers of course.

This is ridiculous. This is the way the financial industry gets subsidies from the taxpayers. This is yet another example of the mechanisms of "the largest heist in history", and it is one of the most primitive kind. There is no sophistication whatsoever here: this is daylight robbery carried out with brute force. By comparison Albanian pyramids of 1996 - 1997 look incredibly sophisticated and innovative financial operations. Capitalism is dead: long live communism for the rich.

The really alarming news is that it is not sustainable. A process of pure money printing cannot sustain the financial industry and the economy: Britain tried it in the 1970's, but to a much smaller extent, with heavy industries and failed miserably. In the same way as the subprime crisis brought the financial system down (only to be rescued by the taxpayers' subsidies), this kind of massive cash printing will bring European economies down. This is how this financial gangrene spreads. The later it happens, the more spectacular it will be.

Democracy on the ropes

(This article was first published on openDemocracy / ourKingdom website titled: "Capitalism no longer exists: it's communism for the rich" on 5 December 2011.)

From a free market, capitalist, laissez-faire perspective the state of the economy and the roots of the current financial crisis look far worse than Occupy London activists think. They criticise basic premises of capitalism: profit making, fractional reserve banking, fiat currency. But the fact is that the current economy and the financial system has nothing to do with them any longer. Capitalism as we had known it till the end of 20th century was turned into a global fraud enterprise, illegal under the existing laws. As recent events in Greece and Italy showed it is now threatening the very foundations of liberal democracies.

Doing a ponzi

In the 10 years leading to the collapse of 2008, the financial system abandoned the fiat currency and fractional reserve banking. This was the system were the money, as the store of value, was underwritten by individual countries and multiplied in a controlled way from currency to broad money. Instead, the financiers and bankers started practicing a depleting reserve banking technique: a mechanism that replaces the currency, i.e. fiat money and legal tenders in the banks' reserves (in terms of their ratio) by papers generated by the banks themselves.

The typical loan-deposit ratio had always been below 100%, for every £1 deposited, the amount lent must be less than £1. With each cycle of lending and deposit the amount “created” tends to zero: the overall impact on the money supply is finite and measurable. And yet, in 2007 UK banks loan-deposit ratio was 137%. In other words the banks were lending out on average £137.00 for every £100 paid in as a deposit. This thereby increased the broad money to currency ratio with an exponential, run away pace; creation didn’t tend to zero, but to infinity [for a fuller account of this process please see The Largest Heist in History]. Because of the latter this mechanism is a classic example of a ponzi scheme, illegal under current laws and prohibited by regulations in all developed countries [for more analysis please refer to the publications listed below this article].

Who did it?

For the last couple of years there has been a fiction creeping into the mainstream media - e.g. BBC, FT, The Economist - that somehow it was the democratically elected politicians who were really responsible for the current crisis. It is a plausible proposition but only in a sense that the politicians allowed the fraudulent and illegal practices to be developed and conducted by the financial industry. But the problem is somewhat deeper.

Before the banking collapse of 2008 governments borrowed a lot of money. But neither Greece's nor Italy's nor the UK's national budgets were deemed as unsustainable. In fact the private banks were all happy to lend to governments in the US, the UK and the entire Eurozone at very good rates. It was only after the financial collapse that started in autumn 2008, when the governments borrowed heavily to rescue the banks from a complete meltdown, that the governments' debts have become an issue to the financial markets. In a nutshell, the governments that saved the banks and financial markets from a meltdown by borrowing huge amounts of monies are now being attacked for having too much debt by the institutions they saved.

In the background there is an issue of links between the financial and political worlds. In the UK everyone knows that there are revolving doors between the Westminster and the City. It is considered normal that successful politicians become top bankers and that top bankers turn into politics. Top bankers also play a key role advising politicians in their fiscal decisions and on the regulatory policy towards the financial industry. Names like Tony Blair, David Laws, Sir James Crosby, Sebastian Grigg come immediately to mind. Until recently all monies lent to governments were willingly lent by the financial markets. All governments' borrowing decisions and decisions on the financial regulation were taken by financiers or on advice of financial experts. In this sense: politicians and financiers are the same people.

There is only one key divide: the private sector pays much more than government, indicating where the loyalties truly lie. Therefore even if one accepts that the politicians borrowed too much money to fund their budgets it was at the advice of the financiers regardless. No one can possibly imagine a layman politician taking a decision to borrow tens of billions of dollars, pound or euros without taking professional advice from a financier, effectively an approval. Even the UK government was advised on the meltdown of the financial system by private financiers: BlackRock, Citi and Credit Suisse. There was no limit to the systemic conflicts of interest.

Doing a Scargill

The financial system, which still operates - from technical and legal perspective - as a ponzi scheme is at its limit. To keep it going it needs additional amounts of liquidity which can only come from the taxpayers. But taxpayers are not prepared to suffer ever more austerity measures in order to subsidise the banking and finance industry. To advance their interest the financial markets started changing democratically elected governments, in Greece and Italy, replacing the prime ministers with... bankers. Modern democracy in Europe is effectively being dismantled.

This situation is in many ways very similar to the collapse of the heavy industries in Britain in the 1970's. The management and trade union barons were demanding ordinary middle class taxpayers keep subsiding heavy industries as somehow indispensable. Now the financial industry is doing the same: their leaders terrorise the UK government in the same way as Arthur Scargill back in the 1970's and 1980's. The only difference is that Scargill and the trade unionists were fighting for jobs and livelihood of workers in a bona fide industry. The financial industry captains are fighting for multimillion pound remuneration in an enterprise which degenerated - from a technical perspective - into a global criminal enterprise. The British heavy industry of the 1970's became inefficient and unsustainable and had to collapse. The current financial industry, having been turned into a classic ponzi scheme - is also unsustainable and will collapse. The longer the governments support it, the more spectacular the eventual collapse will be.

The financial nomenklatura

The Occupy London protesters should focus on demanding the prosecution of the financiers under the existing laws, as fraud was committed by thousands on a global scale. Instead they are more concerned with old style left-right debate: capitalism as evil and socialism as salvation. This is irrelevant. Capitalism exists no more. It was replaced by a giant fraud enterprise akin to the old communism system. Communism for the rich that is.

In the Soviet style communism, which collapsed in 1989, the ruling class, nomenklatura, did not own capital. These apparatchiks were purely beneficiaries of running the countries. They had no long term interest in managing the countries wealth properly but in deriving short term benefits for themselves. Profits belonged to the few and losses were suffered by many. The capital was owned by the entire societies, and the entire societies suffered the consequences of the mismanagement and thieving of nomenklatura.

Very similarly now, to a great extent, the bankers and financiers do not own banks and financial institutions. They are owned by pension funds, saving policies and endowment policy holders, and even by governments and taxpayers. Effectively, the tax-paying middle class who saves and invests owns the financial industry which is in turn under the management of the bankers and financiers, the nomenklatura of the 21st century. And, like in the Soviet style communism system, these financial apparatchiks are not accountable to anybody but only interested in short term gains and squeezing as much as possible from anyone who has any money and cannot escape: by and large middle class taxpayers.

Heading for a meltdown

In the 1980's some reformers tried to make communism work better. They failed abysmally as they could not change the pathological habits and practices that had been instilled. No doubt there are reformers now, like Dr Vince Cable, who try to reform the current version of communism (for the rich). But the reformers have little joy. It looks clear that the financial system, like the old communism before it, is heading for a meltdown.

Whether this meltdown will take the shape of the Czechoslovakian "velvet" revolution of 1989 or, as in Romania, a far uglier version, only time will tell. Both are still optimistic scenarios nevertheless. The financial crisis that had started with the Wall Street collapse in 1929 ended up ten years later with the World War Two. It is impossible to tell whether history will repeat itself. But considering carefully the scale of the current financial crisis and the way it is managed by the world leaders, there is no particular reason to feel overly optimistic.

Economy: "What a beautiful Catastrophe!"

Can you imagine you are a civil engineer trying to design a building whilst one of the most fundamental laws of nature keeps changing the way it is working? For example, if gravitational force were to become much stronger when acting on some of the construction materials? You are likely to end up constructing a building that will not behave as you expected when you designed it.

It is a bit of a loose parallel but economists face the same problem when dealing with the current financial crisis. Macroeconomics theories assume that the financial system works properly even during the financial crisis performing what is known as money multiplication function, multiplying currency to broad money. All the growth expectations, inflation predictions have this mechanism built in. The Keynesian approach of economic stimulus through public investment and many other anti-crisis measures are also based on it. All modern economy exists thanks to the existence of the money multiplier function: otherwise it would a bartering or quasi-bartering system and banks would be simply secure stores of money.

The financial crisis that started in 2008 and continues to the present day is not the first economic downturn in human history. It is also not the first time the banks have collapsed, or have been on the verge of collapse. But it is the very first time that the entire modern financial system is on the verge of collapse or indeed keeps on collapsing. This has happened as a result of turning the financial system from a manageable money multiplication and risk management/optimisation machine into a classic example of a pyramid scheme.

As a result, money multiplication does not function in the economy. Banks are not lending. Whatever money comes into the financial system, for example by a government borrowing or QE, sinks into a pyramid and is used to cash toxic assets. This is a way of preventing the financial pyramid from collapsing: just having enough liquidity to keep the system going. The current raids on the Euro zone are a classic example of banks scraping around wherever possible for more liquidity to be added into a corrupt system.

When money multiplication function does not work in the economy, the entire modern economic theory does not work. This is one of many reasons why so many “plans for growth” devised by the biggest economic brains have not worked in the last 3 years. The solution is actually technically quite simple: it does not require much economic "wisdom", just a lot of political guts. Forensic accountants, receivers and prosecutors are needed rather than economists. This is all about liquidity shortage and the fact the banks are not lending (i.e. performing their money multiplying function in the economy).

What can we expect ahead in 2012/2013? As other currencies and the International Monetary Fund are pulled into rescuing the Euro zone, it is very likely that other currencies and indeed the IMF will come under the threat of collapse, or they will collapse actually.

What should really puzzle everyone is that nothing has changed in the way the financial system has been run for the last five years or so. Even the same people are still in charge. And as more and more money has been pumped into it, the financial crisis has kept on spreading from small banks to larger banks to the entire financial system to sovereign debt to currency systems. Albert Einstein once famously defined insanity as "doing the same thing over and over again and expecting different results". Do the politicians, top economic experts and mainstream media pundits not show strong signs of insanity because they believe that by doing the same thing yet again, i.e. pumping even more money and pulling even more countries and the IMF into it, they will stop the crisis from spreading? It seems rather obvious that, as before, it will spread even further pulling into it more countries and the IMF unless the contagious aspect of it, i.e. a pyramid structure of the financial system, is eliminated. And because the modern economy cannot function without a healthy financial system the crisis will ultimately ruin the western economies altogether. This is the current direction.

As explained in "The largest heist in history": there is no way of winning with a pyramid scheme. The only way out is to liquidate it. Poland learnt it in the early 1990's, Albania learnt it half a decade later. It is obvious that the western world is learning this in a hard way now. Hopefully it will heave learnt before it is too late. The later it is done the more damage will be inflicted. And if it is not done the pyramid will collapse eventually with spectacular effects. No doubt Zorba the Greek’s applause: "What a beautiful Catastrophe!" will serve amply to describe it.

PS. Since this article was written the European Central Bank announced that it was pumping nearly a half trillion new Euros into the European financial system. This confirms the main argument of the blog: the pyramid keeps on collapsing and the politicians and the decision makers keep on trying to prevent it from a collapse. Just one more time: things are getting from worse to even worse.

Debt magic: a story from Devon

On a grim rainy autumn afternoon a tourist comes to a small seaside town in Devon. He plans to stay for a week. He finds a hotel and decides to stay there. At this time of the year, which happens to be during the low season, the hotel is empty and the tourist gets a great deal: an entire week for £100 provided he pays upfront in cash.

As soon as the hotel owner gets £100 he calls the hotel cook. He owes him £100 in unpaid wages as the business has not been good recently. The cook gets his £100 and goes to a local grocer, his childhood friend, who was helping with weekly shopping by providing a small credit line. The cook gives the grocer £100. The grocer then goes to his local wholesaler whom he owes £100. The grocer settles his debt. Quite often the wholesaler spends evenings in the hotel bar drinking whisky. He owes the hotelier £100 for drinks. Now he has money and the hotel owner gets it.

At that point the tourist discovers that the hotel is not really up to standard. Without going into detail (so as not to discourage anyone from visiting Devon which is beautiful and this story is a fiction) the tourist goes to the reception asks for £100 refund for his room and leaves. But he also leaves some residents in this small seaside town happy on this grim day: thanks to him they have cleared their debt.

There is a serious point to the story. The reciprocity of debt is not uncommon. Many people have mortgages and loans on a liability side and savings, endowments and pensions on an asset side. A customer has debts towards a bank and a bank has debts towards a customer. In reality these debts offset each other. However in the world of banking they add up: banks make money by servicing debt in whichever direction, especially those who are intermediaries. France owes the UK €227 billion, the UK owes France €209 billion. Germany owes France €206 billion, France owes Germany €123 billion. This BBC interactive map shows the euro debt structure. Banks make money on all debt.

This is one of many reasons why the global debt must be audited and all reciprocal debt should be offset. This was recommended in "Prime Minister, sort out this mess, please" a year and a half ago. Of course, not all debt would be nullified like in this small seaside town in Devon. But there is no doubt that a huge mountain of debt would be greatly reduced. But such an approach has been ignored thus far because if it were not, banks would lose huge income streams (for acting as debt arrangers/managers) from the taxpayers. No doubt they are unlikely to allow this to happen.

Has Cameron killed the City?

The Germany's strategy of solving the euro crisis is still not completely clear: but it starts looking rational. Unlike other world leaders Angela Merkel understands what behind the financial crisis is. Rather than throwing good money after bad and adding and allowing more bailouts (for example by allowing European Central Bank to print more money), as she was pressured by Obama, Sarkozy and Cameron, in true German style, she called the financial markets bluff and started methodically reforming the financial system first. She also ensures that the execution and control of the reform will be under German control so it is not hijacked again by scammers and many politician who are happy-clappy about the the financial markets. But the jury is still out how it goes as no doubt it will be a bumpy process.

David Cameron decided to opt out from Merkel's reform. He justified it by defending the British national interest or, more precisely, by the City's. Leaving aside a rather dubious point that City interest is congruent with the British national interest, which in the midst of the financial crisis sounds - to put it mildly - irrational, was Cameron's action helping the City in the long term?

The financial industry is heavily subsidised in the UK by the taxpayers (i.e. the costs to the UK economy of having this industry exceed the tax receipts by far). The City does not exist as the UK financial centre but as the main European one competing with likes of New York, Tokyo, Shanghai and Hong Kong. Without ability to do business in Europe freely the City will be a "surplus to requirements" on the world's markets. There is no doubt that very rational financiers in Frankfurt and politicians in Berlin would like to take over the City's position. And the fuming Sarkozy and the French will be happy to help, just finishing off the City. Now Cameron created the best opportunity: the openly expressed desire of vengeance by Sarkozy and much less, but in practice far more lethal, by Merkel will ensure that France and Germany will do all their best to cut the City out of European deals and financial markets. And, with the support of practically the rest of Europe, it will be easy: unlike the war with Iraq a real "cakewalk". This is very likely to result, in a decade or so, in Frankfurt getting the pole position in finance in Europe with some spillover and subordinate business conducted in Paris. When Thatcher went to Brussels to negotiate she brought back the rebate. When Cameron went there he put the financial industry on the gallows.

It was not just Cameron's idea to "defend" the City's interest. He was under pressure from the British financiers. (Having said that Cameron and his team are unlikely to understand such considerations. The mainstream media do not seem to fare any better. There seems to be a complete strategic void in the establishment.) It is clear that they lack a basic survival instinct. The City financiers et consortes give preference to a short term personal gains, like this or next year bonus, over the long term interest of the industry and the country. "Greed is good", who said that?

However, sadly, it seems so British and so unsurprising. In the 1970's the British heavy industries refused to adopt to a changing world: first signs of globalisation. They put a pressure on the British government to subsidise them with taxpayers money and keep them going. As a result within a couple of decades the industry that had led the world into the 20th century was confined into history. The very same process is happening now. The City financiers demand state subsidies (i.e. bailout, quantitive easing, tax exemptions, etc) and want to carry on as before. They disregard the fact that the world is changing. They look after their short term interest and it looks like that the financial industry that led the world to the 21st century will be history in the UK not before long. It is the same approach as militant trade unionists of the 1970's although they most likely were acting unwittingly and were not wise enough to understand that. However considering the current degenerated and pathological state of the financial industry in the UK, which appears to be beyond help, finishing it off, unlike the collapse of the manufacturing, may actually be the best option for the British future. Countries can be successful without overblown financial services: Sweden, Denmark, the Netherlands or Germany. Now it is clear they cannot be successful without healthy manufacturing. These are not emotional arguments but purely pragmatic economic and social considerations.

Last but not least: unlike the UK, Germany went through the 1970's and 1980's managing their manufacturing base excellently. They strengthened it and now are the world manufacturing powerhouse. It looks very likely that in a decade or more - possibly after some unpleasant events like wars - the Germany will have a blooming financial sector, whilst in the UK the City will be seen as British Leyland or British Coal is seen now. And no doubt some will argue that the City collapsed because... it did not get enough support from the taxpayers.

Why don't they sort out this mess?

This is the question to the world leaders, Barak Obama and Angela Merkel. Of course they will have to do it together with other leaders, from China, the EU, the UK. What has to be done was written long time ago. These are quite simple steps described in "Prime Minister, sort out this mess, please" but executed globally. It has to be done in a coordinated manner. As the financial markets degenerated into activities which do not carry any economic value but, at the same time, affect the nominal debt and liabilities between countries and institutions, the world financial markets have to be suspended. On a Friday afternoon, after the closure of the last financial market, the world leaders should announce such an action and start an immediate process of restructuring of debt and financial markets described in "Prime Minister, sort out this mess, please". Part of this process should also be agreeing new rules (like abolishing credit rating agencies in the current form) according to which the financial markets can reopen and function. The capital flows in and out currency zones, like a euro zone, should be suspended for that period (and only allowed by a relevant central bank under extraordinary circumstances).

In practice such process is not dangerous at all. It is simply a long global weekend of the financial markets. No one losses anything by such action as everyone will have what they have had at the time of closure. Of course the outcome of the negotiations will change that but it would be agreed write-offs rather than a messy degeneration of the value resulting from financial gambling. And if it is not done like this, it will happen anyway, one way or another, but quite likely after a global bust up: basically a massive war or a series of wars.

Incidentally the problems that the governments currently experience with the financial markets are not new in history at all. At the end of the 19th and the beginning of the 20th centuries, after the Second Industrial Revolution, the US experienced massive powers of huge trusts and monopolies like Rockefeller's Standard Oil. And the US government managed to deal with it successfully for the benefit of the US and the world economy. Broke it apart. The Sherman Antitrust Act was enacted. Despite two world wars disasters, this was the foundation for the western world economic success of the 20th century.

Looking ahead 200 - 300 years, the future generations will judge the current period in history not too favourably. At best the current financial crisis, caused by quite primitive, easy to understand and predict its consequences the massive global pyramid scheme, will be laughed at and compared to Tulip mania in the Netherlands in the 17th century (e.g. toxic waste financial instruments compared to Tulip bulbs), but more realistically, with an element of distance that the time will give, it is very likely that the current political and financial elite will be looked at as a bunch fraudsters (manipulators) and idiots (who were manipulated). This is not actually the view of the author of this blog but an analytical judgment, i.e. a probable scenario, that the current world leaders should also take into account: how they are likely to be seen by the future generations. But they might not even be able to do that.

Andrew Neil (BBC) is "scared": better late than never

Last Wednesday on "Daily politics" (BBC 2) whilst commenting George Osborne's statement, Andrew Neil said that he was "scared" by the current economic situation. It was a really worrying statement. Firstly if a journalist of such off-the-record knowledge, known for a rather moderate language, said that he was "scared" the situation must be really ghastly, i.e. the economy is on the verge of a systemic collapse. Secondly, the time to be scared was three years ago when the financial system collapsed and when it was more than obvious that unless the fundamental overhaul to the system was done it could only get worse. Basically what's happening now was easily predictable three years ago. In fact the current crisis is very mild indeed as it could have been considering the real state of the banking system.

Incidentally back in May 2010 Hugh Hendry gave a sensible advice: "I recommend you panic". At that time many people took this as an eccentric comment of a financier, although it was obvious that it well thought through advice.

George Osborne should also not be too smug because the UK keeps AAA credit rating and has a very cheap borrowing rate, cheaper than Germany. Currently the financial markets are preoccupied with taking as much money as possible, squeezing Germany to the maximum. Once they finish this process, and in the meantime the UK makes a lot of cuts thereby creating a lot of room for additional borrowing in the future, there is little doubt that the financial markets will turn their attention to the UK and squeeze it for more cash. Hence all the money that the Chancellor is saving now are really destined to the bankers coffers. This is how financial system works these days. It is all about extracting as much money as possible from the middle class taxpayers. Another obvious fact that seems to be completely missed.

The largest heist in history continues (as predicted)

It is enough to read a couple of yesterday's newspapers' headlines "It's official: credit crunch is back" (The Daily Telegraph) and "Day the world's banks wobbled" (The Daily Mail) to realise what mess we are in, that the situation is dire.

The credit crunch is not back. It has actually never gone away for the last three years. The global pyramid scheme is still run by the financial institutions. It keeps on collapsing like any pyramid has to. And the taxpayers - through governments and central banks - are the last pyramid "customers" that were forced to join this criminal scheme and finance it through the tax system. An utter scam.

This process was described and predicted three years ago in the submission to House of Commons Treasury Committee. It was a warning that was ignored and "the largest heist in history" continues. It will lead to absolute ruin: it will be a ruin of middle classes in the West.

To quote the report to the House of Commons Treasury Committee published in April 2009 (!!!):

"(...)

If governments do not liquidate the global pyramid scheme, the money they injected will be, in time, converted into toxic instruments (e.g. securities) and cashed in by organisers and privileged customers of these schemes (or in the case of Albania, gangsters and their customer friends). As the amount injected is around 200 times less than the notional value of toxic instruments, the economy will not even see a difference. It will be a step back to September 2008, only now with trillions of dollars of taxpayers’ money spent to sustain the pyramid scheme. It will be merely throwing good money after bad. But can governments afford to come up again with the same amount money and do it 200 times over or more? This is based on a very optimistic assumption that the notional value of toxic instruments is not increasing. If governments take the route of continuing to inject money, they will make taxpayers dependent on the financial system in the same way that criminal loan sharks control their customers — their debt is ever increasing and customers keep on paying forever as much as it is possible to extract from them.

(...)"

Despite this governments have allowed "the largest heist in history" to continue for years. However now it looks like that Germany may have had enough of this ongoing financial scam and, by the end of the next week, will pull a plug on it, as far as they are concerned.