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.