Financial crisis? It's a pyramid, stupid.: Computational Complexity Analysis of Credit Creation v Austrian School of Economics reserve analysis

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?".

Sunday, 22 April 2012

Computational Complexity Analysis of Credit Creation v Austrian School of Economics reserve analysis

The computational complexity analysis of credit creation presented on this blog is an analysis of the dynamics of the reserves generated in the credit creation process. There are four disjoint and complete (taken together) classes that capture the dynamics of the reserves: full reserve banking, fractional reserve banking, no reserve banking and depleting reserve banking. Briefly, lending with loan to deposit ratio of 0% results in full reserve banking, lending with loan to deposit ratio of more than 0% and less than 100% results in fractional reserves banking, lending with loan to deposit ratio equal 100% results in no reserves banking and lending with loan to deposit ratio of greater than 100% results in depleting reserves banking. The Austrian School of Economics gives the static analysis of the reserves: if a ratio of reserves to deposits is 100% it is full reserve banking, otherwise it is fractional reserve banking.

The relationship between static and dynamic analyses

A static full reserve banking is a result of dynamic full reserve banking credit creation process. A static fractional reserve banking is a result of the dynamics of either fractional reserve banking or no reserve banking or depleting reserve banking. Therefore the static analysis is less fine-grained. Importantly static analysis of reserves by Austrian School of Economics completely misses the pyramid creation aspect of the credit creation process when loan to deposit ratio is greater than 100% (i.e. it is only the case of depleting reserve banking).

This note was prompted by a number of comments from academic economists who considered the reserves analysis on this blog isomorphic to Austrian School of Economics'. Hence they missed the key point of distinguishing a static aspect of reserves from their dynamics.

No comments:

Post a Comment

Subscribe to: Post Comments (Atom)

Comments

"I believe Mr Pytel has nailed it. His blogs are incisive and very well researched and informed." – Mr Jonathan Davis of Jonathan Davis Wealth Management

"Building the Great Pyramid: The Global Financial Crisis Explained is an excellent article – I really enjoyed reading it." – Mr Rajat Bhatia, author of “Financial Chernobyl or Manageable Risk?”, The Hedgefund Journal, September 2007

"I find your premise that banks, particularly those with a loan-to-deposit ratio over 100%, are operating pyramid schemes completely baseless." wrote Mr John Varley, the Group Chief Executive of Barclays plc, to the author.

"I agree with you 100% that it was a Ponzi scheme. The reasons it went on for so long and got so large were the complete corruption of all stop-gaps and regulating mechanisms we had counted on to keep money inflation and leverage in sustainable bands." - Mr Stephan Olajide-Huesler author of "The Eye of the Storm: How Modern Finance, Monetary Policy and Reaganomics created the largest Financial Crisis in history."

"A colleague of mine Greg Pytel an expert on the banking crisis who has greater insight than most is a lot more scathing and equates the mid and lower level [banking] staff akin to African Child Soldiers." - Mr Graham Manville, Assistant Dean and Senior Fellow, School of Management, Southampton University

"You have managed to pick a very simple theory out of a very complicated situation and explain it very simply (to me anyway). This is very diffcult thing to do and a worthy achievement." - [a reader's comment]

"Few studies have been done on the macroeconomic effect of pyramid schemes on the scale of those in Albania, which, fortunately, are extremely rare. The closest analogy to such schemes is the asset bubble, whose economic impact is due to changes in perceived wealth." - Dr Christopher Jarvis, "The Rise and Fall of Albania's Pyramid Schemes", International Monetary Fund, March 2000