Greg Pytel: A bare-knuckle fistfight in the family

What we see now in the UK is a huge bare-knuckle fistfight in the family, i.e. the establishment that is running the country.

First the banks went bust in 2008, had to be rescued and became the wipping boy of the public: public enemy number one. So to counteract this, the expenses scandal sprung up out of nowhere. These things - that the politicians were on the take - have been know for years. But conveniently for the banks the scandal erupted and moved the role of the whipping boy onto the politicians. It seemed to work but the politicians had just enough of it and, conveniently for the politicians, the hacking scandal erupted. (The practice of hacking by the media had been very well known for years: from the primitive sifting through the rubbish of celebrities to most technologically advanced spying technologies). The resulting public inquiry into the practices of the media hit the entire media. So these guys had just enough of it. Hence now, when the Leveson Inquiry is getting into its final lap, conveniently for the media folk, new scandals around the banks have erupted this week. We turned the full circle.

Clearly it is a mafia-style bare-knuckle fistfight in the family. There is a war within the British establishment. It is interesting to watch where it will all end. Thus far we have to sponsor this pathetic and extremely expensive spectacle with our taxes.

Greg Pytel: There is a method in this madness

The publication of this article on this blog is dedicated to Sir Mervyn King, the Governor of the Bank of England, who reportedly said a few days ago:

"When this crisis began [in] 2007 - 2008, most people including ourselves [presumably the Bank of England] did not believe we would still be right in the thick of it, in the middle of it five years later."

Well Sir Mervyn, please speak for yourself and not for "most people". To remind you the analysis that was written at the end of 2008 and has been known by the House of Commons Treasury Committee since 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."

It is well documented on this blog that the actions taken by the governments at the time, in 2007, 2008 and 2009, were designed - which was glaringly obvious at the time too - to turn the liquidity crunch and banks' failures into a perpetual "crisis" spreading it into currencies and the sovereign debt. And the governments, together with the financial industry and the mainstream media, do all their best to keep it that way.

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The Bank of England, backed by the UK government, is going to pump yet another £100 – £120 billion into the economy. Regardless of a seemingly noble plan- to help squeezed businesses and ordinary people- this is yet another example of throwing a massive volume of good money after bad.

And as before, all this money will end up in the banks coffers redeemed for toxic waste (which from practical perspective is infinite) and then transferred to the super rich. It is astounding that the politicians do not see that their behaviour satisfies Einstein’s definition of insanity: “doing the same thing over and over again and expecting different results”. Is it not rather obvious that:

- that the financial system stopped working, i.e. performing properly its money distribution and multiplication function in the economy and instead became a bottomless pit of debt resulting from its financial pyramid structure?

- that money is no longer a credible carrier of value (long term), hence economic theories and assumptions (whether Keynesian more spend or neo-liberal austerity approaches) do not hold anymore and can no longer be applied in practice?

- that any bailout is only a temporary reprieve and the problem comes back soon with a multiplied force (if the politicians are too silly to understand why this is so they have had over three years to learn it from the reality, experience)?

What can be done then? The situation is very similar to a state of the financial system after a war or a massive disaster. The easiest way is to suspend old money (pound sterling, euro or dollar) and issue a new currency (new euro, new pound, new dollar). First paying for the most basic social needs: food and subsistence necessities, social security, health, education, defence and law and order. (There is more than enough slack in the economy to fund it. We do not have a shortage of any goods or of skilled people to provide services.) Only then you can start negotiating the remainder of liabilities in the financial system: (deposits, pensions, and so on) what you are going to honour 100%, what you are going to honour partly and what you will write off completely.

This is the same solution which was recommended over three years ago in a report to the House of Commons Treasury Committee. If all this is done properly there will be little drama. It has been done in the past in critical situations (e.g. Germany and Poland after World War II) and it works: the economies recovered. If, at the time, the financial system worked as today's, i.e. as a giant pyramid scheme, all stimuli such the Marshall Plan would have been wasted.

And, not a small matter, the financial system has to be reformed so it no longer functions like a pyramid scheme as it does at the moment. Again, nothing new or ground breaking: e.g. returning to banking rules and principles of the 1970′s and 1980′s in Germany would do for a starter.

However Europe would require a separate reform as apart from debt problems there are structural problems that the debt crisis exacerbated and brought to light. At present politicians completely mix up these two separate things. It suits the financial industry as it helps them getting money into the financial system, by bailouts and quantitative easing. And this is what they are after: like the heavy industries here were after the government subsidies in the 1970′s.

If it is not done by the deliberate political decision through negotiations, such or a very similar solution will be forced upon the world by the events. The later it happens, the worse, as the mountain of notional debt and liabilities keeps growing. Hence it will be more and more difficult to deal with that in an orderly fashion (i.e. notional losses will be bigger hence, even a greater room for conflict).

At the moment any bailout increases the overall liability and ends up on the financial markets which are a failure, which do not function according to free market rules. This is a textbook example of throwing good money after bad (with no end till a disaster). Is the above not really basic? This is not a financial crisis. This is an intellectual crisis, a demise. It is a stupidity galore.

But there is a method in this madness, there is a reason behind this insanity. Every time we read about obliterated pension schemes and generally falling income and purchasing power of the middle and working classes, the workhorse of the economy, and the growing gap between them and the super rich, thriving market of top end properties in London, luxury goods and services, from systemic perspective it is simply a wealth transfer.

One can argue whether this is right, or wrong, but this is exactly what is happening. Whatever the view is the current crisis is the largest wealth transfer exercise from the middle and working classes to the super rich using pyramid schemes which have exactly the same structures and mechanisms- pretty primitive actually- as Albanian pyramids in the 1990′s.

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This article was published first on Nutmeg blog

Greg Pytel: Barclays' interest rate rigging? Nihil novi

Yesterday it was announced that Barclays Bank was fined for manipulating interbank lending rates. It is business as usual in the City, not even the tip of the iceberg. Don't pick up on Barclays: this shows what the modern banking system degenerated into. It has nothing to do with free market financial trading. It is a crude and primitive manipulation and rigging. Very transparent indeed but regulators and politicians choose not to see this. As previously published on this blog: this also shows what kind of "top talent" the current financial industry attracts.

From a broader perspective it is simply a part of the largest heist in history which continues.

Communism at its "best"

"£140bn kiss of life for Britain: Chancellor and Bank in dramatic bid to hand small firms and house-buyers cheap loans. Banks will be loaned money on condition they pass it on in the form of cheaper loans and mortgages." To start with, the banks are going to pass this money at higher interest rates than they will pay to the Bank of England. It is yet another government exercise in subsidising the ailing and failing parasitical financial industry disguised as an economic stimulus that is suposed to help ordinary businesses and the public. (For clarity, banks are not taking any risk these days. They are "too big to fail", hence the government, i.e. we the taxpayers, underwrite their risk in any event.)

More importantly it is yet another clearly pathetic example of centrally planned economy akin to East European communist countries of 1970's and 1980's when they were on their last legs: governments looking for solutions of economic and financial problems by printing more and more money. This is communism at its "best" where apparatchiks (i.e. the financiers and their cronies) benefit: communism for the rich that is.

Spanish €120 billion bailout

The largest heist in history continues. This is what was written well over 3 years ago:

"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."

(from House of Commons Treasury Committee Report "Banking crisis")

Just relax and keep enjoying this pathetic spectacle. You are paying with your taxes for this burlesque choreographed by intellectually retarded politicians and directed by the thieving and smartassish financiers.

Keynesian approach would not work

Last night on BBC HardTalk Prof Paul Krugman argued that to get out of the current economic depression western countries have to borrow more. "Borrow more to spend their way out of trouble", "solve the problem of excessive debt with more debt" arguments were justified by a classic Keynesian economic approach. They were bolstered by seemingly very convincing examples that the problem is that all the countries are trying to repay their debt at the same time and "my spending is your income, your spending is my income" therefore we devoid each other of income.

Is it convincing? What happens to money that is repaid as debt? If the banking system worked properly debt repaid would end up in the banks' vaults. It would be re-lent as banks do not sit on liquidity. Sitting on liquidity generates no income for them: it is a loss. Repaying public debt does not necessarily reduce overall debt but shifts the debt from the state to private investors who would turn it into viable economic activity. Keynesian approach stimulates the economy largely through consumer spending. Public spending cuts and debt repayment stimulate the economy through private investment. Typically the way out of any recession was through using a combination of both.

However at present banks are famously not lending. The system of money circulation slowed down enormously. This is the key to understand the cause of the current economic depression that politicians, mainstream analysts and policy makers and mainstream media completely fail to grasp. Starting with Keynesian approach, there is a validity in the arguments presented by Prof Krugman. When investors are not confident during downturns, they tend not to borrow and invest. This, in turn, slows down the economy. If the state steps in and spends money it jump starts the economy.

There is an assumption behind this process that Prof Krugman did not mention and it is never mentioned by those who advocate Keynesian approach (e.g. Ed Balls). This assumption is that in the background of the economy there is a healthy banking system that performs money circulation and multiplication function through fractional reserve banking. For example, if the state borrows and spends £10 billion, the money ends up in circulation through the banking system. Normally banks re-lend it and, depending on a loan to deposit ratio, this £10 billion is multiplied up to £60 - 80 or even £100 billion. Then the state has to collect back through taxes this initial £10 billion with some interest, to repay the original debt, but the rest stays in the economy.

Keynesian approach it is not a magic and has its dangers. Ultimately, if the state borrows and spends so much that economy cannot absorb it in a productive way, i.e. above the capacity to collect in taxes that should be at least as much as the costs of borrowed money, this results in inflation growth.

At present the banks are not lending: businesses want to borrow but the banks do not lend. They are not lending not because they do not want to - lending is in banks DNA, this is how normally they make money - but because they cannot. Ever since the banks abandoned the fractional reserve banking and started practicing depleting reserve banking^*. at around of the turn of the century, the banks depleted their reserves and replaced them with toxic waste. The scale of this toxic waste phenomenon, which created a liquidity shortage, and the mechanism that keeps generating it through depleting reserve banking is enormous. On conservative estimate around $1 quadrillion figure or around 20 times the world's annual GDP. The problem is not only the scale but that it is self-perpetuating at exponential, run-away pace through depleting reserve banking. Therefore whenever money comes into banks it is kept there as a liquidity reserve and is also used to "redeem" some of this toxic waste into cash. Sometimes central banks are doing this directly by quantitative easing. (Banks need to pay for their rents, salaries, bonuses, etc.) This is often referred to euphemistically that banks are repairing their balance sheets.

Prof Krugman was wrong: Keynesian approach would not work in the current situation because the money spent would simply be sunk into banks and would do nothing to stimulate the economy. It would be another tranche of good taxpayers money thrown after bad. What is the way out then? It involves three steps:

Firstly sorting out the banks by explicitly stopping them practicing depleting reserve banking, i.e. perpetuating at exponential pace the existing and contingent liquidity hole. Incidentally depleting reserve banking is highly illegal at present as it is a classic case of a pyramid scheme. However this is completely ignored by the financial industry and we are seeing the effects of this the last 4 years. Thus far the politicians, mainstream analysts, policy-makers and media pundits staunchly defend what is - from technical and legal perspective - a criminal practice that brought upon the western economies the current crisis and keeps them in this, making things worse.

Secondly this should be accompanied by a systemic reform whereby all those in banking take a direct personal risk (civil and criminal liability) for their actions, banks should be deregulated and made compete in such a way that there would be no bank anywhere close to "too big to fail" situation. Simply reintroducing free markets into the financial industry with particular focus on eliminating moral hazard. Prosecuting under criminal law (for setting up and operating a pyramid scheme) all those who caused the current crisis and confiscating their (and their families') wealth would also act as an effective deterrent to the new "captains" of the financial industry. All of them would then think hard before they come up with any "financial innovation" (or as it was in the case of the current crisis a good old and crude pyramid scheme, incompetently disguised as a toolbox of financial innovations).

Thirdly debt reduction in order to reduce the money multiplier to a healthy level, between six to eight. This can be done through printing money, basically by inflation, or through debt restructuring, i.e. defaults. This is not a hard thing to do: the hard part will be to decide who should be losers and to what extent. But this problem, directly or implicitly, is inevitable so we may be better off resolving it in an orderly manner rather than through crude manoeuvrings like around the Greek debt which is simply a question whether the Greek taxpayer have to lose by being squeezed or the banks that lent to Greece (with full knowledge that Greece would not be able to repay the money in any event).

Only then will we have a luxury to discuss Prof Krugman proposal of stimulating the economy in a Keynesian way, through public spending. Or maybe it would be better if it is done through public spending cuts? If the banking system is healthy both will lead to economic growth. The former through consumer spending that will filter to investment, the latter through investment that will filter to consumers' pockets. And as ever, typically, it will be a proper balance that works.


^* - more on fractional reserve banking and depleting reserve banking in "Computational complexity analysis of Credit Creation"


COMMENT: I do not hold a strong position how good (or bad) fractional reserve banking is in general. If practiced with loan to deposit ratio of 50% it looks very safe and stable. If practiced with loan to deposit ratio of 99% it is extremely risky and most likely the system would collapse. So it all depends how fractional reserve banking is managed. However depleting reserve banking is a pyramid, is always unsafe and indeed illegal.