Financial crisis? It's a pyramid, stupid.

IMF chief going bonkers

2012-01-24T09:00:00.003Z

Yesterday in her speech in Berlin at the German Council on Foreign Relations, Ms Christine Lagarde, the head of the International Monetary Fund, said:

"We must all understand that this is a defining moment. It is not about saving any one country or region. It is about saving the world from a downward economic spiral."

Well, yes Ma'am, but has it not been glaringly obvious for the last three years? It is not particularly optimistic if it takes over three years for the top world officials to grasp something which is that obvious.

Having recognised the scale of the crisis Ms Lagarde said that Europe should boost bailout fund and consider euro bonds. The net effect of such actions would be to spread the crisis onto thus far healthy economies. She added:

"I am convinced that we must step up the Fund's lending capacity."

In a nutshell Ms Lagarde recommended solving the current crisis with even more debt and more countries dragged into it. It is not a particularly bright idea. As explained three years ago in "The largest heist in history" the only effect would be prolonging the crisis and making it bigger.

If her recommendations are implemented, some time later we will be back into square one but with a much bigger problem. This is the approach to solving the current financial crisis for nearly 5 years (since Northern Rock collapse). And it led from bad to worse to even worse. Some with experience in the financial sector regard people dealing with the current crisis as "outrightly stupid" but one really has to pose a question about their sanity (in the most basic meaning of this word). Albert Einstein's famous remark: "Insanity: doing the same thing over and over again and expecting different results" describes their behaviour very accurately.

BBC defends financiers

2012-01-21T21:35:00.004Z

Last Thursday BBC Newsnight broadcasted an analytical piece about the nature of capitalism.

The issues raised were profound: capitalism as a free market system with seemingly no alternative, "responsible" v "irresponsible capitalism" and so on. It was very insightful.

However all these issues were discussed in the context of the ongoing financial and economic crisis. It was presented as if the current financial mess was a result of a failed system, the current version of capitalism. The truth is much simpler. Indeed it is very basic.

In the same way as the economic system in Albania had nothing to do with the criminally-engineered pyramid schemes which collapsed and caused a huge financial mess in Albania in 1996 - 1997 but much more to do with pure fraud, the current financial mess and resulting the economic crisis have nothing to do with capitalism, socialism, "too greedy capitalism", "irresponsible capitalism" or any economic system or indeed any legal human behaviour. The current financial ills highlighted by the BBC are the result of a huge fraud engineered by the financial industry which is exactly the same mechanism as the one employed in Albania in 1996 - 1997, i.e. it is a pyramid scheme from both a technical and a legal standpoint.

To put this into a small business perspective: it would be the same as discovering a shop where all the money is being stolen from the till by thieving employees and discussing the management practises of a shop owner (the taxpayers for the banking system) or the greedy irresponsibility and the unethical behaviour of the thieving staff (the bankers). Such discussion is obviously important but in the case of our hypothetical situation the shop workers would have been prosecuted for theft. In the real, much more grave situation currently facing us, no-one has seen fit to prosecute the thieving shop workers. The dishonest behaviour continues, under the watching gaze of the powers that be and the public at large, with no-one seemingly aware that any kind of crime is being committed. If the justice system is to mean anything it cannot be more lenient to financiers than it is to ordinary shop assistants.

A discussion about capitalism v socialism, or "responsible capitalism" v "irresponsible capitalism" is generally important. Society will always be looking for an equilibrium that will give it prosperity. However with the BBC Newsnight broadcast, it was the context and timing that mattered. And in this context the discussion was not only vacuous but it was actually a smokescreen. It created an impression that the fraudulent criminal activities (in the technical and legal sense of these words) of the financial industry were not what they were but somehow a result of some systemic failure. The behaviour was maybe irresponsible, maybe immoral, maybe a result of greed, but not a crime. And here is the key to BBC propaganda: you can despise people for being greedy, unethical or irresponsible. They may even be considered as repulsive. But you cannot bring them to justice.

Therefore one cannot consider the programme as simple hogwash. It was in fact, very soft propaganda (therefore quite likely to be effective) which will help, the financial criminals who caused such damage to the economy and brought massive misery to millions, to escape justice. And the BBC seems to be doing a good job of doing this, evading a discussion of the most important historical event that is happening in front of our eyes, i.e. the liberal western democracy, as we know it, is on the ropes.

Euro Concordia

2012-01-14T20:02:00.006Z

Yesterday, on the same day as the French AAA credit rating and the ratings of many other European countries were downgraded, the Costa Concordia cruise ship nearly sunk off the coast of Italy. According to a BBC report:

"We were having supper when the lights suddenly went out. We heard a boom and a groaning noise. All the cutlery fell on the floor," Luciano Castro told Italy's Ansa news agency.

The passenger said people were told there were electrical problems.

Others described chaotic scenes as the liner began to move violently.

"The boat started shaking. The noise - there was panic, like in a film, dishes crashing to the floor, people running, people falling down the stairs," said survivor Fulvio Rocci.

Those on board said the boat suddenly tilted to the left.

Cabin steward: 'We jumped into the sea'

"We told the guests everything was ok and under control and we tried to stop them panicking," cabin steward Deodato Ordona recalled.

It was about an hour before a general emergency was announced, he said."

With the deepest respect and sympathy for the accident victims and their families this reads uncannily like a report from the euro crisis.

The Economist's "Save the City" campaign

2012-01-08T15:32:00.006Z

"Save the City" pleads The Economist in the recent issue's leader. "Finance—the funnelling of savings to their best use—is a vital industry. Britain is very good at it, leading the world in various financial markets, including foreign exchange and over-the-counter derivatives."

The British financial industry would have collapsed back in 2008, had it not been rescued by the taxpayers. Had it happened it would have brought down the entire British economy. It may still do so and The Economist seems to be determined to facilitate this process.

The Economist's circulation is some 1.5 million globally and around 200,000 in the UK alone. How are such articles read in countries like China, India or Brazil? The Germans, Brazilians, Argentinians, Italians, the Dutch must have the same smirk of disbelief when they hear comments that England has the best football team in the world. But to be fair to the English football fans, for some years this has been said with a pinch of cynical self-indulgence and more like a distant dream. Britain is very good in finance? Is The Economist really serious? It sounds like a serious death-wish: British economy was nearly killed altogether by the financial industry.

Interestingly, but unsurprisingly, whilst presenting the value of the City to the British economy, The Economist leader does not even account for trillions of pounds (in hundreds or more) the City has received and is still receiving in explicit and implicit subsidies from the taxpayer. For example an implicit insurance against collapse resulting from "too big to fail" phenomenon. One may wonder whether anybody in The Economist can actually understand this, let alone have an expertise to calculate its value competently in the actuarial terms. It is not that difficult after all.

It may all sound a bit unsporting but after all, hey, we have democracy and free press, don't we?

The ECB decided to subsidise private banks

2011-12-23T03:29:00.004Z

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

2011-12-23T00:38:00.003Z

(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!"

2011-12-18T07:01:00.014Z

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

2011-12-13T20:12:00.004Z

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?

2011-12-10T13:22:00.018Z

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?

2011-12-08T09:20:00.008Z

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

2011-12-02T12:42:00.012Z

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 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)

2011-12-02T12:30:00.007Z

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.

Strategic thinking void

2011-11-30T10:14:00.002Z

When the incoming UK government announced severe cuts and tax rises all group were affected, including the police. Yet with such cuts and tax hikes it is rather obvious - no benefit of hindsight needed - to realise that strikes and public unrest are very likely. When Margaret Thatcher decided to take carry out deep reforms over 30 years she excluded from cuts the police. In fact she improved the police terms and conditions of their employment. Incidentally a few weeks ago the Poland's government showed the same approach to reforms: giving a rather raw deal to almost everybody but improving the police's.

So there was little surprise that when the looting erupted in London and other towns last summer, the police was quite apathetic to react. It looked almost ostentatious as if they were taking their time. As a result the scale of disorder might even surprised the police but it proved a vital point to the government. The point was that the police was important and they better thought twice before they made any further cuts. It is unlikely that it was the police officers conspiracy. It looked it was a manifestation of self-defence, that may got out of hand a bit.

Now the government is making yet another mistake. It is going into confrontation with trade unions. Historically strike were very unpopular in Britain and the public tend to blame the striking folk more than the government for the inconvenience. But this approach was a result of a judgement on the situation that to many in the society seemed fair. In the past the strikers had a good deal and generally were living on the state subsidies, like heavy industry workers over 30 years ago. This stereotype was later transferred onto all public sector workers.

But times changed. No the group that is now being subsidised heavily and most is the financial industry. All taxpayers have to chip in to subsidise the City to much higher degree than heavy industry 3 - 4 decades ago. And the remuneration of financiers is much higher than of the heavy industry workers. The public sector finances are in such a huge mess because the government has to over borrow in order keep the banks afloat. This all is a source of protest amongst all those who are affected by the government spending cuts and tax rises. "We are all in it together" apart from the financial industry who can only carry on their old ways doing business due to the fact that "we are all in it together" keep subsidising them.

Therefore now the public is likely to have a lot of sympathy for the workers going on strike. And it is an irony that trade union are actually fighting for more free market, i.e. cutting subsidies to the financial sector. The striking workers do not want anything more. They want to keep what they have got which, compared to heavily subsidised financial industry, is not that much. The government is likely to make a misjudgement: ordinary taxpayers are likely to accept the strikes as a protest against them subsiding the financial industry. And this can only fuel even more unrest and make other groups join in.

With disaffected unemployed youth that have little prospects as even they find the job they will have to start paying taxes to subsidise the financial industry, not exactly happy police, radicalised trade unionists and public sector workers and the general public who frankly have enough to keep subsidising the banks, the government should think of contingencies for a long period of discontent. Cynics say that some already are ready for it: resign and join the City (i.e. continue to live at taxpayers expense).

"Credit easing": another good money thrown after bad

2011-11-27T10:20:00.007Z

When politicians start doing something right you can be sure that the situation is serious. This cynical comment - sometimes quite unfair - seems to be true this time. The British Finance Minister (the Chancellor of the Exchequer), George Osborne, plans for a "credit easing" programme for small companies worth £20 bn (possibly up to £40 bn). The previous money expansion programmes, i.e. banks' recapitalisation and rounds of quantitative easing, failed to jump start the economy. The reason was simple and obvious before these actions: no benefit of hindsight. Having depleted the banks reserves by running a giant pyramid scheme (effectively banks defrauded the reserves), the banks were holding on to new money to keep them afloat. In 2008 it was already obvious that if the government wanted to jump start the economy, it must have set up an altarnative system of putting new money into economy AND circulating them outside the mainstream financial system.

After over three years the government seems to have understood the first part. Hence the decision to start "credit easing" for small companies. It is an introduction of new money into economy effectively bypassing the banks. The amount mentioned is not staggering. It is £20 bn, but it can be very effective. Typically in a healthy functioning economy, with a healthy financial system, would have multiplied this narrow money in circulation into £140 - £200 bn broad money. This could have jump-started the economy.

However contrary to a recommendation given to the House of Commons Treasury Committee, the government does not provide any mechanism to circulate these £20 bn in the economy safely, generating new credits from the initial injection, "easing". Once businesses start getting credit through "credit easing" these money will end up in the financial system, it will be cashed for all sorts of toxic waste that the financial system has generated for years and keeps generating them or in the reserves. It will not be relent. It will be another way of subsidising the banks. As a result £20 bn will be expanded in a minimal way, if at all. No doubt it will help some struggling small businesses. But there is a very high risk that from the economic perspective it will be a good money, with the best of intentions, thrown after bad money.

Sometimes a half of good solution is a bad solution: "credit easing" seems to be falling into this category. It is likely that in six months time or so the government will be wondering why the programme failed. But is it not obvious now?

Budget. What budget?

2011-11-18T11:24:00.005Z

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.

Debt Dynamics

2011-11-05T10:40:00.006Z

Debt, in itself, generates more debt by attracting interest. At present it appears that the current level of debt, in Eurozone - and in almost all western economies including the US' - attracts more interest than the repayments generated through economic growth (collected as taxes). There is no doubt that recovering from the current crisis will require debt write offs. But how much would it be on a global scale? It makes a significant difference if, for example, 20% of debt on the banks' books (globally) has to be written off for the economy to recover, or 99%. And it is actually likely to be far closer to 99% than 20%. And then there is a question who will be on a receiving end of such write offs: basically who is going to lose loads of money. As the history shows the answer to this question may make the difference between peace and war.

But debt write off is not such a simple process. If it happens it will be a default. Even if voluntary the courts are likely to rule that it is a credit event. This, in turn, will trigger CDS' payouts (sometimes referred to wrongly as insurance against a default; in fact these are the bets put that default would happen). Due to the nature of CDS' these payouts may actually be greater than the underlying debt, value of default (since it is possible to buy CDS' on a particular default event exceeding the value of the debt). So from financial system perspective, debt write offs may trigger liabilities much greater than debt itself: i.e. the cumulative value of CDS' payouts may exceed, by far, the value of written off debt (some estimates go into hundreds of trillions or even quadrillions of dollars). And who is going to pay it? The guarantee will come back again on the taxpayers doorstep.

The current credit creation mechanism in the banking system (lending with loan to deposit ratio greater than 100%) is also unsustainable. Such mechanism needs financial innovations, like collateralising and rolling over of debt, to be operated. The unsustainability of this mechanism is such - it is basically a pyramid scheme mechanism - that even if a sufficient global debt reduction is done (even a total 100% write off), and somehow CDS' liabilities are written off too, the debt write off strategy will not work anyway: the world will be back in debt and soon.

The new debt generated by credit creation with loan to deposit ratio greater than 100% will very quickly (at exponential, intractable, pace to be mathematically precise) return to pre write-off level. But a credit creation process cannot be stopped totally without killing the economy altogether. This is actually what is happening to a large extent now: banks lend very little to genuine businesses. The solution to such quagmire is given by basic mathematics (this is what the work on this blog has been all about): after making sufficient write-offs, lending with loan to deposit ratio (system-wise) greater than 100% should be banned explicitly. Thus far it is banned implicitly as pyramid schemes are banned, but financial institutions ignore it. In practice ledning with loan to deposit ratio greater than 86.5% (or even less) should be banned. This is not a guarantee of a solution to all economic and financial system problems giving a speedy recovery, but without it no solution is possible. The world will keep getting into debt deeper and deeper.

The quagmire of the current situation is that, from technical and legal perspective, for some years (at least a decade but most likely much longer) the financial institutions have been running a massive global pyramid scheme. What we have been observing for the last 3 years is a typical ongoing collapse of the pyramid. It looks exactly the same as Albanian pyramids of 1996 - 1997. The fact is that the financial system - with the support of politicians - is determined to maintain such a massive pyramid scheme. In practice it means more collapses and bailouts and never ending debt for the taxpayers to keep such a loan shark business going.

Lord Lawson: Greeks should vote "no" in the referendum

2011-11-03T16:51:00.003Z

Today at lunchtime, Lord Lawson (a UK Chancellor of the Exchequer between 1983 and 1989) has given a lecture at the National Liberal Club in London. The title, put in form of a question was: "Is the Eurozone crisis a threat to global stability?" It was an excellent review of many aspects of the causes and mechanics of the ongoing financial crisis from macroeconomics perspective.

After the lecture, during a question session Lord Lawson was asked how he would have advised the Greeks to vote in the referendum (if there is one) on accepting the last week's financial bailout deal. His answer was unequivocal "no". Lord Lawson did not answer a question whether he expected colonels back in power in Athens by this Christmas.

Greek recovery: Greece doing Iceland?

2011-11-03T09:45:00.007Z

It is impossible to say whether Greece will (or will not) leave the euro. Let's leave it to fortunetellers. However the rest of Eurozone seems mortified to the point that they decided to parade and grotesquely admonish Greek Prime Minister Papandreou in front of G20 leaders. Cannes, the European film capital, was indeed the fitting location for this tragic farce.

It may well be the case that Germany might not be able to leave euro themselves orderly before the whole thing starts crumbling. So the Greeks get bullied by their European friends. They are told that they will be better off by accepting a massive austerity programme than by defaulting and basically starting from scratch as a bankrupt country. Public spending control and cuts is a good idea. But the Greeks are not the Germans. And even the last time round when Germany went through economic hardship, in the 1920's and 1930's, it produced the leader whose idea about European integration was rather unorthodox.

Greece is told that if they get half of their debt written off, accept a massive economic hardship for a decade, by the 2020 they will still be... 120% in debt to their GDP. It is unsustainable. By comparison the current Italy's debt to GDP is, surprise, surprise, 120% and is considered as unsustainable, And Greeks are meant to approach this level from the other side. Therefore, frankly, Greeks are on a receiving end of a lunatic proposition. The fact that the European leaders do not see this unreal side of their actions does not say much about them. It is actually very worrying.

The concept of bankruptcy was invented and defined in law for a reason. It is possible to reach a point when nothing works better for a debtor than accepting the insolvency and starting with a clean sheet.

Greeks can also take Iceland as an example: it was really the first and the only country that went bust in this crisis. They admitted the game was up. Iceland started negotiated hard with creditors. They have had their national interest in mind: first come Icelanders and then they can pay others. And quite rightly so: this is what sovereign nations, and their governments, are all about and creditors to sovereign nations know exactly that when they lend money.

Not surprisingly although Iceland is still heavily criticised for their actions, it is reviving pretty well. And less than three years ago it reduced its financial and state institutions to a basket case. However the common sense and survival instinct prevailed and Iceland is now where it is. Actually not bad. Greece can recover fast too: if Greece default on all of their debt, by next year, they will be running on the budget surplus, such is the current burden of interest. Take example from Iceland is no-brainer. Besides country bankruptcies are quite common in history so really the fuss, the opposition about the Greeks going bankrupt is about effectively enslaving them, to make them keep paying as much money as they can be squeezed for till the end of the world, and possibly one day longer. A classic loan shark strategy.

There is a side show to the prospect of Greece defaulting that no politician or commentator is taking about. Typically the most important and interesting things are those which are not talked about. Greek debt is supposed to have been "insured" by CDS'. So there should be no problem with Greek default, should it? It does not appear so. Despite the fact that CDS' are sometimes described as insurance against defaults, they are not. (As clearly they cannot bear the costs of Greece defaulting.) They are simply tools of market speculation with heavily misleading financial information about them: financial "weapon of mass destruction" as Warren Buffett called them. They epitomise the pathology of the financial system. Greece has many clever people in finance and wealthy individuals. Therefore it seems quite reasonable to assume that many of them, having common sense and possibly some inside inklings, bought a lot of CDS' betting that Greece would eventually default. They had plenty of money: apart from their own, thus far European bailouts were generous. Technically their CDS' value may actually exceed the Greek debt itself. Many time over. Therefore it is not inconceivable that, even if Greece do not benefit itself financially from the default, the default may actually produce a number of Greek millionaires or even billionaires. Greeks have an upper hand? This is what modern innovative finance is all about. Only if you know how to play it right.

Germany v "Financial Markets": the only game in town

2011-10-27T10:10:00.002+01:00

This morning Herman van Rompuy said in his speech in Strasbourg that he expected Greece to achieve a level of debt of 120% to its GDP by 2020. This is what is considered by eurocrats and the "financial markets" as sustainable. If this figure is anything to go by then we can easily unravel what the "financial markets" game towards Germany is all about. Ultimately the banks love debtors provided they are credible and pay. And none is better than Germany in that respect.

Currently the Germany public debt is on the level of 85% of its GDP. Therefore it would be beneficial for the "financial markets" if Germany "borrowed" additional 35% (to reach a level of 120%). The best way of borrowing would not really be borrowing in a traditional sense of this word (for example to invest) but generating liabilities out of thin air to the financial institutions (e.g. bailouts, rescuing Greece, Italy, etc.). Additional 35% of German GDP would give the "financial markets" around 1 trillion euro.

So by hook or by crook, expect a lot of maneuverings on the "financial markets" to force Germany to part with their money. Another crisis, another "market uncertainty", another threat of bankrupting:... Greece, Italy, Spain, Portugal (take your pick, it does not matter which one). This is what the game is all about, Euro is a very handy tool for the "financial markets" to conduct a process of trying to extort money from Germany for the "financial markets". Printing presses in the US and the UK have a limited speed after all. That is why Germany leaving Euro is quite a plausible proposition. Angela Merkel does not look like a mug and is rather unlikely to be sucked into this game.

Germany Euro Abfahrt?

2011-10-26T22:04:00.011+01:00

For some time there has been a discussion going on Greece possibly leaving the Euro. Greece's current sovereign debt is unsustainable. It can only be propped up with Germany's help. In fact this process to some degree suits Germany as long as it does not cost it too much. Greece's financial problems make Euro weaker. This helps German economy which is based to a great degree on export. So Angela Merkel has to play a balancing game of spending as little as possible on saving the Euro from collapse still keeping the Euro weak, whilst at the same time making sure that Germany, and especially their exports, keep growing. But this process cannot go on forever. Now there is a talk of Italy's joining Greece as the financially failed state of Eurozone. This will elevate the crisis onto a stratospheric level. Italy's debt is, circa, six times greater than Greece's (assuming there are no hidden financial arrangements of some sort of creative accounting) and the business of propping up Italians will be a game of completely different magnitude.

Germany is well known for meticulous planning and forward thinking. They must realise that it would only be a matter of time that if Greece's debt is written off to a large degree, others, Italy, Spain, Portugal, will pick up a begging bowl and join the queue. Germany can hardly afford to pay for Greece's debt. Forget about the rest. German policy and decision makers must understand that. They cannot feed the rest of Eurozone and, through them, the entire failed financial industry (which engineered this entire mess in the first instance). Therefore it appears increasingly likely that Germany end-game of bailout delays and never ending discussions is delaying a real market event: Germany leaving Eurozone. The discussions, and agreements even if made, have very little short and medium term market credibility in any event, let alone long term credibility. The discussions and negotiations time is used by Germany to prepare properly for their exit, gearing up their financial system, and in the meantime keep benefiting from a weaker Euro. If Germany leaves it is likely to take with them a couple of financially prudent and trustworthy countries such as the Netherlands, Luxemburg, Austria and Finland. And the rest of the Eurozone led by Sarkozy and Berlusconi will be left to their own devices. No doubt they will hold interesting summits. If the new German currency gets too strong (for example to impede its exports) there are many ways to weaken a currency in a way far more beneficial to Germany than subsidising failed Eurozone with some of its dysfunctional economies (Greece and Italy) and lining up bankers pockets with massive bailout tranches.

If Germany thinks and plans its future in line with its long term national interest, which is a credible assumption, it seems it makes more sense to start considering Eurozone without Germany (and possibly the Netherlands, Luxemburg, Austria and Finland) rather than Eurozone without Greece. Of course before this happens and Germany walks away with pride of the financial bull untarnished, it will have to show all their good will of trying to do impossible: credibly save the Euro. Hence such an impassioned Angela Merkel's speech in Bundenstag today. And what is the alternative: becoming a dairy cow of the rest of Europe and the entire financial industry? Not really an appealing one.

PS. If some in the mainstream media wonder about the logic and rationale of the risk scenario above (as they are likely to) they are actually quite trivial: whenever you see a failing business or enterprise you actually see the strongest leaving first. Unlike the weakest they have options.

PS2. The recent events seem to make a hypothesis of Germany leaving euro even more credible. The Eurozone masters are going to China to ask for help with euro bailout. Until recently Germany was the largest world exporter and only a couple of years ago lost the pole position to China. If China invests in euro bailout it will start wielding considerable influence over the single currency and is also quite likely to gain better export terms to the EU. This would become a mechanism that is likely to weaken the German position as an exporter on the international markets. It is rather inconceivable that Germany do not realise that. The alternative is to leave euro (with China interest in it) and manage own affairs separately (or possibly with other strong nations: the Netherlands, Luxemburg, Finland or Austria).

Financial Apocalypse Now

2011-10-21T20:46:00.010+01:00

"no one could buy or sell" - Revelation, 13:17

In autumn 2008 the banks lost liquidity as a result of running a massive global pyramid scheme. The governments stepped in and pumped trillions of euros into the system. This saved the banks from collapse. Yet the governments did not liquidate the global pyramid scheme. The money given to the banks only prolonged the existence of the pyramid and increased it in size. At the same time the governments ended up in heavy debt.

This rescue operation worked at the time as the sovereign debt then was not that high and the governments had enough credibility to repay the debt incurred. (Such repayment was to come from the future tax receipts.) Now, on the back of Greece looming default, a new liquidity crunch in the banking system appears inevitable. Basically if Greece defaults many banks will lose the capital adequacy and will require bail outs. As the European governments have the experience of the autumn of 2008 they want to prevent it by setting up a bail out fund to the tune of 2 trillion euros. In fact the Greek debt crisis is supposed to be saved by taking even more debt. Is such situation sustainable? Solving Greek sovereign debt by even more sovereign debt and spreading it

In 2008 when the governments took on massive debts to bail out banks the governments had credibility that they would be able to repay the debt (of course, with taxpayers' money). However with the debt even growing, with hundreds of billions euros added to it since, and very little economic growth it does not look credible at all that the governments will be able to repay the debt after additional 2 trillion euros are added. 2 trillion euros is more than 2.5 times of an unsustainable annual public deficit for 2010 of the entire EU: a deficit that heavily impedes growth and hence the chance to repay the debt itself. In such situation the sovereign debt will be heavily downgraded. This will result in banks ending up in further liquidity crisis as banks reserves will lose in value. As the sovereign ratings will be downgraded, pumping more money into the banks by the government will not even be a theoretical option.

This is a scenario of banks going bust spectacularly and the currencies (as apart from euro other currencies including the dollar) are likely to lose credibility. The only way out - a technical one - will be fast running printing presses: i.e. a hyperinflation. And, in practice, western economic system will be reduced to some form of a barter. And if the EU or the governments try to keep a tight control over it, well, "no one could buy or sell". Angela Merkel seems to realise that there are such risks.

This scenario is not inevitable. There are ways out. But to implement them, the governments must understand the nature of the current crisis first and then be prepared to make difficult political decisions. And the things can keep going, actually getting worse, for some time with taking half measures: you can only imagine what the ministerial discussions in Brussels are all about.

State investment bank and the European banks meltdown (in slow motion)

2011-10-12T23:19:00.005+01:00

As reported on tonight BBC Newsnight, currently politicians and business leaders in the UK propose setting up a structure that would amount to a state investment bank. Originally it was called by the Chancellor of the Exchequer a "credit easing". This means that the government would be lending money directly to businesses bypassing the commercial banking system. Nearly three years ago the author of this blog wrote in the first article "The largest heist in history":

"Deposit accounts records, along with mortgage and genuine business accounts, would be moved to a specially created agency of the Bank of England which would honour them with government help. If a pension fund collapsed due to a bank collapse, individual pensioners would continue receiving their unchanged pensions from the social security system. This would guarantee social stability and a normal flow of cash into the economy."

Finally, years too late some politicians and experts have started realising the obvious: the 2008 crisis exposed the financial system as dysfunctional and that it did not serve the real economy anymore. Therefore any economic stimulus must not have gone through the banks, as it would never reach the business but instead would be consumed by the financial pyramid. A government help for businesses must be provided directly.

In the meantime the European banking system is facing a collapse. There is a talk in Eurozone of setting up a multi trillion euro rescue fund for the banks. But where is this money going to come from? The European countries are in debt to the extent that it prevents them being a source. (Otherwise any more debt will trigger credit rating downgrades and the confidence will collapse. This in turn will trigger another debt meltdown chain reaction.) And there is no other source. However Eurozone countries may still try. This would only prolong the agony and make inevitable collapse even more spectacular.

"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?"

was also stated in "The largest heist in history".

It is of no particular satisfaction to the author of this blog, in fact it is a rather sad reflection, that the process of the financial collapse that he predicted nearly three years ago is happening now. This process was easily avoidable if the decision-makers followed the recommendations described in "The largest heist in history" and refined in "Prime Minister, sort out this mess, please". Of course the particular events and their timing could not have been predicted. But the logic of the process or rather its result, the financial meltdown that is happening now, was trivial to anticipate and prevent. A multi trillion euro question is why the decision-makers did not act accordingly.

It's a pyramid indeed

2011-10-08T15:22:00.012+01:00

The analysis on this blog was written as an intellectual exercise deliberately outside the mainstream academic research, so it was not influenced by the conventional thinking. But the work, especially its technical aspect, was meant to be serious and correct. In August last year the work on this blog was reviewed and used by Ms Marina Stoop of Swiss Federal Institute of Technology in Zurich (one of the world leading universities, alma mater of Albert Einstein and no less than 30 Nobel Prize winners). Under the supervision of Professor Didier Sornette, she wrote her Master Thesis "Credit Creation and its Contribution to the Financial Crisis".

The thesis acknowledges the taxonomy of credit creation process introduced in an article on this blog "Computational complexity analysis of Credit Creation": Full reserve banking, Fractional reserve banking, No reserve banking and Depleting reserve banking (page 29 of the thesis). It concurs that as a result of practice of Depleting reserve banking (or Depletion banking system as it was called in the thesis) "the money multiplier tends to infinity and the liquidity risk is 100% in a finite time." (page 30 of the thesis)

The thesis also cites financial perpetuum mobile example from the blog article showing how Depleting reserve banking works and then concludes:

"This describes well how the bubble economy worked that led to the current financial crisis. In the years preceding the crisis, the money (“wealth”) created in the system was not tied to the real growth rate of the economy. It therefore created the illusion of a perpetual money machine where wealth would grow at an accelerated pace." (page 31 of the thesis).

Having acknowledged that a "Ponzi scheme is a fraudulent investment operation", with respect to Depleting reserve banking, the thesis confirms that it "is a classic example of a Ponzi (pyramid) scheme". (page 92 of the thesis) This is exactly what the author of this blog asserted since the end of 2008: the financial system had been been turned into a pyramid scheme and its collapse was inevitable (and indeed easily predictable).

As this conclusion comes from a leading university in the world, are politicians and, more importantly, prosecutors going to do anything about it?. The ball is in their court.

The graph below shows exactly an exponential growth of Money Multiplier (this time it is expressed as a ratio of broad money to currency supplies in the United States), the direct effect of Depleting Reserve Banking: (source: US Federal Reserve)

Looking at the diverging trend of M3 (broad money) to currency on this graph, it is simply too terrifying to discuss what happened after 2006, when the reporting was ceased. The graph HERE shows even faster increase till 2008, then a decrease of growth, deleveraging between 2009 and mid 2011 and back to the old pyramid pattern. So the current collapse should not come as a surprise.

This is precisely what is achieved by lending with loan to deposit ratio greater than 100%. It is a classic representation of a pyramid scheme. (Both top and bottom graphs: top one showing broad money exponentially diverging from currency and the bottom one - as near linear on a logarithmic scale - showing a pretty steady pace of exponential growth.) This is what is called a Depleting Reserve Banking (not Fractional Reserve Banking any more). This is what the model presented in "The largest heist in history" captures (as said: "the proof of the pudding is in the eating").

Money multiplier v loan to deposit ratio

2011-10-01T17:58:00.006+01:00

I have noted that in discussions going about my blog on some fora - including financial and bankers' ones - many confuse a concept of money multiplier with a concept of loan to deposit ratio. For example:

"Comment:

Re Rosie's excellent questions and the subsequent discussion, it's well worth looking at http://gregpytel.blogspot.com/

The author looks at what happens if the Reserve Ratio is allowed to go negative -- i.e. the banks loan out £101 (or more!) for every £100 deposited. Couldn't happen, right? Read for yourself...

RGB

Response:

That would actually be a very prudent reserve ratio...the banks traditionally would lend £900 for every £100 reserve.and that was in the good old days of Capt Mainwaring,in some cases recently that was stretched to a £100 deposit turning into £4900 in loans!(stupid boys)

The Comment clearly refers to loan to deposit ratio whilst the Response is about money multiplier.

Just as example, loan to deposit ratio of 90% - i.e. lending £90 out of every £100 - gives money multiplier 10, whilst loan to deposit ratio of 101% - i.e. lending £101 out of every £100 - gives unbounded money multiplier (i.e. the money multiplier tends to infinity at exponential pace).

Still confused? Then please read: "Computational complexity analysis of Credit Creation".

Credit ratings: wealth transfer mechanism from taxpayers to private corporations

2011-08-11T23:51:00.026+01:00

London riots provide a perfect attention diversion, or rather a smokescreen, of financial looting of the taxpayers currently implemented by the financial industry that goes largely unnoticed. As the first article on this blog, "The largest heist in history", showed the financial system was turned into a giant global pyramid scheme. Nearly three years ago, in the fall of 2008, it was obvious that "Unless and until the governments identify, isolate and write off toxic instruments held by financial institutions every pound put into “rescue” is very likely to end up being good money thrown after bad."

The current financial system has been operated as a giant global pyramid scheme (where lending with loan to deposit ratio greater than 100% is a pyramid mechanism) for at least last 15 - 20 years. It assures that the liquidity shortage is a systemic feature of the financial system. The excessive debt is not at the heart of the current crisis. The politicians and the "eminent" financial pundits that repeat this constantly to justify the public spending cuts (which quite often can be a very good idea as living beyond the means is disastrous) show the lack of competence on a massive scale. In the current crisis the debt is a manifestation of something far more lethal: too high money multiplier. No wonder that with such leadership the financial situation of the western world is going from bad to worse and whilst politicians are talking about solving the problems they keep creating new ones. The exception in the West is the German Chancellor Ms Angela Merkel. She appears to understand what it is all about and is very skilfully navigating for the benefit of Germany amongst her peers who are clueless.

All the money pumped into the system by the governments, since September 2008, in form of bail-outs and quantitative easing was wasted (as predicted). Basically it was used to prop up the financial industry itself - paying massive amounts for lavish offices, salaries and bonuses - whilst the rest of the economy kept on struggling. But as it was obvious over two and half ago years the financial industry keeps returning for more of taxpayers money.

The first ongoing form of financial looting is the bailouts of countries like Greece. The private banks that took on the risk themselves when they lent money now expect the taxpayers to underwrite the risk that they took. It is a perversion, an absolute distortion of the principles of free market economy which made the western world so successful for most part of 20th century despite two disastrous world wars and indeed social tensions. It is a version of a communism for the rich where the profits go to private coffers whilst the losses are underwritten by the taxpayers. It is a mechanism of funnelling taxpayers money to private pockets.

The second ongoing form of financial looting that appears to be gathering pace now is the use of credit ratings. It is quite crude and primitive. But, boy, it works.

For many years credit rating agencies have been assigning ratings both to private corporations debt and state sovereign debt. If it was just a matter of opinion it would not matter. Anyone, including the author of this blog, is entitled to his/her opinion. However credit ratings are a part of the fabric of the financial system. They dynamically determine the costs of borrowing: what a debtor has to pay to the creditor. The higher the credit rating the lower the costs of debt and vice versa. It has been clear that for some years the credit ratings of sovereign debt was, using the same standards based on historical statistical review of default occurrence, too low compared to credit ratings to the private corporations debt. For example the world has seen no default of AAA rated countries whilst many AAA-rated financial products turned out to be lethally toxic (and it was manifestly clear they were toxic at the time they were assigned AAA). With the downgrade of the US sovereign debt from AAA and the prospects of downgrading other countries', also the prospects of downgrading cities and local governments, this trend of underrating countries' debt in comparison with the private debt looks more prevalent.

The fact that, based on the same methodology, countries are underrated in comparison to private corporations is not just a matter of opinion as President Obama seemed to naively suggest putting a brave face over a big problem. It means the states (countries, taxpayers) pay more money for servicing their debt than if they were private corporations in the same circumstances. In the financial markets of global capital allocation the effect is profound. This asymmetry of the costs of debt constitutes a global wealth transfer mechanism from states (countries, taxpayers) to the private corporations. It is not an ideological opinion or a matter of political ideology but a financial fact. This does not imply whether it is morally right or wrong which is for each reader to decide (or even not decide at all). It is the way the financial industry works.

This wealth transfer mechanism of underrating the sovereign debt in comparison to private corporation debt, is basically a bailout by stealth provided by the taxpayers to the financial industry. It is yet another method that the financial industry is implementing to extract money from the taxpayers. It is not a conspiracy: simply it makes good business sense for the financial industry, whilst making politicians' financial competence look rather questionable. However due to the pyramid nature of the financial system this will also not be enough. Sooner rather than later money will end up in private hands as a way of wealth transfer. It will prolong the crisis, make the pyramid bigger and impoverish the countries and the societies. More austerity. And it will make the final implosion of the financial system even more spectacular than what you can observe with the LHC in CERN.

City thieving reached Inner City

2011-08-08T10:43:00.007+01:00

It is impossible not to reflect that the kind of social breakdown that made streets of Britain look like the streets of Bagdad immediately after 2003 fall of Saddam indicates that City greed and thieving practices reached the inner city.

Bankers are got away with their crimes of stealing money from the taxpayers by organising a massive global pyramid scheme. Moreover they were rewarded for they with hefty benefits and bonuses. To the rioting yobs it looks as if they were given handout bags with trainers and mobile phone by the police when they were leaving looted shops.

What compounded the effect is that a lot of MP's were helping themselves with expenses. They got away with it. "It was a muddle not a fiddle" for most of them to quote a classic phrase. For yobs the MP's are thieves who were allowed to get away with thieving. The mainstream press, the beacon of elite and status in the society, were generating stories (therefore big money) through illegal means (phone and e-mail hacking). The got away with it. The police, a very senior one, was helping themselves by taking bribes from journalists for breaking the law (disclosing confidential information). They got away with it. And so on.

A very few yobs are able to express these so clearly (but one or two suggested just that when questioned by the journalists). But they have perception that those in authority - captains of the financial world, politicians, social elite (like journalists), the police - are criminals. So what they are doing are simply joining them. As they are yobs they are not committing en masse white collar crimes through insider dealings or giving dodgy credit ratings, but, in line with their social station in much more unsightly way, looting and causing mayhem. As it seems this is less dangerous than white collar crimes: since it is immediately visible it is dealt with instantly. Whilst the white collar crimes have a very long term eroding effect. The effects of which we see on the streets of Britain now.

But the outcome is predictable. The yobs will be punished (quite rightly) with harsh sentences whilst financial criminals will be rewarded with even more bonuses. And the social breakdown and moral destruction will continue. You may ask yourself where it all ends.

PS. Nobody should be in any doubt that this article excuses the rioters and yobs. It does not. They are criminals. However it is a reflection that whilst the government is rightly very quick to condemn and fight unsightly physical violence and robbery of the inner cities, it is nurturing the financial thuggery of the City. Basically financial yobs hold the government by the throat.

The largest heist in history continues

2011-08-08T10:25:00.003+01:00

Rather than writing a commentary upon the current events on the financial markets, why not re-read the analysis that is nearly three years old: "The largest heist in history". In particular:

"Governments became the ultimate customers of pyramid purveyors with the hope that when they offer their custom it would somehow stop the giant pyramid scheme from collapsing. This is extremely naive and very dangerous. The incredibly fast growth to infinity of pyramid schemes, which is only accelerating, will ensure that the government will not stand a chance to sustain it, unless this massive pyramid scheme is brought to a halt and liquidated. But there is no sign of governments contemplating doing that yet.

If governments do not liquidate the global pyramid scheme, the money they injected will be, in time, converted into toxic instruments (eg 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 dependant 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.

In a normal free market economy a business that fails should be allowed to collapse. If a business is a giant pyramid scheme, like the current financial system, it must be allowed to collapse and its executives and operators should face prosecution. After all running pyramid schemes is illegal. Letting the banks collapse would have been a far more commercially sound solution than the current approach, provided the governments would have secured and guaranteed socially vital interests directly. For example, individual deposits would be guaranteed if a bank collapsed. Deposit accounts records, along with mortgage and genuine business accounts, would be moved to a specially created agency of the Bank of England which would honour them with government help. If a pension fund collapsed due to a bank collapse, individual pensioners would continue receiving their unchanged pensions from the social security system. This would guarantee social stability and a normal flow of cash into the economy.

The hard part would be to liquidate financial institutions while sifting through their toxic waste and to distinguish genuine non-toxic instruments and the results of pyramid scheme operation. Deposits, mortgages and business accounts are clearly non-toxic in principle. However, in the modern banking they were mixed with potentially toxic assets. This would be a gargantuan task.

(...)

Unless and until the governments identify, isolate and write off toxic instruments held by financial institutions every pound put into "rescue" is very likely to end up being good money thrown after bad. (The governments, as ultimate customers of the global pyramid scheme, are supplying the pyramid purveyors and beneficiaries with tax payers' cash and the largest heist in history continues.) Alongside the liquidation process, but after the toxic waste has been isolated and fenced off in failed financial institutions, governments must launch a fiscal stimulus package and go after the pyramid purveyors and beneficiaries to recover any cash and assets from them and bring them to justice. As the financial pyramid scheme is global, any action—including the recovery cash and assets—must be global, too. It is intriguing that banks in traditional offshore financial centres like Belize, US Virgin Islands, Bermuda, do not appear to suffer from liquidity problems. They do not require rescue packages even though a lot of them are subsidiaries of much larger banks which are affected by the current crisis."

Hence what is happening now, considering the way governments and organisations such IMF acted, was obvious that it was going to happen: "The largest heist in history" was published by the House of Commons Treasury Committee. No benefit of hindsight whatsoever.

Irrational exuberance: two double whammies of the US debt limit increase

2011-08-05T11:30:00.004+01:00

It is a rather unorthodox way of solving debt problems by taking on yet more debt. It is even more unorthodox if the servicing of the existing debts is impossible without taking such additional debt. This is a classic example of a downward debt spiral: sliding into bankruptcy. Yet this is exactly what the US, as well as Britain and many countries in the Eurozone are doing.

What the solution is for the US now, the debt limit increase of another $2.1 trillion on top of the existing $14.3 trillion, will come back later to haunt the world markets: the US will have to continue to borrow to meet their financial obligations. Unless and until the US produces a balanced budget, the problem will keep growing. And they better do it soon as such balance has to be sustained on average through ups and downs of the economic cycles in a long term. This, in fact, was a golden rule that Gordon Brown preached but was never able to put it in practice. US talk of a $2 trillion (or even $4 trillion) debt reduction over 10 years is farcical at best.

Rating agencies, by the nature of their business and, more importantly, their conduct create a lot of uncertainties in the markets. The credit rating is not just a figure that became popular recently. It is typically part of any creditor-debtor agreement on the financial markets. The lower the credit rating, the greater the interest rate that the debtor has to pay to cover the costs of the additional risk. Whilst it seems to make logical sense, such methodology is a source of instability.

If a debtor is less likely than before to satisfy the creditors then its credit rating has to be decreased. Consequently the interest payments on debt have to go up. But with the increased interest payments the debtor is even less likely to satisfy its obligations. Hence another rating downgrade is very likely. And so on.

The credit rating agencies would only have a stabilising effect on the markets if countries in debt had the scope to readjust their finances in order to prevent the downgrades. And they act as if they have such scope. The credit rating agencies methodology and practice is a typical recipe for a downward debt spiral.

Moreover the credit rating agencies credibility has not been enhanced by a rather inadequate (to put it mildly) assessment of many financial instruments in the run-up to the credit crunch of 2007 - 2008. The fact that the agencies did not come clean on what went wrong then should also be a point of reflection.

The US debt is a different kettle of fish to all other financial papers due to its value, and the fact that two-thirds of world reserves are held in US dollars. A downgrade of the US debt will have grave effects on the world markets. Moreover, as many American politicians ask "why we let these guys even be in business" the US may administratively deal with the credit rating agencies; effectively dismantling the financial markets as we know them.

Hence despite the US amassing a huge debt, the agencies seem to be determined to keep AAA rating. This, of course, makes a mockery of the rating system.

An AAA rating of the US debt allows the debt papers to be traded and considered by the financial markets as good as cash. But it is not cash. It is debt and it will have to be repaid at some point. As long as US debt papers function on the financial markets as cash they are effectively printed money that fuels high inflation. For that reason in the last couple of years, we observed high inflation in commodities and other durable assets, such as real estate.

Not unexpectedly the price of gold has been reaching record levels and Swiss Frank started behaving like a commodity rather than a currency. It is becoming clear that the investors use the time to convert as much as possible of the US debt to as much as possible "real wealth". It is clear that the AAA rating of the US debt does not reflect the confidence of sophisticated financial investors. And the world at large is artificially propped up on confidence. It is yet another bubble that is going to burst.

The real effect on consumer markets is that despite very low levels of lending to businesses, very low wage inflation, very low growth, the consumer inflation is accelerating. It is a state of stagflation.

The real effect on financial markets is that the financial bubble keeps on growing. The financial bubble is not an esoteric term describing imbalances. It is a simple formula, a ratio of the liabilities that the financial institutions have or may be demanded to settle, to the means of such settlements such as cash or financial instruments which are considered as good as cash. At present, with an artificial AAA rating, the US debt appears as a mean of settling financial obligations. This has the effect of making an already huge financial bubble look smaller. It is exactly as if an ordinary person mistook the figures on his credit cards statements for his savings.

However once the market returns to its senses, i.e. that the US debt is debt not cash and may not be repaid, its entire value will have to be subtracted from the means of debt settlement AND added to the liabilities of the bubble formula. The effect of subtracting the US debt from the bottom of the bubble ratio and adding it to the top will be the first part of the double whammy. The scale of the financial bubble will be seen instantly. This will have an immediate effect on any dollar denominated transactions and capital and is very likely to lead to a huge credit crunch.

But unlike the credit crunch that happened in 2008 which followed a period of very low inflation, the US debt induced credit crunch will have been preceded by a period of a very high inflation. This will leave the world, or at least a huge part of it, facing huge public debt, very high prices and very limited means to pay. This is the second part of the double whammy: a formula for sliding into poverty.

This article was first published in The Arab Financial Forum Newsletter August 2011, Issue 1

Greeks' upper hand

2011-06-24T08:35:00.008+01:00

Greece is bust but no one formally admits that: i.e. there is no credit event as yet. There is an unusual resistance to face the obvious reality. On one argument why Greece should not go bust is that it would give a "bad" example to other countries that restructuring debt through default is the best for these countries at the costs of creditors. The other argument, not voiced that openly, is that currently a lot of debt is held by private banks (mainly in France, Germany and the UK) if Greece goes bankrupt, these private banks would face liquidity crunch, like or even bigger than at the end of 2008, and would require "rescue" packages from the taxpayers. This, in turn, would undermine the public trust in banks. It is impossible to predict the effect but a massive run on the banks is quite realistic then. Indeed justified. So the process of "rescuing" Greece is in fact an exercise of shifting their debt from private banks' books directly onto taxpayers books. And when Greece will go under private banks will be in safe positions and the taxpayers will get the hit directly. In other words it is a pathetic pantomime played to the public that banks are safe and prudent institutions to keep confidence in them.

However there is the third possibility. It is quite certain that behind many billions of euros lent to Greece there were many CDS' sold on the back of it. The Greek debt CDS market is vibrant.The European Central Bank should make it clear (down to at least 1 billion euro) how many billions of euros would have to be paid if Greece defaults on their debt. It is quite typical for CDS' that they were sold many times over exceeding the underlying debt. Hence if Greece defaulted, i.e. triggered the credit event, then the liabilities of some banks and financial institutions to the counterparties that bought CDS' may be many times (10, 20, 100 times or more: make your own guess) more than the Greek debt (going into trillions of euros). If that were the case then the financial system would go into the meltdown.

Greeks should ensure that they understand the CDS' position vis-a-vis their debt. If Greece is really such a store of toxic waste then they should use it to extract as much money as possible from the rest of the world that cannot allow them to go bust. Indeed some of these rescue loans they should use to insure many times over their own debt. So when the system collapses - as it eventually will happen - they would not be liable for their own debt but the counterparties that sold them CDS'. The financial system is so dysfunctional now, and the bankers are so greedy, that it should not be a problem to conduct such legitimate financial operations.

Incidentally there is nothing new in this analysis. This process, of toxic waste propagating through the financial system was predicted to follow the credit crunch of 2008 in the first article of this blog The largest heist in history written two and half years ago. It was clear already then that the financial system was at a state of utter dysfunctionality and stupidness.

Greece: there is a method in this madness

2011-06-05T13:08:00.003+01:00

Every person with rudimentary understanding of finance knows that preventing Greece from defaulting on their debt by giving it yet more loans (at very high interest rate, by the way) only delays the default and makes it bigger. Everyone knows it is a sheer madness: it is like borrowing even more money on one credit card to pay off the debt on another. A classic financial fools' trap. So why the governments agree to it if it is so idiotic. Well, there is a method in this madness. If Greece defaulted now this would have affected to a great degree private banks. By lending Greece even more money, this time by the countries, Greece is getting into even more difficult financial situation, but it is shifting the debt from private banks onto taxpayers. So when inevitable happens and Greece will eventually go bust it will be mainly taxpayers that will end up with unpaid debt rather than private banks.

This is so trivial: people in power are not that stupid. So why do they do it? Why are taxpayers in business of saving private business such as banks? (Incidentally it is against the EU rules about state subsidies.) The largest heist in history continues and indeed the financial industry loan shark strategy against the taxpayers is meticulously implemented (with the help of the politicians).

S&P: downgrade of US debt outlook

2011-04-18T20:56:00.007+01:00

A rating agency S&P kept America’s credit rating at AAA. However for the first time in its 70 years rating history of the US debt, the agency cut its outlook from “stable” to “negative”. A negative outlook means there is a one-third chance of a downgrade below AAA in the next two years. It is yet another sign that the financial crisis is progressing as expected. This can hardly be called a blow for US debt. It is simply a well predicted result. One can also reasonably expect a US grand finale in some form predicted in an article "A US way out?" two years ago.

The lower the US, and indeed any other country's, debt rating the higher the interest rate that has to be paid on it. Hence the beneficiaries are the banks that, incidentally, caused such massive sovereign debt mounting in the first instance by engineering the pyramid scheme that collapsed causing the credit crunch in September 2008. As predicted two and half years ago "The largest heist in history" continues and there seems to be no end to it in sight.

China is buying up the world

2011-04-07T19:59:00.009+01:00

(making the US a debtor of the whole world)

The US is hooked on China produced consumer products. The US buys massive volumes of goods from China and pays for them with the US treasury papers (the US debt). Can the US stop it? No. That would require moving production from China to the US which would take years (possibly decades) as it took decades to large scale of production of consumers goods to China. Never mind the fact that it could cause the US economy to collapse or at least massive hardships and internal implosion of home budgets as the US produced goods would be far more expensive that China's for the US consumers.

China is getting this massive volume of the US debt papers. These papers on the markets are AAA-rated and markets have to consider them as good as cash in international transactions. Otherwise the US dollar would have collapsed. So the 2/3 of world reserves that are held in the US dollars. No country can afford this to happen as this would have been a financial Armageddon. So China is buying access to the world natural resources, funding development of key infrastructure in many countries, investing in companies paying for it all with the US debt papers. The same logic will apply if China decides to use its massive stockpile of the US treasury papers to buy the European debt or help to finance the ailing European banks. Effectively China is using its cheap labour force to get as much as possible US debt papers which it uses to "buy" the world.

However this way China makes the US a massive debtor to the entire world (wherever China invests). It is impossible to rollover debt to infinity. So at some point, difficult to tell when, the US debt spread all over the world will become too big to roll it over once more. (Technically the growth of the US debt from trade imbalance with China is a pyramid.) In the same way as liquidity crisis happened in 2008 making banks debtors to the taxpayers, the collapse of the US debt and dollar will make the US insolvent to the rest of the world. All the countries and companies that China effectively paid with the US debt whilst "buying" up the world). Also all business entities that sit on the US debt, a huge part of the financial system, will also end up with a mountain of worthless US papers. No one will be able to come to the US rescue. However China will be left "owning" the world. (There is an element of exaggeration in using the words "buying" and "owning". This is to make this risk scenario clear.)

Furthermore China also buys debt of other countries using the US debt papers thereby making the US even a bigger debtor to the rest of the world.

Even if it does not end in such an extreme way (and there is no reason why it should not), China is slowly but heavily undermining the US world position using the trade imbalance between the two countries: by taking over key assets all over the world and buying influence with funding infrastructure project and by making the US a debtor to many countries and significant business interests.

In the same way as countries used to use and sacrifice health and life of soldiers to build their greatness (as we know it from history), China treats its cheap labour force in the same way: it is their real frontline that lets China acquire massive volumes of the US debt, at the same time keeps the US locked in such arrangement.

It does not look too good at all. The US is likely to react at some point (at the end it is a military hyperpower). It is anybody's guess how it will look like.

NB. for those who like historical perspective: Germany started World War 2 in 1939 because Hitler came to conclusion that it was cheaper to kill the creditors than to pay them off. One may start wondering whether the US may, at some point, start thinking in the same way.

Bankers having a free lunch

2011-04-03T09:11:00.003+01:00

Robert Peston published an interesting piece on his blog "Can banks dodge the break-up?". He wrote: "the Bank of England estimated this [state] implicit subsidy [of being protected by taxpayers against failure] as being worth around £100bn per annum at the peak of anxiety about the fragility of banks in 2008-9, and perhaps half that figure subsequently."

The state, taxpayers, are part of economy. Their subsidies, of whatever nature, come at the costs: they are paid for one way or another. If subsidies cost hundred of billions of pounds, these hundreds of billions of pounds must come from somewhere. For example taxpayers pay them by additional costs of government bonds or through some other transactions with the financial markets. "There ain't no such thing as a free lunch."

The City of the 2010's is strikingly similar to the British heavy industry of the 1970's. It provides no financial value to the economy and can only survive with taxpayers subsidies. Any tax receipts from the financial industry are dwarfed by the subsidies, bailouts and stimulus packages. Even City luminaries, top financiers and bankers, bear a striking resemblance in their attitude and characters to their trade union counterparts, so called "barons", of the 1970's. Will the City share the same fate as British heavy industries of the 1970's? The signs are not particularly optimistic.

(Sadly) the financial crisis proceeds as expected

2011-03-31T17:09:00.006+01:00

Robert Peston published on his BBC blog, "Person's Picks"" an article "The unbelievable truth about Ireland and its banks". It is somewhat disconcerting that major media business commentators are surprised with the obvious. (At least to anyone who was bothered to read "The largest heist in history" published over two years ago.)

Indeed the current hit is no end to the Irish predicaments. The same fate is awaiting other countries that have been a part of the global pyramid scheme. UK and the US will not be immune so let us not be surprised with yet another liquidity crunch when it is sparked off by the financial instituions in the UK in order to extract yet more money from the taxpayers. In fact the British government has effectively invited the financial institutions to come for more money by making spending cuts thereby creating a room to borrow more to "help" the banks when they "need" it.

The very first and most spectacular victim of the pyramid collapse in 2008, Iceland, handled the crisis in the best way: took the loses, defaulted on their financial obligations, now negotiates with the creditors in a pretty tough way and pursues on criminal charges all those who engineered the crisis in the first instance. The governments of Ireland and the rest of Europe should take this as an example as otherwise the taxpayers will keep being exposed to the loan sharks' tactics currently pursued by the financial industry.

Regulating financial risks

2011-03-08T10:55:00.024Z

Governments of countries affected by the financial crisis are preoccupied with designing a set of regulations that would prevent the future banking crisis (called "liquidity shortage" or "credit crunch") from happening. The actions are taken on the local level, introducing new regulations, and international level, e.g. Basel III. At the same time nothing is done to break up banks so they are not "too big to fail" or to separate investment banking from high street banking that would prevent using depositors cash for, often very risky, financial speculation.

But is it possible to regulate financial risks? To get to the bottom of it, it is necessary to understand what the major factor of liquidity shortage risk is. Ever since the full reserve banking was abandoned, i.e. the situation when banks were acting as safe storage business and depositors had to pay to keep their money there, when bankers realised some hundreds years ago that at any one time they only get a withdrawal call on a small proportion of the deposits held, banks started circulating money. Circulation is in fact money multiplication, i.e. for every £100 paid in as deposits banks lend out a portion of it. Typically it was between £80 - £90. This made the banking system work as statistical machine whereby for every £100 liability, the bank held only £10 - £20 cash.

The risks of running a banking system in such a way is rather obvious. The first one is psychological: if depositors demanded a large proportion of their deposits, for whatever reason, a bank would not have money to satisfy them. This is called a bank run. The second one is the actual level of cash reserves that banks have to hold to ensure liquidity. Banks were insured for such contingencies in two ways.

The first one was banks lending to one another. In case one bank was short of liquidity another bank was lending it to satisfy the demand. As the interbank interest rate of lending was lower than what banks were offering their customers, all banks were still making money, it was a profit sharing scheme, and the whole system worked like an integrated statistical machine.

The second way of insuring against liquidity shortage was keeping the actual liquidity reserves at the appropriate level. For example, at every one time, for every £100 possible immediate withdrawal call, a bank has say £15. And this is a hard one. Banks create money out of nothing: they are statistical risk machines. Therefore the basic question is : where are the borders between reasonable commercial risk taken by the bank and reckless risk that leads to failure (or even much too high risk which amounts to a downright fraud)?

Sometimes it is possible to identify a straightforward case of fraudulent actions. For example in the run up to the current financial crisis that started in 2007/2008 many banks, including major well known banks, were lending with loan to deposit ratio greater than 100%. This was a classic fraud, known for hundreds of years as a pyramid scheme. (That is why people who were responsible for the banking system in the run up to the financial crisis financiers, regulators and politicians were classic fraudsters or grossly incompetent/negligent. However their sheer number and massive collective influence guarantees their immunity from prosecution.)

However finding a line separating taking commercial risk and reckless risk by banks is impossible. It is changing on day to day basis and it is impossible to cater by regulations or laws for every major economic eventuality. (All those who are old enough may remember that the communist system was an attempt of such a holistic approach to economy that spectacularly failed.) For hundreds of years it was tough justice and self regulation, in a free market setting, that ensured that banking system worked. Later central banks came onto the scene like Bank of England. They ensured that problems were picked up early before they got out of hand and also acted as lenders of the last resort.

Firstly banks owners put their capital and their freedom or even life at stake. Dealing with some else's money is a serious business. If a bank failed bankers were losing a lot: quite often all their and their family wealth, their freedom or even their lives (and even lives of their families). For some centuries of banking such harsh penalties were watered down and concept of limited liability was introduced. However it is not unknown that only a few decades ago Bank of Englad was taking very tough actions on banks and bankers that failed and were rescued. It was not widely publicised in order not to raise panic. Therefore, whilst not advocating returning to exactly ancient methods, financiers and all those who are responsible for handling someone else's money must face a very harsh personal justice in case of failure. This is the first level of deterrent. The current practice of rewarding financiers for recking the financial system is not only a travesty of natural justice but, on a practical level, also ensures more problems in the future.

Secondly banks were only lending to each other, to help in case of liquidity shortage, if they trusted each other. Therefore they were monitoring each other whether they were taking justified commercial risk and the liquidity shortage was statistical event, or a bank in trouble took a reckless risk in which case it was denied a short term credit to cater for liquidity crunch. In such case the bank was allowed to fail with all the consequences for the bankers described above. This was self regulation. In the UK, Bank of England sometimes stepped in (not in the recent case of BCCI thou) to rescue such bank. Nevertheless this also involved harsh penalties for the failing bankers. Sometimes other banks stepped in and took over the failing bank.

The public must realise that depositing money in a bank carries a risk. However such risk can be insured. This means that it has to be backed by additional insurance capital, so the return on deposits would be lower than otherwise would have been. Whether it is a government backed and compulsory insurance or voluntary arrangement, is a policy decision.

In fact a bank going bankrupt every so often, like in any other business, is a necessary part of the free market economy. It weeds out the weak businesses, reckless risk takers, unlucky and fraudsters. It is a proper free market pruning process and banks must not be immune to it as they are at present.

Thirdly, and above all, banks cannot be "too big to fail". For hundreds of years this was precisely the case. If banks are "too big to fail", then the free market is dead. Self regulation does not work. Instead it is a system akin to communist central planning that so spectacularly failed over two decades ago.

In a nutshell, in order to put the financial system back into shape governments must not regulate more but less as it is impossible to regulate dynamic financial risks. It is exactly the same problem as a challenge of centrally planned economies: predicting people's micro-behaviour. Governments must reintroduce free market into the financial industry. Banks must be small enough to fail. Banks must regulate themselves, apart from general law and basic, bottom line regulations (which should be a role of central banks and general justice system). And in case of a banks' failure all those carrying responsibility for managing such bank must be held personally responsible expecting very harsh penalties.

Inflation trap

2011-02-18T19:30:00.017Z

There has been a common wisdom - which was put to practice - that when inflation was going up above the set target, Bank of England (or a relevant central bank in other countries) responded by increasing interest rate. The reasoning behind was that there was too much money in circulation (called broad money supply). This was according to the following mechanism: people were borrowing a lot, they typically spent this money, this money returned again to banks and was re-lent again. The increased interest rate made money more expensive to borrow, hence people could borrow less and usually existing borrowers had to pay more interest on the existing loans. This was suppressing inflation as people had simply less money to spend but the actual mechanism worked through suppressing the volume of money on the market: broad money supply.

The current wave of inflation in Britain is a result of the pyramid scheme engineered by the financial industry. Once the financiers - using a crude pyramid scheme mechanism which was lending with loan to deposit ratio greater than 100% - raided the banks cash reserves the government stepped in and pumped hundreds of billions of pounds into the banking system by directly rescuing the banks and by quantitative easing. The former put the government into heavy debt. In the latter case money is finding its way to the consumer markets causing inflation. All these resulted in pound stirling losing credibility. The situation of other major currencies, US dollar, euro, yen are the same or worse. Hence investors, globally, started moving to a safe heaven of commodities. They started to convert their currency based investments into investment linked to commodities. This causes inflation which in turn undermine currencies even more and the process continues.

The current figures show that the growth of broad money supply in the UK is very low and is lower than the growth of narrow money supply (see graphs below). This means that money multiplier is going down (as money multiplier can be expressed as a ratio of broad money to narrow money). The financial market keeps balancing itself but in the meantime the currencies have little credibility and investors want to minimise a risk of holding them by moving to commodities. Therefore Bank of England faces unprecedented situation: the inflation is going up but raising interest rate would not stop it as the inflation is not a result of high growth of broad money supply. In fact raising interest rate can further damage economy and make things worse by slowing the growth thereby ability to repay the public debt.

Raising interest rate is not a solution and Bank of Englad knows it. Its Governor acts wisely but does not say everything. The problem is, however, that the money multiplier is so high that inflation caused by it is likely to be going up for quite a while. We are getting poorer thanks to the pyramid scheme engineered by the financial industry. The Bank of England Governor Mervyn King observed that "inflation could cause serious problems for families over the next three years". You can say it again, Mr King. And in the meantime the captains of the financial industry keep rewarding themselves handsomely with the money raided from the middle classes since this is what high taxes, spending cuts and inflation are all about. "Prime Minister, sort out this mess, please"

Source: Bank of England

How banks' role changed

2011-01-13T16:55:00.002Z

Traditionally the banks' role was to be a risk agent between a depositors and lenders. Banks were talking deposits and were lending them making money on the interests rate difference between the two. This process was underwritten by banks capital which was risked by banks' owners in case they ended up with too many bad loans and the bank failed. In this case banks owners lost money and possibly some depositors. So on one side there was a pressure on the banks to be careful (as owners did not want to lose their capital) but on the other as there was a large number of banks (in the past) there was competition pushing the cost down and innovation up.

For the last couple of decades the number of banks decreased and they became too big to fail. As a result they were rescued by the government. Banks are no longer risk agents (underwritten by private capital). They became public utilities, huge oligopolies, whose business is underwritten by the state. And they behave as such.

The only way to restore a proper banks' role in the economy is to do what, quite likely, Margaret Thatcher would have done. In line with principles of free market, the banks should be broken up into much smaller enterprises so no bank is too big to fail and capitalise them by selling additional share if necessary. And these banks, indeed a large number of them, should be forced to compete against one another. Depositors will be able to buy an insurance policy against failure or a state may charge a levy on banks as such insurance. And like any other business, sometimes, one of those banks will fail. This will be a proper free market cleansing of weak business which is necessary for free markets to operate. Other banks will pick up the pieces to take over a customer book - a major value of any bank - of a failed bank and if this did not cover deposits of the failed bank the insurance would cover the rest.

The government has to understand such basics: if banking system is regulated properly, there are no banks which are too big to fail, it is not different than any other business.

"Financial markets" loan-shark mechanism at works

2011-01-13T12:00:00.011Z

On 11 January 2011, The Financial Times published the following graphic:

The graph of 10-year government bond yields show that they grew considerably, manyfold, in the last 12 months. Yet nothing has happened in the last 12 months that was not predicted 12 months (or even longer) ago. For at least last 18 months the world financial situation (e.g. economic growth, banks liquidity, sovereign debt, etc) is going very well according to predictions. (It is a matter of judgement but one might say that things are going worse according to "plan".) Therefore 10-years government bond yields should be the same (or within a very narrow margin) now as they were a year ago. But they are not. In a nutshell the system works as follows:

1. In the past year governments were pressurised to cut public spending. Making such cuts creates a financial room for governments to spend more money on servicing the debt (i.e. pay more taxpayers money to the banks).

2. Then the so-called "financial markets" increase bond yields, which results in paying more taxpayers money to the banks. This was facilitated by public spending cuts.

3. Hence, in practice, what governments saved by making these cuts, is transferred to the banks by increased bond yields mechanism. In fact it is more: as the FT graph shows the government debt keeps growing which creates yet more pressure for further public spending cuts. Littles doubt, once they are made the bond yield will be increased further. And the process will be repeated.

It is not a sophisticated financial mechanism. It is not innovative at all. It does not require a "successful" (as the British Prime Minister Cameron called it) financial industry. No need of well qualified bankers to implement it. It is the most classic loan sharks' strategy: primitive no-brainer.

Incidentally it was predicted in "The largest heist in history", an article written over two years ago, that this was the direction the financial industry would go unless governments took a decisive action.

Euro is dead

2011-01-11T10:00:00.002Z

A single currency is not simply about having the same notes and coins in circulation. A key part of a single currency is having the same interest rate on all sovereign debt, in the same way as there is a single central bank's interest rate. Quite often this argument was used to sell the single currency project, Euro, to the public in some countries of somewhat lower credibility than Germany or France. At present, there is no more single sovereign debt interest rate in Euro-zone: for example, German debt attracts much lower rate than Greece's.

The governments must face the fact that the sovereign debt markets decided and Euro-zone governments confirmed it by not introducing a single Euro-zone bonds (i.e. underwritten by all Euro-zone governments collectively): the Euro is not a fully fledged currency any more. It is dead. Now we are dealing with Euro which is a fudge of a single currency. Whether the next step would be to become a single currency again or the Euro-fudge keeps disintegrating is the question for 2011. The inklings are that the latter is very likely to be the case as Germany are unlikely to guarantee debt of other Euro-zone countries such as Greece, Ireland, Spain, Portugal, Belgium, Italy. The list is quite long indeed.

However it is highly likely that European politicians will keep repeating that the Euro is safe and it is business as usual. For an experienced psychiatrist-counsellor this will not come as a surprise. It is called a denial syndrome. For example, some close relatives of a dead refuse to accept this fact for a long time. Indeed this was how the French Finance Minister, Ms Christine Lagarde, came across on the last week's BBC Newsnight.

Happy New Year 2011, Prime Minister (and sort out this mess, please)

2011-01-09T14:22:00.004Z

It is somewhat nauseating to listen again and again about forthcoming massive bankers' bonuses, like in today's Prime Minister's interview on the Andrew Marr Show. The public is entertained continually with bankers' bashing exercises and anti-financial industry "hate campaign". It is all PR stunt to divert public attention from the grim financial reality of the 2011.

The current situation is bad it will get worse this year. Greece and Ireland were "rescued" last year. Portugal and Spain are next in line for such financial markets "benevolence". The UK time will eventually come too. And then the US'. Indeed as last week it was reported on BBC Newsnight Ben Bernanke started seriously hinting possible insolvency of the US. Well done, Mr Bernanke but this is nothing new and you may well wish to read (again?) a nearly two years old piece, "A US way out?", to realise that it may produce rather stunning outcome.

All western countries are waiting to be "rescued" (read: "fleeced") by the "successful", as today David Cameron has called it, financial industry. Indeed the Prime Minister showed today a mind-boggling art of squaring a circle: on one side he believed that the financial industry was lending irresponsibly (to a point that it brought about the financial crisis) but at the same he believed that it was a successful industry.

The reason for all these banks "rescue" campaigns is that the money multiplier remains huge and there is no way out of this mess without massive inflation or debt write offs (defaults), or both. The question is who is going to get hit: the banks are shifting direct loss consequences from themselves upon taxpayers. This is what the rescues are all about. Yet no mainstream media or pundits, politicians or experts dare to answer two questions: "what are the money multipliers of major western currencies, US dollar, Euro, Pound Sterling, etc?" and "what should the money multiplier be in order for the financial system to be solvent"? The answers to these questions may produce some uncomfortable truth: the western world is bust and is simply rolling over its problems. The banks are part of it. They are "rescuing" countries in order to help their insolvent balance sheets (i.e. they are rescuing themselves) shifting direct liabilities upon taxpayers (mainly hardworking middle classes)

In reality massive bankers' bonuses, whilst morally repugnant and even a rather dishonest way of funnelling taxpayers money to financiers' coffers, are a smokescreen, a PR stunt that suits the government and banks, designed to cover that the financial system is bust. It is buying time but this cannot keep going on forever. When your house is on fire you are not going to complain that someone is stealing small items from it. Therefore rather than talking, again and again, about the bankers' bonuses "Prime Minister, sort out this mess, please".

UK's 21st century democracy

2010-12-10T21:23:00.002Z

Today we could read in London's Metro that a gym fan was tried for 2p (two pence) fraud. He used his friend's pass to gain access to the gym and do some exercises.

Only several days ago we could have read that the inquiry into the former Royal Bank of Scotland CEO, Sir Fred Goodwin's behaviour who was ones of those who caused the current financial crisis was dropped by the Financial Services Authority. Little surprise, as expected, since the FSA was at best effectively complicit to the bankers' behaviour.

The ongoing financial crisis is a result of primitive and conspicuous fraudulent practices of the financial industry, regulators and some politicians either by direct involvement or by allowing such a primitive and conspicuous fraud to run for years. The type of this fraud has been well-known for centuries. It is a pyramid scheme. How the pyramid method was implemented by the financial industry in the context of this crisis was described in detail in the first article on this blog: "The largest heist in history". It is nevertheless ironic that for years the crudest of financial crimes has been described by the pundits and the mainstream media as "sophistication of the modern financial industry". This has been public deception on a par with 17th century Dutch tulip mania. This is how historians will judge it in the future.

Thus far the crisis resulted in massive global economic downturn and economic near-collapse of some countries. In Britain it led to massive public spending cuts, increase of taxes and payment obligations by the public (such as the current tripling of the university tuition fees), demolition of traditional pensions schemes and, in fact, savings. And much more is still to come. Don't jump over yet, it will get worse.

Coming back to 2p gym fan's fraud story: if we contrast it with the financiers, regulators and some politicians multi-trillion pound fraud, we have to ask a question: is this what the 21st century British rule of law and democracy is all about? (Ask your local MP.)

Joseph Stiglitz: "We Have To Throw Bankers In Jail Or The Economy Won't Recover"

2010-12-01T11:34:00.006Z

Nobel prize winning economist Joseph Stiglitz told AOL Daily Finance on October 20th, 2010: "This is a really important point to understand from the point of view of our society. The legal system is supposed to be the codification of our norms and beliefs, things that we need to make our system work. If the legal system is seen as exploitative, then confidence in our whole system starts eroding. And that’s really the problem that’s going on. [...] I think we ought to go do what we did in the S&L [crisis] and actually put many of these guys in prison. Absolutely. These are not just white-collar crimes or little accidents. There were victims. That’s the point."

The author of this blog presented such view in an article that started this blog: "The largest heist in history" which Professor Stiglitz has known since January 2009. In fact this blog was only started since experts, politicians and mainstream media pundits ignored such obvious view two years ago. And great majority of them keeps ignoring it. Welcome to the club, Professor Stiglitz.

"I would recommend you panic" *

2010-11-26T16:59:00.013Z

The world is going crazy. Americans are printing dollars Treasury papers (and keep getting into deep debt) to sustain whatever is left of their once top lifestyle. Chinese are buying them in order not to let the dollar fail (at least for now). Chinese are pushing whatever they can of this money mountain out acquiring whatever they can in terms of influence, assets, commodities (and rights to them). This mountain overall keeps on growing. In terms of mechanism we are really dealing with the world money circulation system being turned into a global mega version of Lehmans.

At one point, in the same way as commercial banks refused to roll over Lehmans debt in September 2008, China will refuse to roll over US debt. And the whole system will collapse. This will leave China with still a massive real wealth of assets and possibly notionally even bigger mountain of the US T-papers worth as much as Lehmans shares, ie nothing. I think China already accounted this notional loss as clearly this is the way to finish off the US financially and acquire real wealth globally (influence, assets, commodities and rights to them). This is a war in all but name. The US is defenceless unless it uses real weapons. Quite scary.

The US, for political reasons, cannot stop this process itself. The question is what will happen in the US (or how is the US going to react) if China stops this process or it is simply stopped as such a mechanism cannot run to infinity. (If anything the computer power is limited and ultimately such process is bound to collapse for strictly technical reasons, e.g. lack of sufficient memory or processing power for financial transactions.)

This is crazy: on one side financial institutions' executives caught the national budgets by their throats. The queue of countries waiting to be 'rescued' is long (and includes the UK). Today Portugal seems to have got into a 'rescue' mode (following Greece and Ireland). On the other side China got by the throat the US financial system which is an ultimate foundation of the global financial system.

What will happen when China does not buy another tranche of the US T-papers (because it will refuse or... the financial computer system will collapse)? How is the US going to react? I think, the sheer scale of money involved and the past history teaches us that it will be a very sad, if not dramatic, end.

It is clear that the politicians do not understand the scale of what is going on and that it is getting worse. Thus far every 'significant' government decision (like the recent public spending cuts in the UK) for the last 2 years has always been heralded the beginning of the recovery. And as expected, it always got worse. The reason is that the fundamental cause behind this crisis, too great money multiplier, is not getting any smaller. This crisis is NOT a debt crisis. Debt is only a manifestation of the real cause of this crisis: too high money multiplier, that looks on the outside like a debt crisis. It is like pneumonia of an AIDS sufferer. Indeed it is pneumonia but the AIDS is an underlying problem. Why politicians, the mainstream media and pundits still do not get it seems rather impossible to tell.

^* - a quote from Hugh Hendry interview

Irish crisis: why British government cut public spending

2010-11-17T12:27:00.007Z

The ongoing financial farce in Ireland shows with crystal clarity why Britain was "persuaded" by the, so-called, "financial markets", pundits and all sorts of experts to cut the public spending. If British kept on spending as much as they used to it would not have enough money to rescue Ireland. The UK would have been on the financial edge itself. According to the Bank of International Settlements in Basel the UK banks' exposure to the Irish debt is 222.4 billion euros (page 16 of the report). If Ireland is bailed out, in fact, it will be British financial insitutions that will be bailed out too. Without having made the spending cuts a few months ago Britain would not simply have money to do so. Hence the UK banks would have ended up in a very deep trouble (if not bankruptcy). To summarise the whole saga (which shows the, so-called, "financial markets" modus operandi):

- first Irish banks were run out of money, thanks to a pyramid scheme that was operated, and ended up in a deep financial trouble; Ireland was "persuaded" to make deep cuts to rescue them; i.e. banks' debt was propagated as the country's debt;

- after everything was squeezed out of Ireland itself its rating was downgraded in order to generate even greater liabilities of Ireland towards the, so-called, "financial markets";

- then countries like the UK, Germany were persuaded by the, so-called, "financial markets" to make cuts in order to create a budgetary room to pay more to the, so-called' "financial markets";

- now Ireland has been "attacked" by the, so-called, "financial markets"; Ireland is simply a conduit to squeeze other countries (like Britain, Germany) that are tied to the Irish debt and make them keep paying to the, so-called, "financial markets".

- after Ireland is "rescued" the, so-called, "financial markets" will continue operating according to this modus operandi; there are more countries in a queue waiting to be "rescued"; the, so-called, "financial markets" will decide the timing.

Is this a conspiracy? No, it is not. This is how, so-called, "financial markets" work. This what the City and Wall Street are really all about. (The rest is simply a pretty transparent smokescreen creating a pretence of legitimate business. Like some Greek restaurants operating, in fact, as illegal cassinos.)

The author of this blog described this mechanism well over a year ago. It is well known to governments, policy and decision makers. The, so-called, "financial markets" are so primitive in executing it that any half intelligent and quarter competent financial observer picks it up immediately. This is, in fact, the very same mechanism that typical loan sharks use to extort money from their victims: tie them up to debt, then set the rules that the debt is ever increasing, persuade them to save on everything, borrow from others and work harder in order to increase payments to loan sharks (these days called: "the financial markets"). Simple and primitive, inni't?

If the British government believe that by making cuts, in the way they do them, they will lead the country to recovery and prosperity, they either do not understand the causes behind the current crisis or are actually working for the interest of the, so-called, "financial markets" (for example, hoping to get a job in the City and get spolis of their actions). Or both. The obviousness of that behaviour defies belief. Or maybe one of blog readers can offer a better explanation? There is a way out however: "Prime Minister, sort out this mess, please". It is not that difficult but it requires really tough decisions (including prosecuting the financial fraudsters and liquidating the pyramid scheme).

US-Sino Currency Rap Battle

2010-11-12T23:11:00.008Z

(by Next Media)

Currency wars: where will it end?

2010-11-04T09:33:00.008Z

The current financial crisis put a huge question mark on the credibility of the major currencies. The rounds of massive quantitative easing - printing of trillions of dollars - of unpredictable consequences, major banks balance sheets crisis, sovereign debt crisis and so on. In the midst of it the economic prospects of the US and the EU still look gloom as there is no apparent revival trend that would lead to a sustainable growth. All the governments are doing looks like life support of the dead corpse of the financial system rather trying to stimulate the economy. No wonder, as the financial system was turned into a giant pyramid scheme it keeps on collapsing. And it will keep on collapsing until the pyramid is liquidated. The currencies such as the US dollar, Euro, the British Pound are in fact such a pyramid scheme vouchers.

The recently proclaimed currency wars underpinned by the current US initiative of quantitative easing, kind of a major fiscal offence, are likely to result in further undermining of the major currencies. In fact it is likely to further undermine the world financial system as we know it which is based on fiat money where currencies represent the credibility and financial worthiness of economies they represent. As currencies are used so crudely as financial weapons their credibility as a value store will soon be gone. So what next?

There are economies and businesses in the world that generate profit. They need to store value in a credible way. If the major currencies lose such a role the natural way will be a come back to a barter-type economy. Buying commodities, land, etc. and trading it. It looks likely it will go in this direction but the system will be managed in far more refined manner rather than a typical barter of a gone by age. The obvious candidates would be virtual currencies. Each of which would represent a basket of commodities agreed by parties to a transaction. The obligation to pay a bearer would not be in any currency but in a basket of commodities. However, one can expect, that typically a payment would be accepted by a receiving party in some currency - or currencies - equivalent at the time when it is settled. Technically there is no limit to a number of such currencies: a new one may be created for the purpose of a new transaction. However one can reasonably expect a good degree of standardisation, i.e. a major 3 - 5 virtual currencies, commodity baskets. This would facilitate trading between them and trading between the contracts based on them. In fact China's massive multibillion dollars commodities-for-cash deals are good early examples that such a system is already emerging.

Virtual currencies would be inflation immune within the commodities they represent. They would be durable and non-perishable as they will not be actual commodities but rights to get them on demand when a contract representing a particular currency is settled (i.e. value is exchanged). Such model should be quite appealing to countries like China and India whose development depends to a large degree on the access to commodities. It should also be appealing to commodities producing and trading countries as they would not be dependant on a very uncertain fate of the US dollar (a major, by far, current commodity trading currency). And as a value store, virtual currencies would always store a real value despite the fact that there would always be a risk of a commodity going up or down against the others. After all, this might not be such a big revolution: ultimately it may lead to re-basing the national currencies, turing a full circle from abandoning de-based and worthless paper money and going through a modern form of bartering. This time round not strictly currency based on gold but on various commodities baskets. However there could be a lot of bumps, or worse, along the way.

Currency risk: a China's advantage

2010-10-29T08:56:00.010+01:00

Every now and then we read or listen in the mainstream media that Chinese companies are overpaying for assets. Or that they are undercharging for contracts - like building infrastructure - they are entering into in many parts of the world . Every so often we hear the same arguments from the western companies that lost in competition to their Chinese counterparts. Quite often companies that lost to the Chinese protest and make accusations about Chinese state subsidies, unfair competition, undercutting, etc. All in all, the prevailing media image of the Chinese investors is that their decisions are not commercially sound (because they are overpaying) and politically driven (by overpaying they are trying to build a political influence). Nothing can be further from the truth. Anyone who dealt with the Chinese knows that they are commercially very shrewd indeed. What is the answer? How Chinese can overpay and still be shrewd. The recent negotiations between China and Russia or Turkmenistan regarding natural gas supplies are good examples.

China is sitting on a mountain of foreign reserves, some 3 trillion of the US dollars in value. Around half of that is in the US dollars. It is impossible to spend or invest such massive reserves, or a meaningful portion of it, without undermining their value. In the current economic conditions there is also a very high risk that these reserves will lose value. On top of that Chinese reserves keep on growing, and if Chinese stopped this process, i.e. stopped buying the US securities, the dollar would have collapsed, so their reserves would have lost very significantly. A solution that China pursues is spending a significant portion of their dollar (and generally foreign) reserves on buying assets representing long term tangible value such as natural resources, or making investments that would allow to derive a long term value, e.g. in infrastructure.

In the process of making an investment decision Chinese investors have to take into account that the money they spend carries a significant risk of losing value. Something around 30% - 50%. So if a seller (or a contractor) asks a Chinese company for $1, it represents a risked value of between $0.50 to $0.70 to the Chinese. This is the fiscal arithmetic of Chinese investors that takes into account their currency reserves risk.

On the other side, western companies, especially US' operate in a different fiscal environment, albeit under the same commercial principles. Even if they make investments with their own money, and more often than not it is borrowed money, they have to account for its costs. For example with an effective interest rate of 5%, $1 investment carries costs for an investor of 5 cents a year. So $1 investment represents a risked value of $1 plus interest.

Therefore facing a competition with Chinese investors, western companies, especially US', cannot compete on price. An investment of $1 represent a spending of 50 to 70 cents to Chinese whilst it represents $1 plus interest to a US or western companies. Assuming all other factors are the same (and usually they are quite close) a Chinese company can pay 1.42 to twice the price that a western company can pay acting on the same level of commercial rationality and soundness.

Such issues fly well above the heads of mainstream media pundits, politicians and even western companies' executives. These issues are very important however. They show how western governments' fiscal policy (especially the US') heavily undermined competitiveness of the western companies in the global economy. It all also shows how China is winning commercial game with the west. Crying about and protesting Chinese uncompetitive "commercial irrationality" will not help as it is... commercially irrational.

The chickens are coming home to roost

2010-10-26T14:39:00.005+01:00

Mr Robin Griffiths, technical strategist at Cazenove Capital, told CNBC: "If the (dollar index) takes out the low that was made roughly a year ago I really think that will not only encourage more sales, it will cause a little bit of minor panic. A year ago it was deemed too cheap, if it goes any lower than that it's actually become toxic waste."

The blog readers are invited to read (again) an article published on this blog a year and a half ago: "A US way out?" The pundits are slowly getting the message: the chickens are coming home to roost and the US are doing some form of Chapter 11 to the rest of the world. This is the way the US are trying to recover from "The largest heist in history". It does not look too promising to be successful since it appears that the financial pyramid is too large and its mechanisms too powerful. The relationship between the financial industry and the taxpayer was turned into one akin to loan sharks and their victims. Any new spare financial balance or economic capacity will be eaten by the financial industry.

"To the Simple Man"

2010-10-22T09:09:00.005+01:00

In the wake of the Wall Street crash in October 1929 as Great Depression erupted Julian Tuwim wrote the following poem. Ten years later the world was engulfed by the World War Two.

To the simple man

When every wall is hid by many
new posters freshly pasted up,
when ‘to the people’, ‘to the Army’,
in black print stare appeals alarming,
and any dolt, and any pup
will take for gospel each old lie
that one should go and shoot off guns
and murder, poison, rob, at once;
start drumming into all our noggins
the ‘Fatherland’; the mob incite,
bamboozle with bright-coloured slogans,
egg on with ‘Our historic right’,
‘every inch’, ‘glory’, ‘sacred borders’,
with ‘our forebears’, ‘pay the price’,
with ‘heroes’, ‘flag’ and ‘sacrifice’;
when bishop, pastor, rabbi come
to say a blessing on each gun,
for God has told them, that His will
is that for Country – you should kill;
when gutter tabloid screams and rages
in letters huge on its front pages,
and herds of females lose their voice
throwing bouquets at ‘our brave boys’,
– O, my untutored simple friend,
mate from this land, or other land!
Know that the bells for these alarums
kings strike, with girls with ample charms,
Know it’s all hogwash, lies perverted,
And when these call out: ‘Shoulder arms!’
That somewhere from the ground oil spurted,
With dollars soiling the bright colours;
That in their banks there’s something rotten,
They smelled some moneybags, it looks,
Or cooked some scheme, the oily crooks,
For higher import tax for cotton.
Drum on the pavement with your gun!
Ours the blood, the oil is theirs!
And through each capital and town
Scream out, to guard your cash blood-won:
‘Tell us another, noble sirs!’.

(translated from Polish by Marcel Weyland)

The real end of the Empire

2010-10-21T23:26:00.008+01:00

It has been said on today's BBC "Question time" that for 200 years Britain had greater budget deficit than now. Even after the World War 2 it was able to build an amazing social system with NHS and social housing. "So what's the bother now?" the host, Mr David Dimbleby, asked.

It appears the there is a significant difference. For 200 hundred years at the time Britain was an empire, a real superpower that controlled its destiny. The financial markets and other lenders to the government at that time had really had to rely on what British government had been prepared to pay. And they had to lend if they wanted to exist. In a way it was a synergy but with Britain, as a state, had an upper hand over the financial industry. Now it is the other way round: Britain is at the mercy of the financial markets. It does not act like a sovereign state but like a minion being bullied by a loan shark. This is a reason why we see savage budget cuts now, and despite that, times are very uncertain indeed.

Globalisation is not a new phenomenon. The British Empire was truly global: "the Empire on which the sun never sets". What changed is who is in charge.

On a slippery slope

2010-10-20T12:31:00.014+01:00

This week announced spending cuts on defence in the UK indicate the scale of the current financial crisis. Even, as a result of the previous Labour regime brought about economic disaster, at the end of 1970's the UK did not have to cut its forces that deep. In 1982 it was still able to mount a successful Falklands campaign. In the height of Conservative induced recession of the early 1990's it was able to provide a significant contribution to the First Gulf War. After the defence budget cuts just announced the British conventional military capability will be reduced to symbolic. Only nuclear deterrent will keep British position on the UN Security Council not reduced to a rather indefensible remains of a period when Britain was still a power.

Cuts of public spending in general on a similar scale will happen in other areas. They are also happening other countries like France where a very generous pension age is to be extended from the age of 60 to 65. So be it one might say. Maybe it all makes sense. Maybe it is not in British national interest to remain a significant military power. Maybe rising pension age is good for society. After all people who work longer (in good conditions, of course) are healthier and live longer. Besides industries and businesses propelled by the public sector are usually not the best examples of efficiency and productivity. The point is however not whether such saving and cuts make sense but why they are a financial necessity. Why such public spending cuts are not diverted through tax cuts or other spending to education, research, better pensions, health service, etc.

All the public spending is necessary because of the depth and spread of the financial crisis. This financial crisis is reshaping our social lives. It is done under propaganda of necessity and impunity for all those responsible. There is not much public debate. Having organised a pyramid scheme that pumped the cash out of the economy (and a lot of it is sitting in shadow banking and offshore financial centres), as described in "The largest heist in history", governments have kept taking money out of taxpayers pockets by making cuts and raising taxes, to sustain a pyramid of liabilities created by the financial industry (that incidentally has been funding a pretty good lifestyles of its administrators, i.e. the bankers).

In the UK the Prime Minister, Mr David Cameron, naively believes that this is "taking the Britain out of the danger zone". Nothing can be further from the truth. In fact the bankers achieved what the author of this blog warned about well over a year ago: they control, through mechanisms of the financial markets, the taxpayers in the same way as loan sharks control their victims with bullies with baseball bats. It is not more sophisticated in practice. It is not a socialist view but a laissez-faire perspective. The bankers are running a creeping October Revolution of our times: killing free market-based capitalism and replacing it with a communism for the filthy rich. As the recent Irish experience indicates, they are preparing to come for more. The present improvements of the UK standing on the financial markets after making cuts promises is an encouragement to make further cuts. Once the "markets" judge them deep enough, i.e. maximising a room in the budget to transfer more money to the banks, the "markets" will go the other way. The most obvious mechanism will be through downgrading British rating giving completely free cash to the financial industry. Due to the scale of the financial pyramid the end to this is not in sight. We are on a slippery slope and any talk about a better future is fooling people. Unless it is a better future for the bankers. On the face of it, leaving political wranglings aside, whilst the last Labour administration allowed (or even colluded) the financial pyramid to grow, the current Conservative one appears to sustain it. There is a solution however. But it requires guts, competence and wisdom.

Liquidity v money supply/demand

2010-10-16T22:31:00.019+01:00

On 7 October 2010 The Economist published an article "The costs of repair". Its author wrote:

"So far the current recovery is following this post-crisis script. Output is sluggish and credit is growing weakly or shrinking across much of the rich world. But is this because over-leveraged households and firms have become less willing to borrow or because banks have become less willing to lend? In other words, is the credit problem one of demand or supply?"

Then the author concluded: "Both supply and demand probably play a role."

The question is wrong and the answer is wrong too. The problem is neither of supply nor demand but of liquidity: i.e. too high money multiplier makes it too risky to lend and to borrow. Banks do not have money to lend without fear of losing liquidity and money is too hard to come by to repay loans which is putting off prospective borrowers. In terms of statistical analysis (correlation) such situation will show up on both: supply and demand as causes, as both are causally subsequent to an underlying (and overriding) cause which is too high money multiplier (i.e. liquidity shortage). Here you can read more on liquidity shortage caused by high money multiplier.

Hopefully such money multiplier based analysis of the current financial crisis finds its way into the mainstream.

Incidentally it appears that the mainstream economists put too much weight, without understanding, on statistics and real analysis (in mathematics) and too little (practically nothing) on other branches of maths such as topology (that allow to determine relationships between phenomena which are the subject of an analysis). And The Economist and the mainstream media and the politicians are just confused. Little wonder, over 2 years after the Lehman Bros collapse the financial world remains in a mess and the taxpayers keep paying for it: after stimuli, spending cuts. What's next since the end is not in sight?

PS. Interestingly, it was The Economist that wrote the post script to this article. On 22 October 2010 they wrote in Benoit Mandelbrot obituary: "That markets are not Gaussian has now been accepted. Dr Mandelbrot’s interpretation, however, has not. Even if it had been, the bankers might not have noticed. They preferred algorithms to geometry." It is a good step forward. However if The Economist understood what they were writing about they would refer to topology rather than geometry.

The financial system, as we know it, is dead

2010-09-30T18:47:00.022+01:00

Politicians, economists, bankers and mainstream media financial pundits fail to acknowledge the obvious: the financial system as we have known it for a hundred years or so is dead. Literally.

Until 2008 in the financial system a central bank was at its heart in every country (or a currency region like eurozone). It was regulating the money creation process by creating a lending base upon which commercial banks created credit. In a nutshell if economy had been getting overheated, i.e. there was an oversupply of money, sometimes called a "cheap credit", and inflation increased above what was regarded as an acceptable target (usually pretty low, in single percentage figures), the central bank would have raised the interest rate making borrowing more expensive. On the other side if inflation was too low, or growth too stagnant, the central bank would have lowered the interest rate thereby lowering the costs of borrowing. The interest rate had to be above an inflation rate as otherwise lending would not have made commercial sense. This is an obvious wisdom. What is somewhat less obvious is why it was so? Why if a central bank had raised or slashed interest rate, until the outbreak of the current financial crisis, all commercial banks would have had to follow? By no means this was regulated by any directives or government pressure. These were open market operations that worked until September 2008.

A central bank has a sole prerogative of printing money (whether as banknotes or through electronic credit, but this is the same). When a central bank set its interest rate it meant that it was prepared to lend to the financial markets at that rate. It would have also borrowed from the commercial markets below that rate. This was done using financial instruments bought and sold on the financial markets and priced by the financial markets. I.e. the price was real as other commercial institutions were selling and buying the same instruments at the same price. It is called open markets operations. A central bank was buying the financial instruments if they were giving more yield than its interest rate and selling them otherwise. This was producing the balance of money supply with inflation and growth as the commercial banks were lending at the rate that followed very closely the central bank’s own rate. For any commercial bank the central bank was, in practice, unlimited source of credit supply at the cost of its rate. The difference between a commercial interest rate and a central bank’s interest rate represented operating costs of a commercial bank and a customer risk (i.e. were insurance against bad loans).The existence of a number of commercial banks created competition market so their interest rates followed very closely central bank’s rate. The government did not have to tell the banks to lend money. After all it was their core business. Instead a central bank was raising or lowering its interest rate, did open market operations and the financial markets did the rest. All recessions as we knew them until 2008 were in fact market readjustments, balancing acts, between inflation, growth and money supply.

This does not work anymore. The central banks’ interest rates in the countries that suffered from the financial meltdown of 2008 (US, UK, Eurozone) are at the rock bottom. Below the inflation rates. The commercial banks are scarcely offering credit, well above the central banks’ interest rates. In fact they do not want to offer it at all and the governments are pathetically calling for the banks to start lending. (Well, they would if they could. It is their core business after all.) What’s happened? Why, as before and for a hundred years, central banks cannot intervene through open markets operations and let the financial markets sort that out?

The current financial crisis was caused by the financial institutions, with help from the regulators and the governments, setting up the giant global pyramid scheme by lending with loan to deposit ratio greater than 100%. The banks’ cash reserves were depleted and the money multiplier reached stratospheric levels. In fact no one knows it if risks of contingent and possible liabilities parked in OTC contracts and the shadow banking system are taken into account: the lowest estimates are around 50. Therefore a huge number of financial instruments on the financial markets do not represent much commercial value but the scale and depth of the pyramid scheme. Commercial buyers do not want to buy them. These instruments are worthless. Hence central banks cannot buy them either for newly printed money. Almost any additional liquidity is produced through quantitative easing. This is a centrally controlled process of spending newly printed (or electronically transferred) money on financial instruments for which there are no commercial buyers. This is in sharp contrast to how it used to be: the process of money supply was controlled by central banks and dynamically executed by the financial markets.

This crisis shows that financial system, with all its mechanisms like mark-to-market, worked till 2008. But it was simply killed when it was turned into a giant pyramid scheme. Little surprise there. The current governments’ actions of pouring taxpayers money (through quantitative easing, financial stimuli and spending cuts) are nothing more than pathetic attempts to revive rotting and smelly corpse of the pyramid scheme. Instead this pyramid must be liquidated and the system must be started afresh. There will be losers of course. The current political and financial establishments are trying to push the costs on the taxpayers. Taxpayers sometimes protest that they do not want to pay for the damage caused by the political and financial establishment (who still reward themselves very handsomely for the mess that they caused). It is still not clear who, in practice, will win this argument as the problem simply appears to be too big to be quietly absorbed by the taxpayers in an ordinary course of politics (taxes, spending cuts and government and businesses propaganda). Or, as the signs are, we might end up in an even bigger mess.

Does Bob Diamond (new CEO of Barclays) understand banking?

2010-09-12T11:31:00.015+01:00

The first answer that comes to mind is emphatic: yes. His position proves that. Hence it is worthwhile to reflect on his opinions in the recent Telegraph. As it was reported: "Bob Diamond, the new chief executive of Barclays Bank, has turned on critics of "casino banking" saying that the use of the term "has no basis in reality. [...] [Investment banks] aren't casino businesses. These are real, client-driven businesses. We are providing services to corporate clients, to fund managers, to retail clients through branch banking and high net-worth banking."

Over a year ago the author of this blog observed in his article "Investment banking perverse casino model": "[...] the modern investment banking business is operated like a casino whose owner lends tokens to punters at a very high interest rate. However the punters’ loans and interest become only payable to a casino owner out of their winnings.

No sane casino owner would have ever accepted such a self defeating business model. Yet the banks are such casinos. Banks’ stakeholders (shareholders and depositors) are such casino owners. And bankers are the punters."

Casinos are also "client-driven businesses" providing services. Albanian pyramids as well as a Madoff's pyramid were also such businesses. In fact similarly to Albanian pyramids' and a Madoff pyramid's clients many direct (and indirect, like the whole economy) clients of investment banks went bust. As shown in the "The largest heist in history" the entire financial system was turned into a giant global pyramid.

The crux of the matter is that casinos and pyramids do not create any tangible value but are mechanisms of wealth redistribution heavily biased (i.e. giving the disproportionally large proceeds) to those who control them. That is why gambling, which additionally due to its addictive character is considered by many as vice, although legally accepted in many countries is generally heavily regulated. Financial pyramids, which proved lethal to economies on very many occasions throughout history, are banned altogether in the civilised parts of the world.

An unbelievably professionally shallow character of Bob Diamond's comments (e.g. "[Investment banks] aren't casino businesses. These are real, client-driven businesses.") seems to suggest that he does not really understand the fundamentals of banking (in particular the mechanism of money multiplication). And as a PR exercise these comments were insulting to any half-intelligent taxpayer who has to pay, by higher taxes and cuts in public spending, through his (or her) nose for the costs of the crisis caused by the banks' engineered crude financial pyramid. However it is reasonable to assume that Mr Diamond is representative (or rather above the average) of top financial executives. No wonder then we are in such a massive financial and economic mess now, listening to unreasonable and actually irrational excuses type-"it is global, no one could have predicted that". However, thanks to no more competent politicians, thus far the financial establishment is successful preserving the perverted nature of the financial industry.

James K. Galbraith: "Fraud at the root of the financial crisis"

2010-09-03T18:37:00.020+01:00

James K Galbraith, along with Bill Black and a few others, have been making similar arguments to the author of this blog for a long time. Hopefully the work on this blog contributes to the technical and legal arguments that prove that the current financial crisis is a result of fraud (whose mechanism is a classic pyramid scheme). The title given by this blog author.

Statement by James K. Galbraith, Lloyd M. Bentsen, jr. Chair in Government/BusinessRelations, Lyndon B. Johnson School of Public Affairs, The University of Texas at Austin, before the Subcommittee on Crime, Senate Judiciary Committee, May 4, 2010.

"Chairman Specter, Ranking Member Graham, Members of the Subcommittee, as a former member of the congressional staff it is a pleasure to submit this statement for your record.

I write to you from a disgraced profession. Economic theory, as widely taught since the 1980s, failed miserably to understand the forces behind the financial crisis. Concepts including “rational expectations,” “market discipline,” and the “efficient markets hypothesis” led economists to argue that speculation would stabilize prices, that sellers would act to protect their reputations, that caveat emptor could be relied on, and that widespread fraud therefore could not occur. Not all economists believed this – but most did.

Thus the study of financial fraud received little attention. Practically no research institute sexist; collaboration between economists and criminologists is rare; in the leading departments there are few specialists and very few students. Economists have soft-pedaled the role of fraudin every crisis they examined, including the Savings & Loan debacle, the Russian transition, the Asian meltdown and the dot.com bubble. They continue to do so now. At a conferencesponsored by the Levy Economics Institute in New York on April 17, the closest a formerUnder Secretary of the Treasury, Peter Fisher, got to this question was to use the word “naughtiness.” This was on the day that the SEC charged Goldman Sachs with fraud.

There are exceptions. A famous 1993 article entitled “Looting: Bankruptcy for Profit,” by George Akerlof and Paul Romer, drew exceptionally on the experience of regulators who understood fraud. The criminologist-economist William K. Black of the University of Missouri-Kansas City is our leading systematic analyst of the relationship between financialcrime and financial crisis. Black points out that accounting fraud is a sure thing when you can control the institution engaging in it: “the best way to rob a bank is to own one.” The experience of the Savings and Loan crisis was of businesses taken over for the explicit purpose of stripping them, of bleeding them dry. This was established in court: there were over one thousand felony convictions in the wake of that debacle. Other useful chronicles of modern financial fraud include James Stewart’s Den of Thieves on the Boesky-Milken era and Kurt Eichenwald’s Conspiracy of Fools, on the Enron scandal. Yet a large gap between this historyand formal analysis remains.

Formal analysis tells us that control frauds follow certain patterns. They grow rapidly, reporting high profitability, certified by top accounting firms. They pay exceedingly well. At the sametime, they radically lower standards, building new businesses in markets previously considered too risky for honest business. In the financial sector, this takes the form of relaxed – no, gutted – underwriting, combined with the capacity to pass the bad penny to the greater fool. In California in the 1980s, Charles Keating realized that an S&L charter was a “license to steal.” In the 2000s, sub-prime mortgage origination was much the same thing. Given a license to steal, thieves get busy. And because their performance seems so good, they quickly come to dominate their markets; the bad players driving out the good.

The complexity of the mortgage finance sector before the crisis highlights another characteristic marker of fraud. In the system that developed, the original mortgage documentslay buried – where they remain – in the records of the loan originators, many of them since defunct or taken over. Those records, if examined, would reveal the extent of missingdocumentation, of abusive practices, and of fraud. So far, we have only very limited evidenceon this, notably a 2007 Fitch Ratings study of a very small sample of highly-rated RMBS, which found “fraud, abuse or missing documentation in virtually every file.” An efforts a year ago byRepresentative Doggett to persuade Secretary Geithner to examine and report thoroughly onthe extent of fraud in the underlying mortgage records received an epic run-around.

When sub-prime mortgages were bundled and securitized, the ratings agencies failed to examine the underlying loan quality. Instead they substituted statistical models, in order to generate ratings that would make the resulting RMBS acceptable to investors. When one assumes that prices will always rise, it follows that a loan secured by the asset can always be refinanced; therefore the actual condition of the borrower does not matter. That projection is,of course, only as good as the underlying assumption, but in this perversely-designed marketplace those who paid for ratings had no reason to care about the quality of assumptions. Meanwhile, mortgage originators now had a formula for extending loans to the worst borrowers they could find, secure that in this reverse Lake Wobegon no child would be deemed below average even though they all were. Credit quality collapsed because the system was designed forit to collapse.

A third element in the toxic brew was a simulacrum of “insurance,” provided by the market incredit default swaps. These are doomsday instruments in a precise sense: they generate cash-flow for the issuer until the credit event occurs. If the event is large enough, the issuer thenfails, at which point the government faces blackmail: it must either step in or the system willcollapse. CDS spread the consequences of a housing-price downturn through the entire financial sector, across the globe. They also provided the means to short the market in residential mortgage-backed securities, so that the largest players could turn tail and bet against the instruments they had previously been selling, just before the house of cards crashed.

Latter-day financial economics is blind to all of this. It necessarily treats stocks, bonds, options, derivatives and so forth as securities whose properties can be accepted largely at face value, and quantified in terms of return and risk. That quantification permits the calculation of price, using standard formulae. But everything in the formulae depends on the instruments being as they are represented to be. For if they are not, then what formula could possibly apply?

An older strand of institutional economics understood that a security is a contract in law. It canonly be as good as the legal system that stands behind it. Some fraud is inevitable, but in afunctioning system it must be rare. It must be considered – and rightly – a minor problem. Iffraud – or even the perception of fraud – comes to dominate the system, then there is no foundation for a market in the securities. They become trash. And more deeply, so do the institutions responsible for creating, rating and selling them. Including, so long as it fails torespond with appropriate force, the legal system itself.

Control frauds always fail in the end. But the failure of the firm does not mean the fraud fails: the perpetrators often walk away rich. At some point, this requires subverting, suborning ordefeating the law. This is where crime and politics intersect. At its heart, therefore, thefinancial crisis was a breakdown in the rule of lawin America.

Ask yourselves: is it possible for mortgage originators, ratings agencies, underwriters, insurers and supervising agencies NOT to have known that the system of housing finance had becomeinfested with fraud? Every statistical indicator of fraudulent practice – growth and profitability– suggests otherwise. Every examination of the record so far suggests otherwise. The verylanguage in use: “liars’ loans,” “ninja loans,” “neutron loans,” and “toxic waste,” tells you that people knew. I have also heard the expression, “IBG, YBG;” the meaning of that bit of code was:“I’ll be gone, you’ll be gone.”

If doubt remains, investigation into the internal communications of the firms and agencies inquestion can clear it up. Emails are revealing. The government already possesses critical documentary trails -- those of AIG, Fannie Mae and Freddie Mac, the Treasury Department andthe Federal Reserve. Those documents should be investigated, in full, by competent authorityand also released, as appropriate, to the public. For instance, did AIG knowingly issue CDS against instruments that Goldman had designed on behalf of Mr. John Paulson to fail? If so,why? Or again: Did Fannie Mae and Freddie Mac appreciate the poor quality of the RMBS theywere acquiring? Did they do so under pressure from Mr. Henry Paulson? If so, did SecretaryPaulson know? And if he did, why did he act as he did? In a recent paper, Thomas Ferguson and Robert Johnson argue that the “Paulson Put” was intended to delay an inevitable crisis past theelection. Does the internal record support this view?

Let us suppose that the investigation that you are about to begin confirms the existence of pervasive fraud, involving millions of mortgages, thousands of appraisers, underwriters, analysts, and the executives of the companies in which they worked, as well as public officials who assisted by turning a Nelson’s Eye. What is the appropriate response?

Some appear to believe that “confidence in the banks” can be rebuilt by a new round of goodeconomic news, by rising stock prices, by the reassurances of high officials – and by notlooking too closely at the underlying evidence of fraud, abuse, deception and deceit. As youpursue your investigations, you will undermine, and I believe you may destroy, that illusion.

But you have to act. The true alternative is a failure extending over time from the economic tothe political system. Just as too few predicted the financial crisis, it may be that too few are today speaking frankly about where a failure to deal with the aftermath may lead.

In this situation, let me suggest, the country faces an existential threat. Either the legal systemmust do its work. Or the market system cannot be restored. There must be a thorough, transparent, effective, radical cleaning of the financial sector and also of those public officials who failed the public trust. The financiers must be made to feel, in their bones, the power ofthe law. And the public, which lives by the law, must see very clearly and unambiguously that this is the case. Thank you."

Irish lesson - post scriptum

2010-08-17T23:22:00.008+01:00

In an article "Irish lesson" published on this blog on 14 August 2010, the author argued that the UK credit rating will be cut by the rating agencies, despite (or rather because) of the government savings, public spending cuts and austerity measures.

Recently a credit rating agency, Moody's, has confirmed such an intention.

The so-called "financial markets" have become so transparent, conspicuous and predictable in their rather crude ripping off strategy of the taxpayers that it defies belief. It adds insult to injury: this is exactly like a burglar sending an advance notice to his victims and then robbing their homes in front of their eyes.

We are getting poorer

2010-08-17T22:09:00.022+01:00

Let us look at the current economic figures as reported tonight by the BBC (interest rates given are per annum):

On the "costs" side: the Consumer Price Index is currently running at 3.1%. The Retail Price Index, which reflects the real increase in costs of living, is currently running at 4.8%.

On the "income" side: the wage rise is currently running at 2%. The Bank of England interest rate is currently 0.5% and it is difficult get anything above that on the savings.

Our savings are eroded by a staggering 4.3% a year. Shockingly it is more than Halifax standard variable rate which is at 3.5% a year. However those with mortgages are not that lucky since, typically, they have to earn their living. Their wage is shrinking by 2.8% a year. This is offset to some degree by depreciation of the loan value if an interest of the mortgage is below the rate of inflation (using Halifax rate it is 1.3%). These figures are striking: we are all ripped off, savers or mortgage payers alike. The economy remains in a morbid state.

What does the above tell us? We, the taxpayers, are getting poorer. With trillions of pounds circulating in the economy the difference between "costs" and "income" is substantial. And growing (in an exponential way, i.e. very fast indeed). So on the whole we are getting much poorer. It is clear that this is a process, executed in a rather clandestine way, of inflating out the current liquidity crisis since the effective interest rate (interest rate minus inflation) is negative. This is the way we are paying for the largest heist in history. It begs a question why neither politicians nor mainstream media discuss this aspect of the current economic situation.

Irish lesson

2010-08-14T12:39:00.007+01:00

The UK government was warned in the article “Prime Minister, sort out this mess, please” about the risk that by making all the savings and cuts, without taking adequate protective steps, it is is “inviting” the “financial markets” to downgrade the UK rating. I.e. the saving and cuts are very likely to be perceived by the “markets” as the government's increased capacity to borrow short term by the amount of those cuts and savings. Hence it will be able to pay more in interests to the “financial markets”. There seems to be a little doubt that the “financial markets” are not going to miss such opportunity to get even more money from the taxpayers. “Financial markets” have a very short term strategies. Practically it is all about to the next bonus, a Madame Pompadour view of the world: “aprés nous le déluge”. As it seems the credit rating agencies do not play a role of objective judge of credit worthiness but are merely tools for making money by the “financial markets” players.

After the article “Prime Minister, sort out this mess, please” was published this is precisely what happened to Ireland. On 19 July 2010 The Irish Times announced having made massive spending savings, cuts and implemented austerity measures, Ireland rating was downgraded. The same strategy of the “financial markets” can reasonably be expected towards Britain. This is how the "financial markets" work these days. Indeed they are already half way there, i.e. the government announced saving and cuts without taking adequate protective measures. And the reasons for the UK downgrade will not be important: they will always be found.

Heading towards global Zimbabwe?

2010-08-11T08:15:00.015+01:00

On 9 August 2010, BBC Newsnight reported that $1 trillion stimulus package was not sufficient v, "the recovery is losing momentum" and that quantitative easing (QE) is now expected to follow, to stimulate the economy.

In her report, a BBC Newsnight journalist, Ms Naga Munchetty, gave an explanation what QE was. Her account was absolutely consistent with the foundation premise of this blog, and the analysis based on it. The current crisis was caused by the financial institutions that constructed a giant pyramid scheme (by lending with loan to deposit ratio greater than 100%, thereby generating in a run away manner a massive and uncontrollable money multiplier).

Ms Munchetty said: "Quantitative easing is likened by some economists to pouring liquid down the black hole in the dark." This black hole is nothing mysterious. In fact it is the amount of money needed to reduce the current massive level of money multiplier to an acceptable level. Smaller money multiplier means higher financial liquidity as one dollar of real cash has a smaller number of dollars of liabilities to serve. Historically, when economy functioned properly, it used to be in 5 - 8 region. In simpler terms, this is printing money to support the financial pyramid so it does not run out of cash. Had Albanian gangesters been allowed to do the same in 1997, their pyramids would not have collapsed either. However they did not have a clout of the modern days' financiers to convince Albanian government that this was the "right" way forward.

Ms Munchetty continued: "It's hard to tell how deep the hole is, or when you are close to filling it up." This precisely refers to the fact that we do not know the current level of money multiplier. (As it has been proved on this blog this is a direct result of a lending with loan to deposit ratio greater 100%: it is its characteristics. It is a loss of control of money multiplier resulting from lending with loan to deposit ratio greater than 100%.)

The filling in"holes of confidence", i.e. restoring confidence between banks, companies in the commercial world, mentioned by Ms Munchetty is simply a reduction of money multiplier to an acceptable level. It is also clear why banks are not lending: they hold off to QE money as it reduces the money multiplier, which any lending whatsoever would have increased (even with a minimal loan to deposit ratio).

However, contrary to what Ms Munchetty's suggested, "what happens next" once the black hole of liquidity is filled up is completely predictable. Once money multiplier reaches acceptable level, the banks will start lending again. It is their business and in fact they are urged to do so by politicians and business people. At that point the QE money, trillions of dollars will find its way to the market and will get multiplied. Even if the banks lend with a very low loan to deposit ratio of 50%, this money will be doubled. If they use a conservative 80%, a much more realistic scenario, the money will be multiplied by 5. I.e. every trillion of dollars in circulation will very quickly create a demand for 5 trillion worth of products and services in the current low inflation economy. To economists who "do not know": this means, surprise, surprise raise in inflation at an instant. Now you have been warned.

Any suggestion - supposedly by some economists - that printing money will result in economic growth, as Ms Munchetty also mentioned, defies belief and rational thinking. If that was possible any country would grow its economy by printing money. We all would be rich without doing much work (apart from running the printing presses). Presently Zimbabwe would have led the world as the most successful economy. It is simply amazing what some bewildered or dishonest economic pundits come up with trying to avoid the central issue of this crisis: the financial system has been a massive pyramid scheme with all its fraudulent characteristics.

"Hier liegt der Hund begraben"

2010-08-02T08:00:00.020+01:00

In Britain, the politicians are putting pressure on the banks to start lending. The public pressure and the media are also adding to it. It has been going like that, on and off, for some months, well over a year. Yet the banks whose primary business is to generate income by lending money are not doing so. Why something that was banks "raison d'être" and "modus operandi" for hundreds of years until the outbreak of the current financial crisis in September 2008, became so problematic. Is it not bizarre?

The public perception of the banks is that they are nasty. That it is all down to greedy irresponsible bankers that act against the national interest. Whilst it looks like a reasonable assessment of the state of the banking, it does not explain the root cause. If the banks had had money they would have lent it: this is the business they know very well for centuries and it is very profitable.

The crux of the matter is that by creating a massive pyramid scheme the banks pumped out the massive amounts of cash from mainstream banking to shadow financial institutions, hedge funds, offshore, SIV, etc. The money multiplier (in a simplified way called the leverage) is far too big to allow for further meaningful lending. The money put by taxpayers rescued the system but it was not enough to fill the liquidity hole sufficiently enough so as to reduce money multiplier to manageable level. In fact the government does not know what the size of liquidity hole is. In fact, due to the nature of the OTC market and off balance sheet practices, it appears that it is impossible to assess it but strong indications are (e.g. figures by the Banks of International Settlements in basel) it is massive: globally hundreds of trillions or even quadrillions of dollars. Many times over the world's GDP. Any lending, even very conservative, increases money multiplier still further.

The banks are caught in a "damn if you do, damn if you don't" situation. If they start lending as politicians and the public expect, they will deteriorate still very fragile liquidity situation, with a high risk of another massive credit crunch. If they don't, the economy recovery is very seriously impeded which also has a very serious impact upon the financial markets liquidity. "Hier liegt der Hund begraben."

No politicians' appeals are going to change any of that. They are, in fact, quite populist and rather incompetent. Or maybe bankers are expected impossible, to create a pretext to get them by the throat and sort them out? Politicians becoming more clever than bankers? "Exitus acta probat." Banks do not lend because they cannot. The solution is a reduction of money multiplier: "Prime Minister, sort out this mess, please".

The Economist on weed

2010-07-23T23:40:00.023+01:00

In the last issue of The Economist an article "The banks on methadone" was published.

Its author wrote:

"All these banks are trying to lower the ratio of loans to customer deposits; sounder banks will be rewarded when a new banking levy comes into force next year. Lloyds Banking Group, for example, has a loans-to-deposit ratio of 169%, according to research by Nomura Securities. Barclays and RBS are at 130% and 134%, respectively."

It looks that, at long last, the banks acknowledged that lending with loan to deposit ratio greater than 100% was the cause of the crisis (or at very least that it is a huge problem). This was made clear in "The largest heist in history" written at the end of 2008, immediately after the crisis erupted. However the banks are not going to publicly acknowledged that but are trying quietly do the right thing: reduce this ratio. The snag is that it was not the ratio itself that hit with liquidity crunch but the ridiculously high money multiplier that directly resulted from lending with loan to deposit ratio greater than 100%. High money multiplier means that $1 (or £1, €1, i.e. cash, the legal tender, only real liquidity mean of settling liabilities) has to serve in the system a massive number of dollars (euros, pounds) of banks liabilities ($40, $100, $1,500, anyone's guess could be good as the control was lost by losing control over derivatives and shadow banking markets). This results in banks' assets turing to toxic waste as there is not enough cash in the system going around (due to high money multiplier) to settle the transactions.

Here is a banks' quagmire: continued any lending by banks even with a very low loan to deposit ratio (like 5% or 10%) still increases money multiplier (albeit at much slower rate), therefore exacerbating banks' liquidity position further. So the banks should not really lend at all. But if they do not lend at all the entire system would grind to a halt and the economy would collapse (most likely banks would not get any more of repayment of the loans). So we have a classic: "damn if you do, damn if you don't". So there is little wonder that the banks took all the money from the government but did not start lending again. If the politicians had a bit of intelligence (and basic knowledge of finance) they would have known it. They could not have expected banks to "repair" their balance sheets and lend money at the same time. These two things are contradictory. The point is that there are only two ways of reducing high money multiplier: inflate your way out (print money) or write off banks liabilities (or their combination). Both are not socially and politically acceptable (but a gradual inflating out is already happening).

The writer in The Economist continued:

"But the banks may be wrong to think that squeezing loans will improve these ratios; the Bank of England warned in June that growth in lending is usually the main driver of higher deposits."

It is a mathematical fact that if you stop lending and your loans come back as deposits (which are not re-lent), the ratios would be improved from above 100% to below 100%. However, on practical level the economy, as we know it, would be killed in this process as the money stopped circulating. If you lend less out of your deposits, your loan to deposit ratio will go down (however you may still struggle with high money multiplier). Higher lending indeed drives higher deposits, as the writer in The Economist said, but in absolute terms. This is false in terms for ratios: higher lending drives the loan to deposit ratio higher. This is a mathematical fact. The Economist writer does not understand the basics and confuses a relative figure of loan to deposit ratio with absolute figure of deposits. It is quite amusing to watch the banks doing the right things quietly (so they are not accused of not doing so in the first instance) whilst being lambasted by The Economist for doing these right things.

The paragraph cited in two bits above from The Economist epitomises what went wrong with the banking system (lending with too high loan to deposit ratios) and that mainstream commentators do not have a basic understanding of the mechanism how it works. Even nearly two years later. Although banks got round to it eventually: but it looks that it will be too little and too late and, of course, they will not acknowledge that they were effectively peddling and Albanian-type pyramid scam.

The world has gone bonkers

2010-07-18T16:30:00.014+01:00

The Sunday Telegraph has reported today: "JP Morgan has raised serious concerns about its commitment to its new £1.5bn European headquarters at Canary Wharf because of anger within the bank at the lack of support for the financial sector in the UK."

Has £850 billion subsidy pumped by the UK taxpayers to the financial sector not been enough? The sooner these guys like JP Morgan go, the better. Compared to JP Morgan, Arthur Scargill is a true standard bearer of laissez faire capitalism.

Or, perhaps, it is worse: the bankers want to ensure that "The largest heist in history" continues. That the government supplies the financial sector with massive subsidies, to the tune of hundreds of billions of pounds a year, in perpetuity, fleecing the taxpayers in the same way as loan sharks do their victims.

What a strange world…

2010-07-07T18:32:00.003+01:00

Back in September 2008 the financial system came to a halt and nearly collapsed because the financiers were unable to manage it properly. With all the financial tools at their disposal (spreads, CDS', ratings, etc) they led the system into a catastrophic failure. This was unprecedented event, not a situation that may happen. Therefore the financiers proved conclusively that for one reason, gross incompetence, or another, downright fraud, or both, they are not a suitable profession to judge the credit risk or any aspect of the financial probity and good management.

To prevent the financial meltdown governments stepped in and rescued the banks. Now the same financiers, the same people, are judging the credit risk of the governments, quite often on the debt incurred to avert the banks from going under. They undermine their saviours by speculating with the very same money that governments pumped in. Never mind that these financiers proved in 2007 and 2008 in the most spectacular way that they were incapable of assessing financial risks properly, governments are following the financiers "suggestions", saying that they react to the financial markets' behaviour. The recent cuts in public spending by the British government is a good example of such perversion. Yet neither mainstream media nor politicians pointed to such truly bizarre arrangement: incompetents or fraudsters are effectively telling governments, who rescued them, what to do.

Who on Earth with a sound mind, in any profession, would have followed someone who discredited himself (or, not to be sexist, herself) in the most spectacular possible way (i.e. catastrophic failure) by demonstrating to have been incompetent or a downright fraud? However this is a norm for governments in dealings with the financial world. On one side politicians complain about greedy and irresponsible bankers but on the other they just dance to their music.

It is clear that the politicians are grossly incompetent or corrupt. They either mistake the rules of free markets economy and capitalism in general with the gross incompetence and fraud of the financial world (in which case they are themselves incompetent) or they deliberately conspire with the financial world in fleecing the taxpayers. The revolving doors between the financial world and governments make the latter supposition very plausible indeed. This is not an emotive statement as one might think. This is a reasonable professional assessment reached by any competent fraud investigator.

However the fact that we elect these politicians democratically makes it all damning on us. In democracy we have to acknowledge: "we got what we deserve".

===

PS. For the British taxpayers: this article is not arguing that the British government should not have cut its public spending. This is a more complex subject dealt with in "Prime Minister, sort out this mess, please". It simply demonstrates that the politicians' justification that they had to do so in response to "financial market pressures", to preserve the ratings, etc, is devoid of any logic or honest rationale.

Don't jump over yet. It will get worse.

2010-07-02T08:44:00.015+01:00

"An nescis, mi fili, quantilla prudentia mundus regatur?" - Axel Oxenstierna
("Do you not know, my son, with how little wisdom the world is governed?")

Watching Newsnight report on European banks last night was a truly shocking experience. Neither Mr Paul Mason, who prepared the report, nor Mr Gavin Esler who hosted the discussion, nor the invited pundits Mr Raghuram Rajan and Ms Gillian Tett, went beyond a shallow analysis that described how really bad it was (using some rather vacuous parallels, e.g. "a sticking plaster"). But we know all that: this has been blatantly obvious since the financial crisis erupted towards the end of 2008.

The only sound words of advice from the experts were that we should find out more precisely how bad the banking situation was (implying the size of liquidity hole, i.e. the level of money multiplier). Mr Raghuram Rajan added that there should also be a programme to deal with the banks that are found to be in a bad shape. But this is all trivial and blatantly obvious since 2008. You do not employ experts to find out these. It must have insulted intelligence of any half sober viewer. (But who is actually sober at the time of Newsnight?) This has been described in the "The largest heist in history" immediately after the crisis erupted.

If it takes experts and pundits well over a year to work out such basics, that are not even a start of understanding the causes and mechanism of this crisis, little wonder why got into such mess in the first place and even less hope that the crisis will be resolved peacefully. It provides disturbing reassurance that we are heading for quite a disruptive end to it. The Great Depression that started in 1929 ended with World War Two ten years later. It seems increasingly likely that an event of a similar scale will sort out the current mess since neither the politicians nor the expert have even a basic understanding what they are dealing with.

And the causes are actually trivial. They are huge and of a criminal nature: using a pyramid scheme mechanism the money multiplier (leverage) was ballooned massively. To solve it, it is necessary to reduce it: either by engineering high inflation (printing money solves the liquidity shortage) or liability write downs (less banks liabilities solves the liquidity shortage), or, of course, some combination of the two. The entire process for the UK, including how to protect the taxpayers' interests, has been described in "Prime Minister, sort out this mess, please" but it applies to eurozone (and the US) too. But with clueless (or corrupt) politicians and experts there is very little, if any, hope for an orderly solution of this crisis. "Do you not know, my son, with how little wisdom the world is governed?"

It is time to face reality over global liquidity black hole

2010-06-29T21:56:00.013+01:00

In his article in the FT, "It is time to face reality over Greece's debt", Nouriel Roubini makes a right diagnosis but it is simply too narrow and has been blatantly obvious since "the largest heist in history” came to light at the end of 2008. The global financial system has a massive liquidity black hole: hundreds of trillions or even quadrillions of dollars that resulted from a classic pyramid scheme, that the financial system was turned to, and organised by the financiers and regulators with a blessing of some politicians.

Roubini diagnosis that Greece cannot escape a default applies equally to the UK, US and the entire eurozone. It is only a matter of timing: first Greece then the US. The UK is bust already: yet no one is prepared to admit it: it is an open secret. So as the eurozone.

Roubini recommendations have a deep sinister aspect. If implemented they will mean that having saved the banks, the taxpayers will keep on paying to these banks practically forever. And as before the money will be taken out of them by private "investors" who will pay the bankers handsomely for running such a scam. This "investors'" and bankers’ dream is taxpayers (and their children and grandchildren and grandgrandchildren and …) nightmare. It is a classic relationship of a loan shark and his victim.

Nevertheless there is a solution. World best option is an orderly default. It should take a form of global orderly write downs akin to the US Chapter 11 approach in the private business. This was elaborated in "Prime Minister, sort out this mess, please". It applies equally to the UK as the rest of the financial world that suffers from the liquidity hole. And a new ways of recouping taxpayers money should be considered (and eventually introduced). For example, taxing all money transfers, say 80% - 90%, to and from offshore financial centres (and of course to and from any country that does not sign up to such an arrangement). Such a deal would have to apportion the proceeds from such tax (so no country can be privileged as an offshore banking gateway) and could be used to plug the global liquidity hole.

The world is in the midst of an unprecedented crisis which is moving from country to country. The sheer scale of it, just numbers, makes it completely unsolvable using standard approach: i.e. let’s make taxpayers pick up the bill. It is simply too big for that. This is beyond any moral issues of massive wealth transfer (i.e. theft) from the middle classes to the very rich. Communism for the rich has triumphed. But let's hope that it will be defeated like its more sophisticated Soviet predecessor.

A nightmare round the corner?

2010-06-22T14:19:00.008+01:00

With the current budget the Chancellor paved a way to the UK rating being downgraded soon. Do not be misled by the reaction of the guild market today. Before it the UK was so much in debt that it could not have been downgraded (as should have if ratings were honest measures of the market) as it would simply not pay (and the whole rating system would have been undermined). Now as the Chancellor made a lot of savings thereby creating a capacity for the government to borrow and spend more, the so called financial markets (i.e. bankers) will come back and ask the taxpayers to share it. To get it the UK rating looks likely to be reduced. It will not happen instantly and some pretext will be used.

The taxpayers must watch how much of their hard saved and paid money to the Exchequer, thanks to the Chancellor current budget, will result in the UK debt reduction and how much will be siphoned off to the banks to keep funding on-going salaries and bonus bonanza there and to keep on supporting the financial pyramid that the financial system has become. This is the way the relationship between banks and taxpayers has become akin to loan sharks and their victims.

Prime Minister, sort out this mess, please

2010-06-18T17:39:00.039+01:00

Over the last week in Britain there has been a parliamentary festival "what to do with the public debt". The government is arguing that it must cut the public debt very quickly, and harshly, or otherwise the UK will lose its credibility to the markets, its rating will go down and costs of servicing the debt will eventually skyrocket. The opposition is putting their point across that if the public spending is cut then the economy will not get a necessary investment in order to guarantee future tax receipts that will eventually bring the public debt down. It is an argument between "cut and save" now and "spend, invest and earn more". There are merits to both arguments: but they are both missing the point how to solve the existing financial mess that the last Labour government financially engineered for the UK.

Let us deal with credit rating, and its possible downgrade, for the UK. Originally when credit ratings were invented some years ago they were meant to be an objective tool of assessing the risk of default of a debtor. As long as they were done by creditors, at no conflict of interest situation, they played their objective role.

In the last decade or so, the sense of credit rating has changed. The financial institutions that were selling the financial products (thereby getting into debt themselves) started commissioning the ratings for their own products. The higher the rating the lower the costs of the debt. Ultimately many products that were clearly of no value whatsoever were sold with the highest possible credit rating. Credit rating does not mean any more what it used to mean. Now it is a crude tool used by the financial players to make money and very frequently it has nothing to do with the underlying credit worthiness.

The current public debt has to be seen against this backdrop and the fact that the banks are still full of the financial instruments which they cannot cash on the open market. The massive UK debt means that the government is unable to borrow any more money and pump into the banks. If the banks executive turned up now on the Number 10 doorstep and requested yet another cash injection into the financial system, like they did in September 2008, for example in order to prop up massive bonus schemes for the bankers, they would have had to be turned down. The government simply would not be able to hand over more money. But the bankers need it so they are not going to give up easily.

Now the credit rating is used. The UK is threatened by the financial institutions that unless it cuts its pubic debt its rating would go down and the costs of debt servicing would increase thereby increasing the annul spending by the government. There is nothing far more from the truth. If the rating were cut and the debt could not be serviced, then the government would have to take emergency steps and the banks would not get any more money. The whole Greece saga only happened because the banks assessed that there would be a bailout. If there had not they would not have done anything as they would not gain anything by putting a pressure on Greece. This is a rational economic behaviour. Now they try the same basic crude method with Spain and are testing the ground with the UK.

However the game with the UK is a bit different. The financiers know they cannot risk bringing UK economy down. In fact they are unable to do so as the government would have introduced emergency measures to prevent it, and many financial institutions would have come out as losers from it. So using a crude tool of "credit rating" (which has nothing to do with real credit rating) they are trying to force the UK government to cut the debt, thereby increasing the government capacity to borrow more – at the taxpayers’ costs – in the future. Once the government makes all the big savings, of hundreds of billions of pounds or more, cutting many public services and making everyone feel it, the bankers are very likely to turn up again at Number 10 doorstep with begs of toxic waste that remains in the system and will demand another bailout (or else the banking system will collapse). At that point it will be too late. Like Gordon Brown, David Cameron will have little choice but to cough up another few hundreds of billions to the bankers. All those money saved by savage public spending cuts.

However as there is more than one way to skin a cat (sorry, taxpayers), the process of the bankers skinning (again) the taxpayers may actually be not that conspicuous as asking for another multi billion rescue package. It may also take a form of continuous dripping of money from the Exchequer into the banks (by, for example, so called market operations). In which case we will never see any savings made and the pundits who tend to protect the bankers are likely to comment that even the savings were not sufficient to reduce the public debt. They are also likely to peddle a nonsense how much worse it would be if the cuts were not done.

These scenarios and their mechanisms were presented in the first article of this blog, "The largest heist in history" over a year ago. It is astounding that neither the government nor the opposition, then and now, can foresee such glaringly obvious very high risk scenario.

What could and should the government do to bring to order the financial system that became a vampire squid on the face of taxpayers? How can the government remove a risk of taxpayers being treated by the financial industry in the same way as loan sharks treat their victims? It is not a rocket science. There is a basic five point action plan that deals holistically with the current crisis: resolves the current mess and prevents it from happening in the future.

1. Banks must be broken up so none of them is "too big to fail".

As explained before on this blog a "too big to fail" bank enjoys free insurance against failure. This is anti-competitive and is also a continuous burden on public finances by carrying risked costs of the potential failure, hence this is a free public subsidy. For both reasons such behaviour is completely unacceptable under free market rules and should be, if it is not already, made illegal.

2. Separation of high street consumer banking from investment banking.

In the process of breaking up the banks into businesses each of which is not "too big to fail" consumers banking, typical high street deposit and lending activities must be separated from the high risk investment banking. Under Glass-Steagall Act there has been such a rule and it worked for over half a century. It did not take even a decade after it was repelled and we ended up in the current crisis. Therefore whilst theoretically it may not be necessary, the experience strongly indicates that it is a good practice to separate high street consumer banking from investment banking.

3. Deleveraging of the financial system and write downs of toxic waste (i.e. liquidation of the financial pyramid).

As Mr Will Hutton observed on the Dispatches programme last Monday, the banks leverage is around 50. I.e. around £50 of banks liabilities are covered by £1 real cash. Such leverage is unsustainable. A typical sustainable leverage is 5 – 10, 10 only in times of good market confidence. Therefore between 80% - 90% of so called assets are simply toxic waste. The financial assets must be ring-fenced and the proper orderly process of write downs must be done. The aim of this process is to reduce the leverage to a sustainable level between 5 – 10.

The crux of solving the current crisis is the reduction of unsustainable leverage (50 or more) to a sustainable level (5 - 10) and who are going to be losers of this process.

As there will be losers: i.e. people and companies whose assets will be destined to be written down, the government must find a way to deal with it in form of providing a limited security. The ultimate test of the government guarantees and how they are discharged should be of a public interest. For example if a pension fund goes bust as a result of such assets write downs and ultimately the pensioners are the losers, the government must consider taking over a liability for these pensions (at a level, e.g. 50% or 80%, that it can afford or with a possible cap). Another example is if a bank goes bust. Then the government, through one of the nationalised banks would take over accounts and operations and guarantees individuals and businesses their interest. This will no doubt require some government spending but it is likely to be far cheaper than propping up the entire system with no limits as is happening now. Any new government stimulus package that may be necessary will not end up in the financial institutions black hole of toxic waste but in a newly healed banking system, as described in this point and two proceeding points. The banks will not have a problem to start lending again as they will not have an issue of dealing with massively excessive historical leverage. The losers of such operations whose assets were ring-fenced to be written down will be able to resort to private litigation against all those individuals (bankers, regulators) who brought such misery on them.

There is nothing unusual in this step: write downs are typical actions in corporate restructuring and recovery. However in case of the financial industry it is the sheer unprecedented global scale that is daunting. In that respect banks that hang on to bogus assets, which are in fact toxic waste that should have been written down or significantly valued down, and present them as genuine assets on their books, are no different in their accounting practices from Enron. Whilst Enron was using such "creative" approach to extort money from the banks and private investors, banks are extorting money from the taxpayers. Hence banks must be dealt with as decisively as Enron was: it is far better to pick up the pieces now than to allow such a scam to keep on growing.

4. Setting up an effective deterrant against a future crisis happening (i.e. prosecuting the fraudsters).

This crisis is a result of a massive pyramid scheme whose fraudulent mechanism has been lending with loan to deposit ratio greater than 100%. As it has been argued already on this blog, the financiers, bankers, regulators and some politicians that engineered or are responsible in any other way for this financial crisis must be prosecuted. They must end up in jail and their wealth (or any wealth that was "generated" by them as a result of this crisis) must be confiscated. This is not only a basics fairness, the scammers and fraudsters are not allowed to get away with their crimes and spoils of their crimes, but it will help to fund any compensation resulting from the assets write downs as described in point 3 above. Ultimately there is no better way of preventing the next crisis than prosecuting perpetrators of the current one. Enforcing the law is the best regulator.

5. Reducing the public debt.

The last point will be reconciling the public debt against what is recovered from the scammers, as described in point 4 immediately above, and also against any liabilities of the institutions to the government that resulted from orderly dealing with assets ring fencing and write downs as described in point 3 above. For example if the government owes debt to an investor (e.g. bank, financial institution) but at the same time due to a write down (as described in step 3) such an investor ends up owning money to the government (directly or indirectly, e.g. pensioners, individuals, businesses who lost in such write down and were taken care of by the government), then the government subtracts such write down from its debt to the investor. This is likely to reduce the government debt, possibly quite significantly: it seems that a good portion of a near trillion pounds rescue package can be offset against the government debt. And only then if it is not enough the government must do necessary cuts in public spending to balance the books and bring public finances into black.

Desperate times call for well-thought through measures.

Disappointment or hope?

2010-06-13T10:48:00.014+01:00

Future of Banking Commission produced the report with very sound and thought-through recommendations: the banks cannot be too big fail and separation of risky investment structures from safe deposit banking. There are other sound recommendations. However, what striking is, that is all so obvious. It begs a question why such basic and trivial rules were not observed in the first instance.

Importantly the report does not recommend prosecuting of all those who engineered the current financial crisis. Bankers, regulators and some politicians. This crisis is a result of a giant global pyramid scheme, the same in its structure and mechanism as in Albania in 1996 – 1997.

The circumstances of producing the Future of Banking Commission report reminds a situation of a neighbourhood where houses were notoriously robbed. Its association established a commission and came to a conclusion that houses needed to have a secure lock fitted. Well, done. However such report did not conclude that the Police should be informed and the thieves must be pursued, caught and prosecuted. Languish years in jail and their wealth confiscated to compensate their victims.

This blog has long argued that enforcing law is the best regulator. The Future of Banking Commission report shows three points. Firstly the politicians, and official authorities, are clearly way out of their depth in dealing with the current financial crisis: present the glaring obvious as some kind of achievement. Secondly the establishment has realised, as Mr David Davis put it on today's Andrew Marr Show, that "if we don't do something, next time [a crisis] happens it will break the country - it will go bankrupt". He confirmed the obvious that the scale of the ongoing financial crisis is enormous. Thirdly, by not recommending pursuing and prosecuting all those who caused the current crisis, the establishment is trying to protect them (as they are part of it).

Or maybe our democratically elected representatives will come to the last point later. Albanian government was prepared to prosecute the scammers. Let's hope that our government will live up to the same standards of probity and integrity.

Comment to: To the Chancellor: UK ain't Canada

2010-06-08T18:30:00.015+01:00

For all those who know my blog the comments below should not come as novelty, but it is worth repeating:

1. The banks should be broken up into business units of a size that NONE of them is too big to fail. Any business entity that is or is allowed to become too big to fail enjoys a free survival insurance at the costs to the taxpayers. Not only is this unfair on taxpayers (it is in fact extortion of money through the back door) but it is discriminatory to entities which are not too big to fail. I.e. under the EU rules it a monopolistic and uncompetitive practice which is banned. Hence it begs a question why the authorities allow such illegal practices to exist in the financial sector? Stupidity? Corruption?

For clarity, the current crisis is not a failure of free market rules. It is a result of breaking them and substituting them with communist-like ideology (communism for the rich that is). It is an absolute scandal that the financial sector is run by people who implemented the worst of the communist practices straight from ailing Brezhnev era. The banking communists are the new working class of the 21st century: they successfully executed a revolution of robbing mid-income people and redistributed the spoils to the fabulously rich, making them even richer. Even Soviet communism in its heyday was not that economically perverse.

2. We do not know (and indeed HM Treasury does not know) whether the bailout support the banks got, £850 billion, plugged the liquidity whole. At present it is clear that not more than £70 billion is possible to be recovered by the Treasury and the costs of bailout money is accumulating. Strong signs are that the liquidity hole still exists and may be absolutely massive (possibly even going into quadrillions of dollars globally, and the UK share of it may be huge). Therefore it is likely, above moderate, that the financial institutions in the UK will come to the government for hundreds of billions pounds of more money. (Please note that Greece bailout is in fact a bailout of private banks that lent Greece money.)

3. The basic, intuitive, risk analysis points that the chances of banks asking for hundreds of billions of pounds in form of a new bailout (again) is currently moderate but likely, 3+ (on a classic 1 (min) - 5 (max) scale) but the severity of it is massive, 5 (on the same scale). Hence the overall risk profile - on 1 to 5 scale - is 4+: this is a lot! This means high alert. Just below: imminent. This analysis is intuitive and not mathematically strict. But it is not an argument to ignore it but to prompt the Chancellor to instigate a detailed risk examination.

For the reasons above, whilst the government savings which look reasonable now may turn out to be foolish and for the benefit of the financial sector shafting the taxpayers big time again. How about that?

To the Chancellor: UK ain't Canada

2010-06-08T10:01:00.007+01:00

On 6 June 2010 The Daily Telegraph reported that the British Chancellor of the Exchequer planned spending cuts that would be similar to Canadian ones in mid-1990's. These were the very savage cuts of public spending: 20% a year for three years.

Below is a word of caution that the Chancellor is unlikely to get either from the mainstream media or his political friends (and foes).

Canada had to cut its budget deficit because its government overspent on typical public services. The country lived, for some time, beyond its means. Hence its debt had to be repaid and adjusted to an affordable level one way or another.

British budget deficit, in its vast bulk, is of completely different nature. It resulted from the government actions to save the financial institutions at the end of 2008. Although the British government has been spending too much for quite some years on the public services, it were the banks' rescue packages, stimulus packages that were used to plug the financial sector liquidity hole that make up for a vast bulk of the current budget deficit. We are not in debt because we spent too much on schools and hospitals but because we spent absolutely unbelievably extortionate amounts of monies on financial institutions (or, as Gordon Brown said, to "save the world").

As the author of this blog was officially informed (in writing) by HM Treasury, the government does not know the size of the liquidity hole in the financial system. Therefore it does not know how much (if any) more money (billions, trillions?, of pounds) it is still likely to pump into the financial system to assure the liquidity.

Therefore it is reasonably likely that, having completed a serious of savage cut, Canadian-style, the government will save, say, a couple of hundred billions of pounds. Possibly more. At that time, once the financial industry realises that the government liquidity ratio has improved, another liquidity crisis will crop up in the banking industry. And all the monies that government saved, putting a lot of ordinary folk in hardship, will be used to "save the world" again.

The government, hence the taxpayers, will end up back in square one, with the same massive budget deficit as now (or more), but living under massive austerity spending measures. It is quite clear that this is exactly the same mechanism as loan sharks operate, whose victims are squeezed for every penny. In this case the loan sharks is the financial industry who use the government to squeeze the taxpayers for every penny.

The British Chancellor of the Exchequer should be well advised that before he contemplates any cuts, he has to ensure that the financial industry's liabilities (current, potential or future) are completely isolated from the taxpayers. I.e. that, by legal and other arrangements, the government is prohibited from bailing out any financial institution. Otherwise all the savings, done at the huge costs to the taxpayers, destroying lives of many of them, are likely to become savings that, once again, will be pumped into the financial industry like at the end of 2008.

A short tale about a Bailiff and a Good Man (or a brief history of the current financial crisis)

2010-06-04T11:30:00.017+01:00

Once upon a time, in a village, a Bailiff lived. He was irresponsible, greedy and whilst he was good in collecting other people's money he was not that that good in managing his business. So the Bailiff himself ended up in a deep, deep debt.

In the same village, at the time, a Good Man also lived. The Bailiff pleaded with the Good Man:

- please lend me some money, a lot of money or otherwise I will go bust. And if I go bust then the whole village will go bust as the debtors will be able not to pay their debt. You have to save me, you have to "save the world".

The Good Man was a… good man. Just that. Not necessarily wise. He turned to Bailiff's friends in the village for advice. They all told him:

- you must help the Bailiff or otherwise our village will collapse. You must "save the world".

The Good Man was not wise. That's why he was not rich either. A simple hardworking man. He did not have his money to lend. So he went to a local Bank. He put all his possessions, all what he earned and inherited, as security. He pleaded all his future income. He borrowed as much as he could. He invested them in the Bailiff's business. That was just enough for a short time as the Bailiff's debt was so huge. The Good Man was even proud and bragged that he "saved the world". But only just and for a short time.

In the meantime the Bailiff was paying himself a handsome salary. The Good Man, being under pressure from his family, inquired whether he could get more in repayments. He also suggested that it was rather unreasonable for the Bailiff to pay himself so much whilst he was in debt.

The Bailiff said to the Good Man:

- you are paying for my great talent as a bailiff. This talent is worth all that and more. If I have to stop paying myself that much I would leave the village and will find a job somewhere else. And the village will collapse.

Being not that wise, rather too optimistic about his income and having underestimated his financial commitments, the Good Man overborrowed. The Bank realised that he would not be able to pay back his debt. The Bank eventually got very anxious and decided to sell the Good Man's debt to a local Loan Shark. The Loan Shark, who knew all the tricks of the trade, decided to make a mint out of the Good Man. That's a loan sharks’ business after all. He started sending demands to the Good Man, making him pay as much as he could. And more. The Good Man was starving. His family was starving. And paying. But his debt kept on increasing with penalties for late payments, additional sky-high interest, administrative charges, etc.

To enforce his "rights" and collect as much money as possible from the Good Man the Loan Shark hired… the Bailiff. And the Bailiff was thriving proving to be a man of many talents indeed.

======

For those who still not get it:

1. The Bailiff are the financiers and bankers (especially investment bankers).

2. The Good Man are taxpayers (represented by our democratically elected governments).

3. Friends of the Bailiff are all kind of consultants and advisors that work for governments.

4. The Bank are the financial markets.

5. The Loan Shark are the hedge funds, offshore funds and many shadow banking institutions.

6. The Good Man investment in a Bailiff's business is called "stimulus package".

7. The Good Man costs cutting and saving to repay the loan to the Loan Shark is called "austerity package".

… and so on.

Kill your saviour: currencies' crisis is looming

2010-06-01T11:01:00.026+01:00

In February this year [2010] the author of this blog wrote a report which was commissioned by an organisation of sovereign wealth funds, "Money Multiplier effect on currency risk" ^*. The conclusion was inescapable at that time, which was well before the Greek crisis. The currencies of countries which are heavily in debt are facing realistic to high risk of collapse. This was true especially with respect to eurozone which was (and still is) facing a break-up or major realignment. The US dollar is not much on the radar but does not look much better. Since then German Chancellor, Angela Merkel, confirmed "The euro is in danger".

The global pyramid scheme which was engineered by bankers and financiers (with help and blessing of regulators and some politicians: how are you Mr Gordon Brown?) resulted in a very high Money Multiplier. I.e. $1 (£1, €1) real cash has to service to many dollars (pounds, euros) of liabilities on banks balance sheets. This resulted in ongoing liquidity crisis. Governments "rescued" the banks by pumping cash (and cash guarantees) into them thereby putting economies heavily in debt to a tune, globally, of trillions of dollars. However this has been only a temporary reprieve since it covered only a very tiny portion of banks liabilities (especially toxic papers on their books). Although Money Multiplier was reduced (i.e. improved) as described in "The largest heist in history" the improvement was insignificant and, very likely, it has grown since then. This put the economies into a deep financial trouble. Now chickens are coming home to roost: as predicted at the time (end of 2008) rather than curing the problem in the private financial sector, governments decided to buy their time by spreading it and making it much worse dragging taxpayers (and future generations of taxpayers) into it.

To repeat the advice from the end of 2008: "If governments do not liquidate the global pyramid scheme [as explained in this article what it was but primarily write offs of many financial instruments and liabilities of so-called "casino" banking], 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 dependant 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."

The ongoing liquidity (banking) crisis and the sovereign debt crisis, that just blew up, are two sides of the same coin: much too high Money Multiplier, or in simpler terms the global financial pyramid is simply too huge and keeps collapsing.

There is a perverse, sinister side of this process: the very same bankers and financiers whose institutions (i.e. the vehicles of their actions and source of rather exuberant income; this must not be confused with proper ownership, shareholding) were saved from spectacular collapse with "stimulus packages" are now using their institutions, saved by taxpayers' money, and taxpayers' money to attack the budgets of governments (i.e. taxpayers). Kill your saviour if you have an opportunity to do so and it brings you benefits: it is a free market version of an old rule "dog-eat-dog". In fact a prediction made on this blog over a year ago that the financial system – society relationship would turn into a relationship akin to loan sharks and their victims has materialised. As it is taxpayers, and their children, have to keep on paying ever more, as much as they possibly can, with no hope of any recovery. This is called "austerity packages". Loan sharks developed such ideas for their victims in the past and now the mainstream financial industry has learnt such methods and is scaling it up to encompass entire economies. This was a predicted result of "stimulus packages" exposing governments as weak, incompetent and corrupt.

The next step on this path is very likely to be a currency crisis. We already see its beginning with euro. The US dollar will also not escape a reality check. But as pointed out in April 2009 in an article "A US way out?" this make take some time and end up in a somewhat unorthodox solution.

There is only one way out: a combination to a greater or lesser degree of the two processes:

- Zimbabwe way: inflating this crisis out (printing money will reduce Money Multiplier by increasing the volume of cash available to satisfy liabilities on banks balance sheets);

- Chapter 11 way: write offs of liabilities on banks and countries balance sheets (removing liabilities on banks and countries balance sheets will reduce Money Multiplier by reducing the size of liabilities that cash available has to satisfy): an extreme form of such scenario, which is quite likely, was presented over a year ago in a short article mentioned above "A US way out?".

(And of course banks must be banned from recreating the same problem again, for example by lending with loan to deposit ratio above 100%. This is all on this blog: a bit complicated for a paragraph of explanations here.)

From banks liquidity crisis and banking collapse to sovereign debt crisis to currency crisis. These are the stops on the same path: a collapse of the global financial pyramid scheme engineered by the financial world (or technically a result of much too high Money Multiplier). The Great Depression that started in October 1929 reached its grand finale in 1939 with the World War Two. Whether the end of the current crisis will be as dramatic and "spectacular" time will tell. But there is very little to feel optimistic since politicians live in a state of denial and do not tackle the root cause of the current situation. Well, they are unlikely to have a clue about it.

====================

^* If you would like to obtain a complete copy of this report published by Arab Financial Forum titled ”Sovereign Wealth Funds – Where Are They Going?”, please send a request to Arab Financial Forum Secretariat: info@meconsult.co.uk

Gordon the Firefighter

2010-05-01T21:02:00.011+01:00

Whilst listening to Gordon Brown during the 2010 General Election campaign it is difficult to escape an impression that he behaves like a firefighter in dealing with the current financial crisis. He gets into a combative rhetoric and posture and lambastes his opponents as threats to economic recovery. In 2008 Gordon was "the world saviour". Now he got into even a hotter role.

However one must not forget that the current economic crisis was caused by the government and regulators responsible for the probity of the financial world, at best by monumental incompetence that let the financial institutions behave fraudulently, at worst by a criminal conspiracy to defraud the taxpayers.

Indeed Gordon is a firefighter. But either a stupid one or, worse, one with a hero syndrome. All in all, "the world saviour" in the current firefighting role comes across as a bit of a Walter Mitty.

Since writing this article, the author found that Lord Lamont also compared Gordon Brown to an arsonist posing as a firefighter in his article over a year ago (albeit in a different context). It seems it is not only an unbridled imagination.

FSA is coming back to their senses

2010-05-01T20:19:00.006+01:00

The UK regulator, FSA, appears to be coming back to their senses. Today an actuarial professional who works for a retail bank, has written to the author of this blog:

"I attended a presentation on liquidity from a senior figure in my banks Treasury department - the FSA are proposing a ratio which would in effect mean LTD < 100%."

On one side it is good news, but on the other it is worrying: even if FSA do something right they do not really understand what they are doing. But it is a progress from much-celebrated "Turner Review".

Election 2010 - short of ideas or lack of guts

2010-04-23T10:12:00.009+01:00

All three major parties, Conservative, (New) Labour and Liberal-Democrats, talk the same about the impact of the financial crisis. "We are all in it together" say their leaders. The discussion is on the issues how we are made to pay for that: a combination of public expenditure cuts and raise in taxes. In the last few days, the media brought a story of Goldman Sachs facing fraud charges in the US and the Financial Services Authority investigating the same in the UK. This accompanies the stories of banks' (again) bumper profits and huge bonuses paid to individual bankers.

In contrast, yesterday during the three parties leaders debate an elderly lady, who worked hard all her life, asked a question whether it was fair for her, at the age of 84 years, to live on £59 a week pension.

"We are all in it together.": retired folk on £59 a week pensions and individuals from financial institutions that, allegedly, committed serious fraud and who are responsible for the current crisis and, thanks to the mechanism that caused the current crisis, collect hundreds of thousands or even millions of pounds in bonuses. And if it were not enough, in her article in yesterday's FT, Gillian Tett clearly suggested that individuals in these institutions, or at least in one of them, operate like mafia under a code of silence.

"Irrespective of what Goldman’s clients and service providers have really thought about the bank, most have been reluctant to antagonise the bank, since they feared that Goldman was so powerful that any critic would face some backlash. Hence the fact that so few law firms, consultants – or even bankers – have ever testified in public against the firm, on CDOs or anything else."

Thus far the only action that politicians proposed to curb excessive, if not dishonest, bonuses was to tax banks and bankers on their future income, forcing banks to pay more in shares than in cash. Any effective action was frustrated by those who argued, rather irrationally, that such actions would lead to bankers leave the country. Hence not only would very little be collected but the industry would be damaged as it would relocate abroad, away from the City. This is not only nonsensical. This is also looking through the wrong end of the telescope.

In 1997 when New Labour came to power they imposed a retrospective "windfall tax" on "the excess profits of the privatised utilities".

Leaving aside arguments about legality of the bankers profits, there is a uniform agreement amongst three parties, Conservative, (New) Labour and Liberal-Democrats, that bankers pay has been excessive for some years. Therefore all three parties should have proposed a similar windfall, retrospective tax on the individuals working in the City (including any source of future income like pension pots). The tax should go at least as far back as 1997, when the change to financial regulations was introduced and, to avoid any accusation of unfairness, it should tax net income above a reasonable threshold.

For example, as a reasonable guide (i.e. a template for the politicians), for any tax year since 1997/1998, an individual must pay a 90% tax on any net income received above £200,000. Not only would this recoup billions of pounds for the Exchequer, but it would also go some way in resolving such disgraceful cases like Sir Fred Goodwin's pension as his pot would have been reduced accordingly.

No one can question that £200,000 a year net income is generous especially if it comes from the industry that has been proved to be such a financial disaster and massive liability to the taxpayers. If the politicians are really concerned about the bankers leaving the UK as a result of such measure, they can give an incentive for the bankers to stay. For example, they can allow a 1% tax refund for every year that an individual stays in UK and pays taxes up to maximum 10%. I.e. if an individual stayed and paid taxes for the next 10 years he would have paid 80% tax on all his net income above £200,000 for every year between tax year 1997/1998 and 2009/2010.

As this would be basic tax legislation, like windfall tax in 1997 on "the excess profits of the privatised utilities", all other options against the financial institutions and individuals working for them would still remain open. In 1997 some opponents of the windfall tax argued then that it would damage utilities industry. It did not. By the same token, such tax will not damage banking. This would not be a tax on banks, that might be struggling now as institutions. This would be a tax on individual bankers who collected massive payments whilst they were driving the industry into a disaster. This measure would not be about justice but recouping billions of pounds that the Exchequer needs so badly.

So are our leaders short of ideas or they do not have guts?

Communism (for the rich) is alive (and well)

2010-04-22T08:06:00.003+01:00

In yesterday's Financial Times Martin Wolf published an article "The challenge of halting the financial doomsday machine". It appears that the mainstream analysts are slowly reaching the correct diagnosis albeit in a descriptive manner and in a roundabout way.

What Martin Wolf describes as the financial system has all classic hallmarks of a pyramid scheme (for example, of an Albanian type). However, being clearly out of his depth, he simply still does not realise that banks continue to lend with loan to deposit ratio (LTD) greater than 100% which perpetuates this doomsday machine. (Whilst writing about "leverage" could be interpreted in that way, it is far too imprecise as lending with LTD less than 100% is also leveraging).

Banning lending with LTD greater than 100% would not automatically have made financial system safe. However it would have removed a single mechanism that guarantees that financial system is a doomsday machine. (i.e. you can do whatever but if you do not remove this mechanism the system will continue operating like a classic Albanian pyramid that is guaranteed to fail).

Surprisingly (or maybe not) Martin Wolf appears to be an adversary of a free market competitive economy. He clearly does not like an idea of not bailing out failing banks. Alongside a pyramid scheme operated by the banks, they are classic anti-competitive oligopolies. For centuries, until the current crisis, banks had been allowed to fail and indeed sometimes they had. In that respect there is no reason to consider banks any different than other companies (like oil and gas). Indeed the chief issue is that "banks are too big to fail". If the banks are broken up into much smaller businesses (in a similar way as Standard Oil was broken up nearly 100 years ago) with a clear and transparent ownership (that provides reserve capital, in cash of course) and accountability, then banks can be let go bust. And if this happens individual owners will lose their investment, so they will ensure the safety ofthe system. And even if they fail, as the number of the banks will be very large, a collapse of one or two (or three) banks will be easily absorbed by the system. The kind of communist thinking ("communism for the rich") that Martin Wolf presents will ensure that the problems will not go away any time soon. Lenin is dead, long live... Martin Wolf.

Just a start?...

2010-04-17T08:21:00.011+01:00

Surely the recent news that US' Securities and Exchange Commission accused Goldman Sachs of fraud did not come to this blog readers as a surprise. The author of this blog argued for a long time that the financial industry is the hotbed of pathological behaviour: both in professional substance and in style.

At a time when the western world has been in deep in recession, banks were making "profits". Where could this "profit" come possibly from? Banks themselves are not creating directly any economic wealth. They are a service industry: if their clients, businesses and individuals, are not making money, how possibly banking industry keeps on making money. The only rational answer is that the financial system is in a pathological state: it is designed and set up to fleece the mainstream economy. The actual service provided is nothing more than a cover-up of thieving practices.

There still exists a myth of intellectual sophistication and professional complexity in finance. But, in fact, the industry strategies that amount to, by example, insuring a house before deliberately burning it down are not particularly sophisticated or complex. Rather primitive, dishonest and criminal. Incidentally whilst such strategies in the world of insurance are almost impossible (a role of insurance excess is to prevent that, i.e. that an insurance owner does not have a commercial interest in causing a damage), in the world of financial engineering it is possible to insure a prospective "loss" many times over (i.e. a perverse arrangement whereby a policy holder may have an interest in causing a damage in order to claim insurance exceeding the actual loss).

The SEC's move is good news and hopefully the start of the process of holding financial industry to account. There is no doubt that Goldman Sachs case is not even a tiny bit of the tip of the iceberg, measured in quadrillions of dollars, of what is happening in the world of high finance. It is promising that historically the US' authorities have a pretty good record on trying to root out the pathology from the economic free market. Hopefully Goldman Sachs case is just a good start that will lead to unravelling real causes and mechanics of the current financial crisis, the largest heist in history. As Brad Hintz of the US brokerage Bernstein said: "There is rising public appetite for punishment of the guilty parties that caused the credit crisis."

From rags to riches

2010-03-31T10:39:00.009+01:00

Recently a post (see below this short article) can be found on numerous blogs: a "from rags to riches" recipe. If it worked, we could all make, on average, $11,390,625 ($1 x 15⁶). The whole world would become rich! (Just rich, not fabulously rich.) The financial crisis would be irrelevant. Wouldn't it be great?

But for the same (technical) reasons as the credit crunch happened, the "from rags to riches" recipe will not make us rich. It will fail miserably. Like the causes of the current financial crisis, it is yet another example of a pyramid scheme.

You've been warned.

====

Hi guys/gals,

This is the real thing $6 PayPal fast Cash in few Weeks
FAST CASH $6 PAYPAL as seen on OPRAH and 20/20

Since things went in the tanks with the recession, business has been slow and I have been paying my bills with income from working this system. I am going to show it to everyone I can since it was shown to me and it was invented to be shared amongst the struggling masses.

READ THIS, FOLLOW THE INSTRUCTIONS, PASS IT ON if you would like to make THOUSANDS OF DOLLARS and make your financial dreams come true with only a $6 investment!

There is no limit on how much money you can receive, and you haven't got anything to lose with this Business program. It's simple and it's safe.

FAST CASH $6 PAYPAL as seen on OPRAH
!!!!!!QUICK MONEY!!!!!! -- FAST CASH

At first I thought this was too good to be true...how wrong I was!! I decided to give it a go, it was only 6 dollars, so why not? Well I was astounded!! Money has been, and still is, coming to my account. **Proven by various, highly respected U.S. TV and Radio programs as being 100% legal, feasible and true. ** Oprah Winfrey and ABC's investigation team 20/20 also proved it can be done.
IF A 15 YEAR OLD BOY COULD MAKE $71,000 IN JUST 5 WEEKS AND OTHERS $250,000 IN A FEW MORE WEEKS -- SO CAN YOU!!!
THIS REALLY CAN MAKE YOU EASY MONEY!! IT WORKS!!! BUT YOU HAVE TO FOLLOW The LETTER FOR IT TO WORK!!!!

THE PAYPAL $6 DOLLAR MONEY-MAKING METHOD:
This is all you need:

1) An email address
2) A Pay Pal account
3) Then POST, POST, POST..........

THIS IS A 2009, CURRENT EMAIL LIST
Ever since the internet became popular, the word "scam" has become a daily term. I have never once tried any moneymaking "system" outside of this because of that very reason. However, after reading reports on the validity and reputation of this money making system (seen on Oprah, CNN, and other media forums) I gave it a try. Only hours after implementing this exact system I just about fell out of my chair as money ACTUALLY started rolling in. I couldn't believe it and for that reason, I became a believer in this system.

HERE IS HOW IT WORKS...
There is a list of 6 email addresses (you'll see it as you read further). Each of these people has already taken part in this system. When someone new comes along (such as yourself) he/she removes #1 off of the list, moves the other five email addresses up one position (i.e. #6 goes to #5, #5 to #4, etc.), and adds their Pay Pal email address in the 6 position. This process is what develops the power of compounding. The bottom line is this... Honesty and Integrity creates Profitability. Following this EXACT process is what creates the money, and that is why this system has been raved about. Altering the system creates weak results. The legality of this system comes from the idea that you are of course creating a mailing list, and a "service" is being provided (more on that later.)

INSTRUCTIONS:

STEP 1:
The first thing to do COPY, PASTE and SAVE this entire post in word or notepad on your computer so you can come back to it later. After that, if you are not already a Pay Pal user you need to go to the Pay Pal website at https://www.paypal.com/ and SIGN UP. To receive credit card payments from other people you must sign up for a PREMIER or BUSINESS account (not just a PERSONAL account). This is highly recommended to allow others easy payment options. To place the initial $6 into your account, you will have to verify your bank account with PAYPAL (which may take a few days). PAYPAL is 100% secure and is used by millions of people worldwide.

STEP 2:
Here is where the action occurs. Next send a $1.00 payment to each of the 6 email addresses on the current list from your Pay Pal account. To do this quickly and successfully, follow these simple steps:

1. Login to Pay Pal and click the "Send Money" tab near top of screen
2. In the "Recipient's Email" field type: the email address
3. In the "Amount" field type: "1" (your $1.00 payment)
4. In the "Category" field select: "Service" (Keeping it legal)
5. In the "subject" field type: "EMAIL LIST",
6. In the "message" field type: "PLEASE PUT ME ON YOUR EMAIL LIST". (By doing this, you are creating a service and maintaining the legality of the system by "paying" for the service.)
7. Finally, click on the "Continue" button to complete the payment.
8. Repeat these steps for each of the 6 email addresses.

That's it! (By sending the $1.00 payment to each address, you are implementing the compounding POWER of the system. You will reap what you sow!)

Here is the current e-mail list:
*************************************************
The email list:

1) [1]@gmail.com
2) [2]@gmail.com
3) [3]@gmail.com
4) [4]@gmail.com
5) [5]@gmail.com
6) [6]@gmail.com

*************************************************

STEP 3:
Now take the 1 email off of the list that you see above (from your saved file), move the other addresses up (6 becomes 5, 5 becomes 4, etc.) and add YOUR email address (the one used for your Pay Pal account) as number 6 on the list. This is the only part of the document that should be changed. **Make sure to use the email address you registered with Pay Pal**

STEP 4:
now post new file created in STEP 3 to at least 200 newsgroups or message boards. Keep in mind that there are tens of thousands of groups online! All you need is 200, but remember the more you post the more money you make as well as everyone else on the list!
Use Netscape, Internet Explorer, Fire fox, Safari, or whatever your internet browser is to search for various news groups, on-line forums, message boards, bulletin boards, chat sites, discussions, discussion groups, on-line communities, etc.

For example? Log on to any search engine like Yahoo.com or Google.com and type in a subject like 'MILLIONAIRE MESSAGE BOARD', MONEY MAKING DISCUSSIONS', 'MONEY MAKING FORUMS', or 'BUSINESS MESSAGE BOARD', etc. You will find thousands and thousands of message boards. Click them one by one and you will find the option to post a new message. Fill in the subject, which will be the header that everyone sees as they scroll through the list of postings in a particular group, and post the article with the NEW list of email addresses included. THAT'S IT!!! All you have to do is jump to different newsgroups and post away. After you get the hang of it, it will take about 60 seconds for each newsgroup.

HOW THE MONEY WORKS:
When you post 200 messages in various forums, it is estimated that at LEAST 15 people will respond and send you a $1.00 ($15.00). Those 15 will Post 200 Posts each and 225 people send you $1.00 ($225.00), etc. through 6 levels of email addresses. For comprehension purposes, here is an easy viewing chart:

1) 15(1) = 15 people ($1) = $15
2) 15(15) = 225 people ($1) = $225
3) 15(225) = 3375 people ($1) = $3,375
4) 15(3375) = 50625 people ($1) = $50,625
5) 15(50625) = 759375 people ($1) = $759,375

Within a few WEEKS you begin to see results, thanks to the speed of the internet! When your name is no longer on the list, take the latest posting in the newsgroups and begin the process again. Simply amazing...Follow the system as described, and enjoy your PROFITS!!!

REMEMBER... HONESTY AND INTEGRITY = PROFITABILITY
YOUR NAME COULD CYCLE FOR A LONG TIME!
THIS MAKES IT THE GIFT THAT KEEPS ON GIVING.
REMEMBER, THE MORE NEWSGROUPS YOU POST IN, THE MORE MONEY YOU WILL MAKE!! GOOD LUCK!!

Remember that most news servers will leave the posted messages on there servers for about 2 weeks. If you will post your message again, it WILL again start from the beginning. So you can repeat this over and over again. There are tons of new honest users and new honest people who are joining the Internet and newsgroups everyday and are willing to give it a try. Estimates are at 20,000 to 50,000 new users of the Internet, every day.
!!!!! REMEMBER!!!!! Follow every step, and IT WILL WORK!!!

Make Today A Great Day. Wish U Well...

Computational complexity analysis of Credit Creation

2010-03-22T08:20:00.030Z

This article presents a rigorous analysis of many issues discussed on this blog already sometimes in a less formal manner. Especially a banking practice of lending with Loan to Deposit Ratio above 100% that has been shown to constitute a sufficient condition of causing liquidity shortage in the banking system (i.e. it was a sufficient condition that caused the current financial crisis).

It is estimated that Cash (narrow money) constitutes around 2% of money circulation in the economy. The reminder 98%, sometimes referred to as broad money, is created by banks through Deposit – Loan Cycles. It is called Credit Creation. When money is paid into a Bank it is

either:

a disbursement (cost) that a Bank has to pay out (but even, in this case, unless it is stored privately, it will end up in a Bank as someone else’s Deposit); a dividend to be paid by a Bank to its shareholders is also considered as a disbursement

a Deposit; any other money than disbursement is considered as a Deposit paid into a Bank (e.g. if it is a Bank’s retained profit, Bank’s own money is a Bank’s Deposit on its own books; if a Bank uses its own money to buy an investment product, from Deposit – Loan Cycle perspective, in this model it is considered as if a Bank was lending money to itself).

A Bank can lend out Cash that is paid in as a Deposit: this is Credit Creation.

A liquidity risk is a risk of a situation when a demand made by a Depositor to withdraw Cash (narrow money) cannot be met by a Bank. If Money Multiplier is 1 (or less) liquidity risk is 0%: $1 (or more) Cash Reserves covers every $1 Deposits on a Bank’s Loan/Deposit Balance Sheet. If Money Multiplier tends to infinity liquidity risk is 100% in a finite time: at the limit, $1 Cash would have to cover infinite amount of dollars of Deposits on a Bank’s Loan/Deposit Balance Sheet.

Liquidity risk is directly associated with a phenomenon called “bank run”, when depositors, in large numbers, would like to withdraw money from a Bank to either pay it to another bank or worse, from liquidity point of view, keep it privately. As some depositors cannot withdraw their money it results in destruction of a Bank’s credibility. Then even more depositors follow suit leading to a Bank’s collapse.

1. Full Reserve Banking

When a Bank retains all Deposits paid in, a Bank is not lending. It acts as a Product/Service Supplier of storing cash. This is also called 100% Reserve Banking.

For every $1 paid as Cash Deposit, Bank’s Loan/Deposit Balance Sheet shows Loan = $0, Deposit = $1, Cash Reserves = $1. Money Multiplier is 1 (i.e. in every day’s language money is multiplied by 1, i.e. it is not multiplied, no Credit is created).

Conclusion: Full Reserve Banking is a case of complexity of no growth (O(1)). Ignoring theft and fraud, the liquidity risk of Full Reserve Banking is 0% (i.e. 100% Deposits paid in are always in a Bank and can be withdrawn on demand at any time.)

2. Fractional Reserve Banking

When a Bank lends part of Deposits paid in, a Bank is Creating Credit. A proportion of a Loan to a Deposit from which a Loan is given is called Loan to Deposit Ratio (which may also be expressed in percentage terms: for example, LTD = 0.9 is equivalent to 90%.).

For example, for initial $1 paid in if the Loan to Deposit Ratio is LTD, a Loan given is $1 x LTD. Generally in the money-based economy it can be assumed that, on the whole, this Loan, $1 x LTD, will end up in a Bank as a Deposit and then it is re-lent again. Assuming the same Loan to Deposit Ratio, the next Loan is $1 x LTD². Generally after n iterations from the initial $1, the Loan given is $1 x LTDⁿ. Since LTD is less 1 (100%) then it is a regressive geometric series with limit 0 and the total Credit Created from the initial $1 Cash is $1 x 1/(1-LTD).

Money Multiplier is a ratio of Deposits on a Bank’s Loan/Deposit Balance Sheet to Cash Reserves accumulated. It tells us how many times Cash (narrow money) was multiplied by Credit Creation process (into broad money). Therefore based Loan to Deposit Ratio, LTD, we can calculate a Money Multiplier, MM. It is: MM = 1/(1-LTD). Money Multiplier tells us how many Deposited dollars on a Bank’s Loan/Deposit Balance Sheet are covered by $1 Cash.

For example, let LTD = 0.9 (i.e. 90%), i.e. MM = 10, then for every $1 of initial Cash Deposit (narrow money), the first loan is $0.9, the second $0.81, the n^th $1 x 0.9ⁿ, the total value of Deposits on a Bank’s Loan/Deposit Balance Sheet is $10 and there are $9 of Credit Created (circulated in money-based economy) and Cash Reserves are $1.

Conclusion: Fractional Reserve Banking, with Loan to Deposit Ratio above 0 and below 1, is a complexity case of no growth (O(MM)) of a Bank’s Loan/Deposit Balance Sheets to underlying Cash Reserves as Money Multiplier is a constant number in relation to Loan to Deposit Ratio. We observe that it entails liquidity risk below 100%, since it is always possible that demand for withdrawals, at one time, exceeds Cash Reserves.

It is not a purpose of this paper to argue what level of liquidity risk is acceptable or beneficial for money-based economy and what factors ultimately determine this risk in reality. This may depend on many phenomena that affect human decision making process.

3. No Reserve Banking

We also observe that as Loan to Deposit Ratio is less than 1 and approaching it, the Money Multiplier tends to infinity, and nearly no Cash Reserves are created, the liquidity risk keeps increasing up to 100% at the limit. Nearly all the money paid in as Deposits are turned into Credits. Loans and Deposits tend to infinity on a Bank’s Loan/Deposit Balance Sheets, whilst Cash Reserves tend to remain finite and constant.

If Loan to Deposit Ratio is 1, at the limit, it is a linear growth of Loans and Deposits on a Bank Loan/Deposit Balance Sheet, Money Multiplier is infinity, Cash Reserves’ growth is 0 (i.e. they stay on the level which was when Loan to Deposit Ratio of 1 was started) and liquidity risk (in a finite time) tends to 100%. It is a case of trivial geometric series with common ratio 1 (which is also an arithmetic series).

Conclusion: No Reserve Banking is a complexity case of linear growth (O(n)) to infinity of both Loans and Deposits on a Bank’s Loan/Deposit Balance Sheet. A Money Multiplier is infinity resulting in liquidity risk of 100% in a finite time. No Reserve Banking is also called 0% Reserve Banking.

4. Depleting Reserve Banking

Depleting Reserve Banking, lending with Loan to Deposit Ratio above 1, is not possible, unless there are already Cash Reserves. It is, effectively, a Credit Creation with a “top up” from already existing reserves (this top up may come as a Loan from another bank’s reserves and a lending bank may consider borrowing bank’s debt papers as good as Cash). A Bank is Creating Credit by lending Deposits paid in and topping up from existing Cash Reserves (or a Loan from another bank’s reserves). A proportion of a Loan to an underlying Deposit is called Loan to Deposit Ratio.

For example, for initial $1 paid in if the Loan to Deposit Ratio is LTD, a Loan given is $1 x LTD. Generally in the money-based economy it can be assumed that, on the whole, this Loan, $1 x LTD, will end up in a Bank as a Deposit and then it is re-lent again. Assuming the same Loan to Deposit Ratio, the next Loan is $1 x LTD². Therefore after n iterations starting with the initial $1, the Loan given is $1 x LTDⁿ. Since LTD is above 1 (100%) then it is a progressive geometric series with exponential growth to infinity. The total Credit Created from the initial $1 Cash tends exponentially to infinity: $1 x ((LTDⁿ – 1)/(LTD – 1))

As Loan to Deposit is above 1, and the geometric series is diverging, it is impossible to calculate Money Multiplier based on a ratio of Loans to Deposits on a Bank’s Loan/Deposit Balance Sheet at any one time. We also must know how many times a Deposit – Loan Cycle was executed at what Loan to Deposit Ratio. The general formula to calculate Money Multiplier (when Loan to Deposit Ratio is above 1) is:

i = 1, …. , n

LTD_i is a Loan to Deposit Ratio

ki is a number of Deposit - Loan Cycles with a Loan to Deposit Ratio LTD_i (LTD_i+1 is a Loan to Deposit Ratio that follows LTD_i).

It is a side note but we observe that it looks unlikely that Deposit – Loan Cycles (Credit Creation) starting with initial $1 Cash are uniform processes in money-based economy. Therefore it may be practically impossible to calculate accurate and reliable Money Multiplier when Loan to Deposit Ratio is above 1.

For example, let LTD = 1.17 (i.e. 117%) then for every $1 of initial Cash Deposit (narrow money), the first loan is $1.17, the second $1.3689, the n^th $1 x 1.17ⁿ, i.e. for n equal 220 the 220^th Loan value is over $1 x 10¹⁵. The total value of Deposits on a Bank’s Loan/Deposit Balance Sheet is over $5.8 x 10¹⁵ and there is also over $5.8 x 10¹⁵ Credit Created and circulated in money-based economy. Cash Reserves are initial Cash Reserves minus $5.8 x 10¹⁵. Money Multiplier is over 5.8 x 10¹⁵. In other words, whatever the initial Cash Reserves had been at the start of Credit Creation with Loan to Deposit Ratio of 1.17 (117%), after 220 Deposit – Loan Cycles executions, starting with initial $1 Deposit, the Cash Reserves were depleted by over $5.8 x 10¹⁵.

It is a side note but in practice banks’ Cash Reserves, on a Bank’s books, may be replaced with credit collaterals or other non-Cash financial instruments, being considered as good as Cash. This may result in, nominally, retaining any required reserve ratio, but this reserve would not be in Cash. These financial instruments are a part of Products/Services Supply and their market value/price (in Cash) depends on Products/Services Demand (Money Supply), see the graph on page 2.

Conclusion: Depleting Reserve Banking, with a Loan to Deposit Ratio above 1, LTD > 1, is a complexity case of exponential growth (O(LTDⁿ)) of a Bank’s Loan/Deposit Balance Sheets to underlying Cash Reserves. As Money Multiplier tends to infinity the liquidity risk is 100% in a finite time.

5. Brief computational complexity analysis summary

Let us consider Credit Creation as an algorithm that we would like to implement on a computer. (It is actually a very basic algorithm.)

The cases of Full Reserve Banking and Fractional Reserve Banking, of O(k) where k is a constant equal 1/(1 - LTD), are tractable algorithms. They can be considered as contained algorithms: the requirement on resources is a constant multiple of an underlying parameter of Credit Creation (i.e. Cash).

No Reserve Banking (of O(n)) is also a tractable algorithm but it takes more resources than Full Reserve Banking or Fractional Reserve Banking. In fact it would be a case of concern that at some point, in linear time depending on a number of executions of Deposit – Loan Cycles, the demand on resources will eventually exceed availability threshold. This is non-containable case as there is no upper limit of demand on resources in relation to underlying parameter of Credit Creation (i.e. Cash).

Depleting Reserve Banking, of O(LTDⁿ), is an intractable algorithm. The growth of demand on resources is exponential. This type of algorithms is considered impractical for implementation on computers. (In general, in computer science algorithms with complexity above polynomial are not accepted as general solutions to underlying problems.)

In the cases considered above, containable algorithms of Credit Creation present liquidity risk below 100%. They are of manageable risk as a part of a risk portfolio. Non-containable algorithms present liquidity risk of 100% in a finite time, i.e. it is unmanageable risk as liquidity shortage is a matter of a finite time. In the case of Depleting Reserve Banking, due to exponential growth of a Bank of Loan/Deposit Balance Sheet and Money Multiplier (and also exponential depletion of Cash Reserves) such finite time is assumed to be very short: short enough, in practice, for the liquidity shortage to occur. By computational complexity standards, Credit Creation using Depleting Reserve Banking is intractable, i.e. non-practical for implementation.

6. Depleting Reserve Banking and loss of control of Money Multiplier

Essential to managing liquidity risk is the knowledge of Money Multiplier (MM), i.e. how many dollars of Deposits on banks’ Loan/Deposit Balance Sheets are covered by $1 Cash. As already showed in the preceding sections of this article, if a Loan to Deposit Ratio is always below 1 then the total value of Deposits and total value of Loans on banks’ Loan/Deposit Balance Sheets are the basis for calculation of Money Multiplier: MM = Total Deposits/(Total Deposits – Total Loans).

If Loan to Deposit Ratio is above 1 then the above equation does not hold. In order to calculate Money Multiplier we need more information about each Deposit – Loan Cycle (which may be impractical or even impossible to gather). This is even more complicated: it is possible to execute any number of Loan – Deposit Cycles with Loan to Deposit Ratio above 1 (achieving any arbitrary high Money Multiplier in this process) and then with one cycle only reduce a ratio of total value of Loans to total value of Deposits below 1 on a Bank’s Deposit – Loan Balance Sheets. This may look like an “average” Loan to Deposit Ratio below 1. However this value used in the formula presented above, MM = Total Deposits/(Total Deposits – Total Loans), will not produce a true value of Money Multiplier (most likely, in practice, a real Money Multiplier will be much higher).

Therefore, concluding this computational complexity analysis, Credit Creation with Loan to Deposit Ratio above 1 must not be practiced since:

exponential growth of banks’ Loan/Deposit Balance Sheets is intractable

liquidity risk, in a finite time, is 100%

practical macro control of growth of Money Multiplier is lost

It is a side note but due to exponential growth of a Bank’s Loan/Deposit Balance Sheet and exponential depletion of reserves, Depleting Reserve Banking is a classic example of a pyramid scheme.

It is also a side note but the present liquidity crisis and resulting economic crisis was preceded by a prolonged period of Credit Creation with Loan to Deposit Ratio above 1.

7. Consequences of Depleting Reserve Banking on Mark-to-market and Value-at-risk (VaR)

Depleting Reserve Banking results in Money Multiplier growing at exponential pace without any upper bound (i.e. infinity is the limit) such that each unit of cash has to satisfy ever growing demand on banks balance sheet. In a finite time (in practice, due to exponential growth, very short time), banks run out of cash to service their payment obligations like deposit withdrawals: all cash becomes tied to servicing such obligations and the shortage keeps growing presenting liquidity shortage. Consequently there is a decreasing volume of money (cash) to pay of any non-cash financial (and other) products. This volume decreases at exponential pace (i.e. practically very fast) to zero [as Money Multiplier grows at exponential pace to infinity, cash available to service non-cash obligations decreases to zero]. Hence a Mark-to-market price of any non-cash financial products also decreases to zero, as there is a decreasing volume of cash available to complete a transaction. In such scenario a probability of a non-cash asset losing 100% of its value in a finite time tends to 100%. In other words, as a result of Depleting Reserve Banking, for any arbitrary high loss less than 100% of a non-cash asset, there is always a finite time horizon (in practice, due to exponential characteristics, very short) such that probability of such loss is 100% (it is a certainty).

Conclusion: The effect of Depleting Reserve Banking is such that, if continued, it turns all non-cash financial products into worthless assets (so-called “toxic waste”): Value-at-risk (VaR) as a loss of 100% of a value of non-cash financial products is practically 100% in a finite time.

8. Financial perpetuum mobile

Depleting Reserve Banking (i.e. Credit Creation with Loan to Deposit Ratio above 1) can lead to unusual, unintuitive effects. As noted above a Bank, as a Credit Creator, makes profit, on the whole, by paying out less for taking Deposits than charging Creditors for Loans. It is not typical for a Bank’s customer to expect to be paid more in interest on a Deposit put in a Bank than to pay for a Credit taken out. It is even less typical to expect a Bank to make a profit in such a scenario. It would be a perfect business model, “win – win “, for a customer and a Bank: financial perpetuum mobile.

Let L be a Loan taken by a Bank customer which she immediately deposits in a Bank. Let I₁ be an Interest Rate paid on a Loan by a customer to a Bank and I₂ be an Interest Rate paid on a Deposit by a Bank to a customer. I₁ < I₂. Let D be a total Deposits accepted by a Bank from which it Creates Credits, C = D x LTD. Let LTD > I₂/I₁. (A customer’s Deposit and Loan, both equal L, are, in practice, much smaller than D.)

Customer’s perspective:
L x I₂ - L x I₁ = L x (I₂ – I₁) > 0: since I₂ > I₁ a customer makes profit.

Bank’s perspective:
C x I₁ - D x I₂ = D x LTD x I₁ - D x I₂ = D x (LTD x I₁ – I₂) > 0: since LTD > I₂/I₁ a Bank makes profit too.

A Bank is making profit since it is lending out more than is taking in Deposits with LTD > I₂/ I₁. But such lending is unsustainable: it can only last as long as Cash Reserves are sufficient to top up Loans. However Cash Reserves are depleting at exponential pace. Hence this financial perpetuum mobile will have to come to a halt.

From bail-in to bail-out: letter to The Economist

2010-03-21T13:33:00.011Z

On 28 January 2010 The Economist published a guest article authored by Messrs Paul Calello, the head of Credit Suisse' investment bank, and Wilson Ervin, its former chief risk officer, who proposed a new process for resolving failing banks, "From bail-in to bail-out".

On 3 February 2010 the author of this blog sent the following letter to the Editor of The Economist. The reader are invited to draw their own conclusions why it was not published.

===

To the Editor of The Economist

Sir

The "bail-in" proposed by Paul Calello and Wilson Ervin "bail-in" "From bail-out to bail-in" fails to address the real reason for the banks' liquidity crunch: that the loan to deposit ratio was greater than 100%, creating rapid growth via the money multiplier (which every economics student studies as the process of "deposit creation"). This makes a liquidity risk a certainty, a probabilistic inevitability. When the banking system's exploding liabilities outstripped their ability to get hold of cash, central banks stepped in, in effect printing money to restore banks' liquidity through quantitative easing.

The Calello-Ervin proposal does not deal with this. It does not state at what level the money multiplier would be sustainable and how to keep it below that limit. Instead, it spreads the liquidity risk among shareholders and creditors of different financial institutions, meaning that the next (and inevitable) credit crunch will be more severe and still more widespread than the one at the end of 2008.

An analogy would be a tank in which gas pressure is growing at an uncontrolled rate. Making the tank stronger only delays the inevitable (and much larger) explosion.

In short, "innovative" risk management mechanisms such as the Calello-Ervin proposal cause more harm than good, rather as credit-default swaps have done.

Yours sincerely

Greg Pytel

Nothing happened

2010-03-20T18:12:00.004Z

In his article "Against All Odds", Daniel Gross is trying to prove that, very likely, "AIG might just pay the Fed back" the costs of the bailout. He concludes: "Nobody at Treasury or the Fed is bold enough to predict that taxpayers will ultimately be made whole. Some rough math suggests that final cost to the taxpayers for the AIG debacle could be between $12 billion and $20 billion. Yes, that’s a bitter pill to swallow. But it’s a much smaller pill than we have imagined even a few months ago."

Mr Gross' analysis and arguments are supported by pretty detailed calculations. Yet his "rough math" has the major flaw. It does not take into account the costs of the downturn of the economy caused by the financial crisis in which AIG played a key role. The financial crisis is not really a crisis but, as shown in the seminal article on this blog, a collapse of the pyramid scheme engineered in order to funnel cash from the economy into individuals' hands. The costs of the economic downturn go into trillions of dollars in national budgets’ deficits and far more if we were to add losses of individuals and families that lost their jobs and homes.

The enormity of the current global financial mayhem that will be paid for by generations to come brings a question about a true motivation of publishing articles painting a rather rosy picture as if nothing really has happened.

Money creation and circulation in the economy

2010-03-13T09:25:00.017Z

(This is a draft version of an article. Therefore any comments, corrections and suggestions for improvement are welcome as they will be used to improve it.)

1. Money in economic universe

Economy universe consists of two sets of processes:

Products/Services Creation, Trading and Consumption /Destruction

Money Creation, Multiplication and Destruction

They interact in the following way:

- all Products/Services (including financial) are Supplied onto the Marketplace

- Cash (narrow money) is as the medium of exchange and store of value

- through Market Transactions such as producing goods, selling/buying goods, destroying (consuming) goods, selling/buying services, consumer banks operations (depositing money in a bank, lending money by a bank, withdrawing deposits, paying back loans)

- Credit Creation by circulating Cash through Deposit – Loan Cycle: by accepting Deposits and Lending them out, money is circulated in the economy multiplied in the process (also sometimes referred to as broad money), this is reflected on Loan/Deposit Balance Sheets and Cash Reserves; Loan to Deposit Ratio defines Money Multiplier (an underlying attribute of Credit Creation)

- Central Bank operations such as Creating or Destroying Cash, setting up Interest Rates, Open Market Operations, lending as the Lender of Last Resort

The graph below shows the structure and flow of money in the economy:

Economic universe has the following characteristics:

- ownership/supply of Product/Service

- value/price of Product/Service

- Cash Reserves and Loan/Deposit Balance Sheets

- Credit Creation (Deposit – Loan Cycles) information

2. Economic activities

An economic activity is a Market Transaction which is a transfer of ownership/supply for a price or Depositing or Lending money through as a Deposit – Loan Cycle (Credit Creation).

The model presented on the graph above separates and abstracts a Service of depositing and lending money from a process of Multiplying Money, i.e. Credit Creation, which is a result of lending deposits out. The former is modelled on the graph by a Market Transactions process (of Supplying a Product/Service) while the latter is modelled by Credit Creation. This a dual role of a bank as a Credit Creator and, possibly through it, as Product/Service Supplier is central to money creation and circulation in the economy.

2.1 Products and Services Demand and Supply

Products and services are created and they are ready for sale on the market in exchange for money. This constitutes Supply and Demand characteristics whose balance may be described, for example, by a Fisher’s “Equation of Exchange”, MV = PT. As an example we can observe that if we do not control the growth of Supply of Products and Services (due to its complex structure, natural and unpredictable phenomena, etc.) and we control growth of Money Supply (for example by setting Interest Rates or controlling Loan to Deposit Ratio) then additional Money Supply, through Credit Creation, will result in inevitable Inflation to balance Supply with Demand. A gradual increase of Demand results in gradual increased economic activities to satisfy it on a Supply end.

It is not a purpose of this model to argue the correctness of any theory or equation of Supply and Demand but to show that the model presented in this paper can accommodate any Supply and Demand theory.

2.2 Market Transactions

Money received for provision of Products/Services is either held outside of a Bank e.g. by a Product/Service Supplier), spent on Products/Services (Direct Cash Exchange, No Credit Creation) or is Deposited in a bank (in a form of Deposit or repayment of a Loan previously obtained).

2.3 Credit Creation (Deposit – Loan Cycle)

Banks (modelled as Bank on the graph above) provide Deposits back to the market (to depositors: Deposits paid out) or give loans (to creditors: Loans given), which is Credit Creation. Loans are given using Fractional Reserve Banking method. In extreme cases:

- if Loan to Deposit Ratio is 0% then effectively no loans are provided only deposits paid in are paid out to depositors (Cash Reserves equals liabilities on Loan/Deposit Balance Sheet); in such case a Bank is a store of Cash (in other words Cash Reserves are 100%). This is called Full Reserve Banking (or 100% Reserve Banking).

- if Loan to Deposit Ratio is 100% then all Deposits are turned to Loans and no Cash Reserves are created. This is called No Reserve Banking.

In the first instance, banks do not play a role as a (re)-lender but are a store for money. In the second instance (no Cash Reserves are accumulated to secure demands of depositors to pay out), if loans were 100% secure repayable on demand then such a model could have practically functioned. Typically banks lend with Loan to Deposit Ratio between 0% - 100%. For example, if Loan to Deposit Ratio were 90% than for every $10 on the Loan/Deposit Balance Sheet of liabilities banks accumulated $1 Cash Reserves, i.e. Money Multiplier is 10.

Such a model is possible to function in practice, since money is circulated through banks and not all depositors demand money at the same time, only a fraction of liabilities (on Loan/Deposit Balance Sheet) need to be satisfied at any one time. However, since there are demands on Deposits to be paid out and some creditors may default (not pay back a Loan) Cash Reserves are necessary. Inter-bank lending makes the system function as one big bank balancing supply and demand of liquidity by different banks. Furthermore a role of Central Bank is to act as a Lender of Last Resort in the event that banks’ Cash Reserves are not sufficient to satisfy demand for Deposits withdrawal (State guarantees of Deposits play an ultimate role in a credibility of such system, which works as a statistical machine).

It is not a purpose of this paper to argue a safe or practical level of Loan to Deposit Ratio which determines Money Multiplier and Cash Reserves level (or that Fractional Reserve Banking with Loan to Deposit Ratio above 0% should be accepted as a model). We observe that it is a philosophical debate what level of risk the society should accept, similar to safety of road, train or air travel, or nuclear power stations. We observe that the higher the Loan to Deposit Ratio the larger the Money Supply in economy, however at the same time, the greater the risk of liquidity shortage as the size of Cash Reserves are relatively smaller to overall banks’ liabilities on Loan/Deposit Balance Sheet.

2.4 Central Bank’s role

Apart from acting as the Lender of Last Resort, a role of Central Bank¸ as a creator of Cash (narrow money), is to set control on Money Supply (through Credit Creation) by setting an Interest Rate and acting through Open Market Operations. For example, a higher Interest Rate encourages saving and discourages borrowing thereby reducing Money Supply by reducing volume of Credit Creation, i.e. amount of broad money in circulation. This, in turn, reduces Products/ Services Demand which reduces pressure on Supply, typically resulting in reduction of Inflation. This, in turn, usually results in reduction of Interest Rates by Central Bank. This is a balancing act that a Central Bank plays (in practice, typically using principles behind MV = PT equation as a guide).

3. Additional comments

3.1 Financial Products/Services

Financial (banking) Products/Services are considered like any other Product/Services in the economy. There is no reason to consider them differently: they are simply Products/Services sold as a part of Market Transactions. The importance of banks’ role as Credit Creators (by executing Deposit – Loan Cycles) suggests that if banks collapse the economy will collapse too. Whilst this may be reasonably assumed as a correct hypothesis, this does not make banks unique suppliers of Products/Services in the economy. For example a collapse of electricity producers/suppliers or water producers/suppliers would bring economy to a collapse too. Therefore whilst banks role may be seen as vital, it is not unique.

In this context we separated and abstracted banks’ role as Credit Creators (through Deposit – Loan Cycles) and a role of Product/Services Suppliers.

- when a bank issues a Loan out of a Deposit, on one side it Creates Credit AND, at the same time, it is selling a Product/Service (provision of a Loan) for which a Creditor pays;

- when a bank accepts a Deposit (which may be later issued as a Loan), on one side it makes the first step in Credit Creation AND, at the same time, it is buying a Product/Service for which it pays a Depositor. We consider a Depositor as a Lender to a bank (i.e. a bank is a Creditor to a Depositor).

As noted before, this approach separates and abstracts a mathematical process of Money Multiplication (resulting from Loan to Deposit Ratio above 0%) from a Products/Services Supply of lending money (and other financial Products/Services). A Bank, as a Credit Creator, makes profit, on the whole, by paying out less for taking Deposits than charging Creditors for Loans. Pensions, endowments, savings, wholesale funding, insurance policies, derivatives and so on are financial Products/Services.

3.2 A role of a State in the model

In this description there is no reason to separate a State impact on economy from other providers of Products/Services. For example, taxation is a Market Transaction whereby taxpayers pay for Products/Services delivered by a State. (Whether efficiently or not is another matter and this question also applies to privately sold Products/Services.) Government bonds are financial products sold on the market. For avoidance of doubt, this model does not imply or support any argument whether a “larger State” is better than a “smaller” one, the State sector is as efficient as private sector etc. It also does not imply that such Market Transactions are voluntary (in some case like payment of taxes or law enforcement services, clearly they are not).

4. Economy dynamics

At any point in time a state of the economy is characterised by a set of information about it. This would include all the information at every level of economic activity: all information about every single Product/Service, its price/value, amount of money in circulation and its allocation, Loan/Deposit Balance Sheet, Cash Reserves, Interest Rate and so on. Any economic activity in such a system is a transition from the existing state to a new one. Examples of transitions to a new state:

- a Product or Service is sold at a certain price

- a new product is offered on the market at a certain price

- a prospective buyer of a service agrees a reduction of a price

- such a buyer (as above) completes a transaction

- a bank lends money to a borrower

- a borrower repays (a part) of a loan

- a deposit is made money in a bank

- Central Bank changes an Interest Rate

- … and so on

In general a transition from one state to another, changes the information defining ownership/supply of Product/Service or value/price of Product/Service or Creating Credit or other attributes in the model.

We can consider any economic activity as a transition from one state of economy to a new one. Some economic activities may be null transitions, i.e. result in no change to information about the state of the economy. For example, a re-evaluation of the price of a Product/Service resulting in the same price is an example of a null transition.

The presented model does not imply whether deposits create loans or vice versa. This is akin to “chicken and egg” dilemma. Money circulation is of cyclical nature with iterative or recursive characteristics and description has to start somewhere which may possibly give a wrong impression of any assumed starting point of a cycle. In the context of this model it is a purely philosophical issue of no practical consequence.

Putin says US no better than Greece in handling debt

2010-02-16T20:45:00.006Z

For once, Vladimir Vladimirovich Putin has nailed it. The author of this blog would not venture to suggest that Vladimir Vladimirovich is its posts reader, in particulat "Default: Greece first then US?" However the world should pay attention and consider "a US way out" as a real possibility.

Comment to ”The largest heist in history”

2010-02-14T06:49:00.017Z

The sheer power to blow up the banking system of lending with Loan to Deposit Ratio greater than 100% is all too obvious. If we look at this mechanism ("The largest heist in history", or more rigorously in "Loan to deposit ratio and banks liquidity") which is an exponential growth of balance sheets (credit expansion), we easily realise that even if just one small bank in the financial system started doing that, it would still blow up the banking system by causing systemic liquidity shortage (credit crunch). It does not matter at all what exactly this bank would be doing: borrowing on the wholesale money market, issuing bonds, collateralising and selling its loans, etc, as long as it kept on lending with Loan to Deposit Ratio greater than 100%. The reason being, that if the financial system were not to be blown up, i.e. not suffer the liquidity crunch, the Money Multiplier could have grown to infinity in a very fast, exponential pace as a result of growth to infinity of the balance sheet of this bank. I.e. a single dollar of cash would be sufficient to ensure liquidity of any number (up to infinity) of dollars of this bank’s obligations on its balance sheet.

It is somewhat incredible that almost all analysts, commentators and, most importantly, those responsible for the financial system still ignore that. It is obvious that many are unable to comprehend it: "difficult maths and all that". But this process is simply too trivial. Therefore it is impossible that almost ALL decision makers in the financial industry are genuinely so incompetent that nearly none of them can understand it. Therefore it is very likely that they deliberately engineered such lending with Loan to Deposit Ratio greater than 100% in order to construct a giant global pyramid scheme designed to fleece the system of cash, like Albanian gangsters in 1996 – 1997.

Additional note:

Of course it seems rather implausible that, in practice, if only one small bank started lending with Loan to Deposit Ratio greater than 100% it would have been allowed to do so for long by its competitors. Basically such bank would have grown very fast from a small bank to a very large one and, ultimately, to the largest bank in the world many times over (technically up to infinity) its nearest competitor. And this would not have gone unnoticed. Other financial institutions, which in such system are necessary to co-operate in this process, for example, through wholesale money market, would most likely have stopped it.

(Incidentally, during the time leading to the current crisis, we saw such massive growth of small or medium size banks: Northern Rock, Royal Bank of Scotland.)

We saw prior to the current financial crisis, which was the sufficient cause of it, other banks simply joining in and also starting lending with Loan to Deposit Ratio greater than 100%. As such process became acceptable and widespread it turned the financial system into a giant global pyramid scheme. Before its collapse in the second half of 2008, it looked like an unprecedented growth of the financial sector: but it was nearly all bogus and was bound to collapse spectacularly like pyramid schemes in Albania in 1996 – 1997. Inevitable and easily predictable: no benefit of hindsight needed.

(Please note that lending with Loan to Deposit Ratio greater than 100% was the sufficient, on its own, cause of the current financial crisis, i.e. it guaranteed it. However it is possible that it is not the only problem of the financial industry.)

"Financial risk" - The Economist video

2010-02-13T22:11:00.013Z

After a year and a half since the financial crisis errupted The Economist published the video on their web site titled "Financial risk" that touches upon the causes of the crisis.

It is pretty good, but still some way short of being adequately informative. Two key points are missing:

1. The author of the video does not explain why in the crisis the spread between the prices of Treasury bills and LIBOR grew to "unimaginable" levels and all, what he called, "assets" slumped together in a correlated way. It is obvious and it was easily predictable: in multiple deposit creation process with Loan to Deposit Ratio greater than 100%, the Money Multiplier keeps growing to infinity at exponential pace (very fast) and the risk of liquidity shortage (i.e. "credit crunch") becomes 100% in a finite time: in practice it means that in the presence of cash shortage banks cannot be lent money as the risk of not getting them back is very high and all assets dramatically lose value as there is not sufficient money going around to pay for them. What appears on the video to be discoveries were, in fact, trivial to predict prior to the crisis by any competent financier, i.e. with rudimentary knowledge of mathematics.

2. Considering the above the author of this video should have clearly stated that banks should accumulate cash to restore their capital reserves rather than strictly non-cash instruments/products. Otherwise the banks and the video author may get a nasty surprise that their capital might become little worth toxic junk if another liquidity shortage happens again. And it will happen again if banks continue to generate credit with Loan to Deposit Ratio greater (or equal) 100%.

Bearing these two points in mind, the video is worth watching. It clearly justifies the pyramid model of the current crisis presented on this blog.

Default: Greece first then US?

2010-02-10T10:36:00.009Z

Yesterday Professor Joseph Stiglitz stated on BBC Newsnight, in response to a suggestion resulting from "speculators" (i.e. money markets) behaviour that Greece might default on its debt:

"The absurdity of these speculators is illustrated by what's happening in the United States: the spread, the CDS', the bets on a default in the US government are going up. Does anybody believe that US government is going to default?

The fact that US government can print money, you can bet [on it], or whether there is inflation. But to bet on a default in the US is utterly absurd." [Starts at around 13:25 into the programme.]

With the greatest respect to Professor Stiglitz, I would not dismiss the "speculators" behaviour that easily as "absurd". They are not poor people working in an irrational way. In the past their behaviour was a really good sign of the forthcoming events (including governments' intentions). Do we remember how the Bank of England was building the "firewall" in September 1992 to protect the pound and how it eventually ended? And who made and who lost the money? That what the Germans appear to be doing now. Good luck to them! To answer Professor Stiglitz' question directly: "Does anybody believe that US government is going to default?". The author of this blog believes that there is a realistic risk of this happening, growing with every dollar borrowed by the US government. For more read "A US way out?"

New Labour: could it have been worse?

2010-02-06T18:28:00.011Z

In today's Daily Mail Mrs Margaret Cook, the wife of late Robin Cook, the Leader of the British Parliament House of Commons who resigned in protest against Iraq War in 2003, wrote a tribute to her late husband for taking such stance. Anyone who follows British politics knows how hard, for personal reasons, it must have been for her to do so. And how sincere and reflective must it be. Be in no doubt, despite having been in a shadow of her late husband, Mrs Cook is an intellectual in her own right.

Mrs Cook expressed her take on the ongoing Chilcot Inquiry into the circumstances of the Iraq War in 2003. She wrote:

"Wriggle and obfuscate as they have done at the inquiry, those former ministers and aides who have given evidence have only been able to cover their backs partially.

For we now know that they either followed blindly and willingly into the conflagration or they saw the folly, but failed to speak out.

Some have pleaded that, in retrospect, they made 'honest mistakes'. For people in high and responsible places, there is no such thing."

Many believe, including all eminent international lawyers including Mr Philippe Sands QC, that starting the Iraq War was not only a "folly" (which has been obvious without any benefit of hindsight) but also a crime. Mr Jeremy Paxman remarked on BBC Newsnight, that – apart from "Tony's mates" like Lord Falconer - he could not find any lawyer prepared to argue for legality of the Iraq War. By lawyers' standards there are almost always arguments "for" and "against" in any case. Therefore this amounts to quite a conclusive judgement.

The author of this blog has argued since its inception nearly a year ago, that the current financial crisis was also caused by the crimes of financiers (and quite likely regulators and some politicians) who engineered and operated, or allowed to do so, a giant global pyramid scheme. This financial scam is designed to rob middle classes off their savings and investments and distribute it amongst individuals who effectively (not notionally like, for example, pension funds or unit trust and endowment client-investors) control the financial industry. This has already been dubbed "socialism for the rich", a somewhat natural progression for Islington and Notting Hill New Labour’s "Bollinger bolsheviks".

Calling criminals in high places criminals is a taboo. The mainstream media did not come round to a conclusion that both individuals who decided to start Iraq War as well as individuals who are responsible for the global financial crisis (through a pyramid scheme) must be held accountable for their actions in a Court of law. "Not only must Justice be done; it must also be seen to be done." Accepting "honest mistakes" of politicians who dragged the country into the Iraq War is as foolish as blaming the financiers' greed and stupidity for the current crisis. These are all not acceptable, and to some abhorrent, but at the end they are legal. Therefore this attitude of ostensible criticism by the mainstream media is designed to vent the public anger at the same time allowing war criminals and fraudsters to escape justice (and, of course, preserve their ill-gotten wealth). We should not be surprised if we even see effigies of politicians and bankers being hanged or burnt if it all helps them escaping being brought to book. Financiers will be happy to organise such events (no doubt, they will even make money on them).

Here we are now. But hopefully politicians, our democratically elected representatives, especially a new intake in the British Parliament and there will be quite a lot of them after the forthcoming elections, will take more robust view on both issues.

Spectacularly started New Labour's era of British history appears to be coming to even more spectacular end. Taking a long term perspective, 100 - 200 years after we are all long gone, and our children and grandchildren too, a New Labour period is likely to be judged as a time of crime and stupidity: Britain run by war criminals and financial fraudsters. We shall be in no doubt that future generations, who will have to pay trillions of pounds for New Labour’s rule and maintain memorials of those who fell pointlessly in the illegal Iraq War, will be too benevolent or naïve in looking for excuses.

On the election night on the 1st of May 1997, at a dawn of New Labour era many of us sang "things can only get better". And even those who did not (like this blog's author), had genuine hopes and were well-wishers. But, still going through the Iraq mess and the financial destruction, could it actually have been worse?

PS. Since this article was published, on 7 February 2010 Alistair Campbell, Tony Blair's media guru gave interview on Andrew Marr Show. Compare this interview (especially after 4:20 of the recording) with an interview he gave on 27 June 2003 on Channel 4 News (especially after 3:20 of the recording). It is quite clear there is something he is worried about. What is it? Any clues please post in the Comments section below.