Greg Pytel: No skin in the game

With the appointment of the Governor of the Bank of England, the Chancellor of the Exchequer confirmed that he was determined to ensure that the economic situation of the UK continued to worsen. (It is another matter whether the Chancellor realises that or whether it is his intention.) In that respect he has been doing a pretty good job. As predicted and expected by any sane person, the government actions led to a double dip recession and a growing debt.

Incidentally it would be interesting if the politicians, especially those in the government,published information how their financial situation changed since 2010 (the general election), or actually since the end of 2008 when the economic mess - which was an easily predicted result of actions of the financial industry - became omnipresent in the UK. If their personal financial situation improved - unlike the financial situation of the country - this would show that the politician have been acting in a conflict of interest situation as they have a personal vested interest in worsening the economy. As the UK economy deteriorates, they are becoming better off. Is it not great? The same applies to all the commentators but they are not elected and they do not wield a direct power.. (At very best they would not have a vested interest in not worsening the economic situation of the UK.)

We should not ignore that. Apart from statistically insignificant exceptions, people act for their own and their families benefit. And there is nothing wrong with this provided they do not act in a conflict of interest situation. And this is precisely the same lethal problem as a moral hazard. "no skin in the game", which clearly was one of the reasons that drove the financial industry to a behaviour that caused the current crisis. We should have been wiser by now.

Greg Pytel: Modern kind of democracy

Today we could see a debate in the House of Commons about how much money the UK should pay to the EU budget. When the government decided to pay many hundreds of billions (if not trillions by now) of pounds in form of subsidies to private individuals, i.e. to the banks, to "rescue" them in form of bailouts, in form of quantitative easing or in form of massive implicit insurance policy from collapse (as the government still accepts that the banks exist in a form of being "too big to fail"), interestingly, there was no such debate in the parliament prior to the decision. Well this really epitomises what the modern democracy is all about.

Greg Pytel: Leader of the Opposition: sort out this mess, please

As reported by the BBC today, the Leader of the HM Government Opposition, Ed Miliband threatened to break up the banks unless they separate the retail banking from investment banking, ring-fence the consumers deposits from the risk of investments.

It appears that the Leader of the Opposition starts putting his finger on the problems with the banks. He seems to start understanding how damaging the financial industry in the current form is to the economy. However Mr Miliband still does not have a scooby. Investment banking practices, and the massive risks they pose to retail banking, are not the underlying cause of the current economic woes. It is actually a result. How to fix the banking system and what to do to bring the economy back on track was described well over two years ago, in June 2010, in "Prime Minister, sort out this mess, please". The Leader of HM Government Opposition is well advised to read it. If he understands it he will find that the separation of retail from investment banking is one of the five steps and is actually auxiliary (but recommended).

The underlying behavioural causes, rather than technical were described in "The largest heist in history", behind the current financial mess are the facts that a) the industry is uncompetitive consisting of "too big to fail" institutions and that b) the key decision makers are not exposed to the risks of their own decisions (so called "moral hazard"). This turned the modern capitalism system into its caricature, a kind of "communism for the rich" system with the financial industry living on massive state subsidies (e.g. implicit guarantees, quantitative easing) as a powerful oligopoly.

Therefore banks should be split into many and made into partnerships (i.e. a collapse of a bank would immediately and directly affect the decision makers). This proposal was first published in March 2011 "Regulating the financial risks". (It was also published on Stockopedia.) Subsequently over a year later these original ideas were, well, repeated in The Atlantic, "Free the Banks! The Case for Massive Deregulation of the Financial System", and only then they got some limited, still minimal, traction with more mainstream commentators (tweets, blogs).

It is really disappointing and worrying that those who run UK plc, and those who aspire to run it, do not understand such bare basics. Or maybe it is within their roles not to understand them? The mainstream media commentators, apart from rare exceptions, are not any different.

Greg Pytel: £300m London property: crisis? what crisis?

It has been argued for some time on this blog that the current financial crisis is not in fact an economic crisis but an well organised wealth transfer mechanism from the middle classes to the superrich. E.g. "Crisis? This is how it works", "There is a method in this madness"

A couple of days ago BBC reported that the London's most expensive house ever was on the market for, what was believed, over £300m. And that it was a part of a broader trend. "Knight Frank calculates that what it calls "prime" central London property prices have gone up by 50% since March 2009."

It is worth reiterating: "Every time we read about obliterated pension schemes and generally falling income and purchasing power of the middle and working classes, the workhorse of the economy, and the growing gap between them and the super rich, thriving market of top end properties in London, luxury goods and services, from systemic perspective it is simply a wealth transfer.

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

So if you ever wondered where the quantitative easing money went and we do not see any improvement of the economy, but rather the opposite, the price of this property and the steep price rise of prime properties in London (50% since 2009) should give some clues. And in the meantime the Bank of England balance sheets keep growing full of toxic waste.

Greg Pytel: Still out of their depth

In the wake of the completely predictable - but for some reason considered by the mainstream media and politicians as "unexpected" - news that the UK government's tax receipts dipped last July, BBC Newsnight held a discussion between Jon Moulton and Jonathan Portes moderated by Gavin Esler proceeded by analytical material. Whilst Jon Molton was advocating further cuts in public spending to revive the economy, Jonathan Portes argued for more spending at the moment (and possible spending cuts later once the economy picks up). At one point Mr Molton concluded that the UK government did not have any other choice: either cut or increase public spending. Messrs Portes and Esler implicitly agreed.

As it has been shown in the articles on this blog the current economic situation was caused by the financial industry which was turned into a global pyramid scheme. The spending cuts would not revive the economy as any spending cuts would immediately start choking off the economy at the time when banks do not lend to businesses and are not in a position to do so. More government spending, Keynesian approach, would not work either as the additional spending would be stolen by the financial institutions and used as a part of propping up a pyramid scheme. This additional government spending would be converted into toxic waste held by the banks. One way or another it is the same net effect: no growth of the economy.

The discussion on BBC Newsnight showed, again, the nature of the current economic crisis. It showed that those who comment on it or deal with it are completely out of their depth. They are simply confused: Mr Moulton's alternative - cut or increase public spending - is a vacuous argument.

For years it has been argued on this blog that the very first step of any remedial action taken by the government to revive the economy, be it spending cuts or more spending, must be the liquidation of the pyramid scheme run by the financial institutions. Otherwise, one way or another, it will always be a good money thrown after bad, exactly what we see since 2008.

Greg Pytel: Disturbing news

Standard Chartered has been accused by the US authorities of busting the US sanctions against Iran by aiding the Iranian financial transactions in the US dollar. Is it a disturbing news? Not really, as expected and we can expect more news of this kind about the financial institutions in the future.

The Bank of England downgraded the growth forecast to 0% (no growth), from 2% growth predicted a year ago, for the year 2012. Is it a disturbing news? Not really, as expected and - considering the way the economy is run at the moment - it is unrealistic to expect any good news any time soon. People should get real and accept that the way the government manages the economy is precisely designed to produce such results. This is the fact, this is how it works, not a rhetorical statement.

The government's Funding for Lending initiative is initially expected to lend about £80bn at below-market rates to banks and building societies. Is it going to help the economy? Of course, not. Even if the banks lend the initial £80bn to households and companies this money will come back to the banks in the first cycle of the money circulation and will not be re-lent again (or very little of it). It will then be used by the banks to convert their toxic waste to it and, of course, to pay huge bonuses to those who will do it. It is glaringly obvious that the financial system works in a way that any cash injection done through the banks will eventually be plundered by them. Funding for Lending is another classic example of throwing good money after bad after rescuing the banks and QE. The financial system is below-rock bottom.

The disturbing news is that it appears that those who run the economy, the government and their advisors, and also the mainstream media who comment on it, do not have a clue about what they are doing. As the alternative news is even worse and rather improbable: that they are damaging the economy on purpose. But from logical perspective such option cannot be ruled out either.


[Since this article has been published this morning BBC reported that "the UK's trade gap widened sharply in June, to its worst level since comparable records began in 1997." Is it a disturbing news? I can only reiterate: not really, as expected and we can expect more news of this sort in the future. But, hey, does it really matter? We are really set for more medals in the Olympics and the government folk and the establishment have a time of their lives.]

Greg Pytel: Guantanamo Camp: a new lease of life?

In 2002 Guantanamo Camp was set up as a camp for "illegal combatants", international terror suspects. Like any government's initiative it started a life of its own: jobs and income depend on it including those of most influential companies. For example Halliburton, a US company whose CEO was once Dick Cheney, the US Vice-president at the time when Guantanamo Camp was established, was awarded a $1 billion construction contract to revamp the Camp in 2005.

After a decade there are no longer "illegal combatants" roaming the world, waging the war against the US. There is a little operational case - to justify the expense - for Guantanamo Camp as a place for detention of international terror suspects. So what next for Guantanamo Camp? Is such a lucrative place of income for many influential defence businesses going to be closed? Or is it more likely that a large US company will get a lucrative contract for another revamp or even for running its operations?

Here the LIBOR scandal may come quite handy. Whilst we may be cynical about the capitalism in the US, especially in its current form of the "communism for the rich", the US has an impressive track record in prosecuting the financial fraudsters. From Charles Ponzi in the beginning of the 20th century to more recent perpetrators of the financial wrongdoings behind WorldCom, Enron, Tyco and "NatWest three" scandals. Not that long ago Bernie Madoff experienced the decisive side of the US justice.

It appears it is only a matter of time when the US justice system will start catching up with those behind the LIBOR scandal. In a recent interview on the BBC Radio, Prof Alan Riley from City University Law School said:

"Any fixing of the LIBOR rates is prima facie criminal price-fixing and the United States extra-territorial jurisdiction applies even to price-fixing in London. If price-fixing is proved the US authorities may well seek extradition of executives based in the United Kingdom. Given the effectiveness of the US criminal antitrust regime (in which over 25,000 prison days were handed down in 2009), compared with the failure to secure any home grown price-fixing convictions in the UK under Section 188 of the Enterprise Act 2002 (the Cartel Offence), it is much more likely that US authorities will successfully prosecute bankers than the British authorities".

As the number of individuals involved in the LIBOR scandal is significant the Guantanamo Camp may become handy. The prospect of extraditions to the US is not purely theoretical. Indeed a number of City folk are already taking legal advice on that. And those who do not - who were involved in the LIBOR "business" - should think about it.

Greg Pytel: Below rock-bottom

We may have thought in the last four years that the financial industry reached rock-bottom. But in the last couple of months we clearly heard knocking from below and it looks the financial industry will fall even further.

First a well-known for years industry practice of LIBOR interest rate rigging was found its way to the mainstream media as if it was something out of ordinary. This is the logic of the financial industry, especially in the City, and it is inconceivable - at least to the author of this article but everyone has to make his/her own mind - that The Economist did not know it when they were publishing "Save the City" article.

Then there were comments and explanations from Barclays Bank which - for some reason - was singled out in the LIBOR scandal. Price or financial rate rigging of any sort is wrong in any circumstances under free market principles. It is dishonest. The only kind of rigging which is the exception from this rule is by regulation. But regulation is not an ad-hoc decision of a banker, politician or bureaucrat but an effect of a transparent democratic process safeguarded by the clearly defined regulations. It is hard to believe that those who were involved in or knew about LIBOR rigging did not understand such basics.

We also heard news about HSBC involvement in drug money-laundering and mis-selling of complex financial products. It provided more examples that the financial industry has degenerated into a primitive fraud machine based on deceit. Before the end of 2008 each of this news would have been a massive scandal. These days we all seem to accept that this is how the financial industry works.

The mainstream media do not even dare to discuss the underlying cause of the current financial mess, the real engine of the fraud machine, which is bringing the western economy down. It is worthwhile to look into it again and how it works.

Cautious conclusions, based on other fraud investigations, indicate that a bunch of quite (not that) clever financiers changed the banking system practice from "fractional reserve banking" (i.e. lending with loan to deposit ratio below 100%) to, what the author of this blog called, "depleting reserves banking" (i.e. lending with loan to deposit ratio above 100%, which technically and legally is a pyramid scheme).

"Depleting reserves banking" rather than accumulating cash reserves at every deposit – loan cycle, depletes them. To cover this up a lot of instruments and methodology were invented (so-called "financial innovations") giving an illusion that whilst banks' reserves were rid of cash they somehow still had the reserves to cover for cash liabilities. This has nothing to do with whether cash is a paper or electronic record, but who is the guarantor of liability. Cash is guaranteed by a state. This is the key to understand this crisis: whilst capital reserves appeared to have been sufficient at the start of this crisis they collapsed in value as there was no sufficient cash on the market and only a state intervention prevented the financial system from a melt down.

"Depleting reserves banking" practice, peddled by fraudsters, need an army of incompetent "professionals" to run it. Incompetent to such a degree that they did not understand that this was a crude pyramid scheme that was bound to collapse. Hence a huge bunch of history, anthropology, other social sciences and, importantly, lawyers were employed as banks executives to execute heist designed that way. Typically these people's career in banking was very often based on hang-ups. A huge majority of them were very poor in maths in school and banking environment gave them a sense of massive self-importance. They became "masters of the universe" whilst many of their friends who were so much better in science at school were left behind in pretty poorly paid and mundane engineering jobs.

This mechanism was very important to the heist organisers. It created a mindless and incompetent army of financiers, like child soldiers in Africa. It also built a massive lobbying army protecting heist organisers from criminal consequences. This mindless lobbying army was also strengthened by the senior politicians who were given City jobs after the retirement. It is rather impossible to lock up thousands of influential thieves, most of whom did not even understand they were stealing. A lot of them still believe they were"creating value". Psychologically it is like prosecuting child soldiers in Africa. However this time we deal with the adults who should have known not to do jobs they were not suited for. Like a butcher should know that he cannot operate on humans: even taking appendix out which is a trivial surgical operation.

Is it then surprising that the UK economy is suffering from recession again, so-called a double-dip? Most politicians and mainstream media commentators appear to be surprised. This "double-dip" is a simple and easily predictable result of the way the economy is managed. Its is actually quite surprising that the recession is not even deeper. Are politicians playing stupid or are they really THAT stupid?

Greg Pytel: A bare-knuckle fistfight in the family

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

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

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

Greg Pytel: There is a method in this madness

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

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

Well Sir Mervyn, please speak for yourself and not for "most people". To remind you the analysis that was written at the end of 2008 and has been known by the House of Commons Treasury Committee since April 2009:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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This article was published first on Nutmeg blog

Greg Pytel: Barclays' interest rate rigging? Nihil novi

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

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

Communism at its "best"

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

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

Spanish €120 billion bailout

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

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

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

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

Keynesian approach would not work

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

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

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

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

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

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

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

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

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

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

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


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


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

Prof Mary Beard: "politicians do not have a clue"

Last Thursday, during BBC Question Time, Mary Beard, a professor of classics at Cambridge University told the politicians, Caroline Spelman (Conservative), Lord Oakeshott (Liberal Democrat) and Chris Bryant (Labour), and Peter Oborne, a prominent journalist and political commentator, as she commented on their discussion how to resolve the current financial and economic rather unacceptable situation:

"When you guys - the whole lot of you - start to talk like this I feel really, really worried. Because I know that I have not a foggiest clue what is going to get Europe or the world out of recession. I am not supposed to know, I am not a professor of economics, I am a professor of classics, it's not my job. When I listen to you guys argue what I see is that you do not have a foggiest clue actually."

Professor Beard, as an academic, is a very credible judge to tell when people have a clue what they talk about and when they do not. This is a good part of her general academic experience of assessing students and fellow academics. And she was precisely right: whenever most politicians and mainstream journalists start talking or writing about the ongoing financial and economic situation they are clearly out of their depth. It is only this part of human psychology that keeps us sane that does not allow them to comprehend how they are seen from the outside. Professor Beard told them just this: that the king was naked.

However behind the politicians and mainstream commentators who do not have a clue about the causes and mechanics of the current financial and economic situation, there are people who understand it well and, actually, engineered this "crisis". They take full advantage of it. They oil the wheels of the system giving politicians well-paid jobs in the City they are not professionally suited for and "The largest heist in history" continues.

Cardinal O'Brien does not get it

"Scotland's most senior Roman Catholic, Cardinal Keith O'Brien, has accused the prime minister of acting immorally by favouring the rich ahead of ordinary citizens affected by the recession. The cardinal also denounced David Cameron's opposition to a "Robin Hood tax" on financial institutions. And he urged Mr Cameron not just to help "your very rich colleagues."

The cardinal clearly doesn't get it. The current government is on a mission to build a "big society": bunch of volunteers providing key services and food banks instead of benefits and services guaranteed by the state, i.e. taxpayers, ourselves.

We are all in it together and ultimately we will all be equal: broke. Our, the taxpayers, main role has changed in the last 3 years from paying for services provided to us by the state to subsidising the financial services industry. If we take away the issue of super-rich who are getting richer as the super-rich have always been and always will be, this is the largest equalisation project in history: taking the middle classes to the cleaners. Even Karl Marx and his followers had not dreamt of such radical and progressive system: big society all in it together.

Crisis? This is how it works

Today, not surprisingly, it was announced that the UK is again in recession. Politicians and mainstream commentators keep saying that, somehow, we have been experiencing a crisis, an economic downturn or a double dip recession. Maybe this is correct by some textbook definitions but in reality it is not a crisis or an economic downturn. This is how the current economic system was designed to work. It has very little, if anything, to do with the workings of the free market or capitalism, but much more to do with another, much more disturbing innovation system, that of communism for the rich.

For over a decade, the "captains" of the finance industry with the blessing or possibly the collusion, of the politicians and regulators have engineered a massive global pyramid scheme, the largest heist in history. It is the largest-ever transfer of the wealth generated and accumulated by the middle classes to the super-rich. Every spending cut, increase in taxes, every negative differential of interest rates, i.e. when saving rates are below the inflation, the negative differential between wage inflation and price inflation, additional money printed (so-called Quantitative Easing), significant drop in house prices, amounts to a massive raid on wages, savings, pensions, endowments and generally the wealth accumulated for lifetimes and sometimes through the generations by the middle classes. This heist, this massive misappropriation, continues. We also clearly see the other side of wealth accumulation: the global market for premium properties and luxury goods is thriving and there is no sign of the financial crisis in offshore financial centres.

Obviously the politicians keep saying that they are fighting the crisis and want to bring back stability and prosperity. We have been hearing this since 2008. Maybe some of them, those that are not particularly smart, even believe what they are saying. But this is just a front so that the system, which is extremely efficient in transferring middle class wealth to the super-rich, is allowed to continue operating at full speed. The so-called "financial markets", which are grotesque and primitive parodies of the concept of the free market, keep ruining the economy and the lives of ordinary people. And despite the rhetoric of the politicians and many in the main stream media which supports their claims to be fighting the crisis, this is effectively just a smokescreen behind which the real agenda is hidden, that of cleaning out the middle classes. Both the media and the politicians ensure that the largest heist in history continues and are fully aware of what is going on.

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

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

The relationship between static and dynamic analyses

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

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

How the City ruined the British industry

Yesterday Daily Mail published a serialisation of a new book by Alex Brummer: "Britain For Sale: British Companies In Foreign Hands". It has been argued in many articles on this blog that the financial industry is heavily subsidised by the state, in form of direct subsidies like bailouts and stimulus packages and indirectly by being provided by the state, at a massive costs of the taxpayer, with an implicit insurance against failure ("too big to fail" phenomenon).

Mr Brummer's book shows even more sinister side of the financial industry: how parasitical it has become in the last 30 years and how dysfunctional and damaging it is for the British economy.

As Mr Brummer explains:

"What tipped the balance towards foreign takeovers in the late Nineties and 2000s were three key factors: the cheap cost of borrowing; liberal takeover rules; and the presence of global investment banks in the City, with ready access to the world’s capital.

Throughout the boom years, these banks were allowed to write their own rules. What this meant, in essence, was that a bank which might once have considered it risky to lend ten times its share capital would now lend up to four times that amount.

The result? Foreign companies took full advantage of all this cheap and easy credit to snap up increasing numbers of great British brands.

Not only that, but our eccentric tax system actually made it more profitable for overseas owners to buy companies with borrowed money. For example, foreign firms who buy British companies using borrowed money are able to deduct the interest they have to pay on those loans from their tax bills.

And this had a direct effect on jobs in the UK. Weighed down with often massive debts, new owners were far less likely to invest in the future of the firm and were instead more likely to close down factories and plants, throwing thousands of Britons out of work.

(...)

In the real world, away from the gilded environs of the City, the tragedy is that tens of thousands of jobs have gone. Crucial skills have been lost — probably for good. And the strategic heart of British manufacturing has been ripped out, which affects our ability to climb out of recession.

Still, the outlook isn’t all bleak: bankers and foreign shareholders are doing just fine."

Mr Brummer's book should be dedicated to the British government, the London mayor, Mr Boris Johnson, and The Economist team and its Editor, Mr John Micklethwait, and all City supporters. Maybe they will realise, at long last, that it is not a matter of academic arguments or having different views. Their views are not only irrational but also are highly damaging to the interest of the country.

George Soros: Euro entered "a less volatile but more lethal phase"

In today's FT

"Far from abating, the euro crisis has recently taken a turn for the worse. The European Central Bank relieved an incipient credit crunch through its longer-term refinancing operations. The resulting rally in financial markets hid an underlying deterioration; but that is unlikely to last much longer.

The fundamental problems have not been resolved; indeed, the gap between creditor and debtor countries continues to widen. The crisis has entered what may be a less volatile but more lethal phase."

This is refreshingly very old news.

Greeks take note: Iceland is recovering

In the last few months of 2008, during the outbreak of the global financial crisis, three Icelandic banks Glitnir, Landesbanki and Kaupthing - like the rest of the global financial system - became insolvent and only avoided going bust instantly when Iceland, as a country, took over responsibility for their obligations.
However soon afterwards Icelandic government decided that it could not afford to honour the debt and defaulted, and the the banks went bust anyway. This was despite having taken $2.1 billion loan from IMF. It was an example of Scandinavian common sense (which, as they say, "is not that common"): if you cannot afford to honour your debt, call it a day, go bust and start again.

Since a number of outside creditors lost their money, especially in the UK (a case of Icesave) and the Netherlands, Iceland came under pressure to take austerity measures and keep paying through their nose. Iceland is a country of less than 320,000 so these were massive obligations (around $3.5 billion to the British and Dutch governments alone through savers guarantees). In two rounds of demands, the Icelandic government agreed with the support of vote in the parliament, Althing. However the President Mr Olafur Ragnar Grimsson took a different view, refused to sign the bill and called a referendum. The Icelanders voted decisively for going bankrupt: 98.10%, i.e. not to pay the debt.

Subsequently the Iceland's Prime Minister at the time of the financial crisis break out, Mr Geir Haarde was put on trial on the charges the he had not taken adequate measures to protect the country's economy.

The Iceland's default was the beginning of its quite speedy recovery despite the fact that the western world was in economic crisis. Their currency was devalued by 70% making the economy more competitive. According to IMF Iceland's Gross Domestic Product, having recovered from a massive fall in 2009 of 6.9% and in 2010 of 3.5%, increased be 2.5% in 2011 and such steady pace of growth is expected to continue in 2012. In February 2012 Fitch upgraded Iceland's debt to "investment grade", from BB+ to BBB-. In comparison Fitch rates Greece at B-, six levels below Iceland (and this is after the recent Greece debt upgrade by 4 levels).

In February this year Iceland paid the first tranche of its debt repayment to IMF of $106.6 million and, spectacularly, bought back $443.4 million its bonds with the maturity in 2013 from IMF. Therefore Iceland paid around a quarter of its debt to IMF and ahead of time.

This is in stark contrast to Greece's way of handling the crisis. When Prime Minister Georgios Papandreou called for a national referendum on accepting the EU austerity measures or going bust last autumn, he was deposed and a new Prime Minister, Lucas Papademos, who was responsible for putting Greece in a financial mess in the first place was installed.

Greeks should take note: social unrest and taking on more debt to pay for old is not a way to recovery. As the democracy birthplace they should have more faith in it. As Iceland's example shows the route to recovery from the financial disaster is first default, then putting the political, economic and financial matters in order (and this may involve prosecuting some politicians and financiers who caused the mess in the first instance) and then gradual (and affordable) repayments. Is it a common sense after all?

City top talent

For all those who missed the table compiled by Patterson Associates and published in the paper edition of The Evening Standard on 22 February 2012, here it is:

Value added to the company per £1 in chief executive pay, 2006 - 2010:

SAB Miller:	£21,950
Reckitt Benckiser:	£11,958
Diageo:	£9,199
Rolls-Royce:	£5,182
Tesco:	£1,028
BAE Systems:	-£558
Legal & General:	-£3,495
Barclays Bank:	-£10,787
Royal Bank of Scotland:	-£34,275

Source: Patterson Associates

The table shows the relationship between the notion of "the top City talent" and the skills and abilities to make/lose money for the investors/shareholders. No wonder pension funds, saving rates, endowments' returns are what they are. Any surprise?

For all those who follow "the City top talents" views on the current financial crisis and their depth of understanding, like Mr John Varley analytical view on this crisis (for example published on this blog) the figures in this table should look as expected.

It is likely that curbing City pay would give it a competitive advantage because now top pay in the City appears to attract top talent, but of the wrong sort.

IMF chief going bonkers

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

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

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

"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

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

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

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

Democracy on the ropes

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

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

Doing a ponzi

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

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

Who did it?

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

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

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

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

Doing a Scargill

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

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

The financial nomenklatura

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

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

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

Heading for a meltdown

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

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

Economy: "What a beautiful Catastrophe!"

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

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

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

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

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

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

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

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

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

Debt magic: a story from Devon

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

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

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

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

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

Has Cameron killed the City?

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

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

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

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

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

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

Why don't they sort out this mess?

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

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

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

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