The rise of Michael Moore in recent years has been quite a phenomenon. Some perhaps thought in the 1950s that they had seen the last cinema-style documentary. However, Mr Moore made the genre popular again, in an age when the rest of Hollywood is happiest when stripping cartoons out of the Marvel Comics stable and turning them into 3-D movies, with such entrancing dialogue as this:
Chisel-Faced Marine Sergeant: Is that clear?
Hapless Recruit on some kind of Personal Mission: Crystal.
Whatever you think of Mr Moore, and his films, he has at least enabled the expansion of the documentary movie, and perhaps cleared the path for the production and distribution of the following examination of the financial industry, Inside Job — as directed by Charles H. Ferguson — which you might want to try and catch over the next few months, in one format or another.
Here’s the trailer:
You might also be interested in a ‘Financial Sense’ interview with one of the main contributors to the movie, which you can find here:
The other movie documentary I’ll be trying to see, this year, is of course about the legendary Ayrton Senna, but that’s a topic for a different web site.
Regular readers of this site may be aware of a debate relating to the contractual devices that banks might use to ensure that they are solvent. One of the terms that has been used is a “notice of withdrawal clause”, but what is this?
It might be argued that a notice of withdrawal clause (or a “withdrawal clause”) is merely another term for the more often invoked “option clause”. This has received extensive treatment in the “free banking” literature (for example Dowd (1988), Selgin & White (1994, 1997)), and we can use the following definition:
option clauses… give banks the option of deferring redemption of their notes provided that they later pay compensation to the noteholders whose demands for redemption are deferred” (Dowd, 1998, p.319)
The confusion may stem from the fact that in some instances option clauses and withdrawal clauses are used interchangeably. For example Selgin & White (1997) say:
one possible run-proofing device discussed in the literature is an “option clause” or “notice of withdrawal clause” allowing a bank temporarily to suspend the redeemability of some or all of its liabilities (notes or demand deposits) provided the bank pays a pre-specified (penalty) rate of interest on the suspended liabilities
However, I believe there is stronger textual support for the idea that they are distinct devices. In an earlier article Selgin & White (1994) say the following:
a bank might contractually reserve the option to suspend for a limited time the redeemability of its notes or demand deposits, as Scottish banks did with banknotes before 1765 (when the practice was outlawed) and as banks do today when they include “notices of withdrawal” clauses in deposit contracts
My reading is that they are often used interchangeably (or perhaps as though a withdrawal clause is a type of option clause), because they perform the same economic function. But a detailed reading would reveal them to be different.
In addition to the option clause banks might also offer (and historically did offer) a “notice of withdrawal” clause, specifying that their customers were required to give 30 days notice prior to making a redemption claim. The fact that this clause existed (to protect the bank from a legal point of view if it were ever to suffer a liquidity crisis) does not mean it is always invoked, and banks could routinely not enforce this rule and satisfy immediate redemption requests.
Firstly, note that this is presented as a different clause to the option clause. But secondly, we can see that it differs from the option clause in terms of the default nature of the contract.
Recollect that an option clause allows banks – under certain conditions – to convert a demand deposit into a timed deposit (thus giving them time to generate liquidity whilst avoiding firesale losses). This is seen to be good for the banks (obviously!) but also good for the customers (since it’s better to receive the deposit plus interest at some point in the future than to see the bank being wiped out).
However in the case of the withdrawal clause there is a notice period written into the contract – it is technically a timed deposit (where the notice period serves as a minimum term). But if the bank wanted to offer an instant access account it can simply publicise the fact that it does not routinely enforce this notice period and that it satisfies redemptions on demand.
I suspect the reason withdrawal clauses received less explicit attention in the literature is that unlike the option clause they are not a uniquely “free banking” concept. Indeed, notices of withdrawal are routinely used in contemporary banking. Investopedia define it as follows:
A notice given to a bank by a depositor. As its name implies, a notice of withdrawal states the depositor’s intention to withdraw funds from an account. This notice applies to both time-deposit and NOW accounts
In short, the option clause means that a de jure demand deposit can be treated as a de facto timed deposit. The withdrawal clause means that a de jure timed deposit can be treated as a de facto demand deposit. They are two sides of the same coin – both allow instant access fractional reserve accounts, the only difference is the default position.
So perhaps provisions such as option clauses and withdrawal clauses allow banks to offer fractional reserve accounts that aren’t fraudulent or reliant on legal privilege, but does that make the 100% reserve argument wrong? Not necessarily. The withdrawal clause in particular “works” precisely because it changes the de jure status of the account. A counter argument might be “if a withdrawal clause applies to a timed deposit then you are admitting that fractional reserve banking is irreconcilable with demand deposits”. From the view of legal theory (and depending on your definitions), this may well be correct. However the de facto status of this account is instant access and redeemable “on demand”. In terms of the economic function of the account it exists exactly as “free bankers” envisage.
For several years now there has been a highly successful seminar held at Sidney Sussex college, at the University of Cambridge. Around 30 undergraduates from across the UK converge for a week long, fully paid submersion in classical liberal political economy.
Modelled on the famous IHS and FEE summer programmes, Freedom Week brings together leading academics to lecture and socialise with students in a relaxed, informal environment. Aside from several hours of lectures per day there are formal dinners, BBQs, punting, and social drinking.
The seminar is free: accommodation, tuition and meals are fully paid for; students only need to get to Cambridge by Monday lunchtime and remain throughout the week.
I have previously given talks on the Financial Crisis and Competition and Monopoly, and am always impressed by the enthusiasm and intellectual curiosity of the students that attend. The Freedom Week alumni is growing significantly and it’s helped launch the careers of a number of UK think tankers. This is a hugely important programme of the UK free market movement.
I highly recommend the programme, and encourage people to pass on the details to interested students.
As a derivatives trader for 19 years, Detlev Schlichter resigned his position as a senior bond portfolio manager in 2009 to work full-time on this book, about fiat monetary systems and financial crises. He therefore knows of what he speaks. In this extensive and detailed interview, he explores with Brian Micklethwait what we should do to get our current financial problems behind us; this one really is worth listening to in its 35-minute entirety.
“Paper money systems are unstable and so is our system. It will end. It will most likely end badly. It will most likely end soon.”
Speaking from a heavily-influenced Austrian position, Herr Schlichter examines what would happen if we did the ‘right’ thing by turning off the Keynesian money printing spigot — and exposing all of those malinvestments — and what might happen if we keep going into the Götterdämmerung of the fiat money system with the ‘wrong’ thing, by allowing the spigot to pump even faster.
“Paper money systems have always collapsed in history. None of them have survived. And our system is really not that old. It only became a complete one hundred per cent paper money system in 1971, when the dollar became an irredeemable piece of paper. Central banks could still convert it into gold until 1971.”
Amongst many other sub-plots, debating the relative influences of Hayek, Mises, and Rothbard, there’s also a fascinating sub-discussion about the role of paper money in the collapse of the medieval Chinese empire, which allowed the later domination of China by the western powers of Europe, such as Portugal and Britain.
For those interested in the work of Herr Schlichter, and up-to-date comments upon an unfolding global financial situation, you can find his personal web page, here.
As promised, here is the video of Professor Philipp Bagus delivering this year’s Murray N. Rothbard Memorial Lecture, at the Austrian Scholars Conference, in Auburn, Alabama:
Word reaches Cobden Centre Towers of Dr Mike Haywood’s latest banking crisis digest.
It’s almost reached the point where we hardly dare open the curtains up here, as the folly of following Keynesian economics for decades rebounds around the world, gathering momentum and terror as it strikes its hapless victims, most of whom turn helplessly to more Keynesianism to ‘solve’ the problem. But for those who can take the carnage in their stride, here are the latest ‘highlights’:
MIKE HAYWOOD’S BANKING CRISIS DIGEST
Independent weekly compilation of current internet articles and blogs relating to Global Banking Crisis
You may not have time to read all the articles. To help you be selective, those articles which I consider an important read or viewing, I have prefixed with X
Credit where credit is due. A hat must be tipped to Dr Haywood for performing this digest service each week. But do be careful reading some of the articles above. You may be forced, as I was, to run screaming from the room shouting, “Nurse, the screens!”
Several thoughts pirouetted across my mind as I watched the coverage of Saturday’s protest and riots.
I wondered why anti-capitalists were wearing clothing with prominent labels (don’t they know their Naomi Klein?); I wondered why defenders of the public sector were attacking publicly owned banks; I wondered how one protester could say, when interviewed, “Of course, we all know there need to be cuts” while a sea of people drifted past her waving signs saying ‘No cuts’; I wondered why Ed Miliband, a bloke without an alternative, was addressing the March for an Alternative.
But most of all I was struck by what a boon this all was for the economy, or so some would tell you. The standard Keynesian narrative of the Depression of the 1930’s, for example, holds that it was all about a collapse in aggregate demand which was only solved by, first, New Deal spending, and then war spending. As Paul Krugman once put it
Faced with the Depression, institutional economics turned out to have very little to offer, except to say that it was a complex phenomenon with deep historical roots, and surely there was no easy answer. Meanwhile, model-oriented economists turned quickly to Keynes — who was very much a builder of little models. And what they said was, “This is a failure of effective demand. You can cure it by pushing this button.” The fiscal expansion of World War II, although not intended as a Keynesian policy, proved them right
The fact that large swathes of the planet’s human and physical capital was blown to atoms represented simply an ‘opportunity for growth’.
So surely all the random destruction in the West End should be a good thing? Perhaps not. Back in 1850, Frédéric Bastiat asked “Have you ever witnessed the anger of the good shopkeeper, James B., when his careless son happened to break a square of glass?” In his classic, Economics In One Lesson, Henry Hazlitt took up the story
A young hoodlum, say, heaves a brick through the window of a baker’s shop. The shopkeeper runs out furious, but the boy is gone. A crowd gathers, and begins to stare with quiet satisfaction at the gaping hole in the window and the shattered glass over the bread and pies. After a while the crowd feels the need for philosophic reflection. And several of its members are almost certain to remind each other or the baker that, after all, the misfortune has its bright side. It will make business for some glazier. As they begin to think of this they elaborate upon it. How much does a new plate glass window cost? Fifty dollars? That will be quite a sum. After all, if windows were never broken, what would happen to the glass business? Then, of course, the thing is endless. The glazier will have $50 more to spend with other merchants, and these in turn will have $50 more to spend with still other merchants, and so ad infinitum. The smashed window will go on providing money and employment in ever-widening circles. The logical conclusion from all this would be, if the crowd drew it, that the little hoodlum who threw the brick, far from being a public menace, was a public benefactor.
Now let us take another look. The crowd is at least right in its first conclusion. This little act of vandalism will in the first instance mean more business for some glazier. The glazier will be no more unhappy to learn of the incident than an undertaker to learn of a death. But the shopkeeper will be out $50 that he was planning to spend for a new suit. Because he has had to replace a window, he will have to go without the suit (or some equivalent need or luxury). Instead of having a window and $50 he now has merely a window. Or, as he was planning to buy the suit that very afternoon, instead of having both a window and a suit he must be content with the window and no suit. If we think of him as a part of the community, the community has lost a new suit that might otherwise have come into being, and is just that much poorer.
The glazier’s gain of business, in short, is merely the tailor’s loss of business. No new “employment” has been added. The people in the crowd were thinking only of two parties to the transaction, the baker and the glazier. They had forgotten the potential third party involved, the tailor. They forgot him precisely because he will not now enter the scene. They will see the new window in the next day or two. They will never see the extra suit, precisely because it will never be made. They see only what is immediately visible to the eye.
The resilience of palpable nonsense is staggering. If, as Bastiat and Hazlitt demonstrate, the idea that the trashing of businesses is good for business, then consider what Clinton-era Treasury Secretary Larry Summers said about the Japanese earthquake recently
It may lead to some temporary increments ironically to GDP as a process of rebuilding takes place. In the wake of the earlier Kobe earthquake Japan actually gained some economic strength
This is crass rubbish. Lots of new building activity may take place in Japan but they will simply be restocking on, say, housing. Rebuilding the house you have just watched destroyed does not make you better off.
Yet this drivel has the imprimatur of The Master himself who wrote in The General Theory
Pyramid-building, earthquakes, even wars may serve to increase wealth
That will no doubt come as a great comfort to West End workers and homeless Japanese.
The old adage about how to succeed in banking was the formula of ‘3-6-3’: borrow at 3%, lend at 6% and get onto the golf course by 3 o’clock. Oh how quaint and distant such times feel to us now, with the economy still suffering from the fall-out of a banking crisis for which no-one involved seems particularly willing to accept responsibility.
What would be the modern banking formula? It seems more like 0-15-7 – get money for almost nothing, lend it at double-digit rates (in all probability with nasty conditions attached) and trouser your 7-figure “performance-related” bonus at the end of the year. To those of us who have attempted at any point to earn a crust entirely off our own bat, the self-delusion of senior bankers who describe themselves as ‘entrepreneurs’, ‘risk-takers’ and ‘wealth-creators’ would be laughable if it were not so costly to the real enterprise economy. Reward and risk are supposed to go hand in hand – this is at the heart of capitalism. Banks reap the profits but are protected from losses by the broad shoulders of the taxpayer.
But then banking is anything but a normal and competitive free market. The bailout demonstrated this to dramatic effect – Woolworths can disappear from the high street almost overnight, but RBS cannot. But the problem runs deeper than the damage inflicted on taxpayers by the bailout and the impact businesses and workers by the credit crunch and recession.
Banks make too much money. Banks need to earn a reasonable return on capital, but in a recent report ‘Featherbedding Financial Services’ we at nef (the New Economics Foundation) set out several ways in which banks profit excessively at the expense of taxpayers, customers, investors and corporate clients. This allows them to be relaxed on costs, indifferent about customer satisfaction and yet still enjoy margins that would make a manufacturer or a retailer blush. This is bad news for the broader economy. Banks’ profitability has more than doubled and has outstripped non-financial sectors since the 1970s. Why?
To start with, being “too big to fail” is profitable. Based on calculations by Andrew Haldane, the executive director of financial stability at the Bank of England, we estimate the value of this subsidy to UK banks to be around £30bn a year. The subsidy arises because banks, effectively guaranteed by the government, are able to access much cheaper funds than would otherwise be the case.
But this is far from the end of the matter. We also identified windfall profits to banks from the additional trading in gilts required by the Bank of England’s programme of quantitative easing. This is ironic to say the least, as QE was brought in to revive the economy after the banking crash.
Customers are proving a good source of extra profits, too. The interest spread – the difference between the interest rate that banks pay for funds and how much they charge us – has widened dramatically since 2008. Although perhaps too narrow before the crash for some forms of consumer credit, this suggests that the burden of rebuilding banks’ balance sheets is falling disproportionately on customers instead of shareholders, executives and bondholders. SMEs are all but priced out of the market for credit – no wonder many do not even bother applying for a loan.
Investment banking is also something of a cosy club of financial returns wildly out of kilter with real economic contribution. Institutional investors and corporate customers are getting a raw deal. For example, in the case of rights issues we identify a near trebling of investment banking fees since 2000, having been at a steady level for decades. This has reaped an additional £1bn in fees just through a rise in commission rates.
Reform is desperately needed. Until we see genuine competition, and some customer power, in retail and investment banking, and until incompetent and failing banking institutions and executives are guaranteed to suffer the same fate as they would in any other sector of the economy, our banking industry will be a drag on the UK’s prosperity.
I had a meeting two years ago with James Forsyth, the editor of The Spectator, and talked about the alternative world of Austrian Economics, how many of its economists had predicted boom and bust, etc. He was very attentive. I am glad to see this article in this week’s edition, drawn to my attention by Daniel Hannan.
The Wealth Manager, Tim Price, is clearly aware of the Austrian School and may well use some of the key insights to invest. He quotes Prof Jorg Guido Hulsmann and his book “The Ethics of Money Production.” This is a must read for anybody interested in how the government are destroying your wealth and will continue to do so until the production of money is taken out of their hands. The full text can be downloaded here .
