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By Billy Walsh, on 27 December 11
 I am an artist and serial entrepreneur, and I, like many, have been pillaged and plundered by the United States government. Heckle Sketch is my latest means of satirically venting frustration while communicating important messages about freedom and free market capitalism that are lost to the majority. The majority includes a government which was founded on such principles.
I have been involved in creating successful, innovative businesses for the past 16 years. I have lofty, but also realistic, visions for the advancement of mankind through biotechnology, space colonization, energy efficiency, etc. I have believed I can make a contribution toward these advancements through free market business creation and relevant investment. I am now realizing that I have been duped.
My latest venture, Tangerine Wellness, is a free market solution to rising health care costs, which the U.S. government cannot successfully address. The solution offers financial incentives to employees of large corporations for weight-loss and maintenance – lose weight, earn money is the motto. It is a solution that makes people healthier and has decreased healthcare costs for our clients.
Tangerine is solving the healthcare cost problem, yet we are being hindered from continuing to do so. In addition to the mountains of bureaucracy added to prospective clients’ operations because of massive healthcare reform, the changes have instilled uncertainty about their approach to employee wellness and about offering healthcare coverage at all. Prospective clients are not making market-driven decisions about the health of their employees, nor their healthcare coverage. They are basing their decisions on government coercion, which will result in continued rising healthcare costs.
When you spend over seven years putting your energy, heart and soul into a profitable endeavour that actually solves a major problem only to have the concept dismissed on government whim, you begin to question whether continuing to innovate is worth it. It is one thing to deal with natural free market forces; it is another to deal with free market forces as a secondary factor to unpredictable government intervention. Tangerine continues to be profitable and is wisely shifting toward a consumer-direct approach, but that is no cause for excitement when around the corner could be any new bulldozing regulation.
My nutshell story of Tangerine cuts to the point I am trying to make while leaving out many other similar painful, government-related experiences both in this and past endeavours. Driven by a need to understand the nature of the beast that threatens my survival, I have dug deeply into the landscape of economic theories and schools of thought. I see clearly why government is harming my businesses and others, why it is the core cause of our massive economic crisis, why it is stifling innovation and the advancement of mankind, and why it is so hopeless to expect the system to repair itself.
So, what does one do when one’s dreams are shattered by government injustice and there is no hope to fix the root causes through the current system? Well, if you’re also an artist with a sense of humour, you make fun of the injustice through art while trying to make it a form of education toward a brighter future. “Ben and the Fat Cat Banksters” is my first painting to do this by humorously exposing the harm the Fed produces through fiat money printing and bailouts. Do not be fooled – so long as I can put a brush to a canvas, or commission others to do so, every perpetrator of freedom and free market capitalism that exists will be…HECKLE SKETCHED!
By Steven Baker MP, on 20 December 11
Following his recent paper The law of opposites: Illusory profits in the financial sector, TCC Advisory Board member and founder of Cobden Partners Gordon Kerr appeared on Bloomberg. The video is here.
 Click for video Gordon dealt with the flaws in IFRS, the reasons for the debt crisis, the case for hardening money, the need for international money in support of trade and more.
Later in the day, I said in the Commons that the Government’s response to the ICB report seemed to take accounting for granted, asking the Chancellor to consider the issue seriously in the forthcoming white paper.
By Tim Lucas, on 2 December 11
I was asked recently why it is that market forces do not push down the wages of the top earners in financial services. The answer, it would seem to me, is that the profitability of the financial services sector is based on privilege, rather than normal economic activity, and it is this that drives hiring behaviour.
In a normal industry, where there is a profitable project, a number of different entrepreneurs have the ability to invest in this area. The act of investing produces a good that a consumer buys. The more of these goods produced, the lower the price that consumers will pay such that the profit making opportunity diminishes and the ability to pay higher wages/expand the business diminishes. This process is good for society since it provides more goods demanded by the public at lower prices. The entrepreneurs are motivated to hire additional people in order to invest in these areas increases profits to themselves. A beautiful system, I’m sure you’ll agree.
However, the profits of the financial service industry are far in excess of where they would be in a true market economy without fractional reserve banking/fiat currency/central banks. Profits within the industry are essentially a product of the net interest margin (difference between interest rates at the short and long end of the curve) and the outstanding liabilities (more credit lent means more profit).
The central bank’s action keeps the net interest margin wide since it buys government debt at the short end of the curve and has an inflationary bias. In addition, the ability of the central bank to continue to bail out the industry should it get into “liquidity” trouble encourages more risky behaviour – both in taking on additional leverage and taking additional duration risk. Hence the product of net interest margin and liabilities is artificially kept high by central bank action. These excess profits are paid for by the rest of society through higher inflation.
Given that the vast majority of the banking sector’s profitability is dependent on privilege, it makes no sense for a firm to hire additional people in order to exploit profit making opportunities – there are no opportunities. The rational response is to hire no one at all, except in the case where hiring defends and extends this privilege. This explains the army of remuneration consultants, the bank-funded pro-central bank economists, the lobbyists, the symbiotic relationship between government and banks particularly evident in the higher echelons of the US government where officials seem to pass between top positions in government and on Wall Street so easily.
Some hiring of people of course is inevitable in order that administrative work is done, and this is also beneficial in defending privilege since the industry can argue to the government, from whence its privilege comes, that it is an importnant provider of jobs. However, the insiders with the top positions are very reluctant to hire additional people since this would not increase their wealth though providing additional goods with demand, but rather dilute their privilege through more heads.
By Detlev Schlichter, on 5 November 11
Reproduced by kind permission of Jacob Wolinsky at ValueWalk.com
Can you tell us a little bit about your background?
I studied economics in my home country, Germany, and joined J.P. Morgan as a trader in Frankfurt in 1990. By 1996 I had become a portfolio manager in J.P. Morgan’s asset management division and moved to London, which I still call my home. I specialized in European and global bond portfolios. From 1998 to 2001 I worked at Merrill Lynch Investment Managers, which has since become part of BlackRock, and in 2001 I joined Western Asset Management, the Pasadena-based bond specialist. For Western I oversaw their London-based investment team and was lead portfolio-manager for all their global strategies. When I left Western in 2009 my team there oversaw roughly $65 billion in assets under management for institutional clients from around the world. I look back on my years in the business with many fond memories. I worked with some interesting people and had some fascinating clients. But by 2009 I had become very pessimistic on our financial system as a result of my study of Austrian School economics and my own experience after almost two decades in the business. The two perspectives combined to form a rather unpleasant outlook. I wanted to step outside the industry, think things through, and write a book about it.
What investing style do you subscribe to?
I am not sure I subscribe to any identifiable style, or that I even consider it particularly desirable to do so. Let me explain. I spent almost 20 years in the institutional asset management business. There is very limited room to develop your own style to begin with. These companies are asset-gathering companies. They need to constantly grow and attract new clients. In order to do that they not only try to establish a decent track record but also a specific house style and a clear and distinguishable process that they can market. They try to create a brand. As a portfolio manager you have to play along and do things in a way that fits the process. Incidentally, that was something I was actually quite good at. Now it so happens that certain styles work for some time and then stop working. Markets constantly change. In the industry, however, whenever somebody has good numbers for a while and a good story about how those numbers have been generated, he is usually in a sweet spot. New clients come rushing in. But I have become very cynical in this regard. That is usually the moment you should sell these firms or money mangers. I accept that my take on the style-question is unusual. But that is how I see it.
The truth is I tried many different things over the years. Only now, that I am out on my own, outside the mainstream industry, can I look at things with an entirely open mind, which is refreshing. I like Doug Casey’s distinction between traders, investors and speculators. Many people call themselves investors when what they really do is trading. This is certainly true of many ‘investors’ in the asset management industry. I would now call myself a speculator. Most of the time you do nothing. Until you spot a major dislocation, or a major event or an opportunity, something that you have a completely different view on from most other people. That’s when you go in and take risk. Example: I am convinced this crisis is misunderstood by most. We are witnessing the failure of our fiat money system. This will get much worse. I try to position myself for it.
What attracted you to the Austrian school of thought?
I came across some writings by F.A. Hayek by chance more than twenty years ago. I can honestly say that I felt immediately that I was reading something special, something that made sense, that was true. I found it exceptionally convincing, and it made a huge impression on me. For the next four years I read everything Hayek wrote. Then, I discovered the other Austrians, Mises, Rothbard, Menger. To sum it up, I would say that it is the methodology that makes the Austrian School so special. Ludwig von Mises, for me, is the unsurpassed master of the Austrian School. He understood better than anybody what economics is about, what it can do and what it cannot do, and how it should go about it. Austrian School Economics starts with the individual actor. Purposeful individual action and human cooperation on markets is the driving force behind all economic phenomena. From the starting point of the individual, the Austrians reconstruct and explain all institutions of the market – from the bottom up, so to speak. By contrast, most modern economists approach economics as if it was a natural science, where we must collect observations, statistical data, and look for patterns. This is the right approach for natural sciences because in nature we can’t perceive of purposeful action. But we do understand the actions of humans in the economy. The approach can be and has to be different. Furthermore, macroeconomists implicitly assume that the statistical aggregates and the large wholes that they work with in their models (consumption, investment, retail spending, aggregate demand, and so forth) are what really interact with one another in the real world. This is a tremendous intellectual error. The economy is ultimately driven by countless individual decision-makers. The Austrians do not lose sight of that.
It is no surprise to me that the Austrian School has such a strong appeal for real-life entrepreneurs and risk-takers. No other school of thought understands entrepreneurship, risk-taking, capital accumulation and capital maintenance, relative prices and the real-life elements of time and error, like the Austrian School does. Of course, politicians, central bankers and state bureaucrats are, by contrast, drawn towards mainstream macroeconomics. It gives them the illusion that the economy can be planned and manipulated from the top down.
What inspired you to write a book?
When you begin to understand Austrian monetary theory you realize that our financial system is built on quicksand – elastic, constantly expanding fiat money to be produced without limit and at full discretion by the central banks. I realized that the growing instabilities and dislocations that I observed in my work-life as a portfolio manager over the past two decades were the inevitable consequence of our monetary infrastructure. What amazed me was that nobody around me saw it that way. Whenever a credit boom threatened to turn into a credit bust – as it sooner or later must – everybody was calling for a monetary stimulus, for lower rates and for policy accommodation to extend the credit boom further. Such a policy may indeed prevent a correction now, but only at the cost of making an even bigger correction necessary in the future. But everybody in financial markets is so indoctrinated with a specific and narrow subset of modern macroeconomics – I would say the most toxic aspects of Keynesianism and Monetarism – that everybody believes any policy to be a good one if it only creates some near-term GDP boost. There is no perception of long-term dislocations and market imbalances, of what the consequences of such a policy of artificially cheap credit must ultimately be. I think a gigantic intellectual bubble exists in which most financial market participants operate. That bubble will probably only get pricked by real events, i.e. the massive crisis that is now unfolding. But I wanted to try and give people a different perspective, to debunk some of the erroneous common wisdom that is readily accepted by so many people in the business.
Can you explain to people what your definition of money is?
Money is the medium of exchange. It is the most fungible good in the economy and therefore most readily facilitates exchange of property. It is neither a consumption good nor an investment good. We hold it not to satisfy any of our consumption needs, nor to generate a return. We have demand for it because it gives us flexibility. To hold money balances means to hold purchasing power in its most readily tradable form.
Capitalism developed on the basis of inelastic, inflexible and apolitical commodity money, such as gold and silver – inelastic in its supply and outside political control. Today we live in a world of entirely elastic paper money under discretion of the state, and for the first time in history, such a system spans the entire globe. Remember also, that today’s fiat money system only came into full bloom on August 15, 1971.
Today, most mainstream economists maintain that the perfect elasticity of the money supply is a plus. My book argues that this is wrong. The relative inelasticity of gold makes gold a superior form of money. Elastic money systems must ultimately collapse. Throughout history they always have.
Can you tell us about the US system pre-Fed era?
I should stress first that I am not a monetary historian, although there is a short chapter on the history of paper money systems in my book – all of these systems collapsed by the way. Understanding monetary systems requires theory. History can illuminate concepts or raise new questions. Only theory can explain.
Prior to the founding of a central bank, the Federal Reserve, in 1913 and the subsequent abandonment of a gold anchor in 1933 (domestically) and 1971 (internationally), the US used, for the most part, commodity money. I say ‘for the most part’ as America conducted some interesting experiments with paper money as well, all of them complete disasters. In fact, one of the first historic examples of a paper money system outside Medieval China, was Massachusetts, which, in 1690 when still a British colony, issued paper money to fund military excursions into French Quebec. Then there were the famous continentals, a paper money issued by the Continental Congress in 1775 to fund the Revolutionary War. These early experiments with paper money ended like they always do – with worthless paper tickets. Then in the early part of the 19th century the dollar was defined as a specific amount of gold. This was proper commodity money, a gold standard. There was no central bank. Gold was money. Commercial banks had to redeem their banknotes in specie, which set tight limits on bank credit creation. But the government couldn’t stop interfering, in particular whenever it needed cheap credit, usually to fund wars. Requirements to redeem in physical gold were lifted on a couple of occasions, so in the wake of the War of 1812, when the US was fighting Britain again, and most famously during the Civil War, when the greenbacks were issued and soon inflated into worthlessness. In 1879, the US joined Britain, and in fact most of the then industrialized world, in what became known as the Classical Gold Standard. After the inflation of the greenback era, a corrective deflation was allowed to unfold (but strong economic growth continued nevertheless), and from 1879 to 1914 there was no meaningful deflation or inflation in the system at all. This was a time of hard, inflexible and stable money. This was a period– in the US and globally – of solid economic growth, rising living standards and growing international trade, and of harmonious economic relationships between countries. The Classical Gold Standard was not perfect but probably the best monetary system we have had so far.
Many people have proposed going back to the gold standard? We had many depressions and recessions while on the gold standard, do you think it would be a good idea?
Yes, we should definitely return to a gold standard — not one that is “managed” by the government, but a proper gold standard with no involvement of the state. I wouldn’t hold my breath, however. As we have seen, governments love fiat money. It gives them control over the economy. We will eventually return to some form of gold standard but only after the complete collapse of the present system in a major crisis.
The elasticity of money – which means periods of money expansion and credit booms followed by periods of monetary stagnation or contraction – is the main cause of business cycles. How did this occur under a gold standard? Answer: the spread of deposit banking and fractional-reserve banking, in particular in the late 19th century. These banking practices introduced an element of elasticity into the money supply. They can be profitable for the banks but they are risky and are destabilizing for the broader economy, even under gold standard conditions. That is why many Austrians argue for a 100-percent gold standard, for 100 percent reserve banking. I am not in that camp. I think fractional-reserve banking should not be banned, cannot be banned, and ultimately does not need to be banned. Many of these issues can be solved in a free market. We may have the occasional recession but the system can cope with that.
However, the Fed was founded in a joined effort by politicians and bankers in order not to restrict and contain fractional-reserve banking but, to the contrary, in order to encourage and subsidize it. Money has since not become less elastic but much more elastic. Of course, credit cycles still occur. They now only get much, much bigger. We had a thirty-year credit boom. We will now get a major credit bust. Compared to what we are facing now, the recessions of the gold standard era will look like a walk in the park.
Why do most policy makers seem to be in the Keynesian school and not the Austrian school of thought?
Please remember my answer to the question above about the appeal of the Austrian School. The methodology of the Austrians is superior, but the methodology of mainstream macroeconomics, and Keynesianism in particular, is appealing to politicians. These schools perceive the economy as an organism that sometimes performs below potential, which then provides a convenient excuse for the politicians to get involved. Keynesianism has popularized the concept of ‘aggregate demand’. A recession is now seen simply as a lack of aggregate demand. So politicians have a pseudo-scientific excuse to run deficits and spend money they don’t have. Strangely, the fact that “lack of aggregate demand” can at best be a symptom but hardly an explanation of the recession does not appear to bother too many people.
Truth is, the recession is the result of imbalances that the economy accumulated during the previous artificial credit boom. Once these dislocations (such as excessive levels of debt, overextended banks and inflated asset markets) exist, the cleansing of a recession is needed and unavoidable. That is not a popular message among politicians.
Greece was forced to implement austerity and the budget deficit as % of GDP went up and unemployment skyrocketed. What are your thoughts on the reason why this occurred?
That is not surprising at all. You have to remember that in today’s world GDP is a very poor measure of economic health. In the EU, 50 percent of recorded economic activity is conducted by the public sector. In my adopted home country, the UK, it is 53 percent. The public sector spends more money than all private individuals and corporations put together. This is more socialism than capitalism.
We don’t have to assume that everything the state does is pure waste. For some of these things there would be a proper demand even in a state-less free market. However, we – and in fact the state bureaucrats as well – have no means of telling what is truly demanded by the buying public and what is of marginal or of no productivity, and what is thus complete waste, because the public sector operates outside of market prices and without the guidance of profit and loss. But whatever the state does enters the GDP statistic just the same.
So whenever the state is being cut back – which hardly ever happens, only in cases of default, which is why I am a big advocate of government defaults – a lot of things drop out of the GDP statistics and unemployment goes up because public sector employees are laid off. This drop in GDP is not a lasting problem. We know that a lot of state activity was at least suboptimal to begin with. Now resources (including labor) are being redirected to the private sector, where they will eventually be employed again, and this will enhance wealth and prosperity in the long run. In my view, Greece should stop paying anything to her creditors, declare full default, and shrink the state drastically. For a short while, the statistics would look dreadful. Then Greece would have a massive and lasting recovery. With no debt, a small state and a free economy it could, after some time, outperform everybody else in Europe.
Taxes went up in the Clinton era and the economy still boomed, do you think slightly increasing taxes will be detrimental to the economy?
I object to taxes for moral and ethical reasons (which are subjective) and economic considerations (which are objective). Taxes are always detrimental to the economy. They were so, too, under Clinton. It so happened that other things outweighed their negative impact. Remember, the mega credit boom that started in the early 80s was still in full swing, the Greenspan put was still operable, the NASDAQ bubble was still being inflated. Some of the growth of those years was genuine, that is, based on entrepreneurship, capital creation and innovation, but a lot of it was also the result of easy money. Under these circumstances the tax hikes were not felt that much, that is all.
Today’s environment is very different. The credit boom has ended, and has ended for good. The state and the financial sector have benefitted most from decades of cheap credit and are now severely overstretched. The economy overall is much weaker. Higher taxes would be detrimental. Also, the idea that the gigantic government deficits could be closed with higher taxes is idiotic. To the US I would give the same advice as I just gave to Greece: default, shrink the state massively, go back to hard money. Alas, they won’t do it.
I am curious what you think about the major currencies; Dollar, Euro, Yen, some of the emerging countries?
They are all locked in a deadly race to the bottom. All these currency-areas face the same problems, which are the typical problems of a fiat money system reaching its endgame: massive public debt, uncontrollable deficits, weak banks, addiction to cheap credit and constant asset price inflation. None of these governments want to face up to the reality that they are broke and that what the economy needs is for the market to be allowed to liquidate unsustainable levels of debt and other economic imbalances. As that is deemed politically unacceptable, they will continue to try and buy time by producing ever more currency units and injecting them into financial markets. Inflation and currency destruction will be the endgame. I would stay away from paper money as much as I can. Buy gold and silver instead, and certain other real assets. To guess which of these paper currencies will hit the bottom first is a mug’s game, in my view.
Is inflation or deflation a bigger threat right now?
Inflation and deflation are both unpleasant but it is wrong to call them both an equal threat right now. Allowing deflation now would have a clear advantage, namely it would bring the economy back to a state of balance and toward more proportionate and sustainable structures. A deflationary correction that would allow the liquidation of market dislocations would be painful but it would ultimately restore the economy to health.
If all market interventions, including cheap money from the Fed, would cease now, we would indeed face a sharp economic contraction and most likely a period of deflation. But this is ultimately unavoidable anyway. Current economic structures are simply unsustainable, and the market has a way of dealing with what is unsustainable: liquidate it. The market is craving a cleansing recession, including drops in certain prices. As I said before, this is deemed politically unacceptable. That is why we will get ever more aggressive monetary policy and ever more money printing. This will not solve our problems but it will lead to inflation and most likely complete currency collapse. My outlook for the coming years is inflation, much higher inflation, not deflation. The reason for that is policy.
Hopefully you won’t consider the following analogy tasteless but to ask what is the bigger threat, inflation or deflation, is a bit like asking a cancer patient what is the bigger threat, death or chemotherapy. Nobody will readily embrace either. But it appears to me that in constantly telling us that we need to avoid deflation at all cost, today’s policy establishment is telling us that we should avoid chemotherapy and accept death by hyperinflation.
What are your opinions on Gold?
Gold is the essential self-defense asset. Whenever fiat money systems enter their endgame and are about to collapse, gold comes back. It is the eternal form of money. As Greenspan once said (and he said it when he was already the head the world’s foremost paper money central bank): In extremis, nobody accepts paper money. Gold will always be accepted.
At its current price of $1,720 an ounce I still consider it cheap. Much more fiat money will be created in coming months and years. You want to own something that is not simultaneously somebody else’s liability (such “money in the bank” on your deposit or savings account) and that cannot be created for political purposes at will and without limit, such as paper dollars.
Don’t trade gold, accumulate it.
QEII, Operation Twist, thoughts?
These operations get ever more extreme. It is just part of the logic of the system. We are in a mess because of the trillions that were created out of thin air in the past. To keep the system going a bit longer, the central banks now have to produce ever more money ever faster. Will it stimulate the economy? Yeah, right.
Like a little hamster in his wheel, Bernanke will have to run ever faster to keep the printing press humming and keep the system from correcting. We will get QE 3 and QE 4, no question. By the way, Operation Twist could already be QE3 in disguise. On the face of it, the Fed is just selling short duration Treasuries and buying long duration Treasuries. But the Fed also promised to keep interbank rates near zero for a long time (meaning: forever), and to achieve that they may be buying back short-term Treasuries pretty soon. Listen, there are no exit strategies. The Fed’s balance sheet will continue to grow. It is already bigger than M1. We will get more and more money……
Flashback to September 2008, what do you think the Government should have done?
Nothing. I like Jim Grant’s term: “constructive inaction”. If you believe that the Fed and the government saved us from another Great Depression with all their bailouts and quantitative easing, think again. All they did was postpone the depression – and to make the final disaster worse. All these imbalances are still with us, many of them are larger and have been moved to the state’s balance sheet. Nothing is fixed.
But if you think that this advice – do nothing – is unrealistic and that the government, after having actively supported the build-up of this credit edifice for decades, cannot simply walk away from it once the house of cards finally unravels, then I would suggest the following: Any actions by the government should have been directed toward sustaining the payment infrastructure and maybe to minimize the fallout for bank depositors, who for a long time have actively be lured into entrusting their savings to an increasingly leveraged, government-supported banking system, which has now checkmated itself. I am not suggesting a debt-funded bailout of the deposit base. But the US government allegedly sits on 260 million ounces of gold, some of it confiscated from its own population. Current market value: $450 billion. That could have been handed back to the banks as a backstop against their deposits. This could have been the first step towards abolishing the Fed and returning the country to a gold standard.
If you were Ben Bernanke what would you do now?
Abdicate. His mandate is contradictory and impossible. He is supposed to provide a stable medium of exchange for the American public, and at the same time provide an unlimited backstop for Wall Street and Washington. Well, it is one or the other. We already know which one he chose.
Same question, Barack Obama?
Abdicate is again a good option.
I am not an American so I am looking at this from a distance. It strikes me that the presidencies of George W. Bush and Barrack Obama were both unmitigated disasters for their country. I don’t even think the two as men are necessarily bad or evil. As individuals they may be decent and have good intentions. But the politics are just shockingly bad. The growth of the state, of government involvement in the economy and in all walks of life, the budget deficits, the ever-growing debt pile, the aggressive monetization of debt and the dependency on cheap credit and ongoing market manipulation – this is a complete shipwreck by any standard but, if I may say so, particularly shameful for a country that for freedom-loving people around the world was once a beacon of liberty, opportunity and capitalism. As a generally pro-American libertarian, I can’t tell you how much it hurts to see this once great country go to bits like this.
What needs to be done? Stop printing money, return the country to a gold standard, default on the debt (it will never be repaid anyway!), shrink the state aggressively, stop all foreign wars – the military is the government’s biggest single expenditure item at close to $1 trillion a year.
If you think this is unrealistic then let me tell you that I think all of this will ultimately happen – but not by choice but by necessity, as a result of a massive crisis.
If you were Angela Merkel or Jean-Claude Trichet?
I think that what I said about Bernanke and Obama broadly applies to Merkel and Trichet as well. At the core, the problems are the same. Europe’s problem is not that many different countries share the same currency. Many more and much more different countries did the same between 1879 and 1914 under the gold standard, and it worked very well. The problem is precisely that they do not share an international, apolitical and inelastic commodity money, but a fully elastic and politicized fiat money that comes with built-in expectations of government and bank bailouts. Stop printing money, return to hard and de-politicized money, preferably a gold standard, and shrink the state – the advice is the same.
Who are you endorsing for US President? Ron Paul?
I think the entire political process, not only in the US, but in all modern mass democracies, has become a most degrading and dispiriting spectacle. I agree with P.J. O’Rourke: Don’t vote. It only encourages the bastards. Politics needs to be thoroughly delegitimized as a problem-solving device. It creates more problems than it solves. So I am not endorsing anybody.
Having said this, Ron Paul is, of course, by far the best choice from my point of view. I don’t think that this will surprise you considering what I said above. He is right about ending the wars, abolishing the Fed, returning to a gold standard, shrinking the state. But I fear that he doesn’t have a snowball’s chance in hell to win the presidency. So the crisis will continue. Don’t bet on politics. Trust your own reason. Be prepared.
By Toby Baxendale, on 21 September 11
Andrew Lilico has written a great article for The Telegraph on the dangers of deposit insurance:
In a classic 2005 paper from the highly authoritative Journal of Monetary Economics, Asli Demirgüç-Kunt and Enrica Detragiache investigated the question “Does Deposit Insurance Increase Banking System Stability?“ Their answer, based on an empirical study of a large panel of countries from 1980 to 1997, was that it does not; in fact, as they put it: “explicit deposit insurance tends to be detrimental to bank stability”.
I recommend the whole article.
By Gordon Kerr, on 12 September 11
The 363 page ICB report implies more rules, more regulation, substantial taxpayer costs in drafting, implementing and overseeing. Will this approach work to protect the taxpayer from future bailouts?
I would make three comments:
- the establishment of this Commission has received insufficient recognition for what it is – a formal acknowledgment that our present bank regulatory triumvirate of the FSA, Bank of England and HM Treasury has failed dismally to date and cannot be relied upon to protect us in the future.
- The substantial increase and regulatory cost implied by the Report (it must be noted that this is only a report; draft legislation is not yet available) will have the unintended effect of erecting even greater barriers to entry for competitor banks. This will in turn provide no incentive to our banks to address their culture of entitlement, of high and unwarranted compensation, of disdain bordering on aggression towards customers.
- Having skimmed through its 363 pages, I sense the ICB is unaware of the kernel of the problem: deeply flawed accounting standards and treatments of transactions leading to falsification of profits and capital. RBS for certain, and perhaps other major UK banks, are insolvent. Their liabilities exceed their assets and capital, properly measured and reported. RBS cannot continue as a going concern, and it at least should simply be put through an orderly liquidation process rather than conferred the respect that the ICB proposals imply.
In the context of ‘respect’, I would say that I have considerable respect for the ICB. Martin Taylor, in particular, strikes me from his media appearances as understanding the severity of the crisis and the task he shares with the four others. It is not my place to make apologies on his behalf, but others have commented on the framing of the terms of reference limiting the scope of their responses.
Sadly, however, the measures will fail to achieve their objectives, primarily because the doctors do not appear to understand the cause of the illness.
Early in the Executive Summary (page 10) the ICB refers to one advantage of ringfencing as being to protect retail banks from “external financial shocks”. This implies that the 2008 crisis was caused by such external factors. But the crisis that began in 2007 and continues to this day was not a function of “external financial shocks”; it was a crisis stemming from the insolvency of the banks, as even the Bank of England now accept[1].
IFRS accounting rules, despite the 2009 MTM reforms still allow or encourage banks:
- to “mark up” to market assets whose prices they can claim have risen, thus reporting a profit despite no actual transaction;
- to transfer assets whose market values have fallen (such as Greek sovereign debt)[2] between “accounting classifications” (e.g. onto the “Held to Maturity” book) to avoid recognising losses;
- to pay bonuses despite such banks being loss-making under UK Company Law accounting standards – in other words to operate as Ponzi schemes – and furthermore not to deduct promised bonuses from reported profits.
Retail banks “should have different cultures” the ICB Report pleads (page 11). Dream on. Regulators cannot influence cultures. Only markets, shareholders and the threat of job losses, as feared by workers in insolvent companies outside of the banking sector, will.
I mention shareholders, but when the shareholders are the public sector they seem to impose no such corrective influence. There has been not a whimper of concern from these shareholders in response to the staggering contents of both MP Steve Baker’s and Cobden Partners’ Press Releases of May 15th and 17th exposing RBS’ overstatement of its 2010 profit and capital by about £25bn.
Further, the concept of the ring fence implies that, in a crisis, the investment banking bit can be cut off and allowed to fail, yet exceptions to the ring fence[3] are permitted for banking services that involve an exposure to the sister investment bank. This is not a ring fence, and if this rule survives, expect substantial gaming.
The ICB will counter that they are providing the regulators with sharper teeth. The regulators will not use them. Why should they? As Professor Kevin Dowd points out[4], in 2009 after presiding over the worst financial crisis in living memory, FSA staffers were paid record bonuses after submitting to their pay committees testimonials from the banks they were supposed to have been scrutinising.
[1] “Right through the crisis from the very beginning …an awful lot of people wanted to believe that it was a crisis of liquidity” Sir Mervyn King said. “It wasn’t, it isn’t. And until we accept that we will never find an answer to it. It was a crisis based on solvency.” Financial Times, 24 th June 2011.
[2] Step by step guide how to do this provided by Barclays Capital’s Equity Research team July 2011
[3] ICB Report page 235, footnote 6
[4] “Alchemists of Loss“
By Toby Baxendale, on 1 September 11
Phase 1: Greenspan, the arch money crank
The Greenspan “put”, and the collective adoption by most central bankers of low interest rates after the dot-com bust and 9/11, caused one of the largest injections of bank credit in history. Since bank credit circulates as money, we can say public policy has created the largest amount of new money in history.
This should never be confused with creating new wealth. That is what entrepreneurs do when they use the existing factors of production — land, labour and capital — in better ways, to make new and better products. The money unit facilitates this exchange.
Now to a money crank. He will assume that new money will raise prices simultaneously and proportionately, so the net effect of the economy is that all the ships rise with the tide at the same rate. He’ll say that money is neutral and does not have any effect on the workings of the economy.
One of the great insights of the older classical economists, and in particular the Austrian School, is that new money has to enter the economy somewhere. Injected money causes a rise in the price levels associated with the industry, businesses, or people who are fortunate enough to be in receipt of the new money. Prices change and move relative to other prices. It is often quite easy to see where the new money enters into the economy by observing where the booms are.
Suppose a banker sells government bonds to another part of the government (as has been the case with UK QE policy). For selling, say, £30bn of government debt to the Bank of England, he gets a staggering, eye-popping bonus. With his newly minted money, he buys a new £10m house in Chelsea, a £5m yacht in Southampton, some diamonds for the wife to keep her happy, and lives a happy and rich life. The estate agent spends his commission on a luxury car, and some more humdrum items that mere mortals buy. At each point in time, the prices of the goods favoured by the recipients of new money are being bid up relative to what they are not spending on. Eventually these distortions ripple through the economy, and the people furthest from the injection of new money — those on fixed income, pensioners, welfare recipients — end up paying inflated prices on the basic goods and services they buy. A real transfer of wealth takes place, from the poorest members of society to the richest. You could not make this up. I am no fan of the “progressive” income tax, but I certainly can’t support a regressive wealth transfer from the poor to the rich!
Even when the government was not creating new money itself, it was setting the interest rate, or the costs of loanable funds, well underneath what would naturally be agreed between savers and borrowers. Bankers are exclusively endowed with the ability to loan money into existence, so they welcome the low rates and happily lend, charging massive fees to enrich themselves in the process.
After the dot-com bubble, it was property prices that went up and up. Not only do we have the richer first recipients of new money benefiting at the expense of the poor, we have a massive mis-allocation of capital to “boom” industries that can only be sustained so long as we keep the new money creation growing.
Our present monetary system is both unethical and wasteful of scarce resources. We do not let counterfeiters lower our purchasing power, and we should not let governments and bankers do it.
Phase 2: Bush & Brown – private debt nationalised by the Sovereign
This flood of new money brought more marginal lending possibilities onto the horizon of the bankers.
They devised a range of exotic products whose names are now familiar: CDO, MBS, CDO-squared, Synthetic CDO, and many more — all created to get lower quality risk off the issuing bank’s balance sheet, and onto anyone’s but theirs!
In 2007/2008, bankers started to wake up to the fact that everyone’s balance sheets were stuffed with candyfloss money, at which point they suddenly got the jitters and refused to lend to each other. As we know, bankers are the only people on the planet who do not have to provide for their current creditors; they can lend long and borrow short. Thus, the credit crunch happened when the demand for overnight money to pay short-term creditor obligations ran dry.
Our political masters then decided that we could not let our noble bankers go bust; we had instead to make them the largest welfare state recipients this world has ever known! Not the £60 per week and housing benefit kind for these characters, but billions of full-on state support to bail out their banks. They failed at their jobs and bankrupted many, but they kept their jobs with 6, 7, or 8 figure salaries!
Bush told us that massive state intervention was needed to save the free market. Brown said the same. We were told that there would be no cash in the ATMs and society would most certainly come to an end if heroic action was not taken to “save the world”, as Brown so memorably put it (though he seemed to think he had accomplished this feat singlehandedly). Thank God for Gordon!
Now in Iceland, a country I was trading with at the time, their banks did go bust; no one could bail them out. But within days the Krona had re-floated itself and payments continued; within weeks they had a functioning economy.
Within days the good assets of Lehman Bros had been re-allocated, sold to better capitalists than they.
But with these notable exceptions, socialism was the order of the day. Bank’s inflated balance sheets were assumed by sovereign states. Like lager louts on a late night binge, after a Vindaloo as hot as hell itself, heads of government seemed to care little for the inevitable pain that would follow, as states tried to digest what they had so hastily ingested. Indeed, the failed organs of the nationalised banks survive only on life support, enjoying continuous subsidy through the overnight discount window.
But the sovereign governments, under various political colours, had a history of binging. In our case the Labour Party spent more than it could possibly ever raise off the people in open taxes, and the Tories offer “cuts” which in reality mean that the budgets of some departments will not increase as quickly as they were planned to.
Phase 3: King Canute, sovereign default
Default is the word that can’t be mentioned. In reality, we should embrace default. This debt is never going to be repaid. Never, that is, in purchasing power terms.
S&P ratings agency have hinted at this with the recent US rating downgrade. They know the American government can always mint up what it needs so long as it has a reserve currency. They also know that this is a soft default. In real terms, people seem likely to get back less than they put in.
Hard default should be embraced by the smaller nations like Greece and Ireland, so they can rid themselves of obligations they cant afford to pay. This will be good for taxpayers in the richer countries of Europe, as they will no longer be bailing out those who foolishly lent to these countries. It will be good, too, for the debtor nations, as they can remove themselves from the Euro and devalue until they are competitive again. They will, however, need to learn to live within their means. Honest politicians need to come to the fore to effect this.
Yes, this will be painful and the people who lent these profligate and feckless politicians the money will get burnt.
However, the FT has recently seen prominent advocates for a steady 4%-6% inflation target. This is the debtors’ choice and the creditors’ nightmare, with collateral damage for those on fixed or low incomes, for the reasons mentioned above. Should we let the Philosopher Kings have their way?
“Let all men know how empty and worthless is the power of kings. For there is none worthy of the name but God, whom heaven, earth and sea obey”.
So spoke King Canute the Great, the legend says, as waves lapped round his feet. Canute had learned that his flattering courtiers claimed he was “so great, he could command the tides of the sea to go back”. Now Canute was not only a religious man, but also a clever politician. He knew his limitations – even if his courtiers did not – so he had his throne carried to the seashore and sat on it as the tide came in, commanding the waves to advance no further. When they didn’t, he had made his point: though kings may appear ‘great’ in the minds of men, they are powerless against the fundamental laws of Nature.
King Canute, where are you today? We need honest politicians and brave men to step forward and point out the folly of trying paper over the cracks. Unless banks write off under-performing (or never-to-perform) securities from both the private sector and the public sector, we will progressively impoverish more and more people.
Let better business people buy the good assets of the bust banks, and let them provide essential banking services.
Let the sovereigns that can’t pay their way go bust and not impoverish us any further with on-going bailouts. In all my years in business, your first loss is always your best loss.
Yes, this will be painful. Politicians, fess up to the people: you do not have a magic bullet and you can’t offer sunshine today, tomorrow and forever.
I fear that if we do not do this, we approach the end game: the total destruction of paper money. Since August the 15th 1971, paper money has not been rooted in gold. It is the most extreme derivative product, entirely detatched from its underlying asset. Should the failure of this derivative come to pass, we will have to wait for the market to create something else. Will we be reduced to barter, as the German people were in the 20s?
A process of wipe out for all will be a hell of a lot harder than sensible action now. It is still not too late.
By Gordon Kerr, on 30 August 11
Warren Buffett is the most successful investor on the planet and a very smart fellow. His core team also gave me a job in October 2000 at GenRe Financial Products, and I have always held him in high regard.
He has invested $5 billion in Bank of America on 25th August. But was the Wall Street Journal correct to headline the deal a “Vote of Confidence” in the bank?
My analysis is based purely on the facts presented in this weekend’s WSJ.
In return for his $5bn cheque, Buffett will receive:
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Preference shares bearing a ‘coupon’ of 6%. Technically, preference coupons are dividends; the payment can only be made out of profits. Allow me nonetheless to use the term ‘coupon’ in order to compare the risks and returns of this deal with a bank deposit. The structure here is as close to a coupon as preference share terms allow. Even if the bank experiences a choppy ride, so long as it survives and returns to profit at some future point, any unpaid dividends in loss making years are payable under a contractual cumulation provision.
- Warrants (these are options to buy shares at a pre-agreed price) over 700 million shares of BofA common stock at a strike price very close to Thursday’s share price. The WSJ values these warrants at about $3 billion. Assuming that is correct, Mr. Buffett could either sell them for $3 billion or retain them as he sees fit.
- The deal is not even Tier 1 equity for BofA and is considered expensive ‘bridge financing’ . However, Mr Buffett has secured a 5% penalty charge ($250 million) should BofA redeem the preference shares.
Short term deposit rates are 1% or less in US banks. On this basis, the deal can be characterised as a net investment of $2bn at a coupon of 15% (5/2x 6%). This equates to about 15 times the return on cash short term deposit accounts. Similarly, the redemption premium becomes not 5% but 12.5% of net invested funds.
Let us consider the ranking of the investment in a potential liquidation of BofA. Secured creditors of the bank take precedence over depositors. Preference Shares rank below depositors but above common equity. And yet banks have pledged so many assets to each other via repo and “failed sale” transactions that who can tell how much quality collateral could be viewed as actually supporting the deposit base?
Bearing in mind the recent history of western Bailouts, consider the following range of possible outcomes:
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BofA survives and thrives. Happy days for all stakeholders, excellent return for Mr. Buffett;
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BofA fails. Either there are enough assets in liquidation to redeem deposits or depositors are rescued by a possible Heurta De Soto or Baxendale plan or fresh taxpayer bailout;
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BofA fails and (2) above extends to pay off unsecured creditors but not preference shares;
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BofA fails and preference shareholders are covered by (2) above;
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BofA fails and (2) above extends to protect common shareholders.
Politicians have rarely breathed the words “moral hazard” and “perverse incentives” when they are actually engaged in formulating the bailout package, so outcomes (4) and (5) cannot be completely dismissed, but surely they are unlikely.
But how likely are outcomes (2) and (3)? I just cannot see how governments can attempt a second bailout given that Ireland is now on its fifth. But I don’t know. I suspect Mr Buffett does not know either.
Mr Buffett, like the rest of us, knows that the banking system is in a critical state. Yet like many of us he has a problem: we all need to keep some cash in banks. When you have the quantum of funds under management that he has, you can forget about deposit insurance.
What a smart deal he appears to me to have made. A good chunk of the cash element of his investment portfolio can be parked at a fixed coupon of 15% for the foreseeable future.
Either paper money collapses, in which case all of his cash funds are in turmoil, or there will be another rescue attempt, or hyperinflation, or QE 3,4,and 5 or some ‘unknown unknown’ attempt to prop up the banking system. It is possible that a future rescue might specifically wipe out common and preference equity, and so Mr Buffett’s is seeking a huge upside against the risk of that specific downside.
So what of the headline? I concede that he picked BofA rather than another US megabank, but it is still rather a stretch to term this a “Vote of Confidence” in BofA.
By Toby Baxendale, on 15 April 11
The Interim Report on our banking system by Sir John Vickers was released on Monday. There is no mention in all of the report that a banker is a fiduciary to his client first and foremost. Call me old fashioned, but the casino banking of “lets place our bets” (of course with other people’s money) is now the vogue.
I submit that on the strong foundations of the fiduciary relationship sits a solid and sound banking system. Until we understand this, we are just tinkering around the edges.
Professors Kevin Dowd and his co-author Martin Hutchinson remind us of the partnership roots of banking and how this kept bankers from being too risky, and focused them on the long term needs of their clients, to whom they had open ended liability. Fiduciary or not, this forced honesty in the system.
A fiduciary duty is a legal relationship between one party, the principal, who is dependent on the better knowledge and judgement of the person he trusts, the fiduciary. This relationship exists between the doctor and the patient, the teacher and the student, the lawyer and his client, the accountant and his client and yes, the banker and the client. A fiduciary duty is the highest form of duty for you to dispense advice, offer services and do business. Your clients’ interests are above your own. You must avoid conflicts of interest, and you must only profit from your transactions so long as your client is aware of this. This is contrasted with the ordinary tort duty of care required when individual parties act only to avoid harm to others.
When you deposit your life savings with another party such as a bank, you are not requiring just reasonable tort standards of care, but absolute standards of car, i.e. fiduciary standards. Nothing can replace lost savings set aside for retirement. The banker has an enduring obligation of fiduciary care.
Now, in a modern bank from the very outset we have confusion. Its raison d’être, after providing safety for your money, is to offer to intermediate deposits to pass them through to where they are demanded, to willing borrowers of the bank. We are told by the majority of our bankers that the money in those deposits is ours. In reality, as recognised by law, a deposit is a debt from the bank to the depositor. This comes as a surprise to most, as evidenced by our Cobden Centre survey on banking. Some would say that this is fraud. I would say this is negligent misrepresentation. The latter requires only a false statement of fact being made to induce a party into a contract, which I submit is what actually happens when you go to open a bank account. Most offers of opening a bank account make no reference to the fact that you are becoming an unsecured creditor to the bank. This is a critical point, as most people are very shocked at this revelation. I am amazed that even after the total collapse of the banking system, the majority of people still think that their money is in their bank (and safe!). We have discussed on this web site before how there never is any mention of what you are actually legally getting involved with when you enter into an act of depositing or savings with a bank.
A group of us have tried to make matters very simple and clear up this confusion by supporting this Bill in Parliament. By requiring a distinction between deposits for safe custody and deposits for lending, we have cleared up some confusion in the banking system and laid the foundations for a solid system to grow and flourish.
The banker as fiduciary can then act in your best interest with your money kept aside for safe keeping and instant access, and investing the money you have allocated for lending, thus earning you interest. An honest fiduciary would then advise you according to the time-frame you choose for the investment, and your appetite for risk. You could invest in different parts of the bank to reflect this time and risk profile. At all points in time the bank could pay its safe-keeping deposits out, as they sit in the vaults as cash. Should some of the assets of the banks (the loans) turn bad, it is the liability of the partners, not the current account depositors, still less the taxpayers.
A fractional reserve bank, be it state-supported as they are today, or even a free one as some readers of this site advocate, could never guarantee this all the time. Thus they are immoral and thoroughly dishonest if tested under the fiduciary standard. A fractional reserve free bank could well exist with full disclosure as to the nature of the arrangement, but I would suggest this is not a fiduciary relationship. It implies reasonable standards of care, not absolute standards. This must be the case as the fractional reserve free banker can never say to you with certainty, “you can have all your money back when you demand it”. Only the fiduciary 100% reserve banker can. A fractional reserve free banker can say “with the law of large numbers, I am pretty sure I can guarantee you your money back, but never all of my deposits at the same time”.
That may well be fine for large numbers of people. Not for me. A humorous look at the mislabelled “Fidelity Fiduciary Bank” in Mary Poppins reveals the inherent contradictions. A boy does not want to deposit his tuppence, preferring to spend it on feeding the birds. The bankers attempt to persuade him to part with the money, eventually grabbing it from the boy. Other customers are concerned, and demand their own money back, with a chain reaction leading to a run on the bank.
To found a system of money and banking on such fragile foundations does seem insane to me. As I have said, the first step is to clarify the law with regards to the legal status of the banker and the client.
The establishment of the banker as a fiduciary is the next step in the reform process. This does not mean a banker can never earn anything other than a wage, like a law firm or an accountancy firm. They can always run their business in the most efficient manner, and thus profitably. They would only be forbidden from profiting at the expense of their clients.
Address these issues and we may well move towards an unregulated and honest money-orientated banking system that is wonderfully boring and fit for purpose. I see nothing in this Report that addresses those issues.
By Steven Baker MP, on 14 April 11
Let us establish some principles first. Central banks do indeed pose a risk to economic stability but not because their monetary policy is constantly too tight but because is it systematically too loose. Inflexible commodity money – such as gold and silver – has everywhere been replaced with state-issued fully flexible paper money under the control of central banks for one reason and one reason only: so that the supply of money can be constantly expanded in accordance with politically defined goals (such as a certain growth rate, a certain inflation rate, a certain unemployment rate….and constantly expanding bank balance sheets). Today’s consensus believes the following: When inflation is low and thus not an imminent threat, the central bank should ‘support’ economic growth via low interest rates and a moderate expansion of the money supply.
Wrong.
This is precisely the dangerous fallacy that made the dramatic events of the past four years ultimately inevitable. Yet, nobody seems willing to learn the lesson.
Constant expansion of the money supply and the persistent lowering of interest rates below the levels that would be justified by available savings – the raison d’etre of paper money and central banking – lead to misallocations of capital. Always. This – and not higher consumer price inflation – is the most immediate negative effect of monetary expansion. Today’s consensus is, sadly, still obsessed with CPI inflation (CPI= consumer price index). As long as monetary expansion doesn’t lead instantly to a higher grocery bill, the mainstream considers it a welcome boost to growth and practically a free lunch. This is a gross misconception, and this misconception is in essence still behind most of the commentary on monetary policy today. And it was again on display in the debate about the ECB’s recent move.
You can read Detlev’s superb article in full here but beware: he believes “that a collapse of the paper money system is practically inevitable”…
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I am an artist and serial entrepreneur, and I, like many, have been pillaged and plundered by the United States government. Heckle Sketch is my latest means of satirically venting frustration while communicating important messages about freedom and free market capitalism that are lost to the majority. The majority includes a government which was founded on such principles.