Monday, August 19, 2013

And the Bankers Shall Inherit the Earth

The book "Localism, A Philosophy of Government" says that "The American Middle Class finds itself working harder, but is being systematically stripped of its wealth by a financial system which was designed for that purpose."

It's a bold claim, but no less true for its boldness.   If one looks at the big picture, the present financial system can have no other outcome than this: The big banks and entities closely connected to the government will own the entire world, leaving the rest of us with nothing but the debt they used to acquire it.

When economies were booming, such booms being amplified by easy-credit, the banks leveraged to the moon, 30-1, 40-1, even 100-1.  This allowed them to buy up massive amounts of financial assets.  Leveraging 100-1 is a powerful way to increase one's wealth so long as asset prices are rising.  The risk of course, is that if those prices ever fall, the leveraged person or institution will be wiped out.   This is just what happened, except that under our present financial system, the bad assets were off-loaded onto the books of the taxpayers at above-market prices.   This process is ongoing in the current "QE". At least half of all QE's to date have gone to foreign-owned banks.

In our debt-based fiat system money is created, and a debt instrument is used to back that money.  In boom times it is loaned to the banks who then leverage to the moon and buy up assets.   The only thing that restrains them is the thought that if they over-leverage then the slightest decline in asset values leaves them insolvent.   That restraint has now been removed from the system for the large "too big to fail" banks.

Now in bust times, the government does two things with the newly-created money.  One thing it does is "stimulate" the economy by directly spending money into that economy.   Of course this does nothing on the net.  All it does is take future consumption and move it into the present, subtracting out potential future growth in order to try and get growth now.

That strategy seems to work, until the "future" becomes the present.  Each time that trick is tried it has less effect because at some point any "gain" from the stimulus must immediately be consumed by paying off old debt, either in interest payments or reduction of principal.  It therefore does not produce any new growth into the economy.  This is sometimes referred to as debt "overhang".  Since government spending is dictated by politics, not market realities, the spending by government is always less efficient than private interests spending their own money.   That loss of efficiency represents capital destruction at each cycle of the loop of government borrowing for "stimulus".

Where does this policy eventually lead?  To an economy where government spending is the prime mover.  The money is created via debt and spent into the economy by government action, benefiting most those persons and entities most directly connected to government.  The government becomes the economy as the private economy, the one driven by the reality of market forces, is first deformed and then sucked away by the phony government-created economy.    In the end people will be paid by the government, and then pay the government.   The economy will be compacted into an ever tighter circle.

But the ones who do best in this system are the big banks.   In a debt-based fiat system each time the central bank issues new debt, it is purchased by someone, often the "primary dealers".    Due to QE, when the Fed is not buying the big bank's bad debt, they are buying back the U.S. government debt which they just sold the banks- at a small profit for the banks on each iteration of the cycle.   The government creates the debt, sells it to the banks for a price, but then buys it back from them at a higher price sometimes only a matter of days later.

This is a proxy for the out-right printing of more money, which is done in a non-debt based fiat currency system.    In our system the banks get to stand in the middle and take a risk-free cut of the new money that is effectively being created.  The faster we buy back our own debt the faster the banks make money.  The big banks simply can't lose in this system, nor can, on average, the rest of the economy not connected to the government win.    Over time, they will own everything.  The rest of us will own nothing.  

But you may be thinking, "well I see that the big banks do get an essentially endless supply of free money in this system, which must be at the expense of the rest of us because their new dollars suck value from our old ones, but it is still possible for the big banks to lose if they invest foolishly.   If they leverage 50-1 then only two percent of their investments must go bad in order for them to be wiped out.  Because of that, you can say that they system is designed to help them, but you can't say that they can't lose or that over time they will have everything."

You might be right if the Fed was not also committed to bailing out the big banks when they invest foolishly.   But they are committed to it. That is what the QE's are all about.   They will lay as much debt on the taxpayers as is necessary in order to buy the bad bets that the banks made at above-market prices, while the banks keep all the winnings from their good bets.  Why is the government doing this?  The official reason this is being done is on the grounds that the banks are "too big to fail".  That is, if they collapse then everybody they owe money to will also collapse, leading to a chain reaction of collapses in an over-leveraged system.

Let me be clear, the solution to leverage that threatens the world economy is to limit leverage, not implement moral hazard as policy by rescuing the over-levered from the consequences of their own greed.  And the solution to a bank that is 'too big to fail" is not to bail it out, it is to break it up into pieces that are not too big to fail.    Since these same banks own both parties, you have not even heard a murmur about this option.   I can remember when "Ma Bell" was broken up because the government decided she was a monopoly in telephone service.   If that was a threat big enough to break up a company, how is it possible that these banks, which are essentially holding the taxpayers hostage, should not be broken up?

If they can leverage to the moon and keep the profits from their acquisitions when things go good, but get bailed out by the taxpayers when things go bad, why not keep leveraging, and keep gambling?    When the stream of essentially free money they get from debt and debt buybacks gets bigger when government spends more, why shouldn't they encourage government to spend more?   Again, our present financial system can only have one outcome:  The big banks and entities closely connected to the government will own the world.  They will own everything.   You and your children will own only the debt they created to buy it all.   In a debt-based fiat currency, the citizens are the collateral.   We will either change the system to one more like that proposed in "Localism, A Philosophy of Government", or we will become a nation of serfs.   Once one sees the big picture, this becomes less a prediction and more a simple statement of fact.

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