You know, I think that Will Hutton may have a point. We may really be coming to the end of the Mad Tea Party:
The emergence of a global banking system means central banks are much less able to monitor and control what is going on. And because few countries now limit capital flows, in part because they want access to potential credit, cash generated out of nothing can be lent in countries where the economic prospects look superficially good. This provokes floods of credit, rather like the movements of refugees.
The false boom that follows seems to justify the lending. Property prices rise. Companies and households grow overconfident about their prospects and borrow freely. Economies surge well above their trend growth rates and all seems well until something – a collapse in property or commodity prices – unravels the whole process. The money floods out as quickly as it flooded in, leaving bust banks and governments desperately picking up the pieces.
The collapse of the real estate bubble in the United States was followed by a similar crisis in the United Kingdom was followed by a similar crisis in the European Union which has finally spread to China and the other major “emerging economies”.
China’s banks are, in effect, bust: few of the vast loans they have made can ever be repaid, so they cannot now lend at the rate needed to sustain China’s once super-high but illusory growth rates. China’s real growth is now below that of the Mao years: the economic crisis will spawn a crisis of legitimacy for the deeply corrupt communist party. Commodity prices have crashed.
Money is flooding out of the EMEs, leaving overborrowed companies, indebted households and stricken banks, but EMEs do not have institutions such as the Federal Reserve or European Central Bank to knock up rescue packages. Yet these nations now account for more than half of global GDP. Small wonder the IMF is worried.
but “inventive responses” by which Mr. Hutton means more aggressive international banks and even greater fiscal stimulus won’t be sufficient. They can’t be. The stagnant economies of the United States and Europe and the floundering Chinese economy are simply too large.
In the final analysis and in the long term economic growth can’t be based on credit. That is after all what Keynes taught. His strategy was strictly a short term proposition in which aggregate demand was made to meet aggregate production. No excess aggregate production no stimulus. A growing economy must be based on increased production. You cannot base a healthy economy on trading hats.
I read that as Will Sutton, and then the mention of banks took on a different meaning.
In the article, Mr. Hutton uses another article for his $3 trillion number in excess credit. Even though their theories failing miserably, both he and the IMF still believe in them, and the problem is that there is not enough control.
It is always the same. The beautiful theories are thwarted because the implementers cannot force enough people to submit to their theory. I will not list them to keep from hijacking the thread.
The linked article is no different than all the other adherents of the failing unsound money theories. They are blaming a not a 0.25% interest rate hike, not a planned 0.25% interest rate hike, and not a potential 0.25% interest rate hike. They are blaming a potential potential 0.25% interest rate hike. Because the US Fed is hemming and hawing over a lousy, uninspiring, meaningless 0.25% interest rate hike, this will be the end of the financial system as we know it.
If there is this much turmoil caused by a potential potential 0.25% interest rate hike, the interest rates must be artificially low, and the rate must be exceedingly low.
On a side note: The article Mr. Hutton discusses how the money from the Fed is being used in other countries.
If Mr.Hutton thinks $3 trillion in excess credit is worrisome, he had better not learn about derivatives. It could be leveraged anywhere between 20 and 30 times, and if it is in China, it could be even higher.
It will never occur to Mr. Hutton that the overabundance of credit is the problem. He will continue to advocate creating more credit to increase the money supply because it has always forced the economy to increase. It will never occur to Mr. Hutton that his plastic steering wheel is just a toy to keep him in the backseat and quiet.
The solution is to confiscate and to outlaw gold and cash. If an individual decides to keep money in a bank instead of spending it, it can be taxed or service charged away. Between the central bank and tax policy, the government will be able to control the economy, or so the theory goes.
As he points out, there are too many central banks and too much government intervention. There needs to be a single world central bank. This will solve all the problems, or at least, the problems he is somewhat aware of today. Good luck getting China to knuckle under.
While all the central bankers will work diligently towards a single world central bank, they will fail miserably. No country wants to relinquish its sovereign power, and no country is willingly going to get screwed. Eventually, regulated unsound money will be reinstated by a country or a group of countries.
Firewalls will be re-established in order to keep any contagion from spreading. There will be howls of “free-market” from certain quarters, but there will be not a peep about sound money. Actually, these people will support every unsound money policy they can find.
As Reinhart (sp?) and Rogoff pointed out, whenever banking rules are liberalized and capital flows are not controlled, we get massive banking crises. Lord Acton remains prescient.
“The issue which has swept down the centuries and which will have to be fought sooner or later is the people versus the banks.”
Steve
There are no amount of regulations that can constrain investment bankers with access to unlimited unsound money. If the regulators had the ability to outsmart the regulated, they would be working on Wall Street. The number of people who would pass up a Wall Street salary for a government salary could fit in my bathroom, and I live in a 1960’s on-slab ranch style house. (It ain’t very big.)
The carnage will be worse the larger the problem is allowed to grow, but all will eventually arrive at the same conclusion. It may take another seven years of the beautiful theories not responding correctly, but it will happen. As with anything else, there will be holdouts.
The fact that we went w/o a banking crisis from the 30s until the S&L crisis, relatively minor, and then the big one in 2008, suggests regulation and governance can make a difference, but you need both. If those governing aren’t willing to enforce existing law, the laws don’t matter. So what I think you see, again referencing R and R, is that there is a crisis, laws are tightened, then things go ok for a while. Eventually the finance sector manages to have controls loosened or have those in power not enforce existing laws, and they create another crisis. This just keeps repeating.
Besides Acton, a couple of other good quotes.
“The ‘sound’ banker, alas! is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him.” — John Maynard Keynes”
“[B]anks have never made money in the history of banking, losing the equivalent of all their past profits periodically — while bankers strike it rich.” — Nassim Taleb”
Steve
What you had was about 65 years (1933 – 1998) of regulated unsound, and for much of that time it was responsibly regulated. Sound money requires little regulation other than laws against fraud. This is because the money is somebody’s real money, and people tend to be a little more careful with their own money.
Unsound is not my money, and it is not your money. It is not anybody’s money. When one is playing with nobody’s money, they tend to not be as careful, and there are no amount of regulations you can implement that will induce responsibility.
Unsound money can be beneficial in small controlled circumstances, but it has been allowed to run rampant. Without firewalls between commercial and investment banking, the money supply and the credit supply merge, and when the investors create leveraged credit, it affects the money supply which affects the economy.
There are no way to create enough regulations to control every hole in the sieve, and for every regulation that plugs one hole, two holes will replace the plugged hole. All the world’s debt based currency that are free floating have interconnected balance sheets. Without a firewall, the currency, credit, leverage, and debt, can move between them almost seamlessly, and there is little that can be done.
So far the theories have failed miserably, but if I understand correctly, a few more regulations are the answer. You can fight it as long as you like, and you can be the last holdout if that makes you feel special. Reality is a cold master, and time is a cruel mistress.
We had banking crises back when money was “sound”. (Note when Lord Acton lived.) Is it more likely to happen when money is “unsound”? Maybe. What I do know is that real world experience shows that when we choose to regulate banks, meaning that we also enforce what is on the books, we have been able to do so successfully. The issue is that bankers are always using someone else’s money. Bankers’ interests don’t necessarily align with those of the banks. As Taleb notes, banks go up and down, but bankers do well.
Look, the finance sector peddles a lot of influence. People look at their donations, but we all know that just touches the surface. Offer Senator X a campaign donation of $50,000 and he votes your way a couple of times. Make sure Senator X gets his kid hired at some finance job pulling down 6 or 7 figures, and you own that Senator.
Steve
There is presently bipartisan agreement not to regulate the largest banks or to allow bankers at those banks to fail even when their banks have.
Banknotes are not sound money, and bad investments are not the responsibility of sound money. With sound money, the money supply cannot be destroyed without physically destroying the underlying asset.
With sound money, a banking crisis is the product of fraud or ignorance. Poor investment choices of financiers are the problem of those who have placed their money in investment banks not sound money. A bank can only lend as much sound money as has been deposited, and depositors are investors.
The bank can issue banknotes, and these can be honored by merchants and other banks. If the issuing bank cannot redeem the banknotes, the holder is out of luck, but that has nothing to do with sound money.
The problems arise when the central bank redeems the banknotes as the equivalent of government currency. Now, the bank can issue banknotes at will, and they are essentially dollars. When these equivalent dollars are used as leverage to create more equivalent dollars, the problems increase before any bureaucrat can devise a regulation.
The equivalent money is nobody’s money, and therefore, nobody is complaining. Unsound money can be destroyed, and when this occurs, it takes down the house of cards it was supporting. This can cause a failure cascade, and unlike sound money, there will be nothing left except for now worthless assets.
Glass-Steagall kept the commercial banking sector fairly stable for about 65 years. We shall see how long Dodd-Frank is able to do the same. I predict it will not be anywhere as long, and when the collapse comes, people will be yearning for those halcyon days of 2008.
The days of unlimited unsound money are drawing to a close. There are those who will be dragged kicking and screaming, but unsound money will be put on a short leash once again.
Dave- The finance sector has been very good at convincing people that banks and bankers are one and the same.
TB- Dodd-Frank didn’t go nearly far enough. Also, the finance sector has been very effective at purchasing expert opinion showing that they had nothing to do with the financial crisis. It was the government. It was poor people. It was China. Bankers? They didn’t have a thing to do with it. Half the country has bought into this.
Steve
The most effective regulations are those that allow the financial sector to reap the rewards of their mistakes and bad decisions while protecting the rest of the economy from the fall-out.
@steve
Dodd-Frank will never go far enough. You will always be regulating the last crisis, but the financial sector will have moved on. They are not going to fight you. They are just going to go over, under or around your roadblocks.
Presently, high yield bonds and ETF’s are the big thing, but I have no idea of how Dodd-Frank addresses them. They will affect the financial sector but not necessarily directly.
Most of what the financial sector does is legal. They are not stupid. The reason that they can get away with blaming something else is because nobody wants to fix the actual cause.
With sound money the welfare state collapse or goes bankrupt. With sound money, the military interventions cease, or the state goes bankrupt. With sound money, lowering taxes means closing civil courts that enforce contract laws, or the state goes bankrupt. With sound money, the liberals, conservatives, and libertarians must pay their way.
Unsound money is like a placebo. Under the right conditions it can be a very good solution, but we do not allow and encourage every drug manufacturer to produce an inert drug labeled as the working version. Usually, these are called counterfeit drugs, and they are deemed bad.
I suspect you are confusing the housing bubble with the financial crisis. The financial industry manufactured credit products using the housing industry products as one of its raw materials, but the financial industry uses its own credit products as raw products for its products.
I doubt it is taught in school this way, but the result is that a financial industry crisis is not dependent upon any specific industry. Some are better than others, but the beanie-baby boom of the 1990’s could have caused a crisis if the conditions were right.
For housing, the GSE’s in the early 2000’s were one of the conditions providing pump priming. Prior to this time, G-S was one of the factors that kept them or anything else from getting housing into trouble. Well, except for the S&L crisis, and that had to do with relaxing …
The financial industry is like a giant industrial shredder. Anything that gets close it will tear into little pieces and repackage to sell for a profit, and they do not care if the little packages have any value other than being little packages created by the financial industry. As the Geico ad says, “If you are the financial industry, it’s what you do.”
In another area of the financial industry, they take little packages and bundle them into big packages to resell for a profit, and they do not care if the big packages have any value other than being big packages created by the financial industry. As the Geico ad says, “If you are the financial industry, it’s what you do.”
I am getting tired and bored, but here is a suggestion. If you want to get the economy moving, you need the financial industry and all the horrible practices you decry. The entire economy is dependent upon them, and it is going to be stuck until a decision is made. The decision is to either keep doing things the way they were being done or tighten up, but you cannot have explosive growth without extreme risk.
If you want to know where to place blame, look in the mirror. The financial industry only does what everybody wants it to do – no more, no less. Nixon needed a way to pay off the war debt. Greenspan wanted to be a hero. Clinton wanted to painlessly expand government. Dick Armey wanted to guarantee his future. Bush, Dodd, and Frank wanted to be the compassionate politicians. Americans wanted the economy to expand as fast as possible.
Everybody got what they wanted. I fail to see what everybody is whining about. The financial industry should be awarded a medal.
What does America want? Fiat money makes it all possible. Free education? free healthcare? Subsidized housing? Free food? Highways? How about all of that for everyone who can run the gauntlet of our borders? Wait, maybe that’s wrong, maybe we need 100 million fallout shelters, maybe the environment is stressed by overpopulation, fund planned parenthood. No, wait, our roads and bridges are crumbling, sewers, infrastructure gone to hell. Yet no, intersex bathrooms, education on gender fluidity. What do I mean? You can do it all, right. No, you really cannot. Money and energy spent on one agenda will not pay for another. And more important, who makes these decisions? Practiced politicians who will promise whatever gives them the reins of power.
Not exactly. Lending makes it possible. You can have a credit-based system with a fiat currency or hard money. There were banks before there was fiat currency.