Our thoughts turned to the issue of whether there is any financial or moral equity in the financial system as we were treated to the pre-release of a very thought provoking film called the Four Horsemen. This film is certainly worth watching when it is officially released and our thanks to Ross and Megan Ashcroft for the kind invite. We found it more constructive in its criticism than films like ‘Wall Street II’ and ‘Inside Job’ (films that are still worth watching though). The producers see their role to ask questions, and focus on the system that we act in as agents, rather than agent (banker/financier) focused finger pointing.
According to our analysis and preferred sources there seems to be precious little capital and/or equity in the balance sheets of too many of the institutions that make up the greater banking system. Perhaps there is also little moral equity in the model of finance we have pursued that has got us here also? What the global public seem to be really struggling with at the moment is how capitalism and the laws of bankruptcy and failure apply generally to us as individuals, but not to the central parts of the financial system. Within this, we find the #Occupy protests misguided and lacking intelligent leadership. What they should really demand is more capitalism, and a version founded on a purer Austrian inspired model.
We perceive a general lack of responsibility that has infected the heart of our monetary and financial system. It seems that in the workings of today’s financial system, the gains are often privatised and shared by a tiny few, but that the losses and costs of government support are very publically shared. Capitalism for the many, but socialism for the financial centre. We also have concerns with the responsibility of the financial authorities and regulators. The political class also play a role, and a key part of the financial system allows them to exercise irresponsibility too. We now face a financial system where vast levels of debt have built up, which Austrians like us perceive to be choking and a burden to growth and development. These debts have built up to a concerning level on the private balance sheets of the banking system and the balance sheets of sovereigns. How to get out of this bind is the question all market participants are concerned with. And, what part of our financial system’s foundations allowed such a situation to develop?
If a typical individual wants to consume beyond his means he needs to supplement his income with debt or live off supplementary capital. However debts cannot be run up forever, as creditors call time on their belief in you as a quality borrower, and personal capital (savings) is not inexhaustible either. If individuals get over-extended in their finances they have to pay back loans, or go bankrupt.
Further if one chooses to speculate, and uses a large degree of leverage in one’s speculation, if our speculative portfolio is betting the wrong way, we need to put up more equity to finance our losing positions or lose our positions and exit the game. However, the banking system seems to hold a position where it holds the wider economy hostage. You can’t let us go bust when we get it wrong with our leverage balance sheets or else you’ll all be doomed. Money won’t flow, ATMs won’t spit bills, food will run out… you know the rest of the story.
If we were urged to crudely jot down who benefits and who loses from the current financial status quo, we would answer thus:
Bankers: when they err they can be bailed out. Politicians: they are able to constantly promise more than they are able to deliver in pursuit of re-election. Ultra-capitalists (who own much of the world’s real and productive assets): are able to access vast quantities of cheap credit to fuel their efforts. Speculators: the opportunities for speculation are far higher when there is price volatility (buy low then sell high, or short sell high and buy back low, is more achievable when prices move significantly). And, central bankers: by having control of a printing press they have access to a monetary nuclear weapon and the source of our primary concern.
Savers and depositors (this is almost everyone): their savings are eroded by stealth by the most pernicious tax of all, inflation. Those living on fixed incomes (retirees and others): their purchasing power is eroded every year buy inflation.
…if you accept our suggestions here it seems rather few are benefitting, but rather a lot are losing out.
How did we get here? Well, we believe that one of the core problems can be distilled to two words: FIAT MONEY. We found it instructive that in the summer of 2010 we saw a high profile steward of the financial system question this construct. Dr Robert Zoellick, President of the World Bank, questioned our current monetary system of pure fiat currencies and sought to open a debate about a sounder unit of account. Zoellick had general monetary concerns, but also specific concerns about the US dollar continuing as the World’s reserve currency. When such an individual at the heart of our financial system questions its foundations, one should take note. Our monetary foundations are considered in the Four Horsemen, with interviews from contemporary godfathers of sound money such as Hugo Salinas-Price and James Turk.
Fiat money is paper money, otherwise known as elastic money, whose supply can be manipulated according to the whims of politicians and the financial authorities. Fiat money allows the authorities to print money they don’t have it to balance their national budgets having over-promised to us ‘sheple’ who always want something for free and vote for hand outs, food stamps, and whatever we think we can get for free.
Fiat money allows moral hazard to all but disappear from the banking system, where institutions can gear themselves up to unstable degrees in the pursuit of greater profits from less capital. If these institutions fail, they can lobby their political allies to print more of this fiat money to bail them out. When bankers play their ‘you must bail us out’ trump card the politicians do not usually have the smarts to see the ‘Mexican Stand-off’ that has developed. Fiat money helps perpetuate this flawed model of highly leverage reserve banking that Mervyn King, the Governor of the Bank of England, last year called the worst possible model for banking.
Fiat money being controlled by the authorities who create it at their need leads to volatile changes of prices (normally upwards). This price volatility is fuelled by a fractional reserve banking system’s ability to create or destroy money. This has allowed our economies to become imbalanced towards speculation and less focused on real world enterprise and invention that creates jobs and real wealth. The nurturing of entrepreneurs is the key to creating growth and wealth. For instance, over the last two decades, SMEs have accounted for close to 65% of new jobs created in the United States.
Fiat money allows ultra-capitalists to build empires often built with debt which is gradually eroded by inflation leaving the capitalist with greater equity in the assets borrowed against.
Fiat money allows the creation of excessive levels of inflation which robs you of your purchasing power every day in order that the authorities can keep perpetuating the status quo.
Fiat money opens the way for systematic irresponsibility.
The problem according to the #Occupy movement is apparently the deadly sin of greed. But so many of these protestors want something themselves for free themselves. Better pensions, better benefits, better this, better that. Greed is part of human nature, and this will not be changing any time soon. We need to look beyond individuals and human nature and focus on the basis of our current system that allows human nature to express its less attractive sides. We believe the main facilitator is fiat money.
What the #Occupy movement need to understand when they engage in banker/financier bashing is that our fiat money and fractional reserve banking system have helped our economies become so imbalanced toward speculation, and our system too burdened with debt that cannot be repaid. Too many great minds have been attracted to finance, and we cannot blame anyone’s profit motive; it is in fact the healthy heart of capitalism. We need to re-examine the system that has facilitated this.
We appreciate the comments from Andrew Sheng, Chief Advisor to the China Banking Regulatory Commission when considering our current financial system:
Why should a financial engineer be paid 4 to 100 times more than a real engineer? A real engineer builds bridges, and a financial engineer builds dreams. When those dreams turn out to be nightmares, other people pay for it.
Has our monetary system not always been like this you ask?
No. We have only been on a pure fiat system since August 1971 when President Nixon closed the gold window at the Federal Reserve. Throughout the course of human history, the market (us acting together) has always tended to choose a commodity backed money. In the majority of cases we have opted to use gold and silver to act as this commodity. In general fiat money systems collapse after an average of forty years due to their inherent structural flaws.
Money needs to be two things:
- An effective payment mechanism for transferring value and allowing easy and free trade
- An effective store of value
How does fiat money stack up?
It is excellent at facilitating exchange, but a shockingly poor store of value due to its inflationary nature. The Austrian school of economics find inflation unacceptable and deems it a form of theft; a redistributive tax from the wider economy to the centre. Fiat money is such a poor store of value because the financial system can manipulate its supply and act irresponsibly and corrupt out money. Inflation is a purely monetary phenomenon. World expert on inflation and money, Professor Peter Bernholz, finds that the seven recorded hyperinflations (inflation of >25%/month) in history all occurred under a paper money standard. All of these hyperinflations occurred in the 20th century except for in post-revolutionary France during the ‘assignats’ experiment.
We need a better monetary unit, a more stable unit of account. Money that is outside of the meddling of politicians and bankers. Money that exists outside of the financial system, and that serves us rather than us serving it.
Sound money is the ultimate enforcer of financial responsibility. Commentators aligned with the Austrian school have sometimes called the gold (and silver) backed money the greatest human achievement. The concepts of liberty, freedom and equality have been associated with sound money. These were the sort of ideals that motivated the founding fathers of America, who interestingly enshrined sound money in the US constitution. Section 10, clause 1, stipulates that no State shall ‘make any thing but gold and silver coin a tender in Payment of Debts’.
We stand at an unprecedented juncture regarding our financial system. Our current model has facilitated imbalances and distortions on an awesome scale. Economic realities are reasserting themselves. We believe we are actually witnessing a crisis, neigh failure, of socialism and its attendant welfare state. Fiat money has allowed socialism a relatively short period in history to trial itself. Fiat money and fractional reserve banking act as a parasite that has almost consumed its host. The Austrians talk of liberty, a small state, and the economic and philosophical keystone of sound money. We leave you with a quote from George Bernard Shaw:
You have to choose [as a voter] between trusting to the natural stability of gold and the natural stability of the honesty and intelligence of the members of the Government. And, with due respect for these gentlemen, I advise you, as long as the Capitalist system lasts, to vote for gold.
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