Sunday, 12 October 2008

Stupidity, theft and incompetence

Warning, this is likely to be a rant, but I hope an informed one.

Our leaders, political, financial and hereditary, have no ability to deal this the current economic crisis. This is obvious from their statements and purely reactive behaviour. They do not understand what is going on, let alone how to solve it. This is my analysis of what is going on, followed by my recommendation for the way out.

Fractional reserve banking is the problem. It allows the generation of pseudo money by those to whom it is entrusted. The banks take in a 1(insert your currency unit here) and mark it as yours in their books and then promptly lend out roughly 87.5% of it. This is credited to someone else's bank account, who then pays it to a third party. The bank takes in 0.875(insert your currency unit here)... OK the net effect is a multiplier effect of eight to one, so every (insert your currency unit here) that is issued by the state becomes 8 by the time the process is finished. Now the cash money supply has been growing spectaculaly for quite a long time. This means that money has been being generated at a spectacular rate. Meanwhile, back at the exchanges, people have been putting huge nominal values on their shares. Remember, until these shares are sold this money is not realised. So the people holding the shares think they have something that is valuable. This is not normally an issue, but consider the following...

British Airways announced a pension deficit of £1.5 billion, as I write this, its market capitalisation is £1.2 billion. I think this means it is bankrupt. Worse, this deficit is probably much worse than this as much of its pension fund is in shares. This probably applies to a substantial proportion of the stock market.

What is the reaction of our leaders to this type of problem? To buy or prop up the banks. They won't say this, but they are electronically printing the money to do this. The UK government, for example, has waved around £500 billion saying that they will use that much money to support the banks. By my estimates this is around one-quarter of the entire M4 money supply! If you listen to them they are saying that they are 'borrowing' it. I simply do not believe them - why? - because one of the problems at the moment is that no-one is lending money. If they are borrowing it, it is from the future. Now, remember that 8 times multiplier. By the time that comes into play, they have offered to almost triple the money supply. At the moment, the banks are asking for around £35 billion. Just multiply that by 8 and that is about one-tenth of the M4 money supply. To put this context, it is almost two-thirds of the cash money supply (M0).

This is going to cause inflation, at the best, and at the worst we could be on the edge of the government just keeping on printing money. Why is this a solution for them? Well, if we have a serious bout of inflation the following happens...
  • Debts effectively reduce;
  • House prices can rise again (though slower than the rate of inflation);
  • Money purchase company pensions schemes are saved.
Winners - Those with debts.
Losers - Those with savings or on fixed incomes.

This is incredibly risky. We could end up with a stagflation, where the economy is stagnant (or shrinking) and the value of the currency falling. Alternatively, it could fail to restart the economy, and we enter a period of deflation. What does this mean?
  • Debts effectively increase;
  • Repossessions rise as house prices continue to fall;
  • Money purchase company pensions are doomed.
So, what would I recommend?

The whole game is flawed. It is inherently unstable and unsustainable. We have to change the rules of the game. If I were in charge, I would...
  • Move towards an agricultural society.
  • Move to a co-operative rather than corporate business model.
  • Devolve decision making.
  • Require banks to become mutual societies.
  • Reduce demand for everything.
  • Evaluate decisions on a 1,000 year time scale, not a 4 year one.
We must move towards only doing those things we need - we cannot have a society that encourages greed and consumption, we need one that encourages happiness.

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