Enlightened Economics

Economics for an Enlightened Age

Posts Tagged ‘central banks’

• Banks’ Cheap Money is Economic ‘Poison’

Posted by Ron Robins on March 13, 2011

By Ron Robins. First published March 10, 2011, in his weekly economics and finance column at alrroya.com

Developed world bankers continue to proclaim that enforced low interest rates—cheap money—will lead their countries back to economic prosperity. But didn’t the same policies a few years ago help bring us to the precipice of financial and economic collapse? Do they still not understand that cheap easy money led to many large US and European banks becoming gambling institutions, eventually failing and bailed out at taxpayers’ expense?

And above all, that cheap easy money enticed people, companies and governments, to become horribly indebted, with many individuals and companies failing. Soon, even developed country governments may go bankrupt. As proof that cheap easy money is again causing extraordinary economic problems, just look at where some of it is now going—to the commodities’ markets. There, it helps inflate food prices, thus causing starvation and food riots around the world.

Do the bankers not read history and know that artificially induced cheap easy money can be economic poison?

Of course one simple reason that many bankers advocate cheap easy money is that it makes them a lot of money. When they can—as they did for many years and still seem able to do—‘leverage-up’ their assets in relation to their equity, they can make multiples of profits compared to before. And since, often courtesy of their benevolent central bank, they can frequently borrow at nearly free rates and ‘invest’ those proceeds in bonds/securities/commodities that often offer high potential returns, it is possible for them to make ever bigger profits.

For most large US and European banks, their assets frequently exceeded their equity by 20 to 60 times before the financial crises. That is, keeping it simple, they were somehow able to leverage every $1 of equity, usually by borrowing funds, to create $20 to $60 of assets! The risk in such high leverage is that a small loss in asset values of say, just five per cent, could wipe out their equity and cause insolvency and bankruptcy.

Unfortunately, very high leverage ratios continue in many developed countries’ banking and financial institutions. (Perhaps this is the real unspoken reason for cheap money: to inflate asset markets to keep the banks semi-solvent! Though, that topic is for another post.)

Therefore, the real story is the culture of leverage and risk that numerous developed world banks now embody as a result of easily available cheap money. This is in contrast to that during much of banking history when money was regularly relatively expensive (with higher rates of interest) than today and often difficult to obtain.

The easily available cheap money encourages enormous ‘moral hazard’ among bankers and all players in the financial system. Moral hazard denotes a lack of morality and a carefree greed mentality that produces excessive speculation. It is this attitude that promotes the creation of maximum leverage and the taking of big risks—and not caring too much about any potential losses as they are covered by others. Bankers under the influence of moral hazard are like addicted gamblers who cannot stop gambling. But the gambling is not at the card table. It takes place in their boardrooms and trading desks.

And fortunately for the bankers they can enjoy their moral hazard largely at the expense of taxpayers. As we know, much of the potential and accumulated massive losses in the US and European financial and banking systems have been transferred to governments and central banks. The US and European governments and central banks make light of these burdens saying that as their economies recover these losses will be greatly reduced. However, the ‘central bank of central banks,’ the Bank for International Settlements (BIS), has issued new global bank regulations (Basel III) that—if implemented—might reign in some of the excesses associated with moral hazard.

Of course not all banks speculate or gamble to the same extent. In Islamic banking, spiritual and ethical considerations greatly restrain speculation. Also, for instance, Canadian banks adhere to more conservative principles and are better regulated and so have not suffered the same fate as that of many of their US and European rivals.

For now though, cheap easy money is seen by bankers as our economic salvation. And it inflates global markets, including those related to food and energy. As their prices rise, the unforeseen repercussions of the bankers cheap easy money ‘poison’ assists in creating starvation, food riots, and political upheaval around the globe.

Furthermore, the continuing high leverage, moral hazard, and gambling tendencies within the banking and financial system assures that some of today’s ‘good’ investments will sour and suffer large losses. Will the taxpayers again assume those losses? If not, then what? Until the cheap easy money poison is banished it continues creating conditions for even bigger economic and social catastrophes in the years ahead.

Copyright alrroya.com

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• Gold and Silver Rise Again as History’s Chosen Currencies

Posted by Ron Robins on March 13, 2011

By Ron Robins. First published February 25, 2011, in his weekly economics and finance column at alrroya.com

Gold, “the ancient metal of kings,” is reasserting itself as the currency of choice as it has done again and again since the earliest of human times. In our modern era, as central banks and governments fight to devalue their currencies to gain purported trade advantages, gold rises in value against them all. And central banks are buying gold again amidst serious doubts as to the size of some of their real physical gold holdings. Silver too is experiencing a similar re-emergence. The reasons for gold and, to a lesser extent, silver acting as currencies, are easy to understand.

Gold’s history as a currency extends back thousands of years. The western world’s first known standardised minting of gold currency took place in 564 BCE by King Croesus of western Asia Minor. However, it is also believed that China in the fifth and sixth century BCE, minted the Ying yuan gold coin as well. In the great Gupta Empire of India, from 320 to 550 CE, gold coins were used throughout its domain. And in the early Islamic world around the time of the Prophet Muhammad, the gold dinar coin led as its currency. In Europe, gold coins became an important or central monetary unit for the Greeks, Romans, Venetians, Dutch, Spanish and British.

During approximately 1870 to 1910 all major countries linked their currencies to gold, thereby adopting the gold standard. However, China was the exception preferring a silver-based standard. The first silver coins are reported as being minted by King Pheidon of Argos around 700 BCE.

Gold and silver have historically asserted themselves as monetary mediums due to their intrinsic value. They are consistent, divisible, durable and convenient, and they are nobody’s liability.

Unlike paper money, gold, particularly, has proven itself in maintaining its value over many centuries. The World Gold Council (WGC) says that, “since the 14th Century, gold’s purchasing power has maintained a broadly constant level… an ounce of gold has repeatedly bought a mid-range outfit of clothing… in the fourteenth century… in the late 18th century and… at the beginning of this century (2000 to 2008)… On the other hand, the US dollar that bought 14.5 loaves of bread in 1900 buys only 3/4 of a loaf today. While inflation and other forces have ravaged the value of the world’s currencies, gold has emerged with its capacity for wealth preservation firmly intact… [whether] in the face of financial turmoil… [as] a crisis hedge… [or] as an inflation hedge.”

Since their origins, central banks have realised the importance of gold, and sometimes silver, as a strategic part of their reserves. Commenting on the rapidly rising price of gold, Alan Greenspan, former chairman of the US Federal Reserve, said in a Bloomberg report on September 9, 2009, that, “[the rising gold price is] an indication of a very early stage of an endeavor to move away from paper currencies… What is fascinating is the extent to which gold still holds reign over the financial system as the ultimate source of payment.”

And this is also because, “[the central banks] no longer trust each other… [and] there’s this perception that different countries are trying to weaken their currency in order to get a competitive advantage,” said Francisco Blanch, head of global commodity research at Bank of America Merrill Lynch at a New York City November 2010 conference, reports Fastmarkets. Among the countries whose central banks are increasing their gold reserves are China, India, and Russia—all countries with mammoth trade surpluses and foreign exchange reserves.

However, as throughout history, he who owns gold and how much he owns is often shrouded in secrecy. For a central bank, covertly selling and buying of gold and its currency can be used to secretly manipulate the value of its currency. Some indirect proof of this comes again from Mr Greenspan during testimony to a US Congressional committee in 1998. He remarked that, “central banks stand ready to lease gold in increasing quantities should the price rise.” Therefore, declaring the precise gold holdings of a central bank might be akin to giving away ‘trade secrets.’

Central banks worldwide supposedly hold around 30,000 tonnes of gold, perhaps 20 to 25 per cent of all the gold ever mined. But true independent verification of their holdings is not available. The US based Gold Anti Trust Committee (Gata) has compiled extensive and critical information concerning western central bank gold holdings. Their information and that from other sources suggests the actual physical gold holdings of some western central banks could be 30 to 50 per cent lower than publicly reported.

As an example, the US boasts official gold holdings of 8,133.5 tonnes. However, it is known that some, perhaps a significant portion of these holdings, have been leased out to various financial entities and might not be returned without huge financial losses. Ron Paul, the chairman of the influential US Congress’s Domestic Monetary Policy Subcommittee of the House Financial Services Committee, is so concerned about such activities that he is calling for a full public audit of US gold holdings.

Additionally, gold is possibly set to play a reinvigorated role in the international monetary system. The International Monetary Fund (IMF) as well as most members of the G20 are seeking alternatives to the US dollar as the world’s principal reserve asset. And in this regard, gold—perhaps silver too—could be included in a basket of currencies and commodities that create the basis for a new international unit of exchange (currency).

Moreover, an RBC survey of global financial executives and business leaders reported on Yahoo! Finance on February 3 that “just 52 per cent of respondents expect the dollar to be the world’s currency in five years,” and that “gold is coming back as a reserve currency ‘of sorts,’” says Marc Harris, head of global research at RBC Capital Markets.

Probably since the beginning of civilisation, gold especially, but silver as well, have served as monetary vehicles. Gold has demonstrated itself to hold its value over centuries and in many diverse cultures. And despite today’s sophistication with paper money, gold is still seen by central banks as the ultimate source of payment. Concerns are growing that the real physical gold holdings of some major central banks might be substantially lower than they have reported, and as they unabashedly devalue their paper money, gold and silver rise once again as history’s chosen currencies.

Copyright alrroya.com

Posted in Banking, Economics, Finance & Investing, Gold & Precious Metals, Monetary Policy | Tagged: , , , , , , , , , , , , , , , , | Leave a Comment »

• Severe Debt Scarcity Coming to US

Posted by Ron Robins on December 30, 2010

By Ron Robins. First published December 26, 2010, in his weekly economics and finance column at alrroya.com

If US consumers believe it difficult to borrow now, just wait! In the next few years credit conditions are likely to go back seventy years when private debt was difficult to obtain. Most Americans intuitively believe there is too much debt at every level of society. But the economic and political vested interests do not want them worried about that. They want to give them credit to infinity to keep this economic mess from imploding. The US Federal Reserve’s new round of quantitative easing (QE2) is clear evidence of that. However, Americans are right about their inordinate debt load, and future economic conditions are likely to create a severe debt scarcity.

The principal reasons for the coming debt scarcity are that ‘debt saturation’—where total income cannot support total debt—has arrived, say some analysts; also, the growing understanding that adding new debt may not increase GDP—it could decrease it; and that the banks and financial system are a train wreck in waiting, eventually being forced to mark their assets to market, thus creating for them massive asset write-downs and strangling their lending ability.

The realization that debt saturation has arrived will not surprise many people. But understanding that new debt can decrease economic activity might surprise them. And the numbers illustrate this possibility. In Nathan’s Economic Edge, Nathan states, “in the third quarter of 2009 each dollar of debt added produced NEGATIVE 15 cents of productivity, and at the end of 2009, each dollar of new debt now SUBTRACTS 45 cents from GDP!”

In fact Nathan also shows that for decades, each new dollar of debt produces less and less in return, from a return of close to $0.90 in the mid 1960s to about $0.20 by 2007. One explanation for this is that as societal debt increased it focused disproportionately on consumption rather than productive enterprise, whose return appears greater.

On the subject of consumption, the renowned economist David Rosenberg in The Globe & Mail on August 16 stated that “U.S. household debt-income ratio peaked in the first quarter of 2008 at 136 per cent. The ratio currently sits at 126 per cent, but the pre-2001 norm was 70 per cent. To get down to this normalized ratio again, debt would have to be reduced by about $6-trillion. So far, nearly $600-billion of bad household debt has been destroyed.” This data reaffirms Americans growing aversion to debt, that debt has become too onerous, and is suggestive of debt saturation.

Replacing declining consumer debt is the exponential growth of US government debt. For 2009 and 2010, the combined US government’s fiscal deficits required or require borrowing an extra $2.7 trillion or so. Yet with all that spending—combined with about $2 trillion of ‘money printing’ from the US Federal Reserve (the Fed)—it created only around $1 trillion in increased economic growth!

One may argue that the phenomenal US government borrowings will provide returns far into the future and that the present low economic returns are due to not funding areas with potentially better returns. Some economists say that spending on infrastructure and education provides the best returns. However, with economists such as Nobel Laureate Paul Krugman and numerous others predicting huge continuing deficits for years ahead, and with a Japan-like slump in economic activity, the odds are likely that any new borrowed dollar will continue to provide only poor returns for years to come.

A further, major reason for the coming debt scarcity will be the tremendously impaired financial condition of the banks. The values assigned to many bank assets are fictional according to numerous experts. QE2 is about many things but one of them is aimed at delaying the potential for implosion of the banking system. In 2009, the Financial Accounting Standards Board (FASB) caved in to government and banking industry lobbyists to allow many bank assets to be ‘marked to fantasy’ and not ‘marked to market.’

This viewpoint is best expressed by highly respected Associate Professor William Black (and formerly a senior regulator who nailed the banks during the savings and loan debacle) and Professor L. Randall Wray, who wrote an article on October 22 in The Huffington Post, entitled, “Foreclose on the Foreclosure Fraudsters, Part 1: Put Bank of America in Receivership.” They wrote that, “FASB’s new rules allowed the banks (and the Fed, which has taken over a trillion dollars in toxic mortgages as wholly inadequate collateral) to refuse to recognize hundreds of billions of dollars of losses. This accounting scam produces enormous fictional ‘income’ and ‘capital’ at the banks.”

However, the Federal Reserve may be realizing that it might not have been such a good idea to buy some of these ‘toxic’ securities. Bloomberg reported on October 19 that, “citing alleged failures by Countrywide to service loans properly… Pacific Investment Management Co., BlackRock Inc. and the Federal Reserve Bank of New York are seeking to force Bank of America Corp. to repurchase soured mortgages packaged into $47 billion of bonds by its Countrywide Financial Corp. unit, people familiar with the matter said.”

Also, on November 2, CNBC reported that Citigroup could be liable for huge amounts of toxic security buy-backs as well. “If all four mortgage acquisition channels turn out to be equally as defective… Citi’s liability for repurchases could soar to about $100 billion dollars at a 60 per cent defect rate – and to around $133 billion dollars at an 80 per cent defect rate.”

Clearly, such numbers are staggering. These, as well as many other banks and financial entities, could collapse. Politically, in the present circumstances, it would be difficult for the US government to provide massive new funds to support the financial system. Therefore, it will be up to the Fed to decide what to do.

If the Fed prints ever increasing amounts of new money to try to moderate the financial collapse, hyperinflation could be the result. If it does not print massive amounts of new money, a deflationary depression could be born.

In high inflationary or hyperinflationary conditions, few will want to lend as they get paid back in dollars that are declining very rapidly in value. In a deflationary episode, lending is reduced due to huge loan losses. Therefore, during either, and/or after such events, debt scarcity will be in full force.

Data indicates that American consumers do not want to increase their debt. Debt saturation is occurring, and with it a declining return on each borrowed dollar—even for the US government. Most significantly, the banks and the financial system will probably soon experience a new round of massive real estate related losses and subsequent financial institutions’ bankruptcies. Thus, a new major financial crisis will likely soon engulf America, greatly impairing its lending facilities and creating a severe scarcity of debt.

Copyright alrroya.com

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