Saturday, June 9, 2012

Money (5): Endgame - The End of the Debt Supercycle and How It Changes Everything

Take a look at the chart below, the sovereign debt projections for a few developed countries as a percentage of GDP. This is another eyes popping chart.
Public Debt/GDP Projection (BIS Working Paper

The red dotted line is how it would be if situation remains status quo. The green dotted line is how it would be with serious efforts to cut down deficit spending. The blue dotted line is how it would be with inhumane level of spending cut, like pensions and social services like health care, education, etc.

I first came across this chart from a book:  Endgame - The End of the Debt Supercycle and How It Changes Everything. The authors are no doomsday prophets. This is a very serious book with lots of statistics, charts, historical trends, precedents and a comprehensive survey of the various schools of economics ever put into practice. This is one the most demanding book that I read recently.

The chart below includes private debt.

To summarize - the statistics and trends all lead to a hell of a BANG. The book gave a few possible outcome and possible actions by the various countries, but none is pretty. One thing is sure - these mountains of debt can't be repaid, and most won't be repaid.

The graph below is another way of understanding what the sovereign debt means to the people.

The interest cost is over 250 billion in 2012 for U.S., and is projected to grow to 800 billion in 10 years time. And the annual total tax income of U.S. is only 2 trillion dollars!

The question is ...

Here I would like to explore this phenomena from another angle. 

The Fantastic Growth of the Financial Industry

Size of Financial Assets as Percentage of GDP of the Host Country
Luxembourg2,461% Austria299%
Ireland872% Spain251%
Switzerland723% Germany246%
Denmark477% Finland205%
Iceland458% Australia205%
Netherlands432% Portugal188%
United Kingdom389% Canada157%
Belgium380% Italy151%
Sweden340% Greece141%
France338% United States82%
This is another eyes popping chart. How is it possible for the banking sector to grow to such an enormous size? To give you another perspective - the size of the 3 largest banks in France amounts to over 300% of France GDP. The too big to fail banks has actually increased in size and number after the 2008 meltdown! Now these banks are not only too big to fail - they are too big to bailout!

A note of explanation to those who are not familiar with the banking business. Banks are not into buying and owning real assets like land, houses and commercial buildings. Banks 'assets' are almost exclusively what other owes the banks. In other words bank assets are exactly what the rest of the world owes them.

Now just how much are the banks earning? In U.S. the banking sector profit account for over 35% of all U.S. domestic profits (down from over 40% prior to the 2008 meltdown)! Just exactly what 'productivity' do the banks add to the society to justify such a huge chunks of profits?

It doesn't take an Einstein to see the correlation between the fantastic growth in debt and the fantastic growth of the private banks. Now every country (perhaps except for North Korea) is seriously in debt. We have the grotesque situation where the whole of humanity is owing an astronomical amount of money to a few private banks.


Wednesday, June 6, 2012

Money (4): There are more Debt than Money in our Economy

It turns out that my calculations regarding the Fractional Reserve System could be wrong. One source I came across is stating that 1K of deposit can generate as much as 100K of loans!

Whatever the amount is, for all intent an purposes, the Fractional Reserve Banking allows practically unlimited capacity for the banks to create money. Some countries even abolish the need for reserve. UK is one example.

Now I want to bring you something that will makes you jaw drop.

There are more Debt than Money in our Economy!

I almost fell off the chair when I came across it. How is it possible? How it is possible to be debt free when there is more debt than available money?

I checked a few sources. The basic fact is true, but there is no definitive explanation of how it gets to be so and what it means. Let me try to summarize it here.

Let me bring you back the core fact about our monetary system - over 95% of our 'money' are actually created out of thin air and extended as credit to borrowers. That means that almost every dollar in circulation are borrowed from the commercial banks - and incur interests.

The amount that we borrowed from the banks constitutes our money supply, and the amount that we have to pay back eventually is our debt. The difference between them is the interest spread.

What it means that the society as a whole has to borrow ever larger amount of money to pay back the old debts. The economy can function this way - as long as the banks are willing to continue to extend credit to roll over the old debts. This is like playing musical chair. Everything will appear OK as long as the music keeps playing.

 But it should be clear the total debt will increase at a compounding rate. This is exponential growth in mathematical terms, but in reality defaults do occur, especially during the periodic bust cycle, so the rate of growth will be dampened somewhat.

It should be clear now that our society can never be free of debt. It is a mathematical certainty. Some economists argue that growth in debt is OK as long as the economy is growing at a faster rate. For example it is OK for the debt of a company to grow at the rate of 5% p.a. if the company is expanding at the rate of 7% p.a.

This is one key characteristic of our monetary system - it assumes and demands the economy to grow at an exponential rate. This is clearly an impossibility with real world constraints like limits in natural resources, the decreasing and aging population in developed countries. The periodic boom and bust cycle is inevitable with our current monetary system.

It is clear that the sovereign debt crisis the world is facing now is impossible to resolve without changing the current monetary system. No amount of austerity measure is enough to bring down the debt. The only way debt can be reduced in our economy is via massive defaults, massive reduction of our money supply, and the resulting massive recession.

The way we are trying to solve the problem now is by massive printing of money, in the name of quantitative easing. It is essentially creating more debt and injecting more of the same poison that is killing our economy.

Think about it. Every country in the world (Germany inclusive!) are seriously in debt. Please let me know if you find a country that is not in debt. But just to whom are these money owed to? Something very fishy and very sinister is happening here.

Next: Money (5): Endgame - The End of the Debt Supercycle and How It Changes Everything

Money (3): Money Creation is in the Hands of Private Banks

Over 95% of money in circulation are forms of debt to the commercial bank. Confounded? Disbelieve? Rage?

This is one reason why the ever escalating mountain of debt (government, commercial and private) cannot be repaid. Paying down the debt means reducing the money supply and will trigger a severe recession. It is mind boggling, but it is absolutely true!

There is another factor - all loans carries interest. Try to figure out what this means. I will get back to this point later.

Now I want to bring your attention to a serious consequence of this bizarre banking system that is practiced all over the world:

Money Creation is in the Hands of Private Banks

What does it means to you an me? Please take your time to watch this 20 minutes video clip. Pause and rewind if you need to.

"The privatised creation of money by banks is at the root of debt, poverty, inequality, unaffordable housing. It makes our boom-and-bust economy completely unstable, and is also fuelling the environmental and energy crisis."

The mother of all privatization (piratization!) happened without the knowledge of the world population!

"It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning." Henry Ford

Next:  Money (4): There are more Debt than Money in our Economy

Tuesday, June 5, 2012

Money (2): Money IS Debt

OK - the commercial banks can't simply create money as they like. There are some restrictions. The Central bank requires that the bank keeps a fraction of the deposits as 'reserve'. This is called the Fractional Reserve System.

The reserve is usually very small, 10% - 20%. The Central bank usually adjust the reserve requirement from time to time. You may think - the commercial banks can only loan out 80% of the deposits, that can't be too bad right?

This is the most deceiving aspect of the Fractional Reserve System. Let me show you why. Let say bank A obtained RM 1000 seed money from Bank Negara Malaysia. It can loan out RM 800 of it. Say the customer who took the loan wrote a cheque and buy a wedding ring, which got deposited into bank B. Now bank B can make a loan of RM 640 based on the deposit, and so on.

From RM 1000 of seed money from the Central Bank, the commercial banks can create a further RM 4000 of loans. If the reserve requirement is 10%, the extra loans that can be generated is 10 times the seed money.

Just how much of such money is being created? See the two charts attached, one for Britain, and one for Malaysia.

You may find it hard to quantify the amount shown in the graph. What is important is the exponential growth in the money supply. In both countries the money supply grew 100% in the 7 years leading to the financial meltdown in 2008. The relentless growth in money supply happened all over the world. It is the driving force behind the spectacular growth in share market and housing. Yes, it is the prime cause of inflation! And when it crash, the whole world CRASH together.

The technical name for these commercial bank created money is 'quasi money'. You are right, it is what the name says, they are not real money (which only the central bank can print). In fact, all money hold in the banks as bank balances are quasi money.

But for all intent and purposes, they function as real money. Try default on your house loan and you will know what I mean. From one person taking a loan to buy a house, the seller of the house will see an increase in his bank balance and use the 'money' to purchase further things.

This is the nature of digital money, as opposed to the physical notes and coins you have in your wallet. Any form of monetary transaction in digital form (cheques, bank transfers, credit card etc) can be traced back to a loan with a bank somewhere.

In Britain 97% of money in circulation are commercial bank created money, only less than 3% are physical money issued by the Central Bank. The figure is similar in other countries. In 2011 the total money supply of the world is 50 trillion USD, of which 48 trillion, or 96% are bank created quasi money.

Next: Money (3): Money Creation is in the Hands of Private Banks

Money (1): Ever Wondered Why There's So Much Debt

Ever Wondered Why There's So Much Debt?
Watch this 3 minute video to discover where all these debt came from, and why it can't be repaid...

You may ask how is this possible - if I borrow 500K from bank A to buy a house, the bank will have to remit the money to the seller's bank (say bank B). Where does bank A gets this 500K from?

But bank B will be making loans as well - and some of the sellers will be using bank A. At the end of the day, all the loans from different banks will more or less contra off each other. Whatever tiny amount one bank owes to another will be settled using the Reserve Bank money.

In comparison to the HUGE amount of loans made per day, only a very tiny amount of Reserve bank money is required for this daily inter-banks settlements. In UK where the bank created 'quasi money' has grown to 2 trillion pounds, the Reserve Bank money is only around 60 billion pounds.

HUGE amount of money was created out of thin air this way. 97% of Britain's 2 trillions pounds money in circulation was created this way. It is the same all over the world. The consequences to the society is deep and all encompassing. It will make you revolt if you realize how much it affect our daily life.

Next: Money(2): Money is Debt