Wednesday, September 24, 2008


(Week 9 - Wednesday, Sept. 24)

Yesterday I described how the lower courses of the image I am using to describe the fractional reserve formula that governs how banks can create and issue new money (a stone block wall which resembles a sort of tall pyramid) are ostensibly closely linked to the fortunes of the banking system's biggest customers (large corporations, major public entities, and the mega-wealthy). Thick portfolios of "debt"-paper instruments (securities) which supposedly represent wealth (bonds, mortgages, stocks, etc.) are used as collateral for borrowing massive amounts of money into existence, which in turn constitute the base of "reserves" upon which creation and issuance of the "credit money" that constitutes the bulk of the money supply rests (or at least that is how the world of high finance imagines it to be).

The Middle Courses:

Above the base are the middle courses, where we find the bank deposits of the hard-working, bill-paying, family-raising wage earner, small businessman and consumer (i.e. the "middle class"). In real physical and human terms, these folk are the ones who perform the bulk of the wealth-creation work in society. They make their living by growing food, making things and servicing people's needs. Their money in the bank is where the bulk of the pyramid lies. Ultimately all production is meant for consumption, and the "consumer" in this country is effectively synonymous with "middle class". It buys virtually everything that is sold on the market, either directly or indirectly. The personal credit of middle class has been the great engine of monetary growth since WWII. We have truly established a consumer society, and its real and dubious glories have become synonymous with the "American Dream".

The middle courses can generally be thought of as occupying three zones. The first one up (closest to the base) is where the biggest investments in people's lives are financed. The preponderant factor here is home-loan mortgages. This has been seized upon by the banking system as the great engine of "debt"-money creation in the private economy (which is why it is in trouble now). A certain rate of default can be tolerated in this stratum as long as there is enough floating cash or willing credit worthiness in the housing market to purchase homes that enter into default, thereby avoiding any serious disturbance to the continuing escalation of "real estate values." The system itself is soulless, and does not care if a person has a home (to be sure, people in the system may care). It is effectively concerned that there exists enough solvency in the peoples lives, however desperately obtained, to keep its tottering credit pyramid from crumbling.

The next zone up is maintained by purchases for big ticket items and durable goods. This is the level of borrowing for education, high-end vehicles, luxury lifestyles, small business investment, and personal financial "investments." Higher rates of default are tolerated here, but it would have to be very high to pose any threat to the monetary structure.

The top layer of the middle zone up consists of small business and consumer loans for mid-to-minor capital items (economical vehicles, appliances, furniture, vacations). The consequences of loan default at this level with respect to the economy are less severe simply because "credit money" at this level is not supporting much of a credit structure above it. Very high rates of default can be tolerated. Such a phenomenon usually becomes a political problem before it becomes an economic one, as far as the financial system is concerned. Lesser neighborhood banks could find themselves in trouble, but that is not, relatively speaking, a great threat to the monetary pyramid itself. There is always, it seems, another buyer who can step in cover the equity in a repossessed car.

Tomorrow we will talk about the economic trauma increasing numbers of people are living in in the top zone of the fractional reserve pyramid.

Richard Kotlarz

The complete set of columns from this series is posted at the following websites:

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