(Week 8 - Friday, Sept. 18)
In yesterday's column I described how the 15th century goldsmith banker held a minimum quantity, "fractional reserve," of gold in his vaults, relative to the much greater face value of the receipts or claims for that gold that he had issued, to serve as a hedge against not being able to redeem a receipt in a time of unusually high demand (which would signify his operation's bankruptcy). I also asserted that a pseudo version of the goldsmith's method, recreated in our time as the so-called "fractional reserve system," has planted the seeds of the present collapse of the financial sector.
The "fractional reserve system" of the modern banking era operates according to a formula that defines two-levels of money creation, the second being constructed upon the foundation of the first.
Level 1: "High-powered money" is the bankers' term for money created and put into circulation as a result of "borrowing" from the Federal Reserve itself by our Federal government.
Level 2: "Credit money" is money which is created and enters into circulation through the private-bank-loan transaction by which participants in the economy (except the Federal government) "borrow" money from private banks.
Creation of "High-Powered Money":
When the Federal government determines that it needs to "borrow" money, the Treasury Secretary (or his agent) approaches the Fed, and asks for a loan. The Fed agrees to "loan" the money, but requires security (collateral) in the form of bonds offered by the Federal government and signed by the Secretary of the Treasury.
The government prints and delivers the bonds to the Fed in exchange for newly created dollars being credited to its account at the Federal Reserve. These bonds, then, act effectively as "loan contracts" between the government and the Fed. It is critical to note that the Fed created this money out of nothing ("thin air") at the moment it credited the account. In addition, the face value of the bonds (the value printed on their face indicating the amount due the holder upon maturity) is much greater than the amount of money the government "borrowed." This is due to the "interest" charges which accrue from the date the bond is issued to when it is redeemed (paid off).
As the Federal government spends these new funds they end up on-deposit in the bank accounts of those contractors, builders, suppliers, service providers, employees, etc. to whom the money was paid. For purposes of this illustration, let us ignore the relatively small amount that circulates as pocket cash, and assume that all of it winds up on deposit in the banking system.
This new money "borrowed from" (in actuality "created by") the Fed and on-deposit in banks is referred to as "high-powered" money. The total quantity of high-powered money on deposit in the banking system, combined with a number known as the "fractional reserve ratio" mandated by the Federal Reserve Board of Governors, determines how much "credit money" the banking system can create through the bank-loan process. The formula that governs the procedure works basically as follows.
The "Fractional Reserve Ratio":
Let us assume that the "fractional reserve ratio" has been set by theFed at 1/10 (10%). In mathematical terms, this means that the banking system as a whole (The Fed and the private banks it oversees combined) have the potential of creating an amount of money that is the quantity of high-powered money on deposit, times the inverse of the "fractional reserve ratio." If the ratio is 1/10th, this allows the banking system to create overall an amount of money which is a multiple of the inverse of that number (i.e. 1 ÷ 1/10), which equals 10.
Simply put, this means that if borrowing and spending by the Federal government causes a billion dollars of "high-powered money" to be created and put on deposit in the banking system, the private banks can use this billion dollars as a foundation ("fractional reserve") to create another nine billion dollars of new "credit money." The total amount of new money, "high-powered" and "credit," that can be created through this process, is equal to what the Federal government "borrows" and spends into circulation, times ten (in this case, ten billion dollars).
Creation of "Credit Money":
To show how the process unfolds, let us suppose that $10,000 dollars of high-powered money has wound up on deposit in a given bank. The banker at this institution has thereby gained $10,000 dollars in new "reserves" against which he can create new money to "loan" out. The question is, how much can he create?
Since the banker in our example has $10,000 dollars of "reserves" on deposit, he can create up to $9,000 dollars in new money to "loan." Let us suppose that someone comes in and asks for a $9,000 loan, and his application is approved. The banker writes a check for (or electronically credits an account in the amount of) $9,000 dollars, and gives it to the "borrower." According to the way bankers think about this process, the banker in our scenario has just "loaned out" $9,000 dollars, and has, as required, left $1,000 "in reserve" as a hedge against the bank becoming "insolvent" (i.e. going broke).
At first glance, the process described in the above paragraph looks very much like the method the goldsmith banker used to protect his bank from becoming insolvent. Common sense dictated that he keep in reserve in his vaults an amount of gold which represented a reasonable percentage (fractional reserve) of the face value of gold receipts he had issued that were circulating as money in the economy, as a hedge against an unusual level of demand for the redemption of those receipts by his clientele who, overall, had been "loaned" the same gold several times over. Similarly, the rule governing modern banking which requires banks to keep in "reserve" a certain "fraction" of their money when they create loans, would seem to be a common sense measure to provide a margin of insurance against the possibility that the banks might find themselves in the position of not being able to redeem their depositors' accounts for cash at the teller window.
These two scenarios have, upon cursory look, a very similar appearance. If one examines more closely what is really happening, however, it will be found that these respective processes are very different, and have, not similar, but virtually opposite effects. The fractional reserve practice of the goldsmith banker lent a measure of stability to their system, but the so-called "fractional reserve" formula of modern banking is the very source of its chronic instability. In tomorrow's column we will continue with the description of how the "fractional reserve formula" unfolds, and take up the thread of how it is at the root of the collapse in the financial markets at present.
Richard Kotlarz
richkotlarz@gmail.com
The complete set of columns from this series is posted at the following websites:
http://economictree.blogspot.com/
http://www.concordresolution.org/column.htm
Thursday, September 18, 2008
Column #46 THE FRACTIONAL RESERVE OF THE GOLDSMITH BANKER
(Week 8 - Thursday, Sept. 18)
The mode of banking now in use is commonly described as "fractional reserve banking." The expression "fractional reserve" is one that is carried forward from an earlier form of the craft known as "goldsmith banking." As applied to modern practice, this expression is a misnomer that effectively obscures any true understanding of how our present monetary system operates, and why it is currently in such distress. To get a clear picture of this, it is first necessary to gain an understanding of what "fractional reserve" originally meant, and then how the concept has been misapplied.
In Europe of the 15th century there were many smiths that worked with gold, and therefore required vaults to securely store this precious material of their craft. Over time citizens and merchants that owned their own gold and used it in trade found the metal to be inconvenient and hazardous to keep in their personal possession. Consequently goldsmiths engaged in the sideline business of storing people's gold in their vaults, and issuing a receipt for the storage.
These receipts began to circulate as a currency with tradable value, as if they were the gold itself, and so became a form of paper money redeemable in gold. As payment the goldsmith charged a percentage of the value of the gold stored.
The goldsmith noticed that under normal circumstances only a very small percentage of his customers at any given time would redeem their receipts (i.e. take possession of their gold). For long periods the great majority of their metal merely gathered dust in his vault. At length it occurred to him that he could write more receipts and offer to "loan" the gold he was entrusted to hold to others, with an "interest" charge attached of course. In actuality he had nothing to loan because the gold already belonged to another customer, but who would know the difference. He could, in effect, profit on gold that he had, in a figurative sense, "created out of thin air."
The key to making this scheme work is that he would need to limit the amount of receipts issued such that the gold that he had on hand would, in the normal course of business, represent at least a certain "fraction" of the face value of the outstanding paper claims against it. This gold on deposit, then, would act as a "fractional reserve" that could be dipped into in the event that he experienced an unusually high demand for redemption at any given time.
The goal of the whole arrangement to the goldsmith was to issue as much "interest-bearing" paper as he dared against the stock of gold in his possession (thereby maximizing his income), while guarding against the possibility that the day might come when he would not be able to redeem with gold a receipt that was presented to him.
At first the scheme was a trade secret. As its workings became an open secret, many people regarded it as simple fraud, but others deemed it a necessary way to get the quantity of medium into circulation that a growing commerce demanded. In any case, the populace was eventually obliged to accept the goldsmiths' methods as the accepted way of doing business, or effectively forego much of its money supply.
By this mechanism the goldsmiths effectively began to operate as "banks-of-issue" (banks that create and issue money), and "fractional reserve banking" was born. The scheme worked well as long as there was not a "run on the bank"; that is, a rush by depositors to redeem their receipts for the gold because they had lost confidence in the institution.
As a sidebar to the goldsmith-banker story, it bears mentioning that this group has borne a great onus in the historical reckonings of many would-be monetary reformers. It is easy to find good reason for that assessment, but the whole story is not so simple. It could be argued that they were in effect coming up with a money–creation mechanism that did in fact put a great deal of currency into circulation in an age when that was sorely needed for its own inherent reasons. They operated in a time when the society itself did not have a sufficient sense of the science of money to create an adequate system in the public sphere where it rightly belongs (the same might be said of the situation with respect to money and banking that we find ourselves in today).
Were the goldsmiths simply a class of scam artists, or were they people who saw an essential need of the society around them and found an innovative way, however imperfect, to meet it? The answer presumably is both, and all degrees in between. They were, after all, people. Many deem the legacy they left behind as threatening the demise of civilization. It could also be argued, however, that had they not initiated such a practice, the evolution of Western society would have been seriously hindered. I leave that question to the reader's judgment.
In tomorrow's column we will begin to examine how a pseudo version of the goldsmith's method, recreated in our time as the "fractional reserve system," has planted the seeds of the present collapse of the financial sector.
Richard Kotlarz
richkotlarz@gmail.com
The complete set of columns from this series is posted at the following websites:
http://economictree.blogspot.com/
http://www.concordresolution.org/column.htm
The mode of banking now in use is commonly described as "fractional reserve banking." The expression "fractional reserve" is one that is carried forward from an earlier form of the craft known as "goldsmith banking." As applied to modern practice, this expression is a misnomer that effectively obscures any true understanding of how our present monetary system operates, and why it is currently in such distress. To get a clear picture of this, it is first necessary to gain an understanding of what "fractional reserve" originally meant, and then how the concept has been misapplied.
In Europe of the 15th century there were many smiths that worked with gold, and therefore required vaults to securely store this precious material of their craft. Over time citizens and merchants that owned their own gold and used it in trade found the metal to be inconvenient and hazardous to keep in their personal possession. Consequently goldsmiths engaged in the sideline business of storing people's gold in their vaults, and issuing a receipt for the storage.
These receipts began to circulate as a currency with tradable value, as if they were the gold itself, and so became a form of paper money redeemable in gold. As payment the goldsmith charged a percentage of the value of the gold stored.
The goldsmith noticed that under normal circumstances only a very small percentage of his customers at any given time would redeem their receipts (i.e. take possession of their gold). For long periods the great majority of their metal merely gathered dust in his vault. At length it occurred to him that he could write more receipts and offer to "loan" the gold he was entrusted to hold to others, with an "interest" charge attached of course. In actuality he had nothing to loan because the gold already belonged to another customer, but who would know the difference. He could, in effect, profit on gold that he had, in a figurative sense, "created out of thin air."
The key to making this scheme work is that he would need to limit the amount of receipts issued such that the gold that he had on hand would, in the normal course of business, represent at least a certain "fraction" of the face value of the outstanding paper claims against it. This gold on deposit, then, would act as a "fractional reserve" that could be dipped into in the event that he experienced an unusually high demand for redemption at any given time.
The goal of the whole arrangement to the goldsmith was to issue as much "interest-bearing" paper as he dared against the stock of gold in his possession (thereby maximizing his income), while guarding against the possibility that the day might come when he would not be able to redeem with gold a receipt that was presented to him.
At first the scheme was a trade secret. As its workings became an open secret, many people regarded it as simple fraud, but others deemed it a necessary way to get the quantity of medium into circulation that a growing commerce demanded. In any case, the populace was eventually obliged to accept the goldsmiths' methods as the accepted way of doing business, or effectively forego much of its money supply.
By this mechanism the goldsmiths effectively began to operate as "banks-of-issue" (banks that create and issue money), and "fractional reserve banking" was born. The scheme worked well as long as there was not a "run on the bank"; that is, a rush by depositors to redeem their receipts for the gold because they had lost confidence in the institution.
As a sidebar to the goldsmith-banker story, it bears mentioning that this group has borne a great onus in the historical reckonings of many would-be monetary reformers. It is easy to find good reason for that assessment, but the whole story is not so simple. It could be argued that they were in effect coming up with a money–creation mechanism that did in fact put a great deal of currency into circulation in an age when that was sorely needed for its own inherent reasons. They operated in a time when the society itself did not have a sufficient sense of the science of money to create an adequate system in the public sphere where it rightly belongs (the same might be said of the situation with respect to money and banking that we find ourselves in today).
Were the goldsmiths simply a class of scam artists, or were they people who saw an essential need of the society around them and found an innovative way, however imperfect, to meet it? The answer presumably is both, and all degrees in between. They were, after all, people. Many deem the legacy they left behind as threatening the demise of civilization. It could also be argued, however, that had they not initiated such a practice, the evolution of Western society would have been seriously hindered. I leave that question to the reader's judgment.
In tomorrow's column we will begin to examine how a pseudo version of the goldsmith's method, recreated in our time as the "fractional reserve system," has planted the seeds of the present collapse of the financial sector.
Richard Kotlarz
richkotlarz@gmail.com
The complete set of columns from this series is posted at the following websites:
http://economictree.blogspot.com/
http://www.concordresolution.org/column.htm
Wednesday, September 17, 2008
Column #45 DEFLATING THE "DEBT" BUBBLE VIA BANKRUPTCY
(Week 8 - Wednesday, Sept. 17)
One of the great secrets of the capitalist system is that it depends on bankruptcy to survive. This is how air is let out of the bubble of unsupportable "debt" attached to our money supply due to the demand for ever greater "interest" payments attached to the issuance of our dollars. Otherwise pressures associated with "debt" would become too high for the system to be sustained. Indeed, if one were to check the historical record, this is how capitalism has achieved longevity. The trick for those players who would survive, and even prosper, is to make sure that the air expended is someone else's air.
Regular episodes of widespread financial failure restore a sort of pseudo-confidence in the system because anyone whose balloon doesn't get popped experiences a sense of relief, is in a positions to exercises relatively more control in the social order for his "success," can feel like a "winner" (one of the "smart" ones), and may even wax righteous in their faith in the system. After all, so the thinking goes, does not the occurrence of such periodic convulsions to the economic order provide a way to weed out its "less fit" players (for the good of all or course), and correct "imbalances" in the system (never mind that these "imbalances" are due to the instability inherent in a system in which there is never enough money in circulation for people to pay their debts)?
A prime example of how the debt-bubble-deflation-through-bankruptcy process operates has transpired in the Midwest Farm Belt over the century - almost since the establishment of the Fed. At the time of the passage of the Federal Reserve Act, a third of the people lived on the farm, and at the start of WWII it was still a quarter of the populace. Now less than two percent remain, and it is questionable as to how many of these are "farmers" in the sense of being independent entrepreneurs (as opposed to subcontractors for major food cartels).
In the history of the world there has never been a population that has been evicted off its land, much less from a plain as fruited as the American Midwest, without wrenching trauma. How then was this fiercely rooted rural society removed in little over a generation? It was done by creating a context in which it was not possible for the occupants as a whole to make the ends meet in their financial lives (i.e. pay their expenses, earn a living, and have enough to reinvest into another crop), and then let them work it out in a desperate scramble to see who could hang on.
The factor that made the farm situation untenable was not, as claimed, "over-production" (in a world where tens of thousands of children perish each day of starvation-related causes). It was, rather, the so-called "debt" against a money supply that is "borrowed" into existence from private banks on terms that made it financially "impossible" for the producer (in this case the farmer and supporting rural businessman) to receive enough for his product in the marketplace to avoid the necessity of taking on ever more "debt".
For reasons that are complex, the shortfall of buying power available to complete the market cycle in any "debt-money" regime was directed first in a concerted way against the rural sector (as historically it has generally been). Meanwhile, there were policy papers put out by corporate think tanks that, for example, called for ". . . a program, such as we are recommending here, to induce excess resources – primarily people – to move rapidly out of agriculture." (An Adaptive Program for Agriculture – by the Committee for Economic Development (CED)). The practical way to do this was to manipulate the monetary situation in such a way that farmers could not receive for their product a "parity price" (one that would allow them to make a living, and keep them in structural balance with other participants in the economy).
Fundamentally, the "farm problem" is in reality a monetary problem. Historically, it almost always has been. The key to evicting the rural population from the land was to hide its true nature with a subterfuge ("farmers are being too productive"), and then rig the markets so that their financial collapse played out over a period of time.
Accordingly, farmers were obliged to go broke at a rate of a percent or two per year. Those still struggling to not be one of the losers typically saw no other course but to show up at the auctions of their bankrupt neighbors and pick up the equity in their capital supplies and equipment at pennies on the dollar. Old "debts" (air in the bubble) were wiped out in part because not enough could be salvaged, and the net "indebtedness" of the countryside experienced some relief, but the growth of the bubble resumed, and eventually almost everyone went down, except those who had deep enough pockets, or a position of advantage within the system (e.g. large corporate operations), sufficient to enable them to pick up the pieces of their neighbors' ruined lives. This process was wrenching, both for the rural folk involved directly, and the country as a whole.
The vital rural community is now virtually gone, and what is left effectively are corporate farming contractors (which often are now getting good prices and high subsidies), "Wal-Mart" regional commercial strips (to which there adhere increasingly satellite communities), and food imported from "cheap-labor" plantations (where the Mexican farmer is being economically driven off his land, and effectively compelled to migrate across our southern border).
Of course, since the demise of the rural areas, the "debt-bubble-deflation" scheme has moved on to the manufacturing sector, as our industries (e.g. the automotive complex in Flint) have been shipped overseas. Now the "service industries" are being forced out (e.g. the transfer of customer-service phone banks to India), followed closely by the intellectual sector (e.g. hi-tech programming).
Naturally, this has all been extremely traumatic, but these "adjustments," going back to the pre-WWII days, exist yet in the memory of our more elderly fellow citizens who lived through them. Still, we as a nation have not noticed the economic elephant in the room; i.e. the debt-bubble-deflation-through-bankruptcy process.
The "debt" bubble has to be deflated somewhere, and it was inevitable that the game should move at last to the banking-and-finance sector, which has been most instrumental in bringing this distress to the rest of the economy. This is what is happening at present.
Richard Kotlarz
richkotlarz@gmail.com
The complete set of columns from this series is posted at the following websites:
http://economictree.blogspot.com/
http://www.concordresolution.org/column.htm
One of the great secrets of the capitalist system is that it depends on bankruptcy to survive. This is how air is let out of the bubble of unsupportable "debt" attached to our money supply due to the demand for ever greater "interest" payments attached to the issuance of our dollars. Otherwise pressures associated with "debt" would become too high for the system to be sustained. Indeed, if one were to check the historical record, this is how capitalism has achieved longevity. The trick for those players who would survive, and even prosper, is to make sure that the air expended is someone else's air.
Regular episodes of widespread financial failure restore a sort of pseudo-confidence in the system because anyone whose balloon doesn't get popped experiences a sense of relief, is in a positions to exercises relatively more control in the social order for his "success," can feel like a "winner" (one of the "smart" ones), and may even wax righteous in their faith in the system. After all, so the thinking goes, does not the occurrence of such periodic convulsions to the economic order provide a way to weed out its "less fit" players (for the good of all or course), and correct "imbalances" in the system (never mind that these "imbalances" are due to the instability inherent in a system in which there is never enough money in circulation for people to pay their debts)?
A prime example of how the debt-bubble-deflation-through-bankruptcy process operates has transpired in the Midwest Farm Belt over the century - almost since the establishment of the Fed. At the time of the passage of the Federal Reserve Act, a third of the people lived on the farm, and at the start of WWII it was still a quarter of the populace. Now less than two percent remain, and it is questionable as to how many of these are "farmers" in the sense of being independent entrepreneurs (as opposed to subcontractors for major food cartels).
In the history of the world there has never been a population that has been evicted off its land, much less from a plain as fruited as the American Midwest, without wrenching trauma. How then was this fiercely rooted rural society removed in little over a generation? It was done by creating a context in which it was not possible for the occupants as a whole to make the ends meet in their financial lives (i.e. pay their expenses, earn a living, and have enough to reinvest into another crop), and then let them work it out in a desperate scramble to see who could hang on.
The factor that made the farm situation untenable was not, as claimed, "over-production" (in a world where tens of thousands of children perish each day of starvation-related causes). It was, rather, the so-called "debt" against a money supply that is "borrowed" into existence from private banks on terms that made it financially "impossible" for the producer (in this case the farmer and supporting rural businessman) to receive enough for his product in the marketplace to avoid the necessity of taking on ever more "debt".
For reasons that are complex, the shortfall of buying power available to complete the market cycle in any "debt-money" regime was directed first in a concerted way against the rural sector (as historically it has generally been). Meanwhile, there were policy papers put out by corporate think tanks that, for example, called for ". . . a program, such as we are recommending here, to induce excess resources – primarily people – to move rapidly out of agriculture." (An Adaptive Program for Agriculture – by the Committee for Economic Development (CED)). The practical way to do this was to manipulate the monetary situation in such a way that farmers could not receive for their product a "parity price" (one that would allow them to make a living, and keep them in structural balance with other participants in the economy).
Fundamentally, the "farm problem" is in reality a monetary problem. Historically, it almost always has been. The key to evicting the rural population from the land was to hide its true nature with a subterfuge ("farmers are being too productive"), and then rig the markets so that their financial collapse played out over a period of time.
Accordingly, farmers were obliged to go broke at a rate of a percent or two per year. Those still struggling to not be one of the losers typically saw no other course but to show up at the auctions of their bankrupt neighbors and pick up the equity in their capital supplies and equipment at pennies on the dollar. Old "debts" (air in the bubble) were wiped out in part because not enough could be salvaged, and the net "indebtedness" of the countryside experienced some relief, but the growth of the bubble resumed, and eventually almost everyone went down, except those who had deep enough pockets, or a position of advantage within the system (e.g. large corporate operations), sufficient to enable them to pick up the pieces of their neighbors' ruined lives. This process was wrenching, both for the rural folk involved directly, and the country as a whole.
The vital rural community is now virtually gone, and what is left effectively are corporate farming contractors (which often are now getting good prices and high subsidies), "Wal-Mart" regional commercial strips (to which there adhere increasingly satellite communities), and food imported from "cheap-labor" plantations (where the Mexican farmer is being economically driven off his land, and effectively compelled to migrate across our southern border).
Of course, since the demise of the rural areas, the "debt-bubble-deflation" scheme has moved on to the manufacturing sector, as our industries (e.g. the automotive complex in Flint) have been shipped overseas. Now the "service industries" are being forced out (e.g. the transfer of customer-service phone banks to India), followed closely by the intellectual sector (e.g. hi-tech programming).
Naturally, this has all been extremely traumatic, but these "adjustments," going back to the pre-WWII days, exist yet in the memory of our more elderly fellow citizens who lived through them. Still, we as a nation have not noticed the economic elephant in the room; i.e. the debt-bubble-deflation-through-bankruptcy process.
The "debt" bubble has to be deflated somewhere, and it was inevitable that the game should move at last to the banking-and-finance sector, which has been most instrumental in bringing this distress to the rest of the economy. This is what is happening at present.
Richard Kotlarz
richkotlarz@gmail.com
The complete set of columns from this series is posted at the following websites:
http://economictree.blogspot.com/
http://www.concordresolution.org/column.htm
Tuesday, September 16, 2008
Column #44 "WHERE DID ALL THAT MONEY GO?"
(Week 8 - Tuesday, Sept. 16)
During the recent Bear-Stearns (BS) meltdown, a stock trader friend told me about the billions of dollars that had supposedly been lost, and asked incredulously, "Where did all that money go???" The answer I gave him was "It didn't go anywhere. It wasn't money. It was the air in a speculative bubble." Let me explain.
The morning of the BS crash its stock was trading for $60 (before it fell to two dollars later in the day). This represented a supposed "net worth" for each share then of $60. The next question is "Where was this $60?" The simple answer is that it was an abstract number that was calculated from an anticipated "price-earnings ratio" (i.e. the ratio between the price an "investor" pays for a stock and the amount of money he expects to "earn" from holding it), much as the "value" of bonds, bundled mortgages, and other investment vehicles are reckoned respectively from their "discount rate", "interest rate" or "rate of return".
The concepts these financial expressions refer to are not money. They are only promises (or anticipations in the case of stocks) to pay a "return on investment" at some point in the future. The "value" of stocks expressed in dollars is a theoretical number based primarily on calculations by traders of dividends expected to be paid by the stock, and a subjective estimation of the "risk" that such proceeds might not be realized.
Stocks may have the illusion of being money because, while there is still life in the stock-market game, one can redeem them for cash. This is to say that the owner of a given stock may assume that there is someone out there who will be willing to bet his own cash-in-hand against the prospects that a given stock will pay dividends at a rate that is at least as high as what other traders in the current market expect, and/or there will be other "investors" coming along that will anticipate an equivalent or higher dividend in the future, and thus be willing to pay even more for the stock, thereby allowing the current "investor" to "cash in" (sell his stock) at a profit.
Within a market where participants imagine that they can expect a "10% return on investment" (given the range of financial opportunities available where the "investor" could put his money), for a share stock of in BS to be "worth" $60, there must exist momentarily in the trading culture an anticipation that it will be paying out $6 at the end of its fiscal year. This is affected by many factors, but in general anticipated dividend and perceived risk govern what price traders are willing to pay. Even the most optimistic "investor" realizes that prices of stocks cannot increase exponentially forever, but they are betting that they can buy into the market, and then sell their holdings for a "profit" before the speculative psychology that drives prices up in market goes bust. When it does pop the expectations reverse, and there ensues a stampede to "cash in" one's stocks, such as the one the market experienced yesterday.
I anticipate that there will be cries in the media about how many billions of dollars are being "lost" through this latest market contraction, but this would not be an accurate characterization of what is transpiring. In previous columns we have already seen how virtually every dollar in circulation is created and issued through the process of someone going into a bank and "borrowing" money which the banker creates on the spot with the "writing of a check." If tomorrow's newspaper headlines try to tell us that 'billions of dollars have been lost to the economy' since the morning before, we should ask ourselves, "Does that mean that millions of people were suddenly possessed to walked into banks yesterday, where they took cash out of their pockets or funds out of their accounts, and paid down the principal balances on their loans, whereby the banker was obliged to extinguish (mark "paid") this money, thereby wiping it off of his books, and leaving the nation with billions of dollars less in circulating medium?"
Common sense would tell us that nothing of the sort happened. It follows, then, that there are essentially the same number of dollars in circulation as there were twenty-four hours before. The only change in the money supply will be the net differential between the quantity of dollars "borrowed from" vs. "paid back to" the banking system, as is the case on any given day. What has really happened is that "billions of dollars" worth of speculative air has been let out of the bubble of (unrealistic) expectations that the actual dollars in circulation are expected to support.
Notwithstanding, as we arise to this new day, the papers and morning shows will no doubt be filled with hysteria about how the financial world is about to come undone. A few minutes ago I turned on the radio just in time to hear a financial "analyst" warn that we may be on the verge of another "depression." Such alarming talk carries with it very real danger if it is not carefully considered in that it can become self-fulfilling prophecy all too easily.
We the people have a choice. We can either believe the catastrophic hype we are being bombarded with, or we can look around and see that, as ever, the sun beams down, the rains fall, the plants grow, the infrastructure persists, and the hands, hearts and minds remain willing and able to do the work. The whole "financial crisis" that the world is experiencing right now is not some objective reality that the universe is laying upon us. It is, rather, an illusion that we as a human race have created, believed in, and sacrificed our very life substance to.
This may seem to many to be an extreme, even bizarre, assertion, but it is something that we would do well to contemplate seriously now, as an antidote to being overcome by fears about money. I do not hereby mean to dismiss the very real suffering that people experience under the boot of the monetary system (I suffer with it also), but we can be free of it if we as a society can wake up what is happening. That is what the discourse about money that is being put forth in these columns is intended to be all about.
Richard Kotlarz
richkotlarz@gmail.com
The complete set of columns from this series is posted at the following websites:
http://economictree.blogspot.com/
http://www.concordresolution.org/column.htm
During the recent Bear-Stearns (BS) meltdown, a stock trader friend told me about the billions of dollars that had supposedly been lost, and asked incredulously, "Where did all that money go???" The answer I gave him was "It didn't go anywhere. It wasn't money. It was the air in a speculative bubble." Let me explain.
The morning of the BS crash its stock was trading for $60 (before it fell to two dollars later in the day). This represented a supposed "net worth" for each share then of $60. The next question is "Where was this $60?" The simple answer is that it was an abstract number that was calculated from an anticipated "price-earnings ratio" (i.e. the ratio between the price an "investor" pays for a stock and the amount of money he expects to "earn" from holding it), much as the "value" of bonds, bundled mortgages, and other investment vehicles are reckoned respectively from their "discount rate", "interest rate" or "rate of return".
The concepts these financial expressions refer to are not money. They are only promises (or anticipations in the case of stocks) to pay a "return on investment" at some point in the future. The "value" of stocks expressed in dollars is a theoretical number based primarily on calculations by traders of dividends expected to be paid by the stock, and a subjective estimation of the "risk" that such proceeds might not be realized.
Stocks may have the illusion of being money because, while there is still life in the stock-market game, one can redeem them for cash. This is to say that the owner of a given stock may assume that there is someone out there who will be willing to bet his own cash-in-hand against the prospects that a given stock will pay dividends at a rate that is at least as high as what other traders in the current market expect, and/or there will be other "investors" coming along that will anticipate an equivalent or higher dividend in the future, and thus be willing to pay even more for the stock, thereby allowing the current "investor" to "cash in" (sell his stock) at a profit.
Within a market where participants imagine that they can expect a "10% return on investment" (given the range of financial opportunities available where the "investor" could put his money), for a share stock of in BS to be "worth" $60, there must exist momentarily in the trading culture an anticipation that it will be paying out $6 at the end of its fiscal year. This is affected by many factors, but in general anticipated dividend and perceived risk govern what price traders are willing to pay. Even the most optimistic "investor" realizes that prices of stocks cannot increase exponentially forever, but they are betting that they can buy into the market, and then sell their holdings for a "profit" before the speculative psychology that drives prices up in market goes bust. When it does pop the expectations reverse, and there ensues a stampede to "cash in" one's stocks, such as the one the market experienced yesterday.
I anticipate that there will be cries in the media about how many billions of dollars are being "lost" through this latest market contraction, but this would not be an accurate characterization of what is transpiring. In previous columns we have already seen how virtually every dollar in circulation is created and issued through the process of someone going into a bank and "borrowing" money which the banker creates on the spot with the "writing of a check." If tomorrow's newspaper headlines try to tell us that 'billions of dollars have been lost to the economy' since the morning before, we should ask ourselves, "Does that mean that millions of people were suddenly possessed to walked into banks yesterday, where they took cash out of their pockets or funds out of their accounts, and paid down the principal balances on their loans, whereby the banker was obliged to extinguish (mark "paid") this money, thereby wiping it off of his books, and leaving the nation with billions of dollars less in circulating medium?"
Common sense would tell us that nothing of the sort happened. It follows, then, that there are essentially the same number of dollars in circulation as there were twenty-four hours before. The only change in the money supply will be the net differential between the quantity of dollars "borrowed from" vs. "paid back to" the banking system, as is the case on any given day. What has really happened is that "billions of dollars" worth of speculative air has been let out of the bubble of (unrealistic) expectations that the actual dollars in circulation are expected to support.
Notwithstanding, as we arise to this new day, the papers and morning shows will no doubt be filled with hysteria about how the financial world is about to come undone. A few minutes ago I turned on the radio just in time to hear a financial "analyst" warn that we may be on the verge of another "depression." Such alarming talk carries with it very real danger if it is not carefully considered in that it can become self-fulfilling prophecy all too easily.
We the people have a choice. We can either believe the catastrophic hype we are being bombarded with, or we can look around and see that, as ever, the sun beams down, the rains fall, the plants grow, the infrastructure persists, and the hands, hearts and minds remain willing and able to do the work. The whole "financial crisis" that the world is experiencing right now is not some objective reality that the universe is laying upon us. It is, rather, an illusion that we as a human race have created, believed in, and sacrificed our very life substance to.
This may seem to many to be an extreme, even bizarre, assertion, but it is something that we would do well to contemplate seriously now, as an antidote to being overcome by fears about money. I do not hereby mean to dismiss the very real suffering that people experience under the boot of the monetary system (I suffer with it also), but we can be free of it if we as a society can wake up what is happening. That is what the discourse about money that is being put forth in these columns is intended to be all about.
Richard Kotlarz
richkotlarz@gmail.com
The complete set of columns from this series is posted at the following websites:
http://economictree.blogspot.com/
http://www.concordresolution.org/column.htm
Monday, September 15, 2008
Column #43 A PROPOSED BREATHER
(Week 8 - Monday, Sept. 15)
With six weeks worth of this column having gone out, it is perhaps time to take a look at how it has been received so far, and how it might proceed into the future. The response has been gratifying; more so than I could have expected. I say this with respect to numbers of people who have opted-in, and the many thoughtful questions, comments and critiques received. This is all greatly appreciated.
There are at least two places on the net where these columns are posted (on the initiative of others) as they come out, and a complete set maintained. These are listed at the bottom of this page. Others have offered to do the same, set up a dedicated website, or otherwise help to get these and other of my writings out. There have been more offers than I have been able to follow up on so far, but I am grateful for every one. I am moved by the news that a number of people have indicated that they make hard copies of the columns and give them to people they know who might be interested.
The greatest challenge with the columns so far, I am informed, is that some folks are having a difficult time keeping up with the volume of reading. These articles are meant to be short enough in length to read over the proverbial "morning cup of coffee," but people today often lead harried lives (got to keep up with the monthly "interest" payments, after all), and have a difficult time in finding place for even the smallest tasks. Many are indeed keeping up with whatever they hope to get out of the content, but others are not.
The content is designed to be a tightly reasoned and integrally connected discourse that can (supposedly) in a step-by-step manner help the reader awaken to a wholly different perspective about money than is offered in the conventional dialogue. I write each article in mindfulness that there may well be readers who are joining in for the first time, or rejoining after an absence. Consequently, each installment has to be at least minimally decipherable to the uninitiated within the terms and context presented in any given piece. That said, much groundwork for understanding is laid as the series unfolds, and if parts are missed something is inevitably lost. There are many readers who, according to the feedback I am getting, feel the same way, and experience frustration if they "fall behind." There are others who work to consolidate their understanding by going back over past installments.
In light of these considerations, plus other commitments coming up in the near future, I am contemplating taking a two-week breather from October 5 through 19 during which no new installments will come out. The series would pick up again starting October 20, and presumably focus on the issues that have gained public attention during the run-up to election day on November 4. I would welcome whatever thoughts anyone has about this.
There is yet much that needs to be said about money and the economic times that we live in. I don't anticipate that subject will ever be exhausted. Accordingly my commitment to getting this dialogue out, through New View on Money and other channels, remains ongoing. Thank you for your patience with this process and continuing interest.
I close with a monetary thought for the day:
"I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs."
Thomas Jefferson, letter to the Secretary of the Treasury Albert Gallatin (1802)
Richard Kotlarz
richkotlarz@gmail.com
The complete set of columns from this series is posted at the following websites:
http://economictree.blogspot.com/
http://www.concordresolution.org/column.htm
With six weeks worth of this column having gone out, it is perhaps time to take a look at how it has been received so far, and how it might proceed into the future. The response has been gratifying; more so than I could have expected. I say this with respect to numbers of people who have opted-in, and the many thoughtful questions, comments and critiques received. This is all greatly appreciated.
There are at least two places on the net where these columns are posted (on the initiative of others) as they come out, and a complete set maintained. These are listed at the bottom of this page. Others have offered to do the same, set up a dedicated website, or otherwise help to get these and other of my writings out. There have been more offers than I have been able to follow up on so far, but I am grateful for every one. I am moved by the news that a number of people have indicated that they make hard copies of the columns and give them to people they know who might be interested.
The greatest challenge with the columns so far, I am informed, is that some folks are having a difficult time keeping up with the volume of reading. These articles are meant to be short enough in length to read over the proverbial "morning cup of coffee," but people today often lead harried lives (got to keep up with the monthly "interest" payments, after all), and have a difficult time in finding place for even the smallest tasks. Many are indeed keeping up with whatever they hope to get out of the content, but others are not.
The content is designed to be a tightly reasoned and integrally connected discourse that can (supposedly) in a step-by-step manner help the reader awaken to a wholly different perspective about money than is offered in the conventional dialogue. I write each article in mindfulness that there may well be readers who are joining in for the first time, or rejoining after an absence. Consequently, each installment has to be at least minimally decipherable to the uninitiated within the terms and context presented in any given piece. That said, much groundwork for understanding is laid as the series unfolds, and if parts are missed something is inevitably lost. There are many readers who, according to the feedback I am getting, feel the same way, and experience frustration if they "fall behind." There are others who work to consolidate their understanding by going back over past installments.
In light of these considerations, plus other commitments coming up in the near future, I am contemplating taking a two-week breather from October 5 through 19 during which no new installments will come out. The series would pick up again starting October 20, and presumably focus on the issues that have gained public attention during the run-up to election day on November 4. I would welcome whatever thoughts anyone has about this.
There is yet much that needs to be said about money and the economic times that we live in. I don't anticipate that subject will ever be exhausted. Accordingly my commitment to getting this dialogue out, through New View on Money and other channels, remains ongoing. Thank you for your patience with this process and continuing interest.
I close with a monetary thought for the day:
"I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs."
Thomas Jefferson, letter to the Secretary of the Treasury Albert Gallatin (1802)
Richard Kotlarz
richkotlarz@gmail.com
The complete set of columns from this series is posted at the following websites:
http://economictree.blogspot.com/
http://www.concordresolution.org/column.htm
Saturday, September 13, 2008
Column #42 THE WRONG ANSWER TO THE MORTGAGE CRISIS
(Week 7 - Saturday, Sept. 13)
Over that last year, the reading and viewing public has been increasingly regaled with personal horror stories about vulnerable people being lured by shady mortgage brokers into signing contracts using deceptive practices and on falsified terms. Such contracts typically were loaded with questionable financial gimmicks such as "adjustable rate mortgages," "balloon payments" and "zero-principal mortgages," and had principal loan balances that were simply beyond the financial reach of the borrower.
It is becoming evident that the "sub-prime housing crisis" is only the tip of the proverbial iceberg. Now it appears that the nation's two largest mortgage finance companies, Fannie Mae and Freddie Mac, will need a massive injection of capital (some reports say as high as $300 billion dollars), or an outright takeover by the Federal government, to keep them in business.
So, what has gone wrong? The media is filled with finger-pointing and recrimination about how with the "sub-prime," and now the "prime," mortgage industries have been driven to the verge of collapse. There seems to be a growing consensus that the politically ballyhooed deregulation of the financial industry over the last three decades has allowed unscrupulous financial entrepreneurs to run amok, and that this is the prime cause of the crisis. If only, so the wistful thinking goes, there had been sound financial management in the industry this crisis would never have happened.
That unscrupulous financial entrepreneurs have run amok is beyond doubt, but does it follow that had more prudent financial stewardship been in place, then arriving at a point of crisis would have been avoided? Let us examine the question.
Suppose that the financial industry had not been deregulated and/or had been more conservatively managed. Then hundreds of thousands, if not millions, of these reckless loans would presumably not have been made. This also means, it should be noted, that many billions of dollars of new money would not have been created by the banking system, and loaned into circulation.
When a bank makes a loan for a mortgage, the new money this transaction generates goes from the pocket of the buyer, to that of the seller, and then continues to circulate as he spends it into the money supply. Over the last several decades, the mortgage market has been flogged by government policy and financial practice for all it is worth as an engine of new money generation for the economy. If there had not been all this bloated "prime" and "sub-prime" borrowing, hundreds of billions of dollars that are circulating in the economy right now would not exist. That means that much of the money in the typical person's wallet or bank account would not be there. With a greatly diminished monetary pool, there would be much less money in circulation to make payments on mortgages that had been contracted before the latest wave of borrowing, and less circulating to meet the needs of commerce.
This is a classic catch-22 situation. If we borrow more money from the banks, then we experience a bubble of prosperity, followed by a crisis of excessive "debt" when the payments come due. If we refrain from borrowing, then not enough money enters into circulation to meet old "debts," plus maintain an adequate money supply to do our business. For the last half-century we have chosen the path of rapidly increasing borrowing. The more frugal option, then, is the road not taken, and so we do not experience its effects. Nonetheless, there is a "debt" crisis at the end of either scenario.
The answer to the mortgage crisis is to stop borrowing our money supply at "interest" from a private banking system, and start issuing it publicly through the U.S. Treasury. This would take away the impetus to manipulate the housing market towards higher prices decade-after-decade as the primary engine for "debt"-money creation. Publicly-issued money is the path, I suggest, to a stable market with prices that are consistent with the actual physical cost and human effort required to build and maintain the housing we live in.
None of this is to say that the cavalier conduct of unscrupulous financial entrepreneurs is in any way justified, or that it has not greatly exacerbated the cost in personal suffering of the "debt" crisis. The reality, though, is that a "debt" crisis was sure to emerge, in one form or another, regardless of their conduct. Fiscal stewardship is an administrative problem, but the mortgage crisis is at root a consequence of faulty money creation.
Already in the newspapers I see proposed various schemes to fix the mortgage industry, virtually all of which involve borrowing ever more massive quantities of money to finance so-called "bailouts," and giving yet more control to the people and institutions that have presided over the present fiasco. This is the wrong answer.
Richard Kotlarz
richkotlarz@gmail.com
The complete set of columns from this series is posted at the following websites:
http://economictree.blogspot.com/
http://www.concordresolution.org/column.htm
Over that last year, the reading and viewing public has been increasingly regaled with personal horror stories about vulnerable people being lured by shady mortgage brokers into signing contracts using deceptive practices and on falsified terms. Such contracts typically were loaded with questionable financial gimmicks such as "adjustable rate mortgages," "balloon payments" and "zero-principal mortgages," and had principal loan balances that were simply beyond the financial reach of the borrower.
It is becoming evident that the "sub-prime housing crisis" is only the tip of the proverbial iceberg. Now it appears that the nation's two largest mortgage finance companies, Fannie Mae and Freddie Mac, will need a massive injection of capital (some reports say as high as $300 billion dollars), or an outright takeover by the Federal government, to keep them in business.
So, what has gone wrong? The media is filled with finger-pointing and recrimination about how with the "sub-prime," and now the "prime," mortgage industries have been driven to the verge of collapse. There seems to be a growing consensus that the politically ballyhooed deregulation of the financial industry over the last three decades has allowed unscrupulous financial entrepreneurs to run amok, and that this is the prime cause of the crisis. If only, so the wistful thinking goes, there had been sound financial management in the industry this crisis would never have happened.
That unscrupulous financial entrepreneurs have run amok is beyond doubt, but does it follow that had more prudent financial stewardship been in place, then arriving at a point of crisis would have been avoided? Let us examine the question.
Suppose that the financial industry had not been deregulated and/or had been more conservatively managed. Then hundreds of thousands, if not millions, of these reckless loans would presumably not have been made. This also means, it should be noted, that many billions of dollars of new money would not have been created by the banking system, and loaned into circulation.
When a bank makes a loan for a mortgage, the new money this transaction generates goes from the pocket of the buyer, to that of the seller, and then continues to circulate as he spends it into the money supply. Over the last several decades, the mortgage market has been flogged by government policy and financial practice for all it is worth as an engine of new money generation for the economy. If there had not been all this bloated "prime" and "sub-prime" borrowing, hundreds of billions of dollars that are circulating in the economy right now would not exist. That means that much of the money in the typical person's wallet or bank account would not be there. With a greatly diminished monetary pool, there would be much less money in circulation to make payments on mortgages that had been contracted before the latest wave of borrowing, and less circulating to meet the needs of commerce.
This is a classic catch-22 situation. If we borrow more money from the banks, then we experience a bubble of prosperity, followed by a crisis of excessive "debt" when the payments come due. If we refrain from borrowing, then not enough money enters into circulation to meet old "debts," plus maintain an adequate money supply to do our business. For the last half-century we have chosen the path of rapidly increasing borrowing. The more frugal option, then, is the road not taken, and so we do not experience its effects. Nonetheless, there is a "debt" crisis at the end of either scenario.
The answer to the mortgage crisis is to stop borrowing our money supply at "interest" from a private banking system, and start issuing it publicly through the U.S. Treasury. This would take away the impetus to manipulate the housing market towards higher prices decade-after-decade as the primary engine for "debt"-money creation. Publicly-issued money is the path, I suggest, to a stable market with prices that are consistent with the actual physical cost and human effort required to build and maintain the housing we live in.
None of this is to say that the cavalier conduct of unscrupulous financial entrepreneurs is in any way justified, or that it has not greatly exacerbated the cost in personal suffering of the "debt" crisis. The reality, though, is that a "debt" crisis was sure to emerge, in one form or another, regardless of their conduct. Fiscal stewardship is an administrative problem, but the mortgage crisis is at root a consequence of faulty money creation.
Already in the newspapers I see proposed various schemes to fix the mortgage industry, virtually all of which involve borrowing ever more massive quantities of money to finance so-called "bailouts," and giving yet more control to the people and institutions that have presided over the present fiasco. This is the wrong answer.
Richard Kotlarz
richkotlarz@gmail.com
The complete set of columns from this series is posted at the following websites:
http://economictree.blogspot.com/
http://www.concordresolution.org/column.htm
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