(Week 9 - Friday, Sept. 26)
Following are selected excerpts from President Bush's speech to the nation on Wednesday evening in which he addressed the current financial crisis, and urged the adoption of a proposed $700 billion dollar scheme to "rescue" banks and other major financial institutions. To his words quoted below, I have added my own commentary and explanatory (in my view) inserts in [brackets].
"Financial assets related to home mortgages have lost value during the house decline, and the banks holding these assets have restricted credit." [These "financial assets" are people's mortgage contracts that "investors" have bought up with money borrowed from banks in order to be the recipients of their "interest" payments. (see Col. #5)]
"As a result, our entire economy is in danger." [The condition of our "entire economy" is being linked to the interests of the financial speculators who are buying up our "debt" paper.]
"So I propose that the federal government reduce the risk posed by these troubled assets and supply urgently needed money so banks and other financial institutions can avoid collapse and resume lending." [It is being proposed that the federal government borrow money to replace what the banks lost through speculative lending. The phrase "avoid collapse and resume lending" is an indirect reference to the idea that the money lent to buy such "troubled assets" is on deposit in the lower courses of the fractional reserve pyramid, and constitute, therefore, much of the "reserves" that are supporting the consumer borrowing above it.]
"This rescue effort is not aimed at preserving any individual company or industry." [It is aimed at preserving the gains of the speculative financial "industry".]
"See, in today's mortgage industry, home loans are often packaged together and converted into financial products called mortgage-backed securities. These securities were sold to investors around the world... Two of the leading purchasers of mortgage-backed securities were Fannie Mae and Freddie Mac." [Fannie Mae and Freddie Mac have been presented to the public as financial agencies dedicated to getting people into their own homes. Whatever good may have been done through them in this respect, the President's words are a tacit admission that "when push comes to shove", it is the "investments" of speculators in home mortgages who are getting "bailed out", while the investment of the homeowners who pay them is not taken seriously into account.]
"The decline in the housing market set off a domino effect across our economy." [This is another way of saying that the decline of the housing market has precipitated a collapse of the fractional reserve formula.]
"When home values declined, borrowers defaulted on their mortgages, and investors holding mortgage-backed securities began to incur serious losses. Before long, these securities became so unreliable that they were not being bought or sold. Investment banks, such as Bear Stearns and Lehman Brothers, found themselves saddled with large amounts of assets they could not sell." [The phrase "incur serious losses" makes it seem (though not explicitly) as if banks and speculative "investors" were holding money that is now being lost. They were not holding money; only speculative paper that gave the appearance of being money because there was always someone else waiting in the wings, presumably, that had money in hand that they were ready to trade for that paper. There is virtually as much money in the economy as there was a month ago, except that now the holders of it are not so willing to play at the gaming tables in the casino that the monetary system has become.]
"I'm a strong believer in free enterprise, so my natural instinct is to oppose government intervention. I believe companies that make bad decisions should be allowed to go out of business." [Then why do we not let the speculators go out of business, and leave the productive sector unburdened by their "enterprise"?]
"And if you own a business or a farm, you would find it harder and more expensive to get credit. More businesses would close their doors, and millions of Americans could lose their jobs. Even if you have good credit history, it would be more difficult for you to get the loans you need to buy a car or send your children to college. And, ultimately, our country could experience a long and painful recession." [The American people possess the key to their own credit, and that is to issue their own adequate supply of money directly out of their own public treasury, which is the sure antidote to "recession".]
"But given the situation we are facing, not passing a bill now would cost these Americans much more later." [I find this to be a misguided sense of urgency. It is as if we the people are being rushed to plunge back into the "debt"-money system before we have had a chance to think about what it has wrought. This is our perfect opportunity to see the workings and consequences of the private-bank-money system exposed and examined. If the enforcement of the fractional reserve formula were suspended, we could let the money in the banks just be money (not "reserves"), and that would allow us to take any time we needed to come to our senses.]
"First, the plan is big enough to solve a serious problem. Under our proposal, the federal government would put up to $700 billion taxpayer dollars on the line to purchase troubled assets that are clogging the financial system." [If one finds dead leaves clogging one's gutters, the sensible thing to do is to flush them out, or at least allow the natural flows of water over time to do so. Why, then, do we not allow the "troubled assets (i.e. unsupportable "debt" contracts) that are clogging the financial system" to be flushed out?]
"The government is the one institution with the patience and resources to buy these assets at their current low prices and hold them until markets return to normal." [The President is acknowledging that the government is effectively the borrower of last resort (after the people lose confidence and/or are no longer willing or able to borrow more) for the private monetary system.]
"And when that happens, money will flow back to the Treasury as these assets are sold, and we expect that much, if not all, of the tax dollars we invest will be paid back." [This is wishful thinking. The proliferation of "debt", public and private, will only continue.]
"The final question is, what does this mean for your economic future?" [This "bailout" would insure that our economic life in the future would be consumed by ever greater quantities of "debt."]
"Earlier this year, Secretary Paulson proposed a blueprint that would modernize our financial regulations. For example, the Federal Reserve would be authorized to take a closer look at the operations of companies across the financial spectrum and ensure that their practices do not threaten overall financial stability." [I fear that "modernize our financial regulations" is a euphemism for transferring even greater power to the institutions that have presided over the crisis that is now coming to pass.]
To be clear, I am not singling out our current President as the scapegoat. Truth be told, I don't hear either of the "major" Presidential candidates say anything that gives an indication that they have distanced themselves from the mode of thought that got us into this mess (though some of the less regarded do, namely Ron Paul, Dennis Kucinich, Cynthia McKinney and Ralph Nader). Surely President Bush has had his part in this, but so have previous presidents, and virtually everyone who has in their own sphere helped to shape the economic life. This is not a time for haste, blame or recrimination. Rather, it is a pause for soul-searching, both as individuals and as a nation. I do not exclude myself. I think that there is a bright new future than can come out of this "financial crisis," but it will not happen by making an ill-conceived and massive "bailout" of the failed ideas and practices of the past.
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
Friday, September 26, 2008
Thursday, September 25, 2008
Column #52 TOP COURSES OF THE "FRACTIONAL RESERVE PYRAMID"
(Week 9 - Thursday, Sept. 25)
In the last two columns I have described the lower and middle zones 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). The lower zone consists of a foundation course of money on deposit in the banking system which are the proceeds of borrowing by the Federal government, and a number of layers stacked on top of that which are composed of the money on deposit of the banking system's biggest customers (large corporations, major public entities, the mega-wealthy).
Above the base layers 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") who perform the bulk of the wealth-creation work in society.
The Sub-Prime/Revolving-Credit Courses:
The top zone (upper courses) of the fractional reserve pyramid is made up of the money on deposit in the banking system of the people who are borrowing to live. Any pretense of this being funds that are "invested" is virtually gone. This is the level of "finance" where people live from "paycheck-to-paycheck" (if they are fortunate), and "loans" are taken out to buy groceries, put gas in the car, and pay for uninsured medical care. These are the folks who live in the financial purgatory of sub-prime mortgages, credit card dependency and payday lenders.
Whether consumers in the sub-prime/revolving-credit zone default on their "debts" is of little consequence to the monetary system as a whole. Business at this level is all gravy to the banking system, with little cost, except printing and postage on the billions of "new offers" they send out in the mail. That specifically is why people in the midst of a major credit-card "debt" crisis continue to have their mailboxes stuffed with new offerings, even from the same companies they are in arrears to. If the consumer went bankrupt the "debt" on these cards would lapse, but all the money that could have been squeezed out of their beggared estates would by that time have been collected anyway. Fresh "credit money" created out of thin air could be safely issued again, next time on even harsher terms.
For a system that depends ostensibly on the ability of people to pay their "debts", the controlling factor in the pressure-relieving bankruptcy game is not as simple as "loan repayment, or no", but rather the stratum in which any default occurs. In the base strata of the monetary pyramid, institutional default will convulse and even threaten the existence of the system itself (at least that is the fear fed by the fractional reserve formula). As one moves up the pyramid, this default-phobic reflex becomes progressively less operative to the point where in the top zone the banking system does not even want its customers to pay up. That is why privately credit card companies refer derisively to their customers who do pay their bills in a timely manner as "deadbeats". Their business practices result in keeping the consumer running ever faster on a tread-wheel of revolving credit, at increasingly harsh terms, the end of which is almost certain to be bankruptcy.
It should be noted that the soundness of the financial blocks in the bottom row still depend, however indirectly, on the performance of some of the lesser grade courses on top. Their portfolios are ultimately "debt"-based, and so depend on real people being able to "perform" on their financial obligations. A certain amount of rot can be tolerated, but let that be the problem of the middle managers in the upper layers. Of late, however, these prime players have had to reach further up into the realms of "sub-prime and revolving debt" in an attempt to keep their own stones in the "fractional reserve" wall patched up with enough money on deposit.
The perverse logic of this whole scheme is that if the common man goes bankrupt, even if millions do (especially in the sub-prime/revolving-credit zone), it is treated in the world of high-finance and the politics that attend it mainly with lip service, because their "loan" proceeds are not strategic stones in the wall (not the "reserves" for much "credit money" creation), but if a major bank fails it threatens to bring down the whole credit structure. The crazy upshot of this situation is that there is a degree of reality to it; as long, that is, as we the people accept the dubious "financial realities" of a monetary order that is based on the "fractional reserve formula" as propounded by powerful media, financial and political interests.
And so the public may acquiesce (if history is any guide) to these "bailout" schemes, albeit amidst indignant demands for more "accountability" in the system this time around. Those who labor to make mortgage payments, sub-prime and prime, are losing their homes by the millions, while Fannie Mae and Freddie Mac (the financial agents for those "investors" who "own" their mortgages) are getting hundreds of billions of dollars in "bailout" money. The fortunes represented by the lower courses of the fractional reserve pyramid scheme are thus secured, the banking system is "saved", and the system is made ready to go another round of "debt"-money expansion.
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
In the last two columns I have described the lower and middle zones 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). The lower zone consists of a foundation course of money on deposit in the banking system which are the proceeds of borrowing by the Federal government, and a number of layers stacked on top of that which are composed of the money on deposit of the banking system's biggest customers (large corporations, major public entities, the mega-wealthy).
Above the base layers 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") who perform the bulk of the wealth-creation work in society.
The Sub-Prime/Revolving-Credit Courses:
The top zone (upper courses) of the fractional reserve pyramid is made up of the money on deposit in the banking system of the people who are borrowing to live. Any pretense of this being funds that are "invested" is virtually gone. This is the level of "finance" where people live from "paycheck-to-paycheck" (if they are fortunate), and "loans" are taken out to buy groceries, put gas in the car, and pay for uninsured medical care. These are the folks who live in the financial purgatory of sub-prime mortgages, credit card dependency and payday lenders.
Whether consumers in the sub-prime/revolving-credit zone default on their "debts" is of little consequence to the monetary system as a whole. Business at this level is all gravy to the banking system, with little cost, except printing and postage on the billions of "new offers" they send out in the mail. That specifically is why people in the midst of a major credit-card "debt" crisis continue to have their mailboxes stuffed with new offerings, even from the same companies they are in arrears to. If the consumer went bankrupt the "debt" on these cards would lapse, but all the money that could have been squeezed out of their beggared estates would by that time have been collected anyway. Fresh "credit money" created out of thin air could be safely issued again, next time on even harsher terms.
For a system that depends ostensibly on the ability of people to pay their "debts", the controlling factor in the pressure-relieving bankruptcy game is not as simple as "loan repayment, or no", but rather the stratum in which any default occurs. In the base strata of the monetary pyramid, institutional default will convulse and even threaten the existence of the system itself (at least that is the fear fed by the fractional reserve formula). As one moves up the pyramid, this default-phobic reflex becomes progressively less operative to the point where in the top zone the banking system does not even want its customers to pay up. That is why privately credit card companies refer derisively to their customers who do pay their bills in a timely manner as "deadbeats". Their business practices result in keeping the consumer running ever faster on a tread-wheel of revolving credit, at increasingly harsh terms, the end of which is almost certain to be bankruptcy.
It should be noted that the soundness of the financial blocks in the bottom row still depend, however indirectly, on the performance of some of the lesser grade courses on top. Their portfolios are ultimately "debt"-based, and so depend on real people being able to "perform" on their financial obligations. A certain amount of rot can be tolerated, but let that be the problem of the middle managers in the upper layers. Of late, however, these prime players have had to reach further up into the realms of "sub-prime and revolving debt" in an attempt to keep their own stones in the "fractional reserve" wall patched up with enough money on deposit.
The perverse logic of this whole scheme is that if the common man goes bankrupt, even if millions do (especially in the sub-prime/revolving-credit zone), it is treated in the world of high-finance and the politics that attend it mainly with lip service, because their "loan" proceeds are not strategic stones in the wall (not the "reserves" for much "credit money" creation), but if a major bank fails it threatens to bring down the whole credit structure. The crazy upshot of this situation is that there is a degree of reality to it; as long, that is, as we the people accept the dubious "financial realities" of a monetary order that is based on the "fractional reserve formula" as propounded by powerful media, financial and political interests.
And so the public may acquiesce (if history is any guide) to these "bailout" schemes, albeit amidst indignant demands for more "accountability" in the system this time around. Those who labor to make mortgage payments, sub-prime and prime, are losing their homes by the millions, while Fannie Mae and Freddie Mac (the financial agents for those "investors" who "own" their mortgages) are getting hundreds of billions of dollars in "bailout" money. The fortunes represented by the lower courses of the fractional reserve pyramid scheme are thus secured, the banking system is "saved", and the system is made ready to go another round of "debt"-money expansion.
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 24, 2008
Column #51 MIDDLE COURSES OF THE "FRACTIONAL RESERVE PYRAMID"
(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
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
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
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 23, 2008
Column #50 BASE COURSES OF THE "FRACTIONAL RESERVE PYRAMID"
(Week 9 - Tuesday, Sept. 23)
In yesterday's column I drew a word picture to help the reader visualize the monetary system as a wall made up of courses of stone (bundled "loans" of money borrowed at "interest" from the banking system) that resembles in shape a sort of tall slender pyramid, whose ends slope towards each other, but also curve in such a way that they reach for the sky, but never quite meet. The nature and shape of the wall is determined by the "fractional reserve formula," which governs how banks create and loan out money.
The foundation stones of the pyramid are Federal bonds, which are essentially the loan contracts for money the Federal government borrows directly from the Fed, that winds up on deposit as the initial "reserves" in the banking system. The second course or layer of stones in our pyramid is the first cycle of "credit money" created by banks and then deposited back into the banking system. From there, each cycle of new money created through the loan process and deposited in the banking system is represented by successive courses.
Each course of stone is theoretically of the same nature in terms of the "debt-based-money" it represents, but they occupy relatively different positions in the structure of the wall. If one or more stones (bundles of loans) of an upper stratum failed, that would not threaten the integrity of the pyramidal wall as a whole, as there is little or nothing in the way of newly created money that is being supported above it (i.e. that it is designated as the "reserves" for). If, however, a stone near or at the bottom were to crumble, it could threaten the integrity of the wall as whole (as a significant portion of the loan bundles above it would have been created using it as the original "reserves"). If a few stones at or just above the foundation course were to disintegrate it, would threaten the wall's very existence.
It is obvious that, structurally speaking, the layer of government bonds supporting the dollar is the most crucial. Accordingly, this "high-powered" base strata cannot be allowed to fail without bringing the whole system down. This is why (it is said) the "full faith and credit of the Federal government", "backed" by the full force of same, stands ready to see that this does not happen. This, then, makes the government bonds "backing" the dollar the logical "investment of last resort" (the one that will fail only after all the others have failed), regardless of whatever else is going on in the financial order (which is why these bonds are selling at a premium in the current crisis).
The next several courses up are made of the "reserves" that are on deposit at the major commercial and investment banks. These represent the first levels of "credit money" created on the basis of the "high-powered money" on deposit from loans to the Federal government. They do not constitute the foundation per se, but are so closely linked to it that for a major bank or banks to fail is deemed to be tantamount to the failure of the system itself. If a big bank fails, by the rules of the game a lot of other loans that piggy-back off the "reserves" its money on deposit represents would, by the rules of the banking system, not be supported. In the prevailing view, monetary liabilities for which the large banks are responsible must be honored so as not to precipitate a fatal undermining of the system. When that possibility seemed to loom, the Federal government has in the past intervened (as with FDR's "banking holiday" and "suspension of gold redemption", the Continental Illinois bailout, and the Mexican "debt-restructuring").
Closely linked to the viability of these bottom courses are the fortunes of the banking system's biggest customers, including large corporations, major public entities (states, cities, bonding districts, etc) and the mega-wealthy. These are the "important players", and confidence in the system rests, it would seem, on the public perception of their remaining able to pay their "debts." This imperative is commonly deemed to be significant enough, depending upon circumstances and the vagaries of the political process, to warrant, supposedly, government rescue from insolvency (as for the Chrysler Corporation and New York City bailouts).
In tomorrow's column I will describe the upper courses of the fractional reserve pyramid, and show how their relative positions in the monetary structure accounts for the evidently scant regard the regular hard-working, bill-paying citizen is receiving in the spate of current proposals designed, supposedly, to save the financial system.
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
In yesterday's column I drew a word picture to help the reader visualize the monetary system as a wall made up of courses of stone (bundled "loans" of money borrowed at "interest" from the banking system) that resembles in shape a sort of tall slender pyramid, whose ends slope towards each other, but also curve in such a way that they reach for the sky, but never quite meet. The nature and shape of the wall is determined by the "fractional reserve formula," which governs how banks create and loan out money.
The foundation stones of the pyramid are Federal bonds, which are essentially the loan contracts for money the Federal government borrows directly from the Fed, that winds up on deposit as the initial "reserves" in the banking system. The second course or layer of stones in our pyramid is the first cycle of "credit money" created by banks and then deposited back into the banking system. From there, each cycle of new money created through the loan process and deposited in the banking system is represented by successive courses.
Each course of stone is theoretically of the same nature in terms of the "debt-based-money" it represents, but they occupy relatively different positions in the structure of the wall. If one or more stones (bundles of loans) of an upper stratum failed, that would not threaten the integrity of the pyramidal wall as a whole, as there is little or nothing in the way of newly created money that is being supported above it (i.e. that it is designated as the "reserves" for). If, however, a stone near or at the bottom were to crumble, it could threaten the integrity of the wall as whole (as a significant portion of the loan bundles above it would have been created using it as the original "reserves"). If a few stones at or just above the foundation course were to disintegrate it, would threaten the wall's very existence.
It is obvious that, structurally speaking, the layer of government bonds supporting the dollar is the most crucial. Accordingly, this "high-powered" base strata cannot be allowed to fail without bringing the whole system down. This is why (it is said) the "full faith and credit of the Federal government", "backed" by the full force of same, stands ready to see that this does not happen. This, then, makes the government bonds "backing" the dollar the logical "investment of last resort" (the one that will fail only after all the others have failed), regardless of whatever else is going on in the financial order (which is why these bonds are selling at a premium in the current crisis).
The next several courses up are made of the "reserves" that are on deposit at the major commercial and investment banks. These represent the first levels of "credit money" created on the basis of the "high-powered money" on deposit from loans to the Federal government. They do not constitute the foundation per se, but are so closely linked to it that for a major bank or banks to fail is deemed to be tantamount to the failure of the system itself. If a big bank fails, by the rules of the game a lot of other loans that piggy-back off the "reserves" its money on deposit represents would, by the rules of the banking system, not be supported. In the prevailing view, monetary liabilities for which the large banks are responsible must be honored so as not to precipitate a fatal undermining of the system. When that possibility seemed to loom, the Federal government has in the past intervened (as with FDR's "banking holiday" and "suspension of gold redemption", the Continental Illinois bailout, and the Mexican "debt-restructuring").
Closely linked to the viability of these bottom courses are the fortunes of the banking system's biggest customers, including large corporations, major public entities (states, cities, bonding districts, etc) and the mega-wealthy. These are the "important players", and confidence in the system rests, it would seem, on the public perception of their remaining able to pay their "debts." This imperative is commonly deemed to be significant enough, depending upon circumstances and the vagaries of the political process, to warrant, supposedly, government rescue from insolvency (as for the Chrysler Corporation and New York City bailouts).
In tomorrow's column I will describe the upper courses of the fractional reserve pyramid, and show how their relative positions in the monetary structure accounts for the evidently scant regard the regular hard-working, bill-paying citizen is receiving in the spate of current proposals designed, supposedly, to save the financial system.
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 22, 2008
Column #49 THE "FRACTIONAL RESERVE" PYRAMID
(Week 9 - Monday, Sept. 22)
In yesterday's column I gave a brief description of how a banker who has $10,000 in "reserves" on deposit in his bank can use them as a basis for creating $9,000 in new money to "loan" out. When the borrower spends the money, almost all of it winds up in the bank accounts of the people he pays it to.
To keep the math simple for our illustration let us assume that our borrower spends all the money in one place, and the entire $9,000 ends up on deposit in one bank. From the perspective of the banker at this institution this newly borrowed and spent money is regarded as $9,000 dollars in "fresh reserves." In other words, he can use this $9,000 as a basis for creating yet more money to "loan."
Let us suppose another person walks into the office of the banker in whose bank the $9,000 in "fresh reserves" has been deposited, and asks to borrow some money. Based on the $9,000 that has just been put on deposit in his bank, he can now write a check for newly created money to lend to this new borrower in an amount up to $8,100 ($9,000 times 9/10), leaving, as the banking system describes it, $900 ($9,000 times 1/10) as a "fractional reserve."
The person with whom he spends this newly created $8,100 will presumably deposit it in his bank account, and this deposit will be seen by his bank as $8,100 in "fresh reserves," upon which, in turn, this banker will be able to create another $7290 ($8,100 times 9/10), and leaving an additional $810 dollars ($8,100 times 1/10) "in reserve."
This process can continue for many successive cycles as new money created and loaned out by one bank is deposited in another, where it is seen as fresh reserves that can be used as the basis for creating yet another round of money to loan. For each cycle the amount of new money created and fresh reserves deposited diminishes in proportion to the fractional reserve ratio. In the long run it approaches "0", but it never quite gets there. The amount does, however, become so small that the procedure does effectively provide a limit to how much "credit money" can be created from the quantity of "high-powered money" originally borrowed into existence from the Fed by the Federal government, which ended up on deposit in the banking system, thereby seeding the fractional reserve process.
It may be helpful for the reader to visualize the monetary system as a pyramid. The foundation stones of the pyramid are Federal bonds, which are essentially the "loan" contracts by which the Federal government borrows money from the Fed, and which winds up on deposit(as "high-powered money") as the initial "reserves" in the banking system. The first cycle of "credit money" created by a bank and then deposited in the banking system forms the next course of blocks in our pyramid. From there, each cycle of new money created through the loan process, and deposited in the banking system is represented by successive courses of stones. Each course of stone is shorter by the fraction represented in the fractional reserve ratio (1/10 in our example), so the lengths of the courses (the amount of new money that can be created and re-deposited as a fresh reserve base) are never quite zero. This suggests the image of a pyramidal-shaped wall with ends that slope towards each other, but also curve in such a way(asymptotically) that they reach for the sky, but the slopes never quite meet. The fundamental shape imparted by the fractional reserve ratio gives this pyramid an appearance that is relatively tall and slender, so much so perhaps that it is suggestive of a degree of instability.
Still if the courses of stone are sound, the structure might stand. The problem is that in monetary terms, the courses are not sound; they are crumbling. This is because they are being eaten away by "interest" charges against the money supply.
If a person takes out a bank loan and spends the money into circulation, the value of those dollars (the stones in our monetary pyramidal wall) are, from the moment they are issued, beginning to be eaten away by the interest charges on the loan. For example, suppose a person borrowed and spent $100 from a bank. He has thereby added $100 dollars to the money supply. There is, however, an "interest" charge attached to that money that is accruing as long as that $100 is in circulation. Because this "interest" charge in practical terms constitutes a net subtraction from the net value (amount of money) realized from that loan, it is effectively eating into the principal proceeds of the loan that brought it into being. Given enough time, the monetary value of the loan will be fully consumed (e.g. $100 will still be owed, despite $100 or more having already been paid in, as is typical in a revolving credit scheme).
Looking at the face of the wall, one sees a shape that resembles a pyramid, but one that is fundamentally unstable because the courses of stone of which it is composed (the bundles of dollars that are created and put into circulation via bank loans) are crumbling (being eaten away by "interest" charges). The present monetary system is the ultimate "pyramid scheme" (new "debt" money attracted to the scheme by old "debt" money). One can scramble to find new material to repair the growing holes in the blocks (find new borrowed money to "bail out" the financial interests whose bundles of money are "invested" in the lower courses of the wall), and thereby attempt to save the wall itself (keep the monetary system from collapsing), but patching can be effective only for so long. Ultimate collapse is inevitable.
For one with eyes to see, this is precisely the image, I would suggest, of what is happening with our monetary structure 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
In yesterday's column I gave a brief description of how a banker who has $10,000 in "reserves" on deposit in his bank can use them as a basis for creating $9,000 in new money to "loan" out. When the borrower spends the money, almost all of it winds up in the bank accounts of the people he pays it to.
To keep the math simple for our illustration let us assume that our borrower spends all the money in one place, and the entire $9,000 ends up on deposit in one bank. From the perspective of the banker at this institution this newly borrowed and spent money is regarded as $9,000 dollars in "fresh reserves." In other words, he can use this $9,000 as a basis for creating yet more money to "loan."
Let us suppose another person walks into the office of the banker in whose bank the $9,000 in "fresh reserves" has been deposited, and asks to borrow some money. Based on the $9,000 that has just been put on deposit in his bank, he can now write a check for newly created money to lend to this new borrower in an amount up to $8,100 ($9,000 times 9/10), leaving, as the banking system describes it, $900 ($9,000 times 1/10) as a "fractional reserve."
The person with whom he spends this newly created $8,100 will presumably deposit it in his bank account, and this deposit will be seen by his bank as $8,100 in "fresh reserves," upon which, in turn, this banker will be able to create another $7290 ($8,100 times 9/10), and leaving an additional $810 dollars ($8,100 times 1/10) "in reserve."
This process can continue for many successive cycles as new money created and loaned out by one bank is deposited in another, where it is seen as fresh reserves that can be used as the basis for creating yet another round of money to loan. For each cycle the amount of new money created and fresh reserves deposited diminishes in proportion to the fractional reserve ratio. In the long run it approaches "0", but it never quite gets there. The amount does, however, become so small that the procedure does effectively provide a limit to how much "credit money" can be created from the quantity of "high-powered money" originally borrowed into existence from the Fed by the Federal government, which ended up on deposit in the banking system, thereby seeding the fractional reserve process.
It may be helpful for the reader to visualize the monetary system as a pyramid. The foundation stones of the pyramid are Federal bonds, which are essentially the "loan" contracts by which the Federal government borrows money from the Fed, and which winds up on deposit(as "high-powered money") as the initial "reserves" in the banking system. The first cycle of "credit money" created by a bank and then deposited in the banking system forms the next course of blocks in our pyramid. From there, each cycle of new money created through the loan process, and deposited in the banking system is represented by successive courses of stones. Each course of stone is shorter by the fraction represented in the fractional reserve ratio (1/10 in our example), so the lengths of the courses (the amount of new money that can be created and re-deposited as a fresh reserve base) are never quite zero. This suggests the image of a pyramidal-shaped wall with ends that slope towards each other, but also curve in such a way(asymptotically) that they reach for the sky, but the slopes never quite meet. The fundamental shape imparted by the fractional reserve ratio gives this pyramid an appearance that is relatively tall and slender, so much so perhaps that it is suggestive of a degree of instability.
Still if the courses of stone are sound, the structure might stand. The problem is that in monetary terms, the courses are not sound; they are crumbling. This is because they are being eaten away by "interest" charges against the money supply.
If a person takes out a bank loan and spends the money into circulation, the value of those dollars (the stones in our monetary pyramidal wall) are, from the moment they are issued, beginning to be eaten away by the interest charges on the loan. For example, suppose a person borrowed and spent $100 from a bank. He has thereby added $100 dollars to the money supply. There is, however, an "interest" charge attached to that money that is accruing as long as that $100 is in circulation. Because this "interest" charge in practical terms constitutes a net subtraction from the net value (amount of money) realized from that loan, it is effectively eating into the principal proceeds of the loan that brought it into being. Given enough time, the monetary value of the loan will be fully consumed (e.g. $100 will still be owed, despite $100 or more having already been paid in, as is typical in a revolving credit scheme).
Looking at the face of the wall, one sees a shape that resembles a pyramid, but one that is fundamentally unstable because the courses of stone of which it is composed (the bundles of dollars that are created and put into circulation via bank loans) are crumbling (being eaten away by "interest" charges). The present monetary system is the ultimate "pyramid scheme" (new "debt" money attracted to the scheme by old "debt" money). One can scramble to find new material to repair the growing holes in the blocks (find new borrowed money to "bail out" the financial interests whose bundles of money are "invested" in the lower courses of the wall), and thereby attempt to save the wall itself (keep the monetary system from collapsing), but patching can be effective only for so long. Ultimate collapse is inevitable.
For one with eyes to see, this is precisely the image, I would suggest, of what is happening with our monetary structure 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
Saturday, September 20, 2008
Column #48 THE "FRACTIONAL RESERVE FORMULA" &
(Week 8 - Saturday, Sept. 20)
Two columns ago I described how the goldsmith banker of the 15th century initiated the practice of keeping a quantity of gold in reserve in his vaults which represented a fraction of the outstanding receipts that he had issued against that gold (and which now effectively circulated as money). This fraction was determined by the size of reserve he deemed necessary to be reasonably certain that in the normal course of business (apart from a "run on the bank") he would have enough gold on hand to redeem any receipt for it that was presented at the teller window.
Yesterday I described the first steps of the "fractional reserve" mode of money creation used in modern banking, and asserted that it is superficially similar to the fractional reserve method of the goldsmith banker in that it requires the banker (in the language of the profession) to keep in "reserve" a quantity of money that is at minimum a certain "fraction" of what he is giving out as "loans," as a hedge against the bank becoming "insolvent" (going broke). Anything "reserves" beyond that level are called "excess" (i.e. "reserves" upon which new money could be created, but has not yet been).
Note that in each of these processes the banker is essentially creating new money; the goldsmith when he is writing out multiple claims against a reserve supply of gold in his vault, and the modern banker when he is writing out a check against a "reserve" supply of paper or electronic deposits of money in his bank.
Despite what may seem like close parallels between these two processes, they are fundamentally different, and have opposite effects.
The goldsmith banker is in possession of an actual reserve supply of something (the quantity of gold in his vault) that can be dipped into to stave off catastrophe in a time of emergency (much like a reserve of grain can stave off starvation during a drought). Catastrophe in this case would be defined as the goldsmith running completely out of the precious metal, with the result that he could no longer redeem at his teller window a promissory note he had issued that said the bearer was entitled to receive his (the note bearer's) gold. In this event, public confidence in his operation would collapse, notes still outstanding would become worthless paper, and his business would be declared "insolvent" or "bankrupt." It should be noted, however, that this would not have transpired until his reserve of gold was completely exhausted.
The modern banker is not in possession of any such reserve supply of something that he can dip into to stave off catastrophe in a time of emergency. His "fractional reserve" is a bookkeeping illusion. In yesterday's column I described how if a banker has $10,000 in "reserves" on deposit in his bank reserves, he is allowed to create $9,000 in new money to "loan" out.
In the idiom of the banking profession, of this $10,000, the banker has loaned out $9,000, and kept $1,000 "in reserve." Note, however, that none of the original $10,000 of "reserves" on deposit is actually loaned out. It all remains on deposit. The status of the $10,000 has changed only in the sense that this particular $10,000 has now been spoken for as the baseline of money on deposit that the banker could use to create $9,000 in new money. To speak as if $9,000 was loaned (as if some money on deposit was lent to someone and left the bank), and $1,000 kept "in reserve" (as if it were in any way comparable to the tangible reserve of the goldsmith banker) is to mutter nonsense.
According to the rules of "fractional reserve" banking, if the person who had that $10,000 on deposit came to the teller window and withdrew it, the $9,000 that had been created using it as a baseline would now be unsupported. If the owner of the $10,000 withdrew even a small part of it, say $100, that would mean that 9/10 of $100 ($90) would be unsupported in their formula, and a way would have to be found very quickly to either "call in" (cause to be repaid) $90 of that loan, or find $100 dollars in new "reserves" (money that was not yet designated as supporting newly created money on top of it).
If a modern bank dips into its "fractional reserve" for even a single dollar, the formula by which it is governed is violated, and the whole fragile structure by which it creates "credit money" comes undone. This singular fact transforms what should be among the social order's most stable institutions (banking), into a game of brinksmanship by which, in the pursuit of their mandate to maximize profits, bankers are obliged to come as close to "needing" to use their "fractional reserve" as possible, while knowing that if they miscalculate and step over that line their bank will instantly "fail" (be declared "insolvent"). The banking system as a whole has been moving ever closer to the "fractional reserve" tipping point, has gone past it, and can no longer stop its own fall. That is why the Federal government is, in people's perceptions, being obliged to step in.
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
Two columns ago I described how the goldsmith banker of the 15th century initiated the practice of keeping a quantity of gold in reserve in his vaults which represented a fraction of the outstanding receipts that he had issued against that gold (and which now effectively circulated as money). This fraction was determined by the size of reserve he deemed necessary to be reasonably certain that in the normal course of business (apart from a "run on the bank") he would have enough gold on hand to redeem any receipt for it that was presented at the teller window.
Yesterday I described the first steps of the "fractional reserve" mode of money creation used in modern banking, and asserted that it is superficially similar to the fractional reserve method of the goldsmith banker in that it requires the banker (in the language of the profession) to keep in "reserve" a quantity of money that is at minimum a certain "fraction" of what he is giving out as "loans," as a hedge against the bank becoming "insolvent" (going broke). Anything "reserves" beyond that level are called "excess" (i.e. "reserves" upon which new money could be created, but has not yet been).
Note that in each of these processes the banker is essentially creating new money; the goldsmith when he is writing out multiple claims against a reserve supply of gold in his vault, and the modern banker when he is writing out a check against a "reserve" supply of paper or electronic deposits of money in his bank.
Despite what may seem like close parallels between these two processes, they are fundamentally different, and have opposite effects.
The goldsmith banker is in possession of an actual reserve supply of something (the quantity of gold in his vault) that can be dipped into to stave off catastrophe in a time of emergency (much like a reserve of grain can stave off starvation during a drought). Catastrophe in this case would be defined as the goldsmith running completely out of the precious metal, with the result that he could no longer redeem at his teller window a promissory note he had issued that said the bearer was entitled to receive his (the note bearer's) gold. In this event, public confidence in his operation would collapse, notes still outstanding would become worthless paper, and his business would be declared "insolvent" or "bankrupt." It should be noted, however, that this would not have transpired until his reserve of gold was completely exhausted.
The modern banker is not in possession of any such reserve supply of something that he can dip into to stave off catastrophe in a time of emergency. His "fractional reserve" is a bookkeeping illusion. In yesterday's column I described how if a banker has $10,000 in "reserves" on deposit in his bank reserves, he is allowed to create $9,000 in new money to "loan" out.
In the idiom of the banking profession, of this $10,000, the banker has loaned out $9,000, and kept $1,000 "in reserve." Note, however, that none of the original $10,000 of "reserves" on deposit is actually loaned out. It all remains on deposit. The status of the $10,000 has changed only in the sense that this particular $10,000 has now been spoken for as the baseline of money on deposit that the banker could use to create $9,000 in new money. To speak as if $9,000 was loaned (as if some money on deposit was lent to someone and left the bank), and $1,000 kept "in reserve" (as if it were in any way comparable to the tangible reserve of the goldsmith banker) is to mutter nonsense.
According to the rules of "fractional reserve" banking, if the person who had that $10,000 on deposit came to the teller window and withdrew it, the $9,000 that had been created using it as a baseline would now be unsupported. If the owner of the $10,000 withdrew even a small part of it, say $100, that would mean that 9/10 of $100 ($90) would be unsupported in their formula, and a way would have to be found very quickly to either "call in" (cause to be repaid) $90 of that loan, or find $100 dollars in new "reserves" (money that was not yet designated as supporting newly created money on top of it).
If a modern bank dips into its "fractional reserve" for even a single dollar, the formula by which it is governed is violated, and the whole fragile structure by which it creates "credit money" comes undone. This singular fact transforms what should be among the social order's most stable institutions (banking), into a game of brinksmanship by which, in the pursuit of their mandate to maximize profits, bankers are obliged to come as close to "needing" to use their "fractional reserve" as possible, while knowing that if they miscalculate and step over that line their bank will instantly "fail" (be declared "insolvent"). The banking system as a whole has been moving ever closer to the "fractional reserve" tipping point, has gone past it, and can no longer stop its own fall. That is why the Federal government is, in people's perceptions, being obliged to step in.
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
Subscribe to:
Posts (Atom)