It’s a confusing world……

Open your wallet.  Take out that £10 note.  It’s yours.  Your property, to spend as you wish.  Put it in a bank, and you enter Alice’s wonderland.

Most people in this country believe that when your money is placed in a bank account, it remains their property.  Nothing could be further from the truth.  Once you hand it over, it becomes the bank’s property: what you get in return is a promise that they will repay you if you ask for it.  Why does this matter? Because the bank will then lend it to somebody else – and not on the same terms.

Think about what this means for a while;

If the money has been lent to somebody else… surely it’s not there.   Yet you have been promised instant access?   Surely the person who has borrowed the money has the right to it?  The fact is both you and the borrower can use the money – at the same time.  How can this possibly work?

Well, the banks say “not everyone will want to take their money out at the same time. We carefully plan and monitor withdrawals, and we don’t lend the whole lot out – we keep some in reserve to cover withdrawals”.  True, for every £100 you put in, they keep a hefty reserve.

A truly massive £3.

Worried yet?  It’s only the start.

Ok, so you deposit £100 at Bank ‘A’, and they keep £3 and lend out £97.  Happy days, you get interest, that must be the end of it right?  Wrong.

A business man borrows that £97, and uses it to buy some widgets from WidgeCo.  WidgeCo receives the £97 and deposits it at Bank ‘B’.  Is it dawning on you yet?

Bank ‘B’ now takes the £97 and promises instant access to WidgeCo.  However, Bank ‘B’ keeps £2.91, and lends out the remaining £94.09 to Mr Smith who wants to borrow to buy a house….

So how are we left with your £100 that the bank is keeping safe for you?

You now have a claim to that £100.  The business man has claim to £97 (which he has spent), WidgeCo has a claim to £97.  Mr Smith also has a claim to £94.09.

The person who sells the house get’s the 94.09 and deposits it.  And so on, and on, and on, and on, in a recursive loop until there is no ‘money’ left to lend.

This is fractional reserve banking in process.  On average in the UK, there are 34 claims to every £1 of ‘real’ money in circulation.  Except it’s not real money… it is a flexible concept called ‘credit’.  A close-to-money substitute that we have been conditioned to treat as if it were real money.  I call it a Ponzi scheme perpetrated by Banksters.  It would be fraud, except is has a peculiar legal protection.  It is a legailsed Ponzi pyramid.

Why is this a bad thing?  Well, aside from the moral concept of your property being loaned out again and again and again, there is the boom bust cycle that all this flexi-credit creates.

In the good times your £100 is handed many times, credit increases, and the supply of money expands.  A boom ensues.  Any proposition is listened to, anyone can get a 110% mortgage for a buy-to-let, the poor get pressured into borrowing too much to buy council homes, any speculator can find finance for any mad capped scheme, and silly websites can borrow millions to flush down the plug hole.

In the bad times, banks get worried, call loans back in, credit evaporates, money supply contracts, Joe Bloggs loses his home, businesses fail, ordinary folk lose their jobs, politicians start blaming banks for not lending money, and recession or depression ensues.

Welcome to the credit card society.  Binge and bust banking.

There is a better way.

In 1936 the great economist Irving Fisher proposed a solution, but was promptly drowned out by J.M Keynes’ mad cap ideas that suddenly became all the fashion.  The lunacy of Keynes’ ideas is worth examination, (employ one man to dig a hole, and another to fill it, you will generate economic wealth… not sure how, but that’s Keynesianism for you), but the full expose is best served in one helping at another time.

What Fisher proposed was that we should treat notes and coin and accounts with instant access as cash and force the banks into keeping a full 100% reserve (not the miniscule 3% we are used to today).   This means that banks would be forced to keep your cash safe for you.  Loans should be financed by an explicit undertaking of the depositor to tie his cash up for a pre-determined amount of time.

In short hand you make fractional reserve banking a fraudulent activity, punishable under law.

Think of a safety deposit box.  You go to a vault and store some jewellery.  Do you expect the company providing the vault to then open the box, take your wife’s nice gold necklace, and lend it out to the bank’s best customer’s wife?  Not on your nelly.

We can sort this mess out right now.

Take all of the current and instant access deposit accounts, and call it what it should be called: cash.  Tell the Banksters it is your property.  Tell them we’ll chop their balls off if they dare lend it out – it’s your property.  This is a 100% reserve.

However, if we convert all of the positive balances into cash, owned by you, then the Banksters no longer owe you anything: they no longer have the liabilities.  This isn’t fair as they now have all of those lovely loans that they’ve made, for free.  Not so fast.  All of those loans should be hived off into a separate mutual fund: the interest income (and loan repayments) should be diverted into paying off the national debt.

Banks become very boring and safe institutions.

Think what has happened.

1)      We have formalized credit, and turned it to money – this is not inflationary because no new ‘money’ has been created: credit is now cash

2)      The Banksters have lost their lucrative racket – no more profits from Ponzi.

3)      Banksters are now reformed into Bankers.  They have to look after your money, sell you simple banking services like wire transfers, chequing accounts and so on

4)      An end to boom and bust… at least the greater portion of the economic cycle that is exacerbated by gyrations in credit.

1. No more bank crises.  With 100% reserves no bank can go bust because of a liquidity concern.  Sure banks can lend badly, and lose – but they can’t lend your liquid cash.
2. We stop pouring gasoline on normal business cycles, turning them into booms and associated busts.

5)      Morally, owning your money is right.  Your property remains your property unless you explicitly agree to lend it out at interest, in which case you transfer ownership for a pre-set time.

6)      We kill inflation, and promote stable economic growth and much reduce labour market tensions.  Militant unionists cannot agitate for pay rises to ‘maintain a standard of living’.

7)      We impose discipline on the state.  Governments can no longer spend what isn’t theirs, and pay for it by expanding the money supply.

8)      We can get rid of central banks, and the money planners.  Why would we need bureaucrats?  No more liquidity worries means we do not need a lender of last resort.

9)      100% reserves are the most compatible system to work alongside democracy.  No more monopoly profits for Banksters (at our expense).  Government action will require open conversation and explicit decisions on the part of our representatives.

10)  A worldwide system of full property rights to money and 100% reserves would prompt peaceful and harmonious cooperation amongst nations.  Look at any war in the last two hundred years, and you will find that rampant money creation has played its part and paid for the escalation of most conflicts.  Funny money finances war.

Simples.

Hedgehog Uncategorized

(A speech to the Adam Smith Institute Next Generation Group, 6th October 2009)

I have spent the best part of the last two decades picking my wits against the market. It’s an unforgiving game: I’ve seen ups and downs, and many of my rivals buried under an avalanche of hubris, passion, illogical thought and unchecked emotion.

I have witnessed the sheer folly of the ERM crisis, the Asian crisis, the failure of the Gods at Long Term Capital Management and the insanity of the tech boom.

I have enjoyed the ‘NICE’ decade (None Inflationary Constant Expansion), and scared myself shitless during the credit crisis.

I am a trader.

I risk my own money and live or die by my decisions, and face the threat of personal bankruptcy every time I switch my screens on. I get no salary – indeed I turn up at the start of the month with a large office overhead – a ‘negative’ salary. I have no fancy company pension scheme, no lucrative monopoly or franchise.

I eat what I kill.

Mistakes cost me my livelihood, so, above all, my decisions have to be rooted in practical and logical decision making.

Some have called my kind parasitic, but I would have said that I bring order, efficiency, predictability, stability and deep liquidity to crucial process: a process that makes the whole world keep ticking.

I make money work.

I make the market in interest rate derivatives: a market born out of the neo classical revolution in finance fostered in Chicago during the 1970s. I am a child of Freidman, Fisher Black, Myron Scholes and the modern international financial system.

My analysis was steeped in the neo-classical, efficient markets paradigm.

Friedman’s ideal was working. Enlightened central bankers guided the free market with gentle nudges and short term liquidity infusions, free floating currencies gently adjusted themselves to the constant flow of new information and efficient and rational markets took all in their stride.

Credit flowed, people got wealthier, economies developed and all was well.

And then the crisis struck.

Markets dried up and ceased to make sense. Price moves became highly irrational.

Then the whole market edifice began to crumble. Bear Stearns going bust tore a hole in the system and Lehmans almost collapsed the entire financial world.

What had gone so badly wrong I asked myself? How could this have happened?

At about this time I was listening to the US presidential debates. A load of guff and hot air really – all except this fella called Ron Paul. He banged on about liberty, the constitution and the evil of the Federal Reserve. His ideas were fresh to my ears.

In particular he talked about what seemed like a loopy idea. He wanted Gold as money, and the free market to handle it.

Without central banks.

My curiosity had been piqued.

Well, what a Pandora’s box I had opened.

I had opened the door to Austrian economics. A discipline grounded in logic, human action and inevitable consequences of bureaucratic fiddling in free markets.

I discovered that we had been in this mess time and time again, and it always seemed to have the same set of circumstances surrounding it.

Every bubble, boom, bust and crisis had its origins in the extension of too much artificially created credit.

Historically this was by way of government favour and protection towards the banking industry, but in the 20^th century, money was nationalised and it became explicit governmental policy.

The evidence is glaring. You name any boom and bust, and I bet I’ll be able to show you how this has been caused by expansion of the money supply.

Tulip mania, in the 1600s, was caused by the massive influx of newly discovered Gold into Amsterdam from the new world: in particular the capture of the Spanish Treasury fleet.

John Law’s Mississippi scheme was financed by the pyramiding of paper money on top of French government notes of credit.

In the US, the panics of 1797, 1819, 1837, 1857, 1873, 1893 and 1907 were all the result of banks lending out many times what they took in as deposits.

1921 and its ugly sister 1929 were both the creations of the Federal Reserve’s mismanagement of the economy, and every boom bust since then has its origins in mistakes made by central bankers.

Here’s how it works;

Firstly, you have to have fiat money. Fiat, meaning “let it be”.

In the good old days, money developed out of barter. I have a bushel of wheat, and you have a barrel of fish. You want the wheat, but what if I want to buy a horse? In a barter economy I would have to exchange my wheat for the fish, and try to find a horse owner who wanted some fish. But what if he hated fish?

What was needed was an intermediate commodity, something commonly accepted, trusted, portable and desired by all. Something that was scarce, thus held its value.

The free interaction of people, also known as the market, chose Gold.

I go to the market and sell my bushel of wheat in exchange for Gold.  You sell your fish in exchange for Gold.  I find another person with a horse for sale and then sell my Gold in exchange for a horse.  The guy who sold me the horse sells his Gold in exchange for corn, and so on.  Gold is just another commodity, but its common respect has allowed it to evolve into the higher function of a common medium of exchange, accepted and trusted by all.

Throughout most of history gold was money. The Dollar was worth 1/20^th of a gold ounce, the pound was 1/4 of an ounce, and so on. In this way, foreign exchange rates were fixed, financial calculations were easy, and global trade was greatly facilitated.

Not any more.

Look at a bank note. “I promise to pay the bearer, on demand, the sum of £20”. What does that mean? Nothing. You take this note to the BoE and demand 20 pounds they will laugh at you and give you another £20 note. Today money is just pretty pieces of paper with some nice pictures on it, and this means there is not real limit on how fast the money supply can grow.

Secondly, there’s fractional reserve banking – the system whereby banks can lend out many times what they receive in deposits.

Every bank in the country is, essentially, insolvent, whilst the central bank cheers them on from the sidelines. This means the banks can effectively create money out of thin air.

This is the ‘Bankster’ system.

Thirdly, there’s our terror of falling prices. This is nothing more than a children’s scare story, and that the fastest growth the world had ever seen was during the 19^th century – a period of falling prices.

We love falling prices when it is TV’s and computers.

But when it comes to bread and electricity prices the authorities follow the ‘progressive’ idea that we should have to pay 2% more for them each year that goes by. They then make this happen.

It is these three factors that combine to create a policy of continual inflation of the money supply, and lead to our never ending cycle of boom and bust.

It is madness, but why do it? Simple, it is a hidden tax on the nation’s savings. It allows the profligacy of government and the Bankster’s profits.

Modern monetary history is rich with stupendous bureaucrat led money failures, but I’ll just highlight a few glaringly obvious examples.

In 1987, Alan Greenspan slashed interest rates after the so called ‘great crash’ of 1987, creating the infamous ‘Greenspan Put’.

This allowed the Banksters a get out of jail free card if things went wrong, which it did, time and again. In would ride sheriff Greenspan, and save the day.

Why was there a Tech market bubble?

Could it have anything to do with the world’s central banks cutting interest rates to help save the world from the alleged catastrophe about to be unleashed by the failure of a particularly arrogant hedge fund – LTCM?

And finally: the big one.

Why did we have a crisis over the last two years?

Could it have anything at all to do with the world’s central bankers panicking after 9/11 and massively reducing interest for three long years? Could this have created the greatest property bubble the world has ever seen?

Could this have been the process that almost collapsed the world economy?

And now that the money planners have made money, essentially, free. What about that? What will be the consequence? What happens now?

Austrian economics predicted this crisis and has solutions. Austrian economics can prevent this from happening in the future. Find out about it and understand it.

It’s your responsibility. Your generation is going to pick up the bills for the morons we have in charge of us.  

The massive debts my generation has amassed and the fiscal diarrhoea being sprayed upon us by the establishment. This will be paid back by you.

We are borrowing twenty five MILLION pounds an HOUR.  This will be repaid by YOU.  From YOUR future income.

You have a choice and a chance.

Do something about it.

I’ll leave you with a quote.

“We have tried spending money. We are spending more than we have ever spent before and it does not work. And I have just one interest, and if I am wrong somebody else can have my job. I want to see this country prosperous. I want to see people get a job….. I say after eight years of this administration we have just as much unemployment as when we started… And an enormous debt to boot!”

US Secretary of the Treasury Henry Morganthau, May 1939

Hedgehog Uncategorized

A speech to the Policy Exchange, 31^st March 2009.

I want to talk about two things today;

Number 1: Free markets did NOT cause this crisis… Governments did.

Number 2: Inflation targeting has failed. Money has failed. What should we do?

Free markets did not cause this problem.

In theory, markets work by reacting to prices and direct capital towards where it will be most productively used.  This is how wealth is created.  Usually this works well, but markets are made up of humans, and can be fooled into overshooting by false signals.

Bubbles build up, expanding until people lose confidence.  Bubbles then burst. It’s a corrective process that, relatively benignly, irons out imbalances.

The problem only comes when bubbles go on for too long, because once they get too big, the pop can be terrifying. And that’s what we’ve got now – one hell of a big bang.

False signals have caused a spectacular mal-investment in real estate and its derivatives.

But these false signals did not come from the market, but from government.

False signals.

False signals came from Greenspan’s introduction of welfare for markets. Markets were taught that no matter how much risk they took, they would always be saved. 1987, 1994, 1998, 2001. Each bust bigger than the last, and disaster was only staved off with aggressive rate cuts and increased money supply.

Clearly this was not laissez faire. Just think if events had been allowed to take their course. I bet if LTCM had gone bust then a badly burned Wall Street would have learned a lesson and Lehman’s would still be around today.

In 1999 Clinton mandated that Fannie Mae and Freddie Mac reduce lending standards. The poor were encouraged into debt. This intervention triggered a race to the bottom of lending standards as commercial banks were forced to compete against the limitless pockets of Uncle Sam.

False signals came from deposit insurance. Deposit your money in a boring mutual? Why bother when you can lend it to a lump of volcanic rock in the Atlantic at 7% and be guaranteed to get your money back.

The Basle banking accords required banks to replace rock solid reserves with maths.

Government protected and regulated ratings agencies produced negligent ratings duping pension funds, who were obligated to buy high quality paper, into buying junk cleansed by untested mathematical models.

Central banks create boom-bust.

But most damaging of all was the absurdly low interest rates set between 2001 and 2004.

The resultant glut of cheap money fueled an unsustainable boom encouraging more mortgages to be taken out, and pushing property prices ever higher.

The market responded by pushing scarce economic capital towards highly speculative property development.

As prices rose people remortgaged, and borrowed to consume more. This unchecked process tended to be destructive, as scarce economic capital flowed out of our economy and headed to those economies efficiently producing consumer goods, such as China. Rampant asset inflation clouded our ability to see this depletion process in action.

Everyone had a great time whilst the party lasted, not least Governments who were incentivised to let it run, blinded by ever larger tax revenues.

But all parties come to an end, and central banks had to prick the bubble eventually. Interest rates went too high, and sub prime collapsed, and then all property prices plummeted. Trillions of dollars were ripped out of the financial system, and the credit crunch began.

It’s happened before.

But, despite its complexity, there was nothing new or unpredictable about this process. All the great busts of the 20^th century were preceded by a Government sanctioned fiat currency booms.

In the 1920’s, the Fed pursued a ‘constant dollar’ policy. This was the era of the innovation, Model T Fords, radios and rapid technological advancement.

Things should have got cheaper for millions of people, but money supply was boosted to try and keep prices constant. All that extra money flowed into the stock market, pushing prices to crazy levels, and we all know how that ended.

In the modern day, targeting price changes has been an utter disaster for us too.

It let the Bank of England pretend they were doing their job, when money supply was growing at a double digit rate. It let the authorities relax whilst an economy threatening credit bubble was building up.

And it gave Gordon Brown the leeway to convince people that boom and bust was over.

Things should have got cheaper.

Inflation targeting made no allowance for globalisation, the rise of India and China, and the benign falls in general prices that should have been triggered. Think about it; if all those cheap goods were to become available, consumer prices should fall. We would have had greater purchasing power, and become wealthier for it.

But, the Bank of England was aiming at a symmetrical plus 2% target. Falling prices in some goods necessitated stimulating rises in others. They unleashed an avalanche of under priced debt and we had our own crazy asset boom.

Inflation targeting was a myopic policy.

Governments make terrible farmers.

When a central bank sets interest rates, they set the price of credit.  Inevitably they create distortions.

Consider this; Governments cannot set food prices without causing a glut -or- painful shortages. Now, food is a pretty simple commodity, yet we all understand that central planners simply cannot gather enough information to set the price accurately.

It has to be left to the spontaneous interaction of thousands of buyers and sellers to set the price.

So, why do we think that enlightened bureaucrats can put an exact price on something as vital, yet complicated, as credit?

In a nutshell, if I can’t tell how much my wife will spend on Bond Street this weekend, how can they?

Let’s wake up from this fantasy.

There is a better way.

What’s the cure? Let the invisible hand to do its time honoured job. Leave interest rates to be set by the millions of suppliers and users of capital.

Get the central planners out of the way.

It’s the way it used to happen. The period of fastest economic growth the world has seen was America between the civil war and the end of the 19^th century. Money was free and private and the Fed did not exist.

So, how do we get back to freedom in money? Fredrich Hayek – the great Austrian economist – did the best thinking on this. What he proposed was that private firms should be allowed to produce their own currencies, which would then be free to compete against each other. People would only hold currency that maintained its value, firms that over-issued would go bust Producers of ‘sound’ money would prosper.

History gives us plenty of successful examples of private money working well, 18^th Century Scotland had competing banks, all with their own bank notes. People weren’t confused. It worked. There are many other examples.

In the modern age, technology makes the prospect of monetary competition even more tantalising. Mobile phones, oyster cards, smart tags, embedded chips, wireless networks. The internet. Prices could flash up in the shopper’s preferred currency.

A proposal.

Here’s an idea of how to kick the process off;

Tesco’s want to get into banking. Why not currencies as well? Tesco’s, would print one millions pieces of paper. Let’s call them Tesco pounds. It would be redeemable at any time for £10 or $15. They would then be auctioned, and the price of a Tesco set.

Anyone who owns a Tesco has a hedge against either the £ OR $ devaluing therefore the Tesco has an additional intrinsic value. Maybe they’ll auction at £12.

Tesco would specify a shopping basket of goods that cost £60. It would promise that 5 Tesco Pounds would always buy that weekly shop. The firm would use its assets to adjust the supply of Tesco Pounds so that they kept this stable value.

They would need to otherwise their shelves would be cleaned out!

As central banks inflated the £ and $ away over time, the convertibility into these currencies would matter less. We would be left with a hard currency that meant something.

There would be other competitors and a real choice about which money to hold your wealth in.

McDonalds has a better credit rating than Her Majesties Government, so maybe people would be happy to hold Big Mac tokens? I don’t know – it will be a free choice.

Currencies would sink or swim depending on how well they performed. What’s more, firms issuing the currencies would come up with different ways of maintaining their value. Some would offer Gold. Manufacturers may use notes backed up by steel, copper and oil.

Let’s see what a free market chooses. Somebody might have a brainwave and come up with an idea that nobody has thought of.

That is what free markets are best at.

I can guess the reactions that my proposal might inspire in some. How would the man on the street cope? Well, nobody would outlaw the Government’s money, and people could carry on as before. Through the operation of the market, we would find out what worked best . Step-by step, the economy would be transformed and standards driven up.

In economics, spontaneous orders are always so much more rational and stable than planned ones. Always.

Conclusion.

This is not a crisis caused by free markets. A free and unregulated market in money has not existed for over a century.

This is a Government crisis. A crisis over the monopoly of money.

Inflation targeting seemed so persuasive…. but it was a false God, and we deserve better. Stability and sound money can only come if we put the money supply back where it belongs…

Under the control of the free market.

Hedgehog The Hedgehog's Blog