On fractional reserve banking
Mark Gregory Turansky linked to a series of 5 YouTube videos not long ago. Although factually their content is true they are highly biased, trying to make you believe that the banks basically own the world and that all interest paid in the world somehow ends up as bank profit. It’s time for some fact checking and a discussion on what the real problems are and how they can be solved.
As we all know this is not true, a lot of interest is paid to depositors, and even if it was true and banking was the most awesome and profitable business in the world, by all means, go invest some capital in bank stocks and you can enjoy huge dividends like the rest of the share holders. What most of these anti-capitalistic propaganda movies fail to tell you is that through the stock markets anyone can own and reap profit from any company. The free market, corporate law and free flow of capital is in fact a power anyone can use to great effect in any way the like, to change company policy for instance, not just rich assholes.
Smallville and BadCorp
It will seem like I’m digressing a lot here but bear with me, I will get back to this later. To continue the above reasoning, let’s pretend that the citizens in Smallville are being bullied and treated like crap by BadCorp. What can they do to stop BadCorp, assuming that legal action is not possible, i.e. the behavior of BadCorp is completely legal but highly despicable? Let’s also assume that the Smallville folks are too impatient to go through their representatives in the legislative assembly to create new laws, and the media remains cold to their plight? They could organize their combined capital and also raise it by enlisting and lobbying more persons to join the cause, the internet would be a great facilitator to do this.
In a fairly short time they could use the capital to buy a part of BadCorp. If they did their homework correctly they should also be able to identify other owners that might be willing to join them. Remember they only need to achieve a 51% vote in the next shareholders meeting to succeed. Such entities might be pension funds which - arguably through their immense voting power in all the world’s listed corporations - are extremely powerful institutions at the moment, and most of the time they never even use it. They might send some bored representative that has been ordered to vote basically in line with the proposals coming from the executives and the board because it seems like the best thing to do. Sometimes they fight for lower executive compensation in order to maximize their returns, but that’s about it.
If the Smallville people wanted they could easily find out exactly how much of BadCorp is owned by the institutions that are managing their pensions and try to lobby/threaten them, if they are successful they would be a good way on their way of gaining control. This is only one way, only the imagination sets the limit on how a revolution might be staged at the shareholder’s meeting, the main point is that for any given issue to be voted upon, you only need 51% of the vote, just like in the legislative assembly, with the added benefit of being able to buy more votes.
The debt monster
The most disturbing thing in the videos is perhaps “the debt monster”, since money is debt, and debt is always associated with interest, and interest compounds then soon the interest burden grows too heavy to bear, regardless of the beneficiary. The end result is then systemic collapse if not more debt can be issued to cover interest payments and so on and so forth. One big piece missing in the videos here is inflation which is only discussed in the part where alternatives to the current system is getting attention, in a completely different context. Inflation is inherent to the system and destroys debt, sometimes quicker than it can be created, that’s why debt and rich people seem to go hand in hand, they often have massive debt but seem to manage anyway. If you are clever and can anticipate high inflation better than the institutions creating your debt then you will in effect be able to rip them off since you will be paying 0% interest or even make money from the debt itself by paying back less value than you originally borrowed! Even so, pretend that you’ve negotiated 6% interest and during the period the inflation ended up being 4%, the real interest you’ve ended up paying is then 2%! If you have any brains at all the investment you made with the borrowed money should be able to generate more than those 2%.
However, since both inflation and interest compounds we get exponentials, and since interest usually is somewhat higher - in well managed countries - we will get an exponential on the difference so the stuff detailed above will only make the process slower than if we hadn’t had any inflation at all, the videos are in that sense correct although unnecessarily biased. New debt/money needs to be created to keep up with it. To avoid hyperinflation and overheating as a result of an ever increasing money supply the output needs to keep up too, you know the real stuff we can buy with all these money, like cars and so on. Through the “law” of supply and demand all the things in the world which we place value on needs to be on par with the amount of money or we get massive inflation, more on this later.
The house bubble
Now imagine yourself being a prospective house buyer in 2005, looking at a graph like this. At the same time you know that all the other stuff you place value on, like a MacBook Pro for instance, have not increased in value like this. You can also see from the graph that the increase in value has happened too fast for the slow government to do much about it, through higher interest rates for instance (yes they have massive control of interest rates through the central banks). A lot of people thought “yeah sure why not?”, indeed, why not? Because even if interest rates were not to rise, the interest payments would, through ever higher purchasing prices, eventually reaching an unsustainable level, and since the inflation obviously was low (remember the MacBook) it could not account for, and destroy the value increase. This is a typical scenario where someone has to sit there with the crap in the end. Since we’re talking about real value increase here more and more people will start looking at their houses and see a huge pile of cash that can be converted into so much other stuff they place value on than a house, hence more sellers. On top of that we know that since debt carry interest, the exponential can not continue, best case scenario is a flat line at some point which happened in the 40’s, at that time it was sustainable though.
The bubble had to burst, like all other bubbles but how could it have been prevented? Since the political machinery in a functional democracy is slow it can not be counted upon when prices inflate fast like this. No, the blame can be squarely placed on two main actors here, the person who willingly accepts the debt, and the bank who readily creates it. As consumers each individual has the ultimate power and can choose to exercise that power through the decision to buy or not to buy, the consumer also needs to accept the consequences of that decision. We choose as a collective to create all this debt, every time we loan to buy a house or vote for politicians promising increased fiscal spending, as decision makers in corporations and so on. There is no conspiracy of a few rich bankers, jews or whatever nonsense idiots choose to believe in. In a modern democracy we could create and vote for a party that completely abolishes the banking system, if the citizens of the US want a planned economy they could have it but they don’t want it, and nobody else either because it simply sucks for a million reasons.
So please, go educate yourself so you can exercise the ultimate power of consuming in a better way, if you feel you need it, the graduation test is to be able to realize that a one million dollar house that you think is worth only half that amount, even though the credit is cheap, is simply a bad purchase.
Reining in banks
Now how can ordinary people prevent banks from issuing new debt to people wanting to buy houses that has appreciated in value by unrealistic amounts when they can’t rely on their legislative representatives to act in time? The answer has already been given above, since we are able to choose which funds are to manage our pension capital (if you live in a country where you can’t, see to it that your legislative representative starts working his/her ass off to make this happen, right now!) we can pressure them to to use their corporate voting power to control the behavior of our banks much faster than the politicians.
Even though the current bullshit could readily happen in a market untouched by dirty political fingers - when consumers don’t bother using their power, or are too stupid to use it - it has to be acknowledged that it is in fact a politician who started the avalanche this time, Bill Clinton!
World destruction
And we still haven’t touched upon the heart of the matter yet, damn I’m blabbering! The videos make the case that since debt/money needs to be created at an ever increasing rate, the amount of real world products we place value upon needs to keep up, finally creating a situation where we have ravaged the whole planet in an ever increasing appetite for more stuff to keep our unhealthy financial system going. This is not happening because during events like The Great Depression and the current crisis, debt/money is destroyed in unbelievable amounts and the demand for goods sink dramatically, making such huge dents in the legendary exponential that we can not talk about an exponential anymore, it simply doesn’t exist.
If someone cared to check I bet that the amount of money destroyed equals the difference between inflation and interest to such an extent that the exponential in fact becomes linear. The end result is that growth simply mirrors our technological ability to utilize the earth’s resources, combined with the size of the population, and that ability surely looks exponential at the moment but just wait until the oil runs out and that curve will lose its boner too.
Mano depression
The real question is, do we want a system that is so prone to hysteria and depression simply because money can be created so easily as debt? Of course not, the current situation is giving me ulcers! Well one way could be to use our collective reasoning and perception combined with a good organization in order to control the banks that we own anyway through the voting power of our pensions, as detailed above. Somehow it seems though that we as humans get caught up in the ups and downs on a psychological and personal level too and then the whole “wisdom of the crowds” scenario falls flat on it’s face.
No matter how I wreck my brain for an answer to the problem I can’t come up with a solution that doesn’t involve heavy government regulation with all the huge drawbacks that come with it. No the answer is in the problem, the next time you start to feel like something is too good/crazy to be true, whether it be dot com stocks or house valuations, then realize that it probably is and don’t let your greedy self get the upper hand, show some restraint and discrimination damn it, don’t be another animal in the herd!
We need to change our collective behavior, otherwise we deserve what we get and clever people who realize what’s happening early in the game need to work harder to open the eyes of the others. That’s one of the reasons why we need smart politicians, not dumb.
Even so, if we were to act rationally, interest would still compound at a steady and slower rate, it would still be cumulative though, if inflation can not in the end destroy enough value something else has to, a crash.
The replacement system could be free banking. We have to get the politicians out of the financial system, the central banks have to be abolished and the national currencies with them. We tried central banking under the influence of politics, it didn’t work. A free banking environment could replace all this where every individual is a 100% responsible for his or hers choice of bank, there will be no guarantees or crisis packages. Moral hazard with regards to banking will be a distant and unpleasant memory. It might be painful to begin with before we gain enough experience and the market efficiencies set in, but it will be worth it in the long run. Through modern technology we are better equipped to reap the benefits of free banking than ever, let’s make it happen!
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Tags: bad credit, banking, consumer responsibility, credit, debt, Economy, finance, housing bubble, inflation, macro economy, mortgages