Welcome to Finance and Fury, the Furious Friday edition.

  1. Does the Government need to solve economic problems? Do central banks solve economic problems?
    1. If so – how? These are honest question that do need to be thought about – there seems to be this growing thought through western societies that the answers to both are yes. That individuals are no longer capable of making their own decisions or choices in the economy – and it is up to a higher power
  2. But yet- if we are left to our own devices, would we solve the problems of the economy over time through our voluntary choices?
  3. Going to the extreme examples – If more money redistribution to the people from Governments, or increased government controls over the economy worked so well – then socialist states should rock
    1. People would be clamouring to get into these nations – not get out and go to nations with a freer market – which simply means greater freedom of choice when it comes to economic activity –
    2. The flight from socialist countries and the better quality of life in economically free counties has been the demonstrable trend over the past 100+ years – But whilst you can do a bit of digging and see this – socialist nations do sound great – having governments control the economy and provide everything to people does sound attractive to some people – might sound good but in reality when something goes wrong – there is no free economy left to solve it – no individuals to make voluntary transactions or start a business
    3. reliance on the government is all that is known or allowed – so to get out of any economic worries – more of the same is turned to – with increased gov spending or taking over control of more of the economy – which tends to compound the problem
  4. In western economies – Most economic problems as I see them stem from the trend of increasing regulation and additional controls over our lives that the Financial System plays – Even government regulation that is meant to do good can go wrong
    1. The very nature of the global financial system is moving down the trend of additional control over the economy
    2. No inflation? Drop interest rates. No GDP, increase government spending.

This episode will be a thought experiment – looking at the reversal of the trend – I’m just one man – who knows if these would work and make for a better economy –

These are just my thoughts on reversing trends which have resulted in a fragile and skewed economy – probably missing many problems with these solutions – due to the orders of effects from actions – There are four major structural areas of the economy that need fixing through reversing trends over the past 100 years – falling to the fallacy of the intelligentsia of only having no external feedback loops for ideas – but it is fun to think about so here we go

  • Separate commercial and investment banking
  • Remove reliance on a Central banks fuelling a debt based economy – reforming central banks to remove inflation targeting as a monetary policy
  • Reverse the trends in regulations and increase supply side thinking
  • Enforce anti-competitive behaviours – i.e. monopolistic practices

Big topic – so split this up into Monetary and Fiscal policy – first to points in this episode – last two next week

Separating commercial and investment banking – the interconnected nature of the financial system

  1. This used to be the way things worked – – where you have a bank you put money with and borrow from – and another that invests in speculative positions – talked about this in the episode “What has created a system where the share market can go down so quickly?” and a number of episodes in the past
  2. In summary – In the US – thing called the banking Act of 1933 – one part of this was the “Glass-Steagall” section of the act – forced the absolute separation of the productive banking from speculative banking
    1. Commercial banks were considered productive – Under this act in 1933 – introduced the Federal Deposit Insurance Corporation (FDIC) – only on those commercial banking assets associated with the productive economy
    2. Created a system where speculative losses arising from investment banking to be suffered by the gambler
  3. Worked well for a while – then there came the first mass wave of deregulation –
  4. While Australia has previously not enacted specific Glass-Steagall legislation – we had Commonwealth regulations which effectively imposed many similar restrictions in place until the deregulation of banks commenced in the 1970s and 1980s
  5. These were minor to the major onset in the areas of Deregulations – Two major financial centres of London (UK) and New York (USA)
  6. London – 1986, the City of London announced the beginning of a new era of economic policy – known as the “Big Bang” deregulation – swept aside the separation of commercial deposit taking and investment banking in the UK
    1. the “Big Bang” set a precedent for similar financial de-regulation into the “Universal Banking” model in other parts of the western world – allowing investment banking to snuggle back up to commercial banking – but now with guarantees
  7. USAIn September 1987 – massive ramp up in speculation resulted in a collapse in most major share indices
    1. Within hours of this crash, international emergency meetings had been convened by Alan Greenspan introducing a “solution” – The creation of a new instrument – this was called a “Creative financial instruments” but otherwise known as “derivatives” today – Came up with the derivative instruments as a concept and further increased the risk to the financial system
  8. The USA Still had the problem of separation of commercial and investment banks – but by 1999 – Clinton found himself signing into law a treaty authored by then Treasury Secretary Larry Summers known as the Gramm-Leach-Bliley Act – this removed the Glass-Steagall separation of commercial and investment banking in the US
    1. The new age of unregulated trading and creation of over-the-counter derivatives caused these strange financial instruments to grow from $60 trillion in 2000 to $600 trillion by 2008 – But around $1.2 quadrillion today at best guess
  9. The issue is that the deposit guarantee schemes were left in place – so if you an investment bank – you can team up with a commercial bank and take on an endless amount of risk – they are protected when the inevitable failures take place
  10. Beyond the obvious pitfalls – this Skewed the allocation of resources – more profitable to bet on derivatives and the financial markets than it is to lend under traditional means –
    1. So you can gamble – and if it fails – so what, you get bailed out – almost like covering the losses on your friend who has a gambling problem –
  11. So over the years – there has been an increase in the Interconnection of financial system and share markets – Deregulation of the Financial system – whilst regulation of every other business increased
    1. Seen the increase in speculative investments and products like synthetic CDOs or Derivatives
    2. Massively increased the risks – but under the TBTF legislation – the gains are privatised whilst the losses are socialised
  12. Solution – to reintroduce the separation of commercial and investment banks – aim to try to reduce the speculation using depositors funds and de-risk the financial system from collapsing in on itself
    1. separating deposits from all trading in securities and derivatives would remove the subsidy that deposits provide to such trading, which would also remove most, if not all, of the risks to deposits
    2. Under the Basel III regulations that are currently being put into place – they don’t actually do anything beyond providing more hybrids as Tier 2 capital for banks to bail in in the event of a collapse – and any derivate exposure of the banks is obligated to be repaid above the retention of deposits – as under these laws you are banks creditors – lending them money –
    3. Through De-risking means that Central Banks don’t need to control the economy as much through permanent QE or buying back defaulted assets from gambling – Moves onto the second point


Remove reliance on a Central banks fuelling a debt based economy – reforming central banks to remove inflation targeting as a monetary policy

  1. Some debt is needed – business loans – the commercial productive side to the economy – but when the very money is backed by debt – you get a problem – every dollar printed or introduced into a system is a debt – the US is pretty evident with this – look at any US bill and it has Federal Reserve Note on it
  2. Central banks roles used to be the bank of last resort – but boom busts made them position themselves as such
    1. Aim was to provide stability to banks in the case of bank runs – many historically occurred – but from the deposit insurance schemes and the end of the Benton woods system – no bank runs – why? No speculation within banks and depositors knew their funds were safe – even if a bank failed then they would be insured
  3. There is a fair amount of evidence that most boom bust cycles are due to unsustainable credit-driven booms followed by speculation that comes undone
  4. Going back before the banking act of 1933 – there was not much in the way of regulation on the financial industry – commercial and investment banks could be one in the same and there were massive levels of credit growth to fuel the speculation
  5. Austrian School and theory on debt deflation – Friedrich Hayekand Murray Rothbard – wrote America’s Great Depression (1963) – their view – the key cause of the Depression was the expansion of the money supply in the 1920s, of which led to an unsustainable credit-driven boom
    1. Banks/Share traders – margin requirements were only 10% – Brokerage firms lend $9 for every $1 investor had deposited – When the market fell, brokers called in these loans, which could not be paid back. 
    2. In the Austrian view it was this inflation of the money supply that led to an unsustainable boom in both asset prices (stocks and bonds) and capital goods
  6. Prior to this – Hans Sennholz – argued that most boom and bustsin the American economy – were generated by creating a boom through easy money and credit, which was soon followed by the inevitable bust.
    1. like in 1819–201839–431857–601873–781893–97, and 1920–21,
  7. But this was all under a different monetary system – currency had a backing – Gold – technically didn’t have an endless supply – could but it would destroy the economy with hyperinflation and then debt defaults from rising interest rates to combat this
    1. looking today – under the fiat system we have inflation targeting policy– which gives an unlimited expanse on monetary supply – and guarantees on deposits – and the intertwined nature of commercial and investment banks – all being fuelled by Central Banks through easy monetary policy
    2. deflationary pressures from debt immerge – Inflation only at 1.5%? Quick – Lower interest rates so people borrow more to buy property – pushing up housing prices – which isn’t measured in the inflation statistics (only the costs of construction goods is)
    3. Become a exponentially self-generating monster for speculation – provided “market confidence” with an influx of easy money – under the Fiat system
  8. Look at CBs today – inflation targets driving credit expansion – allows creation of artificial credit for asset pricing controls
    1. But how does this help the real economy? Which is you and i? how does it help small to medium businesses – which make up the lion share of employment and GDP output compared to companies with 200+ employees
    2. Credit expansion cannot increase the supply of real goods or increase the productive nature of an economy – merely brings about a rearrangement – diverts capital investment away from the free market/market conditions – how economic wealth is created – instead incentivise things like share buybacks – upswing lacks a solid base – It is not a real prosperity. It is illusory prosperity
    3. Instead – incentivises the pursuit of paths which it would not follow under normal conditions
    4. Debt Growth is not an increase in economic wealth, i.e. the accumulation of savings made available for productive investment – it has increased the price we pay for things – like property
      1. A lot of the growth we have seen arose because the credit expansion created the illusion of such an increase
      2. Savings plummeted due to lower rates (no incentive to save – look at interest rates today) – growth started to stagnate
    5. The effects in increased money supply create higher prices – does it mean you are wealthy? Only relative to another nation that doesn’t have the same money supply increases
      1. Example – the real value of goods goes nowhere – just the prices of things increase but your PP stays the same or declines in real terms
    6. Property is an example – if the median is earning $65k p.a. but properties cost $600k, compared to earning $25,500 p.a. but properties cost $100k, which would you prefer? – 3.8 multiple versus 9.2 – variation of over 2.4 times
  9. Solution – Change to monetary policy mandate for CBS – also ceasing the inflation targets – also need removing the incentives for commercial banks to lend based on low risk high collateral and back to productive
    1. Some alternative proposals I have seen based around changing the targets from inflation to the economy’s nominal income – is the money value of what the economy produces each year, including both the volume of goods and services (or real GDP), and changes in the prices of these goods and services (or inflation).
      1. Due to issues with the measurement of both – think it would end up back where we started – constant need to increase money supply to fuel both GDP and inflation
      2. As unless structural policies are changed -no amount of money supply can help GDP growth unless they are thinking along the same lines as MMT which theorises this
    2. Money supply – If it needs an inflation target – be it the increase in money supply – or better yet – If there is a measurement to follow as an indicator – interest rate band might be a better idea
      1. In a world with Lots of savings – low interest rates paid as more money can be lent out on mass
      2. Less savings – over time you get higher interest rates – incentivises savings and people start accumulating more
  • All about incentivising demand for your cash – and at a more localised level between banks – every bank pays essentially the same interest rates – based around a homogenous system
    1. Allow for the creation of new banks – no the oligopoly system we have now – where banking is more of a cartel
  1. Money supply should be based around market demand – not artificial supply to meet a statistic
  2. Allow Interest rate movements may swing wildly based on demand for money – if cost of money goes to 10% – introduce additional money supply to get it down
  1. Need to ponder this point a lot more – but there are different options between interest rate equilibriums
  2. May make for a more volatile market – as expectations would change – major reasoning behind inflation targets is guiding expectations in the economy – but that is a game that can be rigged – doesn’t benefit the average individual but those with the deepest pockets already
  3. But a move towards traditional roles of CBs is needed IMO– to be lenders of last resort and provide a monetary base for economy to work off
    1. The Creations of money still occurs through fractional banking – But based around creation of money at the moment – Too much unproductive debt out there –


These are just a few structural changes – reducing the top down interventions into the markets

Might just be wishful thinking – but the concept of more debt or more regulation to solve problems created by debt and regulation do sound crazy to me –but the issue is self interest – everyone has self interest – especially those in the current economic of central banking system –

Power – attractor for some individuals – once they have high levels of power – would they want to give it up? When you can control the economy with just your very words – that is a lot of power – similar to legislative powers – look at Next week –

  • Reverse the trends in regulations and increase supply side thinking
  • Enforce anti-competitive behaviours – i.e. monopolistic practices

Thank you for listening to today’s episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/

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