Monday, December 22, 2008

Financial Crisis - A Brief Review

I have been following my ritual of reading the various online news sources, and came accross an article in the Times, which they have titled '10 Mind Boggling Statistics from the Credit Crunch'. It primarily deals with the UK, but also looks at the bailout a little more widely. It is one of those articles which, whilst crude, paints a very vivid picture. I say crude, because they switch from figures per household, to figures per individual, and provide no explanation of how they found their figures. However, regardless of this, the numbers in all events make disturbing reading. For example for the Royal Bank of Scotlant bailout they give the following:

'2. £20,000,000,000

This is the amount of taxpayer cash that has gone into the coffers of the Royal Bank of Scotland, a bank which was the pride of Scotland until the suffix "troubled" was permanently attached to its name. This is the equivilent of £333 each.'
Or this for the cost of the bailout as a whole:

'1. £500,000,000,000

...or around £8,000 each. £500 billion is a conservative estimate of what taxpayers, you and me included, are paying for Gordon Brown's plan to bail out the UK banking system. [...] £500 billion is a staggering amount of money, equivalent to 4,000 brand new hospitals (at £125 million each), 16 new high speed rail links between London, the north of England and Scotland [...]'
Regardless of whether the final figure is 2000 or 4000 hospitals expenditure of capital, it is a lot of hospitals. I have to commend the Times for their objective in painting the picture in this way, but would like to see this shouted as a headline article, rather than tucked away in an obscure corner of the Money section. I commend this because it is very easy for individuals to turn figures given as £x billions into abstractions. The numbers become beyond imagination. It is for this reason that I often give full numbers rather than abbreviating them.

It is this article that has prompted me into this review. The money is now borrowed, and has now been committed to 'saving' the economy and, one way or another, every individual and business will be paying for all of this borrowing in the future.

So what have we got for these huge sums of money?

We still have a disfunctional banking sector, and there is discussion of a need for further ongoing bailouts. Unemployment is rising at record levels. Manufacturing is contracting. The service sector is contracting. The £GB is falling like a stone. There are widespread reports of a rash of retail failures. House prices are still plummetting. The government is having to bail out industry, and the car manufacturers are certainly just the tip of the iceberg. Repossessions of houses are up. Personal credit delinquency is up. I could go on...

In economics jargon, there is a term called an 'opportunity cost'. Putting it crudely, this is the idea that, if you make one choice, you forego another, and might miss a better alternative choice. Well, the government has made its choice, and there is no way of taking that choice back. It is easy to forget that the government did not have to spend money, or that there were other ways in which to spend this money. When we see the sums put so bluntly, as in the Times article, it helps keep our mind focused on the reality of the opportunity costs. For example, they give a total cost of the bailout to each individual as £8000 per person. That is enough money for each individual to buy a Ford Ka.

Whilst we know that these figures are crude, and not everyone would use that money to buy a Ford Ka, the simple fact remains that, in the future, taxation will make everyone poorer to the extent that they will not be able to purchase a Ford Ka. In bailing out the banks, that money will come from taxation in the future, and the opportunity cost is somewhere in the order of 1 Ford Ka per person.

When we think about this, we need to recognise that these figures are just the cost of the bailout of the financial system. They do not include the wider expansion of debt by the government.

In a previous post I made the point that, if a government borrows to pay a policeman today, they will not have the same money tomorrow to pay that same policeman. This is the reality of borrowing. However, when we start measuring borrowing in the lost opportunity to buy a Ford Ka in the future, it becomes possible to see how the massive expansion in government borrowing of today will constrain the ability of the economy to recover in the future. The taxation will be rising to the extent that the increases have an opportunity cost measured in foregoing purchases of Ford Kas in the future.

This represents a massive contraction in spending in the future.

In other words, in borrowing so much money at this moment in time, the government is ensuring that there will be a further even larger contraction in the economy in the future. The only way that this could be avoided is if the money was being invested in a way in which the return was greater than the investment. This is clearly not the case, and even the government does not claim this is the case (or not that I have read/heard).

It is at this point that we return to what the result of the massive bailout actually is. I have pointed out the continuing collapse of the UK economy, which has continued regardless of the bailout. I have not referenced the points that I make, as every news source is full of articles confirming what I have listed. The UK economy is falling off a cliff.

I had a conversation with someone the other day, and he asked me whether it would have been possible to have just left the banking system to collapse entirely. It is actually a very tough, and very painful question to be asked. I have objected to the bailout from the start, but must confront the alternative of what would have happened if the entire banking system had collapsed. Something had to be done.....did it not?

It is at this point that we need to think about what that collapse really meant. The banks has lent into inflated assets and had lent in the belief that the economy would keep on growing. What they had not realised was that the economy had only been growing due to the expansion of debt in the economy, and that there was actually no real economic growth without their irresponsible lending. I need not detail (once again) the story of the credit bubble (for new readers, I first detailed this in my essay 'A Funny View of Wealth').

So what would have happened if the banks had been left to their own devices?

I have no doubt that there would have been economic mayhem. There would have been bank runs, bankruptcy, people would have lost their savings, and there would probably have been rioting in the streets. This is why the bailouts took place, to avoid a sudden and painful collapse. In such circumstances, it is easy to see why governments took the option of the bank bailouts. The prospect of a collapse of the financial system is very scary indeed.

It seems that, at this point, I might be supporting the bailout. However, the reason why I highlight the opportunity cost is to highlight the fact that, despite the apparent relative calm, the UK is slowly but surely sinking into the same mire that it sought to escape from. The difference is that it is slower, and the damage to the economy is being moved from a short sharp collapse, to a protracted collapse from which it will be ever more difficult to recover. The difference is that we do not have the rioting in the streets today, but if the collapse takes us in any case to the same place, then it will still be rioting in the streets tommorrow (not in the literal sense of today and tommorrow - obviously).

In other words, has the bailout made any real difference to the actual state of the economy? If the borrowing was really just about a restoration of confidence, and that the economy was fundamentally sound, and the financial crisis was about panic and imagination, rather than the real state of the economy, the bailout would make sense. Under such circumstances, spending money to restore confidence would make sense. However, this is not the case, and it is apparent that the flaws and problems of the economy are very real.

One of the ongoing themes of this blog, since I made the first post, is that building a so called 'service economy' (or post-industrial) based upon endless expansion of debt is unsustainable. However, this is what has been undertaken and the result is massive structural imbalances in the economy, such that the economy is geared towards consuming more than it can actually produce. This is not an illogical statement, as the consumption has been based upon the production of other economies, and those economies have also financed a large part of that consumption.

The financial crisis was not something that happened due to the development of financial instruments such as CDOs (Collateralized Debt Obligations), but rather the development of such instruments helped to hide the problems in the structure of the economy. They simply made a debt fuelled economy appear to be sound, and allowed the structural problems to persist. The development of such products unhappily coincided with a change in the structure of the world economy, and allowed economies such as the UK the delusion of ongoing success whilst the economies were actually failing.

What we are today left with is the failure of our economies to adapt to the changed circumstances of the world.

The trouble that we now have is that the banks have been bailed out, and the cost of that bailout is the lost opportunity for economic growth in the future. The massive government borrowing represents a massive future slowdown in consumption. Nothing will stop the restructuring of the economy away from consuming more than it produces. As such, the crisis will in all events wind its way to its own sorry conclusion. That conclusion to this crisis will be mass unemployment, mass bankruptcy, and all of the social upheaval that will go with that process.

The trouble with the banking bailout is that the capital that might have been used in the future for so many constructive purposes is, even as I write, being used to artificially prop up a collapsing economy. It is therefore the destruction of future wealth. Pumping more borrowed money into an economy that has already been distorted into an unsustainable shape by past borrowing is not a solution, but the continuation and deepening of the problem.

I keep coming back to the puzzle in all of this. There are many economists out there who are far more clever than I, and I just can not see why they do not see this. If borrowing caused the problem, how will more borrowing solve it? Even now, they still do not quite seem to grasp it, but they continually touch on the edges of the reality of the situation. Take this example:

Sir John Gieve said the Bank's policy-makers were aware that dramatic rises in the price of houses and other assets were unsustainable, but underestimated the danger this posed to the long-term health of the economy.

"We didn't think it was going to be anything like as severe as it's turned out to be," he said. "I think that's because we, perhaps, hadn't kept pace with the extent of globalisation.

"So the upswing here didn't involve the big increases in earnings and consumption and activity we saw in previous booms. We saw the [increases in] credit, we saw the [rises in] house prices, but we did see a fairly stable pattern of earnings, prices and output."

At least he has realised that globalisation really changed things. However, even today, they are talking about output, but without understanding that output based upon growth in consumption driven debt is not a growth in wealth, but the exact opposite. If they could just grasp this simple idea, they would realise that moving debt growth from consumers into government debt growth is not the solution. It is the problem.

At this point I will end this review, though it only covers the UK, and the UK solution to the financial crisis. I am hoping that what I am offering is a clear and concise explanation of why the bailouts of the financial system were simply acts of destruction, that they will just make a very serious situation even worse. I have posted all of these points previously, but thought it might be useful to pull them all together, and put a more direct and clear argument against the continuation of government borrowing. I have not touched upon the subject of printing money, as I have been discussing this in previous posts (e.g. here), and I will be replying to some of the comments on these posts below.

Note 1: A thanks to Alfred T Mahan who has pointed out that the feeds from this blog often only show the notes (such as this one). I checked the feed, and it works correctly. I think the problem is that, when I write notes after the original post, the 'Blogger' service re-publishes the blog, and only republishes the notes. Writing notes after the original publication is a very convenient way of responding to comments but it seems that it is not a good way of doing such, there may be a slightly longer delay in responding to comments, as I will only be able to do it in follow on posts, or will need to comment myself through the comments facility (I hope this makes sense). As such I will apologise in advance if I am less responsive to comments than previously.

Note 2: Alfred also made a comment on the matter of the repeal of the 1844 Act, suggesting that the upshot will be that, when it finally becomes apparent that the money printing presses have been running, the fact that it was hidden will do more damage. I tend to agree with that view. He also points to history for comparisons of how nations fall into decline, with some apt comparisons.

Note 3: I have this comment from an anonymous poster:

'In other words, by the beginning of the'90's financial dealings and transactions had become fully electronic.

By the stroke of a key, money could be conjured from the ether, by the click of a mouse, money could traverse the globe in a nanosecond.

Money had become pixelated!'
I can understand this sentiment. However, a physical bank note has no more substance than a digital bank note. Both of these are equally built upon a foundation of confidence, and they derive their value purely from that confidence. In both cases, they rely on us all believing that they have value, but in both cases they have no objective value. This is a very difficult subject, and can not be explained in brief. As such, I would point you in the direction of my post on 'synthetic economics'. It is not the easiest of reads, but I hope it will explain the point.

Another poster on the same subject says:

'Computers are a powerful tool for certain but get the inputs wrong and the calculations will be flawed. Garbage in, Garbage out. Computer modeling breaks down by the famous "Butterfly Effect" in complex environments such as weather patterns, social or economic models, but many people can take it as gospel and not realize it can only predict broad trends, and must be verified constantly.

It makes me wonder if the economists have run models and based actions on them forgetting that their actions and others reactions change the economic environment itself, thus changing the effects of the model in unpredictable ways.

That said, some of the reaction of the UK and US seem to be based on more animalistic reasons ie panic after their delusions are shattered, their theories blown to pieces, and the stark reality of an imminent collapse'

On a personal level, I am a little bit of a computer geek, and can build databases and program, so I am sympathetic to the value of technology ( I should have built my own system for this blog, but lacked the time). However, I am also aware of the risks. I read a very good description of a scenario in a book by Sherry Turkle (I think written in 1995), in which a student presents a professor with a computer printout as a solution to a problem. The professor then asks the student something along the lines of 'well the computer knows the answer, but do you?' This is both a potentially fair comment, or completely unfair. It may well be the case that the student does not understand the answer they are presenting.....

Note 4: I have had a question from Jonny, which is very interesting:

'Whilst I appreciate predictions are difficult in such turbulent times, how can house prices fall for such an extended period if deflation will be off-set by inflation? I seem to recall reading yesterday in a Telegraph article that it would take 6 to 18 months for quantitative easing to appear as inflation.

With this in mind, and given UK inflation has effectively begun, aren’t UK house prices more likely to fall for perhaps another year or so before monetary inflation halts further falls?

Or would the effects of the severe recession/depression (e.g. mass unemployment) mean house prices would continue to fall regardless of inflation?'
This is a very good question as it is actually a very difficult question. I have read about hyper-inflation in principle, but here is a good question of the process in practice. The first thing is that, during hyper inflation, the value of cash is destroyed. At the same time the cash price of assets rise, although their real value may not change. At its most basic, what I am trying to say is that, if a pint of milk has the same value as a loaf of bread, whilst the cash value of these may change, the relationship of the value, one to another, does not necessarily change. So it is with housing. If a house is worth 100,000 pints of milk today, all other things being equal, it will be worth 100,000 bottles of milk tomorrow. However, the value of housing was over-inflated, such that all things are not equal. As such, whilst the cash price of a house may rise, the value of that asset will presumably continue to decline relative to other assets.

One of the curiosities in this is that, if you have purchased a house with a large amount of debt, in hyper-inflation the value of the debt will be destroyed. The only way that the banks can deal with hyper-inflation is through the interest rates, such that they charge a rate of interest that ameliorates the collapse in the value of cash. As such, if I am right about hyper-inflation (which is a very big 'if' - which is a warning), then the logical thing to do is to buy into a tangible asset such as property with lots of debt - but only if it is possible to fix the interest rate over the medium term (say 5 years). At the end of the period, you will have an asset which you have paid very little for. Whether this is an ethical thing to do, I am not sure. However, it does illustrate the dangers in hyper-inflation, and why it is so dangerous for an economy. How can an economy work in the circumstances where investors would potentially lose so much...?

Note 5: I have this from an anonymous poster:

The January U.S. crude oil contract settled down $3.84 at $36.22 a barrel, after earlier hitting $35.98, the lowest price since June 2004. London Brent settled down $2.17 at $43.36 a barrel.

Courtesy Oil Drum 18.12.2008

If the proposed cuts in production cause UK oil prices to increase - what then?

We have a severe problem if the cuts do lead to price rises in oil. On the one hand, we have an increase in the $US price of oil, and on the other the devaluation of the £GB against the $US (ignoring the possibility of a collapse in the $US). In such circumstances, the effect will be strongly inflationary. Interestingly, the collapse in oil prices of late has led to scaling back of investment in the industry, with potential for a future explosion in oil prices. Those who are regular readers will see the consequences of this if they think of my commodity brick wall analogy (which can be found here).

Note 6: An anonymous poster has the following to say:

'It looks that today's turmoil is a deliberate dismantling of our civilisation's lifestyle.

Our unsustainable standard of living is being taken down to converge with the raising standard of the third world. As a non economist, how easy would it be to throttle credit at source to bring this mess into being? (By TPTB)

What's next I wonder'

I do not believe that there is anything deliberate in any of this. I always have, and still do, think that this is all the result of a lack of understanding of what has changed in the world economy. As for what is next, much of that lays in the hands of politicians, and I am not sure I have much confidence left in them.

Note 7: I have been given a link to a post here. It is an interesting example of a general conspiracy theory blog, in that it is saying that the 'illuminati' have been 'caught with their pants down'. As such, it is at least novel, as most of the conspiracy theorists believe the crisis is a part of a master plan. More interestingly, there is the following discussion:

'"Some of those new financial poisons were called credit default swaps (CDS's), some sixty to seventy trillion worth that are currently reeking havoc with AIG, Lehman and Citigroup, as well as many hedge funds. But if you think these are bad, wait until you see what happens when interest rate swaps (IRS's) meet double-digit interest rates. It will be like "Frankenstein Meets the Wolf Man." This event will quite literally be a financial Armageddon from which none will escape.'

I had a very interesting discussion with a regular commentator 'MattinShanghai' some time ago on a similar subject. I think that there are still many skeletons in the financial cupboard, and it is quite possible that some of these may yet emerge in the future. However, on a specific answer to this one, I will admit that I am not sure. I will endeavour to dig around a little bit more, time allowing.

Note 8: Anonymous asks the following:

'Since it is now obvious how this is going to pan out, there is no way the govt will change direction now, in your opinion what sort of time scale are we looking at for the final collapse to occure. I'm assuming that the Quantitive easing proposed will be on a scale that will provide an immediate short term boost to the economy, thus delaying the inevitable collapse. Or it could be that this will spook the international markets so much that it will bring forward the collapse.

Either way, I'm factoring this scenario into the direction I'm taking my business so any comments from you will give me more food for thought'

The short answer to this one is 'I just don't know'. What all of this hinges on is confidence and information. It is like house prices. Millions of people had confidence they could only rise - until they stopped. My personal view is that the real world of job losses and business failures is fast moving the situation to a tipping point. In other words, I think confidence is at the point of collapse.

Note 9: Steve Tierney writes:

'So what do you call a state where everybody is the same, working on behalf of the government, for subsistence-level supplies? Where government keep control with draconian powers? I'm sure there must be a name for that...'

And received a gentle chiding from Lord Sidcup, as did I, so I will reproduce the comment in full:

'It seems that Steve Tierney is trying to allude to "socialism" in a way that is neither accurate or useful. I don't see how what is happening now connects to socialism (rather than facism, State corporatism, totalitarianism, fraudism ) in practice or theory -- no more than UK / US 'conservatives' have espoused financial conservatism for the last +/- 15 years. F.eks => Nouriel Roubini calls it the socialisation of losses and the privatisation of profits.

As CE suggests in the article, we are in desperate times -- it seems to me that any pretence at ideological motivations has been abandoned long ago.
It's a minor point, but there is so much irrelevant waffle, posturing, obfuscation and bullshit surrounding the financial crisis that accurate, definitions and thought should be used to describe and deal with it.

Using emotive terms like socialism or capitalism to describe what is happening seeks to hide the reality of our situation rather than reveal it.

I have appreciated your contributions, but found this one less intelligent than your previous posts.'

I am sympathetic to the view that 'isms' can sometimes cloud our thinking, so thank you for that point. However, I appreciate Lord Sidcups' comments (he is a regular commentator), so I was disapointed to read the last lines. As such a little explanation. I am assuming that the comment was directed at my discussion of a conspiracy to hide the truth.

At the start of my post, like most of my posts, I had no clear direction. Normally, over several days, I read a wide range of articles, noting stories that are interesting (selective bias?). I later then write my post incorporating the articles (or easily found articles reporting the same story), often pulling them together in a theme as I go. I had no intention to write about what I am describing as a conspiracy to hide the extent of the crisis. However, as I wrote, the pieces fell ever more clearly into place. I acknowledge at the end of the article that I may be wrong, and hope that I am wrong. However, the coincidence of the repeal of the 1844 Act, the discussion of printing money, and the other factors, led me to my conclusions. I may be wrong, but there is a good possibility that I am right. If this is the case, the sooner we are all aware of it, the better.

I have also recently been offered the possibility of writing an article for a magazine based upon the blog. It is very flattering to be asked, but it occured to me that, even as I wrote the article, that such an article might preclude the continuation of the offer (I do not know yet), due to the controversial nature of the post. However, I do think that it is better to put these ideas into the open, and the aim of this blog is to give my best interpretation of the reality of the situation. As such, I published anyway.

Note 10: Lemming has gently nudged me to get on with my discussion of banking system reform. If I am honest, the complexity of this question is troubling me. As such, I would prefer to delay a little longer until I have, in my own mind, managed to answer some of the questions that my solutions leave unresolved. I have the start of a solution, but I am still gaming that solution in my imagination, and still finding outcomes/questions that I can not answer. It is not entirely satisfactory as an answer to the delay, but normally I find that all of the pieces fall together at some stage. As such, sorry for the delay.

Note 11: Nick asks:

'I know you don't like to give advice on this, but you seem like the best guy to ask- I've been working very hard the past year to save money and have around £15,000 tucked away. The idea of all my work turning to nothing with the pound crashing scares me, and I would really appreciate some advice about what would be (in your opinion I know) the best place / the best commodity to put my savings into to avoid their value being wiped out.'

You are right about advice. I can only give scenarios, and how you respond has to be your own decision. A few months back I suggested gold might be a good idea, but was already concerned at that time that the price was already rising very high, so with lots of caveats. I could give the same advice, but the price is already very high, and I do not know for certain how high it can go. Also, there is the problematic question of when to get out. The price is built on sentiment and emotion. Such drivers are not very helpful in assessing risk...

Note 10: I am afraid, that enough is enough for today. Thank you for all of the comments, and apologies to those that I missed (e.g. Call me Ishmael, whose comment deserves an answer).


  1. Many thanks for your determination and insightful comment on what is turning out to be a truly horrific situation of biblical proportions.

    I note that you frequently refer to a collapse of the UK (and USA) economy and I would be interested to know your views of potential future scenarios.

    In your commentaries, I am uncertain as to whether you are referring to an imminent, complete and total UK economic collapse in which the UK government would be unable to fulfil its public responsibilities, leading to a failure in essential services such as health care and policing, or do you envisage a lesser situation?

    Such a scenario as I mention above, presumably, were it to affect just the UK would be a matter for the IMF to resolve. However, bearing in mind the enormous scale of a potential worldwide problem, IMF assistance would appear to be no more than wishful thinking since we don’t know from where or how the IMF would obtain sufficient funds to bail out all collapsing economies. The prospects, therefore, do indeed look bleak for the UK. Under these worst case circumstances, we would all be competing for scarce resources and our country would revert to Darwinian principles and only the fittest would survive in the longer term or until a more effective and equitable system of governance is devised.

    Presumably, those with assets of value i.e. food, fuel, specialist expertise and tangible reserves in gold/silver bullion, i.e. smaller coins such as sovereigns and pre-1947 silver coinage, would be in a better position to weather the storm. Those holding reserves of gold, even in a total economic collapse would be well placed to purchase essentials whereas those with no such holdings would be forced into bartering and foraging. Gold (and silver) always retains the same purchasing power - it is only the value of currency that alters relative to gold. If this set of circumstances should arise, investment now in gold, despite its higher price, would still seem to be a reasonably attractive and effective option, rather than holding onto what might well turn out to be bundles of worthless cash.

    As you rightly point out, the problem with gold investment is knowing when to best convert it back into currency at a later date assuming that a resolution to this crisis is found.

    So, I suppose my question is a fairly obvious one! Where are we heading? Is it Doomsday, or is it something less biblical?

  2. I can't help but feel that Sir John Gieves is being a little disingenuous when he says that the BoE was "aware" that unsustainable lending had been taking place, as it is on record that it was deliberate policy. Eddie George (Governor of the BoE from 1993-2003) told the Treasury Select Committee in March 2007:

    "In the environment of global economic weakness at the beginning of this decade... external demand was declining and related to that, business investment was declining," he said. "We only had two alternative ways of sustaining demand and keeping the economy moving forward - one was public spending and the other was consumption."

    "We knew that we were having to stimulate consumer spending. We knew we had pushed it up to levels which couldn't possibly be sustained into the medium and long term. But for the time being, if we had not done that, the UK economy would have gone into recession just as the United States did."

    He said he was "very conscious" that stimulating consumer demand could give rise to problems in the future. "My legacy to the MPC, if you like, has been 'sort that out'"

    Clearly "recession" is such a terrifying thing that it must be avoided at all costs. Why? If it really is such a huge problem to shrink by 1% when in each of the previous five years we grew by 3%, then any idea of "tightening our belts" is a fantasy; we can never do it without crashing the economy, apparently. Hence my question yesterday about fractional reserve banking. Is it FRB that prevents us from allowing our economy to shrink, or some other part of the low level 'mechanism' of banking? Individuals and companies seem to cope with an income that goes up and down, so why can't the economy as a whole?

  3. There can be no coverup if there is no crime. For this reason, the extent of the problem will not be neatly summarized by either governments or the mainstream media. Interestingly, in China, my country ex-patria, the government has started to block access to a number of English-language financial websites and recently blocked the audio feed of its own English-language TV channel! When finally - in ten or twenty years' time - the crisis becomes meat for historians I am sure the documents will make clear that the upper governmental echelons knew what was coming and that disinformation and spin were a highly organized part of their remedy.

  4. Lord Sidcup:
    I believe Steve Tierney was referring to an Orwellian Big Brother state as depicted in 1984 as opposed to an inaccurate or useless ideological reference. Times may be tough but chill out.

    I do not see why you feel you had to explain yourself. As I have said before, you are an insightful and perceptive commentator who writes well and tells it how they see it; its because of this refreshing approach that you have regular readers.

    Perhaps it was because the post was of a conspiratorial nature that you felt it was somehow weaker or less logical. Nonsense. You have taken it as your duty to inform and that is what you do. Your writings are all very enlightening; if someone is less impressed by one than the other is neither here nor there.

    Keep up the good work.

  5. CE

    To clarify, the "last lines" that you find disappointing were addressed to ST not yourself, so apologies for the lack of clarity there (must learn to better distinguish 'comments' from 'posts').

    On the contrary, I found the 'Conspiracy. . .' article brilliant, and posted links to it elsewhere. Maybe 'brilliant' isn't the right word, but it seems to me that you very accurately described the correct balance between incompetence/conspiracy/ fraud/panic etc.

  6. CE

    To clarify, the "last lines" that you find disappointing were addressed to ST not yourself, so apologies for the lack of clarity there (must learn to better distinguish 'comments' from 'posts').

    On the contrary, I found the 'Conspiracy. . .' article brilliant, and posted links to it elsewhere. Maybe 'brilliant' isn't the right word, but it seems to me that you very accurately described the correct balance between incompetence/conspiracy/ fraud/panic etc.

  7. I was wondering, surely the markets cannot fail to know about the change in the banking bill re: how much money is beinf printed? I mean how could they not know? And surely they are only a smattering of e-mails away from finding out?

    Are they going to deceive themselves, again?

  8. Jonny

    you're correct. I was responding to what I assumed ST meant which was probably logically nonsensical in itself.

    But, the wider point is that as people get angry and more hysterical, I believe we are going to be faced with an increasing number of straw-man targets and scapegoats. It can be hard to accept the faults are systemic etc. when people and the media want hate-figures and groups to demonise. I have read in various places that this is the fault of bankers / investors / socialists / the chinese / jews / the labour party / democrats / republicans / illuminati (how do I join?) / immigrants / the rich / the poor / lenders / borrowers and so on.

    Whoever wins that vote will be in deep trouble indeed.

  9. Here's a thought on bail-outs that runs counter to anything I've posted before (in the interest of playing devil's advocate!)

    Obviously taking money from productive industry and subsidising unproductive work is undesirable and we would like everybody to be producing useful stuff or offering useful services.

    But we are where we are and we would like the economy to re-balance back to being productive. However, if we assume that a large proportion of the work force is engaged in unproductive work now then perhaps a sudden free market reallocation of capital would be so brutal that we would have 30, 40 or 50% unemployment and rioting on the streets (systemic collapse).

    Therefore, perhaps the purpose of bail-outs is not to save the institutions that are being bailed out but to spread their collapse over a longer time period. This means that we end up with quite a severe depression that stretches out over a decade maybe but we don't see anarchy or revolution.

    What do you guys think?

  10. Hi Cynicus,

    First off I think this is a first class blog that asks some tough questions, its made a big impression on me and changed a lot of my thinking on the Economic crisis current. Esp our future competativness
    The reason I'm commenting is I have a quibble. You say the Banking Bailout has turned a sharp violent collapse into a slower prolonged collapse. That instead of rioting in the streets today we will have it tomorrow.
    I think the bailout was necessary because it bought us time, whether that time will be used wisely is another thing. At least give yourself time to get out the riot squad...
    Personally though, I feel ill when I think about the money involved.

  11. I'm sorry Lord Sidcup didn't find my previous comments helpful, but would point out that I went to some lengths to avoid using any 'isms' in my post and left you to fill in the blanks.

    I find it interesting that you chose to fill in the blanks the way you did.

    Along with everybody else who posts here, I share a sense of horror at what is unfolding around us and, like many, believe there is a fundemental misunderstanding by the 'powers that be' about the situations true nature.

    I'm not a conspiracy theorist. I don't think our leaders are managing a careful descent into Orwellian territory in a deliberate way. I don't credit them with that much intelligence or ability. But I do feel something dangerous is happening here, as a result of the fear the current crisis is creating.

    Where I differ from Lord Sidcup is in his apparent belief that in times of crisis we should let our ideologies go and just 'knuckle down' to solve the problems. A time of crisis, in my humble opinion, is exactly the time to stand firm for what you believe is the 'right way'. You can do that AND knuckle down. They aren't mutually exclusive.

  12. I would like to repost what another person wrote on the guido blog, as it offers a good insight with regards to the role of labour in economics, indeed can be argued the root of all economics.

    sidsid said...

    I offer some thoughts on the matter, taken from something I wrote just before Toady Bliar appeared on the scene. :-

    The easy way to understand the next step is to look upon “The Banks” as “The Bank”. They are all the same, the same motives, the same methods, the same greed, the same codes of malpractice, all governed by a “self regulated” code of practice, and so we can think of them as The Bank.

    Let us return to your bank loan of ten pounds. We already know that what they are lending us is only one pound of the other customers money and nine pounds of notional money, that they have conjured up out of thin air. In the days of hard golden currency this operation was a lot more tricky to obfuscate, but in those days there was much less of it done than there is today. In those days it was widely believed that banks had to have a stock of gold buried safely in their vaults in order to carry out “safe” lending, and this was “normality”.

    The confusion in this matter is down to not realising that currency has no intrinsic value of its own. You can not eat it, drink it, wrap up warm in it. You can not use it for anything other than exchanging it for goods and services. In fact the only thing about currency with any usefulness is the “number” stamped/printed/embossed upon it (plus the units/denomination to which that number refers, of course). It is, in fact, a bartering token. You exchange a leg of lamb for an agreed number of tokens so that you can go and exchange some or all of those tokens for something you need that the man who wanted the leg of lamb did not have. You are given previously agreed tokens for your days work (instead of say two chicken legs and half a turnip) which you are then able to exchange for something that you find more interesting than what you would other wise have received. (Just what you would have got for two chicken legs and half a turnip must remain an enigma). So in fact, because service was paid for with goods, we can say goods = tokens = currency.

    Gold and silver were the metals of choice for tokens because they were relatively free from corrosion, were scarce and already had a “high worth” as decorative metals for the leaders and power seeker. In the “barbarian” days gold and silver were looted, but as time progressed it was bought from mining concerns.

    Here is a very strange affair. With what does one buy token making material? Well one turns the matter around and one pays with goods and services (and possibly a knighthood or two). The important fact, of which we must not lose sight, is that the only things of value are goods and services.

    Currency = tokens, and these tokens must represent goods and services to be of any value. If the tokens are not backed up with goods in the community then the outcome is, as was found out by Germany in the nineteen twenties, galloping and uncontrollable inflation. In part this was due to belief in what was called “the gold standard”. Which in its own way was part of “hypnosis”.

    So, with regard to your loan of ten pounds, you have been lent one pound token backed up by one pounds worth of existing goods, and nine pound tokens backed up by nothing. Granted the tokens look identical and no one, other than the man at the bank, knows that one pound token has value and the other nine are worthless, but, had you been borrowing goods (chicken legs or turnips with which to barter) and not just tokens, then it would have been plainly obvious. Not only when you got them (or more correctly did not get) them from the bank, bur also when you tried to exchange them for what ever it was that you wanted to borrow them for, and which got us into this mess in the first place. The whole thing is criminality masked by hypnosis. This, however, is only the beginning.

    Perhaps this is the point to bring in another fact that is hidden by hypnosis. The only cost in the production and marketing of goods is labour. In fact there is no other cost, anywhere, other than labour. What about the manufacturing machinery and the raw materials and the power and the wagons and building the shops and factories etc. etc. ? Well, raw material itself cost nothing. The cost is in the labour of getting the iron ore out of the ground. Similarly the cost of coal and oil is nothing other than getting it up to the surface. The cost of all raw materials is the same, purely the labour of getting it. There is certainly machinery used in the getting, but that machinery like all machinery was once raw material, and has been transformed, through labour, into a finished product. All production machinery and tools, for whatever industry or business is nothing other than the sum of labour acting upon the raw materials used in their manufacture. An addition layer of labour costs is added by each of the white collar inputs. Designers, supervisors, accountants, sales and marketing, even the canteen ladies. In fact everything that the accountants like to call “overheads”. So the old idea of splitting production costs into “raw materials/labour/overheads” is nothing but a convenience for hypnosis and we are left with the inescapable fact that all cost is labour. The same is obviously true of services, be they solicitor, window cleaner, beautician, doctor etc. From the foregoing it is clear that one man’s raw material is another man’s finished product. This, in turn, leads to the next part of the hypnotic mess.

    Because companies were having to tighten their belts like never before there appeared, in the sixties, a philosophy of “cost reduction”. It was born in America and rapidly, like all unhelpful things, was imported, along with it disciples. It was seized by much of industry, who were already doing it slowly their own way, but not with the whistles and bells that always accompany American (usually foolish) endeavours. The basic tenet was to have brainstorming sessions to reduce costs. “Involve the workers. Make them think that it is in their interest to reduce costs, so that they are able to continue in employment” Many schemes involved fewer or cheaper raw materials. Some involved running machines faster than they were designed for. Some required completely new production techniques. Others involved completely new machines that would not only produce more in the same time as the old machines, but would require much less manpower to run them. Most of these schemes debased the product to a lesser or larger degree, and those schemes that involved buying new machinery only exacerbated the debt. problem.

    What was never comprehended was that when ever cost is taken out of a product someone somewhere loses his job. It matters not if the cost is classed as raw material or labour or overheads. Now, to the “captains of industry” the only job that matters is their own, and so it would have been easy for them to shrug it off as “the cost of progress”, if it had ever crossed their minds, but they were, like us all, “asleep”. Just as were the originators of the idea of “cost reduction”. If this “hypnotic sleep” could have been broken, it would have been comprehended that for every job lost there are less tokens in circulation with which to buy the goods, (which have been reduced in quality, but not in price). When appraised of this fact some merely opened an eyelid and expressed the belief that it may affect others but “it will not affect us”.

    In fact, because of the mounting debt, prices were going up as quality was going down. “Perceived” quality was maintained by the use of clever packaging and advertising. The use of meaningless slogans and endorsement by “celebrities” being the main route. To confound the issue still further those workers who were, through cost reduction, expected to shoulder a bigger burden than before were rewarded by a slight increase in wage. This, of course, encouraged others to want more and so the net labour cost, nation wide, was reduced very little, but many people were out of employment and needed hand outs from the state, which necessitated more taxes, which lead to more demands for increased wages. This led to calls for cost reduction and more sophisticated new machinery and we were on the debt merry-go-round non-stop, right up to the present day. This country was the home of the industrial revolution and led the world in manufacturing and banking. Just look what banking has done for industry. How many thousands of companies have closed their doors through it? How many thousands of workers have suffered through it? And for what?

    However, back to the story. In order to sell more product more and more advertising was done, to persuade people to part with what few tokens they had, and all manner of “special offers” and “deals” were conceived. At the same time the bank realised that it too could help itself enormously, by encouraging the general public to spend tokens that they did not have, by ensnaring them into the net of debt. For every pound lent they received back ten. No wonder that they can wipe off bad debts of millions without turning a hair.

    The real turning point for the general public debt came with the banks aim of creating a cashless society. In that way money ceased even to be tokens and became, what for years it had been for industry, just numbers on ordinary paper. First the credit card, to whet the appetite, and then the debit card. All designed to create, not convenience, but debt. The current figures quoted for debt throughout the country defies belief.

  13. Cynicus, I thought that you and your regular readers would be interested in this link:
    For older readers, they may remember Jim Slater (of Slater/Walker fame) recommending gold bullion, baked beans and a machine gun(!) when inflation was well into double digits in the seventies.
    I can't help but keep coming back to the PSBR.
    As long as the Government has such a vested interest in maintaining the status quo ie. jobs for life AND a guaranteed pension for public-sector employees, and in the case of MPs a "gold-plated" pension as well, then there in no impetus to change.
    The rest of the population are second-class citizens - a form of apartheid indeed!
    Nothing for it but back to the Gold Standard; oh, wait a minute, didn't Gordon Brown sell all of our gold a just about the its lowest point early in the 21st Century?!

  14. Hallo Cynicus,
    I have some questions

    Who is buying public bonds in the international markets now? Might be chinese, indians and other developing in collaboration with international british capital (manufacturing and FDI, finance and banks) that needs to invest somewhere safe at the moment? Are these people the same as those who were lending the money they made in the developing countries to the british banks all these years?

    Thank you!

  15. Yes, the UK economy looks stuffed and could fail. But first the IMF would ride to the scene - and they will not have the money? Then the USA follows on. But what I don't understand is why the Euro is holding up apart from the size of the trade area supporting it. Is it because there are very limited alternatives? There are some real basket cases within EuroLand.

  16. It looks to me that over the past decade or so, the political class have actively colluded in unregulated (toxic stuff) capitalism by the transnational corporate right, in order to fund the Marxist's left utopian dream.

    Of course it's the middle class that got shafted. (RIP)

    Has capitalism hit the buffers?

    To return to toxic capitalism is a no brainer, to return to a manufacturing wealth creating economy is out of the question, to rely on entrepreneurial innovation is out, our competitors are just as good as we are.

    So what's left?

    The ageing Beckhams?

  17. This is an excellent and thoughtful blog. I have some comments about the causes of the current financial crisis, which I offer as constructive criticism. If I have made errors, I am very happy to have them corrected, and wish to encourage thoughtful debate.

    In the post “The Market and the Crash” (Wednesday, July 23, 2008), you state:

    “if we look at the current crisis we see that it has taken place in a time when the banking system has been highly regulated. It is not a free market, but a highly regulated market. All of the current problems have taken place under the regulatory environment created by the Basel Accords, which required banks to meet capital adequacy ratios. ….
    So how is it, in the most stringent regulatory regime in history, that there is now a banking crisis unfolding? The first problem is that the regulations were, in part, responsible for the emergence of SPVs, SIVs and CDOs, which were very useful ways for the banking system to take high risk positions, whilst still meeting the capital adequacy ratios. In other words, the regulatory regime was one of the main reasons for the emergence of new methods, which were actively used to bypass the regulations, and led to the current crisis.”

    It is extremely difficult to see how the past 9 nine years (1999-2008) could possibly be described as one where the banking system was highly regulated or under the most stringent regulatory regime in history.

    In fact, the period from about 1945 until the 1980s was the most heavily regulated era of the twentieth century (and not simply in the banking sector). In the 1980s, the present era of financial deregulation began with the Reagan administration’s deregulatory Garn-St. Germain Depository Institutions Act of 1982 (which was certainly one cause of the Savings and Loan crisis of the late 1980s).

    But, in my opinion, there were three major causes of the current financial crisis, two of which were banking deregulation.

    It was the combination of these three factors in the US that led us to the current disaster.

    These causes are as follows:

    (1) the Financial Services Modernization Act of 1999 (also called the Gramm-Leach-Bliley Act of 1999)
    (2) the Commodity Futures Modernization Act of 2000
    (3) the Federal Reserve’s creation of the housing sector bubble (2002-Summer 2007).

    The huge explosion of sub-prime mortgage loans occurred from 2002 and 2007. The easy money policy of the Federal Reserve was one major cause of this. But this was preceded by two significant acts of financial deregulation.

    First, the Financial Services Modernization Act of 1999 (also known as the Gramm-Leach-Bliley Act) repealed the Glass-Steagall Act of 1933. The Glass-Steagall Act had separated banking, insurance and brokerage firms, and had imposed a strict separation between commercial banking activities and investment banking.

    If I am not in error, its abolition allowed the underwriting and trading of mortgage-backed securities (MBS) and collateralized debt obligations (CDOs) and structured investment vehicles (SIVs).

    Thus it is incorrect to say that “the regulatory regime was one of the main reasons for the emergence of new methods, which were actively used to bypass the regulations, and led to the current crisis.” In fact, the Gramm-Leach-Bliley Act allowed the explosion of the securitization of asset-backed securities and CDOs. No one was trying to “bypass the regulations” in doing this. The act abolished the previous regulatory regime.

    Secondly, my understanding is that the Commodities Futures Modernization Act (2000) made credit default swaps (CDSs) largely unregulated, and this allowed the mass packaging and selling of securities like subprime mortgages to other institutions. Thus the collapse of the subprime mortgage market had disastrous consequences for other US and European financial institutions.

    It is also important to note that role that Gordon Brown and the UK played in this deregulation. A good summary is given by Robert Wade:

    “The UK’s role in the crisis deserves emphasis, because contrary to conventional wisdom, the dynamics at its heart started there. The Thatcher government set out to attract financial business from New York by advertising London as a place where US firms could escape onerous domestic regulation. The government of Tony Blair and Chancellor Gordon Brown continued the strategy, leading Brown to boast that the UK had ‘not only light but limited regulation’. In response, political momentum grew in the US over the course of the 1990s to repeal the Depression-era Glass–Steagall act, which separated commercial from investment banking. Its repeal in 1999 produced a de facto financial liberalization, by facilitating an unrestrained growth of the unregulated shadow-banking system of hedge funds, private equity funds, mortgage brokers and the like. This shadow system then undertook financial operations which tied in the banks, and it was these that eventually brought the banks’ downfall …. It is ironic that the crisis may end up saving Brown from having to resign as prime minister. Yet it is now clear that his aversion to financial regulation, and his lack of concern about the housing bubble … are deeply implicated in the build-up to the crisis.”
    (see “Financial regime change?” New Left Review, September-October 2008,

    I am curious to know more about the role of the Basel accords in this crisis.
    But, at any rate, since Basel II was not even published until June 2004, and not implemented in the US until the years after 2005 (well after the housing bubble began), how could it be a major cause of the current crisis?
    Of course, Basel I (which was published in 1988 and implemented in most Western countries in 1992) could have played a role. But in the absence of the three factors discussed above (the Financial Services Modernization Act, the Commodity Futures Modernization Act of 2000, and the real estate bubble), how could Basel I have caused this on its own?

    Finally, I would note that even the libertarian writers Robert B. Ekelund and Mark Thornton (“More Awful Truths About Republicans,” 9/4/2008, point to the Financial Services Modernization Act as one of the main causes of the crisis.
    They observe that the 1999 act would “make perfect sense in a world regulated by a gold standard, 100% reserve banking, and no FDIC deposit insurance.” However, we do not live in such a world. We have fiat money system. These libertarian writers tacitly admit that, in our fiat money system, the regulatory environment set up during the Great Depression was necessary to prevent the kind of crisis we have seen this year.

    In essence, it was banking deregulation, not regulation, as well as the real estate bubble,
    which caused this financial meltdown.

  18. On the issue of the deregulation of the US financial system, I would note this additional development in 2004:

    “[sc. in 2004] Henry M. Paulson Jr … was head of the investment bank Goldman Sachs. In the spring of 2004, the investment banks, led by Paulson, met with the Securities and Exchange Commission. At this meeting with the New Deal regulatory agency tasked with regulating the US financial system, Paulson convinced the SEC Commissioners to exempt the investment banks from maintaining reserves to cover losses on investments. The exemption granted by the SEC allowed the investment banks to leverage financial instruments beyond any bounds of prudence. In place of time-proven standards of prudence, computer models engineered by hot shots determined acceptable risk. As one result Bear Stearns, for example, pushed its leverage ratio to 33 to 1. For every one dollar in equity, the investment bank had $33 of debt!”

    Paul Craig Roberts, “A Futile Bailout as Darkness Falls on America,”
    October 6, 2008, Counterpunch,
    (Paul Craig Roberts, incidentally, was US Assistant Secretary of the Treasury for Economic Policy 1981-1982. The article is worth reading in full).

    There is more about this on Henry M. Paulson’s biography on Wikipedia:

    “In 2004, at the request of the major Wall Street investment houses, including Goldman Sachs, then headed by Paulson, the U.S. Securities and Exchange Commission agreed unanimously to release the major investment houses from the net capital rule, the requirement that their brokerages hold reserve capital that limited their leverage and risk exposure. The complaint that was put forth by the investment banks was of increasingly onerous regulatory requirements -- in this case, not U.S. regulator oversight, but European Union regulation of the foreign operations of US investment groups.”

    If this was not an extraordinary type of deregulation, then what was it?

  19. Peak Oil, Peak Cristmas, Peak Everthing.

    "We know this spindly piece of garbage will break in a matter of days, weeks or maybe if the owner is especially careful, months; then the legs will break loose of the base, the towel bar will pull out, etc. and the "we cut down a priceless rain forest to make this" piece of human handiwork will be put on the curb where a diesel-buring garbage truck will haul it to the landfill.

    "I for one will not mourn the last Christmas in America. Good riddance to the flaunting of borrowed money and the heedless, desperate purchase of valueless "goods" as gifts for an insolvent nation awash in too much of everything but common sense, accountability and healthy living."

    Charles Hugh Smith

  20. Fools Gold

    Go gold is the cry, gold is the protector, gold is survival.

    Not so methinks, that was yesterday, we don't live in Kansas any more.

    What's the point in having a shed load of gold when visiting a bear shelved supermarket.

    Tomorrow's gold is food!

    I read somewhere that the food requirements of the first world are being produced by two percent of the population.

    Those who control the food supply control the people.

    Restrict credit and I go bust, restrict the food supply and I go hungry - or worse.

    Who is saying there are too many people?


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