Some of the regular readers will know that I have been discussing such a bank run for a long time. I have suggested that the current financial crisis is all about overseas depositors steadily withdrawing their funds from the UK economy (it is not the underlying crisis). The pouring of money into the banking system by the government is an attempt to save the banking system, not only from catastrophic losses, but also from this steady bank run that is resultant from these withdrawals. As that money pulls out of the economy, it is no surprise that the economy comes ever closer to full collapse. It was, after all, the foundation on which the economy was built.
I have recently had a commentator point to an article in the Independent newspaper (many thanks to the anonymous poster). Whilst an occasional browser of the paper, I missed this very important article which, as the commentator points out, was tucked away in the dark corners of the finance section. However, this article should be the stuff of headlines and, in light of the importance, I will quote at some length:
If we think of the numbers that we are looking at, it becomes self-evident why the endless bailouts by the government are falling into a black hole. The government is having to bail out the banks to repay these overseas investors such that, as fast as the money is pumped in, it is pumped straight back out to meet the demands of overseas depositors. With the banks sitting on mountains of toxic debt, with no market left for the sales of these toxic assets, there is nowhere to turn except to the government.
A silent $1 trillion "Run on Britain" by foreign investors was revealed yesterday in the latest statistical releases from the Bank of England. The external liabilities of banks operating in the UK – that is monies held in the UK on behalf of foreign investors – fell by $1 trillion (£700bn) between the spring and the end of 2008, representing a huge loss of funds and of confidence in the City of London.
Some $597.5bn was lost to the banks in the last quarter of last year alone, after a modest positive inflow in the summer, but a massive $682.5bn haemorrhaged in the second quarter of 2008 – a record. About 15 per cent of the monies held by foreigners in the UK were withdrawn over the period, leaving about $6 trillion. This is by far the largest withdrawal of foreign funds from the UK in recent decades – about 10 times what might flow out during a "normal" quarter.
It is as I have long suspected. I have always been of the view that this is not really just about bailing out little old ladies with their savings held by RBS, but also about bailing out all of the overseas investors who stand to lose so much money.
The reason for the bailouts is the can be found in a comparison with the banking crisis in Chile many years ago. I read a paper some time ago on the subject, where an attempt was made by Chile to allow banks to fail, but international pressure forced a reversal of the policy (apologies, I hunted for the paper on the subject, but it is now lost in the 1000+ papers I have lying around). Added to this pressure is the internal pressure caused by politics, and the fact that many advisors to government come from the system that is being bailed out. This has driven governments to think that the banks must be saved, even at the risk of their own downfall.
This ongoing outflow of money from the UK banking system, and also from the UK economy more widely, is at the heart of the financial crisis. Whilst there are no headlines, there is no question that the nature of the problem is as severe as the Northern Rock fiasco. However, the UK government is in the position of guaranteeing this huge outflow and, one way or another, they will somehow need to find ever more money to support the outflow.
Quite simply, the government has made a commitment that it will never be able to keep. The only method will finally be to default through the printing press. As the demands from overseas deposits continues, more money will pour in to the banks from the government, and much of it will just transfer out of the country. The government was never going to have access to such an astonishing amount of resource.
It was a very long time ago that I first realised that the UK was bankrupt. As each day goes by, there are ever more stories that confirm this. It really is very simple. The UK collectively borrowed money that it could never pay back, as it simply does not have the wealth to make the repayments.
Note 1: It may be with relief that you note that this is a short post. I have several real life commitments that are pulling me away from time on the blog. I am hoping to be back to more regular and more deeply considered posts in a while.
Note 2: I have also been distracted by a book which is heavily promoted by the Austrian Economists. It is called 'Economics in One Lesson', by Henry Hazlitt. The book was published a long while ago, so there is a free online version here. It is relatively short ( I read it in about 3 hours approx.) and is one of the most outstanding works on economics that I have read (The Wealth of Nations by Adam Smith still tops my list). As such I strongly urge you to read it (in particular for a regular commentator Lord Keynes, as it covers many of the points that he has made in recent posts).
Note 3: Some replies to the comments on my last post on Quantitative Easing (QE - printing money):
Tiberius mentions that buying gilts directly through QE by the Bank of England (BoE) might 'be in direct violation of the Maastricht Treaty'. I think this is another reason for the circumspection....
Ketley highlights some of the BoE's statements to point out that much of what is going on is about confidence. My feeling is that 'playing' with confidence is a very dangerous game. As soon as the truth 'outs' then the confidence game comes to a messy end. Ketley also notes that there is a possibility of much of the media simply regurgitating press releases on QE, and this does seem to be the case. If only the press would take the time to look around, they might actually find some different perspectives.
An anonymous poster points out the damage of this policy to savings, and asks how much inflation will follow. My simple answer at this stage - I simply do not know. Once this process of money printing starts, it can create self-reinforcing feedback - and this makes it beyond prediction. Equally, there is no firm timescales for when it will kick in.
Lord Sidcup asked for M0 and M4 figures. M0 is no longer reported (interestingly went in 2006, I think), and M4 can be found here (only reports to January 2009 at the moment). For those that do not know what these are, basic definitions can be found here on Wikipedia.
An anonymous poster offered this analogy for QE, which is very good:
It's like we're collectively trying to refuel a car with four flat tyres.If I can take the liberty, I might suggest an alteration - that it is trying to pump air into 4 flat tyres, all of which have punctures.
Paulsc expresses interest in the reply from the BoE to my letter to them seeking clarification of the policy. I have had a reply that they are putting together an answer, and am therefore awaiting a response. (see below for update)
Paul offered an interesting point with regards to the press, identifying their lack of spine over QE. I note that some commentators are dusting off their critical points of view, so there is still 'hope' for the press.
Lord Keynes: You say in your example:
The banks are hoarding the £30 that they have been receiving as interest. Also, the banks refuse to lend any new money to people, so the economy just can’t get that extra £30 to get the economy on track.You are talking about lending for consumption. Lending for consumption = a future contraction....Also, nobody is 'hoarding' money. They are lending it to governments....the banks do not sit with piles of cash in vaults, but buy 'safe' assets according to Basel II requirements. 'Hoarding' is an emotive word for saving and investing. When money is not being consumed (whether by governments or consumers) it is used to invest in new business ventures. This is not hoarding.
You also say:
The central bank removes the extra £30 it injected. We are back to the original situation of £100 in the economy.But who is going to buy the Gilts, and when are they going to be sold again. In a year, in two years, in five......
You later say:
Of course, printing money can be put to productive purposes. If the money was lent directly to the government and they spent it on building new factories producing manufactured goods (e.g., in a high value added industry like high tech) and these goods were bought by domestic and foreign consumers, then of course printing money can generate real growthIn this case, why not print £1 trillion? This would provide massive amounts of money to do things...but the money money would cease to have any value. Money is not a 'magic' thing. It represents a unit of exchange and (if it is not printed in this way) a store of value, and in a good monetary system also represents a contract.
Overall, I do urge you to read Economics in One Lesson. I believe that you read widely on economics, and believe that this book may have a profound impact, as it will give a different perspective to that of the economic theory that led us to this disaster, and is leading us ever deeper into crisis.
Lemming: Regards to borrowing/lending. The key here is that borrowing for consumption is problematic, not that all borrowing/lending is bad. You later mention:
Similarly, is it equally possible that a 'make work' scheme, or a money printing operation *could* produce genuine wealth?If this were the case, then we could hand everything over to government and dig ditches for £1 million a day. There is only one way to increase wealth - to produce goods and services for which there is demand, and increasing wealth can only be achieved in an economy by producing more goods and services. The issue distribution of wealth is another matter, but the root source of wealth is output, not money.
On the other hand, having someone do 'make work' contributes nothing.....what is their output worth? If it is make work, nobody wants the output enough to pay for it....
I hope that helps.
Red: Very interesting link about the China spending spree. The article is broadly supportive of my recent speculation on the Chinese exit from Treasuries, but we will see....
Note 4: I am still hoping to take a look at US QE, but will struggle against events, as I think they are moving fast. One point of note comes from an article here:
It seems that more and more trouble comes out of the woodwork. If everyone goes down the QE route.....what happens then? Global hyper-inflation? How do you guess at the future value in currencies with ever more 'dirty laundry' appearing. I made a bold prediction of the collapse of the $US, and still believe this is about to happen....but....will this delay it? I am not sure....
European banks face a US dollar “funding gap” of almost $2 trillion as a result of aggressive expansion around the world and may have difficulties rolling over debts, according to a report by the Bank for International Settlements.
Note 5: I have finally got hold of a copy of Niall Ferguson's 'The Ascent of Money' and should be able to let you know whether it meets expectations in a day or two. So far, it is excellent.
Note 6: I have just found a reply from the BoE in my inbox, and will post on their reply shortly.