Debtonomics: Currency Crisis



An argument can be made that under our present circumstances analysis of the declining economic order is not particularly relevant: it is best to look forward rather than pick over the past, to let the current regime fall apart and build something new and better on the ruins. While there is something to be said for that approach, we need to understand where we are … and to do so not just to ‘know the enemy’ or grab him by the belt. We are likely to see a post-industrial economy reassembled out of existing components; evolution as much as revolution. How things actually function is important to know, the challenge is to parse analysis from advertizing. Within economics, the truth is liberating to the extent that speaking it will likely get you fired.

Economic processes are fairly straightforward to understand piecemeal but can be much harder when taken together. Much of this is by design, some is happenstance. We are conditioned to think in terms of linear narratives with beginnings, middles and ends. We have been well-trained by television; we like simple, we like dramatic, we like violent, we like ‘happily-ever-after’.

The past 400 years offers proofs that there are no happy endings to industrialization, only varying degrees of ruin. Modernity hollows itself out, the ‘advance of progress’ within nations is like the rot of a body afflicted with gangrene. The flow of funds within economies is similar to the flow of hydraulic fluid in an automatic transmission; there are main-streams, feedback loops and pressure differentials, all offering different outcomes depending on which gear you select and what pedal you push. After some time, the transmission stops working and so does the car … nobody can figure out why.

Individual economic processes can be linear but each is a sub-component of others; narratives multiply, segue into others or intertwine to form multi-layered complex webs which are closely-coupled and brittle. Analysts specialize: they tend to focus on individual processes so as to keep their narratives intact while serving the needs of their sponsors. Life within voluntary constraints is pleasant for the economist who excludes all the bits of unhappy reality outside his specific area of expertise. Hence, the heavy emphasis on conventional econometrics, neoclassical- and DSGE analysis from the establishment: these disciplines self-edit by design.

They also self-edit for a purpose: our present regime is a debtonomy. Lenders conjure endogenous money or debt as the means to private riches for themselves and their clients; tycoons borrow immense sums for their own gain leaving others to meet the costs. This process makes up the entirety of our economic system. Debtonomics follows Fisher 1933, also Minsky 1980 and Keen 2014.

Debtonomics: an indictment as much as a description:

— All economic activity is subject to the First Law, where the costs of managing any surplus increase along with it until at some point the costs exceed what the surplus is worth. Due to the conservation of energy- and matter; there can be no possible work- or goods output greater than the sum of inputs. Debt, false accounting and the use of fossil fuels have allowed us to pretend while shifting costs to others.

— On a cash-flow basis our consumption economy is continually ‘underwater’, the gap between capital cost and system return is financed with debt. When input prices are low, the amount to be financed is affordable. Scarcity reprices resource capital, at some point both capital and necessary credit become too costly. These costs cannot be shifted, the outcome is ‘demand destruction’, currently underway around the world.

— Industrial firms are loss-making enterprises, incapable of organic returns. That the industrial economy cannot afford itself is self-evident: if the enterprise was productive it would retire its own debts. A firm can be a government entity or a business; the larger the size of the firms the greater is aggregated costs and the more it or its customers need to borrow — first law.

— Borrowing represents artificial returns; firms borrow against their own accounts, against the accounts of their customers, against the state or against foreign exchange. Firms’ success has little to do with products but rather their ability to wheedle loans.

— Besides borrowing, an ‘outside’ activity of firms is converting capital — non-renewable natural resources — into waste. The shiny and glamorous wasting process is collateral for loans; the more effectively firms waste or enable it by others, the more efficiently the firm is able to borrow. Another activity is mispricing resource capital; by manipulation in markets and by purposefully refusing to identify capital as such.

— Because waste does not offer a return, the foundation of modern economic development is provision of loans. The industrial country requires its own currency; a national treasury with the ability to offer collateral; strong, well- managed and properly funded banks at all levels; an independent lender of last resort and a system of jurisprudence: the rule of law, private property, enforceable contracts and regulatory constraints on practices. Any two countries possessed of the same material advantages … of natural resources, manpower, education, transportation access, and liberal governments; where one possesses the instruments of credit and the other does not … the first country will industrialize while the second will depend upon the credit of the first and become its subject. Absence of organic credit provision is why nations are unsuccessful at modern development.

Provision of loans is why bankers are ascendant, why they hold the world hostage, why they are free from any accountability for their own crimes and excesses: banks create money by lending it into existence. If there are no banks, there are no loans, if there are no loans there is no money and no industrialization.

Firms borrow from their own bankers or from credit markets, or by issuing shares so that others borrow for the firm’s benefit. Firms borrow against the accounts of their customers whenever these (customers) take on loans to purchase the firms’ goods. As a consequence, business ‘profits’ and any retained earnings are simply the continued ability of firms’ customers to continue borrowing over time.

Firms borrow against the accounts of the state because states generally have greater borrowing capacity than firms and at lower cost. Firms position themselves to gain access to the stream of funds from the state. Access takes the form of direct (contract) payments, subsidies and tax advantages. Holding currency is a form of borrowing against the account of the state: in a debtonomy all cash currency is the unpaid debt of others. Firms borrow against foreign exchange when imported currency becomes collateral for loans in the native currency.

Visualizing flows of funds.

Currency flow diagram of a fictional economy showing how borrowing from foreign exchange works. Funds originate at the left @ ‘Country A’ and flow to the right, by way of ‘Country B’ and back to the beginning where the cycle is (hopefully) repeated. Keep in mind, flows are not static like a graphic. Future graphs of this particular model would show the same components and flows having more-or-less identical relationships, perhaps at a different overall scale.

 
China Sector Credit Flows 2

Figure 1: The arrows on the chart represent flows and are roughly to scale. Credit originates as bank money in country ‘A’ and is sent to country ‘B’ in exchange for goods’ exports or as foreign direct investment (FDI). These funds are aggregated at country ‘B’ central bank where they are used as collateral for loans in local currency. By this simple means the exporter doubles his purchasing power: he holds both the imported currency as well as the newly created currency which is distributed into the economy. This multiplication of purchasing power is why countries are eager to export as well as borrow overseas currencies.

Some of the country ‘A’ currency becomes foreign exchange reserves, some is swapped for gold or other resource capital while the rest is recycled back to country ‘A’ where it becomes ‘vendor financing’ for subsequent rounds of export purchases and FDI. Here, ‘currency’ means the forms of a country’s money and credit in aggregate.

FUNDING The flow of foreign exchange (black arrows)
REFUNDING Flow from the central bank to the commercial banks
DISTRIBUTION The flow from the banks into the economy

When a country creates local currency against overseas collateral the nominal rate of exchange is arbitrary. One unit of currency ‘A’ might be worth one unit of currency ‘B’ or five and a half units or a thousand … or vice-versa. It is purchasing power that is multiplied; that of the one currency being equivalent to that of the other at all times regardless of exchange rate. Purchasing power relationship is inelastic and tightly coupled by way of arbitrage; the simultaneous purchase or sale of common goods with both currencies, such as a third-party currency or petroleum. For this reason, both the black and red arrows in country ‘B’s economy are the same size, they represent purchasing power.

It is in the interests of the trading- and investing partners to maintain exchange rate stability over time, so that nominal and real purchasing power are aligned. Countries and central banks attempt to do so by way of currency pegs, interventions or by adjusting interest rates. Purchasing power borrowed against foreign exchange is always constrained by collateral, it cannot be ‘adjusted’ by cheating because any imbalance between funds and purchasing power is exploited by arbitrageurs.

Conventional analysis sees the world as a dependency of the US Federal Reserve money printing. ‘Hot money’ dollars are hustled overseas by way of carry trades, with speculators looking to exploit interest- and exchange rate differentials for short-term gains. Funds flow toward developing countries when rates favor the trades, they recoil when rates turn against speculators. Inbound flows push asset prices higher, when flows reverse assets are dumped and prices decline, including currency. To support currency prices central banks adjust short term policy rates by taking deposits, hoping to lure the speculators back.

This analysis is overly simplistic and incomplete. The Federal Reserve cannot create new money, it is collateral constrained. Its foreign exchange interventions are zero-sum affairs. Countries gain dollars by exporting petroleum or manufactured goods, borrowing against their American customers as well as by way of FDI, these flows are relatively inelastic and unaffected by borrowing costs. The scale of borrowing against foreign exchange is immense; amounting to trillions of US dollars in China alone; Forex borrowing represents the largest component of lending support for developing countries as these generally do not have organic alternatives. The uncertain potential rise of a few basis points will not affect the demand for dollar loans from overseas’ borrowers. Their choice is to borrow regardless of interest cost or miss the latest chance to develop.

Whereas lenders’ long-term returns from interest payments can be substantial, short-term returns are relatively modest. The greater gain from lending is the requirement on the part of the borrower to repay with money that is more costly to him than the loan is to the lender. Bank money costs the lender almost nothing to create as it requires only keyboard entries. The borrower must repay with circulating money; he cannot create repayment on his keyboard but must beg, steal or more likely borrow repayment- or have it borrowed by others in his name (bailout). Whereas interest cost tends to be a small fixed percentage of the principal payable over time, the expense of circulating money is determined by its availability in the marketplace, by supply and demand. When circulating money is scarce the real worth of repayment can be much greater than the nominal balance due, yet this is invariably when the demand to repay is fiercest, as during a margin call. If the loan is secured and the borrower cannot repay, he must surrender collateral along with other rights. These are always worth more than a keyboard entry.

In this sense, lending malpractice is outright theft rather than usury; with the banks offering loans that cost them nothing as the means to gain high-cost money as well as the real goods and labor that are pledged as collateral. There is also risk: when there is no collateral to seize in the place of circulating money, both borrower and lender are ruined.

When bank money changes hands it becomes circulating money. By acceptance, the recipient banks validate the ledger entries as ‘money’ as well as their worth. At the same time, the borrowers accepts their obligation to retire the loans on the lender’s terms with interest.

Inflation and deflation implications

Conventionally, inflation and deflation represent the inverse relationship between funds and purchasing power. Inflation is increase in unsecured loans, the increase of funds in circulation over time without a corresponding increase in purchasing power. This is also ‘economic growth’. Deflation is the decrease of funds relative to purchasing power. Periods of deflation follows episodes of inflation over long cycles; funds balloon and unit-purchasing power declines followed by reversion to mean.

Model of Argentina national credit flows:

 
Argentina Sector Credit Flows

Figure 2: This could be the chart for Brazil, South Africa, Venezuela, Ukraine, Turkey along with dozens of other developing countries. Argentina’s problem sticks out like a big, pink thumb: unsecured loans by the central bank. This is seen as the increased flow within the refunding channel, costs (losses) are directed to the commercial banks which attempt to distribute them into the economy. The resulting imbalance between funds (pesos) and purchasing power (dollars) is exploited by arbitrageurs (anyone with access to pesos) … instead of being absorbed by the economy, losses are forced back onto the commercial banks which become progressively weaker until they fail. Meanwhile, the same economy is emptied out of purchasing power as the ‘loss-pushing’ process is self-amplifying.

Argentina is poster child for long-running policy errors: the greatest being repeated efforts to industrialize which invariably end in disaster, the other being the central bank making unsecured loans. As it does so it becomes insolvent which in turn triggers bank runs.

 

Any two countries possessed of the same material advantages … where one possesses the instruments of credit and the other does not … the first country will industrialize while the second will depend upon the credit of the first and become its subject. Absence of organic credit provision is why nations are unsuccessful at modern development.

 

So it is with Argentina: without organic credit the country is dependent upon overseas loans. Hyperinflation is persistent across South America because private banks are historically weak and unable to pass costs onto others. The banks cannot provide the credit needed to meet politicians’ delusion of grandeur, partly because credit by itself is unable to provide anything real. To gain credit, countries import dollars and other foreign currencies while central banks are called upon by leadership interests to supplement the commercial banks’ unsecured lending with their own. The outcome is vanishing lenders of last resort, systemic insolvency and runs. Repeated cycles of (hyper)inflation, bank runs and crises pulverize the banks … which are able to recover somewhat with more outside loans … only to collapse when the crisis re-emerges a few years later. Latin American countries cannot free themselves from dead-money debts or develop as they wish.

Whether countries such as Argentina are suited to American-style industrial development is never examined nor are alternative approaches given consideration, only the same cycle of borrowing and failure repeated over and over.

Banks are weak because managers are cronies of government elites, other interests are ignored, or worse. Bankers simply steal depositor funds and leave the country. Unsurprisingly, citizens don’t trust the banks, they do as much of their business as possible with cash and hold savings in the form of real estate or other hard goods that cannot be easily stolen or replicated into worthlessness. Like most countries with inflation problems, Argentina has been in a frenzy to develop, to ‘get rich quick’, to become industrialized.

Argentine lenders have one foot out of the country, together they represent the transmission channel for foreign currency loans. The returns on these loans are appealing to yield-starved overseas investors while spreads are positive for lenders. The pressure to lend in dollars and other foreign currencies is unrelenting. The outcome has been foreign currency flows into Argentina followed by droughts as locals, outside speculators and the lenders themselves remove the funds out of harm’s way as fast as they can.

 

… the requirement on the part of the borrower to repay with money that is more costly to him than the loan is to the lender.

 

When dollars become scarce, Argentines cannot refinance maturing loans. Firms and citizens compete with each other to gain dollars, the contest crowds out commerce and becomes the country’s entire economy … which becomes the big reason why Argentina’s central bank makes unsecured loans.

Hyperinflation is complex and there are many historical episodes with multiple causes. The hyperinflation known as the Price Revolution occurred in Europe during the 16th century due to the flow of gold and silver into Spain after its conquest of the New World; also population increase, the decline of goods output due to wars, the introduction of new banking instruments as well as currency debasements. Hyperinflation in the US during the Revolution was amplified by British counterfeiting. Hyperinflation in Wiemar Republic was accompanied by similar outbreaks in Hungary, Poland and France. A common characteristic of all hyperinflation episodes is countries desperate to develop at any price along with weak- or non-existent private sector banks unable to distribute central bank costs onto others.

Hyperinflation = central bank losses (costs) forced onto commercial banking sector. The central bank attempts to expand purchasing power by adding to the refunding channel flow. Commercial banks attempt to distribute their losses into the economy which they cannot do because increases in the amounts being distributed have the same purchasing power as original foreign exchange funds.

Because the purchasing power of a currency is equal to that of the collateral, commercial banks borrowing from the central bank are continually underwater; a peso returned by a bank to its depositor is always worth more than the replacement they borrow from the central bank. The banks demand more pesos from the central bank to ‘make up the losses with volume’. Meanwhile, the unsecured peso refunding from the central bank is the incentive for depositors to remove funds as quickly as possible and change them for dollars. Both depositors and outside speculators become bankers in miniature, using increasing amounts of pesos to bid for diminishing amounts of ever- more costly dollars in the black markets which are then spirited out of the country. If the central bank attempts to defend a particular exchange rate the dollar arbitrage process accelerates until the country is emptied of dollars. Once the establishment abandons the official rate, depositors use pesos to strip the country of goods, leaving the currency with zero collateral and worthless as a result.

Non-bank businesses refuse to accept pesos — as every increment of time represents a loss of peso purchasing power, every good is worth more than money. Listening to pleas from the banking sector, the central bank believes the economy is running out of funds — when it is really running out of purchasing power.

Deflationary bubble

 
China Sector Credit Flows(1)
 

Figure 3: China’s loans-against-forex model is like Argentina’s and the rest because China is dependent upon dollar- and other hard currency flows as collateral for domestic loans. This contradicts conventional analysis which has China as a US creditor. China cannot create dollars or dollar credit; China ‘lends’ energy (coal) and human labor to the US in the form of manufactured goods, which cost the country very little to produce. Repayment is in the form of dollar loans which cost Wall Street almost nothing to produce.

China’s energy flows are not on this model, China’s real energy costs and externalities are not on any of China’s models.

 

Any two countries possessed of the same material advantages … where one possesses the instruments of credit and the other does not …

 

Who says the Chinese cannot innovate? The Chinese have created two parallel dollar economies within one country. Dollars flow by way of US customers and retailers to Chinese manufacturers. Some are forwarded to the Peoples Bank of China at the official exchange rate where purchasing power is replicated in the form of secured RMB loans into the Chinese economy. The balance are diverted by manufacturers into the loan shark economy where they become quasi-collateral for as many RMB loans as the market will bear. This lending is universally unsecured: when there is no collateral to seize in the place of circulating money, both borrower and lender are ruined.

In China there is no refunding channel between the central bank and shadow finance. The shadow banks are very strong and have distributed their losses into the economy for a long time, these losses have simply not been recognized. Deflation occurs when these losses are finally measured, when inflated Chinese assets are marked to market.

Dollar funds to the PBoC become foreign currency reserves, some of these are swapped for gold or other resource capital while the rest are recycled back to the US where they become vendor financing for subsequent rounds of export purchases and FDI as indicated by parenthesis. Foreign exchange dollars flowing to shadow banking are simply stolen by Chinese elites, shipped out of the country to offshore tax havens by Chinese elites.

There is something in this for everyone: elites claim with straight faces that shadow banking provides loans that the above-ground lenders are unwilling to offer. Within the official sector the relationship between purchasing power and exchange rate is stable; the Chinese establishment pegs the RMB to the dollar. There is organic credit provision; the central bank is careful not make unsecured loans. The official exchange rate allows Chinese officials to insist to the West that their currency is appreciating … for public-relations purposes. The unofficial rate is a de-facto RMB depreciation which continues China’s export advantage for manufacturers and provides funds for more over-development which in turn becomes part of the Chinese ‘growth narrative’ … all of which is used to wheedle more dollar loans.

Analysts suggest that Chinese forex reserves can be deployed to bailout shadow lenders however there is no refunding channel between the PBoC and shadow banks. Because shadow banking costs have already been distributed into the Chinese economy, all that remains is for losses to be recognized, the only other alternative is kick the can down the road and pray. The central bank cannot ‘bail out’ the shadow banks as they are simply shells erected to enable the theft of forex reserves. Any redeployed reserves would be stolen as well. This would starve manufacturers of customers who would lack vendor credit with which to purchase Chinese goods. Because shadow banks are strong, any unsecured central bank lending would be distributed into the Chinese economy as more unrecognized losses. Attempting to bail out shadow banks would precipitate the deflation crisis the Chinese establishment is desperate to avoid: flight of dollar collateral => decline in RMB purchasing power => recognition of losses => bank insolvency and runs out of banks.

Credit cannot expand forever; the ‘Minsky Moment’ occurs when the cost of servicing (unsecured) debt plus the cost of running the actual economy exceeds the cash flow that can be generated by more borrowing.

Observations and remedies.

All claims and money-funds are promises to deliver some good or work in the future. During credit expansions, all promises are held in the same high regard. As results fail to measure up, some promises are held more highly than others. At the end of the cycle the promises are recognized for what they really are; lies.

— Governments are not a hyperinflationary factor where they do not directly issue currency other than to make demands of the central bank and ignore law-breaking.

— Velocity of money or rate of transactions re-using the same funds is not a hyperinflationary factor.

— Hyperinflation is a form of currency arbitrage.

— A remedy to corral inflation is to reduce system leverage by adopting a loanable funds model.

— Increase recognition of the real gains from lending. Allow debt repayment in kind: settlement of ledger ‘bank money’ loans with ledger repayments.

— Countries need to reduce borrowing from overseas lenders and dependency upon them at the same time. A way must be found to penalize overseas lenders short of (inevitable) economic collapse.

— Make use of local- regional currencies as sub-components of national currencies: increase the numbers of ‘central banks’. Increasing the diversity of participants interrupts the feedback loop necessary for inflation- or hyperinflation to take hold. Users are able to switch from an issuer’s inflated notes to alternates. Currency stability within the US during the 19th century is attributed to the gold standard but is more likely the result of free-banking and divers local currencies and issuers, along with the limited convertibility to gold. Currency worth was measured by exchange with ordinary goods and differences ironed out by discounting and arbitrage.

— Introduce peer-to-peer systems that allow users to be their own banks for the purpose of transactions.

— Adopt a scientific unit measurement for money following Le Système International d’Unités, or ‘SI’. Just as there are universally recognized kilograms, moles and amperes, there would be a standard for money that directly relates to the other standards. Prior to the use of abstract reserve funds, foreign exchange ‘money’ was metal — gold or silver — measured by weight rather than worth, and thus universal in all countries.

— Underway is a deflationary finance crisis as losses within major economies emerge, both collateral worth and loans against it are marked down to zero, banks- and credit-dependent industries fail. There is no cure for deflation just as there are no remedies for dying — only palliatives. A strategy is to voluntarily recognize losses before they emerge on their own and assign them to the malefactors who are responsible for them, Doing so will set examples and prevent future cost shifting.

— The larger remedy is to recognize the failure of industrialization and move on to some other fashion trend. Argentina’s repeated attempts to modernize have left the country with dead-money dollar debts it cannot hope to retire; it is bankrupt, it will default. It should start over with a new plan that does not include consumer products, factories or ‘progress’. China strips the world of resources endangering the life-support for all of life … so some tycoons can accumulate stolen symbols. This is insanity.

— Even after a great collapse, the world will still spin.

 

NOTE: Here are some terms that are used in this article:
The gain from lending Borrower must repay with money that is more costly to him than the loan is to the lender.
Funding The flow of foreign exchange
Refunding Flow from the central bank to the commercial banks
Distribution The flow from the banks into the economy
Ordinary inflation Expansion of unsecured credit, bubbles, also ‘economic growth’
Hyperinflation Central bank costs/losses forced onto commercial banking sector
Deflation Recognition of commercial bank losses already distributed into the economy
Strong banks (First Law) Banks able to distribute their losses into the economy
Weak Banks Banks unable to manage or distribute losses

44 thoughts on “Debtonomics: Currency Crisis

  1. James

    This essay is going to take some time to digest, but It seems that money is collateral for money is collateral for money and before you know it we’re talking about a F5 debtnado (NOAA: Strong frame houses leveled off foundations and swept away; automobile-sized missiles fly through the air in excess of 100 meters (109 yds); trees debarked; incredible phenomena will occur.) If commercial banks are capitalized at 3% or less and the shadow banking system is, well, even more shady, then if we start sliding down Hubbert’s Peak at three percent per year, voila, no more banking system in just one year. This is assuming that oil scarcity and maxed prices will blow their loan books all to hell to the tune of at least 3% per year. Will we have a trillion dollar recapitalization every year, like in 2008? How many times will the taxpayers have to save the banks before they’re allowed to expire naturally.

  2. neoBuddhist

    So you are saying all financial problems can be solved by the Chinese gov. and such (Argentina), wouldn’t the US fire some atomics if the Wall Street doesn’t like “peaceful resolution”?
    Could you explain who exactly is the Shadow Banking system? Why has the US allow the Chinese to create it?

  3. Eeyores enigma

    Great piece of big picture thinking man!

    It seems to me that the overhang of iou’s to slices of pie is so monumental that there zero chance of reconciling through any form of adjustments.

    Steve – Could I ask you to explain banks distributing losses in simple terms? Particularly in the China situation? I can’t seem to plug the concept into what I understand yet.

    Thanks for your work!

    1. steve from virginia Post author

      Thanks, Enigma, that is a great question!

      It’s easy … whenever a bank makes a loan it is distributing its losses. It certainly is not distributing its gains, (it can’t and remain in business).

      Just remember the Steve’s First Law of Economics: lending is the process by which the costs of surpluses are distributed to ‘others’. The loans are surpluses to the tycoons and losses to the lenders at the same time …

      Sufficient loans have to be made to these ‘others’ so they can repay their own loans plus those made to the tycoons. 🙂

      Our economy = theft. Steve Jobs borrowed billion$, these loans and much more are repaid whenever some ‘others’ borrow from Capital One or American Express to buy an overpriced iPhone or Mac Pro. These banks are considered to be ‘strong’ because they are able to push costs/losses onto their customers.

      Chinese tycoons have borrowed billion$ as well, these loans are repaid when foolish Chinese wannabe tycoons borrow from shadowy ‘Management Funds’ to ‘invest’ in overpriced empty cities or unprofitable coal mines. Shadow banking also has to be considered strong for the same reason (although it might make more sense to consider the customers gullible).

      When people borrow in order to pay too much — system losses are being distributed. These losses aren’t recognized as such, in fact losses are very hard to recognize because gullible people believe these losses are investments! The morning dawns: the real worth of mines, cities and iPhones emerges from the murk = zero! Recognition of losses already taken is deflation and due to the scale of excess losses, a crash.

  4. neoBuddhist

    Thank you Steve for the only source (or almost) of the economic truth I have ever came across… that our economy = theft. You’re a genius at connecting the dots 🙂
    Sorry, I still don’t understand about this Shadow Banking system, if the bankers can already get what they wanted from the Fed/Treasury, or is it the opus operandi of capitalist history… could you point me somewhere please? Thanks!

    1. steve from virginia Post author

      Just take your time and mull it over. I’m afraid conventional (non-theft) economics is not going to be much help.

      Shadow banking is irregular lending and finance trading. In the dollar system it includes everything from payday lenders and loan sharks to offshore structured finance; hedge funds and black pools engaged in unregulated speculation in stocks, debt and over-the-counter derivatives. Regulated banks also engage in unregulated activities off-exchanges = shadow banking.

      In China, shadow banking includes street-corner currency markets, state-owned banks with off-the-books unregulated exchange activities, banks that are lending arms of manufacturers or other parts of the body along with various impromptu hedge fund-like entities that exist to distribute ‘investment’ losses into the economy as a whole. Since the public purpose of China is to increase a number on a screen (GDP) the most certain way to increase that number is to cheat … push losses onto a public that is too eager to absorb them.

      Shadow banking is the means by which highly-leveraged institutions get that way, it is also the means by which imbalances between funds and spending power are brought into alignment … if alignment is possible. Black markets measure the worth of goods more accurately than officials with less lying but the fact of their existence also amplifies price differences.

  5. rcg1950

    “The large remedy is to recognize the failure of industrialization and move on to some other fashion trend.”

    I guess taking a very very long view of things a love affair that runs on for hundreds of years could be construed as an infatuation and a set of preferences similarly ensconced for centuries a fashion. But this is just a quibble.

    There was an interesting juxtaposition of articles in the local 8-page weekend advert ‘newspaper’ today. First, a surprising history oriented piece (though for the purpose of hyping Poughkeepsie NY real estate) about an old company – Sedgwick – that used to make hand powered mechanical elevators and dumb waiters. They built the one used by FDR himself for getting between floors in his family’s Hyde Park home. It was converted for his use from a preexisting dumb waiter after he succumbed to polio. Early industrial age tech (high tech in the 1800’s). Very fashionable among the bourgeoisie who of course could afford at least a little bit of hired help to actually power these devices. Gone now are these with the end of that way of life — superseded by ranches raised and split, and the bringing of supermarket groceries in via the driveway and back door. Someone took the losses on all those dumb waiters manufactured and ripped out and abandoned. Sedgwick Co. is long gone now along with so many other old tech companies that once populated the Hudson River’s now beaten up banks. Only recently are these industrial ruins giving way to a few parks and real estate developments.

    But fear not, the industrial era of fashion has not yet run its course. The 2nd article featured descriptions of what every chi-chi kitchen should sport in the 2nd decade of the 21st century. Among them, a high tech scale that communicates with your iPhone and advises you if ½ a slice of carrot cake will be enough of a sacrifice to keep you on your diet. And self-watering herb containers that can be suspended from your ceiling so you can have fresh rosemary and thyme all winter long. ‘Don’t leave home without these’ latest fashions at just a few hundred dollars apiece.’ [mounting hardware sold separately] I really doubt that 75 years hence there will be any nostalgic articles about them as there was about Sedgwick’s elevators.

    We don’t need can openers if food doesn’t come in cans. We don’t need snow blowers if we don’t get around by car. We don’t need leaf blowers if we’re not growing golf-course lawns. We don’t need talking electronic scales if we’re all physically active. We don’t need TV if we live in communities that make their own music and put on their own plays. I wonder how much longer it will take for a critical mass of people to figure out how unsatisfying and impoverishing in all ways industrial life has been. And if these alternative ways of life can develop without a total collapse of the current system.

  6. neoBuddhist

    Thanks, Steve. I got more from a few sentences from you than Wikipedia!
    Btw, on Wikipedia, this SB system is supposed to have existed in the US since 1935, is it tolerated by the gov even now because it was also a way for the US to fund covert wars and color revolutions after WWII? Also, is the US’s complete failure to get a handle on this beast due to foolish/corrupt congressmen or to lobbyists since no one seem to understand it (except some Nobel Prize winners… and even those needed bailouts)?
    Also, I still don’t understand the logic of GDP or its usefulness. Is China the only one who figured out how to game this number?
    Thanks!

  7. Reverse Engineer

    Great article Steve!  Also great Infographics! 🙂
    I also covered the Currency Issue this week in Emerging Markets & Peripheral Currency Collapse on the Diner for interested Undertowers.
    I found this quote to be the most enlightening overall:

    Any two countries possessed of the same material advantages … where one possesses the instruments of credit and the other does not … the first country will industrialize while the second will depend upon the credit of the first and become its subject. Absence of organic credit provision is why nations are unsuccessful at modern development.

    The fundamental issue is why the Originators of the Industrial Economy have access to Instruments of Credit and why the developing Nations had no such access, or ability to develop their own independent ones once the Ponzi got underway.
    That is an issue worth exploring in greater detail.
    RE

  8. dolph

    Basically it’s a question of having access to dollars, which are perceived to have usefulness even though they are a fiat currency and thereby worthless like all the others. It is the perception of worth in the debt instrument (treasury bonds) that allows it to have the primary function of being traded for energy.

    Big holdings of dollars are in dollar denominated treasury bonds. All surplus in the economy takes this form which is why interest on these bonds falls over time to zero. Interestingly, though, this means that over time the incentive to store surplus in dollar denominated debt also drops. At the little person level, you can think of this as the incentive to save drops as interest on banks accounts goes lower.

    What this means is that eventually there will be a run out of dollar denominated debt, and into dollars themselves. Velocity of money will increase, and the central banks will create any amount of new currency it takes to replace the ones being used. Dollars, and by extension all currencies, will become like hot potatoes, only used for the moment of trade and nothing else. Basically hyperinflation of the entire global currency structure.

    There is only one asset that will be revalued during this process to account for surplus and that is the physical reserve asset of the central banks, gold.

  9. ellenanderson

    @Dolph – I don’t think that a gold based system could support an industrial economy. That is why they created central banks and then went off the gold standard.

    1. dolph

      That’s true but who said anything about saving the industrial system?!

      As many have pointed out it’s how do you outrun the person next to you. You can’t outrun the bear.

      Maybe you can become a farmer or a miner. Or live life to the fullest then jump from a building as many bankers now seem to be doing. Or become a revolutionary and kill or be killed.

      Or you can acquire gold understanding you have the wealth of kings. There are choices still, in any situation including collapse.

  10. neoBuddhist

    I think the best way to get our solutions out there is via “Darwinism”, but in this case, meaning “functioning”, not suicidal deadends. I also have some ideas to get messages to thousands of people quickly… but it probably will take some cooperation and help from everyone here…

    1. steve from virginia Post author

      Ideas take time. Nobody wants to be rushed. Whatever occurs does so for a reason, not the superstitious kind but for the fullness of development or ripening of the idea like a seed. At the same time, every seed requires fertile ground. So far, the ancien regime holds on to its world with a tight grip. Until that grip loosens … on the imagination … the ground is infertile and unreceptive. At the same time, that gift of extra time makes it possible to ripen the idea.

      See what I mean?

  11. The Dork of Cork

    Is the NYT attempting to humanize financiers before the coming second crash ?

    http://nymag.com/daily/intelligencer/2014/02/i-crashed-a-wall-street-secret-society.html

    A very subtle little piece perhaps.
    Of course the reporter was shocked SHOCKED by this behaviour.

    I liked the Dixie performance.
    “well the first to go were the guys at Bear”

    “In Wall Street land we’ll take our stand, said Morgan and Goldman. But first we better get some loans, so quick, get to the Fed, man.”)

    1. ellenanderson

      That is really disgusting pathological behavior. I actually am shocked. I hope that a lot of people listen to the audio. Apparently it is a party that took place two years ago though.

  12. ellenanderson

    The Archdruid Report has a nice description of fascism. I wish I could post a reply but I cannot get through the Captcha or whatever those chicken scratches are.

  13. The Dork of Cork

    Interesting BBC4 feature tonight .

    http://www.bbc.co.uk/programmes/b03vrz4h

    Flying over post war UK in his Meteor jet he had a birds eye view of post war petro development and went into a sort of inner convulsion rather then conversion.

    In 1955, Nairn established his reputation with a special issue of the Architectural Review called “Outrage” (later a book, 1959) in which he coined the term “Subtopia” for the areas around cities that had in his view been failed by urban planning, losing their individuality and spirit of place. The book was based around a nightmarish road trip that Nairn took from the south to the north of the country – the trip gave propulsion to his fears that we were heading for a drab new world where the whole of Britain would look like the fringes of a town, every view exactly the same.

    I think his thinking managed to influence English thought on planning but given the dynamics of capitalism this petro development which was eventually subdued in the UK of the 1980s deflation – this action was exported to Iberia and Ireland as a reaction.

  14. The Dork of Cork

    His observations of 1970s England are quite effective although he was extremely naive about future prospects as most people were back then.
    This continued failure of 1970s planning & local culture as the country began to inflate / float on a sea of oil obviously destroyed the man.

    http://www.youtube.com/watch?v=EJ8eyMqJkwY

    He seemed to greatly love effective northern working towns which is unusual for a Englishman who normally never consider anything but the home counties as viable.
    Now of course the area orbiting London (southern England) would be almost unlivable for a man of this disposition.

    The greatest transformation of Europe has been the greening of Northern England (although with the destruction of community) and the industrialization of Euro countries that were formally mainly agrarian such as Ireland and Spain.

  15. ronan

    Interesting tweet from William Hague on the Ukraine situation:

    “Agreed with German Foreign Minister Steinmeier today to support new government in #Ukraine and push for vital IMF financial package” – William Hague (UK Foreign Sec).

    An IMF package will be just the tonic for the “unrest” in Ukraine?

  16. Usman

    Hi Steve,
    When country B creates local currency, why doesn’t the exchange rate change? Doesn’t an increase in purchasing power assume a parallel increase in the availability of goods and services?

    1. steve from virginia Post author

      When country B creates local currency, why doesn’t the exchange rate change?

      It certainly can over time but the purchasing power cannot because both currencies are traded against goods whose worth is intrinsic like food, gold or gasoline. Governments try to fool the public and add extra currency believing that no one will notice … but, people always notice.

      Doesn’t an increase in purchasing power assume a parallel increase in the availability of goods and services?

      All else being equal, any increase would be as available the same in one currency as the other. If a good is available with either or both currencies, the price will settle around the purchasing power rather than the rate of exchange that is often fixed arbitrarily.

      In Argentina, a few weeks ago the official rate of exchange was about six pesos per dollar while the unofficial rate was almost twice that. The price was set on unofficial ‘street corner’ exchanges or purchases of common goods like gasoline.

      More purchasing power would naturally attract more goods and services but how this affects the country has to do how economies are structured and people’s habits. For instance, Chinese have no social services so the citizens tend to save a lot of their earnings so increased purchasing power has not increased their level of consumption.

      http://www.goldmoney.com/research/analysis/all-currencies-are-an-inverse-pyramid-based-on-the-dollar

      1. Usman

        Can you define what you mean by purchasing power? I am under the assumption that purchasing power is determined by the amount of money relative to available goods and services. In the above reply, you state that purchasing power cannot change, but in the article you suggest that country B loans money to increase purchasing power. Loans increase money relative to the same pool of goods and services, so shouldn’t that lead to a decline in purchasing power (if my initial assumption is the same as yours)?

      2. ellenanderson

        Hi Steve –
        Thank you for the interesting link. His final statement was: “The last crisis was just the banks. This time we are looking at a potential popping of a full-blown global currency bubble, which was generated as the solution to the last crisis. And this new bubble is all supported on an inflated US monetary base of $3.8 trillion. That’s bubbly gearing of nearly 40 times, or 163 times the monetary base on the eve of the Lehman crisis.”
        As I understand it, the big concern at the time of the 2008 crisis was a sudden stop in the banking system. Are you saying that, in a worldwide currency crisis there will be a sudden stop in the availability of useful commodities? How will it look for the average US citizen?

      3. steve from virginia Post author

        It’s going to be ugly.

        We’re having problems w/ very modest energy constraints. Water constraints will affect California this summer after affecting the Midwest last year. People can do without buying gas, they have no choice but buy food, regardless of price. Fuel shortages-Triangle of Doom could emerge in the form of higher prices for some kinds of foods such as fresh vegetables and beef.

        Up until 2008 the problem was excess leverage/gearing. The problem now is excess leverage. Nothing changes of course. Without credit there is no industry. No industry = no toys. Imagine how ugly it can get when a country of 300 million heavily armed spoiled brats cannot play.

      4. neoBuddhist

        I don’t think it will be like that at all. Most people are innately good so one should have faith in humanity worldwide. Even at the height of the VN war, people from the US and around the world prevented the US nuke option, complete carpet-bombing and cluster bombs, etc… We now even have worldwide ban on cluster bombs (except the US, UK and Isreal), so we are all stepping in the right direction. Peace!

  17. The Dork of Cork

    Much can be gathered by the IEAs own writings.

    “Another strategic priority is the progressive and predictable removal of subsidies for gas,
    coal and electricity consumers and reallocation of budget resources towards energy
    efficiency support measures. Although this may be perceived as socially difficult, it can
    deliver manifold benefits. These include: improving public finances and redirecting resources
    to support energy efficiency; providing price signals to industrial and residential customers
    to modernise equipment and practices, and to invest in efficiency improvements; and
    improving the financial situation of public companies that are burdened with the high
    costs of subsidies. Efforts to reform energy subsidies need to be accompanied with
    targeted support programmes to protect vulnerable communities from the full impact of
    higher energy prices and in parallel to create a strong policy framework to support
    energy efficiency improvements. They also need to be accompanied by the systematic
    installation of meters and the possibility to adjust consumption accordingly.
    Over time, subsidies to the coal industry will also need to be removed. They will need to
    be accompanied by social programmes to support areas where mines are closed and
    support schemes for structural adjustment of the concerned regions.”

    Yeah right …………….

    The surplus produced via efficiency programmes will be merely wasted on conduit (imported ) capital goods.
    Very little of the surplus will be invested back into increasing real end use basic consumption.

    “Energy consumption in the transport sector in Ukraine is relatively small. Rail transport
    plays a leading role in freight and passenger transportation. The rail system length is
    22 800 kilometres (km), of which 8 300 km are electrified. The rail system transports
    over 300 million tonnes of freight and more than 500 million passengers per year.
    Ukraine has 18 ports, 8 shipyards and more than 100 airports.
    Road-based transport energy consumption in Ukraine is about 7 ktoe, 10% of total final
    consumption (compared with 34% in the OECD).23
    The Transport Strategy of Ukraine for the Period to 2020 (2010) sets energy efficiency
    objectives, but does not provide for the actions to achieve them.
    Motor transport has been on the
    increase to reach more than a billion tonnes of freight and 2.5 billion passengers per year.
    The length of general-purpose motorways totals 169 000 km. In the last 20 years, the
    level of car ownership has risen and passengers have shifted away from public transport”

  18. neoBuddhist

    Steve or anyone, could you tell me what are the most easy categories in “creative accounting” in balance sheets? What exactly is cash flow? How should I look at the difference between irs balance sheets vs biz balance sheets? Thank you.

    1. steve from virginia Post author

      The most common tactic is to lodge non-performing assets off-balance sheets altogether. This was the approach popularized by Enron, right now all the giant banks and a good percentage of the medium banks are using this approach. Ditto governments.

      Government accounts are becoming collections of lies and mis-representations. Unemployment ‘rates’ and the various (lying) adjustments are easy b/c there is little in the way of comparable private data collection. Same with energy flow rates and reserves: easy lies. Real information is closely guarded by industries.

      This scratches the surface, there is misinformation spewing from every part of the establishment including its books.

  19. neoBuddhist

    I am a little concern about how almost everything is based on GDP calculation (I don’t get its logic yet because you can get GDP if you have lots of catastrophes and let someone else pay for that. ). Is GDP model is based only on upward ‘growth’? So for some narrative’s sake, could the institutions/govs fudge it since we don’t really have ‘growth’? What does zero GDP mean, for the countries, worldwide? Is it because there are different sets of books for each narratives?

    Btw, Steve, how did you figure out that 10% of oil goes toward transportation (non-personal autos)? What about the US military carbon footprints? I tried reading the IEA reports on carbon emission, but it’s only based on GDP and PPP whatever… but not on per capita! Based on GDP and dollars, I guess it makes sense for the bankers to experiment with the Carbon Market in the EU first.

    Also, how does the IEA measure carbon emission, is it based on productions and inventories?
    Sorry, i have many questions, you can point me somewhere… THank you!

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