This is a 2-part series that will be tackling the fundamental problems with the banking system and how we could change them. In case you missed it, I already covered how modern banking and money creation works in a 3-part series here, here and here. Read up on that first to better understand what we are dealing with. But I will try to recap the basic concepts here for the rest of you.
So, how can we start to actually reform this process? It all seems very complicated. Well, it must begin with understanding the flaws first. Then we need to communicate them so enough people understand. Once that happens, solutions will then arise. Nature is self-correcting, but only if nature knows of the “in-correction” in the first place! I will present some possible solutions in the next part. We live in a very interesting era, where decentralised financial architectures like cryptocurrencies could help usher in some reform in this captured system.
When banks create money out of nothing, they do this first through the market for bank reserves, which starts with the central bank and carries through commercial banks. To expand money supply, the central bank creates an initial amount of reserves out of nothing in this inter-bank market that you and I don’t have any access to. The commercial banks continue this process by way of deposit money creation, mirroring the reserve creation with brand new deposit money by way of loans or investments, which you and I do have access to. Deposit money is how money supply increases, and the best way to think of it is that it is a claim on reserves and there is always more deposit money than reserves. Or put another way, there is always more electronic money than cash. What this actually means is that electronic money is a claim on cash. How? Deposit money consists of over 97% of the money supply and is electronic (digits on screens), while cash consists of 3% and is physical notes and coins. Cash is the tangible subset of money supply that we get to touch. Do you see the problem yet? When bank runs happen and everybody wants to pull their electronic digits into cash, there isn’t enough cash to meet demand. Most people will be disappointed.
1) There is way more electronic money than physical cash.
While this isn’t the real crux of the problem, it remains a fundamental weakness of the financial system. Why? Because the entire financial system is based on trust, or confidence trickery. When systemic crises happen that shake public trust in the banking system, people rush to withdraw and secure their money. This multiplies out and generally leads to bank runs, meaning there is never enough physical cash to honour the mass withdrawal of electronic deposit money into cash. The bank therefore is forced to cease functioning normally, capital controls could be imposed to stem cash from leaving the country, and deposits could be frozen (bail-ins) to prevent people from accessing their money. The system is extremely fragile when confidence fails, and that’s because confidence is the only thing holding it up in the first place.
What this means is that fundamentally modern money is debt and the banking system is based on endless debt in order to increase the money supply. This system is heading towards mass inequality and bankruptcy if unaddressed. With a debt-based system that prints way more claims on cash than cash itself, this presents big problems when a financial crisis arises, especially when the banking sector is involved. The amount of interest charged on newly created money out of nothing is fraudulent and odious, yet is the grease that’s required to keep the system producing new money in the economy. This kind of system is unfair to most people, and ends up enriching a small clique of insiders, creating a Plutocracy. What is ultimately needed is to tweak this process so that most people in the economy benefit from the money creation process without taxing or burdening them unnecessarily. As we are starting to see a trend towards a cashless society, this could be harnessed to address this problem.
2) Charging compound interest on deposit money created out of nothing, particularly mortgages, is fraud. The effect this has on most people is neo-Feudal servitude; debt serfdom.
This is the major problem that needs to be addressed. When commercial banks continue money creation by creating deposit money, often through lending, they charge compound interest. Banks could also make investments and not only loans to expand money supply. But I will be focusing on lending here, because it touches almost everybody. Loans such as mortgages form a big source of its revenues. But it is outright fraud. Let me explain. When you have the power to create money out of nothing, and you charge excessive interest (by way of compounding over a long term), you are re-distributing wealth from the economy to yourself for free. This is the definition of fraud. But it is legitimised fraud, because banks have historically lobbied and taken over governments. In fact, banks are more powerful than governments. Who do you think governments borrow from? Banks of course; the central bank. Expecting interest in return for having created a deposit for a borrower out of thin air, from no real funds of your own, constitutes fraud. The economic argument against this practice is that there exists no opportunity cost for lending out those funds, therefore there is absolutely no justification in charging compound interest on it.
I’d like to further elaborate that the concept of interest is legitimate in finance, – but only when a real opportunity cost exists in lending out scarce funds. So for example, say you are a broker who doesn’t have the magic money printing machine, and instead makes money by charging a spread for some service, which is the difference between your buying and selling prices: you buy low and sell high. Over time you accumulate cash profits. If somebody came up to you and wanted to borrow some money, you are justified in charging them interest for the loan, because you face a real opportunity cost for lending out your funds – they are limited, and you expect a charge for this service at some time in the future – interest. Banks don’t have an opportunity cost on principal amounts that are conjured into existence at the stroke of a keyboard, to be expecting interest for this “service” in return. See the difference?
3) Combining 1) and 2) above leads to an exploding debt time bomb and increased social tension and stress.
This is partly a consequence of 2) and partly due to society’s excesses and needs, consumerist models and values. There is a concept in law by the name of odious debt, when ethical issues arise out of having too much debt overhang. It applies to sovereign debt in general, as odious debt affects the welfare of an entire nation. Well, sovereign bankruptcy is where we’re headed with this system. What we collectively get out of this fractional reserve system, which is completely based on fiat money (not backed by anything other than full faith and credit) is a spiralling debt problem, both private and public. Ever since President Nixon abolished the Bretton Woods system in 1971, the world has entered the era of fiat paper currencies, or as I’d like to call it, Debtocracy. This is because there is no longer any gold to ‘anchor’ fiscal irresponsibility i.e. borrowing too much debt, because gold has a limited supply and fiat doesn’t. Instead, the system is based on perpetual debt creation, because money in this system is debt. I illustrated this quite simply here. On a whole, there is always more money being owed as debt than currently exists to pay it off, due to fraudulent compound interest charged on money creation through lending. And this will only get worse, necessitating ever more debt and so on.
The one unambiguous trend in modern economics since the world entered the era of fiat currency, has been a consistent rise in total inflation. Conventional central banks tell you they aim for 2-3% annual inflation. The big lie is that they aren’t choosing to do this; they are merely managing an inevitable side effect of debtocracy. If you do the calculation, a 3% annual rate of inflation actually means prices will double every 23 years! Did you know that the US dollar has lost over 95% of its purchasing power since 1913, when the Federal Reserve Bank was founded? Money is steadily losing its purchasing power – this is what all central banks do – they ultimately kill their own currency. This will affect everybody at some stage. Look at almost every single major empire in history – its the same story, albeit different ways of getting there. The Spanish Conquistadors ransacked Latin America, and when they hoarded off all the gold back home, it caused hyperinflation and the empire collapsed thereafter. The Romans steadily adulterated the silver content in their Denarius until it was almost worthless. This happened around the time of their collapse. The US dollar is the current reserve currency, backed by oil and the military. Since it contains no precious metal content to forge, the collapse moment will come once de-dollarization occurs en masse and demand for the dollar drops. The Fed has been printing lots and lots of dollars. By the time of full scale de-dollarization, a flood of excess dollars will work their way into the US economy, hyperinflation will ensue and interest rates will be forced through the roof. The empire will soon collapse thereafter and be forced to wind down, unless it devises some strategy at keeping so many US dollars at bay and away from coming home to roost. At the moment, the Petrodollar is that mechanism. How long that will last is anybody’s guess, but the bet is fairly safe to say it won’t be forever.
Full faith and credit means the only things holding the system in place are the taxing ability of government, its military power in securing resources, and the public’s faith in the whole banking charade. In the background, a handful of bankers and associates are getting extremely rich off this scheme while the vast majority slave away on odious 30 year mortgages, which end up funnelling twice the original principal loan to the bank by way of interest. The fiat system as a whole requires endless debt, because contrary to popular belief, paying off debt actually shrinks and destroys the money supply, and is deflationary. So while you pay off your mortgage loan, at least somebody else must be taking out a new one. The banking cartel re-distributes money from the economy to itself by this compound interest on loans. What I mean in technical terms here is that the principal loan is extinguished from the money supply once it is fully re-paid, – this is how money gets cancelled or destroyed in the economy. But the amount of compound interest demanded in return by the bank sometimes eclipses the principal amount, and creates a net gain for the bank, and corresponding loss for society. This is the fundamental fraud at play. In turn, it causes wealth inequality and is responsible for much stress in society. One can even argue that this instrument is the main cause of wealth inequality in society as a whole. So addressing the banking system and its fatal flaw is key if we are to begin solving the problem of inequality.
The system on a national level is tending towards mass systemic sovereign bankruptcy. The national debt will never be fully re-paid, only serviced through repayment, until it no longer can. Japan is a leading example of what awaits the Western world. They have the highest national debt of any developed nation in the world – 220% of GDP. Over 40% of Japanese tax revenues go to servicing their debt. Once it reaches over 60%, and the central bank can no longer keep buying worthless Japanese bonds, its game over. Japan will default on its debt. Its central bank, the BOJ, along with its massive pension funds (at the instruction of the Japanese government), are the sole buyers of Japanese debt (bonds). To get a sense of how screwed Japanese bonds are, consider that 30 year bonds are currently trading at a yield of barely 1%. This is just absurd. What investor in their right mind would buy this instrument other than the central bank? And where does the Japanese government go to make up for the budget shortfall if so much goes into paying off debt and not addressing other programs? Borrowing more debt in capital markets of course, with the Bank of Japan monetising the government debt. You either have to cut down government programs or raise taxes to bridge the budget. But most governments don’t wish to do that, or can’t do that, and so they opt for borrowing in capital (debt) markets by issuing more bonds. Nowadays central banks are openly helping governments with this problem, by holding interest rates low enough to help them service debt repayments easier. But this can’t last forever, because perennially low interest rates flood the world with cheap, easy credit and pave the way for the next credit bubble and financial crisis. The moment interest rates increase significantly will mean massive spikes in government borrowing costs, and some could always be bound to cut spending in other areas, or even default on their debt. It will get to a point where many future promises will be broken, especially welfare, unfunded liabilities and pensions. This is why governments are raising retirement ages and encouraging superannuation. They know they cannot afford most future payouts such as pensions with the growing debt problem, and require a bigger tax base. They can do this by encouraging more immigration or property bubbles, if raising taxes is not an option.
4) The political system is captured and hijacked by special interest groups often putting corporate banking interests ahead of the electorate.
This is the biggest problem that stands in the way of any meaningful monetary reform at the political level, because the political system is not working for the interests of the ordinary person. The system we have is one where those with the most money win power. And those people statistically are a very small minority. This ultimately leads to rule by an Oligarchy. It is a system tailored towards the 1%, held together by the 99%. The 1% have deeper pockets and can therefore purchase influence with the government to get ahead of the queue. Do the 99% have any lobby groups? No. The government is an entity with self-interest and often sells out to corporate lobbying. This is often witnessed by the revolving doors that exist between Treasury, Wall Street, regulators and Congress. It’s a system fully captured by greedy, self-indulgent men who claim to be democrats and capitalists. It couldn’t be further from the truth: they are crony capitalists, closet tyrants, insider traders and prefer socialism for the rich when the SHTF, i.e. privatising gains and socialising losses. They support the bloated State, an ever expanding cash cow, and stand against prudence, frugality and efficiency. To top it all off, they have ruined democracy, under the noses of a largely pacified, ignorant and distracted public. After-all, they control mass media. Elected representatives have forgotten who they are supposed to be working for, who pays their salaries, and who their policies adversely affect most: you and I. They are on tax-payers payroll and elected to uphold the laws. Instead they mis-allocate resources and write the laws for themselves.
Democracy doesn’t really work very well when the candidates are always first selected, then elected. Which means that they are first hand-picked by insiders, bought off by corporate interests, then paraded in front of the public for election. “Elections” are lauded as being game-changing to say, authoritarian regimes, but ask yourself this: does shuffling around the face every 4 years really change anything in the working machinery? Moreover, how much power do the people really have within those 4 years? And what happens if gross mismanagement occurs within the 4 years, – do people get a refund? Do they get punished? No and no. There are no incentives in place to punish malfeasance adequately. Officials behave as if they are above the law, – and they quite simply are. The legal system enables white collar criminality and paper pushing fraudsters; more problematically, it does not do nearly enough to prosecute white collar crime. During elections, if elites happen not to back the winning horse, they hedge their bets by owning the 2 party system with the purchase of influence, deliberately enabling misleading dichotomies and dialectics to divide public opinion in this pendulum system. Such a crooked system eventually produces perversion – people voting to get repeatedly shafted while hoping for different outcomes, and elites using the State as merely a vehicle for their own self-serving agendas.
In the next part, I will be addressing problems 1) and 2) with some solutions. This will in turn address problem 3). Solutions to problem 4) are a whole other matter beyond the scope of this series.