The Daily Reckoning

Bacon, Bacon, Bacon…

The bacon reference has been claimed. Marius Gustavson has written a brilliant article on the sovereign debt crisis facing the world. From The Market Oracle:

Smells Like Bacon

“The Greek debt crisis has led many observers to believe a eurozone-wide contagion is in the making, including all of the PIGS – Portugal, Italy, Greece and Spain – and it could spread to the north-western periphery as well. As Ian Bremmer and Nouriel Roubini recently commented in the Wall Street Journal:

“The current crisis in Greece is only the worst example inside the EU. The PIGS … all boast public debt above or headed for 100% of GDP. Though the PIGS acronym was apparently coined by British bankers, Britain, Ireland and Iceland also smell distinctly of bacon.”

Debt distressed nations being called PIGS, countries smelling of bacon, and dubious political spending referred to as pork. What’s next? Maybe Bernanke will bypass money dumping helicopters and grow wings himself – pigs might fly.

The U.S. budget deficit certainly is soaring. It “widened to a record in February as the government boosted spending to help revive the economy.” How spending money that had to be borrowed from someone else can stimulate is a mystery. It just moves money around. How it indebts future generations is not a mystery:

“The figures show the deficit this year will likely surpass the record $1.4 trillion in the fiscal year that ended in September.” The light at the end of the Keynesian tunnel is a runaway steam train loaded with debt obligations.

Wall Street still only sees the light. It has marked its best 12 month performance since the rebound from the Great Depression.

Who done it?

The latest European blame game has begun. After believing the Keynesian free lunch would provide for a cushy future, it seems Europe’s politicians are descending into an even deeper state of denial and delusion. Marius Gustavson at The Market Oracle continues:

“So far the two PIGS most afflicted by the European debt crisis, Greece and Spain, blame mysterious foreign conspirators, rather than home-grown macroeconomic mismanagement.

“Greek Prime Minister George Papandreou expressed the view that the crisis is “an attack on the euro zone by certain other interests, political or financial,” whereas the Spanish government has, reportedly, ordered an investigation into the alleged “collusion” between American investors and the media to hurt the Spanish economy.”

Considering those evil financial institutions hold vast amounts of government debt, as well as facilitate bond markets, the Greeks and Spaniards might want to keep their mouths shut.

Biting the hand that feeds you is a bad idea. This is no less true if that hand is attached to something as unscrupulous as a bank. In fact, it holds even more true.

Amusingly, those unscrupulous banks find themselves in the same fix as Shylock did. If they hold countries accountable for their excesses by requiring higher bond yields, then the bank’s capital base weakens. If they continue to buy bonds, they expose themselves to sovereign risk.

And yes, losing a pound of flesh does compare to losing capital. The real difference is that Shylock could walk away from the debt. Although, with million dollar bonuses, I suppose bankers could walk away quite comfortably. That’s where derivatives like Credit Default Swaps come in. We’ll leave that for another day.

Me, Myself and the Lenders

Sadly, it seems the delusions of politicians have filtered down to the citizens. They now also feel some sort of entitlement to being lent money.

The vast benefits promised by governments and provided by debt markets seemed endless. When it turns out they aren’t, trouble brews. Greece is just the beginning.

“The importance of the shock to public finances in advanced economies is not yet sufficiently appreciated and understood,” said El-Erian, co-chief investment officer at Pacific Investment Management Co, known as PIMCO.

If Greece is where the world is headed (metaphorically speaking) then things could get interesting.

Bloomberg reports that “Greece’s unions will shut down hospitals, airports and schools today in the country’s second general strike this year to protest Prime Minister George Papandreou’s latest round of budget cuts to curb the European Union’s biggest deficit.”

The Economist, far more insightfully, reports that “Militant pensioners unexpectedly broke through a police cordon blocking the road to Mr Papandreou’s office as he was announcing the new measures.”

Please take a moment to picture that.

Militant pensioners… And it’s not like they have nothing better to do. It’s just that they want to claim what they can while they still can. Marko Papic of Stratfor has forecasted that interest will amount to 6% of GDP for the Greeks by next year. That is past the point of no return, according to Professor Altman, who developed a popular model used to calculate corporate defaults.

His reasoning is that Greece faces structural problems, which are difficult to turn around, even in the long run. Based on this, any bailout will be like a bandaid for a cancer patient. Nobody but two year olds and stock brokers would be comforted. That does leave room for a short term rally. Caveat emptor. Please don’t confuse that with Carpe diem.

One clever solution did pop up in the press. According to two German senior ministers, it would be a good idea for Greece to sell a few of its islands to pay off debt. No kidding, zose German politicians are getting power hungry again.

Meanwhile, the Italians are being themselves as well. “For Greece, the problem is completely over,” said Romano Prodi, a former Italian prime minister. The reason this is newsworthy is that a predictor of the Argentinean debt crisis, Charles Calomiris, has stated that Italy is the next Greece in terms of debt problems – because of political corruption.

Be-ratings Agencies

Those ratings agencies are still at it. Having been beaten and humiliated by the public and the government, they are getting their own back.

The ratings agency Fitch warns of sovereign debt downgrades for the UK if plans for austerity are not outlined. If they are outlined, Fitch will realise the severity of the problem and decide to downgrade anyway.

Karma in action.

So, when will the crisis hit? When does the sovereign debt bubble burst?

After staring into a crystal ball for several moments, the answer strikes as being obvious. The sovereign debt crisis begins when people get rational again. It’s that simple.

Rationality isn’t a terribly difficult thing to get a grasp on. But irrationality is a pain in the neck for an economic forecaster. How long it can last cannot be explained, as it is by nature irrational. So you see the quagmire.

For now, my claim is to be telepathetic, not telepathic, of Mr Market’s intentions.

Tightwire to Nowhere

Regarding forecasts on economic growth, talk has again turned to the letters V U W. V being the rapid recovery that often follows recessions, U being a longer period of anaemic growth, and W being a double dip recession. Nouriel Roubini and his team at RGE have indicated they see an increased risk of the W scenario developing.

That is stating the obvious. Government has gone from being a major player in the economy to being the major player in the economy. If its institutions stuff up, the ability of the free market to correct the mistakes is now severely hampered. The problem is that governments inevitably stuff up.

They can’t even manage their own balance sheet, despite having the power of the law to play with. Now they claim to be gallantly walking a tightwire between inflation and deflation.

The managing director of the International Monetary Fund, Dominic Strauss-Kahn, explained this supposed balancing act policy makers face in their use of fiscal and monetary stimulus:

“If we exit too late … it’s a waste of resources, it’s bad policy, it’s increasing public debt, we should avoid this … But if you exit too early, then the risks are much bigger.”

Michael Pomerleano sees it very differently. Rather than bothering with a balancing act, take a look at where the economy is headed:

“Nationalisation of private debt injects considerable inefficiency into the economic system, inhibiting Schumpeter’s process of Creative Destruction that is essential in a market economy and needed to maintain the private sector.”

But what of the audience watching the spectacle? A V shaped recovery isn’t much different to a U or W if the jobs situation remains awful. One quickly gets the impression they just want to see someone plunge to their death instead of prancing around for applause.

For the “history repeats itself” buffs:

“As historical research conducted by University of Maryland economist Carmen Reinhart and Harvard University economist Kenneth Rogoff shows, financial crises are usually followed by government-debt crises. This starts as private debt is shifted onto the balance sheet of the government, through bailouts and purchases of toxic debt. The government-debt problem is then made worse as the economic downturn leads to an increase in expenditures in the form of unemployment benefits and stimulus spending, coupled with a decrease in tax revenues.”

Here in Australia, the economic outlook could not be more ominous for history fans. According to The Age, the profit outlook for SMEs is the best it has been for 2.5 years.

“Optimism among small and medium size firms about future profits is at its highest level since before the global financial crisis, a survey finds.”

“… before the GFC” are the key words. Just like in 2007, the future is based on optimism. When that turns out to be a load of rubbish, the games will begin again.

Capital Crunch

Enthusiasts of the Austrian School of Economics have mixed feelings for legendary economist Adam Smith. Nevertheless, we don’t like to think of him rolling over in his grave. He must have done so when it was decided that the 20 pound note would bear his face.

You see, Adam Smith was an investor and firm believer in Scottish Free banking. The idea that government should hold a monopoly over issuing currency would not be agreeable to him. Putting his face on a Bank of England note is like having Tony Abbott on abortion ads.

Strangely enough, the UK still has 10 note issuing Banks. People don’t seem interested in the reason. They have bigger things to worry about – like what their government has in store for “its” banks. The Telegraph reports:

“Jonathan Pierce, from Credit Suisse, believes UK banks will have to reduce the size of their balance sheets by as much as £530bn over the next three to four years to meet new regulations.

“According to his analysis, British banks need to issue £420bn-£750bn of long-term wholesale funds. “We don’t think this is plausible and hence we expect balance sheet footings to fall by 6pc-18pc to compensate,” he said.”

In a world that relies on credit to turn, somebody has to get burned if bank balance sheets really do contract that much.

House Prices Uncovered

Based on feedback, it seems property comments are fair game for the Daily Reckoning. So here goes.

That reputable institution, the Reserve Bank of Australia, has not informed us that house prices could rise. It has warned us that house prices could rise. Hmm, so that’s a bad thing now.

It doesn’t have to be. In a free market, an increase in house prices is a signal to builders to build more houses. Once they do, prices normalise again, as supply balances demand.

The idea that house prices can steadily rise relative to incomes is flawed. Why would one generation want to pay more as a percent of their income on housing than another?

More importantly, why would builders not build more homes as prices rise?

The answer is zoning laws, town planning and all regulations remotely similar. Yes, it’s the government again.

If you examine where house prices rise (and then plummet) the most and compare those areas to where prices remain stable relative to income, you will find a remarkable correlation to the intensity of planning and zoning laws.

This was best illustrated in the US. Areas that had the most planning experienced the biggest booms and busts because supply couldn’t adjust to demand. Areas with low planning had little problem and simply built more as demand increased. They haven’t experienced the same subsequent bust either.

Have a great weekend.

Nickolai Hubble.
The Daily Reckoning Week in Review

Similar Posts:

• Pigs Get Slaughtered
• USA Has Fives Times As Much Sovereign Debt As All the PIIGS Put Together
• It’s the Little Economies that Have Trouble
• It All Comes Down to Debt Again for NAB
• The Euro is a Symptom of Centralisation

More articles from The Daily Reckoning….

Zero Hedge

This is an open letter to the economics, finance and banking communities.
I don’t have any dog in the fight, other than to figure out and then
publicize what is best for the greatest number of people. People I
greatly respect advocate for federal-level public banking, state public
banks or a return to the gold standard. I am simply attempting to start
a high-level debate about what the best option is.

Please see responses posted by economists and others below.  I will update the responses as I receive them.

How Is Credit Created?

I pointed out in September:

As PhD economist Steve Keen pointed out recently, 2 Nobel-prize winning economists have shown that the assumption that reserves are created from excess deposits is not true:

The model of money creation that Obama’s economic advisers have sold him was shown to be empirically false over three decades ago.

 

The first economist to establish this was the American Post Keynesian economist Basil Moore, but similar results were found by two of the staunchest neoclassical economists, Nobel Prize winners Kydland and Prescott in a 1990 paper Real Facts and a Monetary Myth.

 

Looking at the timing of economic variables, they found that credit money was created about 4 periods before government money. However, the “money multiplier” model argues that government money is created first to bolster bank reserves, and then credit money is created afterwards by the process of banks lending out their increased reserves.

 

Kydland and Prescott observed at the end of their paper that:

Introducing money and credit into growth theory in a way that accounts for the cyclical behavior of monetary as well as real aggregates is an important open problem in economics.

In other words, if the conventional view that excess reserves (stemming either from customer deposits or government infusions of money) lead to increased lending were correct, then Kydland and Prescott would have found that credit is extended by the banks (i.e. loaned out to customers) after the banks received infusions of money from the government. Instead, they found that the extension of credit preceded the receipt of government monies.

 

Keen explained in an interview Friday that 25 years of research shows that creation of debt by banks precedes creation of government money, and that debt money is created first and precedes creation of credit money.

 

As Mish has previously noted:

Conventional wisdom regarding the money multiplier is wrong. Australian economist Steve Keen notes that in a debt based society, expansion of credit comes first and reserves come later.

This angle of the banking system has actually been discussed for many years by leading experts:

 

“[Banks] do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers’ transaction accounts.”
- 1960s Chicago Federal Reserve Bank booklet entitled “Modern Money Mechanics”

 

“The process by which banks create money is so simple that the mind is repelled.”

- Economist John Kenneth Galbraith

 

“[W]hen a bank makes a loan, it simply adds to the borrower’s deposit account in the bank by the amount of the loan. The money is not taken from anyone else’s deposit; it was not previously paid in to the bank by anyone. It’s new money, created by the bank for the use of the borrower.”

- Robert B. Anderson, Secretary of the Treasury under Eisenhower, in an interview reported in the August 31, 1959 issue of U.S. News and World Report

 

“Do private banks issue money today? Yes. Although banks no longer have the right to issue bank notes, they can create money in the form of bank deposits when they lend money to businesses, or buy securities. . . . The important thing to remember is that when banks lend money they don’t necessarily take it from anyone else to lend. Thus they ‘create’ it.”

-Congressman Wright Patman, Money Facts (House Committee on Banking and Currency, 1964)

 

“The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented.”

- Sir Josiah Stamp, president of the Bank of England and the second richest man in Britain in the 1920s.

 

“Banks create money. That is what they are for. . . . The manufacturing process to make money consists of making an entry in a book. That is all. . . . Each and every time a Bank makes a loan . . . new Bank credit is created — brand new money.”

- Graham Towers, Governor of the Bank of Canada from 1935 to 1955.

I’ve also noted:

In First National Bank v. Daly (often referred to as the “Credit River” case) the court found that the bank created money “out of thin air”:

[The president of the First National Bank of Montgomery] admitted that all of the money or credit which was used as a consideration [for the mortgage loan given to the defendant] was created upon their books, that this was standard banking practice exercised by their bank in combination with the Federal Reserve Bank of Minneaopolis, another private bank, further that he knew of no United States statute or law that gave the Plaintiff [bank] the authority to do this.

The court also held:

The money and credit first came into existence when they [the bank] created it.

(Here’s the case file).

 

Justice courts are just local courts, and not as powerful or prestigious as state supreme courts, for example. And it was not a judge, but a justice of the peace who made the decision.

But what is important is that the president of the First National Bank of Montgomery apparently admitted that his bank created money by simply making an entry in its book …

Moreover, although it is counter-intuitive, virtually all money is actually created as debt. For example, in a hearing held on September 30, 1941 in the House Committee on Banking and Currency, then-Chairman of the Federal Reserve (Mariner S. Eccles) said:

That is what our money system is. If there were no debts in our money system, there wouldn’t be any money.

And Robert H. Hemphill, Credit Manager of the Federal Reserve Bank of Atlanta, said:

If all the bank loans were paid, no one could have a bank deposit, and there would not be a dollar of coin or currency in circulation. This is a staggering thought. We are completely dependent on the commercial Banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the Banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless position is almost incredible, but there it is. It is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon.

This must-see 47 minute video provides details:

So here are the first two questions:

Do you agree that banks create credit by initiating loans, and then obtaining deposits subsequently, to comply with depository requirements? I’m not talking about the coins which governments create (in America, coins represent less than 5% of the total money in circulation).

Do you agree with Eccles and Hemphill that money is debt, in that new credit normally comes into existence when a new loan is issued?

Government Alternative

William Greider is a former Washington Post and Rolling Stone editor, and now writes for the Nation. Greider has written numerous books and articles on the economy over the course of many decades, including one of the leading books on the Federal Reserve, Secrets of the Temple.

In an article in the Nation, Greider argues that the government could solve the economic crisis by taking back the power of money creation from the banks and the Federal reserve:

For the first time in generations, [the Fed is] now threatened with popular rebellion.

 

During the past year, the Fed has flooded the streets with money–distributing trillions of dollars to banks, financial markets and commercial interests …

 

Where did the central bank get all the money it is handing out? Basically, the Fed printed it, out of thin air. That is what central banks do. Who told the Fed governors they could do this? Nobody, really–not Congress or the president. The Federal Reserve Board, alone among government agencies, does not submit its budgets to Congress for authorization and appropriation. It raises its own money, sets its own priorities.

 

Representative Wright Patman, the Texas populist who was a scourge of central bankers, once described the Federal Reserve as “a pretty queer duck.” Congress created the Fed in 1913 with the presumption that it would be “independent” from the rest of government, aloof from regular politics and deliberately shielded from the hot breath of voters or the grasping appetites of private interests–with one powerful exception: the bankers…

 

Banks are the “shareholders” who ostensibly own the twelve regional Federal Reserve banks…

 

The Federal Reserve is the black hole of our democracy–the crucial contradiction that keeps the people and their representatives from having any voice in these most important public policies. That’s why the central bankers have always operated in secrecy, avoiding public controversy and inevitable accusations of special deal-making. The current crisis has blown the central bank’s cover…

 

Altering the central bank would also give Congress an opening to reclaim its primacy in this most important matter. That sounds farfetched to modern sensibilities, and traditionalists will scream that it is a recipe for inflationary disaster. But this is what the Constitution prescribes: “The Congress shall have the power to coin money [and] regulate the value thereof.” It does not grant the president or the treasury secretary this power. Nor does it envision a secretive central bank that interacts murkily with the executive branch…

 

If Ben Bernanke can create trillions of dollars at will and spread them around the financial system, could government do the same thing to finance important public projects the people want and need? Daring as it sounds, the answer is, Yes, we can.

 

The central bank’s most mysterious power–to create money with a few computer keystrokes–is dauntingly complicated, and the mechanics are not widely understood. But the essential thing to understand is that this power relies on democratic consent–the people’s trust, their willingness to accept the currency and use it in exchange. This is not entirely voluntary, since the government also requires people to pay their taxes in dollars, not euros or yen. But citizens conferred the power on government through their elected representatives. Newly created money is often called the “pure credit” of the nation. In principle, it exists for the benefit of all];

 

In this emergency, Bernanke essentially used the Fed’s money-creation power in a way that resembles the “greenbacks” Abraham Lincoln printed to fight the Civil War. Lincoln was faced with rising costs and shrinking revenues (because the Confederate states had left the Union). The president authorized issuance of a novel national currency–the “greenback”–that had no backing in gold reserves and therefore outraged orthodox thinking. But the greenbacks worked. The expanded money supply helped pay for war mobilization and kept the economy booming. In a sense, Lincoln won the war by relying on the “full faith and credit” of the people, much as Bernanke is printing money freely to fight off financial collapse and deflation.

 

If Congress chooses to take charge of its constitutional duty, it could similarly use greenback currency created by the Federal Reserve as a legitimate channel for financing important public projects–like sorely needed improvements to the nation’s infrastructure. Obviously, this has to be done carefully and responsibly, limited to normal expansion of the money supply and used only for projects that truly benefit the entire nation (lest it lead to inflation). But here is an example of how it would work…

 

Instead, Congress should create a stand-alone development fund for long-term capital investment projects (this would require the long-sought reform of the federal budget, which makes no distinction between current operating spending and long-term investment). The Fed would continue to create money only as needed by the economy; but instead of injecting this money into the banking system, a portion of it would go directly to the capital investment fund, earmarked by Congress for specific projects of great urgency. The idea of direct financing for infrastructure has been proposed periodically for many years by groups from right and left…

 

This approach speaks to the contradiction House Speaker Pelosi pointed out when she asked why the Fed has limitless money to spend however it sees fit. Instead of borrowing the money to pay for the new rail system, the government financing would draw on the public’s money-creation process–just as Lincoln did and Bernanke is now doing.

 

The bankers would howl, for good reason. They profit enormously from the present system and share in the money-creation process. When the Fed injects more reserves into the banking system, it automatically multiplies the banks’ capacity to create money by increasing their lending (and banks, in turn, collect interest on their new loans). The direct-financing approach would not halt the banking industry’s role in allocating new credit, since the newly created money would still wind up in the banks as deposits. But the government would now decide how to allocate new credit to preferred public projects rather than let private banks make all the decisions for us.

Here are my third, fourth and fifth questions:

Do you agree with Greider that the American Constitution and/or the inherent right of sovereign nations gives the government the power and authority to itself create credit?

Do you agree with Greider that such government creation of credit need not be inflationary so long as only as much credit is created as is needed by the economy – in other words, the amount actually needed to buy goods and services?

Several monetary commentators have said that – if credit is created primarily by the government instead of private banks – that it would save the government trillions of dollars in interest. Specifically, they claim that private banks charge interest to the government to fund the government’s debt, but that the government would owe no debt on credit it creates itself.

Is that true?

What Is the Best Public Banking Option?

As I wrote in November:

AFL-CIO president Richard Trumka told Congress last week:

If the Federal Reserve were made a fully public body, it would be an acceptable alternative.

The American Monetary Institute proposes the following alternative:

Incorporate the Federal Reserve System into the U.S. Treasury where all new money would be created by government as money, not interest-bearing debt; and be spent into circulation to promote the general welfare. The monetary system would be monitored to be neither inflationary nor deflationary.

Second, halt the bank’s privilege to create money by ending the fractional reserve system in a gentle and elegant way.

All the past monetized private credit would be converted into U.S. government money. Banks would then act as intermediaries accepting savings deposits and loaning them out to borrowers. They would do what people think they do now. This Act nationalizes the money system, not the banking system.

Bloomberg News columnist Matthew Lynn writes:

The U.K. government needs to start thinking about what it will do with all the banks it now owns. The answer is simple: Hand them to the people…

Instead of selling the stakes it acquired in the financial system to other banks, or listing the shares on the stock market, it could create mutually owned societies. Royal Bank of Scotland Group Plc could be a people’s bank, owned by everyone.That would ensure more diversity, competition and stability, all goals just as worthy as getting back the money Prime Minister Gordon Brown’s government spent on bank rescues…

Sovereign nations such as the U.S. and England have the power to create credit and money (and see this, this and this). Taking the credit-creation power away from the banks and giving it back to the nation would ensure that credit is freed up for people’s use, and the stranglehold over the economy is taken away from the too big to fails.

State Public Banks

Many people argue that – given its actions – people don’t trust the federal government to create money.

Fair enough. Why not let the states do it?

Michael Moore recommends that the American people demand:

Each of the 50 states must create a state-owned public bank like they have in North Dakota. Then congress MUST reinstate all the strict pre-Reagan regulations on all commercial banks, investment firms, insurance companies — and all the other industries that have been savaged by deregulation: Airlines, the food industry, pharmaceutical companies — you name it. If a company’s primary motive to exist is to make a profit, then it needs a set of stringent rules to live by — and the first rule is “Do no harm.” The second rule: The question must always be asked — “Is this for the common good?” (Click here for some info about the state-owned Bank of North Dakota.)

As Moore notes, the state of North Dakota already has such a bank, and – because of that – North Dakota is just about the only state which is not running a huge deficit.

PhD economist and candidate for Florida governor Farid Khavari wants to create a Bank of the State of Florida, to create credit without burdening the state and its citizens with high interest charges by private banks.

See this for details.

Local Public Banks

An alternative to federal or state public banking is local public banks, as proposed by Edward Kellogg and others.

As summarized by Adrian Kuzminski:

During this time of financial and economic crisis, it is worth recalling that credible alternatives to our current financial system exist, if largely unrecognized, and deserve serious consideration…

The now-neglected 19th-century American proto-populist, Edward Kellogg … was a kind of godfather to the later populist movement on monetary issues. Perhaps the most profound of American writers on monetary issues, Kellogg advocated a decentralized but nationally regulated monetary system based on non-usurious, low-interest public loans to individuals. His vision inspired 19th-century century mutualists, greenbackers, populists, and others who sought to restructure the monetary system to redistribute wealth.

In our own day, when usurious credit in the form of private finance capital remains the dominant force in economic life, and is largely taken for granted even by educated people, the alternative Kellogg offers is more important than ever. Indeed, I suggest that Kellogg’s theory of money is the best monetary alternative we have to the baleful system under which we suffer…

Edward Kellogg (1790-1858) was a New York City businessman whose losses in the crash of 1837 led him to examine the business cycle, monetary policy, and debt. In a series of writings, Kellogg developed the idea of … having the government provide very-low-interest loans to the general public. These loans would have a uniform, fixed interest rate, established by law. They would be issued locally through a system of public credit banks he called the Safety Fund. Once issued, these low-interest loan notes would circulate as currency, replacing the privately issued banking notes of his day (which today take the form of Federal Reserve Notes)…

In his day Kellogg seems to have influenced even Abraham Lincoln who, according to historian Mark A. Lause, ” . . . had his own copy of Kellogg’s book, Labor and Capital [sic] advocating the government issuance of paper currency as a just means of redistributing wealth, and he corresponded with the author’s son-in-law.” Kellogg’s public currency was intended to end the monopoly over the discretionary issuance of money at interest, which was held then (and now) by the private banking and investment system…

Kellogg proposed to establish local public credit banks, and we might imagine one in each community. These local public credit banks would be part of the Safety Fund. Instead of money being issued (as it is now) through a privatized and centralized money-management system on a top-down basis, primarily as loans at increasing rates of interest from a central bank to major commercial banks, and then to regional and local banks, and then to the public, money in his system would be issued by local federal banks as loans directly to citizens at nominal interest on the basis of their economic prospects. Once lent out, Kellogg’s public credit notes would flow into circulation, providing the basis for a new currency backed by the assets of individual borrowers…

A centralized national currency would be replaced, in Kellogg’s system, by a locally issued currency. But that currency would everywhere be subject to common national standards, ensuring that each local public credit bank reliably issued equivalent units of currency. A dollar issued by one local public credit bank of the Safety Fund, Kellogg intended, would be worth the same as, and be freely interchangeable with, one issued by any other. The independence of local branches would be guaranteed by the discretionary power reserved to them as a local monopoly actually to loan money; the compatibility of their monies would be ensured under federal law by fixing the value of the dollar by law at 1.1 percent/year – that is, by lending money everywhere to citizens at that rate…

The goal is to establish and preserve economic decentralization. Amounts of money lent in Kellogg’s system would vary considerably from place to place, with some areas needing and creating more currency than others. The solvency of local federal public credit banks would be guaranteed by collateral put up by borrowers, and the money supply would be stabilized by repayment of loans as they came due. The interchangeability of public credit bank notes would ensure a wide circulation for the new money…

To achieve a stable currency, Kellogg insisted that this rate be fixed by law; perhaps today it would take a constitutional amendment.

Michael Hudson (Distinguished Research Professor at the University of Missouri, Kansas City, who has advised the U.S., Canadian, Mexican and Latvian governments as well as the United Nations Institute for Training and Research. He is a former Wall Street economist at Chase Manhattan Bank who also helped establish the world’s first sovereign debt fund) and Congressman Dennis Kucinich both support the federal public banking option:

On the other hand, California considered creation of a state bank modeled after North Dakota’s bank in 1977. And the Massachusetts state Senate is currently considering creation of a state public bank, and other states are currently considering creating their own state banks.

So here is my sixth question:

Do you think a federal, state or local public banking option is best?

What About Gold?

Advocates for a return to the gold standard point out that – when a currency is pegged to a hard asset such as gold – it imposes fiscal discipline. Specifically, the government cannot simply run its “printing press” if its currency has to maintain a set ratio to a hard asset, and this prevents funding of endless wars and other misadventures.

I largely agree. But advocates for public banking, on the other hand, point to the numerous depressions which have occurred during periods when the gold standard was in place.

See these short videos (I don’t necessarily agree with the conspiracy theories alleged in the first video, but only with the general question of whether we can assure that the quantity and quality of gold can be assured):

Here is my seventh and final question:

Is there any way to have a hybrid monetary system which provides the benefits of public banking with the fiscal discipline which something like a gold standard imposes?

Responses to This Essay

Steve Keen is an Associate
Professor in economics and finance at the University of Western Sydney.
He identifies as post-Keynesian, criticizing both modern neoclassical
economics and (some of) Marxian economics as inconsistent, unscientific
and empirically unsupported. The major influences on Keen’s thinking
about economics include Hyman Minsky, Piero Sraffa and Joseph Alois
Schumpeter. His recent work mostly concentrates on mathematical
modeling and simulation of financial instability. Keen writes at
DebtDeflation.com/blogs

Keen responds:

I
obviously see the need to reform the financial system, but my analysis
of how credit is created (see my “Roving Cavaliers of Credit” post: http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/)
makes me sceptical that any new system will “hold” so long as
financiers can make money by financing asset-price speculation. I
believe the experience of history should tell us that every system
we’ve tried to far has finally succumbed to a debt-financed asset-price
bubble, whose bursting has brought in at best a recession and at worst
a Depression.

 

I have therefore developed proposals to tackle the
root problem from the other side of the ledger: if financiers can
always be expected to exploit the desire of borrowers to speculate on
rising asset prices, then we have to remove that desire in the first
place.

 

The most effective way to do this would be to redesign
assets in a manner that still encouraged individual ownership and
enterprise, but made the prospects of leveraged gains on asset
speculation much less likely.

 

My two proposals are: to modify
shares so that once they are on the secondary market they expire after
a predefined period (say 25 years); and to limit the maximum leverage
that can be secured against a property to some multiple (say 10) of the
property’s annual rental income.

 

Explaining these in more detail:

 

Shares

 

Shares
purchased in an initial public offering or float would last
indefinitely while held by the original purchaser. But once these
shares were sold, they would have a defined life of (say) 25 years.

 

This would have several benefits over our current system:

 

(1)
Purchasers of shares on the secondary market would be forced to do what
the Capital Assets Pricing Model (the delusional neoclassical theory
that dominated academic finance prior to the GFC) pretended they do
now: to value shares on a sensible valuation of expected future
dividend earnings. You would only buy a share under this system if you
expected a reasonably good stream of dividends from it, because in 25
years it would expire; and

 

(2) It would encourage the act of
providing finance to new ventures. At present, the share market does a
very poor job of providing new finance, with over 99% of the
transactions being secondary market sales in search of capital gains.
With my change, the only way to secure an indefinite stream of revenue
from a new venture would be to provide it with some of its initial
capital. This proposal would drastically shift the balance in favour of
raising initial capital, which is the only truly socially beneficial
role of the stock market.

 

Property

 

The great danger with
the current system is that there is a positive feedback loop between
property prices and leverage. An increase in leverage allows a
purchaser to bid a higher price for a property, which encourages other
purchasers to come in with higher leverage again with the intention of
profiting from selling on a rising market. This is the basic mechanism
that led to the Subprime Crisis.

 

If instead there were a maximum
allowed level of leverage based on the income-earning potential of the
property being purchased, then an increase in price would cause a
reduction in leverage: if a purchaser truly wanted a given property and
was willing to pay more than ten times the annual rental income to
secure it, then he/she would necessarily have to use unleveraged funds
to do so, and the increase in price would cause a reduction in leverage.

 

Stability

 

The
real problem with other proposals–such as government-created credit,
etc.–is that without reform to the way we define capital assets, this
money can still be used to speculate on asset prices. This can lead to
asset bubbles, and those who are successful in them will gain money and
the power that comes with it. They will then be in a position to lobby
for the unwinding of the reforms that were enacted during the crisis–as
we have seen in our own lifetimes with the abolition of almost all the
Great Depression era legislation in the leadup to the GFC.

 

This
proposal would limit that prospect by preventing the formation of the
class of Ponzi Financiers in the first instance. This to me is the real
lesson of financial history: every crisis is caused by debt, the debt
is taken on by Ponzi Financiers who then accumulate the economic and
political power to reshape the system to suit themselves, leading to
its inevitable collapse. We have to stop the Ponzis at the source, and
the source is the potential for leveraged gain on asset prices.

More articles from Zero Hedge….

By Chris Carey, Bailout Sleuth

Regulators closed three banks in the Eastern
United States on Friday, one in New York, one in Florida and one in Louisiana.

The institutions that failed were Park Avenue
Bank in New York City, Old Southern Bank in Orlando and Statewide Bank in
Covington, La. In all three cases, the Federal Deposit Insurance Corp. was appointed
receiver, and arranged for other banks to take over the branches, deposits and
assets.

Valley National Bank acquired Park Avenue’s four
branches, along with its $494.5 million in deposits and $520.1 million in
assets. Valley National, which has headquarters in Wayne, N.J., took over
another failed New York bank on Thursday.

Valley National agreed to pay a 0.15 percent
premium for Park Avenue’s deposits. It entered into a loss-sharing deal with
the FDIC on $379.8 million of the failed bank’s assets.

New York regulators and the FDIC issued
cease-and-desist orders against Park Avenue last month. The orders required it
to take immediate action to correct what state officials called “apparent
violations of federal laws and regulations.”

According to news accounts, Park Avenue and real estate investor David Lichtenstein, one of its major shareholders, have been targeted by lawsuits alleging a number of questionable financial moves.

Centennial Bank, based in Conway Ark., took over
the remains of Old Southern, which had been operating under an FDIC
cease-and-desist order since September.

The acquisition included seven branches, $319.7
million in deposits and $315.6 million in assets. It paid a 1 percent premium
for the deposit, and the FDIC will share in the losses on $282.7 million of the
assets.

Home Bank, of Lafayette, La., took over Statewide
Bank’s six branches, $208.8 million in deposits and $243.2 million in assets. Home
Bank and the FDIC entered into a loss-sharing deal on $163.5 million of those
assets.

Statewide also was the subject of an FDIC
cease-and-desist order, issued last April.

The three banks brought the total number of
failures so far this year to 30. The FDIC said the closings would cost its
deposit insurance fund an estimated $183.4 million.

More articles from the Bailout Sleuth….

You probably heard the news, but if you haven’t, the Turkey-IMF saga has come to an end:

http://www.imf.org/external/np/sec/pr/2010/pr1076.htm

For my part, I am really happy for my good call, done at a time the
consensus view was that the agreement would be sealed in a matter of
weeks, if not days:

http://www.hurriyetdailynews.com/n.php?n=fool-some-sometimes-you-can-2010-01-03

Read more….

By Chris Carey, Bailout Sleuth

TARP-recipient West Bancorporation, Inc. has hired a new chief executive
after an eight-month search.

West Bancorporation, parent company of Iowa-based West Bank, appointed
David D. Nelson, former president of Southeast Minnesota business banking for
Wells Fargo Bank Minnesota.

SEC filings show that Nelson’s salary will be 10 percent higher than
that of his predecessor, Thomas E. Stanberry, who resigned just before the
company announced a loss of $5.3 million for the second quarter of 2009.

West Bank reported a net loss of $16.9 million last year, compared with a
profit of $7.6 million in 2008. The company had  earnings of $2.2 million
for the fourth quarter of last year, but noted that its nonperforming assets rose $1.2 million to $52.9 million and that its provision for loan losses as a percentage of total loans also was up from the same period in 2008.

West Bancorporation got $36 million through the Troubled Asset Relief
Program on the final day of 2008.

According to the company’s SEC filing on Nelson’s appointment, the new
CEO will receive a cash salary of $275,000 with a potential yearly incentive
bonus of as much as 50 percent of that amount. Performance bonuses, if any,
will be paid in long-term restricted stock.

Nelso also received a $125,000 restricted stock grant as a signing
bonus, and will get the same perquisites as other senior executives.

Thomas E. Stanberry, the former chairman and chief executive, resigned
in July 2009, in a move that the company described in its SEC filings as
involuntary. Stanberry had a base salary of $250,000, with additional cash and
stock incentives.

Because of TARP restrictions, Mr. Stanberry did not receive severance
package.

Jack Wahlig, West Bancorporation’s current chairman, noted that the
selection process was a thorough one. 
He praised Nelson for his more than 25 years of experience and his
strong background in credit administration.  He also pointed to Nelson’s ability to build relationships
as a deciding factor in his hiring.

More articles from the Bailout Sleuth….

By Chris Carey, Bailout Sleuth

Regulators seized a New York bank on Thursday, in
a rare departure from the usual carefully coordinated Friday night closings.

The New York State Banking Department took over
LibertyPointe Bank and appointed the Federal Deposit Insurance Corp. as
receiver. The FDIC arranged for Valley National Bank to take over LibertyPointe’s
three branches, its $209.5 million in deposits and its $209.7 million in
assets.

Valley National paid a 0.5 percent premium for
the deposits, and entered into a loss-sharing deal with the government on $181.5
million of the assets.

LibertyPointe was based in New York City and was controlled by real estate
developer Shaya Boymelgreen. It had long been on the FDIC’s list of troubled
institutions.

Regulators issued a cease-and-desist order against the bank last
July, citing a high concentration of commercial real estate loans, excessive
delinquencies and inadequate provisions for loan losses.

Last October, the bank was given 30 days to
raise additional capital to strengthen its financial position.

The FDIC estimated that LibertyPointe’s failure would
cost its deposit insurance fund $24.8 million.

LibertyPointe was the 27th bank to fail so far this year.

More articles from the Bailout Sleuth….

Tom aka Rusty Rustbelt

Perfect Babies and C-Section Complaints

Some issues are like spring flowers, always returning.

The “too many C-Sections” debate is recurring again, raising issues of cost and clinical judgment (some women want sections for cosmetic reasons).

Problem is, Americans expect perfect babies, and if babies are not perfect it is time to call the lawyers.

(John “lover boy” Edwards became very rich filing junk science Cerebral Palsy cases against Ob-gyns.)

The last time I did a cost study on an Ob-gyn practice, all of the contribution margin from Ob was going to malpractice premiums, most of the expenses and all of the physician incomes were derived from gyn services (as I remember the premiums were about $140,000 per physician). So why deliver babies?

Certainly there is malpractice, and it is (in my opinion) malpractice not to do a quick section on a distressed baby (as one of my doc friends said, “we were all trained in the 2 minutes C-section drill). Proper compensation for legitimate cases is important.

Ob-gyns are becoming employees are a means of shifting risk and cost to hospitals and integrated networks. Difficult cases are referred up the specialist chain, often to academic centers (often many miles from home). Medical students are avoiding OB as a specialty.

This is no way to run a health care system, and the plans moving through Congress do not address these issues.

Tom aka Rusty Rustbelt

Read more….

The Great Recession of 2008-09 was triggered by the
excessive debt accumulation and leverage of private agents – households,
financial institutions and even a fat tail of the corporate sector – in many
advanced economies. And while there is a lot of talk about deleveraging, the
reality is that private sector debt ratios have stabilized at very high levels
while, as a consequence of the fiscal stimulus to get economies out of a severe
recession and the socialization of part of private losses, there is now a massive
re-leveraging of the public sector with deficits in excess of 10% of GDP in
many advanced economies and debt to GDP ratios expected to sharply rise and in
some cases double in the next few years.

Read more….

Zero Hedge

Kornelius Purps, director of fixed income at Europe’s second-largest bank, UniCredit, has issued a stark warning to clients who wish to invest in the Britain: “I am becoming convinced that Great Britain is the next country that is
going to be pummeled by investors.” Ambrose Evans-Pritchard reports reports that “Mr Purps said the UK had been cushioned at first by low debt levels but the
pace of deterioration has been so extreme that the country can no longer
count on market tolerance” and that “Britain’s AAA-rating is highly at risk. The budget deficit is huge at
13pc of GDP and investors are not happy. The outgoing government is inactive
due to the election. There will have to be absolute cuts in public salaries
or pay, but nobody is talking about that.” And everyone was wondering why the U in STUPID stand for UK (actally make that just CNBC, who never really bothered to even read the original definition). So can the whole sovereign default wave skip the PIIS and go straight to the U?

From the Telegraph:

“Sterling is going to fall further over coming months. I am not expecting
a crash of the gilts market but we may see a further rise in spreads of 30
to 50 basis points.”

Yields on 10-year gilts have already crept up to 4.14pc, compared to 3.94pc
for Italian bonds, 3.48pc for French bonds, and 3.19pc for German Bunds,
though part of this reflects worries about higher inflation in Britain.

Ian Stannard, currency strategist at BNP Paribas, said markets are fretting
over how the UK will cover its deficit following the pause in quantitative
easing by the Bank of England. The Bank has absorbed £200bn of debt, more
than total Treasury issuance over the last year.

“The UK may have difficulty in attracting extra investors to fill the
gap. We think they will have to do more QE as recovery falters,” he
said.

BNP Paribas expects sterling to drop to $1.31 against the dollar this year and
reach parity against the euro despite troubles in Club Med. “We’re very
bearish on the UK,” he said.

And the biggest insult to the island nation? The insinuation that Greece is actually better off that Britain.

UniCredit said Greece is better placed than the UK in coming months even if
deficits look comparable. “The polls point to a minority government in
the UK, while Greece’s government can count on a majority to push austerity
measures through parliament. Secondly, the British tax system offers less
leverage for a rise in revenue,” he said.

Paradoxically, Greek tax evasion creates scope for a surge in revenues from
tougher enforcement. “It is not out of the question that we will see a
positive surprise in Greece: is there any such hope for Britain?” said
Mr Purps.

Well Mr. Purps, this means that there is still hope for America. As the still sentient part of the population has decided to show the corrupt administration and the criminals on Wall Street the middle finger and maxed out their withholding exemptions, all it will take is an order from the US politbureau that the Treasury can withhold 100% of every paycheck, and in addition, garnish wages in perpetuity, DCFed at Ben Bernanke’s favorite discount rate of -100%.

More articles from Zero Hedge….

Zero Hedge

We present the first two volumes (out of 9) of the massive 2,200 page compendium that represents the just declassified examiner’s report in the Lehman bankruptcy case. We will post the other volumes shortly. Below are the key findings from a quick perusal of Anton Valukas’ report, which we will be combing through over the next week. Pay particular attention to the Repo 105 scam which allows banks to materially misrepresent their leverage ratios whenever they so choose, thank you FASB, corrupt auditors (in this case E&Y) and Federal Reserve.

Some observations:

Lehman actively misrepresented its capital ratio with the benefit of Fed complicity, because instead of using traditional Repo transactions, it used “Repo 105″ which allowed repos to be treated as asset sales instead of financings. Will someone please ask uberregulator Fed how many other banks are using this borderline illegal accounting scheme RIGHT NOW to misrepresent their net leverage ratios?

• Lehman was forced to announce a quarterly loss of $2.8 billion – resulting from a combination of write?downs on assets, sales of assets at losses, decreasing revenues, and losses on hedges – it sought to cushion the bad news by trumpeting that it had significantly reduced its net leverage ratio to less than 12.5, that it had reduced the net assets on its balance sheet by $60 billion, and that it had a strong and robust liquidity pool.
• Lehman did not disclose, however, that it had been using an accounting device (known within Lehman as “Repo 105”) to manage its balance sheet – by temporarily removing approximately $50 billion of assets from the balance sheet at the end of the first and second quarters of 2008.  In an ordinary repo, Lehman raised cash by selling assets with a simultaneous obligation to repurchase them the next day or several days later; such transactions were accounted for as financings, and the assets remained on Lehman’s balance sheet. In a Repo 105 transaction, Lehman did exactly the same thing, but because the assets were 105% or more of the cash received, accounting rules permitted the transactions to be treated as sales rather than financings, so that the assets could be removed from the balance sheet. With Repo 105 transactions, Lehman’s reported net leverage was 12.1 at the end of the second quarter of 2008; but if Lehman had used ordinary repos, net leverage would have to have been reported at 13.9
• Lehman did not disclose its use – or the significant magnitude of its use – of Repo 105 to the Government, to the rating agencies, to its investors, or to its own Board of Directors. Lehman’s auditors, Ernst & Young, were aware of but did not question Lehman’s use and nondisclosure of the Repo 105 accounting transactions. [And why should auditors question anything even remotely shady? After all they need to feed the monkey too.]

The case for why the Fed would be a truly horrible systemic regulator. Here is what happened at Lehman according to Valukas

• Lehman decided to exceed the firm?wide risk appetite limit at several junctures.
• First, though Lehman dramatically increased the limit for fiscal 2007, Lehman nevertheless approached the new limit by May 2007.
• Then, in early October 2007, when Lehman’s risk appetite excesses were at their peak, at least some members of Lehman’s senior management discussed the limit breaches and decided to grant a temporary reprieve from the limits  based on the difficult conditions in the real estate and leveraged loan markets.
• Rather than reduce its risk usage, Lehman cured its risk appetite overages by increasing the firm?wide risk appetite limit yet again.

The firm cooked its books:

• Lehman also failed to apply its balance sheet limits in late 2007. Application of these limits would also have restricted Lehman’s risk?taking. Instead, Lehman dramatically increased the size of its balance sheet, and used increasingly large  volumes of Repo 105 transactions to create the appearance that the firm’s net leverage ratio remained within a reasonable range of such ratios established by the rating agencies.

The SEC was aware of the BS going on at Lehman:

• Lehman’s stress tests suffered from a significant flaw. Although Lehman made a strategic decision in 2006 to take more principal risk, Lehman did not modify its stress tests to include the risks arising from many of its principal investments – including its real estate investments other than commercial mortgage backed securities (“CMBS”), its private equity investments, and, during a crucial period, its leveraged loan commitments.
• The SEC was aware that Lehman’s stress tests excluded untraded investments and did not question the exclusion, because historically it had been the norm to limit stress tests only to traded positions.

The firm overindulged in speculative garbage LBO loan positions:

• Lehman’s principal investment strategy also included participating in leveraged loan transactions. This business grew spectacularly in 2006 and the first half of 2007. Many of these loans were made to private equity firms, or sponsors, who were purchasing companies as part of leveraged buy?outs.
• These transactions were risky for Lehman because they consumed tremendous amounts of capital, were made on terms that strongly favored the borrowers, and often involved bridge equity or bridge debt that Lehman hoped to distribute to other financial institutions (but was committed to keep for itself if it was unable to do so).

Lastly, Lehman directors can sleep well. Once again, nobody in the world is guilty for the biggest corporate bankruptcy in history:

• The Examiner Does Not Find Colorable Claims That Lehman’s Senior Officers Breached Their Fiduciary Duty to Inform the
  Board of Directors Concerning the Level of Risk Lehman Had Assumed
• The Examiner Does Not Find Colorable Claims That Lehman’s Directors Breached Their Fiduciary Duty by Failing to Monitor
  Lehman’s Risk?Taking Activities
• Lehman’s Directors are Protected From Duty of Care Liability by the Exculpatory Clause and the Business Judgment Rule
• Lehman’s Directors Did Not Violate Their Duty of Loyalty
• Lehman’s Directors Did Not Violate Their Duty to Monitor

On the much prevalent conflict of interest of selling portfolios that one has originated (especially as pertains to Goldman’s assorted CDOs held by AIG):

• In one memorandum, Lehman’s Head of Global Strategy expressed the concern that “the team responsible for selling down these positions is the same one that originated them.”628 But several witnesses denied there was any incentive not to sell down the portfolio because they knew that no one in GREG would be getting a 2008 bonus

Attached are Volume one of the report (just the first 240 pages, including the 45 page table of contents) and Volume two. We will upload the remainder shortly.

More articles from Zero Hedge….