Unions, the missing link, part 2

Let us first begin with a bit of history from our fellow money-cartel cousins, the English. The following is from the storied, ineffable history that only greatest philosophers can compass:

The Prime Minister, Harold Wilson, has defended his decision to devalue the pound saying it will tackle the "root cause" of Britain's economic problems. The government announced last night it was lowering the exchange rate so the pound is now worth $2.40, down from $2.80, a cut of just over 14%. The decision came after weeks of increasingly feverish speculation and a day in which the Bank of England spent £200m trying to shore up the pound from its gold and dollar reserves.

In a radio and television broadcast this evening, the Prime Minister said devaluation would enable Britain to " break out from the straitjacket" of boom and bust economics. The only alternative, he said, was to borrow heavily from governments abroad - but the only loans on offer were short-term ones.

The government inherited an £800m deficit from the Conservatives when it was elected three years ago. Mr Wilson said Labour had managed to reduce the deficit, but the cost of hostilities in the Middle East, the closure of the Suez Canal and the disruption to exports through the dock strikes had contributed to the strain on sterling. He said: "Our decision to devalue attacks our problem at the root and that is why the international monetary community have rallied round. "From now the pound abroad is worth 14% or so less in terms of other currencies. It does not mean, of course, that the pound here in Britain, in your pocket or purse or in your bank, has been devalued. "What it does mean is that we shall now be able to sell more goods abroad on a competitive basis." (http://news.bbc.co.uk/onthisday/hi/dates/stories/november/19/newsid_3208000/3208396.stm)

WOW: aren't things EERILY similar: the foreign treasuries holders are moving into the shortest treasury maturities possible, we have a populist labor president, massively over-extended budget, and unsustainable commitments abroad. Consider the data below from the UK:

Year		Increase in weekly earnings			Increase in retail price index
1964		8.3			3.2
1965		8.5			4.8
1966		4.2			3.9
1967		5.8			2.5
1968		7.8			4.7
1969		8.1			5.4
1970		13.5			6.4
Avg		8			4.4

To the chagrin of the armchair speculator, these trends are not monotonic, but for those willing to experiment with a bit of imagination, it's clear that Wilson's "failure" in managing labor could be construed as "success" for those who later benefited from, yes, a boom in real estate prices.

Homeowners have seen the greatest annual real rate of increase in house prices under Ted Heath’s Conservative Government between 1970 and 1974. During his term in office, house prices in the UK rose by an average of over 13% per year in real terms (i.e. after adjusting for retail price inflation). Coming a close second has been Tony Blair’s current Government where the real annual increase in house prices since 1997 has been just over 10%. (See Table 2)

http://www.britsandmortar.com/UK-house-price-history

Could a slack attitude towards unions engender a sufficiently potent wage-price inflation spiral that would allow real estate values to recover? The UK was in horrible straits during the 1960's, yet home prices still managed to surge DESPITE the oil shocks... as a matter of fact, oil shocks proved to be positive for home prices, as it drove replacement cost through the roof.

A fellow blogger has already provided us with a pithy explanation of perhaps what will revivify the real estate market:

Unions: the missing link

The key salient that has, to date, kept the inflation in check has been the transmission of inflation: wages and wealth have been declining. If you are paid $1/day, you will buy no oil if it's $100/bbl. Raise wages to $150/day, and you are now in the oil market.

I'm going to work through my argument backwards: I think it makes more sense, then.

Assume, under the non-inflationary case, it costs $100,000 to replace a home. Imagine this cost assumes:

• Labor cost of L: $70k of L
  
• Materials cost of M: $30 of M
  

Assume that a given home with a $100k replacement cost has a $150k @ 4.5% 30 year mortgage associated with it and a market price of $200k. This gives a monthly payment rate of about roughly $800/mth, assuming 25% down(a bit high, but satisfactory for our no-inflation case.) Our LTR, or loan-to-replacement cost, is 1.5.

The problem is, however, that the $150k @ 4.5% mortgage did not come for free: the refinancing required a counter-party.

Assume that the $150k @ 4.5% mortgage was swapped for a $300k @ 8% 30 year mortgage. Let us compare them:

• $300k mortgage @ 8% implies total payments of ~ $800k.
• $150k mortgage @ 4% implies total payments of ~ $273k.
• This swap implies a loss of $527k of future income for the bank.

Now, someone is holding this mortgage @ 8% with negative equity. On inspection, it seems that the Fed or Treasury is in dire straits: they are holding "toxic" assets. However, the toxicity is derived from the chasm between the actual replacement cost of the asset and the market price implied by the mortgage. Change the replacement cost of the asset, and the implied value of mortgage improves.

• Assume Labor cost of 2L.
• Assume Materials cost of 3m.

These assumptions give us a new replacement cost of $230k for the home. The LTR(loan-to-replacement cost) is 300/230 = 1.3, less than the LTR for the no-inflation case above.

Thus, if we can achieve such inflation, the "toxic" assets will substantially improve in value. Those holding these assets under such circumstances will win capital gains.

A necessary condition for such depository institution-friendly inflation is higher wages. Higher wages are often associated with labor militancy, i.e. unions. Obama's masters have long since decided that the US needs much larger and more inclusive unions in order to effectively transmit this inflation.

I will address the mechanics of transmitting inflation through unions in my next post, along with some examples in history of governments doing this to avert stinging deflation.

Failure of comprehension: Part 2

Continuing the discussion from Part 1 and assuming some familiarity with the concept of unsustainable wealth extraction and illusory wealth, from previous posts, we can take a look at the fractional reserve banking and the phenomenon leveraging through risk reallocation (credit default swaps -CDS)

Example B (the decrease in apparent wealth)
Let's suppose everything starts like in the previous example. Person A deposits all real wealth excess stored in money existing in the kingdom, (100 gold coins). The bank (operating at a 20% reserve limit), keeps 20 in reserves and lends the rest (80 coins) to person B ( a captain who wants to set sail in a trade expedition). B uses the money to buy trade goods from the C (the local camel caravan chief). C deposits the 80 coins back with the bank. Out of his deposit 16 coins (20%) are kept in reserves, and the rest (64 coins ) are lent to D (the captain of the guard) who buys a house, from the home builder E.
Homebuilder E was supposed to deposit his 64 coins with the bank, but house he was building caught fire and the total loss incurred was of exactly 64 coins. He uses the 64 coins to cover the loss. As a result, the high-priest banker remains perplexed when his balance sheet expansion stops after after only 2 deposit-lending cycles, and nobody else wants to deposit money. It is like being all dressed up with nowhere to go . If nothing changes and no new deposits are made, the bank will produce a profit of only 41.4 gold coins. In the previous care when all 100 coins were recycled as reserves the profit of the bank was 115 gold coins.



The Sacred Tablets of Bernankus (the Babylonian god of banking) cannot be wrong when it says (in the First Psalm of Bleeding Dry a Kingdom), that:

After a sufficiently large number of banking cycles, the system reaches the limit of monetary expansion, when the volume of the reserve becomes equal to the total amount of surplus wealth (stored in money/currency) available in a society.

After reading more about the magic of the "consumer economy' from the Tablets of Greenskam, realizes what happened. When that home burned down, real wealth worth of 64 coins was destroyed in the fire. The real wealth excess remaining in the system is (100-64=36) which is exactly the level of reserves when the lending cycle stopped. Through the magic of macroeconomics and banking, a part of the available amount of surplus wealth stored in money, went from the account of the apple farmer to pockets of the builder (without changing the value of the A deposit), and the loss of the homebuilder went became the debt of the captain of the guard (in terms of real wealth). Sometimes the 'sufficiently high number of cycles' required to reach the limit of monetary expansion may be just 2.

In this case the loss was caused by fire, but due to the magic of fractional reserve banking the loss can be actually the illusory wealth component created by the financial sector going up in smoke.
Apparent wealth = Real Wealth + Illusory wealth

The source of the illusory wealth can be:

• -deferred transaction. The home builder had to pay an invoice (64 coins) for building materials he got for building the house. During the time between he getting the supplies and paying them back, the apparent wealth increased with 64 coins
  
• -price fluctuation. Housing market crashed and he had to sell a home at a loss
  
• -capital misallocation and waste. He build a house in a flooding area, and nobody wanted to buy it
  
• -investment capital outflow. He uses the money for starting a brick factory in an Asian Province, where is a severe shortage of housing and they don't have the advanced technology of brick making.
  
• -trade imbalance. The bricks made in the Asian Province (in that new factory) are cheaper than those produced in the kingdom (due to lower wages and an undervalued currency in the Asian Province). For some strange reason, the Asian Province keeps accumulating Babylonian gold coins. In order to get the money back, the high-priest/banker thinks of inventing a some miraculous clay tablets called "treasuries" . The Psalms of Greenskam tell that the strange people from the Asian Province will give back gold coins in return for this magic clay tablets, so that the homebuilder can keep buying bricks from them. Until this miracle occurs (some 200 years later), the trade deficit will suck the amount of kingdom's real wealth stored in money.
  

In the case of fractional reserve banking, losses of real wealth or the collapse of the illusion of wealth, can occur at the both ends of a balance sheet. Most people think of loss only as loan defaults, but lack of deposits (money lent and recycled back into the financial system) is as least as dangerous.

If those 100 gold coins were real stored wealth, at a reserve ratio R=20%=1/5, the bank would create deposits worth 500 coins. Basically a bank multiplies, real wealth with the inverse of the reserve ratio, which is called Multiplier Constant (MC=1/R). Contrary to the common perception, the Multiplier Constant is not the same with the Money Multiplier. The monetary expansion that stops before reaching a complete number of lending cycles is described by the Money Multiplier. Check this wikipedia picture. The Multiplier Constant is gives the expansion at the end of the scale (after Z cycles) while the Money Multiplier describes the expansion at a certain point which can be anywhere between A and Z. The Money Multiplier describes the expansion of Apparent Wealth.

One can calculate the content (percent) of real wealth in the apparent wealth in the system. In our Example B, the Multiplier Constant (MC), given by the 20% reserve ratio (R), is 5. The Money Multiplier (MM) is only 1.8 (180 coins deposits created by 100 coins of apparent wealth reserves). In our case calculate the real wealth content (RWC) of the apparent wealth used as bank capital. In our case:
RWC= 100*MM/MC = 36% (or RWC= MM*R)

Assignment: Considering the reserve requirement in US is 10% (MC=10) use the following official money multiplier (MULT) data published by the FED:
M1 money multiplier
1987-03-11 3.110
2008-03-12 1.612
2009-03-11 1.002

, and calculate the real wealth content RWC of the bank capital in US assuming that:
- the official indicator MULT, is as realistic to asses the real multiplier as the CPI is for assessing the real inflation
- while in 1987 the real average reserve requirement in the economy was close to 10% (MC=10), the excessive bank leverage produced by securitization resulted in real reserve ratios of 4% in 2008 and 3% in 2009. Recalculate the RWC according to this assumption.

If you thought that was bad then take into account that government intervention can bring illusory wealth into the system ( aka TARP, bailouts, stimulus packages or alphabet soups), which in times of crisis is indistinguishable from real wealth. These artificial injections can stop sharply the decay of the Money Multiplier, having an apparent beneficial effect,... as long as the new illusion lasts. If we look to an official MULT chart it seems the fall in the money multiplier was promptly arrested.


Example C (an injection of illusion)
If the case above (Example B) we assume that the 64 gold coin loss was not caused by a fire, but by the house collapsing due t the fact it was build with those cheap bricks made in the Asian Province, and those cheap bricks turn into dust in the hot and humid Babylonian weather. The high-priest banker realizes he has a big problem. It is just a matter of time that another number of houses built with the same bricks will collapse, and the loss of real wealth stored in housing may increase well beyond the 36 coins he has as banks reserves and possibly beyond the 180 coins he has in deposits. The whole banking system may collapse. Therefore he runs to the treasury of the kingdom crying for help. Help arrives from the treasury because the treasury master is one of his former bank tellers who got his job only because the high-priest has bribed the King and the Council of Advisors. The treasurer (who owns himself shares in the bank) agrees to take decisive measures by providing money for a bailout. He borrows 200 coins from other kingdoms and gives it as a very low interest loan to the bank that will do directly to the reserves. In fact the state (treasury) becomes almost the main depositor (investor) of the bank.



One may say that since the gold from the treasury is made of real gold coins, it is real wealth, but I would disagree. The treasury was just an intermediary between foreign banks and each individual subject of the kingdom. The subjects will have to pay for the bailout through future taxes, and this will drain their income, spreading the loss over the next 10-20 years. Obviously, since the tax rates (capital gains) are smaller for the rich subjects, the losses will be paid by the poor.

Few more observations for our example:

• the losses in the system are absorbed on the liabilities side and we can see that only a fraction (~0.7) of the money lent our returns as deposits
• the Money Multiplier looks abysmal (MM=300.61/300=1.002), but a lower Money Constant (MC=3.75), implies that the bank operates at a effective reserve ratio of 27%. That means the real monetary expansion is still slower than before the crisis.
• the reserve created by the bank rescue plan represents only 12.06% of the total bailout money, that means that only 12.06% was actually used to help the economy, the rest (87.84%) was used only to cover the ass of the high-priest/banker and prevent a rebellion of the people.
• based on the balance sheet results and applying the deposit and lending interest, the profit of the bank will still be lower than during the "good times before the criss (93.14 gold coins compare to 115 before)
• the low Money Multiplier value results from the fact that money is stuffed into the bank much faster than the ailing economy can absorb it in new lending (Chart)
• the force feeding with bailout money creates a huge cushion of excess reserves, and thanks to the taxpayer's gift and charity even the real reserves (non borrowed reserves) may start to pick up, but if the losses keep coming and surfacing, then the forced-pumped reserves will start decreasing without generating new lending (Chart) and soon the high-priest will ask for a new bailout.
  

Example D (leverage and credit default swaps)
Let's suppose we go back in time before the crisis. There is no house crumbling and houses sell pretty well. The high-priest banker find out his monetary expansion stops only after 3 cycles. He makes inquiries to see what happened, because there was no disaster. He finds out with surprise that the real wealth loss in the economy was caused by imbalanced trade with the Asian Province. The home builder was buying bricks Made in Asia with Babylonian gold coins, which were exchanged by the Asians for those magical clay tablets called "treasuries".... There were two problems with this new international economic model called "economic gomorization". (The name came from a small town in the middle east, called Gomorrah, where the first ancient free trade conference was held. Initially they wanted to name it after Gomorrah's sister town, but it would have been to obvious for the masses what this free-trade model would do for them):

• out of 64 coins paid for importing each load of bricks from the Asian Province, only 50 were exchanged to treasuries (only 50 gold coins were returning back to Babylon.) The difference (14 coins) was used by the Asians to subsidize the brick export and to build new brick factories, after stealing the designs of the Babylonian investment in Asia.
• because the domestic industry could not cope with the competition from the Asian Province, the only 2 remaining brick factories in the kingdom were closed. The real wealth revenue stream from brick production was lost and 10 well paid industrial workers were laid off. They had to take shitty jobs as "sales associates" in a warehouse selling bricks and other stuff Made in Asia. The whole kingdom became a little bit poorer.

Since the real surplus wealth, stored in money, was decreasing slowly, day after day, so where the profits of the bank (only real surplus wealth can generate monetary expansion and increase bank profits at a fixed reserve ratio). The only way to prop up banking profits was to increase leverage (go below the minimum reserve requirement), but for that ,a high-priest banker would have to circumvent the edicts of the central religious authorities. After a lot of offerings to the Great Geenskam, the Council of the 30 High Babylonian Gods (which was set up by the hidden god Rockfallus) came with the derivatives solution.

The minimum bank reserve limit offers a modest money buffer for absorbing losses. If the high-priest/banker could convince someone to take the risk for a potential loss of assets (bad loans and defaults), then his bank could move both liabilities (deposits) and assets (loans) of the balance sheets in a faith based financial entity operating at almost 0% reserve rate (virtually unlimited monetary expansion). Such a miraculous creation would be known, from that day on, as a Sacred Inexistent Value (or SIV). The high-priest/banker would be able to get a lot of money, if his low profit bank, with a decent required reserve ratio, will start feeding the 0% reserve SIV with loans to be sold to suckers investors. If one would do the sacrilege to bring the bank's and the SIV's balance sheets together, it may look as the hypothetical example presented in Table 4.



If in the 'healthy bank' part the high priest get a modest profit of 56.12 gold coins, in the SIV area he can offer 5% interest on deposits while keeping 30% on loans he can make 156.24 . The whole Bank+SIV (Jekyll&Hyde) finace operates like a bank with only 5.12% (20:1 leverage). In modern baking, leverages of up to 50:1 (2% Reserve Ratio) did happen, but as long as the SIV assets were off the bank's balance sheet everyhting looked OK. Moreover, increasing bank profits through leverage created a massive monetary expansion resulting in a string of assets bubbles.

The true genius of the derivatives drive resides elsewhere though. For centuries bankers have played the inflation-deflation scam to strip all real wealth from a society like money farmers. They start with low interest rates, exaggerated inflation (monetary expansion) -planting the seeds and growing the financial crop- then they produce deflation -harvest time- by raising interests rates and buy all assets at a fire sale price. This method was obvious and may times bankers saw themselves as the target of enraged crowds. In 1929 the deflation was not only created by FED raising rates, but also by priming the deflation shock through the recall of margin loans for shares (show shine boys and house maids were deleveraged, while Warburg and JPM, Lehman and others were shorting stocks at peak).
This time, the inflation and deflation was produced by leverage and deleverage. And the deflation produced by deleveraging happens now even in a ZIRP environment. The Average Joe is not only fleeced directly by the banks, but also indirectly through the increase in public debt for which he will have to pay later... This is simply brilliant.

The role of Credit Default Swaps (CDS)
Most media commentators believe CDS are a form of bond insurance. IMHO that is misleading. Those who were dumb enough to believe CDS are bond insurance, payed dearly for this mistake (AIG for example). I believe CDS are actually an risk transfer intermediation instrument which provides easy(free) money for dealers. Buying CDS protection means buying insurance, selling CDS protection means acting as an insurance broker. In a typical bond insurance transaction we have:
Bond holder <---- Bond Insurance Company

When CDS are involved the transaction is different:
Bond Holder<--- CDS Swap Dealer 1 <--- CDS Swap Dealer 2 <---[,,,]<--- CDS Swap Dealer x<--- AIG

Each Swap dealer makes a few bps only for transferring the risk to someone else. It's like a game of musical chairs. As a another effect they are responsible for moving reserve requirements off the balance sheet of banks. In our case, if the high-priest has bought CDS protection for all SIV assets there is no need for keeping reserves and the SIV can leverage to the sky. Why were the CDS needed? The answer is very simple: because there is not enough real wealth reserve in the system , to act as bank reserve and collateral. Everything is bled dry. Let's see how the game works. To make things simpler, let's assume the loan SIV H was given to a wannabe ship captain to buy a galley. In his first trip the galley sinks will all hands and merchandise. Total catastrophic event and capital destruction. Credit event with complete irrecoverable loss. In the arbitrage ballroom of musical chairs game we will find the following architectures of CDS:
a) the conga of love: 11 players 10 chairs:
High-priest (bondholder)<--K<--J<--[...]<--B<--A (sucker)

Loss in the economy: 100 (the galley went U-boat)
Netting: 100 gold coins (A pays the high-priest 100 gold coins)
Notional value: 1000 gold coins

b) starflower: 16 players, 11 chairs
Among the Babylonians there is a guy called Lahdus who realizes the captain of the galley is incompetent , the ship with sink, and SIV H is a gonner. Lahdus decides to take advantage of the stupidity and greed in the system. He has nothing to do with SIV H but he starts buying protection as a normal swapper... and he buys a lot of protection ;)
Lahdus<--Z<--Y<--X (sucker)
Lahdus<--W<--V<--U (sucker)
Lahdus<--T<--S<--R (sucker)
Lahdus<--Q<--P<--O (sucker)
Lahdus<--M<--L<--K (sucker)
Loss in the economy: 0
Netting: 500 gold coins (500 gold coins transfered from X,U,R,O,K to Lahdus)
Notional value: 1500 gold coins

c) circle of joy: 6 players, 6 chairs
J<--K<--L<--M<--N<--O<--J
Loss in the economy: 0
Netting: 0
Notional value: 600 gold coins
------------------------------------------------------
Total CDS session of musical chairs game:
Loss in the economy: 100 (value of the sunken ship paid by A to the bank, nothing added) Netting: 600 gold coins
Notional value: 3100 gold coins

So, there is no big deal and the system works fine. Well, ... not so fast... Apple farmer A is rich (his net worth is 900 gold coins), but he doesn't want to sell a part of his orchard therefore, he transfers 100 gold coin from his bank account to ... the high-priest. Now, if there were two banks in the kingdom, and A had to pay a SIV loss to the other bank... then the high-priest would go the Dick Fuld way (because he has only 48.8 gold coins in reserve). IMHO the problem is not with he gazzilion dollar in notional value outstanding. That gazzilion CDS cannot amplify the losses in the system. They just move money around, while the total net losses remain virtually unchanged. But the CDS fest was instrumental to hide the lack of capital in the financial system and allow for the unchecked growth of an unstable shadow banking sector. The CDS can produce, by toppling, wobbly banks, a domino, effect which will leave only a few, well hedged banks , still standing when the dust settles (the masters of the derivatives game with support from the FED). Whole fortunes will be lost and we will hear Madoff clients and Greenbergs crying rivers. The big mystery is, what will happen with the financing provided by our Asian province...? I would like to end this entry with another quote from Cicero about the systemic risk:

"If some lose their whole fortunes, they will drag many more down with them . . . believe me that the whole system of credit and finance which is carried on here at Rome in the Forum, is inextricably bound up with the revenues of the Asiatic province. If Those revenues are destroyed, our whole system of credit will come down with a crash."
-- Cicero, 66 B.C. (Translation by W.W. Fowler, 1909)

(PS sorry for spelling mistakes, but I was kindof busy and had to finish in a hurry)

Failure of comprehension: Part 1

I believe that most of the financial debacle we are going through these days is due to the fact that there were two categories of people who truly understood how the system works and what was happening:

• - those who kept their mouths shut and made good money (even if a few of them later became disgusted and quit the game)
• - those who spoke about the game in the complicated language of academia and referenced papers, got approval from colleagues, (who also understood the game very well) , but increased the confusion in which the majority still is today.

Therefore, IMHO, the majority of information available in the public domain, on internet, is usually just a sea of aberrations born out of confusion. It is common to find on blogs and internet forums, (or even in respectable e-editions of main stream media outlets), nonsense like this:

"OMG! There are $1.14 quadrillion of outstanding derivatives and the US GDP is only $14 trillion. We are all going to dieeee!"

or even better:

"We have to abandon the fractional reserve banking scam and return to a sound system based on a god standard and 100% reserve banking"

I believe not even the most outrageous pure lie (or falsehood) can be as dangerous than a half truth constructed on ignorance and repeated as a mantra by a scared and confused crowd. If we really want to get out of this mess, we have to calm down and try to find how exactly the current system works and what exactly really happened. We have to start thinking (and expressing ourselves) in simple, common-sense terms and cut through the fog of lies and confusion. Of course, there is a price to pay for that. Once can make a short and brilliant demonstration, by using specialized terms or equations that cannot be understood by the average people, or one can use simple terms, but it will take a longer time to explain the problems. There is no middle way. If one tries to keep it simple and short, that is equivalent to "dumbing-down" the message and creating confusion by oversimplification.
Yesterday, I went through four respectable economic forums and six blogs discussing fractional reserve banking. Only on one forum I found three participants to the discussion, who truly understood what they were talking about (and they were brilliant). The rest (three other forums and six blogs) ...were ... let's say ...painful to read ...

After banging my head into keyboard, I decided to prove my own ignorance by tackling the issue of fractional reserve banking, trying to explain it in simple and clear terms. So let's start with some simple basic definitions:

Money is a mental (imaginary) collective convention used by a group of people. If you don't believe me just try to visit an isolated tribe in the jungles of Amazon and try to buy some food with a $100 bill. Still, you may get some food, if the locals perceive that federal reserve note as having some (artistic, magic or scarcity) value or if they are polite and bound by the traditions of gift exchange rituals.

Money is anything that is used for exchanging or storing the fruits of our labor. Gold coins, stones, paper banknotes, grains of salt, it doesn't mater. If two parties involved in a non barter trade agree that a monetary transaction is worth doing, then we have goods/services traded for what ever type and quantity of a medium of exchange they like. It is that simple. Money can be anything to which the convention of 'moneyness' is collectively applied/attached by a group of people.(More about that, with a slightly different twist, in this excellent blog)

Here I'm going to twist a little bit the classical definitions of the functions of money, in order to make things more obvious later. Money have two historical functions:
A) Barter intermediation, deferment and/or aggregation for the exchange of the fruits of our labor:

• intermediation- I sell a basket of apples in the market, to a baker, and, with the money I get, I'm going to buy bread from another baker, who makes a better and cheaper bread, but grows his own apples and doesn't need what I sell.
  
• deferment of exchange- I sell my apples in the market now, but I'm going to buy bread tomorrow or next week.
• aggregation- I sell one basket of apples, one bag of potatoes and ten bundles of firewood and with all that money I buy one nice straw hat (to replace my old, worn out, tinfoil hat)

In this primary role, money have a great effect of optimizing and promoting trade and production of real wealth in a society. The use of money allows for specialization and higher productivity. Even today, there are still currencies/money specially dedicated to this primary role, and the communities using them have real benefits. (Two such modern examples are LETS and WIR)

B) Storage of value and monetary transactions (lending) resulted through unbalanced trade:

• storage - I have every day one basket of apples in excess of my needs of buying bread. Since, I find nothing worth buying, I store the value of my excess productive output in money (I could just buy extra bread but it will get moldy in a few days)
• lending - the baker needs my apples but has no money to pay me until he sells the apple pies, therefore we agree to a loan. He makes his pies, sells them and gives me back my money in a week. If I refuse this vendor finance transaction, my excess apples will go bad in a few days and I'll have nothing to sell. This lending transaction is mutually beneficial as lending promotes the creation of real wealth in a society.

This second role raises some important ethical issues. Yes, continual increase in wealth accumulation can be the result of hard work by smart responsible individuals, who can generate more wealth than the average (let's say I work hard to take care of my orchard and I figured out the best way to take care of the apple trees). There is nothing wrong with a fair and honest competitive advantage. In reality, in most cases, consistent and well-above-the-average wealth accumulation is the result of unfair and fraudulent competition allowed to exist or even enforced by a corrupt government or state. Some people, in times of deep crisis and social distress, adopted the radical (and IMHO opinion wrong) solution of devising currency systems that discourage any significant accumulation, through certification and built in depreciation. This was the case of the famous Worgl Experiment, taking place in a small town in Austria, during the Great Depression. While, during those times of deep crisis, the adoption of such a system may have been justified, I don't think that such a system is the right solution, because over a long term it discourages fair and honest competition.

C) Wealth renting. Here things become more complicated. There is always a higher demand for loans than the existing wealth stored in money and available for lending. Because of this natural scarcity, since the ancient times (even before the Babylonian Empire) people with excess wealth stored in money have started to lend with interest, basically, renting/leasing money. Most common form of money renting in antiquity was through direct lending with interest, but there were also quite developed forms of insurance (financing of trade caravans, maritime trade and ... wars) and real estate (financing of housing and commercial real estate). There is a lot to talk about this subject, and those who believe the FIRE economy is a modern invention and our ancestors were stupid and unsophisticated, should read a little bit of history. )

When wealth renting evolved, specialization took it's course and we know for sure that in the Roman Republic there was already a well defined class of moneylenders, (not be confused with the Jewish money changers in the Temple), which were renting their own accumulated wealth, stored in money, by lending with interest. This trade become so profitable that even lending intermediation became very profitable, and the first banks formed around temples. We know that in 371BC one slave working in a Piraeus bank became a very successful wealthy man, by pursuing moneylending and real estate investment with passion. At this stage, we also have the first banking regulations, where state and religious authorities were limiting the interest rates and setting up bankruptcy regulations, especially in the agricultural sector.

It is believed that sometimes in the Middle Ages, fractional reserve banking was invented.Let's study the system with a simple example:


Example A
Let's suppose that we have:
- a small Babylonian kingdom with a population of 100 people
- in average a person produces in a year 11 gold coins worth of good and services and needs 10 gold coins: for buying necessary goods and services (food, clothing, shelter and medical care), and for paying taxes
- the kingdom has an annual wealth surplus worth 100 gold coins
- my great orchard allowed me to obtain in one year a wealth surplus of 100 gold coins (I have realized all the the surplus of the kingdom as personal wealth stored in money)
- the volunteer high-priest (who has a stonemason day job) has received sacred clay tablets with teachings from Bernankus (the god of banking and finance) on how to set up a fractional reserve bank with 20% reserve limit (the Babylonians were very risk adverse bankers)
- the interest on deposits is 1% and the interest on lending is 30%

The whole idea of fractional reserve banking (with X% reserve limit), is to take the money deposited by a person (depositor), keep (X%) in the bank, as a reserve, and lend the (100-X%) rest to another person at higher interest rate.
For example, I, as the only person (person A) with real wealth excess stored in money, can start the process by depositing my 100 gold coins. The bank (operating at a 20% reserve limit), keeps 20 in reserves and lends the rest ( 80 coins) to person B ( a captain who wants to set sail in a trade expedition). B uses the money to buy trade goods from the C (the local camel caravan chief). C deposits the 80 coins back with the bank. Out of his deposit 16 coins (20%) are kept in reserves, and the rest (64 coins ) are lent to D (the captain of the guard) who buys a house, from the house builder E. Of course, E deposits the 64 coins, out of which ... The process depositing-lending cycle is presented in Table 1.




If we suppose we had 50 cycles of depositing and lending, basically the we exhausted even the smallest fraction of a gold coin and the balance sheet of the Babylonian banks creates deposits worth 500 gold coins, loans worth 400 gold coins and keeps 100 gold coins in reserve.

Many people believe that when you deposit $100 dollars in a bank with 20% reserve requirement, the bank simply lends fraudulently $400 to someone else (or $900 in a 10% reserve system). The $500 in deposits and $400 in loans, can be created, in normal conditions, only after a large number of deposit-lending cycles and it is created because of the fact that when people are paid, they usually deposit their money back with the bank.

There are few observations here. The theoretical maximum amount of deposits created is equal to the existing reserve divided by the reserve ratio. 20%=0.2 (100/0.2=500)

After a sufficiently large number of banking cycles, the system reaches the limit of monetary expansion, when the reserve becomes equal to the total amount of surplus wealth (stored in money/currency) available in a society.

Anyway, the balance sheet of the bank looks kosher. Deposits = Loans + Reserves (500=400+100), no money is missing and the bank has a positive cash flow. So where is the fraud? Well,... the fraud is there but it is not obvious, and besides the fraud aspects there are also some big problems. Let's take them one by one:
1) Maturity mismatch fraud. If, in our case, the deposits and the loans are made with an equal fixed one year term there is no maturity mismatch fraud, but in the real world, loans (assets) are long term debt (for example a 25 year mortgage), while deposits (liabilities) are short term debt (such as 'on-demand' checking accounts and certificates of deposits with a maturity up to five years). For the bank balance sheet presented in Table 1, if person A withdraws all money in his deposit, the bank reserves are gone. Nobody else can get their money back on demand, even if all loans are good and will be paid back with interest in time. The bank is mathematically incapable to deliver its obligation to return the money deposited, in the case of short term (or on demand) deposits. In theory, one bank may sell loans (assets) to another bank to get liquidity/cash for returning deposits, but if all banks are hit by withdrawals and have to sell loans (assets), then who will buy those loans? (In our world is the taxpayer who buy toxic assets through government bailouts). This is basically what is happening now also with European banks relying on money market funds, hit by a shortage of short term dollar funding, coupled with the exposure to the US dollar (currency mismatch between assets and liabilities) and resulting in $1.1–1.3 trillion funding (deposit) needs by mid-2007, according to a recent BIS paper. Knowingly making representations that cannot be realistically/mathematically honored, IMHO fits the definition of a fraud. The excuse of government deposit insurance is another fraud, but I will talk about the deposit insurance fraud in a separate section.

2) Risk misrepresentation fraud. Most people believe that when they deposit the money into a bank, the bank just keeps their cash in the vault (in a pile, on a separate shelf, with their name on it, if possible). The banks cannot be held accountable for the ignorance of depositors, but things go actually farther than depositor ignorance. Let's suppose the Babylonian Insurance Deposit Corporation covers all deposits up to only one gold coin. Loan defaults and deposit withdrawals go both directly to the reserves. In Example A, if we suppose we have the first depositor withdrawing his money and the first 10 loans defaulting, the people with deposit accounts have 90% of their wealth wiped out, while the owners and managers of the bank, who made great profits and bonuses,... skate free (limited liability of bank shareholders).

Depositing money in a bank is not equivalent to entrusting money for safekeeping, but is in fact an act of investment low (or zero) dividend shares in a money renting company. Not representing clearly to the people that a depositor= an investor with limited rights in a money renting enterprise, IMHO, is another case of fraud. These two fraudulent characteristics are not a "necessary evil". There are banks practicing fractional reserve banking in a non-fraudulent way (unlimited liability), and those banks make good money without taking insane risks, and they have true depositors, not conned gullible investors in a risky money lending scheme. Here are some quotes form a recent Bloomberg piece:

In today’s crisis, Hoare [of C. Hoare & Co bank] has so far benefited, lifting deposits to about 1.8 billion pounds during the last 12 months. That’s mainly because it’s an “exclusive franchise” for the rich, said Simon Maughan, a financial analyst at MF Global Securities Ltd. The bank’s history has no relevance to the wider banking market, Maughan said in an e-mail. Hoare accepts his bank serves a niche, and it has missed out on historic opportunities to expand.
Hoare & Co. is an unlimited liability partnership, which means the family’s personal wealth, including Alexander Hoare’s solar-panel-topped residence and 50-foot yacht, can be seized if the lender collapses. That gives clients confidence, Hoare said.
“Everything apart from the shirt on our back is at risk,” Hoare said. “It keeps you jolly nervous.”

So there are indeed, non-fraudulent fractional reserve banks. I'm thinking to deposit my money with "C. Hoare & Co" , but... oops ! I can't, because it's "an exclusive franchise for the rich". Well,... I guess I'm going to keep my money in a "normal" bank and pray FDIC does not go bust. It is always a great idea to trust your government for preserving your safety and your property.

3) Excessive money renting profit. This is not really a fraud, but a negative economic effect of fractional reserve banking, which may lead to a larger politico-economic fraud perpetrated on the whole society.

Let's suppose the high-priest is setting up the bank in the courtyard of the temple. He needed clay tablets for the ledger and a table to conduct business. In order to start his bank, the high priest made an investment of 10 gold coins out of his own money for buying the necessary equipment. After one year, everything was great (no withdrawals, no loan defaults) and the high priest payed back 505 gold coins to the depositors (500 @ 1% interest), received 520 gold coins from the borrowers (400 @ 30% interest) and still had 100 gold coins in reserves.
Net profit =520 + 100- 505=115 coins. Not bad for a 10 gold coin investment. An annual profit of 1150% beats any other investment in productive activities, such as growing apples, making bricks etc. Moreover, we said that the total wealth surplus accumulation in the kingdom for the past year was 100 gold coins. Not only that the bank profits account for all the wealth accumulated in the kingdom, but the people of the kingdom are 15 gold coins poorer (total net household debt increased), than the year before, and one former stone-mason quit his productive trade and became a banker (he will not make real things worth 11 gold coins next year). By the way, next year the high-priest will decrease the reserve requirement to 10% in order to improve his profits....

For a 100 gold coins deposit of surplus accumulated real wealth, at 10% required reserve, the bank will generate 1,000 gold coins in deposits, 100 gold coins in reserves, and 900 gold coins in loans. At the end of next year the balance sheet will have:
-1010 coins liabilities (deposits that have to be returned)
-100 coins reserves (capital)
- 1170 coins in assets (money returned by borrowers with interest)
--------------------------------
Profit : 260 gold coins, (for a society that can accumulate in one year by productive means 100 gold coins). That means the total debt of the subjects of the kingdom will be of 160 gold coins. Actually it will be 182 gold coins because the profitable financial services sector will expand, and 22 people who were producing real wealth will switch to service jobs created by a sophisticated financial sector.

This miraculous credit expansion produced by a 10% fractional reserve banking system, will bring extremely beneficial effects for the development of the Babylonian service sector. The banking profits of next year will be used for:
-paying a 30 gold coin bonus for the high priest banker (who was making 11 coins a year as a stone mason). It's a bonus because he takes no salary from the bank. He does it all for the public good, for the people and for increasing the prosperity of the kingdom.
- hiring 3 young virgins who, before the financial miracle, were looming and weaving flax fabric (in the local textile industry at the same average industry salary of 11 coins). The 3 virgins will help the high-priest to study the esoteric complexities of the fertility rituals. The 3 (soon to be former) virgins will be happy with their new jobs, because they will receive an annual salary of 15 coins (36% salary increase for this highly skilled "services workforce" and all coming with a "lighter workload")
-hiring 4 farmers as landscapers with an annual salary of 10 coins (they will make less than before, when they were farmers, but landscaping is better and easier than toiling the fields and growing barley). Plus the people will feel better when they will see manicured loans in front of the temple, royal palace and the homes of well paid bank employees.
-hiring 4 people who worked in the produce market (farming and selling their own products), as bank tellers, at an annual salary of 20 gold coins (82% increase in salary for quitting farming and selling your own goods, and going into the financial services sector)
- hiring 4 flax farmers to sell things in the market at an annual salary of 5 gold coins. OK, these are low paying jobs (compared to what they were making before by growing and harvesting flax), but since the 3 virgins are not weaving fabric anymore, the farmers will go bankrupt anyway, because there will be no need for their flax. These losers will have to get a job to pay their debt and they will have to take these bottom-feeder wages. Plus, we need someone to sell things in the produce market, replacing the guys who became bank tellers. In order to make these 4 losers feel better about their shitty jobs, the high-priest will give them a catchy job title, calling them "Sales Associates"
- hiring 5 former farmers, fishermen and craftsmen to make cheap food and clothing for those who became poor (we must keep the poor happy). The cheap food will be made out of a mix of tar grease, dog turds and cow patties and will be called "healthy fast food". The cheap clothes will be made out of unwoven straw, and will be called "discount value clothing". In order to pitch the sales of this edible and non edible crap, and make the poor feel happier and richer, the advertising campaign will rely on using happy/smiley face symbols with catchy slogans such as "Happy Meals for your kids" and "Roll back prices"
- the remaining 5 gold coins (out of the 260 bank profit) will be used for advertising materials promoting the blessings of "fast food", "value clothing" and of course the blessing of a "sophisticated and innovative financial services sector".

So let's examine again the little kingdom in Example A with and without the financial services sector.
Without the financial services
Production of goods and services: 100X11=1100 gold coins
Consumption of good and services: 100X10=1000 gold coins
----------------------
Surplus: 100 gold coins

With the banking and financial services in place at 10 % reserve requirements (22 people going into financial and associated services).
Production of goods and services: 78x11=858 gold coins
Financial services earnings: 260 gold coins
Consumption of goods and services: (78x10 + 260) =1040 gold coins
------------------------
Surplus: 78 gold coins

Wow!!!! Banking is a blessing. It is true the total surplus value created in the kingdom decreased with 22%, but the average wage increased from 11 to 11.28 gold coins and that is a healthy 2.54% increase in the average standard of living in just one year. Not bad. Not bad at all.... Consumption increased in one year with 4%. Hmmm ... the high-priest/banker who made those great profits from his bank, told the people that the key of getting richer is to consume more. This is a discovery of new type of economy, which from now on will be called "consumer economy".

Of course, there is that little issue of total household debt increasing from 0 to 182 gold coins in just one year, when before, nobody was in big debt. If we add the debt number to the total consumption in the kingdom, we obtain something like this.

Production of goods and services: 78X11=858 gold coins
Financial services earnings: 260 gold coins
Net total household debt: 182 gold coins
Consumption of goods and services: (78*10 + 260) =1040 gold coins
------------------------
Surplus: -(104) gold coins (a real wealth deficit of 104 gold coins)


These guys, who have an obsession with debt and real wealth are annoying. Who cares about total real wealth in the system, when the banking profits are so high? A simple financial calculation (made by using the goal seeking function in a spreadsheet) shows us that, had the subjects of the kingdom, increased their spending to 8%, the average (apparent) income would have increased by 5%. One crazy man said also, that such an increase in spending would have resulted in doubling the banking profits and an increase in the household debt of the "rich" subjects with more than 240%... and that is unsustainable. But who has time to listen to these lunatic nobodies?

If the issue of household debt becomes serious, the rulers of the kingdom can always hide its effects by offsetting it with increased budget spending. The government will always run increasing budget deficits and the part of the household debt will be transformed in public/government debt. Actually, that is not a bad idea. Not bad at all for the following reasons:
- since the poor dumb suckers pay always taxes higher than top business earners, the public/government deficit will be mainly the burden of the poor (which will never be able to pay it).
-the high-priest got recently, some sacred tablets from Warburg-Morganus (the god of central banking). In those tablets there were precise instructions on how to set a separate private bank which is to deal exclusively with government/public debt while offering protection of his private bank. If the Government runs a deficit, it will have to borrow money with interest from this new Babylonian Federal Reserve Bank. The subjects of the kingdom (with the exception of the few wealthy elite) will be forever trapped in a web of debt. The average Babylonian will have to pay a private tax on his household debt and on one on the government debt. Crushed in between paying his own debt and the government debt, the average hard working Babylonian will never be able to escape the invisible chains of modern finance, becoming the perfect slave. After all, the Babylonian Empire was an empire based on slave labor.

Of course, in order for this to work, the government will have to always run ever increasing deficits. Therefore, no matter what king is on the throne and what prime minster is appointed to run the country, the high-priest have to make sure they will always recite loudly to the masses the Creed In The Babylonian Gods: "Deficits don't matter!"

If that is not possible at least they have to recite The Lie Of The Babylonian Public Servant :

"We have to increase deficit spending now, in order to get the country out of the economic crisis, but my stimulus plan will create a healthy economy, a balanced budget and we will reduce public debt in a few years."

Of course than in a few years there will be no balanced budget, the deficit will keep increasing, the public debt will keep ballooning and the slaves will remain slaves. The high-priests who wrote The Lie Of The Babylonian Public Servant, knew very well that when a man is left with , reduced to a debt slave, that will rebel. That is bad for business. Therefore, the high-priests of banking, every few years, have to give something to the slaves, in order to keep them obedient,... something that is worth nothing,... The high priests, using the puppet kings and officials, have to give them the illusion of ... HOPE!

Those who believe that what is happening now is the curse of the modern society, should read at least the ancient classics:

"The national budget must be balanced. The public debt must be reduced; the arrogance of the authorities must be moderated and controlled. Payments to foreign governments must be reduced, if the nation doesn't want to go bankrupt. People must again learn to work, instead of living on public assistance."
-- Cicero, 55 BC

Links for a Tale of Securitized Cod, Babylonian Finance and Simple Math

This is a biographical addendum to "A Tale of Securitized Cod Babylonian Finance, and Simple Math" entries. Many readers send me as links or attachments interesting materials with relevance to the process of unsustainable wealth extraction.

I decided to review each of these links and attachments and include them here a separate of biographical material for those interested in this subject. This task may take a long time, therefore, I will add them one by one over a week or two in this entry through successive edits.

A) The Zeitgeist Movement: Orientation Presentation
This is different from the famous Zeitgeist movie and it is a presentation analyzing in detail the symptoms of a society infected with the unsustainable wealth extraction parasite.
http://video.google.com/videoplay?docid=3932487043163636261


B) Turning the tables on Wall Street. It seems that North Dakota still practices a form of non (less) parasitic banking system as it was use in the Colonies, before the Banking Act of 1864:
http://www.webofdebt.com/articles/state_bank_option2.php

Forty-six of fifty states are now reported to be so insolvent that they could be filing Chapter 9 bankruptcy proceedings within the next two years.¹ Of the four that are not in that category, one is the isolated farming state of North Dakota. What does it have that other states don’t? The answer seems to be: its own bank. In fact, North Dakota has the only state-owned bank in the nation. It has avoided the credit freeze caused by the derivative schemes of the Wall Street bankers by creating its own credit, leading the nation in establishing state economic sovereignty.

North Dakota is an unlikely candidate for the distinction. As Michigan management consultant Charles Fleetham observed last month in an article distributed to his local media:

“North Dakota is a sparsely populated state of less than 700,000, known for cold weather, isolated farmers and a hit movie – Fargo. Yet, for some reason it defies the real estate cliché of location, location, location. Since 2000, the state’s GNP has grown 56%, personal income has grown 43%, and wages have grown 34%. This year the state has a budget surplus of $1.2 billion!”

The secret of its success seems to be the state-owned Bank of North Dakota, which was established by the state legislature in 1919 specifically to free farmers and small businessmen from the clutches of out-of-state bankers and railroad men.

C) The Marxist/Socialist deception. Actually this is lecture given by Richard Wolff a professor of economics at UMass Amherst talks on the current "financial" crisis and capitialism in general. IMHO the symptoms and partial causes of the problem are correctly identified, the solution proposed is completely wrong. I believe that communists/socialists are offering the false solution of replacing the crony capitalist elite with a red elite that usually is far worse. But anyway, here is the lecture:
http://video.google.com/videoplay?docid=7382297202053077236

(By the way, I can't stop thinking at the poor Russians who in order to escape the oppressive unsustainable wealth extraction of the Czar, they chose the wrong solution of Communism where they got more oppression, wealth extraction and incompetent management. Moreover after 70 of communism they made again the wrong choice and they got first wealth extraction form Yeltsin's oligarchs and now again wealth extraction by Putin's siloviki elite)

D)GRAND ILLUSION - THE FEDERAL RESERVE. Background on the Federal Reserve System.

E) The Creature of Jekyll Island. This is a classic and probably most of the readers for this blog have already watched it. I believe this is the best expose on how a hybrid banking cartel has been created in US in order to perpetrate unsustainable wealth extraction through banking.

F) The Money Masters. This movie is the grandfather of Zeitgeist, but IMHO has the best take on the causes of the problem and the best solution. For most of the people only the end (from 3:00:00) is worth watching offering an interesting (and historical) perspective (this documentary was made in 1995). It also contains a great historical review of the first and second central banks of the USA (for those who want to watch it all).

G) Now And The Future. The best site on internet to find unfudged economic data. Great charts.

H) Finster Dollar Index. From the economic underground, this is IMHO, the best inflation-deflation indicator that exists. Period.

(more links to follow)

China, Mercantlisim, and Empire

As much as most would like to claim they understand China, it remains an enigma to all those I know. Even my friends who work in China can not assert a full understanding of why China adopts the economic strategy is has adopted: while it seems that China has compromised herself by cultivating a dependency on US consumption to operate its economy in a ponzi fashion, I find it perplexing that the cabal ruling China would paint themselves into a corner.

Is China's ruling elite stupid? Are they woeful innocents? Somehow, I find this doubtful, and I would like to articulate a theory why so many "economists" and political scientists have such a difficult time understanding China.

Recently, Premiere Wen made the following comment:

"We have lent a huge amount of money to the United States and of course we're concerned about the security of our assets and, to be honest, I am a little bit worried," Wen said in Beijing after conclusion of the second session of the 11th National People's Congress (NPC). "That's why here I would like to urge the US to keep its commitment and promise to ensure the safety of Chinese assets."

Now, let's see what an essay on Deng Xiaoping, the father of the current Chinese political economy, has to say about China's "growth" during the past 30 years:

While the new slogan, "One core, two basic principles," won Deng's support and solved the contradiction inherent in the "two basic principles," it didn't change the basic nature of Deng: Deng, who had lived and worked in France, but who never absorbed the principles of human rights and who had a terror of democratic politics.

His rising career led him to fixate upon one particular relationship out of all human relationships, that between the bureaucracy and the military. Looking back today, I think his "two basic principles" can be summarized like this: 1. We absolutely must carry out economic reforms. 2. We absolutely must not carry out political reforms. His "one core" should be expressed as: Always uphold the Party's right to rule. His whole aim in supporting economic reforms was to breathe new life into a dying Party, not to weaken it.

A lot of observers seem to think that free economic competition will naturally bring democratic politics in its train, that economic reforms will not just call for but will inevitably push forward political reform. But Deng Xiaoping made his calculations on a different abacus. He planned to strengthen the Party's political power through developing the economy.

http://www.rfa.org/english/news/china/baotong-12292008165015.html

It's easy to deride China's strategy as short-sighted, stupid, or naive. However, if one looks at it from a longer-term strategic perspective, it allowed several things:

1) Secure foreign exchange reserves to acquire and own crucial natural resources China lacked.
2) Open markets to Chinese goods and credit
3) Provide credit to for domestic capital expenditure
4) Most importantly, maintained PRIMACY OF THE PARTY

If, over the coming years, China must suffer a mini-depression, well, it's just a step back in another leap forward. Meanwhile, the Party remains in power, able to provide enlightened leadership and stave off imperialist efforts to colonize China and deprive them of their human rights.

As Deng Xiapoing himself said:

To maintain stability, it is imperative to oppose bourgeois liberalization. Implementing the people’s democratic system is just to protect the majority’s human rights, safeguard national sovereignty and realize rights to development and peace.

Why does China resist the US' efforts to "increase domestic consumption"? Implicit in an "increase of domestic consumption" is the cultivation of a potent middle class, a class that will not tolerate arbitrary and incomptent administration "from the top". Chinese, unlike many stereotypes of them, are not blinkered drones: they do agitate and protest frequently.

What is really at stake, then, in this crisis? It's the future of China's middle class: if China's middle class becomes a potent force for "bourgeois liberalization", then the Party is finished. Can the Party channel the energy of China's emerging middle class into a new identity that does not compromise its power? Can you have a middle class with a one-child policy? Can you even have meaningful domestic consumption with a one-child policy?

Or is the one-child policy the 21st Century's, "Great Sparrow Campaign"?

A Tale of Securitized Cod, Babylonian Finance and Simple Math. Part 3

In his "American Notes for General Circulation", Charles Dickens, who was documenting his visit in America for his English readers, made an interesting observation about the American correctional system:

America, as a new and not over-populated country, has in all her prisons, the one great advantage, of being enabled to find useful and profitable work for the inmates; whereas, with us, prejudice against prison labour is naturally very strong, and almost insurmountable, when honest men who have not offended against the laws are frequently doomed to seek employment in vain.
Even in the United States, the principle of bringing convict labour and free labour into a competition which must obviously be to the disadvantage of the latter, has already found many opponents, whose number is not likely to diminish with access of years.

Also during his tour of Boston, he made another observation, about something an English gentleman would find unusual:

We have seen no beggars in the streets by night or day; but of other kinds of strollers, plenty.

Obviously, the time of the Dickens' visit (1842), America was not yet weakened and terminally infected by the unsustainable wealth extraction parasite, while England was shivering from the fraudulent elite malaria. The absence of beggars and the fact that Americans had no "prejudice" against prison labour stealing the jobs of honest people, was just a sign that, at that time, the process of shedding the weakest part of the productive serf population had not started yet in the Land of the Free, while in England this process was in full force. That was the time of :

"Keep ancient lands, your storied pomp!" cries she
With silent lips. "Give me your tired, your poor,
Your huddled masses yearning to breathe free,
The wretched refuse of your teeming shore.
Send these, the homeless, tempest-tost to me,
I lift my lamp beside the golden door!"

Today we live in the time of immigration raids, poor Mexican illegals arrested by the government agents while Lou Dobbs cheers them on CNN. There is just darkness beside the golden door, because the liberty and freedom fueling the flame has been stolen. USA is today is suffering from an unsustainable wealth extraction by a parasitic elite as was England in 1842, and if anybody believes things will get better by themselves soon, ... just look at England today.

There is a simple and easy solution in order to save a country (any country) from the terrible suffering produced by the unsustainable wealth extraction process: get rid of the parasitic elite and destroy the unsustainable wealth extraction process! It is that simple.

Some may think that would require a communist revolution... Well, it may require a revolution (hopefully not a violent revolution as in 1775), but getting rid of the wealth extraction parasite, definitely has nothing to do with communism. It has been done successfully before, at a time when Marx was not even born yet. The proof of that is obvious for those who read about the Currency act of 1764:

The Currency Act of 1764 is an Act of the Parliament of Great Britain (citation 4 Geo. III c. 34) which prohibited the American colonies from issuing paper currency of any form. Additionally, Britain had coined almost no silver or copper between 1760 and 1816 and discouraged any American attempts to do so. The colonies were continuously running trade deficits with Britain and shipping gold and silver to Britain was the only way to balance the excess of imports over exports.^[1] British merchants engaged in credit sales to the colonies, but the severe British financial crisis of 1762 to 1772 caused British merchants to call in colonial debts.^[1] The credit crisis of 1772 caused the bankruptcy rate to double. The inability to provide liquidity by the issuing of paper currency made the monetary contraction more severe. New York City property values and the importation of slaves both fell by one-half.

This Act offset the economy of the colonies and was widely opposed. It hurt trade by removing the circulating medium and went a considerable way in creating the dissatisfaction in the Colonies that eventually led to the American Revolution. Some, such as Benjamin Franklin and Peter Cooper, believed this to be the primary cause of the Revolutionary War.

The colonies created their own money, called Colonial Scrip, before this happened. This money was government-issued fiat currency and had little or no inherent value, as Colonial Scrip was not backed by a Gold or Silver Standard. Some Colonies, such as Pennsylvania and New York, were responsible and issued only enough notes to keep trade healthy, thus keeping the notes at par with gold. Other Colonies had different systems with less discretion and had inflation issues.

It has been said that the Currency Act of 1764 was the result of Benjamin Franklin's testimony to the British Board of Trade in which he explained the benefits of Colonial Scrip, which allowed the government instead of private banks to have the benefit of money creation, thus lowering the tax burden on the people. This was a complete reversal from the established British school of economics in which the Government borrowed hard money (gold and silver) from private banks at interest, and it was viciously opposed by the British banking interests for this reason.

Parliament gave permission, in some cases, for colonies to issue limited amounts of paper currency.^[2] In 1770, the Province of New York was permitted to issue 120,000 pounds of paper currency.

Franklin and many others thought this Act to be the true cause of the American Revolution. Peter Cooper, Vice President of the New York Board of Currency during the 1800s, apprentice of Secretary of the US Treasury from 1801-14 Albert Gallatin, and founder of Cooper Union College, believed that taking away the circulating medium of exchange was a much greater cause for the American Revolution than any other act by Parliament:

"After Franklin had explained [the benefits of paper money] to the British Government as the real cause of prosperity, they immediately passed laws, forbidding the payment of taxes in that money. This produced such great inconvenience and misery to the people, that it was the principal cause of the Revolution. A far greater reason for a general uprising, than the Tea and Stamp Act, was the taking away of the paper money."

A communist or a socialist revolution is not the answer. Communism is just the false option given to the rebelling serfs, in order to distract them from the simple option that would set them free. In communism, under the pretence of pursuing social justice, private property is outlawed (to various degrees), the former elites are expropriated (and sometimes exterminated) while the masses are served with an illusion of equality, which is, in fact, an equality only among the slaves.

Since no one has the right to own private property of any significant value, everybody must be, in theory, equal with respect to wealth distribution.

Today, after the fall of Communism, we all know that the concept of "social equality" in the "worker's and peasant's paradise" was nothing else than a deception. In every communist system, there was a parasitic red elite which had total control over the whole country (the wealth and the lives of its citizens/serfs). Sometimes the elite was distilled to just one single man and his immediate family (Kim, Mao, Ceaucescu), sometimes the elite was the whole bureaucracy of a Central Communist Party Committee (as it was in Brejnev's Russia).

Since the proletarian serfs were under total oppression (the system being akin to a giant hard labour camp), normally, there was no hope and no motivation for working hard or being productive. That sent the productivity of the entire society into a dive. The communist countries could not even compete with the heavily infected NATO countries and USSR lost the Cold War.

All humans have a natural desire to accumulate wealth and prosper. There is nothing wrong with that. This is the driving force behind the evolution of human societies. Getting rid of the oppression produced by the process of unsustainable wealth extraction, should not be perceived as a war against the rich. By the contrary. We all want and should get rich, but the prosperity should be mainly pursued in absolute real wealth terms, not exclusively in relative , illusory and immoral terms.

The only thing required for getting rid of the parasite is to prevent a minority elite group from having an unfair advantage of accumulating wealth at a rate consistently higher than the total rate of wealth accumulation in society. That is all. No Marxism needed and no wealth confiscation. We have to shift the paradigm from a "So long sucker"-style competition, to model of optimal cooperation and fair competition.

I believe the parasite can be killed for good and re-infection prevented forever, just by employing a few simple means. Among them, the most obvious I can think of are:

1) Personal income tax displacement. This is basically a progressive income tax with a twist. It requires only raising the tax-exempt income above the average income in a country (GNI per capita), while maintaining a fix tax rate. for everything exceeding the tax exemption level For example, eliminating all personal income taxes for people making, ...let's say ... less than 20 times the national average income, and taxing everything that exceeds that level at a 50% rate (or pick your own numbers as long as the tax exemption level is defined as a fix multiple of the national average income and the tax rate can cover government expenses). Some may think this is crazy, because it will balloon the deficit. I disagree. Considering that in a severely infected country, most of the real wealth is concentrated among the 10% richest people, it will make little difference. Deficits are generated by the the current tax systems being geared towards extracting more money from the impoverished majority which has little real wealth (moslty illusory wealth), than from the wealthy (in real terms) elite. Since deficits allow the elite to impose an additional private usury tax on the poor , we have government officials and politicians telling us that: "Deficits don't matter".

In the long run, such a tax system will have the positive effect of discouraging the creation of illusory wealth in the society by the top wealthy elites. The level of taxation may increase, if the government deficit/debt requires it, but the tax-exempt income level cannot be decreased, and in any circumstance cannot be brought below the level of the average income (GNI per capita).

The top richest people would not be willing to pay extra taxes on wealth that doesn't really exist, therefore they will have strong incentives to prevent the creation of illusory wealth in the system. Since it will be quite the opposite situation of Bush's 'tax cuts for the rich', those rich and powerful, with influence over in government, will be the first interested in the pursuit of balanced budgets, less spending and the elimination of pork and waste.

We will still have millionaires and even billionaires. A few individuals may even accumulate wealth at a rate above the GNP growth rate, for some years in a row, but they will not be able to do it consistently and as a whole fraudulent cast of masters. Let the people prosper. This is not a fight against every wealthy person The fight should be only against the fraudulent practices of the elite aggregated as an oppressive, privileged group/cast.

2) Progressive inheritance tax. This may be controversial, but it's similar to the previous idea. Let's say we will have a 80% tax for inherited wealth in excess of 40 times the national average income (or pick your number as long as it is a fix multiple of the average income). In US, with a GNI per capita of $46,000, it would mean a person inheriting less $1.84 mil will pay no tax. Everything exceeding $1.84 mil will be taxed at 80%. The precise numbers are debatable as long as the tax exempt levels for income ( salary, capital gains or inheritance) are above the average (not median) income in the country. The point is to make it mathematically impossible for whole elite group to accumulate and inherit wealth, at rates that are always above the total rate of real wealth accumulation in a society.

This would brake the hereditary transmission of the unsustainable wealth extraction virus. People have no incentive to accumulate a an obscene wealth (more than a few million dollars), by any means, if they know they are in fact saving for the government budget. willIt also promote a meritocracy among the rich and that is not a bad thing.

Surprisingly, some of the very rich people advocate essentially for the same things: prevention of unsustainable wealth extraction in order to avoid a total destruction of the society in which they live and became extremely wealthy. One of them, I believe, is Warren Buffet:

Warren Buffett, the third-richest man in the world, has criticised the US tax system for allowing him to pay a lower rate than his secretary and his cleaner. Speaking at a $4,600-a-seat fundraiser in New York for Senator Hillary Clinton, Mr Buffett, who is worth an estimated $52 billion (£26 billion), said: “The 400 of us [here] pay a lower part of our income in taxes than our receptionists do, or our cleaning ladies, for that matter. If you’re in the luckiest 1 per cent of humanity, you owe it to the rest of humanity to think about the other 99 per cent.”
[...]
Mr Buffett said that he was taxed at 17.7 per cent on the $46 million he made last year, without trying to avoid paying higher taxes, while his secretary, who earned $60,000, was taxed at 30 per cent.
[...]
Mr Buffett said that a Republican proposal to eliminate elements of inheritance tax, which raises about $30 billion a year from the assets of about 12,000 rich families, would broaden the disparity between rich and poor. He added that the Republicans would seek to recover lost revenue by increasing taxes for the less prosperous.

He said: “You could take that $30 billion and give $1,000 to 30 million poor families. Or should you favour the 12,000 estates and make 30 million families pay an extra $1,000?”

It's hard to say if such people, found late in life a conscience, or just can afford to say it now, with a 'shutting the door behind you' attitude, after they amassed an obscene wealth, by taking full advantage of the fraudulent system.

3) Leveling the playing field. We all know that in the current system, the unsustainable process of wealth extraction is defended and enforced by the government. The most blatant example is The Federal Reserve Bank which is just a private banking monopoly-by-proxy, enforced by the government.

As long as there is government enforcement of the parasitic process of unsustainable wealth extraction, the markets cannot be truly, free, open and fair. What we have now is not free and open markets, but an institutionalized framework for defrauding small investors, pension funds, well ... and everybody who doesn't belong to the top wealthiest elite.

Here the list of things to do is incredibly long, but we have first to start with dismantling the Federal Reserve System. And we don't need the return to the gold standard. Remember that the Colonial Scrip was just paper, not baked by silver or gold. Silver or gold is not money. Not even paper is money. Money is whatever medium the people are willing to use in order to exchange the fruits of their labour. The concept of moneyness exists only in the unconscious collective of a society or a group of people.

Some may smile when hearing that primitive societies used shells, rocks or beads as money, but money can be anything. Even an ordinary wooden stick with notches marking its value. Incidentally, sticks with notches, (called split tally sticks) were used as interest free money in England, as recently as 1834, and members of the English banking elite of that time, used them to buy stock in the Bank of England.

What it is mind boggling, is that due to the nature of the law of exponential growth, the process of unsustainable wealth extraction from a society or a financial system, in the very long term, hurts even the people who are supposed to profit from it. Any society, or economic system, infected with the parasite of unsustainable wealth extraction, has a growth rate of the real wealth, below the its true potential. It is well known that a prosperous society has a large middle class of free and productive individuals and just few very poor or very rich.

In the long term, by stumping the growth in the countries they exploit, the top wealthiest members of the fraudulent elite become in many cases poorer (in real weakth terms) than the members of the middle class from less infected country, which has enjoyed economic freedom, and consequently higher growth rate real wealth.

Over a long term wealth extraction at unsustainable rates, is detrimental for both the serfs and the masters. Everybody loses with the illusion of achieving relative and illusory wealth. As I've said above, the solution is very simple: unsustainable wealth extraction has to be made mathematically impossible by means of taxation and fair regulation.

I don't know if the set of means, for getting rid of the infection I proposed above, is the best and I'm aware it may be far from perfect, but it is definitely better than what we are told repeatedly, are the only choices we have: communism/socialism or so called unrestricted/unregulated "laisez-faire" capitalism.

If only a handful of people will read this entry and it will make them think more and clarify their own ideas (which may be different from mine) about a fundamental flaw plaguing human for a very long time, then my time, spent writing these three long entries, was more than too well wasted.


------------------------------------------

PS. One of my friends who red the previous part of this entry, told me I made a mistake by linking Icke's "The Turning of the Tide" as background material, since in other speeches David Icke has taken positions that one may characterize as tinfoil-hat kook material. I was suggested that maybe I shouldn't include that link that I can be discredited by association.

It happened many times in history, that certain persons trying to spread words of truth and ideas justice among people, later discredited themselves, by simple self-delusion (it's easy to lose your marbles when you realize the truth and the true extent of oppression and injustice), by becoming the themselves victims of carefully planted deceptions (made in order to discredit their original dangerous message) or simply, by being from the beginning an 'agent provocateur' tasked with discrediting a 'dangerous' truth. I don't know what exactly happened to David Icke and why he made later all those controversial tinfoil-hat claims (such as those about reptillian aliens interbreeding with human-like martian refugees, etc.) I believe it is completely irrelevant for this discussion.

What I know, is that "The Turning of the Tide" contains, among other things, the best expose on some extraordinary powerful and simple methods of controlling the serfs, and I though such knowledge may be useful for understanding the process of unsustainable wealth extraction.

It is the message that counts, not the messenger. In order to conclude my reasons for introducing the link to "The Turning of the Tide", I will use an anonymous quote I found a couple of years ago on the internet. I tried my best to find it's author, but failed, so these words may belong to a complete kook or to a very wise man. There are a few versions floating around on the internet, but the the version I first found, sounds like this:

I maintain that the only true salvation from any oppression or enslavement is self-empowerment. Knowledge. Consciousness. This is true rebellion!

Don't get caught up in the crowd of people that follows the leader, people who think that they are rebels because they denounce authority simply because its the latest fashion. Don't march the streets claiming that you are the enlightened one, because you read a book or saw a film that gave you a glimpse into an uncommon knowledge.

Don't scream phrases into a megaphone that you borrowed from another persons wisdom. And don't proclaim yourself an original thinker because you belong to a group that represents an unpopular belief.

Those are all examples of the other side of the coin of "group think" : leading a false rebellion. False rebellion is dangerous because it gives an illusion that you are free and thinking for yourself.

A TRUE REBELLION, a true revolution begins when you quit following, AND START LEADING. And those that end up following you, should be taught by you to quit following you and start leading. And the only way to lead successfully is by fully understanding your rights as a human being in this world.

A Tale of Securitized Cod, Babylonian Finance and Simple Math. Part 2

In the first part of the entry, I tried to explain the ancient (Babylonian) understanding of the effects produced by unbalanced rates of wealth extraction from an economy. The ancient economists had a simple, realistic and no-nonsense view created by learning during thousands of years of trial and error. The second part will be focussed on the examination, in simple terms, of the modern economic developments, through the lens of the ancient, realistic perspective. In other words: let's see what a Babylonian economist would think about securitizing the cod as a mythological endeavor to create wealth?

In order to keep this entry short, I would like to strongly recommend, to those with a keen interest in the process of unsustainable wealth extraction, five interesting background materials:

• a great radio interview with Dr. Michael Hudson on 94.1 KPFA (http://kpfa.org/archive/id/48892) in "The way we were and what we are becoming"
• an extremely interesting take on the role of usury and fractional reserve banking in the process of unsustainable wealth extraction: "Fractional Reserve Banking as Economic Parasitism" (IMHO this paper has about 10% tinfoil hat material, but there rest is good, ... really good)
• a short video essay explaining the basics of stable and transitional political systems: "The American Form of Government"
• an essay/presentation of the interconnection between personal freedom, productivity growth. excess production, and statism (state used by oligarchies as an instrument to enforce their economic privileges) : Statism is Dead
  
• a long presentation which is IMHO the best and most detailed analysis of the means employed for controlling the individual: The Turning of the Tide . He clearly explains the concepts of Hassle-Free-Zone, Problem-Reaction-Solution Scenario, Opposames, Pyramid-Structure etc (this is an old talk given by David Icke, long time before he went bananas with reptilian aliens interbreeding with Martian refugees stranded on Earth and conspiring together to sacrifice Princess Diana in an Isis-style, ritual sacrifice :) ....This clip is Icke at his best, and if we think it's was made back in 1996, it becomes almost prophetic.)
  

With the prerequisites out of the way, we can return to the tale of securitized cod, Babylonian finance and simple math. In the first part of this entry the hypothetical examples presented were oversimplified in order to demonstrate the inevitability of the inflection point, as being the point in time at which a small oligarchy acquires all the wealth in a system (or a country). For the first hypothetical example the inflection point occurs 78 years after the start.

After the inflection point, not only that the majority becomes completely destitute, but most important, the controlling elites cannot extract wealth at the previously high rates, they were accustomed to. The system becomes useless even for the very elite controlling it.

In real life things are a little bit more complicated, and the Babylonian economists knew it because they knew very well what truly lies behind the economic S-curve. One may argue that modern economists, who developed from it the modern day concepts of Laffer curve, Phillips curve, Kuznets curve etc., do not have such a clear understanding. What the Babylonian economists knew, is that there is a minimum acceptable level of wealth for which a serf remains productive. Bellow this minimum level, an individual cannot be used as productive livestock, and falls from the economic system (becomes a beggar and dies quickly in poverty, tries to rebel and is killed by the state repressive apparatus, commits suicide in despair or simply escapes oppression, by emigrating to a better country/kingdom).

Let's modify our previous simple model by considering a minimum wealth level required for subsistence . Those falling below this level disappear from the productive force of workers/serfs. Obviously, the wealth distribution among serfs is not uniform (there is a wealth scale for the poor and middle class too). The effect of such a wealth dispersion among the poor can be easily approximated in a spreadsheet calculation by imposing a minimum rate of expected wealth growth among the serfs to compensate for the exponential growth of statistical Gaussian dispersion of wealth among the poor.
It's not as complicated as it sounds, but this idea of minimum rate of expected wealth growth among the serfs, is extremely important in modern economics, and is the root cause for the elite generating the illusion of wealth for ordinary people, through various myths, such as the wealth generated by securitization of cod, inflation, housing and stock bubbles etc.

Let's use for the third example the following conditions:
-constant population of 1000 people (each starting with an equal wealth of 1 gold coin)
-the annual growth of the economy is 2.8%
- a group of 10 elite rulers (1% of population) extracts wealth at an unsustainable rate of 9%
- the inflection point is delayed to 80 years, and theoretically the rulers can enjoy all this time without fear of revolt.




If in the same example, if we introduce a minimum expected annual wealth growth rate for the poor of 2.4% , things change significantly. We can see the decrease in the number of productive serfs, generates the the S-curve, which is just the portion of total wealth evolution curve (between the start of the unsustainable wealth extraction process and it's end, at the new inflection point. The lifespan of the society shrinks from a theoretical life of 80 years to 67 years. The stability interval for the society decreases exponentially with the increase in the rate of wealth extraction required by the rulers (if we increase the extraction rate to 12%, the lifespan decreases to 32 years).

This new, early, inflection point, of course, requires a reset of the society by the same old means: revolution, war or a jubilee (partial wealth redistribution) . The Babylonian economists did not care about the hypothetical decrease in total wealth after the inflexion point, because after the inflexion point, ... the society was no more.



Also, the decrease in the productive population, induced by the unsustainable wealth extraction, results in a decreased average growth rate, below the maximum growth potential of the country. In this case it starts with a 2.8% yearly growth and ends with 0%, resulting in an average growth of only 1.7%.

And here comes the modern economic mythology brought by fractional reserve banking, fiat money, inflation, securitization, globalization etc. The impoverished serfs are conned with the perception of illusory wealth growth, and can be maintained fully productive even after the inflection point at the end of the classic 'Babylonian' S-curve. The system can continue to survive even after experiencing a decrease in real growth. It can result in apparently healthy economies which, in fact, are walking zombies in terms of real wealth (as the Icelanders found out).



In our example, the illusion of wealth would be used to move the inflection point back to theoretical level of 80 years. More important the natural "Babylonian" S-curve is destroyed/distorted, and the total apparent growth approaches the theoretical level of growth possible for that country (in our example that is 2.8%) . Also by creating the illusion of wealth for the masses, the rulers can increase the rate of unsustainable wealth extraction. All is needed is to have enough illusory wealth given to the serfs in order to compensate for additional extraction.

We have to remember that the modern economic mythology does not create real wealth. It just creates an illusion of wealth for the masses. The incredible result is that these illusions can actually stabilize a society past the theoretical inflection point of real wealth creation/extraction. All this comes at a great cost. In the last stages of this modern economic 'miracle' the illusory wealth is required to grow itself at an unsustainable rate, and not even the most perfect illusion can accommodate an unsustainable growth rate. In time, even a part of the wealth of the elite becomes illusory, and that makes the jubilee option impossible: The modern S-curve (yellow curve) becomes a hook.

A king may agree to donate 90% of his wealth to the poor, just in order to preserve the viability of his monarchic line, but he may find it very difficult to convince his prime minister and the commander of the royal guard to do the same. In our example, the illusion of modern finance ends after 80 years of unsustainable extraction with the elite owing all wealth in the country, but only 36% of it is real ... the rest belongs to AIG's balance sheets. If the elites would donate all their wealth in a jubilee it would barely cover half of the wealth the poor serfs believe they have.

The big problem with modern financial mythology is that most of wealth illusions don't last very long, because no illusion can accommodate for ever the exponential unsustainable wealth extraction. The solution provided by the elite when an mechanism of illusory wealth creation does not work anymore is simple: they replace it with another illusion. In Iceland, the first illusion was privatizing the fish swimming in the ocean. When that didn't work anymore, the innocent and unsuspecting cod was securitized. (That was a move very good for the cod, because the illusion of securitization falsely increased the the value of the catch, requiring smaller catches. Less cod fished, better chance of survival for the cod).

When the illusion provided by securitization of the cod was not able to hide the effects of unsustainable wealth extraction, ...no problem ... it was replaced by the illusion of easy wealth through by forex trade. The Icelandic government fell because they could not imagine quickly another illusion mechanism, they couldn't invade another country (Monaco is too far away for the fishing fleet of the modern vikings) and there was no real wealth left in the country for a jubilee (since they are facing a huge external debt).

One may ask how can these illusions for the poor can defy the law of conservation? The answer is very simple: sending the the people in real (not illusory) debt. The former fishermen (who not long ago had been converted over night in currency traders), found recently they have to pay a debt 8.5 times larger than their country GDP. I have no doubt that only a fraction of this debt has been actually spent and wasted by the viking equivalent of the American day-traders. If historical patterns are correct, a significant part of this debt, (which has to be payed now by all Icelanders, even by those who continued to fish during the time of collective dellusion), is safely tucked in real money, in the accounts of those who perpetrated the unsustainable wealth extraction.

Moreover, most of that stashed money, probably, is not even owned by the local viking elite, but by unnamed and faceless foreign financial rulers, because today, capital flows freely through the borders, especially when it flows in the right direction of unsustainable wealth extraction. The Argentinian serfs learned that lesson when they tried to get their money out of their accounts from the local branches of big foreign banks, after the collapse of the dollarization/peso-convertibility illusion .

The Russians learned that when, as a result of the '97 crisis, the unsavory class of oligarchs have taken the products of their wealth extraction efforts to the safety of the western banks and the country was left bankrupt. Some of the oligarchs have been recycled by the siloviki revolution and the Russians are relearning the same lesson now: just look how fast the Russian dollar reserves are vanishing.

Globalization is a wonderful invention, which allows the financial elite of a country to loot another country without an actual military invasion. All what they needed, is to bribe the hungry elite of that foreign, less developed country. And it's not only about stealing money from another country. Serfs from one country can be pitted against serfs from another country, without realizing they are all victims of the same globalist wealth illusion and this game brings a real profit only for corporations.

What happens now between China and US is both sad and hilarious. In order to have an export based economic "miracle", China has to resort to currency manipulation and dollar sterilization. As a result the hard earned yuan savings of the poor Chinese serfs are converted in dollar bonds and extended as credit to the once wealthy, American serfs who had their good manufacturing jobs outsourced to ... China. The American serf, although he lost his good manufacturing job when he was outsourced to China, had the illusion of wealth because the recycled trade imbalance money produced an increase in the value of his house and he could buy cheap Made in China crap from Walmart. Now this globalist bilateral illusion is unraveling fast.

The American serf has been foreclosed and the HELOC (or flip-over illusion) has vanished. He is in debt up to his eyeballs and there is no way he can find again a good manufacturing job (his previous job is now in a recently closed factory in China)
The Chinese serf, found himself without that well paid ($200/month) job in an export factory (job stolen from the fat American imperialist serf), because, well ... the American serf has no money to spend anymore. If historical patterns are to be confirmed again, probably in the next stage, the Chinese serfs will discover in horror that most of their savings entrusted to the state banks, are gone.

It is amazing to watch a great Charlie Rose interview from 1994, with Sir James Goldsmith and Laura Tyson (Chair of the US President's Council of Economic Advisers during the Clinton Administration and currently recycled as economic advisor to president Obama).




(Edit: Today, March 7, 2009 I found that this excellent interview exposing the GATT globalist scam has been taken out of the public youtube clips. If anybody knows of at least a surviving transcript, I would appreciate a link.
Edit 2: March 8, 2009. Many thanks to Political Football Fun who found an alternate link. This extraordinary interview can still be accessible for the public as a Google Video clip, although any search for "Charlie Rose" and "Goldsmith" doesn't return any working video clip. The link that still works is : http://video.google.com/videoplay?docid=5064665078176641728)
On one side we have Sir James Goldsmith, trying to expose the scam (and that was back in 1994) and on the other side we have the government official trying hard to sell the illusion to the American serfs. It was all for the good of ..... ordinary Americans .....

It is interesting to note, that a country with a very 'sophisticated' financial system (ie completely infected by the wealth extraction parasite), such as US is, can run several mythological economic technologies in parallel:

• -wealth illusions planted/promoted in foreign countries, which are in fact acts of covert economic warfare and pillaging (see "Confessions of an economic hit man" ).
• -globalist WTO/free-trade/outsourcing/deficit (scamming both American and foreign serfs)
  
• -domestic set of bubbles with global impact: dotcom, housing, subprime, commodities and let's not forget the old stock bubble (here is a great chart courtesy of 'Now and the Future')
  
• -plain inflation (the oldest trick in the book)
  
• -directly charging the taxpayer for the unsustainable wealth extraction. That can be done slowly in time (the usual growth of US government debt-"Deficits don't matter") or in a "shock and awe" style (bailouts)

One may think, that our innovative friends on Wall Street will be able to create another economic myth, and scam the American serf with another 'miracle' in order to delay the inflection point with another 10-20 years. Many believe that, inspired by the wisdom of Allan Greenspan, president Obama will be able to create a new illusion called the Greenscam (renewable, green, alternative energy), and unleash it through the New New Deal (We give you Hope, you give us money!). They may do it, but I don't believe a green bubble can be pumped the required volume for replacing all the illusory wealth lost in the previous the previous bubbles.

Others believe the Fed intentionally tries to bring down the economies of the rest of the world in order to repatriate the money of the local corrupt elites to the financial safety of the US (financial asylum for foreign oligarchs). There are already signs of private capital flight from the rest of the world into US, and there are clues that such a process has already began (these clues range from the Real Estate Chinese Tourism in US to the data on treasuries holdings as determined by Brad Setser). I personally, don't believe the financial immigration of foreign elites (and their accumulated loot) is significant at present. Of course, small spending for contingency plans (such as buying a house in US) is normal, but that is just a sign of people thinking at applying for financial asylum status in US. Even if such a gathering (and taxing) of the capital brought for safety in US, starts on a huge scale, I don't see how it can delay the inflection point with more than 5-10 years.

There is the last group who sees the modern escape from the inflection point conundrum, as a massive plan of extending the dollar seignorage to the whole world. I'm talking about the Steil plan of getting rid of all national currencies and having only three currencies in the world: the dollar, the euro and a new Asian currency. Of course, the new Asian currency and the euro will be in fact proxies for the dollar. For this last hypothesis there are some interesting developments happening all over the world lately.

But let's suppose all these three modern-economics, escape mechanisms will be successfully implemented. USA gets out easy from the current crisis, collecting the wealth of all foreign deposed (or still in power) rulers. Maybe they will kick the can further down the road, for another 10-15 years.... Then what?

The modern arsenal of illusion and covert theft is out of ammo, because the proportion of real wealth will be close to 0 , there will be nobody left to steal from and no economy can function only on illusory wealth. Since there will be little or no real wealth left in the system, no jubilee will be possible. That leaves available only two of the three ancient Babylonian solutions for exit from the current crisis: revolution or a really big war.

There is also the possibility the elites won't have enough time left for implementing new scams as an exit strategy, and they will face an inflection moment much sooner than expected. Here is another great chart from Now and the Future, :




(In the last installment, I will try to present what I believe to be a simple solution to get rid of the instability, oppression and suffering caused by unsustainable wealth extraction in human societies)

A Tale of Securitized Cod, Babylonian Finance and Simple Math. Part 1

Michael Lewis has just published a great piece in Vanity Fair analyzing the collapse of the Icelandic financial miracle. I urge you to read the the whole article, because it is journalism at its best. Here is an interesting quote about how it all started:

Fishermen, in other words, are a lot like American investment bankers. Their overconfidence leads them to impoverish not just themselves but also their fishing grounds. Simply limiting the number of fish caught won’t solve the problem; it will just heighten the competition for the fish and drive down profits. The goal isn’t to get fishermen to overspend on more nets or bigger boats. The goal is to catch the maximum number of fish with minimum effort. To attain it, you need government intervention.

This insight is what led Iceland to go from being one of the poorest countries in Europe circa 1900 to being one of the richest circa 2000. Iceland’s big change began in the early 1970s, after a couple of years when the fish catch was terrible. The best fishermen returned for a second year in a row without their usual haul of cod and haddock, so the Icelandic government took radical action: they privatized the fish. Each fisherman was assigned a quota, based roughly on his historical catches. If you were a big-time Icelandic fisherman you got this piece of paper that entitled you to, say, 1 percent of the total catch allowed to be pulled from Iceland’s waters that season. Before each season the scientists at the Marine Research Institute would determine the total number of cod or haddock that could be caught without damaging the long-term health of the fish population; from year to year, the numbers of fish you could catch changed. But your percentage of the annual haul was fixed, and this piece of paper entitled you to it in perpetuity.

Even better, if you didn’t want to fish you could sell your quota to someone who did. The quotas thus drifted into the hands of the people to whom they were of the greatest value, the best fishermen, who could extract the fish from the sea with maximum efficiency. You could also take your quota to the bank and borrow against it, and the bank had no trouble assigning a dollar value to your share of the cod pulled, without competition, from the richest cod-fishing grounds on earth. The fish had not only been privatized, they had been securitized.

Let me get it straight. The country was poor, the fish catch was collapsing and that suddenly changed when the government intervened, and privatized the fish in the ocean and allowed banks to "securitize cod"? This was not genuine creation of wealth, but replacing a grim economic reality with the illusion of wealth. The mass delusion continued with the forex and carry-trade game and today Iceland has an 850% debt to GDP ratio (and the cod catch is not in better shape today).

This all happened only because the viking fishermen did not understand the simple basics of Babylonian finance. Here is a great clip with a dr Michael Hudson interview on the subject of debt and and what Babylonian economists knew thousands of years ago:



So what exactly the Babylonian and Sumerian economists knew and modern economists don't? Today one can read a scientific paper, which after a rigorous functional analysis of equations describing a "one-sector growth model in continuous time with a production externality and endogenous labor supply", extracts the conclusion that:

"a redistribution of wealth may drive the economy from a steady state with strictly positive output to a poverty trap in which output converges asymptotically to zero"

The Babylonians were not using differential equations, fancy statistical utility functions and so on, but they had a very good understanding of compound interest. The essence of the problem is related to the dynamics of wealth distribution disparity.

Whenever the 1% privileged minority, achieves by force or persuasion, a wealth growth rate consistently higher than the wealth growth of the whole society, the system becomes unstable. Such a system cannot mathematically exist in a stable form. It's doomed to fail from its first day.

Let's suppose we have a small Babylonian kingdom with 1000 people. Out of these 1% are the rulers (king, soldiers, high-priests and tax collectors). They are the the privileged. The rest of the 990 subjects are the peasants, craftsmen, builders... basically the serfs. When the kingdom is formed, by settling the land, everybody has an equal net wealth of 1 gold coin (no fiat money). Let's examine two scenarios over 80 years of economic activity:

Kingdom 1. Constant population of 1000 people. Initial wealth 1000 gold coins, equally distributed. The land is rich, people industrious and the wealth of the kingdom is growing every year at a rate of 3,7%. The rulers (only 1% of population), because they are rulers, demand of wealth growth of 10.1% year. It shouldn't make a big difference (after all there are only 10 privileged people in the whole kingdom). This is what happens if the rulers increase their wealth at a rate higher than the total increase of wealth in their kingdom:



In 78 years all the wealth in the kingdom is captured by the 1% ruling elite.

Kingdom 2. We have the same 1000 Babylonians, starting with 1 gold coin each. The land is not so fertile and the kingdom can grow only at 2.8 % a year. The rulers are greedier and more corrupt, their wealth increasing at a rate of 11% every single year.



In the second scenario the rulers acquire all the wealth of the people in only 61 years.

The Babylonian economists knew very well nobody can escape the mathematical realities of the compound interest rates or the conservation laws. Not even the kings could do it.

When the top 1% elite acquires all the wealth in the country, not only that the 99% majority is destitute, but the elite itself cannot increase anymore its wealth at the previous high levels. The system cannot continue anymore. The Babylonians knew there are only three possible outcomes after this point:

a) external injection of wealth in the system by starting a war and looting another kingdom, but that is nothing else than kicking the can further down the road. After a few years, the rulers will acquire again all wealth in the system and then they will need another war and expansion by stealing wealth from the neighbors. This is why empires have to grow or collapse.

b) wealth redistribution by violent uprising. The serfs can't take it anymore and rebel. They defeat the unpaid troops (there is not enough money left for paying well the soldiers). The top 1% elite is killed or their wealth is simply 'nationalized' and redistributed to the rest of the population. The problem is that after the bloody revolution, the wealth distribution equality doesn't last for long. The most heroic group or revolutionaries and rebels, who fought for equality, becomes the new elite. This new revolutionary elite starts extracting wealth from the country at a rate, of course, higher than the total rate of economic growth. Wash, rinse, repeat. This is how an economic crisis sparked the French Revolution, and in the end King Louis XVI was replaced by Emperor Napoleon. The new French elite of imperial revolutionaries, in order to increase their own wealth extraction rates without causing another revolt, had to engage in an aggressive campaign of conquest. If Napoleon had won in Russia ...

c) wealth redistribution by jubilee-debt forgiveness. That was the favorite Babylonian way, but not because the ancient kings were really charitable and preoccupied for the well being of their subjects. The jubilee was just a partial wealth redistribution reestablishing another start for the income base of the elite. If at the beginning of our hypothetical kingdom, the rulers had only 1% of the wealth, after the jubilee the rulers with restart the process of unsustainable extraction from a 10% base of the total wealth. After the second jubilee they would restart with 20% base .. and so on. The important part is that jubilees make people happy, and they feel rich again, supporting the new king which will start again the unsustainable wealth extraction. This is nothing else than slow boiling a frog in water, in order to perpetuate the hereditary right of the elite to extract wealth from a country. The jubilee is not a charity. It's just the smart elite accepting a temporary decrease in the proportion of the kingdom's wealth they control, in order to preserve their status and being able to pass it to the next generation of rulers. One may argue that such a slow boiling of the serfs with the jubilee trick, doesn't really solve the problem, just kicks the can down the road and ensures the crown for the next generation of the monarchic line. Eventually the refresh base grows high enough the jubilee trick doesn't convince the masses they escaped the debt and poverty trap. After all the Babylonian empire collapsed like any other empire in history.

I believe we haven't evolved too much from the ancient times, at least not with respect to the essential truths governing human societies and of course nobody can escape mathematical realities and the laws of conservation applied to wealth. I red a while ago an interesting essay titled "Striking it Richer: The Evolution of Top Incomes in the United States" . A few numbers and a chart from that essay deserve attention:

	Average Income Real Annual Growth	Top 1% Incomes Real Annual Growth
Clinton Expansion 1993-2000	3.7%	10.1%
Bush Expansion 2002-2006	2.8%	11%

Let's use the same 80 years time frame for the modern economy (1929-2009). The chart shows something very interesting. In US the New Deal amounted to a voluntary partial jubilee, that lasted from the end of WWII to the the appointment of Volcker as Fed Chairman.

Things are a little bit more complicated in the modern world because, today's economic systems are far more complex than Babylonian economies. Today we have fiat currencies, inflation, fractional reserve banking. These discoveries, apparently, have allowed modern economics to find a fourth way of escaping the ancient wealth distribution conundrum. Mathematic realities and the conservation law are defeated by magical (mythological) means.

When the cod catch collapsed, modern economics made the viking fishermen rich (without requiring wealth redistribution) by securitization of cod. Problem solved. And it was done by mythological means, because the new found wealth provided by securitization proved eventually to be a myth.

The second part of this entry will be dedicated to analyzing modern economic mythology from an ancient, Babylonian (common sense) perspective and the possible exit strategies from the current mess.

The moment of truth for China

Lately, everybody seems to be awed by China's foreign spending spree. From Rio Tinto shares, to loans to Russia in exchange for oil and even European companies of dubious viabilities.

Most commentators have labeled that of bargain hunting with a bag full of reserves, but I believe it's more than that. Here is an interesting piece of news that went unnoticed by most commentators:

http://in.reuters.com/article/asiaCompanyAndMarkets/idINPEK1475420090304

BEIJING, March 4 (Reuters) - China can only spend its foreign exchange reserves abroad, not domestically, in support of its economic stimulus programme, a central bank official was reported as saying on Wednesday. Su Ning, deputy governor of the People's Bank of China, said the forex reserve stockpile could not be used directly at home since that would require conversion into yuan and would ultimately just put more of the Chinese currency into circulation, the China Securities News reported.

Althouth Su was simply stating what most economists see as a basic truth about forex reserve management, his comments help clarify comments earlier this year by Premier Wen Jiabao about China using the reserves to support the economy.

That had sparked questions about how China might seek to tap its reserve stockpile, the world's biggest at 1.95 trillion yuan ($285 billion), with some analysts saying the central bank might transfer a slice of it to the finance ministry for spending at home.

Wait a moment!!!.... So if I get it right, if China uses its dollar reserves to get yuan for the much trumpeted internal stimulus, then the yuan soars and the false competitiveness of their exports vanishes. If they want to use the dollar reserves for internal stimulus and maintain their currency manipulation peg, then they will have to print so much yuan it will result in hyperinflation.

Su Ning is right. China is in a Catch 22 situation and cannot use the $2 trillion in dollar reserve for the domestic stimulus. Therefore, they do what they are doing now: they start spending abroad, buying everything they can get their hands on, and this in fact is ... a global cash injection in disguise. Or in other words it amounts to throwing good money after bad. For the black holes on Wall Street $2 trillion is merely enough for a snack.

That also means the much trumpeted Chinese domestic stimulus is based only on internal leverage, and the resulting volume of bad loans and waste will be crushing.

The Chinese government is not into globalist charities. If they are resorting to such a global infusion of liquidity, that means only one thing: they can't sustain anymore the dollar sterilization process, and soon the Chinese "export based economic miracle" , will prove as real as the Icelandic "financial miracle".

This is not a question of if, but a question of when. One month, six months ... maybe a year if they are lucky....

There are no miracles...

For every seller, there is always a buyer...

As the market tanked today, it's easy to become consumed with fear. Naturally, as someone who's usually short AND long on a given day, I'm ambivalent about market direction, but as the astute Karl Denninger pointed out, the real catalyst behind the recent collapse in the S&P lays in a lack of FAITH in the market: the markets do not trust, and so they test, and these tests entail driving up the cost of credit, forcing the weak players to capitulate outright, since no one believes anyone. The result is a positive feedback loop that crashes the markets to absurd levels and causes permanent economic damage... aka Argentina.

Well, today, the light of hope shone upon my contenance:

//

How Washington can prevent ‘zombie banks’

By James Baker

Published: March 1 2009 19:38 | Last updated: March 1 2009 19:38

Beginning in 1990, Japan suffered a collapse in real estate and stock market prices that pushed major banks into insolvency. Rather than follow America’s tough recommendation – and close or recapitalise these banks – Japan took an easier approach. It kept banks marginally functional through explicit or implicit guarantees and piecemeal government bail-outs. The resulting “zombie banks” – neither alive nor dead – could not support economic growth.

A period of feeble economic performance called Japan’s “lost decade” resulted.

Unfortunately, the US may be repeating Japan’s mistake by viewing our current banking crisis as one of liquidity and not solvency. Most proposals advanced thus far assume that, once confidence in financial markets is restored, banks will recover.

But if their assumption is wrong, we risk perpetuating US zombie banks and suffering a lost American decade.

Evidence – a mountain of toxic assets, housing market declines, a sharp economic recession, rising unemployment and increasing taxpayer exposure through guarantees, loans, and infusion of capital – strongly suggests that some American banks face a solvency problem and not merely a liquidity one.

We should act decisively. First, we need to understand the scope of the problem. The Treasury department – working with the Federal Reserve – must swiftly analyse the solvency of big US banks. Treasury secretary Timothy Geithner’s proposed “stress tests” may work. Any analyses, however, should include worst-case scenarios. We can hope for the best but should be prepared for the worst.

Next, we should divide the banks into three groups: the healthy, the hopeless and the needy. Leave the healthy alone and quickly close the hopeless. The needy should be reorganised and recapitalised, preferably through private investment or debt-to-equity swaps but, if necessary, through public funds. It is time for triage.

To prevent a bank run, all depositors of recapitalised banks should be fully guaranteed, even if their deposit exceeds the Federal Deposit Insurance Corporation maximum of $250,000 (€197,000, £175,000). But bank boards of directors and senior management should be replaced and, unfortunately, shareholders will lose their investment. Optimally, bondholders would be wiped out, too. But the risk of a crash in the bond market means that bondholders may receive only a haircut. All of this is harsh, but required if we are ultimately to return market discipline to our financial sector.

This is not a call for nationalisation but rather for a temporary injection of public funds to clean up problem banks and return them to private ownership as soon as possible. As president Ronald Reagan’s secretary of the Treasury, I abhor the idea of government ownership – either partial or full – even if only temporary. Unfortunately, we may have no choice. But we must be very careful. The government should hold equity no longer than necessary to restructure the banks, resume normal lending and recoup at least a portion of taxpayer investment.

After replacing bank management with new private managers, the government should have no say in banks’ day-to-day operations.

The FDIC can assist. Just this year, it has placed more than a dozen American banks – admittedly all small – into receivership. We might also consider setting up something akin to the Resolution Trust Corporation, created in 1989 to liquidate the assets of failed savings and loans. The RTC eventually disposed of almost $400bn in assets of more than 700 insolvent thrifts.

To avoid bank runs and contain market disruption, the Treasury should announce its decisions at one time. Washington will also need to co-ordinate its actions with other major capitals, especially in western Europe and east Asia. At best, this will encourage other countries to take similar steps with their own banking systems. At a minimum, other governments can prepare for the financial turmoil associated with the announcement.

This approach is not pretty or easy. It will cost a lot of money, with the lion’s share coming from US taxpayers, at least in the short to medium term. But the alternative – a piecemeal pumping of more public money into insolvent banks in the vague hope that things will improve down the road – could truly be historic folly.

Eventually our banks and economy will start to recover. When they do, we would be wise to avoid another Japanese mistake – raising taxes. To counter mounting debt created by government stimulus packages, Japan increased taxes in 1997. Consumption dropped and the country’s economy collapsed.

Our ad hoc approach to the banking crisis has helped financial institutions conceal losses, favoured shareholders over taxpayers, and protected senior bank managers from the consequences of their mistakes. Worst of all, it has crippled our credit system just at a time when the US and the world need to see it healthy.

Many are to blame for the current situation. But we have no time for finger-pointing or partisan posturing. This crisis demands a pragmatic, comprehensive plan. We simply cannot continue to muddle through it with a Band-Aid approach.

During the 1990s, American officials routinely urged their Japanese counterparts to kill their zombie banks before they could do more damage to Japan’s economy. Today, it would be irresponsible if we did not heed our own advice.

//

James Baker has promulgated EXACTLY the necessary solution to ENDING the crisis as we know it(in the US, hehe). You want the Obama miracle? You want 2012 to be a bang-up year for the economy? You want 2009 to be just another "oh whoops!"? Follow Jim's advice, and we will be fine!

Bernanke reads the FT, and so does Turbo Timmy. I can assure you both of them read this article. Whether or not they agree... we will see. However, if top-level technocrats are discussing this idea in the cloisters, then I would admonish my readers to KEEP AN EYE OUT for more articles and announcements like this: if, in fact, Baker's idea is becoming consensus, then it is time to start accumulating industrials and commodity stocks AND staying short the banks, like my favorite "safe haven", JP Morgan.

If Baker is ignored, well, then we will have a lost decade...



http://www.ft.com/cms/s/0/b3f299a6-0697-11de-ab0f-000077b07658,dwp_uuid=81377dd2-0733-11de-9294-000077b07658.html

Endgame

What was the point of this crisis?

Create a massive demand for Treasuries and lines of credit denominated in USD.

Why do this?

Once the US has paved-over the bodies of its banking system, the US can then raise interest rates to well over 10%. This will destroy the economies of those who took out US dollar loans, causing a second round of economic crises, but this time distributed across LDC's(less developed countries) and other crappy countries. See what happened in Eastern Europe with the Swiss Franc and Euro denominated debt, and amplify it by 10. One can also defer to the LDC debt crises of the early 1980's.

Objective?

Secure control of LDC governments and make them absorb the inflation from the reflation of the US banking system. Ideally, subordinate China and use China to absorb inflation from US, allowing the US to fundamentally overspend and maintain and expand empire.

Investment strategy:

There are several weapons to play with. One is carbon-credits, an intellectually-dishonest form of taxation to club LDC's and NIC's(newly industrialized countries, often importing much oil and metals) with. Another is the usual oil/energy trade, and clearly nuclear power has become en vogue yet again. Nations that do NOT draw down huge lines of credit in USD will come out far stronger than those that do. This is why China has always maintained large FX reserves, btw, and avoided annihilation in 1997.

We WILL achieve inflation in due course, and so I would argue to have a strong equity short position and commodity-based inflation hedge for the near to mid-term. Sooner rather than later, and definitely sooner than the doomsters anticipate, interest rates will rise, but ONLY after the "host" has been infected with credit.

Initially, however, the hosts will get a huge surge, and so the credit will bring massive reflation to LDC's and NIC's. Unless the debtors responsibly pay off their debts quickly, though, they will be CRUSHED by rising interest rates, which remain inevitable.