Sunday, 6 July 2008

The Good, The Bad and The Ugly

"Whoever controls the volume of money in our country is absolute master of all industry and commerce...and when you realize that the entire system is very easily controlled, one way or another, by a few powerful men at the top, you will not have to be told how periods of inflation and depression originate."
James Garfield, Assassinated President of the United States

"Money is the new form of slavery, and distinguishable from the old simply by the fact that it is impersonal, there is no human relation between master and slave."
Leo Tolstoy

So the ECB has raised its interest rates this week by 25 basis points as inflation has recently reached 4% for the Euro zone and the monetary policy committee decided to act. Claude Trichet, the president of the ECB, has been warning about the threat of inflation for some time, and most expected him to raise rates at some point. While there will no doubt be complaints around a raise in borrowing rates, during a time when borrowing is becoming more expensive, this is exactly what a central should do during inflationary times. By raising rates, they are protecting the currencies value, thus savers are being rewarded for saving. The open markets ie banks people lend from have been raising rates on mortgages and loans, so the ECB is just following the market. They are doing their job - inflation fighting and protecting the value of the Euro - all central banks have one or the other as part of their remit. However viewing the ECB stance compared to say the FED I can't help thinking, is there something more complicated going on? I mean if a central banks job, as they all say, is to protect a currencies value and fight inflation, then why are central banks everywhere, doing things slightly different?

Take Ben Bernanke and the FED. He took over from Alan Greenspan in 2006, which was just when the FED had been raising rates quite swiftly and the credit markets were beginning to take a turn in America. Housing prices, were cooling (falling) but still the economy was was ticking over. However like with all things in economics there is always quite a delay between the stats and what is happening in the real economy. Slowly repoessions started rising, defaults on loans and then in autumn 2007, the credit crunch began, as banks and financial institutions started announcing the losses on these debt packages and banks weren't sure who was holding the bad loans - and they knew there was a lot of bad debt around. This is when Bernanke and Co began cutting rates. The dollar had been falling since the FED first cut rates to 1% back in 2002/2003 however the pace of the declines began to really pick up. The dollar began loosing more value and lost purchasing power, which I will come back to. This in turn, pumped more money into an already, inflated worldwide monetary system - thus unleashing inflation throughout the world.

When the UK economy began to turn with the effects of the credit crunch, the Bank of England were beginning to get pressure to cut rates thus cutting from 5.75% to 5%. This also reduced the value of sterling sliding along with the dollar. But why has sterling fallen as much as say the dollar when interest rates have only dropped 0.75%, while the FED slashed 3.25% off their base rate, in roughly the same time frame? Well its more complicated then many mainstream media reports make out with other factors, such as the economies strength, debt and another factor of inflation that is occurring. As mentioned the FED cut rates by a huge margin pumping more money into the system, in turn a lot of money has gone into commodities, or T-Bills that have been given to the banks for all the bad debts. This raises the prices of such goods, in turn we have to pay more and thus the pound in our pocket is worth less. This in turn has meant that the BoE have not cut as much, but the FED has ensured the world now has inflation back on the agenda.

When you look at the picture you can't help thinking if the main central banks working together to make the situation worse than what it really would be. Why have the FED unleashed inflation, which will draw out the financial problems further (apart from the obvious, of trying to erode the debt)? I can just imagine the central banks discussing future monetary issues back in 2005/6.

FED: "We have put interest rates up from 1% to 5.25%. Foreclosures are picking up and debts are turning bad (A year ago the FED lied and said sub prime was contained)."

BoE: "We put our interest rates down in 2005 and didn't raise them again until a year later, just to keep the credit washing around longer, rather then trying to deflate an already obviously overheated economy. We will wait till credit markets crystallise the bad debts that are occurring in the US, thus causing panic in our financial system at short notice - a credit crunch just like in the early 90's but worse. This will obviously bring economic turmoil to our economy which relies too much on finance."

FED: "At which point, we will pump mass liquidity into the system, raising inflation, this will further exacerbate the economic downturn"

ECB: "We will take a hawkish view to inflation, and raise rates, thus putting further pressure on the Dollar as it is the worldwide reserve currency (Oil etc priced in dollars) as the Euro is the main currency after the Dollar. This will help depress our economy more making our exports less competitive as the dollar will be so weak and will make your imports more expensive thus making inflation worse."

FED: "This will put further pressure on our money, as we already have huge amounts of debt to China, Japan and the Saudis with big trade and account deficits."


And so on. It almost seems like all the banks are thinking of ways to make the current situation worse. As for what is happening in regards to currency devaluation well this always hurts the average person, rather than the rich as people with smaller incomes have to spend a larger proportion of their income on necessity goods such as food and energy. As the Dollar and Pound have slid recently the purchasing power of the average person has reduced. Even Mervin King says the average person is in for a period of lower standards of living. To rub salt in the wounds the sector that have been the prime reason for all the bad investment and loose lending, are the very people who have to be bailed out in the form of the exchange of their very suspect debt, for Treasury bills. The FED has now put around $500 Billion in the system like this, making it the biggest mortgage holder. This is not good news as people like to think. This compounds matters by drawing out the whole crisis. For this system means that the free market pricing can not return prices to equilibrium levels quickly. If banks are not sure who has massive amounts of bad debts that they have exchanged with the Central Bank then why lend and take the risk, thus they are unwilling to lend to each other for longer periods of time. If we let more banks go bust, then this would be bad admittedly (its the credit expansionary phase that has caused this problem), but prices and trust would return back to normal quicker as the system would be more transparent, clearing out the excesses. This liquidates bad assets and investments quicker. As it is currently, all that happens is banks keep putting up interest rates on all types of loans. They simply have to hedge their bets as they are not sure who is underwater and who isn't.

If you remember from an earlier post I said people will all try and predict when the credit crunch will end. Well like I said it starts out with saying a few months to 6 months etc. Most people now, even the most bullish of commentators, have come round to to think that markets will pick up by 2009 next year. Well I'm afraid they are still way off the mark. Markets are absolutely frozen at the moment and its just going to get worse. We have never had the levels of debt we are in, ever in history. This will carry on for some years. As for 2009 for the UK, well by then more and more people will be loosing their jobs and defaults will be rising. It's not just people who loose jobs, its the atmosphere that gets created. Even people with jobs become more apprehensive that they may loose their job, so people go into defensive positions, less willing to take on debt. Take for example the recent BoE mortgage transactions for May. It was at around 42,000, 64% lower than last month of the same year. That is a colossal jump down, and its a figure that will probably show lower in the coming months. Gone are the days of first time buyers taking on £25,000 - £50,000 mortgages, people take on £125,000 - £150,000 mortgages in recent years which means there is an immense contraction of credit occurring. Money creation is built on people taking on debt. If people don't take on debt then the capitalist system becomes pretty much dysfunctional, which feeds through to the economy. When you get paid, you get paid with some form of debt money, for example some person or company has took on debt which gets spent and circulated in the system that pays your wages. Some 97%-98% of money in the system is created like this, which is why theres been lots of money around in the past decade. People have taken on more debt.

So as our central banks seem to be leading us down a path of serious inflation, followed by probably a period of depressionary deflation. In the coming months you will hear economists talk about the dangers of deflation and that it is worse than inflation. This is complete nonsense, as there is nothing wrong with deflation. Most of the 19th Century was deflationary, as the industrial revolution evolved and made huge productivity savings. Put it like this, inflation robs you of your savings and squeezes what little income you have as prices rise (look at Zimbabwe for an extreme example of how the general public suffer from inflation, while the rich and government prosper). Deflation on the other hand means falling prices - exactly what has been happening the past decade. However now the credit markets have reached their limits there should be less monetary inflation as broad money falls. The reason why people have bad views on deflation is that our economy is built on consumer spending, so if prices fall so the story goes, people won't spend and the economy will collapse. Let me disprove this theory. Lets take the electronic deflation that has happened, say the falling price of computers. Why buy a computer when it will keep falling in value? Yet people did buy at various times during the past decade, and people knew it would almost certainly fall in price. People buy things because they need them. The real danger economists fear regarding deflation is that people won't take on debt described above, to pay for a depreciating asset such as a house. This means less money in the economy and more defaults, this is the real reason they fear deflation, our economy is too reliant on individuals and companies taking on debt. Put it like this, the FED has slashed rates to 2% and what good has it done? You will also hear economists saying that we should help homeowners, by letting them default on payments, forgiving them etc. This is ludicrous and can only make matters worse. As I described above, prices won't clear until real defaults occur and all this will do is prospone the defaults. I won't go into it but just look into Japan during the 90's, this is exactly what happened, the government propped up banks and people and said we are not going to let anything fail. A decade after they were still in a mess as prices and trust didn't return to normal levels.

Its not just the ECB who has raised rates. The banks in Sweden, India, China, Brazil, Norway, Russia, Vietnam etc have all raised rates recently. Inflation has been released and most central banks are taking the right steps - apart from the FED and BoE.

All one can do is to stay out of debt. It is very dangerous to have debt in times like these as it is to be a large creditor also. Our Central banks seem to have ignored this in recent years and have been happy to let this debt bubble get out of hand. They are supposed to be a pillar for financial stability, however history tells a different story, from the Great Depression to the stagflation of the seventies to today, which in my opinion is next depression of our time. History tells you that central banks are Robin Hood in reverse, rob from the majority and give to the rich. A transfer of wealth occurs as the rich have already liquidated their assets and wait for a new bottom to buy the assets back at a pittance, as the cycle turns round again, to wait for a new generation of fools and elders who should have learned from history, and the transfer of wealth begins again.

Is is well enough that the people of this nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."
Henry Ford, (July 30, 1863 – April 7, 1947)

"Banking was conceived in iniquity and was born in sin. The Bankers own the earth. Take it away from them, but leave them the power to create deposits, and with the flick of the pen they will create enough deposits to buy it back again. However, take it away from them, and all the great fortunes like mine will disappear and they ought to disappear, for this would be a happier and better world to live in. But, if you wish to remain the slaves of Bankers and pay the cost of your own slavery, let them continue to create deposits."
Sir Josiah Charles Stamp, Director of the Bank of England, (June 21, 1880-April 16, 1941)

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