Sun, 27 Nov 2022 15:10
Something very bad happened in the banking system.
Things can go very badly wrong when you don't understand the banking system.
You soon start joining the dots ....
1929, Japan 1991, and 2008
These are all fundamentally the same.
Bank credit is used to pump up asset prices and when these inflated asset prices collapse, this feeds back into the banking system.
We had to re-discover what they worked out after 1929 before we could see how they had done this before.
The financial crises are the keys to unlock the secrets of the monetary system.
The Japanese financial crisis in 1991 was a very significant key.
A successful stable, economy went completely off the rails.
This was a great starting point to identify what went wrong to cause the following financial catastrophe.
Richard Werner and Richard Koo turned the key.
They both opened different doors into understanding what had happened.
Richard Werner looked into what had happened to cause the financial crisis.
Richard Koo looked into what had happened after the financial crisis.
The Japanese blew up a real estate bubble of almost unimaginable proportions.
Where had the money come from to produce those insane valuations?
Richard Werner was in Japan at the time and realised banks must create money.
They could keep creating more and more money to pump into the Japanese real estate market.
He eventually produced empirical evidence that banks do create money and this got the central banks to start revealing the truth in 2014.
https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf
Private banks create the money supply.
Money and debt come into existence together and disappear together like matter and anti-matter.
Bank loans create money and debt repayments to banks destroy money.
Bank loans create 97% of the money supply
Banks create money, so bank lending is good for the economy.
What about the other side of equation?
We need to think about the associated debt.
This is where global policymakers have been getting into trouble, they don't think about the associated debt.
It's a debt based monetary system and you do need to think about the associated debt.
Freshly created money can be borrowed from the banks to pump up the markets.
They had worked this out after 1929.
What is the fundamental flaw in the free market theory of neoclassical economics?
The University of Chicago worked that out in the 1930s after last time.
Henry Simons and Irving Fisher supported the Chicago Plan to take away the bankers ability to create money.
''Simons envisioned banks that would have a choice of two types of holdings: long-term bonds and cash. Simultaneously, they would hold increased reserves, up to 100%. Simons saw this as beneficial in that its ultimate consequences would be the prevention of "bank-financed inflation of securities and real estate" through the leveraged creation of secondary forms of money.''
https://www.newworldencyclopedia.org/entry/Henry_Calvert_Simons
The IMF re-visited the Chicago plan after 2008.
https://www.imf.org/external/pubs/ft/wp/2012/wp12202.pdf
This is why they put Glass-Steagall in place, to separate the money creation side of banking from the investment side of banking, and it also stopped the money creation side of banking from trading in securities.
They had been using the bank's ability to create money to inflate the value of securities produced by investment bankers.
When it was removed the same thing happened again, and this was the situation before 2008.
"It's nearly $14 trillion pyramid of super leveraged toxic assets was built on the back of $1.4 trillion of US sub-prime loans, and dispersed throughout the world" All the Presidents Bankers, Nomi Prins.
You can see the debt pile up in the banking system as they used bank credit to inflate asset prices.
1929 and 2008 stick out like sore thumbs.
https://www.youtube.com/watch?v=vAStZJCKmbU&list=PLmtuEaMvhDZZQLxg24CAiFgZYldtoCR-R&index=6
At 18 mins.
Not considering private debt has always been the Achilles Heel of neoclassical economics.
By the time I started in 2008 a lot of the doors were already open, and I could go on to open a few more.
No one else seems to have followed this path, but it seemed like the next logical step to me.
If banks create money out of nothing, which they do.
What is real wealth?
This is when you realise they went through this before after they used neoclassical economics last time.
At the end of the 1920s, the US was a ponzi scheme of inflated asset prices.
The use of neoclassical economics, and the belief in free markets, made them think that inflated asset prices represented real wealth.
1929 '' Wakey, wakey
What is wealth?
The Americans had thought rising asset prices represented real wealth, until the Wall Street Crash of 1929.
They had trusted the markets to tell them what was going on in the economy, but this had proved to be a big mistake.
They needed something new to tell them what was really going on in the economy and they invented GDP.
GDP measures economic activity in the economy; the new items produced and sold every year in the economy.
That's where the real wealth in the economy lies.
It may not be perfect, but it's the best measure we have and this is why global policymakers want to grow GDP.
The Japanese pumped up real estate valuations with the money creation of bank credit.
Why did it cause the US financial system to collapse in 1929?
Bankers get to create money out of nothing, through bank loans, and get to charge interest on it.
https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf
Bankers do need to ensure that money gets paid back, and this is where they get into serious trouble.
Banking requires prudent lending.
If someone can't repay a loan, they need to repossess that asset and sell it to recoup that money.
If they use bank loans to inflate asset prices they get into a world of trouble when those asset prices collapse.
As asset prices collapsed, the banks became insolvent as their assets didn't cover their liabilities.
The banks become insolvent and collapsed, along with the US economy.
When banks have been lending to inflate asset prices the financial system is in a precarious state and can easily collapse.
The Japanese could study the Great Depression to avoid this fate.
When the real estate market collapsed, many of Japan's banks became insolvent, and they knew they were facing a Great Depression.
Richard Koo used to be a central banker at the Federal Reserve Bank of New York, and he looked at both sides of the bank's balance sheets around the Great Depression.
Richard Koo shows the US money supply / banking system (8.30 '' 13 mins):
https://www.youtube.com/watch?v=8YTyJzmiHGk
1) 1929 before the crash - June 1929
2) The Great Depression before the New Deal - June 1933
3) During the New Deal - June 1936
The money supply ' public debt + private debt
The ''private debt'' component was going down with banks going bust and deleveraging from a debt fuelled boom causing debt deflation (a shrinking money supply).
It was the public borrowing and spending of the New Deal that helped the economy recover.
The money supply ' public debt + private debt
The New Deal restored the money supply by increasing the ''public debt'' component of the money supply.
Once the New Deal was working, they reduced Government borrowing and plunged the nation back into recession again.
The enormous public spending and borrowing of WW2, eventually sorted things out.
It's all about maintaining the money supply to avoid debt deflation.
They needed to save the banks.
When banks go down this destroys money.
The money supply ' public debt + private debt
If the private debt term is going down, you want the public debt term to go up to compensate.
Japan used fiscal policy to maintain the money supply as they deleveraged. This was the lesson of the New Deal.
They paid down private debt and used Government borrowing and spending to maintain the money supply as they deleveraged to avoid debt deflation.
What happens if you don't use public borrowing and spending to compensate?
The IMF predicted Greek GDP would have recovered by 2015 with austerity.
By 2015 Greek GDP was down 27% and still falling.
The money supply ' public debt + private debt
The ''private debt'' component was going down with deleveraging from a debt fuelled boom. The Troika then wrecked the Greek economy by cutting the ''public debt'' component and pushed the economy into debt deflation (a shrinking money supply).
Greece was pushed into a Great Depression type event by the Troika.
The Japanese learnt the lessons of the Great Depression, but discovered a new problem, Japanification.
What was the good thing about the Great Depression?
https://www.youtube.com/watch?v=vAStZJCKmbU&list=PLmtuEaMvhDZZQLxg24CAiFgZYldtoCR-R&index=6
At 18 mins.
The claims on future spending power in the banking system were removed by the Great Depression, and the system was cleansed and ready to restart.
Japan learnt from the Great Depression.
https://www.youtube.com/watch?v=8YTyJzmiHGk
The debt in the banking system represents claims on future spending power.
They saved the banks, but left the debt in place, not realising the debt in the banking system were claims on future spending power, and this would suck the life out of the Japanese economy for decades to come.
They had come to the same conclusion after 1929.
''The Debt-Deflation Theory of Great Depressions'' Irving Fisher.
https://fraser.stlouisfed.org/files/docs/meltzer/fisdeb33.pdf
Irving Fisher realised the problems after the financial crisis were associated with the debt that had been run up before the financial crisis.
The Japanese could learn from their mistakes, they have been fighting debt deflation since 1991.
They have compensated with public borrowing and spending.
The money supply ' public debt + private debt
The financial crises are the keys to unlock the secrets of the monetary system.
They learnt a lot after 1929.
Financial stability arrived in the Keynesian era and was locked into the regulations of the time.
https://www.brettonwoodsproject.org/wp-content/uploads/2009/10/banking-crises.png
''This Time is Different'' by Reinhart and Rogoff has a graph showing the same thing (Figure 13.1 - The proportion of countries with banking crises, 1900-2008).
We removed the regulations and the financial crises have come back.
What was known became unknown.
Something this big indicated something was fundamentally wrong, and it is, at the lowest level, a general confusion over money and wealth.
Where does the confusion come from?
The classical economists identified the constructive ''earned'' income and the parasitic ''unearned'' income.
Most of the people at the top lived off the parasitic ''unearned'' income and they now had a big problem.
This problem was solved with neoclassical economics, which hides this distinction.
Any serious attempt to study the capitalist system reveals many at the top don't create any wealth; they just extract money from the system.
They confused making money with creating wealth.
Neoclassical economics was born.
Rentiers make money, they don't create wealth.
Rentier activity in the economy had been hidden by confusing making money with creating wealth.
Banks create money, not wealth.
https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf
What you think is happening and what is actually happening are two very different things.
Global policymakers don't know what is happening in the banking system.
Not knowing what wealth is, the neoclassical economist associates wealth with other things, like rising asset prices.
The real world then reveals this is not the case.
1929 '' Wakey, wakey
You then have to wait for a whole new generation to come along, who don't remember what happened last time, before you bring it back again.
When you've got money and wealth sorted out, and know how banks work, you are on the road to enlightenment.
The financial crises are the keys to unlock the secrets of the monetary system.
The Japanese financial crisis in 1991 was a very significant key.
A successful stable, economy went completely off the rails.
This was a great starting point to identify what went wrong to cause the following financial catastrophe.
What changed?
The BoJ used to control the amount of money created by private banks, and direct this for productive purposes.
They used a little known tool in the central banker's toolbox, credit/window guidance.
This was the secret of success of all the Asian Tiger economies.
Their economies got the stable money supply their economies required.
Financial liberalisation would lead to disaster within a few years as things went completely off the rails.
The UK was once the great financial superpower, and it looks like we understood the importance of managing the associated debt in the past.
https://www.housepricecrash.co.uk/forum/uploads/monthly_2018_02/Screen-Shot-2017-04-21-at-13_53_09.png.e32e8fee4ffd68b566ed5235dc1266c2.png
How do the basic elements of the system fit together?
Wealth, money and debt.
It's all got very confused.
GDP measures the new goods and services being produced in the economy every year.
This is where the real wealth in the economy lies.
This is the foundation stone, you really need to know what wealth is as the rest builds on that.
Private banks create the money supply.
https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf
Money and debt come into existence together and disappear together like matter and anti-matter.
Bank loans create money and debt repayments to banks destroy money.
Bank loans create 97% of the money supply
The money supply should grow with the economy, i.e. GDP.
More goods and services in the economy require more money in the economy.
It's a debt based monetary system.
You want the debt to stay at a level where it will not adversely affect the economy.
You want GDP, the money supply and debt to grow together so the economy is not held back by the debt contained within it.
How do you achieve this?
The idea is that banks lend into business and industry to increase the productive capacity of the economy.
Business and industry don't have to wait until they have the money to expand. They can borrow the money and use it to expand today, and then pay that money back in the future.
The economy can then grow more rapidly than it would without banks.
Debt grows with GDP and there are no problems
The banks create money and use it to create real wealth
https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf
When you have a firm grip on what money and wealth really are; and know how banks work, it all falls into place.
The Chinese have been learning from their mistakes and reached the same conclusion.
Davos 2019 '' The Chinese know bank lending needs to be directed into areas that grow the economy and that their earlier stimulus went into the wrong places.
https://www.youtube.com/watch?v=MNBcIFu-_V0
They had pumped bank credit into areas that don't grow GDP, and the private debt-to-GDP had risen to a level they were on the verge of a financial crisis.
Everyone does that with neoclassical economics, but they don't usually see the financial crisis coming, like the US in 1929, Japan 1991 and US, UK and Euro-zone in 2008.
You need to know what wealth is to get the system working properly.
The belief that asset prices represent wealth is where it all starts going wrong.
What goes wrong with neoclassical economics?
1) It makes you think you are creating wealth with rising asset prices
2) Bank credit flows into inflating asset prices.
3) No one notices the private debt building up in the economy as neoclassical economics doesn't consider debt.
4) The banking system and the markets become closely coupled, and as soon as asset prices fall it feeds back into the banking system
5) The money creation of unproductive bank lending makes the economy boom as you head towards a financial crisis and Great Depression.
We got there in 2008; Japan in 1991 and the Chinese saw the financial crisis coming at the last minute.
You think its rising asset prices that are so good for the economy, but it's the money creation of bank credit, being used to fund the transfer of existing assets, that is really driving the economy, as you head towards a financial crisis and are left facing a Great Depression.
Bank credit effectively brings future spending power into today.
They create the money out of nothing for you to spend today, and you make the repayments in the future. When you make the repayments, this destroys money.
Interest is the charge you pay for the service of borrowing your own money from the future.
You need to use bank credit to create wealth, not mess about with financial speculation.
The economy grows with the debt contained within it.
The Japanese studied the Great Depression to avoid that fate.
When the real estate market collapsed in 1991, many of Japan's banks became insolvent, and they knew they were facing a Great Depression.
Richard Koo used to be a central banker at the Federal Reserve Bank of New York, and he looked at both sides of the bank's balance sheets around the Great Depression.
Richard Koo shows the US money supply / banking system (8.30 '' 13 mins):
https://www.youtube.com/watch?v=8YTyJzmiHGk
1) 1929 before the crash - June 1929
2) The Great Depression before the New Deal - June 1933
3) During the New Deal - June 1936
The money supply ' public debt + private debt
The ''private debt'' component was going down with banks going bust and deleveraging from a debt fuelled boom causing debt deflation (a shrinking money supply).
It was the public borrowing and spending of the New Deal that helped the economy recover.
The money supply ' public debt + private debt
The New Deal restored the money supply by increasing the ''public debt'' component of the money supply.
Once the New Deal was working, they reduced Government borrowing and plunged the nation back into recession again.
The enormous public spending and borrowing of WW2, eventually sorted things out.
It's all about maintaining the money supply to avoid debt deflation.
They needed to save the banks.
When banks go down this destroys money.
The money supply ' public debt + private debt
If the private debt term is going down, you want the public debt term to go up to compensate.
Japan used fiscal policy to maintain the money supply as they deleveraged. This was the lesson of the New Deal.
They paid down private debt and used Government borrowing and spending to maintain the money supply as they deleveraged to avoid debt deflation.
They did finish paying back most of the debt some time ago, but the experience was so painful people don't want to borrow anymore.
A debt based monetary system needs new borrowing to keep it running.
It's always a delicate balance between the money being destroyed by debt repayments to banks, and the money being created by new bank loans being taken out.
The money supply ' public debt + private debt
They have to use public borrowing and spending to maintain the money supply.
The BoJ has to keep buying up Government bonds to keep the economy from collapsing into a deflationary spiral.
The Japanese monetary system is still broken today, thirty years after 1991, and they have been fighting debt deflation ever since.
What was the good thing about the Great Depression?
https://www.youtube.com/watch?v=vAStZJCKmbU&list=PLmtuEaMvhDZZQLxg24CAiFgZYldtoCR-R&index=6
At 18 mins.
The claims on future spending power were removed from the banking system.
The system was cleansed and ready to re-start.
Japan could study the Great Depression to avoid this fate.
https://www.youtube.com/watch?v=8YTyJzmiHGk
How did Japan avoid a Great Depression?
They saved the banks.
They used public borrowing and spending to avoid debt deflation.
How did Japan kill growth and inflation for the next thirty years?
They left the debt in place and the repayments on that debt killed growth and inflation (Japanification)
They didn't realise the debt in the banking system were claims on future spending power, and this would suck the life out of the Japanese economy for decades to come.
What happens if you don't use public borrowing and spending to compensate?
The IMF predicted Greek GDP would have recovered by 2015 with austerity.
By 2015 Greek GDP was down 27% and still falling.
The money supply ' public debt + private debt
The ''private debt'' component was going down with deleveraging from a debt fuelled boom. The Troika then wrecked the Greek economy by cutting the ''public debt'' component and pushed the economy into debt deflation (a shrinking money supply).
Greece was pushed into a Great Depression type event by the Troika.
The zero sum nature of the monetary system causes it to behave in very different ways to that expected.
How are we going to pay back all that debt?
If you pay off all the debt there will be no money.
The debt based monetary system is like that.
It's full of surprises.
Private banks create the money supply.
https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf
Money and debt come into existence together and disappear together like matter and anti-matter.
Bank loans create money and debt repayments to banks destroy money.
Bank loans create 97% of the money supply
The money supply ' public debt + private debt
Money and debt are like opposite sides of the same coin.
Private debt and public debt are linked together in ways that we do not understand.
Richard Koo used to be a central banker at the Federal Reserve Bank of New York.
He looks at the system as a whole.
Richard Koo shows the US money supply / banking system around the Great Depression.(8.30 '' 13 mins):
https://www.youtube.com/watch?v=8YTyJzmiHGk
1) 1929 before the crash - June 1929
2) The Great Depression before the New Deal - June 1933
3) During the New Deal - June 1936
The money supply ' public debt + private debt
The ''private debt'' component was going down with banks going bust and deleveraging from a debt fuelled boom causing debt deflation (a shrinking money supply).
It was the public borrowing and spending of the New Deal that helped the economy recover.
The money supply ' public debt + private debt
The New Deal restored the money supply by increasing the ''public debt'' component of the money supply.
Once the New Deal was working, they reduced Government borrowing and plunged the nation back into recession again.
The enormous public spending and borrowing of WW2, eventually sorted things out.
A clanger from the Troika.
The IMF predicted Greek GDP would have recovered by 2015 with austerity.
By 2015 Greek GDP was down 27% and still falling.
The money supply ' public debt + private debt
The ''private debt'' component was going down with deleveraging from a debt fuelled boom. The Troika then wrecked the Greek economy by cutting the ''public debt'' component and pushed the economy into debt deflation (a shrinking money supply).
Greece was pushed into a Great Depression type event by the Troika.
Private debt and public debt are linked together in ways that they did not understand.
Why do you find Governments are often running a surplus when major financial crises hit?
Let's look at Japan 1991.
Richard Koo shows the graph central bankers use and it's the flow of funds within the economy, which sums to zero (32-34 mins.).
https://www.youtube.com/watch?v=8YTyJzmiHGk
As the Government was moving into a surplus, the corporate sector was taking on more and more debt.
This is the zero sum nature of the monetary system, as one thing goes up, something else is going down.
The Japanese Government was running a surplus as the financial crisis hit.
Financial crises come from excessive private debt.
You need MMT to understand the central banker's flow of funds within the economy
A government surplus is sucking money out of the private sector.
A government deficit is pushing money into the private sector.
This is the US (46.30 mins.)
https://www.youtube.com/watch?v=ba8XdDqZ-Jg
The private sector going negative is the problem as you can see in the chart. This is when the financial crises occur.
When the Government deficit covered the trade deficit they were fine, but then they tried to balance the budget
As the Government goes positive, into Bill Clinton's surplus, the private sector is going negative causing a financial crisis.
The current account deficit/surplus, public deficit/surplus and private deficit/surplus are all tied together and sum to zero.
What were those old rules of thumb they developed over the years by trial and error?
Balanced government budgets AND balanced trade (current account)
You can't have one without the other, as the Americans have demonstrated so well.
Global policymakers are getting into serious trouble because they don't understand the monetary system.
The zero sum nature of the monetary system causes it to behave in very different ways to that expected.
Private debt and public debt are linked together in ways that they do not understand.
This is the most deceptive property of bank credit.
Global policymakers haven't realised what is happening as they achieve early success at the expense of an impoverished future.
Private banks create the money supply.
https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf
Money and debt come into existence together and disappear together like matter and anti-matter.
Bank loans create money and debt repayments to banks destroy money.
Bank loans create 97% of the money supply
The central banks have got the basics; they have failed to grasp the wider implications.
Bank credit effectively brings future spending power into today.
The banks create the money for you to spend today, and when you make the repayments this destroys money.
Interest is the charge you pay for borrowing your own money from the future.
Early success can be achieved at the expense of an impoverished future.
This was the secret of the Thatcher Revolution; using bank credit to bring future spending power into today.
All those claims on future spending power that built up in the economy from 1980 to 2008 are the cause of the Productivity Puzzle.
https://www.housepricecrash.co.uk/forum/uploads/monthly_2018_02/Screen-Shot-2017-04-21-at-13_53_09.png.e32e8fee4ffd68b566ed5235dc1266c2.png
Japan is the best example.
In the real estate boom, new money pours into the economy from real estate lending, fuelling a boom in the real economy, which feeds back into the real estate boom.
The Japanese real estate boom of the 1980s was so excessive the people even commented on the ''excess money'', and everyone enjoyed spending that excess money in the economy.
The money creation of bank loans caused the economy to boom, but this was only a secondary effect so debt rose faster than GDP.
There was lots of new money going into the economy, but the inflation was only seen in asset prices, not consumer prices.
The problems were developing in private debt and asset price inflation.
Policymakers looked at public debt and consumer price inflation, and so didn't see the problems developing.
The claims on future spending power were building up in the financial system out of sight and out of mind.
The economy was over-heating and so the BoJ raised interest rates.
Real estate prices were no longer sustainable with higher interest rates.
The real estate ''wealth'' evaporated, but the debt was left.
After the financial crisis, they saved the banks, but left the claims on future spending power in place.
They avoided a Great Depression, but the Japanese economy would flat line for the next thirty years as they made the repayments on the debt they had built up in the 1980s.
https://www.youtube.com/watch?v=8YTyJzmiHGk
This is the cause of Japanification.
Early success had come at the expense of an impoverished future.
They had just been moving future spending power into today with unproductive bank lending, which they used to blow up a massive real estate bubble.
The real estate ''wealth'' evaporated and the claims on future spending power were left to remind them of their folly.
This is why the real estate boom is so good for the economy; it allows future spending power to be brought into today with bank credit.
Bank credit effectively brings future spending power into today.
Banks '' What is the idea?
The idea is that banks lend into business and industry to increase the productive capacity of the economy.
Business and industry don't have to wait until they have the money to expand. They can borrow the money and use it to expand today, and then pay that money back in the future.
The economy can then grow more rapidly than it would without banks.
Debt grows with GDP and there are no problems
The banks create money and use it to create real wealth
https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf
When you have a firm grip on what money and wealth really are; and know how banks work, it all falls into place.
This is how you should use bank credit.