This article appeared on GoldMoney on 17 april 2012 and is republished because the topic is still relevant as of today.
The global credit crunch is beginning to increasingly take on the appearance of a wildfire that has gone out of control. After the subprime mortgage crisis of 2007, the global banking crisis came along in 2008. At the end of 2009 we were confronted with the current sovereign debt crisis for the first time, a crisis which reached its temporary low when Euro member country Ireland nearly defaulted on its debt obligations.
The measures to which governments usually resort when faced with such a severe financial crisis do not seem to work any longer. Government stimulus, reform in accounting regulations, the considerable lowering of interest rates by central bankers and even the printing of money out of thin air have all been resorted to on a truly massive scale, yet none of these measures seem to help the economy out of its current depression. Again and again, new financial crises keep popping up around the globe.
Due to a loss of confidence, our paper based international monetary system has been damaged at its very core. Is it really true that our political-economical system is fundamentally broken beyond repair? It is indeed a question that makes us feel uncomfortable; it is a political-economical “Inconvenient Truth”. Yet we need to ask ourselves: how did we come so far? How has our system grown to such staggering proportions and why are we now being confronted with a crisis of the system itself?
No free capitalism
The current political-economical system, which in its very nature should not be confused with a “normal” free capitalism, has been initiated by the authorities many years ago. It is in effect a joint venture between government and banking, a cooperation that was born out of both parties’ drive for profit. Our government has been forcing us by law, ever since the early thirties of the last century, to make use of paper money, also known as fiat currency, since its use has been endorsed by the government.
The money is being created – by giving out loans – in a joint effort of central and commercial banks. Both the public and financial sector benefit from this creation of credit and money out of thin air: it allows governments to spend more than they normally receive out of taxes and it allows banks to charge interest on the newly created money and credit. Because of the fact that this process causes a gradual but steady increase in the supply of money, while the total amount of available goods and services remains constant, the value of the currency diminishes steadily year after year (a yearly price inflation of roughly 2% is one of the stated objectives of the ECB).
The currency’s depreciation is being paid for by the population; each year their purchasing power diminishes a little more, this is the so called hidden inflation tax. Not only is the general public forced to pay this yearly unfair inflation tax, they also wind up paying for the banks which are deemed “too big to fail”, when they in turn risk slipping into bankruptcy. In our political economy we are in fact dealing with an institutionalized system of coercion, a system that privatises gains and socialises losses.
Our current political economy has become the norm across the globe. It is a highly confusing politico-economical system; it claims being an integral part of capitalism and the blessings of the free market, yet at the same time we are witnessing rampant and large-scale intervention in the markets. This political economical system influences, in a way very difficult for us to see, the behaviour of all the members who participate in this society.
Over the past few years, various monetary and fiscal strategies have caused growth of extraordinary proportions to occur in the financial sector. Moreover it is a well-established fact that governments all over the world take part in this system, as this system brings them budgetary benefit. So firstly we should ask ourselves the question: how does this system actually work?
How the monetary system works
The relative value of the different paper currencies fluctuates with regards to each other and is established on the international foreign exchange markets. Legitimate currency trading is however not the only factor that plays a role in determining the value of the different paper currencies. Governments and central banks also have their impact on the value of their own currency. They can for instance lower or raise the short-term interest rate, adjust the total quantity of money in the system or decrease the value of the currency for use in international trade by imposing capital controls. They could have good reasons for implementing such measures.
Many contemporary countries adopt a monetary policy, which is aimed at weakening their own currency in comparison to the US Dollar in order to boost their export industry. Cheapening your own currency can sometimes result in some very bizarre consequences: the supply of money and credit will grow both in the domestic and the US economy. The money the US consumer spends on cheap foreign consumer goods is being recycled and sent back to the US by foreign central banks; they use it to buy US equities. These equities are then in return being used as collateral in order to create new money in their own local economies. In this way, Americans can keep spending money they don’t have, while the economies of the exporting countries are rapidly expanding.
Governments can also choose to park the funds they have acquired in this manner in tax havens. The Soviet Union for instance chose not to allocate the excess dollars they earned by exporting to the US back in the US. Instead they chose to hold their assets in an internationally operating bank, located in the City of London. They did this because they were afraid the US might simply confiscate their dollars if they had left them in accounts located in the United States.
The Soviets were not the only ones to pursue this policy, the oil producing countries, for various reasons, also decided to keep part of their dollar holdings in financial centres outside of the United States. By following this path, the amount of money and credit did not grow in the countries trading with each other; the money flew instead into the international financial sector.
Over the years an enormous amount of cash found its way into the international financial circuit, the so-called Eurodollar market, and this gave way to a very substantial increase of money and credit worldwide. To avoid supervision, many banks have chosen to move their offices offshore to the tax havens of this world such as the Cayman Islands, the Caribbean Islands or the City of London. This way, money became stateless, stateless because it was beyond the scope and regulation of governments and central banks.
Politics and economics have become interwoven
This monetary intervention has resulted in an enormous increase in the amount of fiat money around the globe, but not only that, it also has politicised the international balance of trade and the exchange rate mechanism. Political power play has eclipsed the market. Central bankers and treasury ministers not only became arbiters of both value and stability of our medium of exchange, they also ended up ruling over the continuity of international trade between the different countries. In other words, we have ended up with some kind of hybrid form of capitalism, a form of capitalism in which politics and economics have become deeply interwoven.
But there is more. Poor regulation and rather peculiar fiscal policies have resulted in a tremendous growth of the banking and financial sector. By imposing too much regulation on the productive sector of the economy and imposing too little regulation on the financial economy, most of the money that was created wasn’t used for investments in the productive sector; instead it was used for speculation in the financial sector. The fiscal policies that were chosen by the governments of the world have resulted in an enormous increase of international debt levels for both companies and individuals over the past few years. A logical consequence of fiscal measures, which promoted the accumulation of debt, while at the same time discouraging the possession of properties and assets.
The interbank market and the financial economy became the ultimate refuge for investors and entrepreneurs who wanted to make money or simply wanted to escape the manipulations of the political economy. The money that was created as a consequence of permanent government deficits and monetary interventions was not only used as a basis for further credit expansion, it was also increasingly used for speculation. Speculation, which has initially been used by international banks and companies to hedge themselves against fiat currency fluctuations. But as a result of far reaching financial deregulation, increasingly powerful computers and the creation of new financial instruments, speculation increasingly became a form of betting on the performance of stocks, interest rates and foreign exchange rates. Money was used to earn more money.
The financial sector grew excessively and became tremendously profitable, as a result bonuses became bigger and bigger. The sector was used, both by governments and by companies, to take out new loans or to refinance old ones. The newly created liquidity was partially channelled into investments and consumption, but was mostly used to purchase stocks, bonds, commodities and real estate. Because of all this, markets rose steadily year after year. Meanwhile governments, the productive sector and the financial economy grew simultaneously in size
All this creation of money and credit comes however at a price. To begin with, rising markets actually only indicate a further depreciation of the value of our fiat money in this monetary system. Some markets rose more than others, but eventually more money ended up in the financial economy than in the productive sector of the economy. As a consequence of this fact, people in the financial markets earned more than people who worked in the productive sector and the wealth gap between those two groups widened even further in the process. People in the financial sector have been compensated more for the depreciation of their currency than people who earned money in the productive sector, merely because of the fact that they got more of the depreciated cash than their unfortunate counterparts.
In addition the financial economy has grown more and more unstable. Much of the newly printed cash was used to purchase corporate and government bonds originating from riskier nations. When interest rates are decreasing, the value of bonds increases. Because of rising bond prices, the returns in the form of interest on principal have diminished across the board. The lower interest rates have forced financial intermediaries in the financial sector to take increasingly bigger and bigger risks in order to generate a reasonable return on investment. New financial products were designed to increase profitability. This in turn made our international financial markets look increasingly like a gigantic “Global Casino”. It would turn out to be the Achilles heel of the political economy.
A combination of power politics, reckless monetary expansion, poor regulation, fiscal error, failing supervision and human greed, brought us to a modern age “tulip mania”, this time however the bubble was blown on a global scale. Everybody participated in it, everybody acted like it was perfectly normal, but nobody truly got the big picture of things. Until very recently everything seemed to be all right. The credit crisis brought us an abrupt end to this financial fairy tale. When the bust sets in, the liabilities remain, while the value of the underlying assets has almost vanished entirely. It turns out that we are much poorer than we previously thought.
Because the very survival of our financial system is dependent on the functioning of our banking system, governments are desperately trying to keep this sector afloat by taking unorthodox measures. Yet bailouts like the ones we have witnessed in 2008 are costing the governments enormous amounts of money, so much so that weaker governments themselves are now getting into trouble. It seems that the global credit crunch has created an ever-growing avalanche of bankruptcies. Due to the fact that many banks own government bonds of weaker nations, not bailing out the weaker countries was not an option, since it would have resulted in a systemic collapse of these bond-holding banks. This is exactly the reason why the bailout of Greece eventually had to be followed by a further bailout of Ireland.
The Political Inconvenient Truth
Despite all the monetary and fiscal measures that have already been taken across the globe, our global debt based economy slowly keeps on sinking. A lot more money will have to be thrown at this problem in order for it to disappear, but meanwhile we see public support for new bailouts quickly eroding.
As a result of all these problems, the political economy itself is at risk. Even a total disintegration of the current political economical system as a result of widespread debt defaults can no longer be safely ruled out. In the long run, such a scenario could even turn out to be a good thing, since the world is craving for more transparent relationships and a more fair distribution of opportunities than those we enjoy today.