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ETFs – Part 2

So far so vanilla. Now lets look at how, as the ETF market has grown, the clever boys and girls of finance have found ‘innovative’ ways of pumping those ETFs up a bit, just like they did to Securities.

Use of Derivatives in ‘Synthetic’ ETFs

The main innovation in ETFs has been the creation of what are called ‘synthetic’ ETFs which instead of actually buying or even borrowing a basket of shares, use derivatives to track the value of the underlying market without the need to match its composition. Instead the  Synthetic ETF enters into an asset swap agreement with a counterparty using an over-the-counter  (OTC) Derivative. Before explaining what the heck that means let’s just look at how quickly the Synthetic market has grown.

Synthetic ETFs have grown very rapidly in Europe and in Asia. In Europe Synthetic ETFs are now 45% of the over all ETF market. Synthetics doubled their market share between 08 and 09.

The key to  Synthetics is the Counterparty. What happens is the ETF Sponsor designs the deal, the AP (Apporved Participant. Usually one of the big banks or brokers) buys the basket of assets to make it, but then swaps that basket with the Counterparty for a different basket of assets in a derivative swap deal. However it turns out that rather too often for comfort, not only will the Sponsor and the AP be the same bank, but more often than not it will be the Asset Management branch of the same bank who will be the Swap Counter-party  as well. It is quite common for  the same bank to play all three roles. So a single bank creates the ETF, appoints itself as AP so it can fund it and then its Asset Management desk becomes the derivative counterparty in order to mutate the whole thing into a synthetic ETF. Think about what this does to the risk. What was market risk, where the risk was spread out across all the different shares, is now a single counterparty risk. The bank has effectively put all  the ETF’s risk in one basket – itself.

But even if it is a different bank acting as the  derivative counterparty  the situation is only very slightly less incestuous because it is nearly always the case that the Sponsor, AP and Counter-party will all be from the same small group of big banks, brokers and Asset Managers. And it is also a statistical fact that all of them will be counterparties with each other many, many times over, via the over $1.2 Quadrillion of other repo, rehypothecation and derivative deals. This, as the Financial Stability Board’s report on instabilities in the ETF market rather laconically puts it,

…may also generate new types of risks, linked to the complexity and relative opacity of the newest breed of ETFs. The impact of such innovations on market liquidity and on financial institutions servicing the management of the fund is not yet fully understood by market participants, especially during episodes of acute market stress.

Not fully understood?  I think we may not have understood what such entanglements of reciprocal risk meant before the first period of ‘acute market stress’, but I think now it is nutty to imagine the banks don’t know how risky such risk incest really is. The FSB report itself concludes,

Since the swap counterparty is typically the bank also acting as ETF provider, investors may be exposed if the bank defaults. Therefore, problems at those banks that are most active in swap-based ETFs may constitute a powerful source of contagion and systemic risk.(P.4)

Please step forward Deutsche Bank and Soc Gen!

A “powerful source of contagion and systemic risk”. Sounds really good for you and me. So why are the banks doing it anyway? The official answer is that using Derivatives means the  ETF can track the value of the market more closely. Though few have complained that Vanilla ETFs don’t track closely enough. And as the BIS report  points out,

…the lower tracking error risk comes at the cost of increased counterparty risk to the swap provider. (P.8)

But this doesn’t answer why a bank would enter into a swap with itself as the counterparty. The whole idea of counterparties, once upon a time, was to hedge some of the risk in the original deal by passing it off to someone else. Using yourself as counterparty keeps the risk in-house. So once again why?

The answer is, according to the BIS report on ETFs,

…that this structure exploits synergies between banks’ collateral management practices and the funding of their warehoused securities. (P.5)

‘Synergies’ sounds like it should be good. Sadly it may not be. As the BIS goes on to explain,

…synergies arise from the market-making activities of investment banking, which usually require maintaining a large inventory of stocks and bonds …. When these stocks and bonds are less liquid, they will have to be funded either in the unsecured markets or in repo markets with deep haircuts. (P.8)

In essence  it costs the banks money to have illiquid assets on their books. The repo markets won’t accept them as collateral unless they come with a deep haircut.   So the banks can do little with them except sit on them. Basically it costs the bank to have the illiquid, hard to sell or Repo, stocks on its books. But.. .if they happen to have created a handy synthetic ETF, then everything changes because,

For example, there could be incentives to post illiquid securities as collateral assets [in the ETF Swap]…. By posting them as collateral assets to the ETF sponsor in a swap transaction, the investment bank division can effectively fund these assets at zero cost….

Handy isn’t it? Assets they can’t repo without hefty haircuts can be posted as collateral to their own ETF with the approval of the ETF Sponsor of course – who will just happen to be… the same bank – without those pesky, hurtful haircuts. In fact,

The cost savings accruing to the investment banking activities can be directly linked to the quality of the collateral assets transferred to the ETF sponsor.

The worse they are, the more illiquid, the more the bank saves/makes by choosing to put them in an ETF rather than having them loiter on its books.

…the synthetic ETF creation process may be driven by the possibility for the bank to raise funding against an illiquid portfolio that cannot otherwise be financed in the repo market. (FSB report P.4)

This is surely financial innovation at its shining best.

Now of course the banks will say they would never consider slipping some old tat into their ETF under cover of opacity. Except that they did, every one of them, do exactly that when they systematically and grossly lied about every single aspect of hundreds of billions worth of shabby mortgages which they intentionally stuffed into CDOs in order to shaft and rob those they sold them to. This is a matter of public record. The 522 pages of the Class Action suit against Citi  which Citi lost ,makes truly shocking reading. The same people, under the same management, with the same world view, same assumptions and same prejudices, looking for the same profits, to gain the same bonuses will do the same with ETFs as they did with CDOs. The bubble will incubate inflated prices and effervescent greed until the top of the market is reached, which will signal the turn to more and more deceitful practices done in the name of keeping it all going so as to avoid a crash. Until that is, the crash comes anyway, as it will, and everyone claims not to have known or even suspected.

There are, of course,  a few inadequate rules convering some aspects of this rather obvious entry point for fraud. The collateral provided by the counterparty has to cover 90% of the value of the ETF. So at least if it did all go awry there should only be a 10% loss. Of course who decides how much the collateral is actually worth? Another entry point for fraud. The types of collateral are limited to cash, equities (shares) and government bonds of OECD countries. Yikes! I wonder how many European synthetic ETFs are stuffed with Spanish and Italian sovereign bonds held at full value with a risk weighting of zero?  I leave you to guess.

Now another wrinkle on this is that when equities are posted as collateral they are given some sort of ‘haircut’. This can be as high as 20%  as is the case in Ireland. This is done so that the ETF sponsor can say that the ETF is super safe because it is ‘over-capitalized’ by 20%.  However in Luxembourg the haircut doesn’t have to be 20%. The amount is negotiated between the Fund Custodian and the Fund Management Company. Except we already know they can be the same company. And even if they are not, the relationship between Management and Custodian is notoriously incestuous. The Custodians rely on the Management companies to bring them work. Who bites the hand that feeds them?  They didn’t when they were Custodians of fraudulent CDOs.

So Ireland 20% haircuts, Luxembourg negotiable. Guess in which country most synthetic ETFs are registered?  The moment you hear that Ireland is reconsidering the 20% haircut in order to compete with Luxembourg you’ll know we have reached Fraud Con 2 . But then you lean back from the keyboard and think – Am I really feeling relieved that Ireland is the alternative to Luxembourg? Let’s face it on the evidence of the last 4 years I would have to say that if you drew the Irish regulator a map, gave him directions and a torch, and left a trail of bread crumbs he still wouldn’t be able to find his own arse.

Anyway I digress.

I should also mention that all the CDOs ever made were subject to rules about over-collateralization. It didn’t save any of them. The over-collateralization turned out to be largely a function/fiction of over-optimistic bubble prices which went massively negative as soon as the crisis started. As the BIS report says of the collapse of CDOs,

Despite the overcollateralization enforced by credit agencies when rating these products, embedded leverage and market risks were materially higher than those modelled. As the unmodeled market and liquidity risks of these products materialised, it led to fire sales that subsequently triggered a broad-based deleveraging process in the financial markets.     (P. 11)

The same dynamic of over-pricing followed by price collapse would undoubtedly be true of ETFs as well. There are few sound reasons to think otherwise.

Dodgy as all this may sound the ‘Death Zone” as mountaineers call it, is still ahead of us as we ascend Mount Finance. Above the tree line of Synthetic ETFs are the Leveraged, Inverse and Leveraged Inverse ETFs. They all use increasingly complex and opaque derivatives contracts to achieve multiples of the rise or fall in value of the market being modelled. These synthetic ETFs offer double and triple gains but with the risk of double and triple losses. What is often not understood is that because these funds are calculated daily if you are foolish enough to leave your money in there for more than a few hours, you will almost certainly lose no matter which way the market moves. Plus it doesn’t take a genius to see that such funds, when a crisis of confidence hits, could easily trigger a stampede to withdraw which could in turn force the banks to sell some of the illiquid assets they put into the ETF which would depress the prices of those assets and rattle the market as to their value and the solvency of those holding them but needing to sell them quick.

Higher up still, where the oxygen of common sense is too thin to support sentient life, beyond even leveraged ETFs, there are now a range of yet more exotic ETF-like products often referred to collectively as ETPs (Exchange Traded Products). ETNs (Exchange Traded Notes) and ETVs (Exchange Traded Vehicles) are in fact not funds at all. They are debt based products. They are so removed from any notion of tracking a market that the name is almost misleading. Why invent them? Well for one thing they are not subject to some of the requirements which apply to Funds, such as rules covering the diversity of the assets they are based on. Some don’t require collateral behind them at all, just the good standing of the issuer (Usually a bank).  ETNs are a debt instrument issued by and backed by the financial institution ‘Sponsoring’ the ETN. As such the risk is entirely based on the rating and solvency of the issuer.

ETVs are similar to ETNs but the debt is not even issued by a bank directly but by an SPV – an arm’s length company created to contain any losses. As such they add even more counterparty risk. You have to marvel at how quickly all these products, so ominously familiar from the first leg of the crash, have been re-invented in their new guises.

At this point you might be thinking that the problem boils down to those crazy Europeans with their inexplicable death-wish love for synthetic rubbish. While I agree with that view of European Banking I do have to point out that while the Europeans are indeed going to shoot themselves in the head with derivatives the Americans are going to garrote themselves with ‘Securities Lending’.

Securities Lending is the practice of taking the securities from one product/place and lending them out to someone else for them to use in some other product/place. We all do it. You put money in your bank but ‘allow’ the bank to lend it out. In effect your money is supposed to be ‘in’ your account belonging to you, but is in fact in Aberdeen being used by a brewer to make more beer and he thinks the money now ‘belongs’ to him. Same money, two places, two ‘owners’. Securities lending does the same thing on a global scale with securities. Securities owned by banks, Pension funds, and in fact every kind of fund including ETFs all lend out their securities (shares etc)….to each other. Don’t worry –  they’re all good for it.

Such lending is the basis of  how shorting is done. Hedge funds rely on it. And now there has been a huge increase in securities lending in the ETF market. What this means is that the securities which are ‘in’ the basket of assets underpinning the ETF are in fact not in it at all but have been lent out to someone else for them to use.  You’ll no doubt recognize this as akin to repo or re-hypothecation. You can read about re-hypothecation and its dangers in “Rumours, disasters and re-hypothecation” and in “Plan B

According to the FSB report,

Some ETF providers are said to generate more fee income from securities lending than from their traditional management fees. (P.4)

The fact that more money is made from lending-out than from taking care of the shop is a worry. But a greater worry is the compounding of such lending. You see, exactly as is the case in re-hypothecation, once a security has been lent out by an ETF  there is nothing – or nothing that can’t be easily gotten around – to stop it being lent out over and over.  Each person to whom it is lent out puts it to work as the guarantee of their business but can than also lend it out exactly as it was lent to them, creating long chains of people all of whom have a claim on it but none of whom will own it, when the  first person pulls the emergency cord. As with re-hypothecation, in the bubble years securities lending leads to a situation of barely regulated leverage and as the leverage grows so does the systemic risk within the system as a whole.

…the use of ETFs as collateral in a long chain of secured lending and rehypothecation may create operational risks and contribute to the build up of leverage.

Leverage is what our present financial system needs like a junky needs Smack. Now ETFs are feeding that habit.

And now for the final thing I want to raise.

ETFs of all sorts are passive instruments which mean they blindly follow and replicate the ups and downs of whatever  market (shares, commodities or bonds) they are following. The idea is that the thousands of decisions of traders in the market will be a robust indicator of ‘real worth and value’ which the ETF ‘efficiently’, but blindly, follows. Fine. But now imagine that the volume of shares and trades in the ETF begins to grow rather large in comparison to the volume of shares and trades in the underlying market. You can imagine a situation where a small number of traders, with a small amount of wisdom between them, is effectively making decisions for a vast number of others who have far greater wealth,  but who are just slavishly following the few. At that point we will have an unpside down market where the blind Many follow the worried Few.  And the huge buying power of the Many, blind as they are, drowns out the market signals of the few real decision-making traders in the actual market. This will lead to greater volatility as huge volumes of blind trades are triggered by tiny signals from below. You end up with a very large tail, thrashing a small dog. We’re not there yet although I think this may already be beginning to happen with some tech stocks like Apple.

Now, and lastly I promise, add in the fact that ETF shares are themselves traded in the markets the ETFs are following, as are the shares of the banks who run and fund those ETFs. Shares in some of the banks who run the ETF market will be in many ETFs. At what point does the value of the ETFs pump up the value of the bank shares, which pumps up the value of the market the ETF is following which pumps the value of the ETF?

We had this sort of run-away feedback in the market for CDOs just before they exploded.

Couldn’t happen? The average daily  volume of trade in options on US ETFs now exceeds those of ALL US stock options combined.

ETFs have in their DNA everything it takes to become monstrously dangerous. They are wide open to all the fraud and shitty behaviour the banks seem not to be able to stop themselves from bathing in. They are awash in leverage and riding on a tide of derivatives which hide so much concentration of counterparty risk that it makes a mockery of ‘risk management’. ETFs are barely regulated by regulators who are massively behind the curve. And the ETF industry is both valuable to those who run it (the Banks) and is gearing up to fight a pre-emptive war with the regulatory authorities.

The ETF industry is just now setting up a new industry association the National Exchange Traded Fund Association NETFA, whose goal  “…will be to address misinformation about ETFs, said Adam Patti, the association’s vice chairman.”

And there you have it. You see there is in fact nothing wrong with ETFs at all. They are honest, well regulated, perhaps even over-regulated, transparent, safe havens in an unsafe world.  Innovative products where risk has been banished or massaged away by experts, for your benefit not theirs. They are just there to serve you.

All you need to watch out for is misinformation.


70 Responses to ETFs – Part 2

  1. daveTshave May 4, 2012 at 3:27 pm #

    Splendid writing as always David. I thought you’d lost interest in posting to the blog but wow, that is a perfect example of quality over quantity in journalism. How can the banksters get away with such opaque nonsense? No, I know the answer to that one… We desperately need a return to a simpler, less disaster prone system.

    Thanks as ever for your insights!

    • Golem XIV May 4, 2012 at 4:57 pm #


      Thank you and welcome to the blog.

  2. BenMc May 4, 2012 at 4:07 pm #


    Thank you for the fascinating and insightful writing that you do. I’m going to have to go back and re-read these articles a few times to properly digest them.

    Presently, I’m still trying to wrap my head around what all of this means for me and my investments. Here’s my current understanding, and I’m hoping that someone will correct me if I’m wrong. Part of my investing plan (Harry Browne’s Permanent Portfolio) calls for me to hold some of my assets in long term US treasuries to hedge against a deflationary scenario. Up to now, I’ve been using iShares 20+yr Treasury Bond ETF (TLT) to gain that exposure.

    Now, if I’m reading your posts correctly, those funds are at a very real risk of blowing up some day, even if the investment they are tracking continues to rally. The shares I hold of TLT could collapse in value due to some unforeseen event involving counter-party risk. The reality is I hold TLT, not long-term treasuries, even though mentally I have been treating them as equivalent. It doesn’t matter if TLT is well-constructed — if the bank issuing TLT has major problems, then TLT could blow up, right?

    I’m guessing that it would be much better to buy the bonds directly, especially if one of the main purposes of holding the long-term treasuries is to AVOID default risk. Can anybody chime in about this assessment?

    • gizmo_rat May 5, 2012 at 3:25 pm #


      Yes, if you are able you should hold your LTTs directly. I believe that a significant proportion of TLT’s income is from securities lending. There may also be some tax implications that favour direct ownership.

      There’s some discussion about this topic here:

      Permanent Portfolio Discussion Forum: TLT vs buying direct

      This comes with the caveat that I’m in the UK and I’m most definitely not a financial advisor !

      Golem XIV, thank you.

  3. Golem XIV May 4, 2012 at 4:56 pm #


    Welcome to you. I am glad you have found something useful in the blog. But PLEASE remember I am NOT a professional and NOT any sort of advisor.

    All I can say to you is that I do think if you want Treasuries as a long term hedge then you would be better owning them. Basically if you think something is a good investment, then buy the thing itself not any sort of paper purporting to be like it, near it, a claim on it or any other sort of paper promise.

    Just remember I’m not an advisor.

    • BenMc May 4, 2012 at 5:31 pm #


      Understood. Thanks for the response.

      The idea of “buying the thing itself” seems to be one of the most important pieces of investment advice that I have come across. I have struggled w/ trying to explain the idea to others. My in-laws were just talking the other week about how their 401k is FINALLY allowing them to “buy” gold and other commodities — via an ETF.

    • Piano Racer May 4, 2012 at 7:06 pm #


      A bond is still a claim on wealth as opposed to actual wealth. I think that ETFs are very vulnerable, but the true bubble is in PROMISES and the only hedge is TANGIBLE ASSETS.

      If it doesn’t hurt when you drop it on your foot, it isn’t a tangible asset. Bonds are not tangible assets, they’re just slightly less ridiculous promises than an ETF.

      I find gold and especially silver to be wonderful in this regard, but it can be absolutely anything. The Alpha Strategy is a great place to start: http://www.amazon.com/The-Alpha-Strategy-Financial-Self-Defense/dp/0936906049

      Short promises, long tangibles; that is how we protect ourselves. Possession is 9/10ths the law, a bird in the hand is better than two in the bush, etc.

      Keep up the great work, David!

      • Piano Racer May 4, 2012 at 9:12 pm #

        Found it on the Wayback Machine:


        This book changed my life.

      • Gary May 6, 2012 at 12:56 pm #

        This is a fanastic blog from golem highlighting the urgency to get out of all paper and get some tangible assets in your hand. The scale of the impending paper collapse either by a deflationary implosion or a hyperinflationary monetization, will destroy all paper and it will revert to its intrinsic value of the ink and paper. If you hold any sort of iou, including that fiat iou called cash imo,
        you will probably have to kiss it’s face value goodbye.

  4. CArratiaM May 4, 2012 at 6:06 pm #

    Magnificent piece Golem.

    I wonder how these empty bubbles can grow so huge before they actually collapse…

  5. Joe R May 4, 2012 at 7:33 pm #

    Off topic but on something you posted on before, Golem.

    $1.6 Billion of MF Globals missing money has been located, half of it in the UK. Link follows.


  6. Pilotfish May 5, 2012 at 4:55 am #

    Synthetic ETF’s sound a lot like our fractional reserve banking system run by central bankers that the government has issued a monopoly to counterfeiting what passes for legal tender. I’m coming to the conclusion if you don’t have the stock certificate in your hot little hand you don’t really own anything except the promise from the brokerage house you bought it from who is supposedly holding your shares on your behalf and in safe keeping. The precious metal ETF’s are plain and simple a play in the paper markets and not the physical market again no gold just a promise of payment in fiat paper, hopefully before it collapses when it is discovered they have a fraction of what they say they have because they leased it out and like synthetic ETF’s of stocks more than one person has a claim on the same gold. Great follow up article and good advise you gave early if you don’t have possession you don’t really own it and even then the government will be looking for a way to tax you out of it. To think pensions funds buy this junk what a crime and the working guy is going to be left holding the bag again, and the fix is more regulation by the people and system that made it all possible in the first place. I keep saying nothing will really change until we give up on fiat currencies and governments that impose them on us.

  7. Desmond Dillon May 5, 2012 at 9:00 am #

    what could a government possibly do to disempower the banksters .?They pride themselves on being to slick to get caught and they cannot stop counterfeiting. This continual robbing impoverishes all of us. Maybe its time for some REAL democracy.

    • Golem XIV May 5, 2012 at 9:10 am #

      Hello Desomond Dillon,

      I think the time to take back our democracy is upon us. Not just take it back but reconstitute it.

      I think what we are doing here and others are doing in other places like this, is the first and most revolutionary step – to step outside of the concensus of agreed certainties and received wisdoms. And to directly challenge the authority of those who try to tell us we aren’t qualified or expert enough to do so.

      It was what ordinary people did in the Coffe houses and Free houses of the early 1600 and it led to the English Revolution.

      We did it then. Those people were no better than us. We can do it again.

      In my mind that revolution remains the unfinished business of the people of these islands. It is ours to finish. And now is the time.

    • Charles Wheeler May 5, 2012 at 5:11 pm #

      We seem to be entering a post-democratic era, where our leaders are ‘elected’ or installed from a narrowing pool of technocrats charged with validating markets. Of course, the libertarian right regard any democratic controls as an an unnecessary interference in the efficient allocation of resources – which is a tautological justification for any allocation the market produces (even if that results in mass unemployment, ‘negative growth’ and near starvation).

      Paradoxically, ‘democracy’ has ossified the political process by legitimising oligarchy. When divine right ceased to be tenable, the ‘social contract’ had to be constructed to justify the rule of the propertied classes (who were largely from the same class that had ruled in the name of God). With the development of capitalism, a rough-and-ready form of democracy was shaped to ensure the legitimation of a rising middle class – secure enough from the ‘rule of the mob’ or genuine proportional representation to ensure the hands on the levers rarely changed. A brief interregnum after the war ushered in a short period of more collectivist ‘social democracy’ – railed at as ‘The Road to Serfdom’ by the libertarians, before lapsing back into oligarchy (‘The Road to Neo-Feudalism’?) as accelerating inequality, creating feedback loops of wealth and political power ensured a return to laissez-faire and reduced social mobility.

      But: how to break that cycle through the same ‘democratic process’ that has brought it about?

      p.s. looks like another Goldman alumnus is poised to take on role as Governor of the BoE as the grip of the giant squid tightens.

      • Charles Wheeler May 5, 2012 at 5:32 pm #

        p.p.s the recent local elections illustrate how the problem has been exacerbated by the very disillusionment this process has engendered, with just 30% turnouts – we now have a London mayor elected by less than 20% of the electorate, and a Tory PM from a party elected by just 24% of the electorate – as the fall in turnout amplifies the support of those who do vote (largely the wealthier and propertied rather than those in short-term rentals with low-paid, insecure, short-term work, many of whom are not even registering to vote) – and thus, those defending the status quo are able to use the stick of an increasingly enfeebled democratic legitimacy (bolstered by the authoritarian apparatus of a police state) to beat down any form of opposition from the disenfranchised.

        • John Souter May 5, 2012 at 7:24 pm #

          Well said Charles -apathy is the most effective tool in the political tool box and it’s dismantling democracy pretty fast with the financial idiocy acting as the wrecking ball.

          Much as I welcome the analysis and exposure of the labyrinthine financial alchemy an invigorated democratic process is our only hope towards a future dominated by the values of conscience.

          If our politicians had any real commitment to democracy they would be concerned by issues such as low turnouts and apathy towards the political process.

          They might even consider there are times when a small freedom has to be tactically shelved in order for a better freedom and democratic process to take form. One such small loss of freedom could be to make voting in elections compulsory. Then, even though 60 -70% were to spoil their papers it would expose the ridiculous claims of ‘wins’ and ‘majorities’ as the Pyrrhic victories they are.

        • Mike Hall May 5, 2012 at 8:02 pm #

          Yes, very well summarised Charles.

          How anyone can regard those turnouts as ‘democracy’ beggars belief. Didn’t seem to get much (any?) coverage on the lame stream media I saw (BBC).

          John, I don’t think they’ll make voting compulsory for precisely the point you make. But it’s a good idea.

          • Labled May 8, 2012 at 1:19 am #

            If i had the chance to vote for None of the Above this week, thats where my tick would have gone.

  8. Mark Redwood May 5, 2012 at 10:00 am #

    Here is an article written for the economist back in June 2011.


    Makes pretty much the same points as Golem does in the article.

    What is curious is that institutions like BIS know how destructive these kind of instruments can be. So what are they doing about them?

    It reminds me very much of Merv King, and rather than a grovelling apology for f…ing up so badly, it was more along the lines of.

    “we knew along that this kind of thing was bad for the economy, and if Labour hadn’t of taken all our power away we would have done something about it…. honestly… really we would have.”

    Yeah, right. Was that a flying pig I just saw swooping over the BoE?

    • Golem XIV May 5, 2012 at 11:02 am #

      Hello Mark Redwood,

      Thanks for the link. Good article.

      I am a master of re-inventing the wheel am I not. I get there in the end though.

  9. MacB May 5, 2012 at 11:30 am #

    As I mentioned on part 1 this idea of multiple claims on the same asset really bothers me and the mechanisms themselves are actually pretty unimportant. But the systemic risk only exists because the real and unreal are mingled in together. Or, more accurately, we only care about the vast systemic risk in the unreal because deregulation has forced us to.

    What I don’t understand is why, in the MSM, we hear so little about the losing side in these bets. In casino terms all we seem to be doing is enabling degenerative gamblers to carry on chasing the money. I’ve given up worrying about the psychology of all this, or the complexity, I don’t think either can be rationalised out.

    For example how many of us actually know what our pensions/savings are invested in? We hear about the big losses, your MF Globals and the like, but there must be a steady stream of counterparties to the big wins we always hear about. Every time another ‘giant of the markets’ is proclaimed, and it’s clear their success hasn’t been due to growth in the real, there’s never an analysis of who’s lost in the trades they’ve been winning on.

  10. Jonathan Sugarman May 5, 2012 at 1:29 pm #


    How dare you belittle the Irish Financial Regulator and his office?!?

    Have you not heard that the days of ‘Light-touch Regulation’ that our ex-Minister of Finance was so proud of, are now truly over?!?

    That is precisely why I was forbidden to record my meeting with the Regulator’s office on February 23rd.year.The Regulator and his office are very busy people, who take their responsibilities VERY seriously; so much so, that more than two months have passed since our meeting, but official minutes of our meeting have yet to be produced. Or perhaps the difficulty lies with with the acknowledgements made during the meeting?!? Time will tell. In Ireland there is a saying that “When God made time, HE made lots of it!”.

    Kind regards,
    Jonathan Sugarman – UniCredit Ireland’s EX Risk Manager

    PS 1
    For readers wishing to learn more about UniCredit’s colourful history in Ireland, please visit my blog. It also includes a link to a documentary made by ABC TV in Australia 6 months ago in which my story features.

    PS 2
    The fact that the Irish Government logs on to my blog almost every week, would imply that someone is getting worried. Last week’s ‘visit’ was on Wednesday at 13:45 by IP address 137.191……
    Perhaps they are re-considering the wisdom of the appointment of UniCredit Ireland’s chairman at the time of my resignation to the current board of the Central Bank of Ireland:

    • Roger May 5, 2012 at 3:48 pm #

      More power to you Jonathan.


      Smash the Banksters


    • Mike Hall May 5, 2012 at 8:12 pm #

      Always a pleasure to see you here Johnathon & in humorous form (cf your opening line, lol), alongside your informative comments. 🙂

      Thanks for your all too rare integrity in our small country.

      • Jonathan Sugarman May 6, 2012 at 9:03 pm #

        Thank-you Roger; thank-you Mike.

        These are interesting times indeed.

        To be continued…


  11. archytas May 5, 2012 at 4:36 pm #

    I’m reminded of the cigarette companies smuggling their own cigarettes to dodge tax through Turks and Cacos (etc.), though in this case the ‘collateral’ left over at any point will be worth that of a pre-smoked cigarette.
    They are effectively evading tax in a scheme underwritten by the tax-payer without consent. Remember the old days of ski-jumping where judges were able to give marks for “style”? The financial system is doing something similar in its mark to model valuing. Only 8% of loans in the UK last year went into productive capacity and I’d guess the return ratio of queezing to GDP is 2.5 : !. QE, TARP and LTRO look mor and more like some Soviet quota scheme designed to keep clapped out production up. It’s time for zero-based budgeting on banks – what would we miss if we didn’t have them? I suggest we’d get more from rolling out broadband to all homes and giving everyone a free credit union style account to take care of savings, personal loans, a small overdraft, mortgage and pension all designed to keep fees to a minimum.

  12. Charles Wheeler May 5, 2012 at 5:24 pm #

    Timely piece by Ben Chu on the causes of the crisis:

    “… the UK’s banking crisis was not a consequence of bad loans made to British households or companies … it is far from clear that UK households were disastrously overly indebted in the years preceding the crisis … There’s no question that UK banks became perilously overextended in the years after the turn of the millennium. Their total assets reached 350% of our annual GDP, almost doubling over a decade. But let’s be clear: this massive expansion of lending was not a consequence of loans to British households. Much of it was lending to other banks (both here in the UK and abroad) as their casino trading arms engaged in an orgy of socially useless speculation.”

    • Mike Hall May 5, 2012 at 8:47 pm #

      Interesting piece Charles, Ben Chou is often worth a read.

      He has rather left the question hanging tho’, as to what then is holding back aggregate spending in UK, if it is not so much debt overhang pay down (whilst there clearly is some of this). Given that the data shows UK stagnating & trending into recession.

      An obvious answer is then unemployment combined with pro cyclical austerity causing even more. That is, a pure act of ideologically driven economic vandalism by the Con Dem coalition.

      Perhaps Ben will revisit this in a future blog.

      How different things might be if Labour could remember where it came from & actually represent the interests of labour. That is, discover MMT & realise that gov deficit/debt ‘targets’ are not required at all. Do they never read anything by a non mainstream economist? You’d have thought they’re getting too hard to miss with all the internet blogs & such.

  13. Desmond Dillon May 6, 2012 at 10:40 am #

    hi Golem and archytas, John and all interested in somehow finding a way to stop the rogues. an ‘invigorated democratic process’ could possibly offer something other than the oppressive fear driven blackmail or violent chaos as currently on offer. Thats exactly the situation in Greece today and probably with us at the next election.

    If we could ban political parties we might get something approaching democracy where the person we vote for actually works for us instead of others who steal our mandate. like political parties and their masters the so called markets.

    to big to fail is an oxymoronic pseudonym for to big to jail. I feel we have to call them out. that is :: we need a systemic breakdown to flush out the rubbish. then no fractional reserve banking and marking to fantasy. we could have the post office everybody wants.

    • Mike Hall May 6, 2012 at 11:56 am #

      I’m not sure fractional reserve is the problem, or in itself would stop the casino. Former US regulator William Black believes proper regulation (getting rid of most Orwellian titled ‘investment’ activities) will do the job. (Home blog http://neweconomicperspectives.org/ )

      positivemoney.org advocate full reserve as well as the ‘functional finance’ of MMT. If that was what was on offer, I’d certainly vote for it. I think the ‘functional finance approach to fiscal management is the real transformational tool for the real economy & majority of citizens.

      All this needs a functioning democracy of course.

      Agree with getting parties out of the political process. Elected officials should have no ‘memberships’ or significant outside vested interests of any kind imo. Parties are just another highly centralised control mechanism for corruption. Likewise trades union ‘sponsorship’ of candidates. The TU movement has been of enormous benefit historically, but what they started needs to move on. They have become too focused on their sectoral interests in modern times, & lost focus on the overall wellbeing of ‘labour’ imho.

      • johnm33 May 6, 2012 at 6:06 pm #

        Fractional reserve banking is the same as a licence to print money, if you run a small enough ‘circle’ of bookeepers who then square things up at the central bank [which we call the clearing banks]. For the real economy this would work better if both the hurdles to the club were reduced and a clear separation existed between the ‘proper’ banks and the bookmaking/merchant banks claims on assets was in place. Otherwise 100% reserves is best [imho]
        The main problem being the antipathetic view of politicians to anything resembling real economic activity, so its much easier for them to create a housing boom which feels like growth until the pin comes out.
        If we switched to a fully backed curreny, what would we buy the gold with? This would mean the only thing you could print money for would be to buy gold, which would put a lot of money in the hands of the sellers to cause mischief with.
        Does this ” In my mind that revolution remains the unfinished business of the people of these islands. It is ours to finish. And now is the time” mean your thinking of entering politics?

        • Mike Hall May 7, 2012 at 12:25 am #

          Yes, I understand the basic rationale of full reserve. However, the economy & banking is full of varying temporal discrepances & is a complex dynamic system.(ie meaningful equilibria do not exist, as Steve Keen says).

          Couple that with a need for the money supply to expand as the economy grows, in a rather ad hoc fashion, & a full reserve system may be difficult to implement with precision. And that’s just for the ‘on balance sheet’ stuff.

          Does it really, & always ensure reasonable allocation of capital?

          How do interest rates respond? Stable? Volatile?

          Or would a return to Glass Steagle plus removal of much of what ‘investment’ banking does (derivative markets trading etc.) & better monitoring/regulation of financial products suffice? Would we need this anyway with full reserve for high street banking? What timescale would be appropriate given where we would start from?

          I don’t think the answers to these questions are straightforward.

          It would entail, i think, more radical changes to the present system than MMT. Has the detail work been done?

          For the majority of citizens, functional finance & the Job Guarantee would be paradigm changing. Would we be best to just make this step first?

        • Golem XIV May 7, 2012 at 10:20 am #

          It does. I think about it often. I want to make a difference. We have three sons one aged 13 and two 11. I cannot stand by and watch thieves and villains steal away from them their chance of living a fulfilling life. I just cannot.

          I write. I canvass for others. We go on protests as a family. But none of this is enough.

          The question is how to enter politics in a way that has a hope of returning to democracy what has been sullied and debased.

          I don’t have a good answer. If you do then I would like to hear your thoughts.

          • Mike Hall May 7, 2012 at 7:17 pm #


            I don’t think going in to politics at this stage would be anything but a waste of your time & skills.

            As an independent, you will be utterly ignored, or where the media do have to give you coverage, you will face a barage of ridicule to the point of very unpleasant personal attack.

            If you join a party (any of them), you face a 20 year slog trying to shift their economic policy away from deeply entrenched, but ignorantly held views based on the false orthodoxy. You probably will not succeed anyway.

            The need is for communication, beginning outside the mainstream but becoming a message so powerful the mainstream cannot ignore.

            It needs a simple & powerful approach to punch a hole in the fog of lies of ‘conventional wisdom’ that collapses its whole edifice forever. Literally, we still live in the age of ‘flat earth’ macro economics. (In reality, it is not ‘macro’ at all, rather falsely aggregated ‘micro’.)

            For sovereign currency governments like UK, US (but not those of Eurozone, suffering under pseudo gold standard ideology), Breaking the following widely held myths would be immensively powerful. If the public at large really understood these simple (when you ‘get it’) truths, most existing politicians would never be elected again.

            Political leaders & media pundits continue to peddle the analogy that national finances are analagous to those of households, They aren’t. Many mainstream economists know this, but never seek to correct this. Bad as they are, they cannot argue against this, making this myth easy to break.

            Taxation does +not+ ‘finance’ government spending. It’s true purpose is a tool to mold resource distribution choices made by democratic process, & in part regulate overall aggregate demand close to balance with available resources.

            Government need never ‘borrow’ in order to spend. It may issue ‘debt’ to offer a risk free interest bearing deposit or for other monetary operations purposes. But these are optional.

            Net accumulated government spending is, in the aggegate & to the £ or US$, the total sum of accumulated Net Financial Assets of the non-government sector. Literally, in the aggregate, accumulated government deficit is the non-government sector’s accumulated financial wealth. The opposite is also true, government accumulated surplus is non-government accumulated aggregate debt.

            These are actually the underlying functions of the existing Uk, US etc (not Euro) systems as they currently exist, but are completely mis-described.

            As Bernard Lietaer said (of these MMT statements), “academically they have never been challenged”. For good reason, they cannot be.

            These are the system’s weak points. ‘Politics’ will always be a question of debate. These falsehoods prop up & constrain the framework of the political narrative. Break them & this framework loses its shackles.

            A few useful blogs I found recently in Bill Mitchell’s archive:

            Fiscal sustanability 101, Parts 1, 2 & 3 (with the usual embedded links to further explanations)




          • Mike Hall May 7, 2012 at 7:44 pm #

            Just found this excellent youtube explaining the Sectoral Balances (accounting identity) approach to understanding Gov budget deficit/surplus (with those of the non-government sector).

            (illustrates one of the points I made above.)


    • John Souter May 6, 2012 at 3:01 pm #

      Problem is Desmond for some reason all the warm blooded vertebrates want the comfort of the pack – group – herd; however you want to call it.

      Our political class are no different except by corrupting their purpose they have distorted their reasoning and position by reversing their stance and now are a tail wagging the beast with an under slung blind eye looking for a future they’re now physically incapable of reaching in any straightforward manner.

      Perhaps the reason why they find ‘hindsight’ reasonable as an excuse but never for action.

      • MacB May 6, 2012 at 3:35 pm #

        John, I happened across this clip which sort of hits the nail for me, especially if you view it in light of the ‘trickle down’ effect. We know wealth didn’t trickle down but I believe behaviours and values did. This is Dylan Ratigan pontificating:-


        What clicked about this was the idea that we’re not going to see a sea change in competitive behaviours but that a directional change is possible. I’m also a bit of a romantic fool and the King Arthur and Camelot imagery works for me. I also like the concept of ‘Alpha Powers’ it’s snappier than TPTB and carries a hint of access for all.

        • John Souter May 6, 2012 at 6:30 pm #

          Mac – I agree but alpha power in that sense is pathological in the first place before morphing through to the mythological – present day – the spin machines of MSM, Lobbyists, Advertising etcetera. All of which I class as the new opiates of the masses.

          As a philosophical anarchist I consider myself enough of a realist to accept my vision of society is a long way off from being practical given our present mind set and development. In fact a society we no need of governance may never be possible since society without an administration would invoke either tyranny or chaos.

          But these are neither excuse nor reason for continuing on a path heading in the wrong direction, towards an unknown destination with a dubious environment.

          Like you and I suspect many others I like fairy tales and in that respect I regard democracy as the tool at our disposal to make that tale at least possible.

  14. Gary May 6, 2012 at 1:32 pm #

    What to do ?

    In four words : repeal legal tender laws. Imo

    Give the people free choice to reject the fraudulent govt/banker paper. We are where we are, there is no painless way out, but we are currently on the path to total wipeout.

    Forget giving these paper swindlers powers to regulate. The regulator quangos get owned with the perpetrators. The crooks own them. Regulation doesn’t work. We have the FSA, the BoE, the treasury, the BIS, and countless Chambers, laws, and quangos. They did not work. So adding another layer of the same also won’t work. The regulators are either incapable of knowing what the banks are doing , or they are captured by the banks.

    Just do something very simple. Give people the choice to reject the fraud. Repeal the legal tender laws, and the fraudsters will collapse in short order.

  15. Bernd May 6, 2012 at 11:25 pm #

    I´m probably being really naive here, but if I understand correctly, what you are saying, then it is that we don´t just have a fractional reserve system for money, but essentially for all assets(rehypothication, asset lending,…). CDOs having been the prefered avenue for mortages, whilst ETFs are the more advanced and more broadly usable version?
    It looks like plain fractional reserve banking squared or cubed.
    What am I getting wrong here?

    • Golem XIV May 7, 2012 at 10:13 am #

      A very good morning to you Bernd.

      I wish I could say you had misunderstood and it was better than you thought….but sadly I think your summary is precise. Squared cubed and beyond.

      People will sometimes say, “Ah you go on as if what is happening now is somehow new. It isn’t. We have had fractional reserve banking and derivatives in the form of Futures since the 1920’s at least.”

      Whcih is of course true. BUT I think there is now a huge difference nevertheless.

      Think of music reproduction. The gold standard is the singer herself. We have had the means of reproducing the sound of her voice since the 1920s at least. But since teh digital age reproducing her voice has become so simple that it no longer requires any industrial underpinning at all. No vinyl production. No cutting machines. No pressing or distribution either. Just press – “copy”.

      This is what has happened to money, debt, investments and assets of every kind.

      The analogy is rough but I think informative.

      Thank you for commenting. I hope you’ll comment again.

      • Gary May 7, 2012 at 11:33 am #

        I think that is an effective analogy. Banker John Exter had another, an inverted pyramid with gold at its base. You inflate up the pyramid and deflate down. Everything above gold is derived or a derivative of gold. What an effective gold standard means is that you constantly Mark the higher layers back to gold, what it means in practice is the higher layers’ size will be restricted severely, or be removed.


      • Jim M. May 7, 2012 at 3:39 pm #

        Would it be fair to stretch the analogy a little further and proudly pronounce that we no longer even need the original voice?

        • Gary May 7, 2012 at 9:20 pm #

          No common unit of exchange ? Then we are back to barter, and therefore no division of labour(specialization) and then you have to make it all yourself. Because chances are you won’t have enough variety of goods under your ownership to barter to obtain the diversity of things that you may require.

          So, we are back to money. How about a non-inflating money that’s value fluctuates exactly with the economy without any central interference of any sort ? Gold is not only a good choice it is the only choice currently known to man that satisfies this criteria, and the reason is because gold has more properties of money than any other substance currently known to man , viz:

          portability, durability, divisibility , fungibility, desirability, not consumed by industry, non-counterfeitable, relatively scarce, demand dominant.

          ie. the demand for money in an economy IS directly proportional to the the demand for gold in the economy and that in turn is reflected by the value of a unit of gold. Nothing else can match it. Bitcoins or similar, may usurp gold in time, but right now very few people even understand or trust computers. Everybody on the planet understands a gold coin in their hand.

          But , I repeat myself.

      • Mike Hall May 7, 2012 at 6:23 pm #


        I do hope you’re not falling for this gold standard nonsense. It would be a massive waste of your energy & talents to go up such a blind alley that, from where the global monetary system is now, has not the slightest chance of adoption in any foreseeable future.

        It is the choice of a very narrow interest group who desire to remove much of the democratic ability to choose what governments do on our behalf. It has a great deal in common with neo-liberal ideology & uses much of their false macro (really mico) economic basis.

        “Gold standard & fixed exchange rates – myths that still prevail.”


  16. Joe R May 7, 2012 at 8:04 pm #

    Golem and fellow readers.

    I have posted before on the topic of democracy taking the initiative against financial institutions, in Part 1 of Golems ETF article. There I mentioned South America, and the recent nationalizations in Bolivia and Argentina, but I neglected to explain myself an dthe example I was trying to raise. South America, with many countries acting collectively, has challenged neo-liberalism, and with some success.

    To explain more fully – the history of South America as a continent between 1960-2000 featured many disastrous neo-liberal economic interventions. These interventions were often accompanied by dictatorial regimes, by violence, by repression and extra judicial killings.

    About the turn of the millennium the political atmosphere changed decisively and a process that had its roots in repression of the 60s and 70s bore fruit. The people woke up, built movements and turned the tide. Across the continent from north to south governments were wrested from dominant US / neo-liberal influence and these left wing leaderships have since consolidated their hold on power, simply by working for their people, and asking for their vote in return. True democracy at work.

    I’d like to summarise by saying, without going into a long history lesson for those that don’t know, that it took many years of being collectively repeatedly shafted to engender a widespread political consciousness, following which an organised political movement emerged to produce the huge collective political backlash by the people of South America against neo-liberalism of these past 10 years or more.

    The tide can be turned, they have and still are showing this. It takes more than a simple protest though.

    Europe, from what I can see, simply doesn’t have this mass collective, organised political will for change.

    The Occupy and Indignado movements have failed to deliver any political change – precisely because they were objective-less. It is an emasculated type of self interested protest. There’s no agreed agenda there, no real purpose, no solution being offered and no vision for society – just a big no!.

    From what I can see it is protest almost as fashion, not as a political movement. The elites and incestuous Tweedle-dum / Tweedle-dee politicians who live in their pockets still have control.

    Believe me, I would like it to think it to be different.

    I think too, like South America, it will take at least a generation of long lasting deprivation and the emergence of new commited political movements before real change may occur in Europe.

    • CArratiaM May 8, 2012 at 4:28 pm #

      Thanks for the interesting points you make Joe R.
      It is indeed very important to try and take a broader look in a search for inspiration, examples and ideas.

      And it was actually South America that gave inspiration to Jean Luc Melenchon, the candidate of the ‘Front de Gauche’ for the last French election. He peaked at about 15% on the polls and finally got about 11% of the votes in a country which is a little traumatised with the idea of “the useful vote” after the 2002 election and the extreme right phantom. Might not seem much, but it seems that he was actually useful to put some real issues on the debate.

      There is an interesting interview (in French) in which Melenchon (JLM) describes his analysis of the parallels between Europe and South America. It can be found here:


      I have translated (I hope correctly, I’m no French nor English native speaker) a fragment of the interview, I hope it can provide some insights.

      Q: You have much written and theorized about what happened in South America during the last 15 years. How is Front de Gauche inspired by those experiences?

      JLM: I have learnt a lot from the south american experiences, and not only during the last 10 years. What is fascinating from the late 90s is to observe how a system falls: when, how, etc. As in Argentina or Venezuela, it’s a fortuitous event which cristalizes the general situation. The violence that is produced can seem disproportionate to the previous situation, but actually, society was at a boiling point without being necessarily aware. The ‘coup de grace’ is given by the middle class that is put into motion, disgusted by the capitalist disorder. This predictable but fortuitous character, with the pressing to death hammer of liberalism over society, I think is what will arrive throughout Europe, and in France in particular.

      Q: More than in Spain or Italy, where the economic situation is more critical?

      JLM: Yes, this is the volcano of Europe, first because of the revolutionary tradition in our history. Next, because the working and middle class is not torn appart by regionalisms. And because we are here to express this will of insurrection. Never someone like me, who comes from the left of the left and a French comunist party at 1% would’ve arrived at our score at normal times. It’s the situation that’s imposing it.

      Q: The economical and social situations in Europe and in Latin America are not comparable, however… what lessons can be drawn for France?

      JLM: Exactly, the other aspect that made me think was the role given to the poor in revolutions, which does not exist in the same way here. We have had to theorise the notion of “precariat”, a word that we have formed from “precaire” and “proletariat”. It’s a transversal class, which goes from the precarious engineer to the precarious cleaning worker. In Latin America, you have put the poor into movement, here we move the “precarious”, cause if we call the poor to rebel, we would loose our time. People don’t assume themselves as poor in a country with egalitarian tradition, public services, etc. No one here says ‘we the poor’ as in South America. It’s a problem of the old left: they only think about status workers, they were never able to think about the reality of the “precariat”.

      On the other hand, I was very seduced by the articulation between social fights and popular sovereignty, at the heart of the new constitutions. The motto of Equator’s president Correa is citizens’ revolution. At La Bastille, our slogan was civic insurrection and citizens’ revolution. Maybe we would have been able to invent it ourselves, I don’t know. But it was actually an idea that we brought from South America, and the fact that it works here gives us strength and legitimity to use it.

      Q: Concretely, which of the South American models you feel better with?

      JLM: There isn’t one model, I take from all. For example, we have deeply studied the Argentinian recovery from the crisis and their way to govern facing the banks.
      I’m also very interestedby the communication techniques of the Kirchner, a mixture of silence and confrontation with the media. In Brazil, it’s the formation itself of the Workers Party, a federation with all types of people, like the Frente Amplio [Wide Front] in Uruguay, that’s how we construct the Front de Gauche. Brazil is also the example on the issue of the poors and the role of the theology of liberation. From Venezuela, what I would get with no hesitation is the idea of a new constitution.

      • Joe R May 8, 2012 at 10:14 pm #

        The translation looks good to my rusty French!….Thanks very much for it and the link.

        Its interesting that Brazils Partido Trabalhador ( Workers Party ) is mentioned. It does seems to be a broad based organisation from what I can see.

        In Brazil everybody has to vote ( its on a sunday ) or have a formal vouched excuse for not voting or pay a fine . If not it causes problems for your CPF your social secuirty number – you cannot apply for certain jobs, sort out federal documents if your electoral situation is not regularised. You cannot ignore it. That is the biggest secret to establishing democracy from what I can see – total participation of the elecorate!

  17. Mike Hall May 7, 2012 at 8:07 pm #

    Couple of somewhat cheering posts at Mike Norman’s excellent blog.

    “Hollande hates the rich and finance. This may just work!”



    “Are Humans getting better? Turns out yes!”


  18. Hudson Cashdan May 8, 2012 at 4:57 am #

    Mike Hall on Gold: “It is the choice of a very narrow interest group who desire to remove much of the democratic ability to choose what governments do on our behalf”

    Quite the contrary Mike Hall- rather than transparently raise taxes to finance the people’s work, corrupt leaders attempt to usurp the democratic process by instead forcing an inflation tax upon the poorest in society. Keynes himself said:

    “Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some…Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

    We must stop thinking about the economy in nominal terms. The economic wealth of this country is based on the production capabilities resulting from the interaction of millions of individuals exerting considerable efforts to leverage the stock of human, physical, and social capital. The signals relating to resource/labor/capital scarcity or abundance that prices send are integral to this process.

    Sound money limits false price signals. Sound money would have signaled the excess production and consumption of housing much earlier, saving us much hardship over the last several years. Although recessions would most certainly still occur, the nominal price declines in a recession would do nothing to impair the existing stock of capital. The labor/capital dislocations would likely be smaller and more manageable. Parasitic finance would be starved of it’s nectar even while productive finance thrives. Democratic institutions would have to be more transparent: taxing, spending, balancing budgets, or borrowing. Sound money satisfies the law of Ockham’s Razor.

    • Mike Hall May 8, 2012 at 11:03 am #

      Sorry Hudson, all the usual falsehoods there.

      ‘Parasitic finance’ has a long history under gold standards. Same with asset price bubbles.

      What the Gold standard principally does is create artificial scarcity of finance for the government sector only. This is especially true during recessions, making them far worse by limiting government action.

      The gold standard also creates fixed exchange rates between countries, builds up trade imbalances & creates pro cyclical conditions. This is what has forced abandonment a number of times.

      Again, the talk is all of ‘capital’ retaining value. Most people are not owners of capital. They cannot be – the system does not work if we’re all ‘rent’ seekers. This is your narrow interest group – those who seek to live off ‘rent’. Moderate inflation is not a problem for most people. High unemployment & the massive loss of production of real goods and services that results, however +is+, & dwarfs inflation effects.

      In a fiat system, taxes serve to finance nothing. This is not their actual function regardless of the common false beliefs.

      Proper laws & regulation are required for any monetary system to function properly.

      BTW Keynes referred to gold as a ‘barbarous relic’, so I think you’re cherry picking out of context there. (As many do with Keynes. Any number of false or contentious interpretations of his work abound. Tho’ my quote there has a certain clarity to it.)

    • Jim M. May 8, 2012 at 2:08 pm #

      Ockham’s Razor is not a law. Never was, never will be.

      Kant’s anti-razor?

      Karl Menger: “Entities must not be reduced to the point of inadequacy”

      It really is possible to over-simplify.

  19. Hudson Cashdan May 8, 2012 at 3:39 pm #

    Mike, there is no such thing as artificial scarcity of finance for the government sector unless the people vote for such scarcity. What you are saying is that, since voters may not support either higher taxes or lower spending, or lend to the govt at a reasonable rate during deficit times in order to bring forward demand, then politicians need another tool to do what is best for the people. The open-ended, non-democratic power to print is the blunt tool that politicians should use to do help people too unsophisticated (in your view) to know what is best for them.

    Inflation is actually very similar to trickle down economics- as easy money drives up asset prices, benefits accrue to the wealthiest and most geared first. After the inflation sloshes around the system, the workers on the bottom struggle to see their wages keep up with their cost of living. In this global, $-based economy you saw what happens in Tunisia, Egypt, etc. when food prices, which make up ~60% of household expenditures, double in a year.

    I do not care for Keynes but EVEN he understood the danger of inflation. A rigid gold standard, which is what Keynes prob referred to, is preferable to our current system, but not ideal either. Freely trading currencies with gold (or anything really) as the store of value/reserve and $, EUR, Yen, etc. as the medium of exchange would be fine. Basically, allow for competing currencies so that people can opt out.

    Finally, you are simplifying capital to mean physical capital only. Every person owns their human capital- that is, the skills that they have developed that add value to society which they can trade for other goods and services that they value. Then there is social capital which enables us to maximize human capital via cooperation in the marketplace. Even if we burned half the $’s & cut off half the credit tomorrow that capital (physical, human, and social) would still exist- the nominal price put on it would be lower but so would all of the other prices. We need to restructure the capital within our economy and, if we let the market do so, I believe that more of it would end up being controlled in a more equitable manner than now.

    • Roger May 11, 2012 at 6:00 am #

      I follow discussions over at the linked in Economist page there was a cheerlleader for a chap called Nial Fergusson a Scot and Harvard Professor who has a new book out. Nial Ferguson wrote a series which aired on Channel 4 televison called the Ascent of Money I have watched the first two episobdes and will watch the rest as time allows.

      I am not a fan of Professor Ferguson he holds an apparently unshakeable view in line with the establishment narrative I am not a great consumer of the modern soundbite history he seems to be pedalling I find it procrustean in the extreme.

      On Gold Buggery I have a simple question do those favouring it have a position in it already a hedge or speculation or position? I suspect that most gold buggery would not meet Aristotles measure of teleia philia that is perfected freindship for a universal good?

    • MacB May 11, 2012 at 9:25 am #

      which doesn’t make sense as Mike does recognise human capital and in particular as a wasted resource – it also can’t be stored, what you don’t use today is gone forever.

      There also seems to be a basic disagreement of understanding on whether the state spends to tax or taxes to spend. If you believe the latter then you’re unlikely to agree with MMT especially around inflation.

      Consider that value is always created as a combination of labour/skill/wealth then the only aspects that could be classed on a ‘use it or lose it’ basis are the first two. Under utilisation of labour isn’t logical, we invest in people from creation through nurture and then we pay them to do nothing. Economically we are indulging in the equivalent of paying to store a depreciating asset.

      By your definition labour and skill is covered by human capital but I dislike lumping the two together. The first can only be grown/contracted by population control whereas the latter can be influenced by education. In short to mid term economic terms the former is static and the latter is variable. But, regardless of definition, we both agree that the placing of wealth/capital within the economy is the problem.

      So how do you think that further deregulation will result in a more equitable spread?

  20. Golem XIV May 8, 2012 at 5:31 pm #

    And as if one cue read this little eye opener on the huge number of very poor ETFs and the almost complete lack of information that would allow investors to avoid them. Accident or by design. You decide.

  21. ahimsa May 11, 2012 at 8:21 am #

    Was just reading latest at Anne Pettifor’s Debtonation.
    Have any of you come across this graph before?
    (Chart taken from a speech, on the 8 May, 2009 by Andy Haldane, Executive Director, Financial Stability, Bank of England.)


    • Mike Hall May 11, 2012 at 10:49 am #

      Supports exactly what Michael Hudson & others say about the rise of the financialised economy.

      It’s a graph of robbery & looting, charting the last 3 decades of neo-liberal de-regulation.

  22. John R. Haldeman May 19, 2013 at 9:30 pm #

    Sounds like ENRON all over again. Except a MEGA amount increase.

  23. Roger January 6, 2016 at 10:04 am #

    Kaiser report calls Big Short on ETF´s. https://www.youtube.com/watch?v=QYbmvZ0LFeY&feature=youtu.be .


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