Guest Post by Emile Woolf: Banking principles? A contradiction in terms

You hardly need an auditor to tell you what you can see for yourself. The unholy trinity of Central Bank, Treasury and the cabal of leading banking institutions has been operating a mutual self-help alliance that has rendered Britain’s banking capability utterly dysfunctional.

In 2008, taking fright at the scale of the financial crisis in which the country was mired, the Bank of England initiated its policy of quantitative easing, sometimes referred to as “asset purchasing” – itself a euphemism for buying electronic money, produced to order by a complicit Treasury.

The banking sector, overjoyed at the prospect of absorbing central bank largesse, used this pseudo-dosh to rebuild balance sheets ravaged by real losses on earlier bad loans.

As the flood of fake money led to near-zero lending rates in the market, the Treasury proclaimed that private sector borrowers would benefit. Predictably, the economic growth that monetary expansion was supposed to stimulate never materialised. There was no “trickle-down” into the real economy – instead, the gush of new fiat money produced another asset-price bubble, another rash of obscene bonuses and inflated consumer prices.

Cause and effect – everywhere

The debacle left its perpetrators in a quandary: unbelievably, some Keynesian economists even claim that it didn’t work because its implementation lacked conviction, and seriously recommend more of the same.

It’s a similar story in the USA, Eurozone, Japan or China: wherever tried, the consequences have been equally dire. Unbridled monetary expansion has led to lavish public sector infrastructure projects that bear little relation to what people want or need: empty motorways; empty state-of-the-art airports. And a trail of public debt without prospect of being repaid in real money, while desperately needed public services are decimated in a pernicious misallocation of resources.

The Treasury’s initiative for stimulating growth, “Funding for Lending”, though now expanded, is testimony only to its naivety. There will always be politicians who believe that chucking cheap money at banks will eventually shame them into undertaking some serious private sector lending. Someone should tell the Chancellor that the banks get away with daylight robbery for one simple reason: they can.

Under the latest version of Funding for Lending, institutions expanding their lending to the private sector, for which they will charge exorbitant commercial rates, are able to pay as little as 0.25% p.a. on their own borrowings. Unbelievably, the  government is actually bribing banks to lend money. Yet such coerced lending will merely generate yet another rash of bad loans.

Fees, fees, fees

Government interference unfailingly leads to resource misallocation. The economy cries out for old-fashioned lending by institutions that take the trouble to understand their customers’ needs. There would be no need for banks to “rebuild” their balance sheets if they had not been stupid enough to squander the money in the first place!

Lending at a rate of 10 times what they pay is not enough for these rogues. So-called “fees” (it sounds almost professional) are charged as a percentage of the sum borrowed; fees are charged on any additional amounts; fees on the existing amount “to reset the covenants”; fees on “change of control” even though only minorities are involved; oh, and all those legal and due diligence fees. You name it. This is robbery raised to the level of an art-form, and it dwarfs any dividend that the shareholders might get.

I am not making this up – any of it.

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Emile Woolf: teacher, lecturer, best-selling author of professional texts, practising accountant, forensic expert witness and, throughout this period, one of the profession’s most widely read columnists and magazine journalists. His subject range includes the wider spectrum of economics, taxation and any related developments that have a financial dimension, always seeking to identify the principle that lies behind the dilemma.

www.emilewoolfwrites.co.uk

You Gotta Pick a Pocket or Two!

As the ECB and other Central Banks continue to prop up the system, one song from Oliver occurred to me as the theft from depositors becomes the “template” for the rest of Europe.

And then there’s the victimisation of the overburdened middle classes everywhere who have been prudent savers rather than spendthrift borrowers…

In this life, one thing counts
In the bank, large amounts
I’m afraid these don’t grow on trees,
You’ve got to pick-a-pocket or two

Why should we break our backs
Stupidly paying tax?
Better get some untaxed income
Better to pick-a-pocket or two.

Too big to jail?

Why should bankers be different?

One of the most frustrating phenomena thrown up by the unending list of banking scandals was highlighted this week by the fine handed out to Scottish and Southern Energy (SSE) for misselling and misleading advertising. The fine was not directed at the board, who would be ultimately responsible for the running of the business and overall strategy, but at the company, thus impacting shareholders who will have been completely unaware of the corporate culture of greed and lack of oversight.

Here is a list of actual criminal activities conducted by banks. Let’s see what the same offence would have resulted in if conducted by a small regulated company (SRC)…

Example – Laundering money for Mexican Drug Cartels
Bank’s Penalty – Fine of $1.9 billion. Directors unaffected. Shareholders impacted.
SRC – Directors individually prosecuted with potential prison term of up to two years.

Example – Misselling Insurance
Bank – Substantial fines. Directors unaffected. Shareholders impacted.
SRC – Regulator bans directors for life and revokes company licence.

Example – Contravening International Sanctions
Bank – Fine of $298M. Directors unaffected. Shareholders impacted.
SRC – Directors liable for up to $1M fine and up to 20 years imprisonment.

Example – Intentionally manipulating financial markets
Bank – Fined between £400M and $1.5 billion. Chairman resigns. Directors personally unaffected. Shareholders impacted.
SRC – Company closed. Directors fined up to $1M. Criminal prosecution.

Example – Intentionally manipulating electricity and power markets
Bank – Fined between $470 and $1,500 million. Directors unaffected. Shareholders impacted.
SRC – Company closed. Directors fined up to $1M. Criminal prosecution.

Violating Antitrust laws
Bank – fined EUR385 million. Directors unaffected. Shareholders impacted
SRC – Directors fined $350,000 personally and up to 3 years imprisonment. Company closed down.

Time to think again?

Guest Post: Patrick Barron on the Cypriot Bailout

This disgusting farce of a week of backroom squabbling by incompetent and clueless politicians and irresponsible bureaucrats over the future of the Cypriot banks should spur a public outcry to get government completely out of money and banking.

The public has too long harbored an inflated opinion of the expertise of government officials that is completely unwarranted, as the Cypriot banking crisis has revealed.  After creating the conditions for massive wastes of resources by manipulating the money supply and interest rate through their central banks, these same politicians and bureaucrats barter with one another like Arab rug merchants, giving no consideration to the legality of their actions or the rights of the parties involved.

Were banks subject to normal commercial law, the courts would appoint receivers to liquidate and/or restructure problem banks in an orderly fashion.  Politicians would have nothing to do with it. It is the politicization of money and banking that has created one money and banking crisis after another all over the world.  Banks should be required by normal commercial law to keep one hundred percent reserves against demand/current accounts.  Such accounts are bailments and not loans to the banker; as bailments, the bankers must be able to satisfy withdrawal demands from all depositors en mass.

Savings are another category of bank liabilities, whereby the public loans its money to the banker for a set period of time.  The banker re-loans this money at interest.  The only possible security for the saving public is the banker’s capital account and his reputation for good banking practices. If his losses become too great, the public can force him into bankruptcy.

Were banks subject to these completely normal requirements of commercial law, there would be fewer problem banks, because bad bankers would be driven from the market.

Guest Post: Patrick Barron on Gold vs The Dollar

Is Gold or the Dollar Overvalued?

by Patrick Barron

A recent bulletin from a major Swiss Bank argues that the price of gold has never been higher, that its price has peaked, that the run up was driven by fear, that fear is now waning and it is time to sell gold.

The problem with comparing the price of gold in dollar terms today and its price in the past is that it ignores dollar inflation.  The price of gold today is around $1,600 per ounce.  It peaked in dollar terms roughly a year ago at just under $2,000 per ounce.  Prior to the recent run up, the peak price of gold at year-end occurred in 1980 at $612 per ounce.  So, let’s look at the price of gold today, taking into account dollar inflation since 1980.

First let’s look at the government’s own Consumer Price Index.  In December 1980 the CPI stood at 86.3.  In January 2013 it was 230.3. (This is hardly believable; i.e., that prices have gone up only 2.7 times since 1980.)  Nevertheless, adjusting for the CPI increase since 1980, the price of gold today should be $1,633…about where it is right now.

But now let’s look at inflation of the money supply.  In 1980 M1 was $.420 trillion and M2 was $1.605 trillion.  As of January 2013, M1 is $2.470 trillion and M2 is $10.445 trillion.  So, taking into account the great inflation in M1 and M2, the price of gold should be either $3,600 per ounce (M1 equivalence) or $3,983 per ounce (M2 equivalence) for the price of gold, IN DOLLAR TERMS, to match its price at year-end 1980.

Another way to look at the relationship between the dollar price of gold and dollar inflation is to calculate gold’s dollar coverage price; i.e., for the Fed, which owns 262 million ounces of gold, to back the dollar in gold and make it truly redeemable, it would be forced to set the price at either $9,427 per ounce (M1) or $39,866 per ounce (M2).  In other words, any lower price the Fed would not be able to redeem all of its dollars.

One last thing.  In 1980, Paul Volcker was clamping down on the US money supply and would drive interest rates to over 20%.  Ronald Reagan continued the Carter deregulation policies, and he reduced taxes and slowed government spending.  The forces that drove the price of gold to $612 in 1980 were arrested by the policies of Paul Volcker, Ronald Reagan, and, to some extent, by Jimmy Carter.  But today government is pursuing the opposite of all four of these beneficial policies.  It is pursuing the same policies that drove the price of gold to its previous peak in 1980, but there are no politically powerful voices advising monetary restraint.

So, which is overvalued today–gold or the dollar?

Guest Post: Emile Woolf on EU Membership

EU membership, in or out? Think it through but tread warily

“Expert” is defined as a  person whose research, knowledge and experience accords them the respect of  their peers in a well-distinguished domain.

Economics is just such a domain, yet the degree of diversity in the views of  so-called experts can be astonishing. Take one of today’s most topical issues: will a UK exit from the EU be a blessing or a disaster? Those who take the former position point to a saving for the exchequer of some £8 billion each year; a return to sovereign integrity and the restoration of democratic self-determination in all areas of national life.

At the other extreme are experts who cite, with equal relish, UK/ EU trading statistics, concluding that the loss of trade following a UK exit would induce a spiral of decline and years of irremedial economic gloom.

Who should we trust? Since criteria defining an expert include “experience”, and since unilateral exit from the EU has never been experienced, reliance on basic common sense may be preferred to any feigned expert opinion.

What does common sense tell you about the following opinion of a leading EU motor industry chief? “All trading countries should have their sovereignty, but don’t even discuss leaving a trading partner to whom 50% of your exports go. That would be devastating for the UK economy.”

This expert’s assertion is widely shared, but it is flawed. “Trading countries” is a contradiction in terms. Nations do not trade. People and businesses trade.  A trade in goods or services occurs when, and only when, the most that a buyer is prepared to pay exceeds the least that a seller will accept. In such circumstance a price will be struck.

The buyer expects the goods to be of merchantable quality, and the seller expects to be paid in a currency whose purchasing power can be trusted to endure. Thus it is and always will be. Free trade is human nature, and the only thing  governments do is get in the way, either by imposing quotas and embargos, or by debasing the currency.

Free trade – that’s what really matters

There is nothing EU membership can bestow that free trade does not already guarantee. But currency debasement, now so prevalent that it passes as policy, will hinder free trade as surely as any embargo. Actions now pursued by central banks everywhere rely on the impossible notion that a weak currency is a good thing because it will induce an export-led revival, ignoring the corollary that there must always be an importer at the other end.

This ludicrous race-to-the-bottom is self-defeating. Everyone else is also flooding the bond markets with newly-printed fiat money, carrying the inescapable consequences of inflation and higher production costs. This internal transfer of wealth is a theft suffered by each country’s own citizens.

The endgame being played out in many troubled EU states  is closing in. Germany is the exception, but for how long will a thriving economy allow a bunch of blunderers control its currency? Berlusconi’s come-back plea to the European Central Bank is “to act like a real central bank and therefore print money – or we shall be forced to leave the euro and return to our own currency!”

And Spain? Right now the only buyers of its government’s debt are the pension funds of its own state workers. Talk about the snake eating its own tail.

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Emile Woolf: teacher, lecturer, best-selling author of professional texts, practising accountant, forensic expert witness and, throughout this period, one of the profession’s most widely read columnists and magazine journalists. His subject range includes the wider spectrum of economics, taxation and any related developments that have a financial dimension, always seeking to identify the principle that lies behind the dilemma.

www.emilewoolfwrites.co.uk

History Repeats Itself

I recommend to commodity friends a book by Anthony Capella called “The Various Flavours of Coffee“.

The book is a novel set around the turn of the 20th century in the coffee industry as the coffee market was transformed from a luxury product drunk in coffee houses and upper income households to a drink available to every family, packaged ground in packets and vacuum tins.

The resultant huge demand led to a massive increase in planting in Brazil and other countries in South America, leading to enormous investment in infrastructure, railways and roads to transport the coffee to ports. Prices soared, stimulating ever more cultivation and production until by the Great War coffee was in huge surplus. The market was flooded with coffee that was produced on plantations where the decision to plant was taken 3-4 years earlier. Brazil tried to control production by paying farmers to destroy bushes and buying up surplus beans to dump at sea, but corruption led to the coffee being taken out of sight of land, loaded onto freighters and shipped to Arabia, where it was relabelled as Mocca and shipped to Europe. It was cheap for Mocca but a higher price than Brazilian.

Which leads me to Copper and other metals where the decision to produce more was taken at a time of high prices some years before the global recession. It is difficult to stop or reduce production, and indeed why would producers want to stop when prices are maintained at artificially high levels by vested interests storing over-production and making it unavailable to the market?

No such intervention has ever succeeded. Have a cup of coffee and think about it…