by Derryl Hermanutz
In, “A Copernican Turn in Macro”, I discussed the emerging understanding of the role of the money system in our macro economies. This is not new knowledge. The ancients were aware of the arithmetic necessity of periodic “clean slates” and “debt jubilees” in order to restore a distributional balance to their credit-debt systems so that an “economy” could function. During the last global monetary system failure, The Great Depression of the 1930s, clear thinkers like Irving Fisher (“The Debt Deflation Theory of Great Depressions”) and CH Douglas (“Social Credit”) laid bare the fatally flawed arithmetic of our bank-debt money systems, and proposed solutions. Douglas' "Money and the Price System" is a particularly clear exposition.
Subsequent scholars, notably Hyman Minsky with his “Financial Instability Hypothesis”, refined this understanding. “Rogue economists” like Michael Hudson laid out the real world and historical national and global consequences of the way private bankers operate the world’s national money systems.
After the Japanese collapse of 1989 Richard Koo emerged as the macro visionary with his concept of a “balance sheet recession” built upon Wynne Godley’s now standard “sectoral analysis” method of national balance sheet accounting:
GDP = C + I + G + X
Koo, like Keynes before him, advocates that G increase during the balance sheet recession, in order to add money into the national accounting equation to bail out the private sectors (C and I) and the national banking system.
In “A Copernican Turn” I argued that under current operation of our money systems governments have to borrow all the money they deficit spend, so adding to G via deficit spending is not an arithmetically viable solution over the long term, and we have arrived at “the long term”. The problem is that our money systems are zero sum balance sheet equations whereas our economies need to earn positive sum monetary “profits” on the money they invest and our banking systems need to earn positive sum “interest” on the money they create. We have superimposed a zero sum money system over a positive sum economy and banking system.
That is the root cause of “financial crises”, though distributional imbalances of money (held as savings by one group of people) and debt (owed to banks by borrowers-spenders, who are a different group than the earners-savers) among a nation’s population and between nations is the proximate cause that illuminates the zero sum nature of the problem and precipitates the resulting financial-cum-economic collapse.
Australian economist Steve Keen, of “Debunking Economics” fame (cheerfully exposing the absurd fallacies of mainstream neoclassical economic modeling that currently ‘informs’ academic economics and economic policy making), is the emerging champion of this new macro monetary understanding, based on his insight that change in the speed as well as direction of “debt growth” is the factor that drives the changes in GDP growth. Mainstream macroeconomics, which doesn’t include the banking system (that which creates all our money on its balance sheet as credits-debts) in its models of the economy, is completely blind to the effects of debt, which is why academics and policy makers can’t understand and can’t figure out viable solutions to our current macro problems and failed to forecast that it was going to occur.
The Economy Exists in a Sieve
A further complication, and in recent decades a major destination of monetary “leakage” out of the real economy’s borrowing-spending-earning-repaying cycle, is the now gargantuan “financial economy”. As an indication of how large this leakage has become, today the US financial industry captures 40% of ALL profits earned by the major corporations found in the S&P 500, even while big bank lending to the real economy is declining precipitously. There is a sieve leaking 40% of all American corporate profit earned today that is not financing things or producing things in the real economy where corporate costs become worker and supplier incomes in the process of producing real goods and services. The 40% essentially leaks into gambling and speculating on price movements in the financial casino economy. This casino is systematically “rigged” in favor of the house - the global banking cartel - as recent LIBOR and other financial crimes revelation is making clear.
None of the money that has ascended into this financial stratosphere is available for Joe Sixpack to earn in the real economy to pay his living and repay his debts. The money has “leaked” (more accurately, it has been “siphoned”) into the financial economy.
If ever there was a throbbing beacon illuminating a Schumpeterian “malinvestment” (where the investment produces no new wealth but merely redistributes financial claims on existing wealth) that is woefully overdue for a good dose of “creative destruction”, the financial economy stands clearly in that light.
What is worse, not only is the financial casino economy a zero sum equation where winners win by taking the money from losers, but this sector is now creating its own ‘money’ via rehypothecation. This is a process of creating loans of shadow bank money against the same collateral over and over again; if the borrower fails to repay the loan a whole gang of diverse global creditors claim ‘ownership’ of the poor little solitary collateral asset that this entire pile of junk money is sitting on. In addition, derivatives like interest rate swaps, are wholly manipulated for bankster fun and profit, as the LIBOR scandal exposed. Systemic price fixing IS the interest rate swaps “system”.
Who Burnt My House Down?
CDS are supposed to function as “insurance” that the insurer who sold the swaps (insurers like AIG, and we all saw how THAT story ended) will pay out on in the event that the underlying borrower fails to repay the underlying loan.
But because the derivatives industry has successfully resisted regulation it is unlike ‘real’ insurance in that the insurers hold vastly inadequate capital (i.e. their own money to cover their own bets) to actually pay out on any large scale insurance event. The sales job was that derivatives distributed risk in such clever ways that systemic default events were “impossible”. The reality is that systemic events are not just possible but are the arithmetically INEVITABLE consequence of our zero sum money system.
And you don’t have to “own” an asset in order to take out insurance against it in this marvelous insurance market. That is, you don’t have to be the party who made the underlying loan and to whom repayment is owed, with this debt being your “asset” - remember, from the perspective of the banking system and shadow banking system where money/loans/debt are originated, other people’s interest bearing debts are your “assets”. So if a borrower fails to repay then the insurer is on the hook for making good not just to the party who lent the money but to every other opportunist who took out insurance against that default.
A gang of neighborhood “modern day capitalists” each buys fire insurance on my house, then they burn my house down and EACH OF THEM collects the insurance. Because I had also bought insurance I collect the insurance too, theoretically, but under this scheme no insurer can actually make the multiple payouts, so it’s first come first collect before the insurer goes under. The “market participants” KNOW when they are going to burn my house down so they are waiting on the insurer’s doorstep the next morning to “collect”. By the time I get there at noon to make my claim all the money is gone and the insurer is bankrupt.