Category: financial crisis

Smoke and Mirrors – The Financial Crisis

Economics is fairly simple math befuddled by it’s association with the great god Mammon. Money has a mysticism that is totally undeserved, somehow 10,000 apples in your backyard is seen as produce to be sold whereas $10,000 is seen as potential realization of ones fantasies. So immersed in the cultural expectations of material wealth are we that we are constantly disappointed at the way in which money seems to just fritter away without a concomitant realization of happiness; “where did it a go?”. Money is an agreed form of exchange: I will work for one day in exchange for a slip of paper entitling me to receive food, shelter etc. This is a perfectly viable concept within human society, the problems arise when the slip of paper is expected to grow of it’s own volition.

Banks arose as a means of storing and transporting money. When someone borrows money they generally use collateral as a means of ensuring that the sum lent will be repaid. Thus a mortgage is based on the value of a house, should the borrower be unable to repay the amount (plus interest) of the loan then his collateral is taken as payment. The system evolved as societies became more industrialized. Money was needed to fund the factories, purchase materials and invest in the future; for this is what it amounted to; instead of there being a tangible piece of collateral, financial institutions lent money on the the nebulous premise of potential revenue. This was termed speculation. The higher the risk the better the return. Business is a never ending series of cycles, thus some years supply chased demand and goods were cheap, then demand had it’s heyday and goods became expensive. Overall the industrial economies expanded and times got better.

Then, about 40 years ago, western financial companies began to notice that there was more money to be made making money than in the old fashioned way of investing in industry or people. Therein lies the path to chaos. Increasingly, manufacturing companies, GE, Xerox, IBM, the mainstays of the American economy, found that it was hard work to actually manufacture a product. It was more profitable to invest in a company, especially a foreign company with cheap labor, than to struggle to expand within the industrial field. These corporations effectively entered the financial retail trade, buying and selling investments. To reiterate, money is representative of labor or a product; when a company invests on the stock market or in bonds its handing over all those promises of labor, or products, however it does not have them, they are merely promises. Another aberration that developed, presumably through the financiers inflated sense of their importance, was the definition of assets. If the bank lends money then that loan becomes an asset, no matter that it may never realize the principal; as opposed to a house which is a tangible asset. Even stranger is that inventory is not an asset, even though it has tangible value. Therefore if a bank lends money to a company which spends it on inventory then the bank has an asset whereas the company has a liability!. In practice this meant that financial institutions could use the ‘assets’ of the loans it had made to borrow money to make more loans.

Approximately 20 years ago the financial sector became bigger than the manufacturing sector. The constant ebb and flow of capital was termed the shadow economy, although we should not forget that a shadow has no substance. This was the smoke portion of the act. 18th century engineers hung over a thousand mirrors in the Palace of Versailles. This had two effects, the reflection of the candles made the room brilliantly lit, and it also gave the impression that the room was enormous, indeed, apparently infinite. Effectively the financiers of today have done much the same. Using the ‘reflections’ of assets they convinced themselves that growth could be infinite. The combination of smoke and mirrors gave the US a $14 trillion economy. This, remember, was at the same time that China, which data showed was outproducing America, was fast approaching a $2 trillion economy. Common sense would tell us that something was amiss. We can now answer the two most asked questions today: 1. where did the money go? And 2. why are we pouring trillions into the financial market but baulk at bailing out industry?

The answer is a variant on the Emperor has no clothes story. There was no money. The financial institutions built a house of cards with nothing inside, each story was based on the outsider’s belief that there was something to build on. Essentially, America has a $4 trillion economy, primarily in the service sector. What the government is desperately trying to do is pour money, treasury notes, anything they can get their hands on, into the house of cards; ideally before the public realizes there is nothing but hot air inside. The point of this exercise is to infuse enough capital into the financial market so that the current fiscal implosion is controlled as much as possible. It is estimated that the government has already poured $4.5 trillion into the ‘bubble’, add that to the true gross domestic product and leave room for another couple of trillion over the next year or so and, hey presto, we come out of the recession/depression as if this were just another business cycle. The saddest part of all this is that the powers that be treat the population as incapable of either understanding what the greed merchants have done, or coping with it if the truth were told. We behave like children and that is how we are treated.