The Financial Jigsaw – Issue No. 7

My unpublished (100,000 word) book “The Financial Jigsaw”, is being serialised here weekly in 100 issues by Peter J Underwood, author

We have seen how the global financial system and each element interact and comply with the laws of chaos theory. see here: https://www.theburningplatform.com/2018/06/23/the-financial-jigsaw-issue-no-6/  Before the inevitable collapse however, many events are likely to take place exacerbated by the in-built dysfunction of the system itself.  The flaws are in plain sight for those who choose to see for themselves.  The masters of the global financial universe are not even trying to hide the facts anymore.

 Major flaws inherent in the global financial system

First, central banks believe that, in addition to price stability, printing money is a tool for promoting growth and underwriting financial stability. This leads to exaggerated volatility in monetary policy and creates opportunities for wild speculation by financial actors worldwide.

The proliferation of these speculators amplifies the impact of the policy on financial markets.

The central banks and speculators have developed an unhealthy mutual dependence. It works in the short term but leads to crisis over time. For example, senior officials speak openly of the stimulus effect on its monetary policy through asset inflation (making stock markets and other assets artificially increase in value). This boosts demand by creating asset bubbles (like the housing bubble that burst in 2007/8). Central bankers would have kept such thoughts hidden a decade ago. Now they have gone public, exacerbated by the internet, and everyone who is listening now knows of their policy of money printing and its inherent dangers for inflation arising in the future and a final collapse. 

Second, financial institutions and banks are woefully short of capital (that is: spare money). Many big banks claim that they have significantly more above the agreed requirement of 8% but they have ways of presenting their accounts and managing their finances in order to cover up the true state of their businesses. The banks have for years used short-term customer deposits (via loans) to lend out and essentially gamble in the financial markets long-term, making them unable to meet the demands of their customers in the short term.

For example, Eurozone banks hold assets (including customer deposits of €30tn (2016), over three times the area’s total Gross Domestic Product (GDP). How could such a large banking system be adequately financially underpinned? Until the Eurozone banks shrink dramatically in size, perhaps up to 50%, the Eurozone will not be stable and crises will continue to arise.

 Third, operators within the global financial system gamble with other people’s money. They are paid big bonuses and share options when the bets work out but suffer no downside when the bets fail and so there remains an inherent bias for high volatility in the financial markets. This is why they are so sensitive to government interventions that produce unstable movements of prices and asset values.  This is known as ‘moral hazard’.

The dynamics of speculation and gambling

Financial engineering and globalization has created a wide field for speculation and gambling. The relative changes in monetary policies of different economies amplify volatility in huge markets like shares, bonds and currencies (forex) and attract speculators as never before. Volatility and speculation are a self-reinforcing dynamic. The free flow of financial capital across borders is now inherently unstable.

This issue is compounded with speculative activities congregating where regulations are lax. This is why big bets tend to originate out of the City of London and other key financial centres inevitably ending up in tax havens. The regulatory authority’s impact diminishes the cost of speculation and is another amplifier for global market instability.

Modern technology and communications have allowed financial institutions to spread their investments around the world instantaneously, and they can park each asset at a location least regulated and requiring the least capital, as well as of course, with attendant tax advantages.

The competition for attracting financial players to various beneficial places inevitably triggers a race between participants to make unreasonable bets and profit. Regulators tend to treat violations of the financial rules with kid gloves, as they fear that any interference might start a storm. This may explain why so few criminal players have gone to jail in the biggest financial crisis since the Great Depression.

The global financial crisis has been raging now for ten years; there is no end in sight. The main reason might be that globalization has amplified the impact of the inherent flaws in the financial system to such an extent that another crisis is inevitable.

It seems that the lessons of the 2008 collapse have not been heeded and we are yet again on a trajectory towards global financial implosion. Without a global ‘super-regulator’, financial instability may become a permanent feature of our global economy.

Central banking remains in crisis

When central bankers speak they display amazing self-confidence. But, if we look at their actions in the past five years, modern central banking really is still in crisis. Not only has their main goal of reviving economic growth not been achieved, financial stability is not present either.

Prudent banking regulations can decrease the risk of a financial crisis but, when the cost of money is under-priced (such that interest rates are so low as to be negative in real terms after accounting for inflation) for an extended period of time, prudent risk management by banks cannot prevent a crisis. When there is a general inflation in prices a bank can only avoid a future crisis by not participating in the market at all. The central banks are the biggest villains in this ongoing saga.

In the short run printing money promotes growth by keeping interest rates (the cost of money) low, thus stimulating companies and people to borrow more and spend more. It encourages businesses to invest in plant and equipment and consumers to advance consumption by spending borrowed money. Globalization has neutralized the first effect, that of printing money, because businesses nowadays separate where to raise finance and where to globally invest. The second effect is unlikely to be significant in western economies, where consumers already have too much debt anyway.

Today’s monetary policy can achieve a meaningful effect in one country only through a sustained depreciation of real exchange rates. However, it works at the expense of all the other countries that trigger competitive currency devaluation and so-called currency wars. The rotating devaluation process eventually leads to global inflation so that every country will eventually be worse off.

Inflation will eventually be inevitable

At the beginning of the 2008 global financial crisis, I expected that the stimulus policy by major governments would lead to global ‘stagflation’ (inflation without growth). Emerging economies are already in this state, as they are more prone to inflation due to low unemployment rates and high sensitivity to commodity prices.

Major emerging economies like those of Brazil, Russia, India, China and South Africa (the BRICS) already show stagflation/disinflation symptoms. They are struggling to juggle low growth and high inflation. QE or Monetary Easing Policy (another euphemism for money printing) to stimulate growth will eventually cause higher inflation, according to some economic models, which may spook currency markets, causing devaluation and further worsening inflation prospects.

Inflation is slow to catch up in developed economies. Despite inflation of commodity prices and manufactured goods, wages in the Organization for Economic Cooperation and Development (OECD) countries are not increasing; in fact the OECD workers are accepting a reduction in real wages, as I am sure you may have discovered for yourself. At some point, there will be a backlash against falling real wages and higher inflation, which is now a significant problem for all OECD economies.

To be continued next Saturday

Author: Austrian Peter

Peter J. Underwood is a retired international accountant and qualified humanistic counsellor living in Bruton, UK, with his wife, Yvonne. He pursued a career as an entrepreneur and business consultant, having founded several successful businesses in the UK and South Africa His latest Substack blog describes the African concept of Ubuntu - a system of localised community support using a gift economy model.

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Not a single comment? I believe that’s a first.

I like this series. Keep it up.

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