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This started as a reply to Seosamh O’Maonaigh 

Yawn….If an ever expanding supply of money is such a great idea then why are the combined economies of the US and EU so fubared.

A good question. Appreciate it. Keep asking the hard ones. The reasons are somewhat different for Europe and the USA. In fact, this is such a good question that I am going to make it a new post.

I’ll start with the USA.

In the USA, a change to banking rules allowed insured loans to be put back into capital and loaned out again. (http://www.federalreserve.gov/boarddocs/supmanual/cbem/0005cbem.pdf page 531) This made capital virtually infinite as long as an insurer could be found. (That’s what a CDS, or credit default swap is – insurance. That’s why AIG, an insurer got into the business.)

So, this creates a huge incentive for banks to make money by loaning into sectors where they can get insurance on loans they make. In the USA, that was in home loans. Companies like AIG created software models that said home loans basically never go bad. So, they would charge extremely low rates for their CDS. And that created a perverse incentive. The big banks decided to defraud the insurers, presuming that the taxpayer would pick up the tab.

What Citibank is on record in the courts for doing is intentionally pushing home loans to unqualified people. They bought cheap CDS from AIG. They made another loan against that insured money, then sold off the first loan – but kept the CDS. When the loan holder failed to pay, the buyer of that security was left holding the bag. And – Citibank collected face value from AIG on the CDS for each failed loan.

At least, Citibank did that for a while. Then AIG couldn’t pay anymore and the bottom fell out. And suddenly, all those CDS backed loans were based on nothing at all.

An inside source told me that one estimate of Citibank’s real reserves when the meltdown happened was worse than 1:2,000. (A normal reserve level is on the order of 1:20) Banks in Europe had bought some of these securities, etc. and got caught in the downdraft. However, prior to the USA’s meltdown the European Central Bank had put a stop to much of this insured-loan capital. That doubtless helped matters.

Essentially, what Citibank did was like you buying some homes, getting fire insurance, pouring gasoline throughout the house, then selling (and collecting full price) on the homes. When the houses explode and burn to the ground, you collect the insurance money. You have collected twice. Can’t beat that business model with a stick, especially with the taxpayer picking up the tab.

Note that this new tweak in the banking laws played hell with the idea of the banking multiplier. Completely out the window. But – note also that
except for being able to get insurance on bad loans, there is nothing in theory wrong with the practice. In fact, if that fraud aspect could be eliminated, this would make Central Banks obsolete. That would mean that economies could function forever purely on privately created money. That should mean that economies should go very well, as if they were in the earliest stages of money expansion – all the time. Without cheaters defrauding us all, it could be fantastic.

The EU is a weak union. It works well in good times. It sucks the big one when times are bad. Essentially, it’s like the US dollar but if the states paid no taxes to the Federal government. In the USA we support weak states (Alabama, Iowa, Mississipi, Maine etc) from the strong states (California, New York, etc.) The EU can’t do that. And, countries can (sort of) game the system of the European Central Bank (ECB).

What happened in the EU was that the ECB approved huge loans to national governments in the weaker nations. They did so without controls. Greeks will get in your face and spit if you say it, but Greece is corrupt and productivity is low per person. (Yes, I know, Greeks put in similar hours to Germans. Germans work their fool asses off.) So governments in the southern EU nations bought elections by spending from those loans. Even for nations, loans need to be invested in infrastructure that pays off. But – here’s the kicker. Germany and France benefited hugely by those loans. Greeks, Italians, Spaniards and Portuguese bought cars, machinery and other Northern EU industrial products. That money went straight into the accounts of those companies. Great for them. They are sitting on those profits now.

In the midst of this, the kinds of loans that we talked about above were also made – but not in housing. In the EU, that loan insurance based capital was pretty much restricted to commercial paper. Now in my view, that makes sense. But the ECB, seeing things getting weird over here, cut way back on that commercial use of the infinite capital loan system. They beefed up banking reserve requirements. When the USA caught the flu, Greece got pneumonia and things have slowly spiraled down from there.

One exception to this was Switzerland. The Swiss banks didn’t have to follow EU rules. That is the real reason why UBS had to cough up the names of all those tax dodgers in the USA. Doing so was against Swiss law. But UBS (and some other Swiss banks) were so deep into the USA’s banking con-game that they were dead. UBS got TARP funds. (Bet you never wondered about a foreign bank getting bailed out by Uncle Sammy.) In return, American citizens are no longer protected by Swiss banking secrecy. A bunch of guys went to jail. And so does the world turn.

 Demographic problem for all the developed nations.

The last piece that is important is that the USA and Europe have a demographic problem. The baby boomers have moved through time contributing work to the economy, bidding up prices for homes, buying all the stuff that is needed to raise families. There was a baby boom in the whole developed world. Those boomers drove the stock market in the 1990’s by putting money into retirement accounts.

Twenty years ago I calculated that 2008 was the year when input into the investments from the boomers should roughly equal demand. From here on out, its demand. Stock prices are still at ridiculous P/E levels. That the crash happened in 2008 is coincidence. Those are two unrelated things. But – the overall demographic issue remains. That demographic issue will tend to favor deflation.


To the extent that the new generation (and older folks who want to innovate and build) is not able to get capital to do the new things that create massive new value, the USA (and EU) will suffer. An economy based on caring for the aged is not much of an economy. For the world to move forward requires capital to be put into the hands of entrepreneurs. We have to make sure that happens. No serious idea that could make money should have to go begging and fail to start. This is more important now than it every was.

And that is why the most important thing in the economy right now is that banking has become a system that does not put money into real ventures. Conning the public and flim-flam gaming of the system that leaves the taxpayers holding the bag is around 40% of the finance industry now. That has to stop!

Most of you BitCoin folks are youngish, in the prime of your lives. I think you collectively understand that something is seriously wrong. I think you get it that you are being shortchanged. But without better understanding of why, you can’t focus your energies where it matters.

I have some ideas I think will work that can completely turn things around for your generation. If you want to hear them, I’ll write them up. In addition to Bill Black’s work on putting the fraud-miesters in prison I have two major ideas: Central bank re-allocation revision and an exchange for loan/investment insurance. Both require some legislation.