|
I'm getting
very suspicious of anything which regulators think is "safe"
collateral...
Fractional
Reserve Banking is not responsible for the bad practice of 'creating money', writes
Paul Tustain, founder and CEO of BullionVault.
It is a speed
limit on money creation, put in place by a
Central Bank to stop banks doing too much of what comes naturally to them.
The Central
Bank used to leave lending decisions to bankers, and step in to liquidate
them when they screwed up. But in a world of Deposit Protection Insurance and
bank bailouts, the Central Bank picks up the tab for excessive money
creation. To limit the risk, they impose the 'Fractional Reserve' to try to
calm the commercial banks down. But it is only necessary because we have a
timid central bank which lacks the gumption to swing its axe in the direction
of bad banks.
Indeed the
current set up - where banks are not allowed to fail - turns out to be even
worse than I previously thought. It does much more than offer succour to the odd unfortunate bank which steps over the
limit of safety. It actually forces banks to be dumb. They have no
choice but to approach the safety limit until they are bound to step over it.
Any bank which does not step up to the plate will underperform all the
others, and be subsumed by a more aggressive competitor. It's how evolution
works; the survival of the fittest, where fitness means adapted to the
prevailing environment. If you do not compete in the skewed environment where
the central bank is a wimp you will expire because of it.
That's why
banks are forced to make rosy judgments on the value of collateral.
I think I can
see how the Central Bank's turning a blind eye to bad banks' unwise money
creation is going to lead to monetary catastrophe, and how it's all going to
blow up and leave us in a really, really big hole. But we need to understand
a bit more about the way money climbs a pyramid of clearers to see what is
happening.
Imagine there
is a fellow called Godfrey who earns his living building sheds. Let's see
what happens when banks start accepting sheds as collateral for new bank
loans.
People can
now get two uses out of a shed. Sheds are materially more valuable to people
who like to use both debt and sheds. Even people who have no
garden tools, but who like debt, can suddenly see
how useful a shed really is, even an empty one.
So Godfrey is
busy building sheds, and he's building lots of them for people like Brad, who
owes his bank a fortune with little prospect of it being repaid any time
soon. Yet the bank believes it is making good profits, because it does not
regard the loans collateralised by sheds as being
doubtful or impaired. For the moment they are considered excellent collateral
to 99% of their market value, and no bank in Brad's city will do any business
whatsoever if it refuses to recognise the
rock-solid resale value of collateralised sheds.
Godfrey takes
on some more employees, and the customers' cheques
don't bounce. There's soon going to be a heck of a lot more sheds, and Brad's
bank will get a very big negative balance with Central.
Eventually,
even with a wimp at the Central Bank, a memo from the Governor to the
exuberant bosses of Brad's bank will question the collateralising
of yet more sheds. Soon after that the shed which used to have two uses is
once again useful only as a store-room for garden tools - which makes it
intrinsically less valuable. The abundant supply of sheds extends the
problem. It will be a very bad time to own sheds.
That's
more-or-less how we got a sub-prime crisis, and all the problems which flowed
from it.
You know, I'm
starting to get very suspicious of stuff which achieves the bank regulator's
seal of approval as tip-top collateral. I mean it's so blinking obvious that
as soon as they say "this stuff is rock solid" that banks are going
to go out and finance purchases which force its value to a ridiculous level,
from which it will eventually fall, to generate huge and unsupported balances
at Central.
But there's
now a rock-solid approved form of collateral out there. It's already grossly
overvalued, infesting the entire global financial system, and
preparing to deliver us a real financial knock-out punch - not the sort of
warm-up act we've just enjoyed with a few sub-prime houses.
I'm talking,
of course, about sovereign debt.
Paul TUSTAIN
This excerpt is taken from Paul Tustain's
new report, Money Printing for Beginners (and Experts). To
read the full PDF for free today, simply register your email address at BullionVault now.
Settlement-systems specialist Paul Tustain launched BullionVault in 2005 to make the security and
cost-efficiencies of the professional wholesale gold market available to
private investors. Designed specifically to meet his own needs as a
risk-averse investor, BullionVault now
cares for 32 tonnes of client gold property – more than most of the
world's central banks own – and all of it privately owned in the user's
choice of low-cost, market-accredited facilities in London, New York or
Zurich.
(c) BullionVault 2013
Please
Note: This article is to inform your thinking, not lead it. Only
you can decide the best place for your money, and any decision you make will
put your money at risk. Information or data included here may have already
been overtaken by events – and must be verified elsewhere –
should you choose to act on it.
|
