18th September 2016 – The Religious Faith of Banking

Northern Rock Runners (Wikipedia)

The Great Northern Run (Wikipedia)


I can resist everything except temptation.

Oscar Wilde.


The Inflation Engine

I love the wit of Oscar Wilde.

Lydia’s banking descendants could write claim-checks on the gold and silver in their vaults and soon the paper claim-checks (which were far more convenient to use in practice) became the dominant money-form on Main Street. A classical gold standard with a gold reserve ratio of 100%. Lydian paper money was as good as gold.

But the bankers were clever. They realised that the claim-checks were becoming the only form of money people used in practice. People asking for loans now asked for it in the freely exchanging paper bills not piles of gold and silver. The bankers knew they could make their money work for them by re-lending the silver and gold in their vaults. But they didn’t even need to move the metal, they could just issue the receipts for the money. Every time the banker made a loan, the banker made profit in the form of interest – in fact it was the most lucrative part of the bankers business.

The credibility of the banker was very important. Nobody would trust a banker if they felt they would not get delivery of their precious metal deposits when they asked for conversion of their receipts into metal. Alas, bankers are smart but they’re also human. They can resist everything… everything, that is, except temptation. It didn’t take long for the bankers to realise that nobody but the bankers truly knew how much gold was in the bank vaults. The banker could play a little trick by lending out many more claim-checks for gold than actually existed in his coffers, thus earning more interest than their money supply would imply. The truth was, the money in reserve, in the vault, was only a fraction of the money in circulation. This was the birth of what exists today: it is called fractional reserve banking.

There are loads and loads of cute YouTube videos explaining this – like this one here. It’s not a conspiracy. It’s how the banking system works. What the banks do is they sort of expand or amplify the appearance of the actual real money in the system… they sort of… let me think of a word… errmmm… INFLATE the money supply. Yes. Inflation. That’s what it is. Because we know from Keynes that Inflation is first and foremost an monetary phenomenon (the rise in prices of everyday goods is just the standard method of measuring the effects of  inflation, that’s all). In the same way that rising mercury in a thermometer is just an “effect” of rising temperature, rising prices is just an “effect” of an inflating monetary base.

Indeed over 90% of the currency we see today gushing around the system is not created by the central banks – it is effectively conjured by the inflationary property of the distribution mechanism; the private banks and their fractional reserve banking. Weird huh?

So you see the central banks can only control a small aspect of monetary inflation, the rest is left to the private banks and, of course, the broader economy’s capacity for business investment and lending. But the tools of the central banker have always been blunt and cumbersome. This is, of course, why, despite huge unconventional measures like quantitative easing measures and Negative Interest Rate Policies (NIRP) there is still talk of Fed impotence.

If you think that is weird, this is the bit which really freaks people out: when a bank issues a loan for currency which it does not have, that currency is simply created, effectively out of thin air. This is what we mean when we say currency is “loaned into existence”. This is what we mean when we say currency and debt are two sides of the same coin (if you’d pardon the pun). Currency = Debt… if you reduce the debt in the economy you also collapse the money supply. It’s just the way our monetary system is designed.


How Irish Eyes Cried

But something doesn’t feel right does it, dear reader? There is an inherent problem to this neat trick. Because the Lydian banking descendants have created a monetary system where there are far more claim-checks for real money (Gold and Silver) in circulation than there is physical money in the banking vaults. If everybody ran to the banks to demand their rightful claim on the money that the claim-check certificates entitle them to, the sleight of hand would be exposed. This is called a “run on the bank” and every single bank in the World is at risk from this.

There is a moral hazard here which most people don’t understand. Most people think they have their money in a bank account for safe keeping. That is not what actually happens. The minute you put your money in a bank account it is no longer your money. What you are actually doing is effectively lending the bank money – to do with it whatever it wants. If the bank fails and goes bankrupt, that money is gone. There is no impenetrable ring fence around “your” money. Of course, often the government “guarantees” consumer bank deposits by offering to prop up the banks’ business in time of crisis. But the financial community knows that the government does not have enough the confidence of the markets to actually back this claim up – there are just too many banks, too many deposits, too much debt. If the government really did back all the banks during a mass run, the government itself would go bankrupt. It’s just another confidence trick to put the public at ease.

After 2008 the Irish government tried to put the public at ease by guaranteeing their deposits and loans… … then immediately asked for and EU-IMF bailout because in doing so realised that their entire economy had turned into big pile of poop. See Lessons From Ireland’s Failed Bank Guarantee in the EU Observer.

On the 30th of March 2010 I wrote a piece called Autopsy on Ireland’s Balance Sheet. Where I referred to the then BBC’s editor, Robert Peston’s, article The Unbelievable Truth About Ireland And Its Banks where he says (I quote) “…the Irish government probably chose the worst of all strategies for propping up the banks. By guaranteeing all their liabilities in the autumn of 2008, they turned the bloated liabilities of the swollen banks into public sector debt.

Indeed my article I quote another piece on bond market vigilantism (bond market vigilantes are a small number of huge bond investors who can exert influence on entire governments – it’s almost like open market activism on the fiscal policies of governments by fixed income investors). I quote:

You cannot simply make bad debts “go away”. You can hide them away in SIV’s or structures off the balance sheets of the banks, then you can then bail out and then subsidize the banking sector with tax-payers money, quantitative easing and a steeper yield curve. Then you can buy all the toxic waste and explode the balance sheet of the central bank while eager think-tanks in Government conspire ingeniously to run massive deficits to stimulate the economy. But the debt is not magically waived, it now just sits on the sovereign balance sheet and it is the sovereign state which now comes under the scrutiny of (foreign) investors and it is the sovereign state which now represents economic credibility of the nation as a whole.

As the greatest financial author of our generation, Michael Lewis, wrote on Ireland “a banking system is an act of faith”. In fact here is a quote from his excellent piece on Ireland called When Irish Eyes Are Crying [RECOMMENDED READING]. In typical Lewis fashion he hones in on an outcast, a financial delinquent, called Kelly. Kelly’s warnings of impending doom in the Irish economy were, of course, widely mocked and derided by the political establishment.

Kelly’s colleagues in the University College economics department watched his transformation from serious academic to amusing crackpot to disturbingly prescient guru with interest. One was Colm McCarthy, who, in the Irish recession of the late 1980s, had played a high-profile role in slashing government spending, and so had experienced the intersection of finance and public opinion. In McCarthy’s view, the dominant narrative inside the head of the average Irish citizen—and his receptiveness to the story Kelly was telling—changed at roughly 10 o’clock in the evening on October 2, 2008. On that night, Ireland’s financial regulator, a lifelong Central Bank bureaucrat in his 60s named Patrick Neary, came live on national television to be interviewed. The interviewer sounded as if he had just finished reading the collected works of Morgan Kelly. Neary, for his part, looked as if he had been dragged from a hole into which he badly wanted to return. He wore an insecure little mustache, stammered rote answers to questions he had not been asked, and ignored the ones he had been asked.

A banking system is an act of faith: it survives only for as long as people believe it will. Two weeks earlier the collapse of Lehman Brothers had cast doubt on banks everywhere. Ireland’s banks had not been managed to withstand doubt; they had been managed to exploit blind faith. Now the Irish people finally caught a glimpse of the guy meant to be safeguarding them: the crazy uncle had been sprung from the family cellar. Here he was, on their televisions, insisting that the Irish banks were “resilient” and “more than adequately capitalized” … when everyone in Ireland could see, in the vacant skyscrapers and empty housing developments around them, evidence of bank loans that were not merely bad but insane. “What happened was that everyone in Ireland had the idea that somewhere in Ireland there was a little wise old man who was in charge of the money, and this was the first time they’d ever seen this little man,” says McCarthy. “And then they saw him and said, Who the fuck was that??? Is that the fucking guy who is in charge of the money??? That’s when everyone panicked.”



Mervin’s Moral Hazard

The reality is, the banking system is, and always has been, an act of faith, a shell game, a confidence trick. There is nothing new or sensational about this, and yet many people choose not to believe it. They think it’s a conspiracy theory or a spook story. Banks don’t have enough money to repay their depositors – it’s as simple as that.

Bank runs on a faith-based trickery are not a thing of fiction, they exist even today. Back in 2007 Northern Rock experienced a run. I don’t know how these things start when they do or why they are triggered – it’s like a butterfly effect thing. But suddenly customers were queuing up outside the bank to be let in so that they might retrieve their hard-earned life savings. And what did the Northern Rock bank do? It shut the doors and simply refused to let the “customers” in! Police cars were called to the queuing masses to deter acts of violence or panic. Fractional Reserve Banking, dear reader.

The truth is these poor people were not “customers”… they were effectively creditors. Mervin King, the Bank of England Governor, was forced to step in and bail out the bank to protect the system as a whole and because a disinflationary backdrop could dissipate unconventional tactics and flippant money-printing. But why was he so hesitant? Why did he spend so long mumbling about “moral hazard”? The truth is, the moment you put your savings into a bank, you lose ownership of that money, the bank does with it what it wants and you take the risk on that bank being able to pay you back in the future. If the bank reveals it has no testicles under its bathrobe then ultimately that’s your problem, not the government’s, not the central bank’s problem. If the bank does get bailed out by someone or something, then you got lucky. But you have no right to this money under all circumstances, it is no longer yours, you should not expect to get it back if the bank blows up. As the tellers at Southpark Bank would say, when the money’s gone… “IT’S GONE!“.

However, in the past, bank runs have been generally localised. Retail banking was a local business despite the globalisation of the banking industry. At the very least a banking crisis could be contained to a particular country or region. One could even argue that the Lehman shock was due more to a collapsing financial system triggering bank runs, rather than the other way around.

But there was a time when there was a run on the entire monetary system. It was effectively multi-national run on the global currency arrangement itself. The mother of all runs on the faith… a swarm of monetary infidels would leave the most powerful men in the World with red faces. The reaction and subsequent consequences would set the tone for the global economic and monetary conditions we observe today. That’s another story for another time… time to hit the send button.





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28th August 2016 – The Birth of a Global Reserve Currency

Bretton Woods Hotel, New Hampshire - Wikipedia

Bretton Woods Hotel, New Hampshire (Wikipedia)

History never repeats itself, but it often rhymes.

Mark Twain / Anonymous (depending on who you want to believe)


Why Dollars?

Well this is daunting. We’re tackling big topics in just small posts. To me, European Monetary History is a vast ocean of possibilities and all I have is a teacup. I just want to get through this History of Monetary Policy stuff so we can discuss twenty-first century issues. But the twentieth century is laden with too many succulent stories for me to pass them by. Just like a raspberry-picker in a French orchard, it would be frightfully rude not to stop and snack on occasion. While there are many recipes I could conjure, coddle and concoct, I need to avoid cornering myself into a culinary compote. Nay, I must cull and collect a chosen few of the ripest monetary-related cuttings and just ingest them raw, as nature intended. So here’s what’s in my fruit basket today…

When we discussed my fictional caveman capital, there was a barter system, where people exchanged physical goods, like watermelons and eggs. Barter still remains the default exchange mechanism. Indeed, Roman Emperor Diocletian resorted to taxation through requisition of real goods instead of the then utterly debased Denarius. As were German doctors and civil servants paid in sausages and potatoes during the Weimar hyperinflation of the early twentieth century and reparations in steel and coal. But while “produce-money” and barter trade is a last resort, it is not a perfect form of money. So the cavepeople started to use pebbles. Alas, there was no method of controlling pebble supply and so it all, rather predictably, ended rather badly, in the chaotic mess of pebble-hyperinflation.

Ever wondered why we always talk about dollars? Spot fx rates are always to the dollar, gold is priced in dollars, oil and gas and pretty much every other commodity too. The business units of large multinational corporations always present their financial figures in dollars. When I’m in the middle of Africa getting my Auntie’s car fixed, before negotiating the price, the oily mechanic sucks a piece of grass between his teeth, leans into the car, nods his head at me and says “can brofonyo pay in dollars?” Brofonyo means “white man” in Ga / Ghanaian but that’s not what irks me. I mean why not Pounds Sterling or Euros or, hell, even Ghanaian Cedis? Why always US Dollars? It’s a fiat currency backed by thin air just like the rest of them. Euros are a bigger economy in many respects and it’s a continent right next to Africa – I mean we’re in the same bloody time zone… so why are you asking me for dollars?

In this short piece we’re going to answer all those questions on one fell swoop. It’s of course because of the path we took through monetary history…


The Difference Between “Money” and Fiat “Currency”

Let’s recap our random walk through monetary history. After the caveman pebble currency crisis, money-forms with less ubiquitous supply would evolve, like precious stones, rare seashells and high value buckskins or “bucks”. Along came my fictional banker, Lydia. She would create a durable currency with a very limited supply using metals which were not readily available to the public – such as copper or silver or gold. Ahead of her time and with the invention of paper, it was possible for her to operate a system whereby consumers did not even need to carry the physical metal assets with them at all times. Instead, they could bank their metals at a secure place (a “bank”) and then just use the paper receipts for the metal to transact in the market place. This was a form of “Money” known as the Classical Gold Standard. Quote from piece Legitimacy of Currency:

What if, just like Lydia’s certificates for investment, one could merely possess a “claim-check” certificate for the precious metal one kept safely in the bank? These receipts or “claim-checks” on the precious metal acted as a record of ownership or entitlement or record of account. So long as a record of account was kept, many of the transactions could occur without the physical effort of transporting metal in bulk. Of course, the claim-checks, just like the bond and share certificates, have no intrinsic value.

The example often given is that when one hands one’s suit to the dry-cleaners one receives a ticket or receipt which acts as a “claim-check” on that suit. The dry-cleaning ticket has no intrinsic value, it’s a worthless piece of paper, but it’s a claim on the real asset (the suit at the dry-cleaners). Likewise, these claim-checks on real, hard, metal assets in the bank could be just as easily used as money. In fact, it could be made even more efficient, with different claim checks (banknotes) for different quantities of precious metal. People transacting in the market place could simply present these claim-checks in place of metal coinage as they were backed by a true, valued physical asset, the copper/silver/gold piled up in the money bank. Furthermore, because the banks were an integral part of the system money could still be loaned into existence, as we’ve touched on before.

If one constructs a monetary system based on an unanchored (fiat) currency rather than physical quantifiable money, then the fiat currency in question needs to have an extremely stable and trustworthy supply mechanism. Herein lies the problem: we’re all human. The temptation is simply too great for humans at the helm of a government or central bank to resist opting for the easy option of spending and funding that spending by simply printing currency – leaving the burden of managing currency credibility to a future generation. In a modern, globalised World under the camouflage of disinflationary influences, it is, indeed, the ultimate temptation. Like a drug-addict needing the next fix: the positives of money-printing are tangible and immediate, the negatives are opaque and delayed. Eventually, though, like some colossal tidal wave rolling through the generations, the negativity accumulates faster than potential remedies can be administered. A systemic breakdown in health or, worse, an overdose. Trust in the currency itself evaporates and currency crisis builds into a tidal wave and comes crashing down on the economy. There is no such thing as a “free fix” in economics…

Caveman pebble hyperinflation was due to the currency not having stable, trustworthy supply and eventually the cavepeople placed no value in the currency and the whole thing exploded, or should I say imploded (we tend to think of hyperinflation as prices going UP violently but actually it is currency worth collapsing DOWN violently), in their faces. Nero started clipping gold and silver out of Denarius coins until they became worthless and the currency collapsed into an inflationary hell hole. Marco reported how he was in awe of Kublai Khan’s promotion of Chinese flying paper money – until people realised the emperor was wearing no clothes and the paper blew away taking the vast Chinese empire with it. Germany’s Prussian Empire had a classical goal standard which behaved exactly like Lydia’s claim-check certificates on precious metals. German Marks could be exchanged at the bank directly for gold. But then, thanks to Wilhelm II’s interventions into World War I, Germany abandoned the Gold Standard and started printing unbacked paper resulting in the Weimar Republic’s Great Hyperinflation. The Deutsche Mark plunged into a bottomless vortex and expired worthless. Schacht later brought the Rentenmark to stabilise the economy – which was effectively backed by physical land and property.


Clipping Dollars

One could be forgiven for thinking there is a common theme here. But these are not anomalies. The monetary graveyard is littered with worthless fiat currencies that have come and gone. Dead paper currencies are the norm, not the exception – I just chose some of the more famous examples. Indeed, if you read enough material you come across some animated, almost caricature-like commentators and Richard Daughty is one such fellow. But I love this clip and I was actually reading Wiggin and Bonner when they were looking for fiat currencies which had stood the test of time. They couldn’t really find many (any) success stories… but they found A LOT of failures. Check this Richard Daughty clip out.

Daughty [with dramatic emphasis]: E-VERY SINGLE ONE OF THEM WENT TO ZERO!

History never repeats itself, but it often rhymes.

Relevance? Well, you see, the US Dollar was not completely exchangeable for gold even in the early part of last century. A piece of legislation called the Federal Reserve Act of 1913 declared that Federal Reserve Notes (Dollars) only had to be backed by 40% gold – i.e. not a pure classical 100% gold standard. This 40% fraction of physical money to paper currency was what we call a gold reserve ratio.

But World Wars brought an interesting dynamic to the currency systems. Because both World Wars originated in Europe, America was actually an economic beneficiary. Europe was a huge trading partner and, while America was shipping goods to Europe, Europe was effectively paying for it in gold and thus effectively shipping gold back to the US. Eventually, one nation, America, ended up with two thirds of the World’s gold supply in its vaults! If this continued, the global transaction system would collapse as there would be no gold liquidity to fund long-lasting trade deficits needed during global wartime – one of the key restrictions of a gold standard. What was to be done?


The Bretton Woods Illusion

Well, the good news was that, while the League of Nations had effectively fallen apart during the World War II, intergovernmental collaboration was not completely dead. While the War was still going on in July of 1944 financial leaders of all the main allied states converged on the US for a conference on how to solve the looming currency crisis and America’s gold glut. It was, rather unglamorously, called the United Nations Monetary and Financial Conference and the outcome would become one of the truly historic inflexion points in monetary history. Because the location of the conference was a huge hotel in Bretton Woods, New Hampshire; the new monetary regime that emanated was eventually given the more glamourous title of “The Bretton Woods Agreement”.

It is perhaps surprising to learn that the International Monetary Fund (IMF) and the World Bank were a couple of spin-off organisations founded by the Bretton Woods Agreement. But, in a more direct, monetary sense, the really interesting reform concerned the currencies of the World and the gold reserve ratio of the US Dollar.

It was decided that, because the US dollar was so powerful and held so much gold, the remaining dominant currencies of the World would become pegged to the US Dollar. This was the beginning of America’s true monetary dominance and the beginning of what we now know as the US Dollar’s status as the “global reserve currency”. Global reserve currency is not just a media buzzword – this was written in black and white in the 1944 Bretton Woods Agreement.

So there was no such thing as a floating rate or even a forex market. In much the same way that the Hong Kong Dollar is pegged to the US Dollar today – all global currencies were pegged, at fixed exchange rate to the US dollar. Weird, huh? Additionally, instead of gold backing the paper currencies, a paper currency was backing the other paper currencies.

Now, wait! I hear you say. The US Dollar may have been backing the French Franc but the US Dollar was backed by a mountain of gold according to the gold reserve ratio, right? Well, yes; initially, gold was backing the US Dollar and the US Dollar was backing the World’s currencies. But, critically, while the US Dollar was being perceived as being “as good as gold”, under the Bretton Woods Agreement no reserve ratio was established. That is, another confidence trick was being played… while the dollar was the reserve currency and the founding pillar of the entire monetary system. There was no binding legislation underpinning the dollar’s commitment to any reserve of anything of physical value, gold or otherwise.

Like all confidence tricks, as it became weathered by political history, the sleight of hand would be revealed. A, perhaps unlikely, card-player at the table would call the US out on their hand – a French chap who happened to be the President of France at the time, a certain Monsieur Charles de Gaulle. But it’s time to hit the send button – that’s another story for another time…


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10th August 2016 – The Face of Monetary Impotence

BoE in Ruins

BoE in Ruins (Wikipedia)

 … it [negative interest rates] is clearly not productive… the big argument about excessively low interest rates for very long periods of time is that it warps investment pattern on real investments.

Alan Greenspan – ex-Federal Reserve Chairman (1987 – 2006). Check this vid out (it’s only 2 minutes).

I woke up this morning and found the front page of the FT staring me in the face – which is something I feel one ought to have interest in, given how I ended my last post. So let me just send a couple of excerpts from my readings.

Firstly, let me introduce you to John Mauldin. Recommended reading because he does a weekly e-letter which is: (a) completely free (b) explains economic issues in a tone which everyone can understand. I really recommend subscribing (click the link below).
Great article a couple of months ago called “Hot Summer Weirdness” about how messed up the financial markets are. Let me give you a few enjoyable quotes from the, normally sanguine, Mr Mauldin:

The ECB wants to create inflation by making borrowers an offer they can’t refuse. European public companies have been issuing new debt at a record pace this year. I can see why, too: interest rates were at record lows. The ECB intends to drive them even lower and possibly negative.

Tumbling Borrowing Costs

Tumbling Borrowing Costs (Mauldin-Bloomberg-BoAML)

If you are the board of a Eurozone company and your central bank offers you free or better-than-free cash, of course you take it. Japan already proved that this can work back in January, when it first bought corporate bonds at a below-zero interest rate. And this new tactic of the ECB is going to affect more than just corporate bonds in Europe. US multinationals with European subsidiaries (and most have them) are going to be lining up to take advantage of a central bank that will buy up to 70% of anything the corporations issue, at rates that can’t be matched in the US. At least for now. You think that’s not going to bring European-style central banking to the United States?
If you’re a corporation in Europe, the harder question is what to do with your free cash. The ECB wants you to buy stuff and drive up prices. That would leave you owning stuff, which isn’t rational if you think deflation will continue. So the ECB has a chicken-egg problem. They can’t have inflation unless businesses and individuals spend their cash, but everyone will hoard their cash until they’re convinced inflation is back.
Liquidity is another problem. Bloomberg calculates that the universe of corporate debt eligible for ECB purchase totals about €620 billion. To produce the desired effect, the ECB will have to own a significant chunk of that market. At some point it then stops being a “market” by any normal definition.

German Banks Hoarding Cash
Speaking of cash-hoarding behavior – which is one side effect of negative rates – one of Germany’s largest banks is seriously considering it. Sources within Commerzbank have told Reuters they are “examining the possibility” of hoarding physical euros by the billions in secure vaults. This would let them avoid the -0.4% NIRP penalty for parking cash with the ECB.
This is truly bizarre. Under normal conditions, holding cash is anathema to commercial bankers. They keep as little as possible on hand and certainly don’t go out of their way to hold more. Yet here we see a major bank considering doing just that. The only way that tactic makes sense is if the bank can’t profitably lend the cash to its customers, which, given the rules for lending in Europe, actually happens to be the case.
Nonbank financial institutions are also storing cash. Munich Re said back in March it would store both physical cash and gold to avoid paying negative interest rates. Management framed the move as a minor test at the time. It may well have been – but you don’t conduct such a test unless you see some chance that you will need to hold cash on a larger scale.

As a sidebar, I thought I would throw in the following rate chart from Europe and Japan, showing just how far out the yield curve negative rates extend. Given that the ECB intends to absorb investment-grade corporate bonds, it is going to push corporate bonds into negative rates when they’re sold on the open market and will push the negative rates out on the yield curve for sovereign bonds. How in the Wide Wide World of Sports does anybody think that pensions and insurance companies can survive in such a market? Remember, they are required to hold a certain amount of government bonds, and their investment return targets are north of 5%. I could do a whole letter on the coming debacle in European insurance companies. It is way beyond the crisis point now.

Negative Rates Grid

Negative Rates Grid (Mauldin-Pension Partners)


Lot of red on that table, huh? Now let us pause a moment to think about what Greenspan (the Original Sinner) said about the effects of negative interest rates and their distortion on the market. Let us think about what Mauldin said about both liquidity and the survival of Pension Funds and Insurance Companies in a market like this. I’m going to end with the front page of the FT. Here is a photograph from my desk:

BoE Impotence (FT)

BoE Impotence (FT)

Headline: BoE runs into trouble on second day of post-Brexit bond buying. It appears pension funds are simply refusing to sell their Gilts to the Bank of England. Despite being offered the chance to lock-in returns on their bonds that they could not have even dreamt of at the time of buying these securities, they’re simply refusing to sell them to the Bank of England. Is this obstinate face of a Balance Sheet Recession or is there simply no liquidity in even the most liquid instruments? I’m not sure I like the answer to either of those questions.


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7th August 2016 – How Debt Sunk The World

Great Depression - Poverty (flickr)

Great Depression – Poverty (Wikipedia)


If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.

J. Paul Getty – Industrial and Oil Tycoon (ex-richest man in the World)

Great Depression - Unemployment (Wikipedia)

Great Depression – Unemployment (flickr)

I love that Getty quote. This is one of my longer pieces (sorry), but if you could sum it up in one sentence, that would be it. But we’re getting ahead of ourselves here. Our historic meanderings have lead us to the edge of an economic precipice in Europe. The Great Depression, like most other periods of severe unemployment, was produced by government mismanagement rather than by any inherent instability of the private economy. Those aren’t my words, those are the words of Milton Friedman, the Nobel Prize-winning economist. Seems like this is a period worth giving some attention to. Let’s start with a quote from last post:

What we are interested in is that, from an economic perspective, two things are clear:

  • How utterly intertwined monetary policy is with political policy to the point, at times, it is hard to decipher when one ends and the other begins.
  • How startlingly effective a supply standard (be it Gold or not Gold) was in bringing to heel even the most parabolic inflation of an out-of-control currency supply.

We begin with the European Union. No, I’m not about to get into another Brexit diatribe – I’ve had enough of reading about that, never mind writing about it. But, as I mentioned in my last post, monetary policy and political policy are so closely interwoven it’s actually impossible to sail a course though monetary policy events without occasionally tacking back into the headwind of international politics.


Dreams of a Multilateral EUtopia

The European Union (EU) was officially formed with the Maastricht Treaty of 1992, but before this, the union of Europe already existed in a different form – as the European Economic Community via the 1958 Treaty of Rome (signed in 1957). But some people have an idea that the birth of the European Union came directly after the Second World War, perhaps with the significant signatures on the Treaty of Brussels in 1948 (don’t you just love looking at government articles with the words TOP SECRET written at the top – makes me feel like James Bond). Some even believe that the founding fathers may have started the discussion before the Second World War, but few realise that actually the European Union was a product of the First World War. It may surprise some to learn that the idea of a Europe united in trade owes it conception, at least in part, to thoughts emanating from British soils.

A British civil servant called Arthur Salter was working with another chap, a Frenchman called Jean Monnet to organise shipping of war supplies from America to Europe at the outbreak of the First World War in 1914. But they grew so sick and tired of all the red tape and protectionist bureaucracy surrounding national interests within Europe, they began contemplating ways of streamlining trade transportation and circumventing the tedium. With time, they shared the international political stage as senior officials in the League of Nations (equivalent of the UN) and had now fleshed out extensive plans for economic cohesion between European states. By then, Salter was in charge of German repatriations in the League of Nations and Monnet, whose political authority and influence was growing rapidly, was the Deputy Secretary General.

They recognised the League of Nations’ fundamental flaws, such as structural impediments and politicisation of veto authority. Never-the-less, inspired by the supra-national structure and the philosophy of international cooperativeness they had witnessed in League of Nations, they wondered if such a model could be tailored for Europe. In their minds, great gains could be made by rising above national unilateralism to pursue interests of a higher, multinational, multilateral cause. But, while Monnet was, arguably, the engineer of the European Union idea, Salter was studious in thought and diligently documenting. Much later, in 1931, Salter assembled his papers into a book with an interesting title: The United States of Europe. It’s worth noting that some of this text dates back to 1919 and so some of his ideas were from before the end of the First World War.

What started out as just a “thought experiment” in the 1910’s began gathering momentum by the 1920’s and early in that gap between the First World War and the Second World War Monnet’s influence would expand and with it his theories of European integration. Monnet would go on to set the tone to a gradualist approach to integration, a evolutionary rhythm still very much the heartbeat of policy progression in Brussels today.

Weighing in on the pro-Union argument was Prime Minister of France, a chap called Aristide Briand. By the late 1920’s political traction on the idea of European integration had a global recognition and even the then British Chancellor of the Exchequer, a certain Winston Churchill, was making encouraging noises about the unification of (continental) Europe. In fact, as early as 1925 he told the House of Commons:

…the aim of ending the thousand-year strife between France and Germany seemed a supreme object. If only we could weave Gaul and Teuton so closely together economically, socially and morally as to prevent the occasion of new quarrels and make old antagonisms die in the realisation of mutual prosperity and interdependence, Europe would rise again.

Meanwhile in Germany, as described in my last post, the Schacht reforms had re-built Germany’s economy in the late 1920’s. Things were looking up for Europe… … …

… … … but in other parts of the continent a perfect storm was brewing. We shall assemble the main factors and then reconstruct this storm, then, piece, by piece…


Piecing the Puzzle


  • Firstly remember last post we spoke about the powerful liberal German politician who appointed the German Economic “Magician”, Schact, in the first place…

Chancellor Gustav Stresemann, an extremely influential liberal politician who subsequently won a Nobel Peace Prize after brokering a peace deal between France and Germany following the Occupation of Ruhr (a herculean healing effort) and subsequently seeing Germany’s re-admission to the equivalent of the UN, or the League of Nations, as it was then called.


  • Secondly, remember how in this piece when talking about the disintegration of the Prussian empire…

As an interesting sidebar, keeping our Austrian angle here for a minute, a heavy majority in both Austria and Weimar Germany wished for Austria and Germany to be reunited as a single state, but, of course, this was strictly forbidden by the other European states in one of the key articles under the Treaty of Versailles.

Now, on the surface, things were looking excitingly positive on the political stage. Ideas on the United States of Europe were flooding in thick and fast. A well-known construct was Briand’s Memorandum on the Organization of a System of Federal European Union which you can see on the World Digital Library here. Excerpt:

At the annual meeting of the Assembly of the League of Nations in September 1929, Foreign Minister Aristide Briand of France proposed the establishment of a federal European union to coordinate economic and political policies. Briand believed that the proposed union should be created within the framework of the League, and promised to submit a detailed plan for a federal union to the 27 European states that were League members…

Briand and Stresemann (Wikipedia)

Briand [left] and Stresemann [right] (Wikipedia)


Europe’s Cracks of Instability

But a direct hit from two political torpedoes in 1929 would derail everything.

Firstly, relating to puzzle piece #1, the key behind the European integration idea was represented by two colossal figureheads in European politics at the time: our friend the French Prime Minister, Aristide Briand, and our friend the German liberal, Gustav Stresemann (who had appointed Schacht to dig Germany out of its hyperinflation). You see, there was a deeply intimate collaboration between Briand and Stresemann on the fabric of the union of Europe and its implementation. Pushing through an objective of this complexity and ambition required Herculean leadership, massive political will and respected kudos: Stresemann had this in abundance. Alas, German politicians seemed to make a disgusting habit of dying at the wrong time. Like his comrade President Hindenburg, Stresemann’s death was exquisitely badly timed – when Europe needed him most. It is regarded as one of the major factors which contributed to Europe’s precipitous capitulation. From this point, the foundations of the Europe’s Great Experiment seemed to crack and crumble.

Secondly, relating to puzzle piece #2, Germany and Austria sought to engage in a “Customs Union” – basically a bilateral common market arrangement. But this meant taking a head-on collision course with the Treaty of Versailles, which drew strict lines (literally) on European boundaries and co-operations between segments of the old Prussian Empire after the devastation of WW1. British Foreign Minister, Arthur Henderson, and Aristide Briand deflected responsibility for a final decision on this to the League of Nations. But this only incensed more outrage, particularly in France, for what was regarded as a blatant breach of the peace treaties, here is a quote from CQ Press

Meanwhile violent denunciation of the Austro-German action had broken out in France, where the trade pact was regarded as a first step toward Anschluss (political union of Germany and Austria), a tearing up of the peace treaties, and the ultimate execution of the Mittel-Europa project, which was to have been for Germany the result of a victorious outcome of the World War. Briand’s policy of reconciliation with Germany, his consent to a scaling down of the reparation burden and to withdrawal of the forces of occupation from the Rhineland, and his project for a “United States of Europe” were condemned throughout the length and breadth of France. Henderson was criticised for not having immediately pronounced the customs-union project a violation of treaty obligations and it was pointed out in the French press that prior to his appointment as foreign secretary in June, 1929, he had written articles in support of the Anschluss.

The European project was falling apart at the seams before it had even begun. But Briand may have had his reasons for pondering over the Austro-German customs union. This was, in part, because the first step of his strategy towards European union was indeed a trade pact based on equal multilateral trade duties or, in effect, a customs union. Just the sort that Germany and Austria had tried to arrange. So, in the back of his mind, he may well have thought that the Austro-German deal could be the first symbolic step to this new European dream. Convincing the Germans of this was easy, if only he could convince his own countrymen… Again from CQ Press

The Customs Union and the United States of Europe

In Germany the proposed customs union is represented, not as a first step toward political union with Austria, but as a first step in the execution of Briand’s project for a United States of Europe. It is worthy of note in this connection that when the United States of Europe project was advanced by Briand at the Tenth Assembly of the League of Nations, in September, 1929, he envisaged a European customs union as a necessary prelude to European political union. “Where you have a group of peoples, grouped together economically as in Europe,” he said, “there ought to be some federal link between them. …It is this connecting link which I desire to establish, and obviously the most important component of this connecting link will be economic agreement, and I believe that in the economic sphere agreement can be reached.”


Briand, Monnet, Salter and the rest of the powerful pro-Union activists were talking about economic and trade union and a “Zollverein” – common market. There was talk of preserving sovereignty for member states with a supra-national “common political authority”. All the stuff we talk about today – and this was nearly a century ago! They came so close…

But, critically, the whole Austro-German customs union affair had damaged relations between France and Austria… and the project relied heavily on trust.

To make matters worse, after the “roaring twenties” decade, speculation and credit extension towards asset prices had overreached and a stock market, which had been running on fumes, suddenly imploded in the “Great Crash” of October 1929.

Great Depression - Car For Sale (flickr)

Great Depression – Car For Sale (flickr)


Why are we printing so much currency?

At this point I’m going fast forward in our time machine to the present day to get some insight from our friend and famous historian Adam Fergusson, speaking about current monetary policy, money printing and QE…

I think the position is, of course, terribly serious right through (again) the Western economies. I don’t see that any of these economies is going to be able to grow its way out of the extraordinary debts they have. The logic of that: if you can’t grow your way out of your debt, you have to repudiate that debt. And there is only one serious way of repudiating your debt and that is by inflating.

Here’s a simplified conceptualisation…

My dad could have had a mortgage of 25k in 1970, just before Fergusson’s book came out. It wasn’t until the mid-seventies when rates started to spike – so he could have got a fixed rate mortgage at relatively low rate in 1970 (base rates would rise as high as 17% by 1979). At the time, 25k was a pretty big mortgage – he may have been earning £5k per annum, so his mortgage would be five times his salary. Now, for the sake of argument, imagine his dad (my grandad) offered to pay his (fixed) interest for the rest of his life. Fast forward to today, 40 years later; even if my dad hadn’t paid a single penny of his mortgage principal down and just allowed my grandad to only pay the fixed interest, the resulting mortgage of 25k today is a mere pittance in the scheme of things. Because today his salary may be £50k; ten times higher than it was 40 years ago. So inflation has effectively paid down his mortgage for him. Thus we can say; on a relative basis, inflation has the effect of eroding the principal value of debt. Note: one can make the same argument by saying, even if he had to pay the interest himself; wage inflation should increase roughly in line with interest rates making this relatively painless. On the flip side, imagine if a normal salary in 1970 was £500k per annum and he’d got a mortgage for five times his salary – £2.5million. In a mirrored deflationary environment his salary would have deflated to £50k today – what we would consider pretty normal now-a-days. Here’s the problem, the debt doesn’t deflate. He still has a £2.5million mortgage! With a £50k salary… Game over. He might as well declare bankruptcy. This is because on a relative basis, deflation has the effect of expanding the principal value of debt.

So, just like the Weimar hyperinflation killed all the savers, the place you do NOT want to be is in a deflationary environment holding a significant amount of debt. Here’s the scary bit. Just look at these two charts of our debt-to-GDP ratios in Western Economies and you will never again need to ask the question: why are all central banks hell bent on cranking the printing machines and inflating the bejeezus out of their currencies?

McKinsey Chart on how global debt has seen a massive $57tillion increase in the last few years – full 136-page report (recommended reading) here.

Mckinsey Global Debt

Mckinsey Global Debt

Trend of US Federal Debt to GDP

US Federal Debt-to-GDP

US Federal Debt-to-GDP

G10 Debt Distribution

G10 Debt Distribution

G10 Debt Distribution

UK’s huge financial (private) debt is on account of the massive influence London’s financial sector has on the economy. Doesn’t look great, though, does it? Let’s be clear here. GDP is the ECONOMIC OUTPUT OF THE ENTIRE COUNTRY. Tax receipts are just a fraction of this. So when we say total debt is 100%, 200% 1000% of GDP, that’s a percentage which relates to the size of the entire economy. There does come a point when just the interest payments on government debt alone are bigger than entire tax receipts of the nation. That’s when you have that Wilde-Coyote-running-off-a-cliff moment – your economy’s about to plummet to the bottom of the canyon… then an ACME anvil is gonna fall on your head.

Now, knowing what we know about deflation, inflation and debt, it becomes more understandable when Fergusson says:

…there is only one serious way of repudiating your debt and that is by inflating.

That’s why the central banks around the globe; the BoE, the BoJ, the ECB, the Fed are all printing the crap out of currency – we’re at war, a currency war, a race to the bottom. Who can devalue their currency the fastest? And it’s why we’re soon to have negative interests rates across all developed economies, it’s why your bank is about to charge you for holding DEPOSITS (not overdrafts) with them. With negative interest rates, banks are effectively being punished for not making loans to customers and customers are being punished for not piling on more debt. Why? Because the government and the central banks effectively want to stoke an inflationary fire in order to engineer an inflation ‘soft default’ on the massive mountain of debt in the economy – and they want you, the diligent middle class saver, to pay for it. Is there some sort of ‘moral hazard’ associated with this monetary sleight of hand? You betcha, there is.


Debt and Deflation in Europe in the 1930’s

But let’s get back in the time machine and head back to the 1930’s and to Europe.

France and Austria’s relationship after the Austro-German customs union debacle is now unquestionably tarnished. Why did I mention the relationship between debt and deflation? Well, you see, at the time Europe was crippled with debt. Every government had borrowed to finance WW1. Indeed in just 5 short years British national debt increased from £650m in 1914 to a whopping £7.4 billion in 1919 (more than a 10 fold increase)! The rest of Europe was in the same treacherous boat and then, of course, after the war more spending was needed to rebuild infrastructure and the economy.

Furthermore, financial institutions were extending credit liberally, whether it was banks offering mortgages to fuel the property boom or brokers offering low margin requirements for highly leveraged stock broking accounts. One bank in Austria, called Creditanstalt, was the top bank in the country. In a pre-globalisation context, I guess you could say it was the European 1920’s equivalent of a bank like HSBC. This was a bank which, in the 1850’s had had an IPO wildly oversubscribed at 43 times. Indeed, it must have been the financial equivalent of launching The Titanic. While it came with a Titanic reputation as “unsinkable”, in the throes of choppy and icy waters of the 1930’s it was making a few wrong turns. Poor management and lack of organisational dexterity meant that in bad times, Creditanstalt found itself scraping the barrel of the loan market as more nimble operatives picked off the lower-risk opportunities. Also, being the ‘Motherbank’ of Austria, when things started to go pear-shaped the Austrian government coerced (forced?) the responsibility of more bad loans on to Creditanstalt’s huge balance sheet.

Meanwhile, back in the rest of Europe, governments, banks, businesses and individuals were already laden with debt and, as we now know, the worst thing that can happen to a severely indebted economy is the onset of dreaded deflation… but Europe’s worst fears were coming true. Because, as people lose confidence and as anxiety grows, business activity slows and slowing business activity is effectively the root cause of deflation. Because the entire banking system and economy works by a series of confidence tricks, the very existence of overbearing debt backs consumers into a causal loop, a self-fulfilling prophecy… the more debt you hold, the more you fear deflation… the more you fear deflation, the more likely it is to happen.

To make matters worse, in 1930 France, a number of banks collapsed. The banks were small enough to be absorbed by the economy in normal conditions but matters were made worse when some became embroiled in scandal involving government officials which inevitably led to the collapse of the French government. The worst case scenario for the indebted economies ensued… the chill of deflation became entrenched in Western Europe.

By May of 1931, Creditanstalt collapsed under the weight of its own debt and non-performing loans on its balance sheet. The bank had owed about $20 million, which was a lot of money in those days, and had only $7 million in capital. The Austrian government, together with the newly formed Bank for International Settlements arranged a loan but it simply wasn’t close to being enough. Creditanstalt was not only too big to fail, it was also too big to save for the Austrian government. Furthermore, still reeling from damaged relationships over the Austro-German customs union affair, France was unwilling to help bail the Austrians out… and just like that… BOOM! A powder keg was lit… the Austrian ship was going down, sinking into a dark, deflationary abyss… and it was taking everyone with it.


History Lessons

What happened next was so catastrophic it would go down in the annals of history as the worst ever global financial disaster and would never be forgotten. It would consume entire continents and it would be known as The Great Depression. The public swarmed to recover capital and there was a run on the banks, the banks stampeded and ran on each other and eventually demanded gold conversion for currencies including dollars which, of course, exported the crisis to America with devastating effect.

Furthermore, the rise in poverty and unrest caused by the depression gave opportunity to a Nazi propagandist called Joseph Goebbels. He would become Hitler’s right hand man and together they would form the darkest and most sinister plots on all humanity.

So in the 1930’s The Great Depression was a debt-induced banking crisis of European making which we exported to America – a favour they would pay us back for handsomely in 2008. But let’s be clear, the failure of Creditanstalt and subsequent effect was a bigger deal than the collapse of Lehman and the Financial Crisis of 2008. The devastation of the latest financial crisis simply does not measure up to the Great Depression of the 1930’s… but national debts are still rising and central bank impotence in fighting deflation/disinflation is becoming more and more alarming every day… so season monetary impotence with a bit of political absurdity and we still have time to put our black mark on history.

So now I’ve put the pieces of one puzzle together, why don’t you try your own hand at this game?

  1. Given we know that we, the largest and most developed global economies, are at record levels of total indebtedness.
  2. Given that we know the Great Depression was precipitated by a collapse of a bank who had been coerced into taking bad loans.
  3. Given we know that negative interest rates in Europe are putting exogenous pressure on banks by punishing them for not making loans.

What does this say for the future quality of loans European banks are taking and thus the health of European bank balance sheets (and thus the health of the European banking system)?

Hint. Hint. Hint. Hint. Hint. I’ll leave you with a quote from Fortune Magazine this week:

“The EU is making the same mistakes over and over and over again,” says Viral Acharya, a professor at NYU’s Stern School of Business. “They’re not demanding that the banks be recapitalized as they should be, and allowing things to get worse by enabling lenders to keep zombie loans they should have dumped years ago.”


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24th July 2016 – The Re-Birth of Germany: Power and Money

I’m Winston Wolfe – I solve problems.

Harvey Keitel [quote from the film; Pulp Fiction]


Schacht - Wikipedia

Schacht – Wikipedia

The Man with Two Names

Horace was a complicated character. Not an easy man to read, perhaps because he never really knew himself or perhaps because he did, yet changed with the weather like and philosophical cameleon. While unquestionably intelligent, maybe he lacked conviction and confidence or what we call “political spine”. His background and upbringing was atypical for a German growing up in the early twentieth century. Even his name was something of an enigma. His father, who had lived in America, had named him Horace Greely, after the famous activist politician and anti-slavery campaigner. But apparently a rather unruly grandmother insisted he be called by a Danish first name – Hjalmar. So from then on he was known as Hjalmar – but one wonders if he secretly preferred Horace.

His education was equally hard to pin down. Having studied Medicine, then Philosophy, then Politics, he was not the obvious choice for President of the Reichsbank in 1923, where the main contingent came directly from an education in economics. Germany was suffering from bouts of hyperinflation so violent, they were literally tearing the country to shreds, this was no time for an amateur at the helm. But perhaps it was time to think outside the box. He was appointed by an interesting duo; two of the three most powerful men in German politics at the time (the third being Adolf Hitler). The first was President Hindenburg, who many considered to be the only viable opponent capable of disrupting and defeating Hitler’s rise to power. The second was Chancellor Gustav Stresemann, an extremely influential liberal politician who subsequently won a Nobel Peace Prize after brokering a peace deal between France and Germany following the Occupation of Ruhr (a herculean healing effort) and subsequently seeing Germany’s re-admission to the equivalent of the UN, or the League of Nations, as it was then called.

These two men of German political prominence, President Hindenburg and Chancellor Stresemann, must have recognised that solving the hyperinflation problem was not about continuing a textbook approach to economics or politics. Not only was the country in a mess, it was a complicated sociological, economic and political mess that school and theory does not prepare you for. After Queen Victoria’s son-in-law Emperor Wilhelm II loaded up on debt and printed the heck out of the currency, Germany’s Gold Standard collapsed along with its economy after WWI (as described in an earlier post – Turbo-printing). Printing more paper money for WWI repatriations had sucked Germany into the swirling vortex of a hyperinflation death-spiral.  Furthermore, the German financing mechanism was destroyed and, even if she wanted to go back to the gold standard, there was simply no gold left in its banking coffers. Perhaps a tough and immeasurable problem needed a tough and immeasurable man to tackle it.


Enter The Wolf

I could go into detailed into on Schacht’s life but let’s just say he had a chequered history having just been fired by his previous employer, General Karl von Lumm, the Banking Commissioner for the then Occupied Belgium. Schacht had allegedly favoured his old employer, Dresdner Bank, for financing state transactions in Belgium. But Schacht’s reputation as an extremely proficient trouble-shooter or “fixer-of-problems” echoed through the halls of the then Weimar Republic with an imposing resonance. Despite his past, it speaks volumes of both the stature of his intelligence and the desperation of the times that he should be Hindenburg and Stresemann’s go-to-man for what basically seemed like Mission Impossible (cue the music). Perhaps we could view him as the Early-Twentieth-Century German-Politico-Economic Equivalent of The Wolf, in Pulp Fiction. You got a problem that needs fixing but looks impossible to fix…? Call The Wolfman… and he should be with you directly…

I’m fascinated by Schacht’s strange mixture of intelligence, humility, arrogance and cowardice. Despite his position and the enormity of the challenge before him, Schacht incredulously had no staff, save for his secretary, a certain Fraulein Steffeck, and set up his office in an old cleaning lady’s cupboard. Fraulein Steffeck’s occasional sideways gaze as he paced around the fog of his own cigarette smoke would provide a unique insight into the profile of a man deep in thought, with the weight of a giant nation on his shoulders. Even by Schacht’s exemplary standards, this challenge was a BIG one. In case there is any doubt about the magnitude of the task before him, let’s just quote a passage from Adam Ferguson’s legendary book from 1975, When Money Dies (a fascinating but perhaps not-so-gentle read for the beach?) which described the monumental “hospital ball” he’d received.

Schachter was faced with incredible disorder. During the previous ten days expenditure had exceeded revenue by 1,000 times. The floating debt had been increased fifteen times. The government would shortly be unable to pay cash wages to the Army, to the police or to its own officials. Already the officers of the Ministry of Finance itself were being paid in part in potatoes. The budgetary estimates included on every page the outrageous reminder, in brackets, that all figures were in quadrillions…


Enter the Rentenmark

What would you do, if you were Schacht, dear reader? I’m not too ashamed to admit that, I’d revert to my special “baby defence mechanism”…I’d soil my pants, throw up and then start wailing in despair until Fraulien Steffeck came to clutch me close to her warm and welcoming bosom. And yet Schacht did none of this. Instead he would conjure a solution to all Germany’s monetary woes with a shockingly simple master stroke. Enter the Rentenmark.

There is a, quite wonderful, quote from a Forbes Magazine article entitled In Hyperinflation’s Aftermath, How Germany Went Back to Gold where the author in turn quotes the great Adam Fergusson’s cult book.

“Dr. Schacht sat in a single room which had once been used as a charwoman’s cupboard, looking on to a backyard in the Ministry of Finance. From this post he transformed the German financial system from chaos to stability in less than a week. His secretary, Fraulein Steffeck, was later asked to describe his work as commissioner:

What did he do? He sat on his chair and smoked in his little dark room which still smelled of old floor cloths. Did he read letters? No, he read no letters. Did he write letters? No, he wrote no letters. He telephoned a great deal–he telephoned in every direction and to every German or foreign place that had anything to do with money and foreign exchange as well as with the Reichsbank and the Finance Minister. And he smoked. We usually went home late, often by the last suburban train, traveling third class. Apart from that he did nothing.

Farmers accepted the rentenmark in trade for their crop, and the crisis was resolved. A new reichsmark replaced the rentenmark a year later, at 1:1, putting Germany’s return to a gold standard on a more long-term basis.

So we see that it takes almost nothing to adopt a gold standard system. The Rentenbank held little if any gold. The rentenmark was not convertible into gold. No preparation was necessary. No staff was necessary. No time was necessary. The only thing that was necessary was a clear policy, namely to maintain the value of the rentenmark equivalent to a prewar gold mark, and a clear means to accomplish this policy, by restricting the supply of rentenmarks to maintain its value.

Renten is the German word for “mortgage”. What Schacht did was audacious. He needed a mechanism to stabilise the currency, but there was no gold supply left to back the currency. So he effectively backed the German Rentenmark with the only thing with more quantifiable, more transparent supply than gold: German land. The very agricultural land farmers were using to yield crops, the very commercial land manufacturers and service-providers were using to produce output became the yardstick to which German money supply was pegged. I’ll admit, it was a bit of a confidence trick. But isn’t all modern monetary policy? In any case, it worked. At inception, one Rentenmark started out its life equal to one trillion of the old German paper Marks and strict limits were put on how and when to print more currency.

What followed was quite an astonishing turnaround. Indeed, the only thing more remarkable than the speed of Germany’s economic collapse was the speed at which Germany was able to rebound, once a currency of trustworthy supply was in place. It is worth bearing in mind that only a few years after a complete annihilation of the economy, Germany had amassed a military machine on a scale the World have never before seen.


Hindenburg and Hitler - Wikipedia

Hindenburg and Hitler – Wikipedia


And the rest, as they say, is History…

Which guy in this picture looks the happier? Hitler’s largest political obstacle, indeed I think it fair to call him Hitler’s political adversary, was President Hindenburg. But he was getting old and by the time he was re-elected he was 84 years old, understandably weak and the weight of warfare and political turbulence seemed to have literally sucked the life out of him.

Schacht played an interesting role here too and this is where the complexity of Schacht’s character is hard to fathom. Schact clearly supported Hitler apparently from a strategic perspective – because he felt the country needed strong leadership. But was he just a cowardly populist and political momentum junkie? Hindenburg would use what strength he had in him to subdue Hitler’s insistence on wanting a prominent seat at the table and openly stated that “a presidential cabinet led by Hitler would necessarily develop into a party dictatorship with all its consequences for an extreme aggravation of the conflicts within the German people”. Alas, at 85 years of age, physically weak and mentally exhausted, Hindenburg eventually caved in to political pressure from his inner circle and appointed Hilter as Reich Chancellor.

Hindenburg died only a year later, in 1934 leaving a power-vacuum Hitler was all too quick to step into – announcing himself as Head of State and Head of Government only 2 hours after Hindenburg’s death. Schacht would eventually became Hitler’s banker and Minister of Economics and his deft stewardship of both the German economy and facilitation of Hitler’s financial might led him to become a recipient of the honorary membership to the Nazi Party and was awarded the somewhat dubious honour of the “Golden Swastika” in 1937. There is no doubt in my mind, Schacht did a lot to pave an economic pathway to pay for Hitler’s rearmament policies.

How much Schacht supported Hitler’s eventual brand of Facism is another matter open to debate. Schacht’s vision of “strong leadership” was clearly different to Hitler’s and he opposed The Fuhrer’s seemingly profligate military expenditure and the nature of his rule. Schacht would eventually become part of a stealthy collective who would form the Resistance Movement in Germany – their ultimate aim being to end Hitler’s reign in a violent coup d’etat. But, 72 years ago, the 20th July assassination attempt failed and thus opposing Hitler, even politically, was a dangerous place to be in Germany. Schacht was arrested and spent the rest of WWII in concentration camps.

Still, it’s hard to place Schacht’s views politically or make sense of his philosophical or ideological direction. Schacht said, in 1946, once the war was over:

I have never believed in war. It is a crime against humanity whether you win or lose. I just read an article in this magazine I have in my hands that one day the moon will fall on the earth, but it is my feeling that until then, we should try to make the world a better place to live in.

But perhaps we should leave the judgement of his character and political ambition to others closer to the matter, such as Chief Prosecutor at the Nuremberg Trials and US Solicitor General and Attorney General, Robert H Jackson, who described him as…

The most dangerous and reprehensible type of all opportunists, someone who would use a Hitler for his own ends, and then claim, after Hitler was defeated, to have been against him all the time. He was part of a movement that he knew was wrong, but was in it just because he saw it was winning.

A pretty damning assessment of his character indeed. Schact had managed to produce a monetary magic trick but he was not a politico-economic Winston Wolfe. Winston Wolfe was a comic book hero in a Quentin Tarantino movie, but this was no movie… and this was no comic.


Learning from History…

However, this is not the place to dissect Schact’s character or his political integrity, I’ll leave that to the historians to debate. What we are interested in is that, from an economic perspective, two things are clear:

  1. How utterly intertwined monetary policy is to political policy to the point, at times, it is hard to decipher when one ends and the other begins.
  2. How startlingly effective a supply standard (be it Gold or not Gold) was in bringing to heel even the most parabolic inflation of an out-of-control currency supply.

But we should end on an economic note, so I leave you with quotes, once again, from our friend, the great economic historian, Adam Fergusson [emphasis mine].

The important thing about the Schact Reforms was that the Reichsbank stopped discounting treasury notes and so inflation stopped “just-like-that” with astonishing speed…

… the effect of having the Rentenmark and a currency everyone believed in was very remarkable. In the first place, because people believed in it, the food started flowing from the country into the towns again…

… it had another effect, that all the revolutionary movements that were taking place in Germany at the time (and Hitler’s beer cellar Pusch) that had happened in early November [of 1923]… …With the introduction of the Rentenmark… all these political movements left or right, ceased to trouble… which was, again, an extraordinary thing. It was at that point, then when something began to grow again…


There are a million random walks I could have taken. I’m sure in the future I will read this all again and take a different journey through the history of money. That’s the beauty of reviewing our monetary ancestors. But, my dear and patient readers, we have gone from Caveman Capital, the Birth of Money and the First Bankers… to Roman Emperor Nero’s Debauchment of the Denarius… to Marco Polo’s account of Kublai Khan’s “flying paper money”… to The World’s First Central Bank, thanks to William of Orange … to a descendent of that, somewhat Germanic, British monarchy, Emperor of Prussia Wilhelm II, and the First World War and the subsequent Weimar Republic and Hyperinflation… and then, in this post, to Schacht’s Monetary Magic Trick and Germany’s economic rebound…


Where on Earth will we go next? I tell you, the chapters to come are the most enthralling of all…


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10th July 2016 – Goodbye to Vote Leave’s Biggest Campaigner

Blooperman - Image Attribution: WikiMedia - Zinneke

Blooperman – Image Attribution: WikiMedia – Zinneke

Will the Real Vote Leave Campaigner Please Stand Up

I think it may be time to say goodbye to Vote Leave’s biggest cheerleader. No, I’m not talking about Nigel Farage, nor Boris Johnson. I’m talking about this little fellow – The President of the European Commission, Jean Claude Juncker.

I’m not going to assassinate his character… well… OK, maybe just a little bit. But it’s not his lack of tact that draws me to him, it’s his predictably unpredictable lack of tact that makes him a truly intriguing specimen. I mean, what can I say about a man who returned to the country he presided over only to say, with great humility, that it had all turned to shit since he left? Mr Juncker was the Prime Minister of Luxembourg, a country with 570,000 people – that’s the same democratic footprint as the Mayor of Sheffield. Some of my non-British readers may not be able to place Sheffield on a map… I wouldn’t let that keep you up at night.

But to be fair to Mr Juncker, he was democratically elected and was subsequently one of Europe’s longest serving premiers. Luxembourg, nestled between Germany and France, is also a founding member of Europe’s union otherwise known as the Inner Six group of nations who signed the 1951 Treaty of Paris, one of the key let’s-stop-blowing-each-other-to-pieces agreements Europe ratified after WWII. With four languages under his belt and a leadership record, it’s easy to see how, on paper, Juncker seemed to have the credentials to lead the way in European politics.

But paper credentials do not count for much when projecting communications toward a population one thousand times larger (and infinitely more diverse and complicated) than his native Luxembourg.

The Taxman

Let’s start with Luxembourg. Under Juncker’s stewardship Luxembourg became a haven for tax avoidance. His administration facilitated legislation which encouraged large multinational companies to use their tax avoidance loopholes to circumnavigate domestic taxation systems in their operational markets. This systematic scheme was exposed by the International Consortium for Investigative Journalists who released a scandal called Lux Leaks. Here they revealed the names of hundreds of offshore asset managers and huge multinational companies who had slipped billions of backhanders through the tiny state. All the household names are there and some not-so-household names – I was genuinely surprised to see the name of one of the hedge funds I used to work at there! Lux Leaks even provided a cute little video showing, simplistically, how these companies went about their avoidance called Tricks of the Trade.

Suffice it to say, this humiliation dogged Juncker upon his affirmation among the political elite within the EU. This was probably the quietest he’d been throughout his career and attempts to brush the taxation issue under the carpet were almost comically undisguised. Indeed, it was the European Commission, led by Juncker himself, who were investigating allegations into… … … well, Juncker himself. Hmmm… I wonder how that would turn out? In an article by EuroActiv:

…an Italian journalist said that it was “scandalous” that while many Italian companies may have been involved in the Luxembourgish tax evasion schemes, leading to a deepening of the financial crisis in Italy, the Southern European country could now witness the former prime minister of Luxembourg, whose country benefitted from these schemes, imposing further austerity measures in Italy.

Ironic indeed.

Juncker the Drunker

Things were not looking good for the EPP’s (European People’s Party) man – who had been anointed via the controversial Spitzenkandidat loophole (referred to in an earlier post on account of its “tenuous basis in law”). Still, Juncker was used to loopholes. Once the tax haven discomfort had been suitably suppressed, Juncker arose again; like a flaming phoenix of political Tourette’s Syndrome. Embarking on a mission to cram as many political gaffs and slap-stick impudence into his tenure as could be conceivably imagined. At times he appeared to remove one foot from his mouth only to dexterously replace it with the other.

First, he sought to energise solidarity within The Union using the diplomatic skills only his mother could love. In Juncker’s view, Nato was not enough. But Juncker’s vociferous calling for an “EU Army” was almost immediately slapped down by the British and other EU states – who didn’t see the appeal in staring down Russia like an English hooligan at a football match in Marseille. These uncontrolled lurches toward European federalism, together with David Cameron’s outright assault on both the process of his appointment and the appointed man in question, marked the beginning of the UK’s not-so-amorous affair with the President of the European Commission. At times I actually enjoyed Juncker’s cavalier charges into the white-hot cauldron of political debate. His lack of predictability was at least making European politics interesting and that’s more than can be said for the other 32,999 people employed by the European Commission.

But adding to Juncker’s humiliation were the rumours that he was a “heavy drinker”, as many, including the Dutch Finance Minister and President of Eurogroup, had claimed. Now, in Britain that normally gets you a knighthood, but then came THAT YOUTUBE CLIP, where a, seemingly inebriated, Juncker seems keen on assaulting every World Leader within slapping distance, kissing the Belgian Prime Minister on the top of his bald head then, incredulously, shouting “Dictator!” at the Hungarian Prime Minister. At this moment Juncker had transcended from the politically blunderous to imbecilic diplomatic abandonment of comedy gold so pure not even the great Austin Powers or Inspector Clouseau could rival (any excuse to include a Peter Sellers clip). Still, David Cameron stuck his knob into a pig – so, hey, we’ve all got our little vices.

What I particularly love about this clip is how the woman to the left of Juncker (the Latvian Prime Minister, Laimdota Straujuma) is continually ushering and laughing nervously in an attempt to distract attention from the obvious embarrassment beside her. You know, the same way a mother laughs nervously when she returns from the toilet to detract from her son, who has pulled down his pants and is busy playing with his “ding-a-ling”, in full view of those in the dentist waiting room… anyway, enough about my troubled times as a hedge fund trader…

Is it a bird? Is it a plane? No… it’s Junckerman!

In many respects Juncker will be missed. He’s added some colour to what was otherwise a very stale, grey organisation. Indeed, the normally, critical ZeroHedge writer, under alias Tyler Durden, and Super Blogger, to sarcastically commentI think I think quite a bit higher of Juncker now”. To the blogosphere he’s a tap flowing endlessly with a golden rainbow of political blog content. Writing about Juncker is easy, one only needs to copy his quotes to get material. Speaking of quotes our dear friend Juncker is quoted to have once said, when referring to Greece and the prospect of a GREXIT:

…when it becomes serious, you have to lie.

Priceless. Gold. Solid Gold. It’s cheered up my, otherwise dreary, weekend. My wife has left me with the three kids and frolicked off to London for a jolly weekend with her sisters. I should on the verge of a mental breakdown. And yet I cannot type these words without grinning – and now cappuccino-sipping mums at this bacteria-infested death-trap of a “soft play” hell hole are staring at me and whispering between mouthfuls of muffin. “Look at him” they chatter… “he’s having a breakdown“. They think I’m as nutty as the slice of fruitcake their precious little Xavier has just chucked down the ball-pit slide – now I know how Jean-Claude must have felt in EU Parliament. But, on a more serious note, his handling of communication on Greece led to the less-the-complimentary nickname of “The Master of Lies”. His mouth seems intent on shooting what is left of his credibility in the foot (the one that’s not in his mouth, that is).

But if you savour democracy and are nervous about sovereignty, transparency, corruption and truth worry not, dear citizen of Europe, Junckerman has the tonic to put your mind at ease. Quoting the Telegraph’s article:

On EU monetary policy

“I’m ready to be insulted as being insufficiently democratic, but I want to be serious … I am for secret, dark debates”

On British calls for a referendum over Lisbon Treaty

“Of course there will be transfers of sovereignty. But would I be intelligent to draw the attention of public opinion to this fact?,”

On French referendum over EU constitution

“If it’s a Yes, we will say ‘on we go’, and if it’s a No we will say ‘we continue’,”

On the introduction of the euro [this one is the BEST]

“We decide on something, leave it lying around, and wait and see what happens. If no one kicks up a fuss, because most people don’t understand what has been decided, we continue step by step until there is no turning back.”

On eurozone economic policy and democracy

“We all know what to do, we just don’t know how to get re-elected after we’ve done it”

I know quotes can be taken out of context and, almost always are. The final quote, for example, is actually quite honourable and makes me smile in the way I think Juncker actually intended – he’s effectively saying he sticks to his principles even if, ultimately, it costs him his job. I think for this attitude, he is, rightly respected and liked by many of his peers – even those who disagree with his politics. But my point is; public-facing politicians know the risks of being misrepresented and are, boringly, “politically correct” for these reasons. But for a man, unelected by the people, at the helm of the largest, most powerful supranational governing body and leader of the institution with “legislative monopoly” in the EU, we are firmly in Prince Philip Territory of political faux pas here. He’s the “colourful character” on a nightclub dancefloor who you just know is going to end his evening being carried out by the bouncers – probably with his teeth missing. But that’s enough about my troubled times as a hedge fund trader … … … why do you think I was at the dentists in the first place?


But it was during the BREXIT debate where Junckerman excelled himself and, like a defective fracking drill, he drove harder to dig to new depths few thought were possible. The RemaIN camp did everything they could to silence Junckerman during the campaign and keep him in his box. Der Spiegel reported that Juncker was made to “promise British Prime Minister David Cameron that the EU executive branch would stay out of the Brexit debate”. Perhaps locking him in a cellar full of cognac. Alas, no cellar is that voluminous and, like a bewildered, bleary-eyed badger, the bedraggled Blooperman crawled out of his hole and started making noises with his mouth… threats that British “deserters will not be welcomed back” or how “community life would not continue as before” and that Britain would be treated as a “third country” if it left the EU may have been semi-accurate, but they did nothing to help the RemaIN campaign and played right into the hands of Vote Leave media hype-machine. It made some voters actually question which way he wanted the referendum to go! Was he making this personal? Was third country an upgrade from fourth?

As if that wasn’t enough, Juncker appears to have now angered the one person in Europe you do not want to get on the wrong side of: Angela Merkel. His immediate and overt meetings with Scottish Nationalist Party Leader Nicola Sturgeon were described as “unnecessarily provocative” and it is rumoured that Merkel has him under her steely gaze and “may have to deal with him” next year. But, to be honest, I wouldn’t put it past Juncker to survive even a full Merkel offensive against him. He has an uncanny ability to flip serious argument into petty tantrums which demeans the entire debate. I’m genuinely starting to wonder if this is a sign of weakness or an exquisitely disguised skill. Merkel is a rational human being and pinning Juncker down into a political corner using any form of rationality is like trying to herd jellyfish with a pair of pliers and a trombone.

The CETA His Pants

The latest big trade agreement on the EU table is with Canada: CETA (Canadian; Comprehensive Economic and Trade Agreement). At any other time it would just be another one of those murky deals between the power elite stealthily slithering between the cracks of democracy (perhaps we’ll talk about that another time, dear reader). But these times are different, every move from every European politician is under scrutiny. Only a few days ago Juncker wanted to push the deal through with minimal democratic friction or even influence from elected European heads of state. Deutsche Welle stated in an article a few days ago that:

European Commission President Jean-Claude Juncker told EU leaders on Tuesday that CETA would fall within the exclusive competence of the EU executive and therefore didn’t need to be ratified by national parliaments in the 28-nation bloc, sources in Brussels told the German news agency DPA.

However, only days later, in true flippant Juncker style he said that he “couldn’t care less” whether state members get to vote on the deal. The whole episode led Sigmar Gabriel, the German Minister for Economic Affairs and Energy, to refer to his positioning as “unglaublich toricht” which I believe, loosely translated means “incredibly stupid”. Then, instead of fast-tracking the ratification from a small handful of key member states (like Germany and France) as was expected, Juncker seemingly threw the cat among the pigeons by requiring ALL 28 member state leaders to vote on the deal. I have to admit I almost have admiration for him.

But we will probably have to say goodbye to our amusing political loose cannon. Juncker is good for entertainment but I fear he’s not particularly good for the future cohesiveness of the European Union. If Merkel doesn’t get him I fear, like a kaleidoscopic firework on Chinese New Year, he will dutifully self-destruct in quite spectacular fashion. Alas, the World will be missing one more colourful politician… and the bloggers will have to find something else to write about.

The fact that he’s a federalist I think is inconsequential, indeed it enamours me and probably other voters to him – at least he has a vision for Europe. But right now Europe and the EU needs cohesive healing rather than bickering, tantrums and divisive in-fighting. Perhaps more importantly, it needs to convey an image of cohesion and objective retrospection above all else. Juncker is not the man to deliver this image.

In recent days he took the bait that UKIP leader Nigel Farage (so obviously) dangled and got embroiled in a petty squabble in European parliament. It actually demeaned his stature, if that, indeed, were possible. I don’t think many Vote Leave campaigners even like Farage – picking a fight with him is like picking a fight with a four-year old kid at the queue for the Teacup Ride in Disneyland… anyway … that’s enough about my troubled times as a hedge fund trader…




…as for the Commission-led taxation investigations…

Bloomberg reports:

European Union nations were well aware that Luxembourg and other countries provided favorable tax rulings during the past decade but opted not to confront them in the interest of protecting their own harmful tax breaks for multinational companies.

A report from EU Parliament TAXE Committee members probing a special tax breaks from Luxembourg found that some EU member countries engaged in “systematic obstruction” of the panel in its efforts to uncover the details behind the “LuxLeaks” scandal.

“Documents we have finally been able to review in recent months show that member states were aware that general tax rulings were being offered to multinational companies such as in Luxembourg, and there was a decision not to challenge them,” said TAXE Committee Chairman Alain Lamassoure, a French member of Parliament from the center-right European People Party political group, at a July 6 news conference.

… go on my little jellyfish friend!


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24th June 2016 – BREXIT: The 12th Hour Came…

12th Hour Came - Courtesy of Gratisography

12th Hour Came – Courtesy of Gratisography

Quote from previous piece:

The pro-EU juggernaut in Britain has a much more powerful political army and a bigger arsenal than the Eurosceptics. Perhaps the most famous “Vote Leave” campaigner, and London Mayor, Boris Johnson is right, this is a David versus Goliath match up. In choosing to part from Goliath (and his Prime Minister and party leader, David Cameron) Boris Johnson too has staked his career on the EU referendum.

But, let’s leave Barack Obama, the European leaders and all the large corporations aside for the minute and examine just the domestic political landscape in the simplest terms. With the four most powerful domestic parties in the UK all wanting the same thing (RemaIN) you’d think they’d come together to deliver a powerful and meaningful message together, in unity, in solidarity. I’ve been waiting for this to happen. But so far it has not. At times it’s as though incumbent politicians here are so vehemently against agreeing with anything the “opposition” party has to say that, even on the things they agree on, they choose not to be even in the same room as one another. Perhaps they are saving this moment of union until the eleventh hour when the campaign will suddenly explode into life… but they are running out of time, it is now the eleventh hour and the 58th minute.

On the flip side, the political minnows on the Eurosceptic side (officially the “Vote Leave” campaign) of the fence seem to be delivering clear, succinct messages and are focusing, at least temporarily, on their commonality rather than their differences. There is nothing to corroborate this subjective, cloudy argument. It’s just my opinion. But, if the logic of causality is not there, the results certainly are, because in May of 2014 something quite strange happened…


Dear readers, welcome to the World of uncertainty. At this point is customary to say, with British politeness, “well nothing more could be done the people have spoken, you can’t point fingers now”. I disagree. All RemaIN voters can and should point the finger. At their very own political leaders.

Jeremy Corbyn, leader of the Conservatives main opposition party was missing in action. So many significant Vote Leave victories were in Labour strongholds. Where was Mr Corbyn’s EU campaign in Scotland and the North of England? The same place the Labour campaign was during the general election: missing in action. Perhaps there is a black hole in the middle of England which sucks all political will out of people. Paralysed between utter disdain for saying anything that might be agreeable with the Prime Minister and his own uneasy history – having been an outspoken anti-EU protagonist himself. The only sound bite I remember of his campaign was how he was definitely NOT on Cameron’s side.

Nicola Sturgeon, leader of the Scottish National Party, who were so victorious in the General Election staged a pretty poor campaign in Scotland. Scottish turnout was 5 percentage points lower than in Wales. Some may say they didn’t know what they were doing… hmmmm. Or maybe she knew exactly what she was doing. The ink is barely dry on the press releases and she’s already started her campaign for a SCEXIT (Scottish Exit from Britain) which, let’s face it, has been her agenda all along.

David Cameron. Where was he? He’s slick and polished with a prepared speech in his hand. He’s happy to bully and banter in the House of Commons but he seems to run a mile at any thought of a televised debate. Why was I hearing more sound-bites from Boris Johnson than David Cameron? Boris is not the Prime Minister… … … … … yet.

Tim Farron, leader of the Liberal Democrats… wait… Tim who? Oh, forget it…


2% is a narrow victory, it’s a rounding error. A display of solidarity from our political leaders could have turned the result. Yet, not once did I see these political leaders stand shoulder to shoulder to send a strong pro-EU message. They didn’t even have to talk. Just stand for a photo-shoot would have been a start!

For those RemaINers who want to point fingers I’m going to say, you’re within your rights to do so. Point them at your own political leaders. The RemaIN campaign was shambolic. Our political leaders are left hopelessly gawping at each other in disbelief like the English back four defenders when that Russian chap headed in a goal in the last minute of our first European Championship Football Game. And yet, like our footballers, for matters in Europe, they only have themselves to blame.

What happens to Scotland? What about Northern Ireland? Indeed, what happens to Europe now? Your guess is as good as mine – I can only hope for a pragmatic EU reaction, even from Jean-Claude Junker, who’s comments frankly did nothing to help the RemaIN campaign (rarely do British voters react well to threats). For all readers, EU members or not, welcome to the world of volatility. Between political uncertainty and reform, fiscal calamity and monetary impotence and unwinding of globalisation – all set to a backdrop of undeniable demographic headwinds (see interactive piece here).


Posted by on June 24, 2016 in David Cameron, David Cameron, Economics, EU, Europe, Politicians, UK


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