The Walking Dead

Now that Europe’s fractionally reserved banking system has been regulated into complete inertia, it is a good time to assess the current bottom line, so to speak. We should mention here that there are essentially two ways of dealing with the banking system. One is to introduce an unhampered free market banking system based on strong property rights and nothing else. Such a system would work best if it were based on sound money, i.e., a market-chosen medium of exchange. The regulations governing such a system would fit on a napkin.

 

zombie bank2

Image credit: Warner Bros, processing fmh

 

The other way is to construct what we have now: a banking cartel administered and backstopped by a central bank, based on fiat money the supply of which can be expanded at will and involving continual violations of property rights. Fractional reserve banking represents a violation of property rights, because it is based on the assumption that two or more persons can have a legally valid claim on the same originally deposited sum of money (for an extensive backgrounder on this, see our series on FR banking – part 1, part 2 and part 3). This legal fiction is very convenient for the banks and the State, but it sooner or later renders the banking system inherently insolvent (a de facto, but not a de iure insolvency).

 

1-EuroStoxx Bank IndexThe Euro-Stoxx bank index, weekly, over the past 10 years. Recently the index has been unable to overcome resistance in the 160-162 area. The bust and the reaction of the authorities to the bust has made zombies out of Europe’s big banks – click to enlarge.

 

Given this system’s inherent insolvency, the regulations governing it obviously won’t fit on a napkin. Instead they fill several volumes the size of telephone directories and keep growing like weeds. In their infinite wisdom, Western regulators and authorities have decided to react to the crash of the banking system in 2008 by suspending the rules of capitalism. In short, they have done precisely what Japan’s authorities did after the 1989 bubble peak: They have completely zombified the banks. Amusingly, the very same people have criticized Japan’s actions sotto voce for decades.

Bank bailouts have proved to be politically unpopular. However, European and US politicians realized of course that it would be even more unpopular if depositors were to find out the hard way that the money they believe the banks to be “warehousing” on their behalf doesn’t actually exist. And so they decided to go with Plan A. Bailing out the banks has of course always been Plan A. One of the main reasons why e.g. the Federal Reserve system was established in the first place was precisely that it makes it possible to privatize the banks’ profits and socialize their losses. The other reason is that fiat money and a central-bank administered fractionally reserved banking system enable governments to impose the vile “inflation tax” and spend money they don’t have with both hands. This is extremely convenient for the financing of both welfare and, perhaps more importantly, warfare.

Nevertheless, the 2008 crisis (and the subsequent euro area debt crisis) scared governments, because it demonstrated the downside of having all these nice inflationary mechanisms at their disposal. The downside is that the large banks have simply become “too big to bail” after decades of unfettered money and credit expansion. A big enough crisis could eventually bring enraged mobs into the streets, wielding pitchforks and looking for someone to hang from the nearest lamp post. And so it was decided to zombify the banks, in order to prevent another round of bailouts (it is noteworthy that it was not decided to return to sound money and free banking – the idea is probably that business as usual can eventually be restored).

 

What’s 26 Billion Between Friends? Or 137 Billion for that Matter?

Among the many new regulations that are supposed to prevent future crashes are restrictions on proprietary trading by banks, but most importantly, new capital regulations which not only prescribe new minimum capital reserves, but also the composition of said capital. The latter rules have been used as a convenient financial repression tool, by declaring sovereign debt a “risk free” asset for which not a cent of capital has to be held in reserve (i.e., they have a “risk weighting” of zero). Banks (and insurance companies, which have also been hit with a slew of new regulations) have become captive buyers of government debt as a result.

This rule has incidentally already contributed to the complete ruin of private banks in Greece and Cyprus, which held primarily Greek government bonds. As it turned out, Greek government bonds were actually not “risk free”. We would submit that the same is true of all other government bonds: In reality, these debts can never be repaid, they can only be rolled over, at least as long as market confidence holds up.

As the Financial Times reports, a new study by JP Morgan has revealed that Europe’s biggest banks are still short of €26 billion in capital according to the newest rules in the works – or €137 billion, depending on one’s perspective:

 

“Europe’s biggest banks would need up to €26bn in new capital — hurting their ability to lend and pay dividends — if regulators’ efforts to level the playing field for the industry succeed, a new report has warned.

The European Central Bank has spent much of its first year as the eurozone’s banking regulator examining ways to stamp out national discretion that allows banks across 19 countries to calculate their capital differently. The Basel Committee on Banking Supervision is separately working on proposals that will limit banks’ room to manoeuvre in a variety of areas including how mortgages and trading assets affect key capital ratio calculations.

Regulators believe a level playing field would boost competition, but research from JPMorgan shows that the various “harmonization” efforts would have a serious financial impact on 35 of Europe’s biggest banks.

“One thing that is certain is banks will be constrained in lending,” said Kian Abouhossein, who led the team that wrote the 189-page report. “We see dividend cuts as the last resort of mitigation action before capital raises.”

Mr Abouhossein’s team found that the anticipated rule changes would reduce the combined Common Equity Tier 1 (CET1) ratios of the 35 banks by 1.5 percentage points by 2018. That is the equivalent of €137bn of their capital being destroyed.

JPMorgan’s report focuses on what the bank thinks investors — rather than regulators — will demand. By that measure, 13 banks will fall short by €26.4bn. Most banks target CET1 ratios of 10 to 15 per cent, well above regulatory minimums.”

 

(emphasis added)

The new regulations have turned out to harbor a great many “unintended consequences”. One we have frequently discussed in these pages is that the reduction in proprietary trading has eviscerated bond market liquidity – and with central bank policies creating a desperate “hunt for yield” among investors, this has created great potential to exacerbate the next financial market crash.

From our perspective it is actually not necessarily a bad thing if banks are constrained in their ability to create additional fiduciary media (i.e., money from thin air), as this makes capital malinvestment less likely. However, looking at this from the perspective of the planners, it will be considered bad news when credit creation stalls out. This will create fresh incentives for central bankers to increase the pace of central bank-directed monetary inflation in the form of direct debt monetization (a.k.a. “QE”), generating even more tinder for financial asset bubbles – all of which will eventually burst to devastating effect.

Keep in mind in this context that when private banks increase their inflationary lending, they are at least driven by the profit motive. While they are notorious for making huge and costly mistakes (see the mortgage credit bubble as a pertinent example), their decision-making is still based on economic calculation. The same cannot be said of central banks – they monetize endless mountains of debt, but there is no economic calculation involved – profit and loss are irrelevant to the central planners. They pursue diffuse goals such as “creating 2% p.a. of consumer price inflation” (no-one really knows what this is supposed to be good for) and “boosting economic growth” (which cannot be done by printing money, as it only ends up misdirecting and destroying existing scarce capital).

 

2-EuroStoxx Bank Index-STEuro Stoxx bank index, weekly – a close-up of the resistance area mentioned above – click to enlarge.

 

We can conclude from this that while the zombification of commercial banks makes them slightly safer for depositors and taxpayers, the long term economic effects of shifting the creation of money substitutes from the private sector to central planning institutions are unlikely to be wholesome. On the contrary, as fewer and fewer actors in the private sector are willing to invest or able to obtain funding for their investment plans, we have to expect government spending to keep growing and play an ever bigger role in the economy (see also the mad-cap plans of the EU and the G20 to splurge on government-funded and directed “investment”).

 

Conclusion

Bank profitability will remain under pressure for some time to come in light of the new capital regulations currently in the works. This will make it more difficult for banks to generate new capital internally, so they will have to tap the capital markets and dilute their shareholders further. It is no wonder that bank stocks remain way below the valuations they once commanded (we actually wouldn’t touch these stocks with a ten-foot pole).

From a wider economic perspective, the new capital regulations are rendering banks moderately safer for depositors (as long as the markets don’t lose faith in government debt that is), but they also contribute to their ongoing “zombification”. Bank lending is going to remain subdued. This wouldn’t represent a big problem, if not for the fact that it is likely to provoke even more government activism.

 

3-Euro Area TMSIn spite of weak bank lending growth, the euro area’s money supply is growing by nearly 14% annualized due to the ECB’s ongoing debt monetization program – click to enlarge.

 

Charts by: BigCharts, ECB

 

 
 

Emigrate While You Can... Learn More

 
 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke

   
 

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • US Financial Markets – Alarm Bells are Ringing
      A Shift in Expectations When discussing the outlook for so-called “risk assets”, i.e., mainly stocks and corporate bonds (particularly low-grade bonds) and their counterparts on the “safe haven” end of the spectrum (such as gold and government bonds with strong ratings), one has to consider different time frames and the indicators applicable to these time frames. Since Donald Trump's election victory, there have been sizable moves in stocks, gold and treasury bonds, as the election...
  • Modi’s Great Leap Forward
      India’s Currency Ban – Part VIII India’s Prime Minister, Narendra Modi, announced on 8th November 2016 that Rs 500 (~$7.50) and Rs 1,000 (~$15) banknotes would no longer be legal tender. Linked are Part-I, Part-II, Part-III, Part-IV, Part-V, Part-VI and Part-VII, which provide updates on the demonetization saga and how Modi is acting as a catalyst to hasten the rapid degradation of India and what remains of its institutions.   India’s Pride and Joy   Indians are...
  • Global Recession and Other Visions for 2017
      Conjuring Up Visions Today’s a day for considering new hopes, new dreams, and new hallucinations.  The New Year is here, after all.  Now is the time to turn over a new leaf and start afresh. Naturally, 2017 will be the year you get exactly what’s coming to you. Both good and bad.  But what else will happen?   Image of a recently discarded vision... Image by Michael Del Mundo   Here we begin by closing our eyes and slowing our breath.  We let our mind...
  • The Great El Monte Public Pension Swindle
      Nowhere City California There are places in Southern California where, although the sun always shines, they haven’t seen a ray of light for over 50-years.  There’s a no man’s land of urban blight along Interstate 10, from East Los Angeles through the San Gabriel Valley, where cities you’ve never heard of and would never go to, are jumbled together like shipping containers on Terminal Island.  El Monte, California, is one of those places.   Advice dispensed on Interstate...
  • A Trade Deal Trump Cannot Improve
      Worst in Class BALTIMORE – People can believe whatever they want. But sooner or later, real life intervenes. We just like to see the looks on their faces when it does. By that measure, 2017 may be our best year ever. Rarely have so many people believed so many impossible things.   Alice laughed. "There's no use trying," she said: "one can't believe impossible things." "I daresay you haven't had much practice," said the Queen. "When I was your age, I always did it for...
  • Pope Francis Now International Monetary Guru
      Neo-Marxist Pope Francis Argues for Global Central Bank As the new year dawns, it seems the current occupant of St. Peter’s Chair will take on a new function which is outside the purview of the office that the Divine Founder of his institution had clearly mandated.   Neo-Papist transmogrification. We highly recommend the economic thought of one of Francis' storied predecessors, John Paul II, which we have written about on previous occasions. In “A Tale of Two Popes” and...
  • Where’s the Outrage?
      Blind to Crony Socialism Whenever a failed CEO is fired with a cushy payoff, the outrage is swift and voluminous.  The liberal press usually misrepresents this as a hypocritical “jobs for the boys” program within the capitalist class.  In reality, the payoffs are almost always contractual obligations, often for deferred compensation, that the companies vigorously try to avoid.  Believe me.  I’ve been on both sides of this kind of dispute (except, of course, for the “failed”...
  • Trump’s Trade Catastrophe?
      “Trade Cheaters” It is worse than “voodoo economics,” says former Treasury Secretary Larry Summers. It is the “economic equivalent of creationism.” Wait a minute -  Larry Summers is wrong about almost everything. Could he be right about this?   Larry Summers, the man who is usually wrong about almost everything. As we have always argued, the economy is much safer when he sleeps, so his tendency to fall asleep on all sorts of occasions should definitely be welcomed....
  • Trump’s Plan to Close the Trade Deficit with China
      Rags to Riches Jack Ma is an amiable fellow.  Back in 1994, while visiting the United States he decided to give that newfangled internet thing a whirl.  At a moment of peak inspiration, he executed his first search engine request by typing in the word beer.   Jack Ma, founder and CEO of Alibaba, China's largest e-commerce firm. Once he was a school teacher, but it turned out that he had enormous entrepreneurial talent and that the world of wheelers, dealers, movers and...
  • Side Notes, January 14 - Red Flags Over Goldman Sachs
      Red Flags Over Goldman Sachs Just to prove that I am an even-handed insulter, here is a rant about my former employer, Goldman Sachs. The scandal at 1MDB, the Malaysian sovereign wealth fund from which it appears that billions were stolen by politicians all the way up to the Prime Minister, continues to unfold.   The main players in the 1MDB scandal. Irony alert: apparently money siphoned off from 1MDB was used to inter alia finance Martin Scorcese's movie “The Wolf of...
  • Money Creation and the Boom-Bust Cycle
      A Difference of Opinions In his various writings, Murray Rothbard argued that in a free market economy that operates on a gold standard, the creation of credit that is not fully backed up by gold (fractional-reserve banking) sets in motion the menace of the boom-bust cycle. In his The Case for 100 Percent Gold Dollar Rothbard wrote:   I therefore advocate as the soundest monetary system and the only one fully compatible with the free market and with the absence of force or fraud...
  • Silver’s Got Fundamentals - Precious Metals Supply-Demand Report
      Supply-Demand Fundamentals Improve Noticeably Last week was another short week, due to the New Year holiday. We look forward to getting back to our regularly scheduled market action.   Photo via thedailycoin.org   The prices of both metals moved up again this week. Something very noticeable is occurring in the supply and demand fundamentals. We will give an update on that, but first, here’s the graph of the metals’ prices.   Prices of gold and silver...

Austrian Theory and Investment

Support Acting Man

Own physical gold and silver outside a bank

Archive

j9TJzzN

350x200

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com