"The rescue of Bear Stearns may have inflicted pain on shareholders, but it saved bondholders, which is unprecedented and ominous."

I was under the impression that in the USA, holders of common shares in a business are normally the very last in line, behind holders of preferred shares, bondholders and just about everyone else, in a bankruptcy. Am I mistaken, or is this different in Europe?

Thanks for a great article.
To what extent does the 'Anglo disease' hold sway in Europe?
Post Thatcher,it is my understanding that considerable steps in that direction have been made in much of Europe.

Jerome, what do you mean by this?

and take back what they grabbed: it's not theirs.

As far as I can tell, there is plenty of responsibility to be shared for this situation, including those in the middle class who couldn't resist the temptation (like my wife and me) to go into debt for a bigger home, a new car, etc. Are we not all part of the machine? Personally, I am just learning now how the machine was set up, including the whole notions of money as debt, fiat currencies, ever-expanding credit, etc.

Anglo disease reminds me of Hayek talking about inflation:

http://mises.org/tradcycl/avoidinf.asp

The influx of the additional money into the system always takes place at some particular point. There will always be some people who have more money to spend [financial sector] before the others. Who these people are will depend on the particular manner in which the increase in the money stream is being brought about. It may be spent in the first instance by government on public works or increased salaries, or it may be first spent by investors mobilizing cash balances or borrowing for the purpose; it may be spent in the first instance on securities, on investment goods, on wages or on consumer's goods. It will then in turn be spent on something else by the first recipients of the additional expenditure, and so on. The process will take very different forms according to the initial source or sources of the additional money stream; and all its ramifications will soon be so complex that nobody can trace them. But one thing all these different forms of the process will have in common: that the different prices will rise, not at the same time but in succession, and that so long as the process continues some prices will always be ahead of the others and the whole structure of relative prices therefore very different from what the pure theorist describes as an equilibrium position. There will always exist what might be described as a prices gradient in favor of those commodities and services which each increment of the money stream hits first and to the disadvantage of the successive groups which it reaches only later--with the effect that what will rise as a whole will not be a level but a sort of inclined plane--if we take as normal the system of prices which existed before inflation started and which will approximately restore itself sometime after it has stopped.

So basically the financial sector, get the new money first before the wage earners and other people lower on the economic food chain. By the time people lower on the food chain get the money, prices have already risen and their buying power in diminished. This expansion of credit continues until the people lower on the food chain finally get access to the debt money flowing into the economy via cheap credit or rising wages. Then there is finally a rise in the price level which triggers the central bank to raise interest rates, and a contraction of debt. The people at the end of the food chain get wiped out and the people at the top of the food chain begin again and are never threatened thanks to their access to discount window lines, TAF, TSLF, and other special forms of credit that the little people do not have access to. Remember! The most important industry in the whole country is banking! ;)

In a non-fractional reserve banking system, or at least a more controlled expansion of money supply the people with economic power would be savers and profitable companies not banks and the corporations that have grown up around them who use their bank leverage to dominate the economy. Also, prices for goods would slowly fall as the creation of new capital, such as factories and so forth would increase the efficiency of the production of products, lowering their price. This natural lowering of prices is covered up by the money that the banks create which cause an offsetting rise in price levels. Currently we are faced with a situation however where in a non-inflationary economy the price of oil would be rising, as it is getting more scarce. When this is compounded by bank credit inflation the effects trigger runaway inflation and give little room for banks to expand credit without triggering further inflation -- leading to a contracting debt environment -- thus, stalling the re-initialization of the money/credit cycle leading to a credit-collapse driven recession/depression.

What about the insurance companies? How does the demand destruction like people taking cars off the road hurt the insurance industry? In a lot of cases isn't vehicle insurance pretty much easy money? Is there a knock on effect in the financial sector? Bond insurance? Is this post entirely misplaced?

Banks gives the middle class the option to take on debt. Some choose not to.
Government takes on debt on behalf of the middle class. There is no choice.

I would like bankers to be given more regulatory control over the government.

How opaque would all of this be if there were a simple and real standard for monetary value? Namely, how would it be possible to hide the obvious fact that it takes real energy to do work and an equivalent amount of money to buy that work if money were equated with energy -- that is energy available to do useful work? It wouldn't be possible to have a fractional-reserve banking system or secondary markets of any kind since money could only be created by expanding the usable energy reserves. What would the economy look like under such a scenario?

See: What is money, really?

I have explored this concept in various blog posts at: Question Everything

George

The Australian counterpart to Dutch Disease is the never ending mining boom now fuelled by Asian demand. The glaring inconsistencies have created what is called the '2 speed economy'. While cities and drought ravaged farmers struggle some outback towns are awash with money. For example up the road from my place a new nickel mine (Avebury) and a new zinc mine (Comstock) just 4km away are competing for miners and construction crew.

In rough chronological order the sequence of boom minerals went iron ore, bauxite, coal, nickel, uranium and LNG. The new wonder 'mineral' is coal seam methane. By happy coincidence coal and LNG exports largely pay for imports of oil and refined fuels. That is likely to turn into a growing deficit in the next few years with $200 oil.

Over the last 20 years this cargo cult mentality has been deeply ingrained into Australians. It seems inconceivable that either Asian demand could collapse or there will be no new discoveries. However I think the run of good luck must end soon.

Thank you for this informed article.

The grandest scam.

Let me ask you, "Where does money come from?" How does it come into existence? The real answer for most of the supply of money is it comes into existence as a "bookkeeping entry" on the books of some bank.

What does this have to do with debt bubbles or transfers of wealth out of the hands of the majority into the hands of the privileged few (or alternatively, why are banks always the nicest buildings in town?)? The answer is that all of our money is bank debt except for coins; this money is created in loan transactions in which you, the rube, or your government, the accomplice, borrow this newly created money from the banks, paying interest on the loan.

Coins, currency, and checking accounts are thought of as money in most peoples minds; you can spend them almost anywhere. You have you money in your pocket or at your bank. You don't think of your house, car, stocks or bonds as money. Maybe you think of your savings account or CD's or money, maybe not, but some economist think of them also as money or almost money.

If you look at the total of coins, currency and checking accounts in the US back in 1913, the total was about 50 Billion. Today it is over 25 times that. Well, as I said earlier, bookkeeping entry is how they inflated the money supply. You go the bank to borrow $20,000 for a car; they have you sign a note payable to them and they add $20,000 to your checking account so you can write a check to the car dealer. The bookkeeping entry on their books is to increase an asset account they call customer notes receivable by $20,000 and simultaneously increase a liability account on their books called customer checking accounts payable. The money supply just went up by $20,000. Notice the note you signed payable to them provides not only that you pay them back the $20,000, but you also pay them interest. The US government wants to spend more than they tax, so they print up some interest bearing bonds, send them over to a bank and the bank creates a checking account balance for them to spend; the money supply goes up as a result.

This system was imposed upon us by collusion in 1913 between government and banks as the federal reserve system was established. You can see why they both like it. When the government cannot tax enough, it has a ready source of funds and the banks love to collect interest for managing the expansion of the money supply.

There are two really serious problems with this scam money system.

The first is that when new money comes into existence it is used to bid up the prices of things. This is why what could be bought for a few pennies in 1913 now requires dollars instead. The price changed because the value of the money was diluted. We don't know today how much of the price increase in oil is due to physical supply demand relationships and how much is due to diluting the value of our money. I think, given the current financial crisis that latter is more significant than the former.

And speaking of financial crisis, this is the second serious problem. Initially when loans are made there is an increase in economic activity because of the demand created by the new money. When loan principal and interest must be repaid it creates a drag economic on activity because repayment of a loan is the reverse of the original transaction and it decreases the money supply. This system amplifies economic swings. Progressively this system concentrates wealth in the hands of the few and concentrates poverty in the hands of the many. Ultimately it destroys the middle class. Ultimately it bankrupts the very banks who spawned the system because ultimately the banks cannot collect the loans they made and ultimately people do not want bank debt money because the banks really have nothing to pay them. Talk about an unsustainable growth curve.

You might get frightened about your checking account and go to get your money, but all they can give you is federal reserve notes (those things in your pocket otherwise thought of as currency or "bills of credit") which is debt of the private federal reserve bank, and if you don't want that, I suppose you could ask for a mountain of coins, which they would politely refuse. But you really could not likely get even federal reserve notes in a run since banks keep only a small fraction of their asset as "vault cash" so they would run out pronto once everyone heads for the door at once.

The problem we all face is that we don't have real money. All we have is bank debt, and debts can be expanded or defaulted upon. When gold and silver coins were money, you had something that was real and others would willing take based on centuries of human experience.

We all have been scammed by our beloved governments and our local, national and international bankers.

I think that maybe we are witnessing the demise of the unstable fractional reserve, debt based monetary system. Maybe we will be lucky and the debacle will take down the federal government as well, so not only can we go back to localized production but also enjoy the advantages of localized government as well.

Hello Jerome,

Fascinating keypost, as usual. Recall that the very first banks were repositories for surplus harvest grains. I have proposed, in earlier postings, of banking being based upon the very roots of our civilization; my speculation on the biosolar mission-critical need for the creation of 'Federal Reserves Banks of I-NPK'.

You borrow I-NPK, then later repay the loan with some percentage of the photosynthesis reward generated by this I-NPK above the Liebig Minimum. Recall that job specialization is only possible by food surpluses, thus this societal food dispersement allows the supply chain replacement of the original borrowed I-NPK [if properly designed & controlled].

I-NPK and sulfur global flowrates are directly tied to decreasing net energy flowrates, thus it greatly behooves the postPeak bankers/investors to charge the absolute minimum for I-NPK & grain storage; the system becomes self-limiting to natural biosolar constraints--not some ficticious scam of charging fixed interest with no ecologic boundary impingement.

Societal parasitic overhead and waste is quickly reduced to what is actually net total ecologic-energy possible without borrowing from future generations. In short: borrowing timeframes will be limited to the natural crop-cycles plus a small time reserve directly related to size of the grain reserves.

If a person chooses to be debt-free: they can use and recycle O-NPK to achieve their harvest reward, then keep or sell the entire harvest, or some portion thereof. Entropy will eventually force 100% O-NPK reliance--afterall, it is the natural Cycle of Life--but I believe an I-NPK based banking system in the postPeak regime offers a graceful decline method, plus encourages the rapid ramping of universal O-NPK and other Element recycling.

Bob Shaw in Phx,Az Are Humans Smarter than Yeast?

Jerome,
Have you read the new book The Gods that Failed: How Blind Faith in Markets has Cost us our Future by Larry Elliott and Dan Atkinson, which came out on Thursday? They are respectively economics editors of the Guardian and the Mail on Sunday.

see
http://www.thegodsthatfailed.co.uk/
for their blog.

A very angry book about the debt bubble - I could feel the steam rising of the pages as I read it yesterday. They managed to squeeze a couple of pages on peak oil with mentions of Colin Campbell and Matthew Simmons into the penultimate chapter, together with some apocalyptic visions of the immediate financial future.

Highly recommended.

It all makes me wonder where we are going to get the necessary investment for 'post carbon' technologies given a banking system that seems to be obsessed with profit without social responsibility.

BobE

Epilogue: ………………………sadly enough, the true ‘workers’ of this world have put their faith in the hands of people that have repeatedly touted how they would represent OUR interests, OUR health, OUR family values, and OUR hopes for a better today and tomorrow. What has NOW come to a head is the ultimate insult levied on ‘each and every one of us’; the lies and broken commitments of those chosen and NOT CHOSEN by us, causing Global economic chaos while THEY continue to prosper beyond measure. I know I’ve said it before and at the risk of being redundant I will say it, again; ALL of these unscrupulous people and the organizations they hide behind must be ‘rounded up’ like the vermin they are and exterminated immediately so they may not be permitted to breed another population of predators that only care about themselves and those who enable them. I have no problem with people making a profit, but I have a HUGE problem with people and/ or organizations making money and advances- while intentionally crippling the masses and the system that allowed them the opportunites to turn a profit in the first place. Being the catalyst of intentionally creating widespread chaos during the process of turning a profit should be a crime punishable by death; just as crimes against humanity and crimes against our environment should be. These ‘petro- dictators’, oil companies, crooked politicians, and self-serving business people & speculators have NO BUSINESS being allowed to do all the wrong they intentionally inflict upon the very people that actually perform the work and drive the economic engine that ultimately creates the opportunities these people knowingly exploit. Whatever the punishment and/ or stringent regulations imposed, I say it wouldn’t be harsh and/ or swift enough!

Wanzinator.............................................(out)

Nah. It is simpler than this.

95%+ of our money comes from debt (Look up Fractional Reserve Banking).

Debt is an exponential function. Exponential functions cannot continue forever in the real world. Therefore they hit a limit and collapse.

It is inevitable. Whether the cause is thought to be oil or tulip bulbs is irrelevant, it will always be something.

What's required is monetary reform. Decouple debt from money creation. Ironically, more deregulation rather than less is the key, allow banks to do as they wish but give them no governmental support. No bailouts. No safety net. No Federal Reserve.

, wonderfully, a programme to invest in housing and vehicle energy efficiency, renewable energy, and infrastructure, paid for by massive tax hikes on the rich, will help solve the current recession and the oil crisis

its this sort of simple punchy message I can get on board with

Boris
London

"That announcement, in turn, made the markets brutally change their expectations about future Fed rate changes."

i dont doubt that markets changed their expectations about the fed. i wonder how realistic those expectations were ?

I remember as a kid just after the war my folks had to put down about 90% to borrow the 10%.

What is wrong with buying only what you can afford. If one cannot save enough one has already washed oneself out of any FICO score and so is already a risk.

The reality comes when the controlling Cabals want you to buy things which make THEM rich, regardless of what is good for you.

"They" are all in an unconscious conspiracy through the culture, the media and peer pressure to guide you to Buy, Buy, Buy. Only a very few non-addictive personalities can withstand this constant pressure.

We as a culture, if we wanted, would have the capacity to create a population controlled by moderation, but unfortunately this will never be allowed.

We have the "Lottery Syndrome" of "well one of us will win, and it may be me". They say Canada 6/49 lottery has a 26 million to one chance at the jackpot and they probably sell 50 million tickets twice a week. I suspect we have a genetically controlled species-survival-strategy to take chances for resources..

Commodity markets work on the relationship between supply and demand, but it appears to me that the critical supply/demand relationship in today's commodity markets is not within the commodity, itself, but the supply of dollars searching for locations for investment.

There are too many dollars looking for a limited number of places to go. Your article seems to confirm that. It certainly seems as if most commodities markets are trading in the speculative, rather than true value, range.

Jerome,

A thought-provoking article indeed but I have my doubts as to your assertion that there is one major culprit (the rich) whose punishment and quasi-expropriation will mitigate our sorrows. As Aangel put it:

there is plenty of responsibility to be shared for this situation, including those in the middle class who couldn't resist the temptation (like my wife and me) to go into debt for a bigger home, a new car, etc. Are we not all part of the machine?

To that one might add the politicians whose vote-seeking behaviour drives them to expand the welfare state and drive up public debt, and the voters who vote for them. In fact, what we are facing is a double tragedy of the financial commons – one between ourselves at national and international level, where almost everybody loses, and one between the generations – where of course the older generation inevitably wins out. There is a combination of market and government failure, just as there is a combination of spiralling private and public debt. We are dealing with a buck that stops everywhere, and a buck that stops everywhere is a buck that stops nowhere.

But even if we assume for the sake of argument that the rich are ultimately to blame and the rest of us are just innocent, misled dupes, there remains a purely instrumental question. You write in conclusion:

And, wonderfully, a programme to invest in housing and vehicle energy efficiency, renewable energy, and infrastructure, paid for by massive tax hikes on the rich, will help solve the current recession and the oil crisis.

One could perhaps argue that ‘massive tax hikes’ are morally a good thing in themselves, as a form of punishment for sin, but what evidence is there that such ‘tax hikes’ actually achieve their objectives of making the rest of us better off in the long term?
Geld ist scheu wie ein Reh (‘Money is as shy as a deer’) and the rich, having lots of it, can be very shy indeed. Those ‘massive tax hikes’ can’t be imposed overnight and you can be sure that once the topic is put on the political agenda, wealth and money will begin to seek another shore --- the sky will be dark as the geese begin to fly away, together with their golden eggs. For most of us, rich or otherwise, our homeland is where we prosper: ubi bene, ibi patria . And if that homeland is abroad, that is where most of us go if we are young enough and dynamic enough. Those that cannot afford to move will then find themselves left to rot in an egalitarian dystopia where all they will be able to share is their misery -- a kind of negative selection of the untalented.
Which is about the last thing any country needs in times of trouble.

As a contrarian, I have to mildly disagree with your analysis.
The real cause of the Anglo Disease is the fact that there is NO real usury law. Under the Reaganites the credit card companies were able to overturn banking state regulations and charge consumers loan-shark rates.
This opened up an epidemic of financial gaming of the system. The solution is easy, establish a
maximum amount of interest(<10%?) that maybe legally charged.
This will direct capital to useful activities and end the speculative mania.
Of course this anti-libertarian message will drive the freakonomists, reactionaries and bankers generally crazy with threats for a capital flight abroad. That can be prevented by coordination of the various fed banks around the world.
;)

In history, the speculative mania and rampant loan sharking actually destroyed the old Roman Republic, where
interest rates were prohibited above 8.33% in the Twelve Tables. Gradually the Roman bankers were able to screw it up to 12%. The ancient historians believed that high (+12%)interest rates would have destroyed the Roman economy and would have gasped at our 16% rates.

http://www.columbia.edu/cu/history/resource-library/ugrad_tan_thesis.pdf

In my untutored opinion, the legal interest rate should be
5%, which would force investment in meaningful projects such as your windfarm. It would also destroy the 'financial economy'.

If you're an adviser to the Democrats, please suggest this benefical fix to our economy. I'm not sure this can be sold to the monied classes. But as a banker, hmmm....can you bring yourself to embrace such 'lunacy'?

So, a question, is there any major currency that is less exposed to this debt bubble? I have always mistrutsted the financial system, my rational mind telling me that the whole caboodle just did not add up. Having read this post and the comments, it seems my lack of trust was not misplaced. I really wonder though, if there is any currency apart from precious metals etc. that did not subscribe to this fractional reserve banking madness? Is the euro any different from the dollar and the pound in this regard?

P.S. I remember once back in the nineties asking an economist how the government of a small island economy like ours could justify paying high interest on money it borrowed. My argument being that, these high interest rates (>35%) would ultimately bilk the taxpayers of the country. His response was some airy, fairy B.S. crap about govt. charging for certain services provided by the govt., but, HEY ISN'T THAT ULTIMATELY CALLED TAXATION!! I didn't buy his explanation, needless to say. By the way if you think I am kidding about the interest rates check:

Bank of Jamaica Economic Data (1993)

I think this link and post is a good place to make a important point that a lot of people don't realize.

I've come to realize that the greed of the wealthy is infinite. Its so large that they not only have to have billions in legal cash flows but billions in hidden flows of wealth to finance dirty wars and bribes etc.

I've been looking into the flow of oil using a modified logistic equation and studying the concept of hot oil. Hot Oil

By having a pretty good idea about how much technology can force increases in production I have a pretty good idea about how much oil was produced in the past. What I have found is that its possible that 10's or hundreds of billions of barrels of oil have been extracted in excess of official production numbers.

In any one year its not a huge amount of oil say 1-5% of the total amount extracted but over time this adds up. What this represents is a very large amount of cash flowing into the hands of the wealthiest people in the world. Lets say its about 100 billion a year right now. This is enough money to finance entirely out of the dark economy the war in Afghanistan for example.

This explains the immense power of the western money masters over the rest of the world. Not only do they print the money and control most of the means of production but they also have access to uncounted dark income which is greater than the GDP of most of the nations on earth. This is easily enough money to own the world given your free to spend it however you see fit.

Obviously this hidden money is a lot more powerful than the nominal public wealth and it goes a long way to explaining how Anglo disease is capable of distorting all institutions to to maintain the status quo.

The Oil industry is the only one large enough and lacking in accounting to allow enormous influx of dark money not even the illegal drug trade can provide the same cash flows.

Just a cursory examination of the oil industry shows that this is quite possible. Given todays post you can see its highly probable.

People advocating change don't understand how deeply the wealthiest most powerful people in the world depend on a opaque large oil market to control the ponzi scheme we see on the outside.

Another question few ask is why do the wealthy need a infinite amount of cash ?

Why does this concentration of wealth continue seemingly without end enough is never enough.
Certainly human greed plays a large role but this does not seem to be a complete answer.

Well it turns out that maintaining a super wealthy lifestyle is very expensive.

Consider one of your 15 million dollar mansions.

Lets assume for now that your really wealthy and you paid cash for it.

A staff of 10 at 30k a year == 300k
Maintenance and upgrades fixed costs == 200k
Taxes at 5% = 750k
5 parties at 100k each = 500k
House guest support = 200k

This already totals to about 2 million a year in expenses to support one top line mansion.

Every 7 years you could buy another mansion for the expenses. Your costs on the mansion alone with this
simple accounting are running 13% of the purchase price.

Given you have even more staff etc on hand to manage managing all your personal assets planes etc you can quickly see that the super wealthy need a return of 20% just to maintain their lifestyle.

This does not include saving money to buy more stuff add that in and lets say its 30%.

The cost of being super rich is the driving force behind this endless concentration of wealth.
Its really a potlatch society at the end of the day with most of the wealth concentrated in the rich almost immediately destroyed maintaining the lifestyle.

No wonder they seem to have infinite hunger for money.

now the euro is the perfect outlet to express skepticism about the value of the dollar

I agree with many of your points in this piece, but not this. What makes the Euro so special in a worldwide currency deflation? The poorest countries in the EU will be nearly bankrupt and need help from the richer countries - when things get stressful, long term cultural wounds/pride come back to the surface. The dollar has problems, but the Euro has more, IMO.

Maybe it's time to stop listening to what is highly self-interested drivel, and take back what they grabbed

What do you mean here? Higher taxes or something more draconian? And keep in mind that the people making the decisions on such action are precisely the ones at the top of the ponzi pyramid. One can hope they turn into altruists overnight but not likely. A tax system like Sweden or Netherlands takes decades to become part of culture - doubling taxes overnight is tantamount to revolution.

One area I totally agree with you on - the next phase of this whole enchilada is equity (or rather, inequity). The worlds GINI coefficient can only stretch so high before the lower echelons realize they have been used. As Herman Daly proposed a few weeks ago on a post here, the gap between the richest and poorest will never be zero, but it can and will shrink.

Well if you are into fantasy:
http://www.fugue.com/pics/goodnews.html

Thx for this good post Jerome.

Used to be Noirette (MoA and here as well)