I will argue here that the financial system is broken mainly due to these points:
- Currently the rich are getting richer (gini coefficient rising), and the poor getting poorer.
- The developed country governments and central banks are having to take on more debt to keep the economy going.
- It seems the fractional reserve, debt laden Developed economies are getting more fragile, and more challenged to provide the products and services they have promised to their citizens.
So how did we get here? To understand that we have to go back to 1971, and recap a few things.
Today all money is ‘debt’ – it is a claim on the productive resources in the future. New money is today created in two ways:
- The Federal Reserve ‘purchases’ eligible collateral – eg Treasuries, and enters a Debit in their Fed ledger, and Credits one of the ‘money center banks (JP Morgan Chase, Citibank etc)
- A bank issues a loan for say a mortgage – the ‘money’ is created into existence by crediting the sellers account with the dollars, the mortgage is created as an asset on the banks balance sheet. The mortgage is the home-owners liability – and when the home-owner pays down the principal, dollars (‘money’) as actually leaving the system.
Due the Vietnam war costing the US too much, and foreign governments pulling their gold from the US, the Nixon administration decided to suspend ‘temporarily’ the convertibility of the US Dollar to gold. The untethering of currency from a gold backing since 1971 has enabled the greatest global monetary inflation ever seen – check out the great site called ‘https://wtfhappenedin1971.com/.
The US economy has grown from 1.2 Trillion USD per year in GDP in 1971 (Revenue) to 22 Trillion USD in GDP in 2020 – about 18x. The average household income was $10,600 per annum, rising to $66,000 per annum – about 6x.
So while our economy has grown 18x (nominally) and incomes have grown 6x (nominally), let’s look at what happened on the financial side of the ledger.
In 1971 the amount of financial instruments was about 4.5 Trillion in the US – with the bottom of ‘Exters pyramid’ held down by gold:
While Money & assets (not counting derivatives) are over 150 Trillion today – which is a 33x increase.
So to re-cap -incomes have grown 6x, but assets have grown 33x. In my mind these increases in Debt are driving making the rich richer, and the poor poorer:
To note here – I’m not against rich people per se, most rich people in the US have worked hard most of their lives and I’m sure have earned it. The issue as I see is that the system primarily benefits the ‘Cantillonaires’ today – the megabanks and the 0.1% wealthiest with the first access to money. So while new debt is created – it is mostly an asset for the 0.1%, while it acts as a drag on the economy, for the majority of wage earners.
So who are these Cantillonaires you ask? It’s named after a French economist – Richard Cantillon – who realized that when new money is created – it benefits most those who first gain access to it – they get to enjoy the purchasing power undiluted. By the time that the new money reaches the regular wage-earner, prices and interest rates have risen to account for the new money, so the nominal amount they benefit – say from a stimulus check – is counteracted by the rise in prices.
We also saw in the aftermath of the 2008 financial crisis how we don’t really have a functioning capitalism anymore where those who take risks are allowed to fail (hence ‘too big to fail’). We have instead a capitalism for the cantillionaires, a crony capitalism where the 0.1% reap the profits, but the losses are socialized – i.e. paid for by the tax payers.
Finally today in we are not only taking on new debt, but we are printing more money – the Fed’s is buying 120B in assets (80B in Treasuries, 40B in MBS) – as this extra ‘support’ is needed to carry 30-40% of the US government spending, while it in actuality it is digging a deeper hole for the majority of people. We are following in the footsteps of Japan, down a Keynesian folly where any mishaps are resolved by ‘printing more, stimulating more’. I’d be very interested to discuss or hear how the developed countries are going to get out of this mess we are in today.
Thanks for reading,
Oskar