Global Financial System – Problems

BANKING SYSTEM PROBLEMS

The G20 nations are experiencing ongoing costly banking problems and an increasing fragility of the banking systems, this has given rise to the largest wave of global banking crises seen since the 1930s Great Depression.

The ensuing productivity growth slowdown will translate into overall anaemic growth rates for the world’s economy. We will be unable to crawl our way out of our debt problem, but instead dragged into debt-enslavement. The resulting deflationary spiral will turn out to be much worse than the 1929 contraction of the world economy.

The advanced economies that that are otherwise generally perceived to enjoy deeper financial markets and higher quality institutions are facing a serious banking crises, created by the slow bank restructuring since the 2008 GFC – although while macroeconomic policies have been used aggressively in dealing with the economic crises of countries such as Greece, Ireland and Spain.

This has affected the global economic pace of recovery which has now led to a potential banking systematic shock; this raises questions about the optimal policy mix in resolving financial crises in advanced economies.
Politics and monetary policy in Canada, USA, UK, EU, Australia and NZ have departed from the principles that have guaranteed success for these nations in the past.

The never-ending aftershocks of the 2008 financial crisis are tempting an insecure and overburdened elite to seek their salvation in state planning, bureaucracy and intervention.

The result is obvious: A catastrophic monetary crisis is inevitable, the likes of which has never been seen before.

The policy of low interest rates and QE has not only set in motion a gigantic redistribution machine but has also eroded banks’ earnings and led to massive and largely unrecognised accumulation of risks in banks’ books.

Artificial low-interest rates have sustained companies which should have been sent into bankruptcy from their share-buybacks by the subsidy of zero interest rates.

These zombie companies which feed off zombie loans will sooner or later fall in a tidal wave of defaults. The cheap credit has also led healthy firms to over-borrow and over-leverage and hide this with creative accounting.

Accumulation of zombie companies is detrimental to the economy’s productivity growth which itself is the only source of long-term growth. No demand stimulus can replace that.

There are several adverse effects that will cause humanity considerable pain in the next few years. The Governments and Banks are not prepared to absorb this type of economic shock!

Following the collapse in the early 1970s of the Bretton Woods arrangements under which global currencies were pegged to the US dollar, which in turn was pegged to the price of gold, the world gravitated to a de facto system centered on the US dollar.

This de facto system is characterized by free-floating exchange rates, massive private capital flows, current account convertibility for most countries, and varying degrees of capital account convertibility for many, with the IMF available to lend balance of payments support to countries in difficulties.

However, the post-BrettonWoods era has seen crisis after crisis, with defaults ranging through Latin America (1980s), East Asia (1997/98), Russia (1998) the developed West (2007/09), and emerging markets (2018–).

The economic system is inherently crisis-prone because of the following drawbacks:

  • The strains in the international monetary system are clear. The dollar-centric monetary system is in urgent need of reform. As James Rickards puts it, ‘If the dollar fails, the entire international monetary system will fail with it’. (James Rickards – The death of money: the coming collapse of the international monetary system)
  • Reliance on a national currency (the US dollar) as the de facto international currency. US dollar interest rates are determined with reference to US domestic conditions and may be too high for some other countries (currently) or too low (during the immediate post-GFC years). Moreover, the US authorities have ‘weaponized’ their currency by denying banking access to actors considered hostile to US national interests.
  • Inequity. Poorer developing countries are obliged to accumulate precautionary dollar surpluses to insure against potential future balance of payments difficulties, so transferring resources to the world’s richest country, the USA.
  • Recessionary bias. Balance of payments debtors are forced to adjust when it is most painful for them to do so, while creditors face no such adjustment pressure.
  • Lack of oversight. The IMF monitors developments and issues warnings but has little power to influence events until approached by a debtor nation.
  • Limited policy coordination. The G20 is perhaps the closest to an economic policy coordinating mechanism, but it has not been very effective in this role.

The US benefits from the system and so has resisted change. However, while as issuer of the world’s currency the US gains seigniorage, prestige, and even an instrument of foreign policy, these benefits come with costs.

In order to provide the world with dollars, the US has to run extended current account deficits, while the (forced) willingness of other nations to buy its debt arguably encourages the US in fiscal irresponsibility, as exemplified in the Trump tax cuts of December 2017.

In the long run, the present system may not be good for the US either.

Although the law says that money is “debt”, a correct application of the general principals of accounting raises doubts about such conception of what is used as money.

Money is equity, issuing legal tender involves transactions whereby money is sold in exchange for other assets (even when it is exchanged against credit claims under lending contracts). So, issuing legal tender as money thus generates income to the issuer. Under the current accounting practices, this income is incorrectly unreported in the income statements of the federal/central banks and instead incorrectly set aside under central/federal banks liabilities.

For public finances, a new approach should lean to cleaning up fiscal budgets and central banks balance sheets from the false practice of considering legal tender as “debt’.

So, if money is accounted as debt, instead of considered as equity of the issuing entities (Reserve Banks /Central Banking system) and wealth for society (public) using it, it inevitably introduces a deflationary bias in the economy, which deserves to be addressed and a deeper analysis.

The currency of a nation is used as money and most people believe it is money, but the reality it the Fiat Currency of a nation is in actual fact “legal tender”.

Legal Tender is a medium of payment recognized by a legal system to be valid for meeting a financial obligation.
Fiat Money, is a Currency without intrinsic value that has been established as Money, often by government regulation.
Fiat Money does not have use value, and has value only because a government maintains its value, or because parties engaging in exchange agree on its value.
It was introduced as an alternative to commodity money and representative money. Commodity money is created from a good, often a precious metal such as gold or silver, which has uses other than as a medium of exchange (such a good is called a commodity). Representative money is similar to fiat money, but it represents a claim on a commodity (which can be redeemed to a greater or lesser extent).

Government issued banknotes began to be used in 11th century China. Since then, they have been used by various countries, usually concurrently with commodity currencies. Fiat money started to dominate in the 20th century. Since the decoupling of the US dollar from gold by Richard Nixon in 1971, a system of national fiat currencies has been used globally.
Fiat money has been defined variously as:

  • Any money declared by a government to be legal tender.
  • State-issued money which is neither convertible by law to any other thing, nor fixed in value in terms of any objective standard.
  • Intrinsically valueless money used as money because of government decree.
  • An inherently useless object that serves as a medium of exchange (also known as fiduciary money.)

The monetary and banking systems that make up the global economic order is a casino backed by hype and driven by ponzi schemes…

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