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Showing posts with label leverage. Show all posts
Showing posts with label leverage. Show all posts

Wednesday, 23 October 2019

Central Banks and the Bitcoin Experiment

Money has gone digital

Money has gone digital.  Less than 3% of currency these days is in the form of cash (coins or paper bills).  I still struggle to understand bitcoin, but I have slowly come to realize that what I don't fully understand are the technological aspects of bitcoin.  To understand bitcoin, you must first understand blockchain. To understand blockchain, you need to know about open-source coding, algorithms and cryptography, then you need to know about hashing and CPUs in order to understand what "mining for bitcoins" means (although I get that "mining" means solving a math puzzle and allowing transactions to use your computer).  However, these lacunae in our technological knowledge notwithstanding, bitcoin is just like any other digital currency (keeping in mind that the US dollar, for example, is already 97% digital) with only one truly significant difference.  Every example of money that we accept without much thought is managed and manipulated by a central bank--bitcoin is not.


Countries and companies preparing their own digital currency

Most countries have their own currencies--197 countries use 164 different national currencies worldwide--but there are only eight [small] countries without a central bank.  The Financial Post reported a few days ago that  last year Stephen Murchison did a presentation to the Bank of Canada on "whether or not the bank should issue its own digital money."  China is preparing the launch of its own digital currency.  Facebook is planning the release of Libra, its own digital money.  The FP article reports that :
 Switzerland’s central bank started exploring the use of digital currencies for trading. Sweden and Singapore both have research efforts underway. [ . . . .]  JPMorgan is already using a digital coin and Vanguard is testing a blockchain-based currency trading system.
Although these reports create the impression of a definite distinction between digital and non-digital currencies; to reiterate, most of the money we use today is already digital.  Since this currency must be encrypted in order to transit over the internet, it can also be described as cryptocurrency.  What distinguishes bitcoin from the crypto, digital money that we accept unquestioningly into our lives is that bitcoin has no central bank.

Facebook, China and even JPMorgan provide a central bank to manage their digital currencies.  We Canadians who have been accepting Canadian Tire money since the 1950s should be at ease with corporations' producing their own money, and recognize that a company (the Canadian Tire Corporation in this case) can be a central bank.  The question bitcoin raises is:  "Do we need central banks?"

Central Banks:  God or the Devil?

Central banks are either God or the Devil depending on your perspective.  Few issues are more likely to spur conspiracy theories than discussions of central banks.  The claim that the Rothchild family has slowly taken over the central banks of the world regularly gets viral play.  Depending on your perspective the US Federal Reserve (the US central bank) either saved the American economy from total collapse in 2008 with 100s of billions in bailouts, or it protected the interests of wealthy bankers at the expense of American sub-prime mortgage holders.  Central banks are either a cabal of fat-cat bankers taking care of themselves, or they are altruistic, public-spirited individuals dedicated to serving the interests and welfare of their countries' citizens.  Individuals with connections to a central bank have insider knowledge not only of monetary policy but of the financial systems and decisions of their home countries.  These financial gurus tend to be in the wealthiest 1% of the 1%--which arouses suspicion.  On the other hand, they help to control inflation and unemployment by decreasing or increasing the money supply, cooling down or heating up the economy.  We barely note their existence until there is a major screw up, as there was in 2008.

What's the difference between the new money and the old money?

The average citizen doesn't understand bitcoin because the average citizen doesn't understand money.  I speak from the perspective of an average citizen.  Even though I have done two posts on the subject (What Is Money?  & How Is Money Created)  and I am an accredited professional in understanding works of imagination, I still struggle to grasp that money, that thing which hard-core realists consider the bedrock of modern existence and survival, what we get up and go to work for, and worry about going to bed, can be such an airy-fairy, shrouded-in-mystery product of imagination.

How the Bank of Canada creates money

I credit this Parliament of Canada website with providing a clear and succinct description of "how the Bank of Canada creates money for the federal government." The article also provides "Information about how private commercial banks create money." The first step is perhaps the most confusing.  The Government of Canada produces bonds and treasury bills, which the Bank of Canada sells to private banks and other financial institutions, but the Bank of Canada also buys 20% of the bonds produced by the Government. This first step is confusing because to the uninitiated (like me) the assumption is that the Bank of Canada is part of the Government of Canada, so it sounds like Canada is buying and selling to itself.  The process would seem to make more sense if the Bank of Canada was a private company, separate from the Government.  In fact, the Royal Bank of Canada was first created as a private enterprise in 1934 but was nationalized in 1938.

However, in the current Canadian case:

Since the Bank of Canada is a Crown corporation wholly owned by the federal government, the Bank's purchase of newly issued securities from the federal government can be considered an internal transaction. By recording new and equal amounts on the asset and liability sides of its balance sheet, the Bank of Canada creates money through a few keystrokes. The federal government can spend the newly created bank deposits in the Canadian economy if it wishes.
The entire process seems like a game of "let's pretend."  "Let's pretend" you are a bank and I borrow some money from you, then I deposit the money I borrowed from you in your bank.  There is no limit to how much money I can borrow from you, and it doesn't matter if you think I'm a good, reliable client or not.  When I spend the money I have deposited in your bank, you take the money out of my account.  Of course, you will never ask me to repay the money I've borrowed from your bank. Later, when I have depleted my account, I will just borrow some more money from you.  In more adult language:

 . . . the Bank of Canada's purchase of government securities at auction means that the Bank records the value of the securities as a new asset on its balance sheet, and it simultaneously records the proceeds of sale of the securities as a deposit in the Government of Canada's account at the Bank [. . . ]. No paper evidence of a bond, treasury bill or cash is exchanged between the Government of Canada and the Bank of Canada in these transactions. Rather, the transactions consist entirely of digital accounting entries.

Most of the Money in the Economy is Created by Private Banks

In the game of "let's pretend," the Bank of Canada only buys 20% of the Canadian government's loans, the other 80% is purchased by private banks and investment firms.

Private commercial banks also create money – when they purchase newly issued government securities as primary dealers at auctions – by making digital accounting entries on their own balance sheets. The asset side is augmented to reflect the purchase of new securities, and the liability side is augmented to reflect a new deposit in the federal government's account with the bank. However, it is important to note that money is also created within the private banking system every time the banks extend a new loan, such as a home mortgage or a business loan. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower's bank account, thereby creating new money [. . .]. Most of the money in the economy is, in fact, created within the private banking system.

As just described, with a click of the mouse, private banks have an asset (money in their accounts) and an equal debt owed to the Bank of Canada.  Why do private banks buy or even want Canadian government debt?  The answer has many names (some of which I have dealt with in What Is Money?  & How Is Money Created) such as "leverage" or "the fractal banking system."  The parliamentary website describes the system as "[t]he limiting rules, known as 'capital constraints,' [ . . .]."  What each of these expressions is telling us is that when you go to a bank to take out a mortgage, or a car loan, or an education loan, or if you use your bank's credit card to buy a cup of coffee, you are creating money.  The money does not exist until you spend it, and when you spend it you have created an asset--money in the bank's bank account.

The Ontology of money

What we are talking about here, in big words, is the ontology of money.  With most things that are borrowed, there is an assumption that they must exist in order to be borrowed--not so with money.  It's as if you go to the bank to borrow a cup of sugar, the bank has sugar, but the sugar they lend you doesn't exist--except that you still owe the bank a cup of sugar.  Guess what?  Now the bank is considered to have even more sugar because the sugar you borrowed is added to the bank's supply. What "leverage," "the fractal banking system," and "capital constraints" all indicate is that the bank is allowed to lend you 10, 25 or even 40 times the amount of money it actually has, depending on the "limiting rules" in place.  For a period of time, the banks in Iceland had no limit on the amount they could lend out and thereby created so much money for themselves that they had more money on their books than the entire GDP of the country.  Imagine you were a bank and the "capital constraint" leverage ratio was 4% and you had a hundred dollars in your pocket.  You could lend your friend $2500 (without touching the $100 in your pocket).  Once you had your first friend's IOU for $2500, you could lend a second friend 25 X 2500 = $625,000.  If you could find a third friend, you could lend him $625,000 X 25!  You'd be a multimillionaire.  Kinda makes you want to be a banker, doesn't it?

The Bitcoin experiment

I call bitcoin an experiment because it attempts to test (prove or disprove) a hypothesis in an empirical fashion.  The hypothesis is that it is possible to create money without a central bank, without a private banking system, in fact, without any of the middlemen who run the financial system.  The mere fact that bitcoin still exists (despite constant rumours of its demise) is proof that it is possible to have a monetary system, to buy and sell, lend and borrow, carry out transactions of every sort on a person-to-person basis, without a central bank and accompanying private banking system.


What's wrong with bitcoin?

As I have taken note, here and there, of what is said to be wrong with bitcoin, I have found the only substantially negative feature of bitcoin relative to other currencies is its volatility.  The value of a bitcoin can change dramatically because its price is based entirely on supply and demand.  The total supply of bitcoins has, by design, been limited to 21 million.  Bitcoin is comparable to gold in terms of its limited supply and consequent fluctuating value. Fluctuations in the value of bitcoins can be unnerving as you are trying to decide if you should save, spend or exchange them.  This forex volatility calculator rates bitcoin (BTC) at least four times more volatile than most currencies.  Today's financial news is full of references to bitcoin's dramatic fall to below $10,000 Canadian.  Of course, if you bought, mined or were paid in bitcoins six years ago, you would still be up over $9000 per coin.  Central banks generally work to reduce the volatility of their countries' currencies, but they can also manipulate them to serve national economic interests in the global market place.

Much is made of the potential use of bitcoin to avoid taxes or for criminal activity.  As such bitcoin is a more technological, efficient replacement for cash, gold, jewelry, and artwork--all common currencies for tax-evading criminal activity (not to mention offshore banking, of course).  The real risk to and of bitcoins is that countries will and have been moving to protect their own central banks and banking systems by banning the use of bitcoin.  China is a leading example.  The second bitcoin risk, and perhaps this is the greatest one, is the competition from countries--like Canada, as the Murchison presentation suggests--when they create their own versions of bitcoin using the blockchain technology which would allow the government to track how every Canadian digital dollar is spent. 


Addendum




Thursday, 23 March 2017

Saint Mathew Pray for Us! Bank Deregulation Is Back!

Shock and awe and bank deregulation

Amid the boom and flash of the spectacular political theatre going on right now, you may not have noticed the announcements in a single utterance on television or in columns in the back pages of your local newspaper—“banks need to start lending money again,” (Trump on CNN), “President Donald Trump promised a meeting of community bankers to strip away some Dodd-Frank financial regulations” (B3 Globe and Mail 10 March 2017) and White House fires Preet Bharara “the high-profile Manhattan prosecutor known for his pursuit of public corruption and Wall Street crime” (A18 Globe and Mail 11 March 2017)—bank deregulation is back! “Bank deregulation” was the precursor to the financial collapse of 2008 causing banks and financial institutions to go bankrupt, individuals to lose homes, jobs and pensions, and triggering the government bailouts of the banks costing taxpayers what is now estimated to be a trillion dollars.  (Historically the British and Americans defined “billion” and “trillion” differently, but these days the American definition seems to prevail.  In the American system, a “billion” is a thousand million and a “trillion” is a thousand billion. Here is a more visual and visceral sense of how much a trillion is.)   The “Dodd-Frank regulations,” about to be "stripped away," were the rules put in place to prevent the collapse of 2008 from happening again.




Saint Mathew, the patron saint of bankers and accountants

Saint Mathew was an apostle of that Jesus the Anointed (who was voted “God” by the Council of Nicaea in 325).  Mathew is the alleged evangelical author of the first gospel of the New Testament  (although his name was not attributed to the text until after he was long gone, and oddly, in the gospel, he refers to himself in the third person--but then again so do I sometimes), and the patron saint of bankers and tax collectors (these days we might suggest that he choose a side), of accountants and money in general  He has a lot to answer for.  Even though I have graduated from agnosticism to atheism since beginning this blog, I’m recommending prayer in this case, because there really don’t seem to be any other options.  Bank deregulation isn’t just on the agenda, it seems a foregone conclusion.  



Bank regulation, bank-robbery deregulation; tomato, tomaato

I have to confess that I broke my pedagogical rule of Do No Harm Part II: Avoid Irony in my last post on bank robbery, but the point I wanted to make is that the next time you hear someone talking about “deregulating banks,” you can substitute “deregulating bank robbery”  and discover that the arguments, the logic and justifications turn out to be the same. So what?  We may be living in a global oligarchy these days with wealth dictating government policy and the law, but perhaps there is some measure of solace in being able to say, “I know you are going to screw us because you have that power, but forget being smug and self-righteous because we know what you’re doing.”

Step one of being un-fooled is to understand what the expression “bank deregulation” means.  Here are three words that you need to know in order to know what "bank deregulation" is all about: "derivatives," "leverage," and "rent-seeking."

  • Derivatives.  I may have talked “derivatives” to death in my earlier post, but basically what you need to understand is that “derivative” means that banks and financial institutions can “bet” on the stock and bond markets.  “Bet” is the important word here.  As described in The Big Short (both book and film), these “derivatives” are not investments in companies or products or services, they are simply companies and individuals betting that a stock will go up or down without actually investing in the company they are betting on or against.  Finance people make “derivatives” sound reasonable by describing them as “insurance”; as in you buy an insurance policy on your house to protect yourself against the possibility that it might burn down.  However, a derivative is more like buying an insurance policy on your cigar-smoking, alcoholic neighbour’s house in the hopes that his house will burn down—so why not buy him a bottle of vodka and a box of cigars for Christmas, his birthday, etc?  In the film version of The Big Short derivatives are shown as being like following your neighbour to the casino and when he bets two dollars on the roulette table, you bet 10,000 dollars with someone else that he is going to lose his two dollars, and someone else bets 100,000 dollars that you are going to lose your 10,000—that’s the derivatives market.  The derivatives market is estimated to be between between 710 trillion and 1.2 quadrillion US dollars.  (see "The Size of the Derivatives Bubble").  Just to put those numbers in perspective once again the total GDP of the USA is 17 trillion.

  • Leverage. How are these crazy numbers possible?  How is it possible that so much money—40 to 70 times the total wealth of the USA, 700 to 1000 times the amount of US paper currency which actually exists in circulation—is being gambled?  The answer is “leverage” (that’s chapter six in The Art of the Deal, the book which Trump’s ghost writer, who wrote the book, called “a tissue of lies”).  “Leverage” is what “bank deregulation” is all about.  If a bank has assets worth one million dollars, the average person might imagine that a bank can therefore lend out to clients up to one million dollars.  Under current US banking regulations the leverage ratio is 4%, which translates as a ratio of 1 to 25.  In other words, if the bank has 1 million dollars, they can lend 25 million dollars.  That’s right; for your mortgage or your car or your kid’s education, they can lend you 24 million dollars that they don’t have—but you, of course, must repay in money that you actually have.  (By the way, the mortgage that you owe to the bank is considered one of the bank's assets.  If you owe the bank $200,000, by regulation the bank is considered to have that money within its assets.)  The current "leverage ratio" (1 to 25) is the key regulation that banks find too onerous, limiting and difficult to comply with.  They want to change the leverage ratio so they can lend you even more money that they don’t have.
  • Rent-seeking.  This is the concept that we really need to watch out for.  The idea has been around since the 1970s, and is being much discussed in financial circles.  I found out about it reading Christia Freeland's Plutocrats:  The Rise of the New Super-Rich and the Fall of Everyone Else.  You might imagine that with all this money floating around it should be easy to cure cancer, end world hunger and poverty, offer everyone daycare and free education from kindergarten to PhD, but as the operations of rent-seeking become more obvious, it is becoming apparent that all this fabulous wealth doesn't actually produce anything, and it isn't the result of anything being produced.  Monumental wealth is being produced simply through the manipulation of government regulations, in particular the laws govern finance and banking. "Money" has become like Tinkerbell's pixie dust, not tied to anything of value, but available to the super rich to sprinkle on politicians, and for politicians to sprinkle back in greater measure on the super rich by adjusting the regulations for banking and finance to their whims and favour.  The disappearing middle class can look back on "trickle-down economics" and crumbs from the big table as "the good old days" because pixie dust may float in cosmic clouds above  but the .1% are exceptional at keeping it afloat and have little motivation to let it fall on the rest of us.





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