The ugly sisters: part 2, the misery-go-round


Read part 1: Inflation and Deflation

by David Malone

The purpose of these two articles is to argue that because of the particular way in which our financial system evolved before the debt collapse, and the actions taken thereafter to bail out the banks and protect their debts, we are now seeing both inflation and deflation in different parts of the economic system.  I started to sketch out how I think these two ‘opposing’ forces have begun to re-enforce each other.

The spiral up out of control

The banks demanded, got and used money bled from us and our society to replace their own lost income, in order to pay the debts they could not pay themselves.  The first round of bail outs merely replaced the bank’s lost capital flow.  It saved them but left them still fairly penniless and thus unable to return to profitability.  So a second round of bail outs was bled from public spending, as well as another ongoing undeclared bail-out in the form of continuous bond purchases.  QE2 and the ongoing bond purchases are always carefully referred to as ‘continuing support for the financial system’, in order to make it sound gentler, like a companionable arm extended to an infirm friend, instead of just a ‘bail out’ which in fact is what it is.

No matter how the truth is disguised, however, by softening language, the brute and politically unpalatable reality beneath is that the public have been made to shoulder the iron burden of paying the bank’s private debts and, moreover, of then being forced to give the banks yet more capital in order that they should again have the means to start to make profits.  Which if you are one of those who insist that these particular banks must be saved at any and all cost then a perfectly logical policy it is too.  But by following this ‘save the bankers’ policy, a strange thing has happened to democracy and the power relation between government and finance.

All the governments who bailed out their insolvent banks have found that the costs have spiralled up and up far beyond the bankers’ confident initial estimates and show no sign of stopping.  This has been brutally clear in the case of Ireland, Greece and Hungary and is becoming evidently true for Spain and Portugal.  It will in time also be seen to be true for the UK and the US.  As these costs have gone up it has meant ever greater growth would be required to pay back the ever greater amounts of money spent.

The whole policy we have followed had two parts.  Save the banks from imminent death and then re-coup the cost by returning the banks to profit.  But the greater the costs the greater the profits will have to be and the faster they will have to be made.  And this time factor is where we are now and is the bit of the plan that has failed utterly and is now killing us.

QE1 was supposed to stabilize the banks and their losses and return them and the broader economy to growth.  It didn’t.  Time ticked on and payments on the first round of borrowed and printed cash for the bail outs, has started to come due.  QE2 also failed to make the banks whole or to bring back confidence and growth.  In fact, since the second round of printing and bail outs, forecasts of growth have been revised down.  Except for the last quarter of last year when they went up, only to crash down again this quarter.  And this sorry state of financial diarrhoea has left governments mired in their own rancid and stinking lies.  Stock markets have gone up but not anything else.  The wealthiest have become wealthier while 42 million Americans must rely food stamps to feed their children while public services are poisoned and uprooted around them.  Housing continues down and unemployment continues up; especially the long term unemployed and the under-employed (meaning those who have found work but not enough to pay their bills).

Governments have squandered trillions – the wealth of a generation – upon a policy which has not worked.  What should they do?  If they were men and women of honour and courage they would admit they were wrong and stop.  But they won’t.  They are too afraid and too in the pocket of those few who have benefited from the general debacle – the bankers.  The result is that the bankers find they have not just regained the power they had but are in a more powerful position than before.

The bankers have our cash, we have their debts.  They are now in less of a hurry than we are.  Our governments are desperate for the banks to make outsized profits because we need them to repay what they have taken from us.  They, already having our money, feel in less of a hurry.

A complete and perfect outcome for the banks

The governments are now more powerless and more clearly supplicant than before.  This outcome was perfectly foreseeable from the start.  But apparently not to our politicians or central bankers.

Now that it is we who need to the banks to make huge profits and make them fast, have you noticed how the whole discussion of banking and the recovery has changed?  Not long ago there was talk of tighter regulation, curbing bonuses and even of banning riskier, unregulated practices.  Where has all that talk gone?  Once, talk of policies was all explicitly in terms of stimulating and lending into the broader economy.  All that talk has faded discreetly away.  Now it is all about ‘letting the banks get on with what they do best’.  It is about ‘cutting the red tape’, the bureaucracy and public spending.  Desperately needed and necessary regulation has become ‘over-regulation’ and there is to be none of that.  Where, for a brief moment, ‘too big to fail’ was a systemic danger we had to deal with, now it would be ‘unthinkable’ to put the banks at competative disadvantge.  And anyway the bankers have re-grouped and told the politicians that big isn’t bad after all, it’s positively good and in fact vitally necessary, and that there can simply be no restriction on their bonuses or on whatever risks they care to run with our money.

Now, albeit as yet discreetly, our governments are actually encouraging the banks to take the money we have given them and to do whatever they want with it, hurt whoever they have to with it, so long as they make outsized profits.  But even this rank and rotten capitulation is not working for our deeply stupid leaders.

For there are no outsized and quick profits to be made from investing for a long term and sustainable future here at home.  Outsized and rapid profits come from speculating not investing.  And so the banks have exported our money and are using it to speculate on anything and everything.  In 2008 they speculated on food and profited.  A few people starved but so what.  They speculated on the currencies and the debt loads of the nations who had bailed them out.  And ordinary tax payers found public services being pulled up by the roots in order to service the extra debts.  But again so what.  What is more important to our political class, bankers’ profits and the city sinecures the bankers have promised them, or people’s lives?

Our banks have started to make profits but not from investing here.  They have been making money from raping other countries.  A tide of hot money provided by you and me has swept in to emerging nations like locusts upon a harvest.  Brazil was clear that ‘we’ in the West were waging a currency war upon them and other emerging economies like them.  Our governments have said nothing and done even less.

But did this rape and plunder actually even ‘help’ you and me?  Well no it did not.  Because the bankers, with the help of that other group of moral degenerates, the big accounting firms, long ago made sure that the banks would book all the profits from such pillage, in low or no tax haven and pay virtually no taxes here.

That was last year.  This year it is not just food but oil as well.  Any opening, any natural unrest or volatility is seized upon and amplified by the bankers ans speculators, a hundred fold with the billions we have given them.

And so where might we be headed?

The bankers’ bail-out fueled speculation has driven price rises.  It caused spikes in  food prices in 2008 and again this last year.  The banks and other speculators made handsome profits but also caused some unintended consequences.  Prices of the staple foods, wheat, barley and rice all shot up.  Those countries across North Africa and the Middle East which have seen riots and revolution are nearly all in the top ten importers of wheat on a per capita basis.  Food prices were a major part of why they rebelled.  Once unleashed however, the tide of unrest has unsettled more countries.  Saudi is now surrounded by unrest and by Shi’ite discontent.  In Yemen the government has murdered its own people and in Bahrain tension is simmering between Shia and Sunni.  All this precipitated in part at least, by the bankers ruthless pursuit of volatility and rapine speculation.

The blind profit-maker continues to hurt everyone including himself.  For unrest caused by food price has led in turn to oil prices shooting up.  The bankers, utterly unable to restrain their personal greed for their collective good, have inflated this market too.  Two weeks ago oil speculators had futures contracts for about 269 million barrels of oil.  Which is a huge number even for the oil markets.  And by the beginning of last week they had added about another 400,000 to  500,000 barrels to that total.  The number of speculative contracts is now far greater than the number there were in 2008 when oil shot to $147 a barrel.

Till now economists have noted that all our printing of hot money has led to inflation being exported so that other countries have endured the pain.  Now some of that pain is washing back home.  And as it does so it is interacting with deflation.  As inflation causes rises in food and petrol/diesel prices it is doing so in an environment of falling wages and rising unemployment, where people have to respond to prices rises by cutting spending elsewhere.  Higher food and petrol are simply eating into any hopes people had for saving for a down-payment, cutting their debt load or even for paying the mortgage they already have.  Household debt is still huge but it is not there because people are continuing to buy their consumer heaven.  It is there because people are using credit to put off just a little longer the day when they cannot pay at all.

Higher oil prices are also interacting with deflation in another unpleasant way.  Since there are few larger single factors in determining the costs of trade and manufacture than energy inputs, a rise in energy of the scale we are now seeing means growth projections are all shot to tatters.  Growth in almost all countries will be revised down.  With higher prices for food and fuel growth will collapse, and without growth taxes and employment will both fall further and national debt payment schedules.  Attempts to lower national and banking levels of debt will all be missed.  As people get poorer so their ability to pay back the debts they owe to the banks will decline further.  The value of all the assets held by the banks will be called further in to question since their value depends on people being able to pay them back.

As inflation goes up, so people’s ability to pay their debts will decline.  If they fail to pay then the assets based on the debt being paid will deflate.  Inflation could therefore kick deflation in debt backed assets into a higher gear.  If that happens the bond markets and CDS markets will all raise their demands, driving nations nearer to the inflexion point where debts run away from ability to service them.  As that point is approached nations will have to raise what they offer to the bond markets.  This in turn will mean borrowing costs within those nations will start to rise as their own banks have to pay more to borrow on the open markets and from their own national banks and even from the ECB or FED.  Once the banks have to pay more to borrow so will their customers, the lowly house buyer.  And once that happens it will cause a huge deflationary pressure on the housing market, house values and the banks and shadow banking system who still hold hundreds of billions if not trillions of dollars worth of debt backed paper assets all still held at mark to model values.  All of which boils down to – boom.  Game over.

The bottom will drop out of the housing and commercial property markets again.  The banks will find another damned up lake of toxic sludge bursts its banks and floods the nation with more suffocating losses.  As the banks face more deflation of their asset values and destruction of the debt based wealth they will call for more bail outs and use whatever cash our idiot politicians give them to chase even more rapid profits which will mean even riskier and more destructive speculation.  Which will create even more bubbles which will raise more inflationary waves some of which will wash home – and round and down will go the misery-go-round.  Nations will be called upon for another round of even more catastrophic bail outs for the dying banks but they won’t be able to because their own debts will be too large.

Of course this is just one possible scenario.  The bankers will have far rosier ones.


David Malone is the author of the book Debt Generation. You can read and listen to excerpts from his book here: