Bank Profits a sign of economic sickness, not health
on August 11th, 2010 at 10:02 am
The record $6 billion profit that the Commonwealth Bank is expected to announce today is a sign of an economy that has been taken over by Ponzi finance. Fundamentally, banks make money by creating debt, and the amount of debt we’ve been enticed into taking on is the sign of a sick economy rather than a healthy one. The level of private debt that is actually needed to support business and maintain home ownership at historic levels (ownership levels have fallen over recent years!) is possibly as little as one sixth the current level.
Because of that debt level, bank profits have gone through the roof as a share of GDP. Back before we had a financial crisis—when debt levels were far lower than today—so too were bank profits as a share of GDP. A sustainable level of bank profits appears to be about 1% of GDP. The blowout from this level to virtually six times as much began when bank deregulation began under Hawke and Keating, and then took off as Howard and Costello encouraged everyone to become “Mum and Dad Investors”, which meant borrowing money from the bank and gambling on share and house prices.
As readers of this blog know, I build models of financial instability, and in my models, one symptom of an economy that is headed for a Depression is a rise in bankers share of income at the expense of workers and capitalists. The model below has yet to be calibrated to the data, but the similarities with the actual data are still ominous.
One empirical reality illustrated by the model as well is that even if firms are the ones taking on the debt (as they are in this model—it does not include household borrowing), workers are the ones that pay for this in terms of a declining share of national income: rising debt is associated with a constant profit share of GDP but a falling workers share.
When the crisis really hits, both workers and capitalists suffer as bank income goes through the roof—leading to a Depression. The only way out of this is to abolish large slabs of the debt, and coincidentally to drive bankers share of income back down to levels that reflect is supportive role as a provider of working capital for firms—rather than a parasitic role as the financier of Ponzi schemes.
This is the real debt story of our economy right now. As the first chart above indicates, private debt is far higher than Government debt, even after the increase last year due to Rudd’s stimulus package. Government debt is currently 5.5% of GDP, whereas private debt—even though it has fallen slightly due to business deleveraging—is over 150% of GDP: 27 times the size of Government debt. The so-called debate that the major parties are having over the size of Government debt is an embarrassment.
Steve Keen @104
“Yes, but however with reservations that weren’t enough to stop me signing. I agree that the stimulus averted a recession”
I was surprised that you had agreed to this. Why? Because people in the “sound byte world” just see the headline
“Because people will see “THE Labor federal government prevented the Australian economy from falling into a deep recession” and not think any further than that – they will not understand that this was (probably) just a “kicking the can down the road” type of exercise (where the problem becomes larger)..”
from…
http://www.news.com.au/business/labors-spending-vital-say-economists/story-e6frfm1i-1225906028751#ixzz0wl9ePPZN
I would have thought you would have obstained rather than do what you have appeared to have done.
(Apologies if I have misinterpreted – it is just my “two bits”).
mahaish,
Trying to outlaw private investment banks as such is, for all practical purposes, equivalent to trying to nationalize the service they offer to customers. To help you see this you can think of the practical consequences of trying to outlaw private healthcare insurerances. In fact the fans of Mises are far more Keynesian (= in favor of socialization of investments) than Keynes himself.
mahaish 103
“hey cyrusp, thanks for your thoughts, but
its no small coincedence that america started to emerge from the depths of the depression post 1934, as it went off the gold standard, due to the fact that going off the gold standard allowed the government to re flate the economy.”
I think you are missing the points raised entirely. The dynamic of the economy was destroyed and not repaired, instead the “can was pushed down the road” instead of fixing the real problem (as now).
Result another depression in 1937…
http://market-ticker.denninger.net/archives/2522-Green-Sharts!-Chicago-Fed-Index-0.63.html
It was WWII that was the ending of the depression when suddenly the banks who previously had nothing to lend suddenly had loads of “money” to lend.
try this (:-:)
http://video.google.com/videoplay?docid=3051024550497129264#
Sometimes you have to live with a bit of misinterpretation when you live in the public eye Sirius. I rely upon having plenty of postings and comments made prior to that one where I say that though I support a stimulus, what’s needed to end the crisis is not stimulus spending but private debt abolition.
When I write a journal paper, or better still a book, I can put all the nuances in. When I have a single issue like that letter, I have to decide whether the single letter is worth it in the context of everything else I’ve done. That’s the judgement I made with that letter.
In a way “The Roving Cavaliers of Credit” was about that topic Philip: it showed that while a free banking system could work, the banks had an inherent bias to providing as much debt as they can. Add that fundamental motivation to the existence of assets that allow Ponzi Schemes to develop, plus the temptation to seignorage (which I didn’t explore in Cavaliers but clearly it is there) and a private banking system will fail every time.
On the other hand, a largely private system with financial assets defined in such a way that Ponzi Schemes can’t develop could well work, because despite the best efforts of the Cavaliers to peddle debt, generally speaking people would not be willing to take on inordinate amounts of it.
Steve,
I see. If 100% reserve banks have every incentive to lend out as much debt as possible, what is to stop them from lending too much and thus returning to fractional banking given gold bugs don’t support state regulations? Also, I doubt that gold bugs would support the redefining of assets such as property and stocks – as markets are never endogenously inefficient from their view. Can you explain the concept of seignorage under a free banking system?
Seignorage under free banking is simple Philip–you use your own notes for direct purchases of goods and assets. And yes, even with 100% reserves, banks will be tempted to lend to finance Ponzi Schemes–which will put pressure on the government to either issue more money or allow fractional lending. I see any such system as breaking down over time so long as the definition of capital assets allows leveraged speculation to appear to be profitable.
Steve,
I can see how redefining assets such as property can prevent speculation by creating a negative feedback loop between price and debt. But how can the redefinition of stocks into voting bonds that have a life of 20 years prevent speculation? I would assume that speculators would still pour funds into moving the price up and down like a yo-yo during the interim.
Have to rush Philip, but no they wouldn’t: with a terminal value of zero after 30 years and a declining share price as a result, you’d be mad to take a levered position when buying them.
Steve is right Philip with regard to free banking and the problem of Ponzi financing. I originally thought that Steves capital re-definitions were not the right way, but I was wrong on second thought and historical analysis.
You see capital markets (i.e secondary asset markets for houses and company stock) are almost completely un-regulated; they maybe many alphabet soup government agencies that watch and apply rules and legislation, but they are not truly regulated by the major powers/laws of fear and greed.
Further, internal manipulation of the markets amplify this lack of natural regulation, which result in what we observe as Minsky instability.
Capital markets need to be regulated – you need to be in fear that you will lose money when you invest, and you need to be rewarded justly if you make a return. T
Fear is not regulated because of entrenched moral hazard – governments support some industries but not all – and the unnatural position limited liability corporations have in the business world (there is no free market if your competitor has nearly unlimited protection)
This extends to government, who should be fearful of their fiscal mistakes, and central banks, who seem to act fearlessly – but not rationally – in manipulating the money supply.
Fear needs to be re-regulated by removing all protections and moral hazards that take away that pencil in the lower back of any capital allocator.
Greed is not regulated because capital markets are established first and foremost as places of speculation, not capital allocation. Change the way you treat capital, and the level of speculation falls back to its rightful place as providing liquidity and liquidity alone, not the entire movement of the market.
Hence, capital itself needs to be re-regulated. It must be be redefined as an investment endeavour -and anything contrary to that treated and taxed as speculation.
We can have free banking, no central banks, sovereign currency and stable financial markets if we re-regulate the principles of fear and greed. Steve’s reforms are a major step in that direction, with subsequent steps being complete re-write of taxation legislation that removes or smoothes the skewness towards unregulated markets and the removal of all moral hazards.
nickmakwell,
Yes I would agree mostly with what you’ve said. Steve’s other reform of eliminating the central bank (as it doesn’t control the money supply) would help to reduce moral hazard within the financial and banking sector. Banks know very well the central bank will protect them in case of a disaster, with the U.S. as an obvious case. The too big to fail doctrine has been put to good use by bankers. Though I doubt we can have free banking due to the problems that Steve has recently pointed out above.
Michael Pascoe has confessed:
“Housing bubble trouble for the middle class”
http://www.smh.com.au/business/housing-bubble-trouble-for-the-middle-class-20100817-127lv.html
Who is next?
Hey ak. Christopher Joye also capitulated a few weeks ago
http://delusionaleconomics.blogspot.com/2010/07/death-of-spruiker.html
It’s fascinating to watch the spruikers progression – it used to be “house prices will plateau”, now it’s “house prices will slowly deflate”.
Shows that sentiment really does turn on a dime.
Housing bubble trouble for the middle class
August 17, 2010 – 11:23AM
http://www.smh.com.au/business/housing-bubble-trouble-for-the-middle-class-20100817-127lv.html?autostart=1
CANADA GOES POP …
http://www.canadianbusiness.com/markets/headline_news/article.jsp?content=b4224275
…Sales in B.C. and Ontario were down 32.6 per cent year over year, but sales in the rest of the country were down 25 per cent as well.
http://westernstandard.blogs.com/shotgun/2010/08/canadian-real-estate-bubble-officially-pops.html
…Canada’s housing market stalled in July as sales sank 30 per cent from the same month a year earlier, …
@AK (#120) and cyrusp (#121)
Thanks guys for the links!
I actually do spend quite a lot of time reading bulls: it’s always amusing and occasionally instructive (if one keeps one’s eyes well peeled)
I wonder if one day we’ll read something like this coming from either Pascoe or Joye:
“I knew it all along, but nobody would listen to me”.
just further to the debate on 100% reserve banking,
in the complexity of commerce we have, how do you predict the demand for credit on a daily basis, if you are bank or if you are the government authority charged with suppling the currency requirements of the banking system.
the reason why the fed employs lagged accounting is that banks have great difficulty in predicting the demand for credit and hence the deposit base
they also have great difficulty in predicting the demands that are going to be placed on the payments system
we do not have a perfectly efficient market
thats why we have over draft fascilities,
so in a world without a central bank with 100% reserve requirements, who is going to provide over draft fascilities.
if the answer is no one,
what odds on a payments crisis in short order if some banks underwritting skills are found to be wanting.
furthermore, banks are capital constrained not reserve constrained when it comes to issuing credit. reserves have little effect on a banks ability to make loans, even though they may effect nett interest margin, and the profit at which a loan is sold at. so a 100% reserve requirement could constrain credit growth by increasing the cost of funds.
now, lower profitability of loans has a direct bearing on return on bank equity, which may force more bank activity off balance sheet, thus bypassing 100% reserve requirements.
but in the end, why worry about bank intermediation in this way when the sovereign government can dampen the level of credit creation in a economy by spending in a manner that increases private sector savings and hence private sector balance sheets.
the only catch is that private sector balance sheet improvements can be leveraged, and we are back at square one if the ponzi mania is strong enough
the more i look at it , the only way to control ponzi like assett speculation is to tax it out of existence
“We can have free banking, no central banks, sovereign currency and stable financial markets if we re-regulate the principles of fear and greed”
the problem is nick,
we have made good progress dealing with some of our character flaws. slavery for instance has just about been eradicated from the face of the earth
we still have to deal with murder, genocide, and lo and behold greed one of the seven deadly sins. unfortunately for the moment regulators and their regulations usually bow to its relentless will eventually.
good laws which are the culmination of our memories of collective misfortune and wisdom, and our painstaking endeavours towards redemption, can be torn apart by egomaniacs in a blink of an eye
we are all ruing the fall of glass steagall
mahaish @126
“slavery for instance has just about been eradicated from the face of the earth”
That is certainly not true. Maybe it’s a question of how you define “slavery”
This thing is like an onion – keep peeling it back layer by layer.
How else do China and other places make things so cheaply ?
This is just the tip of the iceberg…
http://www.labourstart.org/
Don’t look at the union side of the equation – look at how people are treated – and then think you buys all this stuff – made under these conditions.
I have followed this site for many years now and I have seen what happens to people who demand a fairer deal – we are talking mourder – execution – torture – the list is long.
Anyone for Tetley ?
Anyone for Nestlé ?
Glass Steagal may have been good for the USA but it did not stop what was going over the waters – things that the “West” support everyday.
Its interesting to see more articles online in mainstream media outlets recently discussing, and stating that Australia does in fact have an housing bubble. I wonder if this are vested interests who have shorted the banks pushing an agenda or people just jumping on the bandwagon, when things are so obvious they cant be ignored.
Its been tough for a while for me to “keep the faith” if you like that at some point the bubble is going to deflate. Ill be honest, it would be the only chance for me to afford a house, in my lifetime, but it seems inevitable but difficult to keep the belief at the same time. For example where i rent, the average house price is listed as $545,000 for a 4×2 house. Across the road from me a for sale sign has been up for a whole 3 days, before a sold sticker is slapped across it. Would not have expected that today.
All my friends refuse to believe its possible, to a man they insist that population growth and the mining boom in perth will stop any price collapse for houses.
#126 we have made good progress dealing with some of our character flaws. slavery for instance has just about been eradicated from the face of the earth”
Really, what planet do you live in, the United States of ignorance? The cheaply made t-shirt on your back says ‘made in…china, india, pakastan’?
http://ngm.nationalgeographic.com/ngm/0309/feature1/
why don;t you read a bit prior to making eroneous statements…
http://www.ucpress.edu/book.php?isbn=9780520243842
http://www.hrusa.org/workshops/trafficking/CQResearcher.pdf
http://www.worldvision.com.au/issues/Human_Trafficking___Slavery.aspx
http://www.guardian.co.uk/commentisfree/cifamerica/2010/aug/12/drugs-war-on-mexican-people
Do you appreciate how a mineral resource can enslave and oppress people?
http://www.morningstaronline.co.uk/news/content/view/full/93977
“Liberia is a major producer of diamonds but the mining and marketing of these gems are not controlled by the government or anyone else on the African continent. This lack of control of the national economies of both Sierra Leone and Liberia can be traced back to the late 18th and early 19th centuries when Britain and the United States established these areas as colonial outposts under the guise of providing a homeland for former enslaved Africans in the British and U.S.-controlled territories in the western hemisphere”
http://panafricannews.blogspot.com/2010/08/diamonds-imperialist-domination-and.html
hi ferb,
go and have a look at a brookes diagram,
they sprung up in english tea houses everywhere as part of the abolishinist movement
not quite sure if a chinese factory is the modern day equivilent
but i take your point, well worth re considering
cheers mahaish
ferb,
You’re quite right in this case, slavery is still around, though in different forms and linked to the conditions of the worldwide economy.
This book could interest you: Slavery by Another Name: The Re-Enslavement of Black Americans from the Civil War to World War II
Even after slavery was done away with on paper in the U.S., it continued in reality until the social democratic policies of the early post-WW2 years allowed blacks to partially break free of the bondage they were subjected to.
Slavery today is slavery by any other name, quite often defended by the notion of “free contract.”
Steve,
Even though commercial/residential property and the stock market need to be redefined to prevent debt-fueled speculation, what about all other financial devices, such as options, futures, commodity indices, etc.? Won’t these all have to be redefined as well because speculators will simply move their focus here in order to gain unearned rents?
It’s quite likely that Australia’s equivalent of the Wall Street Wizards will make new financial products faster than the government can redefine them.
Spooky@128
“All my friends refuse to believe its possible, to a man they insist that population growth and the mining boom in perth will stop any price collapse for houses.”
I’d spoke to a similar man who was adamant(as above) and that was trying to give him advise.. since he asked for it!!
This is gonna to be a way more interesting than I think.. when “sh1t hit fan”