Serenity Now Economics

“So, first of all, let me assert my firm belief that the only thing we have to fear… is fear itself — nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance” – Franklin Roosevelt, First Inaugural Address

Fans of the sitcom Seinfeld well-remember the “Serenity Now” episode, in which Frank Costanza yells “serenity now” every time he starts to get agitated. Somehow he had come to believe that suppressing his anger and anxiety was a “healthy” way forward. (Just ignore it and it won’t come to anything.) Of course the episode ends with a repudiation of this philosophy and the catch phrase “serenity now, insanity later.”

Now, attempting to apply any sort of maturity and understanding to the character (caricature?) that is Frank Costanza would be frivolous. Yet the broader point (or one of them) is still valid. If you actually care about a given situation, whether it is a relationship, or a project, or some other interest or outcome; then you have to care enough to deal with difficult and important issues no matter how uncomfortable they may be.

That’s not to say that immediate, “in-your-face” declaration of all grievances is the best way to manage difficulties in a relationship. The Bible has plenty to say about suffering wrong and leaving judgement and justice to the Lord. But if you care about a relationship you shouldn’t ignore things that can destroy it.

The same is true with economies. I won’t presume to comment on national sentiment on 4 March 1933 when Franklin Roosevelt uttered the now famous phrase above. The tone and connotation sounds awfully familiar to what is going on today in the not-yet-averted (and perhaps not-avertable) banking crisis. Sometimes there really is more than just “fear” to worry about.

First, a note about “sound money”. Money only serves as a medium of exchange if it is in fact a store of value. That is, if I can produce more today than I wish to consume, I had better be able to store the excess in a form that will not lose it’s value over time, so that I can consume it later. Clearly fiat currencies don’t meet this test, but we have tolerated the slow and continual erosion of our stored production for quite some time.

We used to think of that erosion as “printing” money, but that’s not really how it happens any more. Instead of money being printed into existence, it is “lent” into existence. When you or I take $1000 in cash down to the bank to deposit, the bank will lend it (most of it) to someone else. That someone then makes a purchase and the recipient deposits it into the same bank (or the same banking system). It is then lent out again, and again – each time used to fund a purchase and each time redeposited. In the end that $1000 of actual currency results in upwards of $10,000 in bank deposits. (I’ve seen some claims of a 25-to-1 ratio, but 10-to-1 is more consistent with the Federal Reserves M0, M1, and M2 calculations. Don’t even get me started on M3 money, which the Fed doesn’t report anymore because it would take too much time … or perhaps be too telling.)

Question: what happens when we all decide to take our money out of the bank? Well, I suppose it would work out fine if the bank could demand immediate payment of all outstanding loans (this is what they did in the depression, by the way … it didn’t work). In the end, the only way to make a “call” on all the money is to have everybody take those goods and services back to where they bought them and unwind the entire string of trades. But, what if those trades weren’t assets but services, or assets that have already been consumed? It’s a mess.

Against this backdrop, the central bankers of the world are working overtime tonight attempting to avert a crash of the global banking system. The problem? Well, one of the problems (and there are many) is that people have borrowed too much money (money that was lent into existence) and cannot pay it back. The big, obvious target is sovereign debt in Europe, like Greece and Italy. But these fiscally irresponsible bureaucrats are not the only offenders. So what happens when the trade starts to unwind and the “money” doesn’t really exist?

Well, we’ll hear the standard backward theories thrown about to justify all manner of nonsense. We’ll hear that fear about the collapse of the banking system could be a self-fulfilling prophesy. (“the only thing we have to fear …”) We’ll hear that the system is sound and completely solvent, and these “bond vigilantes” are being completely irrational. (“serenity now … serenity now …”)

Mike “Mish” Shedlock picked up on a story earlier today about a proposal to eliminate bondholder losses in EU bailout deals (original here, Mish’s post here). Why? The article notes: “The concern is that forcing the private sector bondholders to take losses if a country restructures its debt is undermining confidence in euro zone sovereign bonds. If those stipulations are removed, most countries in the euro zone argue, market sentiment might improve.”

Hey guys, confidence in euro zone sovereign bonds has collapsed because they are junk. To argue otherwise is to rely on tautology … “confidence is collapsing because confidence is collapsing.” The notion of fractional reserve lending is fundamentally flawed. You can get away with it for a while; perhaps a long while; but eventually it unravels.

Greece, Italy, Spain, Portugal, Ireland … heck, all of ’em; have borrowed more than they ever intend to pay back. Politicians care about maintaining their power now, regardless of the cost tomorrow. The 10-to-1 ratio of “debt as money” is coming unhinged. The debt is going bad and the “money” is disappearing. Just what percentage of that 10-to-1 has to disappear before the banks have nothing left?

Oh there is a great loss of confidence. The bankers have lost confidence that they’ll be able to continue with the heist. They’re actually worried that they might take a bath if the system unravels. That’s why they argue that the taxpayer should foot the bill … you know … so there won’t be any loss of confidence.

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