I had done quite a bit of work on 2 articles that I seem to have a hard time completing. The first was on the overgrowth of the financial industry, and the second was on the inequities of the 401k system. My research led me down some cyclical roads that left me chasing my brains tail. I will attempt to sum up both articles in an abridged fashion, rather then pour out my “going nowhere” data. (Maybe I can someday get a grasp on how to better articulate my research, and put together a more complete overview? The majority of my problem had to do with not having the raw data I needed, so my research was based on general/fictional assumptions… thus making my research more “theory” then “fact”.) For now this will have to do.
The Financial Industry’s Overgrowth:
In its most basic form, producing goods and providing services are rewarded by creation of a consumer. That consumer is given cash, credit, etc in exchange for that production or service. Those are the nuts and bolts of your economy. That’s it! Everything beyond there is just financial engineering, mathematical widgets, speculative dreams (based on both reality and imagination), etc… The prices, wages, growth, etc… are then set through the markets simplistically complicated “supply and demand” mechanism.
***(Sample1 – Mr. America works (producing/servicing) and gets paid $200.00 by the market. He then consumes, saves and invests. Let’s say he consumes 50% and saves and invests the other 50%. He is hoping that the $100 that he saved/invested will outpace his ability to consume in the future (beating inflation). That speculation has for too long come with the assumption of growth. That $100 he places into the system then needs “servicing” of its own. Someone to monitor, track, pay, hold, guarantee, insure, invest, etc… In order to “service” that $100, we then need the $100 to not only grow above and beyond the expectation of inflation, but beyond the cost of servicing that item. In the past, the servicing cost would be able to skim the top, (assuming there was growth) to pay for itself. In Ponzi fashion, this “skim” has been masked through money creation (fraction reserve banking), thus creating a constant inflow of cash which keeps perma-growth going. The servicing is necessary! …and the banks that provide this actual “service” do it at the cheapest means possible. Bank pay is the worst in finance. 99% of your bankers border on being “underpaid” for the work they do. …to be continued…)***
The Banking industry no longer just provides safekeeping for your cash. As a custodian, they track and service millions of securities, for millions of accounts. Just saying this, versus actually “understanding” this is where some people may lose track of how complex banking has grown. The velocity of straight through processing has allowed facilities like DTC to process over $1.5 quadrillion in transactions per year.
***Sample2 – 1 share of ACME Anvils Inc. may be bought, and then sold. The banks assure that the 1 share is in the right bucket (Mr. X credited 1 share, Mr. Y debited 1 share). They also ensure that the cash was moved for payment. (Mr. Y got paid, and Mr. X made payment). That’s the simple part. Here comes the fun. ACME Anvils Inc has either dividend payments (DIV) or Principal & Interest Payments (P&I) that it makes monthly, quarterly, yearly, random, etc… Determining who was the holder (of this moving target which gets bought and sold, bought and sold, bought and sold, etc.) at such given times, and then calculating the P&I factor, (and new amortized value) and DIV rate becomes slightly more complicated. Vendors are hired to price these. Accountants are needed to prove out. …and paying agents are hired to make the necessary payments to the correct banks where the shares are currently held. (Remember, there are likely millions of shares, held at many different custodians, which are changing hands daily) As a service to the customer, banks generally credit you the money on the day you were expecting payment. In actuality, the bank may or may not have received payment yet. (via wire, check, transfer, etc…) These random payments come in from every direction, with good and bad instructions into income buckets, where they can “hopefully” be applied to the right prepayments you already received.
Now, here comes the not so fun part… Let’s say ACME doesn’t pay what you were expecting, or pays late/early. Trying to apply those payments without correlating equal opposite moves is extremely laborious …and the norm. (Forget the fact that Sprocket Corp, Widgets Inc, and MILLIONS of other payments are coming in from random directions, at random times, …and are all trying to find the right custodians of holders of those securities that have been bough and sold, bought and sold, bought and sold, in volumes of 250,000,000shs per day, by MILLIONS of investors, pension funds, mutual funds, brokers, ect… Oh… now add defaults to the mix. …and also Corporate actions & Class Actions… and now bridge all of this to multiple countries that are all doing the same thing on their own, with their own clearers, paying agents, custodians, etc… Add to that, currency exchanges for the trading in these foreign markets.
UGHHHH… We haven’t even gotten to IT systems where every companies PC’s speak different languages, and want reports in differing ways, and use different account styles, and have differing rules/failsafes, …and we haven’t gotten to regulations from country to country, account opening documents, tax treaties, incorporating agreements.
All of this “servicing” of money now takes millions of workers… Most of who are underpaid grunts. (There is a very small middle class here. It’s mostly servants and kings.)***
Now, returning to Sample1, where the $100 “invested/saved” dollars came into the system, that money needed to outpace inflation and the new “high price” of servicing that money (which was displayed in sample 2). This is where the world of “Fractional Reserve Banking” stepped in. (much the way “subprime”, “monoline”, “leverage”, “credit crunch”, “CDOs”, “derivatives” and “systemic risk” have gone from obscure financial words to “mainstream media terms”, I believe “fractional reserve banking” will become the next popular economic buzz phrase for the public to learn about in 2009.)
Fractional reserve banking has become the way to finance the financial industry. No longer was that “skim” on the $100 able to pay for the burden of the industry. Instead, that fractional reserve system became the new economy. Money creation turned that $100 into multiples above it. (In the US, I assume 10% reserve ratios are used. Japan and China are apparently tighter, with ratios in the high teens, and Euro and UK apparently have little or no reserve requirements. Any particular institution can set its own ratio, (as long as they don’t EXCEED their market’s cap) which doesn’t necessarily have to be as extreme.) This money creation now funded the “servicing” which was necessary.
…but then we have the non-servicing sector of the finance industry. The speculators, the market makers, etc… They guided money towards “profits” (and loses), but in actuality, they never were a necessity of the “servicing” world. In affect, right or wrong, every dollar they made and lost, (for themselves or investors) and subsequently took out of the market, was not real money. It was the “monopoly money” of the fractional reserve banking system. (In the past, they were also able to be paid by the “skim, but their size has now absorbed a portion (or %) of the market.) …and the fractional reserves helped become a multiplier in increasing their stake and effect in the market to the point where, they hold so much monopoly money, that they became the market. In an economic stage of growth, the price tag and expense of the modern financial world can be paid. Without growth, it is unsustainable. In contraction, the size of the overgrowth is exposed, and creates a downward spiral so steep that is more accurately resembles a “void”. (“evaporflation”???)
Now that we see this process unwinding, the top down bailout theory is that we can throw money at the top, and through fractional reserves, we can recreate new money with the same multiplier affect that worked in the past, turning that $100 into $1,000, thus limiting the amount of money that needs to be added to the system, to replace the monopoly money that was already “taken”, “earned”, “made” and to replace the actual money that isn’t being paid due to default, bankruptcy, etc… There is a problem though! The reserves that needed recapitalizing have had an equal multiplier effect that is continuing to grow every day that “growth” is not taking place. Increased jobless claims, price deflation, defaults, etc have caused a death/debt spiral, in which a constant top down influx is needed.
In my theory (I created a pretty decent model economy), I have taken the fractional reserve system, and reversed its direction to see where the unwind goes. I’ve modeled the interest the government lends cash at, against the interest earned by existing loans, and calculated 0-5% spreads (at 25basis point intervals) versus, money creation minus default. (defaults varying from 0.5 -15% of overall debt repayment at 0.5 intervals) Pretty much where I’m still at is… not nearly enough goes to the bottom quick enough, and not a large enough packages have been added at the top! This needs to be hit from both ends immediately and in a big way. (By big, I mean in an equal amount to “at least” the amount monopoly money the non-servicing portion of the financial industry has taken from the system) The way I see it, the multiplier effect on the default level could turn financially catastrophic. Voodoo Economics are a crucial medicine and I believe an unfortunate necessity.
In the world of higher math and financial wizardry, there is no possible calculation or probability factor that can ever even come close to answering the immeasurable variables of risk that exist. (I suppose this is like the “black swan” theory??? I haven’t read the book.) Yet, we rely on this fictional world of numeric evolution as the backbone of our modern day economy. This fictional world of cash then has its own place among the production/service cycle and transparency is the key to unlocking many of the current mysteries, but at our financial poker game, no one wants to show their hand.
My predictions on the “unwind” leads us down a road of eventual inflation, as currency intervention on massive scales is required. If debt is not reduced, and cash injection approaches are increased, the inflation will increase at a rate comparable to the socialized costs expectancies that have been added through default. (Somewhere between 3% and hyper, but closer to 3%) I see Asian banks (preferably Japanese, since I don’t believe in Ch-Enron as long as free speech (whistle blowing) does not exist) being rewarded for tighter reserve requirements, and expect a higher safety level for wealth retention there. I expect Japanese cash to start buying (or possibly leasing) valuable real estate, and loaning to growth oriented corporations, etc… in an attempt to put cash inflow/appreciation to better investment use. (this will level out when commodity/resources prices “level up” so that once again puts the low resource country at an equilibrium.) I believe transparency issues may arise in the EU, where Fractional Reserve Banking may have expanded (to irresponsible levels) or been controlled (prudently) by different country banks at such various levels, that it may put a level of stress on the EURO that it has not yet experienced. I have confidence in their ability to work through this, but it will come at a cost to the currency. …and finally, I see oil in and around the $40-$45 range as the new expected price. Deflation will press on and drive prices lower short term, (I “guess” $29 is absolute low) but ultimately, inflation and alternative prices will settle on the $40 mark. I believe the oil nation cash will eventually make the necessary move of marrying their commodity and their cash to the green revolution.
401k – The Unleveled playing field. (This will be very short)
In the modern day arena, we should not live with the current limitations to “our” investments. When we are “blocked” into a group of 16 accounts to choose from, and have contribution or movement restrictions to a set amount per period, we are not allowing the everyday person to have the same ability to invest that the rest of the market can move with. Those limited options that your HR representative chose are based on what “FINANCIAL RESEARCH” that your HR rep has done??? These are HR people. They are not market gurus and strategists. What the heck do they know about choosing your future’s savings investment vehicles??? (It’s likely that the 401k rep just sold them whatever “package” was hot.) What about fee based unlimited transactions that allow savvy savers the same ability to play the markets that the money movers play? Where are those options? …we could go on and on… but not today.
Thanks for reading, and wish you all a happy holiday season. Now it’s your turn to speak.
All the best, Miss America, Rich Hartmann
p.s. I will be taking a break from posting for the holiday season. I hope to return with Chapter 2 on Alt Energy. Please feel free to add things you’d like me to look into, and I’ll do my best to add them into my research. (Companies, sectors, theories, etc…)