The Market Ticker
Commentary on The Capital Markets- Category [Bank Reform]

This sort of piece is just utter and complete crap:

Far too often people fail to understand banking and credit merely making superficial judgments that lack any real in-depth understanding of the world financial system. The common assumption is that the greatest curse of mankind is that commercial banks create money through lending and then securitize such loans selling them into the marketplace illustrates the childish view of finance and the difference between a Dark Age and Capitalism.


Well, let's begin.  The first statement is in point of fact true once you realize (and you need only pull your wallet out to do so) that all money in a modern economic system is in fact debt.  How do I know this?  Because the $20 in my wallet says on the face Federal Reserve NOTE.

note is a debt instrument.  Period.

Now that's not necessarily a problem.  The problem comes in when the bank (or anyone else) creates credit without boundary.  Specifically the value of "money" (whether in the form of credit or currency) is entirely dependent on its scarcity.  If there is no limit to the amount of "money" available then it is worth nothing.

That is where the problem lies and yet Martin wishes to applaud it!

In Iceland, as in other modern market economies, the central bank controls the creation of banknotes and coins but not the creation of all money through credit. You deposit money in a bank and your statement saw you have 100 whatever and the bank lends 95 of that to someone else so you both have about 100 in book entries.

So now there are 200 in book entries where there were 100 but what is the offset against the other 100 that was created?  In short for every debit there is supposed to be a credit of exactly equal amount and vice-versa; this is the fundamental principle of accounting.  When you violate that principle you have committed fraud -- period.

The question becomes one of what is on the other side of the balance sheet?

One Dollar of Capital says that The Balance Sheet must in fact balance and the entries on the other side ("assets") must have a market-based price; that is, they must be able to be exchanged for "money" in the immediate term for the amount claimed as their value.

That is, you may never commit fraud -- not for a day, not for a week and not for several years in the hope that your claimed "asset values" will some day prove to be correct.

Market discipline is the only means by which we know whether or not asset values as claimed are in fact true.  There is no other means of knowing that the person making the representation is not lying.

Violation of this principle is in fact responsible for all financial panics in anything approaching a "modern" economic and banking system.  It is why the Tulip Mania happened and popped, it is why the crash of 1873 and the "Long Depression" that followed occurred, it is why 1929 and The Great Depression occurred, it is why the Tech Market blew up in 2000 and it's why the housing market blew up in 2008.  It is also why the next panic will come.

Note that this underlying reason for the panic -- that collateral could not be exchanged for cash because nobody would pay what it was allegedly worth -- was in fact admitted, repeatedly, to be the reason that we had to prop up these institutions!  

This isn't conjecture or deductive reasoning on my part it is in fact the raw statement that was repeatedly made by banking executives, our Treasury Secretary (Paulson and then Geithner), our President (Bush and then Obama) and by Ben Bernanke as well -- and later, by Yellen.

The purpose of government-based deposit insurance is not to guarantee against the possibility that the bank made a mistake or even was robbed by management.  It is a guarantee against government malfeasance and dereliction of duty in the detection and closure of a bank before it is able to sport a negative asset position against its liabilities.  That's all.

What Iceland is proposing is that banks not be allowed to lend against thin air -- that is, to lend against nothing!  There is nothing wrong with a bank extending a $100,000 loan on a $100,000 piece of property provided the property can actually be sold and liquidated for that $100,000 at any time on demand.

It is only when the property cannot be sold for the lent funds that the bank has "printed money" (in the form of credit.)  The Bank simply cannot ever lend beyond liquidation value of its assets -- values that can and do fluctuate over time.  If at any time the Bank threatens to go into such a situation it must be closed and all of its transactions unwound.  

The astute will realize immediately that any unsecured lending thus must be backed by a dollar of someone's paid in capital or retained earnings because to not do so means that the bank has, in terms of the monetary impact and mathematics, done something exactly identical to counterfeiting the currency.

If never allowing unbacked credit issuance is enforced reliably and studiously nobody ever loses a penny in their deposit accounts and there is never any unbacked credit creation nor is there any reason for a market panic.

This doesn't mean that there is no business cycle (there still is), it doesn't guarantee against bank failures (they can and will fail) nor does it mean that people's fortunes won't rise and fall as well (they will.)

It simply means that you can't commit counterfeiting and steal from others by doing so.

Now here's the kicker: Spending in deficit is the same thing as the issuance of "sovereign debt" is always inherently unsecured.

Sovereign debt issuance is, in fact, no different than a payday lender who takes a post-dated check after looking at your previous pay stub.  This sort of "borrowing" should come with ruinously high interest expense because there is absolutely nothing you can do if the funds are not there to make the payment.

If you want to know why "modern finance" is full of unbacked credit emission you need only look to the "bargain" made between banks and governments.  Governments that spend in deficit are stealing actual purchasing power in each instance from everyone.  To allow the banks to issue unbacked credit is to allow them a means to steal the portion that would have come from the rich and powerful that control the banks from you instead, and give that a license rather than call it what it is.

Armstrong is not stupid and I must expect that he understands this, for algebra is pretty basic stuff.

Therefore, may I ask exactly what his motive is in penning such a piece?

View this entry with comments (registration required to post)

Main Navigation
MUST-READ Selection:
Wake Up America

Full-Text Search & Archives
Archive Access
Legal Disclaimer

The content on this site is provided without any warranty, express or implied. All opinions expressed on this site are those of the author and may contain errors or omissions.


The author may have a position in any company or security mentioned herein. Actions you undertake as a consequence of any analysis, opinion or advertisement on this site are your sole responsibility.

Market charts, when present, used with permission of TD Ameritrade/ThinkOrSwim Inc. Neither TD Ameritrade or ThinkOrSwim have reviewed, approved or disapproved any content herein.

The Market Ticker content may be reproduced or excerpted online for non-commercial purposes provided full attribution is given and the original article source is linked to. Please contact Karl Denninger for reprint permission in other media or for commercial use.

Submissions or tips on matters of economic or political interest may be sent "over the transom" to The Editor at any time. To be considered for publication your submission must include full and correct contact information and be related to an economic or political matter of the day. All submissions become the property of The Market Ticker.