Many of you have read my various tickers over the years on One Dollar of Capital, including this one from 2009. This also features prominently in my book Leverage; indeed, quite a bit of ink was spent on this very topic.
I am continually asked by various policy-makers to define exactly what I mean by this standard, as it appears that the various previous Tickers are not sufficient for clarity. Thus, the definition set forward here.
One Dollar of Capital is simply the principle that nobody be permitted to "create credit out of thin air", thus artificially expanding the spendable supply of "money" in the system. This, and only this, is the reason for all of the bubbles and financial collapses throughout history. This sleight-of-hand is why Tulip Mania happened, it's why we had a crash in 1873, it's why we had a crash in 1929, it is why the tech market blew up in 2000 and it's why we had a crash in 2008 in housing. It is why we're threatened with collapse in Europe now. It is a scam as old as the money changers during the time of Hammurabi, and until we stop it there will never be stability in the banking and financial system. This sleight-of-hand is in fact exactly identical in mathematical and economic impact to counterfeiting of the nation's currency, a crime which we all should recognize, condemn, and when it occurs the punishment should include both imprisonment and forfeiture of every dollar of ill-gotten gain.
Putting a stop to unbridled credit creation also removes the threat of "inflation" because it makes inflation by sleight-of-hand flatly impossible. It returns the ability to cause inflation to the one place where it should rest -- the entity that is supposed to be in control of the money supply, the federal government (specifically, Congress.) We have in fact had monstrous inflation over the last 30 years; one need only look at the increase in the price of stocks, of college educations and medical services to see it. The bankers and their cronies have tried to hide its impact on the common man through offshoring of labor so as to hold down "prices" in the CPI, but that's a lie too as a man who loses his high-paying job to some slave in China has his spendable income destroyed at the same time as he gets "lower prices" at WalMart.
Simply put, for every dollar of alleged GDP there must be one of dollar of credit or currency with which to buy the goods and services produced. If you increase the denominator, that is, the number of units of either credit or currency in the system then each unit must inevitably be worth less than it was before. Only when those units are exactly in balance with economic output is there zero inflation and protection of the currency's purchasing power.
That is the definition of Sound Money.
So mechanically, how do we get to One Dollar of Capital?
We impose the following standards on all institutions:
Imposition of this model inherently requires resolving The Federal Reserve's manipulation of the currency and interest-rate markets. We have seen that The Fed has intentionally refused to put a stop to manipulation by banks, including the recent LIBOR scandal; indeed The Fed argued that LIBOR was "the best" standard for money rates even while fully aware it was being gamed. The Federal Reserve Act allegedly requires that it both lend only against collateral at real values, but we do a terrible job of actually enforcing full transparency in this regard and an even worse job of stopping The Fed from circumventing the law (e.g. Maiden Lane.)
Note that a move to One Dollar of Capital immediately resolves all derivative concerns, since every underwater position must be netted every night against actual capital. If you cannot post actual capital on an underwater position you must liquidate the position. This instantly de-fangs the derivative monster.
Since no institution can "create credit" there is never systemic risk. Deposit insurance would be unnecessary except that we have a 30 year history of the government refusing to do its job and even participating in book-cooking schemes; during the crisis IndyMac allegedly back-dated deposits with the OTS, its government regulator, aware of the practice and in fact the same individual allegedly responsible this time did the same thing during the S&L crisis. Because we cannot trust the government nor can we seem to prosecute government agencies and individuals successfully when their malfeasance results in the loss of customer funds, FDIC insurance must be maintained.
With One Dollar of Capital Lehman could have gone broke and it would not have mattered, beyond Lehman. The bondholders and stockholders would have lost some or all of their investment, but since Lehman would have been prohibited from lending or guaranteeing the loan of any money that exceeded shareholder and bondholder equity the damage would have stopped there. Companies go bankrupt all the time; systemic risk only arises when you permit firms to commit acts that on any rational analysis amount to fraudulent emission of "money" such that they can imperil everyone else if their deception is forcibly recognized by the market.
Where We Are, Where We're Heading (2013) - The annual 2013 Ticker
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.
NO MATERIAL HERE CONSTITUTES "INVESTMENT ADVICE" NOR IS IT A RECOMMENDATION TO BUY OR SELL ANY FINANCIAL INSTRUMENT, INCLUDING BUT NOT LIMITED TO STOCKS, OPTIONS, BONDS OR FUTURES.
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.
Looking for "The Best of Market Ticker"? Check out Ticker Classics.
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.