The GFC brought into stark contrast just how vital the banking system is to the functioning of an economy.
At the height of the GFC banks did not trust each other. And people did not trust the banks.
Banks viewed each other with suspicion. Letters of credit were no longer accepted on face value. The shipping industry, which relies heavily on letters of credit, ground to a standstill.
Customers lined up outside banks (some with suitcases) to withdraw their savings.
Such was the demand for cash, the Reserve Bank of Australia came close to running out of physical notes.
Modern commerce is a function of faith. When faith in the financial system is lost, chaos follows.
Banks are the Heart of the Financial System
Money pumps in and money pumps out. The flow of money through the system is as vital to economic health as the flow of blood is to our physical wellbeing. We all know what happens when arteries become blocked or, worse still, when a heart stops pumping.
Governments are only too aware of the need to maintain public faith in the banking sector. Government backed deposit guarantees still remain in force five years after the event – albeit the guarantees are now applied to lower dollar levels.
The first premise of my theory is governments must and will support the banking system in times of crisis. They cannot afford to have the heart stop beating. While nothing is ever certain, the prospect of government not wheeling out the defibrillator is extremely remote.
So I go with the balance of probability and assess that the banking system will be rescued. But who pays and at what cost?
Sayings like ‘safe as a bank’ refer to an era of prudence that is not reflective of modern banking.
Yet, by and large, banks are still viewed as these conservative pillars of society.
This chart from last week shows US credit growth exploding from 1980 onwards.
This graph applies equally to the rest of the western world. Who facilitated and profited (handsomely) from this debt mania? The banks. Fractional banking enabled banks to gear up by a factor of 10x or more. This highly leveraged pillar is what our monetary system rests upon.
The Impact of Shrinking Credit
After 30-years of unbridled debt expansion we have reached the stage where there are too many vested interests prohibiting the stabilisation of banking system.
Firmer foundations would require banks to reduce their gearing – lend less. Think of the ramifications of banks systematically reducing the credit flow throughout society:
- Government tax revenues (on which all those entitlement promises have been built) would shrink faster than a wool sweater in a dryer.
- Retail profits would fall and staff would be laid off.
- The lay-off contagion would affect all business sectors and unemployment would rise. (And how does the government afford all this NewStart while on its Jenny Craig budget diet?)
- Imagine the reaction from the real estate industry as property prices fall.
- Bank profits would fall and share prices follow – member balances in superannuation would suffer and cause more pressure on the age pension to fund the shortfall.
- Last but by no means least in a list that could go on and on, bank executive remuneration would collapse to under the $1m per annum mark. Shock, horror; imagine all those Porsches and North Shore homes that would flood back onto the market.
- And the domino effect continues right through society.
I think you get the drift on how society is so hooked on the debt. Due to debt dependency, it is virtually impossible for anyone or any institution to voluntarily embark on the stabilisation process.
There have been token attempts at so-called banking reforms. In reality very little has changed. Bankers still get remunerated for taking risks, and not for being conservative.
The banks are even bigger than they were before Lehmann Brothers’ demise.
And the system is totally dependent upon unlimited central bank support. The system, in my opinion, is more unstable than it was in 2008. A cardiac arrest awaits.
Vern Gowdie+
Chairman, Gowdie Family Wealth
