Today we’re going to explore the work of forecaster Phil Anderson. But no introduction to Phil’s ideas could be complete without a thorough look at the modern banking system. Because two factors underpin Phil’s real estate cycle theory: the capitalised economic rent and the credit creation of modern banks.
If you’re familiar with the intricacies of modern finance you’ll know this: the banking system creates its own deposits, via their lending. This credit creation brings new money into existence.
Now Phil is not, as they say, a ‘hard money’ man. He doesn’t advocate a return to the gold standard. In fact, he sees credit creation as a necessary and fundamentally positive process for the general economy — with a caveat (or two). The main flaw in the process, he says, is whether the credit is created for productive purposes (say building a bridge) or speculation in what he calls ‘government-granted licenses and privileges’. You can see what he means by that by checking out a free series of videos we’re producing with him here.
But one crucial aspect of Phil’s work is how the modern structure of our economy makes banks ridiculously larger and more powerful than they should ever be. Effectively, he says, society works for the banks, instead of the other way around.
Moral Hazard Ingrained in the Financial System
One consequence of this is that banks cannot be permitted to fail when they overreach. If your business goes bankrupt, dear reader, nobody gives a damn. But a bank? The government will allow money printing to high heaven to get them out of trouble.
As Phil points out, this is why the US Federal Reserve has done everything in its power to recapitalise the US banking system and return it to profitably after the collapse of 2008. Savers be damned. Driving down the interest rate means US banks can borrow from the Fed at under 1% and buy long term government bonds paying just under 3%. They then cream profits off the spread, all for doing sweet you know what. Beats going to work, doesn’t it?
The member banks own the Fed. The Fed IS the banks. Of course it will act for their benefit, not the average American or anyone else.
There will come a time however, Phil argues, when the US Federal Reserve will raise interest rates and the spread the banks earn will narrow. That is to say, it will become less profitable for them to simply borrow from the Fed and buy governments bonds. That’s when they’ll go looking for credit growth by lending to consumers and business. Once again there will be times of ‘easy credit’. This sows the seed of another credit boom, and by then, according to Phil, we’re well into another real estate cycle.
You might be inclined to think we’re in times of easy credit right now. Not so, according to Professor Steve Hanke at John Hopkins University. He argues that the US Federal Reserve has actually adopted a contradictory monetary policy. How so?
State Money Versus Bank Money
Here’s the Professor:
‘The problem is that central banks only produce what Lord John Maynard Keynes referred to in 1930 as “state money”. And state money (also known as base or high-powered money) is a rather small portion of the total “money” in an economy. The commercial banking system produces most of the money in the economy by creating bank deposits, or what Keynes called “bank money”.
‘Since August 2008, the month before Lehman Brothers collapsed, the supply of state money has more than quadrupled, while bank money has shrunk by 12.1 percent – resulting in an anemic increase of only 4.5 percent in the total money supply (M4)… The public is confused – as it should be. After all, the Fed has embraced contradictory monetary policies. On the one hand, when it comes to state money, the US Federal Reserve has been ultra-loose. But, on the other hand, when it comes to the largest component of the money supply, bank money, a tight monetary stance has been embraced.’
The commercial banks have had to adjust to higher capital ratios under Basel III rules that govern banking, plus new regulations brought in by the Bank of International Settlements. This has restrained their lending. Hopkins calls it Bernanke’s Monetary Mess. But the history of banks says it won’t be long before the credit machine cranks again because credit growth drives bank profitability.
You can get a sense of where Phil sees all this going in his videos. Phil went on the record at the recent Port Phillip Publishing conference World War D talking about the coming boom over the next decade. But if you couldn’t make it to the conference, Phil’s World War D speech will be released here in the coming weeks.
We know Phil’s going on the record to talk about a coming boom over the next decade or so. That made an interesting contrast with Richard Duncan, who talked about the coming depression. This was no theoretical exercise, either. Where you put your money will depend on which you see coming. We have a feeling the crowd favoured the Duncan angle. But we’re sure Phil doesn’t mind. It is lonely on the other side of the crowd. But often, in the end, that’s where you want to be.
Callum Newman+
Contributing Editor, Money Morning
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