Do Away With the IMF, World Bank, and Central Bank

Mainstream Reckoning I

The past week has been confusing. Stock markets around the world have rallied, but the elation doesn’t seem to be spreading. Instead, the bastions of optimism and long standing opponents of the Markets and Money have turned gloomy and sometimes downright apocalyptic.

The first exhibit is Mr. Debelle, the Assistant Governor of the RBA:

“While most of the recent jitters have been associated with sovereign concerns, I think the risks stemming from the financial sector are still there. A significant risk is that we are still yet to see the full impact of the weakness in the North Atlantic economies on the loans on the books of financial institutions.”

That is gloomy. But hold on to your hats, here comes worse.

Albert Edwards from Société Générale has broken the mould when it comes to being an investment banker. In other words, he is saying it like it is. Exactly like it is.

“My own view on this is that obviously we should never have got into this wholly avoidable mess in the first place. But having got here, there really is no way out that does not trigger a major market-moving upheaval.

“Ultimately economic prosperity over the past decade has been a sham: a totally unsustainable Ponzi scheme built on a mountain of private sector debt. GDP has simply been brought forward from the future and now it’s payback time. The trouble is that, as the private sector debt unwinds, there is no political appetite to allow GDP to decline to its ‘correct’ level as this would involve a depression. So burgeoning public sector deficits and Quantitative Easing are required to maintain the fig-leaf of continued prosperity.”

The main thing we see missing from Mr Edward’s analysis is the role of monetary policy in financing the mountain of private sector debt, while government legislated to encourage it. By setting rates artificially low, the Federal Reserve made money cheap and the government then put that money to use by implementing affordable housing policies. Strangely enough, this was all done while touting free market rhetoric and the benefits of deregulation.

So now, themselves confused, global institutions are having a bit of an identity crisis. Even the IMF has decided to go against the mainstream by suggesting an “overthrow of inflation targeting as the central goal of economic management.” While we agree in principle, we do not “urge inflation be allowed to rise to 4 per cent to give governments a better ability to manage downturns.”

This idea is blatantly stupid. But who are we to claim that? Unlike the IMF, we have not been accused of destroying African agriculture nor disregarding human rights. In fact, if we had the IMF’s track record, we wouldn’t be able to sleep at night. Our humble suggestion, along with many of the people who predicted the crisis, is to not have an IMF, nor a World Bank, or even a central bank.

On that note, it is worth going off on a tangent for a moment. The idea that government formed institutions can bring about free markets and globalisation is a paradox. The book “Globalization and Its Discontents” by Nobel Laureate Joseph Stiglitz is an amusing illustration of this inherent contradiction. The book is not about globalisation, so the discontents identified aren’t even relevant.

The book is about the IMF and its failures. For some reason, Stiglitz thinks globalisation comes about by management from institutions like the IMF. It is in fact the absence of institutions like the IMF and World Bank that defines globalisation. That is something people need to grasp for globalisation and its “contents” to emerge.

Anyway, let’s focus on the suggestion of abolishing central banks.

Last week featured a discussion of how banks are the most regulated businesses in the world. They cannot control the price they provide their goods/services at (the interest rate), nor can they control how much they sell (the money supply). Both of these are controlled by the central banks. (See lasts week’s edition for a more detailed explanation).

Deregulation is meaningless if you can’t even control price and quantity, so blaming the crisis on regulatory reform or greed is just ignorant. Only the central bank has enough influence to cause a crisis in the banking system. A free market doesn’t stuff up that badly.

Ponder for a moment a world without a central bank manipulating interest rates and without a financial services regulator implementing regulations. What do we get? Well, historically speaking, we get the safest banking system possible.

Don’t believe it?

Check out these podcasts on Free Banking and the Austrian Business Cycle. For a more current example of how transactions occur safely, but out of the government’s sight, check out Hawala Banking. You just gotta love the free market at work – because it works.

Fear the Boom and Bust

For those of you who don’t like podcasts, but want an understanding of the crisis, I suggest the following rap video. It is more informative than any economics lecture I have ever been to.

Part of the rap is about the Austrian Business cycle theory, which explains how the crisis we are in comes about and how it plays out. “Blame low interest rates” says the chorus.

Here are the key verses:

“The place you should study isn’t the bust
It’s the boom that should make you feel leery, that’s the thrust
Of my theory, the capital structure is key
Malinvestments wreck the economy

“The boom gets started with an expansion of credit
The Fed sets rates low, are you starting to get it?
That new money is confused for real loanable funds
But it’s just inflation that’s driving the ones

“Who invest in new projects like housing construction
The boom plants the seeds for its future destruction
The savings aren’t real, consumption’s up too
And the grasping for resources reveals there’s too few

“So the boom turns to bust as the interest rates rise
With the costs of production, price signals were lies
The boom was a binge that’s a matter of fact
Now its devalued capital that makes up the slack.”

If this sounds familiar, have a look at the Albert Edwards quote above. Mr Edwards comes up with the same argument almost 100 years later than the Austrian School of Economics.

It’s the “expansion of credit” that signals the onset of another bubble, or “fig-leaf of continued prosperity.” If you don’t see that expansion of credit happen here in Australia, then we may be heading for trouble instead of another fake recovery. We will keep you posted on that.

Mainstream Reckoning II

According to The Telegraph, Société Générale isn’t just talking the talk:

“Société Générale has advised clients to be ready for a possible ‘global economic collapse’ over the next two years, mapping a strategy of defensive investments to avoid wealth destruction.”

So it’s official now. You should be concerned. Alan Kohler is now doing some reckoning in the Business Spectator.

“In general, what we are seeing is not just a Mediterranean muddle – it is the beginning of the great global fiscal stimulus reckoning… In other words, the entire western world is insolvent and each country is facing its own day of reckoning – starting, appropriately enough, in Greece, the place where western civilization itself began.”

The article carried the same title as a book written a colleague of ours in 1992.

“In The Great Reckoning, Lord Rees-Mogg and I [James Davidson] warned that the coming fall in real estate would cost trillions as the ill-considered guarantees kicked in, on Freddie, Fannie and other guarantees that proved to be AIG-style Credit Default Swaps on real estate.”

Noting the date, it would seem Jim is worth listening to. What is his latest claim? Nothing less than an upcoming “Little Ice Age”. He even coined a term to describe the evidence cited by the global warming camp. You’ll find it just below.

Statistical Falsies

No, the subtitle is not meant to read “Statistical Fallacies”. The word “Falsies” refers to the un-biological content sometimes found in bras. Statistical falsies are proving just as disappointing to the global warming camp. I find myself on thin ice here, so let’s get back to the point.

On the real climate change front, the former Chairman of the IPCC has made an intriguing point about the amassing “errors” made by its “scientists”. If, as the IPCC claims, these “errors” are innocent, then why do they all overstate the impact of climate change? Innocent errors would imply a mixture of results, while it seems the fallacious claims of IPCC cited material all point to global warming.

My personal favourite of those “errors” was the claim that Himalayan Glaciers would disappear by 2035. Evidence suggests they got their numbers muddled. 2305 is more like it. Sadly, the data still suggests they will disappear… Just as they have in other places around the world since before man first rudely released the greenhouse gas methane.

The Great American Liquidation Sale

Dan Denning’s predictions of China’s attitude toward US government bonds have gone from being scoffed at, to reality. He reports in the Markets and Money that “foreign holdings of U.S. Treasury securities fell by $53 billion December. China reduced its holdings by $34.2 billion. The end game is beginning in the Chimerican relations.”

CNBC manages to paint a much brighter picture with the title “Foreign Demand for US Treasurys Takes Record Fall”.

One wonders what could happen to the banks, who hold vast reserves of US treasuries to sure up their capital structures. “U.S. Treasury and agency debt makes up about 60% of the world’s banking reserves” says Porter Stansberry. Banks are on shaky ground as it is (real estate). Dan Denning named this a “double collateral whammy”.

Could banks survive a big hit to US Treasury prices?

Of course they could, just not by themselves. They have learned the government will come to the rescue – if the size of their bets are big enough to cause instability to the wider economy.

But then again, the legendary Paul Volcker has other ideas:

“If a big non-bank institution gets in trouble and threatens the whole system, there ought to be some authority that can step in, take over that organization and liquidate it or merge it — not save it… It’s called euthanasia, not a rescue.”

As Mr Volcker is President Obama’s economic advisor, his proposal is worth paying attention to. Except that a fall in treasury prices would spell trouble for just about all banks at once, so it would be more like genocide than euthanasia.

Acronym Update

Thanks to the readers who have submitted their alternative acronyms for debt ravaged nations. Unfortunately, I assumed it was a task that could be safely left to sophisticated and mature Markets and Money readers, so I didn’t do any pondering myself. The endless variations of the following should have been predictable: “PIIGSUSUK (PIGS-U-SUK).”

Although adopting this acronym would allow bacon references going forward, it does not have a nice ring to it.

Strangely enough, the PIIGS matter has become quite an issue. No, not the debt, just the name. Particularly enjoyable was the specific attempt to point out the acronym in a Bloomberg article.

“With all of the issues the EU had with the PIGS, one would think we would see a continued flight to quality,” said Thomas L. di Galoma, head of U.S. rates trading at Guggenheim Partners LLC, a New York-based brokerage for institutional investors. He used an abbreviation for Portugal, Ireland, Greece and Spain.

Did he now! Golly gosh.

Meanwhile, a big thanks to David G. for submitting the best new acronym for debt ravaged nations:


Those nations certainly look like they are leaning towards a collapse.

Also, thanks to James for sending this in:

I quote from the instructions [of Monopoly]: ‘The Bank never “goes broke”. If the bank runs out of money, the Banker may issue as much more as may be needed by writing on any ordinary paper.”

Ah the irony.

Nickolai Hubble
Markets and Money Week in Review

Nick Hubble
Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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