Wednesday, October 22, 2008
We Are Giving Them Our Real Money to Make Up for Losses of Pseudo Money that Never Really Existed
In response to an essay about the government bailouts, I received the following comment:
"I posed a question to a few ‘experts’ asking where all this lost money had gone, or if it ever existed, but got no reply.Is he right?
A couple of days later I heard the same question asked to a BBC radio business program. They went across the road from the BBC studio, to the London school of Economics to ask 2 of their senior lecturers this question.
Their answer? No, the lost money never really existed!
So now we are giving them OUR money to make up for the losses that only really existed as 1s and 0s in their computers. Unbelievable."
Yes.
As derivatives expert Satayjit Das puts it:
[A leading financial writer] coined the phrase "candy floss money" ["candy floss" is the British expression for "cotton candy"].The "lost" bank money which taxpayers are being forced to "replace" had no more substance than cotton candy.
Financial technology spun available "real" money into an exaggerated bubble that, like its fairground equivalent, collapses ultimately. . . . The perceived abundance of liquidity was, in reality, merely an illusion created by high levels of debt and leverage as well as the structure of global capital flows.
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The title is thrilling, the text rather not, lacking, as it is, an explanation for the existence of non-existent money.
ReplyDeleteI do have a theory about how the “money that never really existed” might have (temporarily) been produced, but I need help from a expert in bank balance sheets to verify my idea.
To avoid misunderstanding let me point out that I’m not talking here about money creation through fractional reserve banking (see Wikipedia http://en.wikipedia.org/wiki/F.....ve_banking ). While this does at least have a connection with the real economy, the money creation I’m talking about would take place exclusively within the financial system. Therefore, this type of temporarily existing money would truly be like counterfeit.
Could it be that the trading of derivatives within the financial system leads to a (temporary) money creation?
My reasoning on this is as follows:
“Giver”-bank sells CDS to “Receiver”-bank.
Giverbank receives cash, Receiverbank pays cash: no money creation there - as yet.
But what happens with the CDS on the balance-sheet of the Receiverbank? The CDS does, after all, have a value; it could (in principle) be sold to another bank.
This leads me to the assumption (right or wrong?), that the Receiverbank would book the CDS as an asset on it’s balance sheet. Let’s not think about transaction cost here and assume the “fair value” is the same as what they paid to the Giverbank.
In this case, the financial system as a whole would (seem to) be “richer”: The Giverbank has received money whereas the Receiverbank has (on paper) not lost anything: the cash position is simply replaced by an asset.
Maybe there is a counterfactual assumption or some faulty logic somwhere in my deduction. Offhand, I can think of a mechanism that might refute my conclusion. If the Giverbank would book the price of the CDS under liabilities, it would, on paper, not have gained any money.
When the CDS expires, the monetary ‘inflation’ (if any) of the financial system as a whole would be ended and of course, the ’system’ would be deflated. The CDS then is worthless and has to be removed from the books of the Receiverbank. (This would be true even if the Giverbank would have to pay the amount of the hedged security to the Receiverbank: the latter would take a huge loss, but that would correspond exactly to the profit of the former, while the CDS would no longer have any value of it’s own.
My assumption might account for a large part of the losses in the bank balance sheets. These would occur first by the crash in market prices, and eventually by the expiration of the derivatives, when no new ones can be sold and the Ponzi (oder Madoff) game has come to an end. It is not an explanation for ALL of the financial crisis (the economic crisis being another story anyway).
Other significant problems would still be the housing bubble and, as the economic crisis proceeds, more and more defaulted credits.
I have already published my call for help in my (German) blog ( http://beltwild.blogspot.com/2009/02/neuartige-buchgeldschopfung-im.html ) and on the Webseite of a German Magazine, but so far without any relevant response.
Maybe there is somebody among the readers of this Website with the necessary technical bank accounting knowledge to help? If so: thank you ever so much in advance!