‘The Walking Dead
Now that Europe’s fractionally reserved banking system has been regulated into complete inertia, it is a good time to assess the current bottom line, so to speak. We should mention here that there are essentially two ways of dealing with the banking system. One is to introduce an unhampered free market banking system based on strong property rights and nothing else. Such a system would work best if it were based on sound money, i.e., a market-chosen medium of exchange. The regulations governing such a system would fit on a napkin.
The other way is to construct what we have now: a banking cartel administered and backstopped by a central bank, based on fiat money the supply of which can be expanded at will and involving continual violations of property rights. Fractional reserve banking represents a violation of property rights, because it is based on the assumption that two or more persons can have a legally valid claim on the same originally deposited sum of money (for an extensive backgrounder on this, see our series on FR banking – part 1, part 2 and part 3). This legal fiction is very convenient for the banks and the State, but it sooner or later renders the banking system inherently insolvent (a de facto, but not a de iure insolvency).
Given this system’s inherent insolvency, the regulations governing it obviously won’t fit on a napkin. Instead they fill several volumes the size of telephone directories and keep growing like weeds. In their infinite wisdom, Western regulators and authorities have decided to react to the crash of the banking system in 2008 by suspending the rules of capitalism. In short, they have done precisely what Japan’s authorities did after the 1989 bubble peak: They have completely zombified the banks. Amusingly, the very same people have criticized Japan’s actions sotto voce for decades.
Bank bailouts have proved to be politically unpopular. However, European and US politicians realized of course that it would be even more unpopular if depositors were to find out the hard way that the money they believe the banks to be “warehousing” on their behalf doesn’t actually exist. And so they decided to go with Plan A. Bailing out the banks has of course always been Plan A. One of the main reasons why e.g. the Federal Reserve system was established in the first place was precisely that it makes it possible to privatize the banks’ profits and socialize their losses. The other reason is that fiat money and a central-bank administered fractionally reserved banking system enable governments to impose the vile “inflation tax” and spend money they don’t have with both hands. This is extremely convenient for the financing of both welfare and, perhaps more importantly, warfare.
Nevertheless, the 2008 crisis (and the subsequent euro area debt crisis) scared governments, because it demonstrated the downside of having all these nice inflationary mechanisms at their disposal. The downside is that the large banks have simply become “too big to bail” after decades of unfettered money and credit expansion. A big enough crisis could eventually bring enraged mobs into the streets, wielding pitchforks and looking for someone to hang from the nearest lamp post. And so it was decided to zombify the banks, in order to prevent another round of bailouts (it is noteworthy that it was not decided to return to sound money and free banking – the idea is probably that business as usual can eventually be restored).
What’s 26 Billion Between Friends? Or 137 Billion for that Matter?
Among the many new regulations that are supposed to prevent future crashes are restrictions on proprietary trading by banks, but most importantly, new capital regulations which not only prescribe new minimum capital reserves, but also the composition of said capital. The latter rules have been used as a convenient financial repression tool, by declaring sovereign debt a “risk free” asset for which not a cent of capital has to be held in reserve (i.e., they have a “risk weighting” of zero). Banks (and insurance companies, which have also been hit with a slew of new regulations) have become captive buyers of government debt as a result.
This rule has incidentally already contributed to the complete ruin of private banks in Greece and Cyprus, which held primarily Greek government bonds. As it turned out, Greek government bonds were actually not “risk free”. We would submit that the same is true of all other government bonds: In reality, these debts can never be repaid, they can only be rolled over, at least as long as market confidence holds up.
As the Financial Times reports, a new study by JP Morgan has revealed that Europe’s biggest banks are still short of €26 billion in capital according to the newest rules in the works – or €137 billion, depending on one’s perspective.‘