Friday, 17 October 2008

We had to burn the village to save it

The title of this diary is a quote from the Vietnam era that sums up for many the arrogance and pointlessness of American aggression in Asia two generations ago. It keeps coming to mind each time I read President Bush’s (paraphrased) statement this week: We had to nationalise the banks “to preserve the free market.”

There is no free market when the government owns the actors and sets the terms of transactions. There is no village once it has been burned to the ground.

The collapse of the financial sector is unacceptable. It is unacceptable to bankers who have vested careers, status and equity wealth in the disproportionate expansion of the financial sector. It is unacceptable to politicians who have risen to high office doing the bidding of the financial sector in ceding progressively more generous taxpayer subsidy and regulatory forbearance to its chieftains.

And so in the US, UK and EU we have politicians appropriating more petrol to hand to the arsonists who started the conflagration which is consuming our economic and political fabric. The regulators whose forbearance is a root cause of the current conflagration are handing the arsonists fresh zippo lighters. The policies adopted in these debtor nations will fail, must fail, because they destroy what remained of market economies. In the meanwhile, however, the bankers and the politicians and the regulators cannot conceive of failure and so insist on more of the same – ordering hundreds of billions in more incendiaries to fuel the blaze. The same tax breaks. The same housing subsidies. The same regulatory forbearance. The same ill-transparent, off balance sheet, accounting sleight of hand. The same eradication of market incentives to productive, disciplined saving, investment and labour.

Those who would prudently save will be punished with negative real interest rates and asset deflation. Those who would prudently invest in productive industry will be starved of scarce capital and forced into liquidation. Those who would prudently labour for a decent wage will be slowly robbed by inflation and kept docile by the threat of unemployment.

There can be no more iniquitous alliance than to have the politicians at the service of the bankers, unless perhaps it is to have the military at the service of the bankers too. The US seems to have committed itself to this worst of all possible combinations, with Congressmen threatened by the imposition of martial law if they failed to acquiesce to the Paulson Plan. Thankfully the British and EU militaries are too small and ineffective to be leveraged into a similar threat to global or domestic peace and security.

Subsidised banking seems a faster method of going bust than military adventurism, but the two together will see the US bust even more certainly. The $700 billion appropriated for the Paulson Plan and the $840 billion extended in parallel by the Federal Reserve last month are together more than three times the expenditure on US wars for the past five years. The federal borrowing requirement for 2008 is now in excess of $1.02 trillion, and for 2009 is now estimated between $1.5 and $2 trillion.

Such hyperbolic growth in the fiscal deficit and debt is unsustainable, even with such very tolerant creditors as the Japanese, Gulf Arabs, Russians and Chinese. They can see that each dollar added to the Fed’s balance sheet is tinder for burning those already held or denominated in their reserves. They can project the curve forward. At some point, they must react and restrain further debasement of their reserves and investments, either by collectively raising the prices charged for the resources and products they export, the interest charged on existing and future debt, or the forced exchange of debt for equity ownership of real economic assets.

Or all three.

The cycle of debt deflation is just getting rolling. The banks were only the first bailout and already the federal deficits are ballooning unsustainably. What will be the recourse when municipalities and states face default through catastrophic tax and revenue shortfalls? What will be the recourse when large commercial employers, industries and infrastructure confront failure from collapsing consumption expenditure? What will be the consequence when unemployment, homelessness, political disaffection and crime are resurgent and threaten the political fabric?

We are at the end of the beginning. Hank Paulson has played a clever game for the past decade of exporting dodgy paper to the US creditors abroad while forcing a middle class subsidy of the tax exempt corporatists at home. Now he plays a clever game of devaluing all currency and paper assets, exporting the pain to foreign taxpayers and investors. But this is not a game that America can win without the debasement of everything America once represented as holding value in its formerly prosperous market economy.

In my experience, there is nothing so permanent as a temporary expedient. It is hard to see how partially nationlised banks will ever be more than the means of political redistribution of wealth and power, and so corrupt both the economy and political system.

We had to burn the village to save it.

Perhaps someday we will hear a remorseful Mr Paulson or Mr Brown echo Robert McNamara, early architect and aggressive propagator of the Vietnam War: “We were wrong, terribly wrong.”


I will be out of touch for most of the next nine days, but will check in as and when I can. There may be a guest blogger here next Friday who I'm confident will be enthusiastically received, if he accepts.


pej said...

Always such a pleasure to read you, London Banker - Many thanks. As I keep saying: Gold = Freedom, Fiat Currency = Slavery: Who is your ennemy

Anonymous said...

As for the comment from pej above, we must not only know our ennemy, but how to spell him too...

"Those who would prudently save will be punished with negative real interest rates and asset deflation."

"Those who would prudently labour for a decent wage will be slowly robbed by inflation and kept docile by the threat of unemployment."

So LB, what will be the predominant macroeconomic force, deflation or inflation? This to me is the million dollar question upon which all decisions turn. You seem to be implying both which is not a 'wrong answer' necessarily. So let me ask it this way: in 3-5 years would you expect a new mid-size automobile to cost closer to $2,500 or $250,000?

yoyomo said...

A very radical proposal coming from the likes of Paul Craig Roberts:

"Fractional reserve banking must be reined in by higher reserve requirements, rising over time perhaps to 100 percent. If banks were true financial intermediaries, they would not have money creating power, and the proliferation of debt relative to wealth would be reduced."

This set-up would more resemble the Islamic banks' finance model of 100% equity funding. LB, London is much more of an international city than even NYC and I was wondering if, from where you sit, you see Islamic banks opening up a niche in the West with those who see fractional reserve banking as inherently destablizing.

Without the ability to fluctuate/manipulate the money supply, bankers would have much less power over economic activity and with the world at the limits of physical growth, the need for a rapidly expanding money supply is obsolete. Any thoughts greatly appreciated.

Sackerson said...

Taking away the banks' capacity to conjure up money from nothing seems like a good idea to me, Yoyomo. But who will do it? Isn't the root problem the Western democratic deficit and the electorate's ignorance of how the money system works?

Anonymous said...

thank you for the gift of your blog.

darkcloud said...

great commentary.

thanks to - (one of the very best)

- for guiding me to your blog.

Anonymous said...

Have you misunderstood survivorship bias?

locust said...

London Banker,

There's another angle that needs to be taken into account. The financial crisis presents a golden opportunity for supply siders to once and for all destroy US entitlement programs such as Social Security. This is not an accident. The bail outs are meant to speed matters along.

Just wait. We will soon be told that had the privatization of Social Security been allowed to happen as President Bush wanted, the financial crisis would not have taken place.

D said...


The policies that have been utilized thus far are aimed at propping up insolvent financial institutions, not supporting market prices.

InNoSiNz said...

Bravo! Great post LB!

Hasibul Haque said...

LB, your pieces are as always - great read. Please keep posting more often. Thanks.

Anonymous said...

Thank you LB again. I am horribly sad seeing how a nation that I admired has been throwing away its ideals during the last few years. There is nothing left to look up to, and it will take great people and much patience to regain what has been lost.

Mark said...

LB, if you were a US citizen how would you be invested with a 5-10 year time horizon?

Wisdom-Seeker said...

You meant "expropriating" rather than "appropriating".

The use of the funds might have been approved by those in power, but it was emphatically not approved by the population at large!

Sennacherib said...

I only wish you were wrong; problem is you are right, too right. Each post of yours confirms what we all know but makes it more compact and transportable in the mind.
Hard not to succumb to despair with such powers arrayed against one. Like Samson we find ourselves blinded and nearly impotent in the house of strangers as they consume in hilarity and frivolity the crumbling remainder of our Republic. Like Samson, I would pull the house down about my ears and end the ugly spectacle. But the main pillar was constructed by my own hand. Built far too weighty, built far too upright. I should have modeled it upon American finance and my sorrows would be reduced.
Burn the village to the ground, grind the remainder to dust, salt the earth with lime. That will be the outcome of our national and global folly. Praygod we have fortitude to rebuild, but we shall probably devolve to another feudal era full of feuds.

Don said...

First allow me to express my gratitude for you insights, analysis, etc.. Your blog is much appreciated.

One point I would rebut in today's post is your use of the term nationalization, here referring to the "nationalization" of banks.

Nationalization means government (public) ownership, including the direction in which investments are placed, the administration, some degree of public oversight, government controls, etc. What we are in the midst of today is not nationalization. Taxpayer money is sent to banks, where once it enters the bank's doors it transforms from public funds to private (capital) funds. What banks do with that money will still be determined by the private owners of those banks, based on what is in their best (private) interest. Investment decisions will not be made in the national interest nor more generally in the public interest.

This incorrect usage of nationalization is common, so you are not alone. However, any study of nationalization, in Latin America, for instance, means something entirely different, reflecting true nationalization.

Jason Manke said...

LB - thank you for your critical, constructive, and freethinking posts. The world has not gotten so sophisticated that it is beyond basic laws of nature. Our "fearless leaders" seem to dismiss these facts which one (hopefully) learns early in life:

1. If it is too good to be true then it probably is.

2. What goes around comes around.

I've frequently heard this statement taken from the Great Depression, "Just when we thought it was ending it was really just beginning."

This rings a bell as CNBC screams "bottom" and I see ads running for "the buying opportunity of a lifetime."

All readers please take care not to listen to the many Judas Goats, and think critically about what will happen next. Your finances and way of life depend on it.

Prepare for the worst - hope for the best.

I'm Not POTUS said...


From where I stand, the way the game is played now, is that, all monies belong to the bankers.

The tricks being played simply return the money to their natural owners. Not "rightfull" owners by any means but that is how things are right now. It is only "my" money until they need it back.

Their is probably a better name for this than nationalization. I am nationless, I live in a bankers unclaimed property.

Maybe we should just call a spade a spade. BANKRUCAPITUALTION

yoyomo said...

I don't know how to cure apathy and mental sloth among the general population but I suspect the coming hardships will probably prove to be a potent motivator. As for ignorance of the workings of the financial system, the cartoon "Money as Debt" (which I previously mentioned to you on your blog) is a great teaching tool which everyone on the net should promote among all their friends. Now there is an even more powerful teaching tool that hopefully netizens will promote:

Crash Course by Prof. Chris Martenson

Money as Debt by Paul Grignon

Use your platform to spread awareness of these two great tutorials and not Larry Miller's racist rant.

Anonymous said...

I know that this is not a popular position to take in such a forum, but: Never discount the resilience of the American people. They don't pay much attention or take things very seriously for long stretches of time, and to an outsider they really can seem frivolous, naieve, and ignorant. But when a crisis comes, they have repeatedly demonstrated their ability to pull together and overcome. This includes finding the right leadership and direction at the point of crisis.

I would not bet against them.

Anonymous said...

USA is corrupt to the core and is over, IMHO. No 'right leader' can right this sinking ship.

Knute Rife said...

Did anyone else catch CNBC's interview of Morgan Stanley's John Mack yesterday? He just about flat cam out and said that the capital the Treasury is pumping into the banks will be used to "rebuild capital ratios," i.e. it's going to sit in the vaults to prettify the balance sheets to attract more suckers, er, investors. So much for Main Street seeing any return on this taxpayer "investment."

Anonymous said...

"Perhaps someday we will hear a remorseful Mr Paulson or Mr Brown echo Robert McNamara"

Your article is great but not the above Alice-in-Wonderland-sentence. To avoid such phrases I suggest a reality check (maybe by reading one book by Ann Coulter).

Sackerson said...

@ Yoyomo: thanks, I have posted Paul Grignon (again) and the Crash Course. Hope some more people will take it up.

Blissex said...

«The US seems to have committed itself to this worst of all possible combinations,»

The best from the point of view of the elites that stand to benefit enormously from that course.

«with Congressmen threatened by the imposition of martial law if they failed to acquiesce to the Paulson Plan.»

That threat actually is the only sensible aspect of the story.

I have read rumours that some LETTERS OF CREDIT are being refused.


Civilization itself is built on letters of credit. Without those martial law is the least of the problems.

And in some places things may be already bad. Try to imagine the situation in Iceland now: if you were an oil exporter sending a tanker to Iceland, would you accept a letter of credit drawn on an Icelandic bank? On which bank? And if not, what would you accept? What have the Icelanders got that an oil exporter might take as a secure payment? Gold bars? Dried fish? Lava?

Blissex said...

«Never discount the resilience of the American people. They don't pay much attention or take things very seriously for long stretches of time, and to an outsider they really can seem frivolous, naieve, and ignorant. But when a crisis comes, they have repeatedly demonstrated their ability to pull together and overcome. This includes finding the right leadership and direction at the point of crisis.»

As long as they don' take things a bit too seriously :-). Consider this "alternate future" story of the USA:

(not entirely joking)

Anonymous said...

This is quibbling about history but here goes anyway. The quote "We had to burn the village to save it" is a myth. I believe you are paraphrasing a quote produced by Peter Arnett during the battle at Hue. The quote was never believed by the majority of the press in country. The consensus was that Arnett made it up. As for the current situation, you can fight fire with fire, but too much lending with yet more lending?

Peter J. Bolton said...

Well LB, look on the bright side:

George W. Bush will go down as the greatest of all Presidents and Paulson and Benanke will share a Nobel Prize for Economics bringing them into august company of Koffi Annan, AL Gore and Paul Krugman.

And if this isn't enough wait until the Camp David Summit of Noverber 4, 2008.

Ho hum

Anonymous said...

Is this guy just spouting pseudo-science and seeking media exposure by upmanshipping other gloomier forecasters? Does he want to be the gloomiest? And is there anything in this interview that has real tangibility to support his pessimism?
Interesting perspective though.

Anonymous said...

Gold getting jammed in an environment where expectation would be significant price rise. Dollar is strengthening in the face of the bleakest earnings reports and contractionary quarter in a half century. I hear all the tin-sounding reasoning behind it, but still find it to be an amazing conundrum. Anyone with alternative views? Since gold and dollar action has been progressing very slowly over years, could this have been a setup? Or just the slow pressure of randomized human market activity?

Anonymous said...

I'm late to the thread, but I have to add this:

The Vietnam era quote about burning the village to save it is true, at least in its essence.

There are any number of clips of a soldier in a village lighting the straw roof of a hooch, saying words to that effect.

It's not an exact quote, but does it really have to be?

I'm not really anonymous. I'm zak822.

Anonymous said...

An addition. They were called zippo raids.

Google the term.


Anonymous said...

@anonymous (3 above)

Regarding the dollar, there was a great explanation (and at that time prediction) of a Hans Guenter Redeker from BNP. Here is the link:

yoyomo said...

Jesse's cafe had a good explanation for the dollar squeeze; European banks are stuck with so much toxic US CDOs that they have to buy $ (to settle their dollar debts) on the FOREX market and are bidding up the exchange rate on the $ in the process. This hurts gold as does the dumping by hedge funds.

yoyomo said...

If you have a chance to look at this item I'd appreciate your take on it. I'm curious if these banks have a foothold in London and if you think banking can exist w/o fractional reserves a la Paul Craig Roberts' suggestion - see my comment (3rd from top) above.

Anonymous said...

LB, situation deteriorating inside the citadel. The grains that were stored for the populace are rotting and the rushes need replacement. Fleas and vermin everywhere.

The peasants want out of the safety of the castle walls but the neighboring WS warlords all are laying siege around the moat. They will be fighting over the treasure that remains.

We'll learn soon just HOW connected this citadel is to the King. Maybe not as much as you thought? EH?


steven said...

This is a very, very good post!!!

Sujan Patricia said...

Paul Krugman was awarded the 2008 Nobel Memorial Prize in Economic Sciences for devising a new theory to answer questions about free trade. He is just one in several economics experts that have advised recently that the recession appears to over and that the economy is growing again this quarter.