Financial Armageddon

"If the banks are shutting their doors, and the cash points aren't working, and people go to Tesco and their cards aren't being accepted, the whole thing will just explode.

"If you can't buy food or petrol or medicine for your kids, people will just start breaking the windows and helping themselves.

"And as soon as people see that on TV, that's the end, because everyone will think that's OK now, that's just what we all have to do. It'll be anarchy. That's what could happen tomorrow."

Gordon Brown, quoted by Damian McBride, as he relates how Gordon Brown considered putting troops on the streets in 2008.

This is the latest bit of information that illustrates just how fragile the global financial system has become after 30 years of money printing, and the inflating of one asset price bubble after another. It provides another glimpse into just why central banks continue to keep those asset price bubbles inflated, by continuing with the policy of money printing on an ever larger scale. It illustrates why Ben Bernanke pulled back from even just reducing the amount of money printing he was doing, for fear that it would cause a meltdown in financial markets.

Back in 2002, Gordon Brown sold nearly 400 tonnes of Britain's gold reserves. He did so at a time when the price of gold was rising, having been in a 20 year bear market. At the time, it was obvious that the price of gold had hit rock bottom, and was starting to rise. Brown sold the gold at prices between, $256 and $296 an ounce. The low price for gold came in 1999, at $250 an ounce, and from 1999, gold, like other metals and raw materials, saw its price rise relentlessly, as the new global, long wave boom got under way. By September 2011, gold had hit its peak of $1943 an ounce, or almost 7 times the average price Brown had sold it for. The Liberal-Tories have liked to portray this as just an example of Brown's economic incompetence. It was far from that. In fact, Thomas Pascoe argued, in this Daily Telegraph article last year, that it was part of a necessary conspiracy to protect the banks, whose speculative activities were already threatening to throw the world financial system into chaos, at that time, a chaos that erupted anyway, in 2008, and from which we are still suffering today.

As Pascoe sets out, a number of very large banks had made big, short bets against gold, bets that were going bad, as the price of gold began to soar. Because many of these short bets are undertaken using leverage, i.e. the bank or other speculator borrows huge amounts of money to finance the trade, in the expectation that they can close out their position at a profit, before they need to make good on their margin call, a number of these banks were threatened with bankruptcy. 

This was the problem these banks faced with gold. For years, after 1980, the price of gold had gone in only one direction – down. The general view of financial analysts was that gold was an historical relic. Unlike even silver, it had few industrial uses. It was used for jewellery, and not much else. Global trade was financed now by dollars not gold. Unlike shares, or bonds, or even a cash deposit, gold paid no dividend or interest. Therefore, if you were going to hold it, it could only be if its value was going to rise to give you capital gain, but given the aforesaid, why would it. No wonder its price had kept falling for 20 years. It was a one way bet, and speculators love one way bets. It is what provides the basis of the kind of carry trade that Pascoe describes.

So, it is not surprising that these banks had exposed themselves, to such a massive degree, in short gold positions. Remember that this is not long after Long Term Capital Management, in the United States, had gone bust, and had to be bailed out, by other banks, to the tune of $3.6 billion. It too was supposed to have developed an infallible algorithm for making money. It was also not long after the Asian Currency Crisis, and the Ruble Crisis, and slap bang in the middle of this process came the Stock Market crash of 2000, that wiped 75% off the value of the NASDAQ index. Just before that crash, as happens now with property, there were no end of analysts, newspaper column writers and others, who claimed that the market could only ever go up, because this time it was different from every other bubble! 

No wonder governments and central banks were worried. No wonder they decided to engage in some market manipulation, to ensure the banks did not go down. In fact, such manipulation and intervention is nothing new. In Hong Kong, the state has for many years directly intervened in both the stock and bond markets, buying shares when the stock market looked like it was going to fall sharply. The US Federal Reserve and Treasury deny that they do the same, and its probably illegal for them to do so, but many rumours abound that they do on a regular basis, coming in at the end of the trading day, when they can have most effect, for example. And, in the last few years, there has been no doubt that the US Federal Reserve and Bank of England, as well as other Central Banks have directly intervened in the market. That is what Quantitative Easing is. In fact, the Bank of England, and Federal Reserve, have intervened so much, that both own around 30% of the total debt, issued by their respective governments, and buy up around half of the newly issued debt. 

The Central Banks are now like a hamster on a treadmill. They have now pumped so much money into circulation that unless they continue to do so the financial system will implode, because as soon as the amount of money printing is even slowed down, money will fly out of those bonds that the central banks have been buying, yields on those bonds will rise, but also the money prices of other financial assets will collapse. It is money printing that has bubbled up the price of property, and shares for, example. But, as with the situation in respect of gold, the banks balance sheets themselves depend on these asset prices continuing at these inflated prices.

When, a bank makes a loan, for example a mortgage. That appears in its books as an asset. The person who has taken out the loan is a debtor to the bank. But, the value of this asset depends on the likelihood of the debtor actually repaying the loan. Ultimately, the value depends upon the value of the collateral the debtor puts up for the loan, such as a house. But, as was seen in the US, in Ireland, in Spain etc. where house prices are in a massive bubble, this flatters the financial position of the banks. All of these hugely inflated properties, make it look as though the bank has substantial assets. On the back of that apparently solid and solvent position, the bank is then able to make even more, even larger loans. But, when that property bubble bursts, and when lots of the people who have taken out those loans start to default, the real value of the banks' assets becomes revealed.

As the banks try to sell off the property that acted as collateral for the loans, that situation is even more clearly revealed. Large amounts of property dumped on the market results in all property prices collapsing in a firesale. If the property on the banks' books is valued at this market value – marked to market – rather than at its paper value as established when the loan was made – marked to book – it becomes apparent that the banks are insolvent. The more the banks assets are devalued, the less the bank is entitled to lend. Banks have to pull in large amounts of their loans, which means even more people are unable to pay. The sharp contraction of money-supply results in interest rates spiking, as a credit crunch develops.

At this point, the kind of situation described by Gordon Brown develops. That indeed is what happened in 2008. But, as I set out - Lehman's Plus Five – the situation today is far worse than in 2008, precisely because instead of dealing with the underlying problem, money printing has been used as an alternative, and it has simply exacerbated all of the problems of 2008 as a result.

Back in 2007, central banks had started to try to rein in the money printing, as I set out at the time – Buy Gold and Baked Beans. But, as soon as they did it resulted in the credit crunch that caused Northern Rock to collapse. But, having started injecting money into the system again, even in 2008, the main concern ahead of the financial meltdown was rising inflation as I discussed – at the time. And, in fact, even after the financial meltdown, Britain has continued to have inflation way above the 2% target set for the Bank of England. For a considerable part of that time, it has had inflation of more than double the 2% target! It is only the nature of the US economy, for example, the fact that it produces all its own food, and much of its energy requirements, which has prevented the US from suffering a similar fate. 

But, in 2008, the US Federal Funds Rate, the official interest rate, stood at 6%, compared with 0.25% today. In February 2008, the UK Bank of England Base Rate stood at 5.25%, compared with 0.5% today. When the financial meltdown struck later that year, these official interest rates could then be lowered, but at current rates, no such possibility now exists, and with money printing already on a massive scale, the central banks are essentially out of bullets, when the next financial meltdown strikes, and given that the underlying problems of 2008 have been exacerbated rather than dealt with, strike it most certainly will.

Gordon Brown, was right to be concerned about anarchy on the streets if the financial system did completely collapse. The scenario he depicted did play out, for example in Cyprus earlier this year, when its banking system collapsed. But, the summer riots of 2011, showed just how, images on the screen of such anarchy, can quickly turn into a generalisation of such action. Its no wonder the central banks are doing all in their power to keep asset price bubbles inflated.

A look at how quickly things can deteriorate is shown by Cyprus, as well as by Greece. And Greece shows, for those foolish enough on the Left to think that such a crisis might be beneficial to them, that the main beneficiaries of such situations are usually the fascists like Golden Dawn. In Cyprus workers savings were confiscated, and their pensions nationalised. Having first said they would not do it, the EU has now set into law the right to confiscate workers savings when banks go bust, alongside the capital of the banks' bond and shareholders.

At the moment, they promise not to touch workers savings below €10,000, but the experience of Cyprus shows that if a crisis like 2008 breaks out, let alone one that is worse, the deposit guarantee for saving will almost certainly be abrogated. In fact, savings such as those in Britain's National Savings and Investment system, which theoretically have a 100% guarantee, would be easy pickings for a government desperate to raise cash. At the very least, as with the introduction of capital controls in Cyprus, the Government would be likely to prevent or place limits on the withdrawal of such funds.

Being able to make decisions to protect yourself in such situations is almost impossible. You could take all your money out of the banks etc. and stuff it under your mattress, but that is practically impossible, for security reasons, and because your house insurance would go through the roof. But, in any case, in the past, in such situations, Governments have issued new currency, so any you had under the mattress would become worthless. As interest rates rocket, and people can't afford to pay their mortgages, the banks foreclose on increasingly worthless property, causing further turmoil. Holding gold is no solution if there is large scale deflation arising from a collapse of asset prices, and in any case, government's have frequently made it illegal to hold gold.

No solutions exist on an individual basis to such situations. In Spain, where people have faced eviction, communities have banded together to resist the banks. As unemployment has risen, people have returned to their families in the countryside, where at least they can grow their own food. But, if financial armageddon strikes on the scale I think is likely, and that is suggested by Gordon Brown's fears in 2008, collective solutions by workers on a far larger scale will be required.

When the banks in Ireland were collapsing, I suggested that their workers should take them over. The workers should take no responsibility for the debts of the banks run up by their capitalist owners, and the shareholders and bondholders in the banks should lose their money. They failed to exercise control over the banks' management as they undertook reckless lending over the last 30 years. Workers should demand that the state guarantee the deposits of savers in those banks. It not only failed to properly regulate those banks' activity over the last 30 years, but its policy of money printing encouraged them to make reckless loans, as part of the attempt in the US and UK, at least, to create a low-wage/high debt economy.

Workers in those banks should come together across Europe, to create a worker owned, co-operative bank, as part of a Europe wide co-operative federation, able to assist workers in taking over their firms when the capitalist owners go bust, as well as in helping workers to set up new vibrant worker owned and controlled businesses, as an alternative to the failed capitalist model. The decision of UNISON to set up Credit Unions is a step in the right direction. But, we need much more from Trades Unions in this direction, as with the decision of the biggest US union the United Steel Workers to join with the Mondragon Co-ops to spread workers co-ops across North America – United Steel Workers.

In fact, if UNISON and other unions in Britain followed this kind of model, they could offer workers in Britain, such as those facing attacks in the NHS, with a real alternative model to both the failed private capitalist and state capitalists models, as well, in the case of the NHS, as providing workers in general with a better alternative to a healthcare system that day after day is shown to be unfit for purpose. Not only has it been shown to treat our elderly people atrociously, not only does it have waiting times that are unheard of in socialised healthcare systems in Europe etc. but as Channel 4 News showed recently you are far more likely to die in an NHS hospital than in a hospital in the US or many other countries – Channel4 News.

There is no more chance that the capitalist state will provide adequately for workers than there is that private capital will do so. We have to build our own worker owned and controlled alternative.