In a privately run reserve money creation system, the pressure to expand the money supply is like the force of water carving out a canyon. Overtime, the canyon gets deeper and wider. First, the reserve requirements are whittled away to almost nothing. When reserve requirements have effectively been eliminated, even bankers are willing to admit it might be prudent to have some standard limiting how much new money the banks create.
Capital ratio requirements
As reserve requirements have been phased out, governments have instituted requirements that banks have a net worth, also known as equity or capital, that is a specified ratio to their assets. This ratio of equity to assets is called leverage, because the banks are using what they own (equity) as the basis for speculative juggling of their own IOUs (liabilities) with the IOUs of others to them (assets). The global banking leverage ratio has run in the 2–8 percent range for decades. This means when a bank creates new money by lending out $100, it must have $2–$8 of its own money on hand to cover losses. For example, if too many of the people to whom they have issued mortgages default, or too many of their speculative bets prove bad, and the value of their net equity drops more than the required 2–8 percent, they are broke – insolvent.
By 2007, the bankers were generally operating at 2–3 percent equity. It wasn’t enough. The drops in the value of banks’ assets after the 2007 market crash were well into the double digits and the banks were insolvent. They needed that $16.1 trillion in revolving credit from the central bank to stay afloat (Chapter 3.23 and Chapter 5.53).
After the 2008 meltdown, a global, voluntary regulatory framework for bankers, headquartered at the Bank of International Settlements in Switzerland, signed on to what is called the Basel III Accord . This accord established a voluntary set of standards requiring 8 percent in equity capital as a percentage of all of a bank’s assets. The requirements were to be implemented beginning in 2013. But, under pressure from the banks, full implementation has been postponed until 2019.14 The Basel III Accord is a recommendation, and it is being made law using different accounting standards in different countries.
At 2–8 percent equity, bankers do not have much skin in the game. Unlike a reserve requirement, a capital requirement does not demand the bank set aside a certain value and keep it out of the action.
An asset can be earning new revenue for them and count as equity. The banks are required to keep enough of what are considered low-risk assets to serve as this equity anchor. However, as with reserve requirements, the banks work hard to minimize any loss of profit. In this endeavor, they have had a great deal of control over how their assets should be counted in these calculations. Their manipulation of governments and laws has rendered capital requirements nearly as meaningless as reserve requirements.
Measuring the value of assets
What banks own and count as their equity-capital may consist of precious metals, commodities, property, or claims to any to these. Equity may also consist of high value IOUs such as government bonds, or the IOU promises from institutions with a high rating. Most banks’ assets are other people’s IOUs of one kind or another.
Some IOU promises are more likely to be kept than others. Your high- risk-taking Uncle Ernie is not as secure a bet as Uncle Sam – the US government. And, broad economic conditions can negatively impact even the most responsible of borrowers. Since an IOU is vulnerable to default, and properties pledged are vulnerable to destruction or devaluation, governments require banks to risk-weight the value of their assets.
However, banks have convinced most governments they should be allowed to create their own formulas to determine how to weight their bets when calculating their reportable assets. Banks and governments have established elaborate systems and standards for risk-weighting assets. Unfortunately, the more elaborate the standards, the more likely it is that bankers find ways to game them. And, that is what happens.
It is clear it is NOT easy for banks to see where hazards may lie, and pretty foolish to allow them to create their own formulas for risk- weighting their own assets, when they put the entire economy in jeopardy with their decisions in our current system.
Anchor assets-Government IOUs
In the US, and to a lesser and lessening extent abroad, US Government debt is considered the best bet of all and is expected to anchor a bank’s other bets with a degree of certain return. According to the International Monetary Fund, US dollars make up 63 percent of the foreign exchange reserves held by global banks.15 In the United States, banks count US government debt as sound as cash or gold. So, under our current system, government debt has a key role in the purported stability of the system. Because US government debt fills this anchor role, there must be enough of it to anchor the new money created by the private banking sector. The more money the private bankers create, the more US government debt there must be to count towards the stability and security of their choices. A graph of government debt roughly follows the same exponential curve as the total money supply created by the private bankers.
Hence, it makes no sense to talk about reducing government overspending and debt when the money system in place requires government debt keep up with the money creation of the private bankers.
Politicians with a poor understanding
ANY politician who says the government should keep within its budget, just as individuals should, does not understand our monetary system. And, that is dangerous. Politicians who believe this will be easy to manipulate and will make poor decisions, since their decisions will NOT be grounded in an understanding of our money system.