Amounts circulating in the news since the beginning of the financial crisis, never cease to amaze. To rescue Citigroup, the U.S. government and the Fed must raise more than 300 billion dollars, the government provides French banks over 320 billion to stabilize the system. How to explain these astronomical sums? How could such a disaster he happen?
Thousands of billions of new loans
These amounts reflect the huge increase in large outstanding credit and money creation in recent years.
Thus, banks in the euro zone had, according to figures from the ECB, outstanding loans to individuals and businesses around 6100 billion at the end of 2000.
In October 2008, less than eight years later, this outstanding amounted to 10,900 billion, an increase of almost 80%. In other countries, the increases were of the same order of magnitude.
Data on the money used for this index. In the Euro zone, the money supply increased over the same eight-year period from 4.5 trillion or about 91% to 9.4 billion euros. In the United States it has also greatly inflated, but less than in Europe, with a growth of $ 3 trillion, or about 60% to 7.9 billion. In the UK, the increase amounted to 130%.
In total, 84% of the total in the industrialized countries of the West.
Mechanisms of money creation
How did we get to a steep increase in the volume of credit and the money supply? For decades now, the currency issued is no longer covered by gold reserves.
In systems based on fiat money, now adopted in all countries of the world, the scale of money creation is rather the result of political calculation.
Money creation is the business of commercial banks on the one hand, and the central bank on the other.
In Western industrialized countries, monetary creation is above all by the granting of credit, and to a lesser extent by the purchase of goods by banks or central banks.
If a bank extends credit to a customer, say an amount of 100,000 euros, this amount will be credited to the current account of it. At this time, bank money is created. The client will have the money, buying a house, for example. The money comes on then the seller's account, which has in turn. Other recipients of transfers will put money on savings accounts earn interest. The money flows and created bank accounts until it is removed from the circulation, eg the repayment of a loan.
This money creation does not create value. Thus, the bank customer who took credit has good 100 000 on his account, but also 100,000 euros of debt. Similarly, the bank has 100,000 euros of receivables arising under the credit, but it also has a customer deposit of an equivalent amount in liabilities from its balance sheet.
The limits of monetary creation
Is that commercial banks can create as much money they want? In principle, the answer is "no," because there are "brakes" on three levels. The first is the self-interest of banks to avoid losses by lending to clients of dubious quality.
Then, in the second place come the supervisory authorities, who are supposed to ensure compliance with the regulations in place to limit risk taking too much from the banks. And the third brake consists of the monetary policy of central banks, which ensure to contain an excessive increase in the money supply would Creative inflation.
The brakes have not functioned
In retrospect it seems clear that these three brakes were not effective in recent years.
Regarding the banks restraint motivated by fear of loss, it did not work for two reasons: 1) short-term oriented management and determined by the greed 2) the possibility to get out of debts their balance sheets, creating ad-hoc companies which these loans were sold. This improved their risk profile and even generated additional profits.
Regarding supervisory authorities, so the second brake is on this second point they failed to prevent the situation we live in today. To grant $ 100 million in loans, a bank must in principle to face at least 8 million of equity.
This obligation to match their outstanding loans to equity as security is a regulatory measure designed to protect the public. However, in practice, many large banks secure their loans with much less capital than that.
In almost all countries, supervisory authorities have tolerated the circumvention of these guidelines by the mechanism described above. And laxity has been rewarded: the ad-hoc companies especially now generate losses of such importance that they must be stabilized or saved with taxpayer money.
Born there and fears of a collapse of the financial system if only a few percent of the volume of loans become ill, it can quickly lead to a shortage of capital, or a total loss, and thus the failure of the bank.
Deposits of savers might also be adversely affected, which could trigger a catastrophic chain reaction. To prevent panic, political leaders have put in place guarantees for bank deposits in response to the financial crisis.
Monetary policy blind
Central banks also may limit the distribution of credit by banks, forcing them to hold a certain amount of money in reserve minimum. As for the supply of cash, banks are obliged to take credit from the central bank. The central bank can determine the rate for this credit freely. If it increases the rate, banks generally pass this increase to their customers through higher lending rates. Higher rates generally reduces the demand for loans from companies and individuals, the lower increases. The central bank can use this mechanism to regulate to some extent the volumes of demand for credit and money creation.
In the 1960s and 1970s most central banks have the evolution of consumer prices in the center of their concerns, the money itself that was a secondary objective. And indeed: with the exception of 2008, inflation in consumer prices seemed well controlled. However, the money supply was growing rapidly.
A major reason for this stability in prices was the fact that countries like China and India were gradually to the market economy, and that cheap imports from these countries have limited the increase price and wage levels in industrialized countries.
Blind faith in market efficiency
In addition, some of the money has not been taken for the acquisition of consumer goods such as cars and machinery, but rather to invest in the markets. This has pushed up prices of almost all financial markets, beginning with real estate, stocks, raw materials to complex bonds.
But price inflation in these markets, financed by money creation, not much interested central banks. Because according to current doctrine, the efficiency of markets, buyers, sellers and banks who finance all know better the value of a house or an action that a bureaucrat in a central bank distant.
This confidence in the rationality of economic agents and the efficiency of markets has clearly underestimated the dynamics of speculative processes: application, funded by appropriation, property and existing titles, pushed their prices. This attracts more buyers, who are motivated by speculative gains. At the same time banks can grant more loans, and so make extra profits quickly. For example, if house prices increase, the (new) owners have greater security to guarantee their loans. This price dynamics was reinforced by aggressive investors who used the leverage of credit to increase the profitability of their equity.
For this purpose, a hedge fund collection for example capital from investors. At first, he bought with the money titles. He then these securities are pledged to a bank to take out a loan, which he uses to buy other securities. There again are pledged these securities to take other credits. Some funds have thus taken 30 million credit to equity of only 1 million.
As the loans were secured by mortgage, banks thought they were safe. Central banks, in turn, left them a long time to act, because they were focused on consumer prices, which remained low and trusted otherwise efficient markets. And the market prices rose until, in 2007, the bubble began to burst, with the subprime market in the United States.
The threat of massive destruction of money
Since that time there has been a downward dynamics. Due to the lower prices, many investors want to sell, which reinforces the downward pressure of prices. Values, inflated before the demand was made possible by the creation of money, suddenly collapsed, and the destruction of value turns into destruction of money.
Some debtors are no longer able to fulfill their credit, causing losses for banks and reducing their equity base. As a result, banks continue to extend loans to speculators, which generates forced sales and drove prices. Lack of capital and other means of refinancing, banks are also limiting the financing of productive investments.
Meanwhile, the downward spiral pulls the global economy as a whole down. To contrebraquer, governments and central banks have implemented massive bailouts. But like so many credits were granted and as currency created in recent years, deposited in bank accounts for the majority of these astronomical amounts are necessary to preserve the financial system.
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