Positively Outrageous

Let’s rewind a second to investigate how most of our money in the UK is currently created. In the last post we have touched on how the government/central bank can literally ‘print’ it out of thin air but you may not be aware that your privately owned High St bank also can do the same.  I am not going to bore you with all the technical nuances of fractional reserve banking and its modern variants here but just highlight one point to indicate how totally asymmetric the financial world has become.

If you want to lend some money to a friend you must first have it in your account whereas a bank does not.

“Banks extend credit by creating money” – Paul Tucker, Deputy Governor of the Bank of England

If you go into a bank and obtain a loan this is often brand new money (that did not exist before) created as debt with the borrower (you) promising to repay it in the future with the proceeds of your labour. The offer of the loan is based as much on the bank being convinced you can repay it as anything else. So the request for money triggers the money creation. It is made up of the principal (the original loan amount) and interest (what you pay on top for the privilege of borrowing it). Banks get to type into the system new money and charge you interest on it.

“The process by which banks create money is so simple that the mind is repelled” – John Kenneth Galbraith

I know this is hard to believe but abracadabra is alive and kicking. Hang on, you might be asking, where is the down side? Who wouldn’t want a business where you can make interest on money you didn’t have in the first place? George W Ball certainly liked the sound of it when in the 1960’s he left public office to join a Wall St bank, proclaiming: “Why didn’t someone tell me about banking before?”

There are of course limits on the total amount that can be lent out but these boundaries can be both circumnavigated and woefully inadequate – and guess who gets to pay when it all goes wrong. Yep – the taxpayer i.e. you.

If you are thinking this is all a bit of a scam you are not the alone…

 

“Gentlemen! I too have been a close observer of the doings of the Bank…you have used the funds of the bank to speculate … When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You are a den of vipers and thieves. I have determined to rout you out.

–          Andrew Jackson, 7th President of the United States

That quote was from 1832 (yes, over 180 years ago) about the people running the equivalent of the US Central Bank at that time! So being screwed by the banking system is pretty much standard practice and has been going on for centuries. It’s just at some points it gets to ridiculous levels and that’s where we are again now – and greed has consequences for all of us. In addition, one can see in the UK, but even more acutely over the pond, that the rule of law is no longer being applied. For example, ‘whoddathunk’ economics was the basis for law? Here is the US Attorney General, Eric Holder, stating that banks cannot be held accountable because it might upset the economy.

 

No-one is being prosecuted. One argument that is often dragged out is that it’s hard to pin a decision on a committee. Well that may be true, but if 12 people go out into the street and all stab the same individual I can’t imagine their defence being watertight if the only argument is “it’s not our fault – it was a joint decision”.

All these claims are of course absolute bunkum but that’s what happens when finance takes over politics. I’m an atheist but those of a more religious bent may wish to note that the only time Jesus resorted to violence was when he was chasing the moneylenders out of the temple.

So what can you do? Revolution apart, you can either join them or alternatively stop feeding the system quite as much and that brings us back to some practical basics which you should embrace regardless of how one-sided/corrupt the system is or isn’t . Most of the money banks make is from charging fees and interest.

Sometimes you can’t avoid paying it, but other times it is a free choice. Well when I say free I of course mean the opposite:

‘Slavery is being forced to work without getting paid, and thus the hours you work to make interest payments on consumer debt is a form of slavery — the pay you get gives you no significant benefit’

– Anon

 

To really explain what is happening to your money I need some help from the exponential function and my ‘favourite’ business exponents: payday loan companies.

We will come onto some more of your mental foibles in the last post of this series but let’s start with the exponential function. This is simply a graph which looks like a hockey stick. It doesn’t do much for a long time and then everything happens at once as it shoots vertically upwards. Think about holding two magnets, one in each hand, with your arms outstretched to your sides. Slowly bring them together. Your task is to maintain a constant speed. Except it’s impossible because at the end they slam together regardless of how hard you try. We especially struggle to understand rapid acceleration after a benign period of stability.

“The greatest shortcoming of the human race is its inability to understand the exponential function”

–          Albert A Bartlett

Let’s take some interest rates on borrowed money and see what happens over a period of time. Pretend I am ‘generous’ and lent you £10,000 at the age of 16 and you have to pay it back when you retire at say 65. That’s 49 years of compound interest. Now depending on whether you come to see me on a Monday, Tuesday or Wednesday depends on what interest rates I charge you.

Mondays: 10% (comparable to say what a business loan would be charged at)

Tuesdays: 30% (comparable to what a credit card company would charge)

Wednesdays: 365%* (comparable to what a payday loan company would charge)

*The actual rate quoted by Wonga for example is over 4000% per annum but this includes compounding within a year and therefore the 365% (or 1% per day) is a more realistic figure – and that’s if they were allowed to lend money over the whole year.

Now all you have to do is guess how much you would need to repay me in each scenario when you retire. Go on have a go before you read on.

So if I were charging you 10% I would be asking you to repay about £1 million. Ouch! But of course it gets worse when you are repaying at 30%. Here you would owe me over £3 billion! That’s not Ouch! That’s financial torture. However to really understand true pain go for the payday loan %. Here you would owe me approx £800,000,000,000,000,000,000,000,000. That’s 8 followed by 26 zero’s. To put this in perspective – if you were to put £5 notes on top of one another, you would create a stack that was the same size as the measurable universe – just in your working lifetime… and that’s without any penalty charges. Are you sure you want to sign up for that?

Now back in Roman times, interest charges were sometimes limited to 8% and then 12%. In Canada it’s currently 60% and in the UK as 2 unlimited once pointed out

“There’s no limit”. Cue rendition of Rule Britannia.

So I want to leave you with one last thought. If in the end you don’t remember hardly anything about these posts that’s fine but please commit the following image to your memory banks. Whenever you are dealing with the financial industry – this is how they see you…

Pinso kermit finance

Image taken from PK’s presentation: ‘How to eliminate your student debt by doing nothing’

Whether you adopt the position or not is sometimes your choice.

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