Richard Werner - Hugh Hendry

More Power To The Princes | Professor Richard Werner on The Interview with Hugh Hendry

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Key Takeaways

  • Despite what people think, banks aren’t neutral financial intermediaries
    • Bank lending is responsible for 97% of money creation in the economy
  • Left unchecked, a central bank will seek to maximize its power through boom and bust cycles
  • For sustainable economic growth, money creation has to support business investments
    • Asset purchases should only be funded with existing money
  • Because capital no longer flows internationally, domestic money creation doesn’t affect international exchange rates
  • Quantitative Easing (QE) is being used to support big corporations, at the expense of everyone else
    • In effect, COVID is being used as a cover for redistribution and concentration of wealth
  • “This digital central bank currency is nothing but a current account at the central bank” – Richard Werner
    • It removes the need for retail banks and centralizes power in the hands of the central bank
  • Bubbles are a game of musical chairs, money creation is the music, you stop the music and the bubble collapses

Intro

Banks Create Money

  • Bank lending is responsible for 97% of money creation in the economy
    • Despite what people think, banks aren’t neutral financial intermediaries
    • That said, economic textbooks don’t recognize ba­nk credit creation, and instead focuses mostly on central bank interest rates
  • Central banks represent a small factor in money creation
    • They implement policies to inflate asset prices and start a process that ends in bubbles and busts

Regulatory Moral Hazard of Central Banks

  • The successful Bundesbank was preceded by The Reichsbank, arguably the worst central bank in history
    • Created in 1876, The Reichsbank immediately created an asset bubble, financial crisis, Weimar hyperinflation and implemented policies that got Hitler into power
  • The structure of the central bank influences its actions
    • Unlike the Bundesbank, the Reichsbank was independent from the government and the parliament, and wasn’t held accountable for its actions
  • The ECB was sold to be similar to the Bundesbank, a conservative central bank with no inflation
    • In truth, “The ECB is the revived Reichsbank, independent from government, independent from any parliament or democratic assembly in Europe, not accountable to anyone, it’s a supernational organization just like the Reichsbank was” – Richard  Werner
      • “Power corrupts and absolute power corrupts absolutely”

Case Study: The 1986 Japanese Bubble

  • Japan was successful in the overseas exporting market and stressed the American economy, and this eventually became a political problem
    • The proposed solution was to introduce economic reform in Japan and push for deregulation, privatization, more imports, and consumption
      • The proposal suggested “flexible use of monetary policy”
  • Central Bank of Japan (BOJ) saw the reforms as an opportunity to gain more independence – here is how:
    • Under Window Guidance from BOJ, banks issued massive credit and pushed asset prices up forming a bubble
    • Bubbles are a game of musical chairs, money creation is the music, you stop the music and the bubble collapses
      • Left alone, the bubble collapses to create a credit crunch; banks tighten more which leads to more bankruptcies and asset prices collapsing in a downward reverse spiral
        • The cost was the Lost Decade, which was attributed to the Ministry of Finance and BOJ was granted independence
        • “This is the Bank of Japan taking out the ministry of finance” – Hugh Hendry

Sustainable Economic Growth

  • Money creation has to support business investment, not asset purchases
    • Businesses generate sustainable returns that service and repay credit
  • Credit supply creates its own demand, people will always take money if offered
    • One possible solution is to pass a rule, “Bank credit creation can only be used if it contributes to GDP, and that means it mustn’t be used to purchase assets”
  • Asset purchases (e.g. mortgages) should be funded only with existing money
    • This can be done by setting up non-bank financial institutions that don’t have the power to create credit

Money Creation and Currency Exchange Rates

  • While money creation should affect currency exchange rates, domestic credit creation doesn’t, here is why:
    • The money is created by a central bank in its domestic currency and it stays in the country
      • Capital used to flow between countries under the gold standard, this is no longer the case, capital doesn’t flow anymore
    • Similarly, loan money stays abroad when the International Monetary Fund (IMF) lends to developing countries
  • To make matters worse, the domestic rise of asset prices attracts overseas speculators, who don’t care about sustainability

Economic Policies of COVID-19 Crisis

  • The Fed has freshly issued trillions of dollars reaching 5x the size of previous interventions
    • Additionally, there is no transparency around where the money goes
  • QE is being used to support big corporations, at the expense of everyone else
    • In effect, COVID is being used as a cover for redistribution and concentration of wealth
  • There will be a reckoning and the way out is ensuring bank credit is used only for productive purposes

Maximizing Central Bank Powers

  • Boom and bust cycles maximize central bank powers
    • Since the ECB was founded, bank credit growth has gone up by 20-40% all over Europe
      • The money was not going to GDP, but to asset and property bubbles
    • The result was a recession with 50% youth unemployment in countries like Greece and Spain
  • Federal reserve is going to follow in the footsteps of Bank of Japan
    • Namely, “intentionally create a massive asset market bubble driven by bank credit creation which is going to create when it blows the biggest financial crisis, a global financial crisis” – Richard Werner
      • This was evident in 2008

Digital Currency and Central Banks

  • Normally, banks create credit and handle retail business, whereas central banks control policies but they stay out of retail businesses
    • This is going to change with digital currency, which enables anyone to have a current account with the central bank
      • “This digital central bank currency is nothing but a current account at the central bank” – Richard Werner
    • In essence, the regulator competes with the regulated
      • “The ECB is already so powerful but they are going for the last power grab, they want to be the only bank around by bankrupting the rest of the banking system” – Richard Werner
  • A healthy economy has a multi-faceted banking system with decentralized analysis of people on the ground
    • However, the US barely has 5,000 banks today, compared to 30,000 before the great depression
      • This number is continually going down as a result of lower interest rates and flat and negative yield curves

Additional Notes

  • QE originally referred to credit creation for GDP transactions
  • The housing market has gone multiple times the GDP of the country because of leverage; therefore a contraction in asset prices can wipe out a significant part of the economy
    • The game can only keep going as long as credit creation continues
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Notes By Mostafa Khaled

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