Money Is Now a Total Fiction

Central Banks Gone Wild

By Jeffrey Snider

For the most part the general public has distinct and sometimes divergent views on the Federal Reserve and the European Central Bank (ECB). Obviously, there are political and institutional differences that present both with unique challenges, meaning that what constraints apply to the Fed do not always apply to the ECB and vice versa. It certainly seems that way on the surface when the ECB pledges to buy an unlimited amount of troubled sovereign bonds to keep those nations from plunging into the Greek abyss, while at nearly the exact same moment the US central bank pledges to buy an unlimited amount of erstwhile untroubled mortgage products to theoretically create jobs.

Despite the operational idiosyncrasies of each central bank, they are entangled by something far more pivotal: operative theory. What I mean by operative theory here goes deeper than just their now-constant appeal to debasement. For all intents and purposes, global central banks view "money" as nothing more than "charta", a Latin word for "token".

The word itself is more meaningful than just its Latin etymology. In the early part of the 20th century, there was a school of thought advocating a full fiat system where money was nothing more than a creature of government whim. Through the power of taxation a government can essentially create currency or money from anything it wished: if government accepts sea shells as payment for taxes, sea shells become fiat money. In theoretical terms, if the government tomorrow declared this to be the case, suddenly sea shells have been given "value" through the creation of coercive demand enforced at the point of the figurative government gun.

Earlier this week, Andrea Enria, Chairman of the European Union's banking regulator, the European Banking Authority (EBA), was quoted by Bloomberg congratulating the banking system's continued revival and renewal:

"We want banks to hold on to and keep building capital. The key positive in the response of banks to this exercise is that 75 percent of the shortfall was raised by retaining earnings and other measures -- fresh capital."

There is more than just a rhetorical sleight of hand going on here. That statement may seem uncontroversial on its face since it is technically accurate in the accounting sense, but semantically the word "capital", which is the central focus, has a broader meaning than the generic application used by Mr. Enria.

It is absolutely true that European banks have increased their capital levels by about €200 billion since the mid-2011 stress tests, and have done so largely through retained earnings and "fresh capital". But that connotes successful business practices being applied on a systemic scale, where banks throughout the European continent have been swiftly rewarded for their business and market acumen. Yet, we know that to be an outright falsehood given the constant state of market upheaval and near-permanent monetary interventions, so how do we square the technically true accounting statement with the obvious market rejection of large proportions of European banking?

Into that void delves charta. Fresh capital in the modern monetary sense is a unit on an accounting statement, devoid of any larger connotation. For investors and the process of investing, however, accounting should have meaning - where a business gets its money matters greatly in the process of investment analysis. Since banks are nothing more than businesses in the intermediation industry, we rightfully expect "capital" success to have such positive meaning.

Perhaps the best example of this divergence in meaning is seen in the oldest banking concern in the world. Banca Monte dei Paschi di Siena SpA was in existence before Christopher Columbus sailed backward for India. The bank is commonly described as having survived ages of social upheavals, wars and Acts of God, but it may not survive the age of central bank activism having received bailouts in both 2009 and 2012.

Monte Paschi has been losing money due to a distinct lack of business acumen - first in investing far outside its comfort zone while trying to become a multi-regional bank on par with UniCredit and Intesa (the two largest banks in Italy, and two banks that are also routinely cited as systemic problems). That meant an aggressive expansion through mergers and acquisitions where bank "capital" was deployed in the purchase of other banks and their intermediary artifacts. Efficiently deploying capital requires paying a "good" price for "good" assets.

The bank lost €4.7 billion in 2011, in large part due to writedowns on goodwill created by that unwise capital deployment. In 2007, for example, Monte Paschi bought Banca Antonveneta, another Italian concern that has been a dead weight, loss-producer nearly from the moment the deal closed. Because of the hefty premium the bank paid, creating the accounting ledger of goodwill, these writedowns of goodwill flowed onto the income statement as losses, thus effectively destroying that deployed "capital" or "money".

Destruction of capital has been acute at Monte Paschi in 2012, moreso than perhaps any other bank outside of Spain. When told by the EBA to raise "fresh capital" of at least €3.27 billion earlier this year, the bank found it had no access to it, and not for lack of trying. Apparently, market investors have determined that Monte Paschi is not a good intermediary of money and found it undeserving of fresh money injections that would satisfy the accounting notion of capital.

Without prospects for capital, Monte Paschi was "forced" into Tremonti bond sales with the Italian federal government. Facing a June 30 deadline imposed by the EBA, the Italian government first capped its purchase of these bonds at €2 billion, but as with so many things about political interventions (money is meaningless, after all), by August 23, the total was increased to €3.4 billion. Tremonti bonds are a special class, amounting to a hybrid security that is both debt and equity, thus qualifying to be treated as "capital" for the accounting statements. These bonds require the bank to pay the Italian government somewhere above 8.5% interest in any profitable years. In any year where the bank loses "money" in the course of normal operation, the bonds convert into equity - at book value! In other words, the Italian government will be covering the bank's future losses on past lending at about five times the current market price of the company's stock.

But unbridled expansion ambitions have not been the only source of negative capital for Monte Paschi. According to the Washington Post, the bank's chief executive, Fabrizio Viola, said last month that, "The problem of Monte Paschi was the fact that over the last two years, they invested a lot, in my opinion too much, in the government portfolio," before adding, "It was not a prudent decision." While this speaks to the lack of business acumen in operating a business that is supposed to create positive capital, it also squares the charta circle.

The bank is being rescued by a government in which it loses "money" by investing in that same government. Worse, the "capital" provided by the government is essentially provided by "money" invested by the bank itself through all those bond purchases (by last estimate, Monte Paschi had about €25 billion in Italian sovereign bonds on its balance sheet). This is all well and good, fully satisfying the requirements of all the accounting and national banking regulations in existence. There is nothing illegal here, no statutory fraud nor impropriety. Charta really is the meaningless accumulation of units of account, regardless of source.

This theoretical application in the case of Monte Paschi is by no means unique. While these accounting details are not widespread, the charta infestation has become endemic on a systemic level. And while Monte Paschi exemplifies some of the "fresh capital" that Mr. Enria alluded to, those retained earnings are certainly more problematic. For the most part, capital obtained by retained earnings has been built on the back of ultra-low interest rates created by the ECB's monetary injections. A good portion of European banks, particularly the larger "core" banks, enjoy the privilege of near-zero (in the case of normal monetary operations), low-cost extended maturity (in the case of the LTRO's) and favorably priced (in the case of the SMP) "money" that was created by nothing more than the digital account expressions of expanding the ECB balance sheet.

Of course ultra-low interest rates are not unique to Europe as the United States has been under the thumb of ZIRP for nearly four years - with another three already planned and communicated. Ben Bernanke himself earlier this week addressed the rebuild of retained earnings in the United States through ZIRP. Perhaps far more explicit than the ECB, the Fed Chairman was essentially arguing that increasing the number of charta directly increases the number of employed Americans, therefore providing some purpose to the government monopoly of money.

The full context of that argument, however, argues that "money" is far more meaningful than just the government's imprimatur or eligibility for taxation extinguishment. In addressing ZIRP, Chairman Bernanke acknowledged the flipside of rebuilding the banking system's collective retained earnings:

"My colleagues and I know that people who rely on investments that pay a fixed interest rate, such as certificates of deposit, are receiving very low returns, a situation that has involved significant hardship for some.

However, I would encourage you to remember that the current low levels of interest rates, while in the first instance a reflection of the Federal Reserve's monetary policy, are in a larger sense the result of the recent financial crisis, the worst shock to this nation's financial system since the 1930s. Interest rates are low throughout the developed world, except in countries experiencing fiscal crises, as central banks and other policymakers try to cope with continuing financial strains and weak economic conditions.

A second observation is that savers often wear many economic hats. Many savers are also homeowners; indeed, a family's home may be its most important financial asset. Many savers are working, or would like to be. Some savers own businesses, and--through pension funds and 401(k) accounts--they often own stocks and other assets. The crisis and recession have led to very low interest rates, it is true, but these events have also destroyed jobs, hamstrung economic growth, and led to sharp declines in the values of many homes and businesses. What can be done to address all of these concerns simultaneously? The best and most comprehensive solution is to find ways to a stronger economy. Only a strong economy can create higher asset values and sustainably good returns for savers."

Forget that second paragraph where the Chairman essentially blames George Bush (or at least that he believes the stain of 2008 continues to haunt the real economy four years later) and then commits the logical fallacy of "everybody else is doing it". What is the meat of his argument is the third paragraph, that low interest rates are the only way to achieve a "stronger economy", and by extension, the only way for interest rates, and thus the returns on money and real savings, to eventually rise again. Because ZIRP is only achieved through increasing the number of monetary units, connecting the logical dots here, the only way to get a strong economy and "normal" returns on savings capital is through charta ideology. Savers of real capital have no choice but to suffer in the backdoor socializing of bank losses in order for the economy to recover - though the suffering is real to date, the recover part is conspicuously absent.

This philosophy thoroughly upends capitalism. The entire premise of capitalism is the efficient deployment of capital; capital having full meaning absent in the sense of modern money. Capitalists create capital through successful deployment of "money", turning that "money" into true wealth of productive enterprise. That successful deployment of money creates additional capital that can be "monetized" in asset markets, but the number of new monetary units has no basis in trying to predict or determine successful business acumen. That is the traditional role of intermediation.

Chartalism in this form is nothing more than a theory that capital can easily be replaced by mere monetary units, as if there is no information content relevant to economic efficiency stored in the flow of capitalized money. Past success in the form of stored "earnings" or "money" is, following this line of inquiry, eminently replaceable by determined government planning. In that way, money is now flowed or channeled on the basis of poor past performance rather than on the basis of good expected future performance.

In the past four years, central banks have attempted to resurrect economic health by adding new charta to the system with perfect exclusivity biased to institutions and businesses that have destroyed their past stores of capital, despite the very visible fact that said destruction of capital is the quintessential measure of real economy inefficiency. If the destruction of money has meaning, then so does the creation of money, or at least the methodology of determining how money is acquired. Bernanke's theory, shared by all the major central banks on this globe, is that economies can only recover when capital is disadvantaged in favor of meaningless money. This is not just the theory he espouses in public speeches, it is the operative theory put in practice by central banks in every major economy.

The primacy of meaningless money is such that the entire system of savers, the majority of which have created actual capital and acquired value, need to be hamstrung by ZIRP in favor of institutions that destroyed real capital in the inefficient pursuit of the very policies that central banks directed in the first place. Success is to be shunned and disfavored in the socialized and institutionalized process of debt creation from the very firms that have proven beyond a doubt that they are not capable of maintaining economic efficiency. The ascendancy of chartalism is the only manner in which such a backward system could actually exist.

Unfortunately, real economies run not on meaningless money, but on sustainable and efficient success. All of these banks and central banks need to emulate the ideals cleverly conjured and portrayed in the Smith Barney TV commercials of decades past, when firms used to "earn" their money. The capital on a bank's balance sheet at one time (before fiat money and transcontinental wholesale money markets) denoted success at intermediating the pool of savings, turning past success into additional future success in a virtuous circle that is the hallmark of every thriving economy in history. In short, money is supposed to be about winners and losers. Economies need to reward the virtue of economic winners and delete the societal and systemic cost of the losers. Without monetary meaning, there is no sorting process of winners and losers; there are only losers that are supposed to take comfort in the vacuous experimentations of academic central bankers that passes for progress and evolution.

More than anything, human nature needs value and meaning in money. Maybe central bankers should try their hands at investing without any meaning to money and capital - it doesn't work. Try as they might, particularly with reducing economic agents to mathematical equations and models, modern mainstream economics has tried to dehumanize the economic and financial system. It certainly makes economics appear more scientific, but ultimately that is just the cloak of self-delusion - models are not science.

Perhaps central banks have re-invented an achievable means to a healthy economy with meaningless, inhuman tokens, but the results of the past four years, particularly 2011 and so far in 2012, are rather conclusive and unambiguous doubts. It's easy to blame fiscal profligacy for all the current ills, but such bad habits were borne and nurtured by money without any real meaning in the first place - intermediation removed from its eponymous task. Chairman Bernanke, Andrea Enria and Mario Draghi would be hard pressed to know the difference, however, since their accounting arrangements of all the new tokens make it difficult to discern anything economically meaningful at all. The word debasement itself is not just a semantic accident; it literally means to reduce status or esteem - very human concepts. Welcome to the world where capital, in a still nominally capitalist system, is as pliable and fictionable as TV advertising.