When Countries Go Bankrupt

submitted by jwithrow.bankrupt

Journal of a Wayward Philosopher
When Countries Go Bankrupt

June 30, 2015
Hot Springs, VA

The S&P closed out Monday at $2,058. Gold closed at $1,179 per ounce. Oil checked out at $58 per barrel, and the 10-year Treasury rate closed at 2.33%. Bitcoin is trading up around $262 per BTC as the Greek crisis continues to play out.

Dear Journal,

I have been musing on the modern credit system in my last few journal entries and, ‘lo and behold, Greece has presented us with a real-time example of what happens when the credit expansion hits the wall.

Panos Kammenos, head of the government’s coalition ally in Greece, appeared on local television this past Saturday. “Citizens should not be scared, there is no blackmail,”  Kammenos assured the Greek people. “The banks won’t shut, the ATMs will (have cash). All this is exaggeration.”

The very next day Prime Minister Alexis Tsipras announced that banks in Greece would not open on Monday. “In the coming days, what’s needed is patience and composure,”  Tsipras proclaimed. “The bank deposits of the Greek people are fully secure.”

Here are the details of the Greek government’s capital controls:

  • From Monday, June 29, 2015, banks will remain closed up to and including Monday, July 6
  • Deposits are fully safeguarded
  • The payment of pensions is exempted from the restrictions on banking transactions.
  • Management of credit institutions will announce how these will be paid
  • Electronic transactions within the country won’t be affected. All transactions with credit or debit cards and other electronic forms (web banking, phone banking) can be conducted as normal
  • Prepaid cards may be used to the limit existing before the beginning of the bank holiday
  • From midday June 29, ATMs will operate with a daily cash withdrawal limit of 60 euros per card, which is equivalent to 1,800 euros a month
  • Foreign tourists can make cash withdrawals from ATMs with their cards without restrictions provided these have been issued abroad
  • A special Committee to Approve Bank Transactions has been established at the State General Accounting Office in cooperation with the Finance Ministry, the Bank of Greece, the Union of Greek Banks and the Capital Markets Commission. This committee will deal with applications for urgent and imperative payments that can’t be satisfied through the cash withdrawal limits or by electronic transactions (e.g. payments abroad for health reasons). Wages paid electronically to bank accounts aren’t affected.

Continue reading “When Countries Go Bankrupt”

Markets Restrain Bank Fraud; Central Banks Enable It

by Frank Shostak – Mises Daily:Bank

Originally, paper money was not regarded as money but merely as a representation of a commodity (namely, gold). Various paper certificates represented claims on gold stored with the banks. Holders of paper certificates could convert them into gold whenever they deemed necessary. Because people found it more convenient to use paper certificates to exchange for goods and services, these certificates came to be regarded as money.

Paper certificates that are accepted as the medium of exchange open the scope for fraudulent practices. Banks could now be tempted to boost their profits by lending certificates that were not covered by gold. In a free-market economy, a bank that overissues paper certificates will quickly find out that the exchange value of its certificates in terms of goods and services will fall. To protect their purchasing power, holders of the over-issued certificates naturally attempt to convert them back to gold. If all of them were to demand gold back at the same time, this would bankrupt the bank. In a free market then, the threat of bankruptcy would restrain banks from issuing paper certificates unbacked by gold. Mises wrote on this in Human Action,

People often refer to the dictum of an anonymous American quoted by Tooke: “Free trade in banking is free trade in swindling.” However, freedom in the issuance of banknotes would have narrowed down the use of banknotes considerably if it had not entirely suppressed it. It was this idea which Cernuschi advanced in the hearings of the French Banking Inquiry on October 24, 1865: “I believe that what is called freedom of banking would result in a total suppression of banknotes in France. I want to give everybody the right to issue banknotes so that nobody should take any banknotes any longer.”

This means that in a free-market economy, paper money cannot assume a “life of its own” and become independent of commodity money.

The government can, however, bypass the free-market discipline. It can issue a decree that makes it legal (or effectively legal) for the over-issued bank not to redeem paper certificates into gold. Once banks are not obliged to redeem paper certificates into gold, opportunities for large profits are created that set incentives to pursue an unrestrained expansion of the supply of paper certificates. The uncurbed expansion of paper certificates raises the likelihood of setting off a galloping rise in the prices of goods and services that can lead to the breakdown of the market economy.

Central Banks Protect Private Banks from the Market

To prevent such a breakdown, the supply of the paper money must be managed. The main purpose of managing the supply is to prevent various competing banks from over-issuing paper certificates and from bankrupting each other. This can be achieved by establishing a monopoly bank, i.e., a central bank-that manages the expansion of paper money.

To assert its authority, the central bank introduces its paper certificates, which replace the certificates of various banks. (The central bank’s money purchasing power is established on account of the fact that various paper certificates, which carry purchasing power, are exchanged for the central bank money at a fixed rate. In short, the central bank paper certificates are fully backed by banks’ certificates, which have a historical link to gold.)

The central bank paper money, which is declared as the legal tender, also serves as a reserve asset for banks. This enables the central bank to set a limit on the credit expansion by the banking system. Note that through ongoing monetary management, i.e., monetary pumping, the central bank makes sure that all the banks can engage jointly in the expansion of credit out of “thin air” via the practice of fractional reserve banking. The joint expansion in turn guarantees that checks presented for redemption by banks to each other are netted out, because the redemption of each will cancel the other redemption out. In short, by means of monetary injections, the central bank makes sure that the banking system is “liquid enough” so that banks will not bankrupt each other.

Central Banks Take Over Where Inflationist Private Banks Left Off

It would appear that the central bank can manage and stabilize the monetary system. The truth, however, is the exact opposite. To manage the system, the central bank must constantly create money “out of thin air” to prevent banks from bankrupting each other. This leads to persistent declines in money’s purchasing power, which destabilizes the entire monetary system.

Observe that while, in the free market, people will not accept a commodity as money if its purchasing power is subject to a persistent decline. In the present environment, however, central authorities make it impractical to use any currency other than dollars even if suffering from a steady decline in its purchasing power.

In this environment, the central bank can keep the present paper standard going as long as the pool of real wealth is still expanding. Once the pool begins to stagnate — or, worse, shrinks — then no monetary pumping will be able to prevent the plunge of the system. A better solution is of course to have a true free market and allow commodity money to assert its monetary role.

The Boom-Bust Connection

As opposed to the present monetary system in the framework of a commodity-money standard, money cannot disappear and set in motion the menace of the boom-bust cycles. In fractional reserve banking, when money is repaid and the bank doesn’t renew the loan, money evaporates (leading to a bust). Because the loan has originated out of nothing, it obviously couldn’t have had an owner. In a free market, in contrast, when true commodity money is repaid, it is passed back to the original lender; the money stock stays intact.

Article originally posted at Mises.org.