Michael Panzner relays the alarm

Michael Panzner's latest post discusses a warning from David M. Walker, the nation's chief accountant, about America's vulnerability to potentially unfriendly foreign creditors. This confirms me in my feeling that the recent purchases by the UK of US Treasury securities is extremely significant (see recent posts on Bearwatch).

I have attempted to elicit interest in various quarters, including Iain Dale's influential political blog ("Tuesday open thread", 24 July) but so far I seem to be speaking to the profoundly deaf. Today I submitted the following comment to Iain's Diary, but without much hope of a response - as I have said in an email to Michael Panzner today, the Brits add apathy to financial ignorance:

Okay, one last Cassandra-like call and then I'll admit defeat:

Does it really not matter to your sophisticated political readership that the UK (presumably the Treasury under Gordon Brown) has recently purchased an absolutely massive amount of American Treasury securities, most of it in the last nine months, which quite probably will lose us many billions of pounds through currency depreciation? We have gone in one wild leap from 10th largest holder of American debt, to third place.

The potential downside from this crazy investment (I think it has already lost the equivalent of the first year's interest) worry me less than the implication, which is that the US is using its "special relationship" with the UK to defer (for a short time) the end-stage of a US debt-fuelled global inflationary spiral, with the prospect of a deep economic depression and possibly a wealth-destroying hyperinflation. The problems this would give us make the current floods seem a minor inconvenience.

Or is it that everybody here knows already, and is merely filling the time in the rattling tumbrils with political chit-chat and mutual insult? Is it aristocratic insouciance, or financial ignorance? Surely not the latter, when Americans are discussing their economic problems so openly and extensively.

The rewards of "honest money" and interest-free lending

Some things are so simple that it takes a while to understand them. For me until now, one was the question of how anybody could lend money and not expect interest - for centuries, usury was forbidden under both Christian religious and civil law. In France, interest was illegal until after the Revolution in 1789 - see here.

And then the penny dropped, so to speak. If the supply of money is fixed, and the economy gradually becomes more larger and more efficient, then money gradually becomes more valuable, as The Mogambo Guru explains here. So if real GDP grows at the rate we seem to expect (on average, about 2% per year), then with a fixed money supply, a depositor would earn 2% in real terms, as would a lender. All you would need is adequate security for the return of capital.

Banks would have to cover their running expenses (I believe Swiss banks already do charge depositors for holding their cash really safely), but this would be need to be in the form of explicit costs, which might therefore be better restrained. Borrowers would have no reason to keep switching loans; in fact, the need to charge arrangement fees would act as an incentive to remain loyal to the existing creditor.

But it looks to me like it would mean the end of fractional reserve banking, inflation and periodic banking crises, not to mention the permanent and pervasive importance of money lenders.

Would that really be so bad? If so, then "if you can't beat 'em, join 'em" - would you and other like-minded readers care to join forces with me and start another bank? It seems to be the only game in town.

More on UK purchases of US Treasury securities

I have sent the following email to George Osborne, the shadow Chancellor:

"Please find attached a document from the US Treasury website, detailing major foreign holdings of US Treasury securities (web address top left of document). I emailed this document to the Daily Mail newsdesk yesterday, in the fervent hope that somebody might take an interest.

Between June 2006 and May 2007, the UK has leapt from being the 10th largest foreign holder of American debt to 3rd place (behind Japan and China, both of whom, although increasing in dollar terms, have actually reduced their overall share of foreign commitment to the US).

We have contributed an extra $112.1 billion, i.e. around 55% of the $205 billion total increase in investment by foreigners over that 12 month period. To put it another way, 10 countries have reduced their holdings in dollar terms, by a combined total of $72 billion; we have covered these withdrawals and added another $40 bn.

For comparison purposes, the UK's increase in US Treasury securities is equivalent to some 50% of the £104 billion budget for the NHS for next year (http://www.timesonline.co.uk/tol/comment/columnists/article2039584.ece)

The effect for the UK has been to more than triple its exposure to US Treasury instruments, at a time when the dollar is dropping - and some predict it will fall much further. The potential loss of our national wealth easily matches (and will quite possibly dwarf) that from the sale by Gordon Brown of much of our gold reserves some years ago."

News: huge investment by UK in US Treasury securities

Never mind the conspiracy theorists and the rumoured use of "Caribbean Banking centres" to buy US Treasury bonds; look at this document from the US Treasury, dated 17 July 2007. It shows that in the last 12 months, holdings by foreigners increased by 10.37%, but the UK's holdings shot up over 202% in the same period, from $55.5 billion to $167.6 billion. And the dollar has dropped against the pound at the same time. Can our little island afford such generosity?

Open secrets about banks, credit and inflation

There are things about money that are well-known to some, but not known and understood by all.

• In the USA (and the UK, I understand), notes and coins represent only 3% of all money; the rest is, in effect, various types of IOU.
• Most money is simply created out of nothing, by private banks, as bookkeeping entries.
• Banks lend out money, and also charge interest.
• Since the banks haven't created enough money to cover the interest, they demand it from the borrowers.
• If the total amount of money in the economy stays the same, and banks always charge enough interest to make a profit, then someday banks will own all the money in the world.
• So banks create and lend even more money. Some of this new money is to provide for the interest they have charged on earlier loans.
• Therefore, banks have caused inflation, and as long as they create new money, they will create more inflation.

This is so simple, but so hard to believe. It's like standing up from a game of Monopoly to find that you've been playing for real. And when you read others who explain the money system in these terms, you get the same emotional sequence:

1. amused, complacent toleration
2. a growing sense of unease
3. dawning, half-incredulous understanding
4. appalled outrage

So it is with one of the latest of these explainers, Ellen Hodgson Brown. But there is a world of difference between diagnosis and prescription. Here is hers, and halfway into here is a riposte from Richard Daughty, aka The Mogambo Guru.
Please note that Daughty is not contradicting the diagnosis, only the proposed solution. He is permanently at stage (4) in the above sequence.
Now, what do we do about it? Daughty's usual response "We're freakin' doomed!" reflects his pessimism about attempts to save the system as a whole, but is generally accompanied by recommendations for individual financial survival, namely, investment in commodities such as gold, silver and oil, merely to protect against end-stage inflation.

Michael Panzner on financial liquidity and asset prices

Writing in Seeking Alpha yesterday, Michael Panzner (author of Financial Armageddon - my review here) comments on an article by Yale economics professor Robert J Schiller, which discusses the notion and possible consequences of excess "liquidity" in the world economy. For Panzner's own website promoting his very bearish view on the American economy, see here.

Peter Schiff on US monetary policy

Peter Schiff's latest commentary (today in Forex Street) pours scorn on the Treasury Secretary's professed commitment to a strong dollar, and points out that Ben Bernanke's reasons for a stronger Chinese yuan (renminbi) also imply higher interest rates AND higher consumer prices in the US.

Schiff concludes with the same recommendations as in his book, Crash Proof (my review here): buy gold (he's selling Australian Perth Mint Certificates through a dedicated website) and selected foreign (i.e. non-US) equities.