The Global Financial Crisis

Owen McCaffrey
27 October 2008



The causes
The causes of the current Global Financial Crisis seem perplexing when you watch the news, however the basic answer is deceptively simple. The situation is that governments all over the world have taken away most of the restrictions on banks so that they are able to create as much money as they want (or can). But how does a bank create money you may ask?

Well, it is simple really...

Banking Explained
Banks no longer deal in real paper money, or even gold, but in fact 99% of all money is in the form of electronic credits on a computer screen. When you borrow or deposit some money, the bank simply adds or subtracts some digits from your bank account. The bank need not touch anyone else's bank account to do this, which is important, because if more money is lent out than is deposited, then there will be more money in the economy. In fact, given this way of looking at it, banks do not need, nor do they actually want deposits at all, because they must pay out interest on these deposits whereas they receive interest income from the money they lend out. So a bank could conceivably have $100billion lent out and no deposits, in which case it might make $100million x 10% = $10billion profits every year. However banks must accept deposits and are required by governments to have a certain level of deposits so this never happens.

You may also ask however, that if everybody in the country wanted to withdraw their money in cash at the same time then the banking system might fail. You would be correct, however this never ever happens. So the mountain of credit money continues to grow, year after year. For example, in New Zealand, the money supply has grown by 7.5% every year since 1984.

The Current Crisis
How does this banking system relate to the current Global Financial Crisis? Well, imagine that banks got so excited about this opportunity to make new money (which they did), and started to produce more new loans in order to make more and more profits. Imagine that there was no limit to how much money they could 'make' and that they therefore started to lend out money to people who could probably never even pay it back. But it didn't matter to the bank because they could just create more money. Besides, if the loans did not get repaid the government would always help them right? Yes, that is exactly what happened. The US and world-wide banks lent out too much money to people who could never pay it back and instead of keeping those loans themselves, they packaged them up into bundles and sold them to pension and investment funds. Now it is not only banks, but also any investors who potentially hold these toxic investments that might be worth less than half what they paid for them.

So what is the problem right? I mean, investing is risky, and sometimes you win, sometimes you lose, right? Why not just let those who have made bad, stupid investments lose their money and we all keep going? Well that is the smart solution, well done! ...But the US and global governments have taken the opposite view, that these investments and banks are "Too Big to Fail", which basically means that although we should let them go bankrupt and their competitors take their place, the government wants to 'save' them because when they do fail everyone will suffer from the fallout. But how can the government save them? You might ask. Well, the same way that the banks got themselves into the schtik in the first place - by creating money. Yes, it is estimated that by the end of 2008 the US government will have injected $2trillion into the US economy in order to 'save' the ailing banksand financie companies using money that has been created out of thin air the same way that the banks made their money.

So what will be the result of this solution? inflation, inflation, and more inflation. With so much more money flowing around the economy but not much more goods and services, the prices of everything will rise to reflect, the increase in money that everyone now has. Is this (inflation) a good or bad thing? Well, you can consider inflation to be a tax, because it reduces the value of the money you have and gives some fresh money to someone else. Basically, the US and world governments are printing money and giving it to those people who made poor investing decisions and at the same time taking it away from the average person.

Conclusion
So in summary, the causes of the Global Financial Crisis was the creation of too much money and the solution has also been the creation of (what seems to be) too much money also. Whether this will work or not is uncertain at the moment but one thuig that is certain is that things are going to cost alot lot more very soon because there is so much more money floating around to buy the same goods and services.

The NZ Experience
It is also interesting to note the New Zealand governments respons when over 40 Finance companies have failed over the last 2 years...........NOTHING!! And I think that was the right response. If you invest poorly you should lose your money.

Neither should banks be able to freely create new money in our economy. This function should be given back to the government who could create money for their spending (just like banks do) instead of taxing you and me!