Thursday, August 17, 2017

Our modern statist rulers insidiously debase our currencies with their decreed zero-risk weighting of sovereigns

Lawrence W. Reed in “Did You Know about the Great Hyperinflation of the 17th Century?” FEE August 2017, quotes Nicolaus Copernicus (1473–1543) with: “The greatest and most forbidding mistake has to be when a ruler tries to make a profit from the minting of coins by introducing and circulating new coins with an inferior weight and fineness, alongside the originals, and claims that they are of equal value”

And Reed notes: “Desperate to raise cash and secure material for war, many of the German states in 1618 resorted to the debasement of coinage. They clipped and they melted. At first, they adulterated their own coin but then discovered that they could do the same to that of their neighbors too.”

Our modern governments use much more refined and insidious debasement methods. In order they say to make our banks safe, regulators came up with the risk weighted capital requirements which assigned to the sovereign a risk weight of 0%... yes, you read it well, zero percent.

That means that banks are able to leverage any little net margin obtained on public debt, into great returns on equity. That means that banks will be offering to hold a lot of public debt at low rates which will help to confound all the rest of investors into believing the markets believe that debt to be intrinsically safe.

That also means banks are going to absorb much more of the governments injections of liquidity than would otherwise have been the case.

One day buyers of public debts of these by regulators decreed ultra-safe sovereigns, are going to wake up.

When that happens all bets are off. Interest rates on public debt will shoot up, repaying governments will inject liquidity that will be impossible to drain… and economic realities will be hyper-inflation/hyper-recession messy.

When will that happen? Who knows, in Europe governments have already recruited insurance companies to also operate under a scheme similar to the banks’ Basel I, II and III, and which has quite cynically been named Solvency II.

Why is this all unsustainable? Any system, in which government bureaucrats can, without being responsible for its repayment, have easier access to other peoples’ money than for instance the 100% risk weighted SMEs and entrepreneurs, simply cannot end well.

PS. I often hear the argument that if sovereigns borrow in their own currency they represent indeed a zero risk because they will always be able to repay. Wow they’ve got to be kidding! True repayment does only happens when done with purchase power that has not been diluted by inflation.