How Banks Work

I do not think that most people really understand how banks work. That includes me.

Oh sure, we understand that when we make a deposit our money is now in the bank. But what we do not understand, I mean really understand, is that it is no longer our money. We have exchanged the money for electronic promises to pay. If things go badly for the bank, we as depositors are creditors of the bank. We stand in line with all the other creditors. In fact we stand behind most of the creditors.

We feel safe because the FDIC, the Federal Depository Insurance Corporation, promises that if things get dicey at our bank the reserves of the FDIC will bail the depositor out up to $250,000. But the reserves of the FDIC are 1.35% of the insured amount. In normal times this is adequate. Not every bank will go broke at once. I am sure that whatever money that is needed to insure the deposits will be provided, even if this means printing it.

At least I used to think that.

ATMs still work, for now. The crisis in Cyprus did not work out that way. The government of Cyprus does not have the money to guarantee €100,000 per account. Thus the country’s banks must be bailed out by an outside force, but there are strings. Each depositor will lose about 6% of "their" money, any money over €100,000 at the bank will lose 10%. (My guess is that these numbers might change.)  There is a technical name for this. It is called a whoopsie.

Although all sorts of hyperbolic analogies are being drawn to the US, this really does apply. The US will print whatever money it needs to insure the banks do not fold. I used to be 100% sure of this, now I am only 97% sure.

Banker Tweetie says, "I've Been Sick."No, the Cyprus situation is not the dead canary in the mine I talked about in a previous blog post—unless you are a depositor in a Cypriot bank. But I do picture Tweety Bird saying, "I've been sick."

The risk to the banking system is why on a recent post on pre-investments I suggested that one put some money in the bank, and have some at home. While there could be a riot from a bank closure that also burned down your home, this is not likely—you can't hedge everything.

Remember that once the money is in the bank, it is now the bank's money.  I doubt that things will get bad enough that this money would ever be lost, but it might be delayed in returning to you in a crisis. If things get that bad, the money won't buy anything anyway—you can't hedge everything.

Do not be surprised like this one depositor at a Cypriot Bank was.

Do we really understand how banking works? In our head we do. But in our hearts we do not. Reviewing how Fractional Reserve Banking works might be a helpful reminder.

The Man

I liked this mini-drama a lot. As is typical in such productions, the writing and acting are first-rate. I almost included the tag humor as it is a good example of typical wry British humor. 

John Mauldin is Guardedly Optimistic

John Mauldin Is Guardedly Optimistic. Mauldin tries to justify this by quoting Lenin, who said:

 "There are decades where nothing happens, and there are weeks when decades occur."

We are in such a period. But Mauldin thinks it is a transition into something better.  "If something cannot be sustained, it will change," he said. Mauldin then quotes economist Laurence Kotlikoff who estimates that the US has 200 trillion in unfunded liabilities. (I have talked about this previously.) Mauldin comments, "We can't pay that amount. What happens when we realize this?" He thinks that when this becomes evident change will occur.  "Expenses cannot rise faster than income," he says.  He thinks that, "It is the end of the world, yet I am excited" because things will have to change for the better. 

2020 will be great, after the world economy goes through this transition period. What will be the characteristics of this transition? Here is what he thinks (note that what I put in quotes is not his exact words, but it is close. When I put something in parentheses, it is me speaking.):

Pension and health care are the reason for the troubles due to demographics. Sweden tied benefits to GDP, it is necessary, not heartless. (This means that a certain percentage of the economy is devoted to helping people. This is something I have long advocated.) Eventually everyone will do the same. (I hope he is right.) 

Peak oil is false; energy prices will go up, but no catastrophe. (I agree.) 

Japan is a bug in search of a windshield. (What a great line!) 

In Europe, France is the new Greece—then the US.

In China the demographics are awful—they have more people leaving the workforce than entering it. Japan and Europe have this problem as well. 

"Of course austerity does not work, that is why it is called austerity." (My question would be, "What choice did Greece have?")

"Government has made promises they cannot keep." 

Krugman is not an economist. (Ha.)

Adapt to change, not fight it. We don't have enough money to protect people from change.

Social Security is welfare.

Invest in things that central banks can't print—gold, technology, and corn, for example. 

Alas, his presentation was not well rehearsed for the time he was allotted, so the speech ended somewhat abruptly, but Mauldin does make you somewhat more hopeful. What he calls optimistic is what I have been calling guardedly pessimistic. No, I do not think the crisis I have been predicting to happen in 3 to 7 years is The Powers That Bethe Apocalypse, nor Ragnarök, but it will be very bad.  I am guardedly pessimistic because I do not think the "powers that be" will act against their own best interests. No, the "powers that be" do not meet in secret conclaves and decided the future. They each act in their own best interests, and since they all have the same interests it can appear there is collusion. (The TV drama, The Man, I will post tomorrow assumes that there is a conspiracy. It is a great "drama," but quite wrong-headed.)  

Here is Mauldin's presentation. 

What Do You do?

I am reminded of a story I read many years ago. A Chilean business owner had his business nationalized. They paid him a "fair" price. But he had no place to put the money, no credible investments. Because of capital controls, he could not put the money elsewhere. Added to this there was hyperinflation. He spent many of his evenings in a casino gambling. 

In a world where there are no investments that make sense, what do you do? 

MILAN (AP) -- Lamborghini says its worldwide deliveries of super sports cars rose 30 percent last year to 2,083 units but remained shy of pre-crisis highs.

The Italian carmaker owned by Volkswagen said Tuesday that deliveries were up by half in its top U.S. market and up by 34 percent in Europe despite the region's financial crisis.

Revenues for the year were up 46 percent to (EURO)469 million ($610 million).

The car company, based in Sant'Agata Bolognese, sold a record 2,430 cars in 2008 before the global economic crisis devastated the luxury market.

Last year's sales comprised 922 new Aventador LP 700-4 and 1,161 Gallardos.

Lamborghini previewed the one-off Lamborghini Veneno at the Geneva Motor Show last week to mark its 50th anniversary.

You do not need a Lamborghini to leave Babylon, in fact owning one will keep you in Babylon. 

Are Animals a Part of Sustainability?

In contrast to the sustainability lecture I posted last week, this speaker takes a different approach.  Joel Salatin is the owner of Polyface farm. Rather than shun animals as Bittman implied last week, all the while saying he was not saying that, Salatin incorporates them into his farm. Unfortunately this lecture does not allow us to see the slides.

I wonder how many of those that advocate sustainability actually know anything about farming? Salatin does. What he says, based on my ten years of ranching, make sense.

On a personal level, since I live on a rock, I need a greenhouse.

Salatin is an enjoyable speaker and well worth your time.