Corporations Are Not Humans : Not Even Close ---Episode 37

                       THE GREAT MONEY MACHINE

   There are two common ways to create money without creating value.  One is by creating debt. Another is by bidding up asset values. The global financial system is adept at using both of these devices to create money delinked from the creation of value. 

                                                  DEBT

   The way in which the banking system creates money by pyramiding debt is familiar to anyone who has taken an elementary economics course. In the United States it begins when the Federal Reserve buys government bonds in the open market. Say the Fed buys a $1,000 bond from Person A, who deposits the check in his account with Bank M. The Federal Reserve then credits the reserve account of Bank M with $1,000 to cover the purchase. As Bank M is only required to maintain a reserve of, say, ten percent of deposits, it is thus able to loan $900 against this reserve to Person B, which Person B deposits in her account in Bank N. Now Person A has a cash asset of $1,000 in Bank M, and Person B has a cash asset of $900 in Bank N. Keeping a ten percent reserve, Bank N is able to loan $810 to Person C, who deposits it in Bank O, which then loans $729 to Person D, and so on. The original purchase of $1,000 bond by the Fed ultimately allows the banking system to generate $9,000 in new deposits by issuing $9,000 in new loans ---money created without a single thing of value having necessarily been produced. 
   The total of $1,000 in new money interjected into the banking system by the Federal Reserve is thus pyramided into $10,000 in new money, of which $9,000 is in loans on which the banks involved expect to receive the going rate of interest, let us say 8 percent. This means that the banking system expects to obtain a minimum annual interest return of $720 on $9,000 that has been created simply by entering an amount in the account of a borrower and crediting themselves with a corresponding asset in the amount of the outstanding loan. Now you know why banking is such a good business.
   In this instance, we have used the classic textbook example of how banks create money, assuming an average 10 percent reserve requirement---the actual varies from zero to 14 percent depending on the size of the bank and the nature of the account ---that must be retained on deposit with the U.S. Federal Reserve system. Without such a reserve requirement, the banking system could, in theory, create money without limit. 
   As the United States has spent beyond its means abroad, a growing portion of the total supply of dollars circulating in the world has accumulated in the accounts of foreign banks or foreign branches of U.S. banks. Known as Eurodollars, they are not subject to the reserve requirement of the U.S. Federal Reserve. If banks hold accounts where governments do not impose a reserve requirement, these banks can loan out the full amount of these deposits, should they choose to do so, giving the global banking system the capacity to endlessly expand the supply of dollars.

                                         ASSET VALUES

   The price of a stock or of a tangible asset such as land or a piece of art is determined by the market's demand for it. In an economy awash with money and investors looking for quick returns, that demand is substantially influenced by speculators' expectations that other spectators will continue to push up the price. Nicholas F. Brady, who served as U.S. treasury secretary under President George Bush, observed, "If the assets were gold or oil, this phenomenon would be called inflation. In stocks, it is called wealth creation." The process tends to feed on itself. As the price of an asset rises, more speculators are drawn to the action and the price continues to increase, attracting still more speculators ---until the bubble bursts as when the crash of the overinflated Mexican stock market caused the 1995 peso crisis. 
   
   Vast changes in the buying power of people who own such assets can occur within a very short time, with no change whatever in the underlying value of the asset or in society's ability to produce real goods and services. We are so conditioned to the idea that changes in buying power are related to changes in real wealth that it is easy to overlook the fact that this relationship is often simply an illusion. Consider the following excerpt from Joel Kurtzman's book The Death of Money, describing what happened on October 19, 1987, when the New York Stock Exchange's Dow Jones Industrial Average fell by 22.6 percent in one day : 

   If measured from the height of the bull market in August 1987, investors lost a little over $1 trillion on the New York Stock Exchange in a little more than two months. That loss was equal to an eighth of the value of everything that is manmade in the United States, including all homes, factories, office buildings, roads, and improved real estate. It is a loss of such enormous magnitude that it boggles the mind. One trillion dollars could feed the entire world for two years, raise the Third World from abject poverty to the middle class. It could purchase one thousand nuclear aircraft carriers.

Those who invested in the stock market did indeed lose individual buying power. Yet the homes, factories, office buildings, roads, and improved real estate to which Kurtzman refers did not change in any way. In fact, this $1 trillion could not have fed the world for even five minutes for the simple reason that people can't eat money.  They eat food,and the collapse of the stock market values did not itself increase or decrease the world's actual supply of food by so much as a single grain of rice. Only prices at which shares in particular companies could be bought and sold changed. There was no change in the productive capacity of any of those companies or even in the cash available in their own bank accounts.
   Furthermore, although stock values represent potential purchasing power for individual investors, they do not accurately reflect the aggregate buying power of all investors in the market for the simple reason that you can't buy much with a stock certificate. You cannot, for example, give one to the checkout clerk at your local grocery store for your purchase. You first have to convert the stock to cash by selling it. Now, although any individual can sell a stock certificate at the prevailing price and spend the money to buy groceries, if everyone decided to convert their stocks into money to buy groceries at the same time, much the same thing would happen as did on October 19, 1987. The aggregate value of their stock holdings would deflate like a punctured balloon.  The "money" --- the buying power--- would instantly evaporate. WHAT WE ARE DEALING WITH IS MARKET SPECULATION THAT CREATES AN ILLUSION OF WEALTH.  IT CONVEYS REAL POWERS ON THOSE WHO HOLD IT, BUT ONLY AS LONG AS THE BALLOON REMAINS INFLATED.

The whole nature of trading these vast sums in the world's financial markets is changing dramatically. The trend is toward replacing financial analysts and traders with theoretical mathematicians, "quants," who deal in sophisticated probability analysis and chaos theory to structure portfolios on the basis of mathematical equations. Since humans cannot make the calculations and decisions with the optimal speed required by the new portfolio management strategies, trading in the world's financial markets is being done directly by computers, based on abstractions that have nothing to do with the business itself.  According ro Kurtzman : 

     These computer programs are not trading stocks, at least in the old sense, because they have no regard for the company that issues the equity . . . The computers are simply . . . trading mathematically precise descriptions of financial products (stocks, currencies, bonds, options, futures). Which exact product fits the descriptions hardly matters as long as all parameters are in line with the description contained in the computer program. For stocks, any one will do if its volatility, price, exchange rules, yield, an beta(risk coefficient) fit the computer's description. The computer hardly cares if the stock is IBM or Disney or MCI. The computer does not care whether the company makes nuclear bombs, reactors, or medicine. It does not care whether it has plants in North Carolina or South Africa.