STRESS TESTING BoE and FSA SYSTEM 10 YEARS POST 1997 AS CREDIT CRISIS WINDS 140 YEARS BACK
ATCA
Upon closer examination, complete trust in the decisions of the independent Old Lady of Threadneedle Street -- The Bank of England -- would appear to be the biggest casualty of the Northern Rock financial turmoil in the UK. The hourly television bulletins reinforced the image of a bank run via the queues which formed outside Northern Rock, up and down the country's fifth-biggest mortgage lend er. This represented the first bank run in Britain since the 1860s, which was nearly one and a half centuries ago !
Most citizens in Western democracies have limited trust in politicians at the best of times. Regulators can sometimes be feared in open and despised behind-closed-doors. Central banks are held in high esteem; which is why the Bank of England (BoE), would appear to be the past week's main victim. There is a palpable sense of loss of credibility in regard to the role of the BoE -- and the FSA to some extent -- amongst many at the Palace of Westminster and across the country. Central banking without the perception of serious credibility can itself be a moral hazard to a fiat currency. Notice the falling value of Sterling against many major currencies including the Euro and Swiss Franc since the Northern Rock tremors.
Going back just one week, the panic was prompted by the announcement initially designed to achieve the exact opposite. Only when the B oE said that it would stand by the stricken Northern Rock last Thursday night did depositors start to run for the exit on Friday. Attempts by Alistair Darling, the Chancellor of the Exchequer -- the UK Finance Minister -- to reassure savers served only to lengthen the queues of people outside branches demanding their money. The run did not stop until Mr Darling gave a taxpayer-backed guarantee on Monday, 17th September, that for the moment all the existing deposits at Northern Rock were safe.
No sooner had the queues disappeared than the House of Commons ', the UK Lower Chamber of Parliament's, inquest began. This was the first big test of Britain's new monetary and regulatory system introduced in 1997, when New Labour came to power and Gordon Brown, then Chancellor of the Exchequer, fundamentally altered the financial chess board by giving The Bank of England operational independence to set interest rates and handing banking supervision to the newly created Financial Services Authority (FSA). HM Treasury, the central bank and the FSA reached a new understanding about how they should run the system together. However, the new system was not really stress tested by the markets in the last ten years until September 2007.
Until the high LIBOR rates' differential of 100+ basis points with the base rate began to rear its uncertain head in August, as pointed out on ATCA, Mr Brown's much vaunted reforms of the UK financial system seemed to be working rather elegantly.
The Bank of England enjoyed huge credibility for keeping inflation close to the government's target -- notwithstanding Governor King's one letter to the Chancellor earlier this year in regard to an inflation overshoot -- whilst ensuring steady growth of the UK economy. The FSA won global praise for its capabilities, especially in regulating complex financial businesses, which have helped strengthen London's image as an international centre of excellence, overtaking New York in many key areas. In just a few days a financial hurricane of "category five" has blown a hole in the hard-won reputations of the regulator and the central bank, as the new system of split responsibility between the BoE and the FSA has failed its first big stress test since its inception 10 years ago.
Moral Hazard
Whilst left with no choice, the Chancellor of the Exchequer -- UK Finance Minister -- Mr Darling's guarantee sets a dangerous precedent: it threatens to encourage savers to put their money in high-rate accounts in shaky banks and shareholders to invest in "extreme" non-bank banks, comfortable in the knowledge that the government will be there for them when the going gets tough.
On the one hand, it would be fair to note that by the time the Chancellor acted, he had little choice but to save Northern Rock or risk a disastrous run on other British banks whose share price was coming under excessive pressure. On the other hand, Northern Rock deserves condemnation for its dangerous non-bank banking business model. The Newcastle-based mortgage lender had grown too fast on the back of short term money markets rather than branch deposits. Clearly, this left it utterly defenceless against a shortfall in funding when easy credit dried up in August and September. Fault for that does lie first-and-foremost with Northern Rock's management , but it also looks as if the FSA was caught off guard. Sir Callum McCarthy, Chairman of the FSA, said this week that Northern Rock's business model was "extreme." Referring to Andrew Hunt's ATCA submission, "The UK's Non-Bank Banks and High LIBOR," we would humbly suggest that the problems in the UK banking system have arisen because many banks in the UK -- not just Northern Rock -- have, in effect, been behaving in the same "extreme" way as though they were non-banks. So, Northern Rock is not unique and therefore "extreme" could be defined as mainstream within certain boundary conditions .
Central bankers across the world had been warning about the likelihood of credit tightening for a while . The FSA ought to have paid close attention and discouraged Northern Rock and other UK non-bank banks from pursuing their risky business models . The FSA's vigilance is essential , because it is the guardian of the public scheme of deposit insurance. Last year, it said this scheme was working just fine. But when stress- tested in September 2007, in the extreme case of the Northern Rock bank run, the scheme failed: depositors neither understood nor trusted it at all. And w hy should they have done so ?
Trust in Financial System 's Regulation
The FSA, BoE and HM Treasury are all likely to come out poorly from the Northern Rock episode. At the outset, the BoE, talked tough and wanted to teach financiers a lesson that they should not expect the central bank to bail them out if they took on too much business risk. Unlike the European and American central banks, which injected copious liquidity repeatedly into the money markets, the BoE held back from pumping cash with a clear justification for its stated policy. When it did intervene, it did so rather modestly, insisting on high quality collateral. The BoE argued that central-bank money could do little to save the three-month LIBOR money market, which had reached a fever of a 100+ basis points differential with the base rate.
In the end, t he BoE's tough line turned out to be unworkable, and events forced the BoE to change its declared policy. On September 19th, the day after the run on Northern Rock ended, the BoE performed a U-turn. It announced that over the next few weeks it would be providing extra liquidity to try to sort out the three-month LIBOR market's high differential. Furthermore, it said that it would lend against riskier collateral, including mortgages, which is precisely what other reputable c entral banks have been doing since the credit crunch emerged in early August.
The charge against the BoE appears to be that its pretence turned the credit crisis into a farce. If the BoE had acted more promptly to provide a redressal for the high LIBOR rate, Northern Rock might have survived. Who knows and what good is speculation at this stage ? The 180 degrees turn in the BoE's policy looks either as if the Old Lady of Threadneedle Street made a mistake, or as if the Lady cannot stand up for her strongly held principles and values . Neither characteristic is endearing in central banking.
As the Governor of the BoE, Mr King pointed out, defending his performance in front of a House of Commons committee on Thursday, 20th September, English law prevents the BoE either from staging a covert rescue operation or from engineering a swift takeover; and clear flaws in the protection of depositors mean that, once an overt rescue operation is under way, depositors are likely to flee -- as became the case with Northern Rock. The Governon defended the separation of powers between the Treasury, the BoE and the FSA, but this may not be a solid line of defence . The split power has exacerbated the system's flaws: nobody was in charge of the operation when there was a desperate need for one leader to run the show . Northern Rock fell in the wide cracks that appeared.
This debacle not only holds key lessons for the system which regulates UK financial institutions but also for the way in which the Euro-zone national financial institutions are regulated: with the European Central Bank (ECB) at one end of the spectrum and old national central banks and finance ministries at the other end . What of the chasm of poor de facto regulation in no-man's land which has opened up, post the ECB's creation and the Euro's inception in 1999? When has the Euro-zone financial institutions' regulatory environment been stress tested by the markets in the last decade? How sound is it under extreme pressure? Is the Euro-zone regulatory system 's stress testing going to begin soon as the global credit crunch continues? What are the recent sub-prime linked banking insolvencies in Germany and elsewhere in the Euro-zone suggesting ? Watch the Euro-zone carefully for unfolding answers to these key questions over the coming weeks and months.
THE BANKERS KNOW:
SOMETHING CATASTROPHIC THIS WAY COMES
John Hoefle
By now, most people are aware that former Federal Reserve chairman Alan Greenspan is on a "not my fault" tour, proclaiming to everyone who will listen that he is not to blame for the collapse of the financial system. By saying he "didn't really get it," Sir Alan is choosing to cloak himself in the mantle of incompetence, in the hope that he won't go down in history as the worst central banker of all time. Greenspan, to protect himself, is blaming President Bush, who is admittedly an easy target, while riding to Bush's defense is Vice President Dick Cheney, who wrote an op-ed in the Sept. 19 Wall Street Journal claiming that Greenspan was "off the mark."
Cheney insisted Bush's (and therefore his) record was "superb," adding that "no other president has spent more time or political capital trying to avert a fiscal disaster that everyone knows is coming."
At the same time, both Fed chairman Ben Bernanke and Bank of England governor Mervyn King are being criticized for flip-flopping in their handling of the financial crisis, with King in particular catching flack over the run at Britain's Northern Rock bank.
Why are such senior figures suddenly so concerned about their reputations? What do they see coming that causes them to go into a very public "not my fault" mode?
These comments are de facto admissions that the global financial system is bankrupt, and that the efforts of the central bankers to contain the collapse have failed. Something catastrophic this way comes, and the bankers know it.
Runs on the Banks
Northern Rock, a $230 billion British mortgage bank based in Newcastle, is emblematic of the problems facing financial institutions at this point. The bank ran into serious trouble in mid-September when it could not borrow the money to make new loans, and had to turn to the Bank of England for emergency funds. As word of the bank's problems spread, anxious depositors descended on the bank to withdraw their funds, sparking a panic. Few things scare bankers more than runs, which can easily spread as panic sets in. Even healthy banks can be destroyed by runs, and there are few, if any, major banks that are healthy these days.
The Bank of England, despite its recent assurances that it would not bail out faltering institutions, threw all its promises out the window to stop the runs from spreading. The Bank stepped in as lender of last resort, and the British government, through Chancellor of the Exchequer Alistair Darling, guaranteed the Northern Rock depositors that their money was safe. Subsequently, the Bank agreed to accept mortgages as collateral for loans. This move, like the decision of the Fed to buy mortgage-backed securities and accept asset-backed commercial paper as collateral for loans to the banks, reflects the desperation of the central banks to stop the collapse. Thus far, the Fed, the European Central Bank, the Bank of England, and other central banks have pumped hundreds of billions of dollars into the system in a vain attempt to control its collapse.
The run on Northern Rock in September followed a similar run against Countryside Bank in California in August, amid fears that its mortgage-lending parent Countrywide Financial would collapse. This run occurred in spite of the fact that the bank deposits were insured by the FDIC. Countrywide subsequently borrowed $11 billion from a line of credit set up before the crisis struck, and later received a $2 billion injection from Bank of America.
While the bankers have tried to portray these runs as isolated cases, they actually represent an important inflection point in the disintegration of the system. We have gone from denial, in which the problem was presented as too minor for serious concern, to attempts to dismiss it as a mere "subprime" crisis, to treating it as a larger but still manageable "credit crunch," to the point where panic is openly setting in, and the central banks are openly intervening, and the players are looking for ways to escape the blame for the growing catastrophe.
Gasoline on the Flames
Lyndon LaRouche has compared the central bankers' attempts to pump money into the system to keep it from seizing up as the equivalent of trying to put out a fire by pouring cold gasoline on the flames. By treating the crisis as a "credit crunch" which can be solved by lowering interest rates and providing liquidity for borrowing, the central banks are only making matters worse. The problem here is not a lack of credit, but far, far too much debt, which the central bank actions exacerbate.
The only rational approach to a debt crisis of this magnitude, is to address the economic policies which created it. The U.S. economy has been operating below breakeven for some
four decades, during which period the productive side of our economy has been systematically dismantled and replaced with casino-like speculation and Information Age paper-pushing. As a substitute for the wealth formerly generated by the productive sector, we have gone ever deeper into debt, to the point that we now have an increase in debt of nearly $5 for each $1 increase in GDP. The level of debt is crushing what remains of our economy, and adding more debt will not help.
What is needed is to return to a productive economy, led by manufacturing and supported by scientific and technological breakthroughs, investment in infrastructure and essential public services such as education and health care. The first step in that direction is to put the financial system through bankruptcy, while erecting firewalls to protect the welfare of ordinary citizens. Freeze the debt, stop foreclosures, protect the essential functions including banking; save the people and the economy, and let the speculators take their losses.
The alternative is a hyperinflationary blowout of the financial system, coupled with a savage deflation of living standards, and a descent into corporativist fascism.
Deregulation Is Sabotage
Deregulation has been an unmitigated disaster which has destroyed our economy. Our deregulated transportation system is a nightmare, from our cattle-car airlines to the disappearing rail grid, to the overloaded trucks tearing up our highways, and the decline of our inland waterways. Electricity deregulation, far from lowering prices, has raised them, in some cases to obscene levels. Health care, once the province of doctors, is now largely run by corporate bureaucrats under orders to protect profits, not patients. Financial deregulation, coupled with changes in tax policy designed to promote speculation at the expense of production, has turned our economy from an industrial powerhouse into a bankrupt casino.
Deregulation, to put it simply, was intended to destroy our economy, and we are now seeing the fruits of that effort. At every downward racheting of the system, we are told that further deregulation is required to deal with the problems. Hand in hand with this goes globalization. To make our companies more competitive, we are told, we must outsource our manufacturing to places where wages are lower. The result is that the Midwest, formerly the center of the industrial world, is now a rust-bucket. Our family farms are dying, our food supply increasingly imported by giant agri-business cartels. We are more dependent than ever before on these corporate cartels, which are increasingly global in scope and controlled by the international bankers.
Where we are headed, is a combination of a return to the feudalist/looting model of the British East India Company, paired with the surveillance and control capability of George Orwell's Big Brother.
Complete BS
Virtually everything we are told about the world situation today, is complete bullshit. What we are witnessing is a power grab by the British-centered international financial oligarchy, which wants to put the genie of human progress back in the bottle as a way of maintaining its miserable power over world affairs. The men of the empire have no intention of allowing the United States to fulfill its founding mission of leading the world out of colonialism, and have no intention of allowing the nations of Ibero-America, Africa, and Asia of developing into sovereign nation-states which put the welfare of their people ahead of the demands of the imperial parasites.
Globalization is a euphemism for imperialism, and deregulation is a euphemism for destroying the ability of a nation to protect itself from the empire. The target of the police-state measures put into place by the Bush Administration is not the oft-mentioned amorphous terrorists, but the American people. The war against Iraq was sold to the American establishment as a Malthusian move to secure our oil supplies, and to the public as a move to protect us from an imminent attack from Saddam's weapons of mass destruction, but the real reason was to destroy us as a nation. The beating of the war drums against Iran, and others, is more of the same.
Forget the financial system—it's gone. What we must defend is the concept of national sovereignty and the public welfare, as epitomized by the Declaration of Independence and the Constitution. This is a crisis of civilization itself, and we are the battleground. Save civilization, not speculation.
Creating a Public Credit System
This involves, now, a special problem. And this is where I become somewhat technical, but it's necessary: There is no way, no conceivable way, in which the existing monetary-financial systems, among nations, or of any nation, could be salvaged. The degree of bankruptcy within the existing financial systems, is so far gone, there is no possible way of refinancing any part of this, within the terms of the system. There's only one thing you can do, and from that flows the only method that can work: What you can do, is put the entire, international monetary-financial system into bankruptcy.
Now, that's easily done, technically. Because these systems are so intertwined with each other, there is no such thing as a national monetary-financial system. The banks of the United States, the banks of Europe, don't own anything! They are controlled by the hedge funds. The hedge funds have been using the banks like toilets; they visit once in a while for comfort! Banks don't have resources in them. It's not a matter of settling how many dimes for a dollar. It's impossible. There are no reforms within the framework of the system that can work! Not only because it can't work on a national basis, and because it can't work for a system as a whole. The monetarists can all be unemployed: We don't need monetarists any more. Matter of fact, we would like to get rid of them!
Because, we're going to have to go to a completely new world system, and it's going to have to go by a certain kind of step. And this is the remedy: What has to be done—and my little proposal for this new legislation, for Federal protection of households, mortgaged households, but households in general, and banks; that is, legitimate banks, banks that actually take deposits and loan money, and conduct that kind of business. We need them, and everybody knows that. You need these banks, because those are the ones on which the community depends, for managing its affairs. Without these banks, communities don't function. So those banks, even if they're bankrupt, are going to be protected under this act.
Secondly: No householder can be put out of their home because of foreclosure. We're going to settle it? No! We're not going to settle anything! We're just going to take all this whole package of mortgage paper, we're going to take it, in one big package, and say it's all frozen. It's all taken in receivership by the Federal government. And it's going to sit there. And we'll arrange that the people who live in those houses will pay something to the relevant bank on that account, every month. But they will stay in their houses! We are not going to try to settle the accounts, because we know that the value of these mortgages is going to collapse to a very small fraction of their present nominal value. So any attempt to write down some of the mortgages, or buy off part of it, is not going to work. Because the intrinsic value of these mortgages—we don't know where it lies, but it lies "way down there," someplace!
And therefore, our problem is, to prevent a disruption of the U.S. economy, in particular. Therefore, how do you prevent a disruption? Well, you freeze it! It's like taking a firm into bankruptcy, into receivership for protection—you freeze it.
It now lies in the Federal government. The Federal government is now responsible, at some time in the future, to clean this mess up. In the meantime, it's frozen. The people will stay in their homes; they will pay a reasonable amount, as the equivalent of rent, into the accounts against these mortgages. But the mortgage will sit there in the banks! We're not going to try to renegotiate them now.
In other words, we're creating a firewall, against a chain reaction, already in process. We will have to do the same thing in other categories. What does that mean? It means that the Federal government—and we recommend this heartily to European and other governments to do the same thing—faced with this situation, you have to realize that you have to eliminate the factor of the present system, from the economic and related life of the people in the nation. And it's only by neutralizing that, by putting it in a cage—like a little squirrel in a cage, let it spin as fast as it wants, but it's going to stay in that cage. Because we're going to a new kind of system.
We're going to get out of a monetary system which is the basis for empires, of the type we've been discussing, and we're going to a public credit system, which is what the United States Constitution prescribes. The U.S. Constitution says, "We're not owned by banks. We're not owned by bankers. We own the bankers." Because, in our Constitution, the printing, or uttering of money, or the uttering of a promise to deliver a created money, is the power of the Federal government. The states have no power to utter money. Only the Federal government has the power to do so, and does so, only with the consent of the House of Representatives.
Now, the uttering of money, under this kind of system, is a credit system, not a monetary system. The government utters the currency, or utters the credit, against an issuable amount of currency, as the Congress has allowed it to do: The Congress votes a bill; the government can now utter so much currency, which will be charged to the debt of the United States. That is the equivalent of money.
What do you do with it? Well, you can do necessary things, but you also do something much more fundamental: You use this money, that you've created, this credit, you use this for large-scale infrastructural development, primarily. Because large-scale infrastructural development—and we're way short of it in the United States and in Europe, right now—it means all the things that are the public sector: power stations, mass-transportation systems, health-care systems, so forth. These are things which are essential to all parts of the population. They have no control over their need for them—hmm? They are facilities on which we depend. So therefore, we issue credit; we issue credit for fixing up infrastructure, maintaining it.
Now, when you start to fix up infrastructure, then you really put the rest of the economy to work, in contributing to this work of building up the infrastructure. So now, you issue credit to people who are doing that. Now, you're into the private sector, and you're bringing in firms which supply this or that facility, this or that job. And now, you are stimulating the business, in the community, through infrastructure for the future. And you're doing it in a way which keeps a balance between the ratio of the public sector and the private sector.
But how is this going to function? Let's take another problem here: We have now a floating condition of currencies. Under floating conditions of currencies, the price for lending is uncontrollable. Because, if the currency that you're dealing with is dropping in value against your currency, what are you going to charge for your interest rate? So, under a floating exchange rate in a declining economy, the tendency is, on the one hand, for a demand for cheap credit, and on the other, a denial of a possibility of generating it through the private sector, or through central banking.
So therefore, we have the problem, that, for global development, we must have a fixed-exchange-rate system internationally. What does that mean? Essentially, you try, as close as possible, to actually freeze currencies at their present relative values. Freeze them.
And then go to a state public credit system. How do you do the state public credit system? Well, we have China, we have India, we have Russia, we have the United States, and other nations, which all need a lot of things. And these things involve a heavy reliance on trade, trade goods. So therefore, if we're going to have lending and credit issuing across national borders, we must have a fixed-exchange-rate system. Otherwise, how are we going to determine what the rate of interest is going to be, in terms of medium- to long-term loans?
So, now, what do you have to do? You say, what's the basis for an international credit system? Is it a monetary system? No. The monetary system was a bad idea, didn't work out too well. We get rid of that. We're going to have long-term treaty agreements. What do I mean by long term? I mean 25, 50 years, minimum. That governments, of the world, will enter into treaty agreements, long-term treaty agreements, in the form of trade and related agreements, in a fixed-exchange-rate system; and instead of trying to balance the system by letting currencies float, you balance the system, by letting the prices of goods within currency domains, float, within a regulated range.
So, the problem here, is that, on the one hand, we must immediately take this action. We must immediately bring a group of nations—and we're talking about weeks, now, because this thing is blowing! This is finished. There's no bottom to this crisis—none! You either stop it, by the methods I've indicated, or you don't stop it at all! And pretty soon, you have something worse than Germany, 1923.
You have no choice, that is, no rational choice. Do this, or else, the worst'll happen to you.
So, governments will tend to go along with this, only when they perceive, that they have no choice. Some governments are clinically insane, and won't go along. So therefore, we need to have a stable system, created by agreement among a growing number of nations who are joining the list of those who enter this agreement. And, essentially, we will try to reform the United Nations Organization, to perform a function in accord with this type of agreement.
Creating the Firewall
Now, in order to do that, you're making a transition from a monetary system to a credit system. You have to make it turn on a dime. Because a week of chaos, or two weeks of chaos, may destroy your country—you can't have it. So therefore, you have to come in with a firewall. And the housing and banking protection act is a firewall: The Federal government takes this category—the housing market poses a threat, a threat to the banking system; it's a threat to the entire system. Therefore, we must protect those two pivotal elements of the economic system, otherwise, we don't have a chance of surviving!
Are we willing to plug the hole in the bottom of the boat? If we're not, we're not fit to survive. And our elimination will probably help the human race of the future.
So therefore, we need a method of firewalls; now I mentioned two kinds of firewalls. I mentioned this act; it's a firewall. It is a feasible form of firewall under U.S. law. We just need that one piece of legislation, no more complicated than what I've written. That piece of legislation will create a firewall.
Now, we need another firewall: We need a firewall for the transition from the way the U.S. financial system is operating now, to what we are installing. We also need, in that, we need a firewall in the form of treaty agreements among a powerful aggregation of nations. In other words, if the majority of the powerful nations of the world agree that something is going to be protected, it can be protected. Without such an agreement, it can't be protected: That's a firewall. If these nations agree to come to each others' support and defense, on this issue, knowing that it's their interest that's at stake—a firewall, a transition from a system that has failed, the Cold War system, the present system, the globalization system: These systems have failed. We must, with one fell swoop, get rid of them! Well, you can not reform them, piece by piece: You have to create a firewall, to contain the disease.
And you have to have the backing and support for this firewall, from a sufficiently powerful group of firemen, firefighters. Those firefighters are powerful governments, who agree to cooperate with one another to defend each other's interest, their mutual interest: the same thing as the Treaty of Westphalia, the Peace of Westphalia—the interest of the other. The nations know they're going to Hell, if they don't protect one another. Therefore, the interest of that nation, just as the people in the Peace of Westphalia after the Thirty Years War, knew: They had to go to this, to protect themselves! They had to put the interest of the other, first! And that had to make that a firewall, and all decent European civilizations since that time, depended upon that 1648 Treaty of Westphalia. We need the equivalent now: Firewalls!
And we need, above all, to educate people, to understand that there is no alternative. Because there is no alternative! The boat is sinking! Fix the leak, or get off the boat! Don't try to get a better stateroom.
There's a principle involved in this, which is a sticking point: Most systems, economic forecasting systems that are used, the formal ones, the mathematical ones, are junk. A good economist does not depend entirely on figures. A good economist always looks behind the figures, to what the reality is. He does not go by the financial figures—never believe an accountant. Use the accountant, employ the accountant, but never believe what he writes. You need his figures, you need his head, but you're going to have to decide what it really means, not him.
And the problem is, that we operate, as right now—we're in post-industrial economies, not entirely physically, but ideologically. These economies—look at the government, the government of Germany, the government of other countries—they're all, ideologically, post-industrial societies. They have no perception of reality. They don't like reality! It annoys them. It gets in their way. They would ignore reality where it's possible. "If reality comes in the front door, we will defy it!" That's your present population.
Mathematical Formulas Cannot Describe an Economy
The problem is, that—speaking as an economist, looking at reality as I know it—we are in an insane society, on this kind of issue. Let's take the case of Myron Scholes; he's a good target to hit. He was the famous forecaster who was employed as a mathematician in the LTCM case. And he made a mess, and he keeps making a mess! The hedge fund business, all of these fellows are functioning on mathematical formulas. Every one of these mathematical formulas are utterly incompetent! They're wild-eyed. It's traces of John von Neumann—and he was an idiot. He was a mathematician; he was not a scientist, he was a mathematician.
Therefore, they believe that somehow there's a law, somewhere, that dictates what prices must be, by some mathematical formula. There is no such law. No economist believes that. Every competent economist looks at a physical reality, and thinks in terms of the consequences, the physical consequences, of a certain policy, or a certain trend. Not the price movement, as such. Not John von Neumann's crazy system, which is what people are using.
The other aspect of this, where people fail, is on trends. They believe in statistical trends, in terms of Cartesian systems of mathematical systems, mechanical-statistical universe. They think of bodies floating in empty space. And the empty space is their head. And they have these objects, these balls, are floating in there, and they're watching the trajectory of these balls in this empty space, which is inside their head. And they assume that you can predict a future state, within this Cartesian vacuum, on the basis of a statistical current trend, they extrapolate. And what gets people like Myron Scholes and company into trouble—and they haven't given it up even after the lesson of 1998!—is they think they're all going to compete to use the right mathematical formula! But using the right mathematical formula the way they do, is like a bunch of people betting on the same horse, in a horserace. And if they're wrong, which they probably will be, they're going to lose everything.
That's what's happened with the hedge fund business. They're all using this kind of formula, the same kind of formula, the mathematics that Myron Scholes uses. And they're all creating a system, which is collapsing. They're all going to lose. And the whole hedge fund pile-up, is now hopelessly bankrupt. There are no net assets in the hedge fund domain. They're demanding money be given to them, to bail them out, like beggars on the street. And they're all based on projecting something, like the projection of a trajectory of a ball in empty space—a mechanistic-statistical system.
Real economies do not function in that way. They function in terms of physical laws, as we know, if we know production. A gain, through a technology, or a gain in the way you use a technology; the interrelationship of infrastructure to productivity in manufacturing—these kinds of things. Physical factors. And we have a way of dealing with that in science. It was called, in ancient Greek, "dynamics," or dynamis. Since Leibniz, in modern society, we call it "dynamics."
The kind of dynamics you require to understand an economy is Riemannian dynamics: That is, we are in a universe, in which any assumed a priori axioms and postulates, or definitions, are insane. They're wrong. They're arbitrary. We live in a universe, which nonetheless, does have some laws; it does have the equivalent of laws which are universal. Gravitation is an example of that. These laws define a universe, not as a Cartesian universe, not something open-ended, which is stretching out infinitely in all directions without limit. No, but, a universe in which there are certain things that bound the universe! Like the shells that enclose the universe, and which affect every part of the universe, as a shell, like gravitation. Gravitation, as Kepler defined it, as Einstein defined it later, as Riemann defines it. It's a principle of dynamics. Universal principles.
For example, the difference between man and an ape, is a principle. It's a universal principle. Mankind is creative. That is, mankind has the ability to increase the potential population-density of a species, itself! No animal has that. Therefore, there's a principle which separates mankind from any animal! These bound the universe.
When we introduce a power system, or anything else in the form of infrastructure into an economy, we are creating a boundary condition which contains the space in which we're operating.
And therefore, you do not determine value in economy by Cartesian methods, by statistical Cartesian methods. You determine value in an economy, if you want to succeed, according to the principles which confine the economy you're talking about. The way you design an economy, the way you design its operation, the kind of technologies you develop, the way you apply them, this is the action of the universal physical principles of the universe, as you have come to know them; or as things you have done, you have understood what you have done, which now bound the way you behave. And you're able to see where you're getting, because you think like this.
It was why I have had the success as a forecaster that nobody else has had, on precisely this issue. Because, the field of economics is dominated by people who believe in accounting, as a basis for forecasting; believe in Cartesian mechanistic methods of forecasting, as a way of predetermining trends, who will tell you, "We see the fundamentals are sound." Somebody tells you, "The fundamentals are sound." The economy's collapsing! What's sound about this? This is the Titanic, buddy, it's going down!
We Have To Change Our Thinking
And so, therefore, the other problem we have here, is precisely that: That we have to change our thinking, away from what's prevalent today. And to what many people, as economists understood, but they understood it almost as by instinct. You're dealing with a physical economy. You're thinking about the effect of changes in the physical structure of economy, about the way people live physically, that sort of thing. You think about how this affects the future of humanity, not statistically. And then, on the basis of this knowledge, you inspect something, you think about it. And you come up with some answers, which are good approximations. But then you realize, well, a good approximation isn't good enough, so we're going to do some more research, and we'll try to find out what the principle is involved here.
And that's where we are, when you try to function in economics, today. We do not have competent economics as a theory, taught in any university. We have a lot of things we know about economies, from a physical standpoint, of how they affect the economy. We can make some very good medium- to long-term guesses, about what to do. And if we know what we've done, and how we thought about it, and it doesn't work out the way we thought it was going to, we can get in there, and see what corrects our error.
So, we are going by a kind of approach to physical science, with a lot of trial and error, and pure insight goes into it. And because we take care to know what we've done, we make good decisions. If we go as a statistician, and try to forecast everything just by von Neumann's method, and his and Morgenstern's, then you have incompetence. What you have now, is drastic incompetence.
We have to get rid of the idea, that there's any mathematical law in the universe that determines the value of money. There is none. We can construct systems, of designing priorities, long-term investment priorities, management of currencies, regulation of prices, fair-trade regulations, which give us a good approximation. And if we keep somebody on the job, watching this, to make sure it's working as we thought it was going to, we can do a good job. And that's good economics.
But, if you want to understand economy, what you really have to do, is study Bernhard Riemann, and read some people like Vernadsky who have good insights into some very important, new things, and start to apply that kind of thinking to the way our economies work or don't work. And that's what I do.
So, we've come to this point: We have to make a change. Forget all the usual habits which have been accepted as acceptable, as expert. Know that the experts have created this big mistake, this collapse, and don't ask for their opinion about anything, about how do they think they made a mistake. Because everything they've done is obviously a mistake. Every government of the world, has made major mistakes: China is apparently successful, but I know some big mistakes they've made. India's apparently successful, but I know the poverty in India is greater than it was before. They've made some mistakes—the caste system had something to do with that. Europe made mistakes. The United States made mistakes.
So: We are dealing with good, scientific approximations. And science never had the last answer. It gave us better and better closure on the suspect area of principles. And as long as we remember, how we came to certain conclusions, and are prepared to reexamine them, when the evidence suggests it's time for a little fresh look, that works. But we have to get away from all the assumptions that are taught and believed today, in this society, especially the post-industrial society. And make this change.
It requires guts. It requires the same kind of guts as required for command in warfare: You have to make a decision. You have to think about what the consequences are, if you're wrong. But you still have to make the decision. And we're going to have to start thinking that way, right now: If we do not build firewalls, instead of trying to muddle with this thing, if we do not freeze the system, and ensure that we keep functioning on essential things without any change of step, we're not going to make it! And it will be the end of civilization as we know it.
Oh, somebody will come back a few generations down the line, and start to rebuild. But civilization, as our generation knows it, the living generation now knows it, will cease to exist, very, very soon, unless we change our ways. And I can give you some insight at best, on some of the things we have to think about.