Soros has been banging on about his new theory on why markets tend towards bubbles. Well it’s not a new theory as he’s been going on about it for a long time. In fact he’s made plenty of dough out of this approach for many years. But so has Warren Buffett so what’s the difference?

Well his mani point is that markets do not tend towards equilibrium but can be quite extreme in their pricing. I completely agree with this. But do they alwats revert to an equilibrium point? I think so but unfortunately for many it’s like an elastic band. It either rebounds on you causing a sharp pain or actually complete explodes.

This leads us to the greatest maxim of trading and investing: buy low, sell high.

The best traders are those who are completely detached from the instruments they trade. The ego is removed and there is no emotional investment about being right. But markets move on emotion of crowds since that is what the market is. The market can also be seen as a system in which intentionality is the main driver. Yes the fundamentals (price, yield, forecasts) play an important part in determining a basic price but it is the intention of the market, whether to buy or sell, that really drives the price.

So stock markets happily trade a twice their preceived fair value earnings. Currencies happily trade at a huge premium or discount to perceived fair value. Why does this happen? It’s simply the collective outcome of countless intentions.

And many fortunes have been lost betting against the wisdom of the crowd.

Soros suggests regulators have a part to play here in smoothing or preventing bubbles. He says that the control of the money supply itself is not enough but that credit conditions need to be managed. In essence this is the same thing depending on how you view the money supply.

He thinks margin and capital requirements for banks should be used to make credit less or more available.

He’s right to a point. But he missed the real problem which is the creation of the money supply by the banks.

Banks control both the money supply and the supply of credit . How? Well nearly all money is credit.

Now there’s something for Geroge to get his teeth into.

Forget about government bailouts, now its investors that are bailing out. It’s a case of salvaging whatever is left of portfolios now. Hedge funds are unloading anything with liquidity and currencies are taking the strain,

The horrendous spike in LIBOR rates has seen a reverse run on the $. From global pariah to this week’s must have the $ has risen at a rate of knots in the last month against all currencies except the yen, which has been used to fund most of the speculative investment activity. The Aus$/Yen cross rate is down over 40% in 3 months. The Eur/$ rates has fallen 20%. Eur/yen around 25%. These are not emerging markets, these are the main conduits for global trade and when added to stock market moves of between 25-50% one is faced with the realisation that the whole global financial system is at risk.

I wrote recently that at some point global markets will need to be frozen. That may well happen as not just stocks but currencies go into complete meltdown making any form of economic activity almost pointless.

The recent wholesale and blanket guarantees of bank deposits and lending in many countries have just added to the general lack of confidence in the global financial system.

Added to this commodities have collapsed in price also as that speculative bubble is popped. Even gold, something one would consider in the current situation, has fallen, over 20% in the last few weeks.

Nothing makes much sense at the moment except that the unwinding of years of excess is both savage and yet unpredictable.

One can only hope that somehow the markets can stabilise but the lower it goes the worse it gets as the spiral of margin calls increases and investors seek to recoup whatever they can. It’s probably not the time to sell but at the moment cash is king.

And surprisingly the king of cash is the $…….for now.

New Zealand is fortunate to have its own state backed (sort of) bank in Kiwibank. Promoted by Jim Anderton (who quietly understands the money system) it has come centre stage in the recent financial crisis.

With its NZ Post guarantee it had attracted huge funds from worried savers over the last 12 months. Now that all bank deposits have been guaranteed it is perhaps less attractive. Until today.

Winston Peters, the enfant terrible of NZ Politics, today proposed that Kiwibank handle all government business.

What a great idea. Why continue to pipe $4lbn odd in profits to the Australian banks?

Having domestic control of your monetary system is an absolute prerequisite for a properly functioning sovereign state.

Colonial invaders always replaced the local currency with theirs as soon as local administration was in place. Currency issuance is all about control.

If someone else is in charge of your money then you have limited control over the functioning of your economy.

I suggested in June 07 that the RB use the opportunity of the high NZ$ to buy as much foreign currency as possible whilst the market was hungry for NZ assets. Now with the NZ$ around 0.60 and our overseas borrowing binge fully exposed, the situation is less than favourable.

The lessons of Iceland show that sovereign control of the money supply is essential and as part of that a strong domestic banking system is a necessity.

Blue Monday

Just watching Bush, Sarko and some other bureaucrat from the EU announcing the coming of the new order or is it a new new order. Forget Black Monday its all Blue from here.

Actually they are right. Bretton Woods created US dominance in financial matters to go along with their dominance in military affairs. Whilst Keynes argued for a system of balanced trade the US saw an opportunity to sell the world US$ which they could print for nothing. The seignorage accruing to the US has been the backbone of their economy for 60 years and those holders of US$ and US paper must be wondering how they got sucked in so badly.

I enjoyed Sarkozy saying everyone would be part of developing a solution…..it’s amusing to watch Bush and Sarkozy together. The clash of cultures is stark and it will be interesting to see how this global summit develops and more importantly who gets to set the agenda.

One thing is for sure: leverage is history. The financial markets will shrink and exotic products will become a relic of a distant past. It will be back to basics like borrowing to create and produce rather than borrowing to invest in a synthetic financial product. The fall out from the contraction of the financial markets will be severe. Unemployment will rise not just in the financial industry itself but in all the industries that service it. Asset values will fall. How can property prices rise when the supply of money is contracting?

Of course the one issue I am looking to see on the table is who creates the supply of money: will it be banks once again creating loans deposits at will or will it be sovereign nations supplying money into the banking system to be lent out or supplying it direct to citizens as a basic income.

This is the crucial issue.

Will the sovereign right of Parliament be reasserted for the first time in over 300 years? No one remembers William of Orange but in 1685 his overthrow of the Stuarts, aided by European bankers, laid the foundations of modern banking.He gave away Parliament’s right to create money and placed it in the hands of the bankers.

Plus ca change.

But the time of change is upon us.

The flurry of raised hands for bank guarantees from central bankers and treasury ministers around the world fails to convince me we are out of fire. Certainly guaranteeing interbank lending is helpful as the pipes are well and truly frozen in that part of the monetary world.

The global banking system has now been underwritten, guaranteed and in some cases nationalised completely. There is no surprise in that course of action as it was all they could do. Whether they take stakes in, takeover or buy preferred stock makes no difference. Now they have bought some time we will have to wait and see how it pans out. The underlying problem remains the same though.

They have not addressed the difference between money and credit.

Money is what the sovereign authority issues. This carries no interest burden which is a future claim on goods and services yet to be produced i.e. drives the growth imperative.

Credit is what banks issue based on deposits and “other types of capital” that are in the bank. This carries interest. Credit makes up 97% of the money supply. Credit is treated as money although laws are very clear that only sovereign authorities can create money.

Confused?

There is a strong argument to say that bank credit is fraudulent money. I digress.

Instead of supporting the credit creation system we need to support the money creation system. It’s that simple. Let me be clear: banks do not lend out your deposits. They use your deposits as collateral on new loans.

Take Kiva, my favorite microfinance outfit: I deposit $25, find a borrower and lend them the money. My $25 is gone and i have to wait for it to be repaid. That is true lending. Think of it as investment.

Bank lending is garbage.

The answer is to nationalise the supply of money and remove the interest burden at the point of creation. I think this is likely to happen at some point as governments run into difficulties with their guarantee schemes.

We will need a new monetary authority who will issue new money into the economy and monitor the supply of money in the economy at any given time.

Only then will we be able to build a genuinely productive and healthy society and economy.