Swedish Crisis of the 90s

One of the greatest myths, which is still brought up by some economists, is that during the crisis of the 90s when the entire banking system collapsed in Sweden, thanks to the government intervention the taxpayers actually made profit two decades later.

Wrong.

A detailed study was published a year ago (2015) where all costs and revenues were accounted for. This report can be found here: http://nationalekonomi.se/sites/default/files/NEFfiler/43-5-dbhp.pdf but it is in Swedish only. Therefore, I took the liberty and translated it into English for a wider audience. The translated version can be found here: http://www.datavetaren.se/extra/crisis90s-barr-en.pdf

TLDR, what happened? Prior to the mega crash in 1991 the financial markets in Sweden were deregulated (mainly during the 80s.) This resulted in an enormous credit boom for both households and companies. As a result the real estate market boomed, but when the economy turned south some key real estate companies started to default. The banks were indirectly exposed because of investments in certificates that defaulted too. Once it was clear that banks would default as well, the government intervened. The government injected capital, restructured and sometimes took over the banks entirely. These actions were then "reversed" as they were later privatized over the next two decades. During these two decades the government got revenue by selling shares and/or getting the entitled dividends.

The net result? Minus 21 billion SEK (Swedish kronor) which is the equivalent of $2.5 billion USD. Or only 3/4 of the capital injections were recovered. That may not sound much for a country with 10 million people, but it's not insignificant. Especially when you realize that this amount finances CEO salaries, bonus programs and highly paid upper management staff all with taxpayer money.

To me this is appalling. It can never be justified that taxpayers give free money to banks. The justification of the report is that "it would have been worse otherwise" is something that I'm not willing to accept. If it is true, then an overhaul of the financial system is needed so it doesn't happen again. Banks must be allowed to collapse. That's the premise we need to build on.

The interesting outcome is what happened in Sweden also happened in Ireland but worse. And the proud Swedes promoted their showpiece on how to get the job done (here's appropriate to depict the Swedish chef from the muppet show.) It turns out however, when applied to Ireland, this was a complete disaster. The debt of the Irish government went way beyond their means, so they requested financial aid from both EU and IMF. Because of this failure, the Swedish model was abandoned internationally, and this is the reason why we got the new bail-in rules in 2015. The bail-in rules state that creditors and investors take the first hit before taxpayers. They yet have to be practiced, and Italy is already whining. They'd like to exempt from the bail-in rule as the Italian banking system is on the brink of collapse.

You have probably already figured out where I'm going with this, but let's save that for later.

Private Banks

Few people understand that a bank does not hold your money. You have a claim on the amount stated on your checking account, but it's not your money. This means that if the banks go bankrupt, you should lose that amount. Today, few would be willing to accept that, so the central bank gives a "bank guarantee." In EU this guarantee is up to 100,000€ (or the equivalent amount if your country is not a ECB member state.) This by itself is wrong. It means that your private commercial bank can hold a certain amount of money without risk. Having money at the bank should always imply risk. The only way you can have risk free money (denominated in your own currency) is to withdraw in central bank paper notes.

Think about it: If all banks go under and if everybody used paper notes. And I mean everybody (businesses, citizens, tourists, …) What would happen? Nothing. Except some bank staff getting laid off. Of course, it would be difficult to get new loans from banks (no more banks,) but perhaps you could acquire loans elsewhere? In some sense, the real underlying economy would not change at all.

However, having people storing cash paper notes at home is not what the government wants. So the bank guarantee of 100,000€ is supposed to fix that problem.

But what if the central bank provided electronic cash instead? And at the same time didn't have an upper limit on the amount you could store electronically? Then you can abolish the bank guarantee, and people can freely choose to put their money at the bank (presumably for higher returns) but also being aware that they could lose it all if the bank goes bankrupt. In some sense, people would become as careful when they invest in stocks.

In today's environment, and especially with 0% interest at your checking (and savings!) account, it could happen that most people would withdraw their money from the bank in digital cash (provided you could store it yourself safely.) But that's a good thing! Banks would then have to compete in order to attract customers putting their money at the bank as an investment and not as forced storage due to less attractive options.

The Chicago Plan

What I have said may sound revolutionary to you, but this concept is dead old. It dates back to the 1930s (and what happened during the crisis at that time.) Hard thinking academics (Irving Fisher, Earl Hamilton, Wilford King, et. al.) came up the idea which is later known as the Chicago Plan. Digital cash didn't exist then, but the Chicago Plan did something very similar.

By implementing another banking network, where banks were not allowed to create credit (i.e. no Fractional Reserve Banking or FRB) people could store their money at no risk (precisely because there's no FRB.) The interest paid on this money could be inflation matching and provided by the government, so its purchasing power doesn't drop over time. If people can use these banks to make payments, transfer money between people, then the other (FRB) banks are only institutions where you can invest your money for higher returns, but with the associated risk of losing it all. The Chicago Plan also controlled the creation of credit, but I don't think it's that necessary as long as people are fully aware that you can lose all your money if deposited at a FRB based bank.

The reason why the Chicago Plan proposed a network of new banks instead of letting every citizen having an account directly at the central bank is due to privacy concerns. The idea of a separate network of non-FRB banks is to decentralize the financial records of the citizens.

The Road to Bitcoin

A state controlled banking network, to ensure they are not practicing FRB, sounds... expensive. Think about all controls, regulations, computer software, computer network security, audits, the staff to be paid to run these operations? And how do you ensure that the government is maintaining this with proper updates in an environment where no competition exists?

Although we have some way to go, bitcoin is digital cash in its purest form. It's so pure that it is digital gold. The reason for the latter is due to the strictly controlled money supply reaching a maximum of 21 million bitcoin around year 2140. Some economists complain that this is making bitcoin a horrible currency. Quite the contrary. It makes the perfect currency. Here is why:

  • Policy free. Everybody buying bitcoin knows the rules. Market loves predictability. It can't be more predictable than that.
  • Like cash: no intermediaries. But unlike cash: it's completely borderless. I can load a virtual truck with a ton of virtual gold and ship it to the other side of the Earth and it will arrive in 10 minutes.
  • Programmable. Bitcoin has a scripting language that recently got enhanced. The scripting language enables new innovations on top of the blockchain to support micro-payments (Lightning Network.)

So what about loans? No problem. As long as you find someone willing to lend. Interest rate? Market driven of course. If the world's global productivity is increased by 2%, then any project/company that couldn't match that wouldn't be funded. Is that a problem? No, that's a good thing. It ensures that crappy companies won't get funding.

But my secret love for bitcoin is none of the above. Instead what I find interesting is the separation of money from the state. If the state cannot print money (disguised as "issuing bonds" or "QE - Quantitative Easing",) then it has to acquire money on the open market. Therefore, to raise income it would have to 1) raise taxes or 2) ask for loans on the international market at a real market risk valued interest rate.

And no more inflation. Money becomes market driven. If you mistreat, you'll get punished. This is true for individuals, households, and in this model, including governments. There's no "secret inflation" or constant "higher debt" that governments can use to compensate for budget deficits. If your government can't handle the budget, there'll be incentive for people voting for politicians who would.

Remember that central banks are institutions that consistently fail. We don't need them. We can replace them with technology. The road has been paved and it's nice and shiny. You can choose to walk this road, or (front) run it.

Datavetaren