Some Monetary Lessons from Cyprus
03/19/2013 1:22 PM Cullen Roche
The Cyprus debacle continues to expose serious flaws in our understanding of money. Specifically, Cyprus highlights three key important lessons about money:
1.Money is built around trust. Without it, money is useless.
2.A nation that cannot create its own money or lacks monetary unity is at a substantial (and unnecessary) economic disadvantage.
3.Modern money, being mostly electronic records (at banks), is inherently fragile.
1) Money is a social construct that we create in order to more conveniently transact business. I like to think of money as having “moneyness”. That is, anything can serve as money, but the trouble with money is getting others to accept your money as a final means of payment. Some things are more widely accepted than other things as a final means of payment and therefore serve as having a higher level of “moneyness” than other things. Gold for instance, has a moderately low level of moneyness because it is not widely accepted. Electronic bank deposits, however, are accepted at most businesses for final payment and therefore have a high level of moneyness.
Modern money is mostly electronic money that is regulated by the government and organized through a complex payments system that is dominated by private banks who compete to issue money as debt. We use this system because it is organized, regulated and technologically advanced (ie, it’s better than lugging around gold bars as a medium of exchange). That means the system is built in large part on trust. We trust that our electronic records will be maintained accurately and that the integrity of the system will be upheld both by the entities who compete to run this system as well as the regulators who oversee that system. When the system begins to appear fragile or chaotic (as is the case in Cyprus) the very cornerstone of money begins to buckle.
2) The Euro crisis has exposed the great flaw in the Euro’s design. That is, the nations are very similar to states in the USA in that they are users of a currency without a floating exchange rate. Therefore, there is no rebalancing mechanism should a systemic disequilibrium occur (like trade imbalances for instance). In the USA, there is political unity that allows a federal entity to collect funds from all of its participants in a rather unequal fashion. That is, the rich states pay more into the system than the poor states and the poor states get an unequal amount of the funds via this federal entity every year. That eliminates the risk of a solvency constraint for the poor states who would otherwise become increasingly like Greece over time. In other words, redistribution powers the USA from becoming like Greece. I know “redistribution” is a dirty word in some circles, but it’s as American as apple pie in the case of our monetary system’s design.
Europe’s nations not only can’t produce the currency that would eliminate the risk of a solvency crisis, but also do not have the advantage of this system of redistribution. The result is solvency crisis and severe austerity that doesn’t come with the help of federal funding.
3) Money is fragile. We like to think that money is something we can touch or feel, but I think paper bugs AND gold bugs are wrong. Yes, money CAN BE a physical thing, but today’s money is mostly just records in electronic ledgers. That’s disconcerting to many, but the natural evolution of money from unspoken bonds (apes for instance, have been proven to use modern forms of intangible money as promises) to physical things (like the gold standard) to the current electronic system.
Our money is created almost entirely by banks who compete to issue this money as debt. So the value of our money is distributed by entities who are inherently profit driven which can create an inherent instability if it is abused by these entities or its users. We must better understand this reality so that we can understand the essential elements that make our money system function. Contrary to most economic thinking these days, money is not something that is “multiplied” or originates with the government. It originates with private entities INSIDE the banking system.
Once we understand that money is fragile we might be more cognizant of the reality that it not only requires some oversight. but must be protected not only for the sake of individuals, but for the sake of the society that relies on its existence.
Statistics: Posted by yoda — Tue Mar 19, 2013 6:14 pm
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Daniel J. Mitchell
It doesn’t create a lot of confidence in Europe that tiny little Cyprus, with a GDP less than Vermont, is now causing immense turmoil.
Though to be more accurate, events in Cyprus aren’t causing turmoil as much as they’re causing people to examine both government finances and bank soundness in other nations. And that’s causing anxiety because folks have taken their heads out of the sand and looked at the reality of poor balance sheets.
Looking closer at the specific mess in Cyprus, an insolvent financial sector is the cause of the current crisis, though the problem is exacerbated by the fact that the government has dramatically increased the burden of government spending in recent years and therefore isn’t in a position to finance a bailout.
But that then raises the question of why Cyprus is bailing out its banks? Why not just let the banks fail?
Well, here’s where things get messy, particularly since we don’t have a lot of details. There are basically three options for dealing with financial sector insolvency.
- In a free market, it’s easy to understand what happens when a financial institution becomes insolvent. It goes into bankruptcy, wiping out shareholders. The institution is then liquidated and the recovered money is used to partially pay of depositors, bondholders, and other creditors based on the underlying contracts and laws.
- In a system with government-imposed deposit insurance, taxpayers are on the hook to compensate depositors when the liquidation occurs. This is what is called the “FDIC resolution” approach in the United States.
- And in a system of cronyism, the government gives taxpayer money directly to the banks, which protects depositors but also bails out the shareholders and bondholders and allows the institutions to continue operating.
As far as I can determine, Cyprus wants to pick the third option, sort of akin to the corrupt TARP regime in the United States. But that approach can only work if the government has the ability to come up with the cash when banks go under.
I’m assuming, based on less-than-thorough news reports, that this is the real issue for Cyprus. It needs taxpayers elsewhere to pick up the tab so it can bail out not only depositors, but also to keep zombie banks operating and thus give some degree of aid to shareholders and bondholders as well.
But other taxpayers don’t want to give Cyprus a blank check, so they’re insisting that depositors have to take a haircut. In other words, the traditional government-imposed deposit insurance regime is being modified in an ad hoc fashion.
And this is why events in tiny Cyprus are echoing all over Europe. Folks in other nations with dodgy banks and unsound finances are realizing that their bank accounts might be vulnerable to haircuts as well.
So what should be done?
I definitely think the insolvent institution should be liquidated. The big-money people should suffer when they mismanage a bank. Shareholders should lose all their money. Then bondholders should lose their money.
Then, if a bailout is necessary, it should go only to depositors (though I’m not against the concept of giving them a “haircut” to save money for taxpayers).
But Cyprus apparently can’t afford even that option. And the same is probably true of other European nations.
In other words, there isn’t a good solution. The only potential silver lining to this dark cloud is that people are sobering up and acknowledging that the problem is widespread.
Whether that recognition leads to good policies to address the long-run imbalances – such as reductions in the burden of government spending and the implementation of pro-market reforms – remains to be seen.
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By Chris Edwards
Where is the best place in the newspaper to learn about how the economy works?
In today’s Washington Post the business section has the usual stories about Ben Bernanke’s manipulations, government debt, and regulatory issues. But there is little on the innovation and dynamism that is at the heart of long-run economic growth.
It is entrepreneurs who create growth, and they are often best covered in the obituary section of the paper. Today the WaPo has a Bloomberg story about the passing of Albert Ueltschi, “who founded aviation-training company FlightSafety in 1951 [and] expanded it into an international powerhouse.”
Here are a few highlights:
As pilot of Pan American’s first corporate plane . . . Ueltschi hit upon the idea of opening a testing and training center for the booming aviation industry in the 1950s.
That company today is FlightSafety International Inc., which bills itself as the world’s leading aviation-training company, teaching pilots, aviation mechanics, flight attendants, dispatchers and others each year.
After graduating from high school in 1934, he opened a hamburger stand and used the proceeds to take flying lessons. A year later he borrowed $3,500 to buy an open-cockpit bi-wing airplane, the Waco 10, and made it his next business venture. “I took people up for a dollar a hop, gave lessons, and even put on air shows.”
[I]n 1951, Ueltschi borrowed $15,000 by mortgaging his house and opened FlightSafety at LaGuardia’s Marine Air Terminal.
In subsequent years, Mr. Ueltschi worked his tail off juggling two jobs and building what would become a multibillion part of the U.S. economy. The government did not build FlightSafety. Nor did the government build the thousands of other firms and industries that comprise the bulk of the U.S. economy, such as the electric guitar industry, as I discuss here.
To revive the economy, we need fewer central planners like Ben Bernanke and more decentralized business-builders like Albert Ueltschi. We need more firms like FlightSafety and less like Solyndra. Both candidates for president are promising to create jobs, but what we really need is for the government to get out of way of the people who create companies and industries.
A Few Notes:
Here’s a brief history of FlightSafety and pilot training. As in some other tech industries, it appears that the government helped to boost the demand for this industry’s services. But the basic innovations and advancements were made by gutsy individuals taking risks in the marketplace.
A final note is that the Washington Post does run some articles on live entrepreneurs, not just deceased ones. For example, Thomas Heath’s column is often very interesting and inspiring.
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Lessons From the Full Tilt Ponzi
SATURDAY, AUGUST 04, 2012
In the midst of the Eurozone crisis and corporate bankruptcy scandals such as MF Global last year, a smaller-scale yet meaningful scandal went relatively unnoticed. This scandal erupted on what poker players now call "Black Friday" – April 15, 2011. That was the day when U.S. federal authorities unsealed indictments, seized the domains and assets of the three most popular online poker sites – Full Tilt Poker, PokerStars and the Cereus network (Absolute Poker) – and arrested the owners. Hundreds of thousands of U.S. poker players were locked out of their online accounts and separated from their funds.
Initially, the central charge against these sites and their owners was one of bank fraud and money laundering. While PokerStars was soon able to return money owed to players, FullTilt players have yet to receive the almost $350 million owed to them. In comparison, that’s about 30% of the amount that was looted from the wealthy clients of MF Global. After several more months of investigation, the U.S. attorney in Manhattan was forced to state that "Full Tilt was not a legitimate poker company, but a global Ponzi scheme".
“Not only did the firm orchestrate a massive fraud against the U.S. banking system, as previously alleged, Full Tilt also cheated and abused its own players to the tune of hundreds of millions of dollars,” [U.S. Attorney] Bharara said. “Full Tilt insiders lined their own pockets with funds picked from the pockets of their most loyal customers while blithely lying to both players and the public alike about the safety and security of the money deposited with the company.”
From 2007 to 2011, the owners and board members of Full Tilt received about $443 million in payouts while being well aware that the money owed to players worldwide did not exist and could not be paid out. This included payouts to such trusted names in poker as Howard Lederer, Rafe Furst and Chris "Jesus" Ferguson. Players with funds deposited on Full Tilt had every right to be outraged at this criminal behavior, but, then again, these types of corporate ponzi schemes should be viewed as business as usual in the global economy by now.
Every major bank in the world, including the ones that were allegedly "defrauded" by these poker sites (as if they couldn’t figure out what was really going on with all of the sketchily-named transactions they processed), operate on the exact same ponzi principles as Full Tilt. If the "Black Friday" poker disaster can teach us anything, it is that the money you have on deposit at your financial institution does not really exist and there will soon come a day when the banks, in conjunction with the government, prevent you from cashing out your deposits.
For some reason, most Americans still cannot envision such a scenario occurring, even though it has started occurring in Europe and has already occurred to hundreds of thousands of poker players here (as well as the clients of MF Global). They believe that, at the worst, restrictions will be temporary, losses will be minor and the government will eventually make them whole. Well, let’s look at what is now happening with the funds of Full Tilt players to perhaps get a glimpse of how these future "bank holidays" will play out.
Poker Players’ Association Repayment Updates
On April 15, 2011, forever known as "Black Friday" to the poker community, hundreds of thousands of US online poker players lost the ability to access their accounts on the major poker sites. Since that time the PPA has made it a priority to do everything it can to help those players get their money back. Thankfully, PokerStars fulfilled its obligation to its players and promptly returned their funds. Players on FullTiltPoker and the Cereus network were not compensated however. In July 2011 the PPA released the Player’s Funds Legal Guide in order to help players understand their rights and the various methods to assert those rights as the situation unfolded.
Now, 15 months later, another chapter of the saga has come to an end. As reported here the DOJ, FTP and PokerStars have finally come to an agreement settling the civil cases against those sites and paving the way for account balances to finally be returned. The PPA applauds the efforts of the DOJ and all the various parties for reaching this agreement and especially thanks them for making the return of player funds an important priority of the agreement. While details of the player repayment process, known as "remission of funds," are still not available, rest assured that the PPA will be working diligently to help ensure a fair and easy process for all parties. We have reached out to the DOJ with player concerns before and we will continue to do so. We also will be available to the DOJ to assist it wherever we can in terms of what either the PPA or the players can do to help make the process easier.
The remission process was discussed in the July 2011 PPA Player’s Funds Legal Guide and you can re-read that section to get a general idea of the process. But the specific details of how the process will be conducted with respect to the specific FTP situation are still being determined by the DOJ. The PPA will use this page to keep you informed of all the details of that process as soon as they are available. The PPA will also use this page to provide you with all the assistance it can to help you through this process if you were one of the players affected.
So bookmark this page, return frequently, and keep your eye out for notices of updates. The PPA will make sure the information is here as soon as it is available. Until more information is available the only advice that can be given at this time is to remain calm, gather all the information you still have regarding your FTP account (especially your screen name, your password, and the name under which the account was registered), and stay tuned.
This development was by far the best news a U.S. player with funds deposited at Full Tilt could hope to hear. After 15 months of separation from their funds, most players had been resigned to the fact that their money had vanished for good. Now, it seems that the acquisition of Full Tilt by an even larger online poker company, PokerStars, will make room for players to finally get their money back. However, it still isn’t at all clear what portion of money owed to U.S. players will be remitted or how long it will take for the process to complete.
In the PPA’s 2011 "Legal Guide" referenced above, they say the following:
It has been well reported and documented that contemporaneous with the filing of the April 15, 2011, indictments against the site owners and their payment processors, the Federal Government initiated substantial forfeiture actions against site assets and specifically moved tofreeze bank accounts used by the sites to hold substantial funds. Subsequently the Federal Government has taken legal proceedings to declare these funds forfeited to the Federal Government as the "proceeds" of illegal activity. Many players believe that a substantial reasonthey have not been paid as of yet is that these seized funds represent a significant amount of the sites’ assets, though exact figures are not yet public knowledge. So, players ask, how about seeking to get player money from the money seized by the Government? Answering this question is enormously complex, and whether and how to seek to do it (or not) will once againdepend on the specific circumstances of the individual player. For players to determine that answer for themselves, the basic principles of Federal Forfeiture must be understood and discussed with private counsel.
The only thing we know for sure is that U.S. players will have to submit a petition for remission of funds to the Department of Injustice once the details are finalized. So you have to ask yourself – is this the kind of frustrating, drawn-out and complex process that you want to go through to get your deposited funds from the bank? Are you willing to "stay tuned" for more than a year before the insolvent bank is acquired by a larger entity and you can finally petition that entity (or the government) to reimburse you, at anywhere from 100 to 50 cents on the dollar? Remember, this is really the best-case scenario when severely under-capitalized institutions go bust.
That is especially true if the owners are targets in a civil or criminal investigation, as is the case with Full Tilt. We can easily imagine a situation in which the Department of Injustice indicts a network of major and mid-level U.S. banks on various criminal charges for political reasons, but also as a means of giving those institutions an excuse not to pay out their depositors. Just like it did with Full Tilt, this play could go down after a bunch of board members and upper-level management at these banks have siphoned off billions in compensation, bonuses and redeemed equity shares (many of them already have).
And just like with the major poker sites, there will be one or two high-level guys that take the fall and the rest of the charges will be settled before any sort of trial. The major difference is – who will be able to rescue the assets of these banks and raise the funds necessary to pay out depositors? We are obviously talking much, much greater factors of losses than those endured by U.S. poker players. And as we know all too well, only central governments can step in to backstop these financial ponzi institutions. By the time such a rescue is necessary again, those government ponzis will have been bled dry by the corporate war machine as well.
I suspect that most Americans and Europeans with large deposits in the bank will easily see 25, 50 or even 100% of those deposits disappear into a black hole, and they will not be nearly as lucky as U.S. poker players in finding any "white knights" to reimburse them. If anything, they will have to wait a solid 6-12 months before hearing anything about how to go about getting their money back, and then perhaps another 6-12 months to actually get it. By that time, the state of the global economy and society will be quite nasty, and those funds may be useless anyway. What kind of capital restrictions will be in place across the Western world by then?
The only smart move is, and has always been, to get whatever money you will need over at least a year or two out of the bank RIGHT NOW. Despite their after-the-fact claims to the contrary, most people in the poker community had no idea how or when Black Friday was going to hit, and how extensive the ensuing monetary damage would be. All I know is that the poker players who, for whatever reason, decided to liquidate all of their funds before April 15, 2011 now look like geniuses, while the rest of us look like chumps. But I don’t really care what I look like… I just want to get back the money that is owed to me and learn from my misplaced trust.
Statistics: Posted by yoda — Sat Aug 04, 2012 1:30 pm
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