ECONOMICS AND THE CITY

The how and why of bank failure

Harry D. Schultz

Why have banks been tumbling lately, and why is there worry over more bank failures? Well, there are many reasons, which I have mentioned in my newsletter in the past (such as bad lending practices and bad screening of loan applicants and overlending) but another negative element has entered the scene, the precise ramifications of which are unknowable. Bankers have become the new gunslingers.

You recall the bad old days when the term was applied to a very Young group of analyst traders, centred in New York, who cashed in on a bull market by being bullish. And taking risks that would be unjustified in a normal market climate. They were often ninety-day wonders. They faded when the bull market faded. The beardless gunslingers were relegated to a mythical Boot Hill when their shootfirst-ask-qtiestions-after tactics caused leverage to turn viciously against them. The easy-come money was suddenly easy-go. Now the gunslingers are back, not always by choice however. What happened was that currencies have become as volatile as stocks — so you must expect bankers to behave like stockbrokers, and the more speculative minded to be outright gunslingers.

When a currency has little or no backing any more, when there is no stable value, behind it, then upon what do you base its value? On exactly the same things by which you measure stocks — i.e. the projected earnings of a country (balance of payments) and the divi

dends (interest rate). It is a pathetic ; epitaph on the grave of the defunct monetary system, in whose wake we have only ad hoc arrangements, wherein a man or a company or a major bank can go absolutely . bankrupt simply by doing business in the wrong currency.

It was the Arabs' oil price squeeze crisis which resulted in national deficits that exposed the gunslinger's role and let us all see just how vulnerable the whole system is. Has the view come too late?

The foreign exchange departments of banks would have to be staffed by super-geniuses and get a flawless information input and have supreme judgement, to make generally unerring decisions on currencies they trade in every day. Thus losses are incurred in every bank (yes, I said every bank, without any exception of any kind), through no fault of the bank — but because of the impossibility of guessing right on every exchange rate, which not only move up to 4 per cent in a single day, but also can reverse themselves and then reverse again. Foreign exchange dealers have my deepest sympathy; they are being required to do the impossible.

However, some bank foreign exchange dealers (like some stockbrokers) get carried away with their opinions of the future course of certain currencies (become a bull of dollars or a bear of DM, francs etc) and extend themselves (and their banks) accordingly. If the guess is wrong, millions are lost. If the position is not quickly closed out for fear of taking of the loss — while hoping it will be reversed — more millions are lost. It can result (and has lately) in bank closures and/or emergency mergers or government subsidy. (Banks must also monitor clients trading in currencies.) The simile between stocks and currency is further enforced by use of margin. In 1929 a major cause of trouble was excessive credit or margin buying. In the sickening 'seventies this margin is in currencies. Often only 10 per cent cash backs a currency contract, $10,000 on a future. With floating rates and faithless currency, this margin should be 50 per cent, says my banker friend, Rudi Kraus, and I agree. But, like 1929, it may be too late to avoid a financial panic and bust.

Risks today are higher than ever in man's history. If you put cash in a bank you risk loss through a currency rate change, and also through violent inflation, and also on the viability of the bank itself. A triple threat. Stock and bond markets have crashed far beyond 1929's fall. Commodities have given some value, despite a sell off from the peak. But silver and gold have afforded the best haven. Even the sharp correction in the precious metals has left investors relatively better off than in any other investment. Early investors here have enormous gains.

When stocks fluctuate in a free market it is capitalism reflecting supply and demand. When money in international markets fluctuates like stocks (and as money is government controlled — i.e. a na

tionalised industry), are we perhaps seeing nationalised capitalism?

Currencies are now no better than commodities. Floating rates make it possible for cash to move sharply, whereas previously fixed rates limited rises and falls. This is not, however, to criticise floating. That would be like criticising a thermometer. It's the absence of backing to currencies these days which makes them faithless paper. Paper money was after all first created only as a warehouse receipt for a valued commodity (gold, silver) which was on deposit. It was to save the bother of carrying heavy coins and to facilitate large sums in small weight. But when we get so far away from the original purpose of money that the paper itself is the money and the valuable

backing is discarded, then we live ih a desperate society, subject to gross injustice on all fronts, notably to legalised government corruption (political and monetary) and rule by whim. The fruit born by this bitter tree is anarchy. Democracy and capitalism are both fast losing strength, if not actually dying.

Mob rule and/or socialism are increasingly filling the vacuum. I contend that all evil springs from destruction of monetary value and stability, for society is built on equity through an ability to bank 'stored sweat' — which gold is and money should be — and is when backed by gold and convertible into it.

Dr Schultz is the publisher of the International Harry Schultz Letter