Teaching You How to Fish the Markets, Part VI

May 6th, 2013 | By Shah Gilani

Our last chapter was about how the U.S. Federal Reserve was created and why. But it ended with an extreme example of how the universal central banking model works today.

Cyprus.

As another domino threatened the house of cards holding up European banks, more money had to be pumped into Cypriot banks so their doors didn’t close and rapid contagion wouldn’t implode all of Europe, and then the world.

Only this time was different.

The ECB reached straight into Cypriot bank depositors’ pockets and stole about $6 billion from them. The “how” isn’t important. It’s a simple equation, as revealed in Part V. Governments are the backstoppers of central banks; that’s where their authority ultimately comes from.

Why did the ECB steal depositors’ money? So they could turn around and lend that and more to the insolvent banks to keep them alive. It’s the latest twist in the old “extend and pretend” game.

The big question is, how did banks get so big and so dangerous in the first place?

Or, how did stodgy traditional banking morph into “casino banking” on a global scale?

Here’s how it started…

It’s all based on the American model.

With the Federal Reserve set up as the “lender of last resort,” U.S. banks prospered.

The end of World War I provided banks with a huge opportunity to lend money to European countries, both American allies and to defeated Germany. It was a tidy arrangement for them, on account of de facto U.S. government backing of the loans and Germany’s forced reparations payments.

Meanwhile, back home, the Roaring Twenties were in full swing. Money was plentiful in the form of cheap margin. It took only a 10% down payment to dabble in rapidly rising stocks. Speculation and stock manipulation schemes became rampant.

The bubble burst in 1929. Then wrong-headed moves by the new Federal Reserve, who tightened credit in response to former lax conditions, were compounded by unwise government tariffs that strangled global trade.

The result was America’s Depression.

Bank reform was a huge part of President Franklin Roosevelt’s New Deal to get America back on track. It included separating deposit-taking commercial banks from securities trading investment banks and spawned the Federal Deposit Insurance Corporation to safeguard depositors.

Meanwhile in Europe, Germany couldn’t make reparations payments and resorted to printing money to make do. Massive inflation in Germany led to a collapse in standards of living and the rise of the Nazi Party.

At the same time, Japanese militarism was on the rise. So was Japan’s increasingly acute need to access oil reserves, which it didn’t have and needed to power its industries.

America’s entry into the War woke up its animal spirits and transformed the country into an industrial juggernaut.

After the Axis powers, Germany, Japan, and Italy were defeated, U.S. banks were the only banks in the world in a position to lend, and again, with the de facto backing of the U.S. government, they recapitalized industries and countries across the globe.

The 1950s in America were heady growth days. Corporations were mushrooming rapidly, helping to expand the middle class as they prospered together. Europe was rebuilding, and Japan was using U.S. aid to build factories to manufacture cheap export goods.

As we entered the Go-Go ’60s, huge and growing deposit-taking commercial banks would come face to face with their grossly undercapitalized investment banking cousins and find themselves – and their profitability – under direct attack.

What happened next changed banking forever.

Understanding exactly what happened, why, and how will change your understanding of what banks really do and how what they do affects you and your ability to make money in the landscape they dominate.

Thursday’s chapter will lay it out for you. You’ll immediately see the hidden hand you knew was always there. From there I’ll take you upstairs and show you through the cameras watching you how the casino floor is rigged to benefit the house…

And, of course, show you how to beat them at their own game.

Shah