One hundred years ago today, J.R. Hulse of Greely Colorado and E.B. Rogers found themselves in Sheriff's custody for passing bogus checks in Denver Colorado. They had carefully lithographed checks from one Imperial Tire Company (a fictitious business) drawn against the First National Bank of Oakland and, having succeeded in their scam twice, were finally brought to justice. At the same time (albeit hidden until the Special Committee on Investigation of the Munitions Industry chaired by North Dakota Senator Gerald Nye in 1934) U.S. banks were funneling money to both sides of the European warring foes in World War I. Democratic Appropriations Committee Chairman Carter Glass from Virginia was infuriated in what he referred to as Nye's defiling "the sepulcher of Woodrow Wilson" by suggesting that U.S. banking interests in 1915 may have been profiteering from the war and exercising undue influence on the President to enter the conflict. The facts presented in hearings showed that the U.S. entered the War as much for profit as for ideology.
In the March 16, 2015 Financial Times, two articles featured the U.S. and European apprehension regarding banking in China. One of their greatest concerns at present is the recommendation from Chinese regulators that IT security systems for banking transactions be research, developed and deployed in China. The handwringing over the fear that Chinese participation in IT security equates to inviting surveillance and intrusion into the transparent Western banking system is great theater but masks the occult supervision that has persisted since the Bretton Woods accords.
A recent report by Goldman Sachs reported a vertiginous expansion of "shadow banking" in the U.S. The report written by Ryan M. Nash and Eric Beardsley suggested that this financial intermediation function could divert $11 billion in profits away from traditional lenders over the next 5 years. Competing with traditional banks through decreased regulatory and compliance costs, lower interest rates, and more precise offerings which can be highly mutagenic based on customer segmentation, these institutions and service providers are changing the face of banking 100 years after the current system was coronated.
Late into the evening on Friday of this past week, I entertained two gentlemen who were proposing a social gaming platform on which players could educate themselves on how banking and the money supply work. During our conversation, the very essence of fractional reserve banking was elucidated only to open a hemorrhage of inquisitive probings into why the current system doesn't seem to be working. Apropos to that conversation, the weekend media was awash with handicapping Janet Yellen's decisions at this week's FOMC meeting. Unemployment is manipulated to an appropriate level. Consumer spending is down. The dollar is charging like a mad bull at Pamplona. And investors are "pressure testing" bond portfolios for the ominous sell-off that's either one or two fiscal quarters away. No worries, there's only $1 trillion of pension value at stake. Looks like that vacation in Florida might just have to wait for another lifetime!
So here's a question. Why do we call a financial intermediation system in which transacting parties know details about each other, have transparent terms, and exchange actual value a "shadow" system implying that the current system operates in the "light"? One could suggest that PIMCO's Paul McCulley's 2007 derogatory label to transactions outside the regulated commercial banking market was intended for dramatic effect but that it further obscured the commercial banking opacity in the public arena. In their well researched article in The Regional Economist in October 2011, Bryan Noeth and Rajdeep Sengupta describe the role of the regulated bank as the agency of maturity transformation (analogous to my persistent reference to money as a collective trust-fueled time machine). Regulated banks, given their capacity for relative value asset transformation - the ability to take a fraction of deposits and expand them into a plethora of illiquid asset value through debt - can do things that "shadow" institutions can't. But, hold on a minute. Might this be a good thing? Might it be good for us to develop value exchanges built on consensus asset value rather than on deposit-leveraged capital expansion?
And, back to the FOMC meeting, isn't it the case that one of the reasons why the Fed is so hamstrung with its absence of options is because it has to choose between destroying illusory value created in mortgage instruments by "light" lenders and raising interest rates which, while increasing the attractiveness of depositors, will highlight the absence of real asset value across the economy?
Ninth century BCE Chinese were careful observers of light and constructed elaborate pictographic representations of the interaction of light and darkness. The concept of a shadow - the maternal, the North face of a mountain which was not exposed to the sun, or what we now refer to as yin - did not connote mystery, nefarious, and illusive. In fact, in calligraphy and philosophy, the concept of "shadow" was understood to represent the interface between diffuse light and static form. In other words, the idea of shadow was the recognition that opaque geometry provided an increased precision; a more clear edge of illumination if you will. Our current commercial banking system - with it's Fed dependency, it's market manipulating depositor seduction apparatus (the FDIC), and it's asset value inflationary effect - is NOT light. And the reason why investors are sitting on pins and needles about this week is because there's not even a candle in the window telling us what is coming. It's possible that the "shadow" system - a system in which real value is really exchanged - may finally illumine the pathologies in our teetering 100 year-old fractional experiment and we might step into the Light.