But the banking system is meant to be Rigged….(aka Vijay Mallaya, Nirav Modi)

So how is it that these big corporate houses run by the likes of Vijay Mallaya and Nirav Modi are able to get loans which are beyond their reach, loans for plans which don’t even make business sense and eventually commit and get away with financial frauds worth billions of dollars.

In my opinion, most of us don’t understand the concept of modern banking. But before we try and understand money and banking, we must understand the system which existed before it.

Brief History of Money 

Money is known to be the most efficient system of mutual trust, universally. It enables us to cooperate effectively in trade and industry. But money is essentially a medium of exchange and is based on the principle of trust. Even today, the currencies around the world mention ‘guaranteed by central bank’.  After many experiments with barter systems and then precious metal coins, the invention of paper money came into existence in the 17^th century in France. As the number of transactions between humans increased we invented paper money which was easy to carry around and transact with.

Global Currencies: After the end of WWII when America established its supremacy over the Europe, the US dollar was chosen to be world’s reserve currency which gave birth to the gold standard. The gold standard required all major currencies to be tied to the dollar at a fixed rate and because most of the gold was held in the US vaults the US dollar was backed by gold at a fixed rate of $35 per ounce. However, the gold standard system only lasted for 25 yrs and was abolished by US president Nixon in 1971.

Fictional Money

With this move no currency was backed by anything of value, which in turn gave birth to FIAT currency. FIAT an Italian word which means a currency by force or authority, a currency which is represented by legal tender and is backed by nothing except government promise. So government had the right to create money out of thin air and people have no choice but to accept it, which gave rise to problem no. 1-

In order to raise funds (in case of fiscal deficit) the governments resorted to printing money and issuing unlimited amount of money with only government bonds or securities backing it. So in India for example RBI is a prime buyer of bonds as it prints money and buys these bonds which increase the money supply through which government’s deficits are financed.

The 2^nd main problem is the fractional reserve banking system, which is the basis of banking across the world. FRB is a system where the bank is required to maintain only a fraction of the deposit liabilities, which means, that the bank can effectively maintain a balance of lets say only $10 and lend $100, invest, give loans and also earn interest on it. According to FRB system US and India have to maintain a 10% reserve ratio.  

So imagine, money which gets printed out of nothing by the central bank can further be lend at rate fixed by the central banks and the retail banks can profit from it. It might sound like a joke but that’s how most of the banking across the world operates. Infact some countries like the UK, Canada, Australia don’t have any  reserve requirement. Also imagine if any ordinary person was to print money like this, they would be jailed for doing so, but not the government. There are ofcourse other major hazards to this system, one of them being- In case all its depositors ask for their money back, the bank will go bankrupt instantly. In other words, all banks actually for all practical purposes are BROKE, as the banks have only 10% as reserve and cant afford to return all its depositors back at the same time.

The Crony Capitalism

So how has this scandal been going on for so long? Well we all have a role of play in it, but majorly it is backed by the politicians and the central bank which obeys the order of the government. So for instance many governments across the world raise funds for infra projects from central bank by simply printing it. And in case the projects fail, or are delayed or the banks go bust due to NPAs, the tax payers picks up the tab for it. Yes thats u an me. Paying taxes and getting penalized for this reckless game which someone else is playing. But like I said we too have a role to play in it and it’s a vicious cycle. This easy credit is usually given out to businesses to spur economic growth, without (the so called) growth, economics will not prosper and if economies don’t prosper the politicians will be voted out of power. Over the last decade the banks and the government have been frenziedly printing money pumping in cheap credit into economics. As a result, countries are sinking their economies into big debt traps e.g. the US had $21 trillion debt in 2017, which was 92% of its GDP. Japan has the highest debt at 255% of its GDP.

So is it really surprising that the likes of Vijay Mallaya and so many others get away with the easy money handed out to them as part of this reckless and vicious cycle.  Some also blame it on ‘crony capitalism’ where business houses fund politicians and the politicians pay the business men back. In short, the powerful RIG the system in their favor till the time they are not caught red handed.

Consumerism, capitalism and our human greed is making this cycle even more vicious and no politician seems to be having a solution for it, even politicians with good intend. We too are the victim of the system because of our own ignorance. On the other hand, people who understand it, inside out, they rig the system and rule over the ones who don’t really understand it.

Future of Money

So what does the future hold for us?Is there no hope for the ordinary citizen? Or are we trapped in own creation?

Its difficult to predict the future but till the time central banks are controlled by the governments, its will not be easy to get out this trap. However, the future might be a ‘bit’ different.  Technology can be the game changer. For example BITCOIN, which is a payment system and currency in itself. Bitcoins are completely virtual coins designed to be ‘self-contained’ for their value, with no need for banks to move and store the money. Bitcoin cannot be created out of thin air, and is free from any government interference. Bitcoin is also based on trust as the transactions are constantly verified by minners.

In short, the future of money and transactions is at the threshold and will surely change as the pressure on the monetary system increases and the debt levels in countries mount. The money market too is likely to experiment with many forms of currencies. In Israel, for example, there are some 87 alternative currencies that can be used for various transactions.

One thing is for sure that the traditional form of banking controlled entirely by the central banks and the government is on its way out. People will demand for more transparency and higher accountability for their money from the governments so that Vijay Mallyas of the world are not able to rig the system and get away with it so easily.

Something highly disruptive is on own its way in next 5-10 years, are we game??

It's only a catch up game for India now (vs china)

Great news! India's GDP grew at 7.5% last fiscal year compared to 6.9% in 2013-14 and 7.6% in the fiscal year 2015-16. Whereas China is facing a major challenge in terms of slowing economy and a lower GDP rate of 7.3% last year-2015, lower than that of India. It's called the new normal for China's overheated economy and its anxious trading partners.

The Stock markets around the world keep fretting over the fact that the Chinese economy might have a hard landing, whenever there is some bad economic news flowing in from China. The reported GDP of 6.2% in Q2 2016 rate is among the lowest in a quarter of a century for China. Moreover, these high growth rates experienced by China in the last 2 decades were impossible to sustain over a longer period of time. 

In the first decade of this century, India’s growth reached a take off stage that prompted many people to ask when India would catch up with its neighbour. It was also thought that democratic India may even overtake Communist China. Will that dream come true? 

Parallels not so long ago

Here’s some background to both the counties. China and India, despite being countries with such populations, both accounted for only 4.5 per cent and 4.2 per cent of global GDP in 1950 in Purchasing Power Parity (PPP$) terms. The ratio of China’s GDP to India’s was 1.18 in 1913 ($241 billion/$204 billion); and in 1950 it was 1.08 ($239 billion/$222 billion). Estimates of per capita income made by Angus Maddison and Dharma Kumar suggest that India might have had a higher per capita income in the 50s. However, there was not a marked difference in the level of human development. But what china did in terms of reforms in their economy from 1979 onwards, made them surpass India by leaps and bounds.  

Deng China’s Premier opened China to foreign capital while making room for the growth of villages and local enterprises. Jiang Zemin, Hu Jintao and now Xi Jinping have continued to follow Deng’s principles, but with some adjustments. China’s economic growth was also made possible by a very large net inflow of foreign direct investment, a sign of confidence in the Chinese economy by outside investors. China is the leading nation in exports and the second largest economy in the world.
The country’s per capita income more than quadrupled, ($5,720 equivalent to about PPP $13,000) and abject poverty was completely eliminated. In comparison India’s per capita PPP is only 5350. This is in comparison to 1980 where both country’s PCI was equal, approx $990.

Evidence lies in the numbers

Some simple maths will make things more evident that India cannot beat China atleast in next 25-30 yrs. China is a $10 trillion economy compared to India $2 Trillion as of 2015. Lets say if India GDP grows by an impressive 8% and China by a sluggish 6% even then India will only add a mere $160 billion to its $2 trillion economy every year where as china will add $ 600 billion to its $ 10 trillion economy every year.

So going by the current rate of 8% economic growth India will reach $26 trillion by 2035 whereas china growing at 6% will reach the same 12 yrs earlier i.e.by 2023.

In last 35 years, China has outshined India in all areas expect for software exports. Even now China is building infrastructure including 200+ new Airports, high speed train network across the country which is touted as the biggest infra project in the world ever, road network which promises to reach 90% of its villages and expressways which have already surpassed the overall length of American Interstate highways. In contrast, India builds 15 kms of road per day where as China builds 35 kms of expressway along in a day, doesn’t have a single high speed railway, low quality of roads which only add to its woes and costs and has an awful power and energy infrastructure.

The bigger picture

China’s new economic silk route is another growth story which started in 2013. This 'belt' includes countries situated on the original silk road through Central Asia, West Asia, the Middle East, and Europe. Sensing that the domestic growth will eventually slow down, the Chinese government is targeting $ 2.5 TRILLION trade within a decade through the new silk route. China’s collaborating with the central Asia governments and exploiting their natural resources like gold mines, coal mines, oil and gas, and several of their mineral resources. It doesnt stop there, Chinese are taking over Africa in a big way too.South China sea is slowly been taken over by the china to build a military base and exploit it's rich natural resources including 11 billion barrels of oil.

However its not all good for china at home and abroad. There is public anger against china for exploiting human capital, low wages, sabotaging human rights, land grabbing by force etc. Trouble in their financial markets, a huge property bubble, rising wages, a declining young population, serious environmental issues and the costs associated with it can further slow down their growth and create upheaval in their financial markets.

India’s biggest strength lies in its human capital. It needs to focus on increasing its productivity levels and its skilled manpower. It’s a good time for India to open up its market, apart from cutting red tape as its entrepreneurship gathers pace. According to the present Indian Finance minister India needs an investment of $ 1.5 trillion in the next ten years in infra sector alone. But even in a best case scenario if India manages to grow at 10% annually still India will only reach $26 trillion GDP which china will cross by 2022. 

India will have to do a lot more, else i don’t see it catching up with china in many decades to come unless there is a major failure of sorts in china.

Statutory warning: I am not an anti-nationist, only realistic! Jai Hind!

Yes, the World will repeat 2008 Financial Holocaust

So have we learned the important lessons from the western financial crises in 2008. Or are we still likely to repeat the same mistakes in the future. In all possibility, the world will repeat 2008 and here’s why…

Its been told to death through documentaries, articles, experts, research papers etc. But I have been anxious too, to tell my version of it. A bit late in the day but never too late, I guess.

We are all aware of the sub prime crises that shook the financial world. It was one of the biggest financial crises of all times which took with it, organizations like Lehman brothers. Lehman Brothers which the fourth largest multi billion investment bank in US, with total assets worth $643 billion and debts of $613 billion, when it filed for bankruptcy in 2008. But this was not the end, only the beginning- Bank of America, Northern Rock of England, Fannie Mae and Freddie Mac of US are just a few list of companies which either went bust or had to be rescued by their governments. We all know the consequences of what happened after that. The Global economy crashed and still hasn’t recovered fully.

So, how did the financial system and the banking system which is supposed to be the backbone of any economy ended up breaking that very backbone. How did something like a banking system which is built on trust and trust alone lose its core values. And why do I think that this will happen all over again.

The history of it.

During the crisis of 2008 some of the economics were affected more than the others. China for example was unscathed and continued on its growth path. India also escaped unharmed and largely unaffected, although the economy slowed downed considerably. Lets step back a bit a and see why that happened. All economies work differently with different ideologies. There are three major types of economic systems which are followed by most of the countries. First, a mixed economy where the state government and the private sector participation is mixed, example India. This is also the most common economic system. Secondly, Command and control, where in largely the key sectors and investments are driven and controlled by the state, example China and Cuba. Thirdly, free market where the state intervention is the least and private sector participation is maximum. These markets are also the least regulated and business decisions are largely driven by desire for profit and pleasing the shareholders, eg. America, UK. 

So if the markets are less regulated and desire for profit drives the biggest of corporations including the banks, greed and vested interest are bound to take over the general well being of consumers. Example,  the financial crises itself. The boom in the real estate industry after the 1970’s in US and the changing socio-economic equation was the real opportunity for the banks in the US. Nuclear families and growing incomes led to the desire of owning their own homes. Many did and the ones who could not afford due their low incomes were left out but still felt the need to buy their own homes. 

Sub prime loans were given to consumers from late 1990’s till 2008 who had negative credit ratings, low incomes and instable jobs. Banks pushed home loans at higher interest rates to people who just couldn’t afford to re-pay them back. Big profits were made by the banks by lending money at higher interest rates to these sub-prime borrowers. These loans were further packaged as derivatives by very clever bankers and sold as CDOs to financials institutions, which were further sold to end users. So where did all this actually go horribly wrong.  Simple, sub prime borrowers started defaulting as their already instable jobs started to give away and they were no longer able to borrow because of their fragile credit ratings. Defaults starting happening in large numbers and it all fell down like a pack of cards. 

It is an open secret (well now its not even a secret) that the bankers knew exactly what they were doing and they colluded with the statesmen to keep this going for years. Ofcourse, the congressmen were paid huge sums to keep the liquidity tap open. Its also no secret that the politians are auctioned like the IPL players and big corportes houses bet on the most electable Politian on the condition that they have to pay back the corporates when the time is right.

Over the last 10-15 yrs bankers and top executives have been paid huge bonuses to push complicated financial products to consumers who did not understand much about them or were not explained much of it. Not surprisingly, many of the bankers became millionaires overnight from the huge bonuses they received by selling these derivates to naïve customers. The greed game consisting of politicians and bankers went on till it went all out of control. It was a game similar to the one in a big casino, where, one sometimes starts the game with winning big money and ends up losing everything by the end of it, e.g. lehman brothers.

So the question which really bothers me is that what has really changed in the last 5-6 yrs which will make us less greedy. What has really changed which will stop us from betraying people’s trust and play recklessly with their hard earned money. What regulations have been put in place by the governments to cap the bonuses of the bankers and top executives, Infact immediately after the US government bail out in 2009,the banks which were rescued doled out $33 billions in bonuses. Has there been a change in the way the Politian’s are elected and the elections are funded. Yes, maybe the banks have tightened their grip on credit and they are being more selective about giving credit to their customers but is that enough?

In next 5-10 yrs when the global economy will be in a much better shape, all will be forgotten and our sins will come to haunt us back, yet again. Mr Michael Douglas….GREED IS NOT GOOD. As the Mahatama said- There is a sufficiency in the world for man's need but not for man's greed.