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Finance journalist (and News Weekly music columnist) David James explains how a major contributor to the runaway rise in housing prices in Australia has been the deregulation of the finance sector that has taken place over the past four decades. In Part Two, James will suggest how nations can restore orderly functioning to their monetary systems and bring their property markets back to proportionately reasonable levels.

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At the beginning of Dante’s Divine Comedy, comes this much-quoted line: “In the middle of the journey of our life, I came to myself within a dark wood where the straight way was lost.”

That is suggestive of what has been occurring, for over four decades, in global finance. A profoundly wrong turn was taken in the 1980s, and ever since it has not been possible to return to the “straight way”. Instead, an increasingly fragile financial system has descended into a series of crises that have repeatedly threatened its survival.

The mistake stemmed from an incorrect definition of what money is. The usual definition used is that money is a store of value, a way of transacting and a consistent vehicle for valuing things. But that is what money does, not what it is. Money is a system of rules, usually about value and obligation. As Aristotle commented, money “exists not by nature but by law (nomos)”. This is neither a new nor radical insight; it is rather a statement of the obvious.

Yet, in the 1980s, Western economies “deregulated” their financial markets. In Britain, it was called the “Big Bang” and there were parallel efforts in the United States and Australia. No one seemed to notice – or, if they did, they chose to ignore it – that the whole idea was nonsense, a contradiction in terms. If money is rules, and these rules are iterated as regulations, then how can you deregulate finance? It is like taking the hydrogen and oxygen out of water and still thinking it is water.

Consider cash. Unless physical notes exactly follow the rules set out by the central bank such as size, paper type, image and so on, they are worthless. Or consider the blizzard of rules that apply to mortgages or share purchases.

Profit Over People

So, if deregulation of finance is impossible, what happened? There was a shift away from government setting the rules – what is often demonised as government “fiat” – to private actors, profiteers, setting their own rules. (Fiat money is a government-issued currency that is not backed by a commodity such as gold.) It is a bit like players in a football game deciding to sack the umpire and making up how they want the game to be played. Then, when things inevitably go wrong, the players turn around and blame the umpire.

Thus, when financiers endlessly criticise the U.S. Federal Reserve and other central banks, they are, probably unwittingly, covering up the real truth. It is the financiers who are to blame for the mess, not the authorities. But we can be sure that the world really has come to an end when they start taking responsibility for their own debauches.

Private actors, unlike governments or financial authorities, never consider the whole system. They only follow their immediate self-interest. I doubt if they even entertain questions about the systemic effects of their activities – though, if they do, it is always someone else’s problem.

What problems did deregulation lead to? One consequence is that central banks effectively gave up control over the quantity of money. They are only able to control the cost of money, the interest rate.

Before deregulation in Australia in the early 1980s, governments could institute a credit squeeze, whereby they tamed inflation, or other excesses, by restricting the supply of money, principally by telling banks how much they could lend.

That is no longer possible. The banks can pretty much lend as much as they like, which has led to unlimited lending for housing. In a market with a rapidly growing population and shortage of new home builders, prices have soared.

How much the housing market has been inflated was revealed (again) in the most recent annual Demographia International Housing Affordability report, out of Chapman University. It says that, as late as about 1990, national median house prices were about three times median household incomes. In a well-functioning market, median-priced houses should be affordable to middle-income households. Today, Australia has some of the most unaffordable housing markets in the world. Sydney prices are 13.8 times median household income, Melbourne 9.8, Adelaide 9.7, Brisbane 8.1, and Perth 6.8.

Unable to control the quantity of money, central banks like the Reserve Bank of Australia have instead had to rely on interest rates to control their economies – or rather, fail to control their economies. It is a bit like trying to fight a boxing match with only one hand. You might fare alright for a while, but sooner or later your two-handed opponent will knock you out.

Disastrous Gamble

The excessive bank lending, which sparked intense asset inflation across developed economies, especially in property, was bad enough. Even worse was what happened in the foreign-exchange markets, where traders started making up absurd rules, turning what was supposed to be a forum for trade and monetary exchanges into an out-of-control, high-tech casino literally run by rocket scientists: high-level mathematicians who had worked for NASA.

These people exploited what are called “derivatives”, financial instruments derived from more conventional transactions. They were invented as a form of insurance, mainly in agriculture, in areas such as pork bellies, or grain markets. Farmers would take out a derivative, such as a futures contract, to ensure that the price they got when they sold was enough to justify producing the goods. High-tech financial traders massively expanded these derivatives markets using algorithms and high-speed trading. It is now at absurd levels.

According to the Bank for International Settlements, the daily turnover of the foreign exchange markets is over $US7 trillion ($A10.1 trillion). Less than 2 per cent of that is trade. To give some idea of the relative size, the world economy annually turns over about $US100 trillion (although GDP and derivatives turnover are not strictly comparable as they are different kinds of transactions).

In 2008, this absurdity reached its predictable conclusion when a derivatives crisis related to the U.S. housing market almost destroyed the global banking system. The global financial crisis (GFC) should not have been surprising considering the size of the derivatives trade, but it was very telling that financiers did not see it coming. All they cared about was their own profit, not the safety of the system.

The fallout from the GFC is well known. What is less advertised is that, according to Paul Kanjorski, former Democrat member of Congress and chairman of the subcommittee on Capital Markets, on one Thursday morning in September 2008, $US550 billion was drawn out of U.S. money market accounts.

Kanjorski said:

“The Treasury … pumped $US105 billion into the system and quickly realised they could not stem the tide. We were having an electronic run on the banks.

“They decided to close the operation, close down the money accounts, and announce a guarantee of $250,000 per account so there wouldn’t be further panic … If they had not done that, their estimation was that by 2pm, $US5.5 trillion would have been drawn out of the money market system of the United States and within 24 hours the world economy would have collapsed. It would have been the end of our political and economic systems.”

What Kanjorski did not say is that, finally, the U.S. authorities regulated instead of relying on the markets to self-correct. Of course, that lesson was not heeded, and the folly persisted. As the late Colin Teese pointed out in News Weekly in 2018, the Federal Reserve’s bailout of the banks reached US$29 trillion.

The Present Moment

Where are we now?

In Australia, the deregulation of banking has left us with a society divided: split between older people who bought property when it was reasonably priced and younger generations who will either spend their lives paying off bank debt, or never be able to afford to buy.

It has been estimated that in Sydney, it would take over 46 years to save for a house deposit on an average home. On that basis, a 20-year-old can expect to have saved enough for a deposit by retirement.

Worse, as the Reserve Bank uses its “one hand”, interest rates, to try to control consumer price inflation, the effect on those exposed to asset inflation (huge mortgages), is punishing. The RBA largely ignores asset inflation because it is hard to measure due to the transactions being lumpy. For economists, if something can’t be measured, it doesn’t exist. QED.

Internationally, the financial world continues to be in turmoil. Cryptocurrencies, another exercise in making up the rules of money, emerged. They are marketed as a counter to fiat money, when in fact the problem has been a lack of fiat. They do not solve the problem; they are just another version of the problem.

BRICS+ Ahead?

Deregulation has led to global debt levels becoming unsustainable. The most likely way out will be inflation, possibly hyperinflation, and maybe government debt defaults. Private banks cannot allow defaults without collapsing, so more bank bailouts seem inevitable.

Meanwhile, in geoeconomic and financial terms, the earth is shifting on its access. When, in 2022, Russia was excluded from SWIFT, the platform for foreign exchange, it was expected to cripple that country financially. If anything, it had the opposite effect. Russia survived and has since set out to establish an alternative foreign-exchange system and security architecture, through the BRICS+ forum (Brazil, Russia, India, China and South Africa).

That alliance is now bigger than the G7 and plans are under way to create a trading currency, called the Unit, which is expected to be 40 per cent gold, and 60 per cent a basket of currencies.

More than 80 countries have said they want to join BRICS+, including many in our region. A meeting in Kazan – that will have just taken place as this article is published – may well shape up as being as important as the Bretton Woods meeting after World War II, when the current financial system was devised.

The non-Western world, dubbed the Global South, is indicating that it is fed up with being bullied by the U.S. and Europe with sanctions and other tactics. These countries want an alternative way to trade without such hindrances, so finding an alternative to the derivatives insanity is also attractive.

Yet, if the world is profoundly changing, Western leaders have scarcely noticed. Neither have they realised that their ideas about money have led to catastrophic problems.

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Republished with thanks to News Weekly. Image courtesy of Adobe.