Can wealth be destroyed or merely transferred?

[DeepState]

The central banking system is meant to beable to step in and stop the whole system from collapsing, and that is what they did, and they would have done it quicker if it wasn't for congress playing chicken to win political points.

It is also strongly argued that CBs contributed to the latest crisis by maintaining interest rates at levels below what, in hindsight, was appropriate and not taking into account growing systemic risk. Systemic risk was very visible in certain types of credit creation and the implications were actually known. It was a form of shadow financing in the interbank and corporate short-term financing market together with high leverage against RMBS and CDO still on balance sheet. It was visible, but the view from the Greenspan Fed was that self-interest would keep the risks contained. It did not turn out to be so.

Banking systems prior to the advent of central banking did not see the collapse of the entire system either, although the severity and frequency of these stress points was higher than in the time after the creation of central banking at least in the US. Central banking more generally is the arm through which monetary assets are created and the excess use of seignorage to finance war or other profligate expenditure can collapse economies and monetary systems. This has happened many times in history. Hence confidence in central banking as an independent arm separate from the Treasury is seen to be important.

The Fed was quick and aggressive in taking steps to contain the crisis as facts became available. Treasury is, however, an arm of government and subject to the usual political process. Hence initiatives relating to fiscal elements via shoring up of balance sheets via high quality loans from the government etc. were helpful...when they came. A more troublesome copy of this occurred in Europe where initiatives had to be approved by all countries in the union, each of which has parliaments. How they did that remains pretty amazing to me, but crisis focusses the mind. The importance of these actions was very important and separate to those of the central banks. If these were not forthcoming, the massive destruction of asset value meant that the financial system had actually collapsed. The banking system was, under consensus belief, insolvent in aggregate. Sending interest rates to zero or negative and QE could not save the system on its own. Such was the severity of this crisis. The initiatives from Paulson (Treasury Secretary at the time), working in concert with Geithner (who worked in the New York Fed at the time) basically refinanced the banking system and kept it alive long enough for it to return to sufficient health.

 

[darkhorse70]

So in simple words is there a correct answer haja, my brains cooked

 

[skyQuake]

So in simple words is there a correct answer haja, my brains cooked

Take out a $50 and light it on fire = wealth destroyed (personal)

 

[DeepState]

So in simple words is there a correct answer haja, my brains cooked

What correct answer? There isn't one. They are just answers to impossible questions. Some problems don't have answers other than to try and keep the worst from happening as you go. This is one of them.

 

[qldfrog]

So in simple words is there a correct answer haja, my brains cooked

I am afraid there is no "single answer" once you leave Academia and hit the real world, black and white tends to merge into a greyish mush.
Individual will have their own more or less tinted glasses:
yes wealth can be destroyed : a fire, eathquake, a missile in a jet, wars etc
No one denies this
But the question was asked in the context of financial tools/markets.
Would a share market crash destroy wealth?..
Several way of seing that: "only paper loss with all financial engineering being seen as vapourware overall",
but if you deepen a bit you quickly see too many examples breaking the nice ideology.

Have I summarised it well gents (and ladies)?

 

[Value Collector]

Take out a $50 and light it on fire = wealth destroyed (personal)

Or have you just increased the value of the remaining notes by the same amount you just destroyed.

 

[DeepState]

Or have you just increased the value of the remaining notes by the same amount you just destroyed.

Gosh this is an interesting thread.

...Only if the money multiplier remains fixed and production is unchanged following this event, or something proportionate to this. This is theoretically possible, but not observed in vivo.

 

[darkhorse70]

Or have you just increased the value of the remaining notes by the same amount you just destroyed.

Hahaha, I guess I was just asking to get a better understanding of how it could possibly effect the general economic condition if there was a large paper loss or just because it might make me a more intelligent trader.its a bit more clear now. Thanks fellas

 

[tech/a]

Read this book if you have an interest in this topic.

http://www.penguin.com.au/products/9781921880131/extreme-money-masters-universe-and-cult-risk

 

[darkhorse70]

Thanks tech. Will definitely do.

 

[Smurf1976]

Large connective hubs get formed and this makes them seriously important organs through which finance is channeled. The bigger you are, the bigger you become because you are big (at least in some key parts).

Therein lies the problem. "Too big to fail" is "too big to allow" from a risk management perspective.

To me, it seems that the financial system has gradually changed over the past 40 or so years from being a means of facilitating the "real" economy into a parallel world in its' own right, failure of which seems reasonably possible and involves catastrophic consequences for the "real" economy in addition to the financial world.

As an example, over 1 billion barrels of oil are traded "on paper" every day and yet the world produces only about 90 million actual, real barrels of oil that you can see and touch. That level of trading goes far beyond anything reasonably necessary to enable the buying and selling of real, physical oil and has primarily become an exercise in money shuffling. Go back to 1970 and most oil was sold under long term contract - that's one trade not per barrel but for the entire oil field. And suffice to say that there was plenty of oil being used in 1970, the lack of money shuffling didn't stop the geologists, drilling rigs, pipelines, ships, refineries etc from working.

 

[DeepState]

Therein lies the problem. "Too big to fail" is "too big to allow" from a risk management perspective.

To me, it seems that the financial system has gradually changed over the past 40 or so years from being a means of facilitating the "real" economy into a parallel world in its' own right, failure of which seems reasonably possible and involves catastrophic consequences for the "real" economy in addition to the financial world.

As an example, over 1 billion barrels of oil are traded "on paper" every day and yet the world produces only about 90 million actual, real barrels of oil that you can see and touch. That level of trading goes far beyond anything reasonably necessary to enable the buying and selling of real, physical oil and has primarily become an exercise in money shuffling. Go back to 1970 and most oil was sold under long term contract - that's one trade not per barrel but for the entire oil field. And suffice to say that there was plenty of oil being used in 1970, the lack of money shuffling didn't stop the geologists, drilling rigs, pipelines, ships, refineries etc from working.

Yep, agreed on both fronts.

So the powers that be are trying to ensure that no node is important enough to take out the system. Furthermore, they are working to ensure that no group of interlinked nodes can take out the system. They are also trying to stabilize it by ensuring that banks have more regulatory capital with Basel III and all its variants. Principal risk has become so expensive in terms of capital requirements that the major investment banks have largely shut these down, becoming brokers in a purer sense. Risk taking activity has moved more towards funds management and hedge fund management. Perhaps they'll be in a better position to take it and are more transparent in terms of credit provision for leverage. There are also moves to centralize OTC derivatives and have them cleared and collateralized. If achievable, all of these will reduce systemic risk.

What you describe in terms of derivative activity relative to actual underlying activity is crazy isn't it. But it is symptomatic to sharing the burden of risk across several counterparties and increasing interlinkage and 'complexity'. It's partly for the same reason that FFX activity vastly outstrips world trade. However, it is also symptomatic of excess speculation.

Today deals like the Chinese purchase of Russian oil are also multi-decade arrangements which are akin to your oil example. However, the volume is contracted but price fluctuations probably appear somewhere. Same deal with Japanese long term contracts for our LNG. Some of this will still need to be hedged by gas fired generators in Japan or bulk consumers of electricity. Risk sharing, liquidity and securitization are important. Whilst things can happen without it, much more happens with it....except some of it is bad. How do you sort out the wheat from the chaff? It's pretty tough when the system seems to want to find a way to turn into chaff when there is a buck to make. Still, you gotta try and restrain it. However, dragging it back twenty or forty years would very probably squash our standard of living quite a bit more than the GFC did.

Interestingly, part of the problem is that finance is becoming very 'complex'. Everything is linked to everything. No-one knows how the whole thing works. Prod here, something, somewhere pokes out. But you don't know where.

This is happening to the world production economy. Production chains are getting longer and longer as various productivity enhancements are sought around the world. As a result there are an ever increasing number of parts generated all over the place to produce a single product. When one link goes, the whole production line stops. This happened to car production around the world for certain makes when the Japanese tsumani occurred. It was an indication of the vulnerability of our production chains. Similarly oil is too big to fail.

It's all a very delicate dance and it is unstable (on the border of chaos and complexity) in nature.