Economy, Banks, Pensions, Free market and the Crisis

Question 1 What is the subject of the economy?
Question 2 What is the function of the Board of Directors?
Question 3 What is the cause of the current economic crisis?
Question 4 Can Politics solve the current economic crisis?
Question 5 Can science solve the current economic crisis?
Question 6 What is the role of the universities in the current economic crisis?
Question 7 What is the role of Accountants in the current economic crisis?
Question 8 How do we solve the current economic crisis?
Question 9 How do we solve pension problems?
Question 10 a What are derivates
Question 10 b What is the role of derivates in the current crisis
Question 10 c What is the influence of "going short"
Question 11 What is the LIBOR and EURIBOR scandal


The purpose of this page is to gain a better understanding about the current economic problems, particularly in relation to the banking system. To see what the current situation is, what went wrong, how it should be and what one needs to do and to change in order to achieve this.

In the dutch newspapers the same subjects are discussed (e.g. NRC and de Telegraaf). For an overview and comments from 2009 until 2012 go to: Literature about the crisis in dutch.

The present economical relations are drastical changed. One of the most important changes is the concept of cash money. In fact people don't have any cash money or the importance is strongly deminished. For a discusion about these changes and what the implications are go to: A world without paper money, cash

Answer question 1: What is meant by: economy

We live in a variable dynamic world in which all kinds of (physical) processes take place. The economy is the branch of science which studies these processes, how they interact among themself and how humans influence these processes.

The processes around us and of which we are a part, can de divided as follows: industrial processes, the military apparatus, health, education, Food, Government, banks and insurance companies. Inbetween these processes there is an exchange of goods, money and services. A different word for exchange is flows and as such we use the word cash flows.
What is important now is to see in detail which the various flows are and how they can be influenced.

The following picture shows the different flows. To make things simple we start with three processes: industrial processes, banks and humans

        ..........................          (1)         ..................
       .                          .------------------->.                  . 
       .   Industrial Processes   .         (2)        .       Banks      .
       .                          .<-------------------.                  . 
        ..........................                      ..................
                    ^   |                                        ^  | 
                    |   |                                        |  |  
                 (5)|   |(6)                                  (4)|  |(3) 
                    |   |            ................            |  |
                    |    ---------->.                .-----------   |
                    |               .    Humans      .              |
                     ---------------.                .<-------------   

Each of the three processes is characterized by three parameters: Assets, capital and energy (labour and knowledge) in which the arrows the exchange between these quantities indicate. If you study the picture than you can see that each arrow presents a cash flow. Money is the driving force of the economy. In addition, (1) and (6) are product flows. The flows (4) and (5) indicate labour flows. To compensate the people earn money, these are the flows (3) and (6).

This picture is a first impression. For a more detailed discussion, go to: Economic Model part II
For a specific discussion about the consequences of import and export go to: Economic Model part III In this section also the crisis in Greece is discussed.

Answer question 2: function of the Board of Directors

The function of the Board of Directors consists of two parts: (It should be mentioned that this describes the situation as it should be in the Netherlands. In the Netherlands the members of Board of Directors outsiders and not employees of the company.)
On purpose nothing is written about the shareholders. The primary objective of the Board of Directors is the company and to ensure that the company makes a good, reliable and responsible products and continues to do so. The original investors were at risk and their investment should have been paid back in full. The current shareholders (the owners) get a share of the profit but the goal of the Board of Direktors is certainly not try to optimize this profit and by doing so to revoke the interest of workers.

Answer question 3: what is the cause

In my opinion the main reason of the current crisis is the disbalance between the cash flows versus the product flows.
These are the cash flows within the process "banks". That means case flows internally and between: Commercial banks, commercial banks, credit banking, insurance and pension funds. Worldwide.
At first nothing is wrong if a company borrows money from investors and banks in order to invest and to increase its production process. There is also nothing wrong if those companies then make a profit and pay back their investments.
The problem arises only when those loans then are sold and resold and are going to live on their own without any connection with the original purpose why they were incured. You get a vortex of only money. This Vortex (opward spiral) becomes stronger if pension funds are becoming involved and you become richer from trade in what is actually on paper (paper with some text), without knowing what kind of risks are involved.

Answer question 4: the political influence

The purpose of politics is to govern the country i.e. in matters of general interest. Education, health, traffic, army, police, agriculture, municipalities and finances.
The system works in steps. At one side you have the political parties and at the other side the government and the ministers who are a member of a party.
The result is for each subject: In certain situations standpoints are already fixed in the election program, which makes is extremely difficult to reach a common point of view.

If you consider the ministers than there are three major problems:

Answer question 5: influence economics i.e. science

Is economics a science? Does (the economical) science know how to control the production processes?
The answer on both questions is: No
The problem of the economy is that it consists of many sub-processes which all are related with each other but each on its own is very difficult to describe (mathematically) including the relationships between those sub-processes.
There are almost no economic laws and the one's there are do not say very much.
The most simple law is the law of supply and demand. This law predicts that each economic process (if it is disturbed through an adjustment in prices or wages or etc) always proceeds to an equilibrium position in which the demand is equal to the supply. This law is not very usefull in practice because it does not predict the price afterwards.
The same problems exist which concepts like free-market-regulation, used for the health care systems, education and transportation. Nobody knows exactly what it means. You get a definition like: The market regulates its self (from within) towards an optimum condition that is the best (the cheapest?) for every body. You do not have to regulate from the outside. IMO such an opinion is too optimistic.
In addition most economists do not know what the solution is because there are a great many.

Answer question 6: the role of the universities

The role of the universities is twofold: teaching and performing research.
In the case of economics that means the interaction between (1) the financial processes internally and (2) between the financial processes and the production processes including the Government.
In the case of the financial processes interactions mean for example, international transactions and the impact of the euro.
For the production processes interactions mean for example, the electricity market and the european market.
In the case of the government interactions mean for example, the influence of taxes.
The role of the universities should be independent and have no connection with the politics and business. In addition, the universities, specifically, to a large extent, the professors should agree per issue what the problem is, what the cause is and what the solution is.

Answer question 7: the role of the Auditors

Answer question 8: the solution?

If you consider the current crisis (which in fact is ahorrible name) than it consists of three parts which are closely interconnected:
  1. it is an industrial problem that means a problem of worldwide production and of raw materials.
  2. it is a financial problem that means a problem of state financing, banks, pension funds and insurance companies.
  3. and maybe the bigest problem of the current crisis is that it is a worldwide problem i.e. globalisation.
The main problem of the current crisis is that it is a global problem and infact that there are almost no tools (institutions) available which can force certain modifications partly because different and conflicting interests,
For a solution you should think from a worldwide perspective with the objective that if in the future identical situations arise they should be more local. The only solution is to deminish the global worldwide point of view that means a certain measure of protectionisme.

The most important oponents of protectionisme are the multinationals who operate in europe and worldwide. What makes this so difficult is that it is almost impossible to make a step backwards, but it should be done. Already to declare that globalisation is an unhappy evolution is a step in the right direction. Multinationals can have plants in all continents but only for the local population.

A step in the right direction happens if all European banks start to think more European and even better more nationalistic. A dutch bank has nothing to do with the states debts of Greece.
The second reason for the crisis is that it involves risks.
This starts as a local problem. Someone borrows money (mortgage) from a local branch Office of a Bank, but because this bank operates worldwide it can easily resell this debt worldwide where the buyer of the debt has no idea what kind of risks are involved.
This resell (under the guise we all share the risk) should be banned.
The same problem, you have in the purchase of common stocks, shares and insurances. Here too there is repackaging and reselling involved. This should be prohibited to ensure that products are becoming simpler and transparanter.

Answer question 9: solving the pension problems

The problem of the pension funds in the Netherlands is that they cannot fulfil their obligations.
The origin of these obligations is that pension funds make a commitment to fulfil certain certain guarantees. For examplethey make the commitment that, if someone throughout his entire career (i.e. 40 years) always pays the Fund, throughout the rest of his life every year the participant will be paid 70% of the average of the last 5 years salary, regardless of the progress of the wages of the participant. This warranty is relatively cheap if his wages are constant, but can be extremely expensive if the last 5 years his pay has risen sharply.
Today often a modified warranty applies, as such that 70% of the average wage over the whole 40 years period will be paid out.

The solution of the pension problem is no more waranties but to make the payments from an account build from the payments from the participants that are all born in the same year. This is called the "Year-of-birth-account". For a program which describes this concept go to: Excel programma pensioen.xls. See also for comments the articles: (12) and (19) and (20) all in dutch

Answer question 10 a: what are derivatives

The definition of what are derivatives is explained in the following Wikipedia document: Derivative (finance)
A derivative can de created whenever something ( a house to be build, an event) can be described and when the costs involved for that something to happen (or not to happen) is not fixed in advance. The whole idea behind the concept of derivatives is to share the risk with more parties involved.

An example of a derative is: to buy a product now to be delivered at a future date. The advantage of this is that the producer has money available to buy raw materials to produce the product. The objective of the buyer is that the market price when the products are delivered is higher than what he has paid. When that is the case he can sell the products with a profit. When that is not the case he looses money. That is the risk involved. To calculate this risk is the task of the buyer and that is not easy because many parameters are involved.
Different parameter to consider are: the weather temperature and rain, raw materials, technical issues, political issues and labour rates.
Insurances are also part of derative trade. Examples are: Funeral isurances, Dead risk insurance and Pension Plans. To get an idea what is involved please read this: Derivative trade Examples

Answer question 10 b: what is the role of derivatives in the current crisis

There are three issues involved.
  1. Derivative trade requires a lot of detailed expert knowledge to try to minimise risk, specific in the area of mathematics i.e. statistics.
  2. There is nothing wrong basically with the concept of derivatives. There is nothing wrong with buying a product now to be deliverived in the future.
    I will call this the primairy contracts market. That is the market were producers and investors meet.
  3. The problem with derivatives starts with buying and selling those contracts. That is the market between investors (speculators). That should be prohibited.
    The basic reason is because you do not now what the risks are.
When you study the document Derivative trade Examples you can see when you sell all the three types of insurances you reduce your risk because when the market conditions change this can be beneficiary for some types and bad for other types. That same reasoning is also used to calculate the price and to keep the price for the customers low.
When you sell your whole portfolio to different parties what you want is to make a profit which makes it more difficult for those parties to do the same. This process repeats itself when those parties do the same, specific if they keep the winners and sell the loosers.
The general lesson to be learned is that banks should not be involved in the derivative business. They should not trade in contracts and sell them to govermental organisations nor to private parties in any way.

Answer question 10 c: what is the influence of "going short"

"Going short" is a term in the bond trading business. This means that you lend bonds from some one and you immediatly sell them. After a certain period you buy them back and you give them back to the party from which you lended and the circle is closed.
When you consider this type of trade in detail you will see that you can make a profit from this deal when the market goes down without any of your own money involved that means you make a tremendous gain.
However the reverse can also happen. When the market goes up you have to spend money of your in order to buy the bonds back. When you have the money the problem is not that severe, but when you do not have the money you have to file for bankruptecy and the person who lended the bond to you have to take a loss.

Answer question 11: what is the LIBOR and EURIBOR scandal

For a critical evaluation about the LIBOR and EUROBOR scandal read this: Libor and Euribor scandal

Personal thoughts

The economy is all about producing products. Product Companies are the main driving force of the economy.
The banks should make this possible by giving credit the companies and the companies in return have a debt with the Bank. Before banks do this they need to make a risk analysis. Because they have a debt they pay an interest and that interest should be enough to reduce the risk of the banks and make a profit. This is the basic function of the banks.

The problem of the banks is that they started to trade with all sorts of activities outside the scope of this basic function.
One example is growth. For example every year to get more customers and to sell more mortgages.