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How To Re-Engage The Real Economy Engine

This time I will talk about why bank support measures are not effective to re-engage the real economy engine. In my article about the investment options I rationalized the idea that any financial institution, especially a bank, is a financial utility that facilitates capital and cash flows and allows creating the structured and organized fiscal system. Also, I made it clear that by the very nature banks are entities that are used to make money from money by providing the fiscal services to businesses and consumers, thus transferring their costs to those businesses and consumers.

I rationalized that investments in stocks of financial institutions, especially banks, should be considered thoroughly and the consideration must not be made from the common standpoint of stock investments, but from the standpoint of using the banking facility to manage own cash and capital flows. I rationalized that such investment must be committed only by big businesses, such as industrial conglomerates, holding companies and large private equity and investment companies. Such model contradicts current fiscal system policies. But who has said that existing system is a perfect one? Different “shock” events and current turmoil proved that the system is faulty. In my previous article about the fiscal system complexity I rationalized this point and proved that the prime concept of the system is “to prosper and get bargains”, not “to protect and secure”. I appealed that we, as smart investors, have to learn to leverage this prime concept of the system to hunt for the value.

Based on this knowledge we can give the answer to the question – why we pour so much money to fiscal system and all we have got so far is just the fiscal pipelines with improved tube thickness – bank capital adequacy ratios? Cash is being poured to banks, but the real economy development is still stalled. Cash is flowing to fiscal pipelines, but they are clogged or direct the flow to wrong directions? The fiscal system is clogged with toxic assets. This point is being massaged for some time past and some steps have been made to clean out the fiscal pipelines. These steps were about improving the tube thickness by improving capital adequacy ratios, moving the toxic stuff from one pipeline into another and changing accounting rules – a sort of pipeline cleansing works. Can the problem of restoring the missing water flow be resolved thus? Doubt that. It can improve the capacity of pipelines for moving larger volumes and sustaining higher pressure, but it cannot make the water to flow.

Also, the problem of toxic stuff cannot be solved by moving it from smaller sewage well to bigger one – the toxic stuff increases and gets more toxic requiring bigger sewage well to take it on its balance sheet. It is a fiscal cheating on the real economy. So far we have been carried away by repairing fiscal pipelines and creating sewage wells. Cash infused into the pipelines has either get stalled on balance sheets and banks accounts, or it has been used by banks to perform their prime role – making money from money by getting bargains. Bargains can be found in emerging economies such as China and India and those bargains are warming up these emerging markets to the certain extent. The heating-cooling cycle will repeat again, it is just a matter of time. It depends on how fast the system is heated up.

There is no doubt that fiscal pipelines must be fixed to allow cash and capital to flow again. But providing the prime concept of the system – “to prosper and get bargains” – banks will act as general bargain hunters to profit and will stockpile the cash on their accounts to satisfy different regulatory rules. They will simply direct cash to places where bargains are. Thus, improving pipelines alone does not solve the problem of toxic stuff and does not allow restarting the real economy engine. We should not forget that the fiscal system is just a facilitator. The real value is created only in the real economy. The fiscal system just facilitates transition, perception and accounting of the value created in real economy. It is a sort of value measuring and transition toolset.

The value creation engine must be re-engaged to heal the real economy. Thus money must flow directly to the real economy, but not to or through the banks. I am saying that being in the sound mind. I know that it contradicts prevailing perceptions of the fiscal system, but again – who has said that existing system is a perfect one, after all those “shock” events? All you need to change immaterial is just to change its perception – accounting and regulatory rules. You may cheat on immaterial matter. But you cannot cheat on the real economy. The cash and capital must flow directly to small and medium businesses, to consumers and goods producers, to banks’ borrowers. But not through banks directly – they will cheat and search for bargains – “to prosper and get bargains”. Special rescue and resolution fund must be used as a special vehicle to pour cash to the real economy omitting banks – to support SMB’s, consumers and payers of bills. That cash and capital will land in banks anyway, improving their balance sheets, from the proper pipeline end. The toxic stuff will be resolved little by little and pipelines will be cleaned out.

The value is created and consumed in real economy only. The fiscal system is a facilitator, as all financial institutions are. Any bank support program is nothing but a cheat on the real economy and consumers. As value investors we must invest in real economy, where the real value is created, “to prosper and get bargains”.