Slowly but surely mainstream commentators, economists and policy analysts are all starting to realise that exponential debt is the core of our current economic malaise. This is great news to those of us who have been banging on about this for many years.

But still there is confusion around what to do about it. “Saving” has become the new buzzword, sitting squarely alongside “austerity”, as private individuals are urged to save more and governments are urged to spend less. That sounds like a sensible way forward. But watch the economy tank when that happens. Why?

Simply because when debt is paid down (and no corresponding new loans made) the money supply contracts as the debt is destroyed. The debt never existed as “money” in the sense of notes and coin but as an asset and liability for the bank. The interest is collected and the debt destroyed, leaving the profit for the bank. A monetary system based on debt will always lead to booms and busts as the interest charged overwhelms the ability of the productive sector to pay it. Ironically the system always needs infusions of new debt to stay afloat as the amount of money in the system declines.

Of course, when companies start to lay off workers (their first cost saving option) this creates uncertainty and an unwillingness for new borrowing to take place. This creates a self-reinforcing cycle which in some cases leads to recessions and occasionally to depressions. So what’s the best way out of this?

Austerity? No. Austerity will keep some investors happy but generally this will simply lead to slower growth and higher unemployment. But austerity is also a fact of life. When you have borrowed money and spent it, you know one day you have to pay it back. If you haven’t saved for that day then you will have to forego consumption for repayment. If you are in that position, which many governments are, you have, in fact, over consumed your income and eaten into your future. That’s not a pleasant space to be.

Is there an alternative?

Yes there is. I’d like to propose what i term “Monetary Dialysis”. This process seeks to replace debt money with real money (let’s assume for the moment that fiat money is real). The difference between debt money and real money is two fold: firstly, real money is permanent and once it enters the banking system it remains there; secondly, real money enters the banking system without interest, with no charge for its creation.

This two key differences will lead to new outcomes: a more stable money base and a less inflationary one.

How will this process take place?

The government, instead of issuing new bonds to raise money (primarily from overseas investors), will directly spend the money into the economy. In other words public spending will be funded by new money, not new debt. Immediately there will be a saving in interest costs, with current funding costing 5-6% per annum. The current annual bill (previous to the recent enlarged debt issuance) has been running at close to $4billion a year which is a hefty sum (I am only talking government borrowing here).

I use the term dialysis as a representation of a monetary system that is malfunctioning, not just here but globally. I propose a slow transfusion with the goal to end government borrowing completely by 2017.

Where’s the catch? Ok clearly there needs to be some balancing on the other side of the equation. As well as issuing new money instead of new debt, another part of the monetary dialysis approach is to create stronger limits on the abilities of banks to increase the money supply through the issuance of new debt. This can be done in many ways, using a variety of macro prudential tools, whether it’s increasing capital requirements or other similar actions.

Monetary Dialysis is the first step to cleaning up our monetary system. It will lead to a more stable money supply, lower inflation and clear savings in interest costs. The reduction in public debt will be highly beneficial for the economy and the country as a whole. The cost savings from this clean up will be in the order of $20billion over 6 years.

Now that’s something to really think about.

So finally Gekko is back. Last night I had the pleasure of seeing Wall Street 2: Money Never Sleeps. It doesn’t disappoint. It pushes all the right buttons and manages to communicate the current situation with reasonable clarity. I will be interested to see how the person in the street views it.

I enjoyed the quick hello from Charlie Sheen as Bud Fox and Oliver Stone made a few cameos himself. The plot was fairly straightforward but the message of the film was stark: the system is untenable and has been seriously abused. Sure Gekko used to buy companies and strip them down and sell them on: the ultimate art of financial efficiency and productivity improvement. But now it’s about financial engineering which has nothing to do with the business itself.

As Gekko notes in a speech to a group of students and alumni, the share of GDP generated by financial services got as high as 40%………it used to be around 7%.

This orgy of financial speculation has left our global economies in tatters and we rush to pick up the pieces. Blame lies all around so that shouldn’t be our focus (they lent it, you spent it!) but the ramifications are very serious. We know well that the global financial system nearly collapsed and after trillions of dollars in bail outs and stimulus, it still looks very shaky. Payback will be painful.

The new “Bud Fox” character, carrying the torch for alternative energy, asks the “bad guy” what his number is, how much it would take for him to walk away from the business. His answer: “more”. It’s become nothing more than ego, a game as Gekko would describe it. Ultimately it’s a loss of understanding and values. The disconnect between the financial markets and the real world has grown so wide that a chasm has been created, a big black monetary hole which is dragging us all in. This film has much more impact than Mike Moore’s recent treatise on capitalism because it paints a truer picture: the excess, the egos, the glamour….and the frailties of us all.

Susan Sarandon has a neat role as a nurse turned real estate speculator. She painfully encapsulates the shift from real, productive work to speculation on house prices. Needless to say she comes a cropper.

The bail outs continue and moral hazard is everywhere. Is Gekko redeemed? Not really. He’s more human but the guy still loves the game and is happy to play even under the new rules. The trillion dollar question for the audience is simple: will the rules be changed?

Don’t hold your breath.

So Basel III is finally with us…….phew……can’t wait for Basel IV. I’m not sure about a fifth one as that really would be a joke too far but then again if we can have a Rocky and Rambo V why not Basel V? We will really be up the creek when that one comes out. Is this one likely to change anything? No one seems to think so but then again 2 years ago I said the same thing about Basel II!!

It all comes down to leverage which now is well understood. The new capital requirements simply squeeze poorly capitalised banks a bit harder but really make sod all difference to the underlying problem which as we all know is excess credit creation. This credit creation is also known as money supply expansion. Are credit and money the same thing? well yes and no. When you get a new loan from the bank, you have received credit. This credit appears as money in your bank account and can be converted (though usually ins’t) into note and coin. But here’s the nub. Whilst money, the the form of note and coin, cannot be destroyed (ok you could burn it), when you pay back your loan that money is cancelled…in a puff of smoke. It only existed in your imagination. Of course that same “money” can be relent but new credit can always be created as long as there is enough “equity” in the bank…….come in Tier 1 capital and other assorted IOUs.

For example, the money supply in New Zealand has contracted by nearly $10bln in the period from Feb 09 to Jul 10. That’s why there’s no money in the economy……it’s goneski. But if we dealt in real money it would never disappear; once it was created it stayed in circulation or under your bed but it could not be destroyed.

The ability of banks to inflate and deflate the economy is still very much theirs with central banks acting like the lunatics they are by playing important games with their interest rates. They haven’t quite worked out the mess they made over the last 15 years by focusing on inflation and forgetting about asset prices, leverage and moral free speculation.

Gareth Morgan notes this in his take on it but again misses the real point, as does Basel 1,2 and 3 (and probably 4 and 5). It is the quality of money supplied into an economy that is the most important aspect of the economy. Copious amounts of speculative credit has blown out the “real” economy creating a mess which could take decades to unwind.

But we need to address this sooner or later….otherwise we will get the same maneuvering again ………or is it the same manuva?

Well after years of allowing banks to categorise any paper bearing the words “i hope to pay back” as Tier 1 capital, G20 has agreed to a new global framework on bank capital under which “banks will face higher capital requirements”.

I guess we can call this Basel III or maybe a souped up Basel II. Who knows? When you have an inherently unstable system any new plan for control is likely to end up in the round filing cabinet before it has a chance to be implemented.

But one thing is clear from the latest global pow-wow: monetary stimulus will remain in place for some time as extra tightening through higher capital requirements sucks in more capital. With all the talk of recovering economies and poistive GDP reads in some countries, it is easy to forget the amount of wealth that has been sucked into the black hole of balance sheet never never land.

Who would be a bean counter these days?

It reminds me of the time I was working on the ticket sales operation for the Brisbane Expo back in 1988. It was a $60m take and I was drafted in to make the numbers balance. It was a lot of fun and eventually I got to the point where I had accounted for everything but there was still a pesky $110 I couldn’t reconcile. It simply didn’t make any sense to me but in the end I just gave up and figured it didn’t matter that much.

Now the numbers seem a bit larger when it comes to bank meltdowns. We have a long way to go before we actually can understand where the money has gone, who owes it, who lost it and what the actual impact on the supply of money is.

So in this case G20 are spot on. Deflationary forces abound. I have no worry about inflation at all. Sure we will keep seeing short term rebounds in some statistics and small sighs of relief. Let’s face it, the markets ahve had an enormous rally in the last 6 months. But do they reflect the underlying reality? Nope.

That’s because the crevasses have been papered over with huge swathes of new paper. But underneath they lie there waiting for some poor fool to fall in again. Slowly it feels like the bankers are starting to understand that they let credit growth go bananas and that their carefully constructed inflation numbers didn’t always tell the truth about asset prices.

We still have major systemic problems to deal with. Tightening credit will cause severe pain but low rates will help ease some of that. But catching the tiger by the tail is the only way forward.

Following on from the news about Kiva moving into the US small business market, fleet footed Ben Kepes calls us to action in New Zealand.

Small businesses in NZ have seen no relief from high interest rates in the recent lowering of rates here. At the same time credit is hard to come by and many business owners have resorted to credit cards to keep their businesses going.

This is a troublesome state of affairs given its the productive economy that has to earn the dollars to pay back the humungous debt necklace hanging around the necks of Kiwis.

So what’s the state of play with microfinance at the moment? Well Kiva is going great guns. It’s really tapped into people’s desire to help and be generous in giving but created this new joy of creating and empowering change for people. It connects people together and that personal touch pulls the punters in.

The more tradtional p2p lending services are not finding life so easy. Charis Palmer reports here on recent developments citing problems for Prosper in the US and some success for Zopa in the UK. Locally Peermint has fallen by the wayside, Nexx hasn’t really got going and Lending Hub has joined a busy Australian market.

So there’s no shortage of platforms but it’s proving harder than expected to deliver the business. But there seems to be no platform for small businesses to secure funding. This is certainly an opportunity as there is certainly a strong and established market on the borrowing side with appropriate forms of due diligence available.

The major stumbling block for p2p start ups has been compliance with various regulatory authorities. However there may be ways around this and with politicians supportive of the small business sector the time may have come for a serious attempt to create what would be a mini-corporate bond market funded by the retail investement market direct.

Now that sounds like a major step forward in building a more productive economy.

It’s been nearly 9 months since the $ started to show signs of meltdown fever. Except the meltdown was the rush to buy $ as a hedge against collapsing markets and disappearing credit lines.

In the last few months we have seen markets bottom and even recover some poise, aided and abetted by the action of nearly last resort, quantitative easing. There was nothing left in the toolbox really.

So far so good in some respects. The S+P has rallied 37% off its lows…….mind you its lows were 57% down from the highs and the index still stands 42% off the highs of the last few years. Not that the numbers really matter. The main news is that markets are functioning…still.

And the $ balloon has finally burst with QE signaling a chance to sell the $ without worrying what the equity markets were doing. The Kiwi$ has rallied 32% from its March low even outpacing the hammered Pound, up 21% from its low of $1.35.

Markets can do very strange things. Even whilst the $ was rallying to extreme highs against all currencies, no one really wanted to own it. Now people really really don’t want to own it.

This is all very well but this type of volatility is impossible to manage. How can any investment manager talk about average returns of 10% a year when markets are moving at this rate. How can any business hedge currency risk when currencies are moving like this.

The bigger problem for the US is trying to stop the snowball effect that may happen if markets really decide to dump the $. The noises coming from China may be regarded as monetary brinksmanship but with Russia, looking very wolflike these days, nibbling in behind, it’s becoming a more serious issue.

There’s a lot of politics involved in this but the positioning is clear: the US is weak not just economically but militarily. The exhausting foray into Iraq has stretched the US war machine as well as seriously impacting on its reputation. Historically the ability to create coin or currency was usually backed up by military power. One of the first actions by invading nations was to replace the local currency with its own.

This makes currency both a political and economic issue. So whilst there is unlikely to be any immediate change in the $ role as global reserve currency, there is no doubt that the dance of change is underway.

The short term problem for China is its huge ownership of US bonds and other paper. So they wouldn’t be happy with a complete collapse right now but it seems like less money will be staying in $ and more will be finding a new home whilst they work out how a new global currency system might operate.

But with GM falling apart and US unemployment rising to severe levels, concerns over the health of the $ will only continue to mount.