My apologies but Sprog this week is nothing about HR policies, and contains no exhortations for leaders to act differently. Not mentioning the global financial meltdown would seem to me at this time to invite criticisms of being out of touch, and since someone asked me last week "where has all the money gone?" I found myself writing about the banking system.

Where has all the money gone? 

I spent Friday in London dashing in taxis between meetings with lawyers and accountants. Everywhere I arrived people were watching Sky news screens - it reminded me of 9/11 when we all watched the unfolding events in total disbelief. I met people who are almost as old as me, and so we all remembered the recessions of the early 80s and the early 90s; but we all agreed - we've seen nothing like this and that history is no guide as to what the outcome will be. And when even an accountant asks the question 'where has all the money gone', you know you are in unchartered waters.

So while I am no economist (A level grade C 1975) I thought I would look into this question. Where has it gone?

Well remember that it only ever existed on paper. It was never cash. If we go back to banking fundamentals, if you deposit savings of £100 with a bank, strictly speaking it should keep it in cash, ready for the day you ask for it back. This is how banks started centuries ago as simple deposit holders. However, knowing that you are unlikely to ask for all of your cash back at one time, it can in fact lend it out, keeping just enough to satisfy your normal requirements. But if the bank lends money not by giving out cash, but by creating further deposits (and assuming the borrowers spend that money by cheque and not cash - which is why interbank overnight lending is critical to the system), it can lend a multiplier of the original deposit of £100. For many decades the accepted ratio of reserves to loans was around 20%, meaning in our example that holding the whole original £100 in cash could create £500 in loans. The bank has in effect created £400 of new money. Now of course if all depositors asked for their money back on the same day, the bank was in trouble, as it would take them time to collect back in the loans it had made. So central banks came to stand behind all other banks as the ‘lender of last resort’, giving an assurance that depositors can always get their money back – meaning of course that it is even more unlikely that they will ask for it.

Fractional reserve banking, as it is known, allows the banking system to effectively manufacture money. In the years since the war, as the banking system became more solid and trusted, and as banks became larger, the cash reserve ratio dropped to around 10% meaning that the bank in our example above can now lend out a total of close to £1000 instead of £500 (think of all that extra interest and profit if only we could change the reserve ratio – cue the sound of hands rubbing together in glee and greed). If you ever wondered how some banks could offer savings rates of 5% or 6%, whilst offering loans at 3%, well now you know. It costs the bank £5 per year to have £100 on deposit at 5% interest, but if it can lend out £1000 on the back of it at 3% it will earn itself £30 thus making a very nice profit of £25.

Financial alchemy

This would probably have been ok if it had remained at these levels. After all with strong central banks, and reasonable levels of confidence, a cash reserve ratio of 10% actually works well – credit is freely available, and there is still a reasonable solidity to the system. But then the financial alchemists got their hands on power.  Over the last ten years the cash reserve ratio dropped to probably below 1% (no one really knows, but I have seen one global estimate of 0.79% - the same financial alchemists who came up with the complex packaged financial instruments that no one really understands came up with ways of obfuscating the real ratios from the authorities). At that ratio, the amount that can be lent on the back of £100 of deposits is around £12500 – at 5% savings rate and 3% lending rate the £100 still costs £5 but the loans now make £375 for a profit of £370. If you can get away with it, why wouldn’t you?

Your pension fund is now worth some 30% less on paper than it was one month ago, so a big chunk of the money went to over inflate company stock prices; property prices are still double what they were just 10 years ago, so a big chunk of the money is sitting in your house equity; ask yourself why Chelsea football club is 'worth' £200m - then think of all the multitude of other massively over valued investments - that's where the money has gone.