The Banker’s New Clothes: a Present Day Take on an Old Fable
Once upon a time there lived a vain Central Banker whose only worry in life was to keep the consumers consuming. To finance their consumption, he lowered interest rates almost every hour and loved to show off to his people.
Word of the Central Banker’s refined habits spread over his kingdom and beyond. Two scoundrels – a mortgage broker and an investment banker – who had heard of the central banker’s vanity decided to take advantage of it. They introduced themselves at the gates of the central bank with a scheme in mind.
“We are two very good bankers and after many years of research we have invented an extraordinary method to create a financial security so light and fine that it looks invisible. As a matter of fact it is invisible to anyone who is too stupid and incompetent to appreciate its quality.”
The SEC guarding the gates heard the scoundrel’s strange story and sent for the Chairman of the Economic Advisory Committee. The Chairman notified the Treasury Secretary, who ran to the Central Banker and disclosed the incredible news. The Central Banker’s curiosity got the better of him and he decided to see the two scoundrels.
“Besides being invisible, your Highness, this investment vehicle will be sliced and diced into investments created specifically for your risk appetite.” The Central Banker gave the two men a bag of gold coins in exchange for their promise to begin their financial engineering immediately.
“Just tell us what you need to get started and we’ll give it to you,” said the Central Banker. The two scoundrels asked for lax regulation and low interest rates and got on with their task. The Central Banker thought he had spent his money quite well: in addition to getting a new extraordinary investment vehicle, he would discover which of his subjects were ignorant and incompetent. A few days later, he called the old and wise Treasury Secretary, who was considered by everyone as a man with common sense.
“Go and see how the work is proceeding,” the Central Banker told him, “and come back to let me know.”
The Treasury Secretary was welcomed by the two scoundrels. “We’re almost finished, but we need a lot more gold. Here, Excellency! Admire the ever growing asset prices, feel the potential profits!” The old man bent over the figures and tried to see the value that was not there. He felt cold sweat on his forehead.
“I can’t see anything,” he thought. “If I see nothing, that means I am stupid! Or, worse, incompetent!” “What a marvelous scheme,” he said then. “I’ll certainly tell the Central Banker.” The two scoundrels rubbed their hands gleefully. They had almost made it. More gold was requested to finish the work.
Finally, the Central Banker received word that the two men were finished with their work. “Here it is your Highness, the result of our labor, the most ingenious financial product to date,” the scoundrels said. Of course the Central Banker could not see anything; he panicked and felt like fainting. But when he realized that no one could know that he did not see the value, he felt better. Nobody could find out that he was stupid and incompetent. And the Central Banker didn’t know that everybody else around him thought and did the very same thing.
“Your Majesty,” the Treasury Secretary said, “we have a request for you. The people have found out about this extraordinary financial security and they are anxious to seek their fortunes. May we have your permission to make cheap loans available to all your subjects so they may also partake in this investment scheme?” Naturally, the Central Banker could not decline this humble request, as, in his wisdom, he saw that this scheme provided his subjects (particularly those in a weak economic situation) with a unique chance to buy overpriced assets beyond their means. “All right,” he said. “I will grant the people this privilege.”
Months and years went by until the ingenious financial scheme had become so commonplace that most never even questioned its origin or value.
One summer, a ceremonial parade was summoned down the Wall Street to celebrate the financial prowess of the empire. A group of dignitaries walked at the very front of the procession and anxiously scrutinized the faces of the people in the street. Many people had gathered at the Stock Exchange, pushing and shoving to get a better look. An applause welcomed the regal procession. Everyone wanted to know how stupid or incompetent his or her neighbor was.
People murmured, loud enough for the others to hear: “Look at the big beautiful house I bought, it is bigger than I ever thought I could afford.” “My floating rate loan with zero down was a life-saver.” “The value of my house has already doubled, enabling me to further leverage myself to finance my consumption.”
A lone person, however, who had no important job and could only see things as his eyes showed them to him, went up to the Stock Exchange.
“This is a bubble,” he said. “Fool!” the crowd reprimanded, running after him. “Don’t talk nonsense!” But the person’s remark, which had been heard by the bystanders, was repeated over and over again until everyone cried:
THIS IS A BUBBLE!
The Central Banker realized that the people were right but could not admit to it. He thought he could overcome the people’s fear and discontent by printing money to re-start the economy. So he stood stiffly on his carriage, while behind him the printers spat out bills of decreasing value.
Hanna
Hanna Tikkanen Merk
Contributor to Sustainable Wealth
Executive Vice President, Merk Investments
This report was prepared by SustainableWealth.org, and reflects the current opinion of the contributor. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any investment product, nor provide investment advice. SustainableWealth.org is a trademark of Merk Investments, LLC.
