What You Absolutely Need to Know About Money (Part 6)

Shah Gilani

Our last chapter was about how the U.S. Federal Reserve was created and why. But it ended with an extreme example of how the universal central banking model works today.

Cyprus.

As another domino threatened the house of cards holding up European banks, more money had to be pumped into Cypriot banks so their doors didn't close and rapid contagion wouldn't implode all of Europe, and then the world.

Only this time was different.

The European Central Bank (ECB) reached straight into Cypriot bank depositors' pockets and stole about $6 billion from them. The "how" isn't important. It's a simple equation, as revealed in Part V. Governments are the backstoppers of central banks; that's where their authority ultimately comes from.

Why did the ECB steal depositors' money? So they could turn around and lend that and more to the insolvent banks to keep them alive. It's the latest twist in the old "extend and pretend" game.

The big question is, how did banks get so big and so dangerous in the first place?

Or, how did stodgy traditional banking morph into "casino banking" on a global scale?

Here's how it started…

It's all based on the American model.

With the Federal Reserve set up as the "lender of last resort," U.S. banks prospered.

The end of World War I provided banks with a huge opportunity to lend money to European countries, both American allies and to a defeated Germany. It was a tidy arrangement for them, on account of de facto U.S. government backing of the loans and Germany's forced reparations payments.

Meanwhile, back home, the Roaring Twenties were in full swing. Money was plentiful in the form of cheap margin. It took only a 10% down payment to dabble in rapidly rising stocks. Speculation and stock manipulation schemes became rampant.

The bubble burst in 1929. Then wrong-headed moves by the new Federal Reserve, which tightened credit in response to former lax conditions, were compounded by unwise government tariffs that strangled global trade.

The result was America's Depression.

Bank reform was a huge part of President Franklin Roosevelt's New Deal to get America back on track. It included separating deposit-taking commercial banks from securities trading investment banks and spawned the Federal Deposit Insurance Corporation to safeguard depositors.

Meanwhile in Europe, Germany couldn't make reparations payments and resorted to printing money to make do. Massive inflation in Germany led to a collapse in standards of living and the rise of the Nazi Party.

At the same time, Japanese militarism was on the rise. So was Japan's increasingly acute need to access oil reserves, which it didn't have and needed to power its industries.

America's entry into World War II woke up its animal spirits and transformed the country into an industrial juggernaut.

After Axis powers Germany, Japan, and Italy were defeated, U.S. banks were the only banks in the world in a position to lend, and again, with the de facto backing of the U.S. government, they recapitalized industries and countries across the globe.

The 1950s in America were heady growth days. Corporations were mushrooming rapidly, helping to expand the middle class as they prospered together. Europe was rebuilding, and Japan was using U.S. aid to build factories to manufacture cheap export goods.

As we entered the Go-Go '60s, huge and growing deposit-taking commercial banks would come face to face with their grossly undercapitalized investment banking cousins and find themselves – and their profitability – under direct attack.

What happened next changed banking forever.

Understanding exactly what happened, why, and how will change your understanding of what banks really do and how what they do affects you and your ability to make money in the landscape they dominate.

The next chapter in this series will lay it out for you. You'll immediately see the hidden hand you knew was always there. From there I'll take you upstairs and show you through the cameras watching you how the casino floor is rigged to benefit the house…

And, of course, show you how to beat them at their own game.

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• What You Absolutely Need to Know About Money (Part 4)
• Money Morning:
  What You Absolutely Need to Know About Money (Part Three)
• Money Morning:
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• Money Morning:
  What Everyone Absolutely Needs to Know About Money

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Shah Gilani

About the Author

Browse Shah's articles | View Shah's research services

Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.

He helped develop what has become known as the Volatility Index (VIX) - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.

Shah founded a second hedge fund in 1999, which he ran until 2003.

Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.

Today, as editor of 10X Trader, Shah presents his legion of subscribers with the chance to earn ten times their money on trade after trade.

Shah is also the proud founding editor of The Money Zone, where after eight years of development and 11 years of backtesting he has found the edge over stocks, giving his members the opportunity to rake in potential double, triple, or even quadruple-digit profits weekly with just a few quick steps.

Shah is a frequent guest on CNBC, Forbes, and Marketwatch, and you can catch him every week on Fox Business's "Varney & Co."

He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.

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