Never Mind the Bollocks Here's the Leverage
Webster defines leverage as,
1: the action of a lever or the mechanical advantage gained by it
2: POWER, EFFECTIVENESS
3: the use of credit to enhance one's speculative capacity
Financial leverage is a combination of all three, let's start with the last first. At its foundation, modern bank-debt money is leverage. In Frank Capra's, “It's a Wonderful Life,” Jimmy Stewart tries to explain bank leverage to his panicked customers. If everyone tries claiming their money at once, the bank would instantly be insolvent. The money was leveraged across all the extended loans of the Bailey Savings and Loans. To instantaneously provide the money place-held in every savings account, the loans would all have to be called. Well, then you have insolvency, financial chaos, panic.
After the Great Financial Panic of the 1920s and 30s, the financial system was regulated to limit leverage. This and only this created a relatively stable money system for a half-century. Key to this was the now archaic notion of bank reserves. This limited banks' leverage say 10-1, for every $10 loan, the bank had to keep a dollar in the vault, in reserve. See kids there was a time, when banks were really the only money game in town.
But then starting in the 70s, there was this thing called financial innovation, which was just about creating more leverage. So over the last half-century, leverage was increased with things like securitization, derivatives, private equity, or whatever it’s been innovatively labeled, doesn't matter, the key is just more leverage.
So, in the short golden age of financial stability, when leverage was limited to 10-1, today, looking at the global financial system it’s more like 30-1, 50-1, well who really knows? In the most popular numerical term of our innumerate era, “It's a lot.”
It's all good fun until there's a run somewhere in the financial system and a number of people at the same time want to cash in whatever ticket they hold. Instead of only $1 available for every ten, today there's only one for every thirty, fifty, or again whatever it is.
Going back to Webster’s first definition of leverage, that of mechanical advantage, at some point, bank-debt money needs some tie to the real hard economy. At its foundation, modern bank-debt money is tied to energy consumption, that is the mechanical advantage gained by the burning, overwhelmingly, of fossil fuels.
So when this energy supply starts tightening, say for example let a war commence with a country who provides a great deal of fossil fuels to numerous other countries, money and however it is leveraged becomes less valuable.
Finally, looking at Webster’s second meaning, power, leave aside effectiveness, is least understood. The dollar's international value is based on American military might, the most leveraged value of all.
A certain degree of leverage proved valuable for the money system. A lot of leverage is a dangerous and a very unhealthy thing. Today’s global financial system is leveraged well beyond a lot.