Just Money Ann Pettifor
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Just Money How Society Can Break the Despotic Power of Finance
Just Money © 2014 Ann Pettifor All rights reserved. No part of this publication may be reproduced or transmitted, in any form or by any means, without permission. Cover design by Jordan Chatwin The moral rights of the author have been asserted. Commonwealth publishing.
Introduction “Modern finance is generally incomprehensible to ordinary men and women … The level of comprehension of many bankers and regulators is not significantly higher. It was probably designed that way. Like the wolf in the fairy tale: “All the better to fleece you with.” Satyajit Das.1
The global finance sector today exercises extraordinary power over society and in particular governments, industry and labour. The sector dominates economic policy making, undermines democratic decision-making, has financialised all sectors of the economy including the arts, and has made vast profits, often at the expense of both governments and the productive sector. Yet even as finance capital eludes and defies governments, and as legislators bow to the sector’s demands to cut public services in the name of ‘austerity’, finance has become more, not less, dependent on the state and on taxpayer support. Despite its detachment from the real economy and from state regulation, the global finance sector has succeeded in capturing, effectively looting, and then subordinating governments and their taxpayers to the interests of financiers. Geoffrey Ingham, the Cambridge sociologist describes the power the sector now wields as ‘despotic’.2 In this short book, I hope to briefly outline how society can begin to unpick the knots of jargon and gibberish that finance has used to immobilise the rest of us, and how society can break the power of despotic finance. I will argue that while the finance sector abuses the monetary system for private profit, the system is also potentially a great public good. Our money and monetary system has evolved over centuries as a public infrastructural resource - just as the sanitation system was developed as a public good. Managed well, our monetary system could enable society to do what we can do. And as a public good our monetary system, like our
sanitation system could and should be just – and serve all citizens, not only a wealthy elite. Unfortunately because most orthodox economists treat money as if it were ‘neutral’ or simply a ‘veil’ over economic transactions, the question of how to control the monetary system and in whose interests it should be managed, has long been neglected. In the words of a leading economist who will remain anonymous money or credit is “a matter of third order importance.” Some think that this neglect by the economics profession is not accidental. It has enabled global finance capital to thrive, untroubled by close academic or public scrutiny. For the monetary system to be managed as a public good, there must be greater public understanding of money, and how the system works. If we are to reclaim the public good that is the monetary system; if we are to once again subordinate the small elite that makes up the finance sector to the interests of society and the economy as a whole, there must be democratic and accountable oversight of the system. We know it can be done, because in our recent history, after the 1929 financial crash, society succeeded in wrenching control of the monetary system back from a reckless and greedy wealthy elite. Unfortunately citizens will not receive much help in understanding or taming finance from the economics profession, from regulators or officials because many are either uninterested or ill-informed about the nature of both money and banking. While the dominant, orthodox or neoclassical school of economists may pay little attention to ‘neutral’ money in designing models of the economy, they also conceive of it as akin to a commodity. Money, in their view is represented by a tangible asset or commodity, like gold or silver. In this view money can represent a surplus to be set aside or saved, accumulated and then loaned out. In this story, savers lend to borrowers, and bankers are mere intermediaries between savers and borrowers. Because neoclassical economists conceive of money in this way, and because all commodities have a scarcity value, these economists theorise as if money is subject to market forces of supply and demand, and like commodities, can become scarce. But money is not like a commodity. To
define it as such is to create a ‘false commodity’ as the political economist Karl Polanyi argued.
There is an alternative understanding of money, one that is periodically lost to history. This understanding informs the work of some of our greatest and most influential economists.4 They have all understood that money is not and never has been a commodity, nor is it based on a commodity. Instead money is a social construct – a social relationship based primarily and ultimately on trust. This gap between the orthodox or neoclassical understanding of the nature of money and, for example, the Keynesian understanding of money is as wide and profound as that between 16th century Ptolemaic and Copernican concepts of the heavens. It is a gap in understanding that led the 2013 winner of the Nobel prize in economics, the orthodox Eugene Fama to make the response below to a question posed by a journalist on the New Yorker: Many people would argue that… there was a credit bubble that inflated and ultimately burst. Eugene Fama: I don’t even know what that means. People who get credit have to get it from somewhere. Does a credit bubble mean that people save too much during that period? I don’t know what a credit bubble means. I don’t even know what a bubble means. These words have become popular. I don’t think they have any meaning. So what caused the recession if it wasn’t the financial crisis? Eugene Fama: (Laughs) That’s where economics has always broken down. We don’t know what causes recessions. Now, I’m not a macroeconomist so I don’t feel bad about that. (Laughs again.) We’ve never known. Debates go on to this day about what caused the Great Depression. Economics is not very good at explaining swings in economic activity. ……Let me get this straight, because I don’t want to misrepresent you. Your view is that in 2007 there was an economic recession coming on, for whatever reason, which was then reflected in the financial system in the form of lower asset prices? Eugene Fama: Yeah. What was really unusual was the worldwide fall in real estate prices. So, you get a recession, for whatever reason, that leads to a worldwide fall in house prices, and that leads to a financial collapse ...5
Moving away from an economic orthodoxy based on Fama’s flawed notion of credit as the savings of ‘people that save too much’ will be as revolutionary as the paradigm shift that took place under the leadership of Copernicus. For John Law, John Maynard Keynes, Joseph Schumpeter and Karl Polanyi amongst others, the thing we call money has its original basis in a promise, a social relationship: credit. “I trust that in exchange for my favour to you, you will (promise to) repay me – now or at some time in the future”. The word credit after all, is based on the Latin word credo: I believe. “I believe you will pay, or repay me for my goods and services, now or at some point in the future.” Money, and in particular credit (and its ‘price’ – the rate of interest) became the measure of that trust and/or promise – or indeed of the lack of trust. (If I do not trust you to repay, I will demand/expect more from you as collateral or in interest payments.) Money in this view is not the thing for which we exchange goods and services but by which we undertake this exchange – as John Law famously argued. To understand this, think of your credit card. There is no money in most credit card accounts before a user begins to spend. All that exists is a social contract with a banker; a promise made to the banker to repay the debt incurred as a result of spending on your card, at a certain time in the future, and at an agreed rate of interest. And when we spend ‘money’ on our credit card, we do not exchange our card for the products we purchase. This is because money is not like barter. No, the card stays in our purse. Instead the credit card, and the trust on which it is based, gives us the power to purchase a product. It is the means by which we purchase the good. Your spending on a card is expenditure created ‘out of thin air.’ The intangible ‘credit’ – nothing more than the bank’s and the retailer’s belief that you will honour an agreement to repay - gives you purchasing power. Money in this case is based on the trust your bank has in your ability and willingness to repay credit, and the trust that the retailer has in the bank
honouring your debt. As such, all credit and money is a social relationship of trust – between a banker and its customers; between buyers and sellers; between debtors and creditors. Between shoppers and retailers accepting (and trusting) the promise made in return for a transaction. Money is not, and never has been a commodity like a card, or oil, or gold – although coins and notes have, like your credit card, been used as a convenient measure of the trust between individuals engaged making transactions. So, if a banker trusts you more than most others, you will be given a fancy gold or platinum card. If a banker does not trust you or your ability to pay, you will not be granted a credit card, or you may be given one with a very low limit. As a result you will lose purchasing power. Faith, belief and trust - that someone is reliable, good, honest and effective is at the heart of all money transactions. Without trust monetary systems collapse and transactions dry up. Because trust is so important to the economy, society has developed institutions to uphold trust in, for example, the belief that you will honour the obligations you make when you create money out of thin air and spend it on your credit card. These include the law of contract, a system of accounting, the criminal justice system, central banks and the banking system – that provide confidence to the retailer and banker that you and all those active within the banking and monetary system, will honour obligations. In countries without such institutions – like some in Africa credit is hard to come by, and credit cards are not in use. The Bitcoin mania Bitcoins have introduced millions to a currency that appeared from nowhere and is, apparently “cryptographic proof”. Whereas private banks can create money by a stroke of the keyboard, the creation of Bitcoins involves, apparently, vast amounts of computer processing power. This power is capable of deploying a complicated algorithm that approximates the effort of “mining” coins.6 The Bitcoins so “mined” have become the new ‘gold’ and Bitcoiners the new ‘goldbugs’.
This new currency (which claims to be a ‘commodity’) is a form of peer-topeer exchange. It began life in the murky world of the ‘Silk Road’ ‘an online Black Market on the Deep Web’ (to quote Wikipedia) and has generated a great deal of excitement. It was ‘created’ by an unknown computer scientist, a Bitcoin ‘miner’. It is now used for international payments, but also for speculative purposes. There are two striking things about this new currency: its creators (computer programmers) have apparently ensured that there can never be more than 21m coins in existence. Bitcoin therefore is like gold: its value lies in its scarcity. This potential shortage of Bitcoins has added to the currency’s speculative allure, leading to a rise in its value. However, these rises and subsequent falls in its value has made it unreliable as a means of exchange for merchants. Having to regularly adjust prices upwards or downwards when you are trading goods and services is tricky. Second, this money or currency is not buttressed by any of the institutions named above. Its great attraction to its users is precisely that it bypasses the state and all regulatory institutions. Indeed it appears to be based on distrust. One commentator notes “Bitcoin was conceived as a currency that did not require any trust between its users”.
Equally its scarcity means that unlike the endless and myriad social and economic relationships created by credit, Bitcoin’s capacity to generate economic activity is limited – to 21 million coins. Its architects deliberately limit economic activity to 21 million Bitcoins in order, ostensibly “to prevent inflation”. In reality the purpose is to ratchet up the scarcity value of Bitcoins most of which are owned by originators of the scheme. In this sense Bitcoin ‘miners’ are no different from goldbugs talking up the value of gold; from tulip growers talking up the price of rare tulips in the 17th century; or from Bernard Madoff, talking up his fraudulent Ponzi scheme. As this goes to press, speculators have inflated to delirious heights the value of the Bitcoin. The winners will be those who sell - just before the bubble bursts. In the absence of regulation that reinforces and upholds trust, the losers will be robbed. Trust is central to the millions of transactions that take place every day in every economy for every kind of
good or service. For society and the economy to function effectively, it has to be defended, protected and upheld. This can only be achieved through regulation based on society’s widely shared values of honest and fair dealing, and on the institutions based on those values. ----------------------------------------------------------------------------------------In 2012 it emerged that bankers were manipulating the rate of interest used to determine the value of trillions of dollars of debt, and known as the London inter-bank offer rate or LIBOR. Andrew Lo, MIT Professor of Finance said on CNN that the LIBOR scandal dwarfed “by orders of magnitude any financial scam in the history of markets.”
However the LIBOR scandal did illuminate several points: first that the rate of interest – the ‘price’ of money - is not, it turns out, the result of the supply and demand for money or savings. Interest too is a social construct, set and manipulated, in the case of LIBOR by ‘submitters’ in the back offices of banks. In ancient times trust – in money, in units of measurement, in exchanges – was upheld and enforced by respected community and religious leaders and institutions. These included the chiefs of villages, the officers of temples; and senior, trusted members of the Church or Mosque.9 They ensured that a pound of sugar was weighed correctly; that a pint of beer was indeed a pint; that a yard of cloth was equivalent to the standard, and that money exchanges were fair. Today trust in our monetary system ought to be upheld by public authorities – the courts, accountants, regulators, central bankers accountable to, and trusted by society. However most regulators and central bankers have bowed to the ideology of free markets, and dispensed with powers and regulations to uphold and enforce trust in financial transactions. Instead transactions are “liberalised” - left to the whims of financiers operating in the so-called ‘free’ market of finance. But that ‘market’ too is false. Financiers trashed our financial system by transforming the very human, social relations at the heart of money into
‘products’ they could trade and ‘markets’ they could manipulate. By detaching social relationships from regulation, and allowing them to be enforced by the ‘invisible hand’ of the abstract ‘market’ – regulators, economists and bankers abdicated their responsibility for upholding and defending society’s moral and ethical standards. No wonder fraudsters, cheats and crooks had a field day! Backed by large swathes of the economics profession, criminals, charlatans, Ponzi schemers and common thieves are effectively granted free rein to rob and loot, to cheat and lie, to evade tax, to launder money, to move vast sums of illicit ‘dirty’ money across borders – and to do so unfettered by law or regulation. No wonder the ‘free marketisation’ of social relations was welcomed by finance capital and by criminal elites embarked on what has been called “an orgy of thievery”
No wonder too that it is a deluded and utopian mission,
one that leads inevitably to serial financial crashes, wider economic failure and social breakdown. This deluded economic theory (that trust does not need to be carefully regulated and upheld by qualified, publicly accountable institutions like the law) originates in the flawed understanding that so many professional economists have of money. These free market ‘economists solemnly believe that money is “gold coin and bullion” to quote Murray N Rothbard
credit is just a “surrogate for gold”; that bankers are mere intermediaries between lenders and borrowers, and market forces alone can manage, discipline and regulate the supply and exchange of money. The whole, vast, shaky edifice of today’s liberalised financial system has been erected on this flawed understanding of money, and on hopeless attempts to transform the social relationships at the heart of money into marketable ‘products’. To paraphrase Keynes’s criticism of the Austrian economist Friedrich Hayek, this is an example of how, starting with a mistake, a remorseless logician can end in Bedlam.
It is because of the
flawed foundations of economic orthodoxy – taught in almost every university of the world - that society suffers both periodic shortages of finance, and regular and sometimes catastrophic financial crises.
There need never be a shortage of finance The operations (if not the utterances) of bankers demonstrate that they do not share the orthodox economist’s misunderstanding of money. Both central and commercial bankers have known for more than three hundred years (when the Bank of England was founded) that credit and bank money is based on trust between debtors and creditors; that as such, it can, in collaboration with borrowers and lenders, and on the basis of contract, be ‘created out of thin air’ by both central banks but overwhelmingly by licensed private bankers. (Note: not all private banks create credit. Some non-standard financial institutions – like payday lenders, crowd funders and savings institutions - act simply as intermediaries between savers/depositors and borrowers/investors. Savings banks (that is, oldstyle building societies in the UK and savings and loans associations in the US) only lend out existing and limited savings or funds deposited in their banks. This is not the case for credit-creating, commercial, licensed banks.) Central bankers understand that in a well-developed, regulated monetary system in which credit is created ‘out of thin air’ there need never be a shortage of money or finance. The creation by central bankers of trillions of dollars of ‘bailout’ finance via a process defined as ‘quantitative easing’ reminded wider society of this power after the 2007-9 crash. Yet it is a power that the Bank of England, for example, has exercised since its founding in 1694. Monetary systems as a civilizational advance Monetary systems are one of human society’s greatest achievements. The creation of money by a well-developed monetary and banking system was a great civilizational advance. As a result there need never be a shortage of finance for private enterprise or the public good. There need never be a shortage of money to invest in, and create economic activity and full employment. There need never be insufficient money to tackle energy insecurity and climate change. There need never be a shortage of money to solve the great scourges of humanity: poverty, disease and inequality; to ensure humanity’s prosperity and wellbeing; and the ecosystem’s stability.
The real shortages we face are first, humanity’s capacity: the limits of our individual, social and collective corruptibility, integrity, imagination, intelligence, organisation and muscle. Second, the physical limits of the ecosystem. These are real limitations. However, the social relationships which create money, and sustain trust, need not be in short supply in a well regulated and managed monetary system. Within a sound monetary system we can afford what we can do. Money enables us to do what we can do within our limited natural and human resources. Money or credit does not exist as a result of economic activity, as many believe. Like the spending on our credit card, money creates economic activity. When young people leave school, obtain a job, and at the end of the month earn income, they wrongly assume that their newfound income is the result of work, or economic activity. This leads to the widespread assumption that money exists as a consequence of economic activity. In fact, with very rare exceptions, credit financed the firm and entrepreneur that employed that young person; and an overdraft probably financed the wage she earned in that first job. However, her employment hopefully created additional economic activity (by e.g. producing widgets) and generated income with which the employer could pay down the overdraft, repay the debt and afford her wage. In a well-managed financial system, money provides the stimulus, the finance needed for innovation, for production and for job creation. In a wellmanaged economy, money is invested in productive, not speculative economic activity. In a stable system, economic activity (investment, employment) generates profits, wages and income that can be used for repayment of the original credit. There are many constraints on the ‘production’ of this social construct that we call money, and they include inflation on the one hand, and deflation on
the other. When the private banking system is not managed, bankers can create more money than can usefully be employed. This can lead to too much credit or money chasing too few goods or services. Equally, as now, the private banking system can contract the amount of credit created, deflating activity and employment. But if the banking system is properly managed by public authorities there need never be a shortage of finance for sound productive activity. That is why sound banking and modern monetary systems - like sanitation, clean air and water - can be a great ‘public good’. They can be used to ensure stability and prosperity, to advance development and to finance ecological sustainability, as I explain below. Managed badly, a banking system can fatally undermine social, political, economic and ecological goals – as they do in many low income countries. Bankers and other lenders (including micro-lenders) can charge usurious – and ultimately unpayable rates of interest on society’s greatest asset – trust, expressed as credit. By using their despotic power to withhold credit or finance from the economy, bankers and financiers can cause economic activity to contract, leading to the deflation of wages and prices. Left to run amok, a banking and financial system can, and regularly does have a catastrophic impact on society and the ecosystem. Managed badly a financial system can usurp and cannibalise society’s democratic institutions. We are living through a disastrous era in which the finance sector has expanded vastly – an era in which most financiers have virtually no direct relationship to the real economy’s production of goods and services. De-regulation has enabled the finance sector to feed upon itself, to enrich its members and to detach its activities from the real economy. Productive actors in the real economy – the makers and creators - have periodically been flooded with ‘easy if dear money’ and just as frequently starved of affordable finance. This instability has led to increasingly frequent crises since the ‘liberalisation’ policies of the 1970s; and to prolonged failure since the financial crisis of 2007-9.
Many low-income countries are dogged by badly managed and lightly regulated financial systems, and therefore by a shortage of finance for commerce and production. This is in part because they lack the necessary public institutions and policies that underpin a properly functioning financial sector. No monetary and banking system can function well without a system of regulation, without sound accounting, and without a system of justice that enforces contracts, and prevents fraud. But while low-income countries have been encouraged to open up their capital and trade markets, and to invite in private wealth, they have been discouraged or blocked outright in their efforts to build sound public institutions and policies to manage financial flows and to regulate the creation of credit by the financial sector. The role of ‘robber barons’ In countries with weak regulatory institutions and systems, in other words without a sound monetary system, entrepreneurs are obliged to turn for loan finance to those who have acquired by fair means or foul, stocks of wealth or capital. Poor country governments turn to institutions like the IMF and World Bank, or to the international capital markets, for foreign hard currency. As a consequence of dependence on both domestic and international ‘robber barons’ money is dear. It is lent by powerful creditors, with the authority to create credit; with savings or a surplus, at high rates of interest – rates that often exceed the income or returns that can be made on the investment. If it is borrowed in foreign currency, then volatility in currency movements can both increase the cost of the loan, and also diminish those costs. But volatility is a deterrent to promising enterprises. As a result, innovation can be held back, unemployment and underemployment remain high, and poverty entrenched. Yet it does not have to be this way. With a sound banking and monetary system, there need never be a shortage of affordable finance to meet a society’s needs. Our monetary systems have been cut loose from the ties that bind them to the real economy, and to society’s relationships, its values and needs. That
is largely because our monetary systems have been captured by wealthy elites who, with the collusion of regulators and elected politicians have undermined society’s trust, and now govern the financial system in their own narrow, rapacious and perverse interests.
The stealthy transfer of power to finance capital Many orthodox economists are opposed to managing and regulating finance in the interests of society as a whole. Acting consciously or unconsciously on behalf of creditor interests, many effectively provide justification for ‘easy’ (that is unregulated) but ‘dear’ (at high rates of interest) credit, the worst possible combination for society and, I will argue, the ecosystem. Orthodox economists also have an unhealthy obsession with the state, which they accuse of ‘rent-seeking’ while ignoring the rent-seeking of the private sector. As recently as October 2008 former Governor of the US Federal Reserve, Alan Greenspan made the ideology explicit under cross-examination by a Congressional Committee, chaired by Henry Waxman.
The chair of the committee reminded Mr
Greenspan that he had once said: I do have an ideology. My judgement is that free, competitive markets are by far the unrivalled way to organise economies. We've tried regulation. None meaningfully worked. Greenspan later went on to explain that he had found a flaw in the model that I perceived as the critical functioning structure that defines how the world works, so to speak ... That's precisely the reason I was shocked, because I had been going for 40 years or more with very considerable evidence that it was working exceptionally well. Over this period of 40 years, and thanks to the pervasive influence of the ideology, western governments used ‘light-touch regulation’, ‘outsourcing’ ‘ globalisation’ and other policy changes to effectively transfer power and regulation over the public good that is the monetary system and the nation’s finances to private wealth. This transfer conceded two great powers to the private banking system. First the power to create, price and manage credit without effective supervision or regulation. Second the power to
‘manage’ global financial flows across borders – and to do so out of sight of the regulatory authorities. By this transfer, democratic and accountable public authorities handed effective control of employment, welfare and incomes to remote and unaccountable financial institutions and individuals – e.g. global bond markets - seeking usurious capital gains. This hand over of great financial power took place by stealth. There was virtually no public or academic debate about the impact of this transfer away from public, accountable regulators to private interests. Instead, the public were offered reassuring platitudes about the self-correcting power of free markets. Competition, we were told, would eliminate cheating and fraud. The result was entirely predictable. Small groups of individuals and corporations in the private finance sector made historically unprecedented capital and criminal gains. Vast wealth was extracted from those outside the sector. Those engaged in productive activity experienced low growth. Profits fell relative to earlier periods, unemployment rose and wages declined as a share of GDP. Inequality exploded. Trust and confidence in the banking system and in democratic and other public institutions waned. The reason is not hard to understand. The transfer of economic power away from sound, elected, accountable institutions to wealthy elites had hollowed out democratic bodies and placed key decision-makers – like the heads of global banks - beyond the reach of the law, of regulators and politicians. The economics profession and the universities stood aloof, as enormous powers were concentrated in the hands of small, reckless financiers. Academic economists focussed myopically on micro-economic issues and lost sight of the macro-economy. They obliged the finance sector by largely ignoring its activities. To this day, the economics profession remains distanced from the crisis, and almost irrelevant to its resolution. While our universities turned a blind eye to this capture of a great public good for private gain, knowledge of the monetary system was scant, and
sometimes deliberately buried. Politicians and the media were dazed and confused by the finance sector’s activities. Gillian Tett, one of the few journalists bold enough to explore and challenge the world of international financiers and creditors, blames a ‘pattern of “social silence”…which ensured that the operations of complex credit were deemed too dull, irrelevant or technical to attract interest from outsiders, such as journalists and politicians.’
Finance was too dull and arcane to attract the interest
of mainstream feminism and environmentalism. As a result of this ‘social silence’ citizens were unprepared for the crisis. They remain on the whole ignorant of the workings of the financial system and its operations. They were made ignorant of ways in which money or credit can be deployed as a public good. It is this widespread confusion and lack of understanding that enabled the private financial sector to seize control of, and manipulate the global monetary system. It is obfuscation and confusion that led the financial sector to abuse one of society’s greatest assets: trust.
Overcoming the defeatism of economists and politicians This book has been written in the belief that money and the monetary system are not difficult to understand. Second, that a broad understanding of money and credit, and of the way in which the banking system operates is essential if citizens of democratic states are to reinvigorate and empower the democratic process, and override the despotic, unaccountable power of today’s financial plutocracy. Such knowledge or understanding is vital if we are to see through the academic obscurantism and economic ‘quackery’ of much debate around monetary systems. We need such understanding as a basis for sound financial regulation and policy-making. It is also vital if we are to overcome the defeatism of democratically elected politicians, leaders and economists. Politicians are quick to abandon democratic processes and the interests of those they are elected to represent. Economists are defeatist about the possibilities of recovery from crisis, and about reform – offering us only business as usual, or “secular stagnation”15 as Larry Summers, Professor of Economics at Harvard University opined at an IMF seminar in
2013. Too many gladly subordinate the interests of society to the interests of global finance capital; others wrongly believe that there is no alternative. This is hardly surprising, given the financial sector’s grip on how it is described, not to mention the lavish rewards that await politicians on retirement. Karl Polanyi frequently reminded his readers that ‘militant liberals – from Maucaulay to Mises, from Spencer to Sumner – expressed their conviction that popular democracy was a danger to capitalism.’
Many of the
architects of the Eurozone’s monetary system share that scepticism of democracy, as explained below. This book takes the opposite position: today’s rampant financialisation of the global economy is a grave danger to the revival of employment and economic activity, to the values societies hold dear, and to democracy. The experience of financial de-regulation has shown that capitalism insulated from popular democracy degenerates into rent-seeking, criminality and grand corruption. We have done it before. We can do it again We have been here before. In the 1930s economists and politicians insisted that democracy be placed above the power of money; that finance should be servant, not master, to the economy and society. The economic cataclysm of the Great Depression came to be regarded as the direct consequence of the financial liberalisation (or ‘globalisation’) policies that prevailed in the 1920s. When the UK economy slumped in the 1930s the Bank of England refused to act proactively, which is why it was nationalised in 1945 and remains to this day under democratic control, even if that control is not always exercised. After 1931 control over the finance sector in the United States was wrested from private wealth and placed in the hands of the transparent and accountable state. Under a later mandate (the 1944 Bretton Woods Agreement) the democratic state and central banks were charged with a responsibility to manage, and maintain stability and balance in international trade and finance. All aspects of interest rate, exchange, banking and financial market policy became a matter for government. Central banks were brought under increased public control, even - as in Britain
and France - nationalised. The drivers behind these policies were elected politicians: Franklin Delano Roosevelt, France’s Leon Blum and, later, Clement Attlee’s Labour Party. But it was the British economist, John Maynard Keynes that provided the intellectual underpinnings of this re-ordering of society. Liberalised finance with the support of orthodox economists, has once again weakened democratic oversight of the economy and hollowed out the institutions of states that oversee and regulate the finance sector. If we are to prevent the kind of cataclysm that befell the world in the first half of the 20th century, then greater public understanding of how the financial system operates, and how it can be reformed, is vital. Challenging taboos about money I hope to shed some light on what Keynes called capitalism’s “elastic production of money”, and to indicate how monetary reform can restore oversight of the finance sector to democratic institutions. I have two overriding objectives, First, to challenge and nail the argument that ‘there is no money’ for society to address major threats, to fight poverty and to meet human needs. Money and monetary systems, I will argue, are social constructs, and can and must be managed, mobilised and deployed to serve the wider interests of society and the ecosystem. Second, I want to force into the open a subject that is taboo: the role of private, commercial banks in the creation of money ‘out of thin air’. For too long orthodox economists have misled politicians and others, and focussed only on central bank money creation. They have deliberately down played the role of the private sector: in credit creation or ‘printing’ money; in providing or denying finance to productive sectors; and in generating inflation. Monetarists, such as those that advised Mrs Thatcher’s government, never accuse the private commercial banking system of ‘printing money’. Yet the private banking system ‘prints’ 95% of the money in circulation in Britain, according to the governor of the Bank of England. It is they who hold the power in an unregulated system to provide or withhold finance from those active in the economy.17 Yet neoliberal
economists largely ignore private money ‘printing’ and aim their fire instead at governments and state-backed central bankers whom they accuse of stoking inflation by the excessive creation of money. The blind spot for the private creation of credit is part of the ideology rooted in the belief that “free, competitive markets” are the best way to organise the finance sector and the economy. This belief is in turn rooted in contempt for the democratic state – a contempt actively expressed by the Thatcher government of the 1980s. The monetarist blind spot for the link between private banks’ money creation and inflation goes some way to explaining why Mrs Thatcher’s economic advisers found they could not control both the British money supply and inflation.
aimed only to control the public money supply – government spending and borrowing. Partly as a result of monetarist doctrine, the Thatcher administration presided over a rise in the inflation rate to 21.9% in its first year of office. Only during the fourth year did inflation come down below the inherited rate. As William Keegan explains, the “defunct (monetarist) economic doctrine” led not only to a rise in inflation, but also to a savage squeeze on the British economy and to escalating unemployment.19 Unsurprisingly, “the private sector did not respond…because the methods chosen by the evangelicals made the economic outlook much worse, so that there was no incentive for it to respond.”
Management of the monetary system While the creation of money “out of thin air” is a fascinating, and to many a fresh, discovery, it is not finance per se, but rather the management or control over the ‘elastic production of money’ that matters. There should be no objection to a monetary system in which commercial banks create finance needed for the real economy. Indeed commercial banks have a critical role to play in providing and smoothing the flow of finance around the economy. Bank clerks have critical roles to play in managing myriad social relationships between debtors and creditors, and in assessing the risk of the bank’s borrowers. Assessing Mrs Jones’s application for a mortgage, Mr. Smith’s application for a car loan and a firm’s application for an overdraft is not a role best suited to civil servants in government bureaucracies. However, the power of private, commercial bankers to create and distribute finance must be carefully and rigorously regulated – by publicly accountable institutions - to ensure that finance or credit is
deployed for sound, affordable and sustainable economic activity; and not for speculation. The great power bestowed on banks by society – the power to create money ‘out of thin air’ – should not be used for their own selfenrichment. Nor should customer deposits and their assets (loans) be used as collateral for their own borrowing and speculation. Like doctors and dentists, bankers’ roles must be carefully defined and regulated, and their rewards must be modest. Incompetence, fraud and theft must likewise be punished. Money’s rent It is not just the creation of money and the sustaining of trust in money that this book focuses on, but also the price at which the public good that is bank money is ‘rented’ out to what can broadly be defined as Industry and Labour. That is the rate of interest applied by private bankers to the real economy. A low rate of interest is a moral imperative. But it is also an economic imperative, as it allows private industry to thrive. For capital investment projects to expand, for creative or innovative activity to be sustainable, depends on affordable finance, and affordable finance is cheap finance. Sustainable finance must also be affordable in ecological terms. Our concerns should not be limited to the way our rentier economy uses high rates to extract additional value from citizens, firms and the public sector. As worrying is the way in which high rates of interest lead to rising rates of exploitation and extraction of the earth’s limited supply of assets (forests, fish, land, minerals, clean air etc.) to finance debt repayments. In other words it’s not finance per se that is the most important factor, but how money is managed and spent. Does affordable finance flow to productive, sustainable, employment-creating, income-generating investment? Or is costly credit directed at reckless, de-stabilizing, unaffordable consumption and speculation? Challenging the defeatism
Above all, there should be wider understanding of how a monetary system can be managed to serve the interests of all sectors of the community, and not just the privileged owners of private wealth. Monetarist and other orthodox economists encourage politicians to persist in a form of despair; that society is helpless to control a man-made, socially constructed, globalised, and increasingly anarchic financial system. ‘The clock’ we are told by the World Bank ‘cannot be turned back.’
Instead economists persist in the lie that:
‘there is no money’ – a lie repeated endlessly by politicians of all colours. This book is written to challenge that dominant flawed ideology. In mounting a challenge to finance we must gain confidence from this truth: finance capital has no greater fear than democratic regulation and reform of the monetary system. This is because monetary reform will transform the balance of power between democratic societies, the ecosystem and finance – in favour of democracy, society and the ecosystem. And it will do so in a way that one-party communist states, for example, were not able to achieve. Knowing that should give us courage: another world is indeed possible. But then I am an optimist.
Chapter One: So how is money created today? It's not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed. Ben Bernanke explaining in a TV interview how $85bn had been created to bail out AIG. 22 The journalist had asked if it was tax money? Most orthodox, neoliberal economists would have us believe that banks and bankers are mere ‘intermediaries’ between borrowers and savers; that savings are needed for (and prior to) investment; that loans are made from deposits; and that the price of money – defined as the ‘natural rate of interest’ – is a function of the supply of, and demand for, money or savings. Economists such as John Maynard Keynes, Joseph Schumpeter, JK Galbraith, Victoria Chick, Geoff Tily, Cullen Roche and those who define themselves as Modern Monetary Theorists (MMTers); sociologists, central bankers, commercial bankers, presidents and politicians have long known that none of this is the case. Nor has it been so since before the founding of the Bank of England in 1694. Private commercial bankers are not, nor ever have been, mere intermediaries. Savings are not needed for investment. Commercial bankers do not lend the deposits of their customers on to borrowers. Bankers do not use their reserves ‘parked’ in central banks to lend on. The money for a loan is not in the bank when a borrower applies for a loan. 24
Bank credit-money is produced out of nothing more than the promise of repayment – a promise deemed acceptable by the banker. Credit creates purchasing power. Bank money issued as credit does not exist as a result of economic activity. Instead, bank money creates economic activity. Private bank loans issued by commercial bankers (with a stroke of the computer keyboard) create deposits. It is the loan application together with a risk assessment, the borrower’s promise of both collateral and repayment over a specified period of time at a specific rate of interest - that creates deposits. This was confirmed in the summer of 2013 by Paul Sheard, the chief economist of Standard and Poor’s, in a note headed Repeat After Me: Banks do not Lend out Reserves: Banks lend by simultaneously creating a loan asset and a deposit liability on their balance sheet. That is why it is called credit "creation"-- credit is created literally out of thin air (or with the stroke of a keyboard). The loan is not created out of reserves. And the loan is not created out of deposits: Loans create deposits, not the other way around. Paul Sheard23 After a risk assessment, a contract agreement, and the offer of collateral, money is created by simply entering a number into a computer and charging the sum to the borrower’s account. (In bygone days this bank transfer was made using a fountain pen or quill to make an entry into a ledger. It was then known as ‘fountain pen money’.) The overwhelming bulk of credit is ‘bank money’ created in this way. It exists as nothing more than a promise to repay over an agreed period of time. At the most tangible, it is the quantities expressed on a bank statement. 25
When banks extend loans to their customers, they create money by crediting their customers’ accounts. Mervyn King, Governor of the Bank of England in a speech to the South Wales Chamber of Commerce at The Millennium Centre, Cardiff, 23 October 2012.24 In the Eurosystem, money is primarily created through the extension of bank credit… The commercial banks can create money themselves. Bundesbank25 The Euro’s introduction in the form of notes and coins dated from 2002, but it existed as a means of setting prices, contracting debts & a means of payment for over a year before [being] embodied in these media of exchange. Geoffrey Ingham26 Money’s quality, its acceptability and validity is simply due to its being able to facilitate transactions - as the genius and Scottish economist, John Law, was first to fully recognise. “Money is not the Value for which Goods are exchanged, but the Value by which they are exchanged”. Joseph Schumpeter, History of Economic Analysis, attributes this quote to John Law.27 The delusion of ‘fractional reserve banking’ Those who grasp this much still sometimes fall into another popular misconception, the idea that commercial banks can only create credit or lend on the basis of a fraction of ‘reserves’ or cash or ‘capital’ in the bank. In other words, so it is said, to lend £1000, banks need a reserve requirement of £100 in their vaults, or in the vaults of the central bank. The reality is 26
exactly the opposite. Reserves are created as a result of, and to support lending. Banks keep reserves in the central bank, in reserve. Reserves are funds provided by the central bank, which banks need on a day-to-day basis to settle accounts with other banks, as part of the cheque-clearing process: for no other reason. Frances Coppola has it right: Bank reserves never leave the banking system. They are not "lent out", as is often claimed. When a bank lends, it creates a deposit "from nothing", which is placed in the customer's demand deposit account. When that loan is drawn down, the bank must obtain reserves to settle that payment - but the payment simply goes to another bank (or even the same one), either directly through an interbank settlement process, or indirectly via cash withdrawal and subsequent deposit. The total amount of reserves in the system DOES NOT CHANGE as a consequence of bank lending. Only the central bank can change the total amount of reserves in the system. This is usually done by means of "open market operations" - buying and selling securities in return for cash.28 Money’s quality, its acceptability and validity is simply due to its being able to facilitate transactions. The deregulated financial system – and liquidity It’s important to understand that under our deregulated financial system bankers can create credit or liquidity (i.e. assets that can easily and readily be turned into cash) effectively without limit. There are now few regulatory constraints on the creation of credit by commercial bankers. Furthermore de-regulated finance also encourages financiers in the ‘shadow banking system’ to create or ‘securitise’ more and more artificial or synthetic ‘credit’ products or assets. This has led to a new type of financial engineering known 27
as the ‘originate and distribute’ model for packaging and ‘originating’ financial instruments or collateral that were ‘synthetic’ in that (unlike property or works of art or other forms of collateral) they were created artificially. These packaged ‘assets’ were then used to leverage further borrowing, which in turn generated massive amounts of liquidity for those active in shadow banking. These assets and associated borrowings create tremendous wealth and are often hidden and managed off balance sheets in ‘special investment vehicles’ or SIVs. Central bankers failed to understand these dangerous self-enriching activities, or intentionally turned a blind eye. Some cheered on the finance sector’s increasingly godlike financial engineers. Alan Greenspan in 2004 said that under the deregulated system “Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient.”
Where do notes and coins come from? While banks are not on the whole constrained in their ability to create credit there is one thing bankers cannot do. They are not licensed to issue notes and coins as legal tender. Only the central bank can issue the legal, tangible stuff: notes and coins. So if Joanna Public takes out a mortgage for say, £300,000, and needs £3,000 in cash, the commercial bank has to apply to the central bank for the tangible notes and coins she wishes to withdraw. £297,000 of credit is granted as intangible bank money, and is deposited in Joanna’s account. It is important to understand that central banks place no limit on the cash made available to private commercial banks to satisfy a loan application. Because the central bank provides cash on demand, there is therefore no limit to the cash, bank money or credit that can be created by commercial 28
banks. In other words, there is no ‘fractional reserve’ or ratio. In fact, the demand for cash is falling; but during the long boom the demand for credit accelerated – and central bankers turned a blind eye. They neither limited the quantity of credit created, nor did they offer guidance to private bankers on the quality of credit issued. So banks were freed up to not only lend for productive, income-generating activity, but also for risky, speculative activity. Just as importantly, central bankers in the 1970s relinquished control or influence over the full spectrum of interest rates made on loans by bankers. These include rates on short-term and long-term loans, as well as on safe and risky loans. They abandoned tools and policies used during the Keynesian era to regulate credit creation, and to influence rates across the full spectrum of lending. The purpose then had been to ensure that rates for productive activities were kept low for all borrowers, and therefore repayable. These policies were based on Keynes’s theory that employment, economic activity and profits could only be assured if credit was affordable. His liquidity preference theory was used as the basis of policies that ensured that interest rates during World War II were kept low, to help with affordable financing of the war. They were stunningly successful. More on that below. After the collapse of the Bretton Woods era, credit creation and the ‘pricing’ of credit was left to the whim of the ‘invisible hand’. Private bankers were unfettered in their power to create credit (debt) effortlessly and if they wished, for speculation in property, exotic derivatives, works of art, football clubs, and so on. They were freed up to charge high real rates of interest. The result was entirely predictable. A vast bubble of credit was used to speculate in, and inflate the value of assets: for example, works of art, classic cars, footballers and football clubs, yachts, brands, property, stocks and shares. Assets are largely owned by the wealthy, and can be used to increase wealth when used as collateral for further borrowing. The inflation of assets vastly and effortlessly increased their wealth, and the ability to use that wealth as collateral with which to leverage further borrowing.
At the same time, and predominantly in the Anglo-American economies, ‘easy’ but ‘dear’ credit buried companies, firms, households and individuals in largely unaffordable debt. Credit creates deposits Deposits are created when a banker, having assessed the risk associated with the loan; having confirmed by legal contract the promise to repay, backed by collateral (e.g. property) at a rate of interest and over a fixed period of time; and having obtained the cash proportion of the loan from the central bank, then enters numbers into a ledger or computer. After entering the amount of the agreed loan into the computer, the banker credits the funds to the account of the borrower. This, as Ben Bernanke explained in the interview quoted at the beginning of this chapter is what the Federal Reserve accomplished when it created $85 billion ‘out of thin air’ and credited that amount to the account of a nearbankrupt insurance company AIG, one day in the winter of 2008-9. The money was not raised from taxation, as Chairman Bernanke made clear to the journalist who questioned him. Furthermore, AIG is not a bank, and should never have had an account with the Fed, but major concessions were made to reckless, effectively insolvent firms that posed a systemic threat to the economy during that period. When the loan created by entering numbers into a keyboard is drawn down by the borrower, the payment goes either to the same bank, or to another, either through interbank settlements, or by withdrawing cash from bank A and depositing it in bank B. In accounting terms, these deposits are liabilities for the bank that issued the loan. The reason for this is that claims can immediately be made on deposits, for both the tangible notes and coins and for the intangible bank money element of the loan. Bank A will have to ‘clear’ any payment to Bank B.
The loan itself, however, becomes an asset. The reason for this is that the bank expects to earn interest or a rate of return on the loan when it reaches maturity – in other words, over time. The task of the banker is to ensure a match between income earned from lending, and liabilities incurred from deposits. Once the loan is drawn down the bank proceeds to drain a share of the borrower’s income, in interest payments. By these means do commercial banks create the overwhelming bulk of deposits, and earn interest on a process that costs them little. Andy Haldane, Executive Director, Financial Stability at the Bank of England explained recently that by fixating on inflation targeting, central bankers had turned a blind eye to what was really going on in the credit-fuelled financial system: “Inflation targeting assumed primacy as a monetary policy framework, with little role for commercial banks' balance sheets…what happened next was extraordinary. Commercial banks' balance sheets grew by the largest amount in human history. For example, having flatlined for a century, bank assets-to-GDP in the UK rose by an order of magnitude from 1970 onwards.”30 (To remind readers: assets in this context means bank lending.) In 1980, UK bank credit or lending was just 36.2% of GDP. By the year 2000, bank credit had risen to 136% of GDP. In 2008, bank credit was a whopping 212% GDP, according to the World Bank. Mervyn King confirmed the role of private banks in expanding the money supply in an interview (14 June, 2013) with Martin Wolf just before his retirement as Governor of the Bank of England. Wolf asked the Governor about quantitative easing – had that worked as he hoped? “I’ve always seen this as a way of increasing the broader money supply. And the thing that’s so extraordinary is that, for the past few 31
years, the banking system, which is normally responsible for creating 95 per cent of broad money has been contracting its part of the money supply. And since we at the (Bank of England) only supply about 5 per cent of it, the proportional increase in our bit has to be massive to offset the contraction of the rest.”31 (My emphasis) Banks and bankruptcy If bankers can create credit out of thin air, I hear you ask, how can they be bankrupted? When a banker elicits a promise of repayment on a loan from a customer, and then creates credit for the customer, this immediately becomes a loan asset and a deposit liability on their balance sheet. The loan is an asset because, over time, it will earn interest for the bank. The deposit is a liability because it is immediately owed by the bank to the customer or depositor – who may withdraw it to make payments to another bank. (Time management is a critical function for bank managers.) The bank has to manage its assets and liabilities carefully to ensure funds are available when the depositor wishes to withdraw her deposit. It does this by obtaining reserves from the central bank system each time it creates a deposit. Reserves are used for clearing and settling inter-bank financial transactions. The banking system as a whole has to manage financial transactions and ensure that cheques and other payments are cleared between those receiving payments and those making payments. This is the critical role played by the central bank – e.g. the Bank of England, the Federal Reserve or the Bank of Japan. Central banks perform important roles in helping to maintain balance in the financial system by clearing and settling interbank payments. The central bank helps settle payments between bankers by debiting the accounts of banks making payments and crediting the accounts of banks receiving payments. When payments are made between the accounts of customers at different commercial banks, they are ultimately settled, as explained above, by 32
transferring central bank money (reserves) between the reserve accounts of those banks. In normal times these payments cancel each other out, with only a small amount of central bank reserves needed for settlement at the end of the day. But bankers can get into difficulties, and times are not always normal. If owing to mismanagement a bank finds its liabilities begin to exceed its assets, then no amount of central bank reserves can help it: it is facing bankruptcy. If the public get wind of any difficulties, then there is a ‘run’ on the bank; deposits are quickly withdrawn, and liabilities begin to mount. (Remember though, all licensed banks have deposits up to a specified limit guaranteed by the state, so deposits are on the whole, protected. In this respect banks are very different from corporations, whose customers, in the event of bankruptcy, are not protected by the state.) Until recently commercial banks were prohibited from mixing their lending and deposit arms (commercial banking) with their more speculative investment arms. Then in 1999 President Clinton, under pressure from big bankers, and aided by the economists Larry Summers and Robert Rubin, repealed the Glass-Steagall Act which after the 1929 financial crisis had enforced separation between commercial and investment banking. Other central bankers soon followed suit. Commercial bankers were then freed up to link their own borrowing and speculative activity to the more sober dayto-day role of assessing risk, and supplying credit and deposits to those engaged in the real economy. Because these two sides of banking became so closely integrated, excessive borrowing for reckless speculation by private bankers exposed all those who used the banking system to major – or systemic - risks, costs and losses. As sure as night follows day, excessive borrowing and speculation by bankers helped precipitate the global financial crisis of 2007-9, when most banks faced the threat of insolvency. They were bailed out by taxpayerbacked governments with barely a rap on the knuckles, and with virtually no ‘terms and conditions’. To this day no banker has been jailed, or been held 33
criminally responsible, or had to admit any wrongdoing for his role in precipitating global financial meltdown in 2007-9 – or for subsequent frauds and failures. Where fines have been administered, they have represented but a fraction of the cost to society of financial failure and wrongdoing. Andy Haldane, responsible for Financial Stability at the Bank of England, argued once that even if bankers were to compensate society for the losses endured, “it is clear that banks would not have deep enough pockets to foot this bill.” 32
Despite massive bailouts by taxpayer-backed central banks, I contend that most global banks are still effectively insolvent. Government guarantees and backing, coupled with the manipulation of balance sheets, is what stands between today’s global banks and insolvency. The good news: credit creates economic activity The good news is that when the banking system is properly regulated and managed, bankers create all the credit society needs for purposeful economic activity. When this credit creates new deposits at low, repayable rates of interest, then if used for productive activity, deposits create economic activity (investment and employment). These in turn – if the money is invested in ecologically sustainable activity - generate income (wages, salaries, profits and tax revenues). This income can be used to repay loans and debts. This virtuous economic circle in which debtors and creditors engage at a fair rate of interest, and on the basis of trust in order to invest and generate jobs and income, to create and to innovate, to finance vital projects, and then to settle debts, is how an advanced, sound and stable monetary system can work. It is how a monetary system can be used to finance services vital to for example, women; or to fund the transformation away from fossil fuels to more sustainable forms of energy. It is under the strains of speculation and high rates of interest that the system quickly becomes unstable, and likely to ‘debtonate’. In other words, 34
the system becomes unstable if credit is largely wasted on creating vast bubbles of unpayable debt; or on illusory liquidity. The latter can be defined as fictitious capital or ‘Ponzi finance’ where risks are underestimated, buyers disappear and value quickly evaporates in a crisis. Liquidity becomes illusory when the owner of an asset finds no buyers for his asset, at a time he urgently needs to sell. So for example, I might purchase expensive diamond watches, or collateralised debt obligations (CDOs) believing they are largely ‘liquid’ i.e. can quickly be turned into cash in a crisis. That ‘liquidity’ evaporates when buyers for diamond watches or CDOs disappear from the market – often because a generalised loss of confidence, and because they too are heavily indebted. The ecological impact In the run-up to the crisis of 2007-9, firms, individuals and households, but also banks in mainly Anglo-American economies took on huge debts at rates of interest too high to make repayment affordable. These debts were used to purchase an explosion in financial assets, in property and consumer goods. The rise in consumption led inevitably to a rise in greenhouse gas emissions. In order to repay rising debts, firms and households are obliged to exploit natural and human resources in a way that is damaging in the medium, never mind the long, term. Employees are expected to work longer hours, to generate more goods and services, and to do so at lower rates of pay. Hence the rise in the 1980s and 90s of the phenomenon of 24/7 – shops and firms open for long hours, with workers expected to work unsocial hours. Natural resources (like the land, forests and seas of fish) are exploited at exponential rates, to enable firms and even governments to
generate the income needed to repay debts. (Think of Brazil stripping forests to generate the hard currency needed to repay foreign debts.) These developments add social insecurity and ecological instability to the mix of financial volatility. Society must learn from these grave errors, that the great public good that is the ‘magic’ of credit-creation by the private banking system must be managed and carefully regulated if lending is to be affordable, sound and sustainable, and if society as a whole is to benefit. Management of the rate of interest plays a key role in the regulation of a stable financial system.
Chapter 2: The ‘price’ of money – or the rate of interest While the creation and management of credit was indeed a revolutionary advance for society, perhaps just as important was the impact the greater availability of finance had in lowering of the ‘price’ of money, or the rate of interest. 33 The rate of interest on credit is fundamental to the health and stability of an economy, which is why much attention is paid to it in this book. The level of employment and activity in an economy depends critically on the rate of interest. Too high a rate stifles enterprise, creativity and initiative and renders debts unpayable. There is also a moral dimension to the relationship between those who own assets, the creditors, and those in need of money or credit, but without assets, the borrowers. This moral dimension has been at the heart of the condemnation of usury – exploitative rates of interest - by faiths, including Islam and Christianity A low rate is also fundamental I argue, to the health of the ecosystem. Too high a rate demands ever-rising extraction of the earth’s assets, to generate resources for repayment. Given there is no necessary limit to the volume of credit and debt that can be created by private, commercial banks then credit is essentially a free good – not subject to finitude, or the market forces of supply and demand. From this it follows, as Keynes argued in his Treatise on Money, that: “... if the banks can create credit, (why) should they refuse any reasonable request for it? And why should they charge a fee for what costs them little or nothing?”
Keynes recognised that once the system of bank money evolved, and credit became more widely available, society no longer needed to rely on existing wealth holders for finance. Barons in the castle – owners of a surplus of capital - were no longer sole providers of loan finance to the rest of the economy. Savings were no longer needed for investment. The powers exercised by the owners of wealth could be subordinated to society’s wider interests. Credit creation by banks could provide borrowers, entrepreneurs and innovators with the finance needed for investment – at affordable rates of interest. Creative artists and designers, entrepreneurs and innovators no longer had to turn to wicked, wealthy ‘robber barons’ for usurious finance. The ‘price’ of money vs the price of smartphones The rate of interest on this bank money is determined in ways quite different to the way in which the price of (say) tomatoes or a smartphone or a pair of shoes is fixed. It is different, and cannot be subject to the forces of ‘supply and demand’ because of the very nature of bank money, and of the largely effortless way in which it is created; and because rates are fixed by committees of men and women. To manufacture a product such as for example a smartphone requires manufacturers to engage with first the Land – in the broadest sense of the word. Minerals and crucial elements for the phone have to be extracted from the earth, and then transported to manufacturing sites. The extraction, supply and transport of these minerals are subject to both geological and geographical, but also geopolitical, constraints. Second, the manufacturers of the smartphone have to engage with Labour – in the broadest sense of the word. Labour has to be found and trained; wages have to be negotiated; and sometimes disputes have to be managed. The creator of credit faces none of these challenges. The banker engages with neither the Land nor Labour in the creation of his financial product. Sound banking requires good judgment, a conscience, and accounting skills. But
the mere act of credit creation is effortless in the way that the manufacture of, say, a mobile phone, no matter how slapdash or obsolete, is not. Because credit or bank money is created in this way, there is no necessary limit to the volume of credit that can be created. Of course there are constraints in the management of credit, including the threat of excessive credit leading to inflation; or the contraction of credit leading to deflation. But unlike smartphones, credit does not rely on finite (mineral and labour) resources for its production. Instead it relies on a potentially infinite supply of that essentially human quality: trust. Interest extracts wealth from borrowers and assets from the planet The development of the credit system takes place as a reaction against usury. This violent fight against usury … on the one hand robs usurer’s capital of its monopoly by concentrating all fallow money reserves and throwing them on the money-market, and on the other hand limits the monopoly of the precious metals themselves by creating credit-money. Karl Marx35 As Marx notes above, the development of the banking system, and of a system of credit, arose as a reaction to usury. Rates of interest, in particular usurious rates, extracted excessive wealth from borrowers. Borrowers and wider society eventually reacted against such exploitation, and the banking system began its steady evolution. The extraction of wealth from borrowers is compounded when payments to the lender, creditor or rentier are delayed or halted, so that the lender can make exponential gains from debtors. As such the practice of exploitative moneylending is widely viewed as parasitical, with humanity and the ecosystem as host.
Furthermore money-lending at high rates of interest can help stratify wealth and poverty. The rich effortlessly become richer, and the poor and indebted ever more entrenched in their debt and impoverishment. Usurious behaviour is repellent, but high real, rates of interest are accepted as normal – the necessary ‘price’ paid for ‘easy money’ - in western society. There was a time when Christianity’s leaders condemned usury, and punished usurers with ostracism, denying them the chance to be buried in sacred ground, or married in church. Cosimo de Medici paid for the restoration of a monastery in return for a papal bull that redeemed him of past sins, in a clear attempt to absolve himself and his heirs of any potential charge of usury by the Church. Christianity’s prohibition of usury was to be modified by John Calvin (1509 – 1564) and other Christian leaders, a modification as the Financial Times noted on the 400th anniversary of Calvin’s birth, led to: a huge influx of protestants from France, following in Calvin’s footsteps (who) brought ... skills to Geneva while the lifting of the Catholic Church’s ban on usury paved the way for the city’s preeminence in private banking.36 Even while some branches of Islamic finance circumvent the Koranic law, Islam has always upheld the Koran’s prohibition of the taking or giving of interest, or riba – regardless of the purpose of the loan. “Riba” includes the whole notion of effortless profit or earnings that arise without work or valueaddition production in commerce. In Islam money can only be used for facilitating trade and commerce – a crucial difference with the acceptance of interest by the world’s major Christian religions. Islamic scholars were fully aware that moneylending can stratify wealth, exacerbate exploitation, and lead to the eventual enslavement of those who do not own assets. Because Arabs were the world’s foremost mathematicians, having imported the
decimal system invented by Hindus they fully understood the “magical” qualities of compound interest, and its ability to multiply and magnify debts. Usury is today widely accepted as normal in western economies that have been weakened, morally, politically and economically, by the parasitic grasp of finance capital, and immobilised by heavy burdens of debt. This acceptance blinds society to the way in which usury exacerbates the destructive extraction of assets from the earth. This happens because, as Prof. Frederick Soddy once explained: “Debts are subject to the laws of mathematics rather than physics. Unlike wealth which is subject to the laws of thermodynamics, debts do not rot with old age and are not consumed in the process of living ... On the contrary (debts) grow at so much per cent per annum, by the wellknown mathematical laws of simple and compound interest ... which leads to infinity … a mathematical not a physical quantity …” Prof. Frederick Soddy37 The earth and its assets are finite, and subject to the process of decay. Nature’s curve for growth is almost flat. The rate of interest’s curve is linear. Compounded interest’s curve is exponential, as the late Margrit Kennedy demonstrated in the chart below.38
In order to repay debts that have accumulated exponentially, society is obliged to extract more and more assets from Labour on the one hand, and Land on the other. This means, in macroeconomic terms, that Labour has to work harder and longer, to repay rising levels of debt. It is no accident that the de-regulation of finance correlated with the de-regulation of working hours, and the abolition of Sunday as a day of rest. ‘24/7’ – meaning shops are open 24 hours a day for 7 days a week, became an acceptable practice as the finance sector’s values took precedence over other considerations. It is not just workers who are hurt by finance capital’s exploitation of their labour and the extraction of wealth, by way of high rates on debt. Firms, entrepreneurs, inventors and engineers, innovators, artists of all kinds find their efforts thwarted by bankers, ‘private equity investors’ demanding higher rates, and a larger share of the returns on creativity, investment and innovation. As this process snowballs, rents rise. 42
But high rates have implications for the ecosystem too. First, ‘easy credit’ leads to an expansion of consumption. Shopping malls become the temples of the High Street. In order to pay for credit-financed consumption, seas have to be fished out; forests have to be stripped; and the ‘productivity’ of the land intensified – at the same exponential rate as interest rates rise. High-yield crops, the use of fertilisers and pesticides; the constraining of animals indoors; increases in food production, not just for the world’s growing population, but to make food production more profitable than debt all this must be done in order to repay debt. The effects are well known: soil degradation, salination of irrigated areas, over-extraction and pollution of groundwater, resistance to pesticides, erosion of biodiversity, etc. In other words, the earth’s limited resources have to effectively be cannibalised to repay the world’s creditors. The high real rates of the neoliberal era As I have shown above, the supply of money or credit is without limit. Its over-supply, and the tendency of creditors to lend pro-cyclically, should if anything, suppress its price. Not so. Interest rates, in real terms, have risen steadily over the period since Keynesian policies were abandoned. Indeed high rates of interest have punctured credit bubbles with painful regularity since central banks abandoned management of rates, and regulations over credit creation were lifted in the 1970s. There are very few charts that show the progress of interest rates in real terms – that is in relation to inflation. Because of this I have chosen to highlight the chart below, with acknowledgements to the Financial Times. It shows in nominal terms (i.e. not adjusted for inflation) the official Bank of England Rate between 1914 and 2009. Central bank rates are on the whole lower than commercial bank rates. While this chart does not provide the full picture, note the period between 1933 and1950 when Keynes’s liquidity preference theories were applied by Britain’s authorities. Over this period inflation was subdued. Note also, that as finance was liberalised, and the creation of too much credit chasing too few goods and services led to 43
inflation, the central bank’s rate rose too – both in line with inflation, but also as a symptom of the volatility caused by liberalisation. The central bank rate in turn influenced rises in the full spectrum of interest rates – for shortterm and long-term loans; safe and risky loans and in real terms. These latter rates are not reflected in the chart below.
Dr. Geoff Tily in a study published by the Bank for International Settlements provides the following chart of US long-term real interest rates, which shows the rise of rates in real terms after the mid-1970s.39
The de-regulation of credit creation was begun in the UK in 1971 with a process known as ‘Competition and Credit Control’ – often described by economists as “all competition and no control.” Finance capital – the ‘robber barons’ of our day - had regained control over the spectrum of rates applied to borrowers, from long-term rates used for investment by firms, to mortgages and short term unsecured loans. As de-regulation freed up private bankers to create credit without oversight, and for speculation, too much credit/money began chasing too few goods – resulting, inevitably, in inflation. Secondly, as private bankers were freed up 45
to fix rates on that ‘easy money’, so interest rates were ratcheted upwards. High rates periodically bankrupted firms, industries and economies. Governments reacted to the inflation of the 1970s by introducing policies that suppressed the prices of wages, goods and services. Asset prices, by contrast were not suppressed in the same way. Today, by controlling the dominant rates of interest in an economy, finance capital once again controls and holds the economy to ransom. It is finance capital, not central bankers or politicians that exercises overbearing, and unaccountable power over society and the ecosystem. Determining a sustainable rate of interest Our desire to hold money as a store of wealth is a barometer of the degree of our distrust of our calculations and conventions concerning the future… The possession of actual money lulls our disquietude; and the premium which we require to make us part with money is the measure of the degree of our disquietude. J. M. Keynes, 1937
Keynes’s liquidity preference theory outlined in The General Theory of Employment, Interest and Money provided central bankers and governments with not just an understanding of how interest rates are determined but also with policies for managing, and keeping rates of interest low across the full spectrum of lending during World War II, and beyond.41 This was a time when Britain’s government borrowed more than it had ever borrowed before, and public debt peaked at 250% of GDP. Geoff Tily argues in his book, Keynes Betrayed
liquidity preference theory led [Keynes] to conclusions of the most profound importance. Ultimately, the theory turned classical analysis on its head. The rate of interest was the cause, not the passive
consequence, of the level of economic activity and in particular, of the level of employment. Yet this revolutionary monetary theory is largely ignored by the economics profession, and forgotten by regulators and policy-makers. Central to Keynes’s theory is an understanding of bank money, not just as a means of exchange but as a store of value. He argued that once a system of bank money evolved, society no longer needed to rely on the holders of wealth, the “robber barons” of old. The existence of bank money means, as explained in earlier chapters, that those fortunate enough to own a surplus of capital are no longer sole providers of loan finance to the rest of the economy. Second, under a well-managed banking system (managed in the interests of society as a whole) finance capital need no longer determine the rate of interest for lending. Instead, within a bank money system, finance capital can be held at bay, and forced to play a more passive role in the economy. How, you ask? A lender or creditor’s decision about where to place, and for how long to hold her savings, is determined first by a need for cash, for immediate or nearimmediate use in purchasing goods and services. Second, by the precautionary motive: the desire for security as to the future equivalent of her cash. And third, by the speculative motive: the desire to secure gains by knowing better than the market what the future will bring. Here’s Tily again: The rate of interest, Keynes concluded is therefore determined by the supply of, and demand for, safe assets into which holdings of (stocks) of wealth can be placed for different motives and for different periods of time – to suit the liquidity preferences of the investors. By producing and managing a full range of such assets, governments working with Treasuries and central banks can jointly create and manage a the full range of assets needed by investors, and thereby influence and 47
manage the spectrum of interest rates applied across the economy for loans of different maturities and riskiness However, central bankers long ago abandoned Keynesian policies for the management of rates to meet investor demands for assets that will satisfy their need for liquidity or cash, for security and for speculation. Instead this asset-creation role, and with it the determination of interest rates, was transferred into the hands of global finance capital. Today, as this book goes to press, global financial institutions are gravely weakened by the financial crisis. Investors have lost confidence in these institutions and their ‘products’, and there is a serious shortage of assets. As a result savings and surpluses are poured into a small group of assets regarded as safe by investors: mainly property, gold, jewels, stocks and shares, government bonds. This has led, predictably, to the inflation of these assets. Central bankers appear helpless to deal with this inflation – only because they have abandoned Keynes’s advice of how central banks and governments can intervene, to manage both the production of a range of assets needed by investors, and the pricing, or the rate of interest on those assets. How commercial bankers fix interest rates While central banks have control over the ‘base’, ‘short’ or ‘policy’ rate, they have not since the de-regulation of the 60s and 70s exercised control over the whole spectrum of rates: real, short and long-term; safe or risky rates. Indeed urged on by commercial and central bankers, politicians and regulators deliberately weakened central bank control over the rates of interest that could be charged by commercial bankers. The Bank Rate is of very little relevance to producers in the real economy: no entrepreneur that needs to borrow from a commercial bank pays the ‘base’ or central bank rate (currently 0.5% in the UK and 0.225% in the Eurozone) for their overdrafts or loans. Only banks or financial institutions registered with the central bank enjoy the benefit of the policy rate. 48
The rates on loans made to firms and individuals are determined – socially constructed - by those engaged in the ‘production’ of loans: commercial bankers. Bankers make decisions about the rate of interest on a loan based on their assessment of the riskiness of the borrower, and on the rate of return themselves; but also on what other creditors are offering borrowers in the market place. Given that the banking sector is oligopolistic, there is in reality very little competition, and instead a great deal of collusion on decisions about rates. The LIBOR scandal brought to the attention of the general public (and to economists and the regulatory authorities!) the role played by (a) the cartel that is the British Bankers Association, and b) back office ‘submitters’, in ‘fixing’ the price of inter-bank loans: the inter-bank rate of interest. This was Keynes’s point: the rate is not fixed by the demand for savings, but rather by the demand for assets. For individual loans made by banks to firms and individuals the interest rate is determined by bankers and ‘submitters’ in the back offices of banks like Barclays. Because of the nature of credit-creation, the ‘price’ or cost of borrowing is unlike any other price. It is a social construct a ‘price’ fixed on something that is essentially a social relationship, and that therefore, unlike a commodity, cannot be finite or scarce. History teaches us that it need not ever be high; and it need not be determined by powerful individuals or institutions with excessive wealth. Fixing the central bank’s rate of interest The Bank’s primary objective is to ensure that short-term sterling market interest rates are consistent with the official Bank Rate. The Bank is able to implement monetary policy because it is the sole issuer of sterling central bank money. It can therefore establish itself as the rate-setter by being the marginal supplier or taker of funds at its chosen rate(s).
From “The framework for the Bank of England’s operations in the sterling money markets.” January, 2008.43 Because of its monopoly over the issue of notes and coins, the central bank today controls just the base rate of interest when it provides an endogenous (originating from within) supply of cash to commercial banks that in turn determine the quantity of credit created. It is the sole power to issue notes and coins that provides the Bank of England for example, with a mechanism for setting the official, base rate of interest. The central bank does this by providing cash on demand i.e. without limit to a commercial bank, in exchange for collateral (assets, e.g. Treasury bills, mortgages or bonds). Quantitative Easing, as explained earlier, operates in a similar way: the central bank swaps assets like reserves (which do not leave the banking system but can be used for clearing with other banks) in exchange for government and corporate bonds, mortgages and other assets. If Anybank UK intended to make a loan of say £6,600 to Josephine Bloggs, the bank could approach the Bank of England and demand £300 of that loan in cash (the amount that Josephine is likely to draw in cash). In return Anybank would offer an asset (say a government bond) of £300 to the Bank of England. The BoE holds this ‘collateral’ or asset for a period, and then returns it to Anybank at a discount of its value, retaining say 5% of the asset, or £15. The central bank’s normal approach is to accept a wide range of eligible assets from commercial banks in exchange for cash. The difference between the original value of the asset and the new value – i.e. 5% - is the rate of interest (an arrangement known as a repurchase agreement or “repo”) on a specified date. In other words, the central bank takes its cut, returns the assets to the commercial bank, and it is the ‘cut’ that is the base rate.
The rate at which these assets are discounted is set by committees of men and women - public servants – who decide on a base rate intended to suit, on the whole, all sectors of the economy: Finance, Labour and Industry. In the UK the committee is known as the Monetary Policy Committee, and in the US as the Federal Open Market Committee. The interest rate set by these committees of men and women is known as the Bank Rate. In short central bank control over the Bank Rate is achieved through the central bank discounting assets owned by commercial banks in exchange for cash. The commercial bank pays the Bank Rate in due course, adds its own interest to both the cash and the bank money it has created, and passes both charges on to the borrower. Note that this ‘price’ is not a consequence of demand for cash. It comes about as a result of deliberations by a committee of men and women and the deliberate action of the central bank. That is why it is described as a social construct, not the consequence of market forces. The central Bank Rate has no necessary relationship to rates charged by commercial banks to non-financial institutions. The arrangements to obtain cash from the central bank, allows private banks to expand credit-creation so long as they have sufficient eligible assets to exchange for just the cash-ratio. Because cash is disappearing from everyday life in high-income countries, commercial banks are economising on the cost of obtaining cash from the central bank. Instead commercial bankers encourage their customers to refrain from using the Bank of England’s sterling or cash, and instead to use debit or credit cards for transactions. The rate of interest as weapon Wielding the weapon of interest, finance capital effectively holds society, governments and industry, but also the ecosystem, to ransom over 51
repayment of its loans. However, this is only because society, elected governments and industry have conceded this despotic power to finance capital. This predicament is particularly tragic, given that in theory, the development of banking and of sound monetary systems should have ended the power of any elite to extract outsized returns from borrowers. Today, just as in earlier pre-banking eras interest rates remain high in real terms, even in rich countries. But this time rates are kept high not by a scarcity of money, but by a scarcity of general understanding of the social relationship that is money.
Chapter Three: a brief survey of the evolution of bank money. Many historians and economists have described the evolution of money with more authority, and at greater length, than I can match in this little book. I refer you to an excellent book Money, Whence it Came and Where it Went, by Kenneth Galbraith;44 Geoffrey Ingham’s superb The Nature of Money
to David Graeber’s Debt: The First Five Thousand Years,46. Felix Martin’s recent Money: the unauthorised biography is a fascinating historical overview, and is highly recommended.47 Instead I want to sketch the key stages of money’s evolution, as a basis for what I hope will be greater understanding of key aspects of monetary theory. Without some understanding of monetary concepts and theory, it is not possible to analyse events properly; worse it is not possible to devise appropriate monetary policies that civil society can advocate for, and politicians, governments and central banks can implement. And please don’t be put off by talk of ‘monetary theory’. It really is not rocket science. One of the reasons the public may be a) daunted and b) confused about monetary policy is that most orthodox economists are. Believe it or not, for all their confidence, most economists lack the sound foundation of a full understanding of money. If pressed they are liable to resort to jargon or an airy insistence that money doesn’t really matter and that it is eccentric or even sinister to think it does. Still, let us not be daunted, and begin at the beginning.
Money as trust In the beginning there was trust. People exchanged goods and services, swapped things, did deals, on the basis of trust. Even in a world without coins and notes and banks, this was money as credit. Credit is based on the Latin verb, credo: I believe. In other words, ‘I believe that you will repay me, swap something back, exchange my gift for another.’ As David Graeber, the anthropologist shows convincingly, this system of trust existed long before barter.48 Barter itself was only ever a marginal activity for ancient communities and societies – a way for strangers to exchange goods with one another. By definition barter is only ever an occasional event and there is no evidence that money has ever developed out of it. Credit, with or without the infrastructure of money or coinage systems, has existed, as Graeber’s sub-title has it, for at least 5,000 years. So money, the social construct, is not based on the concept of barter, as orthodox economists would have us believe. It is based on a public or social good: trust. Credit as trust was, and is, the main means of exchange. Over time, societies developed a unit of currency with which to measure the value of goods and services that were exchanged. Even so, as Graeber writes: the value of a unit of currency is not the measure of the value of an object, but the measure of one’s trust in other human beings.49 A unit of currency, or the measure of trust began to be associated with coins, which first circulated nearly three thousand years ago. The development of coinage had one serious drawback. Because coins are physical commodities, usually based on a scarce metal (copper, silver or gold), people began to think of money as a commodity. A unit of currency as “a measure of one’s trust in other human beings” was to be lost.
Today notes and coins make up a tiny proportion of the money we use every day – bank money. In Britain, only 3% of the money in circulation is in notes and coins. Instead money today takes the intangible and invisible form of credit cards, Oyster or Metro cards – or even ‘mobile money’, We never touch it, or indeed see it – except as a charge on our bank account And this is how it should be, for money is a measure of the trust we have in each other. Felix Martin tells a fascinating story of the closure of Irish banks in1970, as a result of a breakdown in industrial relations. Despite the closures, the majority of payments continued to be made by cheque – in other words by transfers from one person’s account to another – despite the fact that the banks at which these accounts were all held were shut.50 Often the landlords of bars and public houses acted as ‘clearers’ of the credits and debts undertaken by their customers – because they had a fair idea of the financial balances of their customers and of their trustworthiness. What this incident proved is that society does not need coins, commodities or even banks to do business; to make undertakings, to give promises and to create credit. Society does not even need banks to bring together those with money but no purpose so that they can meet those with purpose but no money. The Irish experience worked because the communities involved were close-knit, and lenders and borrowers were well known for their integrity or lack of integrity. This is not possible in a bigger economy, in which more people are involved, and more complex transactions and arrangements take place, which is why banks have been necessary institutions. Fiat money The stamp on the coin was the guarantee of a measure of trust, whose value was uniform across a district, or parish, or kingdom. For the convenience of traders, but also to ensure uniformity in tax or rent collection, sovereigns began to establish uniform systems of weights and measures throughout a kingdom, including a measure for the exchange of goods and services on the basis of trust. 55
So early on, money or credit and its measure, the unit of account, were given the imprimatur of the State. To quote Keynes money was: …State-created in the sense that it was the State which defined (with the right to vary its definition from time to time) what weight and fineness of silver would, in the eyes of the law, satisfy a debt or a customary payment expressed in talents or in shekels of silver.51 The state, backed as it was by the law and by institutions that could enforce contracts; and keen to collect rents and taxes, acquired the sole power to issue the currency of a country, or region. Currency in the economic sense of the term, means the unit of account in circulation within a country or geographical area. It has a value defined by the state governing that country. Above all, it is money that has the backing and enforcement of the laws and institutions of the state and is acceptable as payment for taxes. Today that unit of account in Sierra Leone is the leone; in Indonesia it’s the rupiah, and in Canada it’s the loonie or dollar. Currency issued, and backed by the state became known as fiat money. The inconvenience of commodity money Coinage and the commodities that in those days represented money (gold, silver) had limitations. Large amounts were difficult to handle, and were unsafe to carry across distances. This is where pawnbrokers and goldsmiths stepped in. Their shops had good security arrangements and soon they began to receive valuables and gold for safekeeping – in return for receipts – or acknowledgements of a debt. At first all the gold kept in the (trusted) goldsmith’s vault was available to be redeemed immediately by depositors. The receipts were exactly equivalent (as
far as we now know) to the gold deposited. The gold in the vault came to be known as ‘reserves’. Soon the receipts – that could be redeemed for gold – began to circulate as ‘money’, and could be lent out and exchanged. The business of depositing and lending out only the amount stored in the vault is known as 100% reserve banking. As such it is not very different from today’s Peer-to-Peer (P2P) online lending, with intermediation provided then by a goldsmith, and today by a P2P company. The early goldsmiths at first managed the exchange between depositors of gold (lenders or creditors) and borrowers. The money supply was restricted to the amount of gold in the vault; just as the money supply in P2P lending is restricted to the amount that savers are willing to lend – with a ‘reward’ (commission) deducted for the intermediary. Soon however, goldsmiths began to multiply the receipts – the claims against the gold asset for the delivery of a deposit - so that several receipts could be set against the same bar of gold. The ‘receipts’ were to take on a life of their own. They became a tangible form of acknowledgement of a debt. They went on to become the intangible, invisible bank money on which we are so reliant today. In the words of Keynes this was the: discovery that for many purposes the acknowledgements of debt are themselves a serviceable substitute for money proper in the settlement of transactions. When acknowledgements of debt are used in this way, we may call them bank money […] The important economic development was this: the availability of money for society’s activities was no longer artificially constrained by limited amounts of precious metal – such as gold, silver or copper. Society was no longer held back in what could be done, by a limited money supply. Money was no 57
longer scarce. This development was to have a profound impact on societies with banking systems. Bank money and the invention of double-entry bookkeeping Receipts that were easy to carry and safe to transport along hazardous journeys, circulated and were exchanged and accepted in trust. Soon they were deposited with merchants of other banks, and proved useful in facilitating transactions across a wide range of economic activity. The goldsmith or banker, on receiving a receipt of a certain value from a merchant, would, using a quill and ink, deposit the money in his vault, by entering numbers into a ledger. At the same time the banker would have liabilities - claims made against his deposits or assets, for the transfer of ‘receipts’ or money to other banks. For these purposes, the invention of double-entry bookkeeping was both formative for the banking system, and invaluable in keeping track of assets (loans or deposits) and liabilities (debts). The ‘reserves’ (that is the gold in the goldsmith’s vault) became irrelevant and unnecessary to the creation of credit. The ‘receipts’ or bank money alone became money or a guarantee of trust, and could be used to create new deposits. These deposits in turn created purchasing power and facilitated economic transactions and activity – independently of the asset held in the goldsmith’s vault: gold. Trust and confidence invested in a banker was acquired because he so managed his accounts that the daily accrual of assets was carefully balanced by daily liabilities. Furthermore he was careful about assessing the risks associated with lending. Hayekian economists like Murray N. Rothbard call this form of moneycreation fraudulent, counterfeiting and inflationary because, first, receipts 58
did not accurately reflect the value of gold held by goldsmiths, and second, they multiplied the money supply. However, the receipts were issued in the belief they could and would be redeemed, and the money supply would be managed – e.g. to prevent inflation. In other words, faith and trust were at the heart of the goldsmith’s trade. Second, the money supply only multiplied because economic activity (employment) multiplied – and was not held back by limited supplies of, for example, gold. This is not to say that money creation could not be inflationary (or indeed deflationary). Indeed history is littered with tales of inflationary outbursts, of deflationary depressions, of bank runs and of financial and economic failures. Over time commodity and bank money contributed to a mixed managed system of currency, created and issued by the central bank on behalf of the State, and with no fixed value in terms of a commodity (e.g. gold) apart from the law or practice of the institutions of the State. While bank notes declared they could be redeemed in gold, notes were seldom or ever redeemed. However the intent helped build confidence in the system. Whereas commodity money was based on the State-defined value of a particular metal coin or other commodity; bank money came to be quite different. It was based on little more than trust, and the institutional and legal backing of the unit of account, whose value was defined by the state. Wealth, debt and the ‘dark ages’ Back in the days before the establishment of a sound banking system in Europe, entrepreneurs and innovators were dependent, as explained earlier, for investment capital on ‘robber barons’: those who had acquired a surplus of wealth by foul means or fair and who exercised great power over those without wealth. Because finance was scarce, these rich and powerful 59
individuals were able to demand high rates of interest on loans. In the absence of a sound banking system, powerful overlords were free to charge usurious rates of interest in return for renting out their surplus (capital) to poorer borrowers for fixed periods of time. As a result of their control over access to capital, as well as over its ‘price’, economic activity, creative work, employment and innovation were held back, pretty much as they are today in many poor countries. In other words, the interests of those with wealth were opposed to the interests of those engaged in risky innovation, creativity, commerce or production. The holders of wealth, by demanding high rates of return on their surplus or savings, effectively suppressed the risky activities of innovation, creativity, commerce and production. Slowly, if erratically, the medieval system was replaced first, in Italy and then the Netherlands and finally in 17th century England, by a hybrid system of state and private bank money. Understanding bank money With experience, with a sound accounting system, and above all with sound overall management, goldsmiths began to work their way into the trust of the public authorities and merchants. By creating money out of thin air they increased the supply of money and of economic activity, which had previously been limited to the surplus or savings accumulated by the rich and powerful. This increased supply of money led to three important developments. First it began to democratise or open up access to finance to those who would previously have been denied finance by those who owned private wealth. Second, it began to lower the ‘price’ of money (interest rates). Third, it provided an impetus to trade. Today, thanks to the developed bank money system that evolved and now exists in most advanced economies, innovators, creatives and traders can obtain access to credit if, after a risk assessment, the bank believes their
promises can be trusted; if they have sufficient collateral, and if they can demonstrate an ability to generate future streams of income. Most households receive salaries in bank money, the latest evolution of the goldsmith’s receipts. Bank money is intangible and often invisible (unless printed on a statement) - as credits to bank accounts. Taxes are paid by electronic transfers from firms to government; big purchases are paid for by direct debit, credit cards, money transfers, mobile phone transfers. Public transport is paid for by ‘oyster’ or ‘metro cards’. The most tangible of these money transfers – cheques – is fast becoming redundant in western economies. Bank money, which has always been intangible, becomes more so by the day, while the use of notes and coins diminishes. Whereas in poor countries a large percentage of all the money handled is in the tangible form of notes and coins, today in a rich economy such as Britain’s, only 3% of the money we handle is in tangible notes and coins. Perhaps the most difficult aspect of the theory of bank money is this: bank money held in banks does not necessarily correspond to what we understand as income. It does not necessarily correspond to any economic activity. The link that existed between money and gold in fifteenth century Florence or seventeenth century London does not exist in today’s banking system. Banks, as Felix Martin has explained, are institutions that write IOUs on the one hand (deposits, liabilities) and accumulate IOUs (loans etc.) on the other. These IOUs are not equivalent to the quantity or quality of economic activity currently undertaken by actors in the economy. There is no tangible quantity of money that corresponds to the aggregate of employment, or of activity in an economy at any point in time. This is because a tangible quantity or quality is not a characteristic of money. Misunderstanding this simple fact is at the
heart of much orthodox and monetarist confusion about money – leading to vain attempts to ‘limit the money supply’. To repeat: money’s quality, its acceptability and validity is simply due to it being able to facilitate transactions. Given our confused understanding of money, this is a difficult concept to grasp. (I know, because it took me a long time to get my head around the theory!). So you may want to mull over this section, and come back to it later. Banking as a great civilizational advance The goldsmiths’ evolving banking system mobilised the integrity inherent in society’s commercial transactions and exchanges, and enabled economic activity to take place. Banking services were both necessary and sufficient to enable employment, or economic activity to take place across wide areas of activity, and across borders. There was no need - it turned out - to use limited supplies of gold (or silver, or any other commodity) as a means for which (instead of by which) goods and services could be exchanged, or even as a store of value. The ‘receipts’ – i.e. bank money - would do the trick of honouring the trust inherent in the transaction. Indeed the very limited supplies of gold under the 100% reserve system had imposed an artificial constraint on credit creation, and therefore on economic activity, and in particular on the creation of employment. (This is why Keynes called the Gold Standard of the 1920s and early 30s ‘a barbarous relic’. In order to limit the amount of economic activity to the equivalent amount of gold in the vaults of banks, politicians and policy-makers deliberately contracted economic activity – by way of ‘austerity’ policies, which led to a steep rise in unemployment. Society is capable of creating far more work than can be measured by a finite amount of lumps of gold.) Within a well regulated monetary system, the receipts, the promise to repay, and the manner and trust with which ‘receipts’ were valued and then 62
exchanged, were sufficient to spur the investment, employment and economic activity of which society was capable, and to generate income for repayment. Employment creates income (think of your own experience) in the form of wages and salaries. These, in turn, can help create profits, and generate tax revenues – with which to repay private and public debts. As the bearer of society’s integrity, trust and confidence, the goldsmithbanker amassed great power. However, that power was only conceded so long as the goldsmith lived up to the faith his customers had in his judgement, integrity and trust; and the faith he had in theirs. And goldsmiths-bankers needed very fine judgement (and good accounting skills) if they were to retain the right quantity of gold in their vaults to meet unexpected demands from merchants for the immediate and full return of gold deposited. To remain solvent, goldsmiths also had to judge carefully the quantity of ‘receipts’ or credit created, and lent out. The issue of too many ‘receipts’ would cause inflation. Inflation would erode the value of their assets (loans) and invite the community’s blame. Bad judgement in assessing risks would mean debts would not be repaid. Failure to meet demands for the return of deposits, would destroy trust in the goldsmith’s judgement and integrity, and trigger a run on his ‘bank’. And then all hell could break loose. The banker’s shrewd judgment of character, his reputation for sound risk assessment and his sharp mathematical and accounting skills are the basis of the trade’s mystique. It’s a mystique bankers still trade on, even though many lack sound judgement and depend on taxpayer-backed bailouts to compensate for their flawed mathematical and algorithmic models. By these halting steps was the modern banking system developed. Economic activity, and in particular employment, was no longer constrained by the
quantity of gold in vaults. More ‘receipts’ or money in circulation meant more investment and employment. The development of the modern banking system was a great civilizational advance. As a result of that advance, societies with sound banking systems and related institutions, and with democratic oversight of those institutions, could mobilise finance for development. In such societies there is never a shortage of money. Credit allocation ‘democratised’ One of the greatest advances that followed the development of sound banking systems was that the allocation of credit or loans was made more widely available to citizens. Access to finance no longer depended on the whim of the powerful baron in his castle. Instead decisions about credit allocation were made more fairly; on the basis of rules and regulations; on the availability of collateral; on the trustworthiness of the borrower, and on potential streams of income. These procedures effectively democratised the allocation of credit – and ensured that a much wider range of society’s members could borrow to invest, not just those with assets. Loans were granted based on the goldsmith’s assessment of the ability of the borrower to undertake activity that would earn the sums needed to repay; and of the integrity of the borrower’s promise to repay. Today that task would be defined as ‘risk assessment’. This new system of allocating society’s system of trust fundamentally altered the balance of power between society as a whole and private wealth – especially between private wealth and the ‘makers’ - artists, artisans, inventors and entrepreneurs. The activities of goldsmiths and proto-bankers bypassed the existing holders of wealth, and increased the availability of credit.
The increase in the quantity of credit created out of ‘thin air’ had a profoundly radical, and progressive impact: it lowered the ‘price’ of money – the rate of interest. In his History of Interest Rates, Sidney Homer (1977) shows that in Britain from 1700 onwards, yields (the returns on investment) declined slowly. Starting at 6-8% they finally broke through 3%, which culminated in the flotation of the famous British 3% consols (government bonds) in 1751.52 A rate of interest at 3% made creation and innovation affordable and attractive for inventors, artists, entrepreneurs and merchants, because there was a better expectation of making a return (profit) of 3% or more - with which to repay the debt. Repayment of a debt with an interest rate of e.g. 8% was far less likely to be affordable. For the purposes of my argument it is helpful to think of the development of the banking system and of lower rates of interest as the result of a grand struggle between the owners of wealth on the one hand, and the rest of society. The establishment of a banking system that ensures access to credit for all those that are not existing owners of wealth, can be understood as the culmination of a great struggle between the wealthy creditors or moneylenders of pre-banking eras - and debtors. As Geoffrey Ingham explains in his book The Nature of Money: In capitalism, the pivotal struggle between creditors and debtors is centred on forging the real rate of interest (nominal rate minus inflation rate) that is politically acceptable and economically feasible … Weber’s emphasis on money’s status as a weapon in the economic battle directs attention to its political nature. This element is entirely absent from all orthodox economic analysis…This lacuna is the result of the apolitical conception of politics that is to be found in the mainstream meta-theory and, surprisingly as it may appear to some, the Marxist counterpoint. …The conception of 65
money as a neutral instrument that underlies all modern macroeconomic monetary analysis and practice by government and their central banks derives from this foundation.53 The development of a banking system in Italy, and the wresting of control over the allocation of finance from private wealth holders meant that the system was then aimed at wider public and commercial interests. This manifested itself in the glory of the Italian Renaissance, in the Netherlands as the Reformation, in the English and Scottish Enlightenment, and in the emergence of the United States of America. It is no coincidence that the innovation and entrepreneurship associated with the industrial revolution began some seventy years after the establishment of a banking system, and the founding of the Bank of England; and sixty years after interest rates on loans began to fall. As such the development of banking became a public good which society could deploy to finance productive activity, including innovation and research, and to address major challenges. Given the social injustices of the time, the results were not uniformly good or fair. Women, for example did not have the same access to finance as men. But the experience demonstrated that within the framework of a sound banking system, there need never be a shortage of finance for innovations as bold as Robert Stephenson’s steam engine, or for adventures as costly as Captain Cook’s explorations of the seas around Australia and New Zealand. Or indeed for decades of all-out war. The big questions that arose were these: how could society maintain control over this great public good? And to what ends should it be put?
Chapter Four: The defeatism of the meme: “there is no money”. We live in turbulent political and financial times, and in a global economy dogged by failure. We survive precariously on a planet warmed by human greenhouse gas emissions and disturbed by a human-induced mass extinction. The financial system at the time of writing is volatile, corrupted, and widely discredited. Scandals of miss-selling, theft, manipulation and fraud abound. In most western economies, the financial transmission system is broken: instead of lending into the economy of real production, banks are borrowing from the economy. In other words, customer savings or deposits in banks exceed the amount of lending undertaken by bankers. This is bizarre, because banks and the banking system were established precisely to act as lenders into the economy – not borrowers from those active in the economy. That is why today’s broken financial transmission system - in countries as diverse as Japan and Britain - is a historically unprecedented development. The response of governments to threats posed by an out-of-control, and effectively insolvent financial sector is to bow to the interests of finance capital. Governments of the OECD economies have abandoned efforts to manage, re-structure or re-regulate the global banking system so that it serves the real economy and wider society. Instead, politicians and regulators have tinkered with banks’ socalled capital requirements. The reason for this is a mystery to this author, because while banks may need capital to back up their own (often reckless) borrowing they do not, as explained above, need capital for the purposes of credit creation. In other words, they do not need a bank of ‘capital’ to back up their lending. Indeed, before 1988, there were no requirements on private banks to hold ‘capital’, as 67
Bernard Vallageas points out in his paper: Basel III and the Strengthening of Capital Requirement.54 Yet, despite the fact that the banks did not ‘hold capital’ against their lending in the period before 1988 – there were no financial crises between 1945 and the 1970s. ‘Curiously’ writes Vallageas, ‘the adoption of capital requirements (took place) at the same time as the liberalisation of the financial system, and yet, despite their adoption, they did not prevent financial crises, particularly the major 2007-9 crisis.’ Let that be a lesson to regulators and the general public. For all the serious-sounding jargon that emanates from the Basel Committee responsible for regulation, the economic orthodoxy relies on studied indifference to the evidence. As well as increasing capital requirements, policy makers have resorted to the ‘gold standard’ policies of the 1920s and 30s. They have once again imposed or tolerated ‘austerity’ or deflationary policies on whole populations in Europe and Japan. Deflationary policies have the effect of lowering wages, incomes and prices, while protecting the value of assets owned by creditors and international investors. (Assets are both valuable in themselves - think property, stocks and shares, works of art etc. - but also as collateral for further borrowing.) Deflation is welcome to bankers and creditors as it protects the value of loans and debt. Indeed as prices, wages and incomes fall, the value of debt rises in relative terms for creditors. This is in contrast to inflation which erodes the value of debts. The effect of austerity policies therefore is to exacerbate the indebtedness of western firms, households and individuals; to punish those innocent of causing the crisis, while increasing the value of assets (debt) owned by those responsible for it. For a few years after the bankruptcy of Lehman Brothers, rising debt levels were made bearable by the low rates of 68
interest that were the result of central bank action, or reaction to the 2007-9 crisis. However, as noted earlier, central banks can only strongly influence the ‘base’ or ‘policy’ rate – and loans at this rate are only available to institutions in the finance sector. Rates on loans to small businesses, firms and households are influenced by base rates, but also by global financial markets in for example, US Treasuries. (The yield on the US 10-year Treasury bill serves as a reference for global interest rates set by commercial banks.) Finally rates are fixed or set by commercial bankers according to their own assessment of the risk of a lender, and the rate of return on a loan. These interest rates remain high in real terms, that is, relative to the inflation or deflation of prices and wages. However, they are expected to rise even further when central bank rates rise, causing bond yields in global capital markets to rise further. Rises in rates on longer-term assets (bonds and mortgages) will have a punitive impact on household and corporate debtors – especially in the Anglo-American economies. Indeed each time the US or UK economy appears to improve, recovery is choked off by rising bond yields in global capital markets. These in turn raise expectations and justifiable fears that long-term interest rates on mortgages will follow. Disillusionment with democracy The politicians responsible for enforcing austerity policies have not just imposed unnecessary suffering and dislocation on millions of people, their communities and countries. They have caused disillusionment with democracy to set in amongst the unemployed and impoverished in Europe and the US. Austerity has opened up political space for right-wing, populist political parties like the US’s Tea Party, France’s National Front and Golden Dawn in Greece. These are the social and political consequences of enacting policies 69
that enrich the few, while impoverishing the majority; policies based on the interests of ‘robber barons’ and on the flawed theories of ‘defunct’ economists. “There is no money” At the heart of the politically inept responses to the financial crisis is an ideologically-driven and mendacious conviction: that while society can afford to bail out a systemically broken banking system, it cannot afford to finance and address economic failure, youth unemployment, energy insecurity, climate change, poverty and disease. Society, it is argued ‘has no money’ to finance these challenges, to stimulate recovery and create employment. Mrs Thatcher, whose views on the economy still inform the policies of many Conservative and Social Democratic OECD governments, gave clearest expression to the conviction that ‘there is no money’ in a 1983 speech. The state has no source of money, other than the money people earn themselves. If the state wishes to spend more it can only do so by borrowing your savings, or by taxing you more. And it’s no good thinking that someone else will pay. That someone else is you. There is no such thing as public money. There is only taxpayers money. Mrs Thatcher, speech to Conservative Party Conference, October, 1983.55 Today this assertion sits strangely with the facts of the recent bailout of the global banking system. While politicians try to persuade electorates that ‘there is no money’ something quite different 70
happened under the guise of ‘Quantitative Easing’. Central bankers created trillions of dollars ‘out of thin air’, and did so ‘overnight’ to bail out the banking system. And I mean trillions. Quantitative Easing: ‘new money that the Bank creates electronically’. Bank of England website in ‘Quantitative Easing: how it works.’56 The American Senator Bernie Sanders directed the US’s Government Accountability Office to undertake an audit of the amount of ‘state money’ created by the US Federal Reserve, and supported by governments, during the crisis. The conclusion was that $16 trillion “in total financial assistance” had been mobilised for “some of the largest financial institutions and corporations in the United States and throughout the world”.57 Please note that not a cent of these trillions of dollars was raised by taxing Americans, although the liquidity created by the Federal Reserve is backed by US taxpayers. Second, note that the beneficiaries of all this American taxpayer-backed largesse included German, British and French bankers. Here in Britain, the Governor of the Bank of England explained to a Scottish conference in October, 2009 that a trillion (that is, one thousand billion) pounds, close to two-thirds of the annual output of the entire (British) economy”58 had been mobilised (again, almost overnight) to bail out the British banking system. Never in the field of financial endeavour … has so much money been owed by so few to so many.59
Despite this evidence that the state does indeed have “other sources of money” – other that is, than taxation - many have adopted Mrs Thatcher’s reasoning, including those on the progressive end of the political spectrum: Dear Chief Secretary, I’m afraid to tell you there's no money left. wrote Liam Byrne, a British Labour Treasury Minister, in a letter to his successor and published in the Guardian, on 17th May, 2010.60 The British government has run out of money because all the money was spent in the good years … said George Osborne, Britain’s Chancellor of the Exchequer on Sky News on the 27th February, 2012. We will have to govern with much less money around.61 noted Ed Balls, Britain’s opposition Chancellor, in a speech: Striking the right balance for the British economy, delivered at Thomson Reuters, on Monday 3rd June, 2013.62 The mantra ‘there is no money’ confuses electorates, and strips governments of agency when faced by threats from financiers and financial crises. The 2007-9 crash The root cause of the crisis that led to the bankruptcy of Lehman’s and other banks in 2008 was the bursting of a vast bubble of unaffordable credit. ‘Easy’ (unregulated to the point of recklessness) credit was generated by commercial bankers and by others active in the shadow banking system. Commercial banks vastly expanded the amount of money in the economy. When this ‘easy’ credit became too expensive (‘dear’) to make repayment affordable, borrowers defaulted. In other words, it was high, not low interest rates that ‘debtonated’ the vast bubble of credit. This is a contested view, as most economists and commentators locate the cause of the crisis in the 72
low rates of interest set by central bankers after the bursting of the dot-com bubble in 2000-02. However, these rates were set low as a reaction to the bursting of that asset bubble – and while it is true that low rates laid the ground for the next crisis they were not the immediate cause. Vast amounts of easy, dear money unrelated to real economic activity, triggered the crisis.63 Very few economists blame the cause of the crisis on ‘easy’ or poorly regulated and mis-managed credit-creation. Even fewer propose increased regulation of credit-creation. Most focus on the low interest rates that prevailed after the bursting of the 2001 dotcom bubble as causal of the crisis. But it was ‘Easy credit’ that blew up the credit bubble, including variations on ‘liar loans’ or ‘no documentation mortgages’; or the packaged and re-packaged pools of mortgages, ‘sliced and diced’ into securities by banks like Goldman Sachs. The risks on these were then sold and cynically passed on to the ‘little people’ – borrowers and shareholders - as well as to big institutional investors. Nor do most mainstream economists give proper weight to the steady rise in interest rates after 2003-4, and the impact of rising rates on indebted firms, households and individuals. The chart below, from the economist Richard Koo, shows just how sharp these rises were in
the run up to the crisis. 8
UK 6 5 4
Japan 1 0 2003
Sources: BOJ, FRB, ECB, BOE and RMB Australia. As of Mar. 23, 2012.
Chart taken from presentation by Richard Koo, Chief Economist, Nomura Research th
Institute, Tokyo, to the INET Conference, Berlin, 14 April, 2012.
It was higher interest rates that I contend, made debts unpayable and that burst the credit/asset price bubble that precipitated the crash of 2007-9. At the height of the credit boom, as late as 2005-7, loans or mortgages were still being offered to individuals, households and firms, without any real assessment by bankers of the ability to repay. Some of these borrowers were high-risk (e.g. ‘sub-prime’) borrowers. Because they were high-risk, they could be milked for usurious rates of interest. The returns on these loans were scandalously high, which is why banks like Goldman Sachs demanded more of such lending by the mortgage-selling agents of private banks. They wanted to gather up these sub-prime mortgages, bundle them up and artificially create new assets – a mixed bundle of mortgages and loans – they called ‘collateralised debt obligations’ or CDOs. These new financial ‘products’ or assets could be sold again at a massive capital gain; but could also be used as collateral to back up additional new borrowing 74
- by bankers. That is until the individuals, households and firms at the heart of the CDOs defaulted, the debt bubble popped – and the ‘sub-prime’ crisis erupted. To imagine the role that sub-prime debt played in the crisis, it helps to think of sub-primers as positioned at the base of a vast, upside down pyramid of debt. Although their debts were not substantial in the grand scheme of things, nevertheless they were the poorest, most vulnerable borrowers in the market – and most likely to be the first to go under. Balanced precariously above sub-prime debts, were huge sums of ‘structured’ and often ‘synthetic’ debt, made up of collateralised securities, credit default swaps and other complex financial products. These financially ‘engineered’ products created artificially by the shadow banking system in the run-up to the crisis, were explosive precisely because they bore no relation to the real world of productive activity. However, they were tenuously linked to the properties and mortgages – the assets - of poor workers. It took the default of some of the poorest borrowers at the bottom of the financial pyramid to blow up the system. This was an extraordinary development; one in which the debts of the poorest in society caused a systemic crisis for the richest. Costas Lapavistas writes that: “under conditions of classical, nineteenth-century capitalism it would have been unthinkable for a global disruption of accumulation to materialize because of debts incurred by workers, including the poorest.”
The ‘debtonation’ of August, 2007 The crisis began when it became obvious that banks were sitting on significant non-performing loans in a housing market where prices were already falling. At the same time the merged retail and investment banks had built up their own enormous debts – not 75
permitted before the abolition in 1999 of the US’s Glass-Steagall legislation of 1933. The problem was made much worse because of the use of ‘exotic instruments’ like CDOs and CDSs. The cynical irresponsibility of lending at usurious rates of interest to those defined as ‘sub-prime’ borrowers was just the most visible part of their greed and recklessness. Huge loans made against all kinds of property and other risky assets were exposed as unpayable. Because proper regulation and oversight of the finance sector had been neglected, no one had the first clue how bad it would get, or which banks were most likely to default on their debts. On 9th August, 2007 – well before the collapse of Lehman Brothers- bankers realised that some of the banks they dealt with were not in a position to repay debts. As a result of that loss of confidence or trust, ‘credit crunched’. In other words, bankers became unwilling to offer fellow bankers credit. On that day inter-bank lending froze, and a slow run on the banking system began. The intervention of central banks like the ECB, the Bank of England and the Federal Reserve kept banks afloat, but also served to keep the crisis under wraps, preventing the wider public from becoming fully aware of the crisis until the collapse of Lehman Brothers. Years after the ‘credit crunch’ of August, 2007, the global economy struggles to recover from that crisis and the easy (unregulated) creditfuelled bubbles that were violently burst by rising (real) rates of interest. Indeed some argue that western economies are living through the longest period of economic failure in peacetime history. Only during periods of war was economic failure so prolonged. And yet far from re-regulating the financial system, governments stand idly by as the global credit bubble – which was never fully deflated after 2008 – is reinflated by central bank operations. Having done little to re-structure or re-regulate the global finance sector, central bankers have used a range of tools at their disposal – including 76
Quantitative Easing – to help bankers clean up their balance sheets. Commercial bankers have been able to do this by drawing on QE and other forms of cheap finance, and to use these resources for speculation. Speculation, unlike patient, long-term lending, leads to quick and sometimes exponential gains for bankers. These gains are reflected in the way in which QE and other central bank operations have re-inflated the value of assets - owned by wealthy elites. Simultaneously, in the real economy, investment, wages and salaries have fallen, and the poor have become poorer. This apparent collusion between central bankers and finance capital is leading to growing social unease. What is Quantitative Easing? When credit ‘crunched’ in August 2007 publicly-backed central banks came to the rescue of the failed private sector. Central bankers used a routine monetary operation that came to be known as ‘Quantitative Easing’ to inject large amounts of ‘liquidity’ (i.e. assets readily converted into reserves) into the private (and, in some cases, nationalised) financial system. Central bankers undertook this as part of their regular money market operations. Open market operations have been undertaken by, for example, the Bank of England since it was founded in 1694. As already noted, these routine operations are used to achieve policy targets – e.g. lowering or increasing the base (or policy) rate of interest. For some reason QE has attained a sort of mythical status, when really it is what central banks do, and always have done. What is new about QE is the scale of central bank operations. Central banks have purchased or swapped trillions of dollars of assets since 2008-9. About $4trillion of this liquidity has flooded into emerging markets, inflating the value of their currencies, and of assets such as property, 77
stocks, works of art etc. As it is mobile, this money may just as quickly flood out of low-income economies, and out of such assets. This unprecedented scale of liquidity creation through the expansion of bond purchases by central banks has had virtually no effect on economic recovery in any of the economies in which QE the main policy tool deployed to stimulate recovery (Japan, the US and the UK). Nor has QE proved inflationary – despite the alarmist fears of orthodox economists. Why so? Under QE operations, the central bank makes a swap arrangement with a private bank. It exchanges bank reserves for an interest-bearing asset such as a government bond. Reserves cannot be, and are not, used for lending, but instead are used for ‘clearing’ bankers’ day-to-day obligations to other banks, as explained above. By entering into this operation with the central bank, a commercial bank can increase certain assets – central bank reserves, or shortterm loans - on its balance sheet, and can remove more risky assets – e.g. mortgages, from its balance sheet. The latter are placed on the central bank’s balance sheet. This strengthens the private bank’s position – i.e. makes it more viable, and therefore able to borrow and take risks. The Ronaldo Loan One of the assets offered up as collateral in the QE process is a loan made by a Spanish bank (now absorbed into the nationalised bank, Bankia) to the football club Real Madrid. The loan was used to finance €76.5m in transfer fees for the footballer Ronaldo and for Kaka, a Brazilian forward. Bankia put up the loan or bond as collateral with the European Central Bank in return for vital funding,
i.e. reserves. If both Bankia and Real Madrid go bust, the ECB would be in ‘possession’ of the two footballers.65 By taking bonds such as the ‘Ronaldo loan’ on to its books, the central bank shrinks the supply of such bonds on the market. This increases the value or price of said bonds. A higher price for a bond implies a lower yield (equivalent to an interest rate, or the rate of return).1 By this means does the central bank exercise a marginal influence on interest rates (or bond yields) in capital markets. However, increased reserves and a strengthened balance sheet won’t necessarily encourage banks to lend on, as they do not use reserves for lending. What encourages banks to lend is a thriving economic environment, one in which there are borrowers with good collateral and potential income willing to borrow, confident of their ability to invest and to generate profits and income with which to repay the bank at the rate of interest charged. QE cannot alone provide that confidence. Nor can it generate confident borrowers, as the five years of economic failure since Lehman’s collapse, and the twenty years since the start of Japan’s lost decades have so comprehensively demonstrated. Monetary policy alone cannot conjure up recovery. When the finance sector is effectively insolvent; when industry lacks confidence and is anyway too indebted to take investment risks, then monetary policy has to work in tandem with fiscal policy, to help revive the economy. Bank lending cannot revive when there are too few private borrowers active in the real economy, because private borrowers are already heavily indebted and therefore reluctant to take on more debt; unemployment is high, insecurity is rising, and western economies are in a prolonged recession or just recovering from prolonged 1 A bond that pays out $10 a year and costs $100 has a ten percent yield. If the bond doubles in price to $200, the $10 annual payment represents a five percent yield.
recession. In economies practising ‘austerity’, orthodox economists (backed by their friends in political parties) actively discourage the only viable borrower - government – from borrowing to substitute for the absence of private borrowers. Richard Koo, an economist who is best known for his work in Japan, explains why QE did not work in Japan: “If there were many willing borrowers and few able lenders, the Bank of Japan, as the ultimate supplier of funds, would indeed have to do something. But when there are no borrowers the bank is powerless.”66 How to create more borrowers? In the circumstances of a debt-fuelled slump, in which the private sector is inhibited from investing, the borrower of last resort - government - has to intervene, to borrow to stimulate investment and create employment. Public investment will in turn raise confidence, provide opportunities for the private sector, and by way of ‘the multiplier’ – explained below - simultaneously generate income for government via increased tax revenues and reduced welfare payments. The multiplier
New spending has a series of ‘repercussions’ through the economy. This means that the aggregate impact of public spending can be far larger than the original expenditure. So for example, the direct effects of government spending on a wind farm will first benefit the companies that produce the relevant equipment, their existing employees, and those who benefit from the new jobs created as a result. But the increase of employment doesn’t stop there. There will also be a number of secondary repercussions. The extra wages and other incomes paid out are spent on extra purchases, which in turn leads to further employment. So the 80
workers on the wind farm stimulate more demand for food, entertainment, clothes and so on. ‘If the resources of the country were already fully employed, these additional purchases would be mainly reflected in higher prices and increased imports,’ wrote Keynes. ‘But in present circumstances this would be true of only a small proportion of the additional consumption, since the greater part of it could be provided without much change of price by home resources which are at present unemployed.’
But the process continues: ‘The newly employed who supply the increased purchases of those employed on the new capital works will, in their turn, spend more, thus adding to the employment of others; and so on.’
These cumulative repercussions are a virtuous reverse
of the vicious cycle brought on by financial failure and the contraction of economic activity caused by policies for ‘austerity’. How taxpayers protect central banks from the threat of insolvency The reason central banks are able to create large amounts of liquidity for the banking system and to rescue the private finance sector at times of crisis is because they are state institutions, backed by taxpayers. Central banks, unlike private banks or firms or households do not face solvency constraints. They are part of the government of a nation, and nations and their governments cannot be ‘liquidated’ in the way that a bankrupt firm can. (Some would say that Germany was ‘liquidated’ after World War II, in the sense that her financial and banking institutions were destroyed. However, as we all know, Germany remains a powerful nation and was able to rebuild her monetary and governmental institutions. Similarly while Zimbabwe’s economy is moribund, the nation and government of Zimbabwe 81
continue to exist and to function. It is in this sense that nations and governments are different entities from firms.) Furthermore, the sovereign state, the issuer of the nation’s currency can always call on both its central bank, but also private banks to create money in domestic currency to finance bailouts and fund their own spending. (Central banks cannot create money in foreign currencies, and so foreign debt becomes a significantly more challenging repayment burden than domestic debt. And as an aside: because countries of the Eurozone have given up their sovereignty over monetary policy to a European institution (the European Central Bank) these nations’ central banks do not have the credit-creation powers that sovereign governments such as the US, Japan and the UK enjoy.) Private non-financial firms do not have access to banks that can ‘print’ on demand unlimited supplies of money for use by that firm in a crisis – and so firms face the threat of insolvency. Governments have another advantage over companies: an endless queue of taxpayers, one that stretches forward into future generations. If sound tax collection systems are in place, governments can generate the revenue needed to repay debts over future generations – which is why sovereign debt is largely considered safe. Private firms are not guaranteed an endless queue of customers into the future; and while firms or banks may expect future income streams from borrowers or rent-payers, these flows are not as certain as ‘death and taxes’. Of course sovereigns can default on debt repayments and can inflate debt away by printing too much money – but that is not the same as ‘liquidation’ or bankruptcy of a sovereign.
The failure of commercial banks to lend Despite a massive increase in the supply of reserves by central banks and the strengthening of their balance sheets, commercial banks continue to fail in their role as major creators of the money supply, for the reasons outlined above. Borrowers are already indebted; the financial crisis has been exacerbated by ‘austerity’ policies that have increased unemployment, and lowered tax revenues, profits, wages and incomes. Furthermore, the crisis has been used by politicians to promote the ideological aim of ‘shrinking the state’, as Jeremy Warner, deputy editor of the UK’s Daily Telegraph confirmed in a recent article: In the end, you are either a big-state person, or a small-state person, and what big-state people hate about austerity is that its primary purpose is to shrink the size of government spending ... The bottom line is that you can only really make serious inroads into the size of the state during an economic crisis. This may be pro-cyclical, but there is never any appetite for it in the good times; it can only be done in the bad.70
The global banking system has not been fixed, re-structured or reregulated. Debts in the Anglo-Saxon economies have not, on the whole, been deleveraged (written off, or paid down). This overhang of private debt is one of the major barriers to recovery. The failure to lend and thereby create new deposits arises in part, because, thanks to de-regulation of the banking system (on the initiative of the Clinton administration) bankers were freed up over the last few decades to expand their activities beyond lending; and to engage in speculation. They did so with large sums of borrowed money. The result was another historically unprecedented development: the vast build-up of debt owed by private banks and other financial institutions. That bank debt, combined with defaults 83
and ‘non-performing’ loans and mortgages on their balance sheets, brought many to the brink of bankruptcy. Given these conditions bankers dare not risk making new loans to firms and households – especially given the declines in profits, incomes and wages. However, bankers continue to engage in speculation – undeterred by regulators - in the hope of making quick capital gains which can be used to help clean up their balance sheets. (In Britain, at the time of writing, bank lending is still subdued, except for one corner of the economy: the property market. In the first quarter of 2013 lending to this sector turned positive for the first time in several years, aided by government subsidies and the political imperative to inject a ‘bubble’ of confidence into the economy before a general election.) Why corporations are hoarding cash Many big global corporations also have high levels of debt, but have simultaneously built up a stockpile of cash. These corporations are ‘hoarding’ the cash instead of investing in productive, employmentcreating activity. Fearful that interest rates on corporate debts will rise and that the crisis will be further prolonged, corporations are sitting on cash, and not investing. They are imitating the South East Asian countries that after the 1997/8 financial crisis began to hoard foreign reserves, fearful of yet another crisis, and of the power of global capital markets to attack their currencies. The prolonged nature of the crisis, the volatile financial system combined with austerity policies have all served to undermine confidence in lasting recovery by those active in the productive, corporate sector. Furthermore most big firms and corporations are heavily indebted as a result of the easy money era of the 90s and 00s. The result is 84
predictable: companies will not take risks by investing their cash or surplus. Some refer to this hoarding of corporate cash as a “strike” by Capital. I do not see it that way. British corporates, for example, are still heavily indebted, as the Bank of England’s Financial Stability Report showed in November, 2013: “the gross external debts of the (private) non-financial sector have risen to 160% of GDP — an increase of 40 percentage points since 2007… driven mainly by private sector borrowers.”
The Bank explained that
Britain’s private non-financial corporations (PNFCs) had not delevered their debts evenly since the crisis and remained vulnerable to shocks. PNFCs with weaker credit ratings had risen since 2012 and weaker-rated companies had been less able to obtain long-term finance. All these firms remained vulnerable to shocks, including from rising interest rates. Those possible shocks combined with the lack of demand for goods and services in the economy, was a major cause of the hoarding of cash. What this behaviour by corporations illuminates is that financial volatility and high rates of interest are major inhibitors of investment. Both low levels of corporate investment and the wider economic crisis cannot be addressed without first re-structuring, re-regulating and managing global finance capital. . Collusion between central bankers, politicians and Haute Finance Because of the dysfunctional state of the banking system, citizens and small firms (SMEs) cannot (on the whole) access affordable credit – except perhaps from payday lenders and other non-standard financial institutions. This shortage of credit is further contracting economic activity. Individuals, households and firms are denied loans and overdrafts for everyday activity, except at high rates of interest. (Banks quite often blame this situation on a lack of demand for loans; but their pricing of loans often blocks demand.) 85
As a result of austerity and the repression of lending by banks, citizens of the US and Europe have endured years of suffering from rising unemployment (higher for example in Spain than during the Great Depression) or economic inactivity (very large numbers have simply despaired, and dropped out of the US workforce); rising rents and taxes and falling incomes. At the same time, governments have used the crisis to cut back on welfare payments and to privatise public services. Financial institutions have fared better: they have privileged access to loans from central banks at very low, or negative rates of interest. (As this goes to press, the European Central Bank provides loans to European banks at an average rate of 0.225 per cent, up from 0.128 per cent according to the three-month Euribor index.72 ) As noted above, bankers have used ‘easy’ and cheap central bank liquidity to cover their losses; to borrow for speculative purposes and to blow up new bubbles in a range of asset classes (property, bonds, stocks, commodities, etc.). As I write this, bond yields (the rates on sovereign and corporate bonds) are rising, and, because of the interconnectedness of the global financial system, these rises will cause banks to raise interest rates in mortgage and other markets. These rate rises – on loans across the full spectrum of lending – pose a real threat to western economies with heavy private sector debt burdens. By borrowing cheap from the central bank and lending dear into the real economy, private bankers are able, with the help of public servants at central banks, to re-capitalise their institutions and to do more to clean up their balance sheets. These ‘repairs’ to the finance sector’s own finances are made at great cost to society, and to the productive economy as a whole.
High interest rates are like daggers aimed at the asset bubbles created by renewed financial speculation. Borrowing on margin to gamble is fun while you’re winning; but costly when the gamble is lost. That is why rising interest rates once more pose a grave threat to the global financial system. Because regulators and policy-makers have taken a ‘hands off’ approach to the private banking system, the authorities cannot ensure finance is transmitted to the rest of the economy. Central bankers, politicians and regulators have baulked at nationalising and/or re-regulating banks. Even when banks have been nationalised, regulators have not used taxpayer-funded bailouts to require terms and conditions from bankers that would result in better management of credit-creation, and the financial transmission system. They seem unable to learn from the past, when governments regained control over the financial system; when central bankers offered bankers ‘guidance’ on the quality of credit creation and lending that private banks could engage in, and when these were conditions imposed on those that benefitted from the protection provided by taxpayer-backed central banks. During the Bretton Woods era regulators set strict rules on the amounts lent and borrowed, relative to incomes. In some countries such rules still apply. There have been times in western monetary history, most notably after 1933 in the UK and the US when governments and central bankers set out to manage interest rates, and to keep them low for all forms of lending.73 And after the Great Crash of 1929, American regulators insisted in 1933 on the separation of retail banking from investment (speculative) operations. As noted above this legislation was repealed in the US 1999 and encouraged bankers to go on borrowing sprees prior to the crisis. By failing to re-regulate and re-structure the banking system, policy-
makers have exposed citizens of the global economy to further financial crises and economic failure. Nor do politicians have the political will to regulate and stabilise the mobile, footloose flows of international capital “governed” by the private global banking system. Partly because of this regulatory spinelessness, and in spite of a broken transmission system, the finance sector enjoys business-asbetter-than-usual. While bankers and financiers may face solvency questions, they have been told that their institutions are too big to fail, and that they themselves are too ‘too big to jail’, as US Attorney General Eric Holder said in evidence to a Congressional committee on 6 March 2013: I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if we do prosecute — if we do bring a criminal charge — it will have a negative impact on the national economy, perhaps even the world economy. I think that is a function of the fact that some of these institutions have become too large.74 As long as the banks remain vastly complex bundles of businesses, the executives running them remain above the law. No wonder they are lobbying hard to prevent meaningful re-structuring! Despite a supposed commitment to the ideology of ‘free markets’, market forces no longer impose any meaningful constraints on the risks that a handful of very large banks take on. Instead private financial institutions enjoy taxpayer-backed protection - the very inverse of today’s dominant and orthodox free market economic theory. This makes bankers both parasitic on the state and 88
dangerous for taxpayers, given that many question the solvency of the world’s biggest commercial banks. The Financial Times columnist Wolfgang Münchau recently used a ‘back of an envelope’ calculation to assess the extent to which banks are bust.75 The total balance sheet of the monetary and financial sector in the eurozone stood at €26.7tn in April this year. How much of this is underwater? In Ireland, the 10 largest banks accounted for losses of 10 per cent of total banking assets in that country. The total loss will be higher. In Greece, the losses have been 24 per cent of total assets. The central bank of Slovenia recently estimated that losses stood at 18.3 per cent. In Spain and Portugal, the recognised losses are already more than 10 per cent, but the numbers will almost certainly be higher. Nonperforming loans are also rising rapidly in Italy. Germany is an interesting case. The German banking system appears healthy at first sight. It certainly fulfils its function of providing the private sector with credit at low interest rates. But I still find it hard to believe that the German banking system as a whole is solvent. Instead, Münchau writes, regulators “pretend not to see the losses, and extend the crisis.” As a result speculation by the private finance sector has once again been unleashed and new asset bubbles created. These have inflated the prices of stocks and shares, bonds, property, works of art. Post2009 asset price inflation has wildly enriched the rich, while those without assets are further impoverished. Inequality has predictably, widened. When today’s reinflated asset bubbles burst, they too will cause further havoc.
These facts are widely known and understood, but not acted upon.
Chapter Five: The capture of the public good that is banking
While the establishment of a system of credit, and the lowering of interest rates was a great civilizational, advance, the banking system could be captured and then controlled by the ‘barons of global finance’. Geoffrey Ingham explains that this capture includes control over the production of money: “Money expands human society’s capacity to get things done, but this power can be appropriated by particular interests. This is not simply a question of the possession and/or control of quantities of money – the power of wealth. Rather, as we shall see, the actual process of the production of money in its different forms is inherently a source of power.”76 John Maynard Keynes understood well how the prosperity of society is dependent on a sound, managed banking system, based on bank money, and low rates of interest. He also understood that the development of banking was a threat to the owners of great wealth - society’s “robber barons”. Under a well-managed banking system, and with the sagacious use of bank money, surplus wealth is no longer needed for loans and investment. Furthermore, under a well-managed monetary system, and as explained above, interest rates can be kept low by the authorities (the central bank and the Treasury/finance ministry) to benefit society as a whole. Both of these developments were and are anathema to capital-holders, as first, they render excess wealth redundant to the wider needs of society. Second, they reduce the rate of return on lending. Indeed as Keynes argued, 91
a low interest rate policy would lead to the ‘euthanasia of the rentier’; to the disempowerment of capital-holders as a class. But then Keynes too was an optimist. The New Age of the Rentier Today we live in a world in which the public infrastructure that is money production has been captured and subordinated to the interests of a wealthy elite - finance capital. Rentiers - individuals or institutions that live by unearned income - have not been euthanized by the banking system. On the contrary: they are in triumphant possession of it. While capitalists may invest to create new capacity, the rentier simply exploits existing assets for cash flow. The rentier purchases an asset e.g. land, which does not have costs associated with its production (because land after all, is created by nature), and charges rent on it. These rights to an asset enable the rentier to, for example, install tolls and extract fees from travellers; or to purchase hospitals or schools or football clubs and then drain rents from the users of those institutions – much as a landlord charges rent on a property. Here’s Michael Hudson, a scourge of the bank-friendly orthodoxy: U.S. banks don’t make loans for what can be produced in the future. They make loans against collateral already in place – including entire companies with high-interest “junk” bonds. Instead of extending loans to create new factories to employ people, new means of production, bankers look at what can be pledged as collateral on which they can foreclose.77 Rentiers as financial parasites Today’s ‘robber barons’ under the pretext of ‘equity investment’, borrow huge sums of money to purchase e.g. a football club like Manchester United, or a company like Boots the Chemist. They then drain rent (debt repayments) from the corporate body, by diverting cash flows. These cash flows are 92
created and provided by the producers, managers, retailers and customers of, for instance, Boots, or by Man United football fans. Fans provide the cash flows by buying the club’s t-shirts or kit. By these means do rentiers (with little effort) drain the wealth of those with limited amounts of cash, but without collateral or other assets. This parasitic behaviour is bad enough, but to increase the capital gains to today’s ‘robber barons’, governments make this kind of borrowing tax deductible. The result is a double whammy: massive exploitation and appropriation of the assets of companies like Boots, or football clubs like Manchester United. And declining tax revenues for governments from rentiers disguised as ‘private equity finance’ or ‘debt leveraging’ companies: e.g. Kohlberg, Kravis, Roberts, CVC Capital Partners, or the Blackstone Group. These concessions to the rentier sector by governments are a painful form of fiscal ‘self-harm’ because declining tax revenues worsen the government’s rating with bond markets under today’s ‘liberalised’ financial architecture. This leads to higher rates of interest on government bonds – paid by taxpayers mostly oblivious to these decisions. And so the parasitic behaviour of the rentier gradually weakens the body fiscal, and with it the body politic. ‘Neo-feudal’ rentier capitalism: the story of Manchester United Manchester United was taken over in 2005, at the height of the credit boom by the Glazer family of Tampa, Florida. The transaction was a ‘leveraged buyout’ which means that United was acquired, not with the existing wealth of the Glazer family, but with borrowed wealth, i.e. debt. By June 2010 this debt had escalated to over £784m. The debt was secured primarily against the football club itself – meaning that the Glazers borrowed against an asset - the Man U football community that could be ‘milked’ to generate regular, high returns, in the form of 93
revenue streams from the sale of e.g. rising ticket prices, Man U kits, TV rights (paid for by subscriber fans) and T-shirts sold, as I have personally witnessed, to already impoverished child fans in remote parts of Africa. These revenues repay the high real rate of interest on the debt, but they also finance dividends for the Glazers. The interest bill from Man U’s debt of £784 million over eight years, is estimated at £350m and the total cost in that short time (including fees, derivative losses and debt repayments) is estimated at almost £600million. The blogger ‘andersred’ believes that Man U’s total costs from the Glazer structure will top £1bn by 2016. Manchester United is not alone. Football teams throughout Europe have loaded themselves with debt in an effort to reach the top leagues that attract pay-tv revenues. It is a winner-takes-all pattern that is replicated in sector after sector. The money drives up wages for a lucky few but all too often ends in collapse and government bailouts. Rentier capitalism and government bond markets Under today’s liberal financial architecture, governments are encouraged to raise funding for public expenditure by borrowing from the private finance sector, and not from their own central banks. The rates on that borrowing are fixed by invisible and unaccountable players in global bond markets. As a result of this dependence on private finance, the power of the global bond market over governments is used to force policy changes on reluctant electorates. At the same time the restless, reckless, conduct of global bond markets epitomises rentier capitalism. Those active in these markets use uncertainty and volatility to force up bond yields and to then drain streams of revenue from taxpayer-financed institutions. They revel in particular in the usurious rates that can be charged on bonds issued by the poorest, most vulnerable of states, for example Ghana, South Africa or Greece.
Finance capital despotically in command Today in both rich and poor countries finance capital is despotically in command of democracies. Economic activity is held back; firms are bled dry by rentier activity; loans are hard to come by, and the rates on lending often usurious. As a result, productive and creative activity stagnates; firms and even states (think Greece, Spain, Italy) are weakened by the parasitic behaviour of finance capital, or, in the case of firms, are bankrupted. And millions of people are immiserated by unemployment; many more millions impoverished. Inequality has risen to levels unprecedented in history. Today as the anonymous London Banker, notes: “… the state has lost control of the currency as central banks allowed barons in banks and shadow banks to create money from securitisation and quantitative easing. The state lost control of markets as the Securities Exchange Commission (in the US) and the Financial Services Authority in the UK allowed those same barons to set up alternative trading platforms beyond any public scrutiny and to bastardise public exchanges with algorithmic trading and synthetic instruments priced against fraudulent reference rates.”
In the place of ‘the state’ we argue that democracy, operating through the state, has lost control of the public good that is the currency. Democracy and the Euro Otmar Issing, a neoliberal German economist, is well known as the “Architect of the Euro” and was a member of the Executive Board of the European Central Bank as well as its first Chief Economist from 1998-2006. He is also a great admirer of the ‘classical’ economist Friedrich Hayek. In a recent book on the “Making of the European Monetary Union”, Harold James quotes Issing as arguing that “… many strands in Hayek’s thinking…may have influenced the course of the events leading to Monetary Union in subtle ways …What 95
has happened with the introduction of the Euro has indeed achieved the denationalisation of money, as advocated by Hayek.”79 We can replace “the denationalisation” of money with something more explicit: the de-democratisation of money – the utopian fantasy of global finance capital. When academics and beneficiaries of the public purse like Otmar Issing collude with creditors and financiers to grant finance capital such despotic power over society, democracies are inevitably hollowed out and democratically elected politicians rendered irrelevant and powerless. This leads to disillusionment and despair with the democratic political process, and recourse to populism, fascism and other forms of protest. This loss of democratic control over the financial system in general and private credit creation in particular means that the state cannot regulate in the interests of society as a whole. This is partly a result of powerful lobbying and manipulation by bankers; but also of public ignorance of the basic elements of credit creation and bank money. Because the system of bank money evolved behind a veil of deception; and because this deception suits the interests of bankers and speculators – the “neo-feudal rentier class” there is still widespread obfuscation about the creation of money by commercial bankers. This confusion does not just persist in the public mind but also in the minds of professional neoliberal and even ‘Keynesian’ economists: the guilty men (and they are mostly men). They will not understand until the public around them does.
Chapter Six: Subordinating finance, and restoring democracy The crisis of finance capital’s despotic power is one that Italian economists Massimo Amato and Luca Fantacci explain as the result of western society’s subjugation to ‘the yoke of ideology’.80 In other words, this is a crisis of ignorance and political impotence in the face of a set of ideas serving the interests of the few. By shielding its activities from public oversight and academic scrutiny, finance has turned society’s social construct – credit – and the social relationships between debtors and creditors into a false commodity on the one hand, and an artificial market on the other. Social relationships cannot be marketised. Markets cannot buy and sell the trust (or distrust) that exists between debtors and creditors. That much is self-evident. Society’s social relationships cannot be bought and sold like commodities, finished goods or services. They can only be upheld through the setting of standards, oversight and regulation. The task therefore is political: society must reject the marketization of social relationships and of the social construct that is credit. Instead we must once again restore these social relationships to the fields of law, ethics, and standard setting. By regaining democratic oversight and regulation of the great public good that is our monetary system, society will by political means (that is by mobilising political will and enacting legislation and regulation) once again subordinate finance to its proper role, of servicing real markets in goods and services. Today those operating in markets that trade in goods and services struggle to operate efficiently, fairly and sustainably in a world of liberalised finance, as the economist and free-trader Jagdish Bagwati argued in his famous essay: The Capital Myth: The Difference between Trade in Widgets and Dollars.
The question is this: how to subordinate finance? Below I offer some suggestions – none of them new or original. However they are all tried and tested, and have proven effective in limiting the power of finance – which is why perhaps, they are so little discussed and examined. Controlling the social variable that is the rate of interest Liquidity: A measure of the extent to which a person or organization has cash to meet immediate and short-term obligations, or assets that can be quickly converted to do this. Business Dictionary82 To capitalists, liquidity - or the lack of it – matters a great deal. Indeed for many it is a fetish; and in financial crises, as explained above, liquidity becomes illusory, as buyers evaporate.83 As I have outlined in Chapter 2, Keynes’ theory on liquidity preference explains that interest rates can be determined and shaped by the supply of and demand for assets. Not, as many neo-classical economists argue - by the demand for savings.84 Capitalists do not have any control over whether they will invest (they have after all to do something with their savings/capital!) but they do have control over the period they are willing to invest for; the period during which they give up the ability to convert their wealth quickly into ready cash. As Dr. Geoff Tily explains: Interest is paid not as a reward for not spending (saving) but as a reward for parting with the liquidity of wealth. Firms and governments do not need to encourage households to save to gain access to their idle resources. If firms and government are willing to borrow on liquid terms then they would not need to pay any reward for access to these resources ... Debt management policy should permit a sensible and coherent framework for the balancing of firms’, governments’ and 98
households’ differing preferences towards holding and borrowing wealth with different degrees of liquidity/illiquidity.85 So if the government wishes to determine, and to keep low, the rate of interest over a range of time periods, argued Keynes, then it must arrange its own borrowing i.e. issue its own assets (debt or bonds) over time periods that suit the liquidity preferences of the holders of capital. Some may wish to part with capital for just one day (to be sure of cash) for thirty years (to ensure security in e.g. retirement) or for several months – in the hope of making speculative gains. Vital to the control of the rate of interest, argued Keynes, is the provision of a full range of safe government assets that meet those different and varied time preferences. Because of the government’s dominant role as an issuer of bonds, the reward for parting with liquidity over different time periods can then be managed by governments through the debt management office of the finance ministry or Treasury. By creating, offering and managing a range of government assets to meet the demands of investors for liquidity over different time periods, the government can both exercise greater control over its own financing costs, and determine the rate of interest over those time periods in ways that reduce the financing costs of the private sector. Keynes’s great insight was his understanding that the rate of interest is a social variable, one that can be deliberately managed by the public authorities, while at the same time holding finance capital at bay. Just as the social construct that is the central bank’s discount rate (described above in relation to the provision of cash to banks) is managed by the public authority that is the Bank of England’s Monetary Policy Committee. Keynes’s understanding of how interest rates are determined – i.e. not by a demand for savings, but rather by the demand for assets into which stocks of wealth can be invested over different periods of time - meant that interest rates in Britain could be brought down low after 1933, and remained low for the duration of the war. 99
Tily explains how Keynes directed the management of public debt during World War II, and helped manage the rate of interest. “During W.W.II the British authorities adopted a technique known as the tap issue. Under the tap system the Government issued bonds of different maturities (e.g. bills and bonds of 5 year, 10 year and no final maturity) at pre-announced prices, but set no limits to the cash amount of any issue. The ‘taps’ of each bond were held open so individuals and institutions could purchase the maturity of their choice, when and to whatever quantities they desired. The system therefore enabled the public to choose the quantity of debt issued at each degree of liquidity at the price set by the Government.”86 The suite of policies that arose from the theory, established a permanent long-term rate of 3 per cent on bonds set against a short-term rate on bills of 1 per cent, from 1933 onwards. This was an extraordinary achievement, and played a significant role in Britain’s ability to finance the war effort. However, as noted earlier, his revolutionary monetary theory; his understanding of the nature bank money, of the banking system and of how the rate of interest is determined, has been well and truly buried by the public authorities, by the finance sector, and by mainstream academic economists. Controlling mobile capital: the international dimension Just as a well managed banking system ends society’s dependence on ‘robber barons’ at home, so a well-developed and sound banking system should end society and the economy’s reliance on international capital. With a managed banking system, operated in the interests of both Industry and Labour, both government, Industry and Labour need not depend on, or fear ‘bond vigilantes’ or ‘global capital markets’.
However, management of the financial system and of interest rates in particular will be subverted if capital is mobile and lenders in international markets offer higher or lower rates beyond a country’s border – rates not appropriate to the economic conditions in-country. Keynes advocated controls over the mobility of capital, because “the whole management of the domestic economy depends upon being free to have the appropriate rate of interest without reference to the rates prevailing elsewhere in the world. Capital control is a corollary to this”, he wrote in this letter to R. F. Harrod: Freedom of capital movements is an essential part of the old laissez-faire system and assumes that it is right and desirable to have an equalisation of interest rates in all parts of the world. It assumes, that is to say, that if the rate of interest which promotes full employment in Great Britain is lower than the appropriate rate in Australia, there is no reason why this should not be allowed to lead to a situation in which the whole of British savings are invested in Australia, subject only to different estimations of risk, until the equilibrium rate in Australia has been brought down to the British rate.87 Keynes understood that under a bank money system, not only was reliance on foreign capital ended, but that in order to manage the economy, countries should actually close their borders to footloose, mobile international capital. To do so he advocated capital control: the taxing of cross-border capital flows. (Capital controls are taxes, and differ from exchange controls. The latter place limits on the amount of a nation’s currency that can be taken abroad. The Financial Transaction Tax (or Robin Hood Tax) is a form of capital control, a tax or ‘sand in the wheels’ of capital flows.) Professor Jagdish Bhagwati has argued persuasively that China and Japan different in politics and sociology as well as historical experience, have registered remarkable growth without capital account convertibility. Western Europe’s return to prosperity was also achieved without capital account convertibility … 101
… In short when we penetrate the fog of implausible assertions that surrounds the case for free capital mobility we realize that the idea and the ideology of free trade and its benefit … have been used to bamboozle us into celebrating the new world of trillions of dollars moving daily in a borderless world ...
Removing finance’s control over a nation’s currency Keynes also understood that the modern-day practice of using the rate of interest to manage the exchange rate of the currency would hurt the domestic economy, because central bankers are obliged to focus on the interests of the ‘robber barons’ - international capital markets - instead of the interests of ‘the makers’ and exporters of the domestic economy. He argued that instead, central banks should manage exchange rates over a specified range by buying and selling currency rather than by manipulating and ratcheting up interest rates to attract foreign capital. This would both allow interest rate policy to be focussed on domestic interests, and at the same time, ensure stability and transparency in exchange rate arrangements. A suite of policies for subordinating finance to the real economy This suite of policies – management of credit creation; of interest rates across the spectrum of lending; the regulation of mobile capital; and the management of the exchange rate - gradually loosened the control wealthy elites had over the financial system and the economy. They formed the basis of the Bretton Woods financial architecture, which while it endured (1945-1970) was, and still is defined as ‘the golden age’ of economics. These policies in turn loosened finance capital’s control over society, and over democratic institutions. The power, status and prestige of bankers in Britain and the United States were considerably modified. The ‘golden age’ was a period the famous historians Eichengreen and Lindert described as ‘a golden era of tranquillity in international capital markets, a fulfilment of the benediction “May you live in dull times.”’
Keynesian monetary policies managed the banking system in the interests of society as a whole, ensuring that all major stakeholders in the economy enjoyed ‘a share of the cake.’ However, soon after Keynes’s death his theory and its practical application were neglected and discredited. In its place the Hayekian (neoliberal) and socalled ‘Keynesian’ schools of economics restored the old Classical theory. This once again asserted that savings are needed for investment; that bankers are mere intermediaries between savers and borrowers etc. Above all, the Classical theory elevates the role of finance capital and capital markets in the lending markets, and restores to private wealth the power to determine interest rates. It is a collection of plausible fantasies – an ideology - that has enriched the rich, and systematically replaced more democratic policies and financial management. In other words, by removing the policies and regulations that allowed governments to manage the economy, orthodox economists restored to finance capital the despotic power it had exercised before the stock market crash of 1929. Power resided not only with those who had amassed great wealth but also with those who could make new gains through lending. By obfuscating the nature of their business, bankers established a new kind of despotism. Today central bankers retain a tenuous hold over the ‘short’, ‘policy’ or ‘base’ rate charged to banks (and not to other borrowers); but do not exercise influence or control over the full spectrum of interest rates. These are fixed by ‘the market’. As a result rates on the whole spectrum of lending are socially constructed - fixed or manipulated - by finance capital’s minions – by ‘submitters’ in the back offices of banks like Barclays, and by banking cartels such as the British Banking Association. They are not fixed to suit the wider interests of Industry or Labour.
Neoliberal theorists and practitioners (like Jens Weidmann and Otmar Issing, respectively President and former Chief Economist of the Bundesbank) while aware of the nature of credit-creation, appear to have little understanding of bank money, and deliberately ignore the role of commercial banks in credit-creation.90 The effect of this ‘blind spot’ concedes and reinforces finance capital’s power - think of the bond markets - to fix the ‘price’ of money. That helps explain why the neoliberal economic policies of the German Bundesbank and the ECB have placed Eurozone economies at the mercy of the reckless and unfettered speculation of capital markets, and their usurious rates of interest. There are differences though. Today’s robber barons enjoy eye-popping stocks of wealth that are historically unprecedented. And the rates of interest they demand for parting with this wealth make the usurious practices of the money-lenders of the past seem modest. Keynes’s monetary theory buried Keynes knew well that his monetary policies, based on the conviction that low interest rates were pivotal to prosperity, were hardly attractive to those who wanted to maximise returns on their capital. Finance capital understood that his liquidity preference theory would eventually lead to the ‘euthanasia of the rentier’. Because he represented a profound threat to finance capital, and to the interests of the City of London and Wall Street in particular, his theories were inevitably attacked and marginalised. Enormous sums were, and still are, invested in think tanks, bank research units, academics and universities that oblige finance capital by labelling Keynes as an ‘inflationist’ and a ‘tax and spender’, or caricaturing him as being exclusively concerned with fiscal policy. Finance capital and its supporters in taxpayer-backed universities and public institutions are happy to adopt the crudest of tactics to discredit the man. And for good reason: returns on vast stocks of wealth are at stake.
And so his liquidity preference theory has been quietly buried – with the acquiescence of both ‘Keynesian’ friends and neoliberal or monetarist foes. Instead Adam Smith’s classical view of money is revived and used to inform the work of influential ‘Keynesians’ like Paul Samuelson, N. Gregory Mankiw of Harvard (and even Paul Krugman) as well as that of the monetarist Chicago School. Keynes’s fiscal policies for full employment and for recovery from financial crisis were then presented as his sole outstanding legacy – isolated from The General Theory of Employment, Interest and Money. This campaign against Keynes was part of a wider effort by finance capital to undermine our democracy. A renewed appreciation of Keynes’ legacy will not be sufficient to break the power of finance, but it is certainly necessary.
Chapter Seven. Yes, we can afford what we can do How can we restore to our democracy the public good that is the modern banking system? And how can we avoid the confiscation of this public good in the future as we deal with the threat of climate change and energy insecurity? The answers I would suggest are as follows. First, the public must develop a much greater understanding of how the bank money system works. Knowledge is both powerful and empowering. Today’s dominant flawed economic ideology will undoubtedly be weakened by wider public understanding of the financial system. Sadly, we cannot look to our universities for greater understanding. Departments of Economics are overwhelmingly staffed by ‘classical’ or ‘neo-classical’ economists. These have no firm foundation of monetary theory on which to develop appropriate theory or policies. Furthermore university departments are packed with micro-economists who study economic processes in detail, and often in isolation, and then wrongly draw macroeconomic conclusions from such processes. Stephen Cecchetti, at a workshop organised by the Bank of International Settlements in May 2012 highlighted a key flaw at the heart of most micro-economic modelling: Let’s say that we are trying to measure tide height at the beach. We know that the sea is filled with fish, and so we exhaustively model fish behaviour, developing complex models of their movements and interactions … The model is great. And the model is useless. The behaviour of the fish is irrelevant for the question we are interested in: how high will the seawater go up 106
the beach? … By building microeconomic foundations we are focusing on the fish when we should be studying the moon.91 Micro economic models are great, but they are useless. It is no wonder that most mainstream academic economists could not answer the Queen’s famous question: “why was the crisis not predicted?” Their models had missed the deluge that beached many banks and other financial institutions in 2007-9. As the financial crisis rolls on and economic failure intensifies, many economists remain detached from policy debates that could help stabilise the global economy, and alleviate human suffering. And many still do not understand how the private banking system created debts, vast as space, with which to crash the economy. Central bankers – the Guardians of the Nation’s Finances - have also surrendered to defeatism, and given up on any effort to re-structure the global banking system. Robin Harding filed this depressing report after the 2013 annual gathering of the world’s central bankers in Jackson Hole, Wyoming: The world is doomed to an endless cycle of bubble, financial crisis and currency collapse. Get used to it. At least, that is what the world’s central bankers – who gathered in all their wonky majesty last week for the Federal Reserve Bank of Kansas City’s annual conference in Jackson Hole, Wyoming – seem to expect. All their discussion of the international financial system was marked by a fatalist acceptance of the status quo. Despite the success of unconventional monetary policy and recent big upgrades to financial regulation, we still have no way to tackle imbalances in the global economy, and that means new crises in the future.92
If the people lead, the leaders will follow Given the defeatism of our leaders, it is imperative that the people must lead. In particular there are two overlapping groups in society whose engagement in these issues is vital. If they take the lead in debates about the monetary system, credit creation, and about the management and pricing of credit they will stand a much better chance of securing their objectives. The first are women; the second, environmentalists. For women the issue is central because first while women are largely responsible for managing household budgets, they have on the whole been excluded from managing the nation’s financial system and its budgets. Thankfully this is changing with the appointment of women to critically important posts within the economy. However women students, working women, the members of for example, Mumsnet, business women, all largely stand on the sidelines of debate about monetary theory and policy. At present the networks that dominate the financial sector are overwhelmingly male, and often shockingly sexist. Their dismissive attitude towards half the population and their enjoyment of an unequal distribution of knowledge are not coincidental. They are part of the same despotism that harms the great majority, male and female and that feminism is uniquely well placed to challenge. If nothing else, feminists should want to challenge the friends of finance every time they say that ‘any housewife will tell you that you can’t spend money you don’t have’. I hope I have shown that this is nothing more than a ruse to obscure the realities of credit creation, and to enlist prudent women of modest
means to support policies that serve the interests of wealthy and reckless men. Secondly, the refrain ‘there is no money’ most frequently applies to women’s interests and causes. While there is enough money to bail out bankers, there is never enough money to fund all the social services women provide to society. There is never enough money to reduce high rates of maternal and newborn mortality across the world; to pay fair and decent wages to women and to provide adequate and high quality childcare for women at work. The creation and management of society’s money does not currently loom large in contemporary feminism. But it is a feminist issue, and is central to the liberation of women from the servitude of unpaid work. The second group that stands to benefit from engaging in the issues raised by the management of the monetary system are environmentalists. It is my contention that there is a direct link between the de-regulated, uncontrolled expansion of credit, increased consumption and rising greenhouse gases. By isolating consumption from the creation of credit, environmentalists are fighting a losing cause. By failing to understand how ‘easy money’ finances ‘easy consumption’ and with it rising toxic emissions, eco warriors are missing a trick. By failing to understand that repayments on high levels of expensive debt lead to, and demand rising exploitation of the earth’s scarce and precious resources, environmentalists will fail to check rising greenhouse gases and the depletion and extinction of species. The link between liberal finance and increased exploitation of the ecosystem is strong. To protect the ecosystem, it is vital to first manage and regulate finance. 109
But to be armed with knowledge and understanding is not enough. We must go further. We must reinvigorate our political and democratic institutions, because they are the vehicles by which society collectively and democratically agrees to legislative and regulatory change. We must understand that if our democratic institutions have been hollowed out by liberalisation and privatisation; if our politicians have been co-opted or captured, stripped of policy-making powers, and of the power to allocate resources – then that is not accidental, but the deliberate result of finance capital’s actions, its lobbying and its consequent despotic power over us all. To challenge finance, it is essential that we engage in, rebuild and strengthen democratic political parties and institutions; that we participate in political debate and in elections, and in loud, open discussion about issues that have a profound impact on our lives. In other words, we, the people, have to organise politically; and to be clear about the financial and economic transformation we aim for, in order to bring about a more ecologically sustainable world. I have always believed that an alliance between Labour and Industry is important if Finance is to be effectively challenged. The interests of both would be served by subordinating Finance to its proper role as servant, not master of the real, productive economy. Some argue that the financialisation of Industry makes such an alliance impossible. I am not so sure. There are makers and creators out there who resent the bullying of financiers and the costs of rentier capitalism as much as any trades unionist or activist. As to the policies needed to subdue finance capital, these are known, and have been briefly outlined in the last chapter of this short book. We do not have to reinvent the wheel. We do not need a social 110
revolution. We simply have to reclaim knowledge and understanding of money and finance; knowledge that has been available to society for many centuries. We need to reform and adjust monetary policy. We can turn the clock back, and move forward. Of course finance and their friends in the media, the universities and the establishment will resist, because monetary reform is the thing they fear most – even more than the revolts and occupations of city squares by citizens. Protest without concrete proposals for policy changes, and indeed for a transformation, pose no threat to the invisible, intangible global financial system. If we cannot, through sensible monetary reform, dismantle finance capital’s great power then it is my fear that society will react to the immiseration of unpayable debts, unemployment and falling incomes in ways that will be politically ugly, chaotic and destructive. But it need not be this way. I have tried, in this short book, to explain that for those privileged to live in societies with a developed banking system, and with the public institutions needed to uphold the integrity of banks there need never be a shortage of finance. With sound monetary policies in place, we can ensure that society has the finance it needs to transform the economy away from its dependence on fossil fuels, and towards more sustainable forms of energy. Because there need never be a shortage of finance, we can afford to undertake this huge transformation and care for the ageing population, the young and the vulnerable. We can surely afford great works of art and music. In short we can afford all those things we can do, within the limits imposed by human shortcomings, and by the ecosystem.
But that great transformation can only happen if we the people equip ourselves with a full and proper understanding of money-creation, bank money and interest rates – and then begin to demand the reform and restoration of a just monetary system, one that makes finance servant to the economy, and removes it from its current role as master of the economy. With an understanding of what constitutes just money, we - as women, environmentalists, trades unionists, producers, creators, businessmen and women, designers, activists, farmers - can lead our leaders into once again doing the right thing. Namely, adopting straightforward and well understood monetary reforms that will break the despotic power that finance capital exercises over us all.
Acknowledgements I am heavily indebted to Dr. Geoff Tily, author of Keynes’s General Theory, the Rate of Interest and ‘Keynesian’ Economics (Palgrave 2007); and of the re-print: Keynes Betrayed (Palgrave, 2010). Geoff has generously shared his wide knowledge of Keynes, and of monetary theory and policy; pointed me in the direction of experts and scholarship; and has always done so with patience, wit and charm. However, he cannot be held responsible for any of the contents of this book. Many others have illuminated the murkier corners of monetary theory and policy for me, including Professor Victoria Chick, Professor Steve Keen and my colleagues at the new economics foundation, Tony Greenham and Josh Ryan-Collins. Mary Mellor, Margrit Kennedy, Gillian Tett, Susan Strange and Yves Smith have all helped shape and form my thinking, and I am immensely grateful to them for that. I owe a particular debt to Geoffrey Ingham author of The Nature of Money - a book very important to me because of its clear and forensic analysis of money and the monetary system. I owe unpayable debts to my husband and best friend, Jeremy Smith. He has been, and is the wind beneath my increasingly ragged wings. Finally sincere thanks are due to Rachel Calder my agent, and Dan Hind, patient editor and publisher of this book. Both believed in me, and in the book, and that confidence is a gift for any author. Recommended Reading List Akyüz, Yilmaz, 2012, Financial Crisis and Global Imbalances – A Development Perspective, Geneva: South Centre Chick, Victoria., 1977, The Theory of Monetary Policy, Revised Edition, Oxford: Parkgate Books in association with Basil Blackwell
Galbraith, J.K., 1975, MONEY Whence it came, where it went, Middlesex: Penguin Books Ltd Greenham, Tony., Jackson, Andrew., Ryan-Collins, Josh., Werner, Richard., 2012, Where Does Money Come From?, Second Edition, London: nef Helleiner, Eric, 1994, States and the Reemergence of Global Finance, USA: Cornell University Press Ingham, Geoffrey, 2004: The Nature of Money, Cambridge: Polity Press Keen, Steven, 2011, Debunking Economics – Revised and Expanded Edition: The Naked Emperor Dethroned?, London: Zed Books Kennedy, Margrit, 1995, Interest and Inflation Free Money, Michigna: Seva International Keynes, John Maynard, 1973, The General Theory of Employment, Interest and Money, Cambridge: Cambridge University Press Mellor, Mary, 2010, The Future of Money, London: Pluto Press Polanyi, Karl, 1975, The Great Transformation – the political and economic origins of our time, Boston: Beacon Press Strange, Susan, 1998, Mad Money, Manchester: Manchester University Press Tily, Geoff, 2010, Keynes Betrayed, UK: Palgrave Macmillan Other relevant reading Cockett, Richard., 1994, Thinking the Unthinkable, London: HarperCollinsPublishers Daly, H.E., 1973, Economics, Ecology, Ethics, San Francisco: W.H. Freeman and Company Daly, H.E., 1977, Steady-State Economics, San Francisco: W. H. Freeman and Company Elliott, Larry., Hines, Colin., Juniper, Tony., Leggett, Jeremy., Lucas, Caroline., Murphy, Richard., Pettifor, Ann., Secrett, Charles., Simms, Andrew., 2009 - A Green New Deal, London, Green New Deal Group. http://www.greennewdealgroup.org. Also The Cuts Won’t Work http://www.greennewdealgroup.org/?p=161 114
Galbraith, John Kenneth., 1992, The Great Crash 1929, London: Penguin Books Ltd. Geisst, C.R., 2013, Beggar Thy Neighbor, Philadelphia: University of Pennsylvania Press Graeber, David., 2011, Debt, the first 5,000 years. New York: Melville House Publishing Guttmann, William., Meehan, Patricia., 1975, The Great Inflation, Farnborough: Saxon House Hudson, Michael., 2003, Super Imperialism, Second Edition, London: Pluto Press Martin, Felix., 2013, Money, London: The Bodley Head Murphy, Richard,. 2011, The Courageous State, London: Searching Finance Smith, Yves., 2010, ECONNED, Basingstoke: Palgrave Macmillan
Satyajit Das: Traders, Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatoves. Financial Times series Prentice Hall 2010. 1
Geoffrey Ingham, The Nature of Money. Karl Polanyi: The Great Transformation: the political and economic origins of our time. First Beacon Paperback edition 1957. 4 These include: John Law, John Maynard Keynes, Joseph Schumpeter, Karl Polanyi, Kenneth Galbraith and Herman Minsky; and of contemporary economists and sociologists like Victoria Chick, Steve Keen, Geoff Tily, Cullen Roche, Geoffrey Ingham and the school of ‘Modern Monetary Theory.’ 5 Rational Irrationality, an interview with Eugene Fama, by John Cassidy, New Yorker, 13 January, 2010. http://www.newyorker.com/online/blogs/johncassidy/2010/01/interview -with-eugene-fama.html. I am grateful to Lars Syll for drawing this interview to my attention in his blog: Self-righteous drivel from the chairman of the Nobel prize committee, in the Real World Economics Review blog, 23 December, 2013. rwer.wordpress.com/2013/12/23/selfrighteous-drivel-from-the-chairman-of-the-nobel-prize-committee/#more14584 6 When memory becomes money; the story of Bitcoin so far, by Izabella Kaminska, FT Alphaville, 03 April, 2013. http://ftalphaville.ft.com/2013/04/03/1446692/when-memory-becomesmoney-the-story-of-bitcoin-so-far/ 2
Jonathan Levin, Governments will struggle to put Bitcoin under lock and key, The Conversation, 27 November, 2013. http://theconversation.com/governments-will-struggle-to-put-bitcoinunder-lock-and-key-20731 8 Remarks reported by CNN Money, July,10, 2012. http://money.cnn.com/2012/07/03/investing/libor-interest-ratefaq/index.htm 9 See also Michael Hudson and Cornelia Wunsch (eds.): Creating Economic Order: Record-Keeping, Standardization and the Development of Accounting in the Ancient Near East. CDL Press, Baltimore, 2004. 7
In An Orgy of Thieves by Jeffrey St. Clair and Alexander Cockburn, in CounterPunch, 22-24 November, 2013. http://www.counterpunch.org/2013/11/22/an-orgy-of-thieves/ 11 Murray N. Rothbard, page 90 in “The Mystery of Banking” Second Edition, Ludwig von Mises Institute, Auburn, Alabama, 2008. 12 Keynes Hayek – the clash that defined modern economics by Nicholas Wapshott, W.W. Norton & Company, Inc., 2011, p. 97. 13 Verbatim report, He found the flaw? In The Washington Times, written by Jon Ward, 24 October, 2008. http://www.washingtontimes.com/blog/potus-notes/2008/oct/24/hefound-flaw/ 14 Gillian Tett: Silos and Silences – why so few people spotted the problems in complex credit and what this implies for the future. Financial Stability Review No. 14 Banque de France July 2010. Online: http://www.banquefrance.fr/fileadmin/user_upload/banque_de_france/publications/Revue_d e_la_stabilite_financiere/etude14_rsf_1007.pdf [accessed 3/10/2013, 11:03 GMT]. 10
15 See Summers on bubbles and secular stagnation forever, FT Alphaville, 18 November, 2013, 09.27. http://ftalphaville.ft.com/2013/11/18/1696762/summers-on-bubblesand-secular-stagnation-forever/ 16 Quoted in Kari Polanyi Levitt: From the Great Transformation to the Great Financialisation: on Karl Polanyi and other essays. Zed Books 2013, p. 79. 17 See Cullen Roche: Understanding why Austrian Economics is Flawed. Blog Pragmatic Capitalism 10 September, 2013. Online: http://pragcap.com/category/myth-busting [accessed 3/10/2013, 10:58 GMT]
For more on this, see Mrs Thatcher’s Economic Experiment by Victor Keegan, published by Allen Lane, 1984. 19 Mrs Thatcher’s Economic Experiment by William Keegan, Penguin Books, 1984, pg.208. 20 As above. 21 See for example, this editorial from a World Bank publication: Modernizing Multilateralism and the Markets. World Bank Washington, DC October 6, 2008. Online: http://web.worldbank.org/WBSITE/EXTERNAL/NEWS/0,,contentMDK:21 946394~menuPK:51340323~pagePK:64257043~piPK:437376~theSitePK:4 607,00.html [accessed 30/09/2013, 17:10 GMT]. 18
CBS News: Ben Bernanke greatest Challenge. Interview 15 March 2009. Online: http://www.cbsnews.com/8301-18560_162-4862191.html [accessed 3/10/2013, 12:47 GMT].
Paul Sheard: Repeat After Me: Banks Cannot And Do Not "Lend Out" Reserves. New York Standard and Poor’s 13 August, 2013. Online: http://www.standardandpoors.com/spf/upload/Ratings_US/Repeat_After _Me_8_14_13.pdf [accessed 3/10/2013, 12:57 GMT]. 23
Mervyn King, cited by the New Economics Foundation: Banking Standards. Written evidence from the New Economics Foundation. NEF 20 November, 2012. Online: http://www.publications.parliament.uk/pa/jt201314/jtselect/jtpcbs/27/ 27vi36.htm [accessed 17/09/2013, 17:54 GMT]. 24
Jaromir Benes and Michael Kumhof: The Chicago Plan Revisited. International Monetary Fund/Bank of England presentation March 7, 2013. Online: http://www.bankofengland.co.uk/research/Documents/ccbs/Workshop2 013/Presentation_Kumhof.pdf [accessed 15/09/2013, 12:34 GMT]. 25
26 Geoffrey Ingham: The Nature of Money. Cambridge Polity Press 2004, p.6.
Joseph Schumpeter: History of Economic Analysis. Oxford University Press 1954, p. 322. 27
Frances Coppola: There's a problem with the transmission. Coppola Comment Blog 31 May, 2013. Online: http://coppolacomment.blogspot.co.uk/2013/05/theres-problem-withtransmission.html [accessed 30/09/2013, 17:30 GMT]. 28
29 The Reckoning: Taking Hard New Look at a Greenspan Legacy. by Peter S. Goodman in the New York Times, October 8, 2008. http://www.nytimes.com/2008/10/09/business/economy/09greenspan. html?pagewanted=all&_r=0
Andrew G. Haldane (Executive Director for Financial Stability at the Bank of England): What have the economists ever done for us? Vox EU October, 2012. Online : http://www.voxeu.org/article/what-haveeconomists-ever-done-us [accessed 29/09/2013 16:34 GMT]. 30
31 Sir Mervyn King in an interview with Martin Wolf: June 14, 2013: Lunch with the FT. June 14, 2013. Online http://www.ft.com/cms/s/2/350a10a2-d284-11e2-88ed00144feab7de.html#axzz2XV49gsUF [emphasis my own, accessed 29/09/2013 16:40 GMT]. 32 Andrew G Haldane, Executive Director, Financial Stability, Bank of England in a speech The $100bn Question, Bank of England, March, 2010. 33 This section draws on the work and writings of Dr. Geoff Tily, author of Keynes’s General Theory, the rate of interest and ‘Keynesian’ economics: Keynes Betrayed. Palgrave Macmillan, 2007.
John Maynard Keynes: The Collected Writings Vol. VI. Cambridge University Press 2012, p. 196.
Karl Marx: Capital Vol. III pt. 2. New York International Publishers 1894, pp.704 and 708-9. 35
36 Charles R. Geisst: Beggar Thy Neighbour: A History of Usury and Debt. University of Pennsylvania Press 2013, p. 7.
J. Martin Hattersley: Committee on Monetary and Economic Reform, Frederick Soddy and the Doctrine of “Virtual Wealth”. 14th annual Convention of the Eastern Economics Association, Boston 1988. Online: http://nesara.org/articles/soddy88.htm [accessed 30/09/2013, 17:46 GMT]. 37
I am indebted to Margrit Kennedy for use of this chart from her book: Interest and Inflation free money. Seva International, 1995. Online: http://kennedy-bibliothek.info/data/bibo/media/GeldbuchEnglisch.pdf [accessed 30/09/2013, 17:49 GMT]. 38
Geoff Tily in, BIS Papers, No 65. Threat of Fiscal dominance? Keynes’s Monetary Theory of Interest, published by the Bank for International Settlements, Monetary and Economic Department, May 2012. http://www.bis.org/publ/bppdf/bispap65c_rh.pdf 40 John Maynard Keynes in, The General Theory of Employment, published by the Quarterly Journal of Economics, February, 1937. http://www.jstor.org/discover/10.2307/1882087?uid=3738032&uid=2&u id=4&sid=21102814913137 41 Geoff Tily: Keynes´s monetary theory of interest. Bank of International Settlements Papers No. 65. Online: http://www.bis.org/publ/bppdf/bispap65c_rh.pdf [accessed 3/10/2013, 18:53 GMT] 39
Dr. Geoff Tily in Keynes Betrayed: The General Theory, the Rate of Interest and ‘Keynesian economics’, published by Palgrave Macmillan, reprint edition, October, 2010. http://www.amazon.co.uk/Keynes-BetrayedInterest-Keynesian-Economics/dp/0230277012 43 Bank of England: The framework for the Bank of England’s operations in the sterling money markets. Bank of England News January, 2008. Online: http://www.bankofengland.co.uk/publications/Pages/news/2010/140.as px [accessed 3/10/2013, 19:24 GMT]. 42
John Kenneth Galbraith: Money: Whence it came, where it went. Harmondsworth Penguin 1975. 44
Geoffrey Ingham: The Nature of Money. Polity Press, 2004 David Graeber: Debt: the first five thousand years. Melville House Printing, 2011. 45
Felix Martin: Money: the unauthorised biography. Bodley Head, 2013.
In Debt: The First Five Thousand Years, by David Graeber, Melville House, 2012. 49 Graeber: Debt, p. 47. 48
Felix Martin, op. cit.
John Maynard Keynes: The Collected Writings Vol. V, A Treatise on Money: The Pure Theory of Money. Cambridge University Press 2012, page 11.
52 Sydney Homer and Richard Sylla: A History of Interest Rates. John Wiley and Sons New Jersey, 2005, pp. 155-8. 53
Geoffrey Ingham: The Nature of Money. Polity Press 2004, p.198.
Bernard Vallageas: Basel III and the Strengthening of Capital Requirement: The obstinacy in mistake or why “it” will happen again. World Economic Review, No. 2, 2013, World Economics Association. Online: http://wer.worldeconomicsassociation.org/ [accessed: 3/10/2013, 10:54 GMT]. 54
55 Margaret Thatcher in a speech to the Conservative Party October 1983. Online: http://www.margaretthatcher.org/document/105454 [accessed 1/10/ 2013, 13:06 GMT].
Bank of England Video: QE – How it works. Banke of England website. Online: http://www.bankofengland.co.uk/education/pages/inflation/qe/video.asp x [accessed 3/10/2013, 11:17 GMT]. 56
Bernie Sanders: Federal Reserve System: Opportunities Exist to Strengthen Policies and Processes for Managing Emergency Assistance. US Government Accountability Office July 2011. Online: 57
http://www.sanders.senate.gov/imo/media/doc/GAO%20Fed%20Investig ation.pdf [accessed 4/10/2013, 13:34 GMT]. 58 Mervyn King in a conference speech. Sky News Report and Video. Online: http://news.sky.com/story/733003/boe-governor-signals-fragileuk-recovery [accessed 4/10/2013, 14:08 GMT]. 59
Liam Byrne quoted in Paul Owen: Ex-Treasury secretary Liam Byrne´s not to his successor: there´s no money left. Guardian, on 17th May, 2010. http://www.theguardian.com/politics/2010/may/17/liam-byrne-notesuccessor [accessed 4/10/2011, 14:13 GMT] 60
61 George Osborne, Britain’s Chancellor of the Exchequer on Sky News on the 27th February, 2012. Online: http://www.telegraph.co.uk/news/politics/9107485/George-Osborne-UKhas-run-out-of-money.html [accessed 4/10/2013, 14:17 GMT]. 62 Ed Balls: Striking the right balance for the British economy, delivered at Thomson Reuters, on Monday 3rd June, 2013. Online: http://www.labour.org.uk/striking-the-right-balance-for-the-britisheconomy [accessed 04/10/2013, 14:19 GMT].
Ann Pettifor (ed.): The Real World Economic Outlook. New Economics Foundation, Palgrave Macmillan 2003. 63
The book includes articles from a group of economists at the “new economics foundation”, who predicted a bursting of the credit bubble. The “New Statesman” featured our prediction on its front cover. We were wrong. The credit bubble had much further to go. By 2006 concerned, as friends and acquaintances took out unaffordable mortgages and loans, I wrote another book: The coming first world debt crisis. Palgrave Macmillian 2006. There were heated arguments with the publisher about the title, which I did not like. There was no way I argued, that the book’s title would remain current for more than a month, as the crisis was imminent. Again I was wrong: credit creation expanded further, and the implosion did not take place until 2008. See Costas Lapavistas’s Profiting without Producing : How Finance Exploits Us All , Verso 2013. 65 Philip Aldrick: Spanish bank fields Ronaldo as collateral. Daily Telegraph 29 Jul 2011. Online: http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/867 1468/Spanish-bank-fields-Ronaldo-as-collateral.html [accessed 3/10/2013, 12:24 GMT]. I am grateful to Prof Martin Hellwig for drawing my attention to this arrangement. 64
66 Richard Koo, quoted in Cullen Roche’s blog: Quantitiative Easing, the Greatest Monetary Non-Event. 9 August, 2010. Online: http://pragcap.com/quantitative-easing-the-greatest-monetary-non-event [accessed 3/10/2013, 12:25 GMT].
The following paragraphs are drawn from the second report of the Green New Deal of which Ann Pettifor was a co-author: The Cuts Won’t Work, was published by the new economics foundation on 7th December, 2009. http://www.greennewdealgroup.org/?p=161 68 Keynes JM (1933) The means to prosperity. (London: Macmillan). 67
Jeremy Warner: Oh God – I cannot take any more of the austerity debate. Daily Telegraph, 11 September, 2013. Online: http://blogs.telegraph.co.uk/finance/jeremywarner/100025496/oh-god-i-
cannot-take-any-more-of-the-austerity-debate/ [accessed 3/10/2013, 12:29 GMT] 71 Bank of England, Financial Stability Report, November, 2013. http://www.bankofengland.co.uk/publications/Pages/fsr/2013/fsr34.asp x 72 Micheal Steen: Draghi pledges to keep interest rates low. Financial Times, 3 Oct 2013. Online: http://www.ft.com/cms/s/0/35373476-2b4711e3-a1b7-00144feab7de.html?siteedition=uk#axzz2geq1vAe0 [accessed 3/10/2013, 12:33 GMT]. 73 Economists like Carmen Reinhart describe this as a form of ‘financial repression’: Financial repression back to stay. Bloomberg 11 March 2012. Online: http://www.bloomberg.com/news/2012-03-11/financialrepression-has-come-back-to-stay-carmen-m-reinhart.html [accessed 3/10/2013, 12:36 GMT]
Transcript: Attorney General Eric Holder on `Too Big to Jail´ 6 March 2013. Online: http://www.americanbanker.com/issues/178_45/transcript-attorneygeneral-eric-holder-on-too-big-to-jail-1057295-1.html [accessed 3/10/2013, 12:40 GMT]. 74
Wolfgang Münchau: Europe is ignoring the scale of bank losses. Financial Times June 23, 2013. Online: http://www.ft.com/cms/s/0/f4577204-d9ca-11e2-98fa00144feab7de.html#axzz2XV49gsUF [accessed: 17/09/2013, 17:23 GMT]. 75
77 Michael Hudson, Interview on Blog Naked Capitalism 18 September 2013. Online: http://www.nakedcapitalism.com/2012/09/michaelhudson-on-how-finance-capital-leads-to-debt-servitude.html [accessed 3/10/2013, 19:28 GMT]
Anonymous ‘London Banker’ in a blog post: Chop off their Hands, 20 March, 2013. http://londonbanker.blogspot.co.uk/2013/03/chop-offtheir-hands.html 79 Hayek is quoted by Harold James: Making the European Monetary Union. Harvard University Press, 2012, p. 6 (Emphasis my own). 78
In Amato and Fantacci forthcoming. Also Massimo Amato and Luca Fantacci in The End of Finance, Polity Press, 2012. 81 Professor Jagdish Bhagwati: The Capital Myth: the difference between trade in widgets and dollars. Published in Foreign Affairs; May/Jun 1998; 77, 3; ABI/INFORM Global pg. 7 and available here: http://web.cenet.org.cn/upfile/57122.pdf 82 Business Dictonary. Online: http://www.businessdictionary.com/definition/liquidity.html [accessed 03/10/2013, 19:32 GMT] 80
For more on ‘illusory liquidity’read Fragile Finance: Debt, Speculation and Crisis in the Age of Global Credit by Dr. Anastasia Nesvetailova. Published by Palgrave Macmillan Studies in Banking Oct 2007. 84 For a detailed exposition of Keynes’s Liquidity Preference Theory, see Goeff Tily: Keynes Betrayed: The General Theory, the Rate of Interest and ´Keynesian Economics`. New York Palgrave Macmillan, ch. 7. 83
Ibid., p. 202.
Keynes to R. F. Harrod 19 April 1942 in John Maynard Keynes: Collected Writings, Vol. XXV. Cambridge University Press 2012, pp. 148-9. 87
Professor Jagdish Bhagwati: The capital myth: The difference between trade in widgets and dollars. Foreign Affairs; May/Jun 1998. http://web.cenet.org.cn/upfile/57122.pdf 89 Eichengreen and Lindert, The International Debt Crisis in Historical Perspective (MIT Press, 1991), p. 90 Norbert Häring: The veil of deception over money: how central bankers and textbooks distort the nature of banking and central banking. Real-World Economic Review, No. 63. Online: http://www.paecon.net/PAEReview/issue63/Haring63.pdf [accessed 1/10/ 2013, 13:02 GMT]. 88
Stephen Cecchetti: Threat of fiscal dominance? Bank for International Settlements Papers No. 65, May 2013. Online: http://www.bis.org/publ/bppdf/bispap65.pdf [accessed 4/10/2013, 15:12 GMT].
92 Robin Harding: Central Bankers have given up on fixing global finance. Financial Times, 27 August 2013. Online: http://www.ft.com/cms/s/0/020103b6-0b4e-11e3-bffc00144feabdc0.html#axzz2geq1vAe0 [accessed 3/10/2013, 19:38 GMT].