Saturday, 17 May 2014



I want to say at the start that I am not an economist; nor a mathematician. But
as  a social ecologist, I am appalled by the operation of capitalist financial systems that enable 0.01% of the global population to control 80% of the global wealth, and tolerate 1 billion people dying of hunger! 
I continue my struggle to understand financial services, capitalism, money, debt, loans;  to come to terms with the statements about loans and money. It is clear that global wealth is controlled by an elite. 
For a long time, most people in the world have been poor, and subject to the demands of conquerors, monarchs, emperors, rulers, dictators, leaders, and their bankers. Whenever the ruling families wanted money or valuables, it was expected that they obtained them from the citizens by taxation. These demands were made easier once the citizens kept their valuables in bank vaults. The rulers could simply take them and confiscate them as taxation.
For a long time, whenever people had valuables made of gold and silver or diamonds and pearls which they wanted to keep safe, they would place them, for a fee, with the goldsmith, or silversmith, to keep in their vaults.
The smiths, over time, would accumulate a vast store of valuable items. As these items gathered in their vaults, they would use them as collateral for loans and investments or as taxation for the government.
These items were assets that were not ‘liquid’; that is, they were not portable; they could not be moved nor sold on the spot. They could be valued and taken to market, and sold at auction. But their value could not be guaranteed. If no-one wanted to buy the items, they would be worthless.
On the other hand, gold and silver were portable when converted into coins. Coins were used as items of value to pay in exchange for food, shelter, transport, clothing, furniture, equipment, and so on.

For many decades, ‘usury’  was a mortal sin in the Catholic Christian world. Lending money at interest was forbidden: and in many communities that remains the same today. However, that did not mean that usury did not take place. It did mean that it was not carried out by Christians/Catholics. For example, in Italy, Spain, France, the UK and their colonies, money lending was carried out.. Christian borrowers would offer their valuables as collateral for loans. The Lenders would charge interest and take possession of the valuables in the case of default or late payment. The valuables always covered the value of the loans: full reserve.
Times of war gave rise to the greatest demands for capital, and loans.  Wars were carried out by monarchs and emperors, who demanded monies for equipment, the purchase of ships, the payment of mercenaries, far in excess of what they had to hand. So, in effect, usury became sponsored by the ruling families of Christian and Muslim countries as in the Crusades, Norman wars, Napoleonic Wars, Ottoman conquests. Bankers became experts at creating money, and prospered.
We have a picture in which bankers looked after valuable goods for wealthy customers, and created monies for the use of ruling families and the governments of the day. Initially, the  bankers raised the monies and charged government agents fees, not interest.

All new enterprises, whether involved in conflicts or corporate enterprises, required new money. This money took the form of coins of recognized denomination... Of course, anything over 1000 GBP would be bulky, heavy, and not very portable. As coins had replaced valuable items, so coins were replaced with paper, say receipts or promissory notes eg. ‘I promise to pay’. In response to the increasing demands for coins in their hundreds of thousands, notes and cheques became more common and eventually replaced coins.
We have a changing picture. Vaults full of  objects like rings, necklaces, candlelabras, chalices, plates, boxes, pots, knives and forks, swords, etc., made of gold and silver are replaced by coins. As more coins were used so they become more difficult to move. The banks issued pieces of paper to represent the coins and the goods of value.

It is worth noting that even today most people think of money as cash, as coins, as solid. items.
From the start of banks, bankers have been involved in making money portable, transferable, exchangeable, negotiable. The valuable items that they kept for their customers were converted into coins, and later into ‘notes’ or cheques or receipts. The papers were much more portable and very cheap to print.  They could be carried in your pocket or purse or by hand and represented the valuables held in your bank accounts or as land assets. The coins and notes were more reliable items of value and could be added and monitored. Soon, balance sheets were developed as statements of how much value was in the bank account, and how much had been spent: credits were expected to balance debits. Once debits exceeded credits, customers applied for loans, for new money from the banks.
The biggest customers of banks were and continue to be governments who also supervise and regulate banks and devise the rules.
Banks will loan money on the assumption that credits will be paid in the future. Up until the 20th century, it was expected that the assets in the bank would cover the amount on loan: [full reserve banking]: so that if a new venture had assets of $1 million, it could borrow $1 million; and the bank had to deposit $1 million in the Central Bank.

In an attempt to spread the risk of a new investment, the Joint Stock Company was devised: according to which many people could invest in the new venture by buying shares in return for a dividend on their investments. For example, those who invested in the East India Company made a fortune. Those who put their money in the Louisiana Land Company lost it all. The success or failure of a Joint Stock Company is not guaranteed! although it can be insured.

Important aspects of banking are ‘the management of risk’ and the ‘generation of profit’. If a bank has managed risk, it takes a profit.
We have reached the point where banks are used as consultants and charge fees.
We have reached a point when money is not solid as coins. It is represented by numbers. At first these numbers were on a balance sheet. Later, on a computer screen.
As more and more coins were used, so they ceased to be portable. They became represented by ‘numbers’ so money became flexible and highly portable….being moved  on line from one account to another, in milliseconds.
The global expansion of trade and industry saw the rising demand for more new money. For example, the iron and steel industry required the construction of mines, and furnaces before there was any talk of ‘profits’. Railways and roads had to be built before they could have an organized timetable, rail fares, and traffic.
Banks responded by developing ‘fractional reserve banking’. If a bank had $100 in  cash, the bank could lend $1000.  If companies had assets worth $1million, they could borrow $70million, at the discretion of the bank……or even $700 million if the company had good prospects. Over a long time, say 50 years, this would not be a problem. [as long as the companies made profits] although the interest payments would be a lot.[4.5 times the principal]  It becomes clear that companies and banks are dealing in bank created money.  Banks did not have $700 million in hard cash, Banks no longer had reserves that covered their loans.
The application of fractional reserve banking would mean that the monies in circulation are number  entries’ on a contract form or later, digital entries on a computer programme. The profits of the bank continue to be calculated in terms of credit and debit.
The emergence of digital banking has led to quantitative banking. The search for predictability and certainty and secure profits has led to quantitative banking.
Banks and Finance Houses took great pains to hire mathematical experts who could derive formulae to develop predictions for their digital entries.
Today, real Estate/Housing is a major activity of the finance industry. In the USA, the Clinton/the Bush governments wanted to increase home ownership to all families. There developed the ‘sub-prime’ mortgage’ market, which offered  families the chance to buy their homes. These families had little chance of repayment and a high chance of default. Indeed some groups were called ‘NINJAS’: no income; no jobs, no assets.
The irony was that mortgage banks like LEHMAN Brothers were lending money that they did not have to clients who had no income!  

And so was born the 2008 credit crisis. When a large percentage of borrowers defaulted on their mortgage debts, banks and savings and loans companies went ‘bust’: that is, demands for money [debits] were exceeded by the supply [credits]. The finance houses could not pay their bills. All their planning was based on the assumption that there was no risk in the mortgages, and there would be a steady stream of repayments.
This assumption was reinforced by the predictions of the ‘quants’ who devised formulae and methods of packaging the mortgages into derivatives such as credit default swaps, options, futures, insurance; that protected the lenders from losses. But their calculations all assumed that everyone would repay their debts. When no-one paid their debts, the system collapsed!

Waiting to take their money out

Of course, it was easy to blame the borrowers for this crisis. But it should be argued that there should not have been ‘sub-prime’ mortgages. What is the point in giving unemployed workers a mortgage loan, and then expecting them to pay it back with interest.  Such a strategy is fraught with problems, particularly when unemployment increased and companies went bankrupt; interest rates went up; insurance premiums went up; and house prices went down, and everyone wanted to sell, but no one wanted to buy! Government plans were at fault.

We have moved from the 15th century when usury was a sin, and loans were made to Monarchs, and aristocrats, and governments; to the 21st. century when loans could be available to every family in the land.
Loans have always been ‘new money’ created by the banks and banksters to meet the demands of the ‘rulers’ and other clients: on  condition  that money generated in the future would  be paid to the banks.
The borrowers would be credited with an agreed sum. At first, these credits would be cash, gathered up by the bankers. For example, during the Napoleonic Wars, the Emperor wanted cash to pay the wages of his soldiers. The bankers who could raise the cash, and deliver it to the front lines, would get the commission, and the fee. Many banks prospered during times of war!  patronized by the governments and their rulers.
As the demands on banks have become more and more extensive, so banksters have looked to more and more different ways to use money, and make it easier to transfer from one account to another. This has become more marked with the globalization of trade and industry. For example, a corporation in Australia may well be selling iron ore to a steel corporation in the UK. Some time ago this sale would require direct settlements by cash. Today, these dealings can be settled by the transfer of  digital money, in milliseconds. It is still necessary for the dealings to be settled in cash, but sometime later by interbank transfers.

It remains  puzzling to think about a system in which we believe that payments are made in cash, when the evidence shows that payments are made by transferring numbers from one account to another. Even the creation of ‘new money’ by banks is illusory as the banks do not have the cash to cover their loans. Banks add new numbers to an account, they do not print the notes nor coins. The modern banking system is based upon a ‘money delusion’.
There are important distinctions between ‘full reserve banking’ and ‘fractional reserve banking’. ‘Full reserve banking’ insists that  loans made by  a bank are covered by the assets of the bank: that is, $1million loans are covered by $1million reserves held by the Central Bank. And indeed, if new money is covered by old money, there is little danger of bankruptcy, and the amount of money on loan can be regulated by the Central Bank.
Today, in the rich developed countries ‘fractional reserve banking’ is the system.  Governments and Central Banks declare that there must be a lot of new money available to sponsor rapid growth. The demands for money are far greater than the supply. If an enterprise has a regular income, and whose prospects are judged to be good, and has assets worth $1million, it may ask for a loan of $10million or $20million; and may be given a loan of $100million. In this situation, the banks depend upon the success of the enterprises, and there is no question of failure. The investment banks create money. The financial crisis of 2007/2008/2009 was caused when debtors of the banks failed to repay their loans and interest , thus cutting off the supply of  income to the banks. Enterprises failed; countries went bankrupt. Banks failed. In every case costs exceeded  income; debits exceeded credits; withdrawals were greater than deposits; Bank statements were in deficit; debts exceeded credits. Organisations failed and went bankrupt.  The debtors had no way to convert their debts into cash, There were no reserves to cover the debts. Every debtor was in breach of contract. Fractional Reserve Banking does not require debtors nor creditors to have access to reserves that cover the loans. The system assumes that income was secure, and that the loans would generate interest, and create purchasing power.
Lord Adair Turner, once of the FSA, has declared Fractional Reserve Banking to be the cause of financial crises! He sees that any reform of the banking system must stop Fractional Reserve Banking.
Lord Adair Turner, in his recent presentations to INET, identified different forms of money: ‘metallic money’ including coins and notes; ‘fiat money’ created by the Central Bank and the State as notes and bonds; ‘debt money’ created by private banks as loans;‘credit money’ created by private banks as credit cards or cash cards.
 He confirms that 97% of money placed in circulation is credit or debt or digital entries  created by  private corporations., or banks, and 3% is metallic money.
It is difficult for many people to understand that nearly all the money that is in use in the world economy is digital numbers: that is, authorized entries on Bank balance sheets, created ‘ex nihilo’ by their fund managers. The many trillions of dollars that are quoted in statements are not ‘cash’ but are 'digital' entries.
It is time to turn our perceptions of money systems upside down! And to come to terms with  the ‘money game’.
First, from the days of Monarchs to elected  Presidents, governments have identified  and authorized ‘money’ as gold or silver coins and bank notes.
Second, the rulers of the State, and the Central Banks, have produced ‘money’ according to their declared needs: what we call 'quantitative easing'. It is not necessary for them to borrow Money: although that is what they do. The Treasurers of the State only need to  print it and avoid interest.
Third, private banks are entitled to identify digital entries as money. More directly, we all think of the numbers in our bank accounts as money simply because the bank says we can.
Private banks create money as loans, out of nothing. ‘Money’ can be conjured up by bankers and fund managers in the form of loans, and debts. Those accredited with the most ‘money’ have the greatest ‘debts’.
We are caught in a puzzle in which economists talk money, products and demands; and no one refers to money as 'fantasy.' Whereas we were once able to see our gold bars in the vaults, today, we can only see notes in the ATM machine. We can not access all the money in our bank account as cash.

Refer to the writings and videos associated with the:
Institute for New Economic Thinking;
New Economic Foundation;
Lord Adair Turner
IdeasLab 2013
Financial Services Authority, UK
George Soros
Open Society Foundation
Thomas Piketty
Paul Krugman
Joe Stiglitz
Niall Ferguson
The Ascent of Money: Channel 4 video
The Love of Money: BBC video

No comments:

Post a Comment