MONEY, BANKING, DEBT, LOANS.
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;
www.positivemoney.org
www.peoplestandup.ca
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
