Hoist by their own petard?

The confusion over where exactly money comes from seems so widely shared that I wonder whether it is a conspiracy of silence, a conspiracy of ignorance, or maybe just ignorance plain and simple. The smoke-and-mirrors and creative use of jargon is deliberately intended to conceal a simple fact: the banking system, as opposed to any individual bank, has been able to make as much money as it can persuade us to borrow.

A bemused reader of today's Guardian asked, 'Why do banks need to borrow from each other?' and was greeted with the usual confusing and misleading account. The response begins, 'Banks do not have vaults stuffed with money', agreed, but the following sentence about how they 'trade on fairly thin margins' is confusing and irrelevant. Deborah Hargreaves then drivels on about Libor and other irrelevant and technical sounding nonsense for a while. No doubt the reader feels none the wiser.

This confusion is not necessary because the way money is created is simple. Essentially, the banks operate as a kind of closed club, within which small amounts of money are inflated many times over until, as in recent years, the only limit on money creation is the willingness of borrowers to get into debt. Hence the growth of debt-concealing activities that are now unravelling.

This process is explained very clearly in the film Money as Debt, which is available on Youtube and on Google video. A laudably clear written account is given by Richard Douthwaite in chapter 2 of The Ecology of Money. So why the confusion? We can only assume that, if the simplicity of this scam were to become more widely known, in J. K. Galbraith's famous words, 'the mind would be repelled'.

It might also undermine any lingering support for the policy of throwing money at the banks. Since the money they loaned never existed, there is not enough money in the world to actually pay back all the debts of the financial institutions. Our money is being used to attempt to crank the debt-money system back into an upward rather than downward spiral; nothing more.

It is interesting to speculate to what extent bankers, financiers and finance ministers have begun to believe their own fantasy. If the reality of the money creation system were clear to them I can't help thinking they would be following a different sort of policy altogether. Tweet

Lies, Damned Lies, and Accounting

I spent a small but significant amount of time yesterday searching for a cost code to justify the spending of 60 pence. I mention this partly, I confess, to get the frustration and rage that caused me to scream in my office and cause consternation to my colleagues out of my system. But also to offer it as an example of how, in an era where the accountant is an unlikely king and accountability is espoused on all fronts, the petty is rigorously enforced whereas fraud on a grandiose scale is routinely ignored.

I am thinking, you will have guessed, of corporate fraud, of the type practised by Enron executives. Inflating the value of your stock by counting money you haven't received or even invoiced for yet. That particular techniques, known as counting 'unbilled receivables' was invested by the leading accountancy firm then called Arthur Anderson. Oil companies also engage in this creative accounting when, as Shell recently admitted it had done, they overestimate the value of their reserves, which, in oil companies terms, is the value of your companies and hence your stock.

It appears that the rule is, the more preposterous the fraud the more unlikely it is that we will notice. As Kierkegaard famously pointed out about Christianity, if you want to get a whole mass of believers you need to create a really big lie. Which brings me to the money system: the biggest example of fraud that it is virtually impossible for us all to avoid. Galbraith pointed out that the gap between one financial collapse and the last is roughly equal to the length of time it takes those who suffered to forget about it. You can find it detailed in economics books, but who is daft enough to wade through those?

So, here is a brief quotation from Galbraith about how the last crash came about:

Speculation begins when a price is going up and the presumptively wise expect a further increase. They buy and thus produced the increase. More buy, and more and yet more are attracted. Each price increase affirms the good sense of those who have bought before. Those who doubt are reviled as creatures of defective imagination. The buying and the supporting mood continue until the available supply of mentally vulnerable, economically viable buyers is exhausted. Then come the changed views of the prospect, the rush to get out, the pressure now of creditors demanding repayment of the loans that financed purchase, thus forcing sale. In short, the crash.

Sound familiar? I wouldn't be taking on too much debt if I were you. If you own bricks and mortar it is still yours after the crash. But if you own debt it will not be very much use to you. Tweet

There's No Way Like the American Way

I spent a small but significant amount of time yesterday searching for a cost code to justify the spending of 60 pence. I mention this partly, I confess, to get the frustration and rage that caused me to scream in my office and cause consternation to my colleagues out of my system. But also to offer it as an example of how, in an era where the accountant is an unlikely king and accountability is espoused on all fronts, the petty is rigorously enforced whereas fraud on a grandiose scale is routinely ignored.

I am thinking, you will have guessed, of corporate fraud, of the type practised by Enron executives. Inflating the value of your stock by counting money you haven't received or even invoiced for yet. That particular techniques, known as counting 'unbilled receivables', was invented by the leading accountancy firm then called Arthur Anderson. Oil companies also engage in this creative accounting when, as Shell recently admitted it had done, they overestimate the value of their reserves, which, in oil companies terms, is the value of your company's assets and hence your stock.

It appears that the rule is, the more preposterous the fraud the more unlikely it is that we will notice. As Kierkegaard famously pointed out about Christianity, if you want to get a whole mass of believers you need to create a really big lie.

Which brings me to the money system: the biggest example of fraud that it is virtually impossible for us all to avoid. Galbraith pointed out that the gap between one financial collapse and the last is roughly equal to the length of time it takes those who suffered to forget about it. You can find it detailed in economics books, but who is daft enough to wade through those?

So, here is a brief quotation from Galbraith about how the last crash came about:

'Speculation begins when a price is going up and the presumptively wise expect a further increase. They buy and thus produce the inrease. More buy, and more and yet more are attracted. Each price increase affirms the good sense of those who have bought before. Those who doubt are reviled as creatures of defective imagination. The buying and the supporting mood continue until the available supply of mentally vulnerable, economically viable buyers is exhausted. Then come the changed views of the prospect, the rush to get out, the pressure now of creditors demanding repayment of the loans that financed purchase, thus forcing sale. In short, the crash.'

Sound familiar? I wouldn't be taking on too much debt if I were you. If you own bricks and mortar it is still yours after the crash. But if you own debt it will not be very much use to you. Tweet

Out of sight but not out of mind

Just as most economic activity is now negative rather than positive, so most of the economic value of the economy is debt rather than credit. The whole economic system is being extracted and replaced with debt.

The most obvious example of this is the takeover of major companies by 'private equity' firms, misnamed because they really have no equity but fund these takeovers from debt. If they can persuade the banks to lend them enough money they can, like Archimedes with his unfeasibly long lever, move the world.

Concern has been raised about the loss of accountability when firms move from public, quoted status to private status--and you thought accountability was poor amongst stock-market corporations! Once removed from any scrutiny who knows what may befall the employees and suppliers of these firms? Ruthless maximisation of profit behind closed doors is to be expected.

The most concerning aspect of the activity of private equity firms is the way they allow the expansion of debt and delay the need for adjustment in the world economy, which will consequently be even more painful when it does occur. This was exactly the process that preceded the 1929 Crash, as more and more wheezes were found to deal with the problem that there was no more debt to be had and the pyramid-selling scam had come to the end of the road. This explains the willingness of banks to lend vast sums to 'private-equity' chancers.

Since debt is the commodity banks trade in, the move towards debt-based capitalism can only lead to their owning an ever greater share of the economy. Most people aged under 40 belong to the bank, as a consequence of vast mortgage and student-loan related debt. Companies facing hard times are likely to find banks eager to swap their equity for debt, a way in which the bank can come to own something of real value (a functioning company) by creating something with no value (bank debt).

As the economy becomes hollowed out only those with a risk-averse attitude and a willingness to take on frightening levels of debt are able to thrive.

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House price boom: who benefits?

As with the public debt, private debts also enable those who lend money for interest to extract money from those who are forced to borrow it because they control an unfairly small amount of material wealth. The mania with ever-increasing house prices conceals the fact that, since most of this value will end up being paid for out of mortgage-based debt, it will increase costs for those buying homes in the future. Unto those who have shall be given, and from those who have not shall be taken even that little that they do have. This is the real message of the boom in house prices that is drowned out by the voices raised in celebration of the nominally inflated value of housing stock. If you have already bought your home then what you own is still a home, and unless you are prepared to trade down its financial value is of little interest to you. However, if you are either intending to buy or seeking to meet your need for housing through renting, the house price boom is a disaster.

It is the lenders who benefit from the increasing value of houses, since the increased level of loans allow them to create ever greater amounts of money and then to charge interest when they lend that money to struggling home-‘owners’. The banks incur no cost on creating this money but receive its full value as well as vast sums in interest, hence record bank profits. HSBC reported a 37% rise in pre-tax profit in 2004 to £9.6bn ($17.6bn) for 2004, the biggest ever profit for a UK bank. This followed on from Barclays profit of £4.6bn. (up 20%) for the same year, and that of the Royal Bank of Scotland, which was £7bn. (up 14%).

The focus on the house-price boom has also deflected attention from the most vulnerable in the housing ‘market’, those who rent their homes. For economists ‘rent’ is always a dirty word, since it means gaining value for nothing and in the case of housing the landlord always appears to be using his excess of assets to exploit another’s need for a home. But the rush by those on middle incomes to move their money from the unreliable stock-market and into property has made their situation much worse. The concept of a buy-to-let mortgage automatically implies that the mortgagee of an extra property will set the rent at a level high enough to cover his or her mortgage and other expenses, which means charging a higher rent than a genuine owner would need to. This, combined with the annihilation via government fiat of the public housing sector and the abolition of rent controls, has caused a massive increase in the cost of rented accommodation. Again the most vulnerable are paying for the increasing wealth of the rich.

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Bank money: source of debt and destruction

A bank charter is literally a licence to print money. Since the system of requiring a certain proportion of assets to be kept on reserve has gradually been eroded the only control on banks’ ability to produce money as credit is our willingness to borrow, hence the constant stream of junk mail and TV advertising offers of credit. When the banks lend us the money the debt is listed and the money sought and retrieved but at that point it belongs to the bank. They have used our willingness to borrow as an opportunity to create a debt; when we repay the debt the money they have taken from us belongs to them. No wonder we are seeing record bank profits: they are simply creating their profits out of our debts.

No surprise also that we see spiralling levels of personal, business and public debt. Neoclassical economists see no problem with this. On their planet, the creation of money in this way will be balanced out by a corresponding amount of economic growth. Apart from the obvious fact that money supply is growing far more rapidly than economic activity from a green perspective this growth itself is a problem. So the most important first step towards creating the steady state economy that will not put intolerable pressure on the carrying capacity of the planet is to change the system of money creation that generates the need for the growth.

The discussion so far has been in terms of a national currency, but currencies are also exchanged and used to pay for exchanges of goods and services between national economies. This role is now played primarily by the dollar, which has acquired the status of international reserve currency since the agreement establishing the financial structure to dominate global capitalism after World War II. Under the Bretton Woods Agreement, the USA also extracted the right to have its currency—the dollar—considered the equivalent in terms of economic weight of gold reserves. In the post-war exhaustion, low morale and financial desperation of the other world powers the USA pulled off this extraordinary confidence trick which has enabled their dominance for the past fifty years but left us all with a teetering economic system. The coda to the story is that the USA proved itself incapable of maintaining the value of the dollar and, in the face of the need for massive liquidity resulting from the costs of war in Vietnam, Nixon ‘closed the gold window’ on 15 August 1971. This meant that dollars were now themselves no longer linked to the reserves in Fort Knox but floating free, and foreign Central Banks could no longer exchange their dollars for gold.

Global capitalism relies on one country’s currency to provide credibility for the system as a whole. Initially this role was undertaken by gold itself, as a commodity of real value, but the movement towards fiat money which went hand in hand with the capitalist expansion, meant that currencies rather than gold played this role. The reserve currencies—sterling, the dollar, the yen, and the euro—are all used to underwrite economic activity, but just as in banking there is a central bank so in the currency system there is a central currency and this is the currency of the most powerful player in the global economy—the global hegemon.

It is mainly its own credibility and that of its economy and military structure that guarantees the functioning of the international economy, but it needs its own back-up in the form of gold reserves. During its days of empire the UK played the role of preferred currency. At that time US bankers supported the pound, a fact that alienated those outside the charmed circle who could not understand why US gold was being used to support a foreign competitive economy. Similar questions were raised when Chancellor Gordon Brown sold 415 tonnes of the UK’s 715 tonnes of gold reserves in May 1999, reducing the official reserve percentage held in gold from 16.7 to 7 per cent, and substituting currency, a mixture of dollars, euros, and yen. This is a record low level of gold holdings compared with the 2000-2500 tonnes held between 1958 and 1965, most of which were sold during Britain’s financial crises of the late 1960s and early 1970s.

The may seem like technical stuff, but the central point is simple. The nature of money creation via bank debt is undemocratic and unsustainable. Money should be created by ourselves, as citizens, to facilitate necessary economic exchange. Neither we, nor our governments, should be required to borrow it from banks. The debts this create cripple lives and are also fuelling unsustainable economic growth. Tweet

Thinking about money

Money is one of the most marginalised issues of our time. Most people never ask themselves or others questions about where money comes from, what it is, or who controls it. This is a shame, since money quite clearly lies plum at the centre of an economic system that is not called capitalism by coincidence. As David Korten said, ‘Capitalism is the use of money to make money for those who have money’.

This question has become even more pressing in the post-globalisation version of capitalism, where money no longer operates as a tool facilitating trade in products, but is used to make money directly by various confidence tricks in a system which is now commonly referred to as ‘the casino economy’. The creation of money by banks was originally intended to facilitate the exchange of goods. However, from the start a range of financial scams have been perpetrated which remove this need to get your hands dirty making things.

It is no coincidence that globalisation as represented by the vast expansion of trade in goods occurred simultaneously with the liberalisation of financial markets. Countries which had once attempted to maintain political control over finance through setting interest rates, controlling the activities of banks, and through credit and exchange controls were persuaded that further capitalist progress required the market to take on these functions. Money can now be used merely to generate more money for those who have it, leaving not production but finance to play the central role in the global economy: ‘Of the total international transactions of a trillion or so dollars each day, 95 per cent are purely financial.’

Money is useful for the obvious reason that it enables you to pay for a luxurious lifestyle, but more importantly to those who control capital, money gives them a claim over future production so that over time they are enabled to accumulate an unfair share of a community’s resources and power.

There are few subjects in modern life about which so many lies are told and so many misunderstandings encouraged, both politically and personally, than about money. It is, in fact, neither the root of all evil nor what makes the world go around. It is a neat but deceitful political tool that enables those with power under a capitalist system to exercise that power to generate an unfair advantage for themselves. This is why I am launching a strand of this blog to present the issues surrounding money in bite-size chunks.

Readers who have not delved into the inner workings of the financial system should be warned: you are in for an exhilarating but bumpy ride. You should not be surprised to find yourself thinking ‘I just can’t believe it’. I have frequently felt that way myself when embarking on a similar journey. The disbelief is similar to that experienced when watching a confidence trickster, but be assured that, just because the show is good and you have believed it for a long while, that does not mean that it is true. Tweet

Inequality is bad for your health

A recent report from the UN University shows that, on a global basis, the richest 2% of people in the world own half of the world’s wealth. Now only a little experience of economics tells you that the first thing you need to do on hearing a statistic like that is to ask exactly what they were measuring. It appears that in this case they were making a fairly sensible assessment. The measure of wealth is based on assets, always a more important indicator than income, and deducts from these what people owe as debts. So for most UK ‘home owners’ their apparent wealth would be considerably diminished before it was included in the measurement. The study is also wide-ranging, including all the countries of the world. The report, from the World Institute for Development Economics Research based at the UN University, finds that the poorer half of the world’s population own barely 1% of global wealth and that most of the wealth is concentrated, you won’t be surprised to learn, in North American, Europe, Japan and Australia. This is shown in the graphic.

The report gives an interesting perspective on inequality, showing that the concentration of wealth varies markedly between different societies as measured by the Gini coefficient.[1] Two high wealth economies, Japan and the United States, show very different patterns of wealth inequality, with Japan having a wealth Gini value of 0.55 and compared with that of around 0.8 for the USA. Wealth inequality for the world as a whole is higher still. The study estimates that the global wealth Gini coefficient for adults is 0.89. The same degree of inequality would be obtained if one person in a group of ten took 99% of the total pie and the other nine shared the remaining 1%.

The loss of concern with inequality has coincided with the abandonment by the major political parties of any attempt to oppose or even constrain the capitalist economic system which is its cause. Even parties which still call themselves ‘socialist’ will now argue that it is the overall size of the pie that counts, not how much of it you are able to get your hands on. The capitalist system requires inequality for its operation, so that any theorist who suggests that once there is enough money it can be shared with the poor is either a deceiver or has not understood the system. Capitalism operates like a pump, where the energy of those who have least pushes them upwards to become those who have most; inequality is the motor that drives this pump. It causes the capitalist machine to function to its maximum, but caught up in that machine are human lives and the costs of inequality on those lives is very great.

US researchers have found that inequality is bad for the life expectancy of all in a society, rich and poor alike. In a study which compared Gini coefficients for different US states with the life expectancy in the states they found a positive relationship. What surprised them was that the relationship persisted after they had controlled for poverty. So it isn’t being poor that makes you die sooner, but living in an unfair society.

It is a shame that the conclusions from such a substantial piece of work are so weak. While taking debt into account as a negative when measuring assets the authors none the less conclude that the solution to the problem is—more debt! Yes, Professor Anthony Shorrocks is quoted as saying that it draws attention to the importance of enhancing banking systems in developing countries to help generate the funds for business investment. And since banks generate these funds by imposing debts on those who really need assets this is hardly likely to improve the situation.

He also tells us that ‘The report is not about policy recommendations’, which makes me wonder why we invested so much of the UN budget in paying for the findings. Anybody know my favourite word? Could be pusillanimous.

To find out more visit the UNU website link:

http://www.wider.unu.edu/research/2006-2007/2006-2007-1/wider-wdhw-launch-5-12-2006/wider-wdhw-press-release-5-12-2006.htm

[1] The Gini coefficient is a measure wealth inequality where 0 corresponds to perfect equality (i.e. everyone has the same wealth) and 1 corresponds to perfect inequality (i.e. one person has all the wealth, while everyone else has zero).
http://en.wikipedia.org/wiki/Gini_coefficient

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