An Open Letter to The Chairman of the Bank of England (2012)

Mervyn King

From the August 2012 issue of the Socialist Standard

Dear Sir Mervyn

Having heard on the BBC news channel on the evening of the 29th June your condemnations and exhortations concerning the practices of your fellow-bankers I am taking the liberty of writing to you to register my surprise at your remarks. It is not my purpose to be offensive but I find it difficult to accept that a man of your knowledge and experience can view the current crisis of capitalism in moral terms or, indeed, as aberrational.

I am an eighty-seven year old man and a great-grandfather which gives me a particular concern for the future. I was born four years before the awful world economic slump of 1929 and I have lived through some eight or nine ‘recessions’ –as they are euphemistically referred to today. I have witnessed life under the system of capitalism when it was largely unregulated –capitalists had discovered earlier that they required some sort of Queensbury Rules to protect themselves from one another.

Post-1945, when government adopted the war-time National government’s commitment to the Beveridge Report, I experienced Maynard Keynes’ antidote to the caprice of the system, via ‘demand management’: the exchange of bonds for shares and –in recognition that working-class poverty was an endemic feature of capitalism – the institution of a complex scheme of nationalised poverty.

It would be churlish to deny that there was some improvement in social conditions for the producing class: improvement, it has to be said, greatly assisted by the need to make good the awful destruction of the late world war –while frenetically preparing for yet another possible war against our late ‘glorious Russian allies’ and their Leninist philosophy of trying (vainly, as it turned out) to rationalise commodity production through central state planning.

While knowledge was constrained by the cash nexus, science in all fields of human endeavour has brought about a geometrical increase in our potential to create the material conditions of a full and happy life for every human being on the planet. Unfortunately much of our fantastically expanded wisdom and wealth has been siphoned into military establishments which are today a vital indigenous segment of the world economy; a segment which often manifests an independent and dangerous threat to human freedom.

The world of my lifetime has seen the economic murder of some eight billion people through starvation, lack of clean water and necessary medication. The food and medication to keep these people alive was available but the men, women and children concerned did not represent a viable market that would yield profit. They died because they were poor.

In the same period I have seen World War Two –the awful sequel to World War One –that brought homes onto battlefields. Now, since the end of WW2, there is at least one major conflict occurring every single day. In fact, the industrialised killing of human beings that arises from the endemic conflicts of capitalism has itself created investment opportunities effectively making international concord a serious economic threat.

Rich list
It is surely legitimate, Sir Mervyn, to ask such as your good self how you think people in what we hope will be a more enlightened future will see the current phase of what we are told is civilisation. How, for example, would a future economic historian see the current Sunday Times ‘Rich List’ which shows that the wealth of the one thousand richest people in the UK –a mere 0.003% of the adult population –increased by an incredible £155 billion over the last three years? This in a period when wages and social security benefits were, and are, being slashed and the vision and disagreements of the three political parties, marketing the same political product, is confined to the duration, in years, the working class will have to endure the appalling increase in its miseries.

Moral aphorisms appealing to those who have purloined the means whereby the rest of us live have never restrained the appetites of an owning class. It is said that Jesus got his comeuppance for suggesting the meek –by definition, the poor –should inherit the land. Centuries later, in the dying years of the nineteenth century, when Pope Leo mildly admonished the capitalism of his day, opining that “…the wages of the working man ought not be insufficient to support a frugal and well-conducted wage-earner…” (Encyclical: Rerum Novarum, May 1891) public criticism was raised by Italian businessmen who suggested that the promulgation of the document might cause social unrest.

Poverty and riches are two sides of the same coin –almost literally so, for as Shelley put it, “Paper coin, [is] that forgery of the title deeds which we hold to something of the worth of the inheritance of earth”. You cannot be ignorant of the mechanism by which a small minority class dispossesses the creators of all real wealth of the fruits of their labour and rations their access to their needs through a wages-money system.

Whatever the form of society, real wealth is produced, and can only be produced, by the application of human labour power to nature-given materials. Capitalism adds a third element to this simple equation: investment on foot of the promise of profit. The shareholder, whether s/he is a billionaire or a plumber in a pension scheme, seeks a return on their investment and is rarely persuaded by the needs of ‘the nation’ or their perception of morality. Only the threat in the aforesaid ‘Queensberry Rules’ of the system curbs the pecuniary enthusiasm of the more predatory captains of capital and that, as we are currently learning, is not always the case.

Capital on strike
The labour power that provided the fervid productive activity of, say six years ago, when the system was in relative ‘boom’, is still available as are the natural resources of that period. The missing element is capital; effectively, capital is on strike, holding the nation up to ransom as the pensioned editors of their newspapers proclaim when some group of low-paid workers withdraws their labour. Surely the fact that a small minority of satiated money shufflers can visit such overwhelming hardship on the populace in general (as it does periodically) must bring the entire system into question.

Whatever of the past, when the owner of the local factory lived in the big house on the periphery of the town or village and occasionally visited the local hostelry and even bought the lads a pint, capitalism today is a curse on the lives of the world’s billions. Technology has given it a mobility to seek the cheapest labour, circumvent health and safety standards that might impinge on profits or capital on-costs and to force the hand of allegedly democratic authority.

The implications in the current crop of chastisements against bankers and those of their ilk is that capitalism is an efficient, humane economic system that offers the human family the best of all possible worlds except when, as now, it falls victim to the ineptitude or greed of some of its functionaries. That is a lie told in defence of the system. Of course there has been abuse, and even absurdity, in the administration of banks and businesses but it was the uncontrollable greed that fuels the system that gave rise to the activities of bankers and speculators. Nor should we forget that it was the approbation of millionaire and billionaire shareholders that justified the fabulous salaries and bonuses so lately enjoyed by now-discredited servants of capital.

The widespread clarion for a public enquiry might expose some of the greedy swindlers whose dishonest activities have added misery to capitalism’s cyclic trade crisis as well as the self-interested manoeuvrings of politicians in all the three main parties. For a while these scoundrels might suffer in comfort the embarrassment of being publicly pilloried. But the system itself, the vile, anachronistic system that brings dire poverty or mere want to most of the people on the planet, will be off the hook.

What we will not have is an incisive enquiry into the question of capitalism’s suitability for purpose and whether socialism, in a clearly defined sense, offers a better way of life for the whole of humanity. That would be much too democratic.

Such are my thoughts. I confess, Sir Mervyn, that I am a ridiculous optimist who thinks human concern and human honesty might occasionally rise superior to the exigencies of office. Additionally, of course, in submitting this to the Editors of the Socialist Standard, I would stipulate that publication guarantees your right of reply.

Sincerely

Richard Montague

Intervention USA (1989)

From the April 1989 issue of the Socialist Standard

In these days of the enterprise culture, government involvement in industry, commerce, banking and other economic activities is not the flavour of the month. Market forces are in and intervention, or so we are told, is out.

Indeed it would appear that this is true, for all over the world, in Britain, France, Australia and elsewhere, governments have been getting rid of much of what is called “the public sector”. In fact nationalisation, the main form of government involvement in a nation’s economic activity and once seen as a device which would solve all of capitalism’s economic and social problems, is more or less a dead duck.

So obvious is this even to politicians of “the left” that the Labour Party here doesn’t intend to re-nationalise all the Tory sell-offs of the last decade, while in the so-called communist countries private enterprise is being encouraged to compete with ailing state enterprise.

From deregulation…

However, even in such times as these, governments still have to step in and intervene when they think that the interest of the national capitalist class is in danger. For example, in the United States, the very heartland of non-intervention, there has been the growing problem of the Savings and Loans banks. These S and Ls are the rough equivalent of Britain’s building societies and hundreds of them have gone bust while hundreds more are insolvent. Their losses were $6.8 billion in 1987 and $3.8 billion in the first quarter of 1988, although depositors are covered by a government insurance agency.

How did this happen? Just as nationalisation was once seen as the great cure-all, nowadays it is “deregulation” which fills the bill. This means that enterprises in an industry no longer have to conform to laid-down government regulations but are freer to operate as they see fit. This, it is claimed, will produce a capitalism without its attendant problems, will provide greater all-round prosperity, and so on.

Thus the S and Ls were allowed by the Carter administration in 1980 to borrow, not only from small investors for re-lending as mortgages as previously, but from the money markets at ever higher rates of interest. This laid them wide open to trouble, which duly arrived when the Reagan administration further deregulated by allowing the now exposed S and Ls to move into high-risk lending for big property deals and other get-rich-quick schemes of which they had no experience. The result was the spate of bankruptcies and insolvencies already mentioned.

… to regulation

At present the insolvent S and Ls keep afloat by continuing to borrow at high interest rates and their debts are estimated to be increasing by $35 million a day. Sooner or later the government will have to foot the ever-mounting bill. The implications of this are serious for American capitalism. How can it ever tackle its massive budget deficit of $150 billion while it throws away billions at this rate? More seriously, many American banks have collapsed in recent years (almost 200 in 1987 alone) and the additional collapse of hundreds more S and Ls could trigger a disastrous loss of public confidence in the entire American banking system. The Administration have therefore intervened to try to stop the rot.

Bush and his financial advisers have come up with a plan calling for a one hundred billion dollar issue of new bonds to bail out the S and Ls. The interest on the bonds is to be paid to the government by the S and Ls and the other banks though higher premiums for Federal insurance of all bank deposits. Critics of the plan say it breaks Bush’s election promise of “no new taxes” as “the taxpayer”, in the form of the banks’ customers, will have the extra premium passed onto them through higher bank charges. But this will not necessarily happen because the customers may refuse to pay up, in which case the banks and S and Ls will have to bear the extra cost themselves.

This rescue package also calls for a leaner and fitter S and L industry to be taken over and run by another government agency, the Federal Deposit Insurance Corporation, and amounts to back-door nationalisation. So whatever their ideological preferences any government will make use of intervention, even despised nationalisation, when it suits “the national interest”.

All of this reinforces the Socialist Party’s view that whether government use less intervention or more, they are helpless in avoiding capitalism’s pitfalls.

Vic Vanni

HBOS: the Horse That Bolted (2016)

From the January 2016 issue of the Socialist Standard

In 2001 the former Halifax building society which had turned itself into a bank merged with the Bank of Scotland to form HBOS. In October 2008 HBOS failed and was merged with Lloyds Bank in which the government took a major share. The Bank of England and the new Financial Conduct Authority have now issued a 400-page report on The Failure of HBOS PLC (HBOS).

The Report says that HBOS made some unwise lending decisions, investing disproportionally in commercial property and stakes in businesses (hindsight is such a benefit). Even currency cranks who think that banks have the power to conjure up the money they lend out of thin air concede that a bank can get into trouble by making bad loans. What they cannot accept is that a bank can also fail through not being able to secure the funding behind its loans. Some currency cranks (those who think that for a deposit of £100 a bank can lend many times that amount) accept, it is true, that if deposits fall a bank has to cut its lending, but not that every loan has to be funded. The Report, however, takes it for granted that this has to be the case. In his Foreword Andrew Bailey, one of the Bank of England’s Deputy Governors, says that the Report is

‘the story of an institution that became unsustainable through its poor risk management, in respect of the credit risk on the assets side of its balance sheet, and on the liabilities side in respect of the vulnerability of its funding. These are, of course, the fundamental building blocks of banking’ (emphasis added).

Those running a bank have to ensure both that the loans they make will be repaid and that the source of funding for these is secure. As essentially financial intermediaries, banks get their income from borrowing money at one rate of interest and re-lending it at a higher rate.

Accessing ‘wholesale financial markets’

After the merger, the Report says, HB0S pursued a policy of rapid growth, aiming to make a return on its capital of 20 percent. This involved increasing its lending but to do this it had also to increase its funding. Banks have two main sources of funding: what is deposited with them (in the jargon ‘retail’ borrowing) and the money market (‘wholesale’ borrowing). Deposits from customers are considered safer but they cannot be increased at will, if only because of competition for them from other banks and from building societies. It is easier to have recourse to the money market, i.e. borrowing from other banks and financial institutions. This is considered more risky because the interest rate is less predictable – if this goes up it squeezes the margin between the rate a bank borrows at and the rate at which it re-lends – and in a financial crisis can dry up.

To try to grow more in pursuit of greater profits, HBOS had increasing recourse to the money market:

‘The rapid expansion of its balance sheet placed pressure on HBOS’s ability to fund itself. HBOS’s retail funding struggled to keep pace with the Group’s lending growth, with customer deposits growing at an average annual rate of 5% a year during the Review Period, compared with a customer loan growth rate of 10%. As a result, HBOS increasingly accessed wholesale financial markets as a source of funding, raising its wholesale borrowing from £187 billion at the end of 2004 to £282 billion at end-2007.’

Bankers and their regulators use as a measure of a bank’s dependence on the money market the ‘loan-to-deposit ratio’ (which some currency cranks misunderstand as a measure of how much a bank can lend without having to cover it with funding, whereas it is actually a measure of what proportion of loans are covered by ‘wholesale financial markets’ over and above what is covered by customer deposits). The Report says that by 2008 HBOS’s loan-to-deposit ratio had reached 192 percent; in other words, it was lending nearly twice as much as its deposits, the rest coming from ‘wholesale financial markets’. This, the Report notes, was second only to that of Northern Rock.

When the financial crash came and the money market froze HBOS, like Northern Rock, couldn’t renew its borrowing from it except at impossibly high rates and so couldn’t renew the coverage for all its loans, with the result, the Report records, that:

‘By the end of September 2008, HBOS was no longer able to meet its needs from the wholesale market and was facing a withdrawal of customer deposits.’

Yet another example of how the Report, written by practical bankers, takes for granted that a bank ‘needs’ to have funding for its loans. No nonsense here about a bank being able to conjure money to lend out of thin air since, of course, if it could, why would it need to go the money market to try to get funding? On 1 October HBOS was bailed out by the Bank of England.

The new paradigm that wasn’t

The top management of HBOS may well have taken more risks than most of its rivals but at the time they were acting as profit-seeking, capitalist enterprises always do in a boom – assuming that it will continue. In his Foreword Bank of England Deputy Governor Andrew Bailey writes that ‘both the strategy and operation of HBOS, and its supervision by the FSA, were creatures of the time’ and that what happened took place ‘against the backdrop of almost uninterrupted growth over a long period and the rapid development of financial markets’. The Report elaborates:

‘Halifax and Bank of Scotland merged during a period of heightened corporate activity, in the middle of an economic cycle that had begun in the early 1990s. UK domestic economic growth had been relatively steady since the recession of the early 1990s, resulting in an extraordinarily long period (around 60 quarters) of continuous expansion. The growth in the financial services sector was more than twice as fast as the economy as a whole, averaging 6% per annum in the decade preceding the crisis, and increasing its share of nominal gross domestic product (GDP) to around 10%. Confidence in the future prospects of the economy was reflected in both bank and non-bank equity prices, which rose steadily from the start of 2003 until 2007. As the benign conditions persisted for longer and longer, many perceived that a new paradigm of economic stability had been established. ‘

One of the many who ‘perceived’ this, in fact shouted it from the rooftops, was of course Gordon Brown who, as Chancellor, proclaimed the end of the boom/slump cycle. He even recommended HBOS’s chief executive, James Crosbie, for a knighthood. When the crash finally came, and exposed him as a latter-day King Canute who imagined that he could command how the capitalist economy worked, he had become Prime Minister.

Andrew Bailey writes that ‘the criticism in the Report is not that management failed to predict that there would be a global financial crisis’ but in effect that’s it what it is. How else does he expect a commercial bank, which is a profit-seeking capitalist enterprise like any other, engaged in a particular business activity, to have acted in conditions that were ‘benign’ for profit-making?  To have held back and let its competitors gather more of the hay while the sun shone? He must have more experience of how capitalism works than to be that naïve. HBOS did not become ‘unsustainable through its poor risk management’ but because the boom ended. If the boom hadn’t ended HBOS would have survived and no doubt more knighthoods would have been handed out.

The story of the rise and fall of HBOS is a particular case of how all capitalist firms behave when faced with profit-making prospects they ‘perceive’ are going to continue. They go for it but have to face the consequences when, as a result of the collective activity of all the competing firms involved, these conditions come to an end due to overproduction (or, in case of banks, over-lending). It’s happened many times before under capitalism and is a regular feature of the system. It will happen again, even in the field of banking despite the regulations now being put in place after the horse has bolted.

Adam Buick

Is capitalism crumbling? (2009)

From the March 2009 issue of the Socialist Standard

Leftwingers are calling for the nationalisation of the banks. They may get their way. And then?

The severe economic crisis has dominated newspaper headlines – day after day for at least the past six months – like no other story in recent history. The massive layoffs, losses and bankruptcies have grown as familiar as the daily death-count in Iraq and Afghanistan. The ranks of the unemployed are overflowing and no job seems secure.

Not only is the situation spinning out of control, but workers are being reminded how little control they have over their lives. Their own futures are in the hands of business leaders and politicians, who themselves can do nothing more than follow the inhuman impulses of capital.

One bright spot, however, is the market for solution-peddlers and doom-prophesiers, which is booming. On the one hand, there are the experts claiming to know the secret for getting capitalism back on its feet and curing the system of its manic-depressive tendencies; while on the other hand, there is the minority that views the crisis as the beginning of the final collapse of capitalism.

The pages of this magazine, in contrast to that commotion, might seem calm, or even complacent. As in the quieter days before the crisis, we continue to advocate socialism in much the same tone and with the same arguments. Some readers might be wondering how this crisis affects socialists and how we are responding to it. How do we differ from those offering to solve the crisis or from those who say we are witnessing the end of capitalism?

Reformist solutions

As workers, socialists do not necessarily relish an economic crisis, as we face unemployment or wage cuts like everyone else. Being a socialist does not equip a person with a protective force-field to block the harmful consequences of capitalism. There’s no question that the working class, including socialists, will suffer the most from this crisis.

It is in this atmosphere of anxiety that reformists of all kinds step up to offer sure-fire ways to relieve capitalism of its hangover and keep it sober forever more. Most on the Left remain confident that greater intervention and regulation on the part of the state will pretty much do the trick, pointing to how well it apparently worked back in the 1930s. That is certainly debatable, but these ideas will probably be tested by reality soon enough. Even if such measures are more or less effective, the crisis still may drag on for several years – although no one is really in a position to make clear predictions.

The clear aim of reformists is to get capitalism back on its feet again, yet many on the Left like to spice up their own Keynesian reformism with revolutionary rhetoric. They are able to get away with this thanks to the widespread misconception that any involvement by the state in the economy is “socialistic.”

The more imaginative reformists have viewed bank nationalization, for instance, as an integral part of measures to both overcome the crisis and put in place a new system of socialist production – rather than being a temporary measure to prop up the crumbling financial system. Their brand of “socialism” may be very attractive as it offers something for everyone, but they are in fact peddling a form of state capitalism under a false label.

Take the Socialist Equality Party in the US, for instance, which back in September, at the time of the collapse of Lehman Brothers, confidently issued the following demand as part of a “socialist program”:

“The entire financial system must be taken out of private hands and nationalized in the form of a public utility under the democratic control of the working class, with provisions taken to safeguard the holdings of small depositors and share-holders. It must be subordinated to the social needs of the people and dedicated to developing and expanding the productive forces in order to eliminate poverty and unemployment and vastly improve the living standards and cultural level of the entire population.” (“The Wall Street Crisis and the Failure of American Capitalism”)

The author, Barry Grey, presents this demand as one part of a “socialist program that places the needs of the people before the profits and personal fortunes of the ruling elite,” necessary because “there is no solution within the framework of the profit system” to the “crisis of the American economic and political system.” So we can only suppose his nationalized financial system is operating in a “socialist” society (or a society that follows a “socialist program”).

But with socialism like this, who needs capitalism! There will still be a financial system, so one would have to assume that goods are paid for with money and thus produced for the market. There would be no need for any of that in a society where things are produced to directly meet people’s needs, as democratically determined by them. It may sound nice to say that the financial system will take the “form of a public utility under the democratic control of the working class” and be “subordinated to the social needs of the people”, but what would that mean in practice? (Even that “socialist program” sounds a bit dodgy, with its promise to “place the needs of the people before the profits and personal fortunes of the ruling elite,” as it assumes the continued existence of a wealthy ruling elite.)

Perhaps we should compliment the Socialist Equality Party for being “ahead of the curve” on this nationalization issue, as any good “vanguard party” should be, now that many capitalist governments are thinking about implementing that measure. And we might compliment them further if bank nationalization succeeds in stabilizing the financial system. But this organization and so many like it deserve our contempt for dressing up reformist measures to look revolutionary. Their sweet-sounding promises only block the path to revolution by utterly distorting the meaning of socialism.

A collapsing theory

On the other extreme from the reformists, or at least it would seem, are those who argue the final collapse of capitalism has begun and that efforts to prop up the system are doomed to fail.

The reasons given for this inevitable collapse vary quite a bit, however. Some argue, as many Marxists did back in the 1930s, that it is the result of capitalism’s internal contradictions, such as the tendency towards a declining rate of profit. But many more, including the adherents of peak oil theory, view the collapse as the result of capitalism colliding with some outside force that prevents the further accumulation and expansion that is the lifeblood of the system. 

Not only are there a myriad of reasons offered to explain the inevitable collapse, but there are starkly different conclusions reached about what will replace capitalism. There are those who see the collapse as radicalising the population and bringing workers around to a revolutionary standpoint; while others depict a prolonged period of social anarchy or even a return to a pre-industrial life, and advise people to head to the hills after stocking up on gold, guns and vegetable seeds.

Regardless of those particular differences, however, the idea of an inevitable collapse of capitalism clearly implies that a great historical change could take place regardless of our actions. Instead of socialism replacing capitalism, based on the conscious decisions and actions of workers, we would have capitalism ending at some point, and that collapse then stimulating a great social change – for better or worse.

One might wonder, though, what sort of society would exist in the interim, however brief it might be, between the collapse of the old and the emergence of the new. It would be “non-capitalist,” one would assume, but what would be the dividing line between the two? Is it possible for a society to not be capitalist, but still not be anything else either?

The reason for much of the confusion among the “catastrophists,” as they are sometimes called, is that – just like the reformists who confuse nationalization with socialism – they do not have a clear understanding of what capitalism is, exactly. That is to say, instead of understanding capitalism on the most essential level, as a system of commodity production in the pursuit of profit, they get caught up in the various forms of capitalism, and imagine that some are more capitalistic than others.

It is certainly true that forms of capitalism or particular governments can collapse, but this should not be viewed as the collapse of capitalism itself. There are many examples of collapses to choose from, most notably the fall of the Weimer government in Germany that was followed by a fascist regime. For over a decade, Germany went through economic crisis, political upheaval, and a catastrophic war. With no exaggeration, one can speak of that period as a collapse of civilization. Yet throughout it all the capitalist system remained intact.

It is easier to speak of the “collapse of capitalism” if a person has no clear idea of what capitalism means. And if its meaning is unclear, then the understanding of socialism will also be a muddle (just like those reformists who mistake state capitalism for socialism). It is important, therefore, to distinguish between an economic or political collapse, and the end of capitalism itself, which only workers can bring about by replacing it with socialism.

Optimism in depression

The criticism of those two tendencies might lead some to believe that we offer no solution to the crisis, or that we ignore the objective factors of reality and overemphasize the subjective ones.

We do in fact have a solution to this crisis and to economic crisis in general. But our approach to the problem is similar to how we approach other problems, such as the destruction of the environment or war, in that we do not propose a separate solution for each problem. This isn’t because we are indifferent to the problems, but because we recognize the relation between individual problems and the capitalist system.

In a sense, to solve one problem requires the solution of all of them. The fundamental solution to the problem of crisis, for instance, requires the introduction of a new system of production and consumption no longer mediated by the market, where there would no longer be any basis for crises. In other words, socialism is the solution to this particular crisis and the problem of crisis itself, along with every other social problem that is specific to capitalism.

As for objective versus subjective elements, we would certainly recognize that the objective reality of the crisis will have an impact on how people view capitalism. This new situation may create a more favourable environment for explaining socialism.

Already, in the past six months, there has been a tremendous shift in “public opinion”, so that now it is almost fashionable to rebuke bankers for their greed and ignorance. There is no question that more people than ever are wondering whether capitalism is indeed the best of all possible worlds.

Of course, even while the changing reality has stimulated thought and debate, the conclusions people are reaching vary. Many see the crisis as the bankruptcy of “neo-liberalism”, rather than capitalism itself, while the religious minded might even say it is punishment from God. No matter how much the objective reality may influence ideas and test theories, it will not directly deposit the concept of socialism in a person’s mind.

So we still have the task of explaining socialism, and it is more important than ever as workers suffer under the crisis. That explanation, as always, is based on the recognition of the fundamental contradictions and limitations of capitalism, and the realization that this (obsolete) system cannot be reformed beyond a certain point. It is during a crisis that those contradictions and limitations are most evident. Marx describes how the “contradictions and antagonisms of bourgeois production are strikingly revealed” during a crisis of the world market, which is a moment when there is a “real concentration and forcible adjustment” of those contradictions (Theories of Surplus Value).

With the problems so plain to see, and the limitations of capitalism so palpable, the explanation of socialism as the solution may very well begin to seem more concrete and practical – and urgent – than before.

Michael Schauerte

Le Capital (2013)

Film Review from the October 2013 issue of the Socialist Standard

Le Capital (dir. Costa-Gavras)

Le Capital is a European financial thriller made in France by Greek director Costa-Gavras that had its première at the Toronto Film Festival in 2012, was nominated for the 2012 Special Jury Prize at the San Sebastian International Film Festival but to date has not been released in Britain. Costa-Gavras is notable for his Academy Award winning film Z (1969), Missing (1982) which won the Palme d'Or at Cannes and Music Box (1989) winner of the Golden Bear at Berlin.

Costa-Gavras based his film on the 2004 novel Le Capital by French banker Stephane Osmont but was also inspired by the book Totalitarian Capitalism by Jean Peyrelvade. The film stars Moroccan actor Gad Elmaleh and also Gabriel Byrne, the Irish actor memorable in the 1995 noir film The Usual Suspects.

Le Capital is a fast-paced film set in the closed world of investment banking full of cunning boardroom politics, billion-dollar banking takeovers, supermodels, corporate suits in jets globe-trotting from Paris to London, New York, Tokyo and Miami. The main protagonist played with a reptilian self-awareness by Elmaleh occasionally breaks the fourth wall and gives 'Brechtian' asides to the audience. Elmaleh has the best lines such as 'money makes people respect you, money is the master, money never sleeps'.

The film is dominated by memories of the global financial capitalist meltdown of 2008 caused by overproduction in the housing sub-prime market, deregulation of commercial bank securities such as the repeal of the Glass-Steagall Act, and the use of collateralized debt obligations (CDOs) and other derivatives described as 'financial weapons of mass destruction' by Warren Buffett. The crisis was such that Ben Bernanke, head of the US Federal Reserve, feared the end of capitalism and said of the $700 billion emergency bailout of banks: 'if we don't do this, we may not have an economy on Monday'. According to Roger C Altman in The Great Crash 2008 losses totalled $8.3 trillion.

Costa-Gavras makes reference to the 'cowboy capitalism' of a 'brutal hedge fund' who are 'preachers of instant profit'. Elmaleh delivers lines such as 'I am a modern Robin Hood who takes from the poor to give to the rich'. There is also a possible allusion to Dominique Strauss-Kahn, head of the IMF who in May 2011was subject to allegations of sexual assault. The working class represented by one character accuses the bankers: 'You are bleeding the world thrice, the markets want blood, you fuck people with lay-offs, you fuck them with loans and debt, money rots everything'. A female English banker with a 'conscience' delivers an indictment near the end of the film: 'Banks in the claws of predatory stockholders, the dictatorship of the markets, speculation, the rating agencies that run the economy for politicos that threaten society, democratic states that can no longer govern or get rid of banks who stifle them'.

Costa-Gavras concludes in Le Capital that the bankers 'have fun and will go on having fun until everything is blown up in pieces'.

Steve Clayton

The Whole of Capitalism is Unacceptable (2012)

Editorial from the March 2012 issue of the Socialist Standard

Following the 2010 General Election, the new government published the Conservative- Liberal Democrat Coalition Agreement. In this initial policy document were proposals to reform banking, which stated: “We will bring forward detailed proposals for robust action to tackle unacceptable bonuses in the financial services sector...” But what is an “unacceptable bonus”?

Should RBS bank boss Stephen Hester have been forced into waiving all his bonus, worth almost a million pounds? Is it okay that Barclays Bank Chief Executive Bob Diamond is getting a bonus estimated to be around £2million: or should it be less? The total amount of bonuses to be shared out around the City for the 2011-2012 period is £4.2 billion – that’s £2.5bn less than in 2010-2011 but peanuts compared with profits that capitalist firms rake in. Is that still too much? What should the amount be?

When it comes to answering questions like these, to paraphrase Rhett Butler, frankly, any socialist or right-thinking person won’t give a damn. Not about the greed and gross inequality, but about trying to come up with palatable reforms.

How much bankers get paid compared to teachers, nurses or refuse collectors is a distraction from the real problem, which is that a tiny minority have a right to own vital natural resources and industrial assets that provide the majority with all of the products and services that make life possible and acceptable and only allow those resources to be used if there is a profit in it for them.

Politicians encourage people into wanting, believing or hoping that capitalism can actually be made fair, when it can’t. For this deception they employ a we’re-all-in-this-together rhetoric and insincere calls for “responsible capitalism”, “performance-linked pay”, “value for money for taxpayers” and “rewards for success, not failure”. Reactionary newspapers and broadcasters play their part in spreading and reinforcing this futile reformism with their sole focus on capitalistic so-called ‘solutions’. And to be seen on the side of the austerity-penalised majority during an economic crisis, populist exercises are undertaken, like taking away an ex-banker’s knighthood or pressurising a few out-of-favour executives into trousering less money than usual (which can always be got back when the heat’s off).

If most voters just want to see the pay and bonuses of bankers cut back because their greed helped crash the economy, or because they don’t deserve the sizeable amounts they get, or because there’s such a thing as a fair profit, then there’s never going to any meaningful and lasting progress made. While capitalism carries on, there’ll always be widespread inequality in incomes and living standards because capitalism is irreversibly a system that exploits the many to benefit a few. Always has been. Always will be.

The alternative – a classless, moneyless socialist society – is actually very easy to achieve and maintain. A clear majority just knowing what it is and wanting it can bring it about. And as a much more efficient, unwasteful and uncomplicated system, compared to the present one, keeping it going certainly isn’t going to be a problem (not something that can now be said about outdated, failing capitalism).

Seeking to reform the bonus culture will achieve nothing because capitalism can never be made nice. It only thrives on inequality, ruthlessness and selfishness. Only completely replacing capitalism with real socialism will permanently end the disgusting inequality and greed seen in the present class-divided society.

Banking Reform: is it relevant? (2011)

From the October 2011 issue of the Socialist Standard

Banking reforms are never going to stop capitalist crises.

Last month the Independent Commission on Banking, chaired by Sir John Vickers, published its final report. As expected, it recommended that banks should separate their ordinary High Street activities from their more risky (and more profitable) investment banking (their dealings in derivatives, securitised loans, etc). The aim is to avoid a future bail-out of the whole of a bank in the event of another banking crisis like that of 2007-8. If this happened again a bank’s investment arm would be allowed to sink or swim while the proposed requirement for extra capital reserves for the High Street arm should be enough to allow it to weather the storm.

The banks are up in arms and have been lobbying strongly against any such reform because it will hit profits for their shareholders, first, by tying up more of their capital and accumulated profits in reserves and second, by constraining their investment banking activities, since without the prospect of an eventual government bail-out they will become more risky and so more costly to fund. It remains to be seen how successful this lobbying will be, but the government has said it will accept the Commission’s recommendations and implement them sooner or later, if later rather than sooner.

Should we as workers care either way? In a word, no. This is an internal problem for the capitalist class, a fight between two of its factions. The non-banking faction is annoyed at having to pay for what it regards as the irresponsible activity of the banks which contributed to making the 2007-8 crisis worse than it would otherwise have been. They don’t want to be put in this position again and have been exploiting people’s dislike of banks to gain their support for moves towards more bank regulation.

People don’t like banks because they perceive them as parasitic on real activity. Indeed they are, but they are still essential to capitalism. Whereas, the role of industry is to profit by investing money in production, the role of banks is to lend industry that money and, in return, receive a share of its profit in the form of interest. Since profit is derived from the unpaid labour of those who work, banks are parasites on parasites.

But don’t banks lend to individual workers as well as to businesses? Yes, they lend workers money to buy a house or a car or some other big expenditure which couldn’t be paid out of monthly wages or salaries. Banks naturally charge interest on these loans but calculate that in time they will get both the interest and the loan back out of the future wages of the borrower. So, to this extent, worker-borrowers are affected by the level of interest rates.

Does this mean that low interest rates could be said to be in the interests of the working class? It’s not as simple as that because other workers are savers and prefer high interest rates. Some populist demagogues (such as reform-dangling Trotskyists) propose low interest rates for borrowers and high interest rates for savers. At the time of the Northern Rock crisis Militant said that they had “always demanded nationalisation, but on the basis of safeguarding all jobs as well as giving favourable deals to ordinary depositors and mortgage holders” (The Socialist, 19 February 2008.) But it’s not possible to pay depositors a higher interest rate than that offered to borrowers, as banks (and building societies) get their principal income from the difference between the rate they pay depositors and the rate they charge borrowers.

In any event, this is an academic issue since interest rates are not fixed to benefit workers and there is nothing workers can do to influence them.

How banks work
The Report does provide an insight into how banks work. There’s no nonsense here about banks being able to make loans out of thin air by a mere keyboard stroke. Banks are recognised as “financial intermediaries” whose role is to “bring together savers and borrowers”. Banks of course do other things as well (such as deal in derivatives and securities, and underwrite share issues). The Report proposes to “ring-fence” a bank’s “core economic function of intermediating between depositors and loans” from these other activities. It proposes that only what it calls “ring-fenced banks” (which will include building societies) should be able to take deposits from and provide overdrafts to individuals and small and medium-sized businesses (fewer than 250 employees). If they choose, they will also be able to accept deposits from bigger but non-financial businesses and make loans to them. Non-ring-fenced banks will not be able to take deposits from or make loans to individuals or small businesses, but they will be able to do everything else they have been doing until now.

The clear assumption throughout the Report is that a bank’s loans are financed out of its deposits. Ring-fenced banks will, however, be able to borrow money from the money market in a limited way to cover a short-term need to make payments. Here, the Report makes a reference to the famous (or notorious) cash reserve which banks have to keep to deal with withdrawals, and which forms the basis of so-called “fractional reserve banking”. The reserve is not very high now (about 2-3 percent) and doesn’t all have to be kept in cash; part may be held as very liquid assets (i.e. assets that can be converted more or less instantly into cash). “Within a bank”, says the Report, “the treasury function maintains an appropriately sized pool of liquid assets so that it can be confident of meeting its obligations to pay out depositors and other creditors”. The rest of what is deposited with the bank it can lend out (if it can find enough suitable borrowers).

This aspect of banking (which applies equally to building societies, credit unions and savings clubs) has given rise to all sorts of misunderstandings and confusions. Some even believe it to mean that when a bank receives a cash deposit it can immediately make a loan of many times the amount. As stated, the Report doesn’t give any credence to this sort of nonsense. It simply takes it for granted that banks make loans out of deposits.

The Report does propose a new capital ratio requirement. This is the ratio of a bank’s own capital to its assets (loans) and is not the same as the cash reserve requirement. The Report suggests that this should be “at least 10 percent of risk-weighted assets”. This would not normally restrict the amount a bank can lend, nor is it intended to. The money to build up its capital to the required level would not come from depositors but from the bank’s profits or from a share issue. Similarly, a ratio in excess of 10 percent would not mean that the bank would lend more. The Report sees this as increasing a bank’s “loss-absorbing capacity, and is trying to ensure that banks have enough capital and accumulated profit to sustain a potential big loss.

The Report does not go the whole hog and propose a complete separation of “ring-fenced banks,” as was done in America from the 1930s till 1991. Lloyds, HSBC, Barclays, etc can continue to exist as universal banks, but they will have to take legal steps to “ring-fence” their lending and deposit-taking to and from individuals and small businesses, and so separate them from their investment activities. No doubt the banks are already thinking up ways to get round this and, when the present crisis is history, to launch a campaign for de-regulation.

One thing that the banking reform will not do is to stop another economic and financial crisis, as some politicians are suggesting. We hold no brief for the banks but they did not cause the present slump. This was caused by capitalism’s tendency to overproduce for particular markets in a boom, not by monetary policy or institutional arrangements, even if they were an exacerbating factor. So, no banking reform is not going to eliminate the boom/slump cycle that is built-in to capitalism.

Adam Buick

Ireland’s recession (2010)

From the December 2010 issue of the Socialist Standard
The only flourishing industry in Ireland now seems to be economic punditry.
A fellow socialist recently sent me an economic article critiquing the contrasting financial approaches of the various governments in Europe to the current crisis. It wasn’t the first article that I’ve read on this subject! Ever since the storm broke in autumn 2008, the media in Ireland has filled the airwaves/newspaper pages with an endless procession of economists commenting on various aspects of Ireland’s severe economic situation and either second guessing the government’s decisions on various policy matters or attempting to persuade the people that they have much cleverer solutions to ‘our’ problems. Part of my weariness with all this analysis stems from the fact that as a socialist I know booms and slumps are an inevitable part of the economic operation of capitalism and there was clearly an unsustainable boom occurring in Ireland over the years 2004 to 2008. So now we have the consequent contraction which is just going to have to be endured as long as capitalism governs our lives.
In fact, the only flourishing industry in Ireland now seems to be economic punditry and whether you open a magazine, turn on the TV, listen to the radio or surf the net for news, you won’t have long to wait until you encounter the predictions of economists mainly drawn from either academia or the financial institutions or on some rare occasions, the trade unions. Because Ireland’s situation is deemed so critical, we even have Nobel prize winning economists from the United States commenting on us, while just a few years ago we wouldn’t have merited any attention from them as they’d probably have been pre-occupied with China.
In fact one popular media economist, David McWilliams, currently has a travelling roadshow where he tours the country, filling halls and theatres with his views. As the publicity blurb for his ridiculous ‘Outsiders’ tour goes “McWilliams believes Ireland’s political and social divide is not so much about rich and poor, young and old, urban and rural, but about Insiders and Outsiders”. This strange mixture of showbiz and economics has climaxed in a ‘Kilkenomics’ festival held in Kilkenny in late November where stand up comedy will be interspersed with economic analysis. On its website one of the topics listed for discussion is to be ’23 Things they don’t tell you about Capitalism’. As the man said, you couldn’t make it up!
What’s tiresome about all the contributors to this public debate, is that in spite of furious argument over some superficial points, essentially they’re all singing from the same hymn sheet. Corrective action is needed to deal with Ireland’s soaring debt and it’s only the time scale (whether it should be over 4 or 6 years) and the areas of public spending to be excluded from cuts (such as old age pension) that are in contention. It is now anticipated that a general election is only months away and it’s noticeable that the main opposition parties have moderated their criticism of the government’s budget approach; they know full well that room for manoeuvre is extremely limited and if elected (which seems very probable at the moment) they will be implementing the hair-shirt budgets over the next four years.
To give some background, it now seems accepted that whatever reality lay behind the Celtic Tiger had by about 2003/2004 been replaced by an old-fashioned, foundation-less credit boom based on the expectation that property (both residential and commercial) was destined to appreciate at a significant level beyond any other type of investment. This led to a frenzy of construction, some clearly insane even to non-socialists, where perfectly functioning warehouses, hotels and office blocks were demolished so their footprint could be used for even more profitable apartment blocks and fancier hotels.
By 2006 the unsustainability of what was happening began to be widely commented upon in everyday life though this didn’t seem to flag any warning bells with Brian Cowan, the then minister of finance, subsequently promoted to Taoiseach (Prime Minister). The crash has highlighted a structural weakness in Irish politics whereby that opaque interaction between the politicians and leading business people (particularly property developers) masked the rationale for economic decisions. By 2008, a huge proportion of Irish government revenue was attributable, directly or indirectly, to the construction sector in terms of which has now all but vanished. This has left an almost twenty billion euro gap between the government’s annual income and expenditure. The problem has been exacerbated by the government’s initial decision to give a very wide ranging guarantee to all the main banks’ creditors. As the scale of loses (fifty billion and counting) has turned out to be much greater than anticipated, this has increased Ireland’s need to borrow. Whether the government naively underestimated the risks from this banking strategy or was responding to the pressing needs of some well-connected business people has been hotly debated since.
The predominant response to date in Ireland has been a fearful resignation rather than any outright ‘resistance’ as has intermittently been seen in the strikes and demonstrations of France and Greece. Partly this is due to an apathy to the potential power of real politics, that has been engendered amongst great swathes of the electorate, resulting from so many broken promises by reformist parties over the years. Unemployment has risen sharply and emigration as a social phenomenon has returned. A reduction in living standards is seen as inevitable in the medium term. There has been a deliberate divide and rule strategy employed by the ruling class with a vociferous campaign, championed by the media outlets controlled by the media tycoons Tony O’Reilly and Denis O’Brien, waged against public sector worker to separate them from private sector employees.
That is not to say that people are not angry about the situation and the heavy penalties and burdens they are now expected to bear as a result of reckless and profligate activities of bankers and developers. What is perceived to be most galling is how when the senior executives in many financial institutions knew that the balloon was going up, they negotiated or arranged legally watertight generous exit packages for themselves, without a care for the consequences to the mass of the people. It certainly has raised questions about the ‘fairness’ of the system which is a clearly welcome development for socialists. Of course some of the discontent is mis-directed, with talk of betrayal by the government, when the recession is an inevitable part of the capitalist cycle albeit in this exacerbated by the greed and incompetence of the local ruling class.
The power of capitalism over people has never been more nakedly exposed. The government’s daily mantra is the need to restore confidence in Ireland’s position to ‘the market’ when we know ‘the market’ is fundamentally that very small number of people who control multi-billion financial investment decisions. So each government action is quantified as to whether it has reassured the markets (which we’re constantly told is a good thing) or has caused uncertainty (‘a very bad thing’) as the more uncertain the markets are, the greater the interest rate Ireland must pay on the loans it needs to raise. The fact that it’s naturally in the market’s interest to either doubt, or at least feign doubt, about Ireland’s economic outlook in order to justify higher loan charges is never commented upon which shows the whole deal is really a gigantic scam. Perceived wisdom is that it should be easier to make socialists in a recession when the shortcomings of capitalism are more evident. This capitalist recession will eventually end and the Irish economy at some time in the future will inevitably return to growth. If there are more socialists in Ireland at that future time, then at least one positive outcome will have resulted from this sorry and preventable mess.

Kevin Cronin

Who bailed out the bankers? (2010)

From the February 2010 issue of the Socialist Standard

They tell us that we “the taxpayers” did? But it’s not as simple as that

People are angry at the banks. They blame them for causing the crisis. They blame them for having to be bailed out and then still paying their top people obscene bonuses. They see them as producing nothing, just making money out of shuffling money around.

Some of these criticisms are justified. Some are not. Banks don’t produce anything useful, even if they perform a useful, in fact an essential role, under capitalism. On the other hand, they didn’t cause the crisis, even if they did overstretch themselves like any other capitalist business does when faced with easy profits. It is this general capitalist drive for profits that causes crises from time to time. They were bailed out, but not by us.

Not by us? Weren’t they bailed out by the taxpayers and aren’t we the taxpayers? Yes and no. They were bailed out by the government, whose main source of income is taxes, but, no, we are not “the taxpayers”.

True, anybody in employment can produce their payslip and point to a deduction for income tax. But who actually pays this to the state? You don’t. Your employer does. In fact you never see the money that is deducted from your gross pay. It was never really yours. Putting it on your payslip is a bit of creative accounting. What’s important is the bottom line – your net pay, what you actually take home.
Even if you did have to actually pay income tax yourself, as you do with some taxes (council tax, for instance), it wouldn’t make much difference since it’s your net pay – what you have to live on – that’s important for the labour market. Apart from the fairly short term this has to reflect the economic fact that, if you are not paid enough, you won’t be able to keep your working skills in proper working order and your employer won’t be getting what they are paying for.

If, instead of your employer paying “your” income tax, you had to pay it yourself the employer would have to let you take home more to cover this so as to allow you enough after-tax money to keep your skills in working order.

It’s the same with sales taxes such as VAT. This increases the cost of living, and so the amount of money you need to fully reproduce your working skills. It’s not really paid by you, but is passed on to your employer.

In the end, then, whoever physically pays them to the state, taxes fall on employers (and other property owners). We wage and salary workers are not the real taxpayers. They are.

It is true that the profits, out of which members of the capitalist class pay taxes, originate in the surplus value that productive workers create over and above the value of the mental and physical energies they sell to their employer for a wage or a salary. So, yes, ultimately taxes and bailouts to banks do come from the wealth workers produce. But not directly. We’ve already been fleeced. Taxes fall on those who have fleeced us. They are the ones who, via the state, bailed out the banks.

They didn’t like having to do this, even if they recognised its necessity. And they don’t like the banking capitalists exaggerating. Hence their attempt, via the media, to mobilise us against “the bankers”. But the excesses of the bankers, outrageous as they are, are not really our problem. It’s a case of thieves falling out, over what’s already been robbed from us. Certainly bankers are useless parasites, but parasites on parasites – on those who directly exploit productive labour.

Not all the money to pay for the bail-outs came from taxes. Some came from money the government borrowed – from other capitalists. The capitalist class, as taxpayers, don’t like this either because it means that a portion of the taxes that fall on them has to go to repay with interest those capitalists who lent the government the money. That’s what servicing the so-called ‘National Debt’ (actually the debt of the capitalist state) involves: a transfer of wealth from one section of the capitalist class to another section. So, again, not our problem. It’s their debt not ours.

Except that the capitalist class – and their political representatives in the Labour, Tory and Liberal parties who are vying with each other with talk of a ‘new Age of Austerity’ and ‘savage cuts’ – have started a campaign to defray some of the costs of these payments to their fellow capitalists by cutting down on the payments and services they reluctantly provide for the working class. But then, under capitalism, workers always get the shitty end of the stick. Which is one good reason why we should not put up with capitalism any longer.

Adam Buick

Glasgow May Day School (Saturday 9 May 1.00pm till 5.00pm)

May Dayschool 2009

Saturday 9 May 1.00pm till 5.00pm

Banks:Who needs them?

Community Central Hall 304 Maryhill Road Glasgow

Capitalism in Crisis:

1.00 - 2.15pm 2009: The Year of Economic Crisis.

Speaker Brian Gardner

Glasgow Branch.

This year has seen the collapse of banks, of building societies and the closure of factories and retail outlets. As millions of workers throughout the world face the re-possessions of their homes and the grow-ing fear of unemployment we ask why the economic bubble has burst. We look at the various "solutions" that are offered to alleviate the problems and analyse what can be learned from previous eco-nomic slumps. Previously abandoned by political econo-mists the old ideas of Keynes have made a startling come-back to the extent that many politicians are now espousing his ideas as a solution to the present economic woes. We look at the problem from a Marxist viewpoint and con-sider whether these ideas have value in today’s context.

2.15 - 3.30pm The Environment in Meltdown?

Speaker, John Cumming

Glasgow Branch

How serious is the threat to the global environment? Is the melting of the polar ice pack a product of global warming caused by natural causes or the over production of carbon gases? Is the growing water shortage as serious as depicted and is there any possible solution? Is man-made pollution the cause of the threat to the world's oceans and the possible destruction of the marine food chain? All these inter-related pollution problems are examined from a socialist analysis and some of the proposed solutions are examined.

3.30 - 3.45pm Tea break

3.45 - 5pm Can Socialism Solve the problems?

Speaker Paul Bennett

Manchester Branch

Modern society has produced immense social problems. We have millions of people existing on less than a $1 a day in-side a system that could produce enough food, clothing and shelter to satisfy all human needs. We have magnificent ad-vances in human knowledge but seem incapable of solving problems like world hunger, poverty and war. Wealth today takes the form of commodities - articles produced for sale with a view to making a profit. The Socialist Party is unique in that its only aim is world socialism - a society where everything is produced solely to satisfy need not make a profit. How would this new society based on common ownership operate? Could it solve the problems of capitalism?

Looking forward to seeing you all there.

For more information about the Glasgow Branch of the Socialist Party, please visit their Branch Website.

Banks, money and thin air (2009)

From the January 2009 issue of the Socialist Standard

An urban myth is circulating on the internet that banks have been creating money out of thin air.

Those who have seen the cult film Zeitgeist and its sequel Zeitgeist Addendum, popular amongst conspiracy theorists and others suspicious of governments and banks, will have heard recounted the argument that banks can somehow create money out of thin air by the stroke of a pen or, these days, by the touch of a computer keyboard.

In Zeitgeist Addendum this argument is based on what is stated in an educational booklet published by the Federal Reserve Bank of Chicago. Entitled Modern Money Mechanics it first came out in 1975 and has gone through several editions.

Zeitgeist Addendum begins by describing how it thinks the Federal Reserve Bank (the “Fed”) creates money. If, it says, the government wants more money then, through the Treasury, it creates Treasury bonds which it exchanges with the Fed for currency notes of the same face value; as the government has to pay interest on the bonds this adds to the National Debt and so is “debt money”. Both the Treasury bonds and the currency notes have been created out of thin air.

This is one way of putting it but it is misleading. It is rather the other way round in that the initiative to create more currency comes from the Federal Reserve Bank. Once it has decided that more notes are needed it asks the Treasury to print them (for which the Treasury charges). The normal way these get into circulation is by the commercial banks converting into currency some of the reserves they are obliged to lodge with the Fed. Modern Money Mechanics explains:

“Currency held in bank vaults may be counted as legal reserves as well as deposits (reserve balances) in the Federal Reserve Banks. Both are equally acceptable in satisfaction of reserve requirements. A bank can always obtain reserve balances by sending currency to its Reserve Bank and can obtain currency by drawing on its reserve balance” (p. 4).

In any event, both the Treasury and the Federal Reserve are part of government so we are talking about internal state accounting arrangements. It is, however, true that the new currency has been created out of nothing. Since it is not backed by gold and convertible on demand into a pre-fixed amount of gold, it is what in the US is called “fiat money”, that is, money created by a mere act of State.

Modern Money Mechanics does not in fact have much to say about currency creation but concentrates on what it calls “money creation”. It draws a distinction between “currency” and “money”. This is explained clearly enough on the first page of the booklet where money is defined as currency plus bank accounts with a cheque or debit card; which is M1 in the jargon (“In the remainder of this booklet, ‘money’ means M1”).

Congressman Ron Paul, from Texas, a critic of “fractional reserve banking” and advocate of a return to a gold-backed currency, has an even wider definition of “money”:

"M3 is the best description of how quickly the Fed is creating new money and credit. Common sense tells us that a government central bank creating new money out of thin air depreciates the value of each dollar in circulation." (27 April 2006, see here).

M3 includes other types of bank deposits and liabilities not included in M1. In claiming that all new money created by the Fed depreciates the dollar he is overstating his case. All the US currency (but, as we shall see, not bank deposits) is created “out of thin air” but an increase won’t lead to a depreciation of the dollar as long as it corresponds to an increase in the amount required by the economy for its various transactions (paying for goods and services, settling debts, paying taxes, etc). It is only currency issued in excess of this that will cause a decline in its value and so a rise in the general price level.

Everybody accepts that cash (currency, notes and coin) is money. Some might be prepared to include cash deposited in banks as well. But Modern Money Mechanics definition of bank deposits is wider than this. It doesn’t mean just deposits by people of the money they already possess but any account for which the holder has a cheque or debit card, i.e. including credit lines granted to those who banks have lent money to (so enabling Zeitgeist to go on talking about “debt money”):

“Checkable liabilities of banks are money. These liabilities are customers’ accounts. They increase when customers deposit currency and checks and when the proceeds of loans made by banks are credited to borrowers’ accounts” (p. 3, emphasis added).

So, when it talks about “money creation” it is not talking about currency creation but mainly about “bank deposit” (in the above sense) creation.

The Federal Reserve booklet goes on to explain what “fractional reserve banking” involves and how it can lead to the creation of more “money” in the sense of more bank deposits. Banks, it explains, have learned that when cash has been deposited with them they only need to keep a part (a “fraction”) of it as cash as a “reserve” to deal with likely cash withdrawals; the rest they can lend out. What this fraction is depends on the circumstances, but historically it has been around 10 percent.
On the booklet’s definition, in making a loan a bank is “creating money” as their loans will take the form of creating a new bank deposit as a credit line which the borrower can draw on as if they had made a deposit of their own money (except they will be paying interest on it). The booklet then asks “What Limits the Amount of Money Banks Can Create” and answers that this depends on the cash reserves it has decided to hold or is required by law to keep.

It is here that Modern Money Mechanics, by suddenly shifting from what an individual bank can do to what all banks together (“the banking system”) can, opens the way to the misinterpretation of people like Ron Paul and the makers of the Zeitgeist films that banks too can create “money” out of thin air. The booklet explains that US banks are required by law to keep a “fraction” of deposits as “reserves” in its vaults and/or a balance with the Fed, and says:

“For example, if reserves of 20 percent were required, deposits could expand only until they were five times as large as reserves. Reserves of $10 million could support deposits of $50 million” (p. 4).

This is a very misleading way of putting as it could suggest that if banks receive total new deposits of $10 million they can immediately proceed to make loans of four times this. This is not so, and not really what the booklet meant to suggest. What it means is that the banks can immediately lend out only four-fifths of $10 million, or $8 million, and that this circulates throughout the banking system leading in theory to new loans totalling in the end $40 million, bringing total “bank deposits” up to $50 million.

Confusingly, the numerical examples the booklet goes on to give to illustrate this are based not on a 20 percent reserve fraction but on a 10 percent one (which is more or less what the law in the US requires for the kind of bank deposits in question). So, to take its example, if $10,000 is deposited in the banking system, initially say in one bank, that bank can make loans (create credit line bank deposits) of $9000. When it is spent this $9000 will be re-deposited in other banks which can then lend out 90 percent of this, or $8100; which in turn will be re-deposited in banks, allowing a further $7290 to be lent out, and so on, until in the end and over the period, a total of $90,000 new loans will have been made.

This shows how the Fed can practise “fractional reserve banking” to control the amount of “money” (currency plus bank deposits) in the economy. This is done via “open market operations” as explained in a section headed “Bank Deposits – How They Expand or Contract”:

“Let us assume that expansion in the money stock is desired by the Federal Reserve to achieve its policy objectives . . . [T]he Federal Reserve System, through its trading desk at the Federal Reserve Bank of New York, buys $10,000 of Treasury bills from a dealer in US government securities. In today’s world of computerized financial transactions, the Federal Reserve Bank pays for the securities with an ‘electronic’ check drawn on itself . . . The Federal Reserve System has added $10,000 of securities to its assets, which it has paid for, in effect, by creating a liability on itself in the form of bank reserve balances” (p. 6).

The bank from which the Treasury bills were purchased now has reserves above the 10 percent limit and so can turn the $10,000 into loans, which starts the process described above rolling, leading to an extra $90,000 bank lending.

In theory the Fed could contract bank lending in the same way, but this has never happened. So M1 has gone up and up each year. But what about the currency in all this? It too has gone up but passively and almost automatically. With increased banking activity more currency notes are required, which banks get by converting their reserves into this and which, if it hasn’t enough notes, the Fed just asks the Treasury to print more. But this has consequences -– the depreciation of the dollar and the rise in the general price level Congressman Paul doesn’t like.

But has the banking system really created more “money”? Only if you regard “bank deposits” as money. If you don’t, all that has been shown is that currency has circulated in that the whole process depends on the initial deposit or injection of cash being recycled as further deposits by depositors (as opposed to by banks creating a credit line). So, neither an individual bank nor the whole banking system can lend more than has been deposited with it. By the end of the process, in the example given, the first loan (out of the first deposit of $10,000) of $9000 has been used and used again for genuine deposits totalling $90,000. But all this assumes an expanding economy, since where is the money to repay the loans and the interest on them to come from without being assured of which the banks would not lend the money in the first place?

So the banking system does not create money to lend out of thin air but can only lend out money deposited with it and then only when economic conditions permit it.

Today, bank deposits are not the only source of what the banks lend. They also borrow on the money market (as has been highlighted by the present banking crisis). This means that their reserves are an even smaller percentage of their total loans, only about 3 percent in fact. This figure is mentioned in Zeitgeist Addendum as if this was now the “fractional reserve” and that therefore banks, or the banking system, can “create” loans of up to 33 times an initial deposit. Another silly mistake.

If currency cranks such as the makers of the Zeitgeist films have got the wrong end of the stick about “fractional reserve banking” and imagine that it means banks, whether singly or all together, can create money or credit out of thin air this is partly the fault of the way that booklets like the one produced by the Federal Reserve Bank of Chicago try to explain it. Of course the Fed does not believe the “thin air” claim, but to refute the currency cranks it would have not only to re-iterate that no single bank receiving an additional deposit of $10,000 can forthwith loan out $90,000, but also spell out that the expansion of credit line bank deposits still depends on people making real deposits of their own, unborrowed money (whether in cash or by cheque or by bank transfer). Which would restore a sense of reality and explode the myth that banks can create loans out of thin air.

Adam Buick

Crisis and Inflation: Back to the Future? (2008)

From the November 2008 issue of the Socialist Standard

Gordon Brown claimed that he had ended the boom and bust cycle. The current economic crisis demonstrates that normal service has been resumed.

It is one of the ironies of our times that the election of ‘New Labour’ in 1997 was meant to have left ‘Old Labour’ and everything connected with it behind. The popular perception (first outside the Labour Party and then inside it) was that Old Labour meant nationalisation, inflation, labour unrest, and a host of other negative experiences that were associated with life in the 1970s. Gordon Brown was the New Labour ‘iron chancellor’ who had left all this behind, created a low inflation environment and abolished boom and bust.

The current economic crisis has demonstrated that normal service has been resumed. Unemployment is on the up (no Labour government has ever left office with unemployment lower than when it was elected), the financial sector is in turmoil, price rises are at their highest level in years, and state sector wage restraint means that the unions are (understandably) grumbling.

One of the interesting things about capitalism is the way in which when the economy is booming an economic consensus of sorts has a tendency to break out. The general support for Keynesian economics that developed during the long boom of the 1950s and 60s was famously labelled ‘Butskellism’ by the Economist after Tory Chancellor Rab Butler and his Labour shadow, Hugh Gaitskell. In recent years there has been a similar consensus of opinion even if the Labour and Tory parties don’t like to admit it explicitly – it is almost as if when the economy goes well they are afraid to do anything too different, lest they upset the magic formula in the process.

Psychological blow
What happens when an unexpected economic crisis breaks out is that politicians, central bankers and pundits all realise that perhaps the magic formula didn’t work after all. The realisation in the 1970s that Keynesian economics didn’t really work was a psychological and philosophical blow that some never recovered from, and its replacement by something loosely called ‘monetarism’ was never entirely accepted even by those on the political right who had been most well-disposed towards it.

After a series of crises in the 1970s was followed by the big recession of the early 1980s, and then the recession of the early 1990s, another long boom occurred and with it the latest economic consensus. There was little if any new thinking to underpin it – it was merely a pragmatic amalgam of vague aspects of ‘monetarist’ practice with some left-over bits of Keynesian theory. For the politicians and economists, these had emerged by default because they were the bits of these two theories that hadn’t been transparently discredited to the satisfaction of all concerned by the preceding crises and recessions. There is no better example of this dubious consensus than current thinking on the (interlinked) issues of inflation and interest rates.

The persistent rises in the price level that have occurred in the UK and most of the developed world since the Second World War have exercised the minds of politicians and economists in the decades since, and various explanations have been put forward to account for it: wage increases above rises in productivity, excessive government spending, high government borrowing, the expansion of credit, and many others besides. In the 1970s and 80s a highly contentious explanation for it was advanced by Professor Milton Friedman and was adopted by the Thatcher government in the UK: the aforementioned ‘monetarism’. Loosely, this was the view that inflation is caused by an overly rapid expansion of the money supply that increases monetary demand for goods and services in the economy and pulls up prices. It was often linked or integrated with other views, such as inflation being caused by government borrowing (with government borrowing and money supply expansion allegedly being correlated).

The problem for the Thatcher government’s monetarist anti-inflation strategy was that the main definitions of the money supply chosen for the purposes of monitoring monetary expansion were erroneously based on bank deposits. And there was no reliable way they knew of to control their expansion and contraction anyway. Ironically for a Party concerned by government borrowing levels, one method they resorted to was ‘overfunding’, described by Thatcher as when ‘the Government sought to reduce private bank deposits . . . by selling greater amounts of public debt than were required merely to finance its own deficit’ (The Downing Street Years, p.695).

When this and other anti-inflationary tactics didn’t work, the eventual method settled upon by Thatcher and her Chancellor Nigel Lawson was to use interest rates as a policy instrument. In her memoirs, Thatcher stated that in her view ‘the only effective way to control inflation is by using interest rates to control the money supply’ (p.690) and this was one of the main reasons Thatcher and Lawson famously disagreed towards the end of her reign, because he began to use interest rates as a means of tracking the Deutschmark in the European Exchange Rate Mechanism (ERM) instead.

Brown follows Thatcher
It is notable that interest rates have been used as the main policy instrument for controlling inflation ever since, by the governments of Major, Blair and now Brown. This is despite the fact that as a policy it not only arose by default, but has little to practically recommend it. The theory is that when interest rates rise, people borrow less and cut their spending. But this only takes into account one aspect of what happens. Interest rates are the price of borrowing and lending money and when interest rates rise, lenders are affected just as positively as borrowers are affected negatively. A movement in interest rates changes the terms of the relationship between borrowers and lenders in an economy and can create a short term economic disturbance, but it does not affect the level of purchasing power as a whole and can have no significant and persistent effect on the price level (for example, while those with mortgages and other loans are disadvantaged by higher interest rates, those with savings, interest-bearing investments, etc gain to a similar overall extent).


That raising interest rates cannot halt inflation – or even slow its rate of growth – has been demonstrated by a close look at economic history. During the time when Thatcher was Prime Minister the Minimum Lending Rate (as it was then called) for the banks rose from 9 per cent in 1988 to 15 per cent in 1989 yet the Retail Price Index (RPI) increased considerably across the entire period, having an average annual rate of 4.1 per cent in 1987 that had become 9.5 per cent by 1990.

If that was considered a ‘fluke’ it has just been repeated, as the UK economy under Gordon Brown has just experienced a similar situation. Base rates reached a recent low of 3.5 per cent in mid 2003 and were progressively raised to 5.75 per cent last year. Yet throughout this time, the RPI has crept up from a recent historic low of well under 2 per cent in 2002 to around 5 per cent now, the highest it has been since Thatcher left office in 1990.

These two examples reflect what really happens when an economy experiences price rises – which is that instead of interest rates influencing price rises it is effectively the other way around. Banks make their profits generally by lending money out at a higher rate than they borrowed it at, being concerned with the ‘real rate of interest’ after inflation is taken into account – and rates tend to rise in order to protect these banking margins (the contrary idea of the ‘credit creationists’ that banks make profits not by doing this but by effectively creating money out of nothing instead, should never have been taken seriously, and is in present circumstances beyond risible)

Stagflation
The current rise in the RPI in the UK coupled with the economic crisis has led some economists to argue that capitalism is about to be gripped by the kind of ‘stagflation’ that existed in the 1970s, so called because economic stagnation coincided with rising prices. With the credit crunch biting and the financial apparatus of capitalism in turmoil, unemployment is now on the rise and growth has come to a standstill, at best.

In the nineteenth century, when the study of economics developed seriously and Karl Marx developed his critique of it, persistent inflation (and therefore the possibility of stagflation) hadn’t occurred at all after the Napoleonic War ended. Instead, prices generally tended to rise during booms and then fall away during slumps when demand was lower, and price charts from this period show the cyclical ebbs and flows quite clearly, both in Britain and abroad. By the start of the First World War in 1914, for instance, the overall price level was almost identical to what it had been in 1850.
This general tendency for prices to rise during times of economic prosperity and then fall back when there is economic contraction is still evident today. However, it is disguised by something that only existed episodically before the Second World War, after which it has been a permanent feature – currency inflation.

Since the beginning of the war, the price level has risen every single year and is well over 30 times its 1938 level. The cause of this persistent rise in the price level has been an excess issue of currency (specifically currency that is no longer convertible into an underlying commodity like gold). This is because while interest rates and movements in wages and profits, etc change the distribution of purchasing power in the economy, they do not – of themselves – increase the total amount. An excess issue of notes and coins in circulation does precisely this if it is over and above the amount needed to carry on production and trade.

An over-issue of currency injects purchasing power into the economy which is not reflective of real wealth generation; put simply, it is too much money circulating given the level of production of goods and services (and the trade associated with buying and selling them). Before this truth was lost in a fog of now discredited economic theories, inflation was routinely called ‘currency inflation’, to reflect this. And on the occasions it occurred governments could – and did – put a stop to it, like when they withdrew the then significant sum of £66 million in notes and coins from circulation in 1920, which led to a fall in the general price level of around 30 per cent, before the return to the gold standard in 1925.

Printing presses
In 1938 there was £442 million in notes and coins outside of the Bank of England circulating in the UK economy. Economic growth since then has averaged around two and a half per cent a year (typically going up more than this in booms and down in slumps) yet the amount of notes and coins in circulation has persistently increased far beyond what has been needed for the purposes of production and trade. Today, according to the Bank of England, notes and coins in circulation stand at £50,370 million, up from £47,800 million a year earlier, as the inflationary process that started in the late 1930s has continued apace. This is why, unlike in the nineteenth century when slumps led to overall price declines, prices have risen every single year since the war whether the economy has been in boom or slump (because while slumps have put downward pressure on prices this has always been outweighed by the effects of the ongoing currency inflation).

It is true that for some years prices rises in the UK and other countries – while still positive and persistent – haven’t been at quite the levels seen in the 1970s, 80s and early 90s. The main reason for this appears to have been the entry into the world market of vast amounts of low cost goods produced by the massive emerging market economies of the Far East, including China. As rising productivity lowers the amount of labour time necessary to produce goods, this phenomenon is to be expected, and its scale in recent years has been colossal with massive price falls in clothing and leisure goods like electricals according to the Office for National Statistics (prices of many goods have fallen by between a quarter and a half in the last 10 years). Without this effect, overall rises in the basket of goods that comprise the RPI measurement would have been higher still, as has been evidenced by the continuing big price increases of goods not directly affected by this phenomenon, such as fares, catering and leisure services.

What’s happened over the last couple of years is that this low-cost goods effect has started to lessen because of the world economic boom that built up, especially in commodities like oil, metals, wheat, and so on. The persistent, ongoing currency inflation plus the effects of this well-documented commodities ‘bull market’ have meant large price rises are once more a major policy concern (in the 1970s, when price rises took off and peaked at nearly 27 per cent in 1976, this again was a combination of the background effect of currency inflation with a massive bull market in commodities like oil).

One club golfers
Here lies a big current problem for Gordon Brown and other world leaders, and in some cases the central bankers to whom they have devolved responsibility. Unaware of the real cause of inflation, which has been lost in the mists of time, they have reached a stage – more by default than design in some respects – whereby they have only one policy instrument to deal with inflationary pressures (raising interest rates) and one main policy instrument to deal with a declining economy drowning in debt (lowering interest rates). When asked to deal with the two problems simultaneously, they have only confusion, as the two solutions they would have proposed are mutually exclusive of one another.
In reality, such have been the problems on the money markets and the declines in the stock markets in recent weeks – and such is the evidence that the credit crunch is now having a significant effect on the real economy – they have belatedly decided to lower central bank base rates as the lesser of the two evils.


What is germane to this is that in the nineteenth century, Marx wrote that while the market economy’s periodic crises and convulsions cannot be eradicated through government policy, there are occasions when it can make matters worse (he cited, in particular, the 1844 Bank Act which kept interest rates abnormally high). This is in some respects the history of recent times too, as after the credit crunch began last summer base rates have been higher than they might have been because of the view of governments and central bankers that high rates were needed to stave off inflationary pressures.

During any slump, interest rates tend to fall away from their peak reached at the end of the boom as the demand for money capital eases, this being one of the many conditions for an eventual improvement in production and trade, but on this occasion it has been slow happening (especially given the severity of the housing bust and the associated financial crisis). The irony now is that such is the magnitude of this crisis, with a major bank filing for bankruptcy or being rescued almost literally every week (Bear Stearns, Lehman Brothers, Wachovia, Fortis, Bradford and Bingley, HBOS, the entire Icelandic banking system, etc) that wherever central banks decide to pitch base rates, these are being effectively ignored by the banking system as a whole, where the key London Inter-Bank Offered Rate (‘Libor’) is still nearly two per cent above base rates with the credit markets locked into a state of fear-driven paralysis.

The severity of the current crisis, with big falls in demand in the economy and increasing unemployment, may well lead to pressure on retail prices easing somewhat despite the government’s continuing recourse to the printing presses. But whether this happens or not, there is a sense of real danger and panic in the market economy at the moment as the lubrication that keeps the capitalist machine running – the money markets – are dysfunctional.

So, with inflation concerns (and no clue how to handle them), the effects of a recent oil price spike, stock market crashes, soaring unemployment, the most significant financial crisis in most people’s lifetimes, and the return of nationalisation as a means of propping-up failing businesses, it is certainly a case of ‘back to the future’ for Britain’s Labour government.

Most market commentators don’t know whether the most appropriate comparison is with the 1930s slump after the Wall Street Crash or the 1973-4 UK secondary banking crisis and bear market which followed the ‘Barber Boom’ and housing bubble. While capitalism never repeats its history precisely, it may be an especially severe dose of the latter rather than the former . . . nevertheless, given the general panic and helplessness of recent weeks, you wouldn’t want to bet your Collateralised Debt Obligations on it.

Dave Perrin