The slump in Germany (1993)

From the July 1993 issue of the Socialist Standard

The optimism and euphoria that accompanied the reunification of Germany two- and-a-half years ago has evaporated. At the time Chancellor Kohl and other European politicians talked of the coming of yet another economic miracle, not only for a unified Germany but for the whole of the EC.

So confident was Kohl of success that he decided to give the East German currency parity with the West German Deutschmark, in spite of warnings from the Bundesbank officials of the inflationary consequences that would ensue. German social welfare payments were also extended to the whole of East Germany. The result was an increase in the purchasing power of the formerly poorly-paid East German workers who rushed to spend the newly-upgraded currency on goods previously unavailable to them. The extension of welfare payments to the East German population has been estimated to cost the German Treasury DM 170 billion per year.

These measures did not, however, make up for the obsolete nature of East German industry, where manufacturing production has failed to catch up with that of West Germany (see graph). Eighty percent of railways in the East were still steam-driven at the time of unification. East German workers, although paid in DMarks, still get lower wages than their West German counterparts. Inevitably, they have taken strike action to obtain comparable wages.

Steel workers have recently managed to obtain an increase in wages from about 60 per cent of western levels to 80 percent this June and 90 percent by October 1994 (Wall Street Journal, 24 May). These concessions have been obtained against a background of a severe crisis in the European steel industry that has already forced two western German steel companies—Kloeckner Werke AG and Saarstahl AG—into bankruptcy proceedings. Effective unemployment in eastern Germany is up at 30 percent. "German industrial output is now 7 percent below last year", according to the Sunday Times (28 March).

The automobile industry is also being hard hit by the depression:

  Results from Daimler Benz, Volkswagen and BMW are among their worst on record, reflecting world-wide recession and the rapid deterioration of the German economy. Volkswagen, Europe's largest car manufacturer, lost DM 1.25bn (£503m) in the first three months of the year after sales fell by 23 percent in Germany and more than 17 percent across Europe as a whole . . . Volkswagen plans to cut 12.500 jobs over the next two years, while Daimler is shedding 7 percent of its 367,000 workers" (Daily Telegraph, 14 May).

With the inevitable rise in welfare spending accompanying rising unemployment and immigration estimated at 500,000 per year, pressures to cut government spending have developed.

Worsening deficit

The German deficit for the state sector will amount to over 8 percent of GNP this year, which is similar to that in the UK. in order to try to maintain stability against a background of runaway public spending the Bonn government signed a solidarity pact with the local governments of the western and eastern regions:

  Under the terms of the pact the government agreed to certain measures in return for restraint. Income tax is to increase in 1995, but so does public borrowing for Eastern Germany in order to help restructure the obsolete industries there. It was also accepted as part of the pact that there would be no cut in social spending in the economies pursued by the government (Daily Mail, City & Finance. 5 May).

Since the pact was signed, however, there has been a marked change in outlook for the German recovery that these measures among others were supposed to help. According to the Economist (19 May), "the budget deficit is rising alarmingly as recession cuts revenue and drives up unemployment. Unless the government cuts spending its finances will deteriorate further. The Finance Minister T. Waigel has proposed cuts of DM 20bn annually beginning next year”.

Leaking boat

Much of the propaganda extolling the benefits of a unified Europe have suggested that subsidies to ailing industries would help smooth over cyclical downturns, the euphemistic term used by orthodox economists who do not wish to acknowledge the worsening features of recession.

Subsidies have certainly not helped Germany or other European states in difficulty. The crucial restructuring of Europe’s stricken steel industry is in danger of total collapse, leaving British steel struggling against unfair competition from heavily subsidised Continental producers, has warned Industry Minister Tim Sainsbury:

  Mr Sainsbury told his counterparts that Spain and Italy ran the risk of undermining the whole restructuring programme “unless they finally agreed to reduce public funding of their loss-making steel producers as well as to implement radical cuts in capacity" (Daily Telegraph, 5 May).

The German Economics Ministry now forecasts that the western German economy will shrink by at least one percent this year. The vision of Germany as a strong economy at the centre of Europe is fading. "Investors have concluded that Germany is in the same leaking boat as other members of the ERM", commented the Financial Times (22 May). “Unification has swept away its financial stability and the historic strength of the German current account; inflation is now well entrenched; and the all-German unemployment rate is the highest in the EC".

Compounding Germany’s economic difficulties further is its exposure as a result of huge loans to Eastern Europe. It is estimated that total loans to Hungary, Poland and Czechoslovakia by German firms had reached almost $2 billion by the end of 1992. Many banks loans to these regions are not receiving any returns on their investments. Total exposure to Russian banks, hardly the most secure, is greater than that of all the rest of Europe combined.

Interest rates

Many government spokesmen throughout Europe are urging the Bundesbank to lower interest rates in order to bring about European recovery. The fact that interest rates in the US are at their lowest since the 1930s with no major recovery occurring is not explained. The Bundesbank sees its primary function as to prevent inflation, and the fear is that reducing interest rates will revive it. Memories of Weimar and runaway inflation die hard.

The depression has come to Germany and is deepening. The problems of Germany are the problems of Europe and are ultimately caused by the present world slump. The idea that the Maastricht Treaty can overcome these problems is absurd. For the Treaty to work it would have to be assumed that the competing economic powers in Europe have common interests. The violent movements of currency markets, in spite of central banks losing millions trying to restore stability, is indicative of the futility of trying to adjust or solve the problems of capitalism by altering interest rates.

One disturbing feature of Germany’s plight is the revival of rightwing movements. "Opinion polls show a steady increase for parties of the extreme right led by the Republicans", according to the Financial Times (German Survey, 26 October 1992). Failure of the capitalist politicians to solve the problems that result from the depression has led to widespread disaffection with the major political parties. Refugees in Germany are being blamed for unemployment and housing shortages and have become the focus for attacks by neo-Nazi skinheads.

The problems developing in Germany have happened or are developing in other parts of Europe, namely, rising unemployment, falls in production, bankruptcies, growth in extreme rightwing racist movements along with public spending crises. These problems do not develop or emerge exactly simultaneously in each country, but the overall trend is there.

The problems occurring in Europe are fundamental to the capitalist system. When the working class world-wide understand and accept this then the remedy will be the abolition of the system that puts countries and peoples against each other either on the marketplace or on the battlefield.

Terry Lawlor

The problem is not the banks . . . it’s capitalism (2018)

From the December 2018 issue of the Socialist Standard

In April 2017 the German central bank, the Bundesbank, published a paper on ‘The role of banks, non-banks and the central on the money creation process’ (LINK). Accepting the current prevailing definition of money as including bank loans, it was mainly about bank lending and what determined its level. Some have read into it more than may have been intended.

At one point, the article stated:

   ‘. . . a bank can grant loans without any prior inflows of customer deposits. In fact, book money is created as a result of an accounting entry when a bank grants a loan. It posts the associated credit entry for the customer as a sight deposit by the latter and therefore as a liability on the liability side of its own balance sheet. This refutes a popular misconception that banks act simply as intermediaries at the time of lending – ie that banks can only grant loans using funds placed with them previously as deposits by other customers.’ (‘book money’ and ‘sight deposits’ are translations of German terms corresponding to ‘bank credit’ and ‘current account’ in English.)

This passage was seized on by adepts of the thin-air school of banking to support their contention that banks mysteriously create out of nothing the money they lend. But this is not what the passage or the rest of the article says. Just because banks may not get all the money they lend directly from deposits does not mean that they therefore simply conjure it up out of thin air.

The passage was in fact very carefully worded. First, it brings out, with the use of the terms ‘book money’ and ‘accounting entry,’ that what is being described is an accounting practice followed by banks when a decision to grant a loan has been made. Double-entry bookkeeping requires that a loan, like a deposit, be entered both as an ‘asset’ and as a ‘liability’.

Second, its description of the ‘popular misconception’ is qualified by the words ‘at the time of lending’, leaving open the possibility that the loan may have to be funded at some point from deposits. These words were clearly deliberately inserted because this is precisely what the article does go on to explain.

Whatever the way in which the accounts are presented, the money has to exist since, as soon as the borrower spends the money that the bank has put into their bank account, it has to be found. So where does it come from? According to the article, it comes in the first instance from the bank’s ‘reserves’ at the central bank. The article uses the example of where the borrower uses the loan to buy a machine and where the seller puts the money paid for it into an account at a different bank. The first bank therefore owes the second bank money, which is settled by a transfer of some of its reserves at the central bank to the reserves held there by the other bank.

But what are these reserves? Where do they come from? Far from being conjured up out of thin air, they will have come either from the bank’s capital or from depositors. In either case, previously- existing money.

But that’s not the end of the story. In a section entitled ‘Constraints on the creation of money and credit by individual banks’, the article lists three: ‘interaction with non-banks’ (i.e., other businesses and households), banking regulations, ‘and, not least, by banks’ own inherent interest in profit maximisation’.

Banks are profit-seeking financial intermediaries that borrow money at one rate of interest (either ‘retail’ from individuals or ‘wholesale’ from the money market) and relend the money to borrowers at a higher rate. The spread between the two rates is the source of a bank’s income; after it has paid its operating costs, including staff wages, what remains is the bank’s profits.

Banks’ ‘inherent interest in profit maximisation’ affects how what the article describes as ‘the need for banks to find the loans they create’ is met. It means that they are going to seek to obtain the needed funding as cheaply as possible, i.e., at the lowest possible rate of interest:

‘Deposits play a major role in this regard, for while banks have the ability to create money – that is, to accumulate a stock of assets by originating liabilities themselves in the form of sight deposits – they need funding in the form of reserves.’

They need this because, when a bank makes a loan and the borrower spends it, the money will leave the bank and most if not all of it will normally be deposited by those the borrower bought things from in some other bank. Although the immediate way to replace this – fund the loan – will be to use reserves the bank already has or can procure ‘at any time via the interbank market or the central bank’, this is not the cheapest way:

‘Using short term interbank liabilities as a source of funding gives rise to liquidity and interest rate risk because of the danger that the bank might, at some point in the future, no longer be in a position to prolong the short-term interbank loan or that it can only do so at a higher cost. As for interest rate risk, the risk of interest rates increasing for central bank and interbank could drive up funding costs, thus eroding, or wiping out altogether, the income derived from lending.’

Which is precisely what happened to Northern Rock and HBOS during the financial crash of 2008.

To avoid this, banks seek longer-term loans, in particular from depositors (deposits into a bank are in effect, and in law, a loan to the bank). Here they face competition from other banks. Fixing what rate to pay those they want to borrow from is a delicate balancing act. If it’s too low it will put off depositors who will then go instead to one of the bank’s competitors; if it is too high this will cut into their income and so their profits.

Although we can have misgivings about describing a bank’s decision to authorise a loan, and the accompanying accounting practice, as ‘creating’ money rather than simply ‘making a loan’, the Bundesbank article shows that even the banking authorities themselves acknowledge that banks are financial intermediaries which borrow money at one rate of interest and re-lend it at a higher rate; that banks cannot really ‘create credit’ whatever the bookkeeping practice might suggest.

What banks deal in – and lend – is a financial representation of wealth, not wealth itself which can only be produced by humans working on materials that originally came from nature, fashioning and refashioning them into something useful.

There is nothing especially bad about banks compared with other profit-seeking capitalist enterprises. They are merely in a different line of business. Banks are not the cause of the problems that the majority class of wage and salary workers face. It is capitalism and its production for profit. So the solution is not to reform banks but to abolish capitalism.

Adam Buick