Friday, 30 January 2009
Although very complicated in its detail, the credit crunch is at its heart quite simple. Banks create money. They originally did this by issuing bank notes. Gordon would have been familiar in his youth with notes from such as the British Linen Bank and the Union Bank of Scotland, now part of the Royal Bank of Scotland, as Scottish banks, unlike English, still retain the right, closely controlled, to print money. Now banks mostly create money by lending more than they have cash on deposit, again a process fairly closely controlled. This is what Gordon's local bank manager did and, to an extent, still does.
All money is a debt and vice versa. Look closely at your English £5 note and it says in small print "I promise to pay the bearer on demand the sum of five pounds" signed by the Chief Cashier of the Bank of England. Starting with John Kendrick in 1694 down to the current holder, Andrew Bailey, all have signed banknotes promising to pay out if you claim your debt. Of course, today if you found your way in the Bank of England and demanded repayment they would presumably give you another £5 note or possibly five £1 coins. The debt that banks have to their depositors is the base which they use to create more money.
The key to the current crisis began in the 1990s when banks began to borrow from other banks, notably from foreign financial institutions, and then used these loans as the base from which to create more money in the form of loans to companies, as mortgages or to other financial institutions who then proceeded to create more money. It was this process that was almost entirely unregulated.
The money so created was quite specialised being mostly available for the purchase of various kinds of asset notably houses but also such specialised assets as Premier football clubs. So much money chasing these assets led to price-bubbles. These bubbles were finally pricked when one type of loan, sub-prime mortgages in the USA, started to fail though in truth it could have started in many other places. Once begun, the entire process of money creation went into reverse as loans were called in and could not be renewed. The credit-crunch is essentially a money shortage as stark as if all the bank-notes in circulation were piled up and burnt.
The British government response to this has been to provide some of the British banks with huge amounts of money essentially so they could restart the cycle of money creation. So far, £185 billion has been loaned to Lloyds, RBS and HBOS. Barclays and HSBC have also had money pumped in, the former from Abu Dhabi, the latter probably from China. The problem is that far from creating more loans, the money has largely been used to pay off the banks' own debts to other institutions as they fall due and cannot be renewed. The cost of paying back these loans, mostly in euros or dollars, has steadily risen as sterling has fallen.
The result is that, although the loans may have saved the banks from defaulting on their repayments, nothing has been done to stimulate domestic demand, the Keynesian recipe for combating recession. What is required is direct intervention, what is loosely called 'public works'. Yet despite vague promises, very little has actually happened. Indeed far from releasing funds for direct intervention, there has been a continuing squeeze on much public expenditure. Local councils, for example, are actually making staff redundant because of cuts in central funding. Perhaps most ludicrous of all, student grants are being cut by £200 million because demand has exceeded budget limits. It is difficult to imagine a better form of public expenditure in a recession than grants to encourage young people to spend some years training rather than go on the dole. But that is what is happening.
It does seem as if Gordon Brown's childhood vision of the bank manager has totally taken over government policy. Surrounded by appointed ministers and advisers from banking backgrounds, he can do nothing but give them more money whenever they ask for it. It is a sound recipe for disaster.
Monday, 26 January 2009
There are many possible ways to approach the present crisis. The most superficial, and the one favoured by Gordon Brown, is to suggest that it all stems from some problems with the sub-prime mortgages in the USA which have, inexplicably, caused a global crisis. This category of debt, essentially unknown a few years ago, enables blame to be shifted on to various categories of trailer-trash in Florida and desperate house-wives in Ohio colluding with shady American mortgage salesmen; essentially the cast of an updated Arthur Miller play. An apparently deeper analysis lays great stress upon heightened greed in the entire international banking industry inventing more and more complex financial instruments which would conceal their increasingly risky nature behind a smokescreen of incomprehensible mathematics in order to pay themselves ever-larger bonuses.
As the basis for the screenplays which are undoubtedly being written at this moment, both explanations offer endless room for elaboration and they both offer partial truths.
There clearly has been incompetent, possibly criminal, behaviour by financial institutions, the extent of which will probably become clearer as the huge amount of Jarndyce vs. Jarndyce litigation, which is inevitable in the US courts, gradually unwinds. However in order to appreciate the fundamental reason for the current recession one has to dig deeper. In particular, it is necessary to appreciate that the recession derives from the working out of an underlying process in the kind of capitalism which has dominated the world economy for nearly thirty years.
It is usual to compare the present recession with that which followed the 1929 stock market crash in the USA. Certainly the comparison is better than with the recessions of more recent memory in the early 80s and 90s. These were, in effect, created deliberately by the Thatcher government to combat inflationary pressures in the economy and to stamp out the last remnants of the postwar settlement. The 1929 recession did have some common features with today, notably the collapse of a debt-fuelled speculative bubble in the USA with knock-on effects throughout the world economy. However, there are notable differences which render many comparisons dubious at best. Five are particularly important.
First, in 1929 the economic situation in the USA was very different to that in Europe where most countries had been bumping along in a fairly depressed state for much of the preceding decade. The USA, alone, had largely benefited economically from WW1 so that it was unique in having a significant consumer boom in the 1920s. Second, the huge trade deficits which have been run by the USA and the UK for many years, (the British deficit being quantitatively much smaller than the US but relative to its GNP even larger) were largely unknown in the 1920s with the consequence that there was no pileup of American and British financial debts in overseas treasuries. Third, the very high levels of personal debt seen in recent years particularly in the USA and UK and spreading throughout the industrial world were almost unknown. Buying goods on credit, hire-purchase or the ‘never-never’ was in its infancy, credit cards did not exist, most people had no bank accounts and house-purchase, growing but not by any means common, was undertaken under rather stringent financing conditions by specialist agencies. Fourth, both economies had manufacturing sectors which produced most domestic needs from cars and domestic appliances to toys and hand-tools. In both countries, buying foreign goods, whether food or products, was a rare and often rather exotic experience.
Fifth, the political context was very different. Throughout Europe, two competing extreme ideologies, communism and fascism, fought over what was widely seen as a
capitalist system in terminal decline. Even in the USA, in 1932, the White House was
protected by machine-gun posts against any possible assault by the Bonus Army encamped in its thousands in tented-towns around Washington. In contrast, the past ten years have been the calmest of political decades in most of Europe when compared with almost all the twentieth century.
The Great Depression which began in 1929 was never really relieved in peacetime not by Keynes nor Roosevelt nor, for that matter, by Hitler. The Grapes of Wrath, often seen as the classic indictment of the period, was published in 1939 as essentially contemporary reportage whilst Keynes’ General Theory came out in 1936. The most famous of several Jarrow Hunger Marches was also in 1936. Sporadic and localised economic revival occurred in most countries but it was only WWII which finally brought it to an end, particularly in the USA which benefited from 1939 onwards from a flood of orders from Britain and France for war materiél. Keynes’ most notable personal success was in the economic management of the war in Britain which avoided most of the problems of inflation and profiteering which had accompanied WW1. He was also influential in negotiating the Bretton Woods agreement which set up the framework for the postwar international economic scene though its actual form was rather different from the one he originally pursued. Keynesian intervention has, in fact, never pulled any economy out of recession as such despite the rather grandiose claims now made for his policies.
The most important impact of Keynes’ economic thought came after his death in shaping
the way in which economic management to prevent recession was undertaken in national
economies throughout Europe and, to a degree, in the USA. The three decades after 1945 are often referred to as a ‘golden age’ of capitalism in that a formula appeared to have been devised which ensured steady economic growth and full employment under
capitalism. The key point about this period is that it was a political settlement first with the economic tools of Keynesian demand management deployed to support this
settlement. It fell apart in the 1970s because of problems which lay outside Keynesian economics - inflationary pressures deriving from the three parties to the postwar settlement, capital, labour and government, each laying claim to national resources. In Britain, in particular, this inflationary crisis was accompanied by a steady fall in corporate profits to the point where British capitalism was essentially running on empty as the profit rate came close to zero. The British left failed to take advantage of the situation despite gaining political ascendancy in the Labour Party and became mired in a swamp of short-term ‘workerism’ with the prime objective an endless pursuit of money wage increases. (There is a longer exposition of this in Feelbad Britain which can be seen at .
A neoliberal government came in and managed through a turbulent decade to impose a new political settlement, one cemented by the New Labour government after 1997. This settlement pivoted around economic support for business by enlarging the share of profits in national income whilst enlisting the support of a large enough bloc of the electorate, re-badged as consumers, to ensure electoral majorities.
It is the collapse of this neoliberal settlement which is the basis of the current crisis. In future postings, I hope to go further into both the reasons for this collapse and what should be the left response.