There are three main divisions within capitalist society which share the surplus-value which is socially extracted from the working class; the industrialist, the landlord and the banker. These divisions historically reflect the application of the division of labour to the specialised investment of capital in any field of production and distribution, any process of circulation, of which banking is part. Banks produce nothing. They are really middlemen or custodians of idle capital which must be available as a hoard, as potential money capital waiting to be put to use. Their profit is made during the process of circulation. The difference between finance capital and industrial capital is that the owner of money capital who wishes to earn interest on that money throws it into circulation not as capital for himself, but so that others can use it; and consequently gains a profit by this service.
Contrary to popular belief, banks do not dominate the capitalist system (The two largest corporatrions in the world are WalMart, bigger than the Pakistan and Exxon bigger than the New Zealand economies). In the list of companies by revenue size the first financial business enterprise to appear is Fannie Mae at number number 16. This mistaken view is due to the fact that wealth is represented by enormous quantities of money. All wealth under capitalism expresses its value in the symbolic money form, but that form tends to conceal the fact that capital exists in the physical implements of the labour, factories, minerals, buildings, ships, etc. If for some reason, whether it be that the market is already overloaded and cannot absorb further commodities, or that over-production has already taken place, then production will be scaled down, curtailed, or in some cases halted entirely, and workers will be laid off. In these circumstances there will be little prospect of profit, and as experience has shown a number of capitalists, the smaller ones, go bankrupt All the machinations of the banks, either by advancing or retarding credit, whether charging low interest rates or not, cannot alter this. At the moment there is no shortage of cash available for investment. However, in a failing market there is little incentive to the industrial capitalist to commit himself to paying interest when the prospects of earning surplus-value on the borrowed money are extremely remote.
Speculation basically involves buying cheap and selling dear. When it comes to banking, what banks are doing is borrowing money cheap and lending dear, pocketing the difference as profit. Basically the same as any merchant who buys below value but above the cost-price of the producer of the commodity, and then sell above their own cost-price. There is nothing very specialk about banks; they are not wicked finance capitalists against whom the anger of workers should particularly be directed, just capitalists with their capital invested in a particular line of business, no more nor less reprehensible than the rest of the capitalist class.
Banks lend money and charge interest on it, but they don't create this money themselves but many have come to accept a myth that banks can create money "out of thin air." No, they can't. They can only lend out either what has been deposited with them or what they themselves have borrowed on the money market.
True, they don't have to hold all of this as cash, but only a very small proportion, as little as 3%. There's nothing dubious about this. It's what banks do - lend money that people and firms don't want to spend for the moment to those who do want to, and making their profit out of the difference between the rate of interest they pay depositors and what they charge borrowers. It is quite true that banks do not have to retain all the money deposited with them in the form of cash. If they did, they would never be able to make any profit, since it is only by re-lending, at a higher rate of interest, the money they have in effect borrowed from their depositors that they make profits. It does not mean that they can lend out many times any amount borrowed by or deposited with them as cash, raking in the interest. It means that they can only lend 97 per cent of this amount.
The money lent, obviously, is spent on something, the proceeds of which ultimately end up back in the banking system and are then available for lending all over again. This is not creating new money out of nothing. It is re-lending already existing money. If the money lent does not return to some bank when spent - and so become part of its assets - then no more loans can be made. So, banks cannot lend out more than they have.
Derivatives, collateral debt obligations and the rest are not relevant here as they are not bank loans or money. They are what Marx called "fictitious capital" - ie the conversion of a stream of interest into a notional capital sum which can be bought and sold. Packaging and selling these was an alternative to lending at interest that the banks found to turn a profit. According to Marx the securities themselves really have no value and represent nothing more than a legal claim to a portion of future surplus-value. So any sale of these assets (at any price) represents a transfer of value from buyer to seller, although assuming that there is no default on the asset it will serve to eventually increase the amount of value in the hands of the buyer. The owner of a financial asset records the asset in his books as if it had a value just like any other commodity. This turned out to be disastrous when it was discovered that the stream of interest was also in many cases fictitious.
If there is one lesson of the current financial crisis it is that banks can only lend out what they have borrowed either from depositors or from their own borrowing on the money markets. It was an over-reliance on the latter that largely led to the collapse of Northern Rock and the near collapse of so many other banks. If banks could really create vast quantities of credit at "a stroke of a pen" then none would ever go bust. Neither would they need to tap the money markets for funds.
The second and most important function of the banker is to provide money for industry, which is capital. This has a separate function from money as the medium of circulation. The function of capital is not merely the circulation of commodities but their production in the first instance. Therefore, money used as capital is withdrawn from circulation because the wealth which it represents has been locked up in the process of production. The credit system of advancing capital allows individuals to use capital which is not theirs, and has opened the door to all sorts of swindles and reckless speculation. Who would not gamble with other people's money?
Credit creationism is a myth first given respectability by the 1931 MacMillan Report on Finance & Industry, though a significant minority of economists, bankers and trade unionists on the MacMillan Committee rejected it, while others later got cold feet when the implications of what they had signed up to became evident. It didn't stop a version of it (later highly amended by Samuelson and others) entering into standard economics textbooks.
One of the origins of the banking system was the practice of depositing money for safe keeping with the goldsmiths and paying them for this service. The goldsmiths subsequently adopted the practice of paying interest to the depositor, and they re-lent the money at a higher rate of interest to a borrower. This was only an indirect way of the depositor himself lending his money at interest to the borrower. Whether the goldsmith acted as intermediary or whether the lending was done directly the general effect was the same, i.e., the owner of the money (representing a command over goods) was lending it to a borrower, who would thus, for a specified time, have at his disposal the means of buying goods. It was not an act of “creating” goods or values, but only of lending them, the banks being intermediaries between lenders and borrowers. Fundamentally, the same process underlies the modern banking and credit system. Many proponents of the credit creation myth repeat the goldsmiths allegory as proof of creating money "out of thin air" but as this more or less contemporary account makes clear there is nothing about the goldsmith banker being able (or even trying) to lend more than the 100,000 ounces of silver deposited with them, as often ascribed in the many web accounts.
It's from Richard Cantillon's "Essai sur la nature du Commerce en General" written in 1730. Here's what he wrote:
"If a hundred economical gentlemen or proprietors of land, who put by every year money from their savings to buy land on occasion, deposit each one 10,000 ounces of silver with a goldsmith or banker in London, to avoid the trouble of keeping this money in their houses and the thefts which might be made of it, they will take from them notes payable on demand. Often they will leave their money there a long time, and even when they have made some purchase they will give notice to the banker some time in advance to have their money ready when the formalities and legal documents are complete.
In these circumstances the banker will often be able to lend 90,000 ounces of the 100,000 he owes throughout the year and will only need to keep in hand 10,000 ounces to meet all the withdrawals. He has to do with wealthy and economical persons; as fast as one thousand ounces are demanded of him in one direction, a thousand are brought to him from another. It is enough as a rule for him to keep in hand the tenth part of his deposits.
There have been examples and experiences of this in London. Instead of the individuals in question keeping in hand all the year round the greatest part of 100,000 ounces the custom of depositing it with a banker causes 90,000 ounces of the 100,000 to be put into circulation. This is primarily the idea one can form of the utility of banks of this sort. The bankers or goldsmiths contribute to accelerate the circulation of money. They lend it out at interest at their own risk and peril, and yet they are or ought to be always ready to cash their notes when desired on demand. If an individual has 1000 ounces to pay to another he will give him in payment the banker's note for that amount. This other will perhaps not go and demand the money of the banker. He will keep the note and give it on occasion to a third person in payment, and this note may pass through several hands in large payments without any one going for a long time to demand the money from the banker. It will be only some one who has not complete confidence or has several small sums to pay who will demand the amount of it. In this first example the cash of a banker is only the tenth part of his trade."
Cantillon's full account of how the banks of his time operated can be found in Chapter VI
What is of significance for those who describe thmselves as socialists yet espouse the idea of credit creationism is that runs counter to one of the basic precepts of Marxian economics, namely that value arises in the sphere of production not circulation. If banks could create credit with the stroke of a pen, that would mean in effect they could create wealth, and consequently the Marxist Theory of Value would be shown to be wrong. However, as time passes the validity of the Labour Theory of Value, i.e. that wealth can only come into existence when men apply their energies to nature, is all too apparent. If credit creationism were true, the solution to society's problems would indeed be monetary reform, not socialism - exactly the sort of argument put forward by Major Douglas in the 1930s (see below) to the American libertarian anti-fed reserve conspiracy theorists of today.
The confusion about the role of banks in creating money arises partly because of a lack of clarity as to the nature of money. Money is anything that people are prepared to accept as money and which circulates freely. As youngsters we get to play with toy money. This works perfectly well within the confines of play because players accept it as money and it circulates freely between them. The Bank of England's official measure of the money supply employs a number of different definitions leading to a number of different totals. M0 comprised sterling notes and coin in circulation outside the Bank of England (including those held in banks’ and building societies’ tills), and banks’ operational deposits with the Bank of England. On the narrowest definition the new bank deposits that arise as a result of banks lending money to customers do not count as money. On broader definitions they do. Keynesians and the Monetarists include "bank deposits" as money and that this confuses the issue. Especially as even the term "bank deposits" includes two entirely different types. Most people will interpret the term "bank deposit" to mean money that someone has and that they deposit in the bank, ie in effect lend to it even if they are not paid any interest (but are granted free banking in lieu of this). But the Keynesians and the Monetarists also include as bank "deposits" loans made by banks which take the form in effect of a credit line on which the borrowers pay interest to the banks. So, they mean by "bank deposits" both money that is lent to the banks and money that is lent by them. This involves double counting as some of the money that the banks lend will come from the money that has been really deposited with them.
The continuous concentration of money capital into banks and the expansion of the credit system allows a great number of transactions to take place without the mediation of any money. This is due to what Marx calls the mutual settlement of accounts. If there is a series of exchanges based on credit such that Capitalist A owes £500 to Capitalist B, and Capitalist B owes £600 to Capitalist A, the only amount of money necessary to realize the £1100 of commodities is a £100 -- the £500 owed to each (£1000 in total) are simply canceled on the books and no money is necessary to intervene in the realization of this portion of the value of the commodity capital. The amount of actual money intervening in giant purchases is surely very small. The bulk of purchases take place against credit, where the mutual settlement of accounts is always possible. The move towards a "cashless society" , debit and credit cards, can be seen as increasing the velocity of circulation of the currency.
Ultimately money will only be acceptable and circulate freely if people using it have confidence in it. That is why, for so much of modern history, money has either contained precious metals or has been a token representing a call on precious metals. Today a country's currency depends not on how much precious metal backs it up, but on how productively powerful its economy is.
The one institution which appears to create credit is the State, operating through the Bank of England. This is an act of deliberate political policy. The Government, in a variety of ways, instructs the Bank of England to print an excess of paper currency, which the Government uses to finance its own schemes, and without having to introduce tax legislation to deal with particular cases. This inflation of the currency does not, nor cannot, add to existing wealth. What is really happening is that, far from creating credit, the Government is confiscating other people's. This has the same effect as a general increase in taxation. The constant dilution of the purchasing power of money by inflation raises prices and dislocates production and distribution. This is public fraud posing as public credit.
Socialists have no love for banks. A world without banks would be a wholly better place. However to blame the banks for creating our debt-ridden society is just too biblical, like a re-run of Christ expelling the money-changers from the temple. Even if the banks were state-owned, they would still have to lend. If they didn't there would be no point in them existing. Banks and interest are not the villain of the piece but capitalism and production for profit. We need to abolish money before we can get rid of banks. But to get rid of money we need an end to property. And you can't abolish property relations until you abolish capitalism.
Historically, we have the Douglas Scheme of the 30s which did cast the banks as the villain and variants of the belief frequently spring up.
The Social Credit movement was started by Major Douglas whose argument was that there was a ‘chronic shortage of purchasing power’ due to the issue of money being in the hands of banks that had a vested interest in keeping money in short supply so as to be able to command a higher rate of interest on the money they lent out. Although, according to Douglas, banks had the power to create credit with the stroke of a pen they generally chose not to do so; this power should therefore be taken from them and vested in some public body which would make this extra purchasing power, supposedly needed to ensure the full use of productive capacity, available to all in the form of ‘social credit’. Take this power out of the hands of the banks that they use for their own special benefit, and transfer it to the Government and with this power, it can issue certificates, based on the national wealth, entitling all citizens to a share of the goods so abundantly produced in this age of plenty. Thus, the working class will get a greater portion of the wealth it produces, and the petty bourgeois will get a greater portion too, but what is more, though this is not explicitly stated, the small businesses will escape the clutches of its arch enemy ... the financial institutions.
Marxian economics constitute a direct refutation of the illusions up on which Social Credit doctrines are premised. Not only did Marx demolish the "credit creation" theories but this was already a hoary fallacy when John Stuart Mill disproved what he described as this "confused notion" in a work written before 1847 and published' in 1872. The notion that an insufficiency of money was the cause of sluggish trade was criticized by Sir Dudley North in 1691 before the development of the modern credit system and this was quoted by Marx.
Among other things what this theory overlooked from its deficiency of purchasing power standpoint was that interest charged by banks to capitalist firms is not an additional amount that is added to prices and which therefore cannot be paid for out of current income (wages and profits) generated in production. It is instead a part of the surplus value which the industrial capitalist has to hand over to the banking capitalist for the loan of their money and so is already included in total purchasing power.
It is as we shall see, an inadequate conception of the function of money and its relationship to commodities that underline Social Credit proposals. Money was shown by Marx to be, like labor power itself, also a commodity. Gold, or any of the previous materials that assumed the money form, did so, first of all precisely because they are commodities, and hence depositaries of exchange values. One of these commodities by general usage and agreement becomes the money commodity. By virtue of having the attribute common to all other commodities, of being the embodiment of so much labor time, the money commodity thus becomes the general equivalent and measure of value of all the other commodities. Money emerged and acquired its function of medium of circulation as a product of the historical development of exchange. The primitive inter-tribal direct barter beginnings of exchange was only of an occasibnal and non commodity nature since in primitive society goods were not originally produced for exchange, or sale. But occasional barter between one tribe and another developed into a more sustained form and provided an impetus to the development of the private property institution. Goods became more and more produced for the purpose of exchange, rather than for the personal use of the owners. The beginnings of commodity production and exchange, the production of goods for sale, demanded the use of one commodity as the universal equivalent which would serve as the translator of the values of all the others. It will be seen then that exchange did not originate with money but that the converse is true; i.e. that money arose as a medium of circulation only as a result of the circulation of commodities. At this point let us allow Marx to speak. "Although therefore the movement of money is merely an expression of the circulation of commodities it seems as if conversely the circulation of commodities was only an outcome of the movement of money. On the other hand money only has the function of a medium of circulation because it is the objectivized value of commodities. Consequently, its movement as circulating medium, is in actual fact only the movement of commodities under changed forms." (Capital, vol. 1.) Purchasing power resides in the goods which when produced belong to the capitalists. Gold, which was the actual material medium of circulation in earlier times, was with the rise of banking superceded in that function by the development of tokens and of paper representatives, which were convertible into money. Today banknotes and other paper are no longer convertible into gold. Nevertheless gold remains the money commodity since it still functions as the measure of value and as world money.
The commercial credit which the capitalists engaged in reproduction extend to one another by means of the promises to pay, constituted by bills of exchange and other certificates of indebtedness, is the basis from which the modern credit system developed. Banks are the intermediary agencies which facilitate the exchange of goods between the various owners, whereby one set of ccmmodities is sold for another. They act as middlemen between buyers and sellers who are each both borrowers and lenders in turn, since every seIler must also be a buyer before he can seIl. The seIler on depositing the purchaser's check is in reality ordering the bank to collect the debt; to transfer this amount from his debtor's account to his own. When his own debt to another seller is due his check issued to this creditor is in essence an order on the bank to transfer the stipulated amount from his own account to that of the creditor's. "These mutual claims of indebtedness represented by bills of exchange or checks are balanced either by the same banker, who merely transcribes the claim from the account of one to another, or by different bankers squaring accounts with each other." Checks, being orders to pay money are therefore certificates of indebtedness. Banks are institutions for the transference of debts and purchasing power which arise from the sale of goods and services. The issuance of a check is the conversion of commodities into a form of credit money and if cashed, into another form of money, banknotes. Thus we see, contrary to Social Credit dogma that banks cannot create credit from nothing since it is the creation and sale of goods that create credit. Purchasing power derives from the ownership of goods and the consequent command of services and must therefore always be equal to the totality of goods on the market.The bank too occupies the dual position of being both debtor and creditor since it lends out at a higher interest rate the great part of the deposits it has borrowed at a lower rate. This is generally the source of its profits.
The total product of society (minus that portion necessary for the replacement of used up means of production) can be said to resolve itself into income of wages, profits and rent (including money rent) although value is not determined. by these elements of income. The A plus B theorem of Major Douglas, founder of Social Credit, is supposed to demonstrate that A payments for wages and dividends, plus B payments for raw materials, bank charges etc., comprise the cost of production, while only A gives rise to income. Therefore, says Douglas, B payments must Iead to a shortage of purchasing power. But this is fantastic nonsense, aside from regarding dividends as a cost as it can readily be seen that the cost of raw materials has already been included when dividends have been disbursed. Also considering category B it will be realized when viewing the process of production in series that the raw materials of one industry is the product of the previous producers and this product produced the distribution of wages and profits. By adding the cost of production twice and thus doubIing it Social Crediters have certainly merited the description of their propaganda as double talk and this is the twaddle that is passed off as economics. The total income of society can never equal its total product since a part of this product, which represents no profit, must be used to replace the constant capital consumed (means of production). But this does not mean that the result is a lack of purchasing power.
see here
http://www.worldsocialism.org/spgb/archive/socialcredit%281933%29.pdf
http://www.worldsocialism.org/canada/ws34.socred.htm
http://www.worldsocialism.org/canada/ws35.socred.alberta.htm
And its resurgence http://www.worldsocialism.org/articles/major_douglas_rides_again.php
Showing posts with label bankers. Show all posts
Showing posts with label bankers. Show all posts
Tuesday, September 13, 2011
Wednesday, August 31, 2011
Money makes the world go round ....
This article on Der Spiegel Online about the financial sector made good reading . The following is an adaptation of the full article.
Speculation has always existed in economic history, but never to such an extent as today. Over time, the [finance] industry was able to rid itself of overly obstructive regulations. In fact, financial supervision was virtually eliminated. In 2004 the European Union had threatened to limit the foreign transactions of major US investment banks if the United States did not tighten its own regulations. This prompted five investment bankers to travel to Washington to exert their influence on the SEC. They proposed that the SEC be given the power to take a closer look at their high-risk positions in the future, but only if, in return, the banks would be required to keep less of their own capital in reserve to offset the risks of their transactions. From then on, the banks were able to expand their business unchecked. The second part of the deal -- the SEC's supervision -- was pursued far less energetically.
The financial industry had managed to create a belief system which held that what's good for Wall Street is good for society as a whole. Between 1973 and 1985, before deregulation began, profits in the US financial sector made up no more than 16 percent of the total profits of all US companies. This industry's share of total profits increased to 30 percent in the 1990s, and in the last decade it even reached 41 percent. It was no surprise that the myth of efficient financial markets was accepted so uncritically.
Of all people, it was an academic specializing in literary studies who managed to most accurately analyze the insanity of the financial markets and the impotence of economists. With his short 2010 book "Das Gespenst des Kapitals" ("The Specter of Capital"), Joseph Vogl wrote a bestseller that attracted attention among economists. His theory is that crises are not some kind of occupational hazard in the financial system. Instead, Vogl argues, it is the system itself that inevitably leads to new crises.
Vogl was teaching at Princeton University when Lehman Brothers collapsed. He knew nothing about financial markets, and yet he was fascinated by the "confusing empiricism," which had so little to do with theory. According to economic theory, the invisible hand of the market always leads to equilibrium, as Adam Smith wrote in his classic 1776 work "The Wealth of Nations," which Vogl refers to as the "Bible of economists." The same theory is still taught in universities today. But the theory also tells us that today's excesses in the financial markets should never have occurred. This leads Vogl to conjecture that "by no means does the capitalist economy behave the way it's supposed to." While the theory tends to be based on the economics of a village market, completely different circumstances apply in the financial markets, where both goods and expectations are being traded, and where speculative transactions are used to hedge against other speculative transactions.
Vogl describes the principle as follows: "Someone who doesn't have a product, and neither expects to have it nor will have it, sells this product to someone who also neither expects nor wants to have it, and in reality does not receive it."
This type of market will always have a tendency toward excess -- in either direction.
Paul Woolley holds the same view, but from a different perspective. He is intimately familiar with the financial markets, after having made millions working in the London financial district. He spent four years with the deeply traditional Barings Bank. He later worked for the American fund manager GSO.
In Woolley's experience, the idea that financial markets are efficient is erroneous. "All players in the financial markets behave rationally from their own perspective, but the outcome of this process can be disastrous for mankind," he says. His goal is to prove how dangerous the financial markets are. "It's like a tumor that keeps growing," he says. According to Woolley, there is no justification for the fact that this industry brings in more than 40 percent of all US corporate profits and pays the highest salaries in good years, while in bad years it is bailed out by taxpayers.
Woolley has observed the same phenomenon again and again. "The herd runs behind a trend until a crash occurs." Society, he says, also pays a high price for this behavior. "The financial industry is doing a pretty good job of destroying society," says Woolley. Many of his former colleagues, he adds, have a guilty conscience because "they can't believe that the financial industry is still getting away with it." He feels that bankers have a strong incentive to design products to be as complex and non-transparent as possible. These products enable them to earn returns upwards of 25 percent, because customers simply do not understand the extent to which they are being had. Structured mortgage-backed securities, the risks of which even their creators no longer understood in the end, as well as credit default swaps, which allow investors to bet on the bankruptcies of entire countries, are only the best-known examples.
The more activity there is in the markets, the higher the fluctuations and the greater the potential profits. There is little that the traders at investment banks and hedge funds fear more than a boring market, one in which the economy is humming along nicely and the prices show little movement. The conditions that are reassuring to managers and employees in the real economy often lead to depression in the financial sector.
Whoever has the fastest connection to the market stands the best chance of taking advantage of a critical millisecond and thus reacting to a price signal ahead of the competition. The computers are far more efficient than any human trader, because they can process hundreds of pieces of information per second. At the same time, such programs can also amplify -- or even trigger -- a crash. On May 6, 2010, prices on Wall Street plunged by almost 10 percent within a few minutes. To this day, no one knows exactly what caused the so-called Flash Crash. Because this sort of thing happens with growing frequency, the US Securities and Exchange Commission (SEC) has imposed a waiting period on computers in emergency situations. If the price of a stock has dropped by 10 percent within five minutes, trading is temporarily halted, allowing the human players to consider whether there is in fact a real reason for the sharp decline. Computers have long set the tone in foreign currency trading. The currency markets are now too complex for humans to manage alone. "We realized that you couldn't really manage this with the human thought process, it was too difficult, there were too many variables," says New York hedge fund manager Taylor. Many of his roughly 60 employees are IT experts, mathematicians and engineers. They feed massive volumes of data into the computers, including figures on the gross domestic product of countries, interest rates, commodities prices and inflation rates. "The only thing the computers can't handle are political developments, that is why we have me as Chief Investment Officer," says Taylor, although he points out that the money ultimately follows the instructions that are spat out by the computers.
Following the near-collapse of the markets, then-German President Horst Köhler characterized the financial markets as a "monster." And there were plenty of good intentions when it came to taming this monster. "History cannot be allowed to repeat itself," US President Barack Obama promised after the Lehman bankruptcy, while French President Sarkozy spoke of a historic opportunity to create a new world. The United States and Europe did attempt to constrain the monster that was the financial market but because the industry is globally interconnected solo efforts by individual countries are pointless. Internationally coordinated solutions are difficult. As a result, the regulations remain nothing more than piecemeal. Politicians haven't done much more than push around a lot of paper. The financial industry, new regulations are often little more than a sportsmanlike challenge to search for new tricks with which to circumvent the rules. In their conflict with politicians and regulatory agencies, banks and hedge funds have a clear competitive advantage: They hire the brightest minds in the financial world and pay them millions. The public-sector regulators can hardly compete. The banks' lobbyists can exert their influence on this process to make sure that many of the new regulations are watered down. But the monster cannot be tamed with half-hearted reforms
The European Commission has developed a draft of new capital market rules, which includes 165 pages of guidelines and another 500 pages of regulations. Under the proposed rules, banks would be required to keep more capital resources in reserve to protect against risk, and they would only be allowed to borrow up to a certain ratio. These proposals make sense, but the financial industry is already two steps ahead. It has created a world in which the usual rules for exchanges and banks do not apply: the realm of the "shadow banks." For bankers, this is by no means a world of illegal or semi-legal institutions, despite what the term implies. Hedge funds and private equity firms are known as shadow banks. In the United States, shadow banks have already incurred debts of more than $16 trillion, as compared with $13 trillion among commercial banks. It is believed highly likely by some commentators that the next crisis will emanate from this largely unregulated realm of hedge funds. Britain isn't keen on keeping too close an eye on hedge funds, because the financial industry is one of the few remaining sectors in which the British are still competitive worldwide. This poses a huge risk for the financial market.
An effective financial market reform would have to treat shadow banks the same way all other banks are treated. This would mean completely banning so-called short selling, which is essentially betting on falling prices. It would also have to improve licensing requirements on new financial instruments and ban some that already exist, because they are designed solely for speculative purposes. It would also involve establishing a number of other rules that would make doing business significantly more difficult for banks, hedge funds and private equity firms. All of these measures would rein in the financial market and put its importance for the economy into perspective. Banks would have to concentrate once again on the role they played prior to the great deregulation of the financial market, namely to organize payment transactions, manage the investments of private customers and companies and finance their business deals with loans.
But that seems unlikely. There are too many contradictions and conflicts of interest between the countries involved and governments to allow such a massive change to occur.
Speculation has always existed in economic history, but never to such an extent as today. Over time, the [finance] industry was able to rid itself of overly obstructive regulations. In fact, financial supervision was virtually eliminated. In 2004 the European Union had threatened to limit the foreign transactions of major US investment banks if the United States did not tighten its own regulations. This prompted five investment bankers to travel to Washington to exert their influence on the SEC. They proposed that the SEC be given the power to take a closer look at their high-risk positions in the future, but only if, in return, the banks would be required to keep less of their own capital in reserve to offset the risks of their transactions. From then on, the banks were able to expand their business unchecked. The second part of the deal -- the SEC's supervision -- was pursued far less energetically.
The financial industry had managed to create a belief system which held that what's good for Wall Street is good for society as a whole. Between 1973 and 1985, before deregulation began, profits in the US financial sector made up no more than 16 percent of the total profits of all US companies. This industry's share of total profits increased to 30 percent in the 1990s, and in the last decade it even reached 41 percent. It was no surprise that the myth of efficient financial markets was accepted so uncritically.
Of all people, it was an academic specializing in literary studies who managed to most accurately analyze the insanity of the financial markets and the impotence of economists. With his short 2010 book "Das Gespenst des Kapitals" ("The Specter of Capital"), Joseph Vogl wrote a bestseller that attracted attention among economists. His theory is that crises are not some kind of occupational hazard in the financial system. Instead, Vogl argues, it is the system itself that inevitably leads to new crises.
Vogl was teaching at Princeton University when Lehman Brothers collapsed. He knew nothing about financial markets, and yet he was fascinated by the "confusing empiricism," which had so little to do with theory. According to economic theory, the invisible hand of the market always leads to equilibrium, as Adam Smith wrote in his classic 1776 work "The Wealth of Nations," which Vogl refers to as the "Bible of economists." The same theory is still taught in universities today. But the theory also tells us that today's excesses in the financial markets should never have occurred. This leads Vogl to conjecture that "by no means does the capitalist economy behave the way it's supposed to." While the theory tends to be based on the economics of a village market, completely different circumstances apply in the financial markets, where both goods and expectations are being traded, and where speculative transactions are used to hedge against other speculative transactions.
Vogl describes the principle as follows: "Someone who doesn't have a product, and neither expects to have it nor will have it, sells this product to someone who also neither expects nor wants to have it, and in reality does not receive it."
This type of market will always have a tendency toward excess -- in either direction.
Paul Woolley holds the same view, but from a different perspective. He is intimately familiar with the financial markets, after having made millions working in the London financial district. He spent four years with the deeply traditional Barings Bank. He later worked for the American fund manager GSO.
In Woolley's experience, the idea that financial markets are efficient is erroneous. "All players in the financial markets behave rationally from their own perspective, but the outcome of this process can be disastrous for mankind," he says. His goal is to prove how dangerous the financial markets are. "It's like a tumor that keeps growing," he says. According to Woolley, there is no justification for the fact that this industry brings in more than 40 percent of all US corporate profits and pays the highest salaries in good years, while in bad years it is bailed out by taxpayers.
Woolley has observed the same phenomenon again and again. "The herd runs behind a trend until a crash occurs." Society, he says, also pays a high price for this behavior. "The financial industry is doing a pretty good job of destroying society," says Woolley. Many of his former colleagues, he adds, have a guilty conscience because "they can't believe that the financial industry is still getting away with it." He feels that bankers have a strong incentive to design products to be as complex and non-transparent as possible. These products enable them to earn returns upwards of 25 percent, because customers simply do not understand the extent to which they are being had. Structured mortgage-backed securities, the risks of which even their creators no longer understood in the end, as well as credit default swaps, which allow investors to bet on the bankruptcies of entire countries, are only the best-known examples.
The more activity there is in the markets, the higher the fluctuations and the greater the potential profits. There is little that the traders at investment banks and hedge funds fear more than a boring market, one in which the economy is humming along nicely and the prices show little movement. The conditions that are reassuring to managers and employees in the real economy often lead to depression in the financial sector.
Whoever has the fastest connection to the market stands the best chance of taking advantage of a critical millisecond and thus reacting to a price signal ahead of the competition. The computers are far more efficient than any human trader, because they can process hundreds of pieces of information per second. At the same time, such programs can also amplify -- or even trigger -- a crash. On May 6, 2010, prices on Wall Street plunged by almost 10 percent within a few minutes. To this day, no one knows exactly what caused the so-called Flash Crash. Because this sort of thing happens with growing frequency, the US Securities and Exchange Commission (SEC) has imposed a waiting period on computers in emergency situations. If the price of a stock has dropped by 10 percent within five minutes, trading is temporarily halted, allowing the human players to consider whether there is in fact a real reason for the sharp decline. Computers have long set the tone in foreign currency trading. The currency markets are now too complex for humans to manage alone. "We realized that you couldn't really manage this with the human thought process, it was too difficult, there were too many variables," says New York hedge fund manager Taylor. Many of his roughly 60 employees are IT experts, mathematicians and engineers. They feed massive volumes of data into the computers, including figures on the gross domestic product of countries, interest rates, commodities prices and inflation rates. "The only thing the computers can't handle are political developments, that is why we have me as Chief Investment Officer," says Taylor, although he points out that the money ultimately follows the instructions that are spat out by the computers.
Following the near-collapse of the markets, then-German President Horst Köhler characterized the financial markets as a "monster." And there were plenty of good intentions when it came to taming this monster. "History cannot be allowed to repeat itself," US President Barack Obama promised after the Lehman bankruptcy, while French President Sarkozy spoke of a historic opportunity to create a new world. The United States and Europe did attempt to constrain the monster that was the financial market but because the industry is globally interconnected solo efforts by individual countries are pointless. Internationally coordinated solutions are difficult. As a result, the regulations remain nothing more than piecemeal. Politicians haven't done much more than push around a lot of paper. The financial industry, new regulations are often little more than a sportsmanlike challenge to search for new tricks with which to circumvent the rules. In their conflict with politicians and regulatory agencies, banks and hedge funds have a clear competitive advantage: They hire the brightest minds in the financial world and pay them millions. The public-sector regulators can hardly compete. The banks' lobbyists can exert their influence on this process to make sure that many of the new regulations are watered down. But the monster cannot be tamed with half-hearted reforms
The European Commission has developed a draft of new capital market rules, which includes 165 pages of guidelines and another 500 pages of regulations. Under the proposed rules, banks would be required to keep more capital resources in reserve to protect against risk, and they would only be allowed to borrow up to a certain ratio. These proposals make sense, but the financial industry is already two steps ahead. It has created a world in which the usual rules for exchanges and banks do not apply: the realm of the "shadow banks." For bankers, this is by no means a world of illegal or semi-legal institutions, despite what the term implies. Hedge funds and private equity firms are known as shadow banks. In the United States, shadow banks have already incurred debts of more than $16 trillion, as compared with $13 trillion among commercial banks. It is believed highly likely by some commentators that the next crisis will emanate from this largely unregulated realm of hedge funds. Britain isn't keen on keeping too close an eye on hedge funds, because the financial industry is one of the few remaining sectors in which the British are still competitive worldwide. This poses a huge risk for the financial market.
An effective financial market reform would have to treat shadow banks the same way all other banks are treated. This would mean completely banning so-called short selling, which is essentially betting on falling prices. It would also have to improve licensing requirements on new financial instruments and ban some that already exist, because they are designed solely for speculative purposes. It would also involve establishing a number of other rules that would make doing business significantly more difficult for banks, hedge funds and private equity firms. All of these measures would rein in the financial market and put its importance for the economy into perspective. Banks would have to concentrate once again on the role they played prior to the great deregulation of the financial market, namely to organize payment transactions, manage the investments of private customers and companies and finance their business deals with loans.
But that seems unlikely. There are too many contradictions and conflicts of interest between the countries involved and governments to allow such a massive change to occur.
Friday, August 05, 2011
Banking Myths
The first banks were the merchants of ancient world that made loans to farmers and traders that carried goods between cities. The first records of such activity dates back to around 2000 BC in Assyria and Babylonia. Later in ancient Greece and during the Roman Empire lenders based in temples would make loans but also added two important innovations; accepted deposits and changing money. During this period there is similar evidence of the independent development of lending of money in ancient China and separately in ancient India. The Templers began generating letters of credit for pilgrims journeying to the Holy Land: pilgrims deposited their valuables with a local Templar preceptory before embarking, received a document indicating the value of their deposit, then used that document upon arrival in the Holy Land to retrieve their funds. This innovative arrangement was an early form of banking, and may have been the first formal system to support the use of travellers cheques. The Order of the Knights Templar arguably qualifies as the world's first multinational corporation. Banking in the modern sense of the word can be traced to medieval and early Renaissance Italy, to the rich cities in the north like Florence, Venice and Genoa. The Bardi and Peruzzi families dominated banking in 14th century Florence, establishing branches in many other parts of Europe. Perhaps the most famous Italian bank was the Medici bank, set up in 1397. A bank was founded in 1609 under the protection of the city of Amsterdam. This bank at first received both foreign and local coinage at their real, intrinsic value, deduced a small coinage and management fee, and credited clients in its book for the remainder. This credit was known as bank money. Being always in accord with mint standards, and always of the same value, bank money was worth more than real coinage. At the same time a new regulation was introduced; according to which all bills drawn at Amsterdam worth more than 600 guilders must be paid in bank money. This both removed all uncertainty from these bills and compelled all merchants to keep an account with the bank, which in turn occasioned a certain demand for bank money.
Events such at the appropriation of £200,000 of private money by King Charles I from the royal mint, in 1640 caused merchants to lose trust in the existing institutions and drive them to find more trusted alternatives such as the goldsmiths. The goldsmiths soon found themselves with money for which they had no immediate use, and they began to lend the money out at interest to both the merchants and the government. Finding substantial profit in this business, they began to solicit deposits and pay interest on them. The goldsmiths eventually discovered that the deposit receipts they provided were being passed on from one person to another in lieu of payment in coin, which prompted them to begin lending paper receipts rather than coins. By promoting acceptance of the receipts as a means of payment, the goldsmiths discovered they could lend more than the gold and silver coin they had on hand, a practice that became known as fractional-reserve banking. These practices created a new kind of "money" that was actually debt, that is, goldsmiths' debt rather than silver or gold coin, a commodity that had been regulated and controlled by the monarchy. This development required the acceptance in trade of the goldsmiths' promissory notes, payable on demand. Acceptance in turn required a general belief that coin would be available; and a fractional reserve normally served this purpose. The monarchy's urgent need for funds at rates lower than those charged by the goldsmiths, and the example of the public Bank of Amsterdam, which had been able to make an ample supply of credit available at low interest rates, led in 1694 to the establishment of the Bank of England. The Bank of England succeeded in raising money for the government at relatively low rates.
http://en.wikipedia.org/wiki/History_of_banking
The issue of the fractional reserve money and the money supply seems to be generating a huge amount of confusion when the issue is really quite simple. An urban myth is circulating on the internet that banks have been creating money out of thin air. This is another one of the millions conspiracy theories that have existed in the Earth before biblical times until now, and all of them are based on false ideas. Bank can not produced nothing from nothing, money is transformed into capital ( or dead labor ) by a process in the capitalist mode of productions, and it is a product of exploitation, and it did not all from heaven. This concept has been propagated by groups that believe the world is controlled by twelve banks owned by Jews, and therefore, the whole world is controlled by the Jewish people, and they are the ones that controlled the US instead of blaming the problems of our world in the capitalist mode of productions, they are blaming them on somebody else. It is like the Neo-Nazis are blaming the real estates crisis of the US on the Latin American, the blacks and other minorities, instead of blaming the problem on the capitalists over-production, and it is a normal crisis of the capitalist society, and not only that, it is an indication that capitalism is operating properly. Socialists have argued that banks just cannot create purchasing power at will and if they could it would be a negation of the Marxist labour theory of value. There are other flaws in this urban myth that banks can create new money. The ability of borrowers (and most bank lending is to capitalist firms rather than individuals) to pay interest depends on industries which employ people making a profit and continuing to pay wages to their their workers. So, in this sense, interest is a share of profits and so depends on profits being made. As long as profits are being made then finding the money to pay interest won't be a problem. Capitalism won't collapse but it will go through a rough time when profits are down (but they always recover sooner or later).
Terms should always be defined otherwise people risk talking at cross purposes. By "banking system" is meant - all banks together including the Fed. The other term that needs defining is "money". Modern Money Mechanics defines it as currency (MO) + bank loans = M1. Confusion often arises when people think, when this claim is made, that you are talking about M0 when in fact you are talking about M1. This is why it is best to keep to the original definition of money as what the wiki passage calls "base money", i.e money issued by the central bank or government. To include bank deposits arising from bank loans as money is just confusing. (Of course it is useful to know how much money banks do lend, but there's no need to call this "money").
A bank cannot lend more than savers have deposited with it, that in fact it can only lend less than this as it has to keep a proportion of these as a cash reserve to cater for any withdrawals savers are likely to make. Banks don't create money out of nothing. They can only lend out what has been lent to them and they make their profit out of the difference between the rate of interest they charge their customers and the rate of interest they pay their depositors (or they pay on money they borrow on the money market). Generally, small banks are deposit-rich and large banks are deposit-poor. Large banks loan out more money than has been deposited with them by borrowing from small banks. Small banks themselves borrow from depositors and other banks as well. An entire national economy can loan out more money than has been deposited in its banks by borrowing from foreign banks. Money is also printed by the Treasury and injected into the economy through the Federal Reserve, which loans to banks. (Something similar is done in other countries but I don't think there is a strict separation of Treasury and Federal Reserve in most countries.) There is nothing "bizarre" about this. Banks loan out more money than are initially deposited with them, because the initial deposits will cause a certain amount of lending, which causes additional deposits, which causes additional lending, up to a point determined by the reserve ratio. But the total deposits will always be greater than the total money lent, unless we count the money that enters the money from the central bank or treasury.
Many dherents to banks create money out of thin air assert that, with a cash ratio of 10%, a single bank on receiving a deposit of $10,000 can then immediately lend out $90,000 and claim support for this in Modern Money Mechanics. It is not what Modern Monetary Mechanics says. This booklet claims only that the whole banking system, not a single bank on its own, can, under favorable circumstances, increase the money supply (defined so as to include bank deposits and bank loans, not just currency) by x times (depending on the fraction that banks have to keep as a cash reserve) the initial deposit. If this statement was true, then people should be opening their own bank. The trouble is that everybody else would be too. The fact that they aren't is surely further confirmation that it is not true. Modern Money Mechanics argues that, with a cash ratio of 10 percent (which means that banks are required to keep at least 10 percent of what is deposited with them as cash), the "banking system" can expand the "money supply" by 9 times. But it definitely does not say that a single bank can do this on its own if it receives a deposit from the Fed (or from anywhere else). What banks can do is expand M1 but not M0. They do this when they give anyone a loan in the form of a current account. Nothing is remarkable or fraudulent in this. It's what banks (and loan clubs and credit unions) do. If you include loans via current accounts in the definition of money then of course banks can "create" money. What banks are doing is creating loans not out of thin air but out of the money deposited with them. Banks "create" money but this is only because it defines money as including bank loans (since by bank deposits it means not just what savers have deposited but also deposits banks have opened for those borrowing money from it). This means that, by definition, a bank "creates money" every time it grants a loan. Which in fact is not saying much more than that banks lend money. The real question is: in granting a loan does a bank create extra purchasing power which didn't exist before? This definition is misleading in that it does suggest that this is what banks do. But this is not the case (and the passage does not in fact say this). A bank can only lend already existing purchasing power. It can only lend money it already has, either from deposits by savers or what it has itself borrowed on money markets or its own money. What banks do is to channel money that people don't want to spend for the time being to those who need money (but don't have it) for some project. In lending this money they are no more creating extra purchasing power than I do if I lend you $1000. They are just redistributing it from one person to another. Both the depositor and the borrower cannot spend the same money (any more than you and me could both spend the $1000 I lent you). When a bank makes a loan it doesn't creates money. When a bank makes a loan it loans already existing money, either which savers have deposited with it or which they have themselves borrowed (usually on the money market) or their own money.
In the chapter "Bank Deposits - How They Expand or Contract" it is assumed that the Fed wants to expand "the money supply" ( essentially bank loans), so what it does it to buy "$10,000 of Treasury bills from a dealer in US government securities". This bank (Bank A) now has $10,000 extra cash. As it only needs to retain 10 percent as cash it can now lend out $9,000. It cannot lend, as the way you originally put it suggests, keep the whole $10,000 as cash and lent out $90,000. What happens, according to the booklet, is that Bank A's loan of $9,000 is spent and finds its way back to other banks in the system. Assuming it all ends up in Bank B (which won't be the case since parts of it would normally end up in many different banks), then Bank B has an extra $9,000. It can now lend out 90 percent of this, i.e. $8,100. This in turn ends up in Bank C, which can then lend 90 percent of this, ie. $7,290. And so on till in the end a total of $90,000 will have been lent out. Note that even this will not have been created out of "thin air" since it requires the money from the original $10,000 to be continually re-deposited. If, for some reason it isn't, then the process stops and/or the total amount of bank loans does not reach its theoretical maximum.
A more accurate description of the Fractional Reserve process can be found at http://www.federalreserveeducation.org/fed101/fedtoday/FedTodayAll.pdf page 5
"The fact that banks are required to keep on hand only a fraction of the funds deposited with them is a function of the banking business. Banks borrow funds from their depositors (those with savings) and in turn lend those funds to the banks borrowers (those in need of funds). Banks make money by charging borrowers more for a loan (a higher percentage interest rate) than is paid to depositors for use of their money. If banks did not lend out their available funds after meeting their reserve requirements, depositors might have to pay banks to provide safekeeping services for their money. For the economy and the banking system as a whole, the practice of keeping only a fraction of depositson hand has an important cumulative effect. Referred to as the fractional reserve system, it permits the banking system to "create" money." (The inverted commas round "create" are particularly appropriate. They should also have been around "money" as they are using the word to include "bank deposits" and nobody denies that the circulation of money through the banking system leads to an increase in the number of bank deposits.)
The New York Federal Reserve also gives a rather more sophisticated explanation at http://www.newyorkfed.org/aboutthefed/fedpoint/fed45.html
"Reserve Requirements and Money Creation: Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+81+$72.90+...=$1,000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of $500 ($100+$80+$64+$51.20+...=$500). Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity.
In practice, the connection between reserve requirements and money creation is not nearly as strong as the exercise above would suggest. Reserve requirements apply only to transaction accounts, which are components of M1, a narrowly defined measure of money. Deposits that are components of M2 and M3 (but not M1), such as savings accounts and time deposits, have no reserve requirements and therefore can expand without regard to reserve levels. Furthermore, the Federal Reserve operates in a way that permits banks to acquire the reserves they need to meet their requirements from the money market, so long as they are willing to pay the prevailing price (the federal funds rate) for borrowed reserves. Consequently, reserve requirements currently play a relatively limited role in money creation in the United States." (Note that the pyramid is based on the assumption that the money loaned on the basis of the original deposit is also deposited in a bank.)
Backpack Banking
Let's look at a very simple, analogous example that should clarify the issue.
Let's say that we have a holding facility for backpacks. People drop off (aka deposit) their backpacks at this holding facility, and the holder of the backpacks loans out backpacks to those who need them. If you deposit a backpack with him, you can withdraw it at any time with no advance notice. There is no money paid for the service. No backpack-interest is paid (i.e. if he loans you a backpack, he expects to receive it back after a certain period of time, let's say 1 month -- he does not expect 2 backpacks in return for his loan). All of the backpacks in this society are identical. Anyone who deposits his backpack receives a receipt saying "1 backpack" on it. The holder of these backpacks (let's call him the "banker") keeps account of all the backpacks deposited with him, all of the backpacks on reserve, all of the backpacks loaned to others, and all of the backpacks owed. When youleave a backpack with him, this goes down in his ledger both as a liability (since he owes you a backpack) and as an asset (since he has a backpack). When he loans out a backpack, he records this as an asset.
The banker starts with a reserve of 1 backpack, which was his initial capital that he started with. This is an asset. He expects to keep a total of 1 backpack as an asset at all times (after canceling out liabilities and assets) since that is what he has started out with, and he is not in this business in order to accumulate backpacks but
just to increase the distribution of existing backpacks. He already knows, from previous conversations with famous bankers, that during the month in question, the total number of customer withdrawals is never greater than 1 backpack.
Let's say you, Mr. X, deposit 1 backpack with this banker. He credits your account for 1 backpack, and gives you a receipt letting you know that you have 1 backpack in your account. He goes to his own ledger, and notes that he now has 2 backpacks as assets (the backpack on reserve and the backpack you have loaned him), and 1 backpack as a liability (the backpack in your account).
He doesn't want to keep unnecessary reserves of backpacks in his holding center, so he takes your backpack and loans it to Mr. Y. Mr. Y agrees to give it back to the banker at the end of the month. The banker still has 2 backpacks as his assets (but now 1 is a reserve and 1 is a loan to Mr. Y) and 1 backpack as his liability.
As it so happens, Mr. Y does not need the backpack until next week. So he gives it to the banker to hold for him. The banker gives Mr. Y a receipt saying "1 Backpack", credits Mr. Y's account for 1 backpack, and then goes to his own ledger and counts this backpack as both an asset in his reserve of backpacks, and as a liability. He now has assets of 3 backpacks (2 in his reserve and 1 out on loan to Mr. Y) and liabilities of two backpacks (1 backpack in Mr. X's account and 1 backpack in Mr. Y's account).
Since he still has more than enough backpacks in his reserve to cover the usual number of withdrawals during this month of the year, he loans out a backpack once again, now to Mr. Z. Mr. Z agrees to repay the backpack within 1 month. Unlike Mr. Y, Mr. Z actually needs to use the backpack as his school starts the next day. So he does not deposit this backpack, but just uses it. The banker still has assets of 3 backpacks (but now 1 is in his reserve, 1 has been loaned to Mr. Y, and one has been loaned to Mr. Z) and liabilities of 2 backpacks (still one backpack each in the accounts of Mr. X and Mr. Y).
Looking at it from the perspective of the deposits, Mr. X has 1 backpack in his account, Mr. Y has 1 backpack in his account and one which he owes to the bank within 1 month, and Mr. Z has -1 backpacks.
Over time, economists come along and claim that backpacks are not actually the things you wear on your back, but just ledgers in the accounts of a banker. It is said that Mr. X, Mr. Y and Mr. Z, all have backpacks, except in different forms. The banker has apparently created 3 backpacks, if not out of nothing then out of 1 backpack deposit, and economists look upon this situation as a miracle which arises from the peculiar power of the backpack holding system.
But let's say Mr. X decides he wants his backpack today. He withdraws one backpack from his account. To do honor this claim, the banker has to give Mr. X the 1 backpack that was in his reserve. The reserve is now down to zero, and Mr. X's account has zero backpacks in it. The banker's ledger now reads 2 backpacks as assets (the backpacks loaned to Mr. Y and Mr. Z) and 1 backpack as a liability (in Mr. Y's account). The banker thinks he is okay, since he already suspected that 1 backpack would be withdrawn this month, and he does not expect any more backpacks to be withdrawn until the beginning of the next month, at which point he will have been repaid his loan to Mr. Z and perhaps will have received additional deposits.
As it so happens, Mr. Z's dog eats his backpack and he is forced to default on his debt. The banker has to erase 1 backpack from his assets, so he now has 1 backpack as an asset (the backpack loaned to Mr. Y) and one backpack as a liability (the backpack in Mr. Y's account). But the backpack loaned to Mr. Y was already deposited at the bank and credited to his account. Mr. Y decides he wants the backpack the next week, because school is about to start. He tries to withdraw the backpack but his claim cannot be honored as there are no reserves at the bank. The bank is insolvent and is forced into bankruptcy.
So what has happened in in this hypothetical bank? Have new backpacks been created by loaning out backpacks? No. All that has happened is that the distribution of backpacks has changed. People who are not using their backpacks allow the bank to loan their backpacks out to others, with the expectation that their backpacks will return to them, just as if they held their money in a safe and withdrew their money from time to time, as necessary. The bank has economized on backpacks by reducing the need to form hoards. In the absence of a holding system for backpacks, each owner of a backpack would need to have his own backpack and hold it himself while he isn't using it. Instead, in the banking system, 1 backpack can supply the needs of 3 backpack users. Also note that deposits have not actually increased the
bank's assets, since any backpack the bank acquires through a deposit is not only an asset, but also a liability, which cancels it out. It is neutral.
This all can be applied, with appropriate modification, to a bank that holds money and lends it out at interest.
A bank does not create money whether we consider this from the point of view of an individual bank or the banking system. A bank receives money and credits it to your account, which is basically an IOU saying that the bank will pay you whenever you wish to withdraw your money. In normal circumstances it functions just as well as a piggy-bank would -- in fact even better, as it is simpler to use, there is no need to pay for security costs once the sums get large, and you earn interest on your money. When two customers of the same bank participate in some kind of purchase/sale of a commodity and one writes a check to the other, the bank simply credits the account of one client and debits the account of the other. (Just like if person A owed person B $20, and I owed both person A and B $20, and they agreed to have me pay person B $40 and pay no money to person A.) No money actually enters into the transaction. In Marx's terminology, money figures in here only as a measure of value, not as a means of circulation. The same thing holds in the case of two customers at different banks, where the checks go through a clearing house and cash is only used to settle the balance. The banking system greatly reduces the need for means of circulation, since physical money is only needed to settle remaining balances between parties. But any time you are loaning money out, there is a chance that the money will not return to you and it will be lost. The fact that the bank doesn't create money becomes obvious during a commercial crisis, during which too many depositors try to redeem their IOUs (their deposits) than can be redeemed.
Another description can be read here karthiksankar.com/moneycreation/#
Banks get money from what we deposit in them. Deposits are banks’ liabilities, since banks must return it to us when we ask for the money. Banks lend loans by using this deposit money of ours. Loans are bank’s assets.
The Cash Reserve Ratio:
Reserve Bank of India (RBI) is the central note issuing authority in India. Commercial Banks in India are required to hold a certain proportion of their deposits in the form of cash. This minimum ratio (that is the part of the total deposits to be held as cash) is stipulated by the RBI and is known as the CRR or Cash Reserve Ratio. It is a tool used by RBI to control liquidity in the banking system.
The Process: Let’s assume there are various Banks in the Banking System. Bank_1, Bank_2, Bank_3, etc. Let’s assume the CRR to be 10%.
Anand deposits Rs. 100 in Bank_1. Keeping Rs. 10 in reserve (CRR is 10%), Bank_1 lends Rs.90 to Bala. Bala deposits his Rs.90 in Bank_2. Keeping Rs. 9 in reserve, Bank_2 lends Rs.81 to Clara. Clara deposits her Rs.81 in Bank_3. This process continues.
The Math Behind This: Time for some calculations. In the first cycle, the bank could loan out 90% of Rs.100. In the second cycle, the bank could loan out 90% of 90% of Rs.100. Thus the amount of money the bank can loan out in some period n of the cycle is given by:Rs. 100 * (90%)n
Let A be the amount of money infused into the system (in our case, Rs. 100) Let R be the required reserve ratio (in our case 10%). Let T be the total amount the bank loans out Let n represent the period we are in.
From the equation above, the amount of money the bank can loan out in any period is:
A * (1 – R)n
Thus, the total loan amount is:
T = A*(1 – R)1 + A*(1 – R)2 + A*(1 – R)3 + …
T = A * [ (1 - R)1 + (1 - R )2 + (1 - R)3 + ... ]
Mathematics says,
x1 + x2 + x3 + x4 + … = x / (1-x)
Thus,
T = A * (1 – R) / R
How much money have our banks loaned out using the Rs.100 deposited initially? Using the above equation, this would total up to 100 * (1 – 0.1)/0.1 = Rs.900.
In this entire process, to find the total amount deposited (D), we need to take into account the initial Rs.100 too.
D = A + T
D = A + [ A * (1 - R) / R ]
D = A * (1/R)
Which, for our example, will total to Rs.1000.
The cash in reserve for any period is:
R * A * (1 – R)n-1
Total reserve is:
( R * A ) [1 + (1 - R)1 + (1 - R)2 + (1 - R)3 ... ]
which simplifies to A = Rs. 100
The Balance Sheet: This is how the combined balance sheet of the Banks will look like:
Bank Liabilities-Deposits Assets Credits Reserve Total Assets
Bank_1 100 90 10 100
Bank_2 90 81 9 90
Bank_3 81 72.9 8.1 81
- - - - -
- - - - -
Bank_n 00 00 00 00
Total 1,000 900 100 1000
Such is the power of this simple process that banks have created an asset of Rs.1000 using an initial money of Rs.100. In other words, Banks have created money. This type of banking is called “Fractional Reserve Banking”
Why does this process succeed? This process succeeds because most money transfers today do not involve cash or currency. It involves just cheques, Direct Debit, etc. or electronic transfer – mere numbers on a computer screen.
When would it fail?
This system fails in two main cases:
Cascade of withdrawals - When all depositors come asking for their money back at the same time. The banking system will not have enough currency to meet the demands. In fact, one main purpose of the CRR is that the banks must be able to repay deposits when there are significantly large number of withdrawals.
Loan defaults - What would happen when the debtors default or fail to repay the loans? This would also result in banks having insufficient money to pay back depositors.
The financial system is much more complicated than what we have discussed. But the above two are one of the basic reasons for the recent recession – just that it involved a cascade of selling stocks on the market, and defaults of subprime mortgage loans.
SOURCE-blog.karthiksankar.com/moneycreation/
The above described correctly how the banking system as a whole (but not a single bank on its own) can, on the assumption of a 10% cash ratio, eventually make loans totaling Rs 900 from an initial deposit of Rs 100. What is misleading, however, is saying that this means that "banks create money out of thin air". They are lending out only what has been deposited with them (in fact only 90% of this). What is happening is that the initial deposit of Rs 100 is being continually recycled in the form of new deposits. You yourself actually state this yourself when you say total loans amount to Rs 900 and total deposits to Rs 1000:
How much money have our banks loaned out using the Rs. 100 deposited initially? Using the above equation, this would total up to 100 * (1 – 0.1)/0.1 = Rs. 900. In this entire process, to find the total amount deposited (D), we need to take into account the initial Rs. 100 too.
D = A + T
D = A + [ A * (1 - R) / R ]
D = A * (1/R)
which, for our example, will total to Rs. 1000.
In other words, total loans cannot exceed total deposits. What banks are doing is creating loans not out of thin air but out of the money deposited with them.
As it happens, an article Financial Times confirms that banks can only lend money they've already got (either from their own capital and reserves or from depositors or what they have themselves borrowed from the money market):
http://www.ft.com/cms/s/0/1637c530-653a-11df-b648-00144feab49a.html
"Yesterday, the CML [Council of Mortgage Lenders] warned that its own members - who make roughly 94 per cent of all the mortgage loans in Britain - are facing higher costs as they compete for retail deposits to replace maturing wholesale loans. This is likely to mean that rates on mortgages may have to rise even if the Bank rate remains on hold." What is happening is that money which the banks have borrowed from the money market is due to be repaid soon and they are seeking alternative sources of money to re-lend, from depositors. To attract depositors they have to offer them a higher rate of interest. Which means that, to make a profit, they will have to charge a higher rate of interest too to those they lend money to. Banks make a profit out of the difference between the rate of interest at which they borrow money and the higher rate at which they re-lend it. If they really could create money to lend by simply monetarising what a potential borrower would owe them they would never be in the position reported by the Financial Times. But they are.
Banks, in pursuit of profit, have every incentive to make as many loans as they can (since the more loans they make the more income they stand to get as interest) and that in recent years they overdid this by creating all sorts of complicated and dubious loans financed by money they had borrowed on the money market. This all came unstuck when the US housing construction sector "overproduced" houses (in relation to paying demand, not real need, ). That's the way capitalism works. In a boom every capitalist enterprise (banks included) tries to make as much profits as they can. Then one sector overproduces and this has a knock-on effect on the rest of the economy. This happens every time and there's nothing governments can do to stop it. That's one reason why we've got to get rid of capitalism and its production for profit and replace it with socialism and production directly for use.
If you just abolished the Fed and brought in a different monetary system this would still leave corporations owning and controlling productive resources and using them to generate a profit rather than to directly satisfy people's needs. So world poverty, pollution, wars, waste, etc that arise from the competitive struggle between profit-seeking corporations would continue. No monetary reform can change this. Rather than thinking about new banking structures, surely the most urgent need is to get rid of capitalism (of which banking is just a part) altogether! A fundamental point is that it's not "greed" which has caused this crisis, it's capitalism. Crisis is inherent to capitalism and the only way to have a world without crisis is to have a world without capitalism. That means consciously dismantling capitalist social relations: money, commodity production, wage labour, national frontiers and ... banks!!
SEE HERE
http://www.worldsocialism.org/spgb/jan09/page12.html
http://www.marxists.org/archive/hardcastle/creatingcredit.htm
http://en.wikipedia.org/wiki/Subprime_mortgage_crisis
Events such at the appropriation of £200,000 of private money by King Charles I from the royal mint, in 1640 caused merchants to lose trust in the existing institutions and drive them to find more trusted alternatives such as the goldsmiths. The goldsmiths soon found themselves with money for which they had no immediate use, and they began to lend the money out at interest to both the merchants and the government. Finding substantial profit in this business, they began to solicit deposits and pay interest on them. The goldsmiths eventually discovered that the deposit receipts they provided were being passed on from one person to another in lieu of payment in coin, which prompted them to begin lending paper receipts rather than coins. By promoting acceptance of the receipts as a means of payment, the goldsmiths discovered they could lend more than the gold and silver coin they had on hand, a practice that became known as fractional-reserve banking. These practices created a new kind of "money" that was actually debt, that is, goldsmiths' debt rather than silver or gold coin, a commodity that had been regulated and controlled by the monarchy. This development required the acceptance in trade of the goldsmiths' promissory notes, payable on demand. Acceptance in turn required a general belief that coin would be available; and a fractional reserve normally served this purpose. The monarchy's urgent need for funds at rates lower than those charged by the goldsmiths, and the example of the public Bank of Amsterdam, which had been able to make an ample supply of credit available at low interest rates, led in 1694 to the establishment of the Bank of England. The Bank of England succeeded in raising money for the government at relatively low rates.
http://en.wikipedia.org/wiki/History_of_banking
The issue of the fractional reserve money and the money supply seems to be generating a huge amount of confusion when the issue is really quite simple. An urban myth is circulating on the internet that banks have been creating money out of thin air. This is another one of the millions conspiracy theories that have existed in the Earth before biblical times until now, and all of them are based on false ideas. Bank can not produced nothing from nothing, money is transformed into capital ( or dead labor ) by a process in the capitalist mode of productions, and it is a product of exploitation, and it did not all from heaven. This concept has been propagated by groups that believe the world is controlled by twelve banks owned by Jews, and therefore, the whole world is controlled by the Jewish people, and they are the ones that controlled the US instead of blaming the problems of our world in the capitalist mode of productions, they are blaming them on somebody else. It is like the Neo-Nazis are blaming the real estates crisis of the US on the Latin American, the blacks and other minorities, instead of blaming the problem on the capitalists over-production, and it is a normal crisis of the capitalist society, and not only that, it is an indication that capitalism is operating properly. Socialists have argued that banks just cannot create purchasing power at will and if they could it would be a negation of the Marxist labour theory of value. There are other flaws in this urban myth that banks can create new money. The ability of borrowers (and most bank lending is to capitalist firms rather than individuals) to pay interest depends on industries which employ people making a profit and continuing to pay wages to their their workers. So, in this sense, interest is a share of profits and so depends on profits being made. As long as profits are being made then finding the money to pay interest won't be a problem. Capitalism won't collapse but it will go through a rough time when profits are down (but they always recover sooner or later).
Terms should always be defined otherwise people risk talking at cross purposes. By "banking system" is meant - all banks together including the Fed. The other term that needs defining is "money". Modern Money Mechanics defines it as currency (MO) + bank loans = M1. Confusion often arises when people think, when this claim is made, that you are talking about M0 when in fact you are talking about M1. This is why it is best to keep to the original definition of money as what the wiki passage calls "base money", i.e money issued by the central bank or government. To include bank deposits arising from bank loans as money is just confusing. (Of course it is useful to know how much money banks do lend, but there's no need to call this "money").
A bank cannot lend more than savers have deposited with it, that in fact it can only lend less than this as it has to keep a proportion of these as a cash reserve to cater for any withdrawals savers are likely to make. Banks don't create money out of nothing. They can only lend out what has been lent to them and they make their profit out of the difference between the rate of interest they charge their customers and the rate of interest they pay their depositors (or they pay on money they borrow on the money market). Generally, small banks are deposit-rich and large banks are deposit-poor. Large banks loan out more money than has been deposited with them by borrowing from small banks. Small banks themselves borrow from depositors and other banks as well. An entire national economy can loan out more money than has been deposited in its banks by borrowing from foreign banks. Money is also printed by the Treasury and injected into the economy through the Federal Reserve, which loans to banks. (Something similar is done in other countries but I don't think there is a strict separation of Treasury and Federal Reserve in most countries.) There is nothing "bizarre" about this. Banks loan out more money than are initially deposited with them, because the initial deposits will cause a certain amount of lending, which causes additional deposits, which causes additional lending, up to a point determined by the reserve ratio. But the total deposits will always be greater than the total money lent, unless we count the money that enters the money from the central bank or treasury.
Many dherents to banks create money out of thin air assert that, with a cash ratio of 10%, a single bank on receiving a deposit of $10,000 can then immediately lend out $90,000 and claim support for this in Modern Money Mechanics. It is not what Modern Monetary Mechanics says. This booklet claims only that the whole banking system, not a single bank on its own, can, under favorable circumstances, increase the money supply (defined so as to include bank deposits and bank loans, not just currency) by x times (depending on the fraction that banks have to keep as a cash reserve) the initial deposit. If this statement was true, then people should be opening their own bank. The trouble is that everybody else would be too. The fact that they aren't is surely further confirmation that it is not true. Modern Money Mechanics argues that, with a cash ratio of 10 percent (which means that banks are required to keep at least 10 percent of what is deposited with them as cash), the "banking system" can expand the "money supply" by 9 times. But it definitely does not say that a single bank can do this on its own if it receives a deposit from the Fed (or from anywhere else). What banks can do is expand M1 but not M0. They do this when they give anyone a loan in the form of a current account. Nothing is remarkable or fraudulent in this. It's what banks (and loan clubs and credit unions) do. If you include loans via current accounts in the definition of money then of course banks can "create" money. What banks are doing is creating loans not out of thin air but out of the money deposited with them. Banks "create" money but this is only because it defines money as including bank loans (since by bank deposits it means not just what savers have deposited but also deposits banks have opened for those borrowing money from it). This means that, by definition, a bank "creates money" every time it grants a loan. Which in fact is not saying much more than that banks lend money. The real question is: in granting a loan does a bank create extra purchasing power which didn't exist before? This definition is misleading in that it does suggest that this is what banks do. But this is not the case (and the passage does not in fact say this). A bank can only lend already existing purchasing power. It can only lend money it already has, either from deposits by savers or what it has itself borrowed on money markets or its own money. What banks do is to channel money that people don't want to spend for the time being to those who need money (but don't have it) for some project. In lending this money they are no more creating extra purchasing power than I do if I lend you $1000. They are just redistributing it from one person to another. Both the depositor and the borrower cannot spend the same money (any more than you and me could both spend the $1000 I lent you). When a bank makes a loan it doesn't creates money. When a bank makes a loan it loans already existing money, either which savers have deposited with it or which they have themselves borrowed (usually on the money market) or their own money.
In the chapter "Bank Deposits - How They Expand or Contract" it is assumed that the Fed wants to expand "the money supply" ( essentially bank loans), so what it does it to buy "$10,000 of Treasury bills from a dealer in US government securities". This bank (Bank A) now has $10,000 extra cash. As it only needs to retain 10 percent as cash it can now lend out $9,000. It cannot lend, as the way you originally put it suggests, keep the whole $10,000 as cash and lent out $90,000. What happens, according to the booklet, is that Bank A's loan of $9,000 is spent and finds its way back to other banks in the system. Assuming it all ends up in Bank B (which won't be the case since parts of it would normally end up in many different banks), then Bank B has an extra $9,000. It can now lend out 90 percent of this, i.e. $8,100. This in turn ends up in Bank C, which can then lend 90 percent of this, ie. $7,290. And so on till in the end a total of $90,000 will have been lent out. Note that even this will not have been created out of "thin air" since it requires the money from the original $10,000 to be continually re-deposited. If, for some reason it isn't, then the process stops and/or the total amount of bank loans does not reach its theoretical maximum.
A more accurate description of the Fractional Reserve process can be found at http://www.federalreserveeducation.org/fed101/fedtoday/FedTodayAll.pdf page 5
"The fact that banks are required to keep on hand only a fraction of the funds deposited with them is a function of the banking business. Banks borrow funds from their depositors (those with savings) and in turn lend those funds to the banks borrowers (those in need of funds). Banks make money by charging borrowers more for a loan (a higher percentage interest rate) than is paid to depositors for use of their money. If banks did not lend out their available funds after meeting their reserve requirements, depositors might have to pay banks to provide safekeeping services for their money. For the economy and the banking system as a whole, the practice of keeping only a fraction of depositson hand has an important cumulative effect. Referred to as the fractional reserve system, it permits the banking system to "create" money." (The inverted commas round "create" are particularly appropriate. They should also have been around "money" as they are using the word to include "bank deposits" and nobody denies that the circulation of money through the banking system leads to an increase in the number of bank deposits.)
The New York Federal Reserve also gives a rather more sophisticated explanation at http://www.newyorkfed.org/aboutthefed/fedpoint/fed45.html
"Reserve Requirements and Money Creation: Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+81+$72.90+...=$1,000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of $500 ($100+$80+$64+$51.20+...=$500). Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity.
In practice, the connection between reserve requirements and money creation is not nearly as strong as the exercise above would suggest. Reserve requirements apply only to transaction accounts, which are components of M1, a narrowly defined measure of money. Deposits that are components of M2 and M3 (but not M1), such as savings accounts and time deposits, have no reserve requirements and therefore can expand without regard to reserve levels. Furthermore, the Federal Reserve operates in a way that permits banks to acquire the reserves they need to meet their requirements from the money market, so long as they are willing to pay the prevailing price (the federal funds rate) for borrowed reserves. Consequently, reserve requirements currently play a relatively limited role in money creation in the United States." (Note that the pyramid is based on the assumption that the money loaned on the basis of the original deposit is also deposited in a bank.)
Backpack Banking
Let's look at a very simple, analogous example that should clarify the issue.
Let's say that we have a holding facility for backpacks. People drop off (aka deposit) their backpacks at this holding facility, and the holder of the backpacks loans out backpacks to those who need them. If you deposit a backpack with him, you can withdraw it at any time with no advance notice. There is no money paid for the service. No backpack-interest is paid (i.e. if he loans you a backpack, he expects to receive it back after a certain period of time, let's say 1 month -- he does not expect 2 backpacks in return for his loan). All of the backpacks in this society are identical. Anyone who deposits his backpack receives a receipt saying "1 backpack" on it. The holder of these backpacks (let's call him the "banker") keeps account of all the backpacks deposited with him, all of the backpacks on reserve, all of the backpacks loaned to others, and all of the backpacks owed. When youleave a backpack with him, this goes down in his ledger both as a liability (since he owes you a backpack) and as an asset (since he has a backpack). When he loans out a backpack, he records this as an asset.
The banker starts with a reserve of 1 backpack, which was his initial capital that he started with. This is an asset. He expects to keep a total of 1 backpack as an asset at all times (after canceling out liabilities and assets) since that is what he has started out with, and he is not in this business in order to accumulate backpacks but
just to increase the distribution of existing backpacks. He already knows, from previous conversations with famous bankers, that during the month in question, the total number of customer withdrawals is never greater than 1 backpack.
Let's say you, Mr. X, deposit 1 backpack with this banker. He credits your account for 1 backpack, and gives you a receipt letting you know that you have 1 backpack in your account. He goes to his own ledger, and notes that he now has 2 backpacks as assets (the backpack on reserve and the backpack you have loaned him), and 1 backpack as a liability (the backpack in your account).
He doesn't want to keep unnecessary reserves of backpacks in his holding center, so he takes your backpack and loans it to Mr. Y. Mr. Y agrees to give it back to the banker at the end of the month. The banker still has 2 backpacks as his assets (but now 1 is a reserve and 1 is a loan to Mr. Y) and 1 backpack as his liability.
As it so happens, Mr. Y does not need the backpack until next week. So he gives it to the banker to hold for him. The banker gives Mr. Y a receipt saying "1 Backpack", credits Mr. Y's account for 1 backpack, and then goes to his own ledger and counts this backpack as both an asset in his reserve of backpacks, and as a liability. He now has assets of 3 backpacks (2 in his reserve and 1 out on loan to Mr. Y) and liabilities of two backpacks (1 backpack in Mr. X's account and 1 backpack in Mr. Y's account).
Since he still has more than enough backpacks in his reserve to cover the usual number of withdrawals during this month of the year, he loans out a backpack once again, now to Mr. Z. Mr. Z agrees to repay the backpack within 1 month. Unlike Mr. Y, Mr. Z actually needs to use the backpack as his school starts the next day. So he does not deposit this backpack, but just uses it. The banker still has assets of 3 backpacks (but now 1 is in his reserve, 1 has been loaned to Mr. Y, and one has been loaned to Mr. Z) and liabilities of 2 backpacks (still one backpack each in the accounts of Mr. X and Mr. Y).
Looking at it from the perspective of the deposits, Mr. X has 1 backpack in his account, Mr. Y has 1 backpack in his account and one which he owes to the bank within 1 month, and Mr. Z has -1 backpacks.
Over time, economists come along and claim that backpacks are not actually the things you wear on your back, but just ledgers in the accounts of a banker. It is said that Mr. X, Mr. Y and Mr. Z, all have backpacks, except in different forms. The banker has apparently created 3 backpacks, if not out of nothing then out of 1 backpack deposit, and economists look upon this situation as a miracle which arises from the peculiar power of the backpack holding system.
But let's say Mr. X decides he wants his backpack today. He withdraws one backpack from his account. To do honor this claim, the banker has to give Mr. X the 1 backpack that was in his reserve. The reserve is now down to zero, and Mr. X's account has zero backpacks in it. The banker's ledger now reads 2 backpacks as assets (the backpacks loaned to Mr. Y and Mr. Z) and 1 backpack as a liability (in Mr. Y's account). The banker thinks he is okay, since he already suspected that 1 backpack would be withdrawn this month, and he does not expect any more backpacks to be withdrawn until the beginning of the next month, at which point he will have been repaid his loan to Mr. Z and perhaps will have received additional deposits.
As it so happens, Mr. Z's dog eats his backpack and he is forced to default on his debt. The banker has to erase 1 backpack from his assets, so he now has 1 backpack as an asset (the backpack loaned to Mr. Y) and one backpack as a liability (the backpack in Mr. Y's account). But the backpack loaned to Mr. Y was already deposited at the bank and credited to his account. Mr. Y decides he wants the backpack the next week, because school is about to start. He tries to withdraw the backpack but his claim cannot be honored as there are no reserves at the bank. The bank is insolvent and is forced into bankruptcy.
So what has happened in in this hypothetical bank? Have new backpacks been created by loaning out backpacks? No. All that has happened is that the distribution of backpacks has changed. People who are not using their backpacks allow the bank to loan their backpacks out to others, with the expectation that their backpacks will return to them, just as if they held their money in a safe and withdrew their money from time to time, as necessary. The bank has economized on backpacks by reducing the need to form hoards. In the absence of a holding system for backpacks, each owner of a backpack would need to have his own backpack and hold it himself while he isn't using it. Instead, in the banking system, 1 backpack can supply the needs of 3 backpack users. Also note that deposits have not actually increased the
bank's assets, since any backpack the bank acquires through a deposit is not only an asset, but also a liability, which cancels it out. It is neutral.
This all can be applied, with appropriate modification, to a bank that holds money and lends it out at interest.
A bank does not create money whether we consider this from the point of view of an individual bank or the banking system. A bank receives money and credits it to your account, which is basically an IOU saying that the bank will pay you whenever you wish to withdraw your money. In normal circumstances it functions just as well as a piggy-bank would -- in fact even better, as it is simpler to use, there is no need to pay for security costs once the sums get large, and you earn interest on your money. When two customers of the same bank participate in some kind of purchase/sale of a commodity and one writes a check to the other, the bank simply credits the account of one client and debits the account of the other. (Just like if person A owed person B $20, and I owed both person A and B $20, and they agreed to have me pay person B $40 and pay no money to person A.) No money actually enters into the transaction. In Marx's terminology, money figures in here only as a measure of value, not as a means of circulation. The same thing holds in the case of two customers at different banks, where the checks go through a clearing house and cash is only used to settle the balance. The banking system greatly reduces the need for means of circulation, since physical money is only needed to settle remaining balances between parties. But any time you are loaning money out, there is a chance that the money will not return to you and it will be lost. The fact that the bank doesn't create money becomes obvious during a commercial crisis, during which too many depositors try to redeem their IOUs (their deposits) than can be redeemed.
Another description can be read here karthiksankar.com/moneycreation/#
Banks get money from what we deposit in them. Deposits are banks’ liabilities, since banks must return it to us when we ask for the money. Banks lend loans by using this deposit money of ours. Loans are bank’s assets.
The Cash Reserve Ratio:
Reserve Bank of India (RBI) is the central note issuing authority in India. Commercial Banks in India are required to hold a certain proportion of their deposits in the form of cash. This minimum ratio (that is the part of the total deposits to be held as cash) is stipulated by the RBI and is known as the CRR or Cash Reserve Ratio. It is a tool used by RBI to control liquidity in the banking system.
The Process: Let’s assume there are various Banks in the Banking System. Bank_1, Bank_2, Bank_3, etc. Let’s assume the CRR to be 10%.
Anand deposits Rs. 100 in Bank_1. Keeping Rs. 10 in reserve (CRR is 10%), Bank_1 lends Rs.90 to Bala. Bala deposits his Rs.90 in Bank_2. Keeping Rs. 9 in reserve, Bank_2 lends Rs.81 to Clara. Clara deposits her Rs.81 in Bank_3. This process continues.
The Math Behind This: Time for some calculations. In the first cycle, the bank could loan out 90% of Rs.100. In the second cycle, the bank could loan out 90% of 90% of Rs.100. Thus the amount of money the bank can loan out in some period n of the cycle is given by:Rs. 100 * (90%)n
Let A be the amount of money infused into the system (in our case, Rs. 100) Let R be the required reserve ratio (in our case 10%). Let T be the total amount the bank loans out Let n represent the period we are in.
From the equation above, the amount of money the bank can loan out in any period is:
A * (1 – R)n
Thus, the total loan amount is:
T = A*(1 – R)1 + A*(1 – R)2 + A*(1 – R)3 + …
T = A * [ (1 - R)1 + (1 - R )2 + (1 - R)3 + ... ]
Mathematics says,
x1 + x2 + x3 + x4 + … = x / (1-x)
Thus,
T = A * (1 – R) / R
How much money have our banks loaned out using the Rs.100 deposited initially? Using the above equation, this would total up to 100 * (1 – 0.1)/0.1 = Rs.900.
In this entire process, to find the total amount deposited (D), we need to take into account the initial Rs.100 too.
D = A + T
D = A + [ A * (1 - R) / R ]
D = A * (1/R)
Which, for our example, will total to Rs.1000.
The cash in reserve for any period is:
R * A * (1 – R)n-1
Total reserve is:
( R * A ) [1 + (1 - R)1 + (1 - R)2 + (1 - R)3 ... ]
which simplifies to A = Rs. 100
The Balance Sheet: This is how the combined balance sheet of the Banks will look like:
Bank Liabilities-Deposits Assets Credits Reserve Total Assets
Bank_1 100 90 10 100
Bank_2 90 81 9 90
Bank_3 81 72.9 8.1 81
- - - - -
- - - - -
Bank_n 00 00 00 00
Total 1,000 900 100 1000
Such is the power of this simple process that banks have created an asset of Rs.1000 using an initial money of Rs.100. In other words, Banks have created money. This type of banking is called “Fractional Reserve Banking”
Why does this process succeed? This process succeeds because most money transfers today do not involve cash or currency. It involves just cheques, Direct Debit, etc. or electronic transfer – mere numbers on a computer screen.
When would it fail?
This system fails in two main cases:
Cascade of withdrawals - When all depositors come asking for their money back at the same time. The banking system will not have enough currency to meet the demands. In fact, one main purpose of the CRR is that the banks must be able to repay deposits when there are significantly large number of withdrawals.
Loan defaults - What would happen when the debtors default or fail to repay the loans? This would also result in banks having insufficient money to pay back depositors.
The financial system is much more complicated than what we have discussed. But the above two are one of the basic reasons for the recent recession – just that it involved a cascade of selling stocks on the market, and defaults of subprime mortgage loans.
SOURCE-blog.karthiksankar.com/moneycreation/
The above described correctly how the banking system as a whole (but not a single bank on its own) can, on the assumption of a 10% cash ratio, eventually make loans totaling Rs 900 from an initial deposit of Rs 100. What is misleading, however, is saying that this means that "banks create money out of thin air". They are lending out only what has been deposited with them (in fact only 90% of this). What is happening is that the initial deposit of Rs 100 is being continually recycled in the form of new deposits. You yourself actually state this yourself when you say total loans amount to Rs 900 and total deposits to Rs 1000:
How much money have our banks loaned out using the Rs. 100 deposited initially? Using the above equation, this would total up to 100 * (1 – 0.1)/0.1 = Rs. 900. In this entire process, to find the total amount deposited (D), we need to take into account the initial Rs. 100 too.
D = A + T
D = A + [ A * (1 - R) / R ]
D = A * (1/R)
which, for our example, will total to Rs. 1000.
In other words, total loans cannot exceed total deposits. What banks are doing is creating loans not out of thin air but out of the money deposited with them.
As it happens, an article Financial Times confirms that banks can only lend money they've already got (either from their own capital and reserves or from depositors or what they have themselves borrowed from the money market):
http://www.ft.com/cms/s/0/1637c530-653a-11df-b648-00144feab49a.html
"Yesterday, the CML [Council of Mortgage Lenders] warned that its own members - who make roughly 94 per cent of all the mortgage loans in Britain - are facing higher costs as they compete for retail deposits to replace maturing wholesale loans. This is likely to mean that rates on mortgages may have to rise even if the Bank rate remains on hold." What is happening is that money which the banks have borrowed from the money market is due to be repaid soon and they are seeking alternative sources of money to re-lend, from depositors. To attract depositors they have to offer them a higher rate of interest. Which means that, to make a profit, they will have to charge a higher rate of interest too to those they lend money to. Banks make a profit out of the difference between the rate of interest at which they borrow money and the higher rate at which they re-lend it. If they really could create money to lend by simply monetarising what a potential borrower would owe them they would never be in the position reported by the Financial Times. But they are.
Banks, in pursuit of profit, have every incentive to make as many loans as they can (since the more loans they make the more income they stand to get as interest) and that in recent years they overdid this by creating all sorts of complicated and dubious loans financed by money they had borrowed on the money market. This all came unstuck when the US housing construction sector "overproduced" houses (in relation to paying demand, not real need, ). That's the way capitalism works. In a boom every capitalist enterprise (banks included) tries to make as much profits as they can. Then one sector overproduces and this has a knock-on effect on the rest of the economy. This happens every time and there's nothing governments can do to stop it. That's one reason why we've got to get rid of capitalism and its production for profit and replace it with socialism and production directly for use.
If you just abolished the Fed and brought in a different monetary system this would still leave corporations owning and controlling productive resources and using them to generate a profit rather than to directly satisfy people's needs. So world poverty, pollution, wars, waste, etc that arise from the competitive struggle between profit-seeking corporations would continue. No monetary reform can change this. Rather than thinking about new banking structures, surely the most urgent need is to get rid of capitalism (of which banking is just a part) altogether! A fundamental point is that it's not "greed" which has caused this crisis, it's capitalism. Crisis is inherent to capitalism and the only way to have a world without crisis is to have a world without capitalism. That means consciously dismantling capitalist social relations: money, commodity production, wage labour, national frontiers and ... banks!!
SEE HERE
http://www.worldsocialism.org/spgb/jan09/page12.html
http://www.marxists.org/archive/hardcastle/creatingcredit.htm
http://en.wikipedia.org/wiki/Subprime_mortgage_crisis
Friday, February 25, 2011
power brokers
The term "tax haven" is a bit of a misnomer, because such places aren't just about tax. What they sell is escape: from the laws, rules and taxes of jurisdictions elsewhere, usually with secrecy as their prime offering. The notion of elsewhere (hence the term "offshore") is central. The Cayman Islands' tax and secrecy laws are not designed for the benefit of the 50,000-odd Caymanians, but help wealthy people and corporations, mostly in the US and Europe, get around the rules of their own democratic societies. The outcome is one set of rules for a rich elite and another for the rest of us. Nearly every multinational corporation has offshore subsidiaries (not counting those in London) - and the biggest users of offshore finance are banks. Financial Mail recently counted over 550 offshore subsidiaries just for Barclays, RBS and Lloyds - each of which far outstrips any other multinational. Barclays chief executive, Bob Diamond, who told the UK Treasury select committee that he didn't know how many offshore subsidiaries his bank had.
The 1.2-square-mile slab of prime real estate in central London that is the City of London is an offshore island inside Britain, a tax haven in its own right. A Teflon-like, medieval institution dedicated to keeping finance strong and free.The City's "elsewhere" status in Britain stems from a simple formula: over centuries, sovereigns and governments have sought City loans, and in exchange the City has extracted privileges and freedoms from rules and laws to which the rest of Britain must submit. A few symbolic examples illustrate the carve-out. Whenever the Queen makes a state entry to the City, she meets a red cord raised by City police at Temple Bar. In this ceremony, the lord mayor recognises the Queen's authority, but the relationship is complex: as the corporation itself says: "The right of the City to run its own affairs was gradually won as concessions were gained from the Crown.". Then there is the Remembrancer, the City's official lobbyist in parliament, sitting opposite the Speaker, and is "charged with maintaining and enhancing the City's status and ensuring that its established rights are safeguarded". And the City's Cash, "a private fund built up over the last eight centuries". Its assets are beyond proper democratic scrutiny. The corporation has two main claims to being a tax haven: first, as a semi-alien entity, floating partly free from Britain (just as the Cayman Islands are), and second, as the hub of a global network of tax havens sucking up offshore trillions from around the world and sending it, or the business of handling it, to London. the role of the City of London Corporation as a municipal authority (and Lord Mayor) is it is a hugely resourced international offshore lobbying group pushing for international financial deregulation, tax-cutting and tax havenry around the world. In 2008, the City of London accounted for 4% of UK GDP
In his book Treasure Islands, Nicholas Shaxson, describes how Bank of England, in effect encouraged tax havenry in British outposts of the Caribbean and elsewhere. By the 1980s, the City was at the centre of a great, secretive financial web cast across the globe. The Crown dependencies of Jersey, Guernsey and the Isle of Man, which focus heavily on European business, form the web's inner ring. In the second quarter of 2009, Jersey alone provided £135bn in bank deposits upstreamed to the City. Jersey Finance, the tax haven's promotional body, puts the relationship plainly: "Jersey is an extension of the City of London." The next ring of the web contains the British overseas territories, such as the Cayman Islands and Bermuda. Like the Crown dependencies, they have governors appointed by the Queen and are controlled by Britain in myriad ways, but with enough distance to allow Britain to say "There is nothing we can do" when it suits. The web's outer ring contains an assortment of havens, such as Mauritius in the Indian Ocean, Hong Kong and the Bahamas, which Britain does not control but which still feed billions in business to the City from around the world.
Over the centuries, reformers in Britain have tried, and failed, to have the corporation merged into a unified London authority. In 1917, Peter Mandelson's grandfather Herbert Morrison, plainly declared "Is it not time London faced up to the pretentious buffoonery of the City of London Corporation and wipe it off the municipal map?" he asked. "The City is now a square mile of entrenched reaction, the home of the devilry of modern finance." Clement Attlee in 1937. "Over and over again we have seen that there is in this country another power than that which has its seat at Westminster," he said. "Those who control money can pursue a policy at home and abroad contrary to that which has been decided by the people." In 1996, Tony Blair got Labour to replace its pledge to abolish the corporation with a promise merely to "reform" it.
Like any other local authority, the City of London is divided into wards. These elect candidates to serve on the Court of Common Council, the City's principal decision-making body. Unlike any other local authority, however, individual people are not the only voters: businesses can vote, too. Political parties are not involved - candidates stand alone as independents. Before 2002, the 17,000 business votes (only business partnerships and sole traders could take part) already swamped the 6,000-odd residents. Blair's reforms expanded the business vote to about 32,000 and gave a say, based on the size of their workforce in the Square Mile, to international banks and other big players. Voting reflect the wishes not of the City's 300,000 workers, (these workers did not have control of their own votes - the reform programme was comparable to the voting rights of chattel owners in the pre-war American South: the slavery franchise.) but of corporate managements. So Goldman Sachs and the People's Bank of China get to vote in what is arguably Britain's most important local election.
"The Corporation, which runs the City like a one-party mini-state, is an unreconstructed old boys' network whose medievalist pageantry camouflages the very real power and wealth which it holds." - Rough Guide to England, 2006
taken from here
The 1.2-square-mile slab of prime real estate in central London that is the City of London is an offshore island inside Britain, a tax haven in its own right. A Teflon-like, medieval institution dedicated to keeping finance strong and free.The City's "elsewhere" status in Britain stems from a simple formula: over centuries, sovereigns and governments have sought City loans, and in exchange the City has extracted privileges and freedoms from rules and laws to which the rest of Britain must submit. A few symbolic examples illustrate the carve-out. Whenever the Queen makes a state entry to the City, she meets a red cord raised by City police at Temple Bar. In this ceremony, the lord mayor recognises the Queen's authority, but the relationship is complex: as the corporation itself says: "The right of the City to run its own affairs was gradually won as concessions were gained from the Crown.". Then there is the Remembrancer, the City's official lobbyist in parliament, sitting opposite the Speaker, and is "charged with maintaining and enhancing the City's status and ensuring that its established rights are safeguarded". And the City's Cash, "a private fund built up over the last eight centuries". Its assets are beyond proper democratic scrutiny. The corporation has two main claims to being a tax haven: first, as a semi-alien entity, floating partly free from Britain (just as the Cayman Islands are), and second, as the hub of a global network of tax havens sucking up offshore trillions from around the world and sending it, or the business of handling it, to London. the role of the City of London Corporation as a municipal authority (and Lord Mayor) is it is a hugely resourced international offshore lobbying group pushing for international financial deregulation, tax-cutting and tax havenry around the world. In 2008, the City of London accounted for 4% of UK GDP
In his book Treasure Islands, Nicholas Shaxson, describes how Bank of England, in effect encouraged tax havenry in British outposts of the Caribbean and elsewhere. By the 1980s, the City was at the centre of a great, secretive financial web cast across the globe. The Crown dependencies of Jersey, Guernsey and the Isle of Man, which focus heavily on European business, form the web's inner ring. In the second quarter of 2009, Jersey alone provided £135bn in bank deposits upstreamed to the City. Jersey Finance, the tax haven's promotional body, puts the relationship plainly: "Jersey is an extension of the City of London." The next ring of the web contains the British overseas territories, such as the Cayman Islands and Bermuda. Like the Crown dependencies, they have governors appointed by the Queen and are controlled by Britain in myriad ways, but with enough distance to allow Britain to say "There is nothing we can do" when it suits. The web's outer ring contains an assortment of havens, such as Mauritius in the Indian Ocean, Hong Kong and the Bahamas, which Britain does not control but which still feed billions in business to the City from around the world.
Over the centuries, reformers in Britain have tried, and failed, to have the corporation merged into a unified London authority. In 1917, Peter Mandelson's grandfather Herbert Morrison, plainly declared "Is it not time London faced up to the pretentious buffoonery of the City of London Corporation and wipe it off the municipal map?" he asked. "The City is now a square mile of entrenched reaction, the home of the devilry of modern finance." Clement Attlee in 1937. "Over and over again we have seen that there is in this country another power than that which has its seat at Westminster," he said. "Those who control money can pursue a policy at home and abroad contrary to that which has been decided by the people." In 1996, Tony Blair got Labour to replace its pledge to abolish the corporation with a promise merely to "reform" it.
Like any other local authority, the City of London is divided into wards. These elect candidates to serve on the Court of Common Council, the City's principal decision-making body. Unlike any other local authority, however, individual people are not the only voters: businesses can vote, too. Political parties are not involved - candidates stand alone as independents. Before 2002, the 17,000 business votes (only business partnerships and sole traders could take part) already swamped the 6,000-odd residents. Blair's reforms expanded the business vote to about 32,000 and gave a say, based on the size of their workforce in the Square Mile, to international banks and other big players. Voting reflect the wishes not of the City's 300,000 workers, (these workers did not have control of their own votes - the reform programme was comparable to the voting rights of chattel owners in the pre-war American South: the slavery franchise.) but of corporate managements. So Goldman Sachs and the People's Bank of China get to vote in what is arguably Britain's most important local election.
"The Corporation, which runs the City like a one-party mini-state, is an unreconstructed old boys' network whose medievalist pageantry camouflages the very real power and wealth which it holds." - Rough Guide to England, 2006
taken from here
Thursday, November 25, 2010
Greedy Bankers Or Capitialism
Recessions are inherent in the boom bust cycle of capital. "Greedy bankers" are a scapegoat distracting from the fact that this will happen again and again and again. Blaming them implies you could have a nicer capitalism with good bankers. Pinning the blame on greedy bankers lets the real culprits off the hook. This is not just a financial crisis, but a crisis of the whole capitalist economy in which the whole business and political class are fully implicated.
If a few get rich while millions lose out big style, then this is capitalism working as it only can work. If there is recession followed by boom followed by recession, then capitalism is working healthily. Capitalism is working perfectly well. It works the only way it can work - in an anarchic and chaotic manner, negligent and oblivious to the misery and suffering it creates. As usual it is the working class that suffers the cutbacks, the reduced standard of living, and the vicious and right-wing reform programmes that every such crisis engenders.
That capitalism is chaotic is evident. Its frequent booms and slumps— its unavoidable features— become global. The disasters get bigger, and nastier. Those who pointed to the relatively rapid rate of capital accumulation to deny the socialist contention that world capitalism has been in a depressive state since the end of the post-war boom in the early 1970s have had their come-uppance. Marx was right. They were wrong. There can be no such thing as a permanent boom. Marx, the first person to provide a convincing analysis of how the capitalist economic system worked.Capital accumulation proceeds by fits and starts, periods of relatively rapid growth being followed by periods of contraction and stagnation. The graph of long-term growth under capitalism is not a straight line moving up from left to right but a jagged line with peaks and troughs, with each peak normally higher than the previous one. Marx argued that this cyclical pattern of growth was not just accidental but was inevitable under capitalism-it was the way capitalism functioned and developed, its "law of motion" as he put it-with each period of rapid growth ending in a slump and each slump preparing the conditions for the next round of growth.Capitalism is driven, not by consumer demand, but by the drive to make and accumulate profits as further capital and that this is by no means a smooth process.
In order to maintain or increase their share of the market and realise the surplus value embodied in their products, capitalist firms are compelled by competition to reduce their costs by improving their productivity, in particular by the introduction of more productive machines. This leads to an increase in overall productive capacity. During the period of recovery that follows a slump this poses no problem as the market is beginning to recover and expand again. However, as the competitive pressures to increase productive capacity continue, the point is eventually reached when productive capacity in a key industry or group of industries comes to outstrip the market demand for its products. At this point a crisis of overproduction breaks out. As profits fall, production is cut back, workers are laid off and, through the knock-on effect on other industries, the market shrinks, so inaugurating the period of slump. During the slump, the least productive machines are taken out of production and capital is depreciated or simply written off. This purge of under-productive machinery and over-valued capital eventually creates the conditions which allow capitalist growth to recommence, so beginning the boom-slump cycle again. This is how capitalism has developed and continues to develop.
A key factor in this is that capitalism's financial apparatus is largely built on confidence that transactions will be smooth and payments will be met. When this confidence in the efficiency of trade and commerce starts to ebb then things can take spectacular and serious turns for the worse. The erosion of financial confidence is one of the ways in which a downturn in one sector or country can spread to others.
The financial crisis is a reflection of the fact that stock exchange and foreign currency gamblers have realised that countries have expanded their productive capacities beyond market demand. One consequence of this period of slow growth was that significant amounts of profits were not being reinvested in production but, instead, being held in liquid form and invested in financial assets with the aim of making as large a short-term profit in as short a time as possible. All the multinational corporations had treasury departments engaged in financial speculation of one form or another whether on the stock exchange, the bond market, currency transactions, commodity markets or dodgy hedges such as derivatives.
This extra demand for financial assets, deriving from non-reinvested profits, has driven up their price, so creating the anomalous situation of a stock exchange boom in what is essentially a depressed economy. Most of the financial transactions that took place were not investments of productive capital- not used to set up factories or to buy machinery, equipment or raw materials-but are to buy and sell shares or bonds or foreign currencies or commodity futures or property or failing companies to asset strip them. Such purely financial transactions are utterly unproductive, even from a capitalist point of view. Not only do they not result in the production of a single extra item of wealth but they don't even increase the amount of surplus value available for sharing amongst the various sections of the capitalist class. It's a zero-sum game. As socialists have always maintained, stock exchanges are places where capitalists gamble and try to cheat each other with a view to acquiring as large a mass as possible of the surplus value that has already been produced by and robbed from the workforce.
The bankers are not wicked finance capitalists against whom the anger of workers should particularly be directed, just capitalists with their capital invested in a particular line of business, no more nor less reprehensible than the rest of the blood sucking parasitic capitalist class.
If a few get rich while millions lose out big style, then this is capitalism working as it only can work. If there is recession followed by boom followed by recession, then capitalism is working healthily. Capitalism is working perfectly well. It works the only way it can work - in an anarchic and chaotic manner, negligent and oblivious to the misery and suffering it creates. As usual it is the working class that suffers the cutbacks, the reduced standard of living, and the vicious and right-wing reform programmes that every such crisis engenders.
That capitalism is chaotic is evident. Its frequent booms and slumps— its unavoidable features— become global. The disasters get bigger, and nastier. Those who pointed to the relatively rapid rate of capital accumulation to deny the socialist contention that world capitalism has been in a depressive state since the end of the post-war boom in the early 1970s have had their come-uppance. Marx was right. They were wrong. There can be no such thing as a permanent boom. Marx, the first person to provide a convincing analysis of how the capitalist economic system worked.Capital accumulation proceeds by fits and starts, periods of relatively rapid growth being followed by periods of contraction and stagnation. The graph of long-term growth under capitalism is not a straight line moving up from left to right but a jagged line with peaks and troughs, with each peak normally higher than the previous one. Marx argued that this cyclical pattern of growth was not just accidental but was inevitable under capitalism-it was the way capitalism functioned and developed, its "law of motion" as he put it-with each period of rapid growth ending in a slump and each slump preparing the conditions for the next round of growth.Capitalism is driven, not by consumer demand, but by the drive to make and accumulate profits as further capital and that this is by no means a smooth process.
In order to maintain or increase their share of the market and realise the surplus value embodied in their products, capitalist firms are compelled by competition to reduce their costs by improving their productivity, in particular by the introduction of more productive machines. This leads to an increase in overall productive capacity. During the period of recovery that follows a slump this poses no problem as the market is beginning to recover and expand again. However, as the competitive pressures to increase productive capacity continue, the point is eventually reached when productive capacity in a key industry or group of industries comes to outstrip the market demand for its products. At this point a crisis of overproduction breaks out. As profits fall, production is cut back, workers are laid off and, through the knock-on effect on other industries, the market shrinks, so inaugurating the period of slump. During the slump, the least productive machines are taken out of production and capital is depreciated or simply written off. This purge of under-productive machinery and over-valued capital eventually creates the conditions which allow capitalist growth to recommence, so beginning the boom-slump cycle again. This is how capitalism has developed and continues to develop.
A key factor in this is that capitalism's financial apparatus is largely built on confidence that transactions will be smooth and payments will be met. When this confidence in the efficiency of trade and commerce starts to ebb then things can take spectacular and serious turns for the worse. The erosion of financial confidence is one of the ways in which a downturn in one sector or country can spread to others.
The financial crisis is a reflection of the fact that stock exchange and foreign currency gamblers have realised that countries have expanded their productive capacities beyond market demand. One consequence of this period of slow growth was that significant amounts of profits were not being reinvested in production but, instead, being held in liquid form and invested in financial assets with the aim of making as large a short-term profit in as short a time as possible. All the multinational corporations had treasury departments engaged in financial speculation of one form or another whether on the stock exchange, the bond market, currency transactions, commodity markets or dodgy hedges such as derivatives.
This extra demand for financial assets, deriving from non-reinvested profits, has driven up their price, so creating the anomalous situation of a stock exchange boom in what is essentially a depressed economy. Most of the financial transactions that took place were not investments of productive capital- not used to set up factories or to buy machinery, equipment or raw materials-but are to buy and sell shares or bonds or foreign currencies or commodity futures or property or failing companies to asset strip them. Such purely financial transactions are utterly unproductive, even from a capitalist point of view. Not only do they not result in the production of a single extra item of wealth but they don't even increase the amount of surplus value available for sharing amongst the various sections of the capitalist class. It's a zero-sum game. As socialists have always maintained, stock exchanges are places where capitalists gamble and try to cheat each other with a view to acquiring as large a mass as possible of the surplus value that has already been produced by and robbed from the workforce.
The bankers are not wicked finance capitalists against whom the anger of workers should particularly be directed, just capitalists with their capital invested in a particular line of business, no more nor less reprehensible than the rest of the blood sucking parasitic capitalist class.
Wednesday, March 25, 2009
Perfectly understandable
The Edinburgh home of former Royal Bank of Scotland boss Sir Fred Goodwin has been attacked . A police car is now guarding the entrance to Sir Fred's home, in the Grange area of the city.
Three smashed ground-floor windows of the stone villa were clearly visible. In the driveway, the rear window of a dark-coloured Mercedes saloon was smashed, as well as the nearside rear passenger window.
A statement was issued to Edinburgh's Evening News on Wednesday morning by a group which claimed it was behind the attack.
It said: "We are angry that rich people, like him, are paying themselves a huge amount of money, and living in luxury, while ordinary people are made unemployed, destitute and homeless. This is a crime. Bank bosses should be jailed. This is just the beginning."
It said: "We are angry that rich people, like him, are paying themselves a huge amount of money, and living in luxury, while ordinary people are made unemployed, destitute and homeless. This is a crime. Bank bosses should be jailed. This is just the beginning."
No comment ;-)
Thursday, February 26, 2009
Where are they now
Everybody blames the bankers for the crisis , and probably rightly so , but just how much of the consequences of their actions have they had to confront and face ?
The Independent describes how failed bank directors still sit in the board-rooms :
Bradford & Bingley
Michael Buckley (non-exec 2007-08). A director of Nicola Horlick’s Bramdean Alternatives and sits on the M&T Bank board in the US.
Ian Cheshire (n-x 2003-08). Chief executive of Kingfisher, the B&Q group.
Nick Cosh (n-x 1999-2008). Director of City brokers Icap.
Sir George Cox (2000-07). Commentator on the banking crisis and chairs Warwick Business School’s advisory board.
Rod Kent (n-x chairman 2002-08). A governor of Wellcome Trust and chairs the Duke of Westminster’s £13bn Grosvenor empire,
Lady Patten (n-x 2003-08). Sits on the Marks & Spencer board and chairs the Brixton property group.
Stephen Webster (n-x 2003-08). Finance director at Wolseley plumbing goods group.
HBOS
Sir James Crosby (1994-2006). Is still senior independent director at ITV and the Compass catering group, and last month became a director of Mysis, the software company.
Charles Dunstone (n-x 2000-08). A director of Daily Mail & General Trust and the Prince’s Trust besides running Carphone Warehouse.
Mike Ellis (finance director 1987-2004, 07-09). Is now a WH Smith director.
Tony Hobson (n-x 2001-06). Chairs Northern Foods and is a director of water company Glas Cymru.
Philip Hodkinson (finance director 2005-08). Chairs the audit committees at BT and Travelex. Director of HM Revenue & Customs.
Andy Hornby (1999-2009). Remains a director of Home Retail, the Homebase and Argos chains.
Sir Brian Ivory (n-x 1998-2007). Director of Scottish American Investment Trust and Rémy Contreau.
Karen Jones (n-x 2006-09). The founder of Café Rouge recently joined the Virgin Active board.
Kate Nealon (n-x 2004-09). Sits on the Cable & Wireless and Shire drugs group boards.
David Shearer (n-x 2004-07). Senior independent director at STV and chairman of Crest Nicholson.
Lord Stevenson (chairman 1999-2009). Director of Western Union and Loudwater Investments.
Mark Tucker (finance director 2004-05). Returned to the Prudential, where he is chief executive.
Northern Rock
David Baker (1973-2007). Chairs Northeast Enterprise Bond.
Sir Ian Gibson (n-x 2002-08). The former senior independent director chairs Trinity Mirror and the Wm Morrison supermarket group.
Michael McQueen (n-x 2005-08). Chief executive of the FTSE 100 private-equity group 3i.
Nichola Pease (n-x 1999-2007). Deputy chairman at JO Hambro Capital Management.
Matt Ridley (1996-2007 and chairman from 2004). Remains a governor of the Ditchley Foundation conference group with government ministers.
Sir George Russell (n-x 1996-2006). Deputy chairman of ITV and the veteran of boardrooms from 3i and Taylor Woodrow to Camelot.
Sir Derek Wanless (n-x 2000-07). Chaired credit and risk committees. Vice-chairman of Statistics Commission and chairs Northumbrian Water.
Royal Bank of Scotland
Colin Buchan (n-x 2002-). Remains an RBS director. His other boards include Standard Life and two Merrill Lynch trusts.
Jim Currie (n-x 2001-09). Director of Dutch aluminium group Vimetco plus the Met Office.
Larry Fish (1993-2008). Chairman of US Citizens Bank and director of Textron – the Cessna and Bell Helicopter group.
Sir Fred Goodwin (1998-2008). Chairman of the Prince’s Trust.
Archie Hunter (n-x 2004-). Audit committee chairman, still sits on the board and is director of Macfarlane Group and an investment trust.
Bud Koch (n-x 2004-09). A director of the federal Home Loan Bank of Cincinnati.
Janis Kong (n-x 2006-09). Director of Kingfisher, Portmeirion pottery, Visit Britain and chairs the Forum for the Future environmental group.
Joe MacHale (2004-). Still senior non-exec and a director of Morgan Crucible and Brit Insurance.
Sir Tom McKillop (2005-08). Director of BP and a Spanish drugs group, plus a trustee of the Council for Industry & Higher Education.
Sir George Matthewson (2001-06 after nine years running the bank). Now chairs the Edinburgh government’s Council for Economic Advisers.
Gordon Pell (2000-). Still an RBS executive director. Chairs the Business Commission on Racial Equality and is on the FSA Practitioner Panel.
Sir Steve Robson (n-x 2001-09). The former adviser to the Chancellors is now a director of JP Morgan Cazenove, mining group Xstrata and the Government’s Partnerships UK.
Bob Scott (n-x 2001-08). Chairs the Yell group with directorships of Swiss-re and Crimestoppers.
Peter Sutherland (n-x 2001-09). Chairman of BP and Goldman Sachs International and advises EC president Jose Barraso on climate change.
Guy Whittaker (2006-). Now finance director.
Not too bad for people with now a track record of incompetence and negligence
The Independent describes how failed bank directors still sit in the board-rooms :
Bradford & Bingley
Michael Buckley (non-exec 2007-08). A director of Nicola Horlick’s Bramdean Alternatives and sits on the M&T Bank board in the US.
Ian Cheshire (n-x 2003-08). Chief executive of Kingfisher, the B&Q group.
Nick Cosh (n-x 1999-2008). Director of City brokers Icap.
Sir George Cox (2000-07). Commentator on the banking crisis and chairs Warwick Business School’s advisory board.
Rod Kent (n-x chairman 2002-08). A governor of Wellcome Trust and chairs the Duke of Westminster’s £13bn Grosvenor empire,
Lady Patten (n-x 2003-08). Sits on the Marks & Spencer board and chairs the Brixton property group.
Stephen Webster (n-x 2003-08). Finance director at Wolseley plumbing goods group.
HBOS
Sir James Crosby (1994-2006). Is still senior independent director at ITV and the Compass catering group, and last month became a director of Mysis, the software company.
Charles Dunstone (n-x 2000-08). A director of Daily Mail & General Trust and the Prince’s Trust besides running Carphone Warehouse.
Mike Ellis (finance director 1987-2004, 07-09). Is now a WH Smith director.
Tony Hobson (n-x 2001-06). Chairs Northern Foods and is a director of water company Glas Cymru.
Philip Hodkinson (finance director 2005-08). Chairs the audit committees at BT and Travelex. Director of HM Revenue & Customs.
Andy Hornby (1999-2009). Remains a director of Home Retail, the Homebase and Argos chains.
Sir Brian Ivory (n-x 1998-2007). Director of Scottish American Investment Trust and Rémy Contreau.
Karen Jones (n-x 2006-09). The founder of Café Rouge recently joined the Virgin Active board.
Kate Nealon (n-x 2004-09). Sits on the Cable & Wireless and Shire drugs group boards.
David Shearer (n-x 2004-07). Senior independent director at STV and chairman of Crest Nicholson.
Lord Stevenson (chairman 1999-2009). Director of Western Union and Loudwater Investments.
Mark Tucker (finance director 2004-05). Returned to the Prudential, where he is chief executive.
Northern Rock
David Baker (1973-2007). Chairs Northeast Enterprise Bond.
Sir Ian Gibson (n-x 2002-08). The former senior independent director chairs Trinity Mirror and the Wm Morrison supermarket group.
Michael McQueen (n-x 2005-08). Chief executive of the FTSE 100 private-equity group 3i.
Nichola Pease (n-x 1999-2007). Deputy chairman at JO Hambro Capital Management.
Matt Ridley (1996-2007 and chairman from 2004). Remains a governor of the Ditchley Foundation conference group with government ministers.
Sir George Russell (n-x 1996-2006). Deputy chairman of ITV and the veteran of boardrooms from 3i and Taylor Woodrow to Camelot.
Sir Derek Wanless (n-x 2000-07). Chaired credit and risk committees. Vice-chairman of Statistics Commission and chairs Northumbrian Water.
Royal Bank of Scotland
Colin Buchan (n-x 2002-). Remains an RBS director. His other boards include Standard Life and two Merrill Lynch trusts.
Jim Currie (n-x 2001-09). Director of Dutch aluminium group Vimetco plus the Met Office.
Larry Fish (1993-2008). Chairman of US Citizens Bank and director of Textron – the Cessna and Bell Helicopter group.
Sir Fred Goodwin (1998-2008). Chairman of the Prince’s Trust.
Archie Hunter (n-x 2004-). Audit committee chairman, still sits on the board and is director of Macfarlane Group and an investment trust.
Bud Koch (n-x 2004-09). A director of the federal Home Loan Bank of Cincinnati.
Janis Kong (n-x 2006-09). Director of Kingfisher, Portmeirion pottery, Visit Britain and chairs the Forum for the Future environmental group.
Joe MacHale (2004-). Still senior non-exec and a director of Morgan Crucible and Brit Insurance.
Sir Tom McKillop (2005-08). Director of BP and a Spanish drugs group, plus a trustee of the Council for Industry & Higher Education.
Sir George Matthewson (2001-06 after nine years running the bank). Now chairs the Edinburgh government’s Council for Economic Advisers.
Gordon Pell (2000-). Still an RBS executive director. Chairs the Business Commission on Racial Equality and is on the FSA Practitioner Panel.
Sir Steve Robson (n-x 2001-09). The former adviser to the Chancellors is now a director of JP Morgan Cazenove, mining group Xstrata and the Government’s Partnerships UK.
Bob Scott (n-x 2001-08). Chairs the Yell group with directorships of Swiss-re and Crimestoppers.
Peter Sutherland (n-x 2001-09). Chairman of BP and Goldman Sachs International and advises EC president Jose Barraso on climate change.
Guy Whittaker (2006-). Now finance director.
Not too bad for people with now a track record of incompetence and negligence
Thursday, April 24, 2008
mediocre talent - rich rewards
"At the heart of many of Wall Street's problems has been a serious misalignment between the interests of managers and shareholders. It's clear a number of investment banks overlooked basic risk controls in their drive to increase profits. This pattern of behaviour has been exacerbated by a remuneration structure which has encouraged some employees to take spectacular short-term risks, confident that if things work out well they will reap huge rewards, and that if they don't they won't be around to pay the price." - said Richard Lambert , director general of the CBI
The bonus culture has turned thousands of relatively mediocre performers in the banking industry into multi-millionaires, while top performers have earned vast sums. The head of Barclays investment banking, Bob Diamond, was paid £36m last year even though Barclays took a £1.6bn hit from the US sub-prime crisis.
The bonus culture has turned thousands of relatively mediocre performers in the banking industry into multi-millionaires, while top performers have earned vast sums. The head of Barclays investment banking, Bob Diamond, was paid £36m last year even though Barclays took a £1.6bn hit from the US sub-prime crisis.
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