CIVIC REPUBLICAN NEWSLETTER
“Constructing a Humanist Politics”
Issue No 17 Friday 2 January 2009
· The Fundamental Problem That Brought About The Financial Meltdown --- The Creation Of The Money Supply Was Left To Private Banks Not The Government.
What is happening now of interest to Civic Republicanism
· The Fundamental Problem That Brought About The Financial Meltdown - The Creation Of The Money Supply Was Left To Private Banks Not The Government.
A very clever fellow pointed out the meaning behind all those noughts in the year “2000”. They are bubbles. Three bubbles in one year had to point to something and indeed it did – the bursting of the dotcom bubble. Of course, the dotcom bubble seems totally friendly compared to the bursting of the accumulative financial bubble that occurred in 2008 even though the bubble count of that recently passed year was only two. “No” say some bubble soothsayers, the “8” counts as two bubbles giving the year an astonishing four on the bubble scale. So bubble watchers might have seen the cataclysm of 2008 coming. But, of course, no one else did. No one could have predicted the greatest Ponzi Scheme in human history. It happened as follows without anyone apparently noticing
1. Sell mortgages to people who cannot afford them using borrowed money
2. Repackage the loans as “securities” which makes it all but impossible to assess the value of the debt
3. Sell the securities to unsuspecting banks who then find they own little or nothing
4. Continue doing the same to boost the housing market so magnifying the gains from the process.
5. Get the hell out with your winnings before everyone recognizes the blindingly obvious
Nouriel Roubini, a Professor of Economics at New York University, has been widely credited with being the first to spot what was happening in the financial markets and in the economy because of his warnings in 2007. But -uh-um - some of us knew along time before that what was happening, especially those who had lived through the Thatcher boom and bust. Your Civic Republican Newsletter editor had this letter published in The Observer, nearly six years ago, on 9 February 2003:
“Gordon Brown recently prided himself on the fact that the UK alone has achieved economic growth over the last six years. But this growth has been achieved solely off the back of equity withdrawal in the housing market and consumer borrowing on credit cards. Why has this happened?
Because the high pound has created relatively low inflation and low interest rates and this has fuelled the rise in house prices.
The rise in house prices started with the election of New Labour. People were persuaded that this resulted in an economic sea change and so the housing market recovered – just as they believed in the eighties that Thatcher had created a new economic paradigm.
When the New Labour magic is found out, the market will decline and may take a decade to recover, The motor of the New Labour boom will be removed.”
If you go back more like ten years to 19 September 1999 in the same newspaper a letter from your correspondent was published saying”
“The British economy may be in danger of being once again “up the creek”.
The underlying situation is bad but the reality is masked by the high pound (itself largely the result of international unfamiliarity with the new euro). This has the effect of producing low headline inflation due to cheap imports, obscuring the fact that the high pound is hitting manufacturing and wrecking the balance of payments. Wage inflation, unable to feed into shopping basket inflation, vents itself in house price inflation. In many ways the late nineties is a replica of the late eighties. And with one other crucial factor.
Just as many truly believed that Thatcherism has created a sea change in attitudes and the economy that meant that the normal laws of economics could be set aside, so many believe the same thing of New Labour. This psychological dimension compounds the danger enormously.”
A strong creator of this psychological dimension that mysteriously no one ever mentions now – probably out of embarrassment of being so roundly taken in – is the (so-called) independence to set interest rates given to the Bank of England in 1997 with the arrival of Gordon Brown at the Treasury. People now are much more likely to dwell on the true revolution at the Bank he created at the same time in passing its long held regulatory function to a new, private-bank-financed quango, the Financial Services Authority.
However, for many years even normally quite intelligent people thought that the Bank setting interest rates created a revolution in the running of the financial affairs of the country to the extent that, yes, boom and bust had actually been abolished. In reality the change was of little significance. For one thing, the independence was illusory, as now is evident to everyone expect the most gullible, and for another, previous decisions had never been made by a Chancellor alone but by the Chancellor together with a whole range of professional advisors at the Treasury – not to mention some members of his cabinet.
(For more on this go to:http://civicrepublicans.newsvine.com/_news/2007/10/10/1015977-the-independence-of-the-bank-of-england-has-proved-to-be-an-illusion-perhaps-it-always-was-william-rees-mogg)
Your editor’s comments referred to above and published in The Observer were laughed off by many because they were so evidently wrong. I predicted year after year a house price crash and each time the example of being wrong for many years was cited as proof of my error. My reply that the longer I was wrong the worse the eventual crash would be fell on deaf hears. But, seeing is believing, and house prices rose substantially every year. I was proved “wrong”.
John Maynard Keynes famously said: “in the long run we are all dead”. I have never seen that as a very clever remark and it is not obvious what lesson can be learnt from it except the ill-advised one of not planning for your own or your children’s’ future. A better thing to have said perhaps would have been “in the long run we are all right”. An example of the truth of this dictum is Sir James Goldsmith’s belief that the price of gold would rise substantially and he recommended it as the best investment. He held this belief from the early 1990’s and died in 1997 with his prediction still unfulfilled. But in the long run he was right even if he was not around to take the glory.
So why was I wrong for so many years about the state of the British economy before being proved so devastatingly right?
Well sometimes to understand the real truth behind something, whether a political situation, a person or an economy, you have to make a mental leap to imagine something that is so extreme that it never seemed possible. What I failed to appreciate until 2005 was the extent to which the private banks, with the connivance of governments (Blair/Brown were in the forefront of this), had been creating money in a giant Ponzi scheme. “Respectable” long standing institutions were fully in on this, as we now know. The banks were creating money at a fantastic rate and lending it to borrowers.
If shopping basket inflation is low (as it was) this new money has to go somewhere and that somewhere is into asset price rises. A Ponzi scheme is were the value of something is fuelled solely by an expansion of investment into something without any sound economic fundamentals to justify the process. The classic case is of a pyramid scheme (like Madoff’s) were the value of the scheme is generated solely by the arrival of new entrants. The whole scheme comes crashing down when there is no new money from new entrants and no new money from existing entrants.
The banks along with their masters in government have forever forfeited the right to be trusted. Everyone talks about the need for better regulation and there certainly is such a need but this will not solve the problem. What we need is a far more radical adjustment to the way we run the economy. The problem derives from the fact that the banks were totally incompetent, unregulated, criminal (pick whatever word you choose) in governing the money supply.
When we finally get back to something approaching “normal” (which will look nothing like the old “normal”) we must change the way money is created in the economy. There are only two ways of creating money:
1. Private banks create money related to their deposit base (under deregulation very elastically related). This money is usurious (carries interest paying debt)
2. Governments “print” money and spend it into the economy in some way. This money is non-usurious (carries no interest paying debt)
Under deregulation of the last two and a half decades the overwhelming amount of money has been created by private banks. Now traditional economics teaches us that the amount of money a bank can create is limited by the authorities to about ten times its deposit base. But this ratio has become meaningless since deregulation because it is virtually impossible to determine the deposit base of a modern bank. Much of the obfuscation has been created by the massive growth of securitisation, derivatives and swaps. The quantification of the “deposit base” has become impossible. The money creation has thus been out of control. The result is absurd asset price inflation with all the malign consequences that flow from that.
As stated, an important difference between private banks creating money and governments printing money is that money created by the former method carries debt. More money means more debt. More debt means most of us are strapped for cash, but the vast increase in money supply creates a corresponding increase in asset prices. Thus the capital account looks good and is felt to offset the bad current account.
Except, as we know, the asset price is only as good as the created money that supports it. And the private banks have destroyed the currency by excessive debt-based money creation. The expansion of government debt to “rescue” the banks has gone further and pushed sterling into a black hole.
In the future we must use government printing presses to create money. In the past this method acquired a bad reputation but thanks to the current meltdown the reputation of the other method is just as low if not lower.
The argument used to be that if governments create money they will always do it irresponsibly. The experience of the banks doing this job for us must now evoke a hollow laugh. But we have to find a way by which governments can create money responsibly.
If “printing money” sounds dodgy then just consider for a moment what has happened up to now. The government needs money’ to, say, build new infrastructure, pay for a war, pay unemployment benefit, bail out the failed banks, or whatever. So it issues government bonds and sells them providing it with a sum of money. It then has to pay interest to the bond purchasers. But consider for a moment where the money to buy the bonds comes from. It comes from the banks and where did they get it? They created (printed) it – perhaps not as notes and coins, they simple assigned a deposit to an account – but it is exactly the same thing.
And think about this a little more. The bank is creating money to lend to a government – a gold-plated customer. The government will always pay you back. Going on from there, these bonds are so secure, gilt-edged, that they can with a bit of maneuvering be counted as secure assets and so in turn provide a base for more expansion of the money supply.
In other words, the government (that is, you and me) pay interest on money created/printed by a private banks, when they could have just created/printed it themselves. Sounds crazy? Well, it’s utter madness. And we are all paying for this usurious debt with our lives and our futures.
Incidentally, the Private Finance Initiative so beloved of Gordon Brown and New Labour achieves a similar result whereby the government (you and me) is put massively in hock to private finance, again created by expansion of money by the banks. The reason for PFI? To shift capital expenditure off balance-sheet to make the government’s finances look better.
So how can governments printing money ever be responsible? By firstly putting it at a remove from elected politicians who cannot be trusted with the job. We also need to chuck out all ideology-based, Nobel-Prize-winning, economic theories and found the money creation on rigorous practical economic principles to avoid both excessive shopping basket inflation AND asset price inflation. We need a “Monetary Policy Board” to set monetary policy. The Board will be nothing to do with the Bank of England and needs to be constitutionally ring-fenced to ensure the maximum objectivity. It will control monetary policy, i.e. interest rates and money supply.
If this properly constitutionally structured the result will be the end of asset price bubbles and less debt in the economy to improve the quality of life for individuals and the environment for businesses.
In Britain this can never happen under the current lax constitutional arrangements. The mechanism for creating money has to be built, and can only be built, into a new Republican Constitution.
The future is desperately uncertain, for some life-threateningly so. For others their economic future has all but evaporated. If we don’t have radical change, make no mistake, it will all happen again - for those who survive long enough to see it.
Meanwhile, the bubble count does not look too promising. We have three more years of a count of two until in 2011 it settles down to one for the rest of the century (apart from a ten yearly rise to two for one year.)
The best possible civic republican 2009 to all. But perhaps delay cracking open that bottle of b..…….
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……. …….until next week