The Canadian-American economist John Kennet Galbraith once infamously said: “The process by which banks create money is so simple that the mind is repelled.” He was talking about the tendency for bankers to create money out of thin air.
A lot of people tend to think of bankers as “middle-men” who just sit on other peoples’ lifesavings, occasionally loaning some out at interest to businesses and other people who need the money and have no savings of their own. Actually, this used to be true to form. But contemporary banking is very different.
Borrowing from the future: time-travelling bankers
The former Greek finance minister, Yanis Varoufakis once labelled bankers as “time-travelling agents”. He was referring to the common practice of contemporary bankers to mortgage the future—that is to borrow money from it, in order to support the present.
For example, imagine you needed a £1 million loan to start a new property development company. You arrange for a meeting with your bank and ask for the loan. The banker will then take a close look at your business plans and your current financial situation, and try to assess where you will be in the future. This is sort of what Varoufakis was alluding to when he used the “time-travelling agents” analogy. If the banker can imagine you, years down the line, running a profitable property development business, with more than enough accumulated capital to pay back the £1 million, he will happily loan you the money.
Nowadays, this is as easy as literally typing the numbers into your bank account on a computer screen. The bank also gets the double-incentive of charging interest on your loan repayments, so years from now, everyone should be richer. The bank (from charging interest) and you (from launching a lucrative company).
The catch
There is one small catch to this contemporary way of banking. It is too easy. And the more money that is borrowed from the future, the more likely it is that there will be no prosperous future at all.
This is one of the reasons behind the collapse of the world economy in 2008. The banks loaned out astronomical sums of money, at a rate that no one could repay—meaning the economy could not keep pace.
For the people caught up in it all, stuck with unpayable loans, they have no choice but to tell the banks they cannot repay the loans and close the business. This causes unemployment, which reduces overall spending. Reduced spending means less profit for many other businesses, which may also find themselves with unpayable loans. As the economy collapses, people worry that the banks have loaned out all their money.
But the most damage is caused by a so-called “run on the banks”. People fear the banks have loaned out all their money, or may be about to, and rush to withdraw their savings. Of course, this becomes a self-fulfilling prophecy—and the banks’ collapse as the public remove their savings from their vaults.
Booms and busts—the fundamental paradoxes of global capitalism
This cycle of Boom and Bust is a natural fact of life for modern capitalist societies, because of the all-too-common practise of bankers mortgaging and borrowing from the future. The good times (the ‘Boom’ phase) always generates an irresistible temptation to borrow more from the future.
This is the fundamental paradox of capitalism: the more stable the economy is; the more it is ‘booming’, and the more everything looks rosy—the more likely it is to suddenly become unstable and enter the ‘Bust’ phase of the cycle.
Eventually, there comes a point where someone stops and asks, “But where is all this money coming from?” Then confidence is lost and the economy starts to unravel.
Public debt—a necessary evil?
Public debt sounds like a bad thing, but it is actually necessary for a capitalist society to function. The ultra-rich and powerful always fight to make sure they pay as little as possible, and the tax income from the general public is never quite enough to keep the market blossoming. Therefore, the only way through seems to be to borrow money and increase public debt. Even in Singapore—where it is actually illegal for the government to spend more than it receives in taxes, the authorities have to rely on loop-holes in order to borrow money.
To issue public debt, governments have to look to the bankers—the same “time-travelling agents” whose eagerness caused the Bust in the first place—to again borrow money from the future.
So governments, like the UK government, have to take out what are essentially IOUs called government bonds from the banks. This in order to pay for things that tax income alone cannot, new developments such as roads, schools and hospitals. Public debt, therefore, helps to stimulate the economy, as these developments provide jobs and an increased spending power amongst the public. Everyone benefits, including the bankers, who charge the government interest on the government loans.
And the cycle begins again...
This increase in employment, and spending power, helps to reduce debts in the long run and inspires more confidence in the economy. Helping to move developments out of the Bust and back into the Boom phase.
And there is the inherent trouble of human nature, manifest in the bankers. Of greed, And over-eagerness. The fundamental paradox of capitalism is that good times always beget the bad. And, the bigger the Boom, the bluer the skies, the heavier the rainfall that soon comes.
This article was written by Neil Wright of Oakmont Partners Ltd, an investment consultancy firm based in the United Kingdom.
