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For months now we have been bombarded with information about the 'Financial Crisis' the Euro Zone, Growth, Inflation etc. etc. etc.

It's really hard to get your head around what's going on. The language used is so technical.

We get an inkling of what is happening in Greece, Spain and Ireland and hope to hell that doesn't happen here.

Is it all our fault because we borrowed too much so we have to bail out the banks with the money that used to go for public services and welfare?

Would you like to understand why we are bailing out the banks in simple language such as:

"So the simple reason our rulers insist on bailing out the banks is that by doing so the wealthy and the powerful are simply bailing out themselves and guaranteeing the continuation of a system which suits them perfectly."

"The classic neo-liberal, Free-Market world view says only the markets produce wealth while the state is parasitic upon it. It is the logic which wants to turn Great Britain in to Britain Plc."

"Banking is about making maximum profit for those who own the banks (shareholders), those to whom the banks owe money (The Bond holders) and increasingly the senior staff whose bonuses depend not on how much the bank has helped anybody, but on how much money the bank has made. And the fact of our present predicament is that the banks can make much more money, much more rapidly by playing, even deepening, this recession than they can by trying to help us out of it."

See here http://bit.ly/S6bcrb
.
Happy reading!

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Comment by joe taylor on November 5, 2012 at 19:57
We stared this discussion by considering the first three parts of David Malone's blog 'Why are we bailing out the banks?'
 
It was quite a lively discussion (456 views) until it ran out of steam six days ago.
 
You do get an inkling, from these discussions, of what people actually 'know' about the financial system - through prolonged study, as opposed to what people 'feel' about the financial system - by picking up bits of the jigsaw from here and there then constructing a picture in their minds.

David Malone, a documentary film producer, not a banker or an economist, has just published 'Why are we bailing out the banks? – Part Four – What happens now?'
 
We might as well open this up to a wider audience as a discussion in the Forum on the main page
Comment by joe taylor on October 30, 2012 at 11:33
Thanks for the excellent post Gerry. 

Assuming the role of 'those who concentrate single-mindedly on the financial system' and picking up on the Hitler thread: the Treaty of Versailles demanded, as we all know, impossible reparations on Germany which contributed to Hitler's rise to power.  Germany, under Hitler, 'defaulted, or in plain English, refused to pay, then issued its own currency, rather than borrowing, at interest, from the international banksters,  just like America did under Abraham Lincoln. 
.
Countries that produce their own money supply are better able to choose their own destiny.  Countries that allow the private enterprise to produce the money supply, as debt, end up shackled to debt they cannot service and under the control of those they owe.  Is that about right Gerry?  I know it's just one consequence of the capitalist system, which is fundamentally flawed and stacked against the majority of humanity, but to unpick it you have to start somewhere - could that be the place?
 
The public won't be swayed by intellectual arguments. They generally have neither the time nor the inclination to educate themselves by reading appropriate books or taking academic courses. They need a message that is easy to understand and then to become emotive about it. They are quite emotive about banks at the moment.
Comment by Roger Alexander on October 29, 2012 at 11:52

Hitler solved the financial crisis in Geramny by marching people up and down in uniforms and giving them some order in their lives.  I remember losing childhood friends blown to pieces by bombs manufactured to provide 'employment'. I remember seeing the first drone to come into England and now I hear that we have drones based here.... who do I want to kill??   This is all about money, it is the ultimate way to control and dominate populations.

Daniels comment was spot on as I remember all of the develoments he mentioned ... they were an integral part of all our lives.  Gerry is also correct that the solution to this particular crisis is to use what we already have and to help each other.

We do not need growth or expansion. we need comfort and happiness.  We can certainly create those out of thin air by being nice to each other.  I am not saying we should all turn into 'do-gooders' or claim the moral high ground.... there are many of us who create more than we consume ... so what's wrong with giving it away?

Comment by Gerry Gold on October 29, 2012 at 11:22

Like many of those who concentrate single-mindedly on the financial system, Daniel doesn't attempt to explain the underlying forces that led to the removal of regulation - beyond, that is the US needing finance for the Vietnam war. And that one-sided view allows him to propose a return to Keynesian policies, and though he doesn't use the word: growth.

But the problem is - as Prof. Andrew Kliman explains in his latest book The Failure of Capitalist Production - that overcoming the tendency of the rate of profit to fall in the for-profit capitalist system requires growth, which inevitably leads to crises of overproduction.

These crises can be and in the past have been postponed, albeit temporarily, by massive injections of credit. It was the need for this credit (fantasy finance) that strengthened the ant-regulation lobby, and swept the neo-liberal scum to the surface. The post-war period of credit-and-debt-fuelled growth, interrupted by ever-worsening crises, produced massive overproduction and impossible indebtedness. It has now given way to the elimination of value on an unprecedented scale. Proposals to cancel debt are part of that. 

We now have a choice. Either accept the destruction of productive capacity needed to restore profitability (and as a by-product the destruction of ecological systems needed to sustain life) or end the for-profit system of production, replacing it with a democratically controlled one that aims to meet basic needs using methods, tools, fuels and technologies that contribute to the restoration of the planet's life-supporting ecology. 

Comment by Roger Alexander on October 29, 2012 at 10:53

Thank you so much for the post below and now we need an abstract that explains all that in terms that can be addressed in a pub quiz or Starbucks conversation by ordinary people.

Comment by Daniel Buckley on October 29, 2012 at 2:37

A rather long article, but it explains a little background on how we got to this point and how we move ahead and out of the abyss of debt.

There were no financial crises of any consequence between 1945 and 1971 during the Bretton Woods Gold Standard system . The finance sector was managed and regulated by central banks and the state; capital mobility was controlled, the creation of credit, and the rate of interest on  loans (short, long, safe, risky) were regulated.

Levels of private and public debt were also low during the regulated Bretton Woods period, when cross-border capital mobility was constrained. Individuals and governments ‘lived within their means’.

Bankers successfully lobbied for these regulations to be lifted .In the UK first, under Anthony Barber’s 1971 “Competition and Credit Control” system (dubbed ‘all competition and no control’ by economists.)

The lifting of controls on the creation of credit, coupled with the lifting of control over the rate of interest for short and long-term loans, safe and risky loans – led to an explosion in credit creation – and to rising borrowing costs.

In the same year, 1971, President Nixon unilaterally dismantled the Bretton Woods system.. The purpose of the Bretton Woods framework was to prevent the build-up of ‘imbalances’ – large surpluses and deficits between nations. Countries were obliged to restrain both capital flows, but also flows of goods and services, to maintain balance in both their current and capital accounts.

Because the US, by fighting wars abroad, Vietnam etc., had built up massive foreign debts, and did not want to correct this financial imbalance by “structurally adjusting” the US economy, in line with the requirements of the Bretton Woods framework, Nixon unilaterally defaulted on the US obligation to repay debts in gold.

Because gold,  till then a form of ‘reserve currency’ – had been unilaterally abandoned, there was a reserve currency vacuum.

The US made an agreement with the Oil cartel in ’73, to allow them to increase the oil price without restriction , in exchange for the  protection of US Military might, provided that oil trading was conducted in US dollars.The term Petrodollars was formed. Thus we had the oil crisis that year. We had the IRAQ and Libyan oil war and soon we will have the IRAN oil war.

The US offered the world dollars as payment for debts – thus establishing a “promise to pay” – the US Treasury Bill – as the world’s reserve currency. The US dollar being backed by the worlds oil reserves. Thus the petro-dollar enabled the US to become ‘the banker’ to the rest of the world – a system of global financial ‘Hegemony’.

Holding the world’s reserve currency means that the US can issue its debts in its own currency, and repay those debts in its own currency. As central banks have ways of manipulating the currency’s value up or down – that means the US can effectively manipulate how much of her foreign obligations will be repaid at their true value. Her deficit is financed by the glut of petrodollars from the oil producing nations. It can be said that the US greatest export is now the US dollar.

Poor  African countries cannot do the same. Instead they have to borrow in a foreign currency – the dollar – and earn dollars for foreign debt repayments.

In the Eurozone area, countries like Greece do not have the power the US has over their own currency, and  Greece effectively borrows and repays in a ‘foreign’ currency.(the Euro). The UK has a sovereign currency, the pound sterling. There is no restriction on the amount of money the Bank of England can create. The problem is, the present money created by QE is given to the private banking sector with no strings attached. This has been used to shore up their depleted reserves and also enable them to continue speculating in the derivative,foreign exchange and hedge fund casino. This just adds to the inflation of the pound and creates no real Wealth or employment.

 As a result of the de-regulation of credit in 1971 – bankers began creating credit and pumping ‘easy money’ into the economy.

Unfortunately, because the regulation of the rate of interest had ceased, the ‘easy money’ was also ‘dear’ – much dearer on average than during the period 1945- 71.

The outcome of too much credit/money chasing too few goods and services was predictable – inflation.

But, in just the kind of ideological manipulation that we witness today – instead of blaming bankers and ‘easy money’ for inflation, the Tory government – and then a Labour government – turned on the unions, and blamed workers for inflation.

While it was true that unions responded to rising prices by defending their interests and demanding higher wages – they were not causal to inflation.

Higher wages and prices were the result of the inflation of de-regulated credit.

However, both the Labour movement and right-wing governments, and of course the City of London – blamed ordinary workers – the victims of inflation.

 After the Gold Standard was abolished in1971, the private banking sector was freed up to create and then dump trillions of dollars/pounds/euros of debt on , a) individuals and households,  b) firms and governments- because of ‘light touch regulation’ – and because all Political parties effectively colluded in freeing up the banks to lend at prices determined by bankers themselves (see LIBOR – the rate of interest set by the British Bankers Association and the basis of tens of trillions of dollars of debt worldwide); and speculate on global financial markets recklessly .

 The vast inflation of credit/ debt in turn inflated the value of assets: property, stocks and shares, works of art, race horses, brands – in short all those things the rich (rentiers) own, and which effortlessly earn rent for wealthy elites.

By contrast, central bankers, finance ministers and Finance Ministries (i.e. the Treasury) declared (wage and price) inflation to be the greatest evil in the land – and clamped down ferociously.

So policies were implemented (globalisation/’flexible labour forces’/attacks on collective bargaining/prices and incomes policy) – to “tackle inflation” and keep wages/salaries down. Also prices ,  which hurt farmers/small businessmen/entrepreneurs etc.

But political and financial elites turned a blind eye to the massive inflation of the value of assets.

On the whole it is the rich and the better-off that own assets: property, land, stocks and shares, works of art, brands, racehorses – any asset that earns rent (almost) effortlessly.

The rest of us live on our wages and salaries, or else from the profits of our small businesses.

This explains why during the 30 years of financial de-regulation – the rich got steadily richer, and the rest of us (including the squeezed middle professional classes) got poorer.

At the same time de-regulated private banks borrowed crazy amounts of money for the purpose of speculation using  securitisation of many worthless ,high risk assets,( bundled mortgages and loans etc,) The gains from speculation  are much higher (before a crash) than those from sound  investment in the productive economy.

 

Why did the bubble burst?

 The simple answer is that private debt became unrepayable.

This was because while the real cost of debt was rising (as e.g. interest added) real incomes were falling.

Second, the rate of interest on most private debts was high in real terms. Individuals, households and firms had to increase their incomes/profits by more than the rate of interest on their loans each year, to stay afloat.

Unlike the post-war ‘golden age’, when both credit creation, and interest rates were regulated, during the age of liberalisation (unsurprisingly with bankers in control of the ‘price’ of loans) – interest rates rose.

The broken, dysfunctional banking sector;

 Loans/debts are now proving unrepayable. Most of the private banking sector is insolvent. (Note that only a year ago, the EU declared that most banks had passed ‘stress tests’. But only recently 16 Spanish banks were downgraded by Moody’s – because they are effectively bust.

We established banking systems for a purpose: to ensure that the private (and public) sectors could have their activities financed – through lending. Banks are, essentially money- lending machines.

 But the banking system is now broken. Instead of lending into the Real wealth creating economy – as they are designed to do, banks are borrowing from the real economy. Lending has turned negative.  Banks are now a parasite on the Economy of a nation.

In other words, banks have become borrowing machines.

 This is a bizarre and unprecedented development.

 The fact is that, on any fair basis of assessment, most of the world’s global banks are, if not insolvent, at least at risk of insolvency.

 Barclays Bank boasts of having survived the crisis, but like Lloyds and other banks, Barclays had to draw on the ECB’s LTRO facility in December, 2011. A healthy bank would not have needed that taxpayer-backed (backed by Greeks as well as Germans and British taxpayers) subsidy.

Hence the huge dependence of private bankers on taxpayer subsidies – via central banks (QE) and on the very low interest rates engineered by our nationalised central banks (e.g. the Bank of England).

These private bankers simultaneously swear by ‘the invisible hand’ and discipline of the market. Except that is, when the discipline applies to them…..

So while banks have socialised their losses, and only continue to function because of the massive explicit and implicit subsidies provided by the UK’s & Fed’s QE; the ECB’s LTRO – and by the deliberate manipulation of interest rates by central bank Committees – to keep them excessively low .

Their political friends, continue to demand that public services be privatised, this to enable a steady stream of profit to direct to the banks, who will finance this privatisation. This is debt peonage and predatory finance  on the citizen into posterity.

 

The unwinding of the crisis

The Govt turns a   blind eye to Britain’s heavily indebted private banking sector (“the most indebted nation in the world” according to the 2011 Budget Report.)

Nothing is being done to ensure the orderly downpayment or write-off of these debts.

There is now a real threat that ‘de-leveraging of the debt’ – will become disorderly. That is bankruptcies will escalate, households will be ‘foreclosed upon’ by bankers – house prices will fall precipitously (as has happened in the US) unemployment will rise – and bankers will be further bankrupted, because unemployment and falling house prices will trigger further defaults (‘negative equity’) on mortgages. Bankrupted SMEs will not be able to repay debts.

As long as Britain is burdened by this huge and unmanaged (and unrecognised) overhang of private debt – so long will recovery be impossible.

 

The consequence of the financial crisis

 Since 2008 approximately £250bn hollowed out of the UK economy. If the UK had grown at 1% then the assumed loss is £400bn

That is a very big ‘crater’ of economic inactivity – unemployment, bank losses, SME bankruptcies etc.

The Coalition government plans to hollow out another £85 bn in the next few years – in public sector spending cuts.

 Because of the private sector’s high levels of debt, companies are hoarding cash. They need that cash to deal with their debts if the banks should call in the debt. Furthermore, they are reluctant to invest, because they cannot see ‘customers coming through the door’ – either now, or in the near future – in the numbers needed to justify further private investment.

 Because individuals are heavily indebted, and made insecure about future job losses etc., they too are saving, or paying down debt.

The economy is therefore stagnating.

Only the government has the capacity – and the resources – to kickstart economic activity, by investing wisely in sound infrastructure – e.g. retrofitting houses to improve energy efficiency; expanding and increasing access to fast broadband; building sustainable and affordable housing in inner city areas, investing in productive industry to create employment.

 

How to deal with private debts?

 Some debt may well have to be written off – a ‘debt jubilee’ – because it cannot ever be repaid. Market economies have, since the 18th/19th centuries recognised this reality, which is why we have bankruptcy law – the acknowledgement that some debts can never be repaid – and that the state must play a role in the orderly re-structuring or write-off of the debt.

However, the best way to deal with an overhang of debt is to generate the income (wages/salaries/profits (for firms) and tax revenues (for govt) – with which to repay debts.

The best way to generate income – is by creating employment.

In the words of John Maynard Keynes, “look after unemployment and the budget will look after itself.”

 

Government can’t cut the deficit: differences ‘twixt government and you and me

 One of the myths peddled both by the Troika and to an extent the Tory/Labour Party, is the notion that the government can cut the deficit- by e.g. cutting spending and increasing taxes (e.g. VAT).

This is a fallacy.

Not only does the Coalition believe that government can cut the deficit, politicians (and the Troika) believe this can be done quickly.  Economists say that it must be done gradually.

But, unlike yours or my household balance, government cannot cut the deficit.

It can only cut government spending.

The government’s budgetary outcome is not a consequence of government action – but is a result of the actions of the economic system as a whole.

Government can cut spending, but not the deficit – which is the budgetary outcome.

It’s like a small businessman arguing that he can cut back on his debts, by cutting down his cash flow!

While you and I can cut back on spending, take in a lodger, increase income, and cut our deficit – government cannot do that.

The government’s budget balance is dependent on economic activity in the economy as a whole.

If the economic ‘cake’ expands – i.e If economic activity and with it income increases – the government’s deficit will fall, because it will be paying out less in benefits, and collecting more in tax revenue.

If the economic ‘cake’ contracts – especially if government deliberately contracts it – then the reverse happens.

The argument, therefore, is not between deficit-cutting and stimulus,

but between expenditure-cutting and stimulus.

 Government spending generates income – for the economy as a whole – and for government as tax income.

 Sound (i.e. not speculative) economic activity (wise investment in e.g. ‘green’ infrastructure, training, employment) generates income for both the private and public sectors.

Jobs & Income = wages, salaries, profits and taxes.

Just as you and I are better with an income than without, so government is better off as income in the economy rises, and worse off as it falls.

 

Government spending reduces the budget deficit – and the public debt

 It gets better. Unlike for you or me, there is a ‘multiplier effect’ for government spending – which there is not necessarily for personal spending.

In other words, if I pay a builder to fix the roof, I may benefit indirectly, but he does not pay me back. If the government employs builders – then they will pay taxes, go shopping and pay VAT, improve the profits of the shopkeeper who in turn pays corporation tax etc. etc…- all of which goes back to government in the form of (tax) income.

This is called ‘the multiplier’ – a concept developed JM Keynes, and to which he held strongly, but which most neoliberal economists deny exists….

According to a recent report by L.E. K., £1 spent on construction output generates a total of £2.84 in total economic activity (i.e. GDP increase). (LEK UK Contractors Group. Construction in the UK economy. October, 2010 update.)

 George Osborne at the 2010 Tory Party conference said: “Let me tell you what a structural deficit is…It’s like with a credit card. The longer you leave it, the worse it gets.”

The Govt is not like an individual or firm: governments cannot, like a company ‘go into liquidation’ or bankruptcy – not even Zimbabwe.

Unlike you or me, governments can get their own nationalised bank (e.g. the Bank of England) to conjure money out of thin air (or by entering a number and charging it to the government’s account….)

The Bank of England currently does that in a roundabout way through ‘Quantitative Easing’ (the Bank of England gives the money to private banks, for the purchase of government bonds). But central banks have been financing governments since 1694 when the Bank of England was founded.

As a result, and because the Bank of England is a nationalised bank (regardless of all the loose talk about its ‘independence’) the government effectively owes money to itself.

You and I do not have such a bank to call upon. We, regrettably, cannot borrow, spend and owe money to ourselves.

Governments can (except for those trapped by the Lisbon Treaty, which forbids the ECB to lend directly to governments. Instead, governments like Spain and Greece have to turn to private sector banks (‘the bond markets’) for finance.

Governments with sound central banks and well developed monetary and banking systems – can live beyond their means. That is how they finance wars, and other emergency government expenditures.

At the end of World War ll, government debt was 246% of GDP. Times were tough. But the Labour government responded by: spending – wisely. The NHS, schools, housing, infrastructure.

The result: government debt fell steadily to about 20% of GDP. It stayed at that level until the 1970s/80s – and only began to rise with the liberalisation of finance.

Given the scale of private sector debt; given the vast crater of economic inactivity caused by the global financial crisis – and given that the easiest way to reduce government debt at such a time of crisis is for government to spend – given all that, the argument for increased and wise public investment in forms of economic activity that generate income, is water-tight and unanswerable.

All it needs is for citizens to rebut and challenge the fake arguments currently made in support of austerity, and for understanding of the economic facts outlined above to be known and explained to the wider British public.

Comment by Roger Alexander on October 28, 2012 at 22:56

The 'clarification' is nothing of the sort.... it is a bankers explanation of a simple fact.  People built houses and were living in them.. The financiers screwed up their system of demanding money for nothing and the government allowed them to print more money to see if that sorted the cash flow out .... but it didn't.

Comment by joe taylor on October 28, 2012 at 19:12
Thanks for that Gerry, keep up the good work.
 
A point of clarification about the mechanism whereby the banks were bailed out.
 
When people default on loans, principally mortgages, the value of those loans on the balance sheet (assets side) is written down or written off (i.e. valued at zero).
 
This happened so much, at RBS for example, that the assets were less than the liabilities, meaning that if all the remaining assets were sold off, the process still wouldn't be enough to pay all the liabilities
.
So the bailouts involved the government purchasing new shares from the banks in question. The money (central bank reserves i.e. deposits in an account banks hold at the Bank of England) they used to pay for it went onto the assets side of the bank's balance sheet, basically replacing the hole that was left by the write downs. This, of course, was all done digitally.
 
'Where Does Money From - a guide to the UK monetary and banking system' is a book that explains all this sort of stuff in detail. I found it heavy going to be honest.  Web Of Debt and The Deb Generation http://bit.ly/VV88Cz were easier on the head for me.
 
 
Comment by Roger Alexander on October 28, 2012 at 13:25

Now THAT is a step in the right direction Gerry.... let us hope someone follows through.

Comment by Gerry Gold on October 28, 2012 at 13:12

A friend of mine is involved in a conference in Greece run by The Research Institute of Applied Communication and the New Technologies Laboratory in Communication, Education and Media, at the University of Athens. Its main theme is 'promoting more user-friendly economic and financial systems which could contribute to more efficient decision-making models. The events associated with World Usability Day at international level hope to open dialogue to aid the adoption and promotion of the work of many different disciplines who share a common goal to improve consumer knowledge of financial systems and taking decisions.' 

 

I've suggested to him that 'all the brilliant mathematicians and software designers, computing and networking professionals involved in the development and operation of the various components of the currently dysfunctional profit-maximizing global financial and economic systems should now begin to re-engineer them into a not-for-profit replacement that will provide essential services to a productive economy under the democratic control of a global network of local People’s Assemblies. 

 

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