Economic crisis

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Mike Harman
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Sep 26 2008 17:09
Joseph K. wrote:
i've had a flick through the few copies i have (i only tend to read it on long train/plane journeys and don't always bring them home), and can't find it, so it's possible i've mis-remembered.

I think I have that copy. Will look.

mikus
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Sep 27 2008 02:48

I'm starting to think that this plan doesn't look as good as I initially thought it did.

A couple of interesting points. The initial proposal of $700 billion apparently was completely arbitrary and nothing more than a nice, big, round number.

Forbes wrote:
"It's not based on any particular data point," a Treasury spokeswoman told Forbes.com Tuesday. "We just wanted to choose a really large number."

http://www.forbes.com/home/2008/09/23/bailout-paulson-congress-biz-beltway-cx_jz_bw_0923bailout.html

A Swiss investor and a former Japanese head of a management consulting firm say that not $700 billion, but $5 trillion would be needed to solve the crisis, although I don't see any reason to put more stock in what they say than other specialists (one of whom says that no government bailout is needed at all, which might sound a bit loony but he apparently has quite a good record with his predictions).

The credit market is still seizing up despite extremely low short-term interest rates from the Fed. Apparently any inter-bank lending over a day is almost impossible to come by, even in Asia.

It seems to me one of the main issues right now is whether or not the $700 billion will be sufficient to purchase the bulk of the remaining bad assets at inflated prices. Otherwise, the whole plan amounts to little more than manipulation of the books, which won't restore confidence. http://www.nakedcapitalism.com/2008/09/goal-of-paulson-plan-restore-mark-to.html

I'd recommend looking at the blog Naked Capitalism, which has good coverage of events even though many of its readers seem to be gold bugs.

mikus
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Sep 27 2008 03:17

Demogorgon, thanks for the info on the relation of mortgages to increased consumption.

Demogorgon303 wrote:
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Naturally one of these days you're going to be right, but it's not exactly an impressive record. Better to stay within what can be reasonably foreseen and work from there rather than make predictions that might turn out to be utterly false a month later.

Except I haven't predicted when there will be a complete systemic meltdown, the bankruptcy of the US state, or a run on the dollar. I've said the potential for all these things are there in the underlying condition of the economy and were it not for state intervention they would probably have already happened. I've also said that I think there are historic limits to how long such state intervention can go on for - I posted a chart a little while back that shows the projected growth of American state debt which I believe demonstrates this.

Ok, no disagreement here.

Demogorgon303 wrote:
Quote:
I don't think industrial production was stagnating without the overexpansion of credit. Certainly we weren't at the post-war peaks but we were far from stagnation by most figures I've seen. No doubt the expansion of credit and speculation increased profit rates and the rate accumulation but to say that the real economy was stagnating (if that's indeed what you're saying?) is going much too far.

I'm not sure what you're saying. You're quite right to say that growth rates and industrial production were rising during the recent period. I'm not sure how you go from saying there was expansion (which isn't in dispute) to saying this proves the credit boom wasn't the driver for this expansion. It's the cause of the expansion which we appear to be disputing, not the expansion itself.

Okay, I see what you're saying. I thought that you were arguing along the lines of someone like Brenner, who argues that there wasn't very much expansion in the real economy and that rates of profit were low.

Demogorgon303 wrote:
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The government's solution most certainly can relieve the underlying cause of the present crisis, which is the next-to-worthless assets that these companies retain on their balance sheets. I've already explained why this is the case and I haven't seen you attempt to deal with this issue.

Because in one sense it's not in dispute, quite obviously nationalising bad debts will (in theory at least) help the banks and help shore up confidence. What I find lacking in your approach is any appreciation of why we got here in the first place. The credit bubble was deliberately (and explicitly) created by the "Greenspan Put" to save the economy from the downturn that hit in 2001. Remember also the call for "patriotic spending"?

When I said that the plans can get to the cause of the problem, I was not referring to the cause of the present crisis in the historic sense of the ludicrous economic policies, I was referring to what is continuing to plague the financial system, the source of which are the CDOs and MBSs. I was not suggesting that the state can go back in time to solve its problems.

Demogorgon303 wrote:
But, I must emphasise that it remains to be seen whether this proposed package can even actually be created, given the wrangling going on in Congress, etc. All there is at the moment is a proposal from Paulson. Secondly, it's not clear whether the package can come on stream in time to prevent more damage being done. Thirdly, there's no guarantee that it will work. I'm not saying it definitely won't, but I think to talk about it as if it's already succeeded before it's even been finalised is a bit premature. What's been so astonishing about this episode has been the impotence of state intervention so far to prevent escalation and how close things came to a real meltdown. Fourth, assuming it does work, the negative repercussions on the budget deficit, the dollar and the ultimate economic strength of the US are pretty serious - the contradictions that led to the crisis haven't been resolved, they've simply been redirected to other points in the system where they will fester and ultimately express themselves in a new, worse crisis.

I definitely overestimated the rapidity with which the plan would be passed through Congress. But it does look like they'll reach a deal by this weekend. I don't have any problems with the bulk of your points quoted above except for the forth one. The hit to the state's books may not be as bad as the $700 billion would suggest, given that it's conceivable that the debt is seriously undervalued right now (although there is good reason to be pessimistic about this) and that once the market turns around the debt could be sold once again at a minimal loss. So the actual hit to the US budget could be much less, although again we really have no idea here.

Although in this regard it seems ludicrous that the US state isn't taking a stake in the enterprises that it purchases debt from. I suppose the appearance of maintaining a free market is that important.

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Demogorgon303
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Sep 27 2008 10:08
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I definitely overestimated the rapidity with which the plan would be passed through Congress. But it does look like they'll reach a deal by this weekend. I don't have any problems with the bulk of your points quoted above except for the forth one. The hit to the state's books may not be as bad as the $700 billion would suggest, given that it's conceivable that the debt is seriously undervalued right now (although there is good reason to be pessimistic about this) and that once the market turns around the debt could be sold once again at a minimal loss. So the actual hit to the US budget could be much less, although again we really have no idea here.

Although in this regard it seems ludicrous that the US state isn't taking a stake in the enterprises that it purchases debt from. I suppose the appearance of maintaining a free market is that important.

I think they will reach a deal simply because they have to. I have to say the delay on this has surprised me, given the seriousness of the situation. At first, I thought the disagreements were simply a cover to keep the illusion of democracy intact. Now I'm not so sure. I think there are real disagreements about what orientation to take on the crisis. Part of which, at least, is how to sell it to the working class. The state can't be too obvious about bailing out the banking sector when workers are falling into ruin everywhere. And, there's also the question about other sectors of the economy which are also falling on hard times - if you help Goldman Sachs why not General Motors?

You're right about the uncertainty factor in valuing the debt - this is one of the sticking points they're trying to hammer out now. Nonetheless, given that we agree (I think!) a serious recession is on the cards even if this package is successful the scope of defaults seems set to widen rather than diminish. However, I'm pretty certain that by IMF definitions the package would count as state debt - certainly the Frannie nationalisation has. But until the crisis has worked its way through the system no-one will really know.

Earlier on the thread there was a debate between me and Oisleep about the effect of state intervention in the economy. I'd be interested in your thoughts on it.

I haven't read Brenner (although I intend to) apart from this article here which was written when the credit crunch began. I'm not sure how it tallies with your assessment of him as he seems to be saying that the credit boom did revive the real economy and raise profit rates (even if not to the degree of the 60s). I didn't really see much to disagree with in that article, but maybe he says something different in his other works.

capricorn
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Sep 27 2008 18:46

I'm not convinced by the arguments put forward here by those such as Demigorgon and Baboon who are saying that capitalism has only been kept going since the 1960s by having recourse to "credit". Their assumption seems to be that, without this, there would not have been enough purchasing power to buy all that had been produced. In other words, that "credit" makes up for some chronic lack of purchasing power that is supposedly built into the capitalist system.

But if this was the case I don't seem how "credit" would solve the problem. Since what is it? The banks can't and don't "create credit". As is now manifestly evident, they can only lend out what has been lent to them, ie other people's purchasing power. So, bank credit only re-arranges, not increases purchasing power.

The only body which can create additional purchasing power is the government via its Central Bank. It can in effect print more money. But this can only have a temporary effect, certainly not one lasting decades. As what it leads to its inflation, ie a depreciation of the currency so that, in the end, everybody's purchasing power is reduced proportionately. Insofar as it doesn't just lead to a general increase in prices leaving everything else unchanged, inflation benefits borrowers as the expense of lenders because it means they can repay their debts in depreciated money, i.e, once again, a transfer of purchasing power from one group to another without increasing total purchasing power.

In any event, governments haven't been printing more money to anything like the extent they used in the 1970s and have been financing their spending by themselves borrowing from the outside sources.

There has of course been a credit boom but this has been because there has been more money around to lend to banks (remember banks can only lend other people's money). Coming from money that has not been re-invested in production because it has not been profitable enough to do so. In other words, the credit boom has been a consequence of slow economic growth rather than the cause of what economic growth there has been.

As to the present crisis, it is financial rather than economic, caused by some banks using the money for lending that has been sloshing around to make unsound loans. It is true that if this financial crisis gets out of hand, it can react on the real economy. If the banks continue to hoard money, as they have been doing, and this carries on any length of time it will affect economic transactions. Which is why governments through their central bank are making money available for lending which the banks won't -- introducing "liquidity" into the system -- to unclog the situation. This has nothing to with printing money to make up for some supposed chronic shortage of purchasing power in a bid to keeping capitalism from collapsing. As Mikus has pointed out, It's what they've done in previous financial crises, going back as far as the 19th century, as way to get out of a financial crisis, and it has generally worked. Unless they are particularly stupid or short-sighted it'll probably work this time too.

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Demogorgon303
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Sep 27 2008 20:13
Quote:
I'm not convinced by the arguments put forward here by those such as Demigorgon and Baboon who are saying that capitalism has only been kept going since the 1960s by having recourse to "credit". Their assumption seems to be that, without this, there would not have been enough purchasing power to buy all that had been produced. In other words, that "credit" makes up for some chronic lack of purchasing power that is supposedly built into the capitalist system.

Not necessarily. Crises always express themselves in the form of overproduction even if overproduction is not the cause. If there's a slowdown in accumulation, overproduction in the inevitable result.

Quote:
But if this was the case I don't seem how "credit" would solve the problem. Since what is it? The banks can't and don't "create credit". As is now manifestly evident, they can only lend out what has been lent to them, ie other people's purchasing power. So, bank credit only re-arranges, not increases purchasing power.

This, as you must surely know, is not the case. Fractional reserve banking does effectively allow banks to create money out of nothing. The whole Western financial system is predicated upon this and it's the reason why the term "broad money" exists in conventional economics i.e. "real" money but the commercial money (or fictitious capital) created through this process. Central banks don't control the process simply through the issuance of currency (although this is part of it) but through the manipulation of interest rates which influence the rate at which commerical money can be created by the banks. When interest rates go up, credit becomes to expensive and the supply of broad money is reduced and thus economic activity slows. Part of the reason for the chronic credit boom was that the Fed held interest rates too low, for too long thus facilitating a massive expansion in the broad money supply.

Quote:
The only body which can create additional purchasing power is the government via its Central Bank. It can in effect print more money. But this can only have a temporary effect, certainly not one lasting decades. As what it leads to its inflation, ie a depreciation of the currency so that, in the end, everybody's purchasing power is reduced proportionately. Insofar as it doesn't just lead to a general increase in prices leaving everything else unchanged, inflation benefits borrowers as the expense of lenders because it means they can repay their debts in depreciated money, i.e, once again, a transfer of purchasing power from one group to another without increasing total purchasing power.

And inflation is more or less the rule in capitalism since the Second World War. And it's a commonplace that workers' real wages have declined since the 1970s, i.e. a transfer of purchasing power away from the working class. This has been compensated for, to some extent, by the increase in credit. This is certainly the reality in the UK with people borrowing more and more just to make ends meet.

I'm also not entirely convinced (although I used to be) that printing money indiscriminately will necessarily lead to inflation immediately. In a normal economy working at full capacity this may be the case - but where there are strong deflationary counter-tendencies such as plant standing idle and workers in fear of their jobs it doesn't necessarily have to get out of control. In addition, there have been massive inflationary tendencies in the asset markets for decades (the bull stock market, etc.) if not in commodities. The latter have largely been depressed by the lowering of costs associated by shifting production to the "emerging economies". Domestic inflation is the Western countries has actually been pretty high, I believe, but has been masked by cheap imported goods.

Quote:
There has of course been a credit boom but this has been because there has been more money around to lend to banks (remember banks can only lend other people's money). Coming from money that has not been re-invested in production because it has not been profitable enough to do so. In other words, the credit boom has been a consequence of slow economic growth rather than the cause of what economic growth there has been.

Leaving aside the fact I think you are wrong about banks not creating money, I totally agree with what you say about some of the available funds being capital that has no productive outlet. But this in itself leads us back to the paradox at the beginning. With low accumulation, overproduction begins to emerge leading to a problem of effective demand. The reallocation of capital to consumption (e.g. to workers via credit) increases demand, allows accumulation to recover which also increases demand. As long as workers and others can continue paying back the loans everything is fine but its at this point when inflation does start to bite. To control this, the central banks raise interest rates which is exactly what happened in 2005/6 in the US which is when the sub-primers were suddenly faced with mortgages they couldn't pay. The defaults begin and the whole edifice begins to unravel.

Quote:
It is true that if this financial crisis gets out of hand, it can react on the real economy. If the banks continue to hoard money, as they have been doing, and this carries on any length of time it will affect economic transactions. Which is why governments through their central bank are making money available for lending which the banks won't -- introducing "liquidity" into the system -- to unclog the situation. This has nothing to with printing money to make up for some supposed chronic shortage of purchasing power in a bid to keeping capitalism from collapsing.

The major impact that the credit crisis is having on the real economy is the inability to make loans for either investment or consumption. Given that even a normally functioning capitalism needs to have some for of credit, at least for the bourgeoisie, to facilitate the circulation of fixed capital which would otherwise pose problems for accumulation the blockage in the credit system is very dangerous for continued accumulation. But the lack of credit for consumption causes problems at the level of effective demand too which is why the bourgeoisie is so nervous about the ever-important "consumer spending". As consumers are forced to deleverage, they either can't get credit or voluntarily reduce consumption in order to retrench. So a credit crisis hits the systems at both ends at once until the majority of the bad debts have finally defaulted with the commensurate devaluation in real capital, a new market is found for the mass of unsold commodities, or a new rate of profit is achieved which allows the restart of accumulation.

Now, I know Mikus is going to hammer me for being a "gold bug" here, but I think it does play a dimension in this crisis. The global economy effectively abandoned the gold standard permanently when Bretton Woods collapsed in the 70s. Previously, capital had only done this at times of crisis when it needed to print money (e.g. Britain in the 30s). Usually, afterwards they returned to normality with a gold standard being re-established (even if there had been devaluation). In times of crisis, as Marx pointed out, capitalists suddenly want something "real" rather than fictitious capital. The problem is exacerbated today because not only is fictitious capital not "real" but neither is the monetary base - it is a pure fiction based on calculations made by the central banks. Hence the flight into commodities such as oil, etc. in the markets today.

Having said that, I doubt that capitalism could have continued with a gold standard - I think it's fair to say there's not enough gold in the world to express the vast wealth that capitalism has amassed. This is one of the reasons why they've been forced to abandon it - but it also distorts the operation of the law of value in that the monetary commodity is no longer directly tied to value.

The interplay between all these phenomenona are very complex, of course, and I'd be lying if I said I understood them all. That's part of the reason I find the unfolding of this crisis so fascinating.

capricorn
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Sep 28 2008 04:55
Demogorgon303 wrote:
Fractional reserve banking does effectively allow banks to create money out of nothing.

Mikus accuses you of being a “gold bug”. The above claim suggests you are more of a “currency crank”.

The theory that banks can create “money out of nothing” comes in two forms.

In the crude version, it is argued that if the banks have to keep 10 percent of their assets as cash (as used to be the rule; it’s now as low as 1 percent) this means that if someone deposits €1000 in a bank that bank can then lend out €9000. Actually, what it means is that it can lend out €900.

The more sophisticated version takes over from here and assumes that the €900 is then spent and that the people who receive it then deposit it in one or other bank. These banks can then lend out 90 percent of what has been deposited with them, or between them a further €810. So that means that the original €1000 has already become €1710. In other words, the banking system this has “created” an extra €710 “out of nothing”. But the process doesn’t stop here. The €810 also ends up with the banks, who then lend out a further €729. The process continues until, in the end, the banking system has lend out a total of €9000.

The only difference between the crude and the sophisticated version is that the crude version attributes the power to create €9000 out of an original deposit of €1000 to a single bank, whereas the sophisticated version attributies this power to the banking system (all banks together).

Normally only those who adhere to the crude version earn the label of “currency crank” but the sophisticated version (which can be found in most economics textbooks) is also absurd even if mathematically flawless. First, it assumes no leakages, that the money lend out always returns to the banking system; which is unrealistic. Second, and more damningly, it concedes that banks can’t lend out more than has been deposited with them since, while the total lent out might amount to €9000 at the end of the process, the total deposited during it amounts to €10,000. So the banking system has not created anything out of nothing.

All that the sophisticated version shows is that money circulates within the banking system. Which is no great discovery as that’s what the system is about.

I agree with you that it is fascinating to be living through a major financial crisis of the type most of us will only have read about, but we need to keep our feet on the ground when trying to understand it.

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oisleep
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Sep 28 2008 08:17

capricorn is correct demogorgon

mikus
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Sep 28 2008 09:39
capricorn wrote:
Second, and more damningly, it concedes that banks can’t lend out more than has been deposited with them since, while the total lent out might amount to €9000 at the end of the process, the total deposited during it amounts to €10,000. So the banking system has not created anything out of nothing.

Could you expand on what you mean by this? The way I understand the neoclassical theory, say we start with a $1,000 cash deposit (and say that's all the cash there is in our imaginary world) and end up with $10,000 in deposits (assuming a 10% reserve ratio and no hoarding of currency), then the excess $9,000 in deposits is a creation out of nothing, so to speak (for anyone paying attention who is not familiar with neoclassical theory of fractional reserve banking, the $9,000 of "created" money is the difference between the total amount of deposits in the bank and the amount of cash initially deposited).

Is your point that this same $1,000 cash has to be deposited 10 times before there are $10,000 of deposits, or do you have something else in mind? If that's what you're saying, I don't see how that causes any problems for the neoclassical theory. To be honest, I don't see anything wrong with the neoclassical theory, per se -- it's just a different (and in my opinion, less helpful) way of looking at it from Marx's theory. I think the definition of "means of payment" is too loose to be very helpful unless you're very careful, but I think its claim about deposits is correct, so far as it goes. But then again maybe I'm missing something.

I agree, though, that in the context of Marx's theory this is not a creation of money but an increase in the velocity of money and in the mutual settlement of accounts (exchanges that take place with no intervention of any means of circulation), which allows $1,000 to play the role of $10,000 in exchange.

And Demogorgon, you're confusing credit with fictitious capital. If a bank loans me $1,000, the $1,000 is not fictitious capital, even if I use the $1,000 to start a miniature firm employing productive labor. If the bank turns my legal obligation to pay with interest at a certain date (or alternatively my stream of payments) into a marketable commodity then that is what Marx called fictitious capital (fictitious because its "value" has nothing to do with the production of a commodity, but rather with a capitalized stream of income and its relation to the rate of interest). Credit is a prerequisite of fictitious capital but it is not the same thing.

And to set the record straight about me supposedly calling Demogorgon a gold bug, no, I don't think he is a gold bug. I think that some of his claims are reminiscent of the kinds of things you'd here from a gold bug. I was also a bit annoyed that Baboon keeps going off with his ridiculous claims that I'm echoing the British bourgeoisie when I say that this crisis may be resolved. If he wants to play that game, I'd be happy show that he (and to a lesser, but still considerable extent Demogorgon) echo some of the claims of the wingnutty, currency crank free-market bourgeoisie. (I suppose we could say that Demogorgon echoes the claims of the more plausible and measured, but ultimately wrong currency cranks, while Baboon echoes the claims of the totally nuts "fractional reserve banking has got to go!" types).

I'd like to write more but I'm falling to sleep. I'll expand on my points tomorrow, if I get the chance, but I really want to make sure I understand Capricorn correctly on this, because I find it very interesting as I have been reading up on neoclassical theory lately.

capricorn
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Sep 29 2008 04:50
Quote:
Is your point that this same $1,000 cash has to be deposited 10 times before there are $10,000 of deposits

Yes. Obviously banks "create credit" in the sense that they lend people and enterprises money. My objection is to the claim that they do this "out of nothing". Banks are financial intermediaries that borrow money from some people (or in some cases use their own money) and then lend it others. The origin of their profits is the difference between the rate of interest they charge those they lend to compared to that they have to pay those the borrow from. They don't create money by a stroke of the pen and then charge interest on it, as the cruder currency cranks (and modern conspiracy theorists) claim.

The theory of "fractional reserve banking" is not so much wrong (something like they say does happen) as unrealistic (as it doesn't take account of leakages: not all the money will be re-deposited with banks) and misleading. It could just as easily be said that the depositors "created" the credit. In any event, it does not challenge the view (as does the crude version) that banks can only lend out what has been deposited with them.

Nor does it go into what the loans are used for. For instance, the first loan of $900 (out of the first deposit of $1000) will not simply be deposited in a bank, if only because the rate of interest paid to depositors is less than that charged by banks on their loans. It is more likely to be spent on consumption or invested in production. In which case an economic transaction takes place and it will be the seller who deposits the proceeds of the sale in a bank. Once again, making it clear that banks are not the only actors in the process.

mikus
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Sep 29 2008 05:32

Okay, I see what you're saying.

I take it you've been influenced by Edgar Hardcastle on this issue? (He has an interesting essay on this question here: Was Marx a Monetarist?)

I'll try to get back to more of the substantive stuff again in the next day or two.

BillJ
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Sep 29 2008 06:43

Can anyone recommend good (hopefully Marxist) articles dealing with the current crisis?

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Demogorgon303
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Sep 29 2008 09:19

I accept my phrase "out of nothing" was ill-chosen. My point is that the effective money supply is not simply what is printed by the central bank. Hence the difference between M0, M1, M2, M3 and all the other definitions of money used by modern economists. The supply of money/credit etc. does have a

The key issue is still the fact that the bourgeoisie made a whole series of policy decisions, from the 80s onwards, to facilitate the massive expansion of the credit system. I still think the rest of my points are correct.

It seems (so far) that "Meltdown Monday" has been avoided - some traders were apparently expecting a 1,000 point drop on the FTSE if the US rescue package hadn't been agreed. It'll be interesting to see what happens after the markets have had a chance to chew over the details.

capricorn
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Sep 29 2008 10:47
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Edgar Hardcastle has an interesting essay on this question here: Was Marx a Monetarist

That's a good article.

baboon
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Sep 29 2008 11:56

To say that this mess comes from subprime mortgages, as Mikus does above, is like saying that earthquakes are caused by houses falling down.
The US can't rely on "foreign money" as Mikus suggests above. Sovereign wealth funds have already been burnt propping up the greenback and countries will be wary. However, the US expects the world to pay for the crisis, this particular expression of which is only just beginning.

The Idea, generated by the bourgeoisie, that "life's been good" up until a year ago, or that "the good times have ended now" are just big lies. The economic crisis and its effects of misery, unemployment and insecurity have got steadily worse for the working class over the last forty years. During the years of the "boom" of the housing bubble, wages, health care working conditions and job prospects have all continued to deteriorate.

I think that there is a danger on this thread of fixating on many technical and academic points which, it's obvious, even the bourgeoisie doesn't understand. It is important to see that the real crisis of capitalism is the determining factor and not the doomed financial machinations of the bourgeoisie. Seven hundred billion is nowhere near enough and will only add to the overall debt of the US economy - the largest debtor in the world - that before all this extra borrowing, couldn't even pay off the interest on its existing debts.
Good Freudian slip by George W on Friday night: "we are all agreed on the importance for a suspect/substantial deal"

The policy of the extension of credit and debt favoured by the US bourgeoisie over decades, has only ever aggravated the economic crisis and the instability of the system and the current measures proposed (being made up on the hoof) will only further destabilise the economic system further down the road.

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Demogorgon303
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Sep 29 2008 12:20

To further illustrate the bizarre way the credit system works, have a look at the chart in this article from the Telegraph, detailing the total loans vs total deposits by the main banks in the UK. In nearly every instance, the banks have loaned out more than they've received in deposits. One institution had loaned out more than 6 times its deposits. Interestingly, of course, for accounting purposes deposits count as liabilities (because the depositors could take them back) while loans count as assets. Still, one wonders how the banks can loan out money they've never had ...

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oisleep
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Sep 29 2008 12:35

there's nothing bizarre or magical about it at all, banks fund loans to customers by a mixture of two methods, one of these is using money deposited with it from customers (which you see on that table), the other is through the wholesale banking market, i.e. effectively money deposited with it from other institutions (which you don't see on that table).

all that kind of analysis shows is which individual banks are more exposed to a freezing up in the wholesale money markets (i.e. what is happening at the moment) as they rely on them proportionally more to fund their customer lending

this is exactly the problem that northern rock had , i.e. a larger proportion of it's customer lending was funded, not by customer deposits, but by the wholesale money markets, so when that froze so did it, that is also why in response to that the central banks have made available vast swathes of liquidity (which can be accessed by placing illiquid mortgage assets as collateral) to try and plug the gap

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Demogorgon303
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Sep 29 2008 12:42

Where does the money in the wholesale banking market come from?

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oisleep
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Sep 29 2008 13:10

same place as all the other money in the system comes from - money is initially created and flows from central banks, then through fractional reserve discussed above it can be geared up to levels beyond that initial amount (but as pointed out always anchored to that initial base amount in some way or another)

(and obviously over time as capital/value accumulates more money is required in the system to facilitate the circulation of that value)

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Demogorgon303
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Sep 29 2008 13:28

And can someone explain what this quote from the Dallas Fed means?

"Banks actually create money when they lend it. Here's how it works: Most of a bank's loans are made to its own customers and are deposited in their checking accounts. Because the loan becomes a new deposit, just like a paycheck does, the bank once again holds a small percentage of that new amount in reserve and again lends the remainder to someone else, repeating the money-creation process many times."

So lets say Bill deposits £1000 with the Bank. At a 10% reserve rate, the bank can loan out £900. Kevin asks for £500 and the bank duly deposits the money in his account where it now counts as a deposit. This means the bank can loan out £450 of this new amount. The bank still has £400 left from Bill's original deposit, plus a new £450 from Kevin's new deposit which means it can loan out a further £850. Assuming this goes completely outside the bank and isn't used to create new internal deposits this means the bank has leant out a total of £1,350 from an original deposit of £1,000.

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oisleep
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Sep 29 2008 13:53

that's the fractional reserve stuff that was talked about above (although somewhat simplified in restricting the analysis to one bank rather than the banking system in total, and also quite naieve in saying that the money lent to customers end up back in the lending bank as deposits, they end up in the banking system overall (assuming no leakages/hoarding etc..) as deposits but not necessarily in the same bank that lent it out in the first place)

obviously the amount of gearing of the initial central bank money is different depending on whether you are looking at the banking system in totality or just an individual bank operating within that system (and in either case by the amount that is required to be kept in reserve by the bank regulator)

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Sep 29 2008 13:58
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obviously the amount of gearing of the initial central bank money is different depending on whether you are looking at the banking system in totality or just an individual bank operating within that system

It would be great if you could clarify what you mean by this. The question I'm really asking is whether the total amount of money created by what you're calling "gearing" can exceed the total amount of money originally issued at any particular time. Obviously commercial money is "destroyed" when the loan is paid back but this is somewhat compensated for by the interest paid.

Mike Harman
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Sep 29 2008 14:03
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and also quite naieve in saying that the money lent to customers end up back in the lending bank as deposits,

Hmm, well it's pretty common to have one account with some cash in it, and one slightly overdrawn in the same bank - I've had this dozens of times since cash goes in and out of one, but overdraft is only available cheaply on the other.

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Sep 29 2008 14:09
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and also quite naieve in saying that the money lent to customers end up back in the lending bank as deposits

furthermore, since these loans are not made in notes and coins but as digital records on a computer somewhere, they can only exist in bank accounts - only notes and coins can be hoarded. (of course loans could be converted to notes and coins, but iirc these make up <3% of the money stock, so by definition at least 97% of the money in circulation is deposited with banks at any one time - and of course much of that 3% notes/coins is held by banks too).

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Sep 29 2008 14:12
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It would be great if you could clarify what you mean by this. The question I'm really asking is whether the total amount of money created by what you're calling "gearing" can exceed the total amount of money originally issued at any particular time. Obviously commercial money is "destroyed" when the loan is paid back but this is somewhat compensated for by the interest paid.

when you say can it exceed the amount of money originally issued at any particular time do you mean the amount that came from the central bank?

if so then yes it can exceed this amount by a significant multiple through circulation/fractional reserve lending (explained by capricorn above)

the statement you quoted was just about what perspective you are looking from when looking at how the thing works, in your example if you are only looking at one bank in isolation and it has initially lent out £900 but the recipients of that money spent it/deposit it with other banks then obviously that individual bank can't 'gear' up that money anymore, however if you look at the banking sector in total then that £900 will flow back into it in total (again assuming no leakages/hoarding), so in total the banks can lend out another £810 then that £810 flows back into it and they can lend out another £729 and so on and so on. therefore to get a proper view on how this works (in terms of understanding the amount of money that can circulate in society) you need to look at it from a totality point of view and not from the perspective of an individual bank

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Sep 29 2008 14:19
Mike Harman wrote:
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and also quite naieve in saying that the money lent to customers end up back in the lending bank as deposits,

Hmm, well it's pretty common to have one account with some cash in it, and one slightly overdrawn in the same bank - I've had this dozens of times since cash goes in and out of one, but overdraft is only available cheaply on the other.

that does happen of course, but that wasn't what i was talking about as you are looking at it from the perspective of the same person being the borrower and the depositor (as if you borrowed anything more than a small overdraft from your bank you're hardly likely to just deposit that money back in a savings account without doing anything with it, if you did what would be the point in borrowing it in the first place, sure there will be timing differences etc.. but usually the point of borrowing is to use it for something other than just puttinng it back on deposit )

my point however, was that the thing quoted assumes that when a bank lends to someone that money (i.e. the loan) is deposited back with the same bank, which may happen or it may not - if you get a mortgage to buy a flat from your bank, you use that money to buy the place by giving it to the seller, that seller then deposits it with their bank (assuming they had no mortgage to pay off to keep it simple) so where the money that the loan represents ends up depends on what the person who receives the money does with it and which bank they bank with

anyway the point isn't really significant as as i said to demogorgon you need to look at the banking sector in totality to get a proper view of how it all works so when doing that the above issues fall away

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Sep 29 2008 14:32
Joseph K. wrote:
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and also quite naieve in saying that the money lent to customers end up back in the lending bank as deposits

furthermore, since these loans are not made in notes and coins but as digital records on a computer somewhere, they can only exist in bank accounts - only notes and coins can be hoarded. (of course loans could be converted to notes and coins, but iirc these make up <3% of the money stock, so by definition at least 97% of the money in circulation is deposited with banks at any one time - and of course much of that 3% notes/coins is held by banks too).

not really sure what point your making joseph (or what point you are replying to) , my point that you quoted was about the assumption/assertion in the thing quoted by demogorgon that the amount lent out by an individual bank ends up in the same bank again as a deposit. i agree with the point you are making but don't really see what it has to do with the point from me that you quoted

the full coment i made, of which the later part is not shown in your quote, was:-

also quite naieve in saying that the money lent to customers end up back in the lending bank as deposits, they end up in the banking system overall (assuming no leakages/hoarding etc..) as deposits but not necessarily in the same bank that lent it out in the first place

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Sep 29 2008 14:35

oisleep - i agree that the banking system has to be considered as a totality. i was responding to the idea it's "niave" to assume credit advances return to the banking system as neoclassical theory does - it seems like a fairly valid assumption.

edit: i think we're in agreement here and i took that quote out of context.

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Sep 29 2008 14:37

Oisleep, I understand that, I'm just trying to understand the substance of the objections to my original post (which were made by Capricorn not yourself, although you expressed agreement with him/her). So far, no-one seems to be disputing that the banking system creates money but simply my phrase "out of nothing" which is not entirely unjustified given that the money loaned seems greater than the money issued (unless I'm totally misunderstanding you). I was fully aware that this money/credit creation remains "anchored" to some extent in central bank money.

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Sep 29 2008 14:54
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Oisleep, I understand that, I'm just trying to understand the substance of the objections to my original post (which were made by Capricorn not yourself, although you expressed agreement with him/her). So far, no-one seems to be disputing that the banking system creates money but simply my phrase "out of nothing" which is not entirely unjustified given that the money loaned seems greater than the money issued (unless I'm totally misunderstanding you). I was fully aware that this money/credit creation remains "anchored" to some extent in central bank money.

well you initially said that the banking system creates money out of nothing which kinds of assumes/asserts/implies that it is not anchored against something tangible which controls it, which i assume was what capricorn was correctly rejecting/objecting to

also as capricorn points out, banks are not the only actors involved in this process - a bank makes a loan but that is not immediately redeposited, it gets spent on consumer goods or turned into productive capital so all these things have to happen first before it 'comes back' (probably poor choice of words) into the banking system, so the bank is not necessarily the active subject in all of this, so it's not just like the banks sitting in isolation of everything deciding to create money out of nothing, if all the other activity didn't happen then the banks wouldn't be able to do what they do

edit: an alternative to saying banks 'create' money is just to say that they help circulate it