Figure 21
Easy money is cheap money
I look more closely at the subject of prices in Part Two, but for now I want to return to the debt problem. The credit bubble hasn’t really gone away: it only deflated slightly, and has since blown up again in a different form. With the government bailout of the banks, some private-sector debt has been converted into public-sector debt, which has hit a record level, greater even than was experienced at the end of the Second World War, even though there was nothing this time that remotely resembled the global crisis that made such debt unavoidable in the 1940s.
This has serious implications for the wealth of future generations, because surely public-sector debt is merely private-sector obligations carried into the future, in the form of future tax revenues. We talk about public and private sectors as if they are quite different things, but in the end the state is just the people; a collection of individuals. And unless it has somehow become possible to get something out of nothing, debts always have to be paid, one way or another.
Whether all this means we are in for another major financial shock, or whether the difference between perceived wealth and actual wealth can somehow be reconciled more gently over time, I wouldn’t like to guess, though if I were a gambler I’d put my money on another crash.
Figure 22
One thing, however, seems fairly certain: the amount of real wealth in the world today is considerably less than the figure suggested by Credit Suisse or any other financial institution, because the banks are measuring assets in terms of money that has been devalued by the credit bubble and subsequent inflation of the money supply, even though that devaluation hasn’t yet fed through into the economy.
Why hasn’t all this new money fed through into the economy? Because the banks aren’t doing anything with it. With interest rates effectively zero, the banks aren’t lending because there’s no profit in doing so. They have been building up their reserves instead, which is a good thing, but doesn’t alter the fact that money has been devalued.
The idea that governments should stimulate demand by keeping interest rates close to zero is self-defeating. The lack of demand isn’t caused by the cost of borrowing. How could it be, when interest rates are already so low? The lack of demand is caused by the reduction in the real wealth of the majority of the population, which is linked to the shortage of real jobs and the related decline in real wages.
The credit boom boosted demand with debt-based consumer spending – the growth in GDP was artificial, as I’ve shown. So the answer can’t be to increase demand through more borrowing. The answer is to accept lower demand, because this is the real level of demand, and concentrate government policy on creating jobs instead of creating more debt.
There is a fundamental relationship between money and work: when we exchange money, we are ultimately exchanging our labor, and although this doesn’t necessarily apply in practice in the modern world, the principle is still relevant, for reasons I shall explain in Part Three.
But there’s an even bigger issue behind all this, connected to the increasing dominance of accumulated wealth over produced wealth, as seen in the rise of the financial sector relative to real industry. It is this rise that led to the increase in lending, encouraged by ever-lower interest rates – a glut of cheap money that in turn led to the credit and house-price bubbles, and I think this has major implications for the future of the global economy, and for the future of civilization in general.
Representations of wealth, such as money, must be linked to the real wealth created by industry. Money has no other claim as a measure of wealth. Government promises mean nothing if the government cannot back the promise with real wealth. The rise of the financial sector to a position of economic dominance over real wealth-creating industry poses a serious threat to the value of money everywhere, and to the economy in general.
The whole concept of making money from assets such as property and other financial investments, rather than from real industry, is deeply flawed. No real wealth can be created this way; all that happens is wealth is transferred from the borrower to the lender, which usually means from the middle classes to the rich, and this of course reduces the spending power of the majority while increasing the wealth of the financial sector, creating a vicious circle of unsustainable credit creation.
When we take into account the ever-rising productivity of manufacturing and the associated reduction in the industrial workforce, we begin to understand the fundamental problems facing the developed economies of the world. I’ll come back to this after the next chapter. But before we go any further, we need to think a bit more about money and, in particular, what gives money its value.
1 The data for global mineral extraction, which forms the basis of Figure 1, comes from a 2011 United Nations report entitled ‘Decoupling Natural Resource Use and Environmental Impacts from Economic Growth’. The authors of this report in turn based their work on research undertaken by Fridolin Krausmann and colleagues at the Austrian Institute of Social Ecology, who made the following points regarding data reliability: ‘According to broadly accepted principles of material flow accounting, we accounted for the extraction of all types of biomass, fossil energy carriers, ores and industrial minerals as well as for bulk minerals used for construction. Extraction by definition also includes the biomass grazed by domesticated livestock, used crop residues and the tailings that accrue during the processing of extracted ores. Resources extracted but not used (eg overburden in mining, excavated soil, burnt crop residues etc) have not been accounted for. We think our data provides a consistent picture of the overall size and composition of global materials use, and their change over time. Our results match well with other estimates of global material flows covering the period 1980 to 2005.’
2 The United Nations System of National Accounts (SNA) is a global set of accounting rules for nations compiling statistics, and was updated in 1993 to include Financial Intermediation Services Indirectly Measured (FISIM).
3 For more about the link between gold and money, see Chapter 5.
A brief history of money and debt
It might seem as if money is just printed by the government and circulates around the economy indefinitely, via the banks, but for several reasons this is not the case. A balance must be maintained, because the quantity of money in circulation affects its value. As the economy expands, more money will be required to keep up with demand. A shortage of money will constrain overall economic activity relative to primary output, subduing demand and forcing down the price of goods; this is what we call deflation. On the other hand, if the government, or indeed the banking system, creates more money than the real wealth of the economy merits, the lower its value must become, as I explained in the previous chapter. So the value of money can vary almost day to day.
In fact money itself, being just an IOU from the government – a promise written on a piece of paper – has no intrinsic value at all these days. Its value is related to its usefulness as a medium of exchange, and therefore depends on how much of something else it will buy, and this in
