Two books that bust the bank bubble

'Scant attention has been paid to the fact that most money loaned out by banks does not come from deposits, but is created as credit out of thin air.'

The Production of Money: How to Break the Power of the Bankers
Ann Pettifor
London, 2017
192 pages
Fictitious Capital: How Finance is Appropriating Our Future
Cederic Durand
Translated by David Broder
London, 2017
176 pages

British-based economist Ann Pettifor was a leader of the Jubilee 2000 campaign to cancel the debt of many poor, indebted countries. More recently, she was invited by Jeremy Corbyn onto the economic advisory board of the British Labour Party.

She was also much pilloried after the publication of her 2006 book The Coming First World Debt Crisis, at least until the onset of the Great Financial Crisis (GFC) in 2008.

In her latest book, she looks at the banking and financial system, how it led to the GFC, how it has developed since and what should be done to control it.

Only about 5% or less of money, she explains, is created by governments’ central bank. Most money, including in the form of bank deposits, is created by the private banking system.

Much of modern economics takes account of how banks act as intermediaries, taking savers’ deposits and loaning them out to borrowers. However, scant attention has been paid to the fact that most money loaned out by banks does not come from deposits, but is created as credit out of thin air.

The power to create and allocate money like this gives banks extraordinary power over the economy and also over governments — a power that they use to fend off or weaken any regulation that might limit that power.

Fictitious Capital by French economist Cederic Durand examines the same phenomenon as Pettifor.

He also contrasts the extraordinary growth and power of the finance sector of the economy to that of the productive sector, where actual goods and services are created.

Durand explains credit and finance with Marx’s theoretical framework of what he called “fictitious capital”.

Fictitious capital can be created in the form of basic credit. Banks can take money representing a certain value that has been deposited and loan it out as interest-bearing capital.

But they can also create loans many times greater than that deposited. This doesn’t represent any existing value but is a claim over future production.

A home loan to a worker is a claim over their future wages, a loan to a business is a claim over its future profits. However, there is no guarantee that this future production will ever exist.

Beyond simple banking credit, a plethora of more sophisticated financial products have been created in the unregulated grey zone of shadow banking.

Durand describes a chain starting at the borrower’s end of things with the distribution of loans to households or firms or the issuance of derivative products. Then there is their packaging and the creation of asset-based securities on this basis. Then there is the combination of these packages of securities, including options contracts, in order to form Collateralised Debt Obligations. These are then sold to investors on the financial markets.

Financial gains can be made at each stage of this chain as these “products” are sold and resold.

The origin of this chain, and hence these financial gains, in the world of the actual production of goods and services becomes increasingly obscured. Rather, when markets are booming, it appears simply as money creating money.

But the problem eventually struck home in the GFC when the hitherto largely unknown CDOs came to global attention. It turned out that, at base, these products owed their value to the future labour of workers who had taken out subprime mortgages with limited ability to pay for them -- even less so when they lost their jobs and homes.

Relative to the productive sector, the finance sector has grown astonishingly in recent decades.

Durand notes, for instance, that derivatives “having been negligible at the beginning of the 1970s, they were worth $865bn in 1987, before reaching a notional value of $685tn at the end of the 2000s.”

Between 1989 and 2013 the total daily trade on foreign exchange markets rose from $620 billion to $5344 billion.

The growth of the finance sector dipped during the financial crisis, but Pettifor and Durand describe how it has expanded since.

Pettifor says that, “in 2015 US corporate debt increased by $793 billion while total private domestic investment … rose by a mere $93 billion. This suggests that the $700 billion difference was used for unproductive, speculative activities.”

Both authors point to the role of states and central banks, which regularly intervene to support the financial sector and to guarantee deposits.

Notoriously during the GFC, huge sums of public money went into propping up financial corporations. Only one mid-level employee spent jail time.

It has been estimated that in a matter of months in 2008-09, states and central banks propped up the financial sector to the tune of 50.4% of global GDP.

There was no significant strengthening of financial regulation after the GFC. The policies of quantitative easing have continued to aid the finance sector.

However, neither author says that finance is entirely negative and parasitic.

Pettifor examines and rejects several schemas, mostly coming from the left, that would see banks entirely stripped of the ability to create money. Rather she favours vigorous regulation.

Pettifor, in particular, bemoans the level of ignorance that dominates mainstream economic thought, such as that GFC came as a complete surprise to so many.

The readable style of her book reflects her goal of encouraging a better critical understanding of economic theory and policy as broadly as possible.

She criticises the neoliberal and monetarist trends that now dominate the field. She advocates a renewed look at the legacy of John Maynard Keynes.

In particular, she wants to go beyond the trend of remembering Keynes solely as an advocate for budgetary surpluses and deficits to stabilise the economy. She points out that most of his writing was in the domain of monetary policy, directly related to the issues of banking and finance.

However, this leads her to place the main economic battleline in society between the productive and financial sectors.

While aiming her fire at what may be the most obscene and parasitic sector of capital, this led her to set aside the well-known conflicts within the productive sector.

It also leaves her struggling to explain the deeper causes of the expansion of the finance sector. For her, they come down to the ignorance of economists and irresponsible government policy.

This tends to leave her painting a picture in which major economic crises could be eliminated if only we weren’t so lacking in informed policy and theory.

Durand looks more carefully at the origins of finance in the productive sector and, hence, has more to say about the causes of the financialisation of the economy.

He notes that non-financial firms themselves have become increasingly financialised, with decreasing money going into productive investment while their financial payments and revenues increase.

He emphasises the role of globalisation in this. He argues that while in the global North there has been a decline in productive investment, there has been a shift of production to the global South. This has, in large part, generated the relative strengthening of finance within the overall economy.