Consumariat
27th September 2008, 21:37
Ever since the credit crunch set itself in motion there has been an increase in people speaking absolute nonsence regarding economics. From the right wing press I have heard talk of malthusian cycles, from the left there is talk of inherant issues within the so called 'free market'.
What results is a blame game that tries to simplify the issue as being only the fault of 'spivs and speculators' or 'greedy consumption'. I pose to you that if the economy is ever to be stablised and organised for the benefit of all, then what is required in not to appeal to the dead old theories of the 18th and 19th centuries, but to look at the evidence as it has revealed itself in every boom/bust cycle that has occured to this day.
One major cause of the business cylce is the fractional reserve baking system. For those of you that are not familiar with this, I will briefly outline what it is.
When you deposit money in a bank account, the bank is only required to hold onto a small percentage of that money in its vaults. The majority of your deposit is leant out as credit and loans.
Now, imagine that you deposit $100 in an account and that 90% is permitted to be lent out as credit. That $90 in new money functions to increase the money supply and thus increase prices (inflation). So far this does not seem too much of a problem as long as inflation does not get too high. After all, credit is a perfectly acceptable way of investing in new business and creating genuine wealth, and so benefits society.
But the increase in the money supply does not stop there. that newly created $90 will work its way back into the banking system, which will subsequestly use 90% of it ($81) to lend out as further credit. There is now $271 floating around the economy (mostly as credit), but only $100 of 'real' wealth. This process of credit creation will continue on and on creating new money exponentially until that initial $100 of money has become $1000 of new money created essentially out of thin air.
This vast expansion of credit causes over investment in ventures that will ultimatley fail because regardless of there being lots more money in the economy, this money does not represent real capital wealth (factories, machines, land etc). This misallocation of resources then needs to be corrected, and so market mechanisms force the economy into a downturn.
Secondly (and this is what is happening with the credit crunch), the large supply of money artificially forces down the cost of borrowing, which in turn promotes irresponsible behaviour on the behalf of investers. Combine this with speculation that takes place at the peaks and troughs of the business cylces (the 'spivs' don't get completley let off on this one) you get a system which is marked by volitility.
Thirdly, when banks start to fail, runs on them pose an enourmous danger because most money is not in the vaults. In steps the governments with proposals to nationalise or bail out struggling institutions. Who pays for this eventually? The taxpayer of course; the very public that have been hammered by inflation and economic instability.
What we should be doing is banning the practise of fractional reserve banking and relying on genuine savings for investment. Growth would be slower and city traders would not be able to make a killing on the stock exchange, but the economy would enter an era of stability and long term prosperity.
What results is a blame game that tries to simplify the issue as being only the fault of 'spivs and speculators' or 'greedy consumption'. I pose to you that if the economy is ever to be stablised and organised for the benefit of all, then what is required in not to appeal to the dead old theories of the 18th and 19th centuries, but to look at the evidence as it has revealed itself in every boom/bust cycle that has occured to this day.
One major cause of the business cylce is the fractional reserve baking system. For those of you that are not familiar with this, I will briefly outline what it is.
When you deposit money in a bank account, the bank is only required to hold onto a small percentage of that money in its vaults. The majority of your deposit is leant out as credit and loans.
Now, imagine that you deposit $100 in an account and that 90% is permitted to be lent out as credit. That $90 in new money functions to increase the money supply and thus increase prices (inflation). So far this does not seem too much of a problem as long as inflation does not get too high. After all, credit is a perfectly acceptable way of investing in new business and creating genuine wealth, and so benefits society.
But the increase in the money supply does not stop there. that newly created $90 will work its way back into the banking system, which will subsequestly use 90% of it ($81) to lend out as further credit. There is now $271 floating around the economy (mostly as credit), but only $100 of 'real' wealth. This process of credit creation will continue on and on creating new money exponentially until that initial $100 of money has become $1000 of new money created essentially out of thin air.
This vast expansion of credit causes over investment in ventures that will ultimatley fail because regardless of there being lots more money in the economy, this money does not represent real capital wealth (factories, machines, land etc). This misallocation of resources then needs to be corrected, and so market mechanisms force the economy into a downturn.
Secondly (and this is what is happening with the credit crunch), the large supply of money artificially forces down the cost of borrowing, which in turn promotes irresponsible behaviour on the behalf of investers. Combine this with speculation that takes place at the peaks and troughs of the business cylces (the 'spivs' don't get completley let off on this one) you get a system which is marked by volitility.
Thirdly, when banks start to fail, runs on them pose an enourmous danger because most money is not in the vaults. In steps the governments with proposals to nationalise or bail out struggling institutions. Who pays for this eventually? The taxpayer of course; the very public that have been hammered by inflation and economic instability.
What we should be doing is banning the practise of fractional reserve banking and relying on genuine savings for investment. Growth would be slower and city traders would not be able to make a killing on the stock exchange, but the economy would enter an era of stability and long term prosperity.