Banks, Steel and The EU - The Banks

The threat to the steelworks at Port Talbot, and the rest of steel production in Britain, synthesises a range of ideas and issues I have written about over the last few years. The attitude of the Conservative government, when it comes to supporting industry, rather than propping up financial asset prices, is emblematic of the argument I have set out, in the past, that the conflict of material interest between fictitious capital and real industrial capital finds its reflection in the political responses of conservatism and social democracy.

A hundred billion pounds was spent bailing out and nationalising British banks, but the Tory government, in the words of Paul Mason, “does not give a shit”, when it comes to the steel industry, and the 40,000 jobs dependent on it. And let's be clear about what was being saved in the rescue of the banks. What was not being saved were the deposits of savers. In large part, those deposits were already secure, and various deposit guarantees provided by states enshrined that, though I doubt that when the next, bigger financial crash happens, they will be upheld, as experience in Cyprus indicates.

Also, what was not being saved were all of the mortgages and loans provided by the banks. They are part of the assets of the banks, not their liabilities. If a bank goes bust, as happened with Northern Rock, someone else, would pick up those assets, often on the cheap, as part of some new business.

Rather what was being saved were all of those other financial institutions, and all of those astronomically rich individual money capitalists to whom the banks and financial institutions owed money, money which, in reality, represented absolutely nothing more than hot air, which is contained in the various, massively inflated asset price bubbles.

The collapse of Lehman Brothers was the proof of it. If a bank like Lehman's collapsed, what were the actual ramifications? Lehman's, like Northern Rock, and every other bank, relied very little on savers' deposits. It provided the money-capital it required for its activities by borrowing itself in the money markets. The main people to lose money-capital, therefore, would be the bank's own share and bondholders, and its creditors, which, in this case are mainly the other banks and financial institutions from which it has borrowed money.

The idea that the banks had to be bailed out and saved for the benefit of the wider economy is then nonsense. Even setting aside the investment (actually speculating) activities of the banks and financial institutions, which became the major part of their activities, then, as Marx described 150 years ago, the banks perform two different functions, which the bankers and their apologists try to present as being one and the same.

On the one hand, the banks operate as nothing more than merchants – money-dealers. That is they simply shift other people's money from one place to another, and keep the books recording these movements. Firms and individuals pay money into their their accounts that they have received from other firms and individuals, and then make payments out of those accounts to other firms and individuals.

In the same way that a merchant takes on the function of buying and selling, that would otherwise have to be undertaken by the producers of commodities, and so charges the producer for carrying out that function (buying commodities below their value) so the money-dealer does the same. That is apparent when you use a firm that is exclusively a money-dealer (like a bureaux de change) rather than a bank. Provider the costs of the money-dealer are less than the amount they obtain from these charges for the service, they make a profit.

Unlike a merchant, who buys the commodities from a producer below their value, and then sells them at their value, the money-dealer/bank never buys money from the depositor, nor sells it to the payee. In that respect, they are more like a haulier who simply transfers goods sold by one firm to another. And, just as someone would not expect to have their property expropriated, just because the haulier who was transporting it went bust, so there is no reason why someone who has deposited money in a bank, so that it can be paid out again, to cover purchases, should expect to lose that money, just because the bank goes bust.

Yet, as Marx describes, the bankers, and their apologists behave as though all of this money deposited with them was their own money, as though every payment of money they make is an advance of their own money-capital, rather than just this simple transmission of other people's money from one place to another.

The other function of the banks and financial institutions is the actual advancement of money-capital, i.e. the provision of loans. But, even here it is often the case that the bank is not actually advancing capital, for the reason Marx sets out. For example, if a firm owns a factory but needs additional money-capital, to expand, it may borrow money from the bank. Say the factory has a value of £1 million, the firm hands over the deeds to the factory as collateral, and obtains a loan from the bank of say £100,000. But, as Marx says, the bank has not advanced capital here to the firm. It has merely transformed the capital the firm already had, in the shape of the factory, into capital in the shape of money, which is what the firm actually needs to be able to buy additional machines, material and so on.

The bank has not advanced money-capital to the firm, it has merely advanced money, liquidity. In fact, in the process, the bank has increased its own capital, because although it reduced it by the amount of the £100,000 it gave to the firm, it increased it, by the £1 million value of the deeds to the factory, it took possession of, as collateral.

If the valuation of banks and financial institutions were just a reflection of the value of real assets, such as factories, machines and so on, that were the products of loans made by the banks, or were the collateral given in exchange for such loans, there would be little possibility for a bank collapse to cause wider economic dislocation, because, although the shareholders and bondholders of a bank might lose their money, the assets of the bank should exceed its liabilities. It would only be if there were rather a serious economic crisis, which caused a large devaluation of real capital, and so of the assets provided to the bank as collateral, that a problem would arise. In other words, an economic crisis causing a bank crisis, not vice versa.

But, herein lies the real issue, because, although the government line, which is really the line of all the owners of fictitious capital, is that the banks had to be saved, so as to maintain all of the necessary financing of industry, and the provision of money-capital for investment, very little of the banks activity was geared in that direction. British banks have loans outstanding worth about 160% of UK GDP. But 35% of these loans went to other financial institutions, 42.7% went to households for mortgages and another 10.1% went to commercial real estate and construction. Manufacturing received just 1.4% of the total! UK banking’s main activity is just leveraging up existing property assets.

So, what the banks and other financial institutions devoted considerable time, effort, and (usually other people's) money to was gambling. On the one hand, encouraged by a succession of governments that believed that people could become wealthier, not by having increasing incomes, but simply by seeing the nominal value of their house inflated, the banks threw more and more money into unproductive loans for the purchase of houses at ever higher, and more ludicrous prices, and which prices were in turn driven higher because of the willingness of the banks to keep providing loans for that purpose. That is one aspect of the hot air that inflates the asset price bubbles, and which in turn, is the basis of what saving the banks was about, because the banks balance sheets were inflated by the existence on them of these massively inflated financial assets, and those inflated balance sheets, in turn were the capital base upon which the banks loaned out even more money, which was used to blow up financial asset bubbles even further!

The difference between that and the provision of a loan for actual productive purposes is clear and stark. Firstly, a house produces no profit, and so no real basis for a payment of interest, whereas a machine, as a piece of productive-capital, does generate profit, our of which interest can be paid. Secondly, no one would expect the value of a machine to rise by 10% or more in a year, as house prices were expected to rise year after year. On the contrary, the value of a machine, as with any other commodity, would be expected to fall over time.

So, on the one hand, these real assets neither appear inflated on banks' balance sheets, nor are prone to sharp depreciations. That is not the case with property loans. A house produces no profit as the basis of the payment of interest, but as seen recently, capital gain is often confused and conflated with profit, and so the bank's increasing exposure to such loans is justified by, and increasingly based upon the expectation of continual and sizeable capital gains, as property prices are sent ever higher.

Once you have built an economy in which these banks and financial institutions play a significant role, and when the profits of these institutions derive not from the production of surplus value, but from capital gains, you have placed yourself in a straitjacket, because every time those asset prices threaten to fall, the basis of the profits of those financial institutions are exposed, but also, because the assets of the financial institutions are themselves collateralised on massively inflated financial assets, rather than real productive assets, the ability of the banks to cover their liabilities with their assets is also undermined.

We are repeatedly assured by the authorities that the banks have been recapitalised, and are now secure, but no one really believes that to be true, and the number of banks, in Europe, that have collapsed just months after previous stress tests proclaimed them to be safe, shows why no one should believe those assurances. Deutsche Bank is reported to have exposure, via complex derivatives, equivalent to the entire global GDP, or around $75 trillion. And that illustrates the other reason why saving the banks had nothing to do with protecting that wider economy. A large part of the banks activity had nothing to do with either money-dealing or with providing money-capital for industry. It was simply about the investment banking arms of those banks engaging in gambling.

That ranged from the plain vanilla speculation in the stock, bond and currency markets, through to gambling on the futures and options markets for a growing range of ever more esoteric derivative products. Its important not to throw the baby out with the bath water here. Futures markets were developed for quite sensible economic reasons. They originated for agricultural products whose prices could vary considerably. A futures market for wheat meant that farmers could obtain a price for the wheat they were planting today, but which they would not harvest for several more months. On the basis of that futures price, they could determine whether it was worth planting wheat, and if so, how much. They could sell that wheat forward, and thereby guarantee their future income. If the market price of wheat was lower, when it was harvested (because there had been a good harvest, or demand was lower for some reason) the farmer would not have suffered this lower price. On the other hand, if the market price was higher, they would have lost out, but that would be the cost of having a guaranteed price, and a price at which they knew they could cover their costs.

Using options provided a similar guarantee, as a form of insurance, giving the holder of an option the ability to buy or sell at a predetermined price, which they could exercise or allow to lapse, by a specified date, depending upon whether the market price was above or below the option price. This was a sensible means of providing greater stability for both buyers and sellers of such commodities to make investment decisions. In fact, it can be seen how it could be used for buyers and producers of steel, to have planned their investment decisions over a long period, so as to avoid wild swings in prices and profitability.

But, it is not just the producers of wheat (or iron ore, steel and so on) who participate in the futures and options markets. Anyone can buy wheat for delivery at some future date, via the futures market. If the current price of wheat for 6 month delivery is X and I expect the actual market price of wheat in six months to be more than that, I may buy such a contract, just as if I think the price of wheat will be lower, I can buy a futures contract to sell wheat. In the first case, if the market price is higher I will buy wheat at X, as agreed, and sell it at the market price of X + x. In the second case, if the market price in six months is lower than the futures price, I will buy it at the market price of X-x, and sell it at the futures price of X.

What is obtained is not a profit, but once again merely a capital gain. I never had any interest in wheat, or taking delivery of wheat, I merely gambled on whether the price would be higher or lower. The banks, because they can speculate with hundreds of billions of dollars, including hundreds of billions of dollars they do not own, but which they can simply borrow, so as to speculate in this way, can make huge amounts even with a very minor difference in price.

Take a bank that has $10 billion to speculate on a given trade. It borrows an additional $90 billion, called investing on margin, and buys $100 billion of a commodity at a price of $1 per unit. If the price of that commodity rises to just $1.01 then the bank makes $1 billion, and does so using only $10 billion of its own money, a 10% return. What is more, it can repeat this many times. In fact, with a lot of this speculation being carried out by computers with what is called high frequency trading, a bank could undertake such operations several times a second!

So, its obvious why the banks and financial institutions become obsessed with devoting their resources to this gambling rather than lending money to businesses so that those businesses could invest in buying factories, machines, materials and employing workers. Its a bit like if the horse racing industry found that they could make more money from people gambling on the outcome of races than they would make from breeding horses, producing good race tracks and attracting spectators. They would then put all their resources into providing gambling facilities, whilst allowing the racetracks to fall into disrepair, and the bloodstock to deteriorate.

In the end, if that continued, the horse racing industry would collapse, and so would the basis of the gambling. But, in the case of the gambling undertaken by the banks, they have simply generated new things to gamble on. So, for example, its possible to gamble on how much volatility there will be in the financial markets themselves. The VIX is an index of such volatility, and so its possible to speculate on whether this index will more up or down, and by how much, just like spread betting on a football or cricket match.

But, none of the trillions of dollars that goes into this speculation buys one additional factory, machine or piece of material to produce anything. In fact, the large majority of the money that is gambled by the banks and financial institutions, even in the plain vanilla buying of shares, does not have that effect either. It simply goes to pump up the prices of existing shares, and so to inflate the paper wealth of the owners of those shares, be they banks and financial institutions, huge corporations whose directors and executives represent the interests of this money-capital, and not of the business itself, and who therefore, have found that this speculation is more lucrative than actual productive investment, or the 0.001% of the global elite that owns the majority of this paper wealth.

The saving of the banks, as part of keeping the global asset price bubbles inflated, had nothing to do with protecting the real economy – and the same is true of the use of QE – and everything to do with protecting the paper wealth of this tiny minority.

Next Steel.