Capital III, Chapter 34 - Part 9

A private banker, Twells, in his evidence to the Banking Committee, was asked what he thought the effect of the act had been. Honestly, he replied that if he were speaking as a banker he would say it had been greatly beneficial, as it had raised interest rates, and enabled banks to make large profits, distributed as dividends to their shareholders. But, were he to answer as an industrialist or merchant, he would have to answer that it had been deleterious for the same reason.

This testimony was ahead of the crisis of 1857, and Marx comments,

“The following remarks of his are important because they show that he saw the latent existence of the crisis when none of the others had even an inkling of it.” (p 560)

The testimony is as follows.

“A Frenchman sends a broker in Mincing Lane commodities for £3,000 to be sold at a certain price. The broker cannot obtain the requested price, and the Frenchman cannot sell below this price. The commodities remain unsold, but the Frenchman needs money. The broker therefore makes him an advance of £1,000 and has the French man draw a bill of exchange of £1,000 for three months on the broker against his commodities as security. At the end of the three months the bill becomes due, but the commodities still remain unsold. The broker must then pay the bill, and although he possesses security for £3,000, he cannot convert it into cash and as a result faces difficulties. In this manner, one person drags another down with him.” (p 560-1)

This is similar to recent conditions, but in different ways. On the one hand, the example above demonstrates the way restrictions of the money supply kept interest rates high. Money was lent against collateral, here commodities, with a nominal value of £3,000, which was wholly fictitious because the commodities could not be sold.

In recent years, we have lots of credit issued on the basis of collateral whose nominal value is only maintained as a result of a continual over supply of liquidity. Rather than the collateral being in the form of commodities it is in the form itself of financial assets, be they shares, bonds or property. Much as in 1857, when this process led to increasingly tenuous collateral being put forward, today we have the phenomenon of so called “cov-light” collateral, where debt is issued with increasingly limited covenants against the risk of default.

In 1857, the banks were benefiting from the higher interest that resulted from the Bank Act. It might seem then that the low interest rates of today operate in the opposite direction. In a sense this is true. But, there is a misconception that the low interest rates are a consequence of money printing, QE. They are not. They are a result of the high level of supply of money-capital relative to the demand, which results from the exceedingly high rate and mass of profit, since the late 1980's. The basis of bank profit – aside from the capital gains obtained by banks engaging in speculative activity, via investment banking – is the difference between the interest paid by banks and the interest charged.

This used to be the difference between the interest paid on deposits and the interest charged on loans. But, increasingly banks obtained their funds not from depositors but from the money market – borrowing short and lending long. On the one hand, when interest rates are high, the potential to charge a higher absolute rate than is paid, provides a basis for such profits. On the other, when interest rates are low, the potential demand for loans is higher, and so there is the scope to charge a relatively higher rate, proportionate to that paid. For example, if the bank pays 5% and charges 8%, there is a 3% absolute difference, but it is 60% more. If the bank pays 2%, and charges 5%, there is a 3% absolute difference, but it is 150%.

It will depend why the rate of interest is low. Is it because the supply of money capital is high, or because the demand for money-capital is low. If its the former, low interest rates may then prompt an increased demand. If its the latter, the lack of demand causes the interest rate to be lower.

The situation is that the supply of money-capital is high. Banks are unable to make significant profits from lending, and so are driven in search of yield to lend to increasingly risky borrowers. This also leads to the development of a series of derivative forms of borrowing and lending. So, for example, banks lend to credit card companies, store card companies etc. In turn, these companies lend to their customers, at higher rates of interest, up to 30% plus p.a.

This lending is done on more relaxed terms than if the borrower was lending for a mortgage, for example. Similarly, the banks provide mortgages at rates considerably above money market rates, or their deposit rates, and the banks also provide funds via the money market for the pay day lenders, who charge up to 4000% p.a.

This is made possible, not because of money-printing, but because the central bank provides funding for the banks at near zero interest rates. The central bank is able to do that because the excess supply of money-capital over its demand has reduced global interest rates, whilst huge rises in productivity has reduced commodity values, so, despite money printing, inflation has been low.

This has caused historic levels of complacency, which will reverse suddenly, as soon as the processes which created this situation cease and begin to reverse.

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