‘Banking on phoney economics

This is a guest article from Scott Egner who is regular commentator on this site.

‘Banking on phoney economics’

You can tell it’s squeaky bum time when another ‘expert’ on the economy weighs with another ‘devastating’ blow to Scottish independence. I often hear the claim that we didn’t do enough back in 2014 to persuade people about the economic arguments for independence. To an extent I’d agree with that, but probably not in the same way as most others.

My journey to voting YES in 2014 was very much an economic one. I hadn’t really considered the prospect of Scottish independence until the Edinburgh Agreement was signed in 2012. Up until then I had taken more of an interest in the economy in the aftermath of the 2008 financial crisis. Following the crisis, I recall the queen famously asked economic experts what had happened and why no one saw what was coming. Sadly no answer was forthcoming at the time which should be pretty embarrassing if you’re an economist.

It didn’t take much research to discover that a number of economists actually HAD predicted that a financial crisis was imminent. Not being part of the neoliberal mainstream however meant that their commentary never saw the light of day.

So why didn’t the ‘experts’ see it coming? 

To put it simply,  they didn’t understand one of the most fundamental functions of a financial system – how banks work.

If you were to look in a typical economic text you will likely find banks described as “licenced institutions which bring lenders and borrowers together” (Begg, Fischer and Dornbusch). The basic version of this narrative is that banks use the money from depositors and lend it on to borrowers, knowing that the depositors won’t all want to withdraw their money at the same time.

To the lay person like myself this would seem an entirely sensible description, yet it’s entirely false. 

An accurate description, well understood by those warning of the crisis, is as follows – “Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits. In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money ‘multiplied up’ into more loans and deposits.” (Bank of England Q1 bulletin 2014 “Money creation in the modern economy”).

Obviously, the Bank of England paper came well after the crisis. Experts in the economic orthodoxy were advising policy makers based on textbooks which gave a completely erroneous description of the fundamentals of finance. 

The emergence of Thatcherism in 1980 heralded the Milton Friedman ‘monetarist’ ideology and the idea of ‘sound finance’ where public deficits became rather frowned upon. But given Thatcher’s determination to dismantle the industrial heartlands of the north, how could the U.K. economy grow and in what form? Enter the financial services ‘industry’. Central to this new period of ‘growth’ was the deregulation of the city and the financialisation of the economy. Physics and maths graduates found better earnings writing algorithms for financial derivatives than they would designing ships and aircraft.

What were the bankers doing with their new found unfettered power? Making profits and awarding themselves bonuses of course. Only around 10% of lending was for productive purposes, such as lending for business starts for example.  The vast majority of loans went into the more profitable real estate and financial markets. As a result, average house prices almost tripled between 1980 and 1990.

By the mid-nineties, the lure of power was too much for labour and they capitulated to the city of London and adopted the ‘sound finance’ dogma. After their election victory in 1997, Gordon Brown dutifully ushered in ‘light touch’ financial regulation. Labour became the darlings of the neoliberal establishment. If anything, credit-based growth accelerated under Brown and record levels of new debt based money was pumped into real estate and financial markets whilst the party boasted about it’s ‘fiscal responsibility’. The city of London was the global capital of deregulation and a hotbed of money laundering. Getting a Mortgage had never been easier. Any risk was packaged up and sold off to other institutions as ‘mortgage-backed securities’. The loans themselves were seen as assets of the banks and used as collateral to make other loans – there seemed to be only one side to the balance sheet!

The madness came to a grinding halt following the U.S sub-prime mortgage crisis in 2007.

 So how did the house of cards finally collapse? Let’s refer back to that 2014 Bank of England paper – “Just as taking out a new loan creates money, the repayment of a bank loan destroys money”. As long as loans outweigh repayments the system will grind on building up more and more debt. Just prior to the crisis the average house price stood at almost 7 times the average U.K. salary and the total of all private sector debt stood at around £2.7 trillion. Given events in America, Banks we’re becoming risk averse and lending began to dry up. At the same time the ‘housing ladder’, which once seemed a safe bet, no longer had the same appeal to people. Then of course there was the collapse of the Northern Rock building society. Thatcher, Major, Blair and Brown had fostered a ponzi economy grown on ever increasing bank deposits but now the money was leaving the economy faster than it was being created. According to commentators at the time, we were just days away from having to pay for things in hard cash, such was the lack of confidence in the card payments system. The bank defaults came, unemployment soared and the government had to step in, pumping in state cash to shore up the economy and rescue the banks.

This is the point in the story  where the right wing blairite faction of the Labour Party (now the Kier Starmer fan club) try to absolve Gordon Brown from any blame, in fact claiming that he ‘saved the day’. In Nick Shaxson’s excellent book “Treasure Islands”, Labour’s John McDonnell disagrees – “Blair and Brown made a Faustian pact to give the city it’s head.. .it was not a relationship on our terms; it was simply ‘Give them what they want’”. Brown had massively over-leveraged the U.K with record levels of non-government debt. The chickens were coming home to roost.

Rather than assisting the hapless homeowners, the government’s preferred option was to cushion the banks and re-inflate this debt bubble at the earliest opportunity. Once again, rising house prices were spun as the ‘positive shoots’ of economic recovery.  The state had basically created a moral hazard by confirming to the bankers that they, along with their bonuses, were untouchable.

The publishing of the quoted Bank of England paper in 2014 was something of a watershed moment. They were the first central bank to officially acknowledge that commercial banks directly controlled considerable quantities of the money supply. Notably there was also a money creation debate in the same year in the House of Commons which was attended by only a handful of MPs. The hopeful, like myself, naively believed at the time that this might go some way to changing the economic landscape. The dominant right wing media saw to it that this was a ‘non-event’

Now, a decade and a half on from the financial crisis and following the Bank Of England’s intervention, surely the current economic establishment must have revised their erroneous understanding? It would seem not.

This year, a nobel prize in economics was awarded to a paper published by Ben Bernanke who was chairman of the U.S. federal reserve at the time of the crisis. In the paper Bernanke describes the financial bubble bursting as simply a “redistribution of money from debtors to creditors”. So in effect, according to Bernanke, banks are just like big credit unions. The mainstream economic narrative on this side of the Atlantic is no better. BBC’s “Understand The Economy” podcast churns out exactly the same myth in it’s recent episode on banking.

We are conditioned by the media to hang on every word of the so-called experts. They are the ‘go to’ guys of the BBC, mainstream press and the educational establishments. When people claim that our economic case was inadequate in 2014, I would counter that by saying not nearly enough was being done to expose the sham of the U.K. economy. The economic car crash we are witnessing today isn’t just down to any mini-budget. It is a culmination of the last 4 decades of economic ideology adopted by the entire U.K. political establishment. This is worth bearing in mind when you hear of another economic ‘expert’ being wheeled out to disparage an independent Scotland.

Finally, if we really do want to create a positive alternative in Scotland then the Scottish Government need to think long and hard about who they are taking economic advice from. By adopting the UK’s  financial regulations, as per the SNP’ growth commission proposals, there can only be one outcome, and history has shown that it isn’t a good one.

MY COMMENTS

Scott is right, the SNP need to revisit the Growth Commission Report as the majority of recommendations and in particular the currency recommendations have already been rejected by the SNP Conference. That the SNP leadership display no willingness to respect that vote speaks volumes about members views are now handled in the Party. A Scotland build on the same policies advocated by the spivs in London and acceptable to them could cost us our Independence as they will create division and disagreement amongst the entire YES Movement.

I am, as always

Yours for Scotland

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