Capitalism’s Contradictions and Business Cycles

After Yanis Varousakis in Oxford, his fellow ex-Australian, Steve Keen has been speaking in Berlin.

As ever he pursues an unorthodox and original view, which I consider provides great insight. I’ve tried to hone the 45 minute lecture into a short article, focussing and building on what I think is new.

Capitalism, Steve Keen suggests, has an innate contradiction. (It has many, I think most would agree, but he is concentrating on the money system in capitalism). Accountancy demonstrates that Assets minus Liabilities equals Equity or it could be called Capital. So in this scenario it is obvious that everyone is working towards gaining ‘Equity’ (or positive assets) in life. This is, at base, capitalism’s mission for everyone.

But when capitalism has private banks this is destabilising and contradictory for the monetary system. Because we no longer have a specie currency – say gold or silver, where everyone could theoretically have a share, even though, in reality, there is unlikely to be enough gold or silver for everyone in the world, neither increasing population nor economic activity can be accommodated unless more gold or silver is found. This is why the gold standard never worked. Yet it still shapes much money thinking and the belief is both misleading and pervasive.

Fiat money is financial and therefore by definition both a promise and also a claim – all at the same time. Gold or even a gold watch is not ever a debt to somebody else (unless, of course, you’ve stolen it). It is only an asset. Money is both an asset and a liability. If capitalism’s goal is Equity – net positive assets – for all, then that goal can be money only in special circumstances, because money, when an asset for someone, is always somebody else’s liability.

When banks create money they do so as loans – so they are generating claims on people’s ability to pay. The lending bank has the asset and the person borrowing has the liability – most usually a liability that they hope will in time become an asset (such as a house or a business). Once repaid, the borrower has no liability – and once repaid, the bank has no asset.

Yet, in order to create a bank, you have to raise cash from shareholders. So you must start with Equity, which in this instance will also be a liability. It follows that banks must start with positive equity and the non banking sector must in turn have negative equity. The motive is saving – to build positive assets, say by owning bank shares – and also to escape from equity that is negative (liabilities). Yet banks are a source of money in the economy.

Meanwhile the banks need to create assets in the form of loans – otherwise they go bankrupt. But the savings desire, an interest in Equity or increasing positive assets, drives down the velocity (or rate of exchange) of money. It also drives up interest in get rich quick formulas, get rich quicker ponzi schemes – which themselves can sometimes be (only temporarily, of course..) supplemented by additional borrowing. It is in the lender’s interest to create an asset by providing the loan and in the borrower’s to repay it as soon as possible.

As assets are not normally available all at the same time time, a loan usuallly drives up prices. This is especially so when these are second hand assets such as most housing or, say, vintage claret. Assets are always valued on their having limited simultaneous availability – when the availabilty of loans begins to disappear and assets become available all of a sudden, all at once and in large quantity, then asset values decline precipitously.

This inherent conflicting tension within laissez-faire capitalism will always drive so-called business cycles, which turn into bubbles and eventually full blown financial crises.

If everyone is, in effect, trying to achieve Equity or positive assets in capitalism then what is needed is a source of money that doesn’t increase negative assets (liabilities) at the same time.

Because all financial assets and liabilities in an economy must net to zero, by definition, this at first, seems unlikely.

But there is another producer of money where there is no direct liabilty for the recipient and that is of course, the government. Government always spends all the money it creates. Yes, the government has its own consequent liabilities, yet the only – and general, certainly not individual – liabilty is tax and as it owns its own bank as well, it can run if necessary, (as the Bank of England confirms in their staff working paper no 604) on negative equity:

In theory, central banks can operate with zero or negative capital. For example, the central banks of Chile, the Czech Republic, Israel and Mexico have all pursued their policy objectives despite at times operating with negative equity (Archer and Moser-Boehm 2013: 71). However, the ability of central banks to operate in technical insolvency applies only to operations in the domestic currency.

As many know, the fiction of ‘balance’ is maintained by the Debt Management Office issuing Gilts to make up for the difference between the anticipated taxation receipts and anticipated spending ‘deficits’, even though this is not actually necessary because of course, a sovereign government, together with its own bank, alone, creates its own money. And of course the Gilts are actually paid with the same sovereign money.

Steve Keen calls the government and Central Bank the only people who can ‘dis-save’ (in effect prevent saving interfering with the wellbeing of the economy). And that means the government never has to – indeed is by definition incapable of saving at all – never mind ‘saving for a rainy day’! He then concludes with his better known proofs that high private debt destabilises an economy and that, unless a country is running a large balance of trade surplus, government spending is essential to a properly functioning economy. And of course this is why government austerity is such a crazy and counter-productive idea.

As he indicates, personal saving slows down the money in circulation – it doesn’t destroy money. If the government tries to ‘save’ (which it can never do but can only ‘not spend’) it does destroy money – ie reduces the money in circulation.

In conclusion, in falling for austerity we increase the likelihood of frequent, so called ‘business cycles’ and financial crises. In contrast, larger government deficits not only tend to fulfil a duty of care to all the electorate but also mean greater economic activity, equality, and importantly, economic stability for everyone including, notably the business sector.

So when government considers credit guidance for the banks unnecessary, and goes for austerity and generally prefers ‘capitalism’ – subsidised for problems – but otherwise red in tooth and claw, we are, ipso facto, voting at the same time for the idea that we are quite happy with increased instability.

And, like Steve Keen, I suggest that, not a lot of people know that.