Debt

So, we’re all fairly sure that the current economic crisis is something to do with the banks lending money to people who couldn’t finance their debts. We’re reasonably sure of this because we’re quite certain that the American Sub-Prime mortgage market was where the problems started and that if they’d not lent money to those people then we’d all be fine now and would be enjoying the same level of economic growth as before. How true is all this ‘knowledge’ though?

Money is debt. The available pool of cash with which to do things comes from each of our promises to finance our debts. The money you paid for your house with almost certainly doesn’t physically exist anywhere. Unless you’re in the minute minority of people who paid for their house from their earnings, then you got out a mortgage, the majority of which would have been created ex-nihilo. It exists as a string of 1s and 0s on a computer. As you pay/paid your mortgage off most of the money you gave back disappeared. It had never truly existed in the first place. The only money which didn’t disappear was the interest and the reserve deposit equivalent. That is the amount they have which they can lend from. The ‘real’ money that allows them to make fake money out of nothing more than your promise to repay. Their reserve ratio could be as high as 24:1, they could be able to loan out 25 times the real money they have.

Okay, so the bank can lend out more money than it actually has, but this fake money it creates is destroyed as it’s repaid, leaving only the real money and the interest. At a reserve ratio of 9:1 (as I understand it, a fairly low, reasonably common rate) they can collect interest on a £10,000 loan while only having £1,111.12 of real money. The interest on that £10,000 loan is theirs to keep and they only need to recover £1,111.12 to get their initial investment back, the rest of the £10k will be destroyed once repaid anyway. Of course, that £10,000 loan will be deposited somewhere once the loan’s been used for whatever it was intended for. The £10,000 loan, once deposited, can be then used to make a further loan of £9,000. That £9,000 loan can then be used to make a further loan of £8,100, and so on until we’re approaching £100,000 of loans (and the interest payments on those loans) for a £1,111.12 initial deposit. If there were only one loan made then the bank could only collect on the £10,000 initial loan. However, with dozens of smaller loans after the initial large loan the bank can collect on £100,000. Lending to lots of people wanting smaller quantities makes the bank a lot of money from nothing.

So the banks can make the huge loans that large businesses want, then use those to make medium loans that medium businesses want, then use those to make loans that small businesses want, then use those to make loans that consumers want. All of the loans made with the same initial deposit by the central bank. And the interest collected on all of the loans can then be used to make more loans and collect more interest.

Of course, no bank would get the deposits from their own loan from every stage of this process, but since the banking system is a closed system, it effectively means that, since each bank gets some deposits from every other bank’s loans, it works out to the same thing in the end.

So, the total amount of money in the system and the total amount of interest the banks can ‘earn’ is entirely dependent on the demand for debt. If you can find a way to give money to everyone demanding debt in such a way that you can get your money back in some way, with some interest, then you will. Capitalist greed demands that we do everything possible to get that extra penny of profit. It doesn’t matter if your business model is that you lend money to people to buy houses, knowing they will probably be unable to pay, because you’re gambling that their house will be worth enough to cover that by the time you come to repossess it, you will do it, collect your profit and sleep sound at night. Ethical considerations are not part of a capitalist system.

That’s a lot of explaining to essentially say that the sub-prime market was good for the economy, until the housing market started to shrink instead of grow. Once houses were starting to lose value rather than gain it the system stopped working, the gamble turned sour. Our long, sustained growth period was thanks in no small part to the extra money generated by the sub-prime market. It’s just sad that the means we chose to fend off a small deflationary period will have the effect of causing a massive deflationary period. Cest la vie.

Growth isn’t sustainable. I’ve said it many times within the course of writing entries for this blog, but I feel the need to say it once again. Growth is not sustainable. No level of growth is sustainable. No level of depletion is sustainable. It’s logically obvious that both of these statements are necessarily true. Yet, our culture doesn’t accept that logic. It says that either the conclusion is wrong or that some form of technology will appear to allow us to defeat the conclusion. The amazing tech fix.

We have been lulled into believing in the tech fix because it’s worked for so long now that we can’t perceive a time when human innovation will not provide us with new and innovative ways to continue killing the planet. We even imagine such a situation – where we can’t think of a new way to continue business as usual – as horrific. It would be terrible if we had to deal with the Earth as a partner and not as a slave! Tech fixes have been possible because of easy access to cheap energy. If peak oil strips us of our easy access to cheap energy, will the tech fixes be possible? Probably not if we’ve not done wide scale, serious investment in the alternatives prior to the peak. If, as some people argue, the world has already peaked, then we’re too late. Time to ride the roller coaster.