Tag Archives: The City of London

The Economic Devil

There is one great flaw in economic analysis and that it that it has no theories that explain generalised wrong doing within the economy. Instead it recognises that there may be individual wrong doers but that wrong doing can be systemic throughout a particular sector the economy. Unlike Christianity it lacks a devil, Christians can account for wrong doing by referring to the malign influence of the devil, whereas in economics the assumption is that there are only occasional examples of wrong doing. There is on earth an economic Garden of Eden that is the free market system ensures no evil practices will prosper. Competition will force all businesses to adopt the highest standards of conduct through fear of losing sales to more ethical competitors.

Christians would have no difficultly in understanding that the greed of bankers was a key factor in precipitating the crash of 2008/9. It was their desire to accumulate larger and larger bonuses that encouraged them to undertake increasingly risky investments, investments that offered the possibility of greater and greater profits and bonuses. Self restraint was a characteristic absent from the traders and bankers money in the City of London. When it is phrased in these words the Christians seem to have a better explanation for the crash of 2008/9 than do economists. Fundamentalist Christians might suggest that the devil who had corrupted the behaviour of bankers and that this corruption directly led to the crash. Faust sold his soul to the devil in exchange for the love of Helen of Troy and as such was committed to a life of sin. It could be argued that the bankers sold their souls to the devil in exchange for untold wealth. Certainly there behaviour in that time suggested that they were little more than the servants of the devil.

Fortunately economists don’t have to re-invent the devil to explain the wrong doing that takes place within the economy. The corruption of the spirit comes from the belief that the main purpose of all human activity is the accumulation of wealth. It is the quest to maximise income and profit that will lead to the adoption of unethical behaviour. Adam Smith (The Wealth of Nations 1776) stated that when a group of businessmen are gathered together their purpose is not to promote the common good but to further their own selfish interests. He was familiar with the practices of 18th century merchants who would divide a market between themselves; where each would be guaranteed a local monopoly so they could charge the highest possible price for their goods without having to worry about being undercut by a low cost rival.

Today there is a report in the newspapers that house builders are restricting the supply of houses so as to force up the price of houses. The former Mayor of London Ken Livingstone produced a report that claimed that house builders in London made a profit of 26% on each house sold at a time when the average company profit was 10%.

While there is no devil in economics but there is the devil like ethos which is summed up in the words profit maximisation. Any behaviour is deemed acceptable if it results in increased profits for the business. A practice demonstrated when international firms operating in the developing countries hire mercenaries to eliminate local politicians and trade unionists that might campaign for better wages or environmental protections that would increase their operating costs.

Bad behaviour amongst business executives is not unknown to economists, its just that the current generation of economists assume that such behaviours have only a small impact on the economy and its host society. Yet a recent writer on the Italian mafia asserted that London was responsible for facilitating the activities of the various Italian drug cartels through money laundering, which gave the gangs clean money with which to finance their corrupt practices in Italy and other European countries. The very opaqueness of the banking system makes it impossible to know the extent to which such bad practices are common in the London financial markets, whether it is one or two bad apples or the whole barrel that is rotten.What evidence there is suggests the latter.
What I am arguing for is a recognition that there is a devil in the economy, there is an ethos that perverts its workings so as to favour the selfish interests of small groups at the expense of the majority. I would suggest that Gresham’s law needs updating, in its original form it states that bad money drives out good. Gresham was thinking of Henry VIII and his constant debasement of the currency. A contemporary Gresham’s law would state that bad economic practices drive out the good. I do have some experience of this as when I worked in the City of London in the 1960s, new sharp practices began to creep into the city. At first the old established city firms resisted employing these sharp practices, but when it was clear that these new practices were very profitable the old ethical behaviours were soon abandoned.

The old city insurance firms were very conservative in their practices they never employed aggressive selling techniques, such as cold calling. New comers to the market employed much more aggressive tactics and took an increasing share of the insurance market forcing the old established insurers had to follow suit. This had one unfortunate consequence as life insurers competed with each other by offering more and more generous end of term policy benefits. To finance these generous payouts the insurers had to raid their cash reserves. This had two effects the first was to reduce the viability of the company forcing a wave of mergers as these firms sort tried restore their viability through consolidating into a few large companies so building up their depleted reserves. The second was that the life insurance industry was unable to pay such large end of policy benefits and were guilty of overselling their products. This led to the pensions scandal when it was revealed that the many millions who had on exchanged their occupational pension for one provided by an insurance company believing that their promises of a much higher pension, discovered that their private sector pensions generated a pension far less than that offered by their former occupational pensions. What has happened is that the old conservative but financially sound companies of the past have been replaced by more aggressive but less viable businesses. The trusted figure of the man from the Pru is now a figure from the past as he has been replaced by the salesman eager to win your custom.

Christianity has another lesson for economics, according to Christianity mankind is tainted by original sin and only an outsider untainted by human corruption can save them, that is God. Similarly the market system is tainted by an original sin, greed or perhaps more accurately original greed. The economic devil an integral part of the free market, this devil is ever ready to corrupt the participants in the market with the promise of riches. The business ethic, that is the desire to maximise profits is all too often little more than a disguise for this primal greed. Personalising the faults of the market system in form of the devil (even if it’s a metaphor for greed) has one important role it will constantly reminds politicians that the free market is not the solution to all problems, but is yet another flawed human creation that is corrupted with all the sins of its makers. The unregulated free market is a threat to social order as all manner of unethical behaviours are made possible, if there are no laws or regulations to prohibit them. The behaviour of the bankers and traders in the financial markets in 2008 and since demonstrates the folly of leaving the market and its members to set their own rules. Once this is accepted the government will return to its former function of legislating to stop powerful players in the market from abusing their power at the expense of other members and outlaw the most undesirable of economic behaviours. What politicians fail to realise just are there are crimes against the person and property, there also the economic crimes, which are also a threat to the person and property.

Note. A more sophisticated version of the threat that an unregulated market poses to the social order is to be found in Michael Polanyi’s ‘The Great Transformation’.

London’s dire housing situation, are the banks also to blame for this?

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Reading a blog by Holly and Rhiannon on the New Statesman’s website prompted this post. In their blog they described the appalling conditions in which many young people live in London. Conditions reminiscent of those prevailing in the poorest parts of Victorian London. While the obvious villains are the new breed of landlord exploiting a dysfunctional housing market, these people are merely the catspaw in a highly dysfunctional inegalitarian society. Who are the real villains. One group are the third of MP’s who are buy-to-let landlords, who put their chance to earn a profit above the needs of the poorly housed young. What really is happening is a structural change in the economy that disadvantages the young and the poor, who are often the same. There is at the heart of this change a familiar villain the bankers and the City of London.

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How the bankers can in large part be blamed for the poor living conditions of the young in private rental accommodation can be explained by the structural change in the British economy engineered by the banking community. This explanation starts with how a business makes a profit. There are two ways either that business develops and new product or service that people want or it acquires the right to sell an existing service or product and is able to increase the price at which it sells the product or service by exploiting the market. Apple with their successful IPhone would be an example of the first and Centrica and the other energy companies that make up the dominant cartel of energy companies would be the other. Bankers in part have made their money in part through the second route. The banking market is dominated by the big four who can exploit the market for money handling services by collaborating informally. Credit card charges are exorbitantly high and yet no bank undercuts the others by offering a low interest rate credit card. Any deals offered are merely incentives to change card companies. The £80 billion of bonus payments to be paid to the bankers this year is merely another example of increasing the charges for money transaction services made by the banks, its the exploitation of a captive market.

However there is a way of profit making unique to the banks. To understand this other way it is necessary to go back to Tudor times and Henry VIII. Henry was constantly overspending building and furnishing palaces fit for a Renaissance Prince. There were also the almost constant wars against France and the need to build a modern navy to defend the UK against aggressors. When faced with the inability to pay his bills Henry resorted to debasing the currency, that is reducing the quantity of precious metals in the currency. This enabled him to produce many more coins with his limited stock of gold and silver. The losers in this situation were Henry’s creditors who received payment in the new debased currency. The pound in their pocket was now worth much less. Debasing the currency was a common practice for insolvent monarchs who wished to reduce their debts to manageable proportions. Unfortunately this new debased coinage had the effect of impoverishing the less well off as it was inflationary and increased food prices. When the less well off were the majority it had a very negative impact on national well being. Contemporary bankers like Henry VIII have similarly debased the pound sterling to benefit themselves at the expense of the rest of the nation.

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What is little understood is that in contemporary Britain it is the banks that are responsible for the supply of money in the form of bank deposits. Only 2% of money in circulation is notes and coins. It is banks through the process of credit creation that create most of the money in circulation. Realising the significance of this power governments in the Social Democratic era, but since 1971 all limits on the power of banks to create money have been removed by successive governments. The only limit of the amount of money the bank create is what the bank decides its reasonable to create. Perhaps leaving the bankers to decide how much money to create is not the best of economic policies. When Lehman Brothers collapsed it shocked many observers to discover that the banks deposits (bank money) was 50 times greater than its reserves. Later it was discovered that this was general practice and in fact many banks exceeded that ratio.
EU regulations require that banks equity total 1.5% by value of a banks deposits, which means European Banks are entitled to create bank money (deposits) that are 66 times the size of their reserves. The UK banks are marginally sounder as the ratio for them is 1:50. However their opposition to this limit and pleas for delay in its implementation suggest that even that ratio is exceeded in practice by our banks.

The power to issue money gives the banks incredible power. In 2010 the UK’s GDP(National Income) was £1.46 trillion, while bank deposits I estimate as totalling £7.3 trillion. Anybody glancing at these figures will realise that it gives the banks the power to dictate the direction of the economy. It is a power the banks don’t hesitate to use, most notably in 2009/10 when they succeeding in persuading (!) the government to save the banks by adopting a policy of national austerity.

This control of the nation’s money supply gives the banks the ability to direct the nation’s spending policies. If these excessive bank funds had been directed into developing the nation’s infra structure or long term industrial development their effects would have been less pernicious. It is no coincidence that this period of exponential growth in bank money was the period in which the number of new build homes declined catastrophically. To build a new housing estate meant money would be tied up for a long time in a construction project, which was unattractive when quick returns where available in other sectors in the housing industry. With a febrile housing market money lent on mortgages offered a quick return as there was always a large turnover in housing stock. Money was always being repaid from the sale of houses by customers wanting to move up in the housing market. Not only that but mortgage loans could be bundled up and be sold on as as part of a Collaterized Debt Obligation to other banks providing yet another source of ready cash.

The superior purchasing power of the banks enabled them to redirect activity in the housing market away from new build houses to the sale and resale of ‘second hand’ houses. There was a collapse in effective demand for new build houses, as all the money was going elsewhere to more profitable forms of speculation. Simultaneously the rise in prices of traded houses pushed up the prices of starter homes, reducing the purchasing power of the incomes of the first time buyer. Now the average house price is 5 times the average income, whereas most of recent history it was 3 times. Banks had effectively debased the domestic currency by reducing its purchasing power in terms of what really mattered, securing a home.

This change was effectively masked by a decline in interest rates, which reduced the cost of mortgages. In an economy in which people increased derived an income from property speculation it did not seem to matter.

Speculation in the various financial markets further increased the incomes of bankers and traders in the City of London. Bonuses of £1 million were becoming common place for traders in the City of London. It comes as no surprise to discover that this year England has become the largest market for Ferrari. What must be understood that the vast profits derived from this trading was money profits not real profits. It did not add to national wealth so much as become a charge on national wealth. Given that the bankers etc. now had control of a disproportionate share of the nation’s money they could outbid the rest of the population for the most desirable goods and services. Chelsea and Knightsbridge became the home of bankers, poorer residents were pushed out into other areas. Even less expensive areas in London such as Islington have become no go areas for professionals other than those who work in the financial trades.

Inflation figures whether shown in the Consumer Price Index or the Retail Price Index fail to show the extent of the true devaluation of the domestic currency. Since housing is one of the most significant items purchased in an individual’s lifetime it should be shown in a separate index and that would indicate the true decline in the value of the domestic currency. Giving bankers control of the money supply has resulted in them debasing the domestic currency as effectively as Henry VIII. Instead of reducing the value of the content of the currency, they reduce the value of the currency by increasing its supply of money, making each domestic pound worth less. Further by gaining a stranglehold over government economic policy they have been able to limit the incomes (money held) by the majority through persuading the government to adopt supply side economics and domestic austerity, which have kept incomes for the majority in real terms at 2003 levels, which means the bankers and the super rich can through their spending increasingly determine what is produced in the UK. The shrunken purchasing power of the majority means they have less say over what is produced, therefore less affordable housing.

UK government through surrendering control of the money supply to the banks have been able to remake the economy so that increasingly not just bankers but increasingly large parts of the population to look too making income through speculative activities, rather from gainful employment. It is a population with little optimism for the future that is attracted to the gambling websites, as they see it as the only chance of making money. A speculative economy in which the financial elite make fortunes through speculation in currency, commodities and equities is an unfair society as most are denied that opportunity. One such speculative activity is the buy-to-let property market in London, with prices increasing at a rate of 11% a year, the buyer cannot fail to make money. Since all too often its a short term speculative investment there is no desire to make the purchased property habitable.

Bankers I believe share a disproportionate part of the blame for the housing crises in the UK. Only by taking control of the money supply away from the banks can a fair and equitable society be created. There are lots of policies that could achieve this, one of the best is increasing the banks to hold a larger ratio of share equity (reserves) to bank deposits. A gradual increase of the amount of equity to deposit ratio to 1:10 would end many of the evils of the current system.