This is a difficult time for the global economy and for Europe. Capitalism is struggling, China is rising, oil is declining, and the environment is suffering. Is this the end of capitalism as we know it, or just a normal part of international economics?
Not long ago, hardly any one in the world had heard of ‘credit-crunches’ or ‘subprime’ markets. Now, these words are on the tip of everyone’s tongue, as the real effects of this seemingly far-off financial crisis bite at home. Once, good management of an economy did not matter so much; growth was guaranteed simply because there was so much money around. Now, there is a limit on the amount of money being supplied, and only the safest investments will get it.
So where did it all start? Like most global trends, the credit crisis began in the United States. Banks, always seeking to make more and more money, started offering mortgages to families who would be extremely unlikely of ever repaying that money. They then repackaged these mortgages to look like safe long-term investments, and sold them.
But then the people with the mortgages started to default. They were unable to pay, and the bankers holding the supposedly safe investments that were built on the borrowers promise to repay, found themselves holding worthless products. They tried to sell them, but no one wanted them. And then financiers started to realize just how deep the problem went: huge banks had invested billions in these mortgages that simply could not be repaid. International banks found themselves in deep trouble with debts that would never be paid. And they had made loans based on the promise that the money would be repaid. Suddenly, the banks were exposed and vulnerable. They stopped lending money to each other, desperate to keep as much real money as possible in their own vaults.
So because financial companies were throwing money at people in the US, and across the world, without properly checking to see whether those people would ever be able to pay the money back, they created an unstable system that has meant now, when they realized that the money they had been promised would never exist, they will no longer lend money unless they are really sure it will be repaid. And that means, unless you have a high-salaried, secure job, or an amazing business idea and plan, you won’t get a loan for a mortgage or business.
And because banks won’t lend you money, you can’t go and spend it. You can’t start a business. You can’t buy a house. You can’t spend as much on shopping. And because you can’t spend as much, shops that are struggling end up closing. People become unemployed. And then they have even less money to spend! More people start asking for unemployment benefits and social security payments. And so taxes go up, just as the amount of money available goes down. And so the cycle gets worse.
The Banking System
There is another, deeper reason why the supply of money is necessary. Many people do not realize this, but the entire economic system of the West is based on debt, promises and trust. It is called the Fractional Reserve Banking system.
It is based on the simple premise that people will always trust that, when they spend money on a credit card, or when they see on their internet banking that they have hundreds in their bank account, that they actually do, physically, have that money in the bank. If you believe it is there, it does not matter whether it does physically exist. You will be happy to trust that the money is there, and not to actually go and look.
And the shocking truth is that the money does not exist. If everyone, at the same time, went to their bank and all demanded it pay them all the money they keep there, they would all find out that the bank does not actually have in physical currency the amount the savers have stored with their bank.
This is because the fractional reserve banking system is based on the hope that the savers will never all demand their money, all at once. Because we believe the bank has the money, the bank can then lend more money than it actually has. If no one is going to check, then who is to stop the bank making up numbers for how much it has in reserve?
The government does regulate this though – and the banks must have a fraction of the amount actually lent. So, for example, if a bank lends 100 Euros, it must actually physically at least have 10 real Euros in its bank vault. It would therefore have a fractional reserve ratio of 10:1. For every 1 Euro it actually has, it can create and lend 10 fictional Euros. And because so much of this money is transferred by computers, and is never actually seen, it makes the whole process so much easier.
So if you borrow 100 Euros, and then spend that on a new bicycle, the person from the bicycle shop you bought from will take his 100 Euros and put them in his bank. And that bank, from that 100 Euros, will create more money. On the back of that 100 Euros, it will lend out even more fictional money.
The beauty of this system is that, as long as it keeps moving, no one notices the problems. The man who borrowed 100 Euros will pay it back with real money. The bank where the 100 Euros were placed, and which then lent out even more money than the 100 Euros, will also have that money paid back over time.
And so, under the fractional reserve system, the amount of actual currency increases overtime, but it does not devalue the money as long as the opportunities to expand and invest also keep expanding.
And this is the problem. Now, with the credit crunch, banks are making it much harder to get hold of money. Because people can’t get money, they can’t spend it, and so more money cannot be created. Businesses cannot be started. Consumers are not spending so freely – only essential products are being bought. The opportunities to make new markets for products are thus decreasing.
China and Carbon Dioxide
Combined with the credit liquidity problem, we have the rise of China and Asia. It is estimated that China is building a new coal-fired power-station every six days, such it is its demand on energy. Because production of oil has remained the same, but demand for it has massively increased, the price of oil has also risen tremendously. Fuel costs across the world are going up because although the supply of energy remains the same, the demand for it, mainly from new Chinese consumers, has grown phenomenally.
And this too has caused a slowdown in spending – it costs more to go shopping, to transport products, and to cook your food. And so consumers are cutting back on their spending even more. And because there is far more awareness of humanities destructive impact on the environment, large sectors of the global economy might need to be completely restructured or even abandoned if technology cannot adapt. If CO2 emissions are causing global warming, and if the problem is as serious as we have been told, and if politicians really are going to stop emissions rising, then this means completely abandoning air travel and car transport. That in turn would mean the collapse of economies. British life is predominantly based on having a car and being able to commute. American culture adores cars and the freedom they bring. And Japan has produced Toyota, the world’s biggest car company. Yet if we have to abandon cars, because of their destructive impact on the environment, then our entire 21st Century concepts of the world will change, and we will step back 200 years.
Already in the United States, property values in suburban communities are falling as oil prices rise. Commuting to work in the City is no longer a rational way of life. The future involves living in the city and walking to work, not driving there from far away.
The new wave of environmentalism, combined with the rising fuel prices, mixed with the shortage of supply of money, all threatens the fractional reserve banking system. If we have to cut back on car production and buying, and air travel, we are actually reducing our markets and opportunities to invest, which in turn will reduce the ability of the system to create money and wealth. It relies on ever expanding markets and opportunities, on human creativity and innovation, and on an inexhaustible supply of resources. Yet it might just be that we are facing real world limits to eternal growth.
The economy of Spain is one such example. Unemployment is rising, and the booming housing market has come to a shuddering halt. Because the supply of cheap money has dried up, the Spanish, and the people from all over the world who were buying Spanish property, have stopped purchasing.
Some people a few years ago bought properties in Spain, whilst maintaining jobs in England. They would fly to England for the working week, and then at the weekend fly to Spain. This lifestyle is no longer possible with higher fuel costs and the end of cheap flights.
The supply of cheap money was also a problem – because prices seemed to endlessly rise, banks lent money without being too careful, and as a result, the Spanish people have borrowed the same amount as Spain’s GDP! And of that debt, mortgages to buy properties make up 60% of it.
Once, because of the struggling economy in Spain, the value of the Peseta would have fallen, and in so doing the value of Spanish products would have fallen, making them more attractive to foreign buyers because they were cheaper, and thus helping to boost the economy again. But now Spain is stuck with the Euro, and the European Central Bank’s (ECB’s) main concern is not Spain, but rather Germany and France.
Because Germany has taken measures to reduce its public debt and state spending, Germany has found itself to be in a stronger position in this period of economic trouble. Whilst Spain, Italy and Greece (and to some extent, France), really needed interest rates to go down, in order to make borrowing money easier and to help people borrow and invest and thus create wealth, Germany had exactly the opposite problem: stopping people spending too much, and forcing prices to rise (causing inflation). The ECB chose to keep interest rates high, in order to help Germany, and in so doing has sacrificed the needs of the Latin and Mediterranean economies to that of the German one, leading some people to regard the Euro as the old German Deutsch Mark in disguise.
For a long time now, many economists have been predicting the collapse of the Euro single currency, not least of all, Professor Milton Friedman, who said in 2004 that he suspected the Euro zone could implode. Friedman just could not see how the many differing economies of Europe could all cope with one interest rate and how the multitude of languages and cultures could ever function as one economy, which is what the Euro relies on. Given the economic troubles now being experienced, this could be a really important time for the Euro’s future viability.
This is a difficult time for the world economy, and particularly for the Western economies. It is a problem created by capitalism and greed, yet because greed is such an essential component of capitalism, and arguably such a basic trait of humanity (and particularly the powerful decision makers), the global system of market economies is unlikely to be in permanent danger. Capitalism, argued Joseph Schumpeter, undermines itself, and erodes the very things that make it such a success. This then will inevitably lead to periodic crises.
The Russian economist Kondratiev also noted that economies tended to operate in cycles, and gave his name to the phenomenon of Kondratiev waves – periods of expansion and contraction in global capitalism. Thomas Malthus, an economist from the early 1800s, and Karl Marx, the intellectual giant behind communism, also both saw that capitalism could and would be subject to crises as it continued. If money is not re-invested, and if it leaves the cycle of production, the system will struggle.
But it’s happened before and it will happen again. The global financial crisis known as the Great Depression of 1929 was arguably because confidence was lost, loans stopped and the money supply shrank, after a period of unsustainable boom. But the fundamental recognition that a capitalist system fits best with human nature and allows sufficient freedom for human innovation and rewards those who try, coupled with the strong price signals from the market, will make change happen, though it is already too late to avoid serious climate change. But those looking for the socialist revolution and the collapse of capitalism will have to wait a few years longer. The present difficulties are not the beginning of the world revolution.