My last two blog items (on MoneyWeek’s “End of Britain” video/letter, discussing a US debt default and consequences for socialist revolution in Britain and it never being necessary to reduce the level of the national debt covered some arguments I’ve been having with a blogger called Martin Odoni (hstorm), who agrees with the analysis of Warren Mosler in his book “The 7 Deadly Innocent Frauds of Economic Policy“. The following is a short review, drawing on some of my economic knowledge as an ex-Marxist, posing some important questions for British economic perspectives and consequences for socialist revolution.
I have reread Mosler’s book (reading about all of the “seven deadly innocent frauds” – it then goes on to self-promotion in his election campaign which I haven’t bothered with) and done further research into others’ opinions of it, and it is clear that it has a massive flaw in not taking inflation seriously. There is also the slight of hand in suggesting that there is no way an investor can take money out of the US Federal Reserve (Fed) when he/she can, as long as he/she can find someone to swap with on the markets, and this includes foreign currencies (the words “foreign exchange” and its abbreviation “Forex” are omitted from the entire book, as a search of the PDF file reveals, probably deliberately to imply investors are stuck with dollars).
The dollar being the world’s reserve currency, with some other countries’ currencies “pegged” to it, may make it less susceptible to fluctuations in inflation and exchange rates than with other currencies.
Additionally, Odoni (hstorm) assumed that the Bank of England behaves precisely the same way the Federal Reserve does. According to http://en.wikipedia.org/wiki/Federal_Reserve_System, “The Federal Reserve System has both private and public components, and was designed to serve the interests of both the general public and private bankers. The result is a structure that is considered unique among central banks. It is also unusual in that an entity outside of the central bank, namely the United States Department of the Treasury, creates the currency used.”
I’m not an expert in either capitalist (bourgeois) or Marxist economics. Even though I did regard myself as a Marxist in my time in the Militant Tendency/Militant Labour/Socialist Party from 1990-98, I only read two Marxist texts on the subject – “Wage Labour and Capital” and “Wages, Price and Profit” – I have all three volumes of “Capital” (“Das Kapital” in German) but never had the time or inclination to try to read them. The first of these made a lot of sense, but seemed to be out-of-date in not considering advertising and brand loyalty. I couldn’t get my head round the second at all. Oh, I did read Lenin’s “Imperialism, the highest stage of capitalism”, which predicted the tendency towards monopolisation, which ironically Thatcher’s advertising guru Maurice Saatchi recently announced on Newsnight that he agreed with Marxists as far as this was concerned (talking about the Big Six energy companies), but that his Centre for Policy Studies would try to come up with one big idea to get David Cameron re-elected as prime minister.
There are still arguments today about whether the key Marxist prediction of “the tendency for the rate of profit to fall” is actually correct, but it is clear that that was not the cause of the 2007/8 credit crunch. It was due to bankers creating AAA-rated complex “derivatives” that very few people understood but were based on US “subprime” mortgages that poor people couldn’t afford – and when the house prices crashed, there was a massive crisis.
So what conclusions can we come to about the stability of British capitalism nowadays? Are we really the seventh richest country in the world (and what about the increasing disparities between rich and poor)? What will happen when quantitative easing ends? [Some economists predicted big rises in inflation/interest rates when it started; some predict similar things when it ends; have they a clue what they are talking about!?] What about the British housing bubble bursting (made more likely by the extension of the ConDems’ “Help to Buy” scheme)? What about impact from the Eurozone (especially if some foreign banks go under that owe British banks money)? What if there is a US debt default? What about the big fines British banks are having to pay to customers/businesses? Would high interest rates (MoneyWeek’s “End of Britain” suggests 5%) mean that UK plc goes bankrupt, with ensuing social and economic chaos and great potential for socialist revolution (as long as there’s a serious sizeable socialist party to lead the revolution and I think the best potential for such a party is Left Unity)?
I’ll leave these as questions to be considered by others. Feedback would be greatly appreciated!
ThatcheroftheLeft 
Hi Thatheroftheleft! I wanted to reply and establish causes of the 2007 Second Great Depression, as I think it will be called when historians write about this subject in the future. You are correct in part with what you say as regards the derivative and the sub prime mortgages, however I think you may need to look deeper than this. Firstly, origins of the crisis can be traced back to three key problems. (1) Banks are supposed to be utilities of the economy. Yet, when we analyse a balance sheet of say JP Morgan in 2007, what we find is only 30% of its income is generated from intermediation, i.e. banks allocating capital which contributes to funding economic growth. So, why is intermediation so low given this is a banks primary role? The key to this issue is that banks work for shareholders in public markets and the stock markets make demands of bank board members – they expect a 20% return on equity. Now, to achieve a 20% return on equity, (and importantly bonuses are tied into meeting return requirements so Board members will move heaven and earth to achieve annual objectives), the bank can not do this via lending and cross selling products into its customer base alone. So, to meet extraordinary returns (utility businesses make 6-8% returns normally), banks must lend to each other as the capital cost to doing so is zero weighting, with just a small weighted cost for counter-party risk. If a bank lends to a customer, the risk is much higher, they may not repay, a bank may have to put aside say 150-200% of the 8% standard capital charge for default, which eats into profits. So by circumventing their primary role, the capital charges of lending to SME’s as an example are retained within the bank, and its this plus fees that gets banks to 15-20% returns, not lending. Banks and capitalism always looks to innovate to achieve more, and this is often left unchecked. Most central banks do not even know the underlying business models of banks and what drives them, regulators do not look at balance sheets strength, underlying asset base or the business model, its truly incredible, instead they look at one size fits all capital adequacy ratios that protect nobody on a systemic basis given the homogenous system created post repeal of Glass-Stegall Act. (2) US mortgage brokers started off the process of sub prime and selling. They were asked by banks to go out and originate as many mortgage loans as they could to feed into the derivative engine you speak off, because this creates lots of fees and gets assets off balance sheet into SPV vehicles; plus there is no capital charge and all money earned drops straight to the bottom line post variable costs. Mortgage brokers and the investment banks originating derivative based vehicles had no care in the world that adjustable rate sub prime mortgages would default within 18-36 months as the rates ramped for low income families – primarily because they distributed the debt to a bank or investor at the other side the world who would be affected by any default as the risk had been distributed via the alchemy based Alt-a or subprime debt being converted into AAA rated bonds vis S&P or Fitch etc who of course were being paid by the investment bank distributing the debt. This is the link between points 1 & 2, the engine needs assets to produce fees to produce 20% ROE with no capital charges – how else would they achieve this? (3) Banks lend money to each other in order to fund the derivative engine – funded assets are taken off bank balance sheet, bundled up often multiple thousands of mortgages, and placed into an SPV. The cash-flow yields from the mortgages are taken and go through an interest rate swap, floating rate mortgage yields for fixed rate interest to pay out structured bonds to investors in these vehicles (I won’t go into the specifics of the process here, a whole issue on its own!). Investors buy the bonds which are underwritten by AIG or a mono-line insurer, in case of mortgage default, and AIG also used the AAA rating, so it also did not need to keep any capital aside for default making spectacular returns from the derivative engine. All this was going on under the nose of central banks (bernanke et al), and regulators who actually made statements saying distribution of risk is a good thing and that banks are engaged in good practices here, absolutely laughable, no thought process behind mortgage asset origination and distribution strategy, they failed in a supervisory capacity to look further than the end of their nose, and of course their banker friends made huge bonuses, so everyone was happy, until the sub prime defaults began to come through in volume, the mortgage cash-flow yields began to fail from the asset side of the SPV, the swaps failed, and so investors ran to the insurance provider who nearly but for the US bailout nearly collapsed too. It was all too good to be true. But nobody thought to check what type of assets were going into the derivative engine, the regulator had no idea about the fraud being originated to the US people right under their noses. Back to the tale – the Banks also invested and took a portion of the AAA section of the bonds. The reason they did this was risk transfer and relates back to point 1. The banks have swapped sub prime lending risk at no capital charge via the derivative engine to AAA bond risk. This means, rather than keeping those sub prime mortgages on balance sheet at a cost of say 400% of the normal 8% charge (heightened default risk of low income families, so the internal capital charge set by the regulator is higher also), for what is now AAA bond risk at 20% weighting of the 8%. So, capital charges have reduced from say 32% of the asset down to 2%; that difference in lending yield drops straight to the bottom line – this is one of the ways how banks made 20% returns, and what drives them to achieve this. This for me is the important part of this whole story, and regulators still don’t understand it properly, they still think banks are intermediaries and so Basel and Dodd-Frank are geared to wards this type of business, not an underlying business model that is driven via unbridled and unchecked innovation in the search for spectacular returns – this is why alchemy is so well paid, because its founded upon incorrect default assumptions in the derivative engine, investors were ‘sold a pup’ in believing the AAA rate story that investment bankers sold to investors – investment bankers knew that the correlated default risk used in the derivative modelling was premised upon default rates from a different industry (as this was a new venture with no historic default rates so they had to make it up and borrow it from another industry and tweak it), and the assumptions they used were likely to be uncorrelated with mortgages, S&P were not smart enough to work it out vs harvard and MIT maths graduates working at investment banks, so they were sucked in too, blind leading the blind, but it made money and lasted a few years years before it popped and the rest we know is history now, but resulted in a $13 trillion dollar global bail out requirement after the spread of contagion caused in part by the repeal of Glass-Stegall. I hope this has helped and makes some sense as I am writing this on the hoof, let me know your thoughts on whether you agree? Most people reading about the origins of crisis are looking at stories about people and agency, banksters, corruption, being on the take, imprison them all, or looking at this as a technocratic accident etc. This I think is lazy research, the true answers can be found by analysing banks balance sheets and looking for reasons why they do these things, and spectacular lack of supervision via the regulator. Not many people know how to do that and this is why mainstream understanding needs correcting and why I do this. Anyway, let me know if you require clarification on anything, or I need to explain myself better, I am happy to follow up. Thanks, and good blog!
You’re mistaken to think Mr. Mosler doesn’t account for what causes (and what doesn’t cause) inflation.
As I suggested in my review above, I don’t feel qualified to answer Ian Crowther’s arguments. [Perhaps if he’d made the points in layperson’s terms (with better formatting), I’d have felt able to comment.]
In reply to Erick Borling, it certainly struck me when reading “7 deadly innocent frauds” that proposals like giving large amounts of money to everybody (or perhaps all adults) in the country (specifically USA) would cause high levels of inflation and decrease the value of the dollar relative to other currencies – because having more money in circulation would make the money that people already have worth relatively less. This view of mine was validated by some reviews of the book on Amazon (see http://www.amazon.com/Deadly-Innocent-Frauds-Economic-Policy/product-reviews/0692009590/ref=cm_cr_pr_viewpnt_sr_1?ie=UTF8&filterBy=addOneStar&showViewpoints=0&sortBy=bySubmissionDateDescending). The fact that there are no other countries with currencies pegged to the pound, or sharing the currency as the Scottish National Party (SNP) proposes if there is a “Yes” vote in the independence referendum, would probably make the effect of similar policies in the UK much more dramatic in terms of inflation and the relative value of the currency.
[Incidentally, SNP leader Alex Salmond has talked about Scotland not being liable for a share of the national debt if they are not allowed to use the pound (which the Tories and New Labour both oppose). This would be great and is a reason to support independence, and the Radical Independence Campaign, that is arguing for a “Yes” vote on a much more radical programme, should argue strongly for an independent currency (not just for that reason but due to the necessity of controlling interest rates, etc., in a truly independent country).]
For more up-to-date economic analysis by me, see my review of MoneyWeek’s “What Osborne didn’t tell Parliament” (in the 2014 budget), written by financial experts rather than their advertising department (in the case of “The End of Britain”), go to https://thatcheroftheleft.wordpress.com/2014/03/21/budget2014-what-osborne-didnt-tell-parliament-critique-of-new-moneyweek-end-of-britain-argument-need-revolution/