A Mars bar from Tommy Chocolate

In August 2015, jurors at London’s Southwark Crown Court were drawn into the murky world of Pete the Greek, Fast Eddie, Golum, Pooks and Tommy Chocolate – nicknames for traders implicated in a vast financial conspiracy. In the event it was Tommy who spilled the beans and took the fall – sentenced to 14 years for manipulating a key financial indicator, the London Interbank Offer Rate, or Libor.

Most people do not know or care about Libor. But it matters.

Libor is the average interest rate at which banks are prepared to lend money to each other. Libor is also used, though, as a benchmark for other rates, such as mortgages, in which you might have an interest. As an individual, you might have lost just a couple of pence or cents. However, those at the centre of the conspiracy, who were effectively betting in a rigged market, were able to rake off appetizing profits.

In the three years he worked at UBS, Tommy, aka 35-year-old British trader Tom Hayes, scooped up around $260 million for the bank. There were costs and payoffs along the way: in some cases he would offer his fellow conspirators deals worth up to $100,000, though in others he secured co-operation for rather less – a bottle of Bollinger champagne or even a Mars bar.

The Libor scandal has already cost the banking industry in London and New York around $9 billion in fines. And 11 more trials have been scheduled in London. But it is unlikely that the chief executives of the banks, who either knew about all this or turned a blind eye, will get their collars felt.

Tommy’s mistake was to leave an incriminating trail of emails and chat-room messages. Financial trails are usually more difficult to track. The money flows are so complex that no-one knows everything that is going on. The bosses of financial institutions in particular are conveniently ignorant about what their underlings get up to.

Finance in all its forms, from banking to insurance to foreign-exchange trading, employs hundreds of thousands of such people, who earn substantial wages for just exchanging information.

In the financial-services industry worldwide they manage around $100 trillion. Nothing wrong with being paid to work with information, of course. Journalists do it all the time. Regrettably, journalism is less lucrative. Tommy earned around £400,000 per year at UBS, and then clocked up £3.5 million for just nine months at Citigroup. The New Internationalist, I can assure you, is less generous.

Wizards of debt

What exactly are these wizards doing?

You might visualize them juggling pounds or dollars or euros, or their electronic equivalents. Indeed, you could leave the answer at ‘moving money around’. But if you are curious about what money is, you might hesitate.

Check an economics textbook and you may find it is a substitute for barter, a medium of exchange, a store of value, or a unit of account. But that disguises the underlying reality that all money is essentially debt.

If you have cash in your wallet or money in the bank, this is something that the government or the bank owes you. In the case of the government this may not amount to much.

On a £20 note, for example, the Bank of England says ‘I promise to pay the bearer on demand the sum of twenty pounds’. In other words it will cheerfully exchange one £20 note for another. In the US, the Secretary to the Treasury makes a more realistic promise on a dollar bill: ‘This note is legal tender for all debts, public and private’ – but hedges this with a prominent statement on the reverse: ‘In God we trust’.

Nowadays almost all money is created out of thin air by banks when they make loans

Where does all this money/debt come from? You might visualize a printing press. One of the more advanced is the government-owned enterprise, Note Printing Australia in Craigieburn, Melbourne, which has been one of the pioneers of printing notes on polymer rather than paper. But focusing on physical money, plastic or otherwise, will lead you astray. Nowadays almost all money is created out of thin air by banks when they make loans.

Surprisingly, it was only in 2014 that this was acknowledged in the Bank of England’s Quarterly Bulletin.

It pointed out that many statements in the textbooks are wrong. ‘Where does money come from? In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood. The principal way in which they are created is through commercial banks making loans: whenever a bank makes a loan, it creates a deposit in the borrower’s bank account, thereby creating new money.’

In other words, the bank does not wait for anyone to save money that might be lent to a borrower. If the borrower looks a safe bet, then through the magic of double-entry book-keeping it creates the necessary funds by making two new entries in its books.

One is a new account on the debit side for the borrower; the other is a credit to the bank’s accounts where the corresponding loan appears as an asset. The money has thus been conjured up from nothing. Indeed, if the borrower immediately changed her mind and paid it back, it would disappear again just as quickly in a puff of virtual smoke.

In the UK, more than 90 per cent of all the money in the economy has been created in this way by banks. Globally, outstanding bank loans are around $64 trillion.

Slippery operators

If banks could be trusted to manage all this new money well, we could leave it in their safe hands.

But the incompetence and greed that led to the 2008 crisis, and a succession of scandals, of which Libor is just one, have left the reputation of the banking industry in tatters. Formerly viewed as solid pillars of society, bankers nowadays are suspected of being slippery operators who will recklessly gamble with our money, siphon off huge salaries and bonuses, and expect the government to bail them out when it looks as though their business is about to implode.

To avoid having to rescue banks, governments around the world have sought to control them more tightly.

The US has adopted a whole raft of new regulations, one of which has just come into force – the Volcker rule – that prevents banks from trading – that is, gambling – with their own funds. As a result, US banks are no longer looking so profitable, and cities like New York are now looking beyond finance and seeing their future more in entertainment and technology.

The UK is generally more sympathetic to banks. The new Conservative government, for example, when faced with the prospect of HSBC shifting its headquarters from London to Hong Kong, offered a sweetener by reducing the banking levy. HSBC, you may remember, has been laundering money for drug traffickers and terrorists, violating US sanctions against Iran and helping its customers with massive tax evasion in Switzerland.

Tommy Chocolate also knew that the UK was a softer touch for dodgy dealing. Had he been extradited to the US, he could have been behind bars for many decades – hence his decision to come clean in Britain.

These shenanigans may be seen as just the work of a few bad apples who have been attracted to work in the banks because that’s where the money is made, meaning that we just need to jail the odd rogue and introduce a few more banking regulations.

Unfortunately, the problems in the financial sector run much deeper. Furthermore, the way modern money is created is fundamentally flawed and no longer serves the public interest – we need to take back control of this from the banks.

Read more about how we could do this in the new book The Money Crisis: How the bankers grabbed our money and how we can get it back.

The No-Nonsense Guide to International Migration

Author of our No-Nonsense Guide to International Migration, Peter Stalker discusses the complexities of international migration in the wake of the Arab Spring. Chapter 1 and the foreword are available on our website and you can also view all of the weekly No-Nonsense guide blogs.

No-Nonsense Guide to International Migration coverThe No-Nonsense Guide to International Migration
by Peter Stalker

An embrace from Silvio Berlusconi is generally best avoided, at any age. But one of the more dubious welcomes he extended earlier this year was to 20,000 or so migrants from Tunisia in an exodus following the Arab spring. In this case his friendship came with an imminent expiry date. The Italian government issued the visitors with residence permits, but only temporary ones, and firmly pointed Tunisian and other travellers in the general direction of the Alps. After all, these permits, although festooned with Italian stamps, should also entitle the migrants to move freely within the ‘Schengen Zone’, a group of 25 European countries between which there are no passport controls. Unfortunately for Silvio, and the migrants, France saw through this ruse, promptly rounded them up at the border and despatched them back to Italy.

These manoeuvres have now thrown the future of EU migration policy into question. In proposals to be discussed by the EU’s home affairs ministers on May 12, the Schengen Zone rules would be altered so that in ‘exceptional circumstances’, a member of the zone judged not to be controlling its own borders with sufficient diligence or ferocity would see passport controls reintroduced. Just how exceptional even these circumstances are is open to question.

While Italy may complain about people coming from Tunisia these numbers are minor compared with arrivals in Tunisia itself. As Bjarte Vandvie of the NGO network, the European Council on Refugees and Exiles, has pointed out, Tunisia has welcomed some 300,000 people fleeing the fighting in Libya: ‘It is Tunisia that needs help handling its refugees, not Italy.’ It should be noted of course that the UK is not even a member of the Schengen group so there was little chance of any Tunisians making it across the channel.

Doubtless, many of these migrants would be classified as economic refugees. Unemployment in Tunisia is officially around 13 per cent, but probably much higher. Indeed, the original trigger for the Arab unrest was the cry of pain from a desperate young Tunisian man, not even allowed to sell vegetables by the roadside. At that point, he would have been unable to migrate to Italy, thanks to a series of agreements through which the Italy effectively bribed the repressive governments of Tunisia and Libya to ensure that their citizens, however unhappy, stayed firmly put. With the regimes disintegrating, these dubious pacts have also been unravelling and restless people have at last able to leave if they are desperate enough to take to the fishing boats.

As I pointed out in The No-Nonsense Guide to International Migration, the people most likely to migrate are not generally the poorest, but rather those whose lives have already been disrupted and who can also scrape enough cash together to pay for a voyage. Globalization and rapid economic development tend to shake people loose from their surroundings. But suddenly unlocking the political shackles can have much the same effect. As UN staff in Tunisia have noted: ‘Some villages appear largely empty of their young male population, with only women, children and elderly people remaining.’

It would be a shame if the EU commission were to start weakening the Schengen Agreement, which is arguably one of the EU’s greatest achievements. But many governments across Europe are coming under pressure from the anti-immigrant far right, whether the Northern League in Italy, or the National Front in France. The latest in this depressing trend are the True Finns who seem likely to form part of Finland’s next coalition government.

If immigration policy is contentious in Europe, it has also become increasingly polarized in the US, with aggressive state legislation, notably in Arizona, which  among other things would have made it a crime for immigrants not to carry immigration papers and allow the police to demand to inspect these. Mercifully a Federal judge stepped in just before the law was to come into effect. Judge Noonan said: ‘That 50 individual states or one individual state should have a foreign policy is absurdity too gross to be entertained.’ Unfortunately, this has not stopped other states, including Utah and Florida, from taking a similar stance.

High time that the Obama administration, mindful of its Hispanic support base, demonstrated a bit more leadership. Oddly in this case, he might do worse than follow George W. Bush. The previous president is not usually a source of inspiration but from 2004 did try to rationalize US immigration policy, even proposing to offer unauthorized migrants a path to legality. However, faced with opposition from the Republican far right he eventually threw in the towel. President Obama’s approach has been less than audacious. In fact, his administration has been deporting more people than Bush’s. However, as reported by Americasvoice.org he has been  ‘Meeting with a number of Hispanic leaders, so a more cohesive policy may eventually been forthcoming.’

Migration policy is a bit more pro-active in some of the immigrant source countries. I am  writing this from the Philippines which officially has around 2 million workers overseas and regards them as ‘modern day heroes’. The country does make efforts to protect workers through the Philippines Overseas Employment administration.

For example, it asked Saudi employers of domestic workers to submit their police clearance, and guarantee a salary of at least $400 per month. The Saudi government response? It stopped all hiring of Filipino domestics. But even the Philippines is ‘coming under fire from its national federation of migrant groups, Migrante International, for its “slow, dismaying and disorganized action’ in repatriating  workers  trapped in Libya.

The No-Nonsense Guide to International Migration argues for the kind of activist support for migrants that the Philippines Overseas Employment administration at least tries to engage in. But ultimately it is the destination countries who wield most of the power – which they generally do in an erratic and often exploitative fashion. Silvio may be one of the more egregious violators of immigrant rights. But he is far from alone.

The No-Nonsense Guide to Global Finance

Globalization, climate change, terrorism, fair trade, human rights, health, poverty… The No-Nonsense Guides help make sense of these vast and complex issues, all in under 150 pages - providing a concise, ‘no-nonsense’ view that you can read anywhere. Over the coming weeks, we’ll be highlighting each No-Nonsense Guide in our series with blog posts from the authors concerning the subject of each book. Chapter 1 and the Table of Contents are available for The No-Nonsense Guide to Global Finance on our website.

NN Global FinanceThe No-Nonsense Guide to Global Finance

by Peter Stalker 

When writing The No-Nonsense Guide to Global Finance, I was not surprised by the fact that bankers were becoming obscenely rich by taking huge risks. Risk-taking is after all what you would expect from entrepreneurs, many of whom have not just made huge fortunes but also lost them in spectacular bankruptcies. The real shock was to discover the extent to which banking had evolved into a special case of state-subsidized capitalism that underwrites one-way bets. Indeed banks are the corporations least likely to be ‘rupt’. A big enough bank can make huge gains through speculation knowing that if it makes catastrophic losses it can rely on a public bail-out if the state frets that its collapse would crash the financial system. The end result is the now familiar and toxic combination of privatized profits and socialized losses.

I started writing the book at the beginning of 2008. At that time it was intended to be a guide to money. But as I started work, the entire financial system began to implode and the publication had to take on a broader aspect. For me, that had the disadvantage that the book market was soon awash with competitive coverage of finance and its woes. On the plus side, of course, this should have increased the opportunities for us all to learn the lessons of a crisis that may not have hurt bankers too much but has thrown millions of other people out of work.

Unfortunately not. The most recent evidence is the British Government’s feeble agreement with the banks, announced on February 10, known as Project Merlin. Supposedly designed to bring the bankers to heel it represents another dismal capitulation. It only requires banks to hold bonuses to last year’s level (something like £8 billion, in case you were worried). The boss of Barclays alone is in line for a cool £8 million. And as for the requirement that the banks should support British business with additional loans, the increase agreed is derisory. As the Economist, which is no fan of government regulation, has pointed out: “An extra £11 billion of loans, split among four firms with trillions of assets between them, is a rounding error.” And even that assumes that they do not simply offset these new loans by calling in old ones.

Why the timidity? Supposedly this is because we are nervous that these financial wizards would take offence and abandon our shores taking with them whatever tax they choose to pay. But where exactly are they going to go? Perhaps they could decamp to some sunny tax haven like the Cayman Islands. But wait a minute. That would mean that they would have to look to the Government of the Cayman Islands to bail them out next time. Not very wise. Even an economy as large as Ireland’s has been brought to its knees by its rash promise to guarantee the survival of Allied Irish and other second-tier banks.

Now consider the Royal Bank of Scotland, which at its height was the world’s fifth largest bank with loans greater than the UK’s entire GDP, and now nestling in the comforting arms of the British taxpayer. Any country want to host the smart suits from RBS? I thought not.

Nowadays as Stanley Johnson, former Chief Economist at the IMF, has written in the New York Times, the credit rating agencies, such as Standard and Poors, when looking at banks do not just consider the state of banks’ balance sheets but also the creditworthiness of any government that might be expected to prop them up. He says: “the idea that megabanks would move to other countries is simply ludicrous. These behemoths need a public balance sheet to back them.” The only possible shelters are probably London and New York. And even those guarantees may not hold. The largest banks are moving beyond being too big to fail. In most countries they are now too big to save.

The US has also been picking over the entrails of the crisis, through its supposedly bipartisan Financial Enquiry Commission. The main report, published on January 27th, concluded that the crisis was “in no small part due to the widely accepted faith in the self-correcting nature of the markets and the ability of financial institutions to effectively police themselves.” Unfortunately while the main report, backed by the Democrats on the Commission, rightly blames the financial industry, the Republicans members issued rebuttals pointing their fingers at many more culprits, particularly at the regulators. A failure of big business must always be interpreted as a failure of big government. With a Republican Congress for the next few years it seems that the US too will squander another opportunity to bring the banks under control.

If there is to be another edition of The No-Nonsense Guide to Global Finance it will unfortunately not need too many revisions.

Day seven - finding funds

[image, unknown]
[image, unknown]
[image, unknown] [image, unknown]

If all economists were laid end to end
they would not reach a conclusion.


[image, unknown]
[image, unknown]

BEFORE the week finishes we really ought to talk some more about the international banking institutions - more about the IME of course, but also about the commercial banks and the World Bank.

I’m beginning to feel sleepy already.

That’s not always the kind of reaction that the IMF provokes. In countries like Jamaica and Brazil there have even been ‘IMF riots’. The organisation has cut so deeply’ into peoples’ daily lives that they have taken to the streets in protest.

They obviously understand more about banking than I do.

Maybe so. But all they really understood was that the price of their foodstuffs was shooting up, or that they were losing their jobs, or that the government was putting up bus fares yet again. The IMF takes the blame for such things because these are often the remedies it demands before it will give the country’ a loan.

You will remember that the IMF is the place that countries can go to when they’ get into balance of payments difficulties. It was set up for this purpose following the Bretton Woods Conference of t 944 which met to reorganise the world’s monetary system. This same meeting also suggested founding the World Bank to offer longer term finance - we will come to that later.

But the IMF was never intended to be a kind of financial welfare agency to which needy’ governments could go for help. Its purpose was to support a particular economic philosophy - that of ‘free trade’.

After World War II there was a great fear that governments which got into financial difficulties might put up tariff barriers to defend their industries against cheap imports from healthier economies. This, it was argued, would damage world trade as a whole - though, as we have seen, those who would have the most to lose from this would be the most powerful economies. The IMF offered a temporary but reassuring source of money on which countries could draw to help them weather any crisis.

You haven’t said who puts money into the Fund.

All the member governments - 147 of them. Their contribution varies according to their wealth. Those with the highest GNPs and the highest shares of world trade have to supply’ the most.

That seems fair.

Yes, but this has political implications because voting power in the governing body is weighted according to contributions to the Fund. The United States, which supplies the most, finishes up with 20 per cent of the votes. And, given that any major change of policy requires an 85 per cent majority, you can see that the US has something of a stranglehold. Developing countries, which represent over three-quarters of the total population of IME countries, are only entitled to 35 per cent of the votes. The organisation is supposed to be a neutral financial institution. But, not unnaturally, it follows the economic philosophy of its dominant member. S/be who pays the piper calls the tune.

What tune is that?

Mostly variations on the theme of free enterprise. The IMF belief is that if international trade is unrestricted then balance of payments problems will sort themselves out ‘naturally’ as exchange rates move to reflect changes in international competitiveness.

And don’t they?

Well they might do if they were allowed to’ In fact the exchange rates of most Third World countries are fixed by their governments rather than ‘floating’ as ours do - so they only change every so often. Fixing the rate gives the government more control. But fixed or floating the likelihood is that all the natural adjustments in their case would be downwards.

This is because the industrialised countries have taken the more profitable part of international business - and have grown steadily wealthier as a result. And once countries get such a lead they stand a very good change of retaining it.

Watching this inexorable process, many Third World countries have tried to keep a grip on their international trade by controlling the exchange of their currencies. They make it difficult for their own people to buy foreign currencies so they cannot so easily buy goods from abroad. And they often ‘overvalue’ their own currency by quoting a high official rate so that when foreigners buy their goods they are effectively charged more in dollars or pounds.

This kind of thing is very much frowned upon by the IMF which dislikes any kind of obstacle in the way of natural market forces.

What does it matter what the IMF thinks? Surely sovereign governments can do more or less what they like.

Within their own shores they can. But there are too many things over which they have very little control and which can put them into the hands of the IMF. The first is a drop in the price of their exports. A violent downward lurch in the price of cocoa or sugar can be disastrous for a country’ which relies upon one or two such commodities for the bulk of its export income.

Then there are the goods they have to import. The same oil price rises we are familiar with have dealt a real body blow’ to many poorer countries. There has been a steady rise too in the price of all manufactured goods. So back in 1959 when a small truck could have been bought with six tons of jute fibre from Bangladesh, today that same truck costs the equivalent of 26 tons.

So it’s not too surprising that a country’ s balance of payments can suddenly swing into the red. At this point they could always stop imports altogether. But that really’ would bring them grinding to a halt. There would be no oil to fuel the trucks, supplies of spare parts would dry up and all kinds of machinery and vehicles would become useless. And, for those countries which have to import much of their food, starvation would loom up on the horizon. Eventually most governments find themselves turning at some point to the IMF.

I suppose the wicked IMF slams the door in their face.

Far from it. This is the kind of opportunity which allows the IME to demonstrate the superiority of its financial morality.

Generally speaking it advocates the same remedy regardless of what might have caused the problems in the first place. The IMF always assumes that the crisis is internal rather than external and due to profligate overspending.

Balance of payments problems arise, they say, because demand for goods in the country is higher than can be met by local supply - so exports are sucked in to meet the gap. The excess demand, they say is caused by high government spending and probably because general wage levels are too high. This in turn raises the price of the country’s exports and makes them less competitive overseas.

The list of actions to be taken always involves cutting government expenditure and cutting wages all round. It usually insists on devaluing the currency as well to bring the price of their exports down.

I gather that you don’t agree with this.

Well in some cases governments do spend more than they really have - on grandiose armies, for instance, or on food subsidies for the poor. But to place the whole weight of the solution on cutting spending, given the number of factors outside the government’s control, is hardly fair.

But you can see how this approach fits into the kind of monetarist philosophy that we have seen within rich countries. This philosophy disapproves of the government’s taking too much responsibility for the economy and would like to see that responsibility shift to the shoulders of the private sector.

The argument the IMF puts forward in poor countries has the old, familiar ‘supply side’ character. If wages are cut, they say, production costs will fall, there will be a greater chance of increasing exports, and local entrepreneurs will make more profits to re-invest in the economy. Everyone will live happily ever after. The IMF’s role as international financial policeman gives it the opportunity to impose such policies on ‘erring’ governments whether they like it or not. And when agreements are signed regular six monthly visits are made to see if the government continues to toe the IMF line before more funds are handed over.

It still sounds very sensible to me. Anyway they wouldn’t suggest such things if they didn’t really work.

In a very limited sense much measures do work to right a balance of payments problem. But you will remember that monetarist policies only reduce inflation by causing unemployment. So the IMF’s similar solutions act on poor economies by causing a similar kind of recession. As government spending and wages fall the multiplier goes into operation and demand and income certainly’ do fall and imports drop as a result. But local industry usually goes into decline as well, since consumption of local goods drops too. So the balance of payments tends to be righted at the cost of recession and permanent damage to the economy.

In addition the human cost can be enormous. Governments might have been spending some of their money on subsidising food and transport for the poor: real basic needs. But these and other government services will be casualties of the general cutback.

Put that way, it does seem harsh. But some changes are needed - surely?

True. If international market forces continue to make them poorer they will have to do something. But there are several questions, which this raises. The first is to do with timing. The IMF usually sets impossibly fierce targets: governments find it very difficult to comply with those kinds of changes overnight. And the IMF has been criticised for demanding too much too quickly.

Then you might ask what sort of adjustment should be made. A better solution to excessive imports might be to produce more locally - this goes by the name of ‘import substitution’. Yet what the IME usually suggests has the effect of damaging local industry. This is what happened in countries like Jamaica and Chile. But building up local industry in this way would probably involve protecting it for a time from outside competition - not something the IMF would approve of at all.

Then again you might ask why it is that the poor countries are the ones who should be making the adjustments at all. After all, for one group of countries to be in deficit requires others to be in surplus. Should they not be reducing their surpluses? This would be a good deal less painful than what is happening in the poor world.

But, as we have seen, very productive countries like Japan - and West Germany too - are reluctant to take such steps. Rather than taking advantage of mechanisation to reorganise their working styles and to distribute leisure, they prefer to export their leisure time to other countries in the form of unemployment. Poor countries have forced onto them the ‘disadvantages’ of technological progress.

I don’t see much chance of people volunteering for the dole queue so that the poor countries can have a bigger share of industry.

You’re right. Unemployment is already a problem in the rich world and we don’t want to make it worse. Most Western nations are not even adjusting to the microchip revolution in their own countries let alone worrying about the international implications. For the time being it is the poor countries who must take the strain. And while they are doing this, they have to deal with the IMF.

Surely there are other places they can go. What about the commercial banks? Isn’t that what the ‘debt crisis’ is supposed to be about?

Yes the commercial banks can and so lend money. But many of them wait to see what the IMF does before they will lend their support. Their problem is that, unlike the IMF, they cannot impose conditions on the borrowing government. So they watch what the IMF does and then go in after it.

There has been a massive quantity of money lent to developing countries in this way’ in the recent years by the private banks. This is because the oil producers have placed their funds in overseas accounts. The banks concerned have then needed to lend the money out to earn interest and the faster-growing developing countries like Brazil and Mexico had plenty of appetite for such funds.

The banks also like lending to such places because the risks are higher there so they can justify charging higher rates of interest. Citicorp, for example, is one of the largest US banking companies and finds that lending to Brazil is five times more profitable than any of its other lending operations.

But if the risks are higher presumably they should also count of losing some of their money.

You would think so. But this has become the great conundrum of the debt crisis. The scale of debts is now’ so great it w’ould not just be a case of one or two bad debts offsetting the good ones, butane or two huge crashes. Brazil, for example, owes $90 billions, and if she were to default this would cause a whole series of collapses. The banking system is based on depositors believing that they’ could always take their money out - if they wanted to. Once this confidence is shaken there could be a disastrous ‘run’ on the banks. Western governments cannot afford to let this happen - and in the end will have to support the debtor countries in some way. So the banks have charged more money for taking risks yet are effectively blackmailing their own governments into removing those risks.

Very clever. Did they know they were doing that when they made the loans loans?

That’s difficult to say. They were probably so excited about the potential profits that they simply lent too enthusiastically.

I should add that there would not be a ‘debt crisis’ even now if the debtor countries were capable of paying back their loans or even the interest on them. But since the loan series was started the whole world has gone into recession. This has had two important results. The first is that the exports of the countries concerned have fallen as the rich countries are buying less. The second is that interest rates have shot up as monetarist approaches have been adopted in Western nations.

As you can see all of these financial issues rebound very’ quickly back on each other. The character of the international financial scene has changed dramatically in recent years. Rather than having national economies that have links with each other, we now have a global economy which has regional or national aspects to it.

It all sounds a bit out of control to me. And frankly a bit unreal. Can’t we talking more practical terms? What were these countries actually doing with the money that they were borrowing?

In the case of Brazil this money was for ambitious projects in things like mining, shipbuilding and nuclear power. Brazil has always fancied itself to be well on the way toward developed country status. This new money seemed to offer a shortcut towards this. The recession means that many of these projects have had to slow down or stop altogether, resulting in high unemployment.

It could be argued, however, that the poor in Brazil were never going to benefit much even if those projects had succeeded. The new projects would just have concentrated Brazil’s wealth into fewer and fewer hands. But this is generally the way things have gone with massively funded outside projects. They have rarely been of the scale that would cause money to flow around productively inside the country. Usually the benefits have been confined to a small elite in the large cities.

So it’s the projects that are wrong. Not the IMF or the international economy.

There have unfortunately always been development schemes like this regardless of who is financing them. Before the commercial banks entered the scene in this direct way they had usually channelled their funds through a particular international agency - the World Bank.

Another baddie, I’ll be bound.

I can’t, unfortunately, say much that is complementary. The World Bank was set up at the same time as the IMF. There was a recognition thaUwbile the IMF could cope with short-term problems, the World Bank should loan the funds over much longer periods to finance long-term development projects. The money today for this part of the organisation, which is more properly called the International Bank for Reconstruction and Development, comes about a third from governments or central banks of those countries which have surpluses and the rest from the commercial banking system.

This seems unnecessarily complicated. Why couldn’t people borrow directly?

The most important reason is that the Bank guarantees the loans. It might raise the money from banks in West Germany and lend it out in Nigeria. But if the borrowers in Nigeria were to default then the governments who make up the Bank’s founder members would have to cough up to repay the West Germans. So basically taxpayers round the world would foot the bill. This means that there is much risk for the West Germans in lending so there is no justification for high interest rates. Countries who borrow from the World Bank would usually pay close to the general commercial rate.

That still doesn’t seem very generous.

No, and it might be very difficult for many countries to borrow even at the standard commercial rate. That was why part of the Bank called the International Development Association (IDA) was started in 1960. This gets almost all its funds in the form of grants from donor countries and lends them out at close to zero interest over long periods to those countries too poor to make use of normal Bank money.

Sounds like the kind of bank I need.

It’s certainly more like aid than banking. The IDA is only supposed to help countries that would not be credit-worthy on normal Bank terms. This means that a large part of IDA funds have been taken up by low income countries like India, Pakistan and Bangladesh - so much so that the IDA has sometimes been called the India Development Association. Most of the Bank’s money is tied to specific projects like dam construction or building a new steel works. So the money is actually paid over to the corporations who win the contract to do the job. Advance notice of the forthcoming contracts to be tendered for can be seen in a UN publication which advertises itself as ‘a unique source of advance notices for more than $16,000,000,000 worth of world-wide projects’.

That all sounds like very healthy competition.

Well it’s certainly healthy for the corporations But whether the poor people who live in the countries concerned are going to benefit is quite another matter. Most of the projects which the Bank funds favour high-technology solutions.

A good way of increasing agricultural efficiency, for example, might be to redistribute land to landless labourers, instead of having it used inefficiently by large landowners. This, however, will be politically difficult. So a more typical World Bank solution would be to assist those who already own land to use it more efficiently by increasing irrigation and mechanisation. Indeed large numbers of peasant farmers are actually being evicted in Bank-financed projects to make way for larger and larger farms, or roads. They see little of the benefits of increased efficiency.

Surely you are being a little unfair - the Bank must be helping poor people somewhere.

Maybe they are. But such examples have proved very difficult to find. This is not so much a criticism of what the Bank does with its money though it often does use it very badly. The problem lies with the very idea that massive capital-intensive projects, however well-conceived, will help the poor. The very poor are totally unhelpable by the Bank. If you have no land you will not take part in agricultural development at all. And if you rent a little land the chances are that when the new Bank-financed technology moves into an area you will be thrown off and replaced by a tractor.

The central problem with the activities of the World Bank - as with the IMF - is that those who control large amounts of funds are in a position to determine the style of development that poor countries take. It is not that their economic-theories of how progress should be made are superior. It is just that they have the power to put those theories into practice.

The fact that such approaches do not seem to work at all does not seem to dissuade them. Rising unemployment in rich countries and steep industrial decline do not seem to have noticeably disturbed the economists who proposed monetarist strategies. They just argue that their policies have not been properly put into practice.

The permanent stagnation and sometimes total collapse of poor countries who have taken the IME medicine does not seem to unduly affect that organisation’s approach to similar difficulties elsewhere. And that World Bank projects have thrown people out of work and steeply’ increased inequality in the places they operate does not seem to dissuade them from doing the same thing over and over again.

Surely they are not that stupid?

Nobody says they are stupid. They’ have a particular philosophy and this will be reflected in what they put forward as sound economic policy’. It’s up to the rest of us to point out just how unsound such approaches are, no matter how much jargon and theory they come cloaked in.

This is not easy to do given the weight of statistics or academic authority they can usually muster. That’s why I’d like to suggest a few more books you might like to read.

Wait a minute. I thought you said this was going to be ‘Economics in seven days’. I’m supposed to be a modest expert by now.

Well, there are degrees of expertise. You’ve had one kind of shortcut through the more daunting books, but there are a few easier volumes that I could suggest which are only slightly longer cuts. In any case you didn’t really think it was going to be that easy did you?

I had hoped...

Besides, this is a subject so broad that the New Internationalist will always be coming back to it in one way or another. Next month, for example, we’ll look in more detail at multinational corporations - throwing up some interesting aspects of the food industry.

I can’t wait.

Day three - demanding work

[image, unknown]
[image, unknown]
[image, unknown] [image, unknown]

‘Tis money that begets money’


[image, unknown]
[image, unknown]

A printer stuffs a copy of the newspaper he has just printed under his arm before he leaves the factory. An off-duty air hostess takes advantage of a free flight to Hong Kong. A lawyer stands up in court to conduct his own defence. Notice anything strange about these activities?

Now that you mention it - I don’t, no.

Well, the workers are consuming what they themselves produce - a rare event nowadays. Usually we have no idea who makes the things we use: indeed the pattern of international production and consumption is so complex that just documenting the origins of everything that you use in one day would fill quite a thick volume.

Is that the kind of book you’ve been reading then?

Fortunately not. I don’t need to know where anything comes from providing I can pay for it. Money is the great lubricant of international trade - drawing in produce from all over the world - and should allow our own economies to run smoothly at high speed.

But as you might have noticed, the economic machine does stutter and cough a lot. Words like slump, recession, unemployment and depression sully our news bulletins every day’. Everybody should in theory be furiously buying and selling to each other all the time but every so often they seem to slow down, and, moreover they all tend to do so simultaneously - with disastrous consequences.

If factory owners decide they don’t need new buildings, for example, electricians and bricklayers and carpenters will be laid off. These workers in turn will have less money to buy corn flakes and beer and TV sets and shoes. So the workers in these cornflakes and beer industries too start to suffer and have less to spend on holidays and records and coffee. Before you know it you have a full-blooded downwards spiral.

Very nasty. But why did people stop wanting new buildings in the first place?

There could be many reasons. But to find a plausible one let’s look more generally at the various spending decisions that we take every day.

It is the spending of money, keeping it circulating, that makes our economies keep moving.

You probably spend almost everything you earn - and that makes the workers in all the other industries very happy because they then have the money to buy what you produce. But you also save - maybe five per cent of your income, maybe 20 percent. And if you stick that money under the mattress it will drop out of circulation. Just be saving in this way you will start a little downward spiral and make a lot of people very unhappy.

A little recession all of my own. I never realised I was such a creep.

You may not be. If you put the money into a bank someone else can then borrow it so the spending can go on and everyone can stay happy.

You mean someone else will use my money to buy cornflakes and beer? They’re eating my savings.

People who borrow money from the bank don’t usually buy booze or breakfast cereals with it. They know they are going to have to pay the money back eventually - as well as the interest - so they have to look for a way of using it that is going to give them income in the future.

So a shopkeeper might extend his premises, a manufacturer could find a fast new machine for making cornflakes, a taxi driver might buy a new taxi. What they are doing is employing your money to make an investment which they think will eventually pay off. Such investment still involves spending and will generate jobs and incomes for builders, for engineers, for taxi manufacturers so your money keeps circulating and people are kept busy.

John Maynard Keynes
Photo: Camera Press

But how do I know that my savings will be borrowed? I’m scared of causing a recession. I want to keep my money moving.

Deepdown I think you’re a wonderful person. But you could ask the banks to do the work for you. It’s their job to make sure that money is always employed so they play’ about with the interest rates. If there are savings which no one is borrowing they can always drop the interest rate to encourage investors. And if there are not enough savings to finance all the factories that people want to build or machines they want to buy, they’ can increase the interest rate to attract more savers.

Up until the 1930s this is the way that economists thought the market would work: that interest rates would always ensure that all the money’ saved would be used for investment and the money would keep moving. Then came the Great Depression and this theory’ crashed to the ground along with all the bankrupt businesses and suicidal stockbrokers. Half of America’s production was wiped out and a quarter of the workforce lost their jobs. It was a disaster for which the conventional economic wisdom of the day had no convincing explanation.

I have a feeling, though, that you have an explanation.

Actually I’m going to pass on the explanation offered by British economist John Maynard Keynes. In 1936 Keynes published the General Theory of Employment, Interest and Money in which he argued that there was nothing ‘natural’ about full employment at all. Employment could settle down at any level. The economy could stand still with millions of people out of work.

He focussed his attack on the assumption that interest rates would always change to balance savings and investment. He pointed out that investors might be reluctant to borrow money no matter how low the interest rates if they did not think that they would earn enough from them to pay the money back. They wouldn’t build a new factory if they didn’t think they could sell the produce.

Very sensible too.

Yes - from their point of view. But if the money sits in the bank it drops out of circulation and prompts the kind of downward spiral that we started out with when you put your savings under your mattress. This, to go back to an earlier question, is why people might have decided not to order new buildings in the first place. They might just have had a change of mood - a feeling in the water that people will not spend so much. It just requires a few people to become pessimistic about the future for investment to drop. This infects other investors and becomes a self-fulfilling prophecy - things do get worse.

But surely one or two people stopping building factories is only going to put a few people out of work?

No. It’s not just the builders who are put out of work. Don’t you remember? The effects are felt throughout the whole economy when money is taken out of circulation. There is what Keynes called a ‘multiplier’ effect. To see how this happens let’s look at a few figures.

Let’s suppose that there is an economy where $100,000 worth of goods are produced and sold each week - so there is $100,000 worth of income - one person’s expenditure becomes another person’s income. Let’s suppose too that the cautious workers always save 20 per cent of their income - so $20,000 a week is being saved (See the diagram above).

If investors are also borrowing $20,000 a week from the bank there will be no problem. The money will keep moving round and if somebody has a job they still have one the following week.

Now comes the setback. The owners of the factories and shops start to get nervous about the future - because of political unrest, say - and only invest $15,000. So $5,000 will have to stay in the bank.

In the next week of spending, therefore, there will only by $95,000 in people’s pockets - and some builders of factories might have lost their jobs.

But things don’t stop there. Those workers still with jobs can carry on saving 20 per cent of their income. In week two this will amount to $19,000. Investors, however, probably more nervous than ever only invest $15,000 in week two as well, so another $4,000 will get added to the savings in the bank. Overall spending and income will thus drop further to $91,000. And the income will keep on dropping, week after week.

A frightening prospect. When does it stop falling?

Fortunately it will stop. But stability will only be reached when the investors are taking up each week all the savings being created each week and that will not happen until savings are exactly what investors want - $15,000. So total income and expenditure will have to keep dropping until 20 per cent of it comes to $15,000 and that occurs when the figure is down to $75,000.

So you can see that a small drop in investment can have disastrous consequences for everyone’s income. But you can also see that a similar problem would arise if people - nervous perhaps about the possibility of losing their jobs - changed their behaviour and started to save more - say 25 per cent. So the spiral arises when ever spending is reduced - that is when there is what the economists call a drop in ‘demand’.

[image, unknown]

Wait a minute, I think I’m going to read all that lot again.

Fair enough, I’ll fill in here with a few dots... Now if the economy can only be stable when savings are equal to investment you can see that it might well stabilise at a very low level of income with a lot of people having lost their jobs. Economists used to think that the economy would tend towards full employment. Keynes’s breakthrough was to show that full employment would only arise if there was a remarkable coincidence - that all the thousands of investors chose to spend precisely the same sum of money that millions of savers had tucked away in their bank accounts.

Clever chap.

Very. And fortunately he didn’t stop at just pointing out the problem. He also proposed a solution. If there was to be a hiccough in spending then the government should do something about it. It could, he said, encourage people to spend more or it could actually spend more itself.

The central plank in Keynes’ strategy was reserved for government spending. Governments normally collect the money they need through taxation and the spend it on things like education and road building. Keynes said that if private industry wouldn’t take up the savings then the government should borrow that money and spend it itself. It could build more hospitals - or pay teachers more. Or it could pay people to dig holes in the road and fill them up again. The important thing would be to keep the money moving round.

But that just means the government gets into debt. How is it going to pay it back?

If a government gets into debt by borrowing the savings of its own people this doesn’t really matter. The government is the people - or it should be. So it’s just like you moving money from one of your pockets to another. In any case it should be able to pay the money’ back if it can keep the economy expanding. If it borrows enough to keep people employed it will keep raking in their taxes and if this encourages other investors to expand too then the amount that the government can cream off in taxes will increase as output increases. So this kind of ‘deficit financing’ as it is called can be very productive all round.

Did governments take Keynes advice?

Yes they did. Most of the Western governments after the Second World War adopted Keynesian policies of ‘demand management’ - adjusting the level of spending to try to keep everyone employed and spending their salaries. I should add that there were other measures apart from changing government expenditure - like reducing taxes so private individuals could spend more. But taken together the tactics were very successful. Unemployment was kept down to most of the industrialised countries. That’s not to say that there were no economic crises. Many countries suffered from problems with their ‘balance of payments’ for example - an issue that we will return to some other day. But it was thought that the days of massive unemployment were over.

One shouldn’t exaggerate, however, the ease of applying the Keynesian techniques. Governments might not know precisely what was going on - or they might create too much demand, or too little. But generally speaking they were able to keep things moving in the right direction.

Half your life might be spent in a factory and the other half spent consuming what other factories have produced.

[image, unknown]

The constant circulation of money transforms other people’s expenditure into your income.

[image, unknown]

But some of the circulating money is saved so banks have to lend it out to keep the money moving.

[image, unknown]

When investors don’t want to borrow this money Keynes argued that governments should borrow the savings and spend them.

[image, unknown]

Keynesianism involves government intervention in the market to keep it working at full capacity.

Day one - the seven day economic plan

HAVE you noticed that politicians once they get elected seem to turn magically into qualified economists? They might have been a research chemist, a five-star general or even a movie star in their previous life. But sit them down in the national driving seat and they will drone on endlessly about interest rates, budget deficits and even the public sector borrowing requirement.

Doesn’t that make you suspicious? Maybe - just maybe - the skills and training required by both politicians and economists are precisely the same. It’s a bit of a coincidence but entirely possible. The other possibility is that they only appear to be the same; in either case all that is required is a degree of common sense.

On this basis the average New Internationalist reader is as capable as anyone. And even the average New Internationalist journalist should be able to understand the basics of economics and pass them on. That is my excuse for most of what follows. I don’t claim any special expertise. I have read a little, talked with other people, even thought occasionally when I got really desperate, and then written it all down. This is nothing you couldn’t have done yourself; all I hope to do is save you a little time.

But there is one liberty that I wish to take. In order to make this something of a conversation piece I would really prefer it if you were to join in, argue a bit, ask the occasional question. There is a practical problem here, since you could be anywhere from Vancouver Island to Alice Springs, but I propose to get round this by assuming that I know more or less what you would say if you could. How does that sound to you?

Well... I’m, not so sure…

Good enough for me, so let’s press on. This magazine calls itself ‘Economics in seven days’ and it has been divided up like this so that you can take it in one section at a time - starting today. This will be a help if you are diffident about entering strange new territory. But then again it will also help to slow you down if modesty prevents you becoming too expert in too short a time.

Frankly I don’t know that I want to spend any length of time on this.

Absolutely right. I should make it clear that there are some people who need to know no economics at all. If you live in a remote village on the upper Amazon your reluctance is quite understandable.

You will be a farmer or a hunter, growing or catching for yourself most of what you need. You have what is called a ‘subsistence economy’ and having learned this you need read no further. Consider yourself fortunate to have somehow acquired a copy of the New Internationalist; if you choose the other aspects of civilisation you accept with similar discretion you should not go far wrong.

For the rest of us things have become a lot more involved. We produce an enormous quantity of weird and wonderful things - digital rulers, spaghetti measuring gauges, talking cars - but we have little idea of who is using them. From the relative calm of self-sufficiency we have jumped to the frantic dislocation of bosses and workers - producers and consumers.

This changeover has taken quite some time: four hundred years from the economic torpor of medieval Europe to the integrated world economy. And the initial impulse for this ‘Industrial Revolution’ was first felt - remarkably enough - on those wet and windy offshore islands that today make up the United Kingdom. The British people did not suddenly start to work longer hours - there is no evidence that they ever did this voluntarily - what did change was the way that their work was organised.

You mean they were pushed into factories?

Yes, partly. But herding people together in this way was by no means a new idea. Booksellers in Roman times, for example, would dictate the contents of the latest best-seller to row upon row of patient copiests who would take it all down in their best hand. By the eighteenth century, however, this system had become increasingly refined as a ‘division of labour’ was introduced. Jobs were being broken down into easily learned steps so that one worker only needed one or two skills. This speeded up production and was now being used to turn out everything from millinery to coloured maps.

But the really important production boost came from mechanisation. If you want to produce more with human muscle you have to employ - or enslave more people. Harnessing water or steam power to a mechanical loom, say, can dramatically increase output, but it might even employ fewer people.

In those days if you had the money to build factories and buy the equipment you were in a very fortunate position. This was your big chance to become a ‘capitalist’ and use your money to extract more and more output from human labour.

I knew the capitalists would get pushed into the firing line early on. But you haven’t explained where their money came from.

Inherited, a lot of it - Europe’s landed gentry had spent centuries piling up the loot to support their aristocratic habits. But it was to be the nouveau riche of the age, the merchants and the traders who were to supply a lot of the cash needed.

They may have made their fortunes on an international scale - from the new colonies of the British Empire. Indeed what we now call the Third World made a big contribution to Europe’s industrial take-off. Trading in slaves or cotton or sugar or spices was very profitable and the proceeds were used to build grandiose houses and lead extravagent lives, but there was enough to spare too for investment in the noisy new textile factories and the heat and grind of the iron foundries.

Wait a minute, who was buying all this new stuff?

Whoever had the money - and to some extent this included the workers themselves. But the colonies were also to be important markets. And if countries like India already wove their own cloth, then too bad. Such competition would have to be dealt with. Indian textiles in the eighteenth century were much more sophisticated - and cheaper

than the British produce and were in great demand. So to protect their infant industry the British government imposed a 75 percent duty on imports from India and reduced the flow of textiles to a trickle. Then as the British factories grew more sophisticated they overtook the Indians and eventually destroyed their industry.

The economic disparities between rich and poor countries arose, therefore, as much from political and military coercion as from economic superiority. The British did, for example, try the same thing on their American colonies: it was illegal to export machinery to America or to set up blast furnaces. But the Americans were strong enough to fight for their independence and shake off their colonial masters.

Still, Britain continued to do quite well. There was much more being produced and British workers’ houses were filling up with pots and pans and curtains and carpets as possessions spread throughout their households. Mind you, the rate of growth even at the height of the Victorian epoch from 1870 to 1913 was only around 1.6 percent a year, a figure most countries would be very depressed about nowadays.

The Victorians were not, of course, too pre-occupied with economic indicators. Capitalism itself had been born without the intervention of economists and it continued to grow mostly of its own accord. And for the mine owners and the factory bosses this had great advantages. They could, for one thing, be very flexible in their use of labour. Children were coaxed inside the clattering machinery and down the wet and dangerous mines and encouraged to use their small size to great advantage - or at least to the advantage of the owners. The English Factories Act of 1883 did try to put some controls on such exploitation but there was a very strong incentive (money) for getting the most from your workforce, so legislation was interpreted as liberally as possible.

The industrialists were generally unsympathetic to government intervention. Back in the seventeenth century the French Finance Minister Colbert had asked a group of merchants what the government might best do to help them. They are said to have replied: ‘Laissez-nous faire’ - ‘let us get on with it’ - and that’s what capitalists have been trying to do ever since.

And persuading the workers to go along with them?

Generally speaking, yes. But the position for the workers was now changing rapidly. Previously, under the feudal system, the lord of the manor might have been a greedy, bellicose old lecher who treated his serfs more or less as slaves. But he was honour-bound to see to their survival. Capitalism had broken this paternalistic system. People were now free to move from one employer to another and the bosses did not need to accept any responsibility for the workers’ livelihoods - factory hands could be thrown out into the street at will.

So what protection could they expect now? Indeed how would the country as a whole hold together now that money and investment had displaced religion and duty as the focus of national life?

I thought I was supposed to be asking the questions.

Well you’ve got to allow for a bit of rhetoric every so often. Anyway, one person who could have answered my question was Adam Smith, a philosopher turned economist at the University of Glasgow. He would have said that there was an ‘invisible hand’ at work - self-interest and free competition would keep things under control. In The Wealth of Nations which he published in 1776 he showed how such competition in the marketplace would be made to work for the good of all.

Giving free rein to greedy, self-interested individuals might seem like a recipe for social chaos: the strong could crush the weak; manufacturers could exploit consumers. Not so, said Smith. Factory owners who continually exploited or underpaid their workforce would soon lose labour to competitors who offered better conditions. And if they tried to overcharge consumers they would be similarly at risk from their rivals who would undercut their prices. If the market could be kept free, and monopolies broken up, the system would be self-regulating.

Nor need there be any unemployment. In the pursuit of maximum profit, manufacturers would always produce just as much as could be sold. If a worker found himself out of a job all he need do was offer himself elsewhere at a lower wage so that some manufacturer would eventually discover that he could make a profit by employing him: with a lower wage the manufacturer could reduce his price and thus sell more.

Smith also predicted that, with perfect liberty, such a market would constantly expand - that we would get ‘economic growth’. Manufacturers would always be on the lookout for ways to cut their costs and so increase their profits and a good way to cut labour costs would be to invest more and more in labour-saving machinery. The amount produced by each person would increase as more machines were purchased and the whole of industry would grow steadily as a result.

Sounds like Smith had economics all worked out. Full employment, steady growth - what more could you want? Is that it? Can I take the rest of the week off?

Not so fast. He did have a very powerful theory. But it depended on there being a free market. Even in his time it was clear that this was not necessarily the case. As he said himself:

‘People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.’

The imperfections in the market place make for a few more complications and mean that we will have to talk about a few more economists like John Maynard Keynes and Milton Friedman. We’ll do that after a couple of slight diversions. First over the page you’ll find a few statistics that might be useful for later reference. Next we’ll spend a little time talking about money.

Sounds fun

It is, it is.

Primitive communities produce and consume very little. And, relying mostly on human muscle, they cannot make more goods without using more people.


But the ‘division of labour’ backed by powerful machinery can dramatically increase output.


The money for this comes from the capitalist owner of the factory. He invests in machinery now in order to make greater profits later.


Capitalists and workers will, according to Adam Smith, be regulated by the marketplace. The ‘invisible hand’ of competition will ensure that one group cannot exploit another.


And growth is guaranteed by the capitalist’s wish to earn more profit. He will continually invest in more efficient machinery in order to make his workers more productive.

Day two - making money

[image, unknown]
[image, unknown]
[image, unknown] [image, unknown]

‘Money it turned out was exactly like sex. You thought of nothing else if you didn't have it and thought of other things if you did.’


[image, unknown]
[image, unknown]

YESTERDAY we raced through free-market economics and saw how capitalism was expected to grow into a strong and vigorous bloom in the heady atmosphere of free competition.

Less of the flowery language please. Let’s get to the point. I’m sure Smith was very important, but what I want to know about is monetarism.

Why do we have to look at that?

Well, I am the paying customer - and anyway that’s what economists talk about nowadays.

Only a few of them fortunately. True there are people who think that money is the key to everything. But others believe it is just a convenient lubricant. It doesn’t mean that much in itself, it responds to other basic forces.

But if you insist, we will talk a bit about money. A good place to start might be that jungle village, the one that we said goodbye to yesterday. The villagers there have a cashless society: not because they have abolished money, but because they don’t need it. They don’t have to buy or sell anything.

Now let’s complicate their lives a bit. One villager is a skilled potter and another, who is a farmer, wants to offer a sack of corn in exchange for a smart new set of bowls. This is no problem if he lives close by: he can just carry the corn in, and the bowls out. But if the farmer lives on the other side of a river the farmer might prefer to give something lighter, like an emerald. The potter could then swap the emerald for corn with someone else.

The emerald in this case is serving as ‘money’ - a standard means of exchange. Anything can perform this role providing it is acceptable to both buyers and sellers. This usually means it will be something in limited supply and of reliable quality. Shells have been widely used at times and tobacco became a currency during the early days of the American colonies. For many centuries, however, the most acceptable form of money has been gold.

On the whole I think I prefer gold myself.

Perhaps. But even gold has its limitations. You have to make sure that you have coins all the right size. Another solution, which governments later adopted, was to take the gold from their citizens and issue them with corresponding notes and coins which were ‘as good as gold’. These were lighter and more convenient and could just as easily be used for payment, providing everybody believed the central bank was keeping the real thing stored in its vaults.

I’d still prefer gold

Purely a matter of taste. But you might find the checkout girl at Safeways a bit unwilling to accept it as payment for a packet of Daz. The important thing about money is that everyone should accept it without question. That’s the way it oils the wheels of commerce.

It was gradually realised, however, that government-issued notes had become so acceptable that there was no need for them to correspond any more to piles of gold gathering dust in the vaults. It was possible, it proved, to print more notes than there was gold and people still accepted the money.

It’s important however only to print a limited amount. With a restricted supply, notes become just like shells or tobacco or gold. If everybody accepts them, coloured bits of paper will do just as well as a form of exchange.

Is this the famous ‘money supply’ then - all these bits of paper?

They are certainly a part of the money supply. But there is a lot more money around than the notes and coins that have come out of the mint. There is a lot of additional money made’ by the banks.

Consider what would happen if you were to deposit a thousand dollars in the Bank of Montreal. They might pay you interest and give you a cheque-book which you could use to get at your money.

But banks also lend money out as well. That’s how they make their profits: by borrowing at a low rate of interest and lending out at a higher one. So most of your deposit could be lent out again to the next person who wanders into the bank call him Mr X.

Something remarkable happens here - money is created. You have your cheque-book to draw upon your bank deposit and Mr X has the dollar bills.

[image, unknown]

But that’s my money!

It was certainly your cash that went into the hank. But now you both get spending power at the same time. This is only possible because a calculated risk has been taken. The bank is gambling that Mr X will return the money before you write any cheques on it. This need not he a reckless gamble. It would be a small and foolish bank - and certainly not the Bank of Montreal - if it had only one lender and one borrower. When there are very many of both a bank can work out statistically how much of the money deposited with it is likely to be withdrawn by the lenders at any one time.

The money supply, therefore, includes many different kinds of bank deposits - in addition to the original notes. Both the notes and the deposits give spending power. You might have lingering doubts that Mr X has spending power at the same time as you. But consider what happens if you and Mr X turn up in the same supermarket. You can both spend at the same time - you with your cheque-book and he with the cash. Both of you can walk out with packets of Daz on the basis of your bank deposit.

Trade has a way of creating the money it needs to lubricate the system. When the Irish banks went on strike some years ago, for example, business went on much as before on the basis of personal credit and circulating cheques as well as cash. People will exchange goods with each other, bartering if necessary. even when they have no money in their pockets. Having money, either in the form of cash or credit, just makes it easier.

Good grief. If money can appear and disappear like this it’s total anarchy

It only seems like this if you focus on the money rather than the exchange of goods. At any rate, you can now appreciate the difficulties governments have when it comes to measuring the money supply. Not only do they have to count up all the notes and coins but they have to add in the various forms of bank deposits. They might have to consider, for example, that a current account was more ‘money-like’ than a deposit account where you need to give three months notice of withdrawal. All those ways of measuring money supply that you might have heard about: M1, M2, M3 are longer and longer lists of what counts as money. M3, for example, includes as money deposits that can’t be withdrawn for two years, while M2 does not.

As Professor J K Galbraith has put it: ‘The debate over what should be counted as money is between people who do not know, and people who do not know that they do not know’. So if you find all this confusing you are in very good company.

That’s a relief

Good, then while you’re relaxed I’ll throw in another complication which concerns how many times a given amount of money is used. Think of what it takes to sell a monthly magazine like the New Internationalist. The print workers print it, hand it over to their boss who sells it to the publisher, who sells it to the bookstores who sells it to the reader. There are four transactions here. Now let’s suppose that during the month of April the publisher does not pay the printer (this, I should emphasis, is an entirely Fictional case). The publisher claims that the bookstores were slow in paying him so he didn’t get his hands on cash till the end of April. So he gives the printer an IOU.

This is no comfort to the printer who has to pay his workforce in cash. So he goes to the bank to get a loan. Of the four transactions in the month therefore, two have used the customer’s cash, one has used an IOU and one has used credit from a bank. The two credit transactions cause an increase in the money supply in the way we saw earlier.

But suppose everybody paid up on time and the readers’ money got through to the printer’s workforce within April. The money would have moved so fast that there would have been no need for credit. So as the velocity of circulation goes up the money supply needed goes down.

If the printer could have afforded it he could instead have kept reserves of cash to be drawn on in the event of slow payment. In this case speeding up payment would remove the need for such reserves so again less money would be needed.

My brain is whirring round in circles with all this money

Don’t worry if it doesn’t sink in first time round. All you necd to take from this is that money is - as you might expect a lubricant to be - a very slippery commodity’. So anyone - like President Reagan - who claims to be able to understand it and control it should be regarded with the utmost suspicion.

Cash in transit: a bank in Hong Kong.
Photo: Camera Press

At least tell me how he claims to control it

There are a number of way’s to try’ and adjust the money’ supply’. To increase it you could print more notes and put them into circulation by paying government employees with them. To reduce the supply you tax the whole population more highly and then remove from circulation the money you collect instead of spending it.

But since much of the money is ‘made’ by’ the banks the quickest way for a government to affect the money supply is to control bank lending. If you force them to raise their interest rates, for example, this would discourage borrowing and stop banks making money’ by lending out cash deposited with them.

This may well have some effect. But think what would happen in the case of our printer. If he were worried about the high interest payments he might threaten to stop doing business with the publisher unless he got paid on time, and the publisher might similarly threaten the bookstore. If these threats made everyone pay up smartish then the money supply would have been reduced but the velocity would have correspondingly increased.

Now, at last, having established where money comes from, and how fast it can move, we are in a position to look at prices. The next bit, I warn you, is tricky to grasp, but well worth pondering.

I’ll take it slowly

Good. The Total spending in the whole economy is what we have to look at now. Let’s work out what the money spent in one month will be. There are two ways of approaching this.

One is to look at the number of times the money is used each month. If you buy something the shop-keeper will put the money in the bank. This bank can then hand this out to the next customer who makes a withdrawal. The number of times a given banknote is used in a given period is referred to as its ‘velocity’. So the total spending each month must be the total money supply multiplied by its velocity. Agreed?

I suppose so

An alternative way of calculating spending is to start with the average price level of all the goods and services exchanged during the month. If you multiply this price by’ the total number of transactions that took place you should also get the total spending. Yes?

I’ll think about it. You keep going

Right. What you have now is two good ways of expressing the same thing. So they must be equal.

Money’ x Velocity’ = Prices x Transactions.

This is worth looking at again to really see what the implications are. Assume, for example, that the magazine sales that we looked at earlier are included in the total month’s transactions for the whole economy’. When payment was slow the velocity was low, so the money supply’ was increased to compensate for this. But after a bit of tough talking from the printer the velocity went up and the money supply came down automatically. The number of transactions was the same in either case and nobody changed their prices.

Now look at the equation again. If, for example, the total number of transactions in the whole economy remained the same but the money supply went up would this mean that prices would rise.

Only if the velocity remained the same, I suppose

Quite right, you’re really’ getting the hang of this. So if someone says to you that prices are rising because too much money is being circulated you might reasonably be sceptical.

Mm ... I think I’ve got that. Is this where we start to talk about monetarism?

I don’t think so. It’s been a long day’. Some other time.

Money is a convenient invention which helps lubricate the exchange of goods.

[image, unknown]

But there is more money than that printed at the mint. Banks also ‘make’ money by making loans.

[image, unknown]

Such money can appear and disappear as needed, depending on what trade requires.

[image, unknown]

So prices will depend both on the total money supply and the speed at which it moves.

[image, unknown]

The velocity of circulation of money can also move up or down.

Day four - sizing up inflation

[image, unknown]
[image, unknown]
[image, unknown] [image, unknown]

Business succeeds rat her better than the State in imposing its restraint upon individuals, because its imperatives are disguised as choices.


[image, unknown]
[image, unknown]

‘We are all Keynesians now’, as Milton Friedman was heard to say some years back. And Keynes’s ideas were indeed to dominate the economic scene from the Second World War right up to the mid 1970s - a period when most of us could be certain about getting a job.

But then things started to go wrong. After about 1975 the Keynesian tricks no longer seemed to work so well. Keynes died thirty years before. Now his ideas were passing away too - to judge by their gloomy obituaries in the financial pages of the daily press.

You mean all that stuff about multipliers and demand was just a waste of time?

Not at all - would I do that to you? The multiplier effect still happens and there are politicians all over the world struggling to manipulate demand. But economic thinking has had to develop to keep abreast of changing circumstances.

The biggest changes have been taking place in the market itself. Keynes wanted to keep the free market going at full tilt. He was a great believer in it. Indeed he made a lot of money playing the stock market and speculating in currencies.

But the sort of free market that consisted of lots of small soap factories or bakeries competing vigorously had gradually been disappearing. By the mid seventies such companies found themselves working in the shadow of a cluster of huge corporations - Shell, ITT, IBM, Proctor and Gamble - giant enterprises which straddled the globe and often even dwarfed national economies.

Some government-owned corporations too had reached something of the same scale - in their own countries at least. British coal mines, for example, are run by a government Board and you can only buy electricity in Canada from nationally owned power companies. The sheer size of such operations moves them out of reach of normal market forces. Keynes’ success was based on intervention in a free market - keeping it going whenever it faltered. But, as we shall see, the giants in the market don’t respond in the same way so his measures don’t have the same effect. And one result of this in recent years has been record levels of inflation.

Come on - inflation is hardly anything new.

No there has always been inflation of one kind or another. But the inflation nowadays is quite a different animal - one that can survive during a recession. The traditional inflation that you can see in a free market only appears when there is fall employment. For, in Keynesian terms, as well as having too little demand you can also get too much. When investors are confident about the future and are sure they are going to sell more TVs and dishwashers they might well want to build more new factories than usual. But where do they find the builders if everyone is already employed? How would they persuade you to work for them if you already had a job?

In my case they’d offer a more fulfilling and satisfying post. But I suppose other people would move just for more money.

Quite right. And companies can borrow from the banks to pay them more. The result will be inflation because the quantity of goods being produced won’t have increased yet even though there is more spending power chasing them.

Keynes’s answer at this point would be ‘deflation’ - taking money out of those bricklayers’ pockets through taxation, for example, or making it harder for the investors to get credit in the first place. All of this is aimed at bringing demand back in line with supply.

But think what would happen if there were high unemployment. Bricklayers would be standing on street corners with nothing to do so they should if anything offer themselves at less than the going rate just to get a job. Average wages should fall. And since sales drop when people are out of work the manufacturers too should be prepared to reduce their prices to keep in business.

In the last ten years however we have had high unemployment and inflation - a deadly combination.

This is because prices nowadays are determined not by millions of small bargains in the market-place with prices and wages, rising and falling from day to day, but through negotiations between three huge power blocks: the corporations, the governments and the trade unions.

Where did they suddenly appear from? How come the companies got so big?

They wanted to avoid free competition and free enterprise: the more control you have over the market, the less the risk of failure. Have you ever heard of a company called Unilever?

Vaguely, what do they make?

Almost everything you are likely to eat or wash with. Take margarines for example - their marketing of margarine is a classic example of risk avoidance. Unilever controls trough its plantations and other operations some 80 per cent of the world’s trade in palm oil - a key ingredient. Its shipping line brings the oil to markets like the UK where it manufactures all the brands you are likely to have heard of: Stork, Blue Brand, Flora. Its distribution company, SPD, transports the produce to the shops and it even owns the Liptons supermarket chain, not to mention MacFisheries. All these brands and companies have different names and Unilever, whose name appears on none of them, would claim that they are all operating independently in the market-place. You might reasonably be sceptical about this and think that by’ supplying their own materials and selling different brands they were trying to avoid competition.

Maybe. But you’re knocking the multinationals again, based on one case. How about coffee for example?

True. If you want to buy coffee, chances are you will have a choice between Nescafe and Maxwell House (produced by General Foods). These do compete in most ways but not in the one that matters - price.

They will run fierce promotions they will run blitz advertising campaigns, they will package their products to look distinctive and attractive. But they will not try to undercut each other.

And you can’t blame them. If the major competitor drops his price and you follow suite you are both back where you started from but with a lower profit. Better to confine competition to the safer areas of TV advertising, free gifts, and temporary price offers.

Such companies know in any’ case they can attract customers on criteria other than price. Consumer loyalty can be purchased through advertising and packaging. Price differences between products then become less important than identification with the brand. It will come as no surprise to learn that Unilever also owns an advertising agency.

So rare has price competition become nowadays that when it does happen - as occasionally between oil companies - we are all so surprised that we call it a ‘price war’.

I thought this was going to be about inflation. When are you going to get to the point?

Now. When any of these companies finds themselves under any pressure the easiest thing to do is push up the price. A raw material price increase, a wage demand from the workforce, or pressure from the shareholders for more profits - whatever the problem it can now be passed on to the customer at the checkout. The consumer has, after all, been educated to prefer the brand even when the price is a bit higher. But the company also knows their major competitors know the rules of the game and will bring their prices up in line.

Government corporations are in an even stronger position to set prices. In the UK it is not possible to buy telephone calls from anyone except the government. And in the United States and Canada where phones can be in the private hands of Bell Telephone they are still a monopoly and their prices have to he negotiated with the government. In no real sense therefore are their prices dictated by market forces.

Then, set against the governments and the corporations you have the trade unions. Just as the corporations try to avoid competition wherever possible so do their workforces. The United Auto Workers in Northern America or the National Union of Miners in the UK will negotiate en bloc with the organizations they have to face up to.

The consumer is not normally represented at the negotiations when there is pressure from shareholders or trade unions. So the easiest thing to do is to concede that wages or profits should rise - and, with them, prices.

Increased prices will, of course, drive up wages and shareholders’ need for income again the next time round. So have a kind of ratchet effect lifting everything ever upwards and there is no particular reason why it should stop. This would not matter too much if everyone’s income rose in parallel with the prices they had to pay. But the effects are very unevenly distributed. Managers who can set their own wages, and the strongest trade unions, will manage to keep ahead. But those living on fixed pensions or who are non-unionised will be very hard hit. So inflation is unpopular and governments try to get rid of it.

Is this where we get to monetarism then?

Yes, but hang on just a bit longer. There are actually two main ways of stopping inflation in an economy which is based on private enterprise - and they correspond to two distinct political ideologies, liberal and conservative. I should add that there is also a socialist alternative which involves changing the economy completely. But for the time being let’s look at how we cope with capitalism as it is today.

The liberal approach is to control wages and prices through government intervention. The government steps in between the competing power blocs and sets limits to wage and price rises. The limits may be enforced through legislation or through voluntary agreement. In Liberal-ruled Canada today, for example, the government is trying to limit wage rises to five per cent per year.

In the UK there was a ‘social contract negotiated between government, business and unions in the late 1970s. And though it eventually’ broke down it had, in its various forms, brought inflation down from a horrifying 24 per cent to a more manageable nine per cent by the time the Labour government was voted out of office in 1979.

But it was universally reviled. British union leaders felt that they had delivered their part of the bargain only to see prices and company profits continuing to go up. Businessmen felt that such bureaucratic interference took no account of the realities of commercial life.

Those on the right of the political spectrum also have a more deep seated objection to this approach. It is an affront to the freedom of the individual and a form of creeping socialism that will stifle the enterprise and initiative that is needed to create wealth.

Temporary competition.
Photo: Camera Press

So what is their solution?


At last.

I thought you’d like that. But first a note of caution. Monetarism is a particular approach to inflation. Its proponents would not claim that it is a way of directly promoting economic growth. For this you have to couple it with a philosophy which goes under the name of ‘supply-side’ economics, which is something that we will come to shortly.

Stop telling me what you’re going to tell me, and tell me what monetarism is.

If you insist. Monetarism is a theory usually associated with Professor Milton Friedman and the University of Chicago. Friedman’s thesis is that if you look back in history you will see that at times of low inflation the growth in the amount of money of all kinds kept closely in line with the growth in the amount of buying and selling going on. When there is high inflation this is, he claims, because too much money is being created compared with the number of transactions. What the government must do at this point, he says, is to restrict the money supply.

But if you remember the end of the discussion we bad, a couple of days ago on money you should be objecting to this on the grounds that the velocity of circulation would have to keep steady for this to be true. And you would be in very good company. A report about to be published by the Bank of England has shown that Friedman’s efforts to prove that the velocity had remained steady had only been achieved by cooking the statistical books.

The monetarist thesis remains unproved. But it is simple to express: ‘too much money chasing too few goods’ so it has great popular appeal. It is also easier to understand then Keynesianism.

You can say that again.

Still, monetarism itself is not a right-wing theory. It is merely a technical proposition. It does appeal to politicians on the right, however, because it offers a way to control inflation with much less state interference than a full-blooded prices and incomes policy.

But surely the monetarists have brought down inflation.

Yes they have. But not necessarily in the way they intended. Mrs Thatcher in the United Kingdom, President Reagan in the USA and even President Pinochet in Chile have all been ardent followers of the ‘Chicago Boys’ and have cut back the money supply chiefly by restricting credit and having high interest rates.

The restrictions did not, however, have any immediate effect on prices. When Mrs Thatcher took over from Labour in 1979, for example, she found that inflation climbed steadily up again.

This was because the ratchet that caused inflation in the first place was still operating. Inflation only started to fall much later. By the end of her first term in office it was back to the nine per cent she had started out with.

What happened was that companies had started to go bust. A furniture factory whose customers were slow at paying for example might need a bank loan to keep it going but could no longer keep up the interest payments. Workers making cornflakes found it more difficult to buy a new house on credit and so sales dropped. Bankrupt companies and reduced purchases engaged the familiar multiplier with a vengeance and the economy went into recession.

Ironically those corporations least touched by the recession were the huge corporations. They usually had the money to finance their own activities, so relied less on external loans. And when they did run short of cash for any reason they would probably work with forms of IOU. Shell or General Motors are usually considered good credit risks by their suppliers.

But as demand dropped ever more steeply they too were affected by the overall decline. Rather than drop prices, however (for the reasons suggested earlier) they’ cut back on production and laid people off. Those people still employed got their wage increases as before.

It was only when employment reached massive proportions that the corporations and the trade unions felt the need to restrain themselves. There are now three million people unemployed in the United Kingdom (12.5 per cent of the workforce). Inflation is down to around five per cent. But it is unemployment that has caused the fall rather than monetary restraint. So there you have the two ways of dealing with inflation. Both have their advantages and disadvantages. The one that you choose will depend on your political philosophy.

I take it that you are entirely dispassionate about the alternatives.

Well as you might have gathered, the conservative solution to inflation does not correspond very well to the basic cause of inflation which I gave earlier - the three power blocks. This is because conservatives who are ideologically attached to the free market do not like to accept that it is disappearing. They will therefore have the problem that, since monetary restraint has only slowed inflation by causing recession, then as soon as the economy picks up again so will inflation. The corporations are still there, so is the government, and so are the trade unions.

How on earth is the economy ever going to pick up again?

Once again there are two possible ways forward, liberal and conservative. The liberals at this point turn to Keynes again and propose revitalising the economy in the tried and trusted ways - particularly by stepping up government expenditure to increase demand and put people back to work. This might mean building more roads or just increasing welfare payments.

But won’t inflation start again?

Almost certainly. So any liberal approach has to build into it the seeds of some kind of prices and incomes policy and it has to rally popular support behind it.

OK. Now let’s have the conservative line - and be as convincing as you can

This is where we get to the ‘supply-side’ economics. Conservatives argue that what causes economic progress is risk-taking by entrepreneurs. So everything that restrains such enterprise should be removed and things will move forwards again. This means that taxes should be reduced to offer glittering incentives for success and government restrictions should be removed wherever possible. Cutting taxes means, however, that you also have to cut public expenditure, which can be a little painful.

But I can’t be very’ convincing when putting this argument since it bears little relation to the changes in the market that I outlined earlier. The last thing large corporations want to do is take risks, so even offering them tax-cut incentives to do so is unlikely to work. But where free enterprise is a matter of faith it can be sustained in spite of the contradictions all around.

The ‘supply-side’ nature of their approach lies in the notion that if you increase supply through production this in turn will put money in people’s pockets and creates the demand. So in general terms you could say that liberal economists favour promoting demand through government action while conservatives want to promote supply through private enterprise.

Does ‘supply-side’ economics work?

Well there are two test-beds you could look at: the USA and the United Kingdom. Neither of them has got very far along the lines which Milton Friedman and the ‘supply-siders’ would like and they as a result disown them as true experiments, but they are the best we have.

In the United Kingdom monetarism has been followed by recession. But Mrs Thatcher has had to pay out huge sums in unemployment benefit and been unable to go onto reduce taxes. The ‘supply-side’ part of the philosophy therefore has not been tested. So unemployment remains at record levels and growth is minimal.

President Reagan also found that he could not afford to reduce taxes, though in his case because of his substantial defence budget. But he cut taxes any way on principle, so he is now running an enormous budget deficit. The 1984 budget involves borrowing $180 billions which is almost precisely’ what the entire private savings in the USA come to. He is spending all the nation’s savings single-handed.

I must be getting this wrong now. Isn’t this the Keynesian way out of recession?

Indeed it is. And the US economy is currently booming as a result. Keynes however is unlikely’ to get the credit he deserves for this bizarre turn of events. Anyway, this has been very hard work and though I’m sure you’re anxious to hear more, frankly I’m exhausted.

Multinational corporations, trade unions and government agencies are the power blocs which now overshadow the market-place.

[image, unknown]

They are insulated from market pressures so bargains struck between them tend to produce ‘ratchet inflation’.

[image, unknown]

Conservatives attack this inflation through ‘monetarism’, and succeed by causing recession.

[image, unknown]

Liberals prefer government intervention to control prices and incomes directly.

[image, unknown]

Conservatives want to revitalise the economy by giving incentives to producers - emphasising the ‘supply’ side.

[image, unknown]

Liberals prefer to promote demand through Keynesian expansion of spending.

Day five - a third dimension

[image, unknown]
[image, unknown]
[image, unknown] [image, unknown]

The rich people have to eat money, but luckily the poor provide food.


[image, unknown]
[image, unknown]

MOST of what we have said so far has applied largely to the economies of rich countries. Now we want to look at the kind of economy you will find in Third World countries, whether they are capitalist or socialist.

Isn’t it time we heard a bit more abut socialist economics in any case?

Maybe it is. You might even be a bit surprised that the New Internationalist is giving capitalism the spotlight. We have been sympathetic enough to the socialist alternative in the past.

Soft on communism, I would have said

Just prepared to give credit where it is due. But in this issue we’re not going to talk much about socialism not in the Eastern European sense at least.

Thank God for that - but why not?

Well this is meant to be a very basic explanation of economics. Socialism on the whole is much less difficult to understand than capitalism. And you probably know most of it already. The socialist idea that the State should centrally plan the production and distribution of goods is pretty straightforward - even if it is difficult to carry out in practice.

Capitalism on the other hand is relatively easy to practice but much more difficult to describe. All the capitalist has to do is follow his basic instincts and let everyone else follow theirs. But following the financial trail they’ leave behind can be very difficult.

In fact as companies get larger the operating differences between socialism and capitalism have become very blurred. Most of the big corporations spend a lot of time planning the future. Despite all their talk about the free play of market forces they can probably’ tell you how many hamburgers or jars of coffee the are going to be selling in five years time.

But the planning we are looking at today is that of governments. This is because the focus is on developing countries and for them central planning is much more important than it ever was for us.

I don’t like the sound of that. Why don’t they just follow our lead?

Because even if they want to they can’t. Third World countries can’t follow the same path because they are starting from a completely’ different place.

Remember how the early capitalist countries started out? Over a long period of time a series of simple inventions were introduced into agriculture and industry. These enabled production per person to be stepped up and wages could rise as a result. Earnings were then used to buy goods or invest in future production. The capitalist machine today is the product of centuries of steady growth: it can cough and splutter and sometimes look like breaking down completely. but with regular servicing and occasional replacement of parts it has managed to keep going.

In poor countries the economic machine is in a very different condition. Some parts of it are whirring round very rapidly, others don’t work at all - and many are completely missing. Take literacy - which is of economic as well as educational importance. In most developing countries you will find copies of Time magazine, instruction manuals for IBM. Computers and advertisements for Gold Leaf cigarettes. Yet many people will not be able to read them. They may be illiterate or perhaps they do not even speak that particular language. Or, even if they can read, it could be that most of the reading matter is in the capital city and they live in the countryside. Things are often like this in poor countries: their economies are very unevenly developed, many of the parts simply do not connect up.

Time they got themselves organised.

Time things were changed, I’d agree with you there. But you can hardly blame the people in poor countries for their disjointed economies. Many of the things which do not match up came from overseas: it is the rich countries which cause much of the dislocation in the poor world.

Here we go. You’re going to tell me that all the problems in the world are caused by international capitalism.

No - though some of them certainly are. All I’m saying here is that capitalism has certainly shaped the economies of poor countries. Of that there can be no doubt.

I should say again, however, that there are some communities that remain relatively untouched by any outside influences of any kind. You will find subsistence communities in most of the poorest countries from Chad to Peru to Papua New Guinea. Even in India which is one of the world’s biggest industrial powers the majority of the population live in poor villages working the way they have done for generations.

But in every country you will find particular 7-areas and groups of people which are closely linked with the outside world. Even as we speak there are Ecuadorian campesinos cutting bananas to send to Europe. Dumper truck drivers in Jamaica are scooping up bauxite to ship to Canada and tea pickers in Sri Lanka are choosing the leaves that will appear in Australian supermarkets.

According to my watch some of them must be working in the dark - still, it’s very helpful of them, whenever they do it.

True. They are doing precisely what we want them to do - following the pattern of work that was established from the earliest days of colonial contact. Poor countries in general were designated as suppliers of raw materials while we would sell our manufactured goods to them.

Seems like a fair exchange to me.

It might be if the proceeds of the trade were equally shared out. But it is the makers of the manufactured goods who have the whip hand. Take the confectionary industry - importing cocoa from Ghana. They decide what products they are going to make, what ingredients they need and in what quantities. Most of all they decide what they are prepared to pay’ and can change the mix of raw materials if one of them rises in price.

The chocolate and candy end of the business is also the part that is the most susceptible to technical innovation. There’s not much you can do to improve cocoa yields but no end of computer-aided gadgets that you can use with moulding or packing machines. Most of the investment therefore has been made in the rich countries and this is where most of the profit has been made.

But Ghana isn’t a colony anymore. Why don’t they make chocolate too?

They do. But they don’t have the accumulated capital that we have to invest in sophisticated machinery. Nor do they have the education and training at the marketing end. They find for example that there are subtle hut vital differences in national taste: chocolate is milky in Britain, or bitter in France or tastes of peanuts in North America.

And even if they really start being successful at selling such manufactured goods they find that the rich countries raise tariff barriers to keep them out. Developing countries as a result find themselves tied to the economic patterns laid down by the more powerful nations.

But just as important as the economic legacies of colonialism are the social and political ones. Colonial dependencies were usually run through a small elite of settlers or of carefully chosen local people. They were to be the channels through which the trade and the money were to pass to the home government.

Nowadays you will find their successors just as firmly entrenched. They may be the privileged government officials, the owners of large plantations or the local managers of multinational corporations. Their interests and values are linked as much with the rich nations as with their own countries.

I think we’re getting off the point here - is this economics?

I’m just trying to say that the poor countries have ‘dualistic’ economies. There is a small rich elite surrounded by a mass of very poor people.

The rich will control most of the country’s land and industry. Certainly they will earn a great deal, but much of what they get will be spent on expensive imported goods - the swish Mercedes or the Hitachi music centre, they will buy relatively little that is locally produced.

The millions of poor people may be subsistence farmers and so largely outside the cash economy. Or they may work for very low’ wages mining tin or cutting sugar cane for exports. Neither group can afford to purchase very much.

The economic point of all this is that the lack of demand from both the rich and the poor and the lack of investment in manufacturing industry mean that most poor countries have very small economies: their Gross National Product (GNP) will be low. The GNP includes all the goods and services that people work at producing - whether food or clothes or bus rides or police forces.

International comparisons are usually’ made in terms of GNP per head of population. So that of New Zealand is S7.000 while that of Chile is S2,560. This does not mean that everyone in New’ Zealand is richer than everyone in Chile. There are wide discrepancies of income in both countries.

But the inequality is much greater in Chile than in New’ Zealand and is indeed generally’ greater in poor countries than rich ones. This is another indication of the more solid economic base of the rich countries people buying and selling from each other on a more equal basis enables the money’ to move round the economy.

This relative equality’ in the advanced capitalist countries has confounded the predictions of Karl Marx. He correctly foresaw that corporations would grow larger and larger, but he also thought that they’ would use their greater size to exploit their work forces and lower their wages. The workers in the end, he said, would rise up in revolution and overthrow capitalism. This has not happened where he thought it would - in countries like Germany and Britain largely due to the efforts of the trade unions.

You mean they have kept capitalism going?

Very probably. But modern Marxists argue that this has only been possible because the real exploitation and misery has been felt in the Third World.

Why haven’t they risen up then?

Well, cotton pickers in Central America can hardly rush off and seize cotton mills in Manchester or Philadelphia. Geographical separation has a great stabilising effect. And even if they were to try to take over their own plantations they would find opposition, not just from the local owners but also from the police and government who are likely to be receiving aid and equipment from Western governments. International military aid also has a great stabilising effect.

So let’s see what we’ve established so far. Poor countries have small dislocated economies which are orientated towards the needs of Western nations. To make progress they have to connect all their activities up so that local people can buy and sell more from each other.

Fair enough - but how do they do it?

This is where government planning comes in. And generally’ pretty drastic action is needed. Western countries can get away with tinkering with their economies but the poor countries are in such a desperate state that something like complete rebuilding is needed.

The most direct way to do this is through a socialist revolution. The cotton pickers in Nicaragua at least now’ have much more control over this own lives. And socialist governments in general do stand a good chance when it comes to connecting all the bits of the economy. They can distribute assets and income over the whole country so that demand is evenly spread out. There are doubts however about whether socialists promote production as efficiently as they manage distribution. But economic planning is by no means limited to socialist countries. The governments of South Korea and Singapore, for example have strongly directed local business activity, both through incentive and legislation. We may consider their social or political approaches to he restrictive or repressive but economically they have been very successful.

Changing political, economic and social structures simultaneously - in whatever direction - is a process that goes under the heading of development.

I’ve always wondered what that was.

Now you know. It involves both unlocking the existing potential of countries whose development has been held back by’ archaic social structures - and then building on this to produce some kind of economic growth.

How are they supposed to promote growth?

In the case of the poorest countries there is often little point in stimulating demand in the Keynesian style. They don’t have the factories to produce the goods so increasing demand will only push up prices and lead to inflation.

What they have to do is to try’ and promote demand and supply together. Given that so few people in poor countries have wage-earning jobs the best way of creating an even spread of supply and demand is by investing in labour-intensive industries. This would mean starting a number of small cobblers workshops to make shoes, for example. rather than a highly automated shoe factory.

But this might not be what investors would want done with their capital naturally. They might consider that a highly automated Bata shoe factory would give a better return on investment.

A good place to instal the small workshops would be in the countryside rather than the capital - so as to stem the tide of migration to the glamorous city. But a private investor would want his factory to be sited near his biggest market - which is likely to be the capital.

So a government with development as an objective will be in conflict with the ‘natural’ behaviour of the market. It has to promote supply’ in a way that will create general demand.

That smacks to me of ‘supply-side’ economics. I thought we were against that.

There’s nothing wrong with trying to promote the supply of goods. But there are very different ways of doing it, so you will find supply-siders both on the right and the left.

In rich countries the supply-siders of the right want to promote production by reducing taxes on entrepreneurs. People on the left put more emphasis on creating demand but they are also worried about the supply. The fear that, even if demand goes up, manufacturers will not be sufficiently well-organised or imaginative to take advantage of it. So they advocate planning agreements with the major companies to ensure they produce and invest in the national interest - and they might in some cases want to nationalise the companies.

In poor countries the supply-siders take a similar line. They want industry to produce the goods in a way that will best benefit the country.

But where is all this investment going to come from?

A good question to end on - and one that we’ll have to try and answer tomorrow and the day after.

We have used Third World countries as sources of raw materials and markets for manufactured goods.

[image, unknown]

An elite group of politicians and businessmen have served as our point of contact.

[image, unknown]

Meanwhile the mass of poor people have stayed outside the cash economy or earned very low wages.

[image, unknown]

Third World economies have thus been relatively small and dislocated.

[image, unknown]

Development will mean connecting up the different parts of the economy.

[image, unknown]

And changing both political and economic structures simultaneously.

Day six - trading terms

[image, unknown]
[image, unknown]
[image, unknown] [image, unknown]

A false balance is an abomination to the Lord:
but a just weight is his. delight.


[image, unknown]
[image, unknown]

THE world recession’ is the commonest excuse for economic failure that politicians use these days. And, who knows, in some cases it might even be justifiable.

To see how likely this is we are going to have to look more closely at international trade - at all the exports and the imports and the ‘balance of payments’ crises.

Your typewriter I see has ‘Made in Italy’ on the front. Not very patriotic.

Patriotism doesn’t enter into it. You might say I’m contributing to the growth in international trade - doing my bit as a world citizen. That’s according to the ethos of ‘free trade’ anyway. The theory as if we all specialise in making what we are good at and trade freely then the whole world will grow richer.

You can draw a parallel with what happens in your own home. Suppose you are the better cook and your partner is the better gardener you should both be better off if you do the cooking and he or she does the gardening.

I’m a terrible cook and a lousy gardener.

Maybe. But if your partner is a really superb gardener and only slightly better than you at cooking then it will still pay you if he or she sticks to the gardening. This assumes, of course, that you are permitted to enjoy the garden. If the benefits are not equally shared then the ‘division of labour’ is a much more questionable way of doing things.

International trade involves the same kind of specialisation. The rich countries are now good at making manufactured goods and the poor countries have the raw materials. But in this case, as we saw yesterday, the benefits have not been shared equally.

I’m still a bit unconvinced about this Italian typewriter. Don’t we make them as well?

Yes we do. My choice is purely a matter of taste. And my reasons for preferring a foreign typewriter may be very’ minor. But the problems such preferences cause can be very severe. If it happens too often you get a ‘balance of payments problem as imports greatly exceed exports.

Alarm bells start to ring at this point because there will be a leakage of spending out of the home economy and into the Italian one. This will bring the dreaded multiplier into play - much as it did when money leaked into the banks, as we saw on page 15 - and the entire national income can drop as a result.

But the buying and selling of goods is not the only thing which affects our balance of payments. When we buy the services of people in other countries - staying in their hotels for example - this purchase counts as an ‘invisible’ import. And when we build a factory abroad or place money in a foreign bank account we are diverting capital from our home economy.

Sounds terrible - how can we stop it?

Don’t worry. There is a kind of natural control over such dealings because of the foreign exchange market. To do any business in another country you usually need to buy some of their currency. And it can become discouragingly expensive.

Because of the huge volume of international transactions there are dealers buying and selling currencies the whole time. And the exchange rates between them move on the basis of supply and demand. When Australia, say, wants to buy cars from Japan she must do so with yen. So she must sell Australian dollars to buy yen. When Japan wants to buy grain from Australia she must sell yen and buy dollars. If Australia consistently imports more than she exports, and has a ‘balance of payments deficits there will be an excess of Australian dollars on the foreign exchange markets and this will tend to push the exchange rate down.

But think what happens then if the value of the Australian dollar does fall. This will increase the price of goods imported to Australia - and will make Australia’s exports cheaper and easier to sell. The change in the exchange rate will in itself tend to right the imbalance in trade. So you might think that the whole system would look after itself. Unfortunately it’s not as simple as that.

I didn’t think it would do.

The problem is that the exchange rate can also move up and down in a way which has nothing to do with the balance of payments. This is because there is also speculation in currencies as people buy and sell them according to the way they think the exchange rate will move in the future.

There is always a lot of money floating round the world looking for somewhere to stay. Take the US dollar, for example. For many years the United States had a balance of payments deficit. But the people outside the country chose to hang on to the US dollars they were accumulating because they considered them useful for trading with other countries, as a kind of international money, like gold, or just to hold as reserves. As a result there are now many millions of US dollars moving around the world which never touch American soil - a mass of exiled currency of which the ‘Eurodollars’ are perhaps the most famous.

Are these the same as all these ‘petrodollars’ that the Arabs have got?

They are connected. America buy’s much more from the oil-producing countries than she exports to them. So the Saudis can hold their balance of payments surplus in dollars if they want to. Mind you they can change them so they become ‘petromarks’ or ‘petroyen’ or ‘petropounds’ just as easily. The oil surpluses flow around the world according to where they can get the best return.

How do they choose where to put them?

Well, obviously they want somewhere safe. But they will also look for the places where the banks are paying the highest interest rates. They will be influenced too by whether or not they think a currency is going to get stronger in the future - in which case its value will go up and they can make a profit by selling later.

I can see there is money to be made here. But how do you decide whether a currency is going to go up or down?

You could look at the prospects for the country concerned - to see what its balance of payments was likely’ to be in the future. When Britain discovered North Sea oil it was clear that her imports of oil would not be so high in future and that less pounds would be sold. So the value of the pound sterling increased to reflect this. But if everyone judged that a currency was going to appreciate in value, and decided to buy it, then it almost certainly would do so because demand for it would go up - this becomes a self-fulfilling prophecy.

Reserves as here in the US may be kept as gold or currency.
Photo: Camera Press

So the Arabs are speculating in our currencies?

Everybody is speculating in currencies in one way or another. The multinational corporations who do business in fifty different currencies are moving money around the world as fast as a telephone call. Naturally they do not want to get caught out having any of their assets in the wrong currency at the wrong time.

Apart from the activity of speculators it can often happen that the actions of another government can have a severe effect on your own currency - When the United States decides that it will pursue a monetarist policy it will increase interest rates. This attracts money from everyone and people want to buy dollars so they can put them in American banks. The value of the dollar goes up as a result. Other countries must then raise their own interest rates in retaliation to hang onto the foreign money that has been invested in their own banks. So a monetarist approach can cause problems not just in the USA. The banking system will transmit a tight money policy to other countries too and discourage investment. So recession can pass around the world not just because of a general decline in trade but because of the way interest rates are set in one country.

I still don’t see why it matters if a currency rises or falls.

Well if a country has to import a lot of its raw materials then the price of these will rise as their currency falls and this could trigger off a round of inflation. But at the same time their exports to other countries will be cheaper and this may well increase sales.

A rising exchange rate could be worrying too, however, since this makes your goods sold abroad more expensive and makes imports cheaper.

Seems like swings and roundabouts to me.

It may well be. But the central point is that currencies may move in a way that is damaging yet the country concerned will have relatively little influence over what’s going on.

So what can they do about it?

One thing is to try and influence the foreign exchange markets by having the country’s central bank buy or sell its own currency. So the British government could buy or sell pounds in an effort to stabilise the rate of the pound against the US dollar.

Where would it get the money?

Most governments keep reserves of foreign exchange or gold that they can use in the case of emergency like this. So if there is what they think is unjustified speculation in their currency they can try to neutralise it. If there is a temporary problem with the balance of payments which they think will soon right itself they will also draw on their reserves. If they run out of reserves they will have to borrow if they wish to keep going.

Who from?

It could be from another country. or from the international bank or from the International Monetary Fund - the IMF.

Sounds like you’re about to introduce another villain.

The IMF ought not to be a villain - it should be a neutral financial institution. It was set up after the Second World War with contributions from most of the rich countries as a fund from which countries could draw when they were in temporary difficulties.

If the problems are genuinely and obviously temporary then the loan should come almost automatically. It is when they look more permanent that the arguments start. The IMF will look at the country’s economy and decide what they think the problem is and what they think should be done. Any substantial loan will then be conditional on these steps being taken.

That sounds eminently reasonable.

It depends what the steps are. IME policies may remove balance of payments problems, but often at great social and financial cost - as we shall see tomorrow.

A more direct way to cut imports of course is to raise tariff barriers to make foreign goods more expensive - though this is something that the IMF with its free trade philosophy is very loath to suggest.

This is not just an option for poor countries. If demand in the UK economy were to increase, for example, then there is a distinct possibility that this would be met from an increase in imports from countries like Japan.

The Japanese are causing problems everywhere. They have become so efficient at high technology industries like electronics that they also have manpower spare for relatively less sophisticated industries like steel and car production. The technological revolution is raising serious political issues everywhere because it will mean sharing of work if everyone is to be employed. The Japanese, who are at the forefront of such change, are unwilling to take this difficult step within their own country so they are effectively exporting technological unemployment to other countries.

To extend the cooking and gardening analogy used earlier it is as if your partner had so mechanised the gardening that he or she had time to do the cooking and sweep the yard as well - leaving you with nothing to do at all. If the benefits of all this are equally shared you might enjoy the enforced leisure. If they are not, then the relationship is likely to become strained.

So there could be an argument for freezing the imports of Japanese goods to existing levels to ensure that increased demand locally would generate income and investment locally - and increase productivity in the long term.

But won’t they retaliate if we keep out some of their goods?

Not necessarily. The Japanese have an interest in the economic health of the other countries they trade with, so it could be in their long-term Interest too. In any case there is nothing sacrosanct about free trade. It usually offers more freedom to the powerful and restricts the freedom of the weak. So it should be adopted more as an act of strategy than a permanent tenet of faith.

International trade permits a division of labour that could make the world as a whole richer.

[image, unknown]

But the benefits are unequally shared and are taken by the strongest economics.

[image, unknown]

Such trading between countries usually results in a surplus or deficit in the balance of payments of each.

[image, unknown]

Currency exchange rates move up and down to reflect this, but are also affected by speculation and interest rates.

[image, unknown]

Those countries which get into trouble may have to borrow from the International Monetary Fund.

[image, unknown]

Or if they see themselves at a more permanent disadvantage they may be tempted to take protectionist measures.


Subscribe   Ethical Shop