“Credit grows faster than incomes, bubbles inflate and suddenly burst, and recession looms. Is the premise at fault, or is it just greedy bankers who are to blame?”
Societies used to be divided into slaves and masters, vassals and suzerains. Without completely obliterating the past, the Industrial Revolution introduced a new confrontation between capital and labour, between the private property of the means of production, and the hand and minds that put them to use. Other changes resulted from this transformed paradigm. Labourers were no longer the master’s property, they were free to be hired and fired. And government by cooptation replaced the hereditary transmission of power. The machine age also added a new element to the previous division of wealth between land-owning aristocracy and urban merchant bankers. The industrial entrepreneur was multiplying production and taking his share. And the ancient arch-enemies welcomed him with open arms, as their own wealth was also being multiplied. Growth was the new idol that brought riches to all. Even the poor might get a trickle.
The brave new mechanised world did have a few inconveniences, however, and air and water pollution were not the least. But the major problem was the funding of growth, and the periodic collapses of its financial structures. During the 19th century the cycles of boom and bust were perceived to last ten years. These cycles were studied by Juglar, and Engels mentioned them in his introduction to Capital 3. He added that, at the time of writing (1894), the cycles seemed to have a longer, twenty year period. It turned out that there were several cycles going on at the same time, short ones (Kitchin), medium ones (Juglar, Kuznets) and long ones (Kondratieff). This means that most of the time the booming cycles compensate those going bust, that occasionally they all boom together, and that they sometimes all go bust together. As for the causes behind these phenomena, Schumpeter was convinced that technological innovation was the explanation – creative destruction (sic) – and that supply expanded and contracted in consequence. However, unprecedented supply cannot justify the apparent regularity of the various cycles, whereas demand seems well fitted to cause such periodic events.
Growth in supply needs a growing demand. And demand depends on being able to pay. So that growth in supply needs a growing amount of money. But money is nothing more than a promise to pay, a symbol of value mediating exchange. A promise to pay that is either the result of a past transaction, or the result of a transaction predicted to occur some time in the future. It can be either cash or credit. If today’s demand is to grow, yesterday’s incomes must be supplemented by those of tomorrow. And today’s growth increases tomorrow’s incomes, so that it all balances out. Except that something always seems to go wrong. Credit grows faster than incomes, bubbles inflate and suddenly burst, and recession looms. Is the premise at fault, or is it just greedy bankers who are to blame?
The purpose of demand is either investment or consumption. (Supply is less easily defined, as identical goods and services can be destined to both usages.) The value of an investment is returned enhanced by dividends, interest, or rent, whereas consumption destroys value. For example, rent pays the upkeep of a property and taxes, plus something more, whereas home owners must pay for upkeep and taxes as part of their expenses. The fist case is an investment, the second is consumption. (Rising property prices may bring a profit in both cases, but that is just bubble economics.)
If the credit to fuel growth in demand is invested, the promise to pay is guaranteed by the investment. The investment may be an industrial or a commercial enterprise, or a loan to the Treasury, or real estate. In all cases, when all goes well, the investment is returned with a margin that covers the interest on the credit. And the investor using the credit can make a profit of his own. Moreover, increased investments should increase the work force, or their productivity. This is a necessary result, as only labour can create the surplus value of dividends, interest and rent. (Government spending is mainly consumption, in the form of salaries, social services, real estate and military hardware. Government borrowing can be cash or credit. Either surplus incomes are consumed or consumer credit is granted, and in both cases interest is paid.)
If growth in demand is fuelled by consumer credit, the picture is quite different. Consumption uses up value, there is no return, no dividend, interest or rent. So the promise to pay the credit and interest with future incomes is contingent. The borrower (public or private) must be able to create new value, the value of his credit plus interest. And, meanwhile, he needs to maintain his ordinary consumption, which means that his income must grow. Otherwise, paying back the credit will reduce his consumption. So that the increased demand of the granted credit results in a reduced demand when the credit is paid back. The solution is to renew the credit, plus a percentage to cover the interest. But this merely maintains past demand. To maintain the increased demand more credit must be granted. And, for demand to continue growing, even more credit must be granted.
Invested credit is returned, so that its renewal maintains the increased demand. Neglecting interest, this means that the amount of credit grows at the same rate as demand. Consumed credit is not returned, so that the amount of credit must grow faster than demand, to maintain past demand, to maintain previous growth, and to fuel new growth. If growth in demand is to be one unit of value per unit of time, and if credit is granted for one unit of time without interest, then invested credit follows the series 1, 2, 3, 4, 5, etc., whereas consumed credit follows the series 1, 3, 5, 7, 9, etc. It seems obvious that the explosive growth of consumer credit (private and public) cannot be sustained. At some stage the boom must go bust. So why not fuel growth in demand solely with invested credit? The answer lies in the private property of the means of production, and in the tribute levied by the proprietors.
From the very start, humans were able to produce more than they needed to sustain life. This left them plenty of time to sleep and dream, to tell stories, to sing and dance, and to wonder at the beautiful and awesome world in which they travelled. Agriculture put an end to this primal state. It tied people down to a particular place, for life and for generations. It concentrated them along fertile river valleys. And, by labouring from dawn to dusk, these new societies could produce a surplus for the upkeep of a privileged class and the building of monuments. Cities took form and armies conquered, and labour became ever more intensive. Then the steam engine and gas lighting allowed work to continue night and day all the year round. This possibility has been expanded and perfected to this day, on a sleepless planet where billions of humans have adopted the slogan, Work Brings Freedom.
For most of history, the surplus produced by labour was consumed by the ruling propertied class, for the upkeep of artists and courtiers, of armies and artisans. Wealth was land, and its property was only modified by war, murder, marriage or revolution. Even bankers had to limit their investments to commercial enterprises, usury and rented urban property. Marx explained the wasteful luxury of Roman games and feasts by the lack of investment opportunities, the rich had to spend their incomes. Weber linked the birth of modern capitalism to the Protestant ethic, and to its rejection of extravagance. But it was machines and motor-power that really opened the perspective of unlimited investments. The means of production had started with land, then money and trade had proved to be indispensable. Suddenly tools were even more essential, huge tools with gigantic buildings to house them. At last the rich had something to do with their incomes, other than spend them gratuitously. There was however a problematic aspect to the Industrial Age. Multiplying production means multiplying consumption. The mass of goods and services needs a mass market. And if labour earns enough to pay for all it produces, where is the surplus to come from?
The simplest and oldest solution to this dilemma is foreign trade. Consumption is exported and its value comes back as investments, as raw materials or machines. Unfortunately very few nations can play that game at the same time. And it is ruinous for their commercial partners, who must import consumption and export investment. One side gets more investments, and to a certain degree more employment, while the other side looses its investments, and to some extent its jobs. In the past this has often been a casus belli. The other solution is to grant consumer credit.
The surplus of labour can be invested to generate more productivity and employment, more wealth and more surpluses. Consequently, the surplus is no longer consumed, though it remains a part of the wealth produced that must ultimately be consumed. Investing surplus incomes reduces final demand, while increasing supply. The widening gap between the two can be filled by unfair trade and consumer credit, but neither is sustainable, which seems to show that past incomes should be consumed and distributed accordingly. And that growing investments should be financed with credit. The cash of past incomes is consumed, and the credit of future incomes is invested. But this still leaves two unanswered questions. Who owns the investments and who grants the credit? Should the credit, and hence the ownership, be granted to an individual or to a group, and on what grounds? And are private banks the appropriate entities to grant credit out of thin air and obtain interest for it? However, neither question is likely to be asked, much less answered, in the foreseeable future.
Kenneth Couesbouc can be reached at firstname.lastname@example.org.