The collapse of two major banks in Britain and America (Bear Stearns and Northern Rock) should make us pause to reflect on the fundamentals of the world financial system.
When currencies around the world were nationalised at the outbreak of the First World War, the reason was obvious. In order to fight the war, states needed to be able to print their own bank notes without actually having the money to do so. The relevant law in France, passed in August 1914, stated baldly “The Bank of France will no longer reimburse its banks notes in cash.”
The cash in question was gold, and bank notes were but titles to a certain amount of gold coin. The supply of money was dictated by the supply of gold. Although the state played a major role in the currency system – all countries had “central banks”, and use of the national currency was obligatory – its principal function was to uphold the promise to pay the bearer of its bank notes a specific sum on demand. Providing that that promise could be kept, the currency was sound.
After the First World War, attempts were made to reinstate the pre-war system because it was considered to be the indispensable bedrock of the financial system and world trade. How could nations trade freely with one another if their currencies fluctuated in value all the time? However, the “gold exchange standard” created at Genoa in 1922 contained a fatal flaw which soon led to the system’s collapse in the fateful year of 1933. That fatal flaw was that two currencies, the British pound sterling and the US dollar, were taken as having equivalent value as gold. Other currencies could be exchanged for them, and they could be used as collateral for their issue.
This was a fatal flaw because it gave a special privilege to these two currencies. That privilege meant they were always in demand, however much of them was in circulation. The great French economist, Jacques Rueff, identified this flaw as one which permitted “a deficit without tears”. The United States and Britain could basically print as many paper dollars or pounds as they liked, safe in the knowledge that they would be soaked up by other central banks to put in their reserves. They could use this paper to buy goods from abroad, exporting capital in return, without any fear that the increase in the money supply would lead to inflation at home.
As the Second World War was coming to an end, and plans were being laid for the post-war financial system, the old memory of fixed exchange rates persisted (although this was only a consequence of the gold standard, not its principal virtue). However, at Bretton Woods in 1944, the same mistake was made as at Geneva, only this time the United States dollar alone achieved supremacy as a currency with a “reserve” status. When its own link to gold was cut in 1971 – Richard Nixon needed to print dollars to fund the war in Vietnam – the world currency system was set adrift on the system we now live with, one in which currencies fluctuate in value against each other all the time.
What we now remember as the “oil crisis” of 1973 was, in fact, little more than a rational response by oil producing nations to the de facto devaluation of the dollar. Oil rose in price because it was denominated in a debased currency. The oil producers said they would price oil against gold instead – i.e. against real, as opposed to paper, money. This never happened, in fact, and black gold continues to be priced in dollars. But this is one of the main reasons why the United States continues to enjoy the “deficit without tears”, i.e. a seemingly limitless trade deficit, paid for by flooding the world with dollars which other countries use either in their central bank reserves or to buy oil.
In the last twenty years or so, this policy has been applied with a vengeance. The United States Federal Reserve, a private organisation with the privilege of printing dollars but owned by private banks, has flooded the American (and world) financial system with cheap credit. This has been the principal cause of the tremendous rise in the price (inflation) of stocks and shares. Other commodities which have risen greatly in price include property and, of course, oil. The financial system as a whole may be helped by this rise in credit, because the banks make money on it by lending the money on at a higher rate, but the economy and society as a whole suffer.
This is because artificially easy credit generates income for banks in the short term by mortgaging the long term instead. A rise in the money supply now makes profits for the banks but pushes up prices for everyone else. Specifically, a rise in property prices (a fixed and real asset which inevitably rises as the value of paper currency is debased) generates huge problems for the whole economy, and especially for family life. Families cannot afford to have more children; and the resulting collapse in the birth rate stores up trouble in the future for important things like pensions and health care. It also drives immigration, which in turn causes its own problems, specifically the abuse of social costs, which drives up taxes, taking yet more money out of the pockets of ordinary working citizens.
To put it in a nutshell, a system of paper currency, easy credit and high taxes destroys the natural order of society. It breaks the social contract and pays for the present at the expense of the future. The financial system, however, prospers. Banks make money because the cheaper credit is, the more money they can lend. In their search for ever greater income, banks have flooded the Western economy with credit. The current “sub-prime” mortgage crisis in the US and Britain is only the tip of the iceberg. It is now very easy to take out vast loans for property in both countries, many multiples of one’s annual salary, on the basis of no proof whatsoever: I, for instance, have a loan which is many times my own annual income and I obtained it without having any regular salary and without providing any proof of my financial position whatever. It was all done by word. My wife, meanwhile, was recently offered a credit card by our local department store, which duly arrived in the post, giving us £6,000 in instant credit even though she has no income whatever, and even though a card was issued in my name without me even having set foot in the shop.
Once people have difficulty repaying such dodgy loans, then of course the whole system risk collapse. The income from these loans is itself used as collateral for other increasingly baroque financial operations but if the basis for them dries up then the knock-on effect can be very serious, since it is a feature of options and other financial instruments that very large sums can be leveraged for very little money. All this, I repeat, is encouraged by the bank which directs operations at the centre, the Federal Reserve, which never pays its own debts and encourages a climate of easy credit.
The real collapse of the world financial system would come if countries and oil producers started to abandon the US dollar, as some are already doing. Because the US prints limitless amounts of green paper, demand for it has to be kept going somehow. Oil is a major source of demand – and one of the reasons for Saddam Hussein’s downfall was that he decided to sell his oil for euros in 2000. The link between paper currency and militarism is integral. If the dollar is abandoned, then the United States will no longer be able to pay for its limitless imports. Indeed, if oil rises significantly in price, then the very fabric of American life will be threatened since all American cities are constructed in such a way that it is not possible to live in them without a motor car.
The argument is also advanced that state control of the financial system is necessary to prevent financial collapse. This argument is looking a little threadbare as banks collapse in London and New York – the collapse of Northern Rock has caused the British government to pump in nearly twice as much money as it spends every year on the armed forces – and as whole currencies collapsed, in Russia and the Far East, in 1998.
Because the vested interests are so great, the US Central Bank and the other countries of the world will do all they can to keep this racket going for as long as possible. They may succeed for a while. But the world financial system is parasitic on society, and it impoverishes it in the end. It is contrary to the natural order and, sooner or later, it is the natural order which will return.