business corporate responsibility current affairs economics wealth

The economy is an illusion

Last year Lehman’s made sales of $57 billion. Yesterday they went bankrupt with losses of $167 billion. How exactly is that possible? The simple answer is that the bubble burst, that the banks have over-reached themselves. The complicated answer? Even the banks are still figuring exactly what they’ve got themselves into.

It shouldn’t be possible to lose as much money as Lehman Brothers have lost, not if you’re trading anything tangible. James Bruges says as much in a recent Ecologist article: “This doesn’t happen with real things. Eat or use them, they gradually reduce; they don’t vanish into thin air.” That you can lose money so spectacularly is proof that money trading has lost touch with reality, that nobody knows what money is worth any more.

It stems from the basic idea that banks don’t have money, they create it. There isn’t a big pot of cash anywhere in a vault. In 2005, £1 out of every £34 actually existed in real money. All the rest is, in the words of Ann Pettifor, “lent into existence, conjured from the digital banking ether in response to our desire to grow.” (Do good lives have to cost the earth?) As money is required, perhaps for investment, for a mortgage, or in the case of credit cards, for a new iphone, money is created and made available. Because this money is created in the form of loans, it attracts interest, and this is where the banks make their money.

If that isn’t confusing enough, those loans aren’t filed and stored and paid back. They are bundled up, traded, speculated against, passed from bank to bank, in what has become known as the derivatives market. Derivatives are complex financial products with no intrinsic value, but which derive their value indirectly through the performance of other financial assets. Where shares are an actual portion of a real company, derivatives are sophisticated bets on what shares might do. While some are used to hedge bets and guarantee returns, others are hugely risky, entirely speculative, and impossible to value. Last year Lehman had $738 billion in derivative contracts at face value, but depending on how you value them, they were more likely to be worth just $38 billion. They are “financial instruments of a complexity beyond the understanding even of those who invented them”, Max Hastings said today. Little wonder billionaire Warren Buffett describes derivatives as “financial weapons of mass destruction.”

The problem is, a huge part of our economy is tied up in these kinds of games. As Hastings points out “when the City’s activities account for around one third of GNP, the nation is frighteningly vulnerable to their frailty.” He goes on to argue for closer regulation of the markets, because although the banks have failed us this time, we ultimately need them to maintain positive growth.

But do we? When growth is so illusory, and unsustainable, isn’t this a chance to bring the economy back to earth? I’ve read some interesting things about steady-state economies. I don’t understand enough economics to judge that idea just yet, so I’m going to content myself with Ann Pettifor’s advice:

“Those of us who live in the privileged and exploitative economies of the West can all play a part in bringing about a transformation to the international financial system. We can do it by increasing our understanding of the system. And we can do it by declining to dance to Finance’s tune. After all, the financial sector depends on us, the world’s debtor-spenders, to come to the ball. We can turn down the invitation. We can decline the credit card, overdraft or loan. We can live within our means.”


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