I wrote this book about eight years ago, and I explained then what now is occurring. The real matter is money as many economist and politician are now claiming.
The thing that counts is the pure statistical fact that tells us that production has increased. A funny example of the distortion in the calculation of this statistical monument – the GDP – lies in this extremely recent occurrence in the USA. We know, among other things, that the GDP is made up of the balance of payments, meaning the algebraic sum of the positive amount of exports, minus imports. The fact is that, if there is a strong drop in imports as an effect of the crisis, which obviously translates into less consumption, the GDP increases, as this resulting amount will necessarily increase. Therefore, although it produces poverty in the general population, the effect will be an apparent growth in wealth.
So let’s try and understand the discrepancies that hide behind the realization of equilibrium models and what horrific consequences they entail.
Price levels depend on four variables:
1) production costs, 2) demand, 3) supply and 4) the amount of circulating money.
We must consider that, for historical reasons, the cost variable tends to decrease, whereas the variable regarding circulating money tends to increase, and neither of them follow a linear trend but have a constant direction.
Even the other two main variables, demand and supply, have a historical tendency to increase in direct proportion to one another.The theory of equilibrium describes the dynamic trend of the four variabls and their relationship with another two variables, the unemployment rate and profits, which collectively depend on these variables and, in turn, influence their trends.
In ideal conditions, the unemployment rate is constant, costs and profits drop, supply and demand increase in parallel and the amount of money increases less than cost reduction1.
For decades, the growth of the system was ensured by the control of these variables thanks to the intervention of governments on costs, employment and supply, and of the financial authorities on the quantity of circulating capital. Profit and demand depend on the market.
In this pretty picture, one can understand the control of the central banks on interest rates, which determine the amount of money that is created, the worries regarding the drop in employment rates or on their excessive growth, the need to slow down growth (i.e. production) to avoid the imbalance with demand or to put the breaks on consumption to avoid putting pressure on prices, etc. etc.
The growth rate of Western countries and, to a variable degree, of the entire world over the past three decades, gives this model its prestige and credibility.
But there are a few things that this model doesn’t say, and that falsify the whole process.
The debt economy
First of all, this model doesn’t say that increasing growth is based on the indebtedness of the system, in the form of private debt (families and businesses) and public debt (states and public entities). The issue involves both the equilibrium of the system and the nature of power itself.
In other words, the variable amount of money, which apparently looks neutral in the model, conceals an unequal distribution of financial resources, which has a decisive impact both on the quantity and degree of the overall demand.
Suppose someone offers you a job, a house and even the money to eat and amuse yourself. You would be extremely happy, I think. Then you find out that the money you get for your job is less than what you need to live, so each month you get into a little more debt, and you even pay interest on this debt, which increases your debt. Is it reasonable to assume that you’d be a little less happy?
A film made in the seventies illustrated a similar scenario set in a plantation in the Southern part of the United States.
The main character, a widower with two small children, is looking for a job and a decent place to live. He happens to find a farm where they are looking for workers. They offer him a salary of one thousand dollars a month (incredibly high), a house, food, a car, amusements and schooling for his children.
He is extremely satisfied with the conditions and gets straight to work. As a matter of fact, the house is an unbearable cabin, the car is a wreck and impossible to drive, the food is terrible and the amusements non-existent, but one can’t be too picky in his situation.
The surprise comes at the end of the month. That’s right, because when he goes to collect his salary after a hard month’s work, they tell him that they have to detract 600 dollars from his one thousand dollar salary for his accommodation, 400 dollars for food, and another 400 dollars for the car, drinks and amusements (the whiskey was a tad expensive).
Basically, after a hard month’s work, not only had he earned nothing, but he was in debt for a total of 400 dollars. In the film, as one could predict, the whole affair ended up in gun-shots.
The same thing is happening in the world, but strangely enough no one is complaining. The public debt of the State increases in absolute terms every year. The element that drops and that is subject to control is public deficit, which is one of the elements that determine the rate at which debt increases 2.
The increase of financial mass via indebtedness corresponds to an impoverishment of the population and not to its enrichment.
Effectively, in the Western world, impoverishment is increasing in the layers of population that are traditionally poor, and spreading to sectors of the middle class.
In fact, the increase of financial mass entails an increase in absolute terms of interest that is paid on this mass, seeing as money is basically only issued via the mechanism of money creation from the banks. In other words, the more is produced with work, the more we are in debt towards the financial system, which, instead of being a stimulus for productive activities, has become a dead weight for the economic system because of the dimensions it has reached. This is why those who don’t own financial instruments and simply live off their work necessarily become poorer, whereas those who own financial instruments get richer at the same time.
An illuminating example of the cul de sac the system has gotten itself into can be found in the peculiar way in which debt instruments are issued in public deficit.
Basically, public deficit consists in the amount of money that is necessary to cover the expenses of the State, which aren’t covered by the profits of taxation.
Issues into public deficit have to be balanced according to the gross domestic product. According to the Maastricht treaty, the essential prerequisite to access the single currency is to keep public deficit within the annual margin of 3% of the GDP. Over the past years, this percentage has been even higher, up to over 12% of the GDP when the Italian State was in great difficulty.
The perversion consists in the fact that these instruments are calculated on the basis of how much citizens actually produce, but they are not used in favor of those who allow them to be issued thanks to their work.
On the contrary, they’re the ones that foot the bill. In fact, the issue of public deficit ends up weighing in on public debt, and will sooner or later be covered by ordinary taxation.
This all leads to this absurd consequence: in absolute terms, the more we produce, the more we are in debt. In fact, public debt in the State of Italy reached the respectable amount of 2,500,000 billion in 2000.
To cover this horrific amount, Italians should work for over ten years without keeping anything for themselves, meaning no food, no drink, no free time, no children…and taking great care with the air they breathe.
Do you realize how absurd this is? That a group of gentlemen, who aren’t even that anonymous and that hold the majority of this financial wealth, not only have free access to diabolical luxury, but, thanks to debt, above all they have to power to decide on the life and death of entire populations.
This mechanism essentially boils down to the subtraction of wealth from the population, who has no access to returns from the financial world. And this obviously widens the poverty gap.
The second thing that this model is hiding is this: in order to maintain the system’s growth, the rate of taxation will necessarily increase, to avoid increasing public debt.
Even if they try and present it as a symptom of wealth, an increase in taxation always translates into decreasing wealth, especially for the poorer classes.
Here is an example.
A young friend of mine I commute with from time to time is an employee in a travel agency in Rome.
As you know, she’s luck to have a job nowadays. For a working day of eight hours(over ten if you consider 2 hours commuting time), she gets a gross pay-slip of 2,400,000 per month, which is roughly one and a half million after tax.
It is undoubtedly a good salary nowadays, but she has trouble making ends meet at the end of the month, even if she only spends money on basic necessities. She’d like to get married, but her fiancé earns more or less as much as she does and they’re both having trouble saving for the wedding reception, the honeymoon, furniture, kitchen and maybe even to start thinking about having children. Let alone even dreaming about buying a house!
Speaking of taxes, she figured that her gross salary is 1,200 Euros, which is the amount her employer actually spends, but all she actually receives is 800 Euros.
But this doesn’t mean that she’s done paying taxes, seeing as anything she buys – from fuel to clothing, from bread to electricity – the basics to be able to live and work, hide more taxes, and many of them at that. What with VAT, equal to 20% on everything, and the other taxes and duties on production and work, the price of every product is made up of taxes by at least 50%, seeing as we know that companies compensate the taxes they pay with prices.
Therefore, my friend can conclude that 70% of her salary is taken over by taxes.
If you want to read it in terms of time, she works for the State from January to late September, just to have the right to obtain the bare necessities of life.
Should she want to buy a house, she’d have to get into debt, and take out a mortgage with a bank, loading herself with the relevant interest, which would lower her quality of life, which is already on the verge of poverty, even further.
To indulge in the irony, this girl is considered, by general opinion, a lucky person!
On the opposite end of the scale, let’s see what can happen to a person who has two hundred million to invest and who is willing to loose them without fearing the consequences.
Two hundred million is a relatively modest amount on a market like the Italian market, in which five thousand billion lira are traded everyday, and even more so on the American market, where the traded shares amount to four million billion lira and traded on a daily basis.
Our investor carries out all the necessary considerations and then decides to invest on a viable option. He buys one hundred shares at one hundred dollars each, spending about 23 million lira.
The day after, the stock value drops violently by 20%. This isn’t a rare episode; it is simply happens everyday to many shares on the American market. At the end of the day our investor buys two hundred shares at 80 dollars, spending over 36 million lira.
Unfortunately, the next day the stock continues to drop, again by the record breaking 20%.
Stock exchange experts would call this overselling.
Our hero holds strong and then buys 400 shares at 64 dollars each, spending 58 million lira. Overall, this investor has invested 118,680,000 lira and now owns 700 shares. It’s highly probable that the shares will shoot up just as violently at this point, even if they will generally stay below the original level.
All our investor needs is for his stock to get to 85dollars to gain 18 million on his entire investment, which is the salary my commuting buddy earns in one whole year.
And if the stock drops even further, the investor can carry out new bear down brokerage. If the shares drop again there are two hypothetical consequences: either it’s the end of financial capitalism, in which case no one will need the money, from the investor to the employee, or the choice of stock was incredibly wrong, in which case the same game can start over again, once the loss has been taken into account.
After all, we began with the assumption that you need to be rich enough to be prepared to loose the money you invest in order to engage in these activities. If the stock our investor bought at the beginning of the story rises again, instead of dropping, then he will sell a little and cash in, to move onto another investment.
Do not be fooled: this is not an activity reserved to a chosen few. In the Western world, tens of millions of people trade on the stock market and earn more from there than they do from their job.
70% of American families have money invested in options or investment funds that have had an average return of over 20% over the past five years. Basically, one hundred million returns twenty million a year, without doing anything and with all taxes paid.
Oh yes, taxes. Do you know how much our investor pays in tax on the eighteen million he has earned on the little game we mentioned before? A dry cut of 12,5%, without having to declare anything nor making complex calculations required in tax returns, seeing as the SIM, which covers all stock exchange operations, does everything for him.
From what you have read so far, you can see that the more money you have, the less risks you have of loosing it, seeing as you can trade on a downward trend many times and, above all, diversify the risk over a great number of stocks and recover the losses you incur elsewhere.
Here come statistics to save you: according to the figures, over the past 30 years the return on stock has been of about 16% net per year. If you were to apply this principle to our example of the man who owns two hundred million, he would earn thirty two million per year, after tax and excluding inflation. Meaning almost double the salary of my friend for her eight hour day’s work on top of the two hours it takes to commute.
There’s an old saying that says that money makes money and this mechanism of how the stock exchange works is living proof of this fact.
In other words, the thing that creates wealth is the financial activity, which grows at a rate of between three and four times the rate of the real economy.
However, speaking of such things, there’s a small detail that people often forget to mention: Financial wealth produces nothing, if not pieces of paper and, nowadays, memory bytes on computers.
Therefore, whoever makes money from finance has to subtract wealth from those who have produced it with their work.
That’s not all: If financial wealth continues to grow at a higher rate than actual wealth, in the end we will have an infinite number of pieces of paper circulating faster and faster at increasingly variable rates.
Yes, because the more the quantity of financial instruments increases, the quicker they circulate and the more the prices vary. The enormous mass of financial instruments boils down to a permanent loss of any correlation whatsoever between the price of shares or the nominal value of stock, and the actual activity of the companies.
The price of stock, such as that of any other product on the market, depends on demand and supply. Because financial instruments grow at a higher rate than production, the transactions relating to the financial instruments themselves end up bearing the greatest weight of the economic system, and this weight tends to grow at an exponential rate, seeing as the weight itself becomes a financial instrument. This consideration is based on the continuous birth of new financial instruments, especially derivatives, which have characterized financial activities over the past decade.
However, this growth of the financial area is happening at the expense of economic production, which is burdened with an increasing debt from which it cannot escape, if not by destroying most of the financial mass. Furthermore, the growth of financial instruments does not go hand in hand with equal distribution, quite the contrary.
Because of this imbalance, it is impossible for the demand to grow enough, seeing as technological innovation has brought production to a whole new level. Like in 1929, when the world experienced the delights of the crisis of overproduction, today we face the same threat. Then, like today, technological innovation pushed production to record levels. Then, like today, the distribution of financial resources was unequal. This led to a sudden drop in demand and a deep crisis from which the Western world only emerged after the war.
One of the first people to find a solution to the problem of weak demand was Henry Ford, who, like many others, had reacted with obtuse stubbornness to the worker and union protests and initiatives against the closure of the production plant during the first period of the crisis.
Before the crisis, Ford’s production had been directed especially towards a middle-upper class of buyers, given the prices of the cars produced by the company. Ford thought of introducing changes to the models and to the production cycle so as to lower the production price and to raise the number of units to sell the cars to a wider public, including the factory workers in his plant. In 1935, he launched the objective of producing one million cars in that year and, finally, after many years of recession, he took on more and more new workers, and offered them the possibility of buying a car in installments.
This is the birth of the economy based on debt, seeing as Ford’s example was followed by most of the other business owners. Especially after the war, millions of American families, just like millions of European families, were induced to buy every kind of product using credit provided by Banks, financing institutions or the businesses themselves.
The finance of debt
The economy based on debt is leading us towards a new crisis, as it is becoming clearer and clearer that not only is this debt never going to be paid, but that it will also grow faster than the real economy.
As we know, in all times and at all latitudes, an excess of monetary mass compared to the quantity of products in circulation produces inflation. The tool that is normally used to reduce the growth of monetary mass is the increase of interest rates, which generates a contraction of credit. In fact, the banks create money by granting loans to businesses, families and public entities.
This monetary mass created by the banks adds on to the mass of debt instruments created by the State on public debt and to cover public deficit policies, as well as the private ones created via bonds or instruments (one must also take the semi-illegal circulation into account, such as that of post-dated cheques, bills, drafts and receipts).
These are financial instruments that have different origins, but all these instruments have been covering a monetary function for a long time, whatever the Italian Institute of Statistics and the Bank of Italy might say. Infact, they are non-collectible credits in respect of institutional or private bodies, whose existence is only justified by their circulation.
To these instruments, one must add both shares, whose monetary function is increasingly relevant, and derivatives, whose elasticity allows them to be used monetarily in certain circumstances. Regarding derivatives, there is a myth going around that they represent a zero amount game, meaning that the Clearing Houses 3 always open equivalent positions but with opposite signs.
This is, precisely, a myth, seeing as we know that the positions are opened on the margins and not on the underlying capital and therefore, in cases of a strong trend in one sense or the other, the leverage effect generates heavy imbalances in the accounts. The forced closure of positions would lead to panic that would not be that different compared to that of the banks until 1932.
And, speaking of derivatives, options, which don’t have corresponding put positions, are definitely not zero-amount products.
The size of the phenomenon will shed light on the terms of the issue. The bank-notes in circulation in Italy are over 50 billion Euros. On sight and short-term Bank deposits amount to over 2,600 billion, more or less the same as public debt instruments. Once you add the instruments issued by public entities, regions and municipalities, public debt should reach an overall amount of 1,800 billion Euros.
Shares and bonds of traded companies amount to about 1,000 billion, whereas instruments and bonds issued by private entities (from post-dated cheques to banking receipts) amounted to about 1,500 billion in 1998. Most economists, until a few years ago, thought that derivatives amounted to about 50% of all the other financial instruments, which sounds a little low to me, but, if we assume this is correct, it brings us to a grand total of the circulating paper in Italy to about 8,000 billion (my estimate for 2000 is of over 9,000, with a peak of 9,500 in March).
Oh yes, I forgot about the gold reserves and other precious goods, which are now about 24 billion Euros, meaning about 0,25% of the total of all the pieces of paper, so much for the convertibility printed on our banknotes!
It is precisely the non-collectability (meaning inconvertibility) of financial instruments (if not among themselves), which leads us to believe that they all have the same function, which boils down to a more or less elastic monetary function.
For example, one can’t buy a packet of cigarettes with a Treasury Bond, but one can definitely buy an apartment. On the other hand, one cannot present a notary with a truck-full of 20 tonnes of one-cent coins to pay 200 million lira for an apartment, without running the risk of being reformed in a mental institution.
Increasingly often, because of company acquisitions, traded companies don’t issue their own shares but prefer to set a rate of exchange with those of the acquired company.
In this case, the shares have the same monetary function as Treasury Bonds and cashier cheques.
Against this mass of paper, the Italian people produce more or 1000 billion, the Gross Domestic Product. There are an infinite amount of discussions on the way GDP is calculated, but let’s use this number without considering that financial activities weigh on the GDP by about 150 billion.
In other words, the paper in circulation is between 9 and 11 times national production. Not only: whereas, in fact, GDP increases at an average rate that is lower than 2%, financial mass grows at the decidedly higher rate of over 6%.
This is where the concerns regarding inflation and interest rate policies come from. However, this will not solve the problem, seeing as the growth rate of the mass is greater than that of the real economy, which is even in a depression due the high returns on public and private obligations.
Not even low interest rate policies can solve the problem, seeing as they lead to an increase of monetary mass created by the banking system to an extent that is, in any case, greater than the rate of economic growth.
In the end, this castle of cards will implode and burn all the virtual and non- virtual wealth that it represents.
And this is the scenario which normally goes by the name of the burst of the speculation bubble, which will degenerate all of a sudden once the indebtedness of the system has reached its limit.
The near-future scenario
This analysis describes the general mechanism of an economic system that thrives on debt, such as the one that began to exist on 15 August 1971, the date in which Nixon proclaimed the unilateral abrogation of all the Bretton Woods agreements. Those agreements provided for the convertibility of all moneys of the dollar and their convertibility into gold. They also provided for the institution of the FMI as the body that controls and provides direct financial intervention to support the exchange levels that are established at a political level. As one can presume, the FMI had an essential political role in the maintenance of the balance of powers in Yalta, whereas the substance of the power, in the single countries, was determined by the management of credit in respect of public and private bodies.
What are the risks of this situation?
The risks are that, all of a sudden, the impossibility of letting the economy grow on debt, meaning that people and businesses can’t take on anymore debt, could determine a steep drop in demand, precisely in a moment where the system needs it the most, on the crest of new levels of business productivity in the new economy. The growth rate of production in the new economy is incredible. Regardless of all the efforts of Greenspan’s monetary policies imposed on the United States over the past few years that have constantly increased interest rates, the American economy has grown by over 5% per year, so much for that scrooge who thought that it couldn’t even reach 4%.
This happened thanks to the peculiar characteristics of production cycles in the new economy we will talk about later on. The fact is that monetarism, with this method of financial wealth management, needs to cut growth rates otherwise the system could generate uncontrollable inflation.
This inflation is due to the higher growth of financial mass compared to the actual economy, and we have shown that there is no way to stop it, no matter how you adjust interest rates. In any case, the financial mass continues to grow either via public or private debt.
These are the basic weaknesses of the system:
1) An increase of public debt is no longer tolerable, even if it has continued undisturbed over the past ten years.
2) The level of indebtedness of families is forcing wider and wider areas of poverty in the population in all Western countries, including the US, which, among other things, makes certain statistics such as employment rates and economic growth a little ridiculous.
3) The exponential increase of immigrants, meaning people looking for acceptable living conditions (unaware of what they will find over here), an index of an increasing poverty in the third world.
4) The extreme volatility of the financial markets, as well as the extreme sensitivity of the real economy to rate adjustments (the fall of US GDP in the last semester in 2000 from +5.4% in June to 0.9% in December is extremely significant).
5) The enormous production potential of the new economy against an increasingly weak demand on the verge of recession. This makes a sudden crisis of overproduction quite probable.
6) The absolute lack of clarity between economists, politicians, financial operators and central banks on the seriousness of the situation and on possible remedies. Those who try and warn the population about the risks are generally, in the best case scenario, classified as witch-hunters, like Paul Warburg and Roger Babson in 1929.
As far as politicians are concerned, I will never tire of reminding everyone about the optimistic prospects of growth formulated by President Coolidge in his speech on the state of the Union in December 1928, a few months from the fall4.
The signs that are coming from all over the world are those of a slow down of activities in the real economy and an increase in poverty all over the world, whereas the GDPs continue to rise consistently in some countries.
It remains clear that these are contradictory signs, as a growth in GDP should correspond to an improvement in the quality of life of the population. But this isn’t so, for the simple reason that this increase in GDP takes financial activities into account, and not only do these activities not improve people’s lives, but on the contrary they increase poverty.
Furthermore, the signs tell us that the right solution, from an ethical perspective as well as one of pure economic convenience, is to increase the distribution of financial wealth and mesh it into the growth of the real economy to avoid explosions.
The only way to make this maneuver possible is taxation. In other words we need to reduce the pressure on activities in the real economy and shift the weight over to the financial economy. At the same time, financial wealth should be distributed equally, and consider a change of its role in the economy.
Given the proportions between financial activities and those of the real economy, the shift could occur over a relatively short period of time and could be relatively painless 5.
I’ve estimated that, it could be possible to completely de-tax economic activities and shift all taxes over to financial activities in five years, without degenerating in a financial crisis or scaring capital away from countries that adopt these measures.
A final thought. Even in 1929 no one thought that people like Charles Mitchell or Richard Whitney or Ivan Kreuger or Goldman and Sachs would have let people steal their toys. Who were these people? Precisely the Gates, the Colaninno, the Whitemans, and the Soros of their time.
Unfortunately things didn’t turn out that way. The toy broke. And the declarations of a famous and undoubtedly capable economist like Irving Fisher, who in autumn 1929, a few days before the crash, literally said: “Stock prices have reached what looks like a permanently high plateau”, explain why the crash was such a hard one.
1) Obviously in order to avoid the monetary mass exercising pressure on prices, which would generate an increase in costs and, therefore, inflation.
2) Public debt is the sum of debts of the State and public and non-economic entities. Public deficit is the amount that needs to be financed every year to cover the gap in State accounts, which is caused by excessive expenditure compared to ordinary revenue.
3) Clearing Houses are compensation chambers of derivative products. Their function is to verify the correspondence between the positive positions and the negative positions on any relevant instrument.
4) President Coolidge, in his address on the state of the Union, at the end of 1928, literally wrote: “No Congress of the United States ever assembled, on surveying the state of the Union, has met with a more pleasing prospect than that which appears at the present time. In the domestic field there is tranquility and contentment,…and the highest record of years of prosperity.”.J. Kenneth Galbraith, The Great crash, 1929, Houghton Mifflin Co., Boston 1972 in D. De Simone, Un milione al mese a tutti: Subito! Cited on page 11
5) see D. de Simone Un milione al mese a tutti subito!