Cooking the Books 2: Clutching at green shoots

The textbooks may say that the banking system can create loans worth ten times more than an initial deposit in any bank in the system, and currency cranks may misrepresent this to mean that an individual bank can create money to lend out of thin air, but practising bankers and financial journalists know better.

A recent article in the Investors Chronicle (22-28 May), discussing the difference between banks in Asia and banks in Britain and America, gave the views of an investment manager, Mike Kerley:

“‘Consider the banks in the US and the UK,’ says Mr Kerley. ‘They lend out far more than their deposit base and rely on credit markets to fund this, which has been shown to be ill-advised, costly and ultimately catastrophic.’ Although the Australian market is closely aligned with the UK banking model, elsewhere in Asia the deposit base more than covers lending, so there are no serious liquidity issues. ‘Banks are the opportunity in Asia. Asian loans to deposit ratios are 80 per cent,’ he says. ‘Asian banks do what banks should do and make money on margins’.”

This is a typical confirmation that banks make their core profit out of  borrowing money at one rate of interest and re-lending it at another, higher rate. No bank can lend money it doesn’t have so they have to get this from somewhere. In the past all banks used to get the money to re-lend, as banks in Asia still do, from what had been deposited with them. In recent years, however, banks in Britain and America, started to borrow money to re-lend from the money market.

Banks in Britain and America still make their profits (or suffer losses) out of the margin between the rate of interest at which they borrow and the rate at which they lend. The difference is their reliance more on borrowing money from the money market than from depositors (a deposit is essentially a loan to a bank). The money market is a much more volatile source of funds than deposits, as American and British banks eventually found to their cost.

When the crisis began interest rates on the money market went up, so squeezing the margin between the two rates of interest, in some cases wiping it out or even making it negative. Hence the banking crisis. Things seem to have settled down a bit at the moment.

Not that the banking crisis was going to last for ever. Nor will the economic crisis. However, before a recovery can begin stocks must first be cleared, though this won’t be enough in itself. There are signs that this may have started, but is being optimistically seen by some economic commentators as a sign that the depression is over. “Recession is over, says think-tank as it reports growth in April and May”, headlined the Times (11 June) reporting the opinion of the National Institute of Economic and Social Research.

The Times’s own Business Editor, David Wighton, was more cautious:

“If the upturn we are seeing now is in large part because of restocking, there will be a spike in orders which will inevitably fall back again”.

There is still some way to go before economic conditions will be ripe for a recovery to really begin. Unprofitable firms must be eliminated, their capital destroyed or devalued, and real wages must fall, so as to restore the rate of profit. That means more company failures and more unemployment. In short, more misery in a world that could provide plenty for all if it weren‘t for capitalism.