Saturday, March 21, 2015

The Mystery of Banking and Capital in the 21st Century

18 months between posts might seem excessive, but I have been reading books by some impressive economists - Murray Rothbard - The Mystery of Banking, and Thomas Piketty - Capital in the Twenty-First Century. Both authors come from Europe - Rothbard from Austria and Switzerland, and Piketty from France, and their european perspectives are enlightening.

Rothbard's focus is on how money and money supply works, and how the demand for loans led to the concept of Central Banking, and how this has become organisations ( Reserve Bank, Federal Reserve, etc. ) with their own commercial and political agendas that run counter to the aims and needs of the wider community and societies that they supposedly serve.

Piketty has collated and analyzed the records on property ownership, tax payments, deaths duties, and company shareholdings, from 20 countries, the oldest data from the 1700s in France and England, to build a model of how capital builds over time, and how it is used and distributed.

Piketty's key finding is that capital always tends to create returns in excess of the rate of economic growth, and that only in the immediate post WW2 period, did technology allow wage earners to match the earnings of capital ( itself temporarily reduced by the costs and damages of WW2 ).

Piketty expands his argument to include financial inequality ( income and wealth ) as a key factor in social unrest, and rebellion.  Critics have been quick to point to capitalism as the source of equality of opportunity, and of improved health, education and social equality, especially in developing countries.

However, Piketty has already pointed out that we are just leaving the "abnormal" post WW2 period, and that he is warning about returning to the long term trend line, where capital creates capital ( or wealth ), faster than wages can create capital.  And he notes that there is no clear correlation between increased capital and increased social equality, except in situations where improvement of the skills and health of the workforce generate productivity increases and so raises the return on the capital.

The key point that I take from these two books is the realisation that the actions of the expanded central banking system has both increased the growth in returns from capital, and through fractional reserve banking, decreased the ability for wage earners ( and governments that rely on them for tax revenue ) to build up capital.

This might not be a serious problem if the form of capital, and the uses made of it to generate returns, where similar that of the 1700-1900s.

Over this period, labour was a key component in the sources of returns on capital invested.
In the cases of using capital to invest in colonial trade and industries, the labour component was small, slavery was often part of the "capital" owned, and wages were tiny. But in most developed economies the return relied on skilled labour, whether in agricultural, industry, or mineral or timber extractions. So wages were a necessary "cost" and proportional to the nett return.

However, the last 60 years have seen a shift towards money being a commodity in its on right, rather than just the mechanism of exchange, or temporary store of value - the "oil in the cogs of the economy", or the "catalyst in the process of production".

The percentage that financial services contribute to the economy is also growing at around 5% per year - from a current 9% ( 2013/14 ABS ) - and half our overseas "trade" is transfers of money to related companies ( globalisation ).

The nett effect is that money is increasingly a form of capital ( rather than a measure of capital ), and one that can generate a return on itself with very little labour required.

Combine this with fractional reserve banking, and you have a system that shifts wealth to the more wealthy by diluting the existing wealth of the less wealthy, and reducing the capital creation ability of wage earners - an efficient source of the inequality that Thomas Piketty is concerned by.