Does anyone know what the economy is for?

Forgive the statement of the bleeding obvious, but the basic purpose of the economy is to produce what the consumer wants. To be more accurate, the purpose is to produce what the consumer wants BOTH as expressed via consumers’ credit cards, cash, etc, AND as expressed via the ballot box. That is, consumer / citizens express the desire for a portion of GDP to be supplied free at the point of delivery by government: state schools, health care, etc. It shouldn’t be necessary to make those statements of the obvious. Unfortunately it IS necessary, and for reasons set out below.

It follows from the above that where GDP is less than it could be, i.e. given excess unemployment, the consumer needs more spending power, plus government spending needs to be boosted.

Unfortunately, come a recession, a variety of weirdos come out of the woodwork, each with their own pet scheme for expanding the economy. These schemes involve everything BUT the above “bleeding obvious” cures.

For example, there are those who seem to want banks to revert to their pre-crunch excessive lending activities, e.g. Tim Congdon in The Times. And the governor of the BoE claimed that “We cannot have a sustainable recovery at trend growth unless the banking system returns to more normal levels of lending to start up and small businesses.” That is total bunk.

Basic economics teaches that if the marginal (or “least profitable”) unit sold is UNPROFITABLE (i.e. makes a loss), the business should be CONTRACTED NOT EXPANDED. And what did the marginal or least profitable loans made by banks just prior to the credit crunch consist of? They consisted of ninja mortgages and loans to businesses made more or less on demand. On that basis, the banking industry should be CONTRACTED, not expanded.

And a further piece of evidence that the entire banking industry is too large is that UK bank assets as a proportion of GDP were 50% between 1880 and 1970, but then shot up to 500% in 2006.

But the London based elite is mesmerised by senior bankers: even the left of centre elite. Gordon Brown, former U.K. prime minister and head of the supposedly left of centre Labour Party, loved big banks so much that he facilitated the merger of two “too big to fail banks” thus creating one “cannot under any conceivable circumstances be allowed to fail” bank. Pure genius!

The elite adopts the same attitude to Main Street as Marie Antoinette adopted to peasants. The elite prefers the criminals and fraudsters of Wall Street to the honest folk in Main Street.

The businesses which were acting responsibly prior to the crunch were the bog standard boring ones that senior politicians and the elite just cannot stand: garages, hair dressers, you name it. Stalin made exactly the same mistake: he just loved megga investment projects – big dams and canals. Whether such projects made economic sense was, for Stalin, oh so boring.

The reality is that bank finance is just ONE method of financing businesses. One alternative is for entrepreneurs, plus their friends, family and businesses associates to have enough money to finance their own businesses. The extent to which banks finance businesses relative to other methods of finance is very variable: it varies significantly as between different European countries.

A second alternative is the stock market.

Third, at the height of the credit crunch, various German firms (Siemens in particular) greatly expanded the loans they made to suppliers and customers. And there is much to be said for this type of lending: most firms are probably as good a judge of the credit worthiness of their suppliers and customers as the latters’ banks. In short, if bank’s lending operations were closed down altogether, a range of smaller quasi banks would soon take their place: at least they would in a free market.

Problem is of course that the market is not free. That is, it’s only those big banks, favoured by the elite, that get the “too big to fail subsidies”.

But even if quasi banks do NOT make up for any reduced lending by the irresponsible / criminal banks, does that matter? Economies are flexible: most production processes involve a range of possibilities on the capital intensive versus labour intensive scale. In addition, the consumer has a choice between capital intensive produced goods and labour intensive produced products. If borrowing becomes more expensive, consumers will shift some of their spending towards labour intensive produced stuff.

But Mervyn King and the other smartly dressed well paid individuals who work in central London (like people the world over) like to retain power in their own hands. They make complementary remarks about “small businesses”, but they don’t want real power (i.e. money) shifted to plumbers or restaurant owners in Northern England. They’d rather retain power in central London and have the plumbers and restaurant owners come to them begging. And if the elite make a hash of that power by failing to get banks to lend, well the elite still have their cocktail parties to attend, where they can make economically illiterate and hypocritical noises about “banks failing to lend”.

Quite apart from the above point, there is another bank related form of stimulus which is pretty much of a nonsense: cutting interest rates. This boosts the economy only via people and institutions which rely on variable rate loans. To repeat the bleeding obvious point made at the outset (pity it needs repeating): the basic purpose of economic activity is to produce what the consumer wants. So come a recession, put more spending power into ALL consumers’ pockets (not just those who borrow heavily) and boost government spending.

Moreover, “consumer stimulus” leads AUTOMATICALLY to a certain amount bank stimulus (for the benefit of those who seem to think that banks are some sort of end in themselves!). That is, an increased demand by consumers leads to increased demand for working capital by businesses (and in some cases to an increased need for other types of capital investment).

And wouldn’t you know it: the latter is exactly what Modern Monetary Theory involves.

Note added 21st August. A further point here is that interest rates are probably artificially low because we allow maturity transformation (i.e. we let banks borrow short and lend long). See here. This artificially low interest rate means the banking industry is larger than it would be if maturity transformation were abolished.

Also there is some evidence here that it is plain straightforward extra demand that businesses need.