Paul Volcker’s Banking Reform Proposals and Socialist Revolution
A reader wants to know what I think is behind Paul Volcker’s banking reform proposals.
Paul Volcker (1927- )—yes, the same Paul Volcker who was the chief architect of the “Volcker Shock” a generation ago, and a long-time Democrat—is currently head of President Obama’s Economic Recovery Advisory Board. On January 21, Obama with Volcker at his side proposed a series of reforms that Obama dubbed the “Volcker Rule.”
Volcker’s proposed new regulations would ban commercial banks from owning or investing in hedge funds and private equity firms. Essentially, Volcker’s proposed rule would ban, or at least limit, any firm engaged in commercial banking from owning and trading stocks, corporate bonds, commodities and derivatives for its own account.
Unlike his predecessor, Republican Alan Greenpan (1926- ), Volcker is highly dubious about so-called “financial innovation.” He has remarked that “the only useful banking innovation was the invention of the ATM.”
In August 1979, then U.S. Democratic President Jimmy Carter appointed Volcker to be chairman of the Federal Reserve Board—the government body that controls the U.S. Federal Reserve System. Volcker reversed the Keynesian policy of attempting to keep interest rates low by increasing the rate of growth in the quantity of token money that the Fed creates. Instead, he allowed interest rates to increase to a level never seen before—or since.
For example, at one point under Volcker, the federal funds rates—the rate of interest that commercial banks pay on overnight loans they make to one another—hit 20 percent, a far cry from the Fed’s current federal funds target of between 0 and 0.25 percent! These unprecedentedly high interest rates sent the U.S. economy into a tailspin pushing even the official unemployment figures into the double digits for the first time since the end of the 1930s Depression.
But the high interest rates—known as the “Volcker Shock”—did halt the depreciation against gold of the U.S. dollar and the other paper currencies linked to it under the dollar system, bringing the 1970s “stagflation” to an end.
The Volcker Shock marked the transition from the reformist “Keynesian” era of making concessions to the working class and to the oppressed countries to the period of “neo-liberalism” with its rising imperialist exploitation of the oppressed countries combined with the global offensive by the ruling capitalist class against the world working class aimed at raising the rate of surplus value. The abnormally high interest rates, which lingered for many years after the Volcker Shock, also witnessed the emergence of the phenomena now called “financialization.” I plan to examine financialization in a future reply.
Background to the Volcker proposals
Through most of the 20th century, U.S. commercial banking was largely separate from investment and merchant banking. During the 19th century and early 20th century, commercial banks largely confined themselves to taking deposits from industrial, commercial and wealthy individual capitalists. They made short-term loans to business enterprises and discounted commercial paper held by industrial and commercial capitalists.
Perhaps the most important function of commercial banks is to provide a payments mechanism through the creation of credit—checkbook—money. Through fractional reserve banking, they create a large quantity of credit money on a much smaller base of legal-tender “hard cash.” (1)
In earlier times, the legal-tender money consisted of gold, or sometimes silver, coins, or convertible-into-gold—and sometimes silver—banknotes or treasury notes issued by central banks or government treasuries. Nowadays, legal-tender money consists of paper money not convertible into gold issued through the central banks, along with fractional coins made of base metals that are used to make change in petty retail trade.
The legal-tender paper notes and coins—what the lay public thinks of as money—along with the legal obligations of the central banks to pay off the commercial bank deposits in the central banks in legal-tender cash on the demand of the commercial banks—and indirectly the customers of the commercial banks—form the “monetary base” of “hard cash” that backs up the much larger quantity of commercial bank-created credit money. The overwhelming mass of the “money supply” the economists talk about consists of commercial bank-created credit money, and not the legal-tender token money that you carry around in your pocket.
In the past, commercial banks did not as rule make consumer loans nor did they advance mortgage loans to homeowners. Indeed, as a rule only capitalists had dealings with the commercial banks.
Consumer bank loans were the function of saving banks and savings—or building—and loan associations that took small deposits—usually not transferable by check and therefore not functioning as credit money—from the better-paid workers and the lower middle class. In turn, these saving banks would make loans to working-class and middle-class people, including mortgage loans on homes.
In the United States, the saving and loans, greatly undermined by the stagflation of the 1970s and its Volcker Shock aftermath, almost completely collapsed during the recession of the early 1990s. The few savings banks and savings and loans that did survive have been granted the right to issue checking accounts. At the same time, the commercial banks have largely taken over what was once the business of the savings banks and savings and loans. Today commercial banks are willing to take small deposits, though they charge stiff service fees that more than swallow up the tiny amount of interest the deposits yield.
With commercial banks taking small deposits and granting consumer and mortgage loans, and with saving banks and other financial institutions granting checking services, the clear distinctions between commercial banks, savings banks and saving and loan associations have largely broken down.
Investment banks are quite different than commercial banks. They do not take deposits and issue bankbooks. The core business of an investment bank is to underwrite new issues of stocks and bonds—long-term IOUs. They form syndicates to “float” new issues of stocks or bonds. The funds collected can then be used to arrange mergers and organize new and larger corporations—called by some economists “trusts.”
In addition, investment banks reorganize bankrupt corporations that are not liquidated. Investment banks in addition to their role as financiers serve as advisors to corporations when it comes to mergers or divestments. In this role, their function partially overlaps with that of the big corporate law firms.
Investment banks, unlike commercial banks, still deal as a rule only with capitalists. Sometimes, smaller investors come into contact with them through their role as stockbrokers or financial advisors. Investment banks, as long as they stick with pure investment banking, do not grant mortgages against homes. However, recently investment banks became heavily involved in the so-called “securitization” of mortgages.
What is the securitization of mortgages? Until relatively recently, when a bank—traditionally a savings bank or savings and loan, but more recently commercial banks as well—granted a mortgage loan, it would hold the mortgage until it was paid off—or foreclosed. The payments on the mortgage would provide the bank with a revenue stream. The bank would earn its profit on the difference between what the bank collected on the interest payments and what it paid out in interest to its depositors.
Since the bank would hold the mortgage on the asset side of its balance sheet, and since it dealt with the borrower directly, it had both an interest and the ability to determine—within certain margins of error, of course—what were the chances of the borrower being able to repay the mortgage.
This changed with the coming of “securitization.” Under this system, instead of holding on to the mortgages, the direct lenders sell them to an investment bank at a certain markup, much like merchants sell the commodities in which they deal at a markup. (2) Once they have done this, the direct lenders no longer care whether the mortgage is ultimately repaid, they have made their profit. The investment banks, in turn, package the mortgages into “mortgage-backed securities,” a portion of which are then sold to hedge funds, various financial institutions and wealthy investors.
In the period leading up to the crisis that began in 2007, this system meant that potential home buyers who almost certainly could not repay the mortgage loans were able to obtain mortgages on homes they could not possibly afford. In order to grant as many mortgage loans as possible that would then be sold to investment banks, the mortgage bankers would use deceptive techniques, such as allowing the borrower to pay very low interest rates for the first year or so of the mortgages, beyond which interest rates would rise sharply forcing the mortgage borrower into foreclosure. Under the traditional system, the mortgage bankers would never have done this, since if they had they would themselves have been forced into bankruptcy.
But under “securitization,” it was a matter of indifference whether the borrower ultimately repaid the mortgage or the mortgage ended in foreclosure. (3)
This was all the more the case with the development of certain kinds of “derivatives” that supposedly protected investors against defaults.
Derivatives are securities or other financial “instruments” whose value is based on—derived from—other securities. Some derivatives, such as put and call options, have been around for years. But developments in computer technology enabled financial “innovators” to come up with new, often highly complex, derivatives such as mortgage-backed securities and credit default swaps.
The latter type of derivative is a form of insurance that companies like AIG sold to skittish investors wanting to protect themselves from possible loss on their holdings of mortgage-backed and other risky securities. Credit default swaps were also sold or resold to speculators, including investment banks such as Goldman Sachs trading on their own account, gambling on the likelihood of defaults.
The more likely a default or loss of value of an insured security, the more the issuer of the associated credit default swap, such as AIG, would have to pay the owner of the swap. When the real-estate bubble burst, AIG was hit by a hurricane the financial equivalent of Katrina—tens of billions of dollars of obligations that it couldn’t possibly meet. Hence the $180 billion bailout by the Federal government, some $14 billion of which went straight to Goldman Sachs.
Once enough mortgaged home buyers began to default on their mortgages, it was the weaker investment banks that had bought the mortgages and the capitalists who had bought the “derivative” securities created by the investment bankers who were dragged down. In this way, the most recent crisis began in the housing “sub-prime” market, then spread to the very heart of the financial system, and from there to the entire economy.
This “securitization of mortgages” is an example of the kind of financial innovation that was hailed by Alan Greenspan but deplored by Paul Volcker. As long as it lasted, it gave many working people the illusion of sharing in the “great American dream” of homeownership. It allowed the Republican President George W. Bush to boast of “record home ownership,” and it maintained the appearance of prosperity—what Marx called fictitious prosperity—until after Alan Greenspan retired as chairman of the Federal Reserve Board on January 31, 2006.
The crisis hits the investment banks
As I mentioned above, an investment bank does not take deposits. Instead, it raises cash by issuing short-term promissory notes called commercial paper. During the panic of 2008, it was pointed out that the pure investment banks such as Lehman Brothers were at a disadvantage relative to investment banks affiliated with commercial banks, because they lacked a secure “deposit base.” As the crisis hit with full force in the fall of 2008, the investment banks found it impossible to sell the commercial paper they depended on in order to raise short-term cash.
However, the commercial banks faced no comparable pressure on their deposits, which actually are a loan by the depositor to the commercial bank. Unlike the owners of the commercial paper issued by the investment banks, the owners of deposits of the commercial banks enjoy the explicit or implicit guarantee of the governments and the central banks that their deposits will remain convertible into legal-tender cash on demand at all times.
The governments and the central banks are obliged to do this because the deposits of commercial banks, unlike the commercial paper of the investment banks, function as credit money—the medium in which most purchases and payments are settled. This gives a huge advantage in a crisis to investment banks affiliated with commercial banks over the traditional independent investment banks, which are at the mercy of the commercial paper market.
Of the five major independent—in the sense of not being affiliated with a major commercial bank—Wall Street investment banks that existed when the industrial cycle reached its most recent peak in the summer of 2007, two—Bear-Stearns and Merrill-Lynch (the folks who were bullish on America)—were saved from complete collapse only by being forcibly merged, with Federal Reserve backing, with J.P. Morgan Chase and Bank of America, respectively. Both J.P. Morgan-Chase and Bank of America are heavily involved in commercial banking.
One, Lehman Brothers, was forced to declare bankruptcy in September 2008 and was liquidated. The only survivors among the independent investment banks are Morgan-Stanley and Goldman Sachs. This was a 60 percent mortality rate in the course of a single crisis!
For the reasons described above, commercial bank deposits in imperialist countries are either protected through government-run deposit insurance schemes such as the U.S. Federal Deposit Insurance Corporation or are at least informally guaranteed by the central banks through their ability to issue legal-tender “hard cash” paper money. Indeed, since bank deposit insurance funds cover only a very small percentage of the deposits they insure, only the ability of the central banks to create legal-tender cash—paper money—really maintains the continued convertibility into actual cash of the credit money that forms the bulk of the “money supply.”
But this involves a major contradiction. If the central banks are willing to transform all bank-created credit money into legal-tender paper money, this is equivalent to giving the commercial banks a printing press to print their own legal-tender money. However, the commercial banks—unlike the note-issuing central banks, whose main job is to attempt to stabilize the capitalist economy—are driven like all capitalists by the profit motive. There would be no limit on the amount of legal-tender paper money they would create if they were allowed to do so. Therefore, an inconvertible-into-gold paper currency issued by for-profit commercial banks would have no credibility and would quickly collapse.
Consequently, governments and central banks never make the convertibility of bank deposits into central bank-issued paper money unconditional. For example, bank deposits may be guaranteed but only up to a certain point—currently $250,000 in the United States. However, when in May 1984 a run developed on the U.S. Continental Illinois National Bank and Trust Company, the FDIC announced that it was insuring all deposits to halt the run.
If the FDIC, the Federal Reserve System and the government had allowed large depositors to lose money in the run against Continental Illinois, there would have been a chance that a general run on the banks would have developed leading to a general contraction of the “money supply” on a scale that last occurred during the super-crisis of 1931-33. In 2007, a run developed on the British Northern Rock bank, and when all other attempts to halt the run failed, the Bank of England announced that it stood behind all of Northern Rock’s deposits.
The governments and their “monetary authorities” are playing a gigantic game of bluff that they hope will never be called. If they were to erase all boundaries between credit money created by the for-profit commercial banks and the paper money created by the Fed and the other central banks, the dollar and the other paper currencies would be sent into a hyper-inflationary plunge against gold.
If, on the contrary, they allowed massive bank runs to go unchecked such as happened in 1931-33, a Super-Depression—not just a repeat of the super-crisis of 1929-33—would occur. Both the U.S. and world capitalist economies are far more dependent today on the inherently unstable system of commercial bank-created credit money than was the case in the early 1930s. (4)
The evolution of ‘finance capital’ in the United States, Britain and Germany
The core business of the investment banks as I explained above is the underwriting of new issues of corporate securities—stocks and bonds—and the arrangement of mergers and the reorganization of bankrupt corporations. This means that investment bankers are often (5) organizers of large-scale monopolistic corporation sometimes called “trusts” and cartels. (6)
A century ago in the United States, the most famous investment bank was the firm led by J.P. Morgan senior (1837-1913). Unlike today’s investment banks, Morgan’s firm was organized as a partnership, not a corporation, with Morgan as the senior partner. Not until well after World War II did most U.S. investment banks shift from the partnership mode of organization to the corporate form.
In the late 19th century and the opening years of the 20th century, Morgan’s banking house became famous or infamous for the widespread control it exercised over newly organized or reorganized corporations, and for the monopolistic practices it encouraged among the corporations that fell under its influence or control.
The last part of 19th century saw many railroad bankruptcies that gave J.P. Morgan the opportunity to reorganize numerous railroad corporations. (7) Morgan then used the control of these corporations to suppress competition among them. Students of American history know this as the “Morganization” of the railroads.
As the 20th century dawned, the House of Morgan organized a series of corporations, some of which still exist, including General Electric and the one that Morgan considered his masterpiece: United States Steel Corporation, popularly known as the “Steel Trust.” In the days when the “heavy industry” of Department I dominated the U.S. economy, U.S. Steel was, along with John D. Rockefeller Sr’s Standard Oil Corporation, considered the most powerful of the “trusts” that ruled over the emerging U.S. industrial superpower.
In J.P. Morgan Sr’s time, the investment bankers often organized “voting trusts” that gave the investment bankers like Morgan control of the newly organized or reorganized corporations for a number of years. The investment bankers did not actually own these corporations. Instead, they sold the stocks and bonds that they issued to wealthy—often English—money capitalists to finance newly organized corporations. In turn, it was the business of the investment bankers to look out for the interest of the money capitalists who were the ultimate owners and creditors of the corporations.
As long as a corporation was controlled by J.P. Morgan, for example, wealthy English money capitalists who bought stock in it could be pretty sure they weren’t being robbed blind by the corporation’s managers—something that was known to happen in other cases. Mr. Morgan—for a fee, of course, he didn’t work for free—would keep a close eye on the managers and make sure they would dedicate themselves to enriching the owners of the shares and bonds while taking only a “fair” slice of the monopoly profits for themselves. (8)
In addition to wealthy individual money capitalists, insurance companies were major purchasers of the corporate stocks and bonds that were underwritten by investment bankers like J.P. Morgan. Insurance companies are, like the various types of banking institutions, examples of collective money capitalists.
In the United States and other imperialist countries, informal “interest groups” arose that grouped together investment banks, commercial banks and insurance companies with large industrial corporations. The most powerful of these interest groups was the one centered on the J.P. Morgan bank, and the other was centered on John D. Rockefeller Sr’s Standard Oil Company. Today, both the old Morgan and Rockefeller interest groups, along with others, have been united in today’s J.P. Morgan Chase universal bank, which proudly bears as part of its corporate masthead the name of J.P. Morgan.
Like the man J.P. Morgan did a century ago, the corporate name J.P. Morgan towers over American finance capital. The J.P. Morgan Chase universal bank owns among other things a commercial bank—Chase Bank, which was long associated with the Rockefeller interest group—investment banks, hedge funds, merchant banks and insurance companies. But unlike the informal interest groups of a century ago, J.P. Morgan Chase is no informal interest group but a holding company that owns many subsidiary corporations.
The German model of universal banking
In Germany and Austria, banking developed differently than it did in Britain and the United States. As a result of the later development of capitalism in these countries, from the beginning banking corporations not only carried out commercial banking operations but also acted as investment and merchant banks. As owners of corporate stock, they functioned as giant holding companies.
This role of the banks not just as the controllers but the actual owners of industrial corporations greatly impressed Rudolf Hilferding (1877-1941), the author of the 1910 Marxist classic “Finance Capital,” which greatly influenced Lenin’s famous 1916 pamphlet “Imperialism.” Hilferding pointed out that the German universal banks through their growing ownership of large blocs of stock in industrial corporations were transforming themselves into industrial capitalists.
In “Imperialism,” Lenin pointed to this merger of banking and industrial capital in the form of “finance capital” as a key feature of monopoly capitalism, or imperialism. While industrial capital had been the dominant form of the free competitive capitalism of the era of Marx, now finance capital centered on the giant banks was the dominant form.
Such “finance capital” emerges not only by banks taking over or dominating industrial corporations but through monopolistic industrial corporations—like Rockefeller’s Standard Oil Company—coming to influence or dominate large banks. For example, the old National City Bank—now Citicorp—was so closely linked to Standard Oil and the Rockefellers that it was nicknamed the Standard Oil Bank. Later, John D. Rockefeller took a dominant position in another large New York bank—the Chase National Bank. Today the old Chase National is part of J.P. Morgan Chase. (9)
In both cases, the capital belonging to money capitalists—often the idle rich descendants of the once-dominant industrial capitalists—organized through the banks and other allied financial institutions—comes to dominate the large corporations and cartels. Indeed, ultimately it is the centralizing and monopolistic tendencies of industrial capital that gives rise to the domination of “finance capital.”
Changes in banking and finance capital in the post-World War I and Depression eras
In the 1920s, the traditional separation between investment and commercial banking in the United States, which had still been more or less formally preserved in the era of J.P. Morgan Sr, began to break down. The large commercial banks began to establish their own investment banking subsidiaries that sold newly issued stocks and bonds to the moneyed and, as it turned out, gullible public.
In the wake of the 1929-33 super-crisis and the 1931-33 banking crisis that accompanied it, the combination of commercial banking and investment banking was singled out as one of the main causes of the super-crisis. For example, the activities of National City Company, the investment banking arm of National City Bank, in selling Latin American bonds that later proved worthless and ruined many middle-class investors, became particularly notorious.
New Deal reforms of the U.S. banking system
The Banking Act of 1933, known more commonly as Glass-Steagall, required that a banking institution be either a deposit-taking bank—a commercial bank—or an investment bank that underwrites securities and organizes corporate mergers. If a banking institution decided to function as an investment bank, it would be forbidden to take deposits.
The idea behind this reform was that a run on the commercial banks would paralyze the whole system of bank-created credit money. It was the huge wave of failures of mostly small commercial banks that caused the U.S. “money supply” to contract by one-third between 1929 and 1933. Remember, according to Milton Friedman and his supporters, who came to dominate university economic departments during the 1970s and later, it was the one-third decline in the “money supply”—or contraction of commercial bank-created credit money—that caused the Depression, and what even these economists conceded was mass “involuntary unemployment.”
However, the failure of an investment bank or an insurance company that was unaffiliated with a commercial bank would be less serious, since the system of payments—commercial bank-created credit money—would not be directly affected. The supporters of the Glass-Steagall Act argued that the separation of commercial banking from other forms of banking and insurance, combined with deposit insurance, would make unlikely a repeat of anything like the super-crisis of 1929-33 and the Depression it caused.
Many liberals and even Marxists during the New Deal Popular Front era also hailed the separation of investment banking and commercial banking as breaking the power of “finance capital” as defined by Lenin and Hilferding. With the reduction of the power of the banks as a result of Glass-Steagall—a bank would no longer be able to act as both an investment bank and a commercial bank—industrial and banking capital would once again be separate, returning U.S. capitalism to its liberal-democratic 19th century foundations. Or so it was argued. Similar arguments are heard today among liberals who urge a return to a Glass-Steagall-type separation of investment and commercial banking.
Along with the separation of investment and commercial banking, Glass-Steagall created the Federal Deposit Insurance Corporation—the FDIC that I referred to above. The idea is that deposit-taking banks—commercial and savings banks—would purchase deposit insurance from the government-run FDIC. Each bank that belongs to FDIC pays into this insurance fund.
Up to a certain amount of the banks’ deposits—currently $250,000—are insured by this fund. It is the responsibility of the FDIC to determine whether its member banks are solvent or not—that is, to determine whether or not its assets—mostly loans and discounts—exceed its liabilities—mostly deposits. If a bank is judged insolvent, the FDIC is supposed to shut it down. The FDIC either arranges a merger with another, solvent bank, or if this can’t be arranged, it runs the bank itself for a transitional period while the failed bank is being liquidated. In the event of liquidation, the FDIC pays out of the insurance fund the full amount of the bank’s deposits that fall within the limit that is insured by the fund.
U.S. banking crises before the FDIC
In the United States before the FDIC, the failure of a few banks might lead to a general loss of confidence in the banking system. Runs would develop as panic-stricken depositors moved to withdraw their money from the banks. Under the system of fractional reserve banking, even highly solvent banks cannot meet a demand for cash from all their depositors if all them—even a substantial fraction of them—attempt to withdraw their money at the same time. The result would be a dramatic contraction of bank credit, and commercial credit that depends on bank credit. Commerce would become paralyzed, wholesale merchants would slash their orders to industry and liquidate their inventories—commodity capital—in order to raise cash. Factories would suddenly be unable to sell their commodities and would carry out huge layoffs and wage cuts.
The whole system of payments could be disrupted, since there was the danger that checks written against banks’ deposits might bounce during a banking crisis. In many cases, cash would be demanded or checks would be accepted only at a considerable discount. The crisis would rage unchecked until gold arrived from abroad—the crisis would shift the balance of payments in favor of the United States shifting the burden of the crisis to other countries—causing bank reserves to expand and finally halt the crisis. (10) But by the time this happened, the U.S. economy would find itself in deep depression, and it often took years to fully recover.
In other countries, central banks would grant emergency loans or discounts to the commercial banks limiting or preventing bank runs altogether. Recessions still occurred, but they were less violent in the absence of a breakdown of the payments mechanism and the almost complete drying up of bank credit. Already in the 1870s, the Bank of England was closing down and liquidating insolvent banks, repaying depositors, and wiping out their stockholders much like the FDIC does in the United States today. Indeed, until the collapse of Northern Rock in 2007, Britain had avoided bank runs—though not recessions—since the crisis of 1866.
But the United States lacked a central bank, giving crises the sharp edge that they lacked elsewhere. The crisis of 1907 with its associated bank runs—in the United States, not Europe—finally forced the United States to move toward a system of central banking that became the present-day Federal Reserve System. It was assumed that with the creation of “the Fed,” widespread bank runs leading to a collapse of bank credit and credit money was now a thing of the past. Hadn’t that been the case in Europe?
But in the early 1930s, contrary to all expectations, the Federal Reserve System failed to contain the banking crisis. In the early stages of the crisis—1929-30—confidence in the banking system held up as expected. Unlike earlier crises, there was no run on the banks at the beginning of the crisis. However, between the end of 1930 and 1933, repeated waves of bank runs caused credit to collapse in the United States and worldwide transforming the “ordinary” cyclical recession of 1929-30 into the super-crisis that marked the beginning of the Depression. Since the bank runs of 1931-33 and the resulting collapse in credit dwarfed both in duration—about two years—and intensity anything that had ever been seen before, the Federal Reserve System appeared to be a complete failure.
Since the Federal Reserve System had failed so miserably to contain the crisis in 1931-33, the Federal Deposit Insurance Corporation was created in order to supplement the Federal Reserve System’s efforts to counter future banking crises. Each depositor up to a certain limit would know he or she would be paid back even if their individual bank failed. Therefore, they wouldn’t panic and withdraw their deposits during an economic downturn like they had in the past. The system of payments—credit money—would continue to operate smoothly, since checks drawn against deposits in even failed banks would be paid by the FDIC if necessary.
A depression-proof economy?
This is perhaps the only New Deal reform that was supported by Professor Milton Friedman. He claimed that the FDIC would prevent the kind of collapse of the money supply that occurred between 1929-33 and to a lesser extent in earlier crises. Therefore, Friedman claimed, the United States now had a “depression proof economy.”
Moral hazard I
Some capitalist financial experts, however, were opposed to the creation of the FDIC. They pointed out that this would lead to what is now called moral hazard. Before FDIC, depositors knew that they could and likely would lose a part, and maybe all, of their money if their bank failed.
They would therefore avoid putting their money in banks that had a reputation for reckless or speculative behavior. The more sophisticated depositors would seriously study the bank’s balance sheet to make sure it was run on a financially “sound basis.”
But once depositors knew—or at least believed—that they would always be able to access their funds even if the bank failed, they would no longer be so picky. Bankers who were previously restrained, at least to a certain extent, by fear of losing depositors if they ran their banks in a risky speculative way, would be free of this constraining influence. Therefore, more speculative behavior would be expected under the FDIC insurance system than without it.
Another problem, which there is reason to suspect has been a factor in the most recent panic, has been the tendency of the FDIC to overlook the insolvency of particular banks when many banks or some very large banks are in reality insolvent. Fearful of endangering its insurance fund, which after all covers only a small percentage of the insured deposits, the FDIC will tend to look the other way. After all, the FDIC will reason, as long as everybody thinks that everything is alright, there will be no bank runs, and everything therefore will be fine.
The opponents of the FDIC warned that future banking crises might be postponed, but when a crisis did develop it would be much larger and therefore more destructive than earlier, relatively “small” crises. To paraphrase Marx, while private property in banking was maintained, the FDIC deposit insurance scheme undermined the control of that private property.
The cyclical movement of credit and banking
Marx made two extremely important observations about banking and credit in Volume III of “Capital.” First, he explained that the banks are the pivot of the entire credit system. It is bank credit that backs up commercial credit, and today we must add consumer credit as well. Therefore, if bank credit collapses so does commercial credit and consumer credit.
Second, during the economic boom phase of the industrial cycle, credit increasingly replaces cash. As we saw in the main posts, during the boom the industrial capitalists are forced by the pressure of competition to expand production without limit. This means that industrial production will sooner or later expand faster than the supply of money material—gold bullion.
This situation does not occur by accident. Once capitalism has developed to a certain point, this overproduction recurs on a periodic basis. If by chance the quantity of money material is growing faster than industrial production, industry will work at very high pressure—demand will exceed supply at current prices, leading to shortages and price increases—which will force up prices to the point where the production of money material—gold—becomes relatively less profitable than other branches of industrial production and might become altogether unprofitable for a time.
The production of money material will then decline as capital, always in search of super-profits, flows out of the gold mining industry into other branches of industrial production. Inevitably, the rate of growth of money material will fall below the rate of increase of industrial production. The gap will then be filled by an increasingly reckless expansion of credit money and credit of all kinds. The monetary system is replaced by a credit system.
The replacement of cash transactions by credit transactions is a symptom of the ongoing overproduction. It is a sign that production is developing beyond the limits allowed by the capitalist relationships of production. Either capitalist relations of production must be abolished—or a crisis of overproduction will break out that will reduce production back down to the narrow limits that capitalist relations of production are adequate for.
The more the quantity of credit money and credit is ballooned on a relatively smaller and smaller base of “hard cash”—ultimately gold bullion—the more unstable the entire credit system becomes. And since banks are the pivot of the credit system, the more unstable the banking system becomes. As overproduction and its associated “over-trading”—replacement of cash transactions with credit transactions—develops, there are fewer and fewer cash reserves behind each deposit.
Eventually, there is a banking and credit crisis, and credit contracts. Overproduction comes out into open in the form of huge mountains of unsold commodities piling up in warehouses, evaporating order books for the industrial capitalists, the dumping of unsold commodities at prices below their values—actually below their direct and production prices. Industrial production plummets as commercial capitalists slash orders or suspend them altogether for a time, industrial workers and commercial workers are laid off, and wages are slashed below the value of labor power.
The cyclical return of a cash system
As economic activity declines and the general price level falls, the economic system returns to a cash basis for reasons I explained in the main posts. I will briefly review this process here. Economic activity contracts reducing the need for means of purchases and eventually means of payment. Capitalists now demand payment in cash. The fall in the general price level further reduces the amount of money that is necessary to circulate the now reduced total mass of commodities.
In addition, the lower general price level—at least in terms of money material—makes the production of money material—gold bullion—increasingly profitable, both relative to other branches of industrial production and absolutely. This is the exactly converse of what happens during the boom with its overproduction backed by over-trading.
Therefore, after the crisis and continuing for some time after prosperity is restored, the system depends less on credit and more on cash. Banks have larger reserves of hard cash and the demand for credit is less than it was during the period leading up to the last crisis. Industrial and commercial capitalists also have large reserves of cash. They are far less dependent on credit than they were before the preceding crisis. But inevitably the cycle repeats as overproduction again develops and the credit system becomes inflated once again, until the next crisis.
Cyclical movements and long-term evolution of the capitalist system
The long-term tendency of the capitalist system is to evolve from a cash system to a credit system. Therefore, the role of bank capital grows relative to other forms of capital. In the highest stages of capitalist development, bank capital increasingly dominates industrial capital in the form of finance capital.
But this is not a straight-line evolution. It moves in sympathy with the industrial cycle. The power of bank capital is strongest on the eve of and during crises, and least in their aftermath. These changes in the influence of bank capital reflect the changing balance of power between the money capitalists on side and the industrial and commercial capitalists on the other in the course of the industrial cycle.
This changing relationship is measured by changes in the rate of interest. Interest rates are lowest in the period immediately following a crisis. This reflects the strengthened position of the industrial and commercial capitalists relative to the money capitalists. The industrial (and commercial) capitalists can keep more of the surplus value produced by the working class for themselves and share less of it with the money capitalists.
However, as the industrial cycle moves from depression to stagnation through average prosperity and then to boom, the position of the money capitalists improves relative to that of the industrial capitalists. The power of the money capitalists as opposed to the industrial and commercial capitalists reaches its peak when the crisis of overproduction breaks out. At this point, the rate of interest rises to its highest level of the cycle. The crisis then reverses the situation through the mechanism described above.
Now, what is “finance capital”? It is first the power of the money capitalists organized through the power of the banks and other financial institutions. By organizing the power of the individual money capitalists—and even small savers who in themselves are not even small capitalists—the “money power” gains tremendous leverage over industry and commerce. Indeed, the entire “financial services industry” represents a gigantic “union” of the money capitalists.
We therefore see two movements that sometimes reinforce one another and sometimes cross one another. Over time, as capitalism develops and industrial production increasingly tends to exceed the limits of capitalist relations of production—overproduction—the system becomes increasingly a credit system, and the power of finance capital grows.
But periodically this tendency is checked and to a certain extent temporarily reversed in the wake of the recurring crises of the generalized overproduction of commodities.
Finance and industrial capital in the wake of the Depression
The crisis of 1929-33 is unique in the history of capitalism. It was a crisis of overproduction like all others but on a much bigger scale. This is why I call it the super-crisis. I think the evidence indicates that it was the colossal inflation of commodity prices above their prices of production as a result of the World War I war economy that added a crucial non-cyclical element that transformed an “ordinary” cyclical crisis at the end of the decade of the 1920s into the “super-crisis” that overwhelmed the U.S. Federal Reserve System.
The 1920s were plagued by unusually low gold supplies and production of new gold relative to the quantity of commodities produced multiplied by their inflated prices. For example, from the spring of 1920 to the spring of 1929 the U.S. monetary base grew only at an 0.43 percent annual rate (calculated continuously), a sharp contrast to the 8.8 percent annual growth rate between 1929 and 1941. (11)
Not surprisingly, the power of “finance capital” grew rapidly in the 1920s, with its chronic shortage of hard cash, but this growth was sharply reversed during the Depression decade. After World War II, Marxist economists as different as Paul Sweezy and Ernest Mandel noted the reduced role of banking capital compared to the era of Lenin and Hilferding. At least in respect to the role of banking capital, Mandel, Sweezy and other Marxist economists of the day claimed Lenin, perhaps overly influenced by Hilferding, had been proven wrong.
The mistake that both Sweezy and Mandel made was that they confused the temporary aftermath of the super-crisis of 1929-33 and the Depression with the long-term evolution of the capitalist system. Over time, the forces that had led to an increase in the power of finance capital, rooted in the most basic contradictions of capitalist production and its basic unit the commodity, were bound to reassert themselves.
Financial stability after World War II and its causes
The liberal—not neo-liberal—economist Joseph Stiglitz, speaking for many reformers of a Keynesian persuasion, points to the fact that the first decades after World War II were marked by an almost complete absence of banking and financial crises.
Stiglitz believes that the post-World War II period of financial stability arose from the regulations and banking reforms instituted by the New Deal. Other economists—some to the left of Stiglitz—have made similar points. In Marxist guise, the claim is that the New Deal, by breaking the power of “finance capital” by instituting sweeping regulations, not only ushered in a period of unprecedented financial stability but succeeded in greatly reducing the intensity of recessions.
But the later financial deregulation carried out in the years of neo-liberalism, especially the ending of the Glass-Steagall-mandated separation of investment and commercial banking, brought—these reformers complain—a return to financial instability and intensified recessions.
Why were the regulations abandoned if they worked so well?
Many economists and others on the liberal left blame the financial deregulation that began under the Reagan administration and climaxed with the Gramm-Leach-Bliley Act of 1999 that ended the separation of investment and commercial banking in United States. Even before Glass-Stegall was finally repealed in 1999, its restrictions were breaking down in practice. In reality, it was the unfolding of the basic laws of capitalist development that led to the growing combination of investment, merchant, and commercial banking and insurance functions ending up in the hands of a few huge financial corporations. The Gramm-Leach-Bliley Act signed by Democratic President Bill Clinton in 1999 merely reflected this basic economic trend but was not the cause of it.
But didn’t the growing power of extreme right-wing ideologues like Milton Friedman lead to the abandonment of the policies of regulation that were working so well?
A close examination of the actual events indicate that this is not what happened. Keynesian economics had broken down in the 1970s for reasons I dealt with in my maIn posts. The attempts to continue the Keynesian policy of forcing down interest rates by issuing ever larger amounts of token money—policies followed by the Republican Nixon and Ford administrations and continued by the Democratic Carter administration were leading capitalism to disaster. Unless capitalism wanted to commit suicide—it was not so obliging—these policies had to be ended. It fell to Paul Volcker in his role as chairman of the Federal Reserve Board to initiate an end to these policies.
Volcker, however, is not an extreme right winger. For example, he is a Democrat, not a Republican, and he was appointed to head the Federal Reserve Board by Democrat Jimmy Carter, who neither was or is a right-wing ideologue.
Today, Volcker, serving as an advisor to Barack Obama, is a supporter of re-regulating the financial system. He is if anything one of the more liberal—not neo-liberal—members of the Obama administration. Indeed, within the Obama administration, Volcker is a liberal—not neo-liberal reformer—who is fighting the extremely reactionary neo-liberal influence of Larry Summers (1954- ), who is director of the National Economic Council and the chief economic advisor to President Obama.
Nor did the repeal of the Glass-Steagall Act occur under a right-wing Republican administration. On the contrary, it occurred under the very pragmatic if cynical Clinton administration. The retreat from New Deal regulation occurred not because of the influence of right-wing ideologues—though there was and never is a shortage of these hired apologists of capitalism—but rather because of the very real and increasing contradictions of the evolving system of monopoly capitalism.
In reality, the period of exceptional financial stability that followed World War II was the natural aftermath of the Depression itself. Every cyclical downturn is followed by a period of greater economic stability. But just like the super-crisis was far worse than any other capitalist crisis, it was far more effective than any other crisis in creating a period of financial stability in its wake as the system shifted back to a cash basis.
It was the super-crisis itself and not regulation that was the real cause for the long period of financial stability that followed. The regulations of the New Deal worked so well only because they were pushing an open door. But eventually renewed capitalist overproduction ended the period of stability and shattered the regulations as production once again grew beyond the limits imposed by the capitalist system.
The only way to return—for a time—to the kind of financial and economic stability that followed World War II while retaining the capitalist system would be through another Depression on an even larger scale than its predecessor. Perhaps we would call it Depression II or the Super-Depression. Then once again the banking system would be awash in liquidity based not on the printing presses, which is the case today, but on a solid gold basis like was the case in the 1930s.
But who in either of the contending classes would want to pay that price in exchange for a few decades of financial stability in its aftermath? After all, the “mere” Depression led to Adolf Hitler and World War II with tens of millions of dead, among other things. What would be the price of a Super-Depression?
Paul Volcker—despite and maybe because of his role in engineering the “Volcker Shock”—certainly doesn’t want a Super-Depression to gain a few decades of financial stability. But he does want to find ways to take advantage of the current far more limited shift towards a cash system that is part of the aftermath of what is now called the “Great Recession” to create a somewhat more stable banking system.
“First,” Volcker explained in a prepared statement before the Senate banking committee February 2, “surely a strong international consensus on the proposed approach would be appropriate, particularly across those few nations [emphases added—SW] hosting large multi-national banks and active financial markets.”
Here Volcker—who, though he is no right-wing ideologue, is a strong partisan of the capitalist system in general and American imperialism in particular—confirms a key point made by Lenin in “Imperialism” almost a century ago. Modern imperialism represents the domination of finance capital, not industrial capital. The finance capital of a “few nations,” to use Volcker’s words, exploits the rest of the world.
Centralization of finance capital
Today, a few universal banks that combine commercial banking—the functions that used to be performed by savings banks and saving and loans—investment banking, merchant banking and insurance dominate the capitalist world economy.
It goes without saying that the economic power wielded by these universal banks is tremendous. They provide short-term loans and discounts through their commercial banking arms, underwrite stocks and bonds and arrange mergers through their investment banking arms, have huge amounts of voting power in corporations through their trust departments, and own stock outright through their private equity and hedge funds and insurance activities. And unlike the commercial and investment banks of yesteryear, they also function as direct creditors to many working-class and middle-class people through their consumer credit and mortgage granting activities.
Never before has the world seen such money power as this—whether we call it the “money trust,” as the American middle-class reformers of a century ago called it, or “finance capital,” as Hilferding and Lenin called it.
Volcker is willing to accept much of this as a more or less inevitable feature of today’s highly developed capitalism. But one thing alarms him and fills him with dread for the future. This is the outright ownership and speculation in stocks, bonds, derivatives and commodities by the universal banks, which at the same time through their commercial banking activities create and manage the system of credit money.
And this points right to very heart of the central contradiction of the modern capitalist system: the contradiction between globally socialized labor and the private appropriation by a small layer of idle but very rich money capitalists and a tiny handful of top corporate capitalist-managers—especially the top bankers—of the product of globally socialized labor.
Volcker notes, “[E]very banker I speak with knows very well what ‘proprietary trading’ means and implies.” “My understanding,” remember, speaking is Paul Volcker, who is the former chairman of the Federal Reserve System, “is that only a handful of large commercial banks—maybe four or five in the United States and perhaps a couple of dozen worldwide [emphasis added—SW]—are now engaged in this activity in volume.” “In the past,” he continues, “they have sometimes explicitly labeled a trading affiliate or division as ‘proprietary’, with the connotation that the activity is, or should be, insulated from customer relations.”
But at the same time that these banks are trading for their own accounts—in order to maximize their own profits—they are also trading for their customers’ accounts. “Most of those institutions,” Volcker points out, “are engaged in meeting customer needs to buy or sell securities: stocks or bonds, derivatives, various commodities or other investments.”
That is, they have a pretty good idea what trades their customers are making—since they are making the trades for them! These “universal banks”—the core of today’s finance capital—are the ultimate “inside traders.”
All in all, we have an unprecedented centralization of “finance capital”—the centralized organized power of the money capitalists over the rest of society. About four or five banks in the United States plus a few more in the imperialist satellite countries—a couple of dozen on a world scale if we are to believe Volcker—and he is very well informed—have a stranglehold on the economic lives of about 6 billion people. (12) This is the “freedom and democracy” that the U.S. government is sending its young men and women to spread by force of arms to Afghanistan, Iraq, Pakistan and other countries.
One of the arguments for allowing a high degree of centralization of banking capital is that large banks are more stable than small banks. Until fairly recent times, U.S. laws discouraged branch banking in favor of what is called unit banking. Your local bank, instead of being a branch of some mega-bank such as J.P. Morgan Chase, Citicorp, Bank of America or Wells Fargo, would be an independent “community” institution owned by local capitalists.
The argument for a branch banking system is that very large banks are unlikely to become insolvent. Even if they make a few bad loans—or many—they will remain solvent. That is, their assets—loans—will continue to exceed their liabilities—deposits. Therefore, a branch banking system was considered by the financial experts much more stable than a unit banking system. Indeed, one of the reasons given for the extraordinary historical instability of the U.S. economy relative to that of other imperialist countries was the reliance on unit banking as opposed to branch banking.
But what happens if the big banks of a branch banking system turn out to be insolvent, not just face a “liquidity crisis”—that is, a shortage of ready cash. Extremely unlikely, according to the experts. But not in the fall of 2008! The banking crisis of 2008 was to a much greater extent than the banking crisis of 1931-33 a crisis of solvency, not just liquidity.
Too big to fail moral hazard II
And the banking crisis of 2008 was no accident. I explained above that the opponents of the bank deposit insurance schemes such as the FDIC system in the United States were afraid that deposit insurance would remove the incentive of bank deposit owners to make sure that their banks were following “conservative” or “sound” lending policies.
But the “moral hazard” arising from the FDIC and similar bank deposit insurance schemes pales to insignificance in the face of the “moral hazard” that arises when capitalist corporations, especially banks, become “too big to fail.” A bank run against any of the couple of dozen banks that now dominate the world economy would quickly wipe out the various insurance schemes such as FDIC. If allowed to proceed unchecked, such a crisis would lead very quickly to a collapse of the whole system of credit money.
Nowadays, not only are large-scale business transactions carried out with credit money—this was the case in the days of Marx as well—but also much retail trade as well. Credit and debit cards are increasingly used to buy the morning coffee at your local MacDonald’s.
If all the transactions that are carried out with credit money suddenly had to be carried out with state-issued token money—legal-tender bills and coins—economic activity would grind to a halt. The super-crisis that would result would relate to the crisis of 1929-33 in about the same proportion that a general nuclear exchange would relate to World War I.
Now imagine you are the CEO of one of the couple of dozen banks that Volcker referred to. Like all active capitalists, your responsibility is to earn the highest possible rate and mass of profit on the capital for the stockholders of “your” corporation. On top of this, you need to “earn” as an individual money capitalist in your own right as much as possible in the form of a very high salary, a bonus paid in cash, stocks and stock options.
A stock option is a type of derivative security that rises in value much faster than the price of the underlying stock when stocks rise, and can easily become worthless when stocks fall. And remember, in a crisis you come first, your stockholders and your creditors come second, and nobody else counts at all.
If you adopt a highly risky policy—for example, make loans to firms or even countries of dubious credit but charge very high interest rates to compensate for the risk—you can collect most of the interest. If everything goes well you serve both yourself—your stock options especially will rise through the roof—while the shareholders will do alright, too.
But what if things aren’t going so well? What if the “masses” simply cannot repay the huge debt burden they owe to “your” bank, threatening the bank’s solvency?
In this case, you must look out for number one.
If the bank “keeps beating its numbers”—the earnings per share that stock analysts expect—the stock of your bank keeps rising and, to a much greater extent, so will the value of your stock options. Even if the profits are phony, as long as you cash in your stock options before the “bubble” bursts you will come out far ahead.
And you have an ace that lesser capitalists do not have. If the worst happens, you know you will be bailed out! You have a gun to the heads of the government and six billion people who live on the planet. You tell the president, prime minister, congress or parliament if you don’t bail “my” bank out, the entire world economy will collapse into a Super-Depression. It’s either a Super-Depression or the bailout. What president, congress, prime minister or parliament would choose a Super-Depression? The resources of the Treasury and the note-issuing power of the central bank are at your command!
President Obama and the Democratic majority in the current U.S. Congress, lacking any real achievements to point to in their first year in office, have recently taken to boasting about their “achievement” of avoiding a Super-Depression. Instead of incurring a Super-Depression, they carried out every demand of the mega-banks. As a result, the people have to deal “only” with the “Great Recession.” They even insisted on reappointing the Republican Bush-appointed Ben Bernanke, who presided over the crisis, to a second term as chairman of the Federal Reserve Board. No wonder the Democrats are plunging in the polls.
But these bailouts are not without dangers of their own. They cost money. In order to finance them, the U.S. central bank, which issues the U.S. dollar, which under the dollar system functions as the world currency, was forced to double the monetary base over a period of a few months. Thanks to the “Great Recession,” the broader “money supply” that consists mostly of credit money created by the banks has expanded much more slowly—so far. In contrast, even during the “Great Inflation” of the 1970s, the rate of growth in the monetary base was below 10 percent a year.
And with construction spending again trending downward—very unusual in what is supposed to be the early stages of a cyclical recovery—the Fed has been forced to once again allow the “monetary base” to spike upward, since every move to curb the growth of the monetary base leads to an upward movement of the rate of interest on 10-year Treasuries towards 4 percent. All this threatens to renew the fall in housing starts and home prices, which would probably abort the current feeble recovery altogether.
But a failure to slow down the rate of growth in dollar token money will lead sooner or later to a run on the dollar to the ultimate hard cash—what Marx called the coin of last resort—gold bullion. Gold is the one form of money whose quantity cannot be increased either by the Federal Reserve Board—or any other “monetary authority.” The quantity of gold in the world can only be increased through the slow process of mining and refining it. And this is becoming more difficult as the world’s gold mines become ever more depleted
If a full-scale run on the dollar develops—such as last occurred in 1979-80, the only way to stop it is to let interest rates increase dramatically. Or what comes to exactly the same thing—through a new “Volcker shock.”
Paul Volcker, who by virtue of his experience is the capitalist world’s leading authority on “Volcker shocks,” is well aware of these dangers. The only way to avoid explosions in the quantity of token money—without incurring a Super-Depression—is to avoid a banking and credit crisis like that of the fall of 2008 in the first place.
But what if panics like occurred in the fall of 2008 cannot in fact be averted? “[T]here has been, and remains,” Volcker stated, “a strong public interest in providing a safety net—in particular, deposit insurance [emphasis added—SW] and the provision of liquidity in emergencies—for commercial banks carrying out essential services.”
Translation: We must guarantee that no disruption in the convertibility of credit money into token money ever occurs if we are to avoid a Super-Depression. Therefore, Volcker would like for commercial banking proper—the management of the system of bank-created credit money—to be separated from all other lines of financial activity.
The current system of combining basic commercial banking activity with investment banking and stock market and commodity speculation, merchant banking and insurance has created a system so unstable that governments and central banks are faced periodically with a situation of either allowing the unthinkable collapse of the system of credit money, or finding themselves expanding the supply of token money so rapidly that it is only a matter of time before a new run on the dollar and a resulting runaway inflation occurs, followed by new and greater “Volcker shocks” with all their disastrous consequences.
But Volcker is above all a realist. The best he can come up with is to end the worst abuses: the practice of combining “proprietary trading with commercial banking.” That is, to divorce commercial banking from stock market and commodity speculation. In the current political climate, it is far from certain that even this will be possible.
With the great financial and economic power wielded by the universal banks comes great political power. The universal banks that today dominate the world capitalist economy are very much opposed to Volcker’s proposals or any other move that will in any way interfere with their basic responsibility as capitalists—to make the highest rate and mass of profit possible.
The fundamental problem
But even if the worst abuses can be curbed, as Volcker hopes, the more fundamental problem will remain. The centralization of capital in the “financial services industry”—commercial banking, investment banking, merchant banking and insurance—is not accidental.
Capitalism began with the often forcible separation of the direct producers—small peasant farmers and craftspeople—from their means of production. But as capitalist production proper emerged, it was the capitalists themselves who began to be expropriated
“This expropriation,” of the capitalists by other capitalists, Marx explained, “is accomplished by the action of the immanent laws of capitalistic production itself [emphasis added—SW], by the centralization of capital. One capitalist always kills many. Hand in hand with this centralization, or this expropriation of many capitalists by few, develop, on an ever-extending scale, the co-operative form of the labor-process, the conscious technical application of science, the methodical cultivation of the soil, the transformation of the instruments of labor into instruments of labor only usable in common, the economizing of all means of production by their use as means of production of combined, socialized labor, the entanglement of all peoples in the net of the world-market [emphasis added—SW], and with this, the international character of the capitalistic regime.” (“Capital,” Vol. I, Ch. 32)
A point will inevitably be reached—remember, Marx is writing in the 1860s, more than 140 years ago—when “[t]he monopoly of capital becomes a fetter upon the mode of production, which has sprung up and flourished along with, and under it.” Marx continues: “Centralization of the means of production and socialization of labor at last reach a point where they become incompatible with their capitalist integument” [emphasis added—SW].
The centralization of bank capital in the hands of a couple of dozen banks worldwide, the inevitable merger of this bank capital with industrial capital and the resulting “moral hazard” and threatened collapse of either the system of payments—credit money—or the system of legal-tender token money is simply a sign foreseen by Marx that the “centralization of the means of production and the socialization of labor” are finally closing in on the point when they have “become incompatible with their capitalist integument.”
Only the last act now remains to be performed. The workers under pain of their own ruin and the destruction of modern society must see to it that the “expropriators are expropriated.” The situation is reaching such a point that this is the only “reform” that offers a meaningful remedy to the explosive financial and economic contradictions that now confront us.
1 A fractional reserve banking system, is a banking system that through loans and discounting creates a much greater quantity of deposit liabilities than it holds in cash reserves. The deposit liabilities, also referred to as bank money, serve as a means of purchase and payment—that is, function as credit money. The so-called “money supply” includes not only cash—legal-tender paper money and coins—but bank deposit liabilities that can be used as a means of purchase and payment through the writing of checks or more recently through electronic transfers using debit and credit cards.
Such a banking system is inherently unstable, because if all the depositors—or a considerable number of them—demand payment of their deposits in cash, the commercial banks will be unable to meet the demand, threatening the collapse of the entire system of purchases and payments.
2 Remember, the traditional distinction between commercial banks that deal only with industrial and commercial capitalists—or large money capitalists—and savings banks that take small deposits and grant personal loans and mortgage loans on homes has largely broken down.
3 Alan Greenspan, the head of the U.S. Federal Reserve System during the turn-of-the-century housing and real-estate boom, has been bitterly criticized for allowing the “housing bubble”—with its “securitization” and the granting of loans to people who almost certainly could not repay them—to go on. But if he had used either the Fed’s regulatory powers or its ability to raise interest rates and tighten the money supply by restricting the quantity of the Federal Reserve token money it issues, he would have been criticized by liberals for throwing the economy into an “unnecessary” recession and depriving many working people of the “American dream” of home ownership, much like Paul Volcker was criticized during the 1979-82 Volcker Shock.
Greenspan’s problems were further intensified when gold production began to decline after 2001. This indicated that the general price level had once again risen above the relative labor values of commodities that were falling due to the continuous growth in the productivity of labor in all or almost all branches of industry, on one side, and the value of gold, which was under upward pressure due to the exhaustion of the South African and other gold mines, on the other. As gold production declined, the dollar price of gold began to rise, leading to rising dollar prices of other primary commodities such as oil.
The Fed was eager to avoid a repeat of the stagflation of the 1970s, so it began to slow down the rate of growth of the supply of token money that it was creating. But while doing this, Greenspan didn’t want to be blamed for causing a recession. He therefore, at the same time that he was reducing the rate of growth of the monetary base in order to hold in check a renewed devaluation of the U.S. dollar, encouraged the financial “innovations” such as “securitization” that temporarily made possible an ever greater inflation of credit relative to the slowing rate of growth of the “monetary base.”
By encouraging this reckless inflation of credit while avoiding a reckless inflation of paper money, Greenspan succeeded in postponing the outbreak of the crisis until after his retirement from the chairmanship of the Federal Reserve Board.
4 Both the Austrian School and Milton Friedman have denounced fractional reserve banking as the source of capitalist instability and crises. Both the Austrians and Friedman wanted to suppress the creation of credit money by the banking system. Instead of a fractional reserve system, the Austrians wanted a system of 100 percent reserve banking where every dollar of deposit liabilities would be backed by a dollar of gold reserves that the banks would have to keep on hand at all times to redeem their deposits. Friedman wanted every dollar of deposits to be backed by green paper dollars, issued by a government “monetary authority,” that would increase in quantity at a steady unchanging rate.
In real life, however, the evolution of the banking, monetary and credit system has gone in the exact opposite direction advocated by reactionary utopian bourgeois economists whether of the Austrian School or Friedmanite persuasion. The real world capitalist economy obeys the economic laws discovered—not created—by Karl Marx, building on the work of the classical political economists, and not the imaginary economic laws invented by the various marginalist economic schools.
5 Not always. John D. Rockefeller Sr was the organizer of the original “trust”—Standard Oil Trust—in the 1870s. In his person, Rockefeller combined the functions of an industrial capitalist—the owner of oil refineries and a landowner—the owner of oil-bearing and, later in his career, mineral-bearing lands as well. Like all industrial capitalists—and in modern times, landowners as well—Rockefeller inevitably also became a very large money capitalist. The fact that all industrial capitalists are also money capitalists contains in embryo the merger of banking and industrial capital that is the essence of “finance capital,” according to Lenin.
Rockefeller become so rich that he became a powerful force in National City Bank—ancestor of Citicorp—which was nicknamed the Standard Oil Bank.
Later, John D. had a falling out with his brother William Rockefeller. Brother William and his descendants stuck with National City Bank, while John D. and his descendants moved over to another large New York bank—Chase National. Chase National eventually merged with another larger New York bank, the Bank of Manhattan. More mergers occurred, including with a corporate descendant of the original House of Morgan, eventually leading to what is today the largest and most powerful universal bank in the world, J.P. Morgan Chase.
6 When Rockefeller first organized the Standard Oil monopoly, he used the legal device of a “trust.” A trust fund is a sum of capital administered by a person or institution in the interests of another person. Rockefeller pressured his “competitors” to deposit their stock in a trust fund that was controlled by Rockefeller, giving him de facto control over almost all oil wells and refineries in the United States while preserving the fiction that these remained independent competing capitalist enterprises.
The Rockefeller oil monopoly produced so much outrage that the courts declared the Rockefeller trust illegal. It was replaced by another legal device, the holding company. A holding company is a corporation that owns stocks in other nominally independent corporations. Economists began to use the word “trust” in a generic sense to refer to large production associations where individual enterprises enjoy a limited administrative autonomy but are ultimately answerable to a “trust”—generally a holding company. Even the Soviet Union had trusts, which were administrative units that helped to organize and coordinate the individual factories, wells and mines.
In the United States, the word “trust” rapidly acquired an extremely pejorative meaning. The U.S. government passed anti-trust laws that were supposed to prevent monopolistic trusts. In time, the media itself was trustified. The trusts then used the media to suppress the word “trust” as applied to capitalist monopolies. Therefore, the very word “trust,” when used to refer to a large corporate monopoly—as opposed to a trust fund—has been suppressed and has virtually died out in American English.
7 A major function of investment banks is to reorganize corporations that fall into what in U.S. law is called Chapter 11 bankruptcy. In a reorganization, the bankrupt corporation is not liquidated. It continues to function, though some of its debt might be written down. The bondholders may not be paid in full, or the repayments may be postponed. In the late 19th century, there were many bankruptcies among railroads as a result of “overbuilding”—the railroad equivalent of overproduction—of railroads, somewhat similar to the airline bankruptcies of more recent times, and consequent cutthroat competition.
When Morgan reorganized a bankrupt railroad and “re-floated” it by issuing new stocks or bonds, he would take control of the railroad. Morgan ended up controlling more and more railroads. Naturally the various railroads he controlled were not likely to compete with one another but instead divided up their markets and worked together to maintain rates and profits. This blatantly monopolistic practice was dubbed the “Morganization” of the U.S. railroad industry.
8 J.P. Morgan might have exercised more power over more corporations measured in terms of money than John D. Rockefeller did. But Morgan excised his power mostly through his control of “other people’s money,” not his own. Though almost unimaginably rich by the standards of ordinary people—and even the typical capitalist of the time—J.P. Morgan was still not nearly as rich as John D. Rockefeller Sr. It is part of American folklore that after Morgan’s death in 1913 John D. Rockefeller is said to have declared something to the effect “and to think he was not even a rich man.”
9 In “Imperialism,” Lenin mentions that the United States was dominated by two banking groups, a clear reference to the John D. Rockefeller and J.P. Morgan interest groups. Today, we can update the readers of “Imperialism” by informing them that these two groups are now happily united in one corporate holding company—J.P. Morgan Chase.
10 The large-scale run on the banks and the associated credit collapse would induce a deep depression in the U.S. economy. As a result of the contracting home market, U.S. businesses would have to find more markets abroad—increase exports—while imports into the United States would slump. This would swing the balance of trade and payments sharply in favor of the United States causing a major inflow of gold into the U.S. banking system. The rising reserves of the U.S. banks would at some point halt the crisis but at the same time worsen the crises or recessions in other countries.
As the U.S. economy became more powerful, U.S. banking crises threatened the stability of the entire world economy. The sharp, if short-lived, crisis of 1907 finally forced the United States to move toward a central banking system that became the current Federal Reserve System.
11 These growth rates are in terms of dollars, not gold. But they reflect the fact that a ballooning supply of credit was increasingly balanced on a stagnant mass of hard cash during the booming 1920s. However, during the Depression decade that followed, the U.S. economy was increasingly awash in cash. With money so abundant, the rate of interest fell to very low levels as the power of the money capitalists relative to the industrial and commercial capitalists declined.
12 Both Marx and Lenin pointed out that the banking system creates a ready-made apparatus of universal control and bookkeeping that later on under socialism will be crucial for the organization of a planned economy. This is much more true today than it was in the time of Lenin—not to speak of Marx—because banking capital is even more centralized into a handful of banks than it was in Lenin’s time, and because of the rise of modern electronic computing information technology. All that is necessary once the workers win political power will be to combine the universal banks into a single organization of universal bookkeeping and control under the workers’ government.
This should not be confused with the various proposals to nationalize the banks—partially carried out in various countries—that were proposed by various bourgeois authorities during the 2008 banking crisis and will doubtless arise again in the banking crises to come. The idea here is that under the guise of temporary nationalization, huge amounts of government funds are pumped into the banks. Later, when the banks are “restored to profitability, the banks are re-privatized through the sale of newly issued stock to wealthy money capitalists.