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The Financial Crisis for Dummies

EconomicsPosted by john sloboda Sat, May 26, 2012 11:33:57
My colleague Richard Parncutt has just put together one of the best lay analyses of causes and solutions to the current global financial crisis that I have seen. It is as

I am reproducing it in full here, because Richard's site does not have a reply post facility. Anyone wishing their response to Richard to be public rather than privately emailed to him, may post it here.


Richard Parncutt

25th May 2012

Forget about all those pages and youtube files out there called "financial crisis for dummies". They are generally good and interesting, but they are not getting to the point. Their authors can't see the wood for the trees.

National debt, income inequality, and taxation

First of all we have a contradiction that is plain for anyone to see. National governments are struggling to pay their debts, while at the same time multinational corporations are making gigantic profits. In most countries, the gap between rich and poor has been steadily rising for decades (income inequality). Now in 2012, ordinary people in the middle and working classes are being asked to accept "austerity measures".

This is distortion of the truth (aka bullshit) and it should be identified as such. If money is needed, the people who should pay first are those who have it. Where else is it going to come from? Clearly, the rich are not being taxed enough. We should be taxing wealth more directly, in addition to income, and separately from it. We also urgently need transaction taxes (e.g. Tobin tax) to generate income and curb financial speculation, and we urgently need environmental taxes (e.g. carbon taxes) to combat global warming and other environmental problems. Regarding wealth tax, we need more transparency about the total wealth of individuals. Everyone with any net wealth (or at least those whose wealth exceeds a given threshold) should pay a fraction of a percent of that wealth to at least one national government every year.

What I am saying is not left-wing or right-wing. I am talking about rescuing the framework within which both left and right operate. That is the modern democratic system that we know and love, which is based on a balance between free enterprise and social security. This system is under threat and everyone is wondering what the solution might be.

Four ways to distort the truth: Complexity, bias, manipulation, and secrecy

Everyone is talking about the complexity of the crisis. But just imagine the following idea. Perhaps there is a simple solution, but we don't know what it is because it is somehow being suppressed. Perhaps the people doing the suppressing don't even realise they doing it. So who are those people? Clearly, they are the people who are profiting from the crisis and the system that caused it. Please note that I am not talking about some kind of plot. The people involved are not plotting, on the whole. They are simply looking after their own interests, as everyone does in one way or another. One of the ways that they do that is to promote complex accounts of the finance crisis. This makes them feel important, because they understand something that others do not. It also makes them feel comfortable, because it means the main problems that caused the crisis may never be addressed. The rich and their sidekick economists are right that there is a complex side to the crisis, but public awareness of this complexity will not lead to a solution. Instead, it will lead to confusion. I will argue on this page that we can reduce the problem to its main components. When we do so, it becomes rather simple. It is then possible to solve it completely and sustainably.

When discussing these issues, it is important to be aware of bias. When the rich complain about paying more tax and present complex economic arguments to justify not paying it, we should just ignore them, just as we would ignore anyone who is obviously biased. Of course most people want to avoid paying more tax and will try all kinds of methods to prevent that, including distortion of the truth. You can justify just about anything by quoting passages from the Bible, similarly, you can find an economic theory to justify just about anything. That does not mean it is true. But when a group of rich people start talking about increasing wealth taxes, our ears should prick up. more

If the rich are asked to pay more tax, they respond by manipulating public opinion. Since that is exactly what I am trying to do with this page, I should explain myself. I am not rich, so my means are limited. The wealthy are at a great advantage, because their contacts with individuals, colleagues, employees and media always depend on wealth. One of their favorite narratives is the "rags-to-riches story". It is true that many famous people dragged themselves out of poverty by a combination of good ideas, hard work and good luck, in a context in which social security was almost non-existent.

Think of Bob Marley. But the truth is that not anyone can do that, and the ones who did not succeed are not famous, so we cannot use them as examples. The least controllable factor is luck - being in the right place at the right time. Luck also includes the people with whom one interacts to get good ideas, and the motivation to work hard. It is a logical fallacy to conclude from examples like Marley that "anyone can make it". In fact, the probability that a person born in poverty will "make it" is very small, regardless of good ideas or hard work. The rich may or may not understand that, but that is not the point. The point is that they are generally good at looking after their interests (that's why they are rich), so they use their economic, social and political resources to spread such fallacies and justify the massive gap between rich and poor.

Another common form of manipulation is to claim that anyone on the left of centre is probably a communist who is plotting to take over the world and take away our freedom. Half a century after McCarthy we still have to deal with rich people and their sidekicks pedaling this kind of nonsense. It would be equally ridiculous to claim that all rich people are Nazis.

In the process of increasing wealth taxes, we must also target secrecy and increase transparency. Top of the list of problems in this area is the tax haven. The Swiss bank secret, for example, is surely one of the greatest scandals of all time. For decades, dictators have been stealing money from their own people, who live in poverty, and hiding it in Swiss bank accounts - with the full knowledge of bank officials who are also making money out of the deal. The individuals in Switzerland and elsewhere who are responsible for perpetuating this corrupt system have all kinds of excuses and are generally treated with respect. What could be more outrageous than that? We urgently need to make international agreements about wealth tax to ensure that people don't just shift their assets from one country to another to avoid tax. This should be an election issue in all countries. And it's not a question of how much we should tolerate tax havens and tax secrecy. There is never any plausible justification for these things. By democratic means we can and should get rid of them altogether. more

The end of national debt

We have grown so used to national debts that we think they are normal. But they, too, are outrageous. Consider this: When politicians borrow money for their country from private sources, they are obliging future generations to pay it back. But future generations are not consulted, nor are they generally very happy about paying other people's debts. If someone asks me to pay their debts, I am not happy about it. Why should future generations be happy about it? According to simple democratic principles, this widespread practice should be illegal.

If a country does not have enough money to meet its needs, just forget all those economic theories and get to the point. Of course public institutions can always be made more efficient - but that is seldom the main problem. If the government doesn't have enough money to finance the public sector, the main solution is taxation. Someone has to pay the bill! And given that the gap between rich and poor is far too wide in all countries, this generally means taxing the rich, because that is where the money is. You won't find much of it anywhere else.

Another method is to print more money, which causes inflation. That effectively reduces the assets of the rich. By using this articially created money (in fact money is always artificially created) to improve social services, the gap between rich and poor is reduced. In the end, this method would be similar to taxing the rich. When confronted with this idea, the rich just laugh and make jokes about how economically irresponsible it is to print more money. But in fact when you consider the main points and don't allow yourself to be sidetracked by unclear economic theory, printing more money is a reliable method of redistributing a country's wealth, provided the rich don't convert their wealth to other currencies in advance. You don't need an economics degree to understand that.

But it is more honest and direct to tax the rich directly. Even the rich would agree with that. Of course international exchange is a problem, but that is also a problem with wealth tax. In both cases international agreements are needed.

Three concrete steps

Given these arguments, how can we move toward a more stable and fair financial system? The problem will not be solved by complicated economic theories, which change from one generation of economists to the next. Besides, the problem is not only economic - it is also moral and historical. Here is a simple, transparent, practical solution:

1. Pay off existing national debts. This involves first establishing which debts were legal in the first place, because only they should be paid. In many cases, legal investigations will be necessary. These should happen in independent procedures within each country. If a debt is found to be illegal, it should be canceled. Having established which debts are legal, they should be paid off, slowly but surely. Since the gap between rich and poor is currently far too wide, that should primarily be achieved by taxing the rich.

Incidentally, a large part of the Greek national debt could be paid off by a combination of reducing local tax evasion and increasing local wealth taxes, combined with direct assistance from the European Union - similar to the

Marshall Plan after the Second World War, but financed by wealth, speculation and environmental taxes. I am talking about giving, not lending, and the numbers would be much smaller than the trillions spent by EU countries in 2008 to bail out corrupt banks. The Greek people may not be entirely innocent, but they are certainly not responsible for a global crisis that, as everybody knows, was jointly created by banks, corporations, governments, and those economists who could have warned them, but did not. It is undemocratic to treat the inventors of δημοκρατία as scapegoats while the guilty live in luxury. Perhaps the Greeks would be better off leaving the EU and regaining control of their currency, as described here.

2. Make it illegal for governments to borrow from private sources. Just repeating: National debts oblige future generations to repay them or to pay interest on them. But we have no right to force future generations to do anything, just as we have no right to reduce their quality of life through global warming. Moreover, if a sovereign nation has control over its own money supply and taxation system it has no need to borrow from private sources. Its income is based on taxation. Further information: link

For many people that is the most surprising assertion on this page, and it certainly surprised me when I learned about it. But this idea is surely perfectly clear and indisputable. What right do we have to borrow from future generations? None at all. What right do politicians have to give away a portion of the autonomy of their democratically elected successors? None at all.

3. Make it illegal for banks to lend money that they do not have. I expect that most bankers would object to this point, and present me with a cascade of impressive sounding economic arguments. But the problem is not economic, it is moral. Lending money that you don't have is a form of lying. Fractional reserve banking, as this practice is known, is remarkably similar to crimes such as fraud and counterfeiting. A bank's reserves should not be 5% or 10% or 20% of the money it is lending, it should be 100%, otherwise there is no money to lend. No wonder the economic system is in crisis. For further information look at the last few minutes of this video.

Again, this is a surprising idea when you first consider it. But on further consideration it is perfectly feasible. In fact, it is hard to imagine how the financial system could possibly work any other way. If you or I cannot lend money that we don't have, why should a bank? If I tried to make money by lending money that I had borrowed from someone else and charging more interest to my debtor than I was giving to my creditor, I would be committing a criminal offence. Besides, everyone would hate me when they found out. My reputation as an honest person would be ruined. No wonder we are not very impressed with the banks.

The bottom line

Underlying all this is a broader issue. The monetary system is, or should be, created, owned and controlled by democratic nations. Private companies are free to use it, but not to control it. Sovereign nations, not banks, must remain in control of the money supply. If we accept that principle, it follows that sovereign nations should never pay interest on debts to the private sector. Never. At the moment we have a situation where banks, not nations, have control over the money supply. People think they are living in a democracy because they vote for politicians in elections, but what actually happens after that is determined by big banks and corporations. This is a familiar problem, and what I am trying to say on this page is that there is a practical and feasible solution, and I am grateful to Bill Still for having made these points so clearly and forcefully.

If these simple principles are followed - and the transition will be easier than it appears, provided that existing, legally sound contracts are respected - we will get our free enterprise back. In free enterprise, there are many legitimate ways to make money, but they can generally be reduced to two categories: good ideas and hard work. Both good ideas and hard work generally benefit society, which is why free enterprise has been such a successful idea. Once you have money, you can lend it to people and demand interest, at which point we are starting to talk about capitalism. Capitalists rely on the legal system to ensure that they get their money back. If you are a bank, you can look after money for some people while at the same time lending that same money to others. The money supply is under the control of a democratically elected government. A legal system is in place that prevents people from tricking each other. The law prevents fraud, money laundering, phishing, political corruption. It also prevents suppression of competition by monopolies. From these examples it is clear that legal regulation is an integral part of free enterprise. By restricting freedom, they paradoxically make the system more free. But freedom was always a paradoxical thing.

An important point is that the law should generally prevent trickery. Democracy only works if voters understand the issues, so political honesty is an essential ingredient. The law should prevent people and banks from lending money they don't have, in order to make money on the interest; and it should prevent governments from borrowing from private sources, because they don't have the courage to tax the people who voted for them. Borrowing from the future is like taking money from babies, obliging them to pay it back they grow up. Don't worry about those babies, they won't object! That's not free enterprise, that's cowardice. I am also saying that we need a healthier attitude to taxation. Rich capitalists think they "made" their money. But money is not made by individuals, it is made by governments, and society is the ultimate source of any wealth. Paying back in the form of taxation is and always was a part of the deal, and deals are an important part of free enterprise. Right? So don't act like you're surprised or offended or something when the tax collector comes along, and don't waste your valuable time on tricks to avoid or evade tax. Instead, devote your time and money to generating good ideas and good products.

Another advantage of this approach is that it eliminates dependence on growth. It has been clear for decades that national economies cannot continue to grow forever, if only for ecological reasons. We are reaching the limit of our natural resources. So economic theories that continue to rely on growth are dinosaurs. We must give them up and plan for a future without growth. But people are still talking about growth, because growth makes it is possible to lend money that one does not have, and borrow money from the future. Growth enables such virtual debts to be repaid. Obviously, this time-honored idea is no longer working. It may be painful to give it up, but we will have to do it.

Governments are local or regional, but money is increasingly global. One of the most difficult challenges facing the human race today is the establishment of a democratically controlled global financial infrastructure that can enforce the principles that I have set out at a global level. An important task of such an infrastructure would be to ensure that rich individuals and multinational corporations are taxed in a fair and open manner, and the taxation is fairly distributed among national economies. Such an infrastructure would stop countries competing with each other to create the best conditions to attract investments/money: low taxes for big corporations, cheap labour, few environmental constraints, ignoring human rights violations. Instead, countries would compete to produce the best ideas and the best products - according to basic principles of free enterprise. Voters need to be informed about this problem so that it becomes a political issue in all countries. We should be electing politicians who are working toward this goal and developing realistic long-term solutions.

Like Sam Cooke in the song "Wonderful World", I don't know much about history, biology and so on, but I do know that one and one is two. I am not an economist, but I do understand some basic things about morality and I also think that I am able to distinguish the wood from the trees. This page is about the wood, but most of the information you can find on this topic is about the trees. Of course it is important to understand the detail, but until we start focusing on the main problems, everyone will be confused and the problem will never be solved.

The opinions expressed on this page are the personal opinions of the author. Please send me suggestions for improving this page. My email address is on my homepage. I thank John Sloboda and Emilios Cambouropoulos for their contributions and discussion.

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