Listener 27 July, 2002.
Keywords Business & Finance, Macroeconomics & Money
Because there is no coincidence of wants, money acts as an intermediatory in the conversion of something we have (including our labour) into something we want (perhaps the groceries). This role can be summarised as C→M→C* where a commodity (C) is converted (sold) into money (M), which is used to purchase a different commodity (C*). In this way money facilitates the specialisation of production upon which modern standards of living depend, because it enables each to concentrate on producing one thing well, and convert it into all the other things they want to consume.
However over time, the commodity to money to commodity circuit gradually reversed to M→C→M+, where the commodity is the intermediatory in the increasing of money holdings. Money becomes something of value in itself, rather than a means to an end. We became obsessed with it, as it began to shape the way we thought and what we valued, such as in the pretence that the wealthy are more beautiful, more intelligent and more refined than the rest of us.
The next step was the bypassing of commodities in the making of money, which could be described as M→FP→M+, when money (M) gets converted into Financial Paper (FP) which is converted into more money (M+), without much involvement of real goods and services. Energy ex-giant Enron, and the telecom ex-giant WorldCom are examples of corporations which have gone bust from their paper shuffling (although they are not alone). Yet the US energy system and telecom systems remain largely intact – the C has been out of the circuit.
The commodity-less circuit requires injections of additional money – as investors forgo the immediate opportunity to purchase real goods and services in exchange for financial paper. The purest form is the ‘Ponzi scheme’, named after a US fraudster of the 1920s. He promised a 100 percent return on an investor’s deposit in 90 days. As more people invested more funds, their later deposits were used to payout double the earlier investment. The apparent (but short term) success of the scheme attracted more funds, the upward spiral continuing until there were insufficient new deposits, and the scheme collapsed. Ponzi schemes are illegal in New Zealand, but some flourished recently in east-central Europe. Pyramid selling, also illegal, is another scheme for attracting cash at unreasonable returns based on a spiral to infinity.
In order to work, such schemes have to seem plausible. Suppose the greedy and gullible investor is presented with shares (financial paper) in an apparently sound company. The company can issue as many shares as it likes providing there are those willing to purchase them. Which they will, if they believe the share price will go up. That means some holders of the shares – those who bought them cheaper or paid as a part of their remuneration – can sell out, converting their financial paper into real money. This works as long as the share price continues to rise, or investor believe it will. Ideally the corporation should generate profits which underpin the beliefs from the commodities it deals in (it says it does, of course) but that is a hard yakker. It is easier to manipulate public expectations (corporate public relations bills can be huge) and, where necessary, to manipulate the financial and accounting information, which underpin the financial paper. Not all corporations concentrate on the hard yakker.
In principle that manipulation is restrained by accounting rules, and by auditors. But in the case of Enron the auditors failed miserably to assess the misapplication of the rules. (In any case there were glitches in the US accounting rules – especially that employees could be paid with shares without affecting the reported corporate profit). The case of Worldcom appears to involve pure accounting fraud. As the deceit unwinds, the certainty is that some people have parted with real money for the pretend money of financial paper – shares in worthless corporations. Their real money will have gone (illegally and legally) to others – often to people who had created the financial paper and sold it for real money. Investors overlooked there is a M→FP→M- circuit which complements the M→FP→M+ one. Reminded by the crashes, they are poorer, angrier, and vowing vengeance.
The threat is not only that these shocks may be sufficient to tip the US economy back into recession, with the rest of the world following. The longer run consequence may be a collapse of the triumphalism of US conservatism with its populist slogans of ‘freedom’, of accusing all forms of government of being ‘coercive’, of attacking the welfare state, of ‘greed is good’. Their corporate doctrine of maximising ‘shareholder value’ and claiming regulation inhibited ‘enterprise’ is likely to crash too. American business may rebound in the long run, but its new ethic may be more like that which flourished under Roosevelt. Perhaps American economic hegemony will also decline. We may be at a turning point of world history greater than the collapse of the Berlin Wall.