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Interview with Alejandro Nadal
The Key Organizing Principle of Society:
Macroeconomics – Markets or Sustainability
Part 2: The Day That Capitalism Changed Forever
Mexico City, Mexico
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Dr. Alejandro Nadal at his home in Mexico City. All photos by Nic Paget-Clarke
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Quick Links:
Part 2: The Day That Capitalism Changed Forever
2.8: Bretton Woods -- How Do We Organize the Monetary System?
2.9: Trust, Money, and Seigniorage
2.10: The Separation of Finance from the Real Economy
2.11: Private Banks as the Most Important Source of Money Supply
2.12: The Banking and Financial Sector
2.13: Macroeconomic Priorities for Social and Environmental Sustainability
Part 1: The Myth of the Invisible Hand
Download the entire interview PDF.
Alejandro Nadal is, “an economist. I studied law first and discovered economics when I was finishing law school. I decided to finish law school and then go into economics. I teach comparative economic theory. I’ve done a lot of work on microeconomics, which is market theory, how prices, how the Invisible Hand works. But then I’ve done a lot of work on macroeconomics, which is the analysis of entire capitalist economies. How do they work? I’ve done a lot of work on separate levels of studies in different industries.
“And then at the same time, I did a lot of work on the environment. I’m really concerned about what we are doing to our planet. I’ve done a lot of work on the drivers of economic degradation, not only talking about how bad things are but exactly what economic forces are driving the destruction of the environment. There are many dimensions, from climate change to genetic resources, and things like that.
“I write a weekly column in a newspaper in Mexico, La Jornada. I think that’s very important, to get out there and try to send some of the messages of the alarming things that I’ve discovered in my research to the general public. That’s more or less what I do.”
Nadal taught economics for many years as a professor at El Colegio de México and was director there of the Center for Economic Studies. “I just retired a couple of years ago. But now I teach in other places. I have a course in Barcelona at the University of Barcelona. I have a course in South Africa. These are compressed courses – a very intense, 12-hour course in 2 weeks on macroeconomics, the state of the global economy, the evolution of macroeconomic theory. And here in Mexico I also teach post-graduate courses in things like theory of economic development, macroeconomics, that sort of thing.”
Nadal is the author of Rethinking Macroeconomics for Sustainability and Arsenales Nucleares: Tecnología Decadente y Control de Armamentos. He is a former member of the Board of Directors of The Bulletin of the Atomic Scientists. He was an economic advisor to the Zapatista negotiating team in 1996. Also, in the context of the Convention of International Trade in Endangered Species (CITES), he is currently involved in analyzing the economics of wildlife trade.
This interview was conducted (and later edited) by Nic Paget-Clarke for In Motion Magazine on August 2, 2018 in Alejandro Nadal’s home in Mexico City, Mexico.
Part 2: The Day That Capitalism Changed Forever
2.8: Bretton Woods -How Do We Organize the Monetary System?
The dollar-gold standard / the reserve currency of the world
Alejandro Nadal: In the United States, one of the most amazing facts that people don’t know is that since 1973, the rate of growth of wages (has) become zero, or close to zero, of real wages. This is amazing.
In Motion Magazine: Well, related to that, could you tell the story of the process which starts with the United Nations Monetary and Financial Conference held in 1944, in Bretton Woods, New Hampshire, and brings the U.S., the world, to its current, extraordinary period of financialization?
Alejandro Nadal: IThe expansion of the financial sector is one of the key traits of the world economy since the ’70s, the ’80s. So, how is this related to Bretton Woods and also to profits, which is the key variable in any capitalistic economy? And, strangely, you never see those in the national accounts. You don’t see statistics about profit rates, anywhere. You have to build them. You have to construct an analysis to understand what happens to profit rates.
After the Second World War, the United States emerges as the dominant power. Its infrastructure is intact. Its industrial base is intact. Germany and Japan are devastated. Europe is devastated. Russia was devastated. China was just beginning their great civil war after a lot of turmoil and the Japanese occupation. The world is a mess. The U.S. has the largest gold reserves in the world, and you convene a conference in Bretton Woods trying to reach an agreement on how the international payments system would work in the future. How an international monetary system would work in the future. Trying to avoid the mistakes and problems of the ’20s and ’30s. To get away from the gold standard. Try to get away from competitive devaluations to maintain your competitiveness in the international markets. Trying to get away from these things. How do we organize the monetary system?
And they come up with a system in which every currency would have a fixed exchange rate. And they would all be related to the dollar and the dollar would be pegged to gold. The dollar would be the only currency pegged directly to gold at a rate of $35 per ounce of gold, and all other currencies would have a fixed exchange rate with the dollar and among themselves. And everybody would know that if you had dollars you could exchange your dollars for gold at that rate.
This was a system of fixed exchange rates. It wasn’t the gold standard. It was a dollar-gold standard. It was designed to give hegemonic power to the United States.
The gold standard had a lot of problems because the supply of gold is limited and you need to get gold to expand your monetary supply. It’s a big mess. The gold standard was not the solution of anything. Everybody knew that one of the important belts of transmission of the effects of the Great Depression had been the gold standard so that mechanism was rejected, correctly in my view. That’s not a good idea.
But it still subsisted in a very limited way through this relation between the dollar and gold. It was a way in which the United States could impose monetary hegemony on the entire world. The dollar became the preferred currency for reserve – the reserve currency of the world – and the privileged means of payments, of settlement of transactions in the world.
You had this system of fixed exchange rates that had to be accompanied by controls over capital flows. If you do not have controls over capital flows then it’s going to be very difficult to maintain a fixed exchange rate, as we know from the world today.
The IMF, the World Bank, and GATT
So, what came out of Bretton Woods were three or four basic things. Number one, fixed exchange rates, U.S. dollar convertibility with gold.
(Number two,) the creation of the IMF (International Monetary Fund) to supervise the entire operation of the system and to provide assistance to countries experiencing difficulties with balance of payments. In other words, you could allow for some adjustment in exchange rates but only if you informed the IMF and only if you had a certain degree of difficulties in your balance of payments. There was some degree for adjustment for exchange rates.
And what else? (Number three) you create the World Bank which wasn’t called the World Bank it was called the International Bank for Reconstruction and Development.
And as far as international trade, (number four) you had the General Agreements on Trade and Tariffs – GATT -- which was the precursor of the World Trade Organization (WTO). The United States Senate rejected the idea of a world trade organization, so they just had the General Agreements on Trade and Tariffs.
That’s basically what comes out of Bretton Woods. .
The competitiveness of the U.S. starts to deteriorate
The life of the Bretton Woods system coincides with the golden era of capitalist developments, what everybody calls the Golden Era of 1945 to 1975. The world economy grows at a very swift pace. Per capita incomes double in the United States. This is the happy era of capitalism.
In this period of time (though), very rapidly after the war, the competitiveness of the U.S. starts to deteriorate and you begin to have trade deficits with the rest of the world. I don’t know exactly the year in which this happens, (but) when I say very rapidly I mean fifteen or twenty years after World War II, Germany and Japan rebuild very rapidly. It’s an amazing story of how this was rebuilt, but you had the technology, the education, you had a workforce that was highly trained, very well trained.
Very rapidly, Germany and Japan start, for example, eroding the position of the U.S. in international markets even, and what is most important, not only in consumer goods but in the machinery to produce consumer goods -- machine tools for example. So, the deficit of the U.S. starts to show very rapidly, which meant that you were paying the world with dollars and these dollars could be converted into gold because of Bretton Woods.
I believe in 1968, maybe even before that, the amount of dollars circulating in the world, in the global economy, in the world economy, was greater than the amount of gold reserves that the U.S. had. So, the whole idea of convertibility was going down the drain.
The French, (President Charles) de Gaulle, as the outspoken leader of a country, of an ally of the U.S., says, “You know I’m getting worried because you guys are printing dollars, you are paying us with little green papers, and if I were to change this into gold, you guys don’t have enough gold. According to my calculations you have a deficit. If everybody wanted to trade those dollars for gold, you don’t have enough gold to maintain this arrangement that came out of Bretton Woods.”.
“August 15, 1971: the day that capitalism changed forever
So, in 1971, August 15 -- that’s the day that capitalism changed forever – (President) Nixon closes the (gold) window. He orders his Secretary of the Treasury (John Connally) to close the window and announces, “We are not going to let you change your dollars into gold anymore.” Wow! That’s really amazing. It’s the United States reneging from the most important multilateral treaty that existed in the world. The news is a shocker for everyone. But, if you look at the story, nothing really happened.
2.9: Trust, Money, and Seigniorage
Trust in the health of an economy
Nothing happened, for one good reason. Money doesn’t need to be backed by anything except trust. You don’t need to have silver or gold or whatever metal you want to imagine to back up the value of a currency. If you look at the world today, all currencies are what we call fiat money. Fiat money means it is not backed by the value of any commodity, or anything.
In Motion Magazine: Is it trust in guns?
Alejandro Nadal: No, you don’t need guns to back the value of your currency. You need to have trust in the health of an economy. That’s all. Those are big words. ‘Trust.’ What does that mean? ‘Health of an economy.’ What does a healthy economy look like? But basically, that’s what it boils down to.
For example, I tell my students, “Take out a hundred-peso bill, in Mexico. What does it say? It says ‘100 pesos.’” That’s the only thing it says. In the old days, when I was a kid, those bills said, ‘The Bank of Mexico’ – the central bank – ‘will pay to the bearer of this note the value of a hundred pesos.’ If I went to the Bank of Mexico previous to when I was born, that meant that the bank would give you 300 grams of gold for that hundred-peso bill – or whatever it was. (But), all of that disappeared and the bill said that the bank would give you 100 pesos, which meant that they would give you another new bill of 100 pesos.
Today, a 100-peso bill, or 20 or 50, whatever the denomination is, doesn’t say anything. It just says Banco de Mexico, 100 pesos, 50 pesos, 20 pesos. It doesn’t say that the bank will pay you 100 pesos. It doesn’t even say that. And that’s good enough for everyone. If I go and buy a meal at a restaurant, I can pay cash and they will not say, “What is this piece of paper? What do you mean 100 pesos? What is this?” They have trust in the fact that everybody accepts that bill. And everybody accepts that bill because that bill has a certain purchasing power.
Of course, if you have hyper-inflation, then that trust will break. Everybody knows that if tomorrow a piece of bread will cost 3,000 pesos then they will not take money, like living in Zimbabwe or the Weimar Republic, typical examples of hyper-inflation.
Fiat money, ‘fiat’ means faith, it means trust. When we say fiat money, we mean exactly that.
The origin of money
The origin of money is closely related to the problem of trust. Is there trust or not? In the very, very old days, and I’m talking three thousand years ago, we don’t need money. I brought you a chicken and I gave you a chicken because I was going to the store and I heard that you were going to have a party tomorrow and I thought, “I’ll take this chicken to him.” And you say, “What can I ...” And I say, “I was walking down to the store and I thought maybe you need this chicken. Goodbye.”
And then a week later, you will drop by my place and you will bring a pancake that you cooked and you thought it would be good for me to try it. Because we trust each other. We are neighbors. We are friends. We live close by. We help each other. You helped me last year with the floods and I helped you ten years ago. Whatever. We trust each other. We don’t need money.
But guess what? Alexander the Great was marching nearby with his army and the soldiers came and said, “Hey Nic, we need to eat something. What do you have?” And you said, “Huh, I’ll never see these guys again.” And you said, “Well, I can bake you a cake for this evening, but how are you going to pay me?” And they say, “Well, we have some pieces of gold we picked up from these Persian guys two weeks ago.” “OK, that’s fair enough. Give me those pieces of gold.”
This saying, “Money is the source of all evil.” I put it the other way around, “Evil is the source of money” because I don’t trust these guys. Hey, they are marching soldiers, they are going away. I want to get something back for my cake.
So, money becomes a central part of the equation because there was this lack of trust.’
The power to create money
(Now,) ‘seigniorage’ is the word used to describe the advantages of you having the power to create money. Imagine you are the king and I am your banker. And you say, “Alejandro, I need to buy stuff. I’m organizing a big party and we don’t have any money.” And you ask me, “Can you create some money? You are my banker.” “Sure. Of course.” So, I (set up) my printing press and this afternoon I will give you a thousand dollars. That’s great because now you have purchasing power that didn’t exist before. You didn’t have a thousand dollars. And tomorrow morning you will go to the market and you will buy stuff for a thousand dollars. You had purchasing power out of nothing.
That ability to create money confers on you a huge economic advantage. (Of course,) I will tell you, “Hey, Nic, wait a second. I did have some costs in printing money. I needed to pay for the electricity and the ink and the paper and my employees and that amounts to one dollar. So, instead of you having the purchasing power of one thousand dollars, you have the purchasing power of nine hundred and ninety-nine dollars.” And you will say, “I’m happy with that.”
That’s ‘seigniorage’ – the difference between the cost of producing a bill of money and the purchasing power of that bill of money. That is your seigniorage.
So, the biggest advantage of fiat money is you can create it without having to get gold or silver. How can I back this new purchasing power? Forget about it. That’s a relic. In fact, Keynes, has this phrase. “The gold standard,” he says, “is a barbaric relic from the past. It prevents you from creating money and when you have a crisis you may need to increase your supply of money. And if you are hamstrung because you don’t have gold then you cannot increase your supply of money. Forget about this relic from the past.”
In Motion Magazine: Isn’t it dangerous making money out of nothing?
Alejandro Nadal: Yes and no. Yes, it is dangerous. In fact, I think today it is dangerous, because, you know what, the power of making money out of nothing, or creating money out of thin air, as the expression goes, is now in the hands of private commercial banks. They have this power.
2.10: The Separation of Finance from the Real Economy
Flexible exchange rates
So, back to Bretton Woods. Bretton Woods collapses because the U.S. reserves of gold are insufficient to keep it in place. It collapses, and now what happens? Well, you get rid of the system of fixed exchange rates because when the U.S. says, “I cannot convert your dollars into gold,” it means that the keystone of the entire edifice is gone. You don’t have a fixed exchange rate between the dollar and gold, and you immediately open the door for flexible exchange rates in the entire system.
(Then) what happens? A company in Mexico that needs to buy some Mercedes Benz trucks because it is building a road (says), “My problem is I need to get some Deutsche marks to buy those Mercedes Benz trucks. I (was) ok because we live(d) in a world of fixed exchange rates. I knew how many pesos for each Deutsche mark, and I knew what was the price of these trucks. But now that system is gone and now the exchange rate may fluctuate so I have a risk now. And Mercedes Benz has a risk with me also.
“We need to take care of that. We need to hedge against changes in the exchange rate. We don’t want to lose money in the operation. We need to hedge against that risk and the way to do that is we need to be able to move capital from one country to another. From one economic space to another. We didn’t have that because Bretton Woods had controls of capital flows but now the need for those controls is gone but the controls are still in place. We need to dismantle that somehow.”
But then we also realize, “Hey, there is a risk but I can do some calculations and some arbitrage.” The idea of making arbitrage is taking advantage of the fact that there are differences in prices in a given market. “I can make a benefit out of changing the path of my transactions.” It is very simple
Just imagine that the value of all currencies is moving among themselves and these exchange rates are fluctuating. “What do I need to do? If today I buy U.S. dollars and with those U.S. dollars I buy Sterling pounds, and with those Sterling pounds I buy Swiss francs, and with those Swiss francs I buy Deutsche marks, at the end of that sequence of transactions I may get more Deutsche marks for each unit of peso that I spend than if I go directly to my bank and buy the Deutsche marks directly against the pesos because these exchange rates do not form a system of prices.”
The end result depends on the sequence. There are disparities. In other words, the end result is path dependent.
System of prices
By the way, ask any economist, “What is this ‘system of prices’? I hear you guys, you talk all the time about this ‘system of prices.’” Ninety-nine percent of economists don’t have an answer to that. They don’t know. And a well-educated economist should be able to tell you that a system of prices is one in which -- regardless of which sequence of transactions you (follow) between different commodities – in an exchange of two given commodities – (again) regardless of the path that you follow in the transactions -- you will always get the same result. The price of apples expressed in shoes will be the same regardless of your transaction directly between apples and shoes, and going from apples to cheese, and then to whatever articles you want, and then to shoes – you will get the same amount. That is a ‘system of prices.’ The definition of that is given in Walras (Marie-Esprit-Léon Walras), the father of General Equilibrium Theory.
Anyway, exchange rates today are not a system of prices.
The foreign exchange market: a playground for speculators
So, when Bretton Woods collapses, you have these risks of exchange. In those days, everything was fluctuating so you had to make these transactions and you had a risk, but you also realize you had profit opportunities. You can speculate in the exchange market and the forex (foreign exchange) market. The foreign exchange market is now a playground for speculators.
What do you take into account? Inflation rates. If I want to speculate in the foreign exchange market, I look at the rates of exchange, at their differences, at the margin between buying Japanese yen and selling Japanese yen because I’m going to do both operations. What is the time span that is required by their bank? If I need to stay there for five days, or two days, or six hours. What is the rate of inflation? What is the local rate of interest? I look at these differentials: exchange rates, inflation, interest rates -- and then I speculate. I have a robot. I have great software that calculates optimum paths for exchanges in the forex markets of the world. And that is why today the forex markets of the world have nothing to do with trade relations, with the value of commodities that are being traded.
I don’t have the number right now because they change all the time, but it’s 300 times or 160 times – those orders of magnitude – greater than the value of trade flows. It has no relation with whether you are buying Mercedes Benz trucks or soy beans from Brazil. It doesn’t matter because this is a casino.
The collapse of Bretton Woods opened up a gigantic space for speculation and profits and that is pure finance. That is a huge step in the separation of finance from the real economy. And that has led to a whole bunch of problems and difficulties.
Dismantling capital controls
But with that collapse you still have capital controls. “You needed to get rid of capital controls.” Gradually there was a movement to get rid of those capital controls (and) luckily for global capitalism, in 1979, 1980, Paul Volcker, the president of the Federal Reserve, appointed by (President) Jimmy Carter, he increases the leading interest rate from 4, 5% to 17% because, “you want to quell inflationary pressures in the U.S.” It wasn’t hyper-inflation. It was 12%, maybe.
He introduced this huge hike in the interest rate in the U.S. and that provoked – because it is a big economy, the largest economy in the world – that measure in the U.S. provokes a global recession. A very important recession. In 1980, ’81, everything contracts. The price of oil and most basic commodities and raw materials drops dramatically, while the cost of servicing debts increases dramatically. You have a perfect recipe for a crisis.
Mexico exploded in 1992.
And still you have to get rid of these capital controls because this prevented you from exploiting these opportunities for speculation. “If I cannot move in and out freely, how can I take advantage of these disparities, and exchange rates, and the fact that they are moving around? (How) can I make some profits by speculating? I can’t because the French require so many things for me to move in. The Japanese are so resilient with capital controls. I cannot go into those economic spaces in such a way that I can reap the benefits of speculating in the currency markets and the forex markets.”
In Motion Magazine: And this is simultaneous with (U.K. Prime Minister) Margaret Thatcher saying, “I like (economist Friedrich August von) Hayek”? She initiated these changes along with (President Ronald) Reagan, no?
Alejandro Nadal: They co-exist, all these things. She’s a spokesperson ...
In Motion Magazine: ... of what was happening?
Alejandro Nadal: Exactly. The most important thing is that those capital controls were still there, regardless of Reagan and the rest of the world. This structure was still there.
So, how do you dismantle this thing? Slowly and gradually some things were being dismantled. But, in ’79, ’80, the U.S. provokes this global recession, the global economy contracts. What does this mean?
(As I just said,) it means the price of oil and raw materials collapses -- they go down. And the cost of servicing the debts that many countries had at the time -- some of them had increased their indebtedness, very importantly – (they) became prohibitive because now the interest rate goes up (and) the raw materials that you sell, especially in the South, (their prices) go down. You have a crisis going on.
Something happened in the global economy. It was that this crisis was going on and a lot of countries had to go on their knees to the IMF to ask for help. Mexico was number one. We declared a unilateral moratorium on payments. “We cannot pay our debt. We cannot service our debt. We are up to here in debts and oil -- which we are very rich in.” Mexico had a lot of oil. We had just made a giant discovery of oil in offshore Campeche, but the price of oil has gone down. “We need help.”
And the IMF says, “Sure. Don’t worry. You came to the right place. We’re going to help you and we’re going to stabilize your economy -- under these conditions.” And that’s where you bring in neoliberalism to all these countries who request assistance from the IMF.
And the World Bank says, “Yes, I will also help you but with the same conditions that my colleagues with the IMF are asking of you, which makes sense because this is how you should do things because markets work well and you guys have all sorts of controls over markets. We have to get rid of those things. Your fiscal expenditures are too high and wages are too high. And the size of the state -- you have a company producing bicycles owned by the state! You guys are crazy. You need to downsize the state, privatize things, deregulate markets. You need responsible fiscal policy -- reduce all these expenditures you have. And you need to deregulate the financial markets. You need to get rid of these capital controls that you have.”
This was the golden opportunity to dismantle the remnants of the Bretton-Woods system. “You already have flexible exchange rates but you still have capital controls. You have to get rid of them.” So, the 1980s was the golden opportunity to finalize this dismantlement of Bretton-Woods.
The ’90s became paradise for speculation and capital flows. The ’90s is filled with financial crises involving inflow of capital into many “emerging markets” -- that’s what they call these countries now – (and then) reversal of capital flows and crises like the ones that hit in 1994, 1995. You had Malaysia, Thailand, Indonesia, Korea – you name it. All over the place. Which, by the way, (follows on) other crises like the Savings and Loans Crisis, – but that was way before.
What I’m trying to say is the economic history of the second half of the 20th century coincides with this expansion of finance and one dimension of that is the forex markets. The other dimension of that is something that was already happening but it consolidated in the second half of the 20th century, which is the role of private banks as the most important source of money supply. And that is an amazing fact, an amazing story by itself.
2.11: Private Banks as the Most Important Source of Money Supply
Means of payment
In Motion Magazine: What is that story?
Alejandro Nadal: Let’s start with today and then we’ll make a little bit of history. Today, in any capitalist economy in the world, the amount of money in circulation, in other words the amount of means of payments that allow an economy to function, the vast majority of that money in circulation is not created by the central bank of these economies, it is created by private commercial banks.
Typically, only about five or seven percent of the money in circulation in a capitalist economy today is made up of money created by the central bank, which is what we call ‘high power money’. In other words, if you look at the amount of money in circulation in Germany today, or Europe, because of the European Economic and Monetary Union, or Mexico, or Brazil, or the United States, only about five or seven percent of the money in circulation is really made up of federal reserve notes, cash, and coins. The rest is made up of things that are used as means of payment, in other words as money, by agents in the economy -- and those things that are used as money are created by commercial banks.
And what am I talking about here? I’m talking about checks. I’m talking about things like debit cards. And for transactions involving huge amounts of money, I’m talking about lines of credit, credit letters, all sorts of different financial titles that are used in transactions. If I’m buying a ship made in Korea, obviously I am not going to be paying with a check. I’m going to be paying with lines of credit and other types of titles – but they don’t involve cash. So, most of the transactions in an economy, 93 or 95% of an economy, are carried out through means of payment, are carried out by private banks.
The fairy tale about banks
Now, this is difficult for many people to understand because it’s counter-intuitive, but also it goes against the idea we have been given since we were kids, that when you save money you deposit your money in the bank to keep it safe and the bank pays you an interest. And then the bank, with those deposits then lends that money to investors who demand credit to make their investments, their transactions, and they pay you interest. And the difference between the interest that they pay you and the interest that the bank pays you, that’s the profit for the bank. The banks are, in other words, simple intermediaries between people who save and people who demand capital for certain transactions -- for consumption or for investment. It doesn’t matter.
That’s the idea that everybody has in their mind. How banks operate in our complex world, etc. The only problem with that idea is it has absolutely no validity whatsoever. It’s a fairy tale. That’s not the way banks operate at all. And there are many ways to demonstrate this.
One way would be if you look at the amount of savings in an economy, and you look at the amount of credit provided by the banking system, there’s no relation whatsoever. If the amount of credit given by the banking system were to be limited or constrained by the amount of savings that are deposited in the banks, credit would be a tiny fraction of what it is today.
So, what is this thing called credit? And what are these deposits? How does this work? The advantage of the fairy tale is that it is very simple and easy to believe. Easy to understand, and people believe. The funny thing is … I always wondered, people believe simple stories, but they also tend to believe in complex mysterious stories. And the more mysterious and the more unreal, sometimes they are more credible. … Precisely because of that, people believe it.
Well, this is the other way around because it is a very simple story. “Some people save, they deposit – and the deposits are lent. And,” -- to finalize the fairy tale -- “this operation happens in something called the ‘loanable funds market’. There is a market for funds that are loanable. They are deposited and now the bank can lend them. They are loanable funds.” The inventor of this expression is a Scandinavian economist called Knut Wicksell. Irving Fisher, in the U.S., also has the same terminology. “You have a market for loanable funds and in that market, what is the price? The price is the interest rate. There is a demand for loanable funds, and the supply of loanable funds, and the equilibrating price for that is interest rates.”
That is a fairy tale. That’s not how it works.
This is how the banking system works
And by the way, don’t think of one bank, think of the banking system in order to understand the story. Because if you think of one bank it is difficult to understand. I’ll explain why.
Let’s start with one bank. You have a project to invest in a factory for the manufacture of shoes. OK? You go to the bank, you talk to the manager. The manager asks to see the project. And you say, “Well, this is the project, these are my projections.” The banker says, “OK, Nic, you know we like you, you’ve been a client of the bank for a long time. We know you are a responsible client. You always pay your debts. My group of experts will examine the project. Come back next week.”
Next week, you come back and the guy says, “We love your project. Everybody thinks it’s great. The committee that looked at the project, looked at the economy, the economy is booming. Everything looks great. Let’s approve the loan.” So, he will tell you, “Here’s the million dollars that you requested. Here’s a contract. You sign the contract. We have just opened an account for you here in the bank and if you go to the ATM machine you can put in your debit card. Here is your check book and your debit card.” And you go into the ATM and you say, “Wow, yes, one million dollars is credited to Nic. Yeah, OK.”
And then you go out with your checks and your debit card, you start doing all sorts of transactions. And remember, this is fiat money and everybody will accept your check, you know. And the guy selling whatever that you need will accept your check because he knows that this check that you gave him from Citibank, he is going to deposit that in his account in Bank of America, and Bank of America and Citibank will settle the account in a clearinghouse and the accounts will be balanced by the end of the day. And you know that. And tomorrow you know that, and your supplier of cement knows that, and next day he will go up to his ATM and he will see that, “Oh, now I have now nine hundred dollars credited to my account because this was the amount Nic paid me yesterday.”
The banks recognize all of these titles and documents and instruments, means of payments, among themselves. That is why you have to think of the entire banking system. They all recognize each other through the clearinghouse.
What has been happening is, first of all, the loan that your bank gave you was a piece of paper saying that if you needed a million dollars in cash right now they would give it to you. “But I know that you don’t need a million dollars in cash right now because I have a series of calculations and my routine. I have a hundred years in the business. I know that the only thing I need to do is keep some in reserve because you might need $50,000 in cash tomorrow. I need to keep some reserves because I know you may need that. OK?”
But really what happened is we signed a paper saying that I promise that I will put at your disposal a million dollars in cash, cash meaning high power money emitted by the central bank. If you need greenbacks, I will give you a million of greenbacks. It’s a promise but I know you don’t need the million dollars right away -- but I do need to keep some reserves.
On the other hand, you signed a contract and you now have the obligation to give me back a million greenbacks, plus interest. That’s your promise (over) a certain period of time. That’s a contract that you signed. And the guy, your supplier of cement, he received the promise (on) your part that you will give him $900 in cash. Your check means, “I promise to give $900 in cash whenever you need it. If you go to the bank today with your proper ID, go to my bank, my bank will honor this promise and will give you $900.”
So, we are talking about promises. The bank promises you. You promise your supplier. Your supplier goes to the bank and the bank recognizes that promise, and takes that check into his account, and the clearinghouse will honor that promise. But really nobody took the greenbacks and gave you the million dollars in greenbacks. You didn’t give $900 of greenbacks. We are dealing with promises to provide greenbacks.
But it’s money. It’s money. It’s used as means of payment. You got your cement and started operating. You hired people. You also paid them by checks, or your bank credited their account electronically, because you gave orders to your bank, etc. There’s no physical transmission of greenbacks. Ninety-five percent of the transactions in the economy are carried out in terms of these means of payment emitted by private banks.
It doesn’t mean that the banks don’t need deposits. They want all the deposits they can get from the public, from people who save money. The bank needs to have some cash in reserve. But if the deposits are reduced and people don’t always make deposits, and the bank finds it doesn’t have enough cash reserves to keep safe all these clients that I have coming around, as a bank I benefit from these contracts because you, if you are my client, you have to pay me in greenbacks. Not a little check saying I make a promise. No, no, no. Where are the greenbacks? You need to pay me in dollars and with interest. I will benefit from all of these operations. I have an interest in keeping them growing.
Now, if I run low on my reserves I need to do something about that to keep the thing going. So, what I will do is I will borrow some cash from other banks who have an excess of reserves and I will pay an interest on that because I need to maintain my reserves. And if all of us banks are running into the same problem, which means we are lending a lot of money and our loans are increasing and we don’t have enough reserves as a system, guess what? The Federal Reserve will come to our help and provide us the cash needed for those reserves. And of course, we will have to pay interest on that.
The Federal Reserve accommodates its policy to the needs of the banking system
But this means something really profound. It means that the Federal Reserve not only does not control money supply, but it accommodates its policy to our needs as a banking system. Now this is a major, major thing. It means that what we think of as a central bank in reality is at our service.
I know I am making a bit of a caricature of the whole system, but essentially, I think that is how it works. You know people think that the government or the Federal Reserve will impose regulations on reserves. Yes, sure, of course, when there is need for reserves the Federal Reserve will come into back up the banking system. Why? For a very simple reason. The Federal Reserve doesn’t want the economy to collapse or to slow down. The government doesn’t want the economy to slow down. So, it’s happy with these autonomous decisions of the Federal Reserve.
In Motion Magazine: So, the Fed’s money is the money we give them in taxes?
Alejandro Nadal: No. The Fed is not the government. That is the Treasury.
In Motion Magazine: The Fed itself is private banks?
Alejandro Nadal: It’s private banks. It’s not the government.
In Motion Magazine: Even the people making the decisions come from other banks?
Alejandro Nadal: Sure.
In Motion Magazine: What does that mean as far as who runs the country?
Alejandro Nadal: What composes the dominant class or the elite in a country like the U.S., the driver’s seat? Somewhere in that important seat is the financial and banking sector.
2.12: The Banking and Financial Sector
Banks are multinational corporations
In Motion Magazine: Has this process gone beyond country borders?
Alejandro Nadal: Oh yes, in many, many ways. These banks are multinational corporations in and by themselves. Citigroup owns the largest bank in Mexico, for example, which is a very important source of profits for them. And they are all over the place. And they speculate.
We just spoke about banks, but maybe that is not even the most important part of the banking and financial sector. It is not the most important sector. You still have the stock exchange, the forex markets, and most importantly, the market for financial derivatives, and another market which is the shadow banking system and the over-the-counter-transactions which are not regulated by anyone.
When I focus on the banking system, everybody is working on that, but much more difficult to understand is how do these other financial markets operate and what are the implications.
In Motion Magazine: Who are those people?
Alejandro Nadal: They are the 0.001 percent. They don’t see the world except through the lens of some numbers, dynamic flows of currencies and instruments and derivatives. The institutions are more well known. You have hedge funds, pension funds, gigantic ones, that get involved in these financial transactions. You have the banks and other financial agents. There are many things here that are very opaque.
One of the things that I do is I look at the apparent implications of this and one of the things that comes out of this is if you look at macroeconomic policies, as I tried to do in that little book, they are geared to the interests of the financial sector. They are not organized for the objectives of economic development, or sustainability. They are organized around the needs of the financial sector.
What does the financial sector need? Well, first of all, it needs to fight inflation because inflation is really bad for the financial sector. Then it needs stability.
In Motion Magazine: Because inflation devalues their money?
Alejandro Nadal: Well, yes, exactly. If I lend you money and then the inflation rate is very high, even if I try to earn interest I lose money because when you re-pay me the purchasing power of that money is less. (Also) the financial sector discovered that there was another enemy which was called deflation and they cannot decide which is worse. That’s when the prices are going down.
So, the financial sector exploded, and maybe it’s not an exaggeration to say, but the global economy caters to the needs of the financial sector. And that’s a terrible thing because we do have environmental and social problems that are critical and if we are thinking of catering to the needs of the financial sector, then we are moving in the very wrong direction. That’s not a good road to take.
2.13: Macroeconomic Priorities for Social and Environmental Sustainability
Urgent for our own survival
In Motion Magazine: In the last portion of your book you offer various proposals for macroeconomic policies which would place social and environmental sustainability at the core. Can you talk about the main ones?
Alejandro Nadal: As I just said, maybe it’s not inaccurate to say the global economy is organized around the priorities and interests of the financial sector and we need to change that radically. What we need to do and it is urgent for our own survival, is to organize macroeconomic policies around the priorities and needs of, let’s say, sustainability in a broad sense.
That would include the question of reducing social inequality and increasing the capacity of the environment to resist the onslaught that we have unleashed on soils, water, genetic resources, biodiversity, climate, the atmosphere, etc. We need to organize our economies in a different manner. We are not moving in that direction whatsoever.
To do that, I don’t have a recipe for that. You probably need to change the political landscape and that’s not going to happen until we have a very serious crisis on our hands that tells people that we really need to get our act together. But if you asked me today, “What would you do?”, we could find some general principles of how to organize matters so that we could advance in that direction of sustainability – social and environmental sustainability.
One of the principles would be immediately putting a rein on, controlling, the main components of the financial and banking sector. This would be urgent because without that the Titanic will continue on its path to the iceberg.
We need to reorient how money creation is carried out. We need to reorient credit. Just imagine, today, poor campesinos worldwide, and I’m sure you have encountered this from your contacts with La Vía Campesina, they are not eligible for any kind of credit, for loans. Credit for small-scale agriculture worldwide is at a very, very low level. In Mexico, it’s zero. I would say it is zero. You need to do something with the financial and banking sector. You need to control that and regulate that. This would allow you to recover your monetary policy as an instrument for development.
Fiscal policies – you need to do something with fiscal revenues, and move away from this idea of, ‘You cannot touch the one percent because then capitalism will go elsewhere.’ That’s absolute rubbish. You need to change that. You need to increase expenditures in education. Just imagine environmental education. Education in general. Health. Infrastructure for environmental expenditures needs to be increased seriously. In Mexico, I can tell you right now that expenditures that can be quantified as environmental investment are marginal. Public expenditures in these things are marginal.
You need to re-regulate or revisit trade relations. This is terrible. Once again, if you look at small-scale agriculture and look at, I already mentioned credit and loans are at a very low level, or zero, if you look at public expenditures for these social groups, they are very low. Even if you focus against poverty elimination, that’s not sustainable, it doesn’t make a big difference. You still have all these problems. But in addition to that you have trade relations that have created very unfavorable economic context for these social groups, in terms of prices. Very adverse price structures against them. Expensive inputs, everything they need has gone up but the prices of their output have either stagnated or gone down. The terms of exchange for these groups are very unfavorable.
Combine these things: unfavorable terms of exchange, loan credit, and very small public support – you have a catastrophe. You have a social and environmental catastrophe because these guys (the farmers and peasants) are curators of the environment. Certainly, they are the curators of genetic resources. They are the guys that select seeds. ‘This corn is very good. This one is not so good.’ If you dismantle the social fabric that underpins this capacity of communities to select seeds and conserve genetic resources – if you undermine that, then you have a big, big problem in your hand. You don’t notice it today, but you will in a few years down the road.
Look at wages. Look at key processes for the economy. We need to reorganize the entire macroeconomic policy package and that means, yes, re-regulating a whole bunch of economic activities.
Growth is the engine
In Motion Magazine: You say in your book that growth is the engine of capitalism. It’s what makes it keep going.
Alejandro Nadal: Well, capitalism has in its DNA letters that spell growth. Capitalism is accumulation, growth. What we call companies or firms in a capitalist economy are what Marx calls -- very accurately I think … -- “private centers of accumulation.” They need to grow because if they don’t grow the competition will eat them. Every unit has to keep on growing. And, if you look at the formula for the circulation of capital, capital implies growth.
In Motion Magazine: Which makes a person rather anti-growth. But you point out that that’s a classist approach to life. There’s a lot of poor people in the world and they shouldn’t be living their lives in that manner.
Alejandro Nadal: Absolutely.
In Motion Magazine: Is it possible to have a sustainable society while also growing in order to deal with the situation? The changes that you propose in your macroeconomic package are reforms, current ones, they are not new ones.
Alejandro Nadal: I don’t talk a lot about these things because I don’t have a very sophisticated set of answers to the questions that are really the urgent questions that you are posing. And those are the questions that we face.
My simplistic take on this is the following. First of all, the world economy can have growth in a sustainable manner, that can be growth that is environmentally responsible. I think that is possible. And socially responsible too. But for this to happen you need to have some kind of democratic social control over the forces that are behind growth. I guess what I’m saying is growth is too important to leave it to the capitalists. -- I’m paraphrasing the idea of, “War is too complicated to leave it to the military.” Growth is too important an issue to leave it to private capitalist centers of accumulation.
So, what do you need? As you point out, you have half of the population of the world, I think more than that, living in poverty, in conditions that need to be improved urgently. We need growth for that. We need socially-, democratically-supervised, monitored control over this growth.
Published in In Motion Magazine November 25, 2018.
Part 1: The Myth of the Invisible Hand
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