10   The Mathematical Nihilism of a Subprime Economy

William Krehm

A subprime economy may be defined as one dominated by the fiction of "risk management." The concept of "risk" is enacted rather than properly defined in terms of what it might be, where, when, and for whom. Above all there is the privileged position of deregulated and globalized banking for whom the "bankers’ exit" or the marketing of swaths of supposedly defined "risk" to naive third parties. That terminates the banks’ own exposure with a positive gain at the expense of the ultimate investor.

The scenario was set up by the Cold War that climaxed under President Richard Nixon in the US with the abandonment in 1971 of the gold standard. The gold standard could hardly hold up under an explosion of stresses: the cost to the Western dominant states of the Cold War, combined with the deregulation and globalization of the financial system, the technological revolutions involved and the costs of the huge non-marketed physical and human infrastructures associated with these developments. Many of these costs came in the form of public services covered out of taxation. This new and rapidly expanding layer of costs, that most English-speaking economists tried explaining away by equilibrium theory had been the subject of questioning by an entire school of French economists.

With some mathematical training, and intense reading of economic literature in the Ricardo-Marx tradition, I was able to identify what Pierre Biacabe and other French economists had decided must exist, because in different countries and at different times they found that the price level often rose, when the volume of production fell rather than rose. With no acquaintance at the time of the existence of such conclusions by Biacabe and others, I associated it with the deepening layer of taxation that was collected by the state and entered price as a layer of costs that was not market-determined. That I called the social lien. This led to the publication of a 60-page manuscript sent out blindly to 30 academic publishers throughout the world. It was published in La Revue Économique of Paris in May, 1970.

Among other results, this led to my close relationship until his death in 1987 with François Perroux, who provided insight into another important aspect of the process that was reshaping the economies of the world, but that was denied recognition by economists of officially recognized schools. This was the notion of the "dominant revenue" that by its volume and rate of reward of a privileged class is identified with the welfare of society as a whole. In the given instance this took the form of elevating interest to the position of the sole means of fighting "inflation" identified with any price level above a perfectly flat one.

The French Concept of the Dominant Revenue

Ever since the banking legislation under President Delano Roosevelt in the US in 1933 that eventually became the model for banking legislation in other lands, there had to be at least two distinct ways in which central banks tried controlling the tempo of their economy. For if there were only a single one, it would endow a privileged revenue with a dominant position – to use a nomenclature of which Roosevelt’s economists had never heard. Under Roosevelt’s banking legislation, the central bank published the benchmark interest rates at which one bank could borrow from another bank for overnight loans – the Federal Funds Rate in the United States, or at the Discount Rate at which banks could borrow from the central bank itself, usually at a somewhat higher rate. Or alternatively or as a supplement to the manipulation of the benchmark rates, the statutory reserves required that the banks redeposit with the central bank a percentage of the deposits they received from the public, and on this the central bank paid no interest. This had the effect of supplementing the use of the benchmark interest rate or replacing its use entirely. It also provided the government with a cost-free source of funds, and it supplemented or wholly eliminated the manipulation of the interest rates as the sole regulator of the pace of economic activities. Interest, after all, is the prime revenue of money-lenders and speculative money, and attributing a monopoly position to the benchmark interest rates was tantamount to endowing finance capital with a monopolist position over the economy. Central bankers mistake what I called the "social lien" for the price effects of too active an economy, i.e., inflation. In fact they elevated interest to what François Perroux had defined as the "dominant revenue" of a new era that was dawning.

The Dominant Revenue — The Compass for Understanding History

Perroux defined as "dominant revenue" the privileged revenue, the rate and volume of which is taken as an index of the well-being of society as a whole. This may seem so under a given power distribution. As that passes from the hands of one class to that of another, the revenue of another class takes over. Thus under feudalism it was the non-monetized economy of the warriors that was dominant. After the Napoleonic Wars, in Britain the highly protected large landowners were privileged. With the removal of the protection of the Corn Laws, the industrialists who profited from the lower wages resulting from cheaper food costs succeeded the landowners.

Then with the deregulation and globalization of banks that permitted them to take over the other "financial pillars" which had been forbidden them under the Roosevelt banking legislation, power shifted to speculative finance. But with the deregulation of the banks beginning in 1971 that allowed them to take over stock brokerages, insurance and mortgage firms, they acquired access to the cash reserves that each of these maintained for the needs of its own business. Once the banks acquired access to these, it applied them as the monetary base for the bank multiplier. In 1946 the bank multiplier amounted to the banks lending out of a multiple of about 10 to 1 of the cash in their vaults. But with deregulation and globalization, this grew rapidly as layer upon layer of cash reserves of the non-banking financial pillars were taken over by the banks as money and then the banks created a growing amount of near-money – interest-bearing – by lending it out.

And then for the next storey, this newly created near-money was again traded as though it were legal tender and served to support a further mixed storey of near-money and legal tender created by being loaned out. There was a constant confusion of near-money with legal tender. This process gradually created a subprime economy before economists were aware of what was overtaking our society.

In this process the distinction between legal tender and interest-bearing loans and investments tended to disappear. By 1998 the ratio had risen to 380 to 1, while the denominator of the fraction tended to vanish completely. But that would leave us with a zero denominator. Because of this, the statistic that COMER compiled – to avoid a zero denominator to the ratio which would transform it to a meaningless infinity, we made use of the cash in the banks’ tills and what was kept for its ATM machines and the other needs of its customers. That, however, was not available for supporting the banks’ spreading speculations. For once banks could no longer freely provide change for a $10 bill, runs on banks would take over.

That is when COMER started warning about the deregulated and globalized banks flooding the world economy with near-money earning interest as high as possible that craved ever higher speculative returns. That was the beginning of the subprime banking that has deluged the world. Economic Reform started warning against this 5 and 6 years ago as it appears in the second and subsequent issues of Meltdown just now appearing in a series.

William Krehm

– from Economic Reform, April 2008