What is credit?
Now, more than ever, there is an imperative need for people to understand the nature of credit in a capitalist society. In a time when we are seeing the high seas of finance increasingly rocked by rolling crisis and systemic instability, from Enron to the sub-prime mortgage debacle to the dot.com bubble to the asian financial crisis- in such a time it is imperative that average citizens develop a useful critique of the way credit functions in the global economy.
The workings of the world of finance are tangled and confusing. To most of us, it all seems to take place behind closed doors, through a dizzying array of credit instruments and agents- stocks, bonds, futures, shorts, hedge funds- which very few of us understand. Actually, most people in the world of finance don’t understand it either.
This video will not seek to explain all of the details of those complicated instruments and procedures. Instead it will explain the credit system in the abstract asking three main questions: why is there credit? What is credit? and why should we care about it?
1. Why is credit necessary in a capitalist society?
If you haven’t seen my videos on capitalism and capital you should see those. This is the basic circuit of capital which distinguishes a capitalist society: M-C-M. Capitalists must constantly be turning their money into commodities and then back again in order to compete with each other. The production process, in which the commodities of raw material and labor power create new commodities for the capitalist to sell for profit, is the sole source of value creation in a capitalist economy. If this circuit of capital is ever broken- if capital is frozen in any stage of the process, in the form of money or commodities, it looses its value. This is bad-it’s the stuff crisis is made of. So capitalists are always looking to perfect the circuit of capital- to turn their money into commodities and then back into money faster and more efficiently.
Unfortunately this is easier said than done. There are many temporal and spacial inconsistencies in the circuit of capital which prevent a smooth flow of M-C-M.
In order for capitalists to make their initial investment M-C, they need money. If the investment is a small one this isn’t too much of a problem. But often times capitalists need a lot of money- to build a factory or skyscraper, for research and development, etc. In order to save up the money for this investment they would have to hoard their money- that is, take it out of the circuit of capital long enough to save up for the investment. This is not a desirable solution because, as I have already stated, the goal is to constantly keep money circulating through the circuit of capital (that’s the whole point of being a capitalist.) This is where credit comes to the rescue, as we’ll discuss in a moment.
Once money is invested in new production, capitalists still have a problem. The building of factories, skyscrapers, roads, etc. takes a long time. The money they have invested in production is frozen in production, waiting for projects to be completed. And then once the project is complete, it takes many years to recover the cost of a skyscraper or a factory. Capitalists want that money right away so that they can return to the circuit of capital.
And different types of production have different turnover times. Some commodities can be made in a matter of seconds, others take years. Capitalism is plagued by a confusing diversity of turnover times. It is constantly seeking to get new products on the shelves for consumers to buy and to invest new money in production, but the diversity in production times makes it hard for all of this to be coordinated.
Lastly, people have to buy all of this stuff in order to complete the circuit C-M. Remember that in the production process workers are always creating more value than existed before. If at the beginning of the production cycle we’ve spent money on wages and raw materials and at the end of the production cycle we have commodities of greater value than those wages and raw materials we have a “realization problem”- that is, where does the value come from to buy this new value if value is always expanding? Here I’ve made a bit of a simplification that I don’t have time to get into any further, but the point is that consumers don’t always have enough money to buy all of the commodities that they make.
The basic problem in all of these examples is that of time and value. The production of value takes time. But the circuit of capital only functions smoothly when time isn’t a barrier.
2. What is credit?
This is where credit comes to the rescue. Credit advances money capital ahead of the production of real value. When capitalists need money for an investment they borrow it. Eventually value is created and they can pay back the loan. When consumers need money to buy commodities they borrow it. Eventually they create the value of that loan in the form of wages for their labor which they use to pay back the loan. As long as the economy continues to produce enough value to pay back all the credit that has been advanced capitalism grows at an even pace. But when production can’t keep up with the growth of credit we see explosive, destructive results.
Let’s look a little closer at some examples of credit creation to see how this process works.
Stocks. When a company needs a ton of money for investments they sell shares of the company as stock. When you buy a share in one of these initial public offerings you are lending the company money in return for a share of future profits. The piece of paper you receive saying that you own a share of future profit is a type of credit money. It’s value is fictitious, that is, you have no way of knowing, for sure how much value that stock certificate represents. If the company is profitable, its shares will be worth a lot. If it goes belly-up its shares are worthless.
People then trade and sell these stocks-these fictitious values- to each other on the stock market. In a form of mass insanity, traders buy and sell slips of paper that are nothing more than fictitious value- promises of the creation of future value. The price of these stocks can then inflate way above the actual value of the company due to hype, trends, rumors, false information, etc. In the dot.com bubble of the 90′s we saw over-enthusiasm and hype about internet markets create a huge “speculative bubble”- that is a rise in stock prices way above the actual assets or future assets of a company. In the case of Enron, we saw a company prop up its stock prices by “cooking it books”- that is lying about the actual value created by the company.
Because fictitious values can inflate so far above real values there is a lot of money to be made by playing the stock market. At the same time, the most profitable investments are often the riskiest. While great wealth can be made on the stock market, no value is actually created. In fact the value of stock is always eventually beholden to the actual production of value in society by productive capitalists. At the same time, the actions of stock traders has real effects on the economy. We’re noticing a lot of these effects now as we see what happens when the fashions of finance create huge speculative bubbles in mortgages.
Government debt is another source of credit and therefore of fictitious value. When the government sells bonds it is borrows money in return for an IOU. Now, where does the value come from to pay back that fictitious value? Government don’t engage in capitalist production- they aren’t part of the circuit of capital. So how do they get value to pay debts? Government revenue comes from taxes. Tax revenue comes from taxing wages and profit- that is, they are deductions out of the circuit of capital.
Again, it’s important to point out that the government is not creating any value by doing this. In fact, government bonds are highly fictitious in that they are only loosely tied to the actual production of value in society. Government expenditures are in a large part subsidies to capital- they build infrastructure, invest in research, protect private property, educate workers, etc. But there is no clear way of knowing exactly how directly these government expenditures contribute to value creation. On the other hand, government bonds are often considered more secure than stocks because people trust the government to be able to pay them back eventually- the government doesn’t go out of business.
Banks create credit in a unique way because unlike other institutions that loan money, banks are also entrusted with guarding the general money supply. Not only do they house the savings of workers and capitalists, but they also act as a clearing house for IOU’s between capitalists. There is a constant flow of money through the banking system in the form of checks, bills of exchange between capitalists, government securities, stocks, deposits and withdraws. Because the volume of these transactions exceeds the actual amount of paper money held by the banks, and because paper money is slow to circulate, most of this money takes the form of digits in computers. Banks only need to keep enough paper money in their vaults to cover the average demand for cash withdraws. Thus paper money only represents a portion of the total money in society.
This makes it easy for banks to create loans. All they have to do is enter digits into an account, and- wa-lah!- a loan is created. This loan is now fictitious value- it is new money created out of thin air. This is a point that is harped upon extensively on the internet now-a-days and so I won’t go into it in detail here. But, what isn’t often pointed out is that, like any fictitious capital, that loan is paid back through the creation of real value. That money that was created out of thin air becomes real value once it has gone through the circuit of capital and been valorized by human labor. And if it wasn’t for these bank loans capitalists wouldn’t have a way of overcoming the temporal obstacles to the circuit of capital.
But banks can easily create way too much fictitious capital through the creation of this credit money. Because they profit from interest on these loans, and because they have to do nothing but enter digits in a computer in order to get this profit, the temptation is to give out a lot of loans and not worry about whether they can be paid back with real value. Like any fictitious capital, this can get out of hand and create speculative bubbles which hurt a lot of people when they pop. Banks behaving badly can ruin the role of money as a measure of value and thus threaten the entire structure of the economy. That is why there is close federal regulation of banks and hierarchy of monetary institutions culminating in the Federal Reserve to keep the money supply safe from abuse. Of course, this doesn’t always work. That is a topic for another time.
3. Why should you care?
Remember that an economy is an ensemble of social relations which organizes the productive powers of human labor and distributes the products of this labor in some way or another. Thus labor is the source of value in any economy and the true study of social relations in any economy is a study of the way in which this value operates. In a capitalist society value is created in the productive part of the circuit of capital- that is, by workers working for capitalists. But in perfecting the circuit of capital capitalists run into temporal barriers and thus it becomes essential to have money capitalists to lend money, creating money ahead of the creation of value. And so arises a huge faction of the capitalist class dedicated solely to the managing of money and credit money.
But in doing so fictitious value is created and we run into a serious problem: if the temptation of fictitious profits causes fictitious capital to grow far beyond the possible production of real values we encounter financial crisis. This is a deeper manifestation of the same conflict laid out in my video “what the hell is money?”- the conflict between money as a medium of circulation and money as a measure of value. What is missing from this picture is a description of the limitations to productive capitalists in catching up to this fictitious value creation. I will discuss this in a future video on the “falling rate of profit.”
I have been quite pleased in recent years to see a growing number of libertarian celebrities from Ron Paul to Aaron Russo to Alex Jones raising serious questions as to how money capital is controlled in our society. This has led to interesting discussions about the role of credit, money and banks. I agree with them that private ownership of money capital is both immoral and leads to serious abuses that threaten the measure of value in society. However I think that their critique falls short of an understanding of the relation of money capital to the entire circuit of capital. I would argue that private ownership of productive capital is equally undemocratic and that the behavior of individual productive capitalists in competition can also destabilize value creation and have serious effects on all of our lives. In fact money capital arises as a response to the erratic behavior of productive capital. I also think that the large, hegemonic powers attributed to the federal bank by libertarians is exaggerated- that the federal bank’s power is limited by its position in the circuit of capital. I will go much deeper into this in a future set of videos on crisis theory and a future video on money capitalists.