The Low Arithmetic of High Finance

October, 2008

Contents List:

The Banking Crisis
Financial Responsibility
Arithmetical Education
Where Will the Money Come From?
Inflation - or Debasing the Currency
A Question
The Banking "Bail-out"

Return to:

World Views
Ardue Site Plan

See also:

Looking Backwards and Forwards
Currency Sense and Nonsense

The Banking Crisis

Collapse of Western economies has come about chiefly because financial operators indulged in some highly questionable practices to which the guardians of the people turned a blind eye. For example, opportunists sold large quantities of shares they did not own, confident that the resulting drop in price would enable them to "buy them back" cheaply before "settlement day". No shares would actually have changed hands: only money would have flowed from the actual share-holders to the speculators.

For further example, Banks and Building Societies extended too much credit to borrowers who were far too anxious to "take the waiting out of wanting" and who in due course proved unable to pay their debts. Regrettably, the officers of the banks helped themselves to fat bonuses on the basis of loans made, ignoring any downstream risk of default.

It is now clear that as a result of these and other even more devious malpractices, much imaginary money has gone to what the late Bob Beckman used to refer to as "money heaven"; the lending institutions are "skint"; and the lending pendulum has belatedly swung so far in the direction of prudence that the banks are reluctant to lend to anyone at all even to one another because there is no longer any basis for mutual trust.

We cannot yet be sure that in their desperation to "save the system" by spreading "safety nets" beneath the financial institutions, our politicians will not be too lenient and fail to control what the Governor of the Bank of England rightly calls "moral hazard". Governments have themselves become much too comfortable about being in debt. As the current crisis is essentially one of mass psychology, we can hardly be confident that governments know what they are doing; so we must try to keep a sharp eye on them.

Financial Responsibility

If we, the people, were educated to be financially responsible, we should neither fall victim to the blandishments of loan sharks nor be very happy about governments pledging large sums in our name. If our politicians were as "prudent" as they used to profess themselves to be, the tax-payers of future generations would not have to shoulder the burden of a gargantuan national debt. Not only the Treasury but also a large proportion of the UK population would have savings to tide them over a two- or three-year recession, and national morale would not sink into a slough of despond threatening an outright slump as fundamentally good businesses grind to a halt for lack of financial lubricant.

Arithmetical Education

Despite the proliferation of so-called universities in recent years, the great British public is, in general, poorly educated in matters pertaining to money. Decimalisation and hand-held calculators not only make "doing sums" too easy; they obscure the real meaning of the sums themselves.

The country schoolmaster who first taught me arithmetic always insisted: "Keep your quantities big and your figures small". In those days before decimalisation, the largest weight was the ton. There were 20 hundredweights to the ton, 8 stones to the hundredweight, 14 pounds to the stone, and 16 ounces to the pound. A large proportion of the school day was therefore spent in practising arithmetic involving weights and measures. Doing the sums inculcated a good knowledge of the multiplication table and country boys and girls, who almost always had personal experience of moving all manner of loads and shapes, had a pretty good idea of what the various units meant.

For measures of length, we had "inches" at the ends of our fingers, "feet" at the ends of our legs, and we measured lengths of string and rope in "fathoms" (i.e. six feet or two yards) by horizontally extending both arms. Now that EU standardisation obliges us to measure lengths in millimetres instead of feet and inches, and weights in grammes instead of pounds and ounces, our quantities have become too small to relate to parts of our bodies, our figures too large to be carried in our heads, and our arithmetic has "lost touch" with the natural world. With large numbers expressed as decimals, we have difficulty in working out where, exactly, to put the commas and the decimal point. The resulting numbers mean very little to us.

When the Chancellor of the Exchequer pledges 500 billion pounds of tax-payer indebtedness to support the banking system, we have no clear idea of what it implies. It may help us to appreciate the enormity of this undertaking if we compare it with another large number the human population of Planet Earth, which is said to be approaching 8 billion. If you "keep your figures small" and divide 500 by 8, the answer is 62.5. This means that the Chancellor has committed the equivalent of 62.5 pounds sterling for every man, woman, and child on Planet Earth. Taking the population of the UK as 60 million and doing a more difficult sum with larger figures, we can work out that this implies a commitment of more than 8,000 pounds sterling for each man, woman, and child in the country. People naturally ask where all this money is going to come from.

Where Will the Money Come From?

If we ask the Chancellor where he expects us to find the money to pay for the promises he has made on our behalf, he may offer one or more of several possible replies. He may say first of all that all he was doing was "under-pinning" the banks that is, providing insurance in the event of future banking problems; that most of his undertaking would probably not be called upon; and, if it were, the state would ultimately realise a profit from the interest the banks would have to pay.

If pressed further, he might say that the interest the state itself would have to pay on the money he might have to borrow to make good his commitment could be spread over many years, and the tax-payer would hardly notice the re-payment instalments.

In the last resort, the Chancellor might be forced to admit that a Chancellor who has to borrow such enormous sums must be in charge of a very unreliable economy and that the value of its currency cannot be relied upon. In such a case, the value of the pound sterling would fall in comparison with that of "stronger" currencies such as that of, say, China. Then UK citizens would have to pay higher prices for imported goods and services as well as higher taxes to repay the National Debt.

The ultimate meaning of these enormous figures is that paying off the debt would burden many generations with higher prices and taxes if inflation did not come to the rescue.

Inflation or Debasing the Currency

The smallest copper coin I remember was the farthing. It had the King's head on one side and a lttle bird (it might have been a wren) on the other. The farthing was worth a quarter of an old penny and there were 240 old pennies to the pound sterling. Hence you could get 960 farthings for a pound.

In 1945, my father paid about 250 pounds, i.e. 230,400 farthings, for a house roughly equivalent to the one I now live in. The market value of my house a month or two ago was said to be about 250,000 pounds. On that basis, it appears that the value of the pound has in a little more than fifty years shrunk to the value of less than one farthing in my father's money,

That is what is meant by house price inflation. From this example, you can see that inflation is the same thing as devaluation of the currency. In former times, debasing the currency was deemed to be a criminal offence.

I think the kindest thing one can say is that since 1945, successive United Kingdom governments have been very poor guardians of the value of the pound sterling. Even if they did not deliberately debase the currency, they at least permitted financial sophistication by obscure parties to turn theft into into a work of art and allowed it to become a mainstay of political life.

The value of any currency is at the mercy of public opinion much more immediately and directly than is the life of a "democratically elected" government. Once people have lost confidence in their money, its value can fall very quickly and can be very difficult to restore. Hence the currency of any country has no lasting value. This may be why it is called "currency", because its current value is not expected to stay the same for very long. Whether a currency is "strong" or "weak" is entirely a matter of confidence, and it will maintain its current value only so long as the people who conduct large transactions in it, including banks and Chancellors of the Exchequer, refrain from undulging in "confidence tricks".

A Question

We may reasonably ask politicians: How much of the "growth" in Gross Domestic Product (GDP) you used to take so much credit for represents "real" value such as a house, and how much is due to nothing but debasement of the national currency?

The Banking "Bail-out"

I sincerely hope the emergency action instigated by the UK government works as advertised and enables "old-fashioned" ethical banking practice to be resumed. However, to quote Sir Francis Bacon: "Hope is a good breakfast, but it is a bad supper."