Last time I went through the different types of capital and the two types of financial capital: own capital, called equity, for example the money put in by owners as shares, and foreign capital, money the organization has borrowed.
Before I get any further on my understanding of Capitalism, I need to take one more step with understanding financial capital. Bear with me as I find this bit rather spooky.When companies (or even countries as we saw in the last post) draw up a balance sheet they put the money they have borrowed in as a liability, and accountants put a minus sign in front of that number.When a lender lends the money to, say, a company, the accountant put a plus sign in front of that figure to show that it represents and asset. For a bank to lend the money it does not need to actually have the money in its own account. It merely has to have a licence to lend money.
This is the first point about financial capital: suppose you were to add up the total of all the money that was lent in the world (all the plusses) and then total all the debts and then compare them, what figure would you arrive at?
The answer is zero. It HAS to be that way, because that is the way accounting works. If you take from one account you have a minus in one and a plus in the other.But the spooky thing about financial capital does not stop there: when a bank lends money it generally requires the lender to offer some kind of guarantee or security. This could be shares or real assets like buildings.So the national balance sheet is actually counting the same thing twice: the value of the real assets and the value of the money are actually the same thing. For any period of time, unless the bank has lent more that it can get back guaranteed:Total value of assets: 100 at least.Total money “created” by banks: 100
So the next question is: if you were to add up the sum of all assets in the world, how would it compare to the sum of all the money lent out or the amount owed?Before we answer that question we should be open to the idea that someone could borrow money with the security of , say their house, and then the house loses its value because the real estate market falls. The debt is still there but the collateral is not. So this is a case where there could be more money in the world than the value of assets. If the reverse happened the claim of the bank would only be on the amount of money owed, so if the house increased in value, the bank has no claim on it. So it is possible that the value of assets could exceed the amount borrowed.
Now, suppose the situation was that the debts were higher than the value of all assets. This is just a thought experiment so hang in there with me. If the issuer of the debt were to call it in, and if all lenders were to demand their money back over night, there would not be enough money to pay it. Even though the global sum of plus and minus should be zero. In fact, though, there would be a lot of bankruptcy. From Wikipedia; Bankruptcy is a legal status of an insolvent person or an organisation, that is, one who cannot repay the debts they owe to creditors.Truth is, there is far more money in the world than the value of real assets.
So on paper, the world is broke. I might have this wrong, but it seems that the banks, from starting out as businesses that simply helped people exchange value in an efficient way, have become the organizations that can put a claim on the total world resources.I am looking forward to comments on this, as I have not been able to find many references to this kind of analysis. It bears thinking about a little more deeply, because the ability of the banks to create money seems to be one of the things as the heart of what we call Capitalism. And it does not seem, when you describe it as I have done above, to be particularly sustainable.