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The Ghost of Adam Smith
Yet, in the year 1788, with debts totalling 1.5 million pounds, Livesey, Hargreaves and Co. went bankrupt. To put this bankruptcy in perspective, at the time, the two largest cities in Lancashire, Liverpool and Manchester, were estimated to have populations of only 30-35,000, and the entire outstanding note issue of the Bank of England was only about 10 million pounds. During the course of bankruptcy proceedings, it was revealed that the firm had been financing its business by repeated issuance and circulation of accommodation bills. Bills of exchange had for a long time been used in commercial practice. They were used to facilitate the repayment of a loan of money, or used as a payment mechanism. However, with an accommodation bill, the bill was not used to facilitate an underlying transaction, but simply created as a debt owing to be used as currency to pay for goods and services, or in some manner benefit the issuer. People generally think of debts as something to avoid, but the wizards of finance have long known the secret of profiting from the creation of debt instruments when they are not actually in debt. During this period, there was considerable debate regarding the economic consequences of these transactions. Adam Smith advocated the 'real bills theory', that if the banks confined their lending to the discount of real bills, that the paper currency created by the banks would be at the appropriate level. There are some logical problems with the 'real bills theory'. Since the distribution of goods might result in one or dozens of bills, depending on the number of hands through which the goods passed and the credit terms of the sales, tying notes to real bills would not result in an automatic regulation of the volume of currency. The real problem with the "real bills theory" however, was the failure to see that conceptually and legally, the creation of an accommodation bill, and the creation of bank notes shared similar characteristics and economic consequences. The creation of bank notes resulted in the creation of a bank liability which the banks sought to profit from. It does not really matter whether the bank notes were created by discounting bills of exchange, or as a form of loan advance exchanged for a customer's promissory note. In either case, the bank is seeking to profit from creating a liability when the bank was not in debt. Modern banks no longer issue bank notes, but now seek to profit by creating another form of bank liability often called a "bank deposit". Today, most bank loans are advanced by the bank creating a bank deposit. Like Adam Smith, modern economists insist that there is nothing wrong with the banking system, that the banks seeking to profit by creating their own liability creates a perfectly functional financial system. They insist that a financial system based on an exponential increase in debt is not only stable but actually benefits everyone involved. To this end, they claim that banks are providing an essential service. In my paper, the "Nature of Money", I have taken a different approach, arguing that the banking system is a pyramid scheme, which would collapse even if operated in a relatively prudent manner. However unpopular this view may be, consider the beliefs of the modern world. Belief #1- That giving 100% financing on houses with an inflated value, with payments that do not even cover the interest to people with poor credit who do not earn sufficient income to make the loan payments is sound lending and can be very profitable to the banks. Belief #2- That providing loans on commercial real estate which does not generate sufficient income to pay the loan payments is sound lending. Belief #3- That loans to governments who do not generate sufficient tax revenue to fund obligations and whose citizens do not earn sufficient income to meet their own debt obligations is sound lending. Belief #4- That banking services are so essential that the payment of large bonuses to bank staff is always right. Belief #5- That the banking system is so essential that governments who can not pay their present debt obligations should borrow unlimited funds to bail out the collapsing pyramid scheme created by modern bankers. Belief #6- That it is important that people, corporations, and governments who can not afford their present debts to go even deeper into debt, and that by going even deeper into debt, that this will save both the financial and economic systems. One must wonder and certainly consider the possibility that the worlds governmental, financial, and academic leaders are completely brain dead. Livesey, Hargreaves & Co, as well as many historical depressions should remind us of the dangers of seeking to profit simply by creating financial instruments. Modern man may think that he has got it right this time, that the science they call economics has found the magical path to successfully manage the creation of financial instruments. History is more likely to show the blindness of the modern age. When the global financial and economic system completely collapses, there will be great debate as to the cause, and what could have been done to prevent the collapse. Yet, how many will truly understand these issues. The blow up of sub-prime mortgage loans will be seen as the first straw. This eroded bank capital, causing a pull-back in bank lending, the second straw. Then economies began to slow due to the lack of bank loans, the third straw. As personal and corporate cash flow fell, problem loans spread to all other loan areas, the fourth straw. This created even more bank losses, causing an even greater contraction in lending, the fifth straw. Government bailouts did not help as they did not address the fundamental problems which required both a change in the fundamental nature of the banking system, and a major reduction in global debt levels. Government bailouts actually made matters worst as they increased government debt and married the financial system with the political system, the sixth straw. Globally, we will now witness an economic collapse, followed by social collapse followed by political collapse. Even now, the birth-pains of these developments can be seen. When these events occur, I wonder how many will think of Livesey, Hargreaves & Co, and the ghost of Adam Smith. John Kutyn |
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In the late 1700's, the firm of Livesey, Hargreaves & Co. was one of the largest cotton manufacturing enterprises in the early stages of the Industrial Revolution. Historians claim that the firm employed between 700 and 1000 printers and were said to be the means of giving bread to 20,000 people. The firm was a symbol of wealth and progress.