Go to Sections 5 & 6 for an analysis of the crises. Read Sections 1 to 4 for an explanation of the factors underlying them.
1. Commercial Banks: Banks make their profits by lending out the money in their customers' accounts at a higher-rate of interest than they are paying to their customers. The system works only if the banks maintain enough reserves to meet any sudden demand for repayment from their depositors.
2. Bonds: When a government or a large company needs money to cover its current expenditure it can get it by selling bonds. The US Treasury might sell bonds with a face value of $1000 bearing a promise to pay the holder $1000 on June 1, 2022 and interest at an annual rate of 5%. The market value of the bond goes up and down as market interests rates go down and up; but it will converge on its face value of $1000 as 2022 approaches.
3. Central Bank: National currencies have an associated Central Bank. In the UK it is the Bank of England. Central Banks buy bonds from their governments and others at a Bank Rate of their choosing. The money to pay for the bond is created by transfer from the Bank to the receiver's current account. The Central Bank cannot go bankrupt since it is authorised to issue any required amount of new money to pay for the bonds that it buys.
4. Government Deficit and Debt: Governments spend money on education, defence, social services, transport and so on. The amount they spend is their expenditure for the stated period. The government can pay for a large part of its expenditure with its income, mostly derived from collection of taxes. But often its income is less than its expenditure. The difference is its deficit for the stated period. To pay for the deficit the government borrows money by selling bonds. Governments are continually issuing and repaying bonds and the net total of bonds issued constitutes the total government debt at the stated time.
The interest paid on the debt is part of the government's expenditure. It can become excessive. If government debt is already high, to borrow more may undermine the government's credit-worthiness and lead to inflation. The alternative is to cut government expenditure, causing hardship.
5. The 2008 World Financial Crisis: For some years house prices in the US had been rising steadily. Mortgage companies could make more money by selling 'sub-prime mortgages' to less well-off buyers and to speculators. Banks all over the world were keen to increase their profits by lending to these mortgage companies. Then it became clear that there would be huge bank losses if US house prices fell and interest rates rose. This perception became self-fulfilling. Sub-prime house buyers found not only that they could not afford the mortgage but that their house was worth a lot less than they had paid for it. In 2008 Lehman Brothers, the huge US and international financial institution, became bankrupt. Banks all over the world were affected and there was fear of a meltdown of the banking system and a calamitous recession in world trade. In late 2008 world leaders agreed on a massive transfer of money to the commercial banks from their central banks.
6. The eurozone crisis: As the world was beginning to recover from the 2008 crisis, another one was starting. The euro is the currency of the 17 countries in the eurozone. There are no central banks, only the ECB (European Central Bank). But the ECB is not obliged to buy bonds from the 17. So countries, with large deficits and low credit ratings, like Greece, have to pay high market interest rates and cut their expenditure, risking civil unrest. Because they are in the eurozone individual countries have lost the option of devaluing their currency to restore growth. The crisis is spreading to countries inside and outside the eurozone because the markets judge the eurozone to be unstable and damaging to the world's banking system.
At the meeting of all 27 EU countries in Paris towards the end of 2011 there was a loose agreement, with only the UK dissenting. The eurozone crisis would be solved by taking a further step towards a federal Europe: control over national budgets would be yielded to Brussels. It is likely that many national parliaments will rebel against this proposed surrender of sovereignty and that the crisis will continue. One solution would be for Germany to leave the eurozone and allow the mark to rise against the euro; and for the ECB to relax its rules for buying the bonds of the remaining 16. At present this is unthinkable.
I hope that one day people who are prominent in public life (scientists, broadcasters, presenters, clerics, commentators) will see it as a duty to tell us clearly and briefly 'where they are coming from' - that is, to publish their fundamental beliefs or their 'My Credo in a Nutshell' (acronym 'mycian').
My website will eventually provide space for such Credos. For the moment it carries those of Charles Darwin, Winston Churchill, Bertrand Russell, Albert Einstein and Pope John Paul II, written at critical points in their lives. To read them, please go to http://www.mycian.com/.
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