Part (3)
Another area for improvement relates to a lack of global homogeneity. Currently, each country applies its own criteria to the accounting control systems of major companies listed on the stock exchange. The globalized context in which money moves around makes it advisable for the measurement and control methods used by these companies to be the same everywhere, but this is not happening. This abnormality poses additional risks,
as I will explain below. In the US accounting system, the financial assets of American companies have to be updated regularly, to reflect increases and decreases on their books that translate into profits and losses.
In Europe, most countries do not operate this way. The companies listed on the stock market only adjust the value of their assets on their books when they unload them. Thus, when difficulties are foreseen due to a drop in value of such assets on the market, the company's directors will determine not to sell them in order to avoid the appearance of losses on their balance sheets.
Clearly, the US accounting system is more transparent, but the European system is more secure in that it prevents major shocks, as its accounting method keeps companies from having to speak of losses (which always has a potential for causing panic among investors), resorting instead to euphemisms like “cash shortage”, “liquidity problems”, etc.
In any case, a consensus should be reached on one or the other method by the governments of the world's major economies, adopting a single global accounting system for any company listed on the stock exchange, especially those operating in the financial sector. The economic authorities of every nation need to acknowledge once and for all that the financial sector is globalized, and therefore needs global rules to minimize risks.
Another worthwhile step would be to return the stock market to its original role of financing new projects and maintaining existing ones, and reducing the predominance of “short-termists”, who sometimes take big risks (and obtain big profits) that can even push companies into bankruptcy. This should be regulated and controlled by agreements between governments and the financial sector, in order to prevent these highly destabilizing practices of the virtual economy.
There are many other steps to take, but one of the most important for preventing future risks is to introduce instruction in the basics of economics in schools so that young people have a better understanding of this subject, as it will affect them their whole lives much more than other subjects they are studying.
In conclusion, we are living in an exciting age, the age of the economy of abundance, and if we are able to predict and prevent the risks it poses, we may find ourselves in the first era of human history in which poverty is no longer an insoluble problem, as it can be solved with the possibilities that this economic model offers for the creation of hundreds of millions of jobs around the world, once all nations learn how to apply it and abandon the practices and mentalities, still prevailing in many places, of the economy of scarcity.
FREQUENTLY ASKED QUESTIONS ABOUT ECONOMICS
Below is a list of the questions I have been asked most often in recent times on this subject, although I have already answered some of them in other written works.
What caused the global financial crisis of 2008?
At the end of the last century there were two basic types of institutions in the financial sector: traditional banks and investment banks. Both are to money what a riverbed is to water. If you make changes to the riverbed that aren't well planned, you may cause the river to dry up or, conversely, to overflow. In the case of this crisis, poor decisions resulted in an initial overflow of money that led to a subsequent monetary drought. These decisions dried up credit, which in turn dried up demand.
Why did this happen? The role of traditional banks was to act as a depository of the people's money and, with a profit margin from interest, to loan it to anyone who needed it with the due guarantees, since it was other people's money they were lending. The central banks of each country supposedly supervised these banks to ensure they didn't do anything outlandish that would put the money of their depositors at risk.
Meanwhile, investment banks sought capital from others and invested it in high-risk transactions, with the aim of increasing profits for their clients, and for themselves, if these transactions proved successful. These banks were, along with pension funds, the big investors in stock markets around the world.
Then, at the end of the 1990s, US President Clinton lifted the restrictions on traditional banks related to stock market investment, while allowing other financial institutions to act as traditional banks as well. Many other countries imitated this initiative.
The result was a massive injection of money into stock markets around the world, thereby creating artificial demand. Thus began a problem whose consequences would be felt years later.
At the beginning of this century, banks and financial institutions began granting huge loan packages, mostly for housing but also to purchase other goods. They gave out more loans than businesses and the public needed for their usual demand, and these loans encouraged people to spend beyond the real possibilities of return.
The financial sector was delighted because, on paper, it was making a lot of money. With these theoretical profits it distributed generous dividends to its stakeholders. As will be shown below, these lavish profits led to huge losses, which we all ended up having to pay for.
The lending institutions had already granted loans to people who were able to pay it back, so they began lowering the requirements in order to provide loans to less solvent borrowers.
The borrowers receiving this money assumed that the experts knew what they were doing, and thought: If the banks are prepared to give me money, it must be because I can afford it. So they bought bigger houses or new cars they neither needed nor were really able to pay for.
The banks and financial institutions knew that these were high-risk mortgages and lending operations. And so to control this risk, they took out default insurance with various insurers (especially with the company AIG). If someone defaulted on a mortgage or a loan, these insurers would have to cover the cost. In this way, the banks wrote off their risks and were able to seek new loans to continue operating, and as a result they went further and further into debt. The insurers assumed this risk on a global scale, convinced that the housing market would continue to boom.
But this conviction was far from logical. Having inflated demand with so much credit, housing prices ended up falling due to a supply surplus because too much housing had been built; more than what people needed. Mortgages were foreclosed and the insurers had to pay for the defaults. All of them, all over the world, and at the same time. They couldn't pay. So the banks took massive losses all on the same day, because responsibility for the defaults ultimately fell to them, and as a result they went under and took the financial system with them.
These were the reasons for the financial crisis that began in 2008, the consequences of which are still being felt today in many countries.
As you can see, it was a flagrant violation of the Formula outlined above, as it created fictitious (and therefore not natural) demand, as a result of the excessive credit. This produced a bubble that came close to bringing down the global economy.
Financial institutions, with the support of governments, were the ones that created this disaster, because while credit has the capacity to build a modern economy, a lack of credit has the power to destroy it swiftly and completely, which is what inevitably happens when people are unable to get loans to buy a house, start a business, fill store shelves, or buy a car. In short, without credit, demand dries up and this undermines the other factors of the Formula: production, trade and labor. And the excessive credit initially gives rise to excessive consumption, which inevitably leads to a monetary drought.
The banks were left in a disastrous state of insolvency, with massive debts, and ceased to fulfill their social role, which is to be the channel for the flow of cash; they held up the circulation of money while they licked their wounds.
They pushed the world to the brink of collapse, as all this happened very fast. The situation stabilized very slowly, through huge injections of money taken from public taxes into banks around the world. But we must not forget that this crisis could happen again unless governments and central banks impose sufficient controls on financial institutions.
In short, as can be seen, the key to this crisis was a severe manipulation of demand, which was no longer natural.
What is money?
It is one of man's most brilliant creations, because without it we would never be able to feed the billions of inhabitants of the world today.
First of all, it is worth clarifying that money is nothing more than a simple convention. Its solidity depends on the confidence that its holder needs to have that he will be able to exchange this piece of metal or paper in his hands for goods in the country that issued that currency.
Money was born out of a need for individuals and societies to have an effective instrument for exchanging goods.
In the most ancient times, in societies much simpler than ours, these transactions were limited to the mere exchange of merchandise between individuals. Thus, for example, a man in possession of a wheat surplus would seek to exchange it for animal hides for clothing from a man who produced more than he needed. Probably this was how the art of haggling was born, an art still practiced in many parts of the world, because it must have been difficult to determine, for example, how much wheat should be given in exchange for a sheepskin. It would be reasonable to assume that these transactions would have been sealed after long nights of discussions that no doubt would have been enjoyable in themselves.
Things started to get complicated when, as a consequence of demographic growth and production specialization, it became harder to make significant trading deals and compare prices and values, which represented an obvious obstacle to large-scale trade. This problem was resolved with the ingenious invention of what we know today as money. Once it appeared, trade expanded quickly, since it facilitated the exchange of goods both between individuals and between communities.
In the beginning, in the absence of a monetary system, trade was conducted using chickens, cows or pigs as units of reference. In fact, the first Roman coins minted bore images of these animals and received the name of "pecunia", a term derived from "pecus", which in Latin means "livestock".
But what is money, really? As I mentioned above, it is a convention, an unwritten agreement, as physically it is generally just a piece of metal or paper of barely any value in itself.
Without attempting to offer an analysis of its evolution throughout history, I will point out a few important points that will hopefully shed some light on what it is.
Until a short time ago, all the money placed in circulation in a country corresponded to the total value of the gold reserves held in the national bank. This was what is known as the economy of scarcity. This system lasted from ancient times right up to our days. Money was thus a kind of check to bearer, payable immediately, issued by the State, which the holder expects to be able to exchange in gold or equivalent goods at the value specified. For example, if the Bank of France had 100 tons of gold in its coffers, it would produce and circulate coins and bills equal to that total value; its division into smaller units gave rise to what has come to be known as national currency, to which each country gave its own name. This meant that the value of any currency in circulation was guaranteed by the equivalent proportion of gold deposited in the State Bank. In some cases, the coins were even produced directly in gold or silver, and thereby acquired value in themselves.
