A financial intermediary can benefit from the backing ofgovernment; the converse is also true. That is, when govern-ments need to borrow money (historically, to finance wars;more recently, to finance chronic peacetime deficits), they relyon banks. The result is that often large banks and governmenthave a cozy relationship, based on mutual dependence.

The importance of reputation makes financial intermediariesfragile. They are subject to shifts in sentiment. When people arevery trusting of its reputation, an intermediary can expand andfund many risky, long-term projects.

When a bank gives customers short-term deposits backed bylong-term loans, that is known as maturity transformation. Inpart, the bank is able to do that because it is pooling the fundsfrom many depositors. The bank holds a small cash reserve, butotherwise it has funds tied up in long-term loans. It counts onthe statistical likelihood that on any given day, only a fractionof customers will want to withdraw their deposits. The bank’suse of pooling means that any one customer can make a com-plete withdrawal from the bank’s small cash reserve, as long asnot too many customers seek to withdraw at once. Even thoughmuch of the savers’ deposits are tied up in long-term loans, thebank can still process the typical pattern of cash withdrawals

Financial intermediaries in general, and banks in particular,address a mismatch between the desires of natural savers andborrowers. As savers, we want our funds to be immediatelyavailable should we suddenly need them. Also, we want tobe assured that when we seek to withdraw our funds, at leastour principal will be returned. That is, we want our financialassets to be liquid, with minimal risk

Money is one form of financial intermediation that enablespeople to trade across time. In an advanced economy, with itsindirect, roundabout forms of production, trading across timeis pervasive. For example, suppose that you want to build afruit business. You will plant trees this year, and in the future,you will harvest and sell the fruit. You need funds today thatyou will only be able to repay over a period of years.

Abuse of power is another practical problem. We have seenpeople place faith in government to help implement the basicsocial rule. An effective government gives people confidencethat defectors will be punished and that cooperators will berewarded. That confidence helps induce more cooperationand less defection.To implement the basic social rule, government officialsare granted unique powers

A legal system administered by government is anotherimportant institution promoting trust. Those of us whoown property are confident that no one is going to useviolence or threats to steal our possessions. That confi-dence is based on our belief that other people will coop-erate with the laws against theft, and that belief is inturn based on our faith that the government will retaliateharshly against those who violate those laws

The basic social rule can support any type of group. It canbind together a charitable organization or a criminal gang.In particular, the basic social rule is needed in order to bindtogether the strangers doing tasks for one another in themarket.

One of the main techniques that people use to deter defec-tion is retaliation. We punish people who defect. Economistshave noted, however, that in many situations it takes coop-eration to punish defectors. Social trust requires people tocooperate in retaliation. You cannot have trust if people defectfrom punishing defectors!

We have illustrated the two most important circuits of credit creation in moderncapitalist economies: lending to non-financial businesses and to households. Butthese are not the only possible outlets for new credit. Banks can also advancecredit to governments, to financial speculators, or to borrowers in foreigncountries. And in addition to creating new credit, banks devote great energies totheir own speculative trading in financial assets (a process we will consider furtherin Chapter 19).Whether they are lending to businesses or households, banks are still positioned“above” the real economy on our road map. This position reflects both their uniquepower to create new money, and the fact that they do not directly produce usefulgoods and services which are the ultimate goal of economic activity.Stanford EFE2 01 text.indd 234 08/04/2015 09:26Stanford, Jim. Economics for Everyone : A Short Guide to the Economics of Capitalism, Pluto Press, 2015. ProQuest EbookCentral, http://ebookcentral.proquest.com/lib/forsythtech-ebooks/detail.action?docID=3440440.Created from forsythtech-ebooks on 2025-08-12 18:08:29.Copyright © 2015. Pluto Press. All rights reserved.

Private banks begin business with an initial investment of capital by their owners.Then they rely on a combination of deposits, commercial borrowing, interbanklending, and help from the central bank to finance their day-to-day money balances.But at any point in time, the total loans they have issued vastly exceed the moneyactually owned by the bank. The ratio of total outstanding loans, to a bank’s internalcapital, is called its leverage ratio. (“Leverage” refers to the degree to which abusiness is financed with borrowed money.) At the peak of the financial expansionthat preceded the 2008 global financial crisis, the leverage ratio of major global

Banksuse a special overnight clearing-house system to settle their net balances everyday. If more money left the bank than came in, the bank owes a net balance tothe clearing-house, which it finances thanks to routine overnight loans from otherbanks (called interbank lending). The opposite occurs when a bank draws inmore money in a day than is transferred out; it then lends to other banks throughthe clearing-house.

Even government fiscal policy supports the monetary system, by providinggovernment bonds and currency that are essential to the daily operations ofprivate banks.But despite all this government support, the day-to-day creation (anddestruction) of money has become the domain of the private banks and otherfinancial institutions which control credit. And their actions, in turn, are driven bythe same motivating force that propels capitalism as a whole: namely, the pursuitof private profit

n modern capitalism, credit is the main source of new money, and the crucialjob of issuing new credit has been mostly handed over to banks and other privatefinancial institutions. Hence they have replaced government as the most importantplayers in the monetary system

To be effective, it must be accepted as a valid form ofpayment by most participants in an economy. In this regard, money is a socialinstitution. It requires the trust and faith of the people who use it. Anyone whoaccepts money payment for something must be confident they’ll be able to spendthat money when they want to buy something else.More fundamentally, money is also a political institution. Its existence andvalue relies on the political and legal authority of the official body (usually anational government) that endorses it.

Thanks to its usefulness as both a means of payment and a store of value, moneyis necessary to facilitate exchange between different buyers and sellers. Withoutmoney, trade would have to occur on a barter basis – where one product orservice is traded directly for another.

Money allows individuals or companies to storewealth in a flexible, convenient form. Few people get intrinsic pleasure frommoney, purely for its own sake. True, it must be thrilling for rich people tosee all those zeros in their bank statements (just as kings and emperors inprevious epochs enjoyed running their hands through piles of gold coins).But in general, money is useful only for what it can buy. When they can’t findanything better to do with it, or when they fear losses on other types of assets,individuals or firms will simply set aside their money (in cash, bank accounts,or term deposits).

Credit gives a person or company purchasing power, evenwhen they don’t yet own the funds to pay for their purchases. No longer doesan individual have to save in advance in order to make a major purchase(like a sofa, a car, or a home). And no longer does a business have to save inadvance (out of their past profits) before making a new investment. Instead,a bank or other financial institution provides the needed purchasing power:through a loan, a line of credit, a deposit into a chequing account, a bond, orthe issuance of a credit card. In return, the borrower promises to pay the loanback later – with interest, of course

Currency is no longer minted from precious metal. Instead,currency consists of paper money and non-precious coins officially issuedand sanctioned by the government. Most people still think of “money” as“currency.” But in fact currency accounts for a very small share (as little as 2-3percent) of total money outstanding in a modern economy

money is anything that allows its holder to purchase other goodsand services. In other words, money is purchasing power. Early forms of moneywere tangible objects with some perceived intrinsic value (such as trinkets or coinsmade from precious metal). Today, money is very different: it is usually intangible(in fact most money today consists of electronic entries in bank accounts), and itsvalue depends completely on social convention and government pronouncement

Modern specialization is so extensive that only a minorityof people in a modern economy directly provide goodsand services for immediate consumption, such as food ormedical care. Instead, many of us work in industries thatsupply intermediate inputs, meaning materials, machines,information, or logistical support for businesses that offergoods and services for direct consumption. And evenamong those who work in businesses that provide imme-diate consumer satisfaction, many of us perform admin-istrative tasks to manage or support those workers whoactually serve customers

Increased wealth accompanies specialization. Our ances-tors were much less specialized than we are. As recentlyas the 18th century, many households still sewed theirown clothes, built their own homes, and grew much oftheir own food. As of 1700, nearly everyone in the worldlived in economic misery by today’s standards. Even in theUnited Kingdom, the most advanced economy at the time,the average income per person was only about $2,500 intoday’s dollars.4 Today, in the United States, a householdwould need twice that average income to even reach th

of specialization and trade depend on the public’s trust infinancial intermediaries. At times, intermediaries may enjoymore trust than they deserve, enabling them to finance anunsustainable boom. Once the fragility of the intermediariesis exposed, the level of trust falls, and there can be significantadverse consequences for economic activity.

There are in a pound upwards offour thousand pins of a middling size. Those ten per-sons, therefore, could make among them upwardsof forty-eight thousand pins in a day. Each person,therefore, making a tenth part of forty-eight thou-sand pins, might be considered as making four thou-sand eight hundred pins in a day. But if they had allwrought separately and independently, and withoutany of them having been educated to this peculiarbusiness, they certainly could not each of them havemade twenty, perhaps not one pin in a day; that is,certainly, not the two hundred and fortieth, perhapsnot the four thousand eight hundredth part of whatthey are at present capable of performing, in conse-quence of a proper division and combination of theirdifferent operations.55 Adam Smith, The Wealth of Nations, book 1, chapter 1, section 3.

Economics and politics have always gone hand-in-hand. Indeed, the firsteconomists called their discipline “political economy.” The connections betweeneconomics and politics reflect, in part, the importance of economic conditions topolitical conditions. The well-being of the economy can influence the rise and fallof politicians and governments, even entire social systems.But here, too, the influence goes both ways. Politics also affects the economy– and economics itself. The economy is a realm of competing, often conflictinginterests. Determining whose interests prevail, and how conflicts are managed,is a deeply political process. (Neoclassical economists claim that anonymous“market forces” determine all these outcomes, but don’t be fooled: what theycall the “market” is itself a social institution in which some people’s interests areenhanced at the expense of others’.) Different economic actors use their politicalinfluence and power to advance their respective economic interests. The extent towhich groups of people tolerate economic outcomes (even unfavourable ones) alsodepends on political factors: such as whether or not they believe those outcomesare “natural” or “inevitable,” and whether or not they feel they have any power tobring about change.Finally, the social science which aims to interpret and explain all this scrabbling,teeming behaviour – economics – has its own political assumptions and biases.In Chapter 4 we’ll review how most economic theories over the years have beenmotivated by political considerations. Modern economics (including this book!) isno different: economics is always a deeply political subject.

he economy must be a very complicated, volatile thing. At least that’s how it seemsin the business pages of the newspaper. Mind-boggling stock market tables. Chartsand graphs. GDP statistics. Foreign exchange rates. It’s little wonder the media turnto economists, the high priests of this mysterious world, to tell us what it means,and why it’s important.

Economics encompasses several sub-disciplines. Economic history; moneyand finance; household economics; labour studies and labour relations; businesseconomics and management; international economics; environmental economics;and others. A broad (and rather artificial) division is often made betweenmicroeconomics (the study of the economic behaviour of individual consumers,workers, and companies) and macroeconomics (the study of how the economyfunctions at the aggregate level)

Economics is the study of human economic behaviour: the production anddistribution of the goods and services we need and want. Hence, economicsis a social science, not a physical science.

These are the building blocks from which the most complicated economictheories are constructed: work, consumption, capital (or “tools”), finance, and theenvironment. And they are all visible, right there in your neighbourhood. As wego through this book, we will build a simple but informative economic “map” thatincludes all of these elements

My main goal with this book, and throughout my career as an economist, hasbeen to encourage non-experts – workers, union members, activists, consumers,neighbours – to develop their natural, grass-roots interest in economics, by:• Studying the economy, and learning more about how it functions.• Thinking concretely about their personal role and stake in the economy(rather than abstract indicators like gross domestic product, stock markets,or foreign exchange).• Recognizing that the economy embodies distinct groups of people withdistinct and often conflicting interests, and that economics itself reflects thosedistinctions and conflicts. Economics is not a neutral, technical discipline.• Being ready to challenge, when necessary, the way “expert” economistsexplain the economy and (even more dangerously) tell us how to change it