Industry has always depended on credit. Without it we would not have had an industrial revolution. When Adam Smith described his pin factory which, through the division of labour, increased production from, at most, 20 pins per day per operative, to more than 48,000, all that was needed was a market for that massive increase in production. Markets had previously been small and localized affairs, requiring little in the way of transportation. Industrial markets required mass transportation which was first achieved with canals and turnpikes. But canals took many years to build before they could ever earn a penny return. That required a great deal of money and at that time money was scarce. Wealth was accrued in land and property rather than in spare cash. The only way such projects as canals could be financed was to get money from huge numbers of people whose repayment would come out of the future earnings of the projects themselves. The same applied to the later railways, and the whole industrialization process. So banks have always played a central role in the financing of industry.
But trading in derivatives is different from investing in industry. In theory, the profits that banks can make from such speculative trading could support further investment in industry. The bankers themselves claim that obvious defence. But in practice, speculative trading is an end in itself. The returns from it far exceed what can be earned from real economy activities such as manufacture or distribution. So the profits earned are invested in further speculative trading, as well as, of course, rewarding the traders for their â€˜socially uselessâ€™ work. Thatâ€™s how bubbles are created, and thatâ€™s how the City came to be so out of proportion to Britainâ€™s real economy. And, as flagged up elsewhere on this site, thatâ€™s how the banking industry, which started out so supportive of the real economy, has allowed itself to be taken over by the speculative element which is no more than parasitic on the real economy.
It is to be hoped that Sir John Vickers, Martin Wolf, Clare Spottiswoode, Martin Taylor, and Bill Winters, members of the commission on banking regulation, will grasp the nettle. It may sting in the short term, but the refocus on real industry is essential for our longer term well-being