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 ‘socially useless’ work. That’s how bubbles are created, and that’s how the City came to be so out of proportion to Britain’s real economy. And, as flagged up elsewhere on this site, that’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
Fighting for Fairness by Remaking the Real Economy 
This article gets to the heart of one of the most important issues in world economics today. Trading (gambling) on derivatives, or for that matter exchange rates or commodity prices, has minimal real value to the real economy. Bankers will argue that these activities provide “liquidity” to markets. It would be truer these days to say that they utterly swamp and overpower markets because of the unbelievable volume of this activity – doubters should just look at the sometimes hysterical day to day movements on exchanges, and the sheer volumes, if they doubt this. This damages the real economy by destabilising it, and creating an extra layer of uncertainty.
It’s a free world, and if individuals wish to gamble, that’s fair enough. The banks however, are gambling with enormous volumes of depositors’ money, not their own, but for their own personal benefit and bonuses. Depositors should rightly object to this enormously risky activity and governments should (actually must!) regulate to forbid this kind of trading by banks on their own account. If they genuinely only traded on behalf of specific customer requests, I guess that could be allowed, although there is a question whether that distinction can be maintained.
In general press and political commentary, there seems to be an unfortunate simplistic concentration on the separation of “investment banking” from retail banking. It’s the trading activity which is dangerous, not the more traditional merchant banking which is a legitimate and necessary activity within “investment banking”.
Here’s to courageous regulators who will ignore the special pleading of the bonus motivated banks, preferably worldwide.
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Re the volume of this speculative trading, John Lanchester (‘Whoops! why everyone owes everyone and noone can pay’) quotes the International Swaps and Derivatives Association as estimating the “total size of the market as $54 trillion … close to the total GDP of the planet and many times more valuable than the total number of stocks and shares traded in the world.” That was in 2008. The actual money involved was much less because most of the bets are very highly leveraged or “naked”. As we have seen banks getting involved in this trade for themselves, puts their real economic role at risk – we’ll be told how we shall be paying for it this coming week. Non-banks involved in this trade, such as hedge funds, are not merely “socially useless”, but actually damage the real economy by corrupting bright young people, with extreme trading bonuses, who might otherwise have contributed something worthwhile to the economy. A tax on all derivative transactions might be one way of compensating this, even reducing the scale of the trade.
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