Series : Governments submit to “Too Big to Fail” banks (part 8)

The Liquidity Trap

4 December 2014 by Eric Toussaint

Because of the policies of the central banks and the governments, the economies of the industrialised countries have fallen into what J. M. Keynes named a ’liquidity Liquidity The facility with which a financial instrument can be bought or sold without a significant change in price. trap’. While central banks inject liquidity into the economy and lower interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
, the banks and big corporations prefer to keep the cash available and/or use it to speculate. The profits are not reinvested, they are used to increase dividends or to buyback their own shares.

A complete overview of the actions of the central banks of the industrialized countries since the beginning of the crisis and their possible consequences requires an understanding of the dilemma they now face, a dilemma of their own creation.

To put it simply, the central banks are asking themselves for how long they can continue injecting massive amounts of liquidities Liquidities The capital an economy or company has available at a given point in time. A lack of liquidities can force a company into liquidation and an economy into recession. into the banking system and at the same time maintain near-zero interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. -rates or, at least, interest-rates that are lower than inflation Inflation The cumulated rise of prices as a whole (e.g. a rise in the price of petroleum, eventually leading to a rise in salaries, then to the rise of other prices, etc.). Inflation implies a fall in the value of money since, as time goes by, larger sums are required to purchase particular items. This is the reason why corporate-driven policies seek to keep inflation down. rates. They know very well that this policy, designed to protect the banks and big non-financial corporations Non-financial corporations All economic agents that produce non-financial goods and services. They represent the greatest share of productive activity. , threatens to produce new speculative bubbles. The question is not if these bubbles will burst, but when?

At the same time the directors of the Central Banks know that if they seriously reduce liquidity injections they will be endangering the big banks, and recently-formed speculative bubbles will burst. If, on top of that, they increase interest-rates, this will make the banks even more fragile and result in more bubble-bursts. An additional difficulty is that higher interest-rates would automatically increase the cost of servicing public debt and thus aggravate state deficits. [1]

Of course, there are alternatives (See - They imply radical political choices and changes, namely to stop favouring the richest 1% and to make reforms in the interests of the 99%. However the central bankers do not have the will to change the class content of their policies. They are at the service of the 1%, the hand that feeds them.

This brings us to the horns of their dilemma: whether to continue in the error of their present policies—high liquidity injections and low interest-rates—or to make the error of changing them while adhering to the same logic. [2]

The present policy of low interest-rates and high liquidity injections has produced the following effects: [3]

1. The banks, with a few notable exceptions, are managing to stay afloat because the central banks provide funds that are no longer available on the financial markets. Interbank lending has been severely reduced and the unloading of long-term bank securities such as covered bonds and others has become very difficult. [4] The fresh money gives the banks access to the Money Market Funds MMF
Money Market Funds
Mutual investment funds that invest in securities, including money funds.
for their day-to-day finance (see parts 1 to 3).This access can dry up overnight as was the case in 2011. Banks are clearly dependent on state and central bank Central Bank The establishment which in a given State is in charge of issuing bank notes and controlling the volume of currency and credit. In France, it is the Banque de France which assumes this role under the auspices of the European Central Bank (see ECB) while in the UK it is the Bank of England.

support (see also parts 5 et 6).

2. The banks have continued their speculative activities by entering into other highly lucrative markets, eschewing, for the time being, the property market to speculate on commodities Commodities The goods exchanged on the commodities market, traditionally raw materials such as metals and fuels, and cereals. and food, peaking in 2008-2009; sovereign bonds (since 2009); corporate bonds Corporate bonds Securities issued by corporations in order to raise funds on the Money Markets. These bonds resemble government bonds but are considered to be more risky than government bonds and other guaranteed securities such as Mortgage Backed Securities, and therefore pay higher interest rates. , stocks and shares (since early 2013); and foreign exchange. Thus their trading Market activities
Buying and selling of financial instruments such as shares, futures, derivatives, options, and warrants conducted in the hope of making a short-term profit.
activities have not diminished. Speculation techniques have changed—in some cases for the worse, as in the increase in high-frequency trading.

3. The banks have reduced their lending to consumers and to the small and average businesses which create the majority of jobs. In 2013, consumer bank loans in the Eurozone withered by 2% and loans to business by around 3.5%. The peripheral EU economies are the worst affected. Contrary to the wishes of the central banks, who want more money injected into the economy, banks have toughened their conditions for granting loans to the real economy. In the US the situation is not much different from that of Europe and Japan where, since 2013-2014, the banks have gone back to the business of making risky loans on structured products, in particular containing mortgages and car purchases. However the central banks are taking no action at all to impose lending on banks and so create demand and foster growth or support the little there is.

4. Big non-financial companies in search of finance can issue their own corporate bonds. Banks and other institutional investors Institutional investors Entities which pool large sums of money and invest those sums in securities, real property and other investment assets. They are principally banks, insurance companies, pension funds and by extension all organizations that invest collectively in transferable securities. buy them because they give a good return and are easily sold on the secondary market Secondary market The market where institutional investors resell and purchase financial assets. Thus the secondary market is the market where already existing financial assets are traded. . The losers are small and average businesses which do not have this possibility. Mario Draghi proposes that the banks offer businesses structured loans that will enable bankers to take the entailed risk off their balance Balance End of year statement of a company’s assets (what the company possesses) and liabilities (what it owes). In other words, the assets provide information about how the funds collected by the company have been used; and the liabilities, about the origins of those funds. -sheets as Asset Asset Something belonging to an individual or a business that has value or the power to earn money (FT). The opposite of assets are liabilities, that is the part of the balance sheet reflecting a company’s resources (the capital contributed by the partners, provisions for contingencies and charges, as well as the outstanding debts). Backed Securities (ABS ABS
Asset backed security
A generic term designating a security issued by an intermediate entity (SPV) between a transferor and investors in the context of a securitization operation. This security is a bond. When the assets backing these securities (called underlying assets) are made up of mortgage loans like subprime loans, they are called Mortgage Backed Securities (MBS). MBS are subdivided into Residential Mortgage Backed Securities (RMBS), backed by mortgage loans made to private individuals and Commercial Mortgage Backed Securities (CMBS). The term Collateralized Debt Obligations (CDOs) is used when the underlying assets are bonds issued by companies or banks, and Collateralized Loan Obligations (CLOs) when these assets are bank loans.
). What is this all about? Banks that grant loans to small businesses can include them in a mixed bag of the same kind as the Collateralized Debt Obligations CDO
Collateralized Debt Obligations
The term CDO covers multiple means of structuring paper products for financial assets. These include bonds, loans and sometimes non-listed shares. Such derivatives enable banks to render normally non liquid debts liquid, thus increasing the tradability of the asset. From the buyer’s point of view, CDO are also supposed to reduce risk by diluting it, since there is less chance of default on a bouquet of credits than on one single credit. In reality, the absence of clear information about the composition of CDO and the fact that they are often combined with high risk assets make them a very risky product.
(CDOs) that caused the subprime crisis. They may then be deposited at the central bank as ABS and removed from their balance-sheets. These ABS are then considered to be collateral Collateral Transferable assets or a guarantee serving as security against the repayment of a loan, should the borrower default. for loans at 0.05% from the central bank. Banks are lending to businesses at 5% to 6% in Italy and in Spain, and between 3% and 4% in France and Germany. Whenever he gets the chance, Mario Draghi, President of the ECB ECB
European Central Bank
The European Central Bank is a European institution based in Frankfurt, founded in 1998, to which the countries of the Eurozone have transferred their monetary powers. Its official role is to ensure price stability by combating inflation within that Zone. Its three decision-making organs (the Executive Board, the Governing Council and the General Council) are composed of governors of the central banks of the member states and/or recognized specialists. According to its statutes, it is politically ‘independent’ but it is directly influenced by the world of finance.
, hastens to point out the opportunity for banks to make good profits. In spite of such attractive encouragement the banks remain shy of increasing loan offers, structured or otherwise, to local enterprises. [5] Mario Draghi has now had to announce that as from the end of 2014 the ECB will purchase ABS directly. [6] On top of that, The ECB will also purchase corporate bonds issued by non-financial companies and increase the purchases of covered bonds issued by private banks.

5. Banks’ policies concerning sovereign debt Sovereign debt Government debts or debts guaranteed by the government. are both complementary and contradictory. On the one hand they have no qualms about speculating on the sovereign debt of certain countries, to who’s difficulties they have contributed. When they do not intervene directly they use their other financial structures, such as hedge funds Hedge funds Unlisted investment funds that exist for purposes of speculation and that seek high returns, make liberal use of derivatives, especially options, and frequently make use of leverage. The main hedge funds are independent of banks, although banks frequently have their own hedge funds. Hedge funds come under the category of shadow banking. , SPVs (Special Purpose Vehicles) or pension funds Pension Fund
Pension Funds
Pension funds: investment funds that manage capitalized retirement schemes, they are funded by the employees of one or several companies paying-into the scheme which, often, is also partially funded by the employers. The objective is to pay the pensions of the employees that take part in the scheme. They manage very big amounts of money that are usually invested on the stock markets or financial markets.
. At the same time (see part 6) the banks have increased their stock of sovereign debt as a source of high returns, Italian and Spanish bonds being the most significant examples. Bonds from other countries, such as the US, the UK, Germany and other strong Eurozone countries, are easily negotiable securities that can be quickly transformed into liquidity, if needed, are used as guarantee. In accordance to Basel regulations back-up capital deposits are not necessary against sovereign bonds, so the banks buy them freely. [7]
It is no surprise that the banks’ policies seem to be contradictory: They are caught between the hammer of their speculative activities (seeking high returns) and the anvil of their other investments.

6. This said, the banks have by no means cleaned up their activities, and have barely reduced their use of leverage Leverage This is the ratio between funds borrowed for investment and the personal funds or equity that backs them up. A company may have borrowed much more than its capitalized value, in which case it is said to be ’highly leveraged’. The more highly a company is leveraged, the higher the risk associated with lending to the company; but higher also are the possible profits that it may realise as compared with its own value. , (see

7. Generally, central bank and government policies have had very negative effects on the health of the economies while contenting the banks and the rest of the financial sector, along with the big non-financial corporations. Millions of jobs have been lost, millions of families evicted from their homes, poverty and inequality have greatly increased, the quality of public services has been seriously and purposely downgraded and new speculative bubbles are in preparation

8. Here is a list of known speculative bubbles in preparation, for the moment generating high returns:

-The corporate bonds bubble. The last big crashes took place in 1994 and 1987 (see ).

- The stock exchanges are expanding too fast (the last bubble burst in 2007-2008).

- The commodities bubble (see There was a minor commodities crash caused by high-frequency trading in May 2010. Oil prices fell 40% between June and November 2014, causing concerns that some heavily indebted oil companies may be in danger of defaulting. The last big commodities crash happened in 1981-1982.

- Some economists warn of a property speculation bubble forming in Germany and perhaps in the US. On 18 May 2014 the Governor of the Bank of England, Mark Carney, warned that a housing bubble was forming in Britain. [8]

The bursting of even one of these bubbles can have far-reaching effects

Patrick Artus of the bank Natixis warns of the possibility of a crisis due to the reflux of capital placed in Italy, Portugal and Spain during the second half of 2013. where investors were promised greater returns than in the emerging countries such as Brazil, India, Indonesia, South Africa and Turkey from which they had withdrawn. [9] This speculative capital can flee as quickly as it arrived if the situation declines in these countries or if other countries offer higher returns.

What is new with current bubbles is that they occur in situations of stagnation or weak economic growth in the industrialized countries, whereas previous bubbles, over the last forty years, developed during periods of economic euphoria and fairly high growth.

9. Because of central bank and government policies, the economies of the industrialized countries have fallen into what Keynes called the ‘liquidity trap’. While central banks inject liquidities and reduce interest-rates, the big banks prefer to keep their resources stashed away in readiness for the explosion of the time-bombs they see on their books, and to hedge against the bursting of the new bubbles they are creating. The industrial and service companies do not invest because demand, whether private or public, is anaemic. They either sit on enormous reserves of liquidities or use them to speculate. At the end of 2013, Apple, the computer company, held $150 billion in cash or equivalent. This amount represents the annual budget of the whole EU (more than 500 million people)! At the same time, the world’s biggest non-financial companies have $2.8 trillion. [10] According to another estimate, European companies are withholding the unprecedented sum of €2.4 trillion in their treasuries—that is, sixteen times the annual budget of the whole EU! [11] This is unheard of. The big corporations are sceptical about investing their resources in the productive economy and/or lending to consumers or small businesses. Big company profits are not reinvested in production. They are paid out as dividends or used to bay back their own shares. In the US in 2014 corporations redistributed 95% of their profits to shareholders. [12]

According to Keynes, to escape from the liquidity trap, the authorities must increase public spending to stimulate demand, and so stimulate the economy. Investment spending could be directed towards renewable energies, big public engineering projects, public buildings—especially schools and hospitals—, and a massive effort could be made towards an ecological transition. More staff could be taken on in the public services, particularly in health, education and social services, and they could have higher salaries. Pensions and benefits could be increased. Of course, central banks and governments will not hear of such proposals.

10. As a result of their policies, the central banks’ balance-sheets have considerably increased in volume. That of the ECB has tripled in the five years from 2007 to 2012 and that of the Fed FED
Federal Reserve
Officially, Federal Reserve System, is the United States’ central bank created in 1913 by the ’Federal Reserve Act’, also called the ’Owen-Glass Act’, after a series of banking crises, particularly the ’Bank Panic’ of 1907.

FED – decentralized central bank :
has quadrupled between 2006 and 2014. This enormous expansion in such a short period has enabled the big private banks to remain as powerful as ever without bringing relief to the economies in crisis. Despite dramatic announcements, no radical measures have been taken to truly clean up the banking system. Thanks to the actions of the central banks, and the government decisions that follow in their wake, the big private banks continue their extremely speculative, and often fraudulent and even criminal, activities. They are helped by a permanent mechanism of transfusion of resources (unlimited public lending at very low and sometimes negative interest-rates). Some of them, even among the bigger ones, are simply on life support: In addition to the unlimited public lending, they have been recapitalized with public funds and their obligations guaranteed by the governments.

The same policies applied by the central banks and governments have caused a huge increase in public debt. This is due to several connected factors: the cost of bank bail-outs; the multiple costs of the crisis for which the central banks, governments, private banks and the big corporations are responsible; ever more tax breaks for big business and the wealthy. These are all clear indications of the illegitimate character of a large part of public debt. The cancellation of this debt is one of the essential proposals for ending the crisis.

The central banks and crises in the capitalist system

In the capitalist system, crises serve as regulators: speculative bubbles burst, then asset prices approach their real value; profitable companies sink; capital is destroyed; unemployment increases and wages are reduced. Crises are part of the metabolism of capitalism. This is not to justify crises or capitalism, but simply to indicate that crises are an essential part of the way capitalism works.

Until now public intervention, meekly responding to the demands of the employers, has managed to avoid or prevent the crisis from fulfilling its normal function of purging the capitalist system, other than creating massive unemployment. While among the population the victims of the crisis are counted in tens of millions, those responsible for it have made no attempt to clean up capitalism. Liquidations of big companies have been very limited, the banks have not cleaned up their books and new bubbles have formed or are forming. Productive investment has not been relaunched. The profits are not reinvested, they go directly into the capitalist’s coffers. That is, they go to the richest 1%.

The fact that only a small number of banks in Japan, the UK and the US have failed is entirely due to the assistance they have received from the central banks and the governments of the EU. Those in power have considered that the private banks were ‘Too Big to Fail’. Government policies that persistently favour the interests of big business and attack the populations’ social and economic rights, insufficient or reduced public and private investment and the continual bursting of speculative bubbles are the ingredients of prolonged crisis. Unless a radical turn-around in favour of social justice is taken, the crisis is going to last for many years to come.

End of the Series: Governments submit to “Too Big to Fail” banks.

Éric Toussaint, is a historian and political scientist who completed his Ph.D. at the universities of Paris VIII and Liège. He is the President of CADTM Belgium (, and sits on the Scientific Council of ATTAC France. He is the co-author, with Damien Millet of Debt, the IMF, and the World Bank: Sixty Questions, Sixty Answers, Monthly Review Books, New York, 2010. He is the author of many essays including one on Jacques de Groote entitled Procès d’un homme exemplaire (The Trial of an Exemplary Man), Al Dante, Marseille, 2013, and wrote with Damien Millet, AAA. Audit Annulation Autre politique (Audit, Abolition, Alternative Politics), Le Seuil, Paris, 2012.


[1Note that increases in prime interest-rates will have very negative effects on the treasuries of developing countries, who will have greater difficulty in refinancing their debts and will see much capital flee to safer industrialized countries. Central bankers do not care about this: The president of the Fed said as much in February 2014. This may bring to mind the events of 1980-1981 when interest-rates made a bound following Fed decisions. Several authors have analysed the effects of the change in Fed policies that took place in October 1979 (see especially Gérard Duménil, Dominique Lévy, and Eric Toussaint’s many articles published in coordination with the CADTM).

[2The Fed has started a cautious change of direction as of December 2013 by reducing its monthly volume of purchases of MBS and US Treasury bonds. In November 2014, The Fed stopped its purchases of MBS and US Treasury bonds. On the other hand, at the same time the ECB and the Bank of Japan have increased their purchases!

[3Other than the banks’ crimes and misdemeanours that are discussed in the series “Too Big to Jail”.

[4Covered bond issues by banks in 2013 ($166 billion) was the lowest since 1996 and less than half the 2011 level ($370 billion). See Financial Times, “Europe covered bond issues slump”, 27 November 2013.

[5In 2013 in Europe, all types of ABS fell by 38% from 2012 (Financial Times, 18 February 2014). In 4 years, the drop is more than 80%! (Financial Times, 3 September 2013).

[8BBC News, ‘Bank of England’s Mark Carney warns on housing market’, 18 May 2014.

[9Patrick Artus, ‘Où peut se localiser la prochaine crise financière?’ (‘Where will the next financial crisis come from?), Natixis, Flash Marchés #181, 26 February 2014, (in French). In this report, Patrick Artus also mentions the possibility of a financial crisis being caused by the UK: ‘Le Royaume-Uni est un candidat possible, avec l’ouverture très rapide de son déficit extérieur due à l’asymétrie entre progression de la demande et progression de l’offre, ce qui est une cause habituelle des crises’ (‘The UK is a possible candidate because of the very rapidly widening gap between supply and demand, a situation that is often at the origin of crises’).

[10Financial Times, « Concentrated cash pile puts recovery in hands of the few », 22 janvier 2014.

[11Financial Times, ‘European Corporate buybacks sink to 2009 lows’, 2 November 2012. The article refers to studies by Thomson Reuters. According to The Economist, Canadian companies held $300 million in cash in 2012, 25% more than in 2008. This phenomenon is happening in all the industrialized countries: In Japan in 2012 corporations had the equivalent of $2.8 trillion in liquid assets, 75% more than in 2007! (The Economist, ‘Dead money. Cash has been piling up on companies’ balance-sheets since before the crisis’, 3 November 2012).

[12See Alternatives économiques, “les bénéfices des entreprises du S&P 500 sont reversés à 95% sous la forme de dividendes et de rachats d’actions”, n° 340 – November 2014 (in French)

Eric Toussaint

is a historian and political scientist who completed his Ph.D. at the universities of Paris VIII and Liège, is the spokesperson of the CADTM International, and sits on the Scientific Council of ATTAC France.
He is the author of Greece 2015: there was an alternative. London: Resistance Books / IIRE / CADTM, 2020 , Debt System (Haymarket books, Chicago, 2019), Bankocracy (2015); The Life and Crimes of an Exemplary Man (2014); Glance in the Rear View Mirror. Neoliberal Ideology From its Origins to the Present, Haymarket books, Chicago, 2012, etc.
See his bibliography:
He co-authored World debt figures 2015 with Pierre Gottiniaux, Daniel Munevar and Antonio Sanabria (2015); and with Damien Millet Debt, the IMF, and the World Bank: Sixty Questions, Sixty Answers, Monthly Review Books, New York, 2010. He was the scientific coordinator of the Greek Truth Commission on Public Debt from April 2015 to November 2015.

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