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Are financial services really useless?

This comment on the Guardian’s Comment is Free this morning set me thinking.

Financial services are the lifeblood of any economy (and a million miles from being “socially useless” – sorry, that’s just ignorance) and for the UK to specialise in this area is just about the greatest stroke of genius going. Finance is labour intensive and offers high wages for all (even a City secretary earns £40-50k).


Certain financial services are indeed essential for the proper functioning of an economy: cash handling, payments and the creation and management of credit are services no healthy economy can do without. But financial services are the handmaiden of the real economy, which is the production and exchange of goods and services.


The negative aspect of all this occurs when financial services become an end in themselves. Then they are not the handmaiden of the economy but parasitic on it. This occurs when credit is misused. The purpose of credit is to help production to proceed. The classic case is the credit a farmer needs to buy his seeds, and care for the growing plants until the time the harvest is gathered in and sold, when the credit is extinguished and the cycle begins again.

But when credit is advanced for the purchase of land, no productive capacity is thereby created nor production engendered, for the land was there from time immemorial and is in no way “produced”. Thus, the credit is effectively dead – the idea of death is implicit in the very word “mortgage”. Now, Ricardo’s Law predicts that funds directed towards land purchase tend to drive up the price of land titles. This leads to the development of a credit-fuelled bubble-market in land titles, which grows to the point that the price of land cannot be justified by its underlying rental value. At that point the bubble collapses.

The devotion of financial services to this end might be thought of as a cancerous pathology. For most of the time, it is financially attractive to provide funding for the speculative purchase of land, and most people are not aware of the approaching danger. The economy seems to be booming and land prices are rising, whilst people are making fortunes by trading on stock markets. Optimism reigns. It seems as if there has been an end to boom and bust. Until it happens again.

How can it be prevented? Regulation will not work because people come to believe that things are not the same as before and regulations get dismantled just before the time they are most needed. The problem must be tackled at source. Fiscal reform is needed so that nobody will bother to speculate in land since it will never be profitable to do so. And it should be absolutely forbidden to give credit or make loans for land purchase, or to use it as collateral. Which of course will mean a revolution in the world of finance. But anything else is just whistling in the wind.