The Financial-Industrial Revolution's Origin and Destiny

Mark Bryan

[En français]

The industrial revolution made the modern world. Before it took off in the late eighteenth century, most people in Europe and elsewhere lived sustainably on renewable resources in traditional societies. Such limited energy as was available came from wind (sailboats, windmills), hydropower (waterwheels), wood (heating and cooking fireplaces and stoves), and muscle power (human and animal labor). There was no electricity, little or no heavy machinery, no modern medicine, virtually no appliances or other labor saving devices, and no telecommunication. Travel was laborious and slow. Almost everything had to be made by hand with simple technology. Death and birth rates were high, mostly because of infant mortality.

Imagine a world without fossil fuels or electricity and you begin to come close to what it was like. Life was simpler, to be sure, more natural, anchored in traditional wisdom and reliant on herbal remedies—since widely disparaged—and certainly without the stresses associated with modern life. Ritual and community were strong; most people were embedded in an intense network of social relations.

The gap between then and now is enormous. Our world today would be a total and unimaginable fantasy—or nightmare—to anyone living 250 years ago.

The question is: How did we get from there to here?

Most explanations of the industrial revolution, and indeed the rise of the whole modern world, miss the mark. They invoke purported causes such as the development of science, technological innovation, political stability, and the use of fossil fuels, beginning with coal.

None of these factors, alone or even in combination, provides a plausible explanation. All of them were present at other points in the past, and did not lead to an industrial revolution.

The ancient world, especially the Greeks, arguably had a scientific revolution, as well as considerable technological innovation, and, under Hellenistic monarchs and later the Romans, political stability, and yet no industrial revolution occurred. The potential for fossil fuels was there as well. China, at various times in its long history, also had the same ingredients, but, again, no industrial revolution occurred. Perhaps also India and the Arab world.

These conditions again obtained in Britain in the eighteenth century, but this time an industrial revolution did occur.

What was the difference?

The vital factor, I argue—present in late seventeenth and early eighteenth century England, and absent in earlier situations—was an institutionalized system of broad, debt-based finance. For the first time in world history large-scale credit became available to fund public and private enterprises.

This “financial revolution” is seldom noted, and even more rarely, pardon the pun, credited. The classic work on the subject—The Financial Revolution in England: A Study in the Development of Public Credit, 1688-1756, by P. G. M. Dickson (1967)—remains out of print.

Credit, to be clear, long preceded the financial revolution. A recent popular book by David Graeber—Debt: The First 5000 Years—traces credit all the way back to the temple economies of Sumerian city states.

But the traditional sort of credit Graeber describes was severely limited. Commercial loans were generally made to finance a relatively narrow, reliable range of projects, such as the planting of a cash crop, or goods expected from a trading expedition, and usually had to be paid off in hard-to-get precious metals.

More importantly, traditional loans of this sort depended on finding the relatively few potential creditors who had already accumulated savings they could lend. Today, it is still widely believed that money lent out by banks comes from the savings deposited in those banks, just as money borrowed from a friend or relative is presumed to come from savings or wealth they already possess. But it doesn't.

The financial revolution in England over 300 years ago overcame these limitations by vastly expanding the scope and function of credit. It established a credit system independent of savings and current resources, and it did so by institutionalizing the process of creating money “out of thin air.”

It takes a little history to understand this financial revolution—history that is not taught in our schools.

It was the goldsmiths in seventeenth century London that took the first step. Clients deposited gold with them for safekeeping, receiving in turn certificates of redemption. The goldsmiths discovered that only a few clients were likely to redeem their deposits at any given time. This allowed them to issue more certificates (as loans) than they actually had gold on hand to redeem them.

This new expansion, or leveraging, of the money supply (more certificates circulating than the actual gold backing them) has come to be known as fractional reserve banking.

Note that nothing is backing this new additional money, apart from confidence in the supposed ability of the borrowers to repay it in due course. It is created merely on the say-so of the lenders. The borrower suddenly has new money to spend—money that was not there before and that was not minted, earned or saved up by anyone. It is a slip of paper, with a corresponding accounting entry in the lender's book—no more and no less.

Important as this step was, the goldsmiths remained private proto-bankers, limited by the deposits they could attract. They were vulnerable to “runs on the bank”—sudden, excessive withdrawals by depositors which left them unable to pay out gold as promised, leaving them insolvent. Money created out of thin air, essentially as a confidence trick, could just as easily vanish into thin air as soon as confidence wavered.

This problem was exacerbated by Charles II’s insistence on ever-greater loans to conduct his military campaigns, which he could not repay. A major default by the monarchy occurred in 1671, putting many goldsmiths and other money-lenders out of business. This pattern was typical of early modern finance, where monarchs borrowed largely to fund their wars of conquest without sufficient income from taxes and royal estates to repay them.

An ingenious and fateful response to this financial instability came with the foundation of the Bank of England in 1694. A group of about 1500 investors agreed to assume the royal debt—since renamed the “national debt”—in return for a monopoly on the right to issue their own notes (loans, that is) to the public guaranteed by the reliable repayment of the government’s debt through taxation. These notes—which subsequently became known as British pounds—soon started circulating as the currency of the land.

This currency-as-debt was still ultimately denominated in precious metals, but the presence of the royal imprimatur, backed by the power of the state to meet its obligations by forceable taxation, made its indebtedness “as good as gold” for the creditors.

As this new arrangement sprung into being, nobody seemed to ask the very obvious and important question:

Why is it that a group of private investors was granted the unprecedented license to automatic public taxpayer backing and, if need be, outright bail-outs for their own privately-issued notes (loans), which were allowed to function as the currency of the land, displacing precious metals?

Since the power of the state to tax its citizens rests on a perpetual right, it follows that any private loans backed by tax receipts can also be issued, and reissued, in perpetuity. The result was a perpetual national debt used to back up perpetual private lending.

But the private bankers immediately took a further step, making full use of the fractional reserve principle of the goldsmiths: they proceeded to lend far beyond the actual amount of government debt on their books. Thus, only a fraction of the notional “money” they generated out of thin air was formally backed by the taxpayer.

Which leads to another very important question that also wasn't much discussed, then or now:

What if confidence lapses, there are bank runs, and it turns out that the government guarantees are insufficient?

The modern answer to this question is... bail-outs; it turns out that the taxpayer is on the hook not just for the government debt, but for all the private debt issuance as well.

But that's not all. Not only were these private loans backed by the taxing power of the state, but the bankers issuing them took full advantage of the relaxation of traditional prohibitions on usury. This allowed them to charge as much interest on these loans as the market would bear. In other words, they were able to skim off a generous profit for themselves simply by virtue of issuing money which they alone were allowed to freely create!

Sounds outlandish? You bet! ? Yet this is the essence of the financial revolution, which Alexander Hamilton, one of its admirers, accurately called “the English system,” and it remains the basis of our financial system today.

How does all this explain the industrial revolution? Think of it this way: for the first time in history a widespread source of reasonably secure credit became available, backed by the state, and free of the worst risks previously borne by individual lenders like the goldsmiths, or earlier family bankers like the Medici or the Fuggers. This made a huge difference: borrowers who could tap into this new credit found themselves with the wherewithal to invest in modernized production methods, becoming more profitable and outstripping their competitors.

This happened initially in agriculture, with the improvement of landed estates, and then spread to manufacturing. And even though these new loans had to be repaid with interest, which was commonly at usurious rates, the benefits of the improvements gained made the loans profitable for the borrowers as well as for the lenders.

For the first time in history, it became possible to systematically and reliably borrow against the future, betting that the future will always be bigger, better and richer, making it perpetually possible to issue ever more debt with which to roll over previously issued debt. This is what made steady economic growth through investment in innovative production methods—in short, industrial revolution—possible.

Which leads to yet another very important question that wasn't much asked:

What happens when it turns out that the future is not going to be bigger, better and richer, because the essential resources have been exhausted?

The modern answer to this question, which we are staring at now, is this: financial, economic and political collapse.

But we are getting ahead of ourselves. Remember that the price to be paid for industrialization was the interest charged on the borrowed money. This means that an enterprise, if funded by borrowed money, had to grow to compensate the lender as well as to repay the principal. Gradually, previously steady-state traditional enterprises were either destroyed by their more productive industrial competitors, or they too financialized, putting themselves on an ever-accelerating treadmill of debt.

Albert Bartlett and Chris Martenson, among others, have elaborated in Malthusian fashion the idea that the modern economy functions on the self-defeating principle of exponential growth.

But yet another questions remains: Why did exponential economic growth catch on and continue for the last 250 years? It turns out that exponential growth has a very specific driver: the usurious rates of interest charged by the new financial system created by the financial revolution.

In short, the use of borrowed money at interest provided something that did not exist earlier: a compelling motive to grow economically. Once the reciprocal exchanges of traditional, more or less steady-state economies were replaced by the use of credit borrowed at interest, it became necessary to come out ahead: one had to gain more from any exchange than the other party in order to make a profit and to pay interest to the lender.

For the first time in history a fateful imperative to growth—and exploitation—was built right into the economy. Usurious credit is what kicked economies into overdrive, forcing borrowers to exploit both people and natural resources far beyond what was allowed in traditional economies that were based on reciprocity among participants.

So yet another question--never adequately addressed--arises:

Why is it that personal vices and mortal sins have been assigned the role of foundational economic principles?

Ambition and avarice, previously private vices, were institutionalized in the financial system by usurious credit, allowing them to be legally and culturally objectified and thereby enormously magnified. No longer merely personal qualities, they assumed the power of social imperatives.

For a long time, as long as new resources and pools of labor could be exploited, all went well for the exploiters (and badly for the exploited). New frontiers were opened up and “developed,” in the New World and elsewhere, usually at the point of a gun, and slaves and indentured servants were brought in to do the labor.

Simultaneously, peasants in the old world, forcibly displaced by enclosures and the modernization of agriculture, were herded into factories as workers. Deprived of their traditional, largely independent and sustainable ways of life, they became wage-laborer consumers who had to buy goods and services at market prices.

It turned out—for a considerable time--that the globe had enough land, minerals, arable soil, fisheries, and forests to support an unprecedented explosion of production. It also turned out—for a considerable time—that the globe had enormous untapped sources of energy—particularly fossil fuels—which magnified productive potential many-fold.

The exploitation of these resources is what we call the industrial revolution.

And now it has run its course. The resource limits of a finite planet have finally been reached. There are no new frontiers left. Population has exploded, arable land has been used up, forests have been cut down, fisheries have been depleted, minerals have become scarce, the environment has been degraded and polluted. Investments in the production of fossil fuel energy, which has underpinned economic growth, have finally reached the point of diminishing returns, even as they continue to drive costly and destructive climate change.

In the meantime, the banking system has continued to lend out far more money than there are real assets in the world to back it. Hundreds of trillions of dollars of debt now dwarf the potential of the global economy to ever produce enough to repay it. We are facing another cyclical boom-bust financial crisis, to be sure, but this time it really is different: the potential for recovery and further growth can no longer be presumed to exist. The system has plateaued, for the moment, but having been designed for endless exponential growth, not for a steady state, it is destined to unravel.

It is important to understand, in sum, that “the English system,” now established worldwide, is a privatized, usurious financial system established as a monopoly by the state to benefit private investors, and is involuntarily backed by its taxpayers (as evidenced in the recent bailouts of banks deemed “too big to fail”).

This system is the root cause of the industrial economy.

What are the lessons in all this?

1. Exponential growth, powered by the financial system, is unsustainable, and doomed to collapse. This is the nature of any exponential process.

2. The true villain of the piece, and the cause of exponential economic growth, is our current, outrageous financial system, defined by the lending of money at usurious and therefore exponential interest rates by a private monopoly backed by the state.

3. The vast power unleashed by this financial-industrial revolution has completely corrupted those who have been able to manipulate and benefit from it, resulting in an inhumane, narcissistic culture of arrogance, contemptuous of traditional, sustainable ways of being.

4. Our financial system is a relatively recent invention, devised by clever, selfish men for their personal gain. It is not the product of any natural or inevitable process, nor of democratic deliberation. It is a scam. We need not be stuck with it, and the sooner we rid ourselves of it the better.

5. A sustainable, post-collapse economy on a finite planet will require a return to reciprocal, cooperative arrangements for the exchange of goods and services. Loans will have to be based on current collateral, not on leverage or on speculative exploitation of (increasingly non-existent) resources.

6. Usury will have to be prohibited in future lending. The monetary system, by which money is created through lending, cannot be a for-profit monopoly, whether it be private or public.

7. Any future financial system will have to be designed to avoid concentrations of financial power, making it possible for it to be held accountable by the public. If money creation is to serve the public, it must be done locally by institutions that are locally controlled.

Adrian Kuzminski is the author of The Ecology of Money: Debt, Growth, and Sustainability (2013), Fixing the System: A History of Populism, Ancient & Modern (2008), and Pyrrhonism: How the Ancient Greeks Reinvented Buddhism (2008), among other works.