Question

Why are credit markets important for capitalism?

Answer 1

Credit market :

• Credit Market, also known as bond market, is a broad financial market where stocks, shares, bonds, debts and other securities are traded extensively.It is a market place where money is borrowed and lent majorly in the form of bonds and debts. When debts are issued to companies looking to raise funds, then the market is known as a primary market, whereas when the securities are traded in the market, then that market is coined secondary market. Trades occur generally in the form of bonds, but notes and bills are also commonly found in the credit market. The participants in the credit market are banks, government, corporate companies, traders, institutional investors, and individuals.
• The credit markets play a very crucial role in sustaining the growth of almost all the countries. Their main function is to provide intermediation of funds between the savers and investors and thus improve the efficiency of allocation of resources. They also play an important part in the monetary transmission mechanism. Looking at the interest rates and the investor demand for the type of bonds (risk free: e.g. - government bonds, highly risky: e.g. – junk bonds) in the credit market, one can assess the financial health of the financial community one is dealing in.

redit markets can be segregated into five types of markets:

1. Corporate Bonds
2. Government Bonds
3. Municipal Bonds
4. Mortgage backed
5. Funding

Out of these, government bonds are the least risky as the treasury bills are served by the government itself and thus the chance of default is very low.

• Currently, the US has the highest market share (44%) of the credit market. Since the subprime mortgage crisis in US in 2008, the liquidity in the US credit market has gone down by 70% , and it continues to worsen. The European credit market is no longer functioning efficiently after the Euro zone sovereign debt crisis (2009-2012) . All these factors have created a negative sentiment in the credit markets worldwide.

Credit markets important for capitalism :

• When the credit crunch hit in 2008 and governments bailed out banks with trillions of pounds so they didn't collapse many people recognised that this was because of the huge amounts of debt in the system. Banks had loaned money to people and companies with no idea if they'd be able to pay it back, and these debts had then been sold on and bets taken on their future value.
• So if the crash was caused by credit and debt, is it the fault of the banks for lending money, or people for borrowing? And couldn't we just regulate the system to get rid of this toxic aspect?
• The system of credit and debt is not just something added on to capitalism that could be removed. It is an important part of the system that allows it to expand beyond its own limits, but ultimately contributes to its instability.
• During a boom there is a frantic scramble for capitalists to invest and grab a bigger share of the market from their rivals. But sometimes an individual capitalist or company might not have the capital up front which they need to invest to keep ahead, whereas other capitalists may have surplus value from past rounds of production that they need an outlet for. Banks play an important role in mediating between these two possibilities, lending the profits of one capitalist as capital for another to invest.
• This allows capitalists to accumulate more rapidly, driving capitalism forward. However, it relies on the confidence that the money lent can be repaid. And as the boom reaches its peak and people realise all that has been produced cannot be sold, and that therefore profit might not be made, the debts are called in. In this way the system of credit and debt that fuelled the boom also accelerates the crash and ultimately adds to its destruction.
• So the credit system lubricates the accumulation process. Capitalists do not have to wait for one round of production to be finished before they can begin another, and have an outlet for surplus value they have accumulated that they do not wish to invest directly in production.
• Through this process capital also appears to generate profit as banks pay interest on surplus value they hold, and charge interest on money they lend.
• The rate of interest is irrational, depending on the supply of and demand for credit, not actual production.
• But it is still important for the capitalist. The rate of interest still needs to "make" more money for the capitalist sat in a bank account than it would invested in production.
• This leads capitalists to see money itself as self-expanding rather than value coming from the exploitation of workers.
• Sometimes as well as borrowing capital from banks, a capitalist who needs money to invest might sell bonds in a company. The people who buy bonds are promised a share of the money that the company makes - providing a profit is made.
• These bonds that promise a share of future surplus value can be traded at a price way above their original value if traders believe it will guarantee them an income in the future.
• But it also means they can become worthless as the market crashes and people no longer believe the company will make enough surplus value to pay out.
• These shares and bonds are described by Marx as "fictitious capital" because they are not capital themselves but merely the promise of future earnings. If they lose their value no capital has been destroyed - money has simply been transferred from the shareholder to the company.
• It is not just capitalists who borrow money. Increasingly over the last 30 years workers have been encouraged to buy on credit, resulting in huge amounts of personal debt. This allowed capitalists to raise the rate of exploitation of workers, without affecting the number of goods and services a worker could buy, thus helping to maintain their profit rates.
• These debts too can be traded and gambled on in the belief that they will be repaid in the future. This further ties the workers into the system and exposes them to the disorder of the financial system. As Marx put it, "Banking and credit thus become the most potent means of driving capitalist production beyond its own limits - and one of the most effective vehicles of crises and swindle."
• So despite major economic crises invariably involving crashes of the banks and financial institutions it is wrong to blame finance, the banks or money itself for the crisis. These are essential elements of the capitalist production process and it is capitalism itself that is prone to crisis by its chaotic and unplanned nature. Credit and debt intensify both the boom and the slump, but do not ultimately cause either

What are the most important aspects of a capitalist system:

• The most important aspects of a capitalist system are private property, private control of the factors of production, accumulation of capital, and competition. The starkest counterpoint to capitalism is communism; in a communist system, there is no private property, a central government controls the means of production, capital is not accumulated by individuals or private businesses, and competition is nonexistent. Put simply, a capitalist system is controlled by market forces, while a communist system is controlled by the government.

Private Property :

• The right to private property is a central tenet of capitalism. Citizens cannot accumulate capital if they are not allowed to own anything, nor can they buy or sell things. As long as the owner stays within the parameters of the law, which generally are broad in capitalist systems, he may do what he wants with the property he owns.
• A private citizen may purchase property from another private citizen at a price that is mutually agreed upon and not dictated by a government. In a capitalist system, the free market forces of supply and demand, rather than a central governing body, set the prices at which property is bought and sold.

Factors of Production:

• In capitalism, private enterprise controls the factors of production, which include land, labor and capital. In contrast to a communistsystem where the government owns and controls these factors and thereby sets production levels and prices, private companies control them in a capitalist system and set prices and production at levels that maximize profit and efficiency.

Accumulation of Capital:

The centerpiece of a capitalist system is the accumulation of capital. In a capitalist system, the driving force behind economic activity is to make a profit. Devotees of communist and socialist systems consider this greedy and selfish. Capitalists, however, see amassing profits as a way to provide a powerful incentive to work harder, innovate more and produce things more efficiently than if the government had sole control over citizens' net worth. This financial incentive is the reason capitalist economies see innovation as going hand-in-hand with their market system.

Competition :

• Competition is the other vital attribute of a capitalist system. Private businesses compete to provide consumers with goods and services that are better, faster and cheaper. The principle of competition forces businesses to maximize efficiency and offer their products at the lowest prices the market will bear, lest they get put out of business by more efficient and better-priced competitors.