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In a series of articles, Tony Thomson, one of our associates with 40 years of experience as an analyst and consultant in securities and payments explains:
- Why the current global money system is inherently unstable and vulnerable to political abuse
- How this has happened on a global scale and has brought about the current financial crisis
- How it can be stabilised with the application of laws that are essentially moral and not subject to political manipulation
Troubles with money 1 – The value illusion
Troubles with money 2 – Fiddling while the economy burns
Troubles with money 3 – A moral basis for value exchange.
Troubles with money – the value illusion
Our present money systems encourage instability by encouraging people to believe that money is a permanent store of value as well as an exchange medium. It is not. It is a store of promises that only have significant value when they are disposed of as a consideration for a good or a service of some sort. You could perhaps burn notes to cook and keep warm, or melt down coins to fabricate a knife or a plate, but the nominal value of the input would greatly exceed the value of the outcome. As far as I know, nothing of any practical use can be created from the electronic record of a bank balance.
Media of exchange are essential for the vast scale of specialisation and co-operation that makes modern society possible. It is said that quite advanced ancient trading civilisations (the Carthaginians, for example) got by without coinage, but the sheer logistical inconvenience of going shopping with a cartload of your home-grown corn to swap for the weekly groceries and a new plasma TV would probably defeat all but the most determined viewer and kill the consumer goods trade stone dead.
Over millennia people have discovered ways around this inconvenient problem of non-standard and bulky media of exchange by finding media of higher value-density that can be standardised, like gold coins or goldsmiths’ certificates of deposit. Innovations like these have made possible the huge increase in the volume of trade on which our civilisation depends. But when commercial trade and individual freedoms expand to the point at which most income is earned in cash rather than kind, cash in the form of, or backed by, high-value material has a severe limitation. Firstly, there just simply is not enough high-value physical material to provide the stock of exchange media needed and secondly, the effort required to create or obtain it and set it aside for use as an exchange medium diverts excessive resources to what is essentially a non-productive activity.
Our modern money and banking systems use two main methods to overcome these problems:
Fiat money
Which is money that is exchangeable for value because the government declares that it is legal tender for the settlement of contracts and that taxes must be paid using it. The government does not fix its value or promise to exchange it for anything else. Typically central banks hold government bonds (which are essentially claims against future tax revenues) as assets to back the liability of the fiat money that they issue. This delightfully circular arrangement balances the books without requiring the bank or the government to acquire and hold anything of real value.
Fractional reserve banking
This is what banks are doing when they lend you other people’s money as if it were their own. They borrow money from any source they can (customers’ deposits, other banks and corporations, investors) and lend it out to others, hoping to make a profit out of the difference between the interest rates they pay and receive. They keep as little of the money as possible in the central bank in order to maximise their profits. However, out of prudence and regulation they have to keep a liquid reserve of central bank cash, and securities that can be turned into cash very quickly, in case depositors and other lenders start wanting more of their money back than other depositors/lenders are putting in.
The cash and liquid reserves they keep are typically very small, and were even smaller until recently, so that an international bank with an excellent reputation for soundness could easily have 25 times the value of loans and deposits owed to customers compared with the value of their cash balance at the central bank.
This is possible because whenever a bank lends money to a customer they nearly always receive it into a bank account (as a deposit) and spend it by paying it into their supplier’s bank account (as a deposit), whereupon it is available for a bank to lend to someone else for as long as the supplier doesn’t ask for it in central bank money/notes. And so the money goes around and multiplies!
All these customers generally think and behave as if they had the money that the bank tells them is in their accounts whereas, of course, all they actually have is a promise from the bank that it will find the money from somewhere and give it back to them when they ask for it or their contract requires. That means that, taking the banking and monetary system as a whole, bank customers can appear to have about 25 times as much money as the central bank has actually issued.
Thus it is, with these two mechanisms, that we have a banking system in which practically unlimited amounts of exchange media (aka “Money”) can be created by the central bank inventing it and by commercial banks lending it many times over.
Therefore, unlike a cart-load of corn or even an ingot of gold, which is pretty, durable and has at least some industrial uses, modern money has absolutely no intrinsic value. Even the contract that it represents has no intrinsic value. If you take a note from the cashier of the Bank of England that says “I promise to pay the bearer on demand the sum of ten pounds” to him and demand your ten pounds then the best he can do for you is to give you another note that says exactly the same. The Bank has no physical assets of any value to give you in exchange for its promise to pay. Since June 2008, it doesn’t even have any gold. All it has is a stack of bits of paper, but mostly just electronic notes in a database, which all say something along the lines of “I promise to pay …”.
In practically every country or currency union, that real or virtual pile of promises consists mostly of promises made by their own or other governments. In general, governments have very little income beyond that which they can extract from their subjects through taxation or monopolies and, as we can see from the protests and riots currently taking place in Greece, no government can be entirely confident of the consent of their people to repaying debts acquired by their predecessors. In fact, if we go back in time before the invention of central banks owned by national governments and authorised to print their own money, the record of governments in repaying their debts has been bad, with defaults, forced loans, coin-clipping and debasement commonplace.
Governments are run by politicians, who take it up as a career in order to exercise power. They are jealous of the power that they have and protect it carefully, particularly when it involves money. For example, it is well known that when PM Gordon Brown took his much-praised step of freeing the Bank of England to set interest rates he took away its power to regulate the banks, leaving Prudence perched on the three-legged stool of HM Treasury, FSA and the Bank. What is perhaps less well-known is he also retained the power to tell the MPC exactly what to do if the Government felt it necessary.
And so we have it. The value of your savings in a bank account or in any other investment denominated in money terms depends entirely on the promises of two groups of people in whom you must place your trust – politicians and bankers. |
