Friday, October 7, 2011

The Myth of Money

One of my favorite posts this year was The Fictions Which Bind Us written back in April of this year. In it I discussed how essentially we play a lot of games of make believe within our lives and yield power to some rather absurd things that do not in fact exist in any true form. In that post I mentioned that the two leading contenders in this were countries & governments along with our financial systems. The last post was on governments and countries and this one will be on the financials- why our misunderstanding of what money is and where it comes from has allowed us to make it a completely fictional system that has created two classes of people on this planet- those who work for "money" and those who can create it.

Occupy Wall Street Protester 

To most of us it seems perfectly normal that pieces of paper, or increasingly plastic cards and computer digits somewhere in a bank computer, are money. For all of our lives this has been the case, and so we never really think about it too much. But what is money? Like all human inventions it came about as a matter of convenience. Farmer A had lots of barley and trader B had brought salt from over the mountains and both needed what the other had. Initially there could be direct trade of X amount of salt to Y amount of barley. This bartering system is still alive and well in large parts of the world where subsistence farming takes place, and to a lesser extent forms a portion of the underground economy in developed nations. But what if the salt trader didn't want barley? Maybe he wanted to bring back silk. so the barley farmer goes to trade for silk, and then gets silk to trade for salt. To avoid the hassle of intermediate trading a commodity took the place as the intermediary store of value, it was something that would be easy to carry, non-perishable, rare enough that it had value in small quantities but common enough that people all over had access to it, and ideally would be recyclable. Independently around the earth most societies moved to using precious metals such as gold, silver, and copper as this form of intermediate barter good- and thus the first "money" of human culture came about.

Through the better part of human history we used a fixed commodity system of exchange. While one can argue that even at this point money is a completely fictitious thing that only has value because people agree that it has value, its basis on an actual commodity that has use and thus value doesn't remove it from what makes sense to our everyday experience. Where money becomes something that has value simply by decree and how some people gave themselves the power to create it at will is a two part story involving the evolution of banking and the use of a worthless commodity symbolizing value by decree of force.

Mongol Leader Khublai Khan Introduced Paper Money
And He'd Kill You If You Didn't Accept It

In the 9th century AD the Chinese first started issuing paper money- but only rarely and usually used with expiry dates, in military emergency, used as promissory notes to facilitate long distance trade or to tide over soldiers. In most cases the paper could at least eventually be traded in for an amount of real precious metals and were not deemed worth any real value on their own but only as a symbol of an actual commodity. In the 13th century the Khan of Mongolia decreed that he'd rather use paper for his money- and he had a monopoly on its printing. His first round of notes, in order to keep their value were backed by gold or silver. A second round of notes were printed 50 years later that were not backed by anything, when the khan needed money to go to war against the Song. This removed the inconvenient restrictions of actually having to mine precious metals, and most importantly for the Khan he had as much as he wanted, assuming he didn't run out of paper wax and ink. Practically though it also helped administer what had become a huge empire, made collecting taxes from the population easier and made financing his war much less painful in the short term. The question is, why on earth would anyone accept paper to have the same value as gold? Well because the Khan said so, and if you attempted to still use gold you were killed. If you tried to cut in on his monopoly and issue paper notes like his, he had you killed. And just to make sure no one kept using gold and silver he confiscated all of it. So everyone agreed to go along with this game of make believe that paper was worth as much as gold or silver depending simply on the number displayed.

The problem with paper money is that people in power always need more money, be it for waging war, pacifying would be enemies with gifts, or endearing supporters with wealth. The reasons listed above and in the last sentence note why paper money was good for the Khan, and you will notice that hardly any of these reasons seem to be good for the people of his empire. As the need for money increased through war and gifts, the supply of this money grew, and this move turned into an economic disaster for his empire as the "money" became worthless and his decrees of paper value became increasingly meaningless. This experiment with what is known as fiat (latin: let it be so) currency was the first of several failures through human history. The first paper currency in the West was introduced in Sweden in 1661, the Bank quickly over extended itself and had to ask the government for help, and they got their bailout (some things never change). Although to most people this looks like a failure, bankers saw the opportunity for large amounts of unearned income. So following this "failure" of the Swedish experiment the Bank of England was formed in 1694.

Where do banks really get money from?

The other part of our story has to do with the evolution of banking. The well established problem with gold and other precious metals as a store of value is that they can be stolen, then melted down and there is no way to tell if the gold is the item that was stolen. Jewelry, aside from being a way to display wealth, was also a safe way to store it close to your person and thus not allowing thieves to steal it while unattended. Another option that became popular was storing it with a gold smith, since they had to have large quantities of gold on hand anyway they were already investing in vaults and security, and for a small fee you could store your gold with him. Gold smiths started to also be the people that people could borrow gold from, since they had so much in storage. Eventually they were not just lending out their own gold, but also the gold that people were storing with them, since in most cases the gold rarely ever left the vault, and on no occasion did all the people storing it come and ask for it at once. This created the early form of banking, and eventually it became profitable for the gold smiths turned bankers to even pay people to keep their money with them giving them an interest rate much lower than that they charged people that lent from them. 

This is how many people today still think the banking system works, that banks can lend money that it has based on the money that is entrusted with it by those who store their money with them. This however is not the case. It wasn't enough that you could lend out other peoples money and not have enough if they all asked for it back, apparently you can't make enough money that way. Why allow yourself to only lend out up to your total worth if no one actually ever takes all the money out? The answer to this question by the banking community was why not indeed. So fractional reserve banking was born, a strategy which, depending on the arbitrary rules, allows banks to only have to have a fraction of the amount of cash and other assets on hand 
that they can lend out. So if a bank only needs to have ten percent reserves on hand, and lets say you deposit $100,000, that cash in their vault can be lent out at up to $1,000,000. Of course these special rules only apply to banks, you (assuming you're not a banker) and I can not do this. If we lent out money we didn't have it would be called fraud. The other problem that this created was that occasionally people would get wind that people weren't paying back their loans to a certain bank and in an effort to make sure that they got their money out of the bank (since it wouldn't have enough to give everyone) everyone would try to get their money out at the same time resulting in the collapse of the bank, a phenomenon also known as a run on the bank. To counter this bankers thought it would be a great idea to create central banks that could act as a "lender of last resort", to ensure that there was always money to cover runs on any given bank. Who was this lender? Indirectly it's the countries tax base and wage earner, as the money becomes printed, further increasing inflation and thus robbing the value of existing currency- this ability to cover these kind of sudden shortfalls does not exist so easily in a system with a fixed standard, as gold and other commodities can not be summoned up at a moments notice, and thus we entered a world wide largely fiat system.

Despite the framers of  the US constitution writing in it that only gold and silver would be money precisely because a fiat currency that they used to finance the revolutionary war caused so much economic disaster, and despite Americans throwing off two central banks through the 19th century (including an epic struggle by Andrew Jackson) America instituted a de facto central bank in 1913 with the Federal Reserve act. Note that the American Federal reserve is not really a Federal entity as it is run by private large banks and it is also not a reserve, but instead a monopoly that has been given the sole right to print paper currency- not all that unlike the Khan. It is maintained under the same principles, and though most of us do not need the guns held to our head, and the penalty is often not death, it is however jail time and the threat of force to at least imprison or take away the fruits of your labor. Not unlike the Khan, when our paper currency was eventually decoupled almost entirely from gold FDR had American's gold confiscated via an executive order in 1933 and also like the Khan made it illegal to use as money.

The Fed's initial stated goal was to maintain stable prices and protect the value of the currency, and later it was adjusted to also include optimal employment. Its initial mandate has been an abject failure by any measure as shown in the graph  above illustrating the relative value of a dollar since 1913. While $20 or an ounce of gold would buy you a very nice suit in 1913 (and in golds case also a really nice toga in 450AD), $20 in 2011 buys lunch for a couple of people at McDonalds- gold still buys a nice suit. Gas prices too, although they seem to be ever increasing, are really a reflection of the devaluation of the currency and not so much the increase in the cost of gas, as gas priced against gold has been phenomenally stable over the past 40 years (since Nixon completely decoupled the US dollar from gold) with the price of oil actually decreasing slightly in the last few years (most likely due to golds slightly high value due to financial uncertainty). This is not an argument that the whole world should adopt gold as the only form of money, just that it has remained stable and our engineered monetary system which was supposedly designed to create stability has failed miserably.

So with some of the history out of the way, again we have to ask, what is money to the average person? It remains as it was in even the earliest days post bartering where it was a commodity that acted as an intermediate store of wealth that represented our saved goods and labor. For most of us we work and instead of getting barley or salt we get something that we get a universally accepted intermediary agent that we can use to get the goods or services we want. Why then are we using the current system at hand? Why do we accept that what some people tell us is money does in fact have value? Why do we allow ourselves to use an intermediary that looses value at a rate of between 4% to 10% (inflation numbers taking into account energy and food prices in consumer prices or higher if you calculate it based on the actual supply of money) annually, and also can be manipulated at will by the few people that have been given the exclusive rights to print it? Why do we play along with this made up fiction when our government behaves no better and just as predictably as the Khan of ancient Mongolia? Why do we go along with a system that allows the people who have access to the money first to buy commodities at discounted prices as they get to spend it before the money has entered circulation and prices have adjusted to inflation? Why is it ok that the rules for some of us are different than the rules for others who can lend or print money literally from nothing while the rest of us must labor or trade goods of real value for it? Why do we look at these digits or paper with no intrinsic value and pretend that they are a thing of worth? Why do we let less than one percent of the population become rich off of doing nothing but manipulating fictitious numbers, while the other 99% has to add value by actually producing something that people want?

When I was a teenager I use to read about decline and fall of the Greeks and Romans, and I never understood how countries that had produced such luminaries in thought and some of the brightest and bravest warriors the world has ever seen could be bullied and controlled by emperors like Nero and Caligula, or have open oligarchies like the thirty tyrants rule over them. The sad truth I've come to realize over the years is that however small our piece of the pie is, we cling to things of injustice because we have a perceived stake in these things too. Even when Roman leadership had completely failed its citizens and the institution that had once been a servant of the people became their master, they lacked the imagination to refuse this and create in the world another way by simply all agreeing that this is not in fact the way things are. We too will remain shackled to a system that is failing quickly and decisively because as a whole we lack the courage to throw off our investment in this doomed system we are all attached to. Our financial system is not real, it exists entirely on the willingness of all of us to believe it is real and enforced by those who hold guns telling us that we play by their made up rules or there will be consequences. As "money" with more 0s than I can keep track of gets handed out to those who are politically favored, or are connected to large banking interests or investment firms at what point do we as a people say "enough"? At what point do we tell the Khan that he has no clothes?

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