The Trouble with Money
Including Paul Grignon’s wonderful video
All money is now created by lending. Banks lend money they don’t have and when that money is deposited in another bank, or the same bank – it doesn’t matter which – they are allowed to re-lend 90% of it again and again.
In my piece ‘Why the LibCon’s “Big Society” won’t work.’ I outlined why consumerism, as a socio-political and economic system, is technically unsustainable (even if working correctly) due to limited resources and failing habitats. I mentioned too that, in times of trouble, the surplus usually destined for welfare is re-directed into the pockets of the elite ruling classes. Mechanisms such as favourable taxation arrangements for the wealthy, the acquisition of cheap foreclosed capital (debt and real resources) and the withdrawal of welfare from those less able to borrow, all add up to a further concentration of an already highly concentrated pool of money and resources at the top.
Those mechanisms I have outlined can all take place within the legal frameworks supported by governments without the need for overtly illegal practices. One of the reasons why the rich can feel at ease when others starve to death is that the legal frameworks, nationally and internationally, cling to the notion that the wealth accumulated in the pool of ever expanding ‘money’ will ‘trickle down’ to the bottom making everyone better off in the long term. But, as we have seen, the dream of a global consumer-led market economy is coming up against the inevitable inflationary effects of limited resources. The value of labour entrusted to exploiting resources thus diminishes as resources become scarce; inflationary pressure first forcing labour rates down and then creating mass unemployment as the value of labour becomes less than the value of subsistence – in short, when the energy lost in a person’s physical exertion is more than the energy gained in the food, shelter and rest given in exchange for the labour.
As we know, many colonial empires – realising that their rapid expansion might be too inflationary for their own good – solved their labour problem with slavery. Though the old empires were not yet up against the final limits of the earth’s resources, they were expanding their economies more rapidly than resources could be extracted and the effects were precisely the same. If some humans were deemed expendable, one simply worked them to death under force of arms.
But if this gloomy picture was not bad enough, the situation is exacerbated by the fact that the mechanism we use to trade the value enshrined in labour and materials, food, energy and everything else is very poorly organised. The mechanism I’m referring to is, of course, money.
The problem of how to ensure that money represents the value of the things it is exchanged for has been with us for a very long time. Who creates and controls money, either as cash or as an electronic notional entity, is thus of very great importance. Throughout history, many commodities have been used as money to try and emulate the value, in terms of human effort, that has gone into producing those commodities: gold and silver coins represented the human costs of extracting the metal and making the coins; salt represented both the labour used in collecting the salt (and the labour saved in preserving food with the salt). Indeed, even the word ‘salary’ is derived from the Latin word for ‘salt’ because Roman soldiers were paid according to the value of a salt ration.
Even paper money once reflected the gold reserves of the issuing governments or banks. The term ‘Promise to Pay the Bearer’ on every bank note is a reference to those days when money was valued according to a commodity’s worth in terms of the labour needed to extract the commodity from the ground – in theory one could take a pound note to the Bank of England and exchange it for gold.
But, as localised farming economies were replaced by an industrialised global economy and as the power of nation states and empires were usurped by international and multinational corporations, it became impossible for competing governments to adequately control the fluctuating values of gold, silver and other commodities; the huge growth in the global population, and thus growth in the demand for money, also began to outstrip the system’s ability to match each unit of currency with any particular commodity. On top of those structural problems, the growth in the financial markets, by which I mean the buying and selling of alternative currencies such as stocks, shares, bonds, promissory notes and so-on, created a number of financial systems and institutions that, together, were worth a great deal more than the currencies issued directly by the governments.
On top of the structural problem between the governments and their main banks, there was also the ruling that private banks did not have to actually have on deposit the money that they were allowed to lend. Before banks were regulated by governments, they would lend as much as they could, regardless if they had the money or not. If the depositors found out, they might all want their money back at once but such ‘runs’ on banks were rare. But the early regulations did, anyway, allow for ‘fractional reserve banking’ to aid the growth of the money supply.
A bank might have reserves made up of gold, silver and government bonds but the law allowed them to lend more than they had. In the 17th Century, the Bank of England was allowed to lend 2 X their reserve.
Things came to a head in the 1930s. After nearly 2000 years of commodity-based currencies, and increasingly risky fractional reserve banking, the two most powerful economies, those of the United States and Great Britain, ditched the gold standard for good. Trading in the financial markets after the First World War had become reckless; speculators, banks, governments and millions of individuals became infatuated with the idea that technology and exploration would produce limitless growth. And like many speculators before them in bogus schemes such as the 18th century ‘South Sea Bubble’ (1720 -1721), the investors of the 1930s had been persuaded by government and the banks themselves, that returns on investments were as good as guaranteed. So sure were the speculators that such a fiction would come true that banks often loaned investors the money to invest without demanding any real collateral; and much like the sub-prime crisis of the last two years, the money supply vastly outstripped the value of the resources the money was supposed to represent.
What replaced the gold standard was an astonishing piece of economic and political brinkmanship. For centuries, governments and kings had raised money for their wars and extravagances through the issue of bonds. In effect, a bond is a promise to pay the bearer interest on a loan at a later date. The government issues bonds to their main bank, such as the Bank of England or the Federal Reserve. In the past, kings and governments raised huge amounts by this process; remember, if a government sells bonds it is borrowing money from the person or bank that buys the bonds.
Sometimes, the public were asked to buy bonds directly and sometimes the bonds were used by the banks as part of their reserves. But the interesting thing is that the main banks, the Fed or the Old Lady, didn’t actually have to have to buy the bonds from government with existing money, they simply credited the government with the required amount. So, effectively, money was created out of nothing. Amazing as it might seem, this measure sometimes called a ‘bonds issue’ and in modern times called ‘quantitative easing’ was once only used in emergencies. But since the 1930s, this system has been pretty much the only mechanism governments have used to create money in the economy. But governments are really minor players in this strange world of money; by far the biggest role is played by the banks.
All money is now created by lending. Banks are allowed to lend more than 10 times what they have as real reserves; they lend money they don’t have and when that money is deposited in another bank, or the same bank – it doesn’t matter which – they are allowed to re-lend up to 90% of it again and again.
At this point, I urge you to find 45 minutes and watch a video by Paul Grignon. If you haven’t yet grasped the enormity of the problem, this will shock you to the core.
Follow the link below and settle down to the best lesson about money on the net.
Coming soon: How a new global economy needs to be structured and how we progress from our currently unsustainable global consumerist economy to one that takes us all to a reasonable standard of health and prosperity. Meanwhile, please read and sign the Sirisuk Declaration by going to www.sirisuk.org