Out of Thin Air

What is money? It sounds like a simple question, right? Better yet, where does money come from? Doesn't it come from, as my wife jokingly said, "... the ATM?" While you can get money from an ATM, that is clearly not it's ultimate source. In reality the concept of money is not all that complicated, however, I'm willing to bet that many readers have some serious misconceptions about it. I would also argue that this is no accident. For the most part we are not taught nor encouraged to think in detail about the more fundamental concepts around money, and more broadly, economics. I think this is partly so because the corporate elites in our society, those who control most of the money and its power are more than happy for us to stay ignorant. What better way to push through outrageous bailouts, bonuses and job cuts than when most people are content to shrug their shoulders and mutter, "well, these guys are really smart, right, they must know what they are doing, right?" Moreover, if people understood better, understood the outrageous injustices present in our economic and monetary systems they might get so pissed off as to march off and change it! After all, we still live in a political democracy, and with enough mobilization and commitment the will of the people can still be a powerful force.

So, this will begin a series of posts where I attempt to focus in on some common misconceptions about our economic system, and why I think it needs to be reorganized around the needs of people, and not the needs of money. Before beginning I have to confess to harboring from a rather young age a strong dose of skepticism around the wonders of "free market" economics. In college I remember taking a first economics course and upon finishing deciding I could not stomach any more. I think this revulsion was largely a combination of two factors. First, it often seemed that the simple models of how our market driven system was supposed to work were so crude and simplistic as to be virtually worthless when applied in the real world, and second, even in spite of this apparent crudeness the implication was that these economic "laws" were somehow akin to physics. The assumption being that they held as much predictive power as, for example, the laws of gravity. This is very serious indeed, because I think many people are of the belief that they are natural laws and thus could not be changed, when nothing could be further from the truth. Anyway, let's get back to the topic at hand, money.

Let's start with a somewhat silly, but rather illustrative example. A group of 10 people are midway on a trip across a vast desert when their vehicle fails and they find themselves stranded. After stretching their legs for a bit the vehicle suddenly explodes and all the provisions they had with them are destroyed. They decide that in order to survive an "economy" will have to be set up. They find 100 pennies amongst the whole group so they decide to issue 10 to each as their new "currency." Each agrees they will work to provide some useful service or product that will help them survive. Joe decides that he will make simple pottery vessels to store and transport water. He is able to make ten in a week, and he sells nine for 1 penny each and keeps the tenth for his own use. He uses his money to buy necessary items from his colleagues. The pots work well but break rather easily. Joe starts to get the hang of making his pots and he finds he can double his production, making now 20 a week. His mates now would like to buy two each but they do not have enough pennies to pay the previous price of 1 penny per pot. Joe is faced with a dilemma, he will have to cut his price in half if he is to sell his pots. His colleagues face a similar situation, price deflation, and must cut their production, or rather, have no incentive to increase production. This is a result of scarcity of their "money" supply. The group endures and eventually multiplies, but the total number of pennies remains the same. Joe cannot feed his offspring on the poor income from his pots. He has the capacity to produce more, but is shackled by the "tight" money supply. Joe asks to borrow pennies from a friend, but he also needs his money and will only agree to lend if Joe pays him interest. But are there enough pennies in the money supply to pay this additional interest fee? The money supply is fixed. If one of the group were able to lend his coins in this way, using compound interest, it is not hard to see that eventually this one individual would own the entire money supply, all the others would be flat broke and probably in debt bondage to the one "banker." If this scenario sounds a little bit like the beginnings of industrial capitalism, when the money supply was tied to a limited, controlled commodity, like gold, then you are right. Those in charge of such a tight money supply understand that they can control everyone and that over time more and more of the money will accrue to them if they lend it with interest compounded annually.

Now, consider changing the scenario slightly. Rather than fussing about the pennies, one of the group volunteers to act as group accountant and goods merchant. He will issue a small wooden stick to record the production of a good or service by his mates, and they will bring their goods to him for distribution and purchase. The group agrees that the accountant should be "paid" for this service, so he gives himself 10 sticks per week as a salary. Now, when Joe produces a pot, he is paid a stick, and there is no arbitrary limit on how many pots he can produce, he just gets a money stick for each one. He now has an obvious incentive to increase production. The accountant can easily make sticks from the trees and bushes. The sticks themselves are plentiful and have no intrinsic value, but they keep account of the production of goods and services and can be traded for them, they are the group's "money." All the others do the same, as they increase their production their money supply grows along with it, they all have more purchasing power and can now buy multiple pots from Joe at the penny per pot price he initially set. There is no inflation or deflation, prices can stay stable, and the amount of money simply grows with the increase in production of goods and services. The stranded group finds it is able to prosper and multiply.

The above examples are borrowed, with some paraphrasing, from the book The Web of Debt, by Ellen Hodgson Brown. I read this book recently and was frankly astounded with how well these simple examples highlighted both the basic concepts around money as well as the stark differences in systems where the money itself is thought of as the thing of value rather than simply the productive capacity of every individual. In the first example, the productive capacity is strangled because there is not enough money to go around. Naturally, under such conditions it is easier for the supply of money to be unscrupulously controlled by a small minority of the community, enriching itself at the expense of the rest of the group. Sound familiar? The second example shows what money really is, it is just an agreed upon system to account for the production and distribution of goods and services, it has no intrinsic value of itself, but serves as a medium of trade and accounting, providing the lubrication for the gears of commerce. When money comes into existence with the production of goods and services there is never a shortage of it and the supply of money simply grows with the increase in production, so that supply and demand increase together, without price inflation or depression of output.

Another paradox that comes into sharp focus in the above example is the so-called "Impossible Contract." Put simply, when money is lent at interest the money supply is not increased to cover the additional costs of the interest. The result is that there is never enough money to pay off the interest, or put another way, there will always be losers. Someone will always have to go to debtors prison. The system sets up an economic dog-eat-dog mentality, with the bankers eventually controlling all the money. The Impossible Contract was understood by many ancient cultures and is perhaps partly responsible for the ancient proscriptions against usury, and Christ's famous eviction of the "money changers" from the temple. Closer to home, it was also recognized by Benjamin Franklin, who was a proponent of state "banks" that would lend and spend money, without interest, directly into the community. His own State of Pennsylvania having successfully done this in the years prior to the American Revolution.

But perhaps the most astounding revelation in Hodgson-Brown's book is that the right to "coin" money, a right designated to Congress in the US Constitution, has been given over almost completely to private, for profit banks, the principal culprit being the Federal Reserve System (or Fed, for short). The Fed and the US Treasury department have for years reported several indicators of the US money supply. The simplest of these just count the notes and coins in circulation, and at most account for only a few percent of the total money in the system. The vast majority, measured as M3, represents loans issued by commercial banks (including the Fed). Where does this loan money come from? The answer is that it comes out of thin air! When a bank makes a loan it simply adds an accounting entry on its books for the amount of the loan (and not including the interest to be paid). Normally when we think of borrowing and lending we are thinking about things that already exist, like your neighbor's milk or eggs, but the banks don't actually have the vast majority of money that they lend! It is really your money! Your agreement to pay back the loan based on your productive capacity, but with additional enormous interest costs! The banks are largely just unproductive middlemen who extract an enormous cost from all of us as we go about our productive lives. Curiously, the Fed is no longer reporting the value of M3. Now I wonder why that could be? Let's look at the impossible contract again. So where does the additional money come from that must eventually cover the interest charges? Well, it can only come from additional bank loans, but these are also issued with interest due, so we have a pyramid scheme of gargantuan proportions, that is slowly but steadily inflating the money supply, and simultaneously devaluing the purchasing power of every dollar in your pocket. If by now you are muttering that I must be crazy, just look at this figure which shows the value of the US dollar over time. Also note that from the time of the Federal Reserve Act the value of the dollar in real purchasing power has been steadily declining, as it must based on the above reasoning.

Our present monetary and economic system is slowing but steadily impoverishing the public at the expense of a small minority of private banking and corporate fiefdoms. As the simple examples demonstrate, the system cannot endure, and indeed appears now to be teetering near the verge of collapse. While many additional factors also contribute to our present, unjust system that has "monetized" the productive capacity of the people and turned it over to a private minority, it seems clear that a first step towards regaining control of our economic future is to regain control of the monetary system for the benefit of all and not the enrichment of a small minority of parasitic "bankers." More about that to come.