Money is now more than ever disconnected from its original social purpose. Here are 7 tough facts they won’t tell you in economics 101. By Eva Zaki of OurXchange.net
1. Money as we Know it is a Fallacious Legacy
People could not travel through dark woods with bags of gold coins without being robbed. Nothing new there. In the 7th century, goldsmiths created the « double currency system » to address the issue of security. They took gold deposits and handed out certificates of receipt representing the amount of gold deposited.
With the multiplication of transactions, people would no longer take delivery of their gold and use it for payment: they would mostly exchange the certificates.
As gold deposits remained in the vaults, goldsmiths (who became bankers) saw an alluring possibility. They started betting on the unlikelihood that depositors would all come and withdraw their gold at the same time.
Gold being a finite resource, their purpose was to multiply their gains by issuing much more than what they actually had in custody. Bankers created what is known today as the « fractional reserve system » to circumvent scarcity. To this day, actual reserves held at the bank are only a fraction of the money being created.
2. When Gold Convertibility Was Abolished, New Cards Could Have Been Dealt, A New System Could Have Emerged. Instead, The System was Maintained and Enacted into Law.
After gold convertibility was abolished, it became irrelevant to use double currency and fractional reserves. But instead of regulating these tempting practices, new political decisions backed by the banking industry led to the monopolization of money creation by private bankers, and to the tremendous power it confers to the owners.
In 1971, France realized that the US didn’t have the required gold reserves at Fort Knox to back the formidable issuance of dollars, which was the only currency convertible into gold. France asked the US to deliver gold against its dollar reserves.
At that time (early 1970’s), the U.S. had already nearly exhausted the huge gold reserves accumulated post-World War II. That is when Nixon decided to abolish the dollar convertibility into gold (« Nixon Shock »).
From then on, the US dollar would only represent people’s perception of the soundness and productivity of the U.S. economy.
Instead of reforming the double currency and fractional reserve systems, policymakers and private bankers around the world created what was to become the current monetary system.
In 1971, nations had the opportunity to democratically enact new legislation with respect to the Double Currency and Fractional Reserve Systems. But no democratic mechanisms allowed informing the people and inviting them to the ballot boxes; quite the opposite: the system’s old features crystallized in their present form, which is an invitation to abuse for the banking industry.
3. The « Golden » Era of Funny Money
In the early 1970’s, the post-Bretton Woods agreements led to the possibility for private banks to create money and lend it to governments at interest, while prior to that, most central banks around the world had been issuing interest-free money to allow states to function.
This new reality means that States borrow not only from commercial banks, but from bond markets at large. When a State issues sovereign debt, it relies on institutional and private investors to buy its debt, thereby making them its creditors.
From then on, fiduciary money (also called « fiat money ») replaced gold: all reserve currencies became an instrument whose value rests solely on the public’s perception and trust in its value. The value is derived from governement law and regulation, i.e., perceived government backing. It is « legal tender », i.e. the accepted medium of payment. It has no intrinsic value, and there is no objective standard to fix its value.
Clearly, fiat money provides much leeway for printing money without the public being able to sort out the wheat from the chaff. There is a big distinction between real money (central money, issued by central banks), and virtual money (scriptural money, created in the form of credit by commercial banks).
Though the distinction is of great importance, the public at large totally ignores it. Very few know that when a client puts money in a bank, the bank writes an IOU on the depositor’s account (a promise to deliver the money if the depositor asks for it). The fractional reserve system means that the money will be available if needed, but should all depositors reclaim their money at once, the bank could not fulfill its promise.
4. The New Double Currency System
The new system involves Central Money and Scriptural Money. Central money is the « official » money issued by central banks representing “faith in the country’s economic health”. Scriptural money is the money created by commercial banks based on the amounts of Central Money they hold with the Central Bank.
Due to the fractional reserve system, a commercial bank needs to hold only 10%-15% of its total commitments in « real money ». The other 85%-90% can be scriptural. Scriptural means credit.
The result is that today, only approx. 10% of all money issued is real money, and 90% is scriptural money, which boils down to « debt ». While central money is a low interest-rate debt from the central bank to the commercial bank, scriptural money is a higher interest rate debt issued by the commercial bank to individual or corporate borrowers.
Scriptural money consists in a bookkeeping entry, created by a mouse click, on the borrower’s account. Concretely: a mortgage is a debtor position whereby the bank owes the borrower money, against a creditor position whereby the borrower owes the bank the same amount. The bank pays the credit amount immediately, and the borrower pays at the expiry of the loan. On repayment of the loan, the scriptural money “disappears”. This is the best case scenario: the borrower reimburses his loan and the credit ceases to exist.
But if the borrower is insolvent, things get complicated. « Foreclosure » cases have been widely documented during the subprime crisis (July 2007). The lending bank seizes the house of an insolvent borrower and has the option to realize the asset. In that case, the operation could be summarized as: the bank issues scriptural money to a struggling debtor, the debtor fails to pay his mortgage interest, the bank seizes his property.
Not only does the bank earn interest on ex-nihilo money, but it can seize a real asset and realize it with potential profit.
5. The Money Bubble
The monetary system in its present form involves the maintenance by Central Banks of extremely low interest rates; officially to revive the economy, but coincidentally, to reduce the debt service burden. In the current economic context since the “debt crisis” broke wide open in 2007, no Western state can afford to raise interest rates to say, 5% or 6%…
In the US, as of end 2012, the debt-to-GDP ratio reaches 106% and the debt ceiling (16.394 trillion USD) has been hit on 31.12.2012. It was raised for the 77th time since March 1962. No one even mentions decreasing it. It is simply unthinkable that a debt of this volume will be refunded some day.
In all advanced economies, sovereign debt has become a permanent obstacle on the way to growth. In any of the G7 countries, interest rates must imperatively be kept at near-zero levels. For that purpose, inflation is strictly monitored. Any triggering event that would force interest rates up involves a major risk of a world bond market crash and a sovereign default chain reaction. It has become a matter of national security to prevent the extremely fragile money bubble from bursting.
In this context, it seems optimistic to expect countries to significantly reduce sovereign debt: first, money IS debt. Secondly, historic figures show that sovereign debt naturally increases and multiplies over time, because part of it is dedicated to supporting existing debt.
Only drastic anti-social measures can reduce it. Unpopular measures are resisted by taxpayers who refuse to shoulder a huge and unwarranted burden. In this context, austerity measures would have to stretch over a decade or more. But most probably, states must be prepared to say goodbye to “growth”. Politicians, whether left or right, have great difficulty balancing the debt problem with the discourse on growth and budget. Corporations, too, in their 2012 earnings reports, have started grappling with the grim economic climate.
6. The real nature of money: an exchange mechanism for Society
Let’s go back to basics. Let us imagine living in a small village that has a basic economy using barter. On a Sunday morning, you go to the marketplace to buy potatoes. In exchange for the goods, you offer the merchant a wood stove. But she doesn’t need that; instead, she needs an oil lamp. However, you don’t have that. To pay her back, you sign an IOU. With this certificate, the merchant can find whatever goods or services she requires in Society. By signing this IOU, you acknowledge the value of the goods you just bought, and allow the merchant to convert the same value into whatever she needs and can find in Society.
As defined here, money is a mechanism to transfer an acknowledgment of debt within Society. It is the recognition by society of an individual’s labour, the value of time and effort. The merchant is being paid back for growing potatoes.
Would it make sense for the IOU to bear interest at its issuance? The merchant would then pay for being refunded. In comparison, in today’s system, nations « borrow » money from their central banks. Interest paid on the issuance of money is borne by Society at large.
Members of society are indirectly paying interest on compensation for labour. The only possible consequence of this ever increasing drain is the loss of purchase power for citizens and taxpayers: those who carry the fiscal consequences of the debt servicing and are not in the ranks of money creators. The loss of purchase power can be observed directly, even if it occurs subtly, primarily through inflation and currency devaluation; and secondarily through the stagnation of wages and the inability of the economy to support sufficient job creation.
7. State Bankruptcy
This alarming situation poses an impending risk of state bankruptcy. How long can a state manage with a crushing burden of debt? Most political leaders have tried to delay indefinitely the necessity to address this question. But pressing fiscal issues have already started to impose themselves as absolute priorities in all political… and now economic agendas.
The fiscal debate now overshadows all other aspects of the economy (fundamentals, indicators, microeconomy). This vital and extremely sensitive issue takes precedence over anything else. Even in election years, is no longer possible to ignore the danger posed by the debt system to a country’s sovereignty, security and sustainability.
It is quite possible that when important governments officially fail (and that is progressing as we speak), they will fall prey to speculators and rating agencies. But what awaits them is much bigger. We could imagine international finance coming to the “rescue” and presenting a new system based on a single global currency to be issued by a super world bank (World Bank, IMF, BIS, or a combination thereof). This is only a fictious scenario…
The solution that could emerge from an international finance cartel would offer temporarily lifelines… and permanent prisons. Until the solution tackles the root causes of our addiction to debt, it will be fake.
Only a democratically organized money creation entity can lead to a democratic monetary system… and a democratic political system.