TCS Daily


Money and Ruin

By Jon N. Hall - April 22, 2010 12:00 AM

In its beginning money had intrinsic value. Money was valued for itself, not just for what it could buy, as it was made of precious metals. But as history transpired money became almost abstract. First, money's metals became less precious, then money became paper backed up by gold, then paper money lost its gold backing, and now money is nearly incorporeal. Money now consists of magnetized spots on computer files. These digital configurations (the ones and zeros that make up the binary code of computers) are shipped around the world at the speed of light. Indeed, when money is being transmitted through the ether via Wi-Fi or satellite, today's money is light.

Although the love of it is said to be "the root of all evil," money itself is one of Man's more marvelous inventions. Without money, commerce would be reduced to barter. Money makes our modern economy possible. Could civilization exist without money?

The beauty of money is that it allows us to store value. We can actually store the value of what we create in our work ... out in cyberspace. Money's ethereal nature allows us to prepare for hard times, and to save for college or for the down payment on a house. Without money, how could one postpone gratification? If one received a sack of potatoes for one's work, they'd best be eaten soon or they'll rot. Not so with money. Put it in the bank and you'll be able to tap into it years later.

Despite its centrality to life as we know it, money has been getting a lot of disrespect lately. Some advise us to get out of money. In what seems an unprecedented advertising blitz, gold merchants are all over TV. "The dollar? The euro? The yen? Unreliable," says Gordon Liddy as he crumples paper money and flings it away. "Buy gold," he urges. But if money is so unreliable, why do the purveyors of gold want to swap their gold for it? (Perhaps the gold bugs have gone off the money standard, and expect some other medium of exchange for their gold.)

Money is also shown disrespect by the way individuals use it. Spendthrifts disrespect money by living beyond their means. The extravagant don't seem to realize that spending money is spending life, spending one's future. Perhaps the most inane thing ever said about money is: "it's only money." People who spout such foolishness don't know anything about money and haven't had to work very hard for what money they have. They're unserious. Perhaps folks lost their appreciation for what money is simply because there's so much of it floating around.

The disrespect shown to money by the citizen is troubling, but what is truly alarming is the position taken towards money by the government. The Federal Reserve has created trillions of new dollars to stabilize the financial sector, fight the Great Recession, bailout Wall Street, and prop up real estate prices. All of these actions are quite beyond the original mandate of the Fed, which is to preserve the value of the U.S. dollar.

Although the federal government creates money, so does the private sector. With our fractional-reserve banking system, commercial banks create money whenever they extend a loan (the multiplier effect). And like the Fed, the banks use "thin air" to create money. But because the government dictates to commercial banks the fraction of their deposits they must retain in liquid reserves, the government is ultimately responsible for the creation of money by commercial banks.

Through the Community Reinvestment Act, Congress pushed commercial banks to make more and more home loans, thereby increasing the private creation of money. And the CRA pushed banks to make loans even to borrowers who couldn't put up the standard twenty percent down payment. With no skin in the game, such borrowers could simply walk away from their homes when default came knocking. So government policies, like the CRA, ramped up the private creation of money by the banking industry.

Holders of U.S. dollars must be able to trust that the creators of dollars won't create so many new dollars that it destroys the value of the old dollars, i.e., their holdings.

But government has interests that conflict with the preservation of value. These interests include the flagging economy and unemployment. Professional politicians want things the way they were during the booms so they can get reelected. So the politicians urge the banks to make more loans, get the money circulating again, rev up the velocity of money. C'mon, bankers, make some loans, we have an election coming up.

So money takes a hit and its value goes south. But government is playing with fire. For if money is utterly destroyed, there will be no denominator of value. What will be the value of everything -- the businesses, the real estate, the farms, the intellectual property; the aggregate American wealth created in the 218 years since the establishment of the U.S. Dollar and the U.S. Mint in 1792 -- if there is no standard (i.e., money) with which to valuate everything?

Perhaps not as serious as Armageddon or a direct hit by a rogue asteroid, the dollar's collapse would nevertheless precipitate one gigantic "reset." The pain and confusion would be horrible. We'd have to start all over.

But can America begin again?

It was a miracle that America began even once. In "Tattered Liberty," Mark Steyn writes hauntingly about the specter of American decline. An omen of decline was seen when the ratings agency Moody's recently reported that fiscal adjustments to preserve America's AAA rating could "test social cohesion."

Social unrest popped up in Greece recently in riots over proposed austerity measures to deal with their financial crisis. Bloomberg reported that Greeks were even polled on whether they wanted to leave the euro and go back to the drachma. But French President Sarkozy "said the European Union must support Greece or risk destroying the euro."

The cause of such dilemmas is debt accrued from extravagant government spending. And with fiat currencies, such as the U.S. dollar, whenever money is created, debt is incurred. An object lesson on national decline is playing out in Europe even now, but our new leaders in D.C. want America to be like Europe.

Regardless of whether our money is gold, paper, magnetized spots on direct access storage devices, light or even non-hybrid seeds, the Laws of Money, like the Laws of Physics, are eternal, immutable and incorruptible. Attempt to break the Laws, and suffer the consequences.

Metaphysicians might quarrel with such a postulate, but today's money is a case of the material having become immaterial. We who use money are all low-rent Platonists now; we put not our trust in gold, but in something ethereal. The photons that make up today's money are about as close to immaterial as central bankers are going to get. But when money becomes worthless, the immaterial will be immaterial.

Our medium of exchange, our store of value, in a word our "money," is just numbers. And because numbers are so easily manipulated we must keep an eye on them, lest they get too large and bring us to national ruin.


Jon N. Hall is a programmer/analyst from Kansas City.

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13 Comments

Wrong. Banks create CREDIT, not MONEY
When it comes time to pony up actual money, they have to get like everyone else but the FED does -- from someone else.

If fractional-reserve banking were true as described, then banks would be making tens of thousands of percent profit margins. They wouldn't bother nickle and dimeing us with account fees, ATM fees, etc.

Banks can increase the velocity of money by issuing out more loans (and thus collecting more money in the form of payments -- velocity is velocity, after all). The author says so himself.

But why bother with that too if the the magic of fractional reserve banking is real?

Hell, banks would be PAYING us to take loans just to jack up their 'ability to create money' under fractional reserve borrowing.

What a joke.

Check, please.
"Hell, banks would be PAYING us to take loans just to jack up their 'ability to create money' under fractional reserve borrowing."

Well, I think you went a bit too far with that one. If they were PAYING us to take loans, then increasing their ability to create money (so they can lend it out) would result in more loans....and them PAYING us even more.

no, under 'fractional reserve banking' the banks get to 'create' tons of money
out of thin air.

So, you deposit $8k and then they give you a $100K loan...that $92k being 'created out of thin air' via fractional reserve banking. They are only 'burdened' with maintaining reserve levels at around 8% of total loans outstanding.

If they could really 'create' $92k that way, then it would be in their interest to get that principle back as fast as possible and screw the interest. And, they would be bending over backwards to encourage people to deposit money with them as opposed to treating customers they way the presently do.

It's all bunk, of course. They never, ever 'created' money out of 'thin air'. Only the FED can do that. No. The 8% reserve requirement only mandated that the CREDIT they created and extended be limited. Banks still have to have that $8k in the bank for their reserve AND cough up the $92k from somewhere else -- other depositors or their own capital or something. They can't create it.

And the FED is talking about doing away totally with the reserve requirement...to get banks to lend more and thus increase the velocity/churn of the money in circulation. After all, the FED - as lender of last resort - can create all the money necessary to cover the withdrawals for the occasional bank run that happens.

So, when you hear people talk about 'fractional reserve banking' and the powers of the banks to 'create money'...they really don't know what they are talking about. And many of those folks work at the FED, too. The FED even published manuals describing the banking system working that way, for crying out loud.

"Put it in the bank and you'll be able to tap into it years later."
If any is left after bank fees and inflation.

Forbes says it best...
"Imagine if the government decided to increase the number of minutes in an hour from 60 to 70. You can hear policymakers congratulating themselves: "People will work longer at the same pay. This will be a boon to productivity!" Or if Washington increased the number of inches in a foot from 12 to 15: "Home buyers will thus get more house for the same price and that will stimulate home buying!" Preposterous? It's no more foolish than what we and other countries routinely do with our currencies."

http://www.forbes.com/forbes/2010/0510/opinions-steve-forbes-fact-comment-short-money-treatise.html

Recall the French 35 hour weeks to create more jobs?
That did not work either.

Money and gold
It may have been different at one time, but nowadays money is more valuable than gold. Intrinsically, even. Because money is the great facilitator of trade. Its value is that it can replace actual goods with an abstract notation representing their value with a simple number. Thus bales of cotton or bars of gold don't actually have to trade hands across the oceans. A simple electronic blip can do the task instantly.

The virtue of modern money lies in its evanescence. It is no thing, but rather an abstract conception with only a numerical existence. Gold, on the other hand, is clunky and of limited use (teeth, electrical contacts and thug's jewelry). And it subjects the bearer to being knocked over the head and having his wealth readily taken from him.

Bravo
It's just such comments as this that make your otherwise insufferable presence here tolerable. Good point.

Roy and Fools Gold
"It may have been different at one time, but nowadays money is more valuable than gold."

OMG...you really have problems with reality, don't you?

When we left the gold standard, $35 could buy an oz of gold. Now it takes over a thousand (and rising) to buy the same oz.

"Because money is the great facilitator of trade. Its value is that it can replace actual goods with an abstract notation representing their value with a simple number."

So? Good Money is also that which can be a decent store of wealth. AND gold backed money is just as 'great a facilitator' of trade as any other.

So, on Planet Roy we should settle for a currency that does only one but not both, I suppose.

And again: nobody on this thread is proposing people carry hard gold any more than they need to carry hard cash on themselves (which they equally risk getting knocked on the head and getting stolen...except on Planet Roy, I suppose).

Debit cards work just dandy.

Money in its various forms
"Gold backed" money is not gold. It's money. Money with a guarantee. Just like all money has some sort of implicit or explicit guarantee.

Debit cards are not, IMO, a very good form of money. Auto rentals and hotels can put claims on this money as a surety against damages. Monthly debits can double up in a given month. Lots of things can happen, triggering a flood of cascading events that can cost the holder a lot of (his own) money. A check book is simpler and safer. You can keep your check log in pen, not just trust it to the bank to keep your balance straight.

Cash also holds a great advantage for criminals, as it's not readily traced. That's why it's not as easy as it used to be to buy a BMW with a roll of hundreds.

Gold also has its advantages. In India it's fairly fungible, and can be used for many sorts of purchases. And in wedding rings, it won't tarnish.

Those who go through life using credit cards have their entire pattern of purchases open to public scrutiny. But they are awfully convenient to use.

The main question is one of trust. Try this experiment. Print up some bills stating that they are backed by the value of some index of gold price, not just the full faith and credit of the dumb old US government. Then use them at your corner grocery. Report back to us on how the transaction went.

This isin't just me saying so...this article is a perfect 'case study' explaining it
While it deals with the current scam where the banks aren't really creating much credit for new mortgages, it clearly shows that it is the FED -- not the banks -- that create MONEY.

Be prepared to become ticked off when reading this, btw:

http://www.bullionbullscanada.com/index.php?option=com_content&view=article&id=6227:the-us-governments-zero-down-payment-mortgages&catid=47:us-commentary&Itemid=132&source=patrick.net

>In its beginning money had intrinsic value

No, in the beginning people knew their neighbors and a hand shake or equivalent sealed a deal. Money facilitated dealing with strangers.

I could give my IOU to my local grocer and he could use my IOU to pay his milk guy but this is . . . messy. Money is an IOU for goods and services that is countersigned by the government.

The Government just printed 2 trillion or so of these IOUs but there is no runaway inflation. Why not? Because the people who received the IOUs are not buying goods and services with them. Money in placed in Swiss banks does not cause inflation.

The socialistic administration is ruining America, the ideologues don't care about our nation, what matters is the destruction of our America, free and envied to transform in a vast empty field

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