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Money is a Claim on Resources

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Peruvian Gold Mining Rush (photo – bizfluent.com)

by Greg Buck

Following up the recent series on China, credit, and why it matters, I think a primer on money would be in order for a lot of readers. Unfortunately, most people have an antiquated idea of what money is and how it works, and this makes it very difficult to understand the danger of too much credit.

Most people still cling to the notion that money is a “lubricant”, facilitating transactions in an economy, and that it is a “store of value” because it can be saved and then spent later. Well, money is these things, but the problem is that it is so much more than this. The most important of these is that “money is a claim on resources”.  This is why it’s so important to make sure that the amount of money out there does not get ahead of the real world out there. The tail should not wag the dog.

Back in the day, money was saved by stashing it in the bank, and the bank put that idle money to work by lending it out, at interest. The interest paid to the depositor was compensation for the risk taken in lending their money. Banks could, within limits, lend more money than they had on deposit, because it was highly unlikely that all depositors would demand their money back at once.  This “lending more than what you have” is known as fractional reserve lending, and it was permitted subject to very tight controls on banks, for obvious reasons.  One of the most obvious restrictions was that banks were not allowed to gamble with their customers’ deposits!  “Banking” banks and “investment” banks were kept separate, and any taxpayer-backed deposit taking institution was tightly regulated, precisely so that they could not take deposits from the public, gamble with them, lose them, and then turn around and demand a bailout.

Up until the 1970s, the US dollar was backed by gold.  What this means is that dollars could be exchanged for physical gold.  This is very important to understand, because it placed a limit on how many dollars could be printed.  To fund the Vietnam War the US printed a hell of a lot of dollars, and after the war a lot of those dollars were exchanged for gold. Holders of dollars wanted gold, not paper. Then Nixon “closed the gold window” and the US defaulted on its debt by ceasing to pay the gold promised in return for those dollars.  Simultaneously, and in order to prevent the expected stampede out of the “newly worthless” dollar, the US created the “petrodollar”, doing a deal with Saudi Arabia whereby the Saudis agreed to insist that all payments for oil be made in dollars, and in return, the US became the Saudi’s biggest ally.  So, the world’s reserve currency was created, and its name was the US dollar.

Bingo!  The gold standard was gone, and the world’s banks were no longer limited to issuing new money backed by anything. The shackles were off. They could create as much “credit” as they damn well liked.

Over the coming decades, the lobbyists and politicians went to work, and we soon arrived at a place where money is created “ex-nihilo”, literally out of thin air.  Banks lend money into creation.  They don’t on-lend existing deposits, or even multiples of existing deposits. They lend out of “nothing”.  Lending out of “nothing” is synonymous with “creating infinite credit”, and it has two very big drawbacks.

The first we saw in 2008.  Allowing banks to extend unlimited credit eventually led to a credit crisis, because the amount of credit out there was way beyond what could possibly be paid back.  The response of governments and central banks was to drop interest rates to the floor, so that the existing outstanding credit became less onerous and could over time be paid back.  Phew.  But as I stated in an earlier article, money is fungible.  It heads off and finds an unexpected home, and it does not stay in the bathtub.  Instead of using the headroom provided by lower rates to pay down loans… you guessed it… people simply took the opportunity to take on bigger loans, aided and abetted by the cheering banks and politicians.  Yay.  House prices are going up!  And share prices.  And bond prices.  And antiques, old cars, art, and bitcoin.  Yipee.  We’re all wealthier.  Really?  All that happened is that we and the politicians were not forced to address the ballooning debts, and banks were rescued from the folly of their extension of unlimited credit.

So where does this leave us today, ten years after the GFC?  Massively increased debt and sky high asset prices, with interest rates still pinned to the floor.  In other words, the problem which caused the GFC has simply been made bigger, and there’s no headroom of lower interest rates ahead.

The second is the claim on resources.  “Financialised” assets like stocks or bonds, investment property, retirement accounts etc, are “worth” more when their “price” goes up because they can be exchanged for more “stuff” in the real world.  But we live in a finite world. We desperately need to live “sustainably”.  We definitely do not need to be consuming more and more and more.  We need the exact opposite of sky high asset prices fueled by cheap money created with a tap on a keyboard. Why do we believe fool politicians and central bankers telling us that we are better off when the “money” value of “things” goes up?

How did we come to tolerate a system in which people who do not have “money”, created out of thin air, starve, and how did we come to believe that all of the claims behind “money”, created out of thin air, can possibly be honoured without the world as we know it being wiped out?

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6 COMMENTS

  1. Thanks, Mr Greg Buck, and here’s my two cents.

    The conversation about money goes on between people who have money, who are in the game.

    There are 7 billion of us. That’s seven thousand million. One and a half thousand million are in China and one and a half thousand million are in India. Lotta folks.

    Every human being need to eat every day and every person in a cold climate needs shelter.

    The Bozos who are talking money at the top (as you describe, Greg) not only don’t care about the have-nots; they plan to eliminate them. Think I am talking only about in China and India? I am talking about MOST members of our species.

    We should be eliminating the ones who are doing this. Not because they fail to be “kind” to the poor, but because they are a menace to the planet and even to themselves. They are out of their cotton-pickin’ heads.

    At 10pm tonite, Sunday, in USA eastern standard time, there is going to be a big TV show called “Cruel and Unusual.” It is not Gumshoe-esque. It is about “Ten hurricanes, hundreds of deaths, and 207 billion dollars damage” — so says the trailer ad.

    People will watch it thinking Mother Nature was the one who was “cruel and unusual.”

    Please somebody help us.
    Note: Dee quoted Dr Day’s prediction that the bank surprise will occur after a winter weekend. That means one with a blizzard. Do we need more proof that the Bozo make blizzards at will? Not to mention the hurricane that destroyed Puerto Rico the other day?

    As you are checking out at the supermarkets here, the clerk says “Do you want to contribute to relief in Puerto Rico?”

    YES INDEED I DO. By the method mentioned above.

      • Mary, the public consists of individuals. Individuals are powerful and when they come together they become awesomely powerful.

        Perhaps people could begin with taking an inventory of what they know to be true. Then identify what they believe to be true. Belief can be true but not necessarily. When I look at what I know to be true it does not amount to much but I have learned that I can do anything I focus my attention on and all people can do this too. Truth can not be learned, it must be realised.

        There are two ways to be fooled, to believe what is not true, and to refuse to believe what is true.

        Time for people to stop compulsively filtering their perceptions of reality through a screening mesh of what they want and do not want to be true.

        The question then becomes, how do we do this? Does the answer lie with the children and the shaping of their minds?

  2. Well I don’t believe that anyone has the capacity to engineer the weather but I must say that the planet’s megalomaniacs can and should be harnessed, just like the sun and the wind

  3. 800k for a one bed apartment in suburbia . At 5% per year over thirty years that’s 2 million to pay back ,that’s close to 70 k a year net payments . One has to be on 140 k a year ( 70 k tax) .
    After that there is nothing left to cover everything else that one needs to eat live survive .
    Taxation and compounding interest usury has destroyed the good people of this nation .

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