Money, Power then Chaos
Have you visited your bank recently and made a deposit? Well, if you have been saving consistently, you have probably grown your credit and can take out a secure loan to serve as capital for a startup business you’ve always dreamed of, or maybe even a mortgage plan for your future home, which is all very bold and forethoughtful. But, just how much do you understand about where your bank savings end up? Is it all just notes sitting somewhere in an air-tight safe awaiting your summoning? What are the origins of banking notes, and who prints them? Why are banks such an integral part of society? Let’s explore.
Money and power
So what is the story of money and power?
The good
Man himself is the beginning and the end of every economy
~ Carl Menger
The concept of money is as old as civilization itself and has existed for over millenniums. But in the beginning, it was simple. Your neighbor owed you a load of firewood or you owed somebody a piece of meat. Credits and debits were kept in your head, a mental ledger.
But then when intelligent humans started expanding their trading horizons across other tribes, they realized they needed something that everyone could agree had value. They needed a commodity that had five general characteristics: easily recognizable; relatively scarce; can be substituted with another of equal value; can be cut into smaller pieces, and can be moved around with ease. Commodity money was established. From Rice, to wheat to fish, beans, shells etc. If it had the five characteristics, someone was probably using it as currency — barter trade.
But there was a problem with this setup. If organic produce went bad it would cause problems for the economy. So a much more stable currency was needed and at around 2500 years ago the first coins were minted in China. These coins shared all the characteristics with commodity money but were also very durable.
Coins worked. But only if people trusted that the king or queen who issued them wasn’t cheating on the metal content. This also meant that an authority now controlled the supply of your currency. Money and political power became linked and Centralized. Nonetheless, minting coins steadily and predictably allowed for economic growth and stability. Governments would even cut one-eighth of a piece of the coin to serve as a tax charge. Taxes built Castles and financed government campaigns.
Governments like France began debasing their coins(substituting cheaper metals for silver and gold). But then this became an issue because if no one can trust the gold or silver content of your coins, how can you trade with other countries? International merchants found a solution. They recognized that if an I owe you came from reputable sources, it could be used as a form of currency. Peoples’ loans had value — Paper money. This money was based on someone’s promise to pay.
A sound money, and in turn a sound economy can only be a part of the market
In the 15th century, merchant families like the Medici began acting as clearinghouses for these I owe yous. Picture this — A trader bought Italian cloth worth 100 gold coins from the Medici. The promise to pay the Medici was then put on paper. Meanwhile, the Medici owed 100 gold coins to another trading partner for the delivery of wine from France. The three parties didn’t go through the expense of having to move around the gold. Instead, the paper was transferred. Everyone agreed that the paper had value. But only if everyone trusted the Medici — a solvent middleman. They had essentially created a paper money machine.
Within a few generations, the families Became wealthy. Their enormous wealth helped fuel the Italian renaissance and elevate them to high levels of political power. Power to marry into royal families and to get elected as popes.
Meanwhile, as people accrued more and wealth it became risky to keep bulk gold in hand. People trusted goldsmiths to keep their gold at a small fee(banking) because their whole business model relied on their reputation. Their facilities had to be fortified and protected given the value of the materials they worked with. The goldsmiths would write receipts detailing how much gold was being held and where the holder of the receipt would be able to collect.
The goldsmith, on realizing that the coins were gathering dust, begins to lend out these gold coins and charge some interest on the loan. Later on, the goldsmith realizes that people don’t even want the coins, they just want the piece of paper. So now the goldsmith could make a loan using the pieces of paper. Effectively, the goldsmith and the early day bankers had acquired the power to print money. Soon more and more paper money circulated and began to rival the crown’s coins. The power to control currency was slowly slipping away.
The bad
Banking establishments are more dangerous than standing armies
~ Thomas Jefferson
For centuries European countries built fleets and armies and waged war on each other to rule the world. But war is expensive and taxing citizens just wasn’t enough. The kings and queens needed a groundbreaking financial revolution — government bonds. The loans came from rich families and goldsmiths who by now had become powerful financiers and bankers. Sovereign debt and deficit spending had been born.
In 1694, The Bank of England was established to fund a war against France. England’s central bank was privately owned and granted the monopoly to issue banknotes — in essence, paper that could be redeemed for an equal amount of gold from the government coffers. The bank soon managed the entire debt of the crown.
Being able to issue currency gave you the power to control that monetary supply by backing it with essentially, the debt of the state. When the US gained independence from Britain, the first article gave congress the exclusive right to coin money. This currency’s value was tied to gold in government vaults.
More and more banks were established and from 1701 up until the panic of 1907 the financial system of the US experienced regular boom and bust cycles.
High levels of volatility made it hard to plan for the future yet people still yearned for predictability and stability. In 1913, the US bankers and politicians decided that it was in the country’s best interest and theirs to have a permanent central bank. They created the Federal Reserve. Among its jobs was to expand or contract the supply of a single national currency, The Federal Reserve Note AKA the Dollar was tied to gold and strategic control of it would help regulate booms that lead to bursts
But even after all that, the whole world, from 1929 to 1933 experienced a severe economic crisis — The Great Depression. This would have a profound effect on monetary policy worldwide.
The Ugly
Money is a great servant but a bad master
~ Francis Bacon
Soon the FED had printed all the money it legally could to pump life back into the economy. The only thing missing was the gold. In 1933, President Roosevelt issued a controversial executive order, forcing all US citizens to sell their gold to the Federal Reserve at a fixed price or go to prison. The FED offered far more cash to foreign governments for their gold. Many jumped at the offer. Gold flowed in and dollars spread across the globe. World War II devastated nearly every major economy except for the US because the dollar had become the most stable and trusted currency. The country emerged as a global superpower. Other countries pegged their currency to the dollar which could still be redeemed for gold. The US owned more than half the world’s gold reserves. By 1966 foreign nations had had enough of the US collecting gold and printing cash. They also had more value in dollars than what the US had in its vaults. They demanded gold for their paper dollars which innevitably, lead to arguments about the paper dollar and their currency. In 1971 president Nixon settled the matter. He severed US currency from the gold standard. Never again could anyone legally demand US gold in exchange for paper dollars.
For better or for worse, the dollar was now solely backed by the full faith and credit of the US government.
What is the wealth of a nation now? Well, it’s a gigantic hole of money that we owe to the rest of the world that’s never going to be paid back. When a government spends more money than it collects in taxes it simply creates more. Remember for every 20 dollar bill there was 20 dollars worth of gold in a government vault. Not any more.
Today governments create currency by first creating bonds. These bonds are sold in the market, generating funds for the government that issued them. Large banks buy these bonds and sell them to the Federal Reserve at a profit. You see the FED is America’s central bank but it doesn’t have any money. New money isn’t exchanged it simply appears on the bank’s account like magic. Yes, that’s right, magic.
What’s more, the Fed is a private entity and not a government agency and its shareholders are banks that earn a dividend of as much as 80 billion dollars per year sold to the very same banks that sell government debt to the FED. The FED also sets the bar for how much interest you pay for commodities.
Compound interest is the eighth wonder of the world. He who understands it, earns it, He who doesn’t… pays it
~ Albert Einstein
Central banks aim to create new money carefully, strategically, and very slowly. Releasing more money to the economy causes prices to rise ideally by 2% per year. This means that the buying power of 1 dollar in your pocket will be 98 cents next year and less every year to come. If you earned a dollar in 1913, you could buy 16 loaves of bread. Today, a dollar barely buys you 1. This doesn’t mean that things used to be cheap but rather that the value of your cash is slowly deteriorating.
You play a key role in the magic money-making machine. All that money in your bank account is property of the bank on their balance sheets and they can do just about anything they want with it case in point make new money. Here’s how: Say your bank account shows $100, the bank can decide to hold $3 and loan $97 to John to buy something. In the bank’s computers, you still have $100, but John has $97 new virtual money. No cash or gold is backing the new money — just his promise to pay it back. This is new money created as debt. When this cycle continues, as banks typically have multiple accounts, your $100 will generate a whole lot more cash for the bank. This is called Fractional Reserve Banking.
what’s more, banks don’t even need your deposit to create new money. If they consider someone creditworthy for a loan, they can put new money into his/her account and start charging interest. Every transaction you perform on your bank account is made possible by essentially, digital currency made by the banks. You still think Bitcoin is the first digital currency?
Conclusion
The only useful thing banks have invented in the past 20 years is the ATM.
~ Paul Volcker
former chairman, Federal Reserve
Well, now you know. Your bank money isn’t sitting in a safe inside the bank, even though that thought may give us comfort. The existing banking system has extracted enormous value from society without delivering anything meaningful in return. In medieval Europe, a banker who couldn’t pay his depositors was hanged. Today that same banker is bailed out, paid bonuses, and enjoys tax benefits too. What are your thoughts on all this? Let me know in the comments.
