Money Could be So Much Better

“Dollars, dollars, everywhere, but not a drop to drink.”

Reach into your wallet and if you’re lucky, you probably have some crisp green notes inside. Take them out. Feel the cotton-linen blend between your fingers (that’s right greenbacks are not made of paper as the rappers would have you believe, they’re made of cotton and linen) and notice that unmistakable smell that is money. There’s nothing quite like having that tactile experience of money — better yet if that money has a portrait of Benjamin Franklin on it. From Rai Stones to seashells, mankind’s experience, encounter and regard for things of value has evolved throughout the ages and even today we’re evolving. Because that greenback that you just molested, is probably the closest you’ll get to government-issued money again as you go about your day.

Public & Private Money

What most people don’t realize is that money as we know it, consists of two components, private and public money. Say what? Isn’t money just money. Ah dear Padawan, if only things were as simple as that. Public, or government money is made up of the stuff the green stuff you just fingered. It also consists of the change that you just spared that homeless person. Public money comes in the form of paper (cotton-linen in our case) bills, metal coins (China has some versions which feel suspiciously like plastic), plus most importantly, deposits that commercial banks have with their nation’s central bank — in our case, the Federal Reserve. The last distinction is important and I’ll get to why it’s important in a minute. Private money on the other hand is the stuff that you and I probably deal with most often. It’s when we make a transaction on our credit card or a payment on our mortgage. Whilst you may be the sort to haul a wad of greenbacks to your local savings and loan, most of us make our mortgage payments through regular deductions or checks. In fact, cash, according to the San Francisco Federal Reserve, only made up about 1 in 10 of total payment value, with credit and debit cards amounting to over one third of all payment value. So the stuff we come into most contact with, credit car debt, student loan debt, mortgages and car payments — all that stuff? — it’s private money — in other words it’s not from the Federal Reserve. And while this private-public hybrid monetary system we have is hunky dory most of the time, as the credit crisis in 2008 showed, it can very easily turn sour when there’s a lack of confidence in the financial system — when people like you and I lose faith in private money.

So is the answer then for us to rely on more cash — which is public money issued by the central bank or private currencies such as Bitcoin, the cryptocurrency du jour? Satoshi Nakamoto, Bitcoin’s eponymous creator certainly thought so, but there are also scores of others who argue that the problem is not public money, it’s the way public money courses through the financial system. Think of it as the heart being the problem, as opposed to the blood which it pumps out. It doesn’t matter how good your blood is if the pump ain’t working. The options are anything but straightforward.

Better than a Canadian quarter any day if you ask me.

Take for instance cash. It’s widely accepted, anonymous (for the most part) and issued by the Federal Reserve. But if you lose your cash that’s it. You can’t get it back. If your Benjamin Franklin takes a sail down the East River, that’s it for your cash. Same with Bitcoin and other cryptocurrencies. Forget your private key and it’s curtains for your cryptocurrency deposit. In God We Trust because only God can help you then.

But what about bank deposits I hear you say? Surely that’s my money? Nope. A bank deposit is basically an IOU and if the bank goes under (which before the 1930s and Franklin Roosevelt’s New Deal happened with shocking regularity) all you’re left with is a great big ole’ F U. Although your deposit with a bank is accessible, digital and the first US$250,000 is guaranteed by the federal government through the Federal Deposit Insurance Corporation (FDIC) , it’s not federally issued money — it’s private money. When a bank makes a loan to a business and credits the loan amount to the business’s checking account — the sum of new money becomes instantly spendable. The business owner can head out to the nearest ATM, withdraw the money which now becomes a liability of the Federal Reserve and buy himself a shiny new Buick. Why he would want to is beyond the scope of this post, but he could. And because banks are able to lend out more money than they have in deposits — the key ingredient for the savings and loan crisis of the 1980s and the 1990s as well as the 2008 Financial Crisis — the central bank, the Fed has little control over how much banks lend out other than through the reserve requirements imposed on banks — which currently stand at having only a dollar for every ten that they lend out. Think about that for a moment. Imagine the ability to miraculously create out of thin air one Alexander Hamilton for every George Washington you have in hand. Powerful stuff.

But wait, there’s more. If you call now…

Money market mutual funds which invest in the short-term debt of companies, repo lending and a variety of other private loan treaties also add to the private money supply — but with one big difference, these vehicles don’t have access to the Federal Reserve’s discount window nor are they able to make deposits with the Federal Reserve.

The line for the bank was unusually long.

Private money would be aided further as digital payments start to replace cash. Think about your Apple Wallet as well as your Starbucks prepaid card — they’re all forms of private money — which have huge consequences on the economic landscape. With the decline in cash, essentially, private, for-profit commercial banks as well as technology companies would control the access, technology and pricing of all available payment methods and the Fed would be paralyzed to do anything about it. Which is why even one of the world’s most pro-digital currency countries is hesitating when contemplating the ultimate demise of cash. In June, Sweden’s central bank governor, Stefan Ingves wrote in the International Monetary Fund’s Finance & Development magazine,

“Today cash has a natural place as the only legal tender. But in a cashless society, what would legal tender mean?”
Nothing more than a pile of IOUs.

Before we get ahead of ourselves, legal tender doesn’t even mean what it used to. In the old days, cash was more akin to legal tender. Where you could literally take a dollar bill, head out to the Federal Reserve and demand for its equivalent in gold — it extinguished the debt that the Fed owed to you for carrying around that dollar bill. But thanks to Nixon, a dollar today is more like that class reunion you promised to attend — you’ll be there if you’re there. One person’s money is always another person’s debt. Because dollars are no longer backed by gold, they’re just a bunch of promises made by the U.S. government to pay you back if and when they feel like paying you back. The same way your bank deposit is an IOU from your bank. And if these IOUs one day become as reliable as your promise to attend your friend Lisa’s daughter’s third birthday party, then you can bet your bottom dollar that that dollar won’t buy you anything. Case in point? Venezuela, Zimbabwe and the other long list of economic basket cases that litter the global economic landscape.

So what are the alternatives?

Depending on which side of the coin you fall on (pun unintended), you could either weigh in favor of an increasing role for public money (chances are you shop at Whole Foods) or an increasing role of private money (gun control to you is an abomination).

A Bigger Role for Public Money

For the Warby Parker-wearing, quinoa-munching crowd, you’ll be surprised to note that the governments most in favor of directly issued digital currencies which would bring public money back into the fore are also some of the most authoritarian — of the lot, China, Iran, Uruguay and Dubai are all exploring central bank issued digital currencies and Venezuela has already done so with its Petro. On the other side of the coin, Germany Japan and Switzerland have all rejected the idea. A government-issued digital currency would allow a government (no matter how virulently it claims to the contrary) to monitor how its citizens spend their money and even if the government in question didn’t monitor its citizens spending habits, the mere fact that a digital currency issued forth from a central bank would have this facility would be too tempting for even the most self-respecting politician to pass up. It could be used to monitor political contributions, capital flight and any other number of nefarious purposes that cash is currently being used for. Is it any wonder then that authoritarian governments are in favor of central bank issued digital currencies?

Bitconnect guy found alternative employment in Venezuela.

Yet some conservative liberals (is there even such a thing) argue in favor of a greater role for central bank-issued digital currencies. John Cochrane, an economist at the Hoover Institution, a liberal think tank, argues that increasing the role of public money would help put a damper on recurrent financial crises. Cochrane suggests that government issued digital currencies which earn interest would prevent runs on banks during financial crises — but that argument fails to consider that that’s what the FDIC is for to begin with, or consider the fact that a Fed-issued digital currency would obliterate the role of commercial banks. Because by giving citizens access to Fed deposits, during a financial crisis, it’s entirely imaginable that depositors would flee commercial banks for the Fed, as depositors search for the safest harbor. Over time, that could result in the demise of commercial banks, leading to all money being government-issued money. And while the death of commercial banks may sound like it’s a good idea, for now at least — it’s really not.

Because banks are commercial entities, they can make loans to whoever they so choose — as widely discovered during the 2008 Financial Crisis. For some favored clients like Countrywide Financial’s CEO Angelo Mozilo, extremely favorable mortgage rates were offered by the banks he worked with, whereas for those with far less substantial means and political influence, highly prejudicial floating rate mortgages with low teaser rates that exploded to affordability were offered. Such favoritism is entirely acceptable in commercial banks, but imagine if the Fed was the only lender? That’s called corruption. And if the Fed was the only deposit-taking bank as well as the only lender, the scope and potential for corruption would be on an altogether unimaginable scale — and it’d be extremely difficult to prove. And if you think we already have a Wall Street government, just wait till the Fed becomes the only issuer of money — you ain’t seen nothing yet.

A Bigger Role for Private Money

If banks can’t be trusted to handle money and the government can’t be trusted to handle money, who can? Perhaps we can. In 1984 (see George Orwell’s book of the same title), the Nobel prize-winning economist Friedrich Hayek said,

“I don’t believe we shall ever have a good money again before we take the thing out of the hands of government.”

A huge contributor to Thatecherism (the same brand of economic theoryas Reaganomics), Hayek believed that government should take a limited role in economic activity and leave things to the free market. His work led to the economic revival of the United States as well as the United Kingdom in the 1980s and the rise of the financial services as global powers, putting New York and London as the two epicenters of global finance. That the rise of financial behemoths and the centralization of so much economic power in the hands of privately held financial institutions has wrought regular crises is moot — there has to be a better way.

Panhandlers updated their signs for the 2008 Financial Crisis.

Which is where Bitcoin and its brethren come into the equation. For now, cryptocurrencies are far too volatile to satisfy Hayek’s definition of “good money.” To be good, money, at the very least should have a dependable and reliable tradeworthiness for a basket of goods or services. Accepting Bitcoin as payment shouldn’t require an extra roll of the dice by merchants. But yet Bitcoin and other cryptocurrencies do address the elephant in the room — trust.

Financial crises throughout millennia have been and will continue to be caused by that which is constantly in short supply — trust. The key perhaps, to making money “good,” is, as Boston University economist Perry Mehrling suggests,

“Making sure that people who are making promises are doing so with the intention and ability of fulfilling those promises.”

At least with cryptocurrencies, the blockchain ensures that promises made are promises kept. Smart contracts on the Ethereum blockchain ensure that promises made are promises kept — trust be damned! If I don’t have enough Bitcoin to transfer to you, the transaction won’t pass. That’s that. There’s no room for fraud. Nor is there room for second-guessing whether, in the words of Shakespeare’s Shylock in The Merchant of Venice,

“My meaning in saying he is a good man is to have you understand me that he is sufficient.”

As far as cryptocurrencies are concerned, a person or entity’s sufficiency ought never to be called into question — that’s the beauty of the blockchain.

The Jury is Still Out

At the very least, that the debate over the future of money is being had is a a sign that the evolution of what mankind considers to be money is being given serious consideration. Whether it’s cryptocurrencies or government-issued digital currencies, the ideological battle for the various stores of value and mediums of exchange continues.

Whereas money was once merely seen as a means to an end, to bridge underlying transactions, the 2008 Financial Crisis brought to light an unprecedented awareness of the dichotomy between public and private money — a distinction hitherto unconsidered and one which thankfully, is gaining greater public attention. In the words of Yale economist Gary Gorton,

“Human history can be written in terms of the search for and production of safe assets.”

I would argue that that search and production is still ongoing.