The reason our financial system has routinely gotten into trouble, with periodic waves of depression like the one we’re battling now, may be due to a flawed perception not just of the roles of banking and credit but of the nature of money itself.
In our economic adolescence, we have regarded money as a “thing” - something independent of the relationship it facilitates.
But today there is no gold or silver backing our money.
Instead, it’s created by banks when they make loans (that includes Federal Reserve Notes or dollar bills, which are created by the Federal Reserve, a privately-owned banking corporation, and lent into the economy).
Virtually all money today originates as credit, or debt, which is
simply a legal agreement to pay in the future.
always been merely a “relation,” a legal agreement, a credit/debit
arrangement, an acknowledgment of a debt owed and a promise to repay.
Money as a “unit of account” (a tally of sums paid and owed) predated money as a “store of value” (a “commodity” or “thing”) by two millennia; the Sumerian and Egyptian civilizations using these accounting-entry payment systems lasted not just hundreds of years (as with some civilizations using gold) but thousands of years.
Their bank-like ancient payment systems were
public systems - operated by the government the way that courts, libraries and
post offices are operated as public services today.
This was valued against other commodities by weight:
Prices of major commodities were fixed by
Hammurabi, Babylonian king and lawmaker, has detailed tables
of these. Interest was also fixed and invariable, making economic life very
But grain was perishable, so silver eventually became the standard tally representing sums owed. A farmer could go to market and exchange his perishable goods for a weight of silver, and come back at his leisure to redeem this market credit in other goods as needed. But it was still simply a tally of a debt owed and a right to make good on it later.
Eventually, silver tallies became
wooden tallies became paper tallies became electronic tallies.
The revolutionary advance of medieval bankers was that they succeeded in creating a flexible money supply, one that could keep pace with a vigorously expanding mercantile trade. They did this through the use of credit, something they created by allowing overdrafts in the accounts of their depositors.
Under what came to be called “fractional reserve” banking, the bankers would issue paper receipts called banknotes for more gold than they actually had.
Their shipping clients would sail away with their wares and return with silver or gold, settling accounts and allowing the bankers’ books to balance. The credit thus created was in high demand in the rapidly expanding economy; but because it was based on the presumption that money was a “thing” (gold), the bankers had to engage in a shell game that periodically got them into trouble.
They were gambling that their customers
would not all come for their gold at the same time; but when they
miscalculated, or when people got suspicious for some reason, there would be
a run on the banks, the financial system would collapse, and the economy
would sink into depression.
Banks still engage in money creation by advancing
bank credit, which becomes
a deposit in the borrower’s account, which becomes checkbook money. In order
for their outgoing checks to clear, however, the banks have to borrow from a
pool of money deposited by their customers. If they don’t have enough
deposits, they have to borrow from the money market or other banks.
The banks suck up cheap money and return it as more expensive money, if they return it at all.
The banks control the money spigots and can deny credit to
small players, who wind up defaulting on their loans, allowing the big
players with access to cheap credit to buy up the underlying assets very
That is what happened in September 2008:
“Monetizing” Loans Not with Gold But with Homes
The shadow banking system allows banks to get around the capital and reserve requirements now imposed on depository institutions by moving loans off their books. Large institutional investors use the shadow banking system because the conventional banking system guarantees deposits only up to $250,000, and large institutional investors have much more than that to move around on a daily basis.
The money market is very liquid, and what protects it in place of FDIC insurance is that it is “securitized,” or backed by securities of some sort.
the collateral consists of mortgage-backed securities (MBS), the securitized
units into which American real estate has been sliced and packaged,
It is the way our system is set up:
Instead, they are vacuuming up our money and lending it back to us at higher rates. In the shadow banking system, they are sucking up our real estate and lending it back to our pension funds and mutual funds at compound interest.
The result is a mathematically impossible pyramid scheme, which is
inherently prone to systemic failure.
What is the next logical phase in our economic evolution?
Credit needs to come first. We as a community can create our own credit,
without having to engage in the sort of impossible pyramid scheme in which
we’re always borrowing from Peter to pay Paul at compound interest. We can
avoid the pitfalls of privately-issued credit with a public credit system, a
system banking on the future productivity of its members, guaranteed not by
“things” shuffled around furtively in a shell game vulnerable to exposure,
but by the community itself.
Consider, for example, one called “Friendly Favors.” The participating Internet community does not have to begin with a fund of capital or reserves, as is now required of private banking institutions. Nor do members borrow from a pool of pre-existing money on which they pay interest to the pool’s owners.
They create their own credit, simply by
debiting their own accounts and crediting someone else’s. If Jane bakes
cookies for Sue, Sue credits Jane’s account with 5 “Favors” and debits her
own with 5. They have “created” money in the same way that banks do, but the
result is not inflationary. Jane’s plus-5 is balanced against Sue’s minus-5,
and when Sue pays her debt by doing something for someone else, it all nets
out. It is a zero-sum game.
They are basically barter systems, not
really designed for advancing credit on a major scale.
Profits generated by the community can be returned to the
This money need not be spent. It can just be shifted from the Wall Street investments where it is parked now into the state’s own bank. There is precedent establishing that a state-owned bank can be both a very sound and a very lucrative investment.
Bank of North Dakota,
currently the nation’s only state-owned bank, is rated AA and recently
returned a 26 percent profit to the state. A decentralized movement has been
growing in the United States to explore and implement this option. [For more
When the credit is advanced by a bank, when the
bank is owned by the community, and when the profits return to the
community, the result can be a functional, efficient, and sustainable system