Money Myths and Freedom

I cut my "intellectual curiosity" teeth on the mysteries surrounding money, and read extensively on matters "economics" for many years - both the orthodox, as well as the radical and oddball. And I'll never forget my amazement when I first fully understood how money was created out of thin air.

For the benefit of those of you who may be a bit hazy on the development and history of the monetary creation mechanism - here's a short summary.

Money was originally a commodity of some sort - usually silver or gold, but also stuff like salt and tobacco, or any commodity that people valued and were willing to exchange for something else.

Later came fiduciary instruments - which were receipts for real commodities (gold or silver etc.).

The easiest way to understand this transition is the example of how goldsmiths got into "banking".

Goldsmiths had the gold. You could buy from, and sell gold to, a goldsmith. You could do one more thing. You could have the goldsmith store your gold for you and give you a receipt.

It wasn't long before these receipts became useful negotiable instruments. So, if you wanted to pay for something, you could use one of your gold receipts - which was guaranteed redeemable for the stated amount of gold on presentation at a particular goldsmith.

It also wasn't long before the artful goldsmith realised he could actually issue more gold receipts than he had gold on deposit.

These "extra" gold receipts were in the form of loans to trustworthy individuals. A reputable goldsmith was able to discover the right ratio for gold on deposit - as a percentage of gold receipts in circulation. But of course, it was possible to make a mistake, and have everyone rushing to cash in their gold receipts at the same time - only to find there was not enough gold to redeem them.

That was the original "run on the bank"!

Gold merchants evolved into private banks - issuing their own fiduciary paper money - backed by gold or silver. Banks got it wrong sometimes too - and panic ensued!

However, if a bank was prudent, and built up a good reputation, then it could possibly lend into circulation ten times as much in gold receipts (now fiduciary paper money) as there was gold in the vault. And as long as the clients had faith in the bank, this worked out fine. The loan created the money, and the repayment of the loan destroyed it. The profit was in the interest.

This process is called fractional reserve banking. And as a discovery it was of enormous importance, for it made it possible to monetise the creditworthiness of an individual - to monetise that individual's future capacity to produce something of value.

Today, of course, we have moved far beyond fiduciary money - or notes that can be redeemed for some valuable commodity. Now we have what is termed "fiat" money. This is paper money (looking just like the previously issued commodity-backed fiduciary money), but with no backing whatsoever. In fact, a typical dollar bill promises to pay just "one dollar". In other words, the best deal you're likely to get is to take in an old wrinkled note and ask for a crisp new one in return!

And now, we have moved even beyond paper "cash" - with credit cards, digital money and any number of potential derivatives.

Back in the depression of 1929 (and at other times), many people of social conscience, found it unconscionable that banks should be able to "make" money in this way - and this led to a number of reformist ideas designed to diminish the power of the bankers.

One such reformer was Major CH Douglas, an Engineer from Scotland, and his Social Credit theory. Another was Silvio Gessell. There were others also.

Social Credit is, in essence, a theory stating there is never enough money in circulation to purchase the total production of a society. Therefore the state should issue extra money debt-free in the form of a citizen dividend. In other words, money should be "spent" into circulation, rather than loaned. There was a complex formula for "proving" this called the "A+B Theorem". Douglas's heart was probably in the right place, but his thinking was muddled.

Silvio Gessell's idea was to make money automatically depreciate. That way, people would not want to hang on to it - but spend it as quickly as possible. The idea was to increase the speed of circulation of money, and therefore stimulate economic activity. No mention was made of how this practice would impact on the formation of capital though!

Douglas's ideas (and those of many others) were based on a moral judgement that lending money at interest (usury) was "evil" - therefore, lending money into existence (as bankers do), is not only bad business but bad morals. And he proposed a form of debt- free money - spent by the state into circulation via public works, education, healthcare and public dividends etc.

At the core of these reformers' ideas was the implicit demand that the state be the only issuer of money. They didn't want it done by private issuers.

Today, we have the situation where the issuance of money is monopolised by the state - even though the banks are private. And if you doubt it's monopolised - try creating your own money!

What is the primary issue here is the MONOPOLY status of money issuers. A monopoly, whether private or public, can only be sustained by government edict.

Just about all the myths and misguided ideas about money and banks end up proposing some sort of "Social Credit" solution - although not necessarily using that name, or even being aware of such an idea - as a reformist agenda

There has always been a deep suspicion about banks, and reformers have always wanted money creation to come under "people's" control - i.e. state control. But, of course, it is already under state control, via the state's issuance of monopoly status to both currency and central banking.

Every time you hear someone railing against the banks or the FED, and you scratch beneath the surface, you will probably find a person deeply committed to the idea of the "state issuing money on behalf of, and for the benefit of, the people".

This is a major fallacy, and essentially a statist position.

There is nothing inherently wrong with issuing credit - against the creditworthiness of an individual or entity. In fact, this process has made it possible to achieve great societal progress and advancement. The next logical step in the evolution of money would be the privatisation and de-monopolisation of this process.

For what is really the basis for issuing any form of credit? The ability of the person receiving it to repay it out of future productive effort. In other words, YOU are the basis for credit creation!

In the age of digital money, it is entirely feasible that a private organisation could begin issuing "credit" to you - against your contractual agreement to repay it at a predetermined time. This is already done with credit cards - which are no more than electronic bookkeeping systems of credits and debits.

So, you open your account, and this private company issues you with 5,000 "credits". You have to pay this back of course, but you can do so out of income generated by your future production, work or effort. That's 5,000 of new money lent into circulation. And it has its own control mechanisms, for as it is repaid, the money goes OUT of circulation and is cancelled.

Don't knock credit. When used wisely, it is the catalyst for achieving things NOW that you couldn't do otherwise. Take just the process of buying your own home for example. How many people do you think would even have a home, if it wasn't for the mechanism of borrowing against their future earning capacity? And of course, businesses use it all the time.

Private money can also be issued debt free. And example of this mechanism is "airpoints". Airpoints are a form of private debt- free currency. No one goes into debt in order to receive airpoints. Instead, the airlines create this "money" out of thin air, in the form of bonus points for frequent flyers. Once you have sufficient points, you can spend them on travel. There are many examples of this sort of thing. Not only that, but it is possible to use these airpoints for purchases other than air travel - like hotel accommodation for example.

The issuance of money is entering a rapid evolutionary period, as new technologies make it possible to launch innovative private money systems. This is good news. The last thing we want and need is for the state, either directly or indirectly, to control or monopolise the money-creating mechanisms of a dynamic society. Yes, it does that now - but any future progress demands the state step away from the "money business".

Private money is already here in limited form - as in the frequent flyer points already mentioned. Another is E-gold, which is rapidly becoming a functional private money. A lot of its growth is due to the existence of e-gold market-makers - those who are increasing e-gold's usefulness and value, by providing various exchange services. Imagine how its functionality would be increased if a private, gold-denominated money card was issued. Not an ordinary fiat money ATM card, but a card denominated in grams of gold.

However, e-gold is NOT the same as frequent flyer points. E-gold is a fiduciary instrument - having 100% backing in real gold. It cannot, therefore, create new e-gold out of thin air.

Money "madness" always returns when things get tough. So if we see a major cyclical downturn to the world economy, or some sudden economic crisis, you can expect to see the return of crank theories as a way of solving the problem.

So, if you are confronted with a new idea in this area, apply this simple "litmus" test, to see if it will increase or decrease your personal freedom.

Is the projected reform designed to monopolise monetary creation even more? Is it a cover for a state-issuance project? The answers to these two questions will guard you against falling for some quack solution.

The future of money is to be found in the totally free market.

Friedrich Hayek, the famous economist of the Austrian school, had a most interesting idea. He proposed that the best form of money would be competing currencies in the same economic sphere - not just between nations, but within nations. In other words, de- monopolise money. A free market in money issuance would deliver the very best of monetary systems - and give people the freedom to choose the money they wish to use.

In the fast changing era that is upon us, you can expect to see both changes to money, and money issuance mechanisms. And you can expect the arrival of innovative alternatives to one of history's most persistent monopolies - the monopoly of money and credit creation. It is one of the last barriers to overcome before we can enjoy true freedom.

Yours in freedom

David MacGregor