Even the apparently simple question of where money comes from is hard to answer. It’s not the government printing press; money really originates when banks make loans. And since they charge interest for those loans, part of the endless-economic-growth model is in place right from the beginning — without the growth, you can’t pay off the interest.
Bill McKibben quoted in Enough is Enough: Building a Sustainable Economy in a World of Finite Resources
This is fascinating and disturbing. We use money every day, talk about money every day, lose sleep over money, make and break relationships for money, plan our lives around money…but what on Earth is it?
It’s a medium of exchange, a unit of account, a store of value…yes, we know this. We value money, but it’s not actually the thing itself. It’s not the item of sustenance bought with money, nor the craved experience paid for using money, nor the boosted status acquired in money’s reflected glow.
Money is not “wealth”, though we value it as though it were.
It’s clearly some kind of proxy, a ticket to wealth if not wealth itself. The nearest analogy that comes to mind is an IOU. You could if necessary trade my IOU onwards to a third party in return for quick cash, and it could then be traded on to a fourth party and so on. But the cash equivalent value of that piece of paper would fall to zero as it travelled more than one or two handshakes away from me. Confidence in the Bank of Don Cropper just isn’t enough to sustain any kind of a market in my debt notes.
In the case of proper money, however, the cash equivalent of a five-pound note remains precisely five pounds, all else being equal, no matter how many hands it passes through. That’s because an IOU from the Bank of England is national currency underwritten by the government of 60+ million people. That government has our confidence because it has the power to raise, notionally, as much money as it wants from the population, whether today or in the future. It can pay off today’s wealth tickets with more wealth tickets drawing on future income, and pay off those with yet more wealth tickets ad infinitum. And the bearer of a national IOU, no matter how far down the chain of transactions, can be sure that it will be honoured.
The money itself, then, that creased note or metal coin, is a promise, an obligation, and as long as we all value that promise and believe in the promiser’s sense of obligation, then we can trade that promise as much as we like, without it losing “value”.
But in a financial crash, when share and house prices collapse as they did in 2008, proxy wealth in the form of money disappears, taking real wealth with it. Yet the government still stands and it retains the capacity to tax the public into the indefinite future. It can still, in theory, pay out on all those promises — given enough time. So what just happened? Here’s a clue:
[A] common belief holds that money originates from the printing presses and coin mints of governments. Some of it does, but only a small fraction. In the United Kingdom, for example, the Bank of England and the Royal Mint create about 3 percent of the money in circulation as banknotes and coins. Private banks create most of the money in the form of interest-bearing loans. Banks do this by a simple trick of bookkeeping.
The bank loans you money to buy a car, it enters that sum as a liability in one column of its books, and as an asset in another column. Everything balances out. Electronic money appears your account, which shortly after you convert into a car, an actual car. There was no money to begin with. It materialized out of thin air and you ended up with a car. “Wealth” was created with a few keystrokes on the computer. Ok, you mortgaged part of your future for the pleasure-thing today. But the future hasn’t happened yet. In the here and now, money and wealth have been magicked into existence. By a bank.
It gets better, for the banks, in that they don’t have to keep sufficient funds on deposit to cover the value of their liabilities. In fact, the alchemy of post-industrial capitalism seems to demand that they don’t have funds just lying around. It’s called the fractional reserve system — banks only need to hold reserves to cover a fraction (in some cases a vanishingly small fraction) of the liabilities they take on. In sum, there are very few restrictions on how much money the banks can create. So long as everyone believes that the government can honour its IOU commitments. So long as everyone has confidence that the future flow of new wealth goods and services exceeds the value of today’s debts.
So now we know: banks make money, literally. No wonder bankers get a little carried away with themselves.
But it turns out that confidence in government promises is a limited commodity compared with the optimism and self-interest of those who have the privilege — granted by the rest of us — to “make” money. When confidence goes, as it did in 2008, money goes back where it came from, ie to nowhere.
And trillions of dollars simply evaporate.