Money is fascinating and useful stuff.
It's not the root of all evil, and the Bible doesn't say it is. What the Bible does say is that the love of money is the root of all evil. Similarly, according to the song in Irma la Douce, it's not l'argent that is the root of all evil, it's le grisbe. Dirty money. Loot.
Money is useful. Anyone who has never had a problem that money could have solved is spoiled rotten, and I've yet to meet them.
But what is money? And how is it made? And if it can be good stuff, or evil stuff, what's the difference?
What this page is not
Disclaimer 1: This is not an economic theory. I'm not an economist. I'm a logician with some undergraduate studies in Ethics, and an interest in writing.
There's a reason that economic theories don't work. Some of them of course just don't make sense! But even those that do make sense and are based on sound research and reasoning tend to stop working soon after they are published. The reason for this is very simple: Sound economic theories tend to suggest ways in which you can make money by taking it from someone else. As soon as this becomes known, people take advantage of it, and this steadily changes the way the economic system works until the theory no longer works.
And nor am I an accountant. I have worked as an auditor and qualified as a CISA (long lapsed), but in this role I worked with and for accountants as a computer specialist.
Disclaimer 2: This is not Marxism. Marx decided that for an individual to make money from capital was evil. This page, when we get to it, will decide that there are good and evil ways of making money, but that Marx's approach is just plain wrong. And in glorious hindsight obviously so!
Marx identified a real problem, and the popularity of his theories shows this. But his solution was simplistic, and a glorious failure in practice, and again in hindsight that's not surprising. His theory has had some political success, but those who promote it have mainly just brought more injustice and misery into the world, sometimes with the highest motives, but often just with pure old-fashioned greed and power lust as the motivation.
Meet the new boss, same as the old boss - Pete Townsend, Won't get fooled again, echoing the theme of George Orwell's Animal Farm
But if you go carrying pictures of Chairman Mao
You ain't going to make it with anyone anyhow - John Lennon, Revolution
What is money
Money has two important characteristics.
1. Money is a medium of exchange. It's negotiable. If you have money, you can exchange it for something else of value.
2. Money is a store of value.
If something has these two characteristics, then it's a form of money, and if not, then it ain't. And it's hard to imagine how anything could have either of these characteristics without at least some measure of the other. They are in a sense two ways of looking at the same thing.
But of course, some forms of money are better than others in one or the other of these respects, or in both.
History of money
It's interesting but not terribly useful to speculate on what the first form of money might have been. It was possibly created independently in several different forms, at different times and in different places. And the idea caught on.
Gold and silver can be regarded as early forms of money, which is why St Peter says "Silver and gold have I none" to the cripple he is about to heal, and why the French word for money also means silver, and the German word means gold, and similarly in many other languages.
But they had an obvious disadvantage... metals can be mixed or alloyed. How do you tell real gold from a mixture of gold and a less valuable metal? Just weighing the stuff was not enough.
Coins
So coins followed. A coin was originally just a smallish, certified ingot of a precious metal. Many early (and also more recent) coins bore the image of the person who certified the contents, such as Caesar as mentioned in the Bible, and carried a promise that anyone caught issuing fake coins would be severely punished.
These early coins are definitely money. And, they have an intrinsic value owing to their precious metal content.
The next step (and possibly the most important step of all) was to issue coins that had little intrinsic value, but merely had statutory face value, in that they were certified as valuable by someone, again such as the Roman Emperor. These are also money, but they're not quite as good a store of value as ones that contain precious metals. If the empire goes bust, a genuine gold coin will still have its full value, but a copper one less so.
This is revolutionary in many ways. Just one for now... these base metal coins with little intrinsic value were almost as good a medium of exchange as the precious metal coins had been, but not as good as a store of value. The two functions of money have begun to be decoupled. But there are far more subtle and far-reaching consequences.
But first a couple of fascinating asides. Some coins have even had more than their face value in intrinsic value. In the 1960s, a pound's worth of Australian florins was worth about one pound seven shillings as silver bullion, but again the monarch's head was on the coins, and again there were severe penalties for melting them down. Some more recent collector's coins have also had more than their face value in gold content, but their purchase price has been even higher than their intrinsic value as bullion. Buyers presumably believe that they have far more collectible value than either their face value or their intrinsic value. It is even questionable whether these collector's editions are real money. They can in theory be spent or negotiated, but only for a small fraction of their value, so in practice this only happens by mistake, and so they are a very poor medium of exchange. And they may not even be a good store of value. The bullion value is far less than their original purchase price, and in any case in theory it's still highly illegal to melt them down. So the bullion value belongs to the issuing government, not to the coin's owner, who owns only the face or collectible value whichever is greater. Food for thought?
In some instances the change from intrinsic to statutory face value happened gradually. Coins were minted that still had some precious metal content, but not as much as their face value; This was known as debasing the currency.
But the important thing is, whenever a person accepted a newly minted coin that was debased (that is, it had less than its face value in intrinsic value, and perhaps no intrinsic value at all) they were giving assets in exchange, so the mint (and its owners) were in every sense making money. And this was new and revolutionary. And far more revolutionary than it appeared at the time. Coining precious metals just converted money from one form to another, but issuing coins made of base metals created new money.
Banknotes
The next step was to "coin" money that didn't even pretend to have any intrinsic value, most notably banknotes. The exact terminology and history is much discussed; The earliest paper money was probably issued in China, and (much, much later) news of it came to Europe via travelers such as (but not only) Marco Polo. But negotiable paper promissory notes and similar "paper" also existed in Europe long before news of this Chinese paper money was brought by these travelers.
These forms of "paper" were (and are) both a store of value and a medium for exchange.
Some banknotes have had guaranteed equivalence to a precious metal. The pound sterling was once worth exactly one pound of sterling silver (a particular purity of silver), but that was before banknotes. The US dollar was once backed by the gold in Fort Knox (and some smaller deposits elsewhere). This concept is now largely obsolete.
The most popular and recognised form of money worldwide is probably the US dollar bill, also known as the "greenback" or the "green stamp". When people talk about a suitcase full of money, or a truckload of money, or wads of cash, they naturally think of banknotes. They are a basic part of our civilisation and culture.
Negotiable securities
In today's financial systems there are many other things that are forms of money, that is, they are negotiable and a store of value. Even shares can be issued in such a way as to make them negotiable by the bearer.
The rules vary greatly from country to country. Even the terminology does. The term "debenture" is possibly the worst, it has a well defined legal meaning in most English-speaking countries, but that meaning varies considerably from country to country. The various meanings do not even overlap in some instances.
And there are "derivatives", including "swaps". I was once given an example of a swap by a man whom my then employer introduced as "one of only three men in the world who fully understand swaps". I asked a question: "In that example, haven't we used that swap to defeat our own lending controls?" The interview was suddenly terminated, without further discussion. Maybe it was because he felt I would never understand, but I like to think it was because I did understand.
I recommend the 2010 non-fiction book The Big Short by Michael Lewis as a primer on swaps and derivatives, or the Oscar-winning 2015 film of the same name. But maybe I still don't understand!
The important thing is, if these securities are usable both as a store of value and a medium for exchange, they become a form of money. But we're getting a bit ahead of ourselves here, because there was another, far more revolutionary step in process.
Credit cards etc
The next big step was the result of what I like to call the communication revolution, which is ongoing and which started before the computer existed. But today, these communications are computer-based, and to me the most exciting thing about a computer has long been not its processing and storage of information, but its use in communication. But each of the three are essential for the other two to realise their potential: Processing, storage and communication
Credit cards and debit cards and electronic banking have a lot in common, and can create money. Loans have always created money, in that both the borrower and the lender have use of the same money at the same time (and again this is reflected in the common money supply measures). But communications supercharged this.
Similarly, credit cards and debit cards both give access to money that would not otherwise even exist. A credit card is a loan by the issuer to the cardholder of the credit limit of the card, while a debit card is a loan by the cardholder to the issuer of the balance of the account. In either case, both have use of the same money at the same time, so in a sense new money has been created and injected into the system.
And predicting how all of this will affect the value of various forms of money is rather complicated, that's why there are so many different measures of the money supply for example, and one reason that skilled traders can accumulate wealth by playing financial markets. From time to time, someone manages to work out a new way to play these markets and accumulate wealth, but as soon as this method becomes publicly known, it stops working as people take advantage of it. This is one source of market corrections..
And another source of corrections is of course that sometimes large numbers of people, or people with significant assets, or both, get the market wrong. This can be because they've made a mistake, or because there's been a major fraud, or because the economic system has been changed by significant acceptance of a new theory, or probably other reasons, and normally more than one of these. But the important thing is, when people with significant holdings realise that they've overcommitted and suddenly change their strategy, that causes a financial crisis. This just means that people have lost a lot of money, either because someone else now has it, or because the amount of money in the world has been reduced. This reduction in the amount of money available can for example be caused by people being a lot more reluctant to lend it. If lending creates money (and it does), then calling in the loans destroys it.
Cards and computers and in particular the combination of the two are the reason that someone like me got involved in the finance industry. In the 1970s, the accountants, and especially the auditors, of the world realised (to their credit) that they had lost the plot. The meaningful financial records no longer existed as paper ledgers to be "ticked and flicked", instead they were spinning around on hard drives and backed up on 6250bpi magnetic tapes.
I unintentionally developed a "party piece" for our top executives. "Let me tell you how important what I do is to you. If someone were to break into our vaults and steal every negotiable security, every investment diamond, and so on, our organisation would survive. Our share price would take a hit because our insurance would increase, but that's about all. If someone were to launch a recruiting campaign and we lost all our top dealers to them, we would be making a statement to the stock exchange and our share price would take a far bigger hit, but again we would survive. But if our corporate database were to be irretrievably lost, we would be ringing the Prime Minister and whatever the time of day he would take the call. Because our organisation would no longer exist." I gave it impromptu on a suitable occasion and was subsequently asked to repeat it several times.
These days of course all the accountants I know use computers regularly, and so they know quite a lot about them. But unfortunately, often not as much as they and their customers think they do. Let me suggest some generally reliable (but not infallible) and related rules of Information Systems:
- Beware the person who thinks they know the lot. They know nothing.
- Beware the person who has never made a mistake. They have never learned anything.
- Beware the person who thinks they never will make a mistake. They never will learn anything.
How money is made today
There are three ways of making money:
Method 1: Work for it.
Method 2: Use assets to generate income.
Method 3: Get someone else to give it to you.
And I will claim these are the only three ways, and always have been, and always will be. (I think you now see why I saw the need for the disclaimer above, and worse is to follow.) In practice, many (perhaps all) money-making efforts have elements of two or all three of these.
Method 3 is the interesting one. Where does this money come from? Again there are three ways:
Method 3.1: Receive it in exchange for work and/or use of assets.
Method 3.2: Fraud and/or trickery.
Method 3.3: Some form of loan.
And again, I will claim that these three (and again in practice, combinations of the three) are the only methods of getting someone else to give you money, but that money acquired by any of the three is equally real. Methods 3.1 and 3.2 are fairly obvious, as is I think bundling work and assets together as 3.1 (noting that all Marxists will object violently). It's 3.3 that is the interesting one. Method 3.3 is the one that creates new money. More on this below.
These apply equally to individuals, banks and governments. These days, when a government issues a banknote, those who initially accept them are giving the government money. And that's not necessarily a bad thing, but there are obvious pitfalls.
Let us examine that claim a little more closely. The government doesn't make money by printing the banknote, they make the money by issuing it. It's a subtle but important distinction. When (and only when) someone accepts the banknote, that person (whether a natural person or a legal entity) has given the government money, and it's only at that point that this money enters into the more meaningful "money supply" figures such as M3. It's only at this point that the money has been created.
Bitcoin and others
Bitcoin and similar cryptocurrencies are a fascinating development.
Bitcoin is a means of exchange and a store of value. But at first sight it has no intrinsic value whatsoever, and no issuing authority, which would suggest it has no value and is worthless. But that's not true! The value of Bitcoin stems entirely from its goodwill, and that is a valid asset backing. Whether it's a very good asset backing is another question. If that goodwill were to vanish, the value of Bitcoin would then be zero.
It does however have some other problems apart from the volatility that this goodwill-only backing suggests. Notably, we don't know how many Bitcoins Satoshi Nakamoto (the creator of Bitcoin) has, and what they will do with them. If that is an alias of a single natural person, then at one stage their Bitcoin holdings made them the third richest person on earth, on paper.
But Bitcoin is real money. It was created almost entirely by method three, that is, other people gave it to them. There was work involved, use of time and talents, but those didn't create the money, and neither did the initial creating (known as mining) of Bitcoins by the creator. That money was created when others accepted Bitcoins.
Subsequent Bitcoin mining seems at first to be a little more complicated, but it's not. It's work and use of assets, but it's not productive work. The thing giving those new Bitcoins value is the same goodwill as the existing ones, so in that sense all Bitcoin holders are handing over a little of the value of their holdings every time a new Bitcoin is created. That's of course unless the mining of a Bitcoin somehow increases that goodwill. It is not obvious why it should.
Is it a bubble? A bubble is only a bubble if it eventually bursts. So we don't know. Is it a scam? Only if the bubble bursts. So probably, even its creator(s) don't know that. But if the bubble were to burst, and assuming that the creator(s) have cashed in some of their holdings, it may be the most successful scam yet seen. We do not know.
Money can be created but also destroyed
There are lots of ways of losing money. But one particularly interests us here: The inverse of Method 3.3 of gaining money. Because this is the way in which money is not only lost, but actually destroyed.
For example, when credit is tight, and people are calling in old loans and not issuing new ones, this reduces the money supply by destroying the money that those loans represented.
Fascinating?
Good and evil
Working for money is good. I don't think anyone seriously questions this. Getting a fair day's wage for a fair day's work is a good thing.
Using assets to create money can be good. I don't think it sensible to question this (although some have). For example, a tradesman requires the tools of their trade. Their income is partly a reward for labour, and partly for owning those tools. But where do we draw the line? A farmer derives income from owning a farm, but only because they also work it in some way so that there is produce to sell. Is this also legitimate? A factory owner derives income from managing the factory, but also from owning it.
The ability to store value is in general a good thing, but it's a two-edged sword. If for example the little guy were to be given access to a store of value that did not depreciate, the Australian superannuation industry would collapse overnight. If we could save a dollar today and it would have the same buying power when we retired, we would not need investment advisers or superannuation funds, only savings accounts.
That sounds like a good thing, but it means that the next generation need to commit to supporting us in retirement to a level that they currently don't. Maybe that's a good thing too, but it could create a bubble if either the population or their productivity were to decline markedly.
Using assets to deprive workers of a fair day's pay is evil. Again, I don't think it's sensible to question this (although, incredibly, some have). Using assets to take property or other assets by force is evil (and this might include military action, gangsterism, lots of things, the devil is in the detail).
Giving other people money can be a good thing. This underlies all charity work and the welfare state. In particular most (not all) people want the right to give money to their children. More generally, most (not all) people want the right to give money to anyone they choose, whenever they choose, and particularly but not only when they die.
Taking money by deception is evil. Most agree on this too. Again, the devil is in the detail. When a government chooses to devalue its currency, is that a good thing? Devaluation is of course largely an obsolete concept, as most currencies are now floated on the market. Is this a good thing? The jury is probably still out on that.
Short selling is a standard and accepted part of many financial markets. It's called taking a position. It makes money for those who are successful at it, but that money comes from somewhere. It appears to be fraudulent, as a short-selling contract is an agreement to sell something that you do not own, so it's not yours to sell. And it has resulted in many financial disasters. Why is it legal?
Inflation is a form of devaluation. Is this a good thing? I think there is room for discussion on this. Whenever the value of a currency drops, whether by means of devaluation or inflation, this means that all holders of it have given the issuing government money. It could be argued that this not only advantages the government, but also the rich, who have access to forms of investment with high returns that are unavailable to the poor, or even to the moderately well off.
Interest rates available to small investors rarely exceed the inflation rate in many democracies. Doesn't this mean that those governments are taking from the poor to give to the rich? As the poor have far more voting power than the rich, how is this possible? (And again, I think you can see why I see the need to distance myself from Marx!)
Watch this space
Like most web pages, this is perpetually under construction. There are likely to be empty headings from time to time. Tough.
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