The Illusion of Money (1)

Originally this post was going to be about the growing trend for businesses not accepting money any more. But it has moved about in different directions and I've settled on focusing on the idea of the illusion of money. And once again, this has grown into more than one post.

Much of the following is derived from an excellent book called The Secrets of the Temple, by William Greider, ISBN 0-671-47989-X It is quite an eye-opening book about the Federal Reserve in the US and the power invested in it. I believe it provides a better, more balanced exploration of the Fed than a documentary I saw last week called Freedom to Fascism.

The illusion of money is ancient and universal. It is present in every human transaction and absolutely necessary for each transaction. Money is worthless unless everyone believes in it. A buyer could not possibly offer a piece of paper in exchange for tangible goods if the seller did not also believe the paper had any value.

This shared illusion comes down the ages. It is old as stone coins and wampum. It is a power universally conferred by every society throughout history. Many different objects have been seen as money. For some, it was seashells, others dogs' teeth. Groups used tobacco, whiskey or cattle as money during transactions. And in time, shiny minerals like silver and gold were used. All evolving to paper and numbers in an account book. And now plastic.

For contemporary people, they have some difficulty acknowledging that they share this linkage with the primitive past. Money is now deeply embedded in elaborate technology. Money is now ruled by electronic accounting and payment systems that are growing in speed and complexity. For many people, today's concept of money is real and not like quaint and amusing tokens used by ancient tribes. A dollar bill is rational; seashells are blind faith.

Of course, modern money requires a leap of faith. It requires the same social consent that primitive societies gave to their money. Yet in fact, modern money is even more distant from concrete reality.

Over the centuries, the evolution of money has been a long and halting progression. During this time, human societies hesitantly transferred their money faith from one object to another. At each step, the object of this faith moved farther away from real value and closer to pure abstraction.

A good example would be cattle used by some African tribes. Now, for the people in these tribes, the cattle is of value. If the money illusion were to collapse for some reason, the coins are still cattle. The seashells that became precious currency among aboriginal tribes in North America and other continents were desirable things. Pre-Revolutionary colonies like Virginia and the Carolinas used tobacco as currency, which was a valuable commodity in its own right. And even silver and gold were not entirely useless; they could be fashioned by an artist into beautiful items.

In that sense, modern money is utterly worthless. At the same time, it becomes more efficient because its value does not get confused with the value of real things. Therefore the money illusion is now refined to a new level of abstract faith. Which is only visible if one consciously pauses to consider how the money process has evolved. At each stage in history, one can see money retreating from concrete reality.

It is suggested that paper money originated with the goldsmiths of Europe. These goldsmiths held private gold hoards, deposited by wealthy citizens for safekeeping. The goldsmith would issue a receipt for the gold deposit. Over time, it became clear that the receipt for the gold deposit could be used in commerce since whoever owned that piece of paper could go to the goldsmith and claim the gold.

This provided two boons for the goldsmith: security and lending. For many of the wealthy citizens, it was dangerous to travel about Europe with gold. The receipt gave a level of security. If a merchant in Antwerp wanted to purchase something in Paris, there was no need to transport gold for the transaction, they just needed to send a receipt for the appropriate value. At the same time, groups like the Knights Templar innovated many of the financial techniques that can be considered the foundation of banking. Often it was these “warrior monks” that ran the banks and transported receipts from one place to another.

The other boon for the goldsmiths and groups like the Knights Templars was the discovery that they could safely write more receipts and lend them to people. This would exceed the total gold that was on hand but as long as the lender always kept a responsible minimum of gold in reserve to honour any withdrawals, no one would be the wiser.

This is the origin of fractional-reserve banking and the bank doing the lending would be created money. This private money system endured centuries and was inherited by the American Republic.

In the States, privately owned banks created money by issuing paper bank notes, paper that was backed by a promise that at any time, the notes could be redeemed for gold.

In the nineteenth century America, the money in use consisted mainly of these privately issued bank notes, backed by gold and silver guarantees. Yet the money's value was extremely dependant on the soundness and honesty of each bank that issued notes. Banking scandals were recurrent in the States, especially on the frontier. There ambitious bankers were eager to make loans for new enterprises, sometimes printing paper money that had no gold behind it. Be it in the States or elsewhere, governments had to impose regulations to keep banks honest, but the bankers were still free to create their own varieties of money. And all too often, if a bank failed, their money failed with them.

Over time, the money illusion was transferred to a new object: demand deposits or more commonly known as checking accounts. So instead of just being a substitute for gold, paper money now existed simply as an account in a bank's ledger and was redeemable by personal drafts or checks.

This shift took time. People were hesitant about the change. In the United States, the transition was inadvertently stimulated by government regulations. During the Civil War, the National Bank Act was enacted. This federal law established a system of national charters for banks. It encouraged development of a national currency based on bank holdings of U.S. Treasury securities. At the same time the law placed a heavy tax on new bank notes issued by state banks. So in order to avoid the tax, banks encouraged their customers to use demand deposits; encouraged them to write personal checks instead of drawing out their money in cash.

It took quite some time for the general public to overcome its natural distrust of checks. But by the turn of the century, 1900, most people were persuaded. Personal checks, written by the buyers themselves now were accepted as just as valuable as dollar bills.

Currency, obviously, remained in use but demand deposits became the bulk of the money supply. The nationalization of currency issuance, completed with the creation of the Federal Reserve in 1913, simply continued this arrangement in the States. A new dimension of trust was added to the money illusion.

During the twentieth century, the last prop of the money illusion was removed: the gold standard. Demand deposits had been backed by the same promise that applied to currency, that is, any private citizen could, in theory, go to the bank and redeem their money in a quantity of gold.

Well that promise was extinguished by government edict, starting with the warring nations in Europe, during World War I. Belatedly the United States joined these countries in 1933. Without the gold standard, money became only money or “legal tender for all debts, public and private” as it is printed on each Federal Reserve Note. So now a citizen can still go to the bank and redeem the pieces of paper but their money will be redeemed only in new, identical Federal Reserve Notes.

Whereas most mainstream economists applauded the abandonment of the gold standard, the change was traumatic for some ordinary citizens. The main question was: what is money really worth? Still to this day some people yearn for a return to the old guarantee - “a dollar as good as gold”.

Of course main economists, like John Maynard Keynes believes that the transition from gold is a historic liberation of money. It was an enlightened step beyond the obsessive attachment to shiny metals. So “commodity money” was replaced by “representative money”.

Yet economists like Keynes did agree that without the gold standard, money has to be managed. Its true value would ultimately be determined by governments, by the judgements of fallible humans or, more specifically, by the monetary policies of central banks like the Federal Reserve or the Bank of Canada.

For many people, this is a deeply disturbing situation. They long for some system that would take money regulation out of human hands and return it to some sort of fixed set of values that is impersonal. Proposals have be suggested from the “invisible hand” of market forces to some sort of higher authority. In the meantime, for people in the United States, every coin and bill offers their citizens the reassuring motto: “In God We Trust”.

And tomorrow I will conclude this post with the current abstraction of money which troubles me: plastic.