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29 October 2010
By Ellen Brown
By understanding that money is simply credit, we
unleash it as a powerful tool for our communities.
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.
Money as Relationship
In an illuminating dissertation called "Toward a
General Theory of Credit and Money" in The Review of
Austrian Economics (vol. 14:4, pages 267-317, 2001),
Mostafa Moini, Professor of Economics at Oklahoma City
University, argues that money has never
actually been a "commodity" or "thing." It has
always been merely a "relation," a legal
agreement, a credit/debit arrangement, an
acknowledgment of a debt owed and a promise to repay.
The concept of money-as-a-commodity can be traced back
to the use of precious metal coins. Gold is widely
claimed to be the oldest and most stable currency
known, but this is not actually true. Money did not
begin with gold coins and evolve into a sophisticated
accounting system. It began as an accounting system
and evolved into the use of precious metal coins.
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.
In the payment system of ancient Sumeria, goods were
given a value in terms of weight and were measured in
these units against each other. The unit of weight was
the "shekel," something that was not originally a coin
but a standardized measure. She was the word
for barley, suggesting the original unit of measure
was a weight of grain. This was valued against other
commodities by weight: So many shekels of wheat
equaled so many cows equaled so many shekels of
silver, etc. Prices of major commodities were fixed by
the government; Hammurabi, Babylonian king and
lawmaker, has detailed tables of these. Interest was
also fixed and invariable, making economic life very
predictable.
Grain was stored in granaries, which served as a form
of "bank." 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 Credit Revolution
The problem with gold coins was that they could not
expand to meet the needs of trade. 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.
Today, paper money is no longer redeemable in gold,
but money is still perceived as a "thing" that has to
"be there" before credit can be advanced. 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.
As British author Ann Pettifor observes:
[T]he
banking system . . . has failed in its primary
purpose: to act as a machine for lending into the real
economy. Instead the banking system
has been turned on its head, and become a borrowing machine.
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 cheaply.
That's one systemic flaw in the current scheme.
Another is that the borrowed money backing the bank's
loans usually comes from shorter-term loans. Like
Jimmy Stewart's beleaguered savings and loan in
It's a Wonderful Life, the banks are "borrowing
short to lend long," and if the money market suddenly
dries up, the banks will be in trouble. That is what
happened in September 2008: According to Rep. Paul
Kanjorski, speaking on C-Span in February 2009, there
was a $550 billion run on the money markets.
Securitization: "Monetizing" Loans Not
with Gold But with Homes
The money markets are part of the "shadow banking
system" where large institutional investors park their
funds. 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. Often, the collateral
consists of mortgage-backed securities (MBS), the
securitized units into which American real estate has
been sliced and packaged, sausage-fashion.
Like with the gold that was lent many times over in
the 17th century, the same home may be
pledged as "security" for several different investor
groups at the same time. This is all done behind an
electronic curtain called MERS (an acronym for
Mortgage Electronic Registration Systems, Inc.), which
has allowed houses to be shuffled around among
multiple, rapidly changing owners while circumventing
local recording laws.
As in the 17th century, however, the scheme
has run into trouble when more than one investor group
has tried to foreclose at the same time. And the
securitization model has now crashed against the hard
rock of hundreds of years of state real estate law,
which has certain requirements that the banks have not
met—and cannot meet, if they are to comply with the
tax laws for mortgage-backed securities. (For more on
this, see here.)
The bankers have engaged in what amounts to a massive
fraud, not necessarily because they started out with
criminal intent (although that cannot be ruled out),
but because they have been required to in order to
come up with the commodities (in this case real
estate) to back their loans. It is the way our system
is set up: The banks are not really creating credit
and advancing it to us, counting on our future
productivity to pay it off, the way they once did
under the deceptive but functional façade of
fractional reserve lending. 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.
The Public Credit Solution
The flaws in the current scheme are now being exposed
in the major media, and it may well be coming down.
The question then is what to replace it with. 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.
The simplest public credit model is the electronic
community currency system. 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.
Community currency systems can be very functional on a
small scale, but because they do not trade in the
national currency, they tend to be too limited for
large-scale businesses and projects. If they were to
grow substantially larger, they could run up against
the sort of exchange rate problems afflicting small
countries. They are basically barter systems, not
really designed for advancing credit on a major scale.
The functional equivalent of a community currency
system can be achieved using the national currency, by
forming a publicly owned bank. By turning banking into
a public utility operated for the benefit of the
community, the virtues of the expandable credit system
of the medieval bankers can be retained, while
avoiding the parasitic exploitation to which private
banking schemes are prone. Profits generated by the
community can be returned to the community.
A public bank that generates credit in the national
currency could be established by a community or group
of any size, but as long as we have capital and
reserve requirements and other stringent banking laws,
a state is the most feasible option. It can easily
meet those requirements without jeopardizing the
solvency of its collective owners.
For capital, a state bank could use some of the money
stashed in a variety of public funds. 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. The 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 information, see
www.public-banking.com.]
We have emerged from the financial crisis with new
clarity: Money today is simply credit. 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 of finance.
Ellen Brown wrote this article for YES! Magazine, a
national, nonprofit media organization that fuses
powerful ideas with practical actions. Ellen is an
attorney and the author of eleven books. In
Web of Debt: The Shocking Truth About Our Money System
and How We Can Break Free, she shows how the
Federal Reserve and "the money trust" have usurped the
power to create money from the people themselves, and
how we the people can get it back. Her websites are
webofdebt.com,
ellenbrown.com, and
public-banking.com
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