MONEY: ITS FAILURE AND ITS FUTURE.
PART ONE: ITS FAILURE.
Welcome to this year’s lecture, ‘Money: Its failure and its future’. Actually, it is two lectures this year. Part one will deal with money’s failure and part two will be about its future. This unfortunately means that the lecture you are about to here is a rather bleak one. Since I do not want it to be all doom and gloom, I am going to start on an upbeat note and talk about something that applies to a wider context than the main topic of this year’s lectures.
I want to begin by talking about the fishermen of the Indian state of Kerala, and a problem they faced, prior to 2001. It was this: The fish they caught were intended to be sold at market, but the only way they had of finding out if they had a buyer was to go to a market and engage in face to face communication. If the market they went to had no need of their fish, they would not be able to visit another, because the markets were about ten miles apart, the fish were perishable and the markets closed at 8AM. Choose the wrong buyer, and the whole catch would have to be thrown back into the sea. Economists call this a ‘coordination problem’.
But then these workers got hold of technology familiar to us all that matched buyers and sellers much more effectively. They got themselves mobile phones. Now, while they were still out at sea, they could phone ahead and arrange the best deal for their catch.
Now, I am not really interested in fish, but rather the fact that these workers made the jump from what was essentially stoneage communications to 21st century communications. What if developing countries can achieve a similar leap forward with agriculture, banking, education, energy, money and civil engineering and so on? If so, what they might develop into would be a new kind of civilization. Some people, for instance Marshall Brain, call this a ‘4th generation civilization’. But, since I am unsure as to how many civilizations there have been, I will play safe and call it a next-generation civilization.
So what is this next-generation civilization? I see it as being a civilization that uses the only resources we have- natural capital and human potential- with maximum efficiency. Because it has achieved this, it has eliminated- as far as is physically possible- the obstacles to greater social cohesion and personal development. Citizens of next-generation civilization would find themselves much further up Maslow’s famous pyramid of the hierarchy of needs than is the case for all but a few of the nations’ population today. This would make next-generation civilizations the best platform we have ever had for realizing the transhuman pursuit of social and individual excellence.
To achieve such goals, next-generation civilizations must become more than just life-as-we-know-it but with cooler technology. It would require a reinvention of all the systems, institutions and beliefs of which our lives are comprised, many of which are centuries old. Now, obviously we would be here until the Rapture if we were to embark on a comprehensive survey of all that needs to be done. So, I will be focusing mainly on a technology without which any civilization more complex than the most basic would be impossible. I am talking about money.
Speaking of money or, rather, wealth, a thought may have occurred to some of you. If we acknowledge that a next-generation civilization could be achieved, why should we suppose it would emerge in developing countries? In many ways, these are places that have barely reached the 20th century. Dreaming up some glitzy, high-tech civilization sounds like an undertaking for people of affluent countries with plenty of time on their hands, not something that would concern those struggling to get by on one or two dollars per day. And then there is the matter of corruption. Stories abound of the terrible misallocation of wealth that goes on in the world’s poorest countries. The African Union estimated that some 25% of its annual GDP is lost to corruption. As they are so far behind, and the corrupt and criminal tend to thwart dreams of a better life, why look to such countries for the rise of NGC?
We should not think that developing nations have no advantages. There is, for example, the ‘latecomer’s advantage’. There is no rule that says a country has to retread all the steps that lead to the modern world. They can leapfrog straight to the latest technologies and practices. Indeed, this leapfrogging makes a great deal of sense, because the most modern technologies often do the same job as predecessors, only more cost effectively and less wastefully. The cost of purchasing and burying copper wire for a communications infrastructure would be more than $100 million. Cell tower infrastructure would cost a relatively small tens of thousands of dollars. If a city like Zinder in South Niger were to adopt PCs, then by the time 10% of the population were using them, the power they consume- 1,500 KW- would exceed that of all households today. Mobile devices, on the other hand, would consume just 74KWs, and as they run off of batteries they would be more useful in areas where power outage is a common experience. It is for reasons such as these that countries like El Salvdore and Panama have adopted mobile communications faster than the USA.
The fact that the rich nations have well-established systems and infrastructures could be an impediment to progress. W. Brian Arthur, External Professor at the Santa Fe Institute and author of ‘The Nature of Technology’ has written about how established technologies and practices can delay the adoption of new methods, even though those new methods are superior. In 1955, the economist Marvin Frankel noticed that cotton mills in Lancashire were not using the more modern and efficient machinery. This was because the old brick structures that housed the old machinery would have to be torn down before the new machinery could be installed. As Arthur wrote, “The outer assemblies thus locked in the inner machinery and thus the Lancashire mills did not change”. To this day, whenever a technology is so interwoven with the fabric of everyday life or business practice that replacing it seems too much bother, we say it has become ‘locked-in’.
There is also a psychological aspect to consider. Established technologies and practices can lead people to adopting certain ways of doing things, and upstart technologies that obsolete the old ways can be threatening. Sociologist Diane Vaughan called this ‘Psychological Dissonance’ and wrote:
“(We use) a frame of reference constructed from integrated sets of assumptions, expectations, and experiences…This frame of reference is not easily altered or dismantled, because the way we tend to see the world is intimately linked to how we see and define ourselves in relation to the world. Thus, we have a vested interest in maintaining consistency because our own identity is at risk”.
Therefore, established technologies, infrastructures and methods can create hysteresis- a delayed response to change- that holds the new at bay, at least until the old ways simply cannot be stretched any further. So, it could be that developing countries which lack many of these established infrastructures and technologies, would adopt the new and accommodate themselves more quickly to the methods and practices they make possible.
As for the problem of corruption, we should not think that it only goes on in the poor nations of the world. The reason why the corruption that goes on there seems so overt and in-your-face may be because it is immature. In the West, centuries of adjustments and fine-tuning have evolved institutions that divert real wealth from those who create it to those who set the rules. As world-renowned linguist and social philosopher Noam Chomsky pointed out, using violence in order to get people to obey, as the Soviet Union did, will ultimately fail. What is needed are systems of indoctrination to ensure that citizens agree to what the ruling class want. This can be achieved by, among other things, entering the school system and educating the nation’s future workforce towards the ‘correct’ way of thinking (one third of textbooks in American schools are provided by corporations) and censoring material that questions state dogma (a study by Vincent Navarro of John Hopkins University that found a correlation between class and race and wealth inequality was refused publication by every major medical journal in the US). These and other insidious practices successfully hide much of the elite wealth appropriation that goes on from view. It would be no mean feat to successfully un-entangle those immoral methods of wealth creation from the beneficial forms that is vital for any successful civilization.
But much of the corruption in developing countries will be relatively easy to deal with. Much of it consists of plain old bribery, for instance having to pay your boss before he will hand over your wages. If you were working online for a foreign company and your wages were wired directly into your account, that form of corruption would be much reduced. Moving to a cashless society using mobile devices that recognize their rightful owner and refuse to work for unauthorized users- say by using biometrics to identify users- would leave folks less vulnerable to theft. In countries like Niger, Senegal and Uganda, parents may have to pay bribes to get their children into school. With Internet access and availability of free educational resources like Kahn Academy and Granny Cloud (the latter being a service in which retirees voluntarily give some of their time to running lessons over Skype) that form of corruption is rendered obsolete. Many other forms of overt corruption would be harder to get way with in a country where the mass adoption of camera-phones and social networking makes surveillance possible.
SPEAKING UP FOR CAPITALISM
Now, we are getting close to the point where I say some negative things about modern money mechanics, capitalism, and free market libertarianism. So I think it might be wise to say something about what I shall call the ‘Categorization Fallacy’. When thinking about such things as
I have noticed that people tend to label them as ‘good’ or ‘bad’, and which label they apply depends to a large extent on their political ideology. If you lean toward the right, you probably think ‘government’ and ‘taxes’ are bad; ‘The Rich’ and globalization are good. For those who lean more to the left, ‘The Rich’ are evil and so is globalization. Government and taxes (or rather, government that taxes the rich) is good.
But this black and white good/bad attitude is overly simplistic and can lead to flawed conclusions. If you think government is bad this may well lead you to conclude that the solution is no government. No, the solution to bad or ineffective government is always better government. Taking the stance that anything on that list is ‘good’ can lead to an ‘it ain’t broke so don’t fix it’ attitude. But all products of human ingenuity are imperfect works in progress. Rather than slap a simple good/bad label on the technologies, systems and institutions underlying and supporting the modern world, we should instead lift the hood on all of them, examine the way they function, how that influences us psychologically and how that, in turn, affects the behavior of societies and civilization as a whole. What aspects succeed in favoring greater social development and personal achievement and how might they be improved? What acts against these goals and what might replace them?
So, before we get down to critizing current monetary and financial systems, let’s say some nice things. Such systems can claim to have done a great deal to increase wealth and raise living standards. It is easy to forget just how well off are in comparison to our ancestors. They longed for a world in which there was ample leisure time, an abundance of food and other material pleasures. For the averagely well-off citizen of a country like America, their daily life is, more or less, the realization of utopia that our ancestors dreamed of. When criticizing the negative aspects of globalization, I think there is a tendency to view it in light of the remarkable affluence we enjoy in the West. Anti-globalization protestors speak darkly about predator corporations moving to poor countries in order to exploit workers by putting them in sweatshop factories for shockingly low wages. But, those wages are only shockingly low by our standards. In countries like Vietnam they represent premium pay. If Western production were kept out of the developing world, that would only condemn workers in so-called sweatshops to return to subsistence agriculture. Globalization is not all bad and great harm would befall developing nations if it were simply ended.
That said, the richer the world becomes the less tolerant we should be of poverty and hardship. No blame for hunger and famine can be attributed to a world that does not have the capability to produce enough for everybody. But a world like ours, which does have the capacity to feed the world, should face constant pressure to do so. Particularly as the health issue in rich countries is no longer the hungry poor but rather the obese poor.
It is often said that developing countries cannot aspire to reach the same standards of living as first world nations. I agree- they should aspire to do better. We might view the capitalist system and the markets that support it as a centuries-long experiment testing the question ‘does material comfort bring happiness?’. The answer to that question is, ‘yes, but only up to a point’. Beyond that point, competing to out-do your neighbors in the fight to achieve ever-greater levels of material wealth does nothing whatsoever to improve life quality and can even have dire results for civilization.
THE DECLINE OF EMPIRES AND THE AGE OF DECADENCE
In 1976, a retired army officer called General Sir John Grubb wrote a series of essays about empires past and present. There were, he noted, remarkable similarities between them. Empires last around two hundred and fifty years or ten generations, and during their lifespan they pass through several identifiable stages.
The Age of Discovery
The Age of Conquests
The Age of Commerce
The Age of Affluence
The Age of Intellect
And, lastly, the Age of Decadence.
The ins and outs of most of these stages need not concern us, but it would be worth examining that last stage in a little more detail. The Age of Decadence precedes the collapse of an empire, and what drives it toward collapse is greed, the corrupting effects it has on society and the detrimental impact it has on the environment. The historian Arnold Toynbee showed how the collapse of 21 civilizations could be attributed to just two causes: Excessive concentration of wealth in the hands of a few, and an inability to introduce significant changes in response to shifting sociopolitical or socioeconomic circumstances.
During an age of Decadence, material wealth becomes less a means to an end and more an end in itself. The powerful compete to fill positions of authority, not really in order to better carry out their civic duty, but because they expect it will enable them to grab an even larger slice of the pie. Conspicuous displays of wealth are a common theme in an Age of Decadence.
This lust for more wealth is not restricted to the elite. The citizens, too, crave more and are encouraged to pursue materialist desires via the availability of easy credit. The desire to live off of a bloated welfare state is another common symptom. Others are an overstretched, poorly disciplined army, an obsession with sex, the veneration of celebrity, and a debasement of the currency resulting in severe economic and financial crises.
If all that sounds familiar, that could be because the West is now in its own Age of Decadence. There are two ways of responding. We could adopt a kind of pessimistic fatalism: We are heading for collapse. Or we can be optimistic and recognize that we stand on the cusp of change. There will be great challenges ahead of us, but it would be foolish to ignore the fact that there is also great opportunity. Thanks to the amazing advances in computing and communications technologies, ordinary people are more capable than ever of educating themselves about what is going on, viable alternate ways of doing things, and more able to organize into groups large enough to have a strong influence on the world’s stage. But, in order to guide the future in a direction that is positive, we must have a clear understanding of the deficiencies of the current system.
I would imagine that, in any Age of Decadence, there is a temptation to seek out somebody to blame. In our day and age it is politicians and bankers who are often singled out as the culprits. But that is unfair, because these are issues that run deeper and wider than anything that can be conveniently attributed to any one group. The problems are systemic, involving decades or even centuries long changes to politics, the financial system, religion, economics, the educational system, and more, modifications that we all, one way or another and to a greater or less extent, share some responsibility for having brought about.
So, since the answer to the question ‘who is to blame?’ is the general and rather unhelpful ‘everybody’, we should focus instead on WHAT is to blame. I suspect that a thorough understanding will necessitate not considering politics on its own, or anything else, but rather the way the political system, the monetary system etc. are interconnected, with cause and effect propagating back and forth along the network of systems, organizations and institutions that form the basis of our current civilization. And when we focus our attention on a particular aspect of the overall system, as we shall shortly do with the monetary system (always baring in mind that it is part of something larger and therefore not entirely responsible for the situation we are in) we must be careful not to be distracted by non-problems, or problems that do not matter as much as we may think.
THE REAL PROBLEM WITH MONEY
As far as most people are concerned, there is only one problem with money: Lack of it. The hardship poverty causes is not in question. But a careful analysis of the financial and economic crises we have faced reveals a different root cause. Our problems are not caused by a lack of money, but rather because we are using the wrong kind of money.
Money, you see, is not value neutral. It has a design (I do not mean how it looks; I mean how it functions) and that design affects us psychologically which, in turn, influences the kind of society we build for ourselves. Money can be designed to encourage cooperative, altruistic behavior resulting in societies with a strong sense of community where wealth is distributed fairly (which is to say ‘not equally’ as that would be unfair given that individuals make disproportionate contributions to the economy). Alternatively, the ‘engine’ of money can drive competitive, aquisitive behaviour resulting in a society ( if that is the right word) were selfishness rules and wealth is concentrated in the hands of a few, leaving many in desperation. Throwing more bad money at the problems it has caused will ultimately only serve to exaggerate those problems. The solution has to involve rethinking money.
As we think about building our next-generation civilization, a critical question to answer will be how it can be that the current monetary system can generate such great wealth and yet there are still billions living below the poverty line. Part of this understanding comes from seeing how money was changed over generations from a convenient unit of currency and medium of exchange to a tool for social manipulation.
A BRIEF HISTORY OF MONEY
What we use as money originated in Venice in the thirteenth century. Back then, people used gold coins as money. As you can imagine, walking around with gold in their pockets made folk vulnerable to theft and the goldsmiths saw a business opportunity in that unfortunate fact. They could charge customers a fee for keeping their gold safely locked away in the vaults. The townsfolk agreed that this was a good idea, handed over their gold along with the fee, and were issued with receipts that could be later exchanged in return for their gold.
The townsfolk then adopted the attitude that those receipts were as good as real money. Indeed, in one way they were more convenient. It was much easier to carry around slips of paper rather than gold coins. And so tradesfolk accepted those receipts in payment for goods and services.
So far this all sounds like legitimate business practice, and that is because it all fits comfortably into the category of ‘profit making’. That tends to be generalized to mean any scheme that produces more money than was spent setting it up and maintaining it. But I think it more helpful to apply a more refined definition. Profit making applies to those schemes in which an individual or group risks its own capital in bringing to market a product or service that an informed public chooses to pay so that they may have access to it. The essentials of profit making are that it is wealth accumulation through democratic consent and it is non-zero sum. After all, it entails bringing to market something that makes a mostly positive contribution to our lives. To give a simple example, Apple gets rich, we get iPhones.
Given that definition we can see that there are ways of accumulating wealth that do not count as ‘profit making’. Most obviously, there are all those overtly criminal ways in which one may increase one’s own wealth. I guess any reasonable person would agree that people who get rich using such illegal methods do not deserve their fortune as the likes of Steve Jobs did. There are also methods that, while not illegal, do occupy a moral gray area and there can be disagreement as to whether those who get rich using such methods really deserve their wealth or not. One of these methods forms the very basis of modern money and came into being when people began using those receipts as money.
The goldsmiths noticed that the townsfolk preferred to use those slips of paper as ‘money’. The more astute goldsmiths also noticed that when their customers did withdraw their gold, they rarely withdrew it all at once. Instead, they preferred to withdraw just a part of the total deposit and leave the rest where it was. So, the goldsmiths figured they could get away with issuing loans in excess of the gold that was in the vaults. Customers came along, receiving receipts they assumed were ‘real money’ i.e. represented a certain amount of gold. In reality, that gold did not exist.
The idea of selling somebody something you do not have sounds like fraud. Remember, though, that the goldsmiths did have some gold, just not enough to back all the paper money they were issuing. Since their customers rarely demanded all their gold, their scheme worked so long as debt repayments provided sufficient reserves to meet those needs. On the other hand, if word got around that a lot of that paper money was essentially worthless, there would have been a rush to withdraw what gold there was before somebody else got to it. As for the act of issuing loans rather than buying and selling gold, it meant the customer was no longer dealing with a goldsmith but rather a bank, an organization whose main source of income comes from other other people’s debt. Issuing loans is not intrinsically bad. There are times when it is very useful to borrow money. But when you are profiteering from debt there is a temptation to increase it as much as possible, since the more debt there is the richer you get.
The rest of the goldsmiths’ story is a rather familiar one of great wealth made and reputations lost; of rules and regulations established and subsequently eroded as the lure of riches overrode common sense. And the reason why it is familiar is because the practice of making money out of debt now forms the very basis of the modern monetary system.
When a person, business or country borrows money, they are not given money that somebody else deposited or that the bank has in its vault. Instead, if a person wants to borrow, say, £10,000, the bank types £10,000 into that person’s account and, hey presto, there it is. This kind of money is called ‘Fiat money’ after a phrase in the Latin version of the Bible, ‘Fiat Lux’ or ‘let light be’. The reference is obvious: Banks have the ability (or rather, the authority) to make money out of nothing.
Eventually, that newly created £10,000 will end up being deposited in another bank account. When that happens, that bank is obliged to hold ten percent of that deposit in reserve and is entitled to issue the other ninety percent as new loans. However, that ninety percent does not come out of the original deposit. Instead, it is £9,000 created on top of the original $10,000. This process repeats every time money is deposited in an account. Thus, the supply of credit money is expanded. This process is known as ‘Fractional Reserve Banking’.
What gives fiat money value? One answer is: The money that already exists. The new money steals value from the money already in circulation. When the money supply is expanded irrespective of demand for goods and services, that upsets the equilibrium of supply and demand and diminishes the buying power of each pound, dollar or whatever. This devaluing of the currency manifests itself in higher prices for goods and services. In other words, you get inflation. Today one would need $405 to purchase goods that cost $100 in 1975.
You may have noticed that this provides only a partial answer to the question of where fiat money gets its value from. After all, if the new money gets value by stealing it from the money that already exists, where does that money get its value from? The answer to that question can be found in the definition of ‘real money’ in a fiat money system.
If you have ever played Monopoly, chances are that somebody held up a pretend banknote and said, “imagine if this was real money!”. But have you ever wondered why it is not? The reason why is because you cannot pay tax estimates with it. Why do we pay taxes? Not really for the reasons most often given. We are told taxes are essential if we are to have services such as road maintenance or garbage disposal. But that is not true because even if we did not pay taxes all such services would still be provided. This is because there is a demand for them, and wherever there is demand market economies adapt to meet it. That is just good business sense. And it does not require so-called ‘real money’ in order to make this happen, because just about anything can serve as a medium of exchange and unit of currency: Stones, beads, bones, seeds…and, yes, Monopoly money.
But you cannot pay taxes with anything other than what the law says is to be used for that purpose. And since you are required to pay taxes, you are therefore obliged to procure that which is used for this purpose. So the real purpose of taxes is to give value to whatever government decrees to be ‘real money’ and the definition of ‘real money’ in a fiat money system is, yes, ‘that which is used to pay taxes’.
The fact that this is what ‘real money’ is under the current system, coupled with the way the fractional reserve system creates money out of debt through the issuance of loans, has implications for what money represents. The common assumption is that money equals wealth. It is not hard to see why: The more money you have, the richer you are. But, the money creation process commences with government defining what is money by saying what is to be used to pay taxes. Since we never stop paying taxes we always owe money to the government, which is to say, we are always in debt. Furthermore, the way the fractional reserve system works inherently creates more debt. In fact, today ninety seven percent of all money is created as debt. So, in a fiat money fractional reserve system, money equals debt. It may be the case that the more money you have the richer you are, but it is also the case that the more money there is the more debt there is.
It is also debt that can never be repaid and which somebody must be burdened with. This is because of the application of interest. Whenever money is loaned it almost always has to be paid back with accrued interest. This is the banking system’s main source of income. But the money needed to pay back all debts as well as the interest does not exist. It is never created. This means that whenever a bank assesses somebody’s credit rating, they are determining how successful or aggressive that person will be in taking money from others. Every pound or dollar that exists is money owed by somebody to somebody and the debt-based monetary system is akin to a game of musical chairs. When the music stops, there is an inevitable loser. Only, the stakes are high because, while banks get to make money out of nothing and lend it at interest and government steps in to bail them out whenever the system is losing them money, you will not get that loan unless you agree to forfeit something of real value should you fail to make repayments. Since that something is often your home, being the inevitable loser in this financial game of musical chairs is dire indeed.
As Peter Joseph explained, “The fractional reserve policy…is in fact a system of modern slavery. Money is created out of debt, and what do people do when they are in debt? They submit to employment to pay it off…And it is the fear of losing assets, coupled with the struggle to keep up with the perpetual debt and inflation inherent in the system, that keeps the wage slave in line, running on a hamster wheel with millions of others”.
Now, obviously, there must be some benefits to this system, otherwise it would not have spread in practice to the great majority of banks in the world. Basically, the earlier you get the newly created money the more you benefit. Therefore, those who have the authority to issue money benefit the most: Governments and banks. Borrowers who get this money early- for instance large corporations and government contractors- are next in line of those who benefit. They can spend the money before inflation caused by the new money raises prices. Prices do rise due to inflation, so holders of assets such as houses or shares will see gains in the value of that asset without there necessarily being any real improvements made. As for those at the bottom of the pyramid- for example people on fixed wages or incomes- by the time the money trickles down to them, the prices of things they need to buy have increased. Since their wages remain largely unchanged and their savings now buy less, in some cases they have to take on debt just to be able to afford what they were previously able to buy. Which means, of course, going back to the banks. And so the rich-poor divide gets bigger and bigger. In practice, then, the debt-based fractional reserve system is one designed to redistribute wealth from the bottom of the financial pyramid to the top.
This conclusion was borne out by studies conducted by the monetary analyst Helmut Cruz. He found that there was an upward concentration of wealth from the bottom eighty percent to the top twenty percent, especially the top ten percent, and this transfer of wealth occurred independently of the cleverness or industriousness of the participants. It was, instead, due exclusively to the interest feature of the monetary system.
The problem here is not inequality. Unless you are some kind of idiot socialist, you have to concede that some degree of inequality is essential in any fair and just economic system. This is because there are individuals and businesses that are cleverer and more industrious than others and it is right and proper that they are duly rewarded. The belief that ‘the rich do not deserve their fortune’ is too general to take seriously, but the same could be said for its opposite: That everybody who occupies that exulted ‘one percent’ position deserves every penny or cent or whatever they have accumulated. As the economist Joseph E Stiglitz wrote:
“Economists long ago tried to justify vast inequalities…The justification they came up with was called ‘marginal productivity theory’…this theory associated higher incomes with higher productivity and a greater contribution to society…Evidence for its validity, however, remains thin…Those who have contributed great positive innovations to our society…have received a pittance compared to those responsible for the financial innovations that brought our global economy to the brink of ruin”.
THE PURPOSE OF LOANS
Banks create money through loans, but what are those loans used for? Money is created for three purposes. There is, for instance, the purpose that I would guess most people would think was the main reason banks loan money: For investment in productive enterprise. Sometimes, somebody trying to start a new company or an established company seeking to expand into new markets will lack sufficient funds to do so. They will therefore require a loan. If the company is successful, it will make a profit, resulting not only in the lender being properly compensated but also in society benefitting from capital accumulation. Banks do not produce wealth. But, as this example shows, they do play a supporting role in wealth creation by funding direct investment in the creation of new wealth, as well as generally supervising the monetary system.
Arguably, this purpose for which loans are issued is the most socially beneficial contribution the banking system makes. So you would think that the vast majority of loans would be used for this purpose. But no: Currently in the UK, only eight percent of bank loans are made for investment in productive enterprise. So what is the remaining ninety two percent used for?
They are used to fund consumption in goods and services, and mostly to fund investment in secondary markets for stocks and shares, bond markets, stuff like that. Such investments have no direct link to the creation of real wealth. But language is cleverly used to make it seem like they do. We hear about workers trading in ‘financial products’ in the ‘market for financial derivatives’ and this is all part of the larger ‘financial industry’. Terminology like ‘product’, ‘markets’ and ‘industry’ make it seem like this is as much a contribution to the real economy of goods and services as, say, greengrocers selling their produce. But it is not.
That is not to say that only physical products have real value. Consultants can earn high wages because their knowledge is so valuable. When a painting is sold at auction for a six-figure sum, obviously the raw materials of the art piece had little to do with that price. More intangible qualities are what attracted such a high price tag. There are all kinds of genuinely valuable, nonphysical commodities circulating in the economy.
CASINO OF THE WEALTHY
But what we are talking about here has nothing to do with the real economy. If you look through the smoke-and-mirrors use of language, a more honest description becomes clear: One of players betting on abstract concepts within a virtual global casino, entrance to which is limited to the already wealthy. That would be OK, I guess, if these games had no real life consequences. But they do. That’s not to say a game or two on sites like www.boomtownbingo.com/hunnie-bingo-review ever hurt anyone, moderation in all things of course.
Profit making is a synonym for earning money. But what this casino for the wealthy does is not profit making, since it is not investing effort and resources in trying to generate real wealth. Instead, it involves finding ways to secure for oneself a greater share of the wealth others have created. It is therefore a parasite, feeding off of the real economy. Furthermore, whenever top executives of banks and financial institutions are awarded huge salaries or bonuses, the labor market mechanism dictates that senior executives in other areas should be similarly rewarded. But, in order to do this, shareholders have to be kept happy, and this is achieved by paying them higher dividends.
The money needed to pay for all this does not come out of nowhere, but rather out of the company’s revenue. As this is obviously finite, greater financial rewards for executives and shareholders means lower wages for ordinary people. Now, I said before that unequal outcomes are essential in the interest of fairness. But at some point that inequality gap becomes so large that any sense of fairness is lost. The banker, J.P Morgan, considered a pay ratio of 20:1 between the highest paid and lowest paid to be optimum. In today’s largest corporations the ratio is 1000: 1. My favorite story of pay injustice is the revelation that Wal-Mart made its employees clock out and work part of their shift for no wages. And the owners of Wal-Mart, remember, have as much combined wealth as the bottom one hundred million American families.
Morally dubious as this is, it is perhaps not quite as objectionable as speculative investment. A lot of investment made in raw materials play no part in the production process that gets products into the hands of ordinary people. Instead they are made in the hope that the ‘asset’ will rise in value and so make money for the holder of that asset. This would be OK if we were talking about nonessentials like vintage wine. But speculative investments are made on staple foods, such as wheat. This betting of food prices in financial markets has lead to an average increase of fifteen percent for food prices, resulting in over 44 million people being driven into extreme poverty.
According to the logic of the free market, consumption is good and must continue, but paying wages is bad and to be avoided wherever possible. But, as many have pointed out, if you have no wages what are you supposed to consume with? The debt-based monetary system thinks it has the answer: More debt. Or, more precisely, generating loans to fund the consumption of goods and services. In the UK, personal debt is roughly equal to the entire annual output of the economy, a crazy result of a culture with an obsessive focus on consumerism, promoting the belief that we can have all we want whether we can afford it or not. It makes you wonder how such a large debt can ever be repaid.
But maybe we are making a wrong assumption in thinking debt is intended to be repaid? It is easy to see why such an assumption would come to our minds. We all learn as children that the word ‘loan’ refers to something that must eventually be given back. But the financial world does not always adhere to basic rules of social conduct.
An American economist called Hyman Minsky showed how there are three categories of debt, which he labelled ‘hedge lending’, ‘speculative lending’ and ‘ponzi lending’. Of those three, only hedge lending fits the definition of a loan as commonly understood: the borrower expects to pay both principle and interest out of cash flows from current investments. But ponzi lending is a thoroughly different beast. A ponzi borrower has no cash flows to service their debt, preferring instead to constantly refine to avoid default. The act of continually borrowing, accumulating interest (and the fact that other ponzi borrowers behave similarly) ensures that the value of the underlying asset keeps rising. So long as the banks keep extending credit, the ponzi borrower can cream off a tidy sum for themselves, extracting revenue from assets whose value keeps rising simply because banks keep extending credit. As you might expect, this cannot last forever. After the boom period there is the bust. But by the time the system comes crashing down, the ponzi borrower is largely insulated from the fallout because they have gotten so rich. The rest of society is not so well insulated.
Then there is the use of debt as an alternative to conquest as a means of getting hold of another country’s assets. We saw earlier how, under the fiat-money fractional reserve system with its built-in inflation and interest, people are obliged to take on debt and so come under pressure to join the ranks of wage slaves. This does not just apply on an individual basis, but sometimes to entire nations.
The country Nigeria borrowed around $5 billion from the World Bank, but because of the interest charges it was made to pay back $16 billion. Then it was told it still owed a further $28 billion. Little wonder that President Obasanjo lamented, ‘if you ask me what is the worst thing in the world, I will say it is compound interest’. The developing world spends $25 in debt repayment for every dollar received in foreign aid and grants. Former economic hit man, John Perkins, claims this is a deliberate ploy:
“We economic hit men…will identify a country that has resources our corporations covet, like oil, and then arrange a huge loan to that country from the World Bank or one of its sister organizations…It’s so typical of the way the IMF and World Bank work. They put a country in debt, and it’s such a big debt that it can’t pay it, and then you offer to refinance the debt and pay even more interest. And you demand this quid pro quo which you call ‘conditionality’ or ‘good governance’ which means basically that they’ve got to sell their resources, including many of their social services…to foreign corporations”.
What is going on here? Why do the elite consider their privileged position entitles them to so much that entire countries can be brought to the brink of ruin, just to benefit a few rich people in addition to foreign corporations?
We have to remember to stay away from ‘who is to blame?’ type questions and focus instead on what is to blame. That is, examine the underlying system. Taking the broadest view first, we are talking about economic theory that was largely established prior to the twentieth century. Why should that matter? It matters because, prior to the twentieth century, it was assumed we lived in a Newtonian universe. The Newtonian universe was a perfectly ordered mechanism and its success in accurately predicting orbits lead to expectations that everything could be understood with linear cause-and-effect thinking.
But Newtonian physics had always been limited in what it could achieve. It could only accurately predict the orbit of two bodies assuming no other celestial bodies were involved. In other words, Newtonian physics can be applied successfully only to a highly simplified model of the universe, one which removes all the complex interdependent systems.
But this fact was either missed or ignored by economists, who sought to apply Newtonian mechanical models to the economy, one of the most complex, adaptive, open systems imaginable. And, just like the astronomers, they had to simplify the economy. Economists imagined perfectly functioning free markets, corporations run with impeccable efficiency and individuals who know everything taking place in markets. Or, to put it another way, players with the mind of God. Does that sound like the real world to you? Me neither.
THE FREE MARKET FALLACY
Advocates of the free market are big on putting down state intervention and defending the free choice of players. Their argument, at first glance, seems reasonable enough. The world should be thought of as comprised of individuals who are free to participate fairly in an open market. If only government did not interfere, competitive self-regulation, defined as ‘the causal, resulting, and adaptive mechanism that guides and shifts rational decisions, based upon the logic of seeking and maintaining success in the marketplace”, would naturally achieve a balanced, equitable society with everybody properly compensated for their work.
But there is a very great difference between how the free market should work according to its advocates, and what actually results from its mechanisms. What actually results is freedom alright, only it is freedom of the powerful to dominate, suppress and beat others by whatever competitive means possible, and the freedom to exploit the desperate and misfortunate. The flaw in this thinking lies in the fact that the free market is too myopic. This is not caused by people being evil in any traditional sense, but rather because the free market system cannot rationalize anything that cannot be turned over through money, and certainly not anything that has an interest to slow consumption. This means that the real world is full of ‘externalities’ that result as either an inherent byproduct of the narrow, mechanistic logic of the free market system, or something unrelated and unforeseen. And these effects put pressure on an individual or company to reduce their ethical and moral standards, since that is the only way to reduce survival deficiency (ie make them, once more, competitive in the free market).
This is best illustrated with Peter Joseph’s thought experiment about a nice guy called Geoff. He owns a T-shirt store. Naturally, Geoff needs inventory, so he purchases his shirts at bulk rates, always mindful to assure customer satisfaction by competitive association, basing his decision on what to buy, pricewise, on the price competition of rival stores in his region. Geoff has employees who he cares about. He wants to see them be well. He drives their pay- in a competitive manner, of course- in order to reduce the likelihood of them seeking more lucrative employment elsewhere. Geoff is not greedy, nor is he corrupt in any traditional sense. He is merely a player in a free market mechanism that is the director and orientator of proper social action through free enterprise and competition.
Now let’s introduce an externality and see what effect it has. A few years back, a typhoon struck Thailand, damaging its industries. This resulted in limited means to keep money flowing, and there would be limited to no state intervention, as that is deemed an interference in this world. Now let’s add another externality. A Western company has been hit by massive lawsuits, losing it lots of money. This company decides to offer contracts to manufacture clothes to the vulnerable, typhoon-decimated society. But, due to their own externality, the only way this company can keep afloat is to offer 12 cents an hour for a ten hour work day. The misfortune that the Thai community suffered leaves them no recourse but to ‘voluntarily’ agree to submit to what is almost slave labor. And the company offering such low wages is not doing so out of greed; they are merely trying to recover from a major lawsuit.
What can the market see? Only competitive cost efficiency. It cares nothing for humane working conditions, the health of workers or the community as a whole. It is indifferent to these things so long as they do not affect the bottom line. Obviously people need some rest and some means of acquiring the basics of life, so you cannot get away with making people work 24/7 for no wages. Having said that, there are places where people can be bought for a price cheap enough for them to be considered disposable commodities. There are some twenty seven million slaves in the world today. And that is REAL slavery, btw, not the ‘wage slaves’ we talked about earlier. From a humanitarian point of view this is not to be tolerated. But from a free market perspective it is very beneficial. People laboring for little to no pay? It does not get more cost effective than that!
What has all this got to do with Geoff? Well, it has everything to do with the ethical integrity of the labor that produces the shirts he sells. He is driven, by the pressure of competitive association, to buy shirts offered at the most competitive price possible. So, logically, he buys the shirts made in Thailand. He is an exploiter of what is virtually slave labor. This also brings into question Geoff’s ‘green’ credentials. Geoff does try. He recycles religiously, rides a bike to work in order to do his bit to cut down on CO2 emissions. But the cotton his shirts made from is produced in the USA, sent all the way via shipping freighter to Thailand, before being brought all the way back. This makes no logical sense whatsoever from an environmental perspective because one of those shipping containers has been found to pollute as much as 50 million cars. But it makes perfect free market sense because it is cheaper to produce shirts this way.
Now let’s talk about Geoff’s own employees. Yet another externality compromises Geoff’s ethical integrity. The town he lives in used to be home to an automotive manufacturing plant that provided employment for hundreds of people. But no longer. Maybe market logic dictated the company moved overseas where labor is cheaper. Maybe mechanization lead to a downsizing of the workforce. Whatever the reason, there is now a surplus of labor in town and this translates both in a reduction in the cost of labor and to a loss of purchasing power.
In such a climate, could Geoff stick to his ethical principles and stock only locally made shirts produced by workers paid a decent wage? If he did so, the shirts he sold would have to be sold at a higher price. With people feeling the pinch (today, fifty percent of Americans do not have enough savings to go three months without employment) is it likely that his customers will forgoe the far cheaper offerings of his rivals? If customers cannot afford to be ethical, neither can he.
Loss of purchasing power would lead to a reduction in the amount of spending going on in the town. Geoff would notice his rivals reducing their paid wages and the price of their merchandise. Market logic would dictate that he, too, must pay lower wages in order to remain competitive.
Can we consider Geoff to be an ethical person, when he has sweat shop labor making his T-shirts and the wages he pays his staff are so low daily life is a huge struggle for them? Peter Joseph commented, “obviously it is a trick question, because it assumes isolated behavior, and free will decisions, absent external forces and pressures that inhibit and alter our behavior”.
The point here is not that nobody benefits from a free market system operating within a debt-based monetary system. Obviously, some benefit a great deal. The point is that it produces more losers; those people hit by externalities, lumping them with misfortune that the system ruthlessly exploits in its ceaseless drive toward greater cost efficiency and endless consumption. Advocates of the free market seem blind to this fact. To them it is like, I dunno, like a competitive sport with everybody starting on an equal footing and inequality of outcome dictated by individual ability and nothing else.
But the fact is there is no equality of opportunity and if ninety two percent of all bank loans are not for investment in productive enterprise, but rather for purposes of rent extraction, then the rich-poor divide cannot be the result purely of self-made millionaires earning profit as it I define it.
Rent extraction is not to be confused with rent as in, say, somebody running a taxi service who rents out spare seats to those who need a ride. That counts profit making because it generates real wealth in the form of a useful service, and people can choose whether or not to pay to access it. Rent seeking, by contrast, has nothing to do with investing one’s own effort and resources in trying to generate real wealth, but rather in trying to secure for oneself a greater share of the wealth that already exists. Lobbying politicians to enact legislation that will make it harder for new products to gain entry to a particular market is one example, private equity takeovers of perfectly viable businesses is another. There are many forms of rent extraction and all have a cost in terms of resources that could otherwise be applied to the creation of real wealth.
The amount of economic power we bring to the table has a great influence on our capacity to secure the wealth we need to live and prosper. Rent seeking activities ensure the distribution of economic power is extremely unequal. Such extreme inequality encourages the emergence of an elite who can use their power to further entrench their position, working to change the rules of the system to favor them. This is clearly illustrated by considering the issue of land ownership.
Before there was neo-classical economics, there was classical economics. In classical economics, Adam Smith divided inputs into economic activity into three classes- or factors- of production, those being land, labor and capital. According to Smith, no wealth is possible without some application of each of these factors. Smith provided a key contribution to economics because, by assessing the economic contribution to participants and the rewards they received in terms of social class (rent for landowners, profit for capital providers and wages for laborers) classical economics encouraged examination of the impact of power relations on the distribution of wealth.
However, classical economics predicted a world of diminishing returns, anticipating that as population numbers increased, production would intensify and growing demand would drive up the cost of land and, consequently, drive down the returns of labor and capital. But what really happened was that not only did land values steadily rise, wages and profit did as well, all thanks to technological advances that classical economics failed to take into account.
Neoclassical economics was established in response to this deficiency, but it too made a number of mistakes. One of the biggest was to consider land and capital to be the same thing, rather than distinct factors of production. Even today, nothing of tangible value can be created without some contribution of land, since ‘land’ includes natural resources that provide raw materials. But neo-classical economics was established to support the vested interests of land ownership. As Martin Wolf explained, “the powerful owners of natural resources wanted to protect their unearned gains. In practice, therefore, the tax burden fell on labor and capital”. By excluding land from economic models, landowners ensured that revenue earned by land ownership was exempt from tax, unlike revenue earned by labor and capital. I know that some people some people think that taxes of any kind are theft, but if we must have taxes wouldn’t it be better if it were consumption and resources that were taxed rather than labor and enterprise? After all, one could argue the case that the current arrangement encourages an unsustainable exploitation of natural resources and places an unnecessary burden on wealth creation.
It also hides the massive advantage that landowners have, whereas under classical economics and its analysis of land as a distinct factor of production, the advantage of that tiny proportion of the population who control access to most of the world’s resources would be laid bare for all to see.
That advantage is the ability to charge non-landowners for the right to use their land. Land, particularly the most valuable and in-demand land (which these days means land in or near the central business districts of major cities) is obviously of fixed supply, and therefore demands a greater share of income earned from production than it otherwise would.
Sometimes, landowners invest labor and capital in improving their land, and extra revenue earned as a result of such investment can be considered profit. But that is quite different to increase in wealth from the general uplift in land values. If you happen to own land in an area chosen for structure investment, the value of your land rises automatically, and not because of any effort you have expended or any investment you have made. As land reformers would say, land values arise not from the efforts of the landowner, but rather from those of the wider community. Wealth generated by the general uplift in land values is therefore wealth that the wider community is entitled to, but does not receive. Instead, it is concentrated in the hands of the land owners.
HOMELESS PEOPLE AND PEOPLELESS HOMES
The social deficiency of our current economic system lies in the way it takes what should be basic human rights and tangles them up with a government and banking system motivated by money creation. Because resources that should be basic human rights are used as investments, we have the bizarre outcome of a surplus of supply of resources and people going without those resources. There can be, for example, homeless people in a city with people-less homes.
During the millennium, so much money (i.e., debt) had been created that lending became a production line process. As Micheal Hudson explained, banks and other players in the global casino understood that “the poor are honest. They’ll do anything they can to repay their debts even if the debts are not valid; even if the debts are much more than they expected”. A market trading in packages of debts rose up, further swelling the profits and bonuses of the players who traded in them. Such was the complexity and lack of transparency of these ‘products’ that many simply did not nor could not know if the homes that were the underlying assets had any tangible value. For a while, the existence of a thriving market was considered security enough, but eventually, with so many having no idea of the origin or validity of such loans, the market for mortgage-backed securities turned to the principle of the ‘greater fool’ theory, which basically entails selling dubious investments for a greater price than you paid for it, your customers obviously being the type P.T Barnum had in mind when he said, “there’s one born every minute”. Inevitably, the bubble burst and tens of thousands of sub-prime borrowers suffered foreclosure. In Baltimore, for example over 30,000 homes lie empty and tens of thousands of people have nowhere to live.
SOME EFFECTS OF FIAT MONEY
I want to narrow focus now and look at the influences the kind of money we are using has on us, psychologically. As we have seen, debt-based money requires endless growth because borrowers must find additional money to pay off interest. It requires endless consumption, and endless cost efficiency, which means losing jobs to cheap overseas labor and, once competitive enough, automation and robotics. That would be be OK if the technologies of abundance were used to fairly distribute the incredible quantity of stuff we are now capable of producing, but sadly the mindset of the corporations views mechanization as not a means for abundance but rather as a way to save even more money in the process of production, delivering much of the productive economy into the hands of a minority while condemning many to economic exclusion and social deprivation. The result is economic competitive behavior driven by fear and insecurity.
Under such a system it is little wonder that we focus, almost to a point of obsession, on making money. Ever noticed how, when an individual is described as ‘successful’ it is almost always because they have a lot of money? We may not know anything else about this person like, say, whether he or she has a friend in the world. But they have lots of money and that is all that matters, apparently.
We can all recognize that there are socially valuable roles that people take on without expectation of payment. The most obvious example is parenting. Raising the next generation is considered by many to be the most important job anybody can undertake. But, because this is voluntary work, it is considered to have no value according to the rationale of the Gross National Product. As far as the GNP is concerned, anything that does not involve the direct exchange of money is to be disregarded. But, anything that involves monetary transactions is considered a gain. As a consequence, should social decay get to a point where paid intervention is needed, in the form of psychological counselling, say, or social work or increased police and private protection, that then registers as an improvement according to the GNP. As economists Cliff Cobb, Jed Halsted and Jonathon Rowe explained, “the GNP not only masks the breakdown of the social structure and the natural habitat… it actually portrays such breakdown as economic gain”.
As well as focusing on money creation, the kind of money we use also compels us to adopt short-term thinking. Since sustainability requires intergenerational thinking, the way the importance of the immediate future totally outweighs the long-term future in the business and financial world is clearly at odds with the premise of the next-generation civilization. Of course, the monetary system cannot be held solely responsible for short-termism. Long-term planning is inherently risky, due to the difficulty in accurately forecasting events that are located further in the future. But that being said, there is a key impetus toward short-termism that is very much a consequence of the conventional monetary system. When it comes to the discounted cash flow techniques used in financial decisions, analysts take into consideration the intrinsic risk of the investment project, the cost of equity capital and the current and anticipated interest rates. Now, if an entrepreneur can make the same amount of money simply by leaving it in a bank where it will accrue interest rather than invest it in productive enterprise, why risk one’s money on the latter? This is why, in a world that used interest-baring currency, financial investments are focused mainly on the short-term.
So, our debt-based monetary system places a firm preference on short-term thinking, encourages us to be obsessive consumers, is relentlessly working to displace as many of us from the labor market as it possibly can, considers voluntary work like parenting or caring for elderly relatives to be of no value, registers social decay, ecological disaster and war as improvements to a nation’s economy, and leads to an unrelenting concentration of wealth in increasingly fewer hands, while simultaneously burdening more people and even whole countries with debt and condemning them to competition driven by fear of deprivation.
Of course, it is not all bad. The rich may be getting richer and often in ways that have nothing to do with any real contribution to the real economy of goods and services, but the poor are seeing their standards of living improve as well, and that is mostly attributable to the genuine profit-making ventures of those who apply their talents in bringing products and services to market. There is planned obsolescence and other dubious ways of ensuring scarcity, meaning we do not use our technologies of abundance as efficiently as we might, but despite these dubious practices modern industry does succeed in delivering astonishing technological innovation into the hands of ordinary people.
But let us not let the glitz of shiny new tech toys mask the deep structural problems inherent in our current economic system. According to the IMF, there have been around four hundred and twenty five systemic crises, which amounts to an average of more than ten countries in crises each and every year. And, given that it would require two or three Earths-worth of resources to support us if all nations were to adopt the consumption levels of the richest countries (which they are striving to do) we are clearly heading for ecological disaster if we continue behaving as we have been. Empires in the past have collapsed as a response of runaway greed and there is no reason to suppose ours is exempt from this possibility.
Well, that is enough negativity. In the next lecture, we will see how money can be re-invented in ways that would make it more useful to the ambitions of the next-generation civilization.
*hero image used from http://ipcloseup.wordpress.com/2012/03/12/wall-street-discovers-patents/