Thursday, 22 May 2008

Money as a self-referential system

Posted by: Ian Angell
{Ash’s comments on the madness in money markets have spurred me to write on what I consider to the basic problem: the paradoxical nature of money}

We all know what money is don’t we? According to the famous economist, Professor J.K. Galbraith: “Money is nothing more or less than … what is commonly offered or received for the purchase of goods, services or other things.” Money circulates as a consensus, a statement of trust in the value that permeates such instruments of exchange. It even addresses the thorny question of what value is: money is the commodity whereby value is expressed as price. Bearers of monetary tokens believe the promise, that on demand, or even after a period of time, they may exchange amounts of that money for goods and services to the value specified, or for alternative promissory instruments to the same value.

But why do we accept these circular promises? Because money works! And why does it work? Because everybody else accepts money as having value! In fact the modern world couldn’t manage without it.

Surely money must be more than mere self-referential social convention? It is, after all, underpinned by the whole complex science of Economics. Or is that too just another social convention? For there is a sting in the tail of Galbraith’s comforting statement. The scientific/economic portrayal of money is not sufficient because of the failure of these descriptions to address that most human and private, irrational and perverse of issues, namely ‘value.’

Cynics, like my esteemed colleague Emeritus Professor Kenneth Minogue would no doubt say that money is raised by government for the sole purpose of paying for itself - a classic self-referential system. All of economics is just a side effect of this system operating. This raising of money is made possible by institutionalising ‘property.’ The commonly perceived notion of ‘personal property’ is of ‘things belonging to someone.’ However, for a long while this somewhat naïve view of property has been superseded by a far more pertinent definition: property is a government-sanctioned monopoly right over an enclosure, which is legally enforced through their courts.

Government, and government alone, claim the right to signify ownership – but at a price. They will bestow rights of ownership on those groups that generate the maximum revenue for the state – government will seize under-producing property and transfer it to those who promise productivity. Whatever the pretence, this has nothing to do with what is popularly understood to be the moral justification of property owning.

‘Ownership rights’, therefore, are rented from the state, to be paid for, which means some of these assets, or rather the government-guaranteed rights over the assets, must be made productive; namely turned into property, monetized, and subsequently rented or sold – either way, new debt is incurred somewhere in the economic system.

Government can seize these assets through the courts at any time, simply by passing laws claiming ownership for itself, before possibly transferring it to others - at a price. However, the government cannot behave arbitrarily, because excessive seizure will limit the willingness of individuals to turn their assets into property, undermining the viability of the whole system – a harsh lesson that is eventually learned by every socialist state.

When paying the required price, rendering “unto Caesar the things which are Caesar’s” (as recommended in Mathew 22:21), the normal assumption is that government money is being used, namely the notes and coins that the government prints and mints. But that would be wrong. Most of the money supply is actually created by the population itself, over and above the government float: that float being a mortgage on state-owned property and future taxation.

In England a £50 bank note states that the Bank of England promises to pay the bearer £50 on demand. When a customer goes into an English bank and demands £50, what is she given? Another note with the same promise – just a piece of paper. What an amazing alchemy, only in this case it is paper and not lead that is being transmuted into gold!

The real magic, however, lies elsewhere. The vast majority of money does not exist as the notes and coins of the government float, rather as imaginary numbers that the government-backed Fractional Reserve System allows to be written into a bank ledger. Every time a loan is taken out, the bank – which, by the way, doesn’t need to have all the money requested - simply magicks that money into existence. All it needs is the customer’s promise to repay, and it has government-backed threats to ensure that the customer does repay, and with interest. The state’s money supply depends on the total debt incurred when purchasing or renting various property rights within its jurisdiction, which is why they must guarantee that the majority of debtors repay their debts. This they achieve by intimidating debtors with the threat of legal action, and for which they rake off their cut in this extortion racket. The more assets that can be turned into property, the greater the debt, the greater the supply of money.

However, this must not be seen as some form of conspiracy between the banks and government – rather a paradox. It is a systemic consequence of the way that money operates: money is a promise to repay a debt, with money! The beauty of this self-referential system (that is both money and property) is that no one is in control; everyone involved is trapped, sleepwalking through an explosion of peculiar emergent economic and social effects. We are all stakeholders (to a greater or lesser extent) in money and property, and in this role most of us have a vested interest in keeping the system going. From this position, government may be seen as an emergent homeostatic sub-system, necessary for maintaining the continuity of the system.

The system itself is, however, in a permanent state of unstable equilibrium. If too many customers demand that their ledger entries are returned in cash, in the form of those pieces of paper, a ‘run’ on the bank will result, and the magic collapses. A bank can also collapse when too many people default on their loans. Both situations occurred in the winter of 2007/2008 when problems with US sub-prime mortgages triggered the financial woes of Northern Rock Building Society, Bear Stearns and many other institutions worldwide.

Only blind confidence (and not a little ignorance) keeps this whole self-referential anti-gravity cash machine from crashing to earth. The whole process stays aloft because of the time-lag between borrowing and repayment (in full, plus interest.) But repayment requires the creation of brand new money in that interim, in order to pay the interest over and above inflation. This must lead to an exponentially increasing demand for money, that itself needs an increased scale of indebtedness.

Unfortunately, there is a serpent in this economic Garden of Eden. The symbiosis between government, banks, and major ‘rentiers’ is not enough keep the show on the road – it needs a perpetual supply of new energy (new debt) to keep the implicit exponential growth going. The artificially closed economic system that cannot remain homeostatic indefinitely – exponential growth is unsustainable. The monetisation of real estate, raw materials, food, and labour (and its products) can only go so far. We cannot keep raising prices to generate more debt, because that debt has to be repaid. New assets have to be created within the human value system. It requires the input of new energy to avoid the decline into entropic death – hence the need both for creating new property, and re-enclosing unproductive old property, thereby reviving it.

There can never be enough old money around to fund the requisite exponential growth, even when inflation is taken into account, and so governments must always be on the lookout for discoverers, innovators and entrepreneurs that can facilitate the creation of new property (raw materials, inventions, customers etc.) in order to generate an infusion of new debt, and hence new money. If that new property is not forthcoming, then the whole self-referential system starts oscillating out of control. Does this situation sound familiar?

1 comment:

Govind said...

Dear Ash,
Could you please explain what you mean by Poker. I am not sure if all your reader would have read Liar's Poker and understand that the game of Investment banking is a game of Liars Poker