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 However, for a long while this somewhat naïve view of property has been superseded by a far more pertinent definition: property is a government-sanctioned monopoly right over an enclosure, which is legally enforced through their courts.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?

The Future of Money?

In this blog I want to resurrect an idea that I first published in the Financial Times over a decade ago: Off-Planet Banking!

Oh, if only money could talk … would it say goodbye?

We all know what money is, don’t we? Money is the notes and coins that governments print and mint to facilitate economic transactions. Money is a statement of faith in the value of instruments of exchange. Bearers of such instruments believe the promise that, on demand, or soon after, they may exchange amounts of that money for goods and services to the value specified, or for alternative promissory instruments to that value.

Most of us in advanced economies assume that every commercial transaction requires money! But does it? Barter is primitive! Or is it? Surprisingly, spontaneous new forms of barter and exchange are occurring all over the Internet, by-passing money at least in part. House owners swap properties for vacations. Social networks, appearing in games like World of Warcraft or Facebook, leak out into the real world, and on the basis of newfound friendships, exchange advice and barter services. Why bother? The recipients of such ‘favours among friends’ don’t need to dip into their savings, and they avoid the need to pay sales taxes; and the seller was paid with a promise of reciprocation that carries no burden of income tax.

Bartering is just the start. A shared sense of trust is all it takes to create a currency. Local communities have such trust in abundance, so they can issue their own notes of credit that will pay for goods and services in and around the locality. The idea of a Local Exchange Trading Scheme (LETS) was first introduced in Canada to kick-start the local economy of a depressed mining community, which boasted a high degree of internal community trust. They cut right across the vicious circle of untrusting formality that is the banking system. Banks work on credit-worthiness calculated on formal employment status, or ownership of capital goods. When you are not credit-worthy, the cost of borrowing goes up, and you become even less credit-worthy. With LETS the uncredit-worthy get credit.

LETS need trust; trust needs a sense of community; social pressures in a community ensure that all debts are repaid, reinforcing a virtuous circle of communal trust. A closed community can play this non-profit zero-sum game for the mutual benefit of all. Everyone starts at zero, and keeps track of debits and credits by double entry bookkeeping of IOU tokens. Usually measured in hours of work, these tokens assume that an hour’s labour is the same, no matter what the work; baby-sitting, gardening, window cleaning, hair-dressing, consulting. However, as the market for such tokens got more sophisticated, some schemes have introduced agreed differential rates to pay for more highly skilled work like doctoring, accountancy or advice on computing.

The idea of token money is not a new idea. It was the origin of bank notes. Chinese family businesses, which have spread across the globe in many diaspora over the generations, use Fei-Chien (flying money) to bypass the national financial regulations of their host countries. A huge underground banking system based on a code of trust has developed within the worldwide Chinese community. In India the system is called Hawalha (Hindi for trust) Banking. These systems are as old as money itself, and far more ancient that what we would call banking.

How does hawalha work? The basic model is that a person in India (say) hands over a large sum of Rupees, and in return is given half a bus-ticket. He then travels to England where, at a prearranged meeting, he matches his half bus-ticket with the other half sent by mail to his contact. He is then paid in Sterling, a sum equivalent to his original payment – minus a fee. My Indian students tell me they would never bypass Indian Government currency regulations in this way.

This confused situation is becoming even more confused as new technology changes the nature of government money. Such money is becoming electronic information; mere strings of binary bits stored on a smartcard. Using this technology, now Global Exchange Token Schemes (GETS) are possible. What constitutes money will no longer be monopolized by national governments. “Money does not have to be created legal tender by governments. Like law, language and morals it can emerge spontaneously. Such private money has often been preferred to government money, but government has usually soon suppressed it” (Hayek). In the Information Age, in the age of Internet can government keep suppressing it? Hayek’s vision of the Denationalisation of Money can now become a reality.

The LETS (and now GETS) idea can become a mechanism for company money. Then buying and selling goods and services within the company community, employees and customers, becomes a form of transfer pricing, which like the above schemes are invisible to the taxation authorities. In devising loyalty schemes, supermarkets are basically the issuing ‘plastic money’. Companies can go much further. The real issue is not “dollar bills, but Bill’s dollars” {can anyone tell me the origin of this quotation?}; Bill Gates’ dollars. A company can issue a proportion of its equity as digital cash. Instead of the value of money decreasing as governments profit from the hidden tax of inflation, the value of money can actually increase if the company’s shares go up in value. Such alternative currencies can spring up anywhere. With networked tills accepting digital cash, the transaction costs of exchange will become insignificant. It will be of little consequence for traders whether there are one or one thousand currencies in circulation.

Such company schemes can be computerized and they can go global! And why be restricted to the globe? Why shouldn’t information wealth leaves tribal grounds and moves to the deregulated common grounds of space? Although both international law and domestic law are applicable to this 'Global Commons', operators can choose which domestic order is most favourable, convenient, and tax efficient. There “We need banking, not banks” {again can anyone identify the source of this quotation?}, so why not off-planet banking. Satellite companies have spare capacity. A satellite acts as a depository for digital cash, and hand-held PCs linked to ‘transceivers’ move cash anywhere, anytime. It will be secure because customers send not only their digital cash and other information capital, but also the digital safe that secures it – and they hold the only key.

The virtual reality of off-planet commerce beckons: this illegitimate offspring of 'pirate radio' and the 'flag of convenience' is not such a silly idea. Off-planet commerce will service any (information) product that can be dematerialized. Pop-records, films, books, newspapers, sporting events, software, money are all now just strings of binary bits. Payment can be by credit card (or soon digital cash), just like products advertised on CNN are sent by mail from warehouses based in low tax countries to minimize price and cost.

With only the most rudimentary telecommunications infrastructure even poor states can get in on the action – they merely act as tax-havens and data-havens for footloose organizations. There are no barriers to entry; this is hi-tech business by proxy. Previous disadvantages of the Third World, like bribery, corruption, incompetence and political instability, are obstacles no longer; since, except for a brass plate, a company has no physical presence there – business is all off-planet.

The big-boys of the G7 cartel can no longer use their technological superiority to keep the rich pickings for themselves. The Third World no longer has to plead for crumbs, it too can slice the cake. The OECD are already crying foul over the “unfair lowering” of tax rates and a “race to the bottom” that could lead to “fiscal degradation” of the tax base. They “ain’t seen nothing yet.”

These pressures will make a mockery of restrictions on international money transfers. Disintermediation and dematerialization are the key words. Strapped for cash, governments will tax anything in solid form: taxes on physical property will inevitably rise, and property values will fall. Frantic taxmen are even talking of a “bit-tax”: they intend to extort their share of this trade by taxing data flow by volume; just like they do with whisky. Under the smokescreen of chasing narco-dollars, the USA is using money-laundering laws to track down tax-flight dollars in Switzerland and Grand Cayman; Germany wants to staunch the haemorrhage of euros to Jersey, Guernsey, Liechtenstein and the Isle of Man. The battle has only just begun. Soon under-reporting of taxes will snowball into the total migration off-planet of a state’s taxation capacity.

But dematerialized E-cash is the ultimate in ‘liquidity’. If income or sales are taxed at ‘source’, that source will find its lowest tax level. If that tax is based on ‘residence’ then it can be collected only if the authorities have global access to data on international money flows. Off-planet commerce will purge itself of intermediaries who meekly report their audit-trails to governments. When there is a direct link between buyer and seller, like in the black economy, both sides have much to gain by keeping their transactions to themselves. Look to the horizon; through a sky full of laundered and untaxed dollars the Information Age is dawning. The rich individual is finally free of the grasping and ungrateful tribe, and will escape to what William Rees-Mogg calls “the greatest tax haven of them all, Bermuda in the sky with diamonds.”

The term ‘Capital Flight’ will take on a whole new meaning. The worldwide government conspiracy over the issuing of money will finally be smashed. Then, like in William Gibson’s science fiction novels, governments will try to ban money. The ‘control freaks’ of government will have finally lost the plot.

So we all know what money is ... or do we?

Money makes the world go around?

Money makes the world go around. Oh no it doesn’t! It’s inertia that makes the world go around … until it stops.

Inertia! What a powerful influence, or at least that’s what John Donahoe, the new boss eBay, is hoping. Donahoe is raising eBay’s fees and changing its rules, and assuming that its clients won’t desert the auction site in their droves for another fleamarket.com. Some of the smaller players in this eBay ‘community’ are threatening a boycott this May Day. The activists claim that the site is favouring the big players to the detriment of the vast number of small timers.

The Internet is really fascinating. Why is it that one site (possibly two) rise to dominate each sector, and people stay loyal despite better offers appearing in the more boutique specialist competitors? Don’t give me that brand loyalty nonsense. Brand recognition, yes! Google, Amazon, eBay, Skype, Facebook/Myspace are the first points of call in their particular sectors, and so they rule their particular roosts. Do they give a superior service to their clients, or is it apathy or laziness that fuels this inertia? Is it an example of ‘better the devil you know’? Or is it the gravitational pull of a critical mass, preventing large enough numbers to break away to form a viable competitor?

Whatever the reason, it is only to be expected eventually that familiarity breeds contempt. Is eBay taking its community for granted? If so, they had better beware. Entropy is a permanent fact of every system. A ‘tipping point’ will eventually be reached where the system dives into decline, and users will move on to more favourable climes.

I wonder which of the Internet Big Boys will be the first to fail?