Monday, July 27, 2015

My opinion on money, risk and stagnant wealth

Found a need to talk out my opinions on money in various posts, and mentioned stagnant wealth in a post where I speculated that it can be a key component in generating unemployment. To me that's just fascinating to consider, but if I go back to some of my thoughts for my idea of money as an abstract enumeration of a favor, there is the wonderful question I've not yet tried to answer, how does money get created?

Trying to find a simple explanation for money, I came across the notion that it is really just a social IOU, where your society promises to pay you back for some favor you did some other entity, but how does that entity get the money in the first place to give you?

Seems simple enough if I think about banks. Let's say a person with lots of valuable things goes to a bank and has them keep some of those things in a vault, like say, piles of gold bullion. The bank hands what was for a time called bank paper to that person, and off he goes and uses it in a way we would associate with money. But it's NOT money.

In the United States, long ago, a federal bank was created, and banks were pushed to using federal reserve notes instead of always issuing their own bank notes as their notes were more risky--if the bank failed their notes were worthless!

But the federal reserve notes are backed by the federal government of the United States of America and are money. So money removes most risk, so that the entire nation has to fail versus some bank for it to be worthless. That's much better, now isn't it?

So the money flows through collateralized loans. Easy. Federal Reserve System loans federal reserve notes to banks, which loan to other entities through collateralized loans, and the money flows into the system, which most of us just call the world. Technically the flows are into the nation, but reality is the currency of the United States travels the planet. Other flow is through salaries to federal employees, of course, but that's negligible compared to the loan flow.

Now on to how wealth can be stagnated. Imagine a well-known and successful individual in a community needs someone to do something but for the moment has nothing but an IOU to give in return! The other person agrees, does the favor, and accepts the IOU. And imagine these IOU's from this high status individual are used in a way we might associate with money. And the person with the IOU gives it to someone else in exchange for a favor. And this goes on indefinitely, but eventually someone decides to call it in. And the trustworthy high status person gives something in return as promised, in exchange for the IOU. But what if at some point in this process some person just sits on it? Then there is no return on the favor. Someone did something without getting anything back for it.

Notice plenty of people can get a return on favors as the IOU travels, but the last person to do something, for some reason sits on it, and the original person has to pay nothing in return, even though he would. The original favor stagnated.

So something like money can be created very easily and people generate IOU's to each other routinely. For instance I think of corporate paper, where I found out just now with a search there are corporate bonds which are long-term and others with shorter terms called commercial paper as an example where there is a HUGE market. But it's still NOT money. What makes money is the IOU is from society itself with a guarantee from that society, so the risk is lessened greatly.

Now imagine some wealthy person does enough favors to gather a lot of money, and sits on it. For instance puts piles of actual cash money all in a vault.

The social IOU's are not fulfilled and are removed from the monetary system. That is stagnant wealth.

Notice if instead the wealthy person buys gold bullion with the money and puts THAT in a vault, it's not the same thing, as the favor was repaid. That is, if you do someone a favor, and they give you money, and you buy some gold with it, then the favor was repaid. You can do what you want with the money as long as you do SOMETHING. If you do nothing with it, then it stagnates.

Money is to be used. And society has to see that it gets used.

Notice that savings are use of money as long as the money is saved in a bank or with investments, as the bank loans the money out, or the investments are a loan in and of themselves.

Without banks you can't have a modern monetary system, as then there is no bulk way for the government to inject new notes into the system. That new money flows out from the banks through collateralized loans only.

There is no way to get the bulk of monetary flow to the people without banks.

Loans are critical to the modern monetary system in getting money into that system in the first place and in maintaining liquidity of the monetary instrument.

Wow that sounded fancy, but I'm no expert. But I like writing things like that here and there.

When money dries up, people have less money with which to pay strangers to do services as explained with my idea of limited social trust. So they may instead turn to close community or do without some services. For instance, you might rely on a close family member to fix something--or try to fix something--versus taking to a repair person. Or build a garden in your backyard to allay costs in shopping at the grocery store.

That pulls more money out of the system and maybe the repair person is no longer employed, or someone working at the grocery store gets laid off, and the impact expands outward causing higher unemployment.

Flush with money though the middle-class which drives most economic activity can hire someone to do repair work. Shop at the grocery store. And may even get pedicures. I've never had a pedicure, but I find them fascinating to contemplate. To me pedicures explain so much about why you need a robust money supply for a healthy economy where most people are gainfully employed.

In the modern era you can collapse an economy easily--just convince enough people to be prudent, do as much as they can without money, like grow gardens for their food, and eliminate expenditures like pedicures. You can crush an entire nation that way.

Money is a powerful tool, but it comes with consequences.

A healthy economy in the modern world requires that we depend on others and have a much larger community in many ways than at any other time in human history. That's a great thing.

James Harris