Creating Wealth Read online

  Money is not neutral with respect to competition and cooperation. Our current money creation process, with interest built in, systematically promotes competition among its users, largely due to the need to pay interest on the bank-debt money that drives the system. The story of the Eleventh Round below, taken from The Future of Money,3 illustrates this problem as a parable.

  THE ELEVENTH ROUND

  Once upon a time, there was a small village where people knew nothing about money or interest. Each market day, people would bring their chickens, eggs, hams and breads to the marketplace and enter into the time-honored ritual of negotiations and exchange for what they needed with one another. At harvests, or whenever someone’s barn needed repairs after a storm, the villagers simply exercised another age-old tradition of helping one another, knowing that if they themselves had a problem one day, others would surely come to their aid in turn.

  One market day, a stranger with shiny black shoes and an elegant white hat came by and observed the whole process with a sardonic smile. When he saw one farmer running around to corral six chickens wanted in exchange for a big ham, the stranger could not refrain from laughing. “Poor people,” he said, “so primitive.”

  Overhearing this, the farmer’s wife challenged him. “Do you think you can do a better job handling chickens?”

  The stranger responded: “Chickens, no. But there is a much better way to eliminate all the hassles. Bring me one large cowhide and gather the families. I’ll explain the better way.”

  As requested, the families gathered, and the stranger took the cowhide, cut perfect leather rounds in it and put an elaborate and graceful little stamp on each round. He then gave ten rounds to each family, stating that each round represented the value of one chicken. “Now you can trade and bargain with the rounds instead of those unwieldy chickens.” It seemed to make sense and everybody was quite impressed with the stranger.

  “One more thing,” the stranger added. “In one year’s time, I will return and I want each of you to bring me back an extra round, an eleventh round. That eleventh round is a token of appreciation for the technological improvement I just made possible in your lives.”

  “But where will that round come from?” asked the wife.

  “You’ll see,” said the stranger, with a knowing look.

  Assuming that the population and its annual production remained exactly the same during that next year, what do you think happened? Remember, that eleventh round token was never created, meaning that it didn’t materialize out of thin air. As the stranger had suggested, it was far more convenient to exchange rounds instead of the chickens on market days. But this convenience had a hidden cost beyond the demanded eleventh round — that of generating a systemic undertow of competition among all the participants. The equivalent of one out of each eleven families would have to lose all of its rounds, even if everybody managed their affairs well, in order to provide the eleventh round to the stranger.

  The following year, when a storm threatened some of the farmers, there was a greater reluctance to assist neighbors. The families were now in a wrestling match for that eleventh round, the round that had not been created, which actively discouraged the spontaneous cooperation that had long been the tradition in the village.

  This story is a simplified description of how our money system pits every user against all its other users. It is simplified mainly because it assumes that there is no growth in the population, in the production and the money during this story. In reality, all three of these variables grow over time, obscuring the underlying process. However, it is nevertheless systemically correct that anybody who pays interest uses someone else’s principal to do so. Even within a single family, money issues are the most frequent reason for a family breakdown. When everything becomes monetized and fosters the same competition driving the currency, aren’t we losing something important?

  The Building Blocks of the Economy:

  How Assumptions Create Reality

  There are plenty of theories in the economic pantheon that are worthy of criticism; Herman Daly and John Cobb characterize the error of faulty economic assumptions as the “fallacy of misplaced concreteness” in their book For the Common Good.4 They argue that most economists work primarily with abstractions and are sometimes tempted to adjust reality to their abstractions rather than developing more robust explanations when reality and theory are in conflict. This applies to economic thinking about prices, the “free” market, the economic behavior of human beings, resources and just about every basic tenet of the science of economics.

  Assumptions have also guided the construction of frameworks and institutions to facilitate the economic activities needed for modern human commerce. These in turn have shaped our lives, everything from the products we use to the rapid urbanization of the planet. If we can identify these hidden assumptions and use the tools available today to reshape the monetary institutions, we are on the road to changing our cities and the quality of our lives.

  The Banking System

  Most people are not aware of the role that bank financing plays in the creation of money, or the fact that the creation of money is done by private banks, and that the system is not working well. After all, there are all sorts of government logos, symbols and statements on the dollars we use. Furthermore, the dollar printing presses are located in the United States Mint, and the US Department of Treasury stores and distributes them for our use. However, contrary to what all this suggests, that doesn’t mean that the government creates money.

  You can have as many dollar bills that you want, on the condition that your bank can debit your account (today in electronic form) for the same amount. Your bank similarly requests dollar bills as needed, and gets its own account debited as well. Dollar bills represent only a very small percentage of the amount of dollars in circulation. The vast majority of the money that changes hands in the world is on computers and ledgers, not in actual notes and coins. Even on a personal level, very few of our typical transactions use cash — we use checks, credit cards, debit cards and direct transfers from our bank accounts to others.

  So how does the government obtain the money it needs? Like you and me, through income (in the government’s case through taxes) and by borrowing. Money is created for the government by the banking system when it incurs debt by issuing bonds at the state and local level, and treasury securities at the federal level — which are loans that are made by the banking system and then sold on the international market, with the principal and interest repayment guaranteed by our tax system.

  THE US GOVERNMENTAL DEBT MAZE

  The US federal government also has an array of what it calls non-marketable securities that aren’t traded on the market like US Savings Bonds: intergovernmental debts (when the federal government borrows from savings accounts like Social Security) and Certificates of Indebtedness the Treasury issues that don’t pay interest. All of these still represent government debt.

  Bonds are the long-term debt incurred by all levels of government for long-term investment in things like roads, wastewater treatment systems, water pipes, prisons, libraries and schools. At the federal level, the long-term debt takes also the form of treasury notes (a one to ten year debt), treasury bonds (20 to 30 year debts) and something called a Treasury Inflation-Protected Security (or TIPS) which are issued for 5, 10 and 20 year debt. At the state and local level bonds legislatures and city councils vote on bonds, and then they are bought by banks and other investors. Typically the low interest paid on the municipal bonds is tax-exempt, so investors can earn income from the interest paid (with state and local taxes) without paying taxes on it.

  Short-term debt is also incurred by the government, usually to address the need for cash flow, just as a business might have a credit line for times when income is less than expenses. At the federal level, short-term debt is loaned by the banks in the form of treasury bills, which all mature in less than one year. At the state and local level, short-term debt comes in the for
m of tax anticipation notes and bond anticipation notes, which are loans from the banks, usually at a low rate that is linked to the rates on the treasury bills at the federal level. So when a city issues a bond for a school but they don’t have the money in hand yet (it takes time to sell the bonds to the banks), they can go to a bank for a bond anticipation note. When a city needs to pay its bills but all its taxes aren’t collected yet, they go to the bank for a tax anticipation note.

  In short, the government triggers the creation of the money it needs by going into debt. The debt incurred by government is first and foremost to the banking system. The banks do not always have to be US banks — foreign banks and governments also buy US government debt. But despite concerns that China, the oil countries and other foreign interests own a lot of US debt, the majority of the debt is still owed to private banks — private businesses that are set up to make a profit on the process of managing money. All of this interest paid on the debt is the equivalent of an invisible tax, because all the interest does ultimately come from the taxes we pay, even though we don’t get to vote on the interest rates.

  Internationally, six central banks — including the Federal Reserve in the United States — are owned by the private banks although most countries do have publicly owned central banks.5 It makes no difference, really, whether the central banks are owned by the public or by private banks; their function is still the same. Their main function is to keep the system working. They were established to help avoid banking panics and runs on banks, and to maintain the standing of the US currency in the world. They also play the role of “lender of last resort:” if banks and financial markets aren’t willing to buy government bonds, the Federal Reserve will do so. Finally, most central banks have expanded their mission over the years to regulate private banks. However, experience has proven that their interventions don’t always work the way they hope it will.

  Government is not the only one to trigger the creation of money by the banking system in this way. Individuals and businesses also do the same when they take loans from banks for their homes and businesses. So when we go to bankers for a loan, they are not opening their vault and taking money out to give us, they are creating new money based on the fractional reserve system. When we take that money and put it into another bank — that other bank counts that money toward its reserves, on the basis it can in turn create more new money. It’s not a bad business model. The single most profitable business in the US by SEC code, is the central bank, the Federal Reserve.6 But most people simply don’t know that the Federal Reserve is barely more “federal” than Federal Express.

  Money is a lot of things: textbooks describe it as a means of exchange; it is a unit of account, a store of value and a vehicle for international trade. We have combined all these functions into one instrument, and this instrument is controlled by private banks that need to earn interest on the issuance of the money to make their profits. Because all of the money we currently use comes from this system, for the rest of the book, we will refer to this type of money as bank-debt money.

  The “Free Market” System

  Evidence of both markets and money predate recorded history. Money was used to facilitate market exchanges, as proven by the many forms of small tokens (whose most logical use would be as a medium of exchange to value an exchange of goods) that have turned up in archaeological digs around the world. Arguably, markets represent a characteristic feature of human existence — we are partly defined by the fact that we share goods and services. No person is independent of society; the trading and sharing we do provide for our needs in a way apparently unique to our species.

  The problem arises when we move the market to the center of human existence, instead of it being a mechanism with its appropriate place in a more diverse set of human institutions. Amory Lovins captured the central issue facing our economic thinking when he said “. . . markets make a good servant, a poor master and a worse religion.”7 The giant global experiments with planned vs. market economies have demonstrated that the market is a very efficient and effective way to allocate goods and services, but when we ignore its failures in other areas and use it as a universal panacea for all our problems — from saving endangered species to fostering support of the arts — we are making it our master and our religion.

  Even contemporary environmental economists are not bucking this trend. Their antidote to the warped regulatory system is to start to place financial values on the environmental services offered by the planet. How much would it cost to replace the pollination services bees offer when they are extinct? How much would it cost to replicate the global water cycle to produce healthy water? Can we buy our way to climate stability, and if not, what would it cost to restore our climate to health? The “objectivity” of the market is still seen as a final arbiter for the need to make real value judgments in a pluralistic society. But the market is not objective — it is a contrivance as human and value-laden as any other institution.

  A three-day introduction to Environmental Economics conducted in Bulgaria in 1993 illustrates the values hidden in our market mechanisms.8 The methodological emphasis was on cost-benefit and cost-effectiveness analysis to help regulators determine the most appropriate technologies to introduce to address problems. Participants also learned something about risk assessment, so government could be sure that the issues they faced were, in fact, the greatest risks to human and environmental health. After learning the new tools for environmental management, Bulgarian regulators had a gestalt experience: one of their teams determined that the best way to handle the case study they were given, in which a factory in a city was belching waste that killed people rather quickly, was to relocate all the native Bulgarians that lived there to a cleaner part of the country and move in Vietnamese workers, who had a perceived lower value in their society. Needless to say, the goal of the workshop was not to teach this lesson, yet it’s not surprising that the fundamental assumptions being used about the price of life could lead to this outcome.

  When the US Bureau of Labor Statistics found in 2007 that corporate CEOs earn 885 times what minimum wage employees earn (Do they do 885 times more work? Are they 885 times more clever?) and 364 times more than the wages of an average employee, can we hear echoes of aristocrats and feudal serfs, even as we’ve begun the 21st century?9 Because of these inherent inequities in major economic institutions, the market is not an invisible hand driven by the rational decision making of autonomous individuals. It prevents the vast majority from obtaining anything that resembles the decent life, liberty or a chance at happiness that the USA’s founders promised.

  Equity and self-determination are basic human needs. Any society will be more stable — less likely to be disrupted by unrest, revolution or other conflict — if all of its institutions provide people a voice in their own destiny and insure a level of fairness in all relationships. This is no less true of economic institutions than governance institutions.

  The Financial Market as a System

  The term financial system is used so frequently that we often lose sight of its meaning. Systems have certain characteristics, and by understanding more about how systems work we gain valuable insights into how to improve our local financial system. Each local economy is a bit like a different kind of car. Each make and model has its own unique features — a convertible roof, cruise control, one burns diesel while another uses high test gasoline; there are hybrids, electric cars, trucks and vans. But they all have a transmission, wheels, a steering system, gauges that give you an idea of the fuel level, warning lights. So by understanding what all cars have in common, you also can understand more about your particular vehicle.

  To start at the most basic level, the definition of a system is, according to the Merriam-Webster dictionary: “a regularly interacting or interdependent group of items forming a unified whole.”10 In a car, these are all the components, and the unified whole that is formed is greater than the sum of individual parts. If you lined up the wheels, the e
ngine, the axles, the steering wheel, the windshield, the seats, the body, the mirrors and the gauges along the floor of your garage, it would just be a large pile of stuff. But once all the parts are working together, the car can roll out of the driveway and down the street.

  A system is a unified whole with interacting parts, and the parts have characteristics that all systems share. One part is that system’s flow — something that moves through the system and interacts with other parts (like gasoline moving through the engine and making the pistons move up and down). Another part is a system stock — a place in the system where the flow might tend to accumulate (the gas tank). When we describe the interacting parts of systems, we assume that one variable in a system has an effect on other variables. The word for this effect is feedback, and interactions can produce either positive feedback or negative feedback. Positive feedback is when a change in one variable produces a change in another variable in the same direction (more gas, more speed). Negative feedback is when a change in one variable produces a change in another variable in the opposite direction (more brake, less speed).

  Positive and negative feedback among different variables in a system can produce a number of different results. In our car example, the goal of the system is equilibrium — the driver of the car wants to travel at the speed limit, so there is a combination of positive and negative feedback that produces a relatively consistent result. The same is true in our bodies, where our body temperature is maintained at a relatively constant level of 98.6ºF through the positive feedback of metabolism combined with the negative feedback of perspiration.