I recently wrote a post titled “Why do you want money?” in which I questioned the true purpose of money in our lives. But this opened up the bigger questions of what money actually is and how it works. The funny thing is that most of us spend our lives chasing money, and yet even those educated in economics and finance rarely have a proper understanding of the basics of money, including the politicians responsible for managing our economy.
Here are 10 things that you really should know about money, but probably don’t:
The value of money, no matter what its currency, is defined not by the quantity of money, but by the real things that people are prepared to swap it for. Therefore its value is actually based on the degree of confidence that people have in their ability to swap it for other things that are truly useful.
A very long time ago, people would exchange real goods and services for real good and services. These days banks are allowed to create paper or digital vouchers that we call money and use to swap for real good and services. A voucher for Next or M&S is exactly the same, only that you perceive it as less valuable because the only people who will accept it in exchange for real things are Next or M&S.
Money is created by banks when they issue loans, meaning that all money is in fact a debt to a bank. Reducing debt in the economy means reducing money in the economy. If there was no debt, there would be no money. Increasing debt is unsustainable and leads to recession, but reducing debt reduces the money supply and leads to recession. A continuous boom and bust cycle in the economy is therefore inevitable.
When a bank issues a loan, it literally just creates money as an electronic record in your account. The money never existed before. They are NOT lending out other people’s savings like most people think they do. This is not a conspiracy theory. It had been confirmed by the UK government, commercial banks and the Bank of England.
Creating money out of thin air is a criminal offence. However, a banking license is literally a license to legally create money out of nothing and not be put in prison for it. If you or I create a fake £10 note we could be arrested, but a bank can create billions and it is perfectly legal.
97% of the money in the British economy was created by commercial banks out of nothing, and not by the Bank of England. There are no notes or coins to represent this money. If everyone tried to take their money out of banks as cash, they would soon find that only 3% of it exists.
Since all money is created as interest bearing debt, the amount owed will always be more than the amount in existence.
Amount owed = amount created + interest.
It is therefore impossible to pay off the debt in the economy. Society must continually work harder to repay the growing debt or default on the loans.
When a person or business defaults on their loan, the bank repossesses their assets such as their home, business premises and vehicles. By doing so, the bank is taking real assets as compensation for your failure to repay money that they had created from nothing. So if you repay your loan, they profit from the interest that you pay them and if you don’t repay the loan, they profit from the real assets that they repossess.
Banking regulations governing the creation of money have not been updated since the 19th Century when electronic money did not exist. Electronic money therefore provides banks with a loophole to create vast amounts of new money every year.
We often take it for granted that there is inflation in the economy. Inflation simply means that you get less for your money than the year before. But why would this be so? As industry becomes more efficient, shouldn’t we always get more for out money than the year before?
Sadly not, because the banks are continuously creating more money, pushing down the value of each individual pound, dollar or euro. This means that you must continuously work to acquire more money in order to compensate for the reducing value if your savings.
Technically money could go up in value (and it does sometimes relative to other currencies), but tends to be a downward slope.
When you put your money in a bank account, that money then becomes an asset of the bank. It can do whatever it likes with your money. You simply have an IOU from the back that it will return your money when you ask for it. Banks assume that only a certain proportion of people will ask for their money on a given day. One of the reasons that banks collapse is because if too many people ask for their money at the same time, they simply don’t have it.
The private banks create and hold the vast majority of money in the economy. It is a hugely profitable business, and profit can often be maximised by taking big risks with people’s money. However, if the banks do fail then the government will bail out the banks using taxpayers money. In essence, they create money out if thin air, gamble with it and pocket the profits, but when they make a mistake, the public pick up the bill. Heads they win, tails we lose.
This also presents a huge issue of moral hazard, because we protect the bankers from their own mistakes and give them little incentive to take care.
If anyone is interested in this topic, The Ethical Film Club are holding a screening of the Positive Money documentary 97% Owned in Brockenhurst, Hamsphire (in the New Forest) on April 4th 2015. Visit www.ethicalfilmclub.com