Rethinking Money

by Bernard Lietaer

  In time, a few astute goldsmiths observed that the bulk of the coins stayed with them on deposit, because their clients never retrieved all their coins at the same time. The goldsmiths realized that they could thereby issue receipts in excess of the gold coins they stocked and increase their income by lending out money without having to increase their actual reserves. In other words, they began to issue more money than they actually held in coins.

  This process, now called the fractional reserve system, and the remaining elements of what constitutes modern banking and monetary standards were largely put in place and became standard practice in Europe by the mid-1600s.

  These banking practices are explored in some depth in the next chapter, including how the banking system creates and lends money, which is all debt based, and how one is obliged in the current monetary system to incur debt and compete with others over scarce resources with some devastating consequences.

  By the late 17th century, the need to finance wars gave further impetus to the money-creating mechanism. A special relationship began between the emerging private banking systems and governments. The oldest surviving agreement of this type can be traced back to 1668, with the license of the Swedish Bank of the Estates of the Realm (the name was changed in 1867 to Riksbank, as the Swedish Central Bank is still known). The agreement gave the power of emission of paper money to a private bank, the Bank of the Estates of the Realm, when the crown urgently needed money to fund a war against Denmark. The same situation took place in Britain a generation later with the founding of the Bank of England (1688), to which the monopoly of emission of paper money was assigned by King William of Orange in 1694, when he needed 1.2 million pounds for a war against the French. From England, this practice spread around the world. In the United States, this same deal—bank-debt money accepted as legal tender by the government—was part of the Federal Reserve Act of 1913.3

  This liaison between terrestrial seats of power and the banking system is still with us today.

  During the latter days of the gold standard, the actual gold reserves of the Bank of England, for example, were treated as a state secret because the amount of gold backing for the British pound was much lower than publicly admitted.4 The last vestiges of the gold standard in the United States were removed by President Nixon in August 1971, when he officially stopped any convertibility between the U.S. dollar and gold, even for central banks, thereby severing the last link between a physical commodity and the money system. Their values were severed and divorced from each other.

  National currencies are now technically defined as “fiat” money. Fiat takes its origin in the very first word that God spoke in the Latin version of Genesis: Fiat lux (“let light be”). It implies the godlike ability to create something out of nothing (“ex nihilo”) through the power of the word or, in practice in this case, the stroke of a pen. This means that money isn’t something that comes out of a farm, a mine, a mint, or even a printing press. It comes into being by the power of the word or, in these times, a stroke of a computer key.

  DEBT AND TAXES

  So what makes one form of money more desirable than another? As economics professor L. Randall Wray writes, “In all modern economies the government defines money by choosing what it will accept in the payment of taxes. Once it has required that the citizens must pay taxes in the form of particular money (for example dollars), the citizens must obtain that money to pay taxes. In order to obtain that which is necessary to pay taxes, or money, they offer labor services or produced goods to the government (as well as to markets). This means the government could buy anything that is for sale for dollars merely by issuing dollars.”5 Therefore, a sovereign government does not really “need” to raise taxes to pay for its expenses. Once this is understood, it becomes clear that neither taxes nor government bonds “finance” government spending. Instead, taxes are required to give value to money.

  In reality, in the money domain, everything starts and ends with government. At the commencement of the process, the government decides what it will accept in payment of taxes. Historically, it has chosen specific commodities, such as wheat or other food products, bronze or copper ingots, beaver pelts, tobacco leaves, or gold or silver bullion. This obligation puts the population to work to find or produce those commodities. Today, with fiat currencies required for the payment of taxes, the population works, trades, and invests in national currencies so they can meet their responsibilities.

  It’s the same story worldwide. This is true regardless of the country of issuance, the political philosophy (capitalist, communist, socialist, fascist, totalitarian, despotic, or democratic), and the different designations, and despite differences in material composition, shape, or particular motif. The currencies are, each and every one of them, the same type of money that is required by the state for the payment of taxes.

  By type, what is meant is that all national currencies have the same design features. The design does not mean how the money actually looks—pictures of heads of state looking presidential or regal—but how it is created. This in turn informs how it operates. Like a car, money has an engine that drives certain behaviors, and how that engine is built will influence its performance.

  Not only are all conventional national currencies fiat based but also they are hierarchical in that the monopoly of currency creation has been given to the banking system under the supervision of a central bank. Furthermore, conventional currency needs to be kept scarcer than its usefulness to maintain its value, and consequently, there is competition to procure it. The implications of the functional dynamics of national money have some profound repercussions for society at large, which are explored in some depth in the next chapter.

  There is yet another layer to the obfuscation of money’s true nature. This comes from the science of economics itself.

  THE MISSING PIECE

  Though each respective school of economics and its thought leaders differ in fundamental ways on a broad range of economic issues, they do share a common oversight—each fails to look at money itself. This blind spot is not a mere coincidence but, rather, endemic to the discipline. Economics textbooks, for example, define money by what it does, as discussed earlier—a store of value, a medium of exchange, a unit of account—rather than what it is. More important, never questioned is the assumption that the same monetary tool is needed to play all three roles. This disregards the fact that some of these roles may operate at cross-purposes. For example, a medium of exchange functions optimally when it is available and circulates, but a store of value can result in a currency’s effective removal from circulation. Traditional economics has never decoupled monetary architecture into its constituent parts. To do so would give rise to a very different reality, as will be shown. Yet such considerations are absent in the work of these monetary luminaries.

  Suffice it to say here that among the many consequences of this one omission is this: The theoretical postures of several major economics schools are at best compromised. They fail to acknowledge the reality that a monopoly of one type of money, in the form of fiat, scarcity-based, interest-bearing national currencies, imposes a limited set of Industrial Age values and actions on all the economies and cultures of the world. This, in turn, makes a mockery of the very concept of free markets, as no one is really free in such a system.

  HOW DID WE GET HERE FROM THERE?

  No matter whether it’s along the corridors of power, in the boardrooms of major corporations, or sitting at the kitchen table working out a family’s monthly budget, government policy relating to all financial matters and monetary procedures is determined by the self-styled science of economics.

  So, how did economics get to be so complicated and mystifying that it has earned the label of “the dismal science”? And perhaps more important, how devastating are the consequences of government policy following in the misguided footsteps of the economists? And how does that affect the money in our wallets?

  The father of economics, Adam Smith, was
a moral philosopher. “Smith’s true subject was the friction between individual desire and societal norms. What might lead one person to cheat or steal while another didn’t? How would one person’s seemingly innocuous choice, good or bad, effect a great number of people down the line? In Smith’s era, cause and effect had begun to widely accelerate; incentives were magnified tenfold. The gravity and shock of these changes were as overwhelming to the citizens of his time, as the gravity and shock of modern life seem to us today.”6

  Smith’s inquiries were set against the background of the development of our modern-day banking system with the formation of central banks in Sweden and England, while the earlier discoveries of Newton and his contemporaries ignited the imaginations of the ruling and educated upper class. The Age of Enlightenment’s zeitgeist was one of cool-headed rationalism and empiricism, which stood in stark contrast to the era of dark religious superstition that had preceded it. For example, Newtonian physics made it possible to calculate the distance and velocity of a cannonball being shot out of a cannon and to predict the movement of the heavenly bodies in interstellar space, both with precise meticulousness, theoretically down to a fraction of an inch. Consequently, everything had to be measured and codified. If it couldn’t be sensed, in other words quantified, then it was deemed nonsense and duly dismissed.

  Subsequently, the burgeoning science of economics was stripped of the moral inquiries and concerns that previously informed it as part of the field of applied philosophy. Economics had to be transformed into a science, meaning that it now required a backbone of mathematical formulae to provide the necessary empiricism.

  What is critical to understand is that both the math used and several of the assumptions made to formulate economic theory were fundamentally flawed. The physics of the time assumed that all systems were closed and static, upholding the Newtonian perfectly ordered view of the cosmos. In his book, The Origin of Wealth: Evolution, Complexity, and the Radical Remaking of Economics, Eric Beinhocker details many of the inherent misconceptions in the equilibrium theory used in traditional economics. He concludes that economists’ “willingness to make trade-offs in realism for the sake of mathematical predictability would set a pattern followed by economists over the next century.”7

  Newton’s neatly ordered view of the universe was shattered some 200 years later by Einstein with his famous equation E = mc2. Energy and matter manifested in an exquisite interchangeable dance. Suddenly the boundaries of reality changed and grew. Matter transforms into energy and energy into matter. But the revolution had only just begun. Newtonian mechanics that had ruled for centuries could only handle two-body astronomical problems, meaning that it could predict with precision, for example, the orbit of the moon around the Earth, assuming no other celestial bodies were involved.

  But these equations could not solve for anything beyond two bodies—throw in the sun, the Earth, and the moon, and the equations were hopelessly complex. Realizing this severe limitation, mathematicians and physicists developed statistics that yielded, for instance, a fairly precise way of predicting what happens to billions of molecules in a gas. But the complex, interdependent systems in the middle, which is just about everything in our lives and the universe, were well beyond the capabilities of Newtonian physics. This massive blind spot was overlooked by a culture hooked on believing it could understand everything with linear, cause-and-effect thinking. All systems and their inherent complexity were seriously underestimated.

  It would be some two centuries later, with the development of computers with massive computational prowess, until equations that would have taken a stadium full of people working for hundreds of years to solve could be solved in a matter of seconds. Relatively precise solutions to the three-body problem were demonstrated. A new field known by various names, including nonlinear dynamics, fractals, chaos, or complexity theory, began to emerge. The concept of the butterfly effect, whereby a flutter of a butterfly wing might cause a massive change in the weather countries away, became common knowledge. In short, it was now understood that everything affects everything else in multifaceted, often unpredictable ways. The critical middle, the stuff in between, as it were, is the infinite complexity of systems that are totally interactive, interconnected, and interdependent.

  In other words, the fabric of the cosmos is underpinned by a system that is dynamic and open, not fixed and closed, as Newton and his contemporaries believed. Contemporaneously, theoretical physicists, rather than looking into outer space and the movement of large heavenly bodies, focused in the realm of quantum mechanics and observed a waltz of infinite possibilities in the inner space of subatomic particles in atoms and molecules. Danish physicist Niels Bohr presented a counterintuitive newfound reality that views life as a game of chance, a roll of the dice as it were, with infinite probabilities that all coexist in parallel dimensions.

  As Eric Liu and Nick Hanauer write, “Science—which we mean broadly to include physical discoveries, insights into behavior, awareness of patterns of experience—tells us today that the world is a complex adaptive system, not a linear equilibrium system; that the elements within are networked, not atomized, that humans operate in that system as emotional, reciprocal approximators, not rational self-regarding calculators.”8

  Clearly, then, the economy does not exist suspended in a vacuum. In reality, the economy has little in common with Newtonian mechanical models, which imply images of perfectly functioning free markets, impeccably efficient corporations, and skillful players who know everything taking place in the markets. Nor does Einstein’s more evolved view go far enough. The financial system instead exhibits many traits and emergent properties common to the complex, adaptive, open systems found in nature and the biological sciences, systems governed more by randomness and chance.

  Perhaps anthropologist Gregory Bateson summed up the current debacle best: “The source of all our problems today comes from the gap between how we think and how nature works.” 9

  THE CONSEQUENCES

  While much of the groundwork of conventional economics remains frozen in an outdated Newtonian paradigm, several bright but marginalized economists looked to the natural ecosystems for answers. Biologists and complexity experts have determined that the long-term sustainability of any complex flow network depends on an appropriate balance between two opposing requirements: efficiency and resilience. Efficiency is the ability of a complex flow network to process volume of whatever flows through it per unit of time, in an organized, streamlined manner. Resilience is its ability to cope with change while preserving its integrity. Both efficiency and resilience of a network depend in turn on two key structural variables of the network: its diversity and its interconnectivity. However, this dependency operates in opposite directions: efficiency tends to be increased by streamlining, i.e. by reducing diversity and interconnectivity. In contrast, resilience increases with diversity and interconnectivity.

  For instance, an ecosystem’s resilience increases with its diversity and interconnectivity, because they provide options and additional choices to fall back on in tough times, such as a drought, an attack, or a disease. So if an animal in the higher levels of a food chain has only one source of food that becomes unavailable due to blight or illness, most likely that animal will also die. For example, the problem of the panda is that it eats only one type of bamboo, i.e. it lacks interconnectivity. Similarly, if a store or factory has only one source for critical merchandise or parts and that supplier goes bankrupt, that business may also get into trouble.

  What is important is that optimal functionality in nature—and by extension in all complex flow networks, such as the electrical grid, the human body, and the money system—requires resilience. And to be resilient, there must be more choices and options to fall back on if attacked, struck by disease, or experiencing business failure. In short, there has to be a minimum of diversity.

  In the current systems in business, finance, and economics, the focus is almost exclusively on efficiency,
and therefore tends to disregard resilience. With efficiency, the focus is on the volume of throughput within a given time period. Bigger is better. More is best. This has been the yardstick used to measure the relative success of a system, whether in nature or in economics. Many economists urge endless growth in the size of the gross national product (GNP), since they assume that growth in volume is a sufficient measure of health. Total system throughput (TST) is the equivalent measure for ecosystems. But GNP and TST both are poor measures of sustainable viability because they ignore network structure. Subsequently, the experts cannot, for example, distinguish between a resilient economy and a bubble that is doomed to burst; or between healthy “development,” as former World Bank economist Herman Daly describes it, and explosive growth in monetary exchanges simply due to runaway speculation.

  The impetus for setting up GNP was indeed noble. Following the crash of 1929 and the Great Depression in 1932, the United States developed a set of measures on which to base a new national accounting scheme. With better accounting and better data, it was believed that the horror experienced by so many could be averted.

  This set of measures, the GNP, computed the value of goods and services produced by American businesses and nationals, both at home and abroad. But though more sophisticated than anything that preceded it, and more comprehensive regarding who was included in its accounting data, its theory regarding price and value still reflected earlier classical economic assumptions. As a result, what the GNP measured was still limited exclusively to adding up the flow of bank-debt money through the economy.