Saturday, November 28, 2009

The problem of money

Given the global financial crisis, which is now looking worse due to Dubai, I think we can all agree that money is a problem. Specifically, is the particular way we choose to create money the best one? Since it's led to financial collapse, probably not. Internationally, money is a difficult and complex issue which I'll not get into here. Locally, things are a bit simpler. Many of the following ideas come from Geoff Davies' Economia, which I recommend to all interested readers. 

I think what would work well at a local level would be a currency which,

  • is a medium of exchange, not a store of value
  • is backed by a basket of commodities which decline in value over time

  • so that the currency itself declines in value over time

  • and which cannot be lent at interest

I'll explain below.

Money today has two functions, as a medium of exchange and as a store of value.

A medium of exchange is plainly necessary, so that we don't have to note down which part of a living cow we'll give when we slaughter it in June for this hoe we get in January. I can give my mate Joe an IOU, "Jim owes Bob one-twentieth the cow Betsy". If I only accept IOU from Bob, it's just an IOU. If Bob can give the IOU to someone else in payment of his own debts and I'll give that one-twentieth of a cow to that person instead, that IOU has functioned as a medium of exchange. Money is simply an IOU anyone will accept.

Getting people to accept your money is the most difficult part, as creators of local currencies have found. That's why people also try to make their medium of exchange a store of value. If Jim gives Bob an IOU, Mary may or may not accept it for Bob's debts; if Jim gives Bob a sack of wheat, well wheat has intrinsic value, so it can be a store of value as well as a medium of exchange.

This is why so many people instinctively look back at gold and silver with nostalgia, thinking that if the stuff has intrinsic value, people will accept it. Unfortunately gold and silver don't have intrinsic value, they're usually just pretty, and sometimes but not always useful. And we don't really have enough of them anyway. We only have about 160,000 tonnes of gold in the world, total - 0.024kg or less than one ounce of gold for each of the 6.7 billion people on Earth. Or if we consider silver, about 43 billion ounces have been produced ever, about 6 ounces each. The medieval silver penny had a bit over a gram of silver, so that 6 ounces would allow some 170 pennies. One gold ounce and 170 silver pennies in coin each year - not really enough for all the things we'd like to buy and sell, I'd say.  

Still, it's not clear that a paper or electronic store of value is necessary, as opposed to just putting it in real goods, or getting share of a business, etc. 

When money is a store of value, this encourages people to hoard it. This is especially true if they can lend it at interest; putting it in the bank is in effect lending it at interest to the bank, the bank then lends it at higher interest to credit card holders, mortgagers, etc. In this way wealth tends to concentrate into the hands of a few, and drain away from the many. Then when the wealthy few screw things up, it screws everyone up; whereas if wealth were more evenly distributed (not necessarily 1:1 for the top and bottom quartiles, but let's say 5:1 rather than 100:1), mistakes of the few would not ruin the many.

Having money as a store of value is thus inherently inflationary and creative of unemployment and poverty, since whether people hoard it at 0% interest, or lend it out at 5% interest, the total debt will always exceed the money supply. By definition, there's never enough money in the community to repay all its debts. The sudden realisation of this in the last quarter of 2008 was basically the cause of the US economic collapse.  But it also leads to other nasty things like environmental damage.

Let's say I own an acre of forest, and know I can take a cord of wood each year forever without damaging the forest. If money is not a store of value, how do I store my wealth? My wealth is in that forest - so I take care of it. But if money is a store of value, and if my debts exceed my income, I'll be tempted to cut two or ten cords of wood. Sure, that'll mean that in ten years I have no more forest - but if I don't repay my debts, I won't have the forest in ten years anyway. Thus, debt exceeding the money supply drives environmental damage. 

The solution then is to ensure that we have money which is a medium of exchange, but which is either not a store of value, or has a declining value over time.  Then we get a more reliable economy, and are less tempted to plunder the environment.  

The well-known examples of Worgl and the like show good evidence of this. Currency was issued, and had to be stamped each month to be valid currency, this stamp cost some fraction of the currency's value (one-tenth maybe, I forget how much). So your $100 paid you in January would be worth only $90 in February. This encouraged you to spend the lot today. 

Further back in history, the Egyptians had large granaries in which farmers were obliged to store their grain. When you brought in (say) 100lbs of grain, they'd give you a receipt for it, a clay tablet with "100lbs, January" stamped on it. Anyone who brought that tablet back to the granary could get grain in exchange. But because rats and damp and so on ruined the grain over time, if you brought it back in February, you'd only get 90lbs of grain for it, in March only 80lbs, and so on. So the grain tablets functioned as a medium of exchange which was a declining store of value - and people spent them quick, giving life to the rest of the economy.

It seems a crazy idea, but in fact inflation has the same effect. If I have $1,000 in cash in January 2008, I won't be able to buy as much with it in January 2009. My money declines in value over time. The difference is that while the Worgl stamps or the Egyptian clay tablets have a predictable decline in value, inflation is unpredictable. Which makes everyone nervous and leads to all sorts of financial shenanigans, as we saw with the subprime mortgages.

Obviously this combines very badly with lending at interest. If you can lend out $100 in January and have the right to demand that they give you $110 in February, then you make $20 profit, and again we have debt exceeding the money supply. So we'd have to ban lending at interest

This seems impossible to us in our debt-laden economy. How would banks function, how would houses be built? Yet Islamic banks manage it, and Jews through history have had many successful businesses in this way. Rather than lending $100,000 at 5% to a restaurant owner so she can double the size of her restaurant, the bank simply becomes a 50% shareholder in the restaurant, and gets a 50% share of the profits... and a 50% share in the losses. This makes banks very cautious about who they invest with, makes them look seriously and in detail at them.

Would this be a bad thing, for banks to become more cautious in their investments? Nobody would get rich overnight, but while missing out on the booms we'd miss out on the busts.

Locally then what we could have is a warehouse which takes in grain, timber, cloth and the like, things for daily life. In exchange for these goods which perish they give currency which declines in value over time.

This could also be an indirect tax system. If the goods actually rot away at the rate of (say) 4% each month, then the warehouse owners (the state) could have the currency depreciate at (say) 6% each month. The 2% difference is currency they issue to pay people in state service, being police, building roads, manning libraries and so on.

The currency could not (by law) be lent at interest. That combined with its depreciation would mean nobody hoards it, so it gets spent and encourages production of other non-perishable things. Because it's a declining store of value people would seek to store value in other things, like improving the land they own.

I think this would work very well locally. As for currency at a state, federal or international level, I don't know what would work best. But since I believe that peak oil will mean a reduction in the range of our lives, perhaps preventing even city states from working well (at least as large as they are today), this doesn't concern me a lot. Money exists because people trade, not the other way around.

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