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Home > Blogs > Bill Sharon > Making Up Money

Making Up Money

Making Up Money Bill Sharon

The trillion-dollar coin is getting a sustained amount of press these days. Essentially the idea is that if the Republicans continue to be intransigent about raising the debt ceiling the President could use the law that allows the Treasury to mint commemorative coins to make one with a face value of a trillion dollars. It would then be deposited in the Treasury’s account at the Federal Reserve and voilà; the government has a boatload of money to work with. Apparently this is legal (although one wonders why not mint 16 instead of 1 and solve the whole problem all at once). Whether or not it is a good idea, it does prompt a question that no one seems to want to deal with: What is money?

From my recollection of Economics 101 many years ago, money was described as a means of exchange and a store of value. Instead of bringing commodities to a central marketplace for trade we developed symbols of value that allowed us to buy and sell goods and services in a highly efficient manner. Banks facilitated this by distributing capital from those who had no immediate use for it to those who did. In retrospect, this seems like an antiquated model from a simpler day. When you look at the numbers, it clearly is.

The current estimates are that there are $1.2 quadrillion of derivatives in the marketplace. That’s 20 times the size of the world economy, which leads one to believe that money is no longer a means of exchange. But when you take up this issue with a classically trained economist they are likely to pat you on the head and tell you that you simply don’t understand. They describe something called bilateral netting that reduces the net exposure to a much smaller, manageable number.

The problem is that bilateral netting assumes an orderly collapse of a derivatives market in which the issuing bank or insurance company has the ability to honor its contracts. That sounds nice on paper but it’s difficult to forget the trillions of derivative contracts that were hours away from default at AIG. Add to that the very small portion of Dodd/Frank that has actually been implemented and you begin to understand that nothing has really changed.

There are many sources in print and online predicting the next financial crisis. That’s not our purpose here. A crisis is a symptom, much like the rash you get when you have shingles. The problem is systemic; the virus is in the nerves. There is a view that the problem would be solved if people and governments would simply act responsibly, pay their debts and not spend more money than they have on hand. Unfortunately, that idea doesn't comport with how a debt-based monetary system functions. Debt is the operative term; money can only be created in the economy by creating a debt, and that debt requires the payment of interest.

The three natural regulators of a debt-based system are:

  1. Backing the currency with a precious metal in order to cap the amount of money that can be created
  2. Capping interest rates so that servicing the debt maintains some proximity to the growth of the economy
  3. Bubbles and bankruptcies that allow the system to re-establish itself when the debt inevitably outstrips the economy’s ability to pay it down

Over the past forty plus years we have eliminated all three of these natural regulators, most recently as a result of the failure of Lehman Brothers and the relatively new concept of “too big to fail”.

So what now? It would be useful for us to lift our heads from pouring over the spreadsheets and understand that money is a belief system. The pieces of paper and plastic that we carry in our wallets work because we believe they work. We only need to look at the Dutch Tulip Bubble, the Weimar Republic or any one of dozens of other examples to understand how fragile that belief system is and what can happen very quickly when it fails.

Returning to the gold standard, hectoring people about being more responsible and/or firing teachers and policemen is not a solution. Going backwards never is. Simple answers may gain audience share on cable television but we are faced with a far more complex problem whose core lies in understanding the meaning of money.

There are elements and experiments out there that might give us a hint at where we might begin to craft some ideas. Local currencies and state banks along with more radical ideas like bitcoin and time banks may seem like marginal ideas but they are a place to start. We need not only a national and global conversation. Whatever money is going to become will require people to believe in it regardless of the rational reasons for implementing it.

The idea that we could mint a trillion dollar coin is the signal that we are getting ready to have the conversation about the meaning of money. It’s going to be a very interesting discussion.

Tags: 1.2 quadrillion , AIG , bit coin , derivatives , Federal Reserve , gold , interest rates , local currencies , money , state banks , time banks , Treasury , trillion dollar coin
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  1. nsamjose says:
    Wed Jan 30 06:26:27 GMT 2013

    The post is pretty interesting. I really never thought I could have a good read by this time until I found out this forum. I am grateful for the information given.

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