Y ou probably have a lot of misconceptions about money. Both about what it is, and about what it isn’t. Because money represents power, control, the ability to get things done, even politically. But what makes money so personal, and so fraught, is that it seems most of us never have enough of it, while those with too much of it, seem to always get their way. Something must be wrong with the money system, most people think. This isn’t an article about income and wealth inequality or the many failures of capitalism. I’m writing strictly to convince you of one thing: central bank money is real. And whatever you think about the global financial system, it’s one of the most sophisticated record-keeping machines ever devised. I covered this subject in Episode 27 of The Radical Secular podcast.
Money Isn’t A Thing, It Represents A Thing
The next time someone starts claiming that “debt-based” money “isn’t real,” you’ll be ready. Let’s take the “money isn’t real” claim. What’s true about it, is that central bank currency is paper, and paper has no intrinsic value. Nor do electronic bits zipping around the internet between banks. But neither banknotes nor electronic money are the thing that they represent. Dollars are backed by tangible, countable assets throughout the economy. Dollars represent a claim on those assets. So money is effectively record-keeping, rather than something of inherent value. Writing was invented for this purpose, before any other purpose. The oldest clay tablets in existence were financial ledgers. Try to think of it this way: A $100 banknote is money, but it isn’t valuable. What it does, is convey to the a potential seller of a $100 item, that you are the temporary holder of a government promise of $100 in value, that will be transferred to them when you hand them the banknote. It is more like a standard $100 check written against the Federal Reserve bank, that anyone can cash, no questions asked.
As for “debt-based money,” it’s true that central banks create “keystroke money” (out of nothing) and lend it to banks, which in turn lend it to consumers and businesses. But every transaction in accounting has two sides. When money is created “out of nothing,” that is to say loaned into existence by a bank, a debt is indeed created. But the borrower then goes and creates an asset on the other side of the ledger. That new money might build a building, dig a mine, or help start a business that didn’t exist before. When the loan is repaid to the bank through use of the new asset, there are more dollars circulating than there were before the loan. But it wasn’t a magic trick. This is how central banks manage the money supply to expand for a growing population and economy. How much they decide to lend into existence each year is based on economic conditions. Their formula is to provide for a low, stable inflation rate of around two percent.
You might wonder, well what if the central bank prints too many dollars? How do they get back out of the system? One way of removing dollars from circulation is through taxation. And when I say “remove from the economy,” in the past, that meant actually destroying the money. Fun fact, the British government used to burn the wooden tally sticks that it received in payment of taxes. When they stopped using tally sticks in 1834, there were so many leftover sticks to burn that the fire which began in the office of the exchequer consumed both houses of Parliament.
While this story is humorous, the lesson is real. Today, we don’t destroy dollars paid in taxes, we transfer them to the Treasury department electronically. But it’s important to note that taxation is what fundamentally gives money its value beyond its ability to purchase assets in the economy. Taxes complete the cycle that began with money creation: You need dollars to pay your taxes, if for no other purpose. And the US government has agreed, and is bound by law to take back the currency it issues, as payment of any tax, fee, loan, or other government obligation.
I’ll quote from Let’s all please stop calling dollars ‘fiat money.’ Financial Times July 2, 2021:
Bank dollars don’t have value just because your bank says they do. Your bank has regulators poking into its books, to make sure those loans are sound assets with decent returns. And your bank pays premiums to the Federal Deposit Insurance Corporation, to guarantee your deposits in case it fails anyway. If bank dollars are just a social convention — a meme — then your mortgage is just a meme, too.
Now, take the Fed. It’s just a special bank. Like Bernanke said, commercial banks have deposit accounts at the Fed. When the Fed lends them money, it marks up their accounts with dollars we call reserves. And, just like when the commercial banks lend you money, those reserves are a liability for the Fed. But there’s a crucial part of the process that didn’t make it into 60 Minutes: when the Fed marks up those accounts, it’s also buying assets. It swaps, one for one: reserves for assets.
When we say the Fed is printing money, we imply that there was nothing, and now there is something. Ta da! But again, that’s not at all what happens. The Fed has to buy something. Usually it’s a Treasury bill, but in an emergency it can be a more questionable asset. Then the Fed credits back reserves. To believe those reserves are just a meme, you have to believe the assets are just a meme. But they aren’t. Don’t take my word for it. The Fed’s assets provide a return, every year, lean years and fat years, without fail.
OK. Now let’s do the Department of the Treasury. It has an account at the Fed, too, but it cannot just magic dollars out of its account. The Treasury can put dollars in its account collecting taxes, or by selling Treasury bills. There is no fiat, no decree. There is no money printer, anywhere. It’s all transactions on a balance sheet, assets for liabilities.
There are a lot of very high-profile and otherwise smart people who promote various flavors of money denialism. That money is an “intersubjective agreement,” or a “shared fiction,” or a “hallucination,” in the words of James Howard Kunstler. Even insightful thinkers like Yuval Noah Harari have bought into this idea.
In an interview with Smithsonian, prior to the release of his book Sapiens, Harari had this to say:
The truly unique trait of Sapiens is our ability to create and believe fiction. All other animals use their communication system to describe reality. We use our communication system to create new realities. Of course not all fictions are shared by all humans, but at least one has become universal in our world, and this is money. Dollar bills have absolutely no value except in our collective imagination, but everybody believes in the dollar bill.
But that’s wildly wrong. Dollar bills have inherent value, not because we all agree to a collective fiction. Dollars are a legal creation of the sovereign government of the United States of America. They are, in effect, a contract between government and citizen. Dollars only exist and have value because of the existence of our government. And at its most basic, as I’ll repeat, it’s because we are legally required to use dollars to pay the government our taxes and other obligations of citizenship—the social contract.
Let’s test the “shared hallucination of citizens” theory with a thought experiment: If every person in the United States decided tomorrow that dollars were indeed worthless and started using glass beads or gold or Bitcoin or cigarettes or some other commodity to trade with each other, those citizens would still need to get their hands on some dollars at tax time, or risk penalties from the IRS. And if they committed fraud or failed to pay their dollar-based taxes for too long, they’d end up in a very real jail cell. Say the government issued “fizzlesnitch” instead of dollars? You’d need to dump your dollars and get your hands on some fizzlesnitch before the next tax deadline. So who, then, creates the value of a dollar? The government, not citizens.
Philip K. Dick said, ”Reality is that which, when you stop believing in it, doesn’t go away.” Dollars are like that. The only way to make the dollar disappear would be to completely eliminate the United States Federal Government. Plenty of anarchists and right-libertarians would like nothing better. But they’ve gotten way ahead of themselves by declaring dollars to be an illusion, so long as the issuing government still exists.
What About Gold Or Silver Or Bitcoin?
You might think that there’s something fundamentally wrong with what central banks do, because it’s not tied to some supposedly immutable standard like gold, or silver, or cryptocurrency. But those are commodities, not money. Commodities fluctuate wildly in value, and have nothing to do with the functioning of the money system.
No commodity or stock can ever actually be money, unless the central bank agrees to take those assets in payment of government fees or taxes. And that’s the bare-bones definition of any currency. I’m going to repeat this a third time, money is that thing that the issuing government will accept as payment. Even if governments started taking cryptocurrency instead of dollars or fizzlesnitch, the amount you’d owe would change from day to day along with that commodity’s value, converted to dollars (or fizzlesnitch). Even if you find private parties willing to trade other assets for gold or cryptocurrency, therefore, they’re still not money. They’re assets. Such a transaction is barter, which is very inefficient to maintain on a large scale. Even stablecoins, which are denominated in central bank units, still can’t be directly used in most cases for cash transactions. To pay your taxes, or be guaranteed that a store or private party will sell you something at a cash price, you must convert any assets you might own to central bank currency. This isn’t because those people or stores “believe” in money, it’s because they, themselves, need it to pay their taxes.
If you like the idea of being on a “gold standard” or wish we could transition to cryptocurrency, you would probably like to go back to some non-existent time when financial transactions could take place between two individuals with no third-party bank or government involvement. If you did, you’d be going back to bartering commodities. Currencies are something different. They aren’t meant for strictly private exchanges. Currencies have always had issuing authorities who controlled their value, going all the way back to Sumerian temples that set exchange rates between silver and grain.
No one wants gold or silver or even cryptocurrency for their own sake. We want what they can buy. We need a representation of value. And it’s much better if that thing that represents value, doesn’t have value itself. No one likes to carry large amounts of gold or cash, because they could be lost or stolen. Even Bitcoin isn’t safe. You’ll easily give up your Bitcoin code words, or transfer the coins, if someone threatens you or your family with violence. But you can carry a secure credit or debit card allowing you to transfer as much money as you have, to anyone, securely. And you’re not responsible for losses if someone steals your card.
Unless you’re a crook with something to hide, isn’t that better in every way?
But Aren’t Central Banks “Evil?”
Central banks print banknotes, and put electronic money into circulation. That’s their job. In some countries they work independently and base their decisions on economic data. In other countries, they are under control of the head-of-state or the legislature. So a central bank could make good or bad economic policy, but the central bank is no more “evil” than the government that runs it. How good you feel about governments and central banks in general, will vary in inverse proportion to how much anarchism clouds your worldview. If you like the gold standard, it’s probably because you have the fantasy of wresting the power of money creation away from governments.
Functionally, as stated in the FT quote, a printing press has nothing to do with the money supply. Money creation is all electronic. Only less than ten percent of the money supply is paper currency in circulation. And if you don’t understand how the system works, you’ll tell yourself that means that money is somehow “fake.” Which is the terrible implication of the unfortunate term “fiat currency. ” This is the claim that money is only worth what the government says it is, by “fiat.” This couldn’t be more wrong. A unit of central bank currency such as a dollar is always valued in proportion to the total money supply, and in proportion to the available assets (labor, raw materials, manufacturing capacity, and capital) that exist in the economy at that time.
So, once again, money is very real. When you have money, you have a legal claim on a portion of goods and services produced by the economy. It’s by no means just paper or electronic data. It’s first and foremost a government-recognized record of value that you earned, produced, received as a gift, or are otherwise entitled to.
Remember, governments don’t just print money, as mentioned, they also take money out of circulation through taxes. Central banks can be best thought of as a regulator, maintain a balanced money supply through the combination of money printing, tax collection, and issuance and retirement of government debt. If the government prints or spends too much money, it can cause inflation. If it prints too little, spends too little or collects too much in taxes, it can cause deflation. Inflation drains purchasing power per unit of currency, raising prices, hurting savers, those on fixed incomes, and pushing up interest rates. Deflation is even more destructive to the economy, as assets depreciate, and people delay purchases in anticipation of lower prices. Fiscal policy concerns taxation and government spending. Monetary policy involves regulating the money supply and interest rates. Getting both exactly right is vital to a strong economy. And you can’t do monetary policy at all without a central bank that controls its own currency.
Isn’t Debt Bad?
If the government borrows too much, or too little, this has serious consequences. Because every ledger has two sides, government debt in the form of US Treasury securities, represents a valued and highly stable asset to the private sector. And when the government borrows money, it’s usually spent into the economy immediately. The government’s red ink is therefore private sector black ink, as Stephanie Kelton says. People freak out that a government which borrows too much could be forced to default. But insolvency is impossible for any government that controls its own currency. Worst case, the government prints money to pay off its debts, leading to inflation.
The key to avoiding inflation caused by large debt, or too much government spending is to keep fiscal or monetary expansion below the maximum amount of resources available in the economy. For best outcomes, the idea is to spend just enough to maintain full employment and purchase all available goods. Spend too much, wages and price will rise. Spend too little, high unemployment and spare resource and manufacturing capacity represent permanently lost opportunity. Just the right amount of borrowing and spending will stimulate a sluggish economy without sending it into inflation.
Borrowing isn’t always bad, and paying off debt isn’t always good. When the government pays off debt, it reduces assets held by the private sector. A balanced government budget can actually be bad for the economy, if the government isn’t collecting enough taxes, or spending enough to reach full employment.
The problem is never “money printing” or “taxation” or “government debt” in and of themselves. The problem is always doing too much or too little of any of those things for the given economic circumstances.
Could decentralized cryptocurrency eventually fulfill the libertarian-anarchist fever dream to create a stateless, decentralized money system? In theory it’s possible. Governments could decide to accept cryptocurrency in payment of taxes and other debts. It’s very unlikely to happen, and here’s why. Central banking isn’t actually about money at all. It’s about sovereign power, and the ability of a government to issue and control its own currency. Which is the same as saying to control its own destiny. Relinquishing that control would dramatically reduce the power of any government which made such a decision. It would subject their monetary policy to the whims of the global commodity and currency markets. It would be like a nation deliberately tying its own hands.
One of the main ideas behind Bitcoin was to limit the number of coins that could ever be mined. The intent was to prevent inflation. But if Bitcoin were ever to be adopted as a decentralized replacement for central bank currencies, the hard limit of 21 million coins would be highly deflationary. And possibly as much as 1/3 of all Bitcoin ever mined, has been lost in stranded Bitcoin wallets. Remember, money’s supposed to be a record of value, not the value itself. Theoretically if you lose money, as long as there’s a record of it, you’re still entitled to reclaim the value it represents. A debacle like “stranded Bitcoin” couldn’t happen with a well-designed digital central bank currency.
Any artificially-quantity-constrained decentralized currency lacks a mechanism to increase its supply when required. In that sense, Bitcoin is very much like the limited supply of gold on Earth. Scarcity would limit the economic growth of any country deciding to use such commodity-based money in the long-term. It’s why the US abandoned the gold standard in 1971, and it’s why no other country uses it.
Some countries have already pegged their currencies to a central bank currency such as the dollar or Euro. But these are often struggling economies that have suffered from hyperinflation in the past. Hyperinflation only occurs when a government suffers some sort of catastrophe and needs a quick fix. Rational central banks know that they can’t increase the money supply beyond the capacity of their economies. So when a central bank throws caution to the winds, it’s almost certainly because of a larger national crisis. One example would be a government paying off large debts denominated in currencies it doesn’t control. Reckless money printing can never service foreign debts, since foreign exchange rates will always reflect the fundamental strengths or weakness of a nation’s currency. And the same difficulties would befall any nation that had to repay debt in cryptocurrency.
Nations like Greece and Spain lost their central banks when they joined the Euro. They have come to wish they still had control over their own destinies. Instead, they’ve adopted harsh austerity measures, with very high opportunity cost. At least there’s still a European Central Bank. Can you imagine the chaos that would result from the world’s largest economies adopting a global currency controlled by no one?
So long as Bitcoin remained a curiosity, governments didn’t need to worry about regulating it. But now that it’s a heavily-traded trillion-dollar commodity, it’s only a matter of time before governments step in. China is well on its way to issuing a cryptocurrency, but it won’t be a commodity currency like Bitcoin. It will be a central bank currency. Why? Because China is 4,000 years old, anything but short-sighted, and has demonstrated a strong desire to stay in control of its own destiny. It’s also realized the destabilizing potential to its own economy of an anonymous, energy-hungry, decentralized currency. Commodity-money or “hard-money” enthusiasts have a saying: “Good money drives bad money out of circulation.” Sort of a reverse Gresham’s Law. And it could hold true if governments were naive enough to fail to stabilize their own currencies. But no nation wants hyperinflation or insolvency to drive its citizens back to bartering commodities. It’s a matter of national pride. And this is why the fever dream of ending the reign of “fiat currency” will never materialize. It’s in no government’s interest.
Central banks hold all the cards. They can issue their own digital currencies. At the same time, their governments can crack down on the trading of decentralized currencies, as China recently did, sending the price of Bitcoin tumbling. Decentralized crypto bulls haven’t reckoned with what will happen when the world’s central banks all begin to follow China’s lead. And it’s highly likely they will. Already the US and EU are putting together proposals for their own digital currencies, and plan to implement regulatory regimes even sooner. Joining dozens of other developing countries, Vietnam just announced two days ago its central bank is working on issuing a digital currency using blockchain. Notably, that currency is not going to be Bitcoin, which the State Bank of Vietnam doesn’t recognize as currency—for all the above mentioned reasons.
On the other hand, Bitcoin is the commodity of choice for international criminals from ransom hackers, to extortionists, to drug cartels, to human traffickers. And it’s been a boon for money laundering. Now that the FBI has found ways to track crypto through public ledgers, this may be less of an issue. Improved tracking and regulation are definitely on the way.
Seize The Means Of Production!
Like libertarians and anarchists, communists and some socialists also fantasize about eliminating money. The most radical on the left propose “seizing the means of production.” They often overlook that even that act would entail transferring the ownership of the means of production from private to public hands, by making entries in a ledger, either at the central bank or private banks. So money is unavoidable, even for socialists.
“Nationalize the banks,” means “turn over all their assets and liabilities to the Central Bank.” Radical restructuring of the economy would still always require money. Unless we reach Star-Trek-levels of sustainable abundance, we’ll always need to maintain a ledger to keep track of value, and help allocate scarce resources. So if we want to reform the world’s money system into something better, we need to start by understanding what that system is, why it exists, and how it functions.
It’s deplorable that money is often abused, stolen, hidden from public view, manipulated, and used to manipulate. Money can be an obstacle or a solution, depending on who has it, and what they are doing with it. Central banks can make bad policy. But central bank money is not fake. And we’ll always need its record keeping function. There’s no possible utopian future, when government somehow gets out of the business of regulating the money supply. Nor would we ever want that important function to end up in private, unaccountable hands.
For a comprehensive summary of the history and role of money, including Modern Monetary Theory, please watch The Radical Secular episode 27, Money, Money, Money.