Our World Balances On A Sea Of Debt

What is needed is a root and branch re-evaluation of that most curious of cultural inventions – money, argues Darius Guppy.

In the year 1994 there resided in the cell next to mine a certain ‘Tommy.’

Now Tommy had been imprisoned for counterfeiting Dutch Guilders to such a high standard that he had fooled the banks themselves.

As was customary among prisoners who became friends, Tommy allowed me to read his legal papers and I quickly became fascinated by the Judge’s sentencing speech, the gist of which was that Tommy’s activities had been parasitical. By creating money out of little more than thin air he had reduced the purchasing power of more deserving members of society. What would happen if everyone behaved like him?

Immediately I thought of arguments used, in a different context, by Thatcherites and neo-liberals in general regarding inflation. Inflation, just like counterfeiting, dilutes the value of the community’s hard-earned wealth and as such constitutes a terrible social evil. Creating too much money - ‘real’, just as much as ‘fake’ - can wreck an economy. Such indeed was the reasoning of the Nazis when, during World War Two they came up with a plan – that came close to implementation - to ruin Britain’s economy by flooding the country with near perfect counterfeit bills.

A lot of nonsense has been written and said about the world’s current economic woes - how the crash is the fault solely of the banks and how, by implication, Governments are blameless and in particular how it could all have been avoided and will indeed be made right by greater financial regulation, and so on. All of which constitutes a classic example of what the philosopher Alasdair MacIntyre terms “the fallacy of managerial expertise”: an attempt by ‘experts’ to blind us with science in order to justify their own over-paid existences and mask their confusion. After all, if they had been so skilled, then why is it that not one of them - either politician or finance minister or financial journalist or just plain financier - was able to predict the current debacle?

These ‘experts’ will tell you that the present difficulties are simply the result of abuses and excesses in a system that is basically sound. In short, all that is required is for some faults to be corrected. But do not believe them. For the reality is that the problem is systemic and a little tinkering here or there will achieve nothing in the long term.

In fact, what is needed is a root and branch re-evaluation of that most curious of cultural inventions – money – how it is created, how it circulates within an economy and how it can best be used to serve the interests of the community itself.

To begin then, the experts owe it to the people to explain to them in the simplest terms how it is that money actually works.

Such is the task I propose to undertake in this essay and for this it seems to me that the layman must grasp two fundamental concepts above all others:

First, that the confusion should not be made between ‘legal tender’ and ‘money’ as a whole. In particular, were one to ask the man on the street - indeed were one to ask most politicians and even most bankers - who it is that actually creates the money which rules our lives they would no doubt reply “the State.”

And in this they would be wrong.

For while it is true that Governments create legal tender – which is to say the physical notes and coins that circulate in an economy – that legal tender represents, at its absolute highest, only 3 per cent of the total money in circulation in the global economy. It is in fact the commercial banks, largely unaccountable and privately owned, that create the world’s money in the manner I will describe below.

Indeed, even were Tommy responsible for printing every single note in circulation throughout the world his power to dilute the rest of our wealth would amount to only a tiny fraction of that of the real manufacturers of money - which leads us to the second most fundamental point of all - that the activities of my friend Tommy and the activities of the bankers are in essence identical: the creation of money – which is to say claims on the rest of us - out of nothing.

Without knowing it, therefore, Tommy’s judge punished him for usurping not so much the role of the State as the role of the banks.

More to the point, the very same mistake – namely the mis-identification of where money truly originates - has been made by virtually all our politicians, economists and financial commentators.

Consider the absurd contradiction at the heart of neo-liberal, Monetarist, Thatcherite economics which has constituted the Western orthodoxy for the past few decades: to emphasise on the one hand that the money supply should be brought under control whilst simultaneously allowing banking – where the money is actually manufactured – to run riot!

To grasp how the global fraud works we will need to step back in time and imagine ourselves next to the original goldsmith-banker.

Now our goldsmith-banker has a vault in his business premises and in this vault ten of his customers each deposits a bar of gold weighing one kilogram - for safekeeping and in the hope of a return for lending our banker their gold and thereby depriving themselves of the benefits they would enjoy had they elected to spend their wealth now.

Classical economic theory would have it that our banker fulfils a useful social function – namely bringing together those who have a surplus of money with those who have a deficit but who, despite this, nevertheless have the energy, work ethic and vision to make a profit for all concerned out of this union. In short, our banker lends the ten gold bars in his vault to certain of his other customers who in turn use this wealth to embark on profitable ventures, ventures that generate a surplus by the end of year one. Happily, the vault now contains eleven gold bars out of which our banker can pay his depositors and himself a reasonable return.

This process, which for obvious reasons depends first and foremost upon economic ‘growth’, continues apace and is refined, at least to begin with, in ways that appear eminently logical. In particular, our banker soon questions the wisdom of keeping all the gold bars in his vault where security is a concern. Likewise, the procedure of having to descend to the vault and withdraw the gold bars and transport them to different parts of the country and carve them up into smaller units becomes too burdensome. The picture is further complicated when one appreciates that by now thousands of banks have sprung up all over the place and have begun to lend to each other.

At this point therefore he comes up with an idea – to create a token, a token in itself valueless, such as a piece of paper, that will represent a given quantity of the gold either in his own vault or held to his account at some giant, more secure vault – a precursor to Fort Knox if you like. Such a token can then be circulated and exchanged within the economy in a manner that is relatively hassle-free. Historians credit one of the first examples of such an instrument – the cheque – to the Knights Templar. In this way, a pilgrim could encash a cheque drawn on a European preceptory at a Templar branch in the Holy Land.

So far so good. And good it remains just so long as for the face value of each of the pieces of paper in circulation there exists a corresponding amount of gold sitting in a vault somewhere that can be accessed in the real world.

At this juncture therefore the virtual and real economies are able to advance pretty much in lock-step.

However, it is at this precise point that something truly wondrous and truly diabolical occurs.

For our banker and his banker friends make an imaginative leap.

Experience has taught them that the bearers of the pieces of paper which they have created rarely attempt to claim the gold their paper – or their ‘money’ - represents en masse.

Our banker reasons thus: “just so long as the pieces of paper that my friends and I have put into circulation are not encashed simultaneously then it is largely academic how many such pieces we create. If, for example, we have one kilogram of gold in our vaults and we issue ten pieces of paper to ten different clients each with a face value equivalent to that one kilogram, then so long as two people do not come to the bank on the same day demanding their gold we will be able to keep out of trouble.

Clearly, the most crucial part of our scheme is to create a culture of confidence. The bearers of our pieces of paper must feel secure about our ability to convert their paper back into their gold, or real wealth. Best therefore to give names to our institutions such as ‘prudential’, ‘guarantee’, ‘trust’, ‘security’, ‘fidelity’ and so on.”

The reader will appreciate the beauty of the scheme: for now, instead of earning interest on a single piece of paper our banker can earn interest on ten such pieces of paper! Moreover, whilst charging interest on these ten pieces of paper, he has only to pay out a reduced rate of interest on the single gold bar that has been deposited with him!

And, incredibly, this is indeed exactly what happens.

Currently the average fractional reserve requirements for banks amount to under 10% which means that for every dollar (or equivalent) the banks have on deposit they can lend out at least ten such dollars – virtual dollars which they summon from nowhere – and on which they charge interest.

Just as incredibly, this fact – the key to understanding how the international financial system actually operates and why the world is in such a mess – is discussed virtually nowhere in mainstream circles: not in The Financial Times, not in The Economist, not in the broadsheets, not in Parliament, not in the City and not in the economics departments of most Universities.

Either the process is unknown in these circles therefore - a sign of mediocrity - or it is indeed understood but kept deliberately quiet - a sign of wickedness.

Let me repeat: supposedly ‘sovereign’ Governments – representative of their people, at least in theory – do not control the single most important mechanism when it comes to their economies: namely the production and distribution of money. That role has been diverted in large measure to the banks which manufacture money out of nothing and charge interest on that conjured-up money. In fact, beyond a pathetic interest rate cut here and a token cut in VAT rates there our politicians have zero real power when it comes to directing their country’s economy.

Only in a world of lies and illusions, a world in which actors become our leaders and our heroes, could such sorcery be possible.

The picture has of course become a great deal more complicated. Soon pieces of paper are no longer required and instead entries on a bank’s ledger will suffice. Eventually, a further layer of virtuality is added when computers emerge and with them credits in cyberspace. Likewise all sorts of financial instruments and ‘products’ are devised by the experts – Collateralised Mortgage Obligations, Put and Call Options, Floating Rate Notes, Preference Shares, Convertible Bonds, Semi-Convertible Bonds and endless other ‘derivatives’ – but in essence these additions constitute mere variations of the same basic Three Card Trick.

Moreover, the illusion becomes self-reinforcing. Those involved in the process, sitting behind their computer screens, shuttled from one air-conditioned capsule to another, stressed by the pressure and the volatility of the hallucinogenic nightmare they inhabit, yet sheltered from the tactile realities of the outside world, no longer control the beast they have created. How far removed from the days when wheat landed on the docks and merchants met in coffee houses and bazaars to haggle over things they could feel.

Now it may be argued that while it is true that money is manufactured in the manner I have just described – in other words by creating loans to the banks’ clients – surely just as much money is destroyed every time a loan is repaid? This is true to an extent. However, the point to be grasped is that while money is indeed created and destroyed in vast amounts every second of the day, the interest on that money remains un-destroyed and accumulates within the system – and at a compounded rate, moreover.

The reader will appreciate the problem and how it is that the process described is far more inflationary and far more parasitical than the activities of all the Tommys in the world put together. For while that money, which by now has mutated into a vast mutual-indebtedness monster, grows exponentially, the wealth it is supposed to represent cannot grow at the same pace for very long. In short, while there is no limit to the number of zeros we can create on a computer – zeros which represent claims on us and on what we own - there is a very real limit to the amount of oil in the ground, the amount of wheat in the fields and the amount of livestock in our farms.

Granted, the discovery of a continent here, a technological invention there and an increase in efficiency somewhere else can accommodate the growth in the real economy that is required to keep pace with the growth in the virtual one, but only to a point – which is of course precisely why the economic explosion begins with the discovery and opening up of just such continents from the early 16th Century on and is reinforced with the advent of the industrial revolution. Capitalism, banking and growth become inseparable, but in a world bounded by the real, logic dictates that the virtual economy must eventually peel away from the real one and sooner or later the day of reckoning arrives - when the gulf that separates these two economies is too large to be sustained - for no power on Earth can match the power of compound interest in the ether.

Consider the well-known tale of the Chinese Emperor and his opponent at a game of chess to whom the Emperor asks what reward would satisfy him in the event his victory. The opponent, his subject, replies that a single grain of wheat, doubled for each of the 64 squares on the chess board, would suffice. The Emperor, imagining that he has a good deal, plays on and loses, only to learn that he now owes his adversary the equivalent of 2000 times the current annual worldwide production of wheat.

Such are the miracles of compound growth. Such too is the reason why financiers have been able to award themselves increasingly astronomical sums. For their virtual printing presses are calibrated to an exponential production while no such calibration applies to Mother Earth.

It was the 1921 winner of a Nobel Prize for Chemistry and not for Economics, Frederick Soddy, who was among the first to articulate the mechanism by which money is created by the banks and how it mutates into debt in the ways I have described and his arguments have been developed over the years by thinkers such as Herman Daly and Richard Douthwaite.

In fact, the reasoning can be extended to cover not only bankers but the financial sector as a whole. A company makes a certain profit; a multiple of many times can be applied to that figure to arrive at a ‘value’ for that company (the price-earnings ratio) – based, as ever, on the assumption of future growth. That value can then be leveraged yet further for it to raise debt against its share price and so on and so forth. Taken to ever more ethereal extremes, such super-ovulation can mean that a single company with nothing more than an idea to be applied to the internet and a turnover less than your average Fish ‘n Chips can create yet more tokens – share certificates - worth several times the entire annual production of diamonds for the continent of Africa, a process known, retrospectively, as the dotcom bubble.

There are a couple of features which should be immediately apparent.

First, such a system constitutes in effect a redistribution mechanism from the poor to the rich which is of course precisely why the banks and Western Governments are so desperate to ensure its survival and the hegemony which results from it.

Money breeds more money and develops a quality akin to matter – the larger the agglomerations, the greater their gravitational pull or, as the Bible puts it: “unto he that hath shall be rendered and from he that hath not shall be taken away, even that which he hath.”

Indeed, contrary to what they may tell you, the banks never really want their loans to be repaid at all. Just so long as the interest is funded it is in fact to their benefit for the capital to remain outstanding on their books as ‘assets’ and for the debts to be rolled over. Every time the IMF or World Bank extends a line of credit to some impoverished nation, are they being ‘charitable’ therefore or are they simply perpetuating the enslavement? Second, such a system relies entirely, as do all Ponzi schemes, on the assumption of continued growth, hence its inherent instability. Once that growth is threatened the edifice collapses. Householders in Britain today will appreciate such a phenomenon – the result of ‘leverage’ - only too well: put up 10 per cent for a property and borrow the rest from the bank. That property’s value need rise by only 10 per cent and you have doubled your equity. But on the flip side that value need fall by only 10 percent and you are wiped out.

Which in turn explains precisely why a contraction of a mere 2 or 3 percent in the global economy leads not to a correspondingly minute fall on international stock markets, but to financial Armageddon.

Likewise with the banks – lend ten times more money than you possess and when the economy grows – or at least pretends to grow – Porsches galore, but when the lack of growth is exposed it requires only 11% of the loans on your books (in value terms) to be bad and you are bust. The truth is not that these institutions have suddenly become insolvent therefore, but that they were never really solvent in the first place since the assumptions on which they were founded could not apply in the real world. Simple false-accounting has meant that by rolling over their debts they have been able to keep them on their books as ‘assets’ rather than losses and forestall the evil hour.

There is an overarching name for the process I have outlined – ‘usury’ - and our predecessors from the Ancient and Medieval worlds appear to have appreciated much better than us its ultimate destination: ruin.

In sum, I have argued that both the analyses of the current economic crisis and the sticky-plaster remedies advanced by politicians, financial journalists and the financial industry itself to counter that crisis are woefully inadequate because they fail to grasp what is in fact a simple and devastatingly effective swindle, a swindle largely invisible because it has become so deeply embedded in our culture.

The consequences of that swindle, in particular the desperate need for economic growth, the consumption, wastage, and the environmental and cultural despoliation which it engenders, together with some possible antidotes worthy of consideration, must be dealt with separately.

In the interim, suffice to say that some original and radical thinking, the type of thinking one encounters nowhere in any of the political parties, will be required.

Readers of the Telegraph in particular should take note - a degree in PPE or History and a few A-Levels in the Bleedin’ Obvious will not make the problems go away.

[The above article was published in the Daily Telegraph (the Telegraph), February 21, 2010; although I have italicised a word here and there and have altered the layout and fonts to conform to my house style, no significant edits have been made. This is a truly remarkable article, not content-wise, I’ve been reading stuff like this since 1980, but the fact that it was published in one of the mainstream “heavies”. Convicted fraudster Darius Guppy, your crimes have now been totally expunged.]

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