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Research - Problems and Limitations
November 1st meeting
James' notes on the purpose of money and its problems:
Beginning with the obvious, money is simply a medium of exchange.
Money is anything that a group of people accepts as a stand-in
for goods and services. The hand-waving mystification of academics
and bankers notwithstanding, it really doesn't go deeper than
that. Any complexity to the topic is introduced by the complexity
of group psychology, not by the technology of money itself.
Continuing with the obvious, individual human beings have not
been self-sufficient for a very long time, and probably not ever.
Each of us needs and wants things that someone else has or does.
The options for the routine and systematic exchange of these things,
these goods and services, are limited. I can think of only three.
One, each of us provides our goods and services for free, in the
expectation that our needs and wants will be filled by others
doing the same thing. This option has been tried many times through
history, and its persistent failure probably indicates a conflict
with basic human nature, to put it politely.
Two, for each thing we want or need, we find someone who can provide
it, and who also wants something we can provide. This happy double
coincidence is rare, and can't be expected to satisfy the needs
of any but the simplest of subsistence economies in which only
a small set of basic, low-value goods are traded.
The third option is to invent or discover a form of money: artifacts
that can represent any good or service and which more or less
maintain their value over time. This is the only option for sophisticated
economies with a wide variety of goods and services, some of them
of such high value that barter is made practically impossible.
Money, in effect, sits between a body of goods and a body of buyers
and mediates exchange. The value of money, just like the value
of goods and services, is described by the venerable law of supply
and demand. If there is plenty of money in circulation for relatively
few goods, the value of money goes down and (which is to say the
same thing) prices go up. This is inflation, and there tends to
be lots of consumer confidence during inflation. There's lots
of money flying around, and people are encouraged to spend theirs
too. The down-side to this inflationary euphoria is that it tends
to get out of control and end either in the currency inflating
itself to worthlessness or a devastating correction. In such a
correction, the supply of money dries up, as it did in the Great
Depression of the 1930's when people and especially banks were
too scared to spend it and held on to it. Consequently, the value
of money goes up and prices go down. There's very little money
in circulation and people are scared to let theirs go. The trick
is to avoid either of these damaging extremes.
Because stability of supply is so obviously crucial to the success
of a form of money, precious metals like silver and gold are an
obvious option. The supply of precious metal is naturally limited.
With rare exceptions, even large gold finds are not sufficient
to upset the balance of supply of money and demand for services.
They are also arbitrarily divisible, can be mixed with other (base)
metals, and a lot of value (in equivalent goods or services) can
be carried around in a small pouch. For most of history, money
has been precious metal.
The same thing that made precious metal an attractive choice for
money has in the past century made it a poor one: its supply cannot
be manipulated. With increasing expectations for continued growth
and prosperity from our economic system there is a corresponding
demand for control over prices. Ideally, the amount of money in
circulation should always correspond to the sum total of goods
and services available for purchase (aggregate supply). If the
total body of available goods and services shrinks, so too should
the money in circulation so that those goods do not become overpriced.
If more goods and services are created, the money in circulation
should increase to match. This is much easier to manage with paper
than with metal.
For these and other reasons, paper has become the money of the
past century or two.
Whether an economy uses paper or metal, banks will be happy to
store your money for you. Not only that, but they create money,
and this is perhaps the most critical and suspicious fact about
a bank.
A bank has two fundamental functions: it stores money and it lends
money. It is in the lending of money that money is created. Say
a person deposits $100 with a bank. They naturally assume that
this money is theirs to be withdrawn and put into circulation
at any time. A certain amount actually does get withdrawn and
circulated. The bank, however, doesn't keep what remains in the
account ready for withdrawal; it lends it out. Under current Canadian
law, they can lend up to $97 of the $100 deposit, leaving only
$3 ready to hand over on demand. The borrower naturally assumes
that his $97 loan is his money, available to be withdrawn and
put into circulation at any time. This loaned money is created
money. It is money that is available for circulation in the economy
that was not available, did not exist, before the loan. Before
the loan, there was $100 available to circulate. After the loan,
there is $197 available for circulation. Money, $97 to be exact,
has been created simply at the decision of an account manager
and a few strokes of a pen or taps at a keyboard.
I wish there were more mystery to it than this, but there isn't.
The obvious and fatal flaw is that if both the borrower and lender
want to withdraw the entirety of what they naturally assume is
their money, only one can do so. The early bird gets the worm,
the late-comer gets nothing, and the bank is broken and must cease
operations. There is no deeper mystery.
The operation of a bank is dependent on the statistical regularity
that of the total funds deposited, only a small percentage will
be demanded on any given day of operation. As with other systems
dependent on statistical regularities, there are aberrations,
and the system fails. No engineer could design such a system and
keep his job. However, like every other aspect of the economy,
banks are a psycho-social phenomenon and can't be held to the
same high standards as congenial, predictable engineering materials.
There is also the bald fact that banks well entrenched and it's
hard to imagine a force capable of displacing them from the economy,
even if their harmfulness to the public good was conclusively
demonstrated.
I don't know yet whether to consider banks and their operations
a fundamental flaw in the economic system. Their usefulness as
a deposit institution is unquestioned, and the modern economy
depends in very large part on the increased money in circulation
that results from loans. It is difficult, though not impossible,
to imagine a system in which every loan to a borrower reduced
the amount of funds available to the depositor. It would require
a very enlightened depositor. There are also other flaws in the
economic system that seem to over-ride any effect of banking sleight
of hand.
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