Re: Food for thought
> However, the bigger elephant in the room IMHO is money. What is it? Where does it come from? How does it work?
The definition of Money according to the US Federal Reserve System is printed on dollar-denominated currency bills: "This Note is Legal Tender for all Debts, Public and Private".
This is true for any sovereign country having a debt-based, Sovereign Fiat Currency System, such as the US, Canada and/or the UK, Australia, New Zealand, etc. The rest of the EU (outside the UK) is a bit screwed up in this respect because the EU's Currency System while it is debt-based, it is neither Sovereign nor Fiat. Fiat here does not mean the Italian car. The EU member countries cannot issue Sovereign Currency in a Sovereign Denomination - all of them share the same currency, namely the Euro. The outcome of this arrangement being that, Germany being the dominant economy in the EU, the Euro has become a proxy for what used to be the Deutsche Mark.
In other words, Money is a financial instrument which can cancel any debt. It is actually the only financial instrument having the power to cancel any debt, public or private. I.e., I can't pay my telephone bill - my debt to the phone company - with a Credit Default Swap, but I can always pay this bill with paper or coin Money.
There are two kinds of Money: coin and printed bank notes (bills).
Exchanging coin money as an act of canceling debt is - in reality - a barter transaction: the inherent value of the minted coin is - In Theory - the value embossed on the coin. If I go buy one liter of milk at the corner store and pay for it with nickel coin - let's say US quarters - I have bartered N grams of nickel with an inherent value of X for a liter of milk.
In reality - at least in the US - the value of the metal the coin is minted from is higher than the stated value embossed on the coin. For example, US pennies have an embossed value of one cent - 1/100 of One US Dollar - but the inherent value of the copper each penny coin is minted from is actually 2/100's of One US Dollar. Which is why it is now illegal in the US to melt pennies and sell them as copper metal. Which is also why commodities trading in copper and nickel in the US used to be very strictly regulated. It no longer is.
Paper Money has no inherent value. Paper Money is a only the material representation of a potential transaction by which a debt may be canceled.
I can use paper Money to pay for something - i.e. cancel a debt. The creditor - the entity I am indebted to - accepts my paper Money, which cancels my debt. Creditor does not necessarily mean a Bank, it can be a sporting goods store, for example. If I decide to buy (acquire) a pair of trainers, I incur a debt: the cost of transfer of ownership of the trainers, from the sporting goods store, to me (buying something is an act of ownership transfer). By paying for the trainers with paper money, or with coin, I am canceling this debt.
I do not have to pay for the trainers with paper or coin money: I can choose to stay in debt, by using a credit card to acquire the trainers. In this case, the credit card issuer - the Bank - cancels my debt to the sporting goods store, by transfering money from my credit line to the store's bank account. In doing so, the Bank cancels the initial debt to the sporting goods store, and creates a new debt: I am now indebted to the bank. I cannot necessarily cancel the debt to the Bank by selling my newly-purchased trainers to the Bank: trainers are not Legal Tender for all debts, private or public. The Bank will only accept Money as a debt cancellation instrument.
If I pay for the trainers with coin or paper money, no money is created. Money - paper or coin - is exchanged between myself and the sporting goods store, in return for the trainers' ownership transfer. This Money cancels my debt to the store.
If I pay for the trainers with a credit card - i.e. borrow money from the bank to pay for the trainers - I have two choices:
- pay the full amount due in full directly to the bank. I have 20 days from the date of purchase to do so. In this case, no Money is created. OK, strictly technically speaking, Money has been created by the Bank when it extended credit, but then this newly created Money is destroyed in full when I pay back the full amount to the Bank. 20 days is an insignificant enough amount of time that it does not matter.
- pay less than the full amount I owe the bank. In this case, Money has being created: the Bank will charge me interest on the credit it extended to me. This Money has been created by the Bank: the Money which canceled my debt to the sporting goods store, allowing me to own the trainers, did not exist before the transfer of ownership of the trainers was executed. And, at the same time, the same Bank is charging me interest on the Money it created for my trainers. The unit-denominated amount that I have to pay back to the Bank, in order to cancel my debt in full, will be greater than the initial cost of transfer of ownership, because the Bank will charge me interest on the amount it lent to me.
So, the act of Money creation is the result of a commercial exchange transaction between three private entities: myself, the sporting goods store, and the Bank.
As such: contrary to popular belief, the US Federal Reserve - and Central Banks in general - do not print, or create money. In the US of A, the physical act of minting coin or printing currency is done by the US Department of Treasury.
Money is created by financial transactions between private parties and private banks, and whenever the outcome of such a financial transaction results in the creation of a debt.
Whenever the US Government borrows money from private banks - US Treasury Bonds - Money is being created. It is not the Government which creates this Money, it is the private banks lending money to the Government at interest that create Money, just like in the trainers example.
The US Federal Reserve has the power of canceling debt owed to Banks: The Fed can buy the Treasury Bonds from the private banks, and cancel them. However, and again, contrary to popular belief: the Fed buying Bonds from the banks and canceling them does not create Money. On the contrary, it destroys it: the Money created when private Banks extended credit to the US Government has now been destroyed by the Fed.
There is no physical act of printing paper bills or minting coin whenever the Fed buys and subsequently cancels US Treasury Bonds: this is a statutory fiat action by the Fed. The Banks do not receive trucks of cash as a result of the Fed canceling Bonds. In reality, the act of the Fed canceling Bonds only allows Banks to purchase more Bonds, or issue more debt - lend money to people, companies, etc. I.e. create new Money, but only after the previously created Money has been destroyed.
Of course, the Fed does not cancel US Treasury Bonds on a regular basis. Most US Treasury Bonds are traded and held by banks to maturity. Whenver a Bond matures, and it pays back to the Bank everything that was owed, then the Money created by this Bond is destroyed, and the Banks can purchase new Bonds or issue new debt.