Saturday, March 17, 2007

Three Unproductive Drains of Value: Part 2

It looks like it's been considerably more than a week since my last post. Sorry about that. This is a long one, so here's a summary. I start by talking about coins, their original purpose, and the mutually dishonest practices of coin-clipping on the one hand, and debasement by the issuer on the other. I then move from metal to paper, talking about the dishonest practices of counterfeiting and fractional reserve banking, and the pyramidal wealth transfer system fractional reserve baking establishes. I then talk about how the effects of fractional reserve banking have been intensified and unified under the Federal Reserve system. Finally, I talk about how the system might be reduced, if not eliminated.

Currency Debasement

This is a more recent phenomenon. People have been stealing from each other for time immemorial, but monetary inflation--or rather, deliberate monetary inflation, while still an old practice, is comparatively new, mainly because standardized currency is a historical phenomenon. Our current monetary system is so removed from historical monetary systems that this is a phenomenon people are unlikely to recognize, or understand if pointed out to them, however it is no less dishonest and economically damaging than plain theft. The last remaining link between our currency systems and previous ones is coinage, so that is where I shall begin.

The original purpose of coinage was to make trading in gold and silver more convenient than it had previously been. Gold already had the advantage of being a metal that does not tarnish, was rare enough that a great deal of value could be represented by a small, portable amount of gold, and it was easy enough to verify the purity. Coinage was an attempt to make it easier. The people that made the coins basically made an easily recognizable package with a standardized content of the metal. The difference between accepting raw metal and accepting a coin was like the difference between buying a scoop of sugar from the bulk bin at the grocery store, and buying a standard five pound bag of sugar that has been certified both to be exactly five pounds, and be pure sugar, by the FDA.

Like anything that improves convenience at the expense of vigilance, coins introduce a number of methods for dishonest gain, and, like theft, the illegitimate methods used by individual criminals, and the "legitimate" methods used by governments are treated differently.

First, there's coin clipping. That's where a person shaves a small amount of metal off the coin. To use the earlier analogy, that's the equivalent of the grocery store buying those certified five pound bags of sugar, opening each one and removing a quarter pound of sugar and resealing them, and proceeding to sell them as five pound bags, while selling the rest as bulk sugar... a clearly fraudulent practice.

However, individuals are not the only ones that debase currency. The very governments that issue the coins can also debase them at the source. For example, they can simply lower the gold content in the coin, but issuing them as if they had the same purity as the previous, more pure coins. Merchants still think in terms of trading in gold, but actually they are trading something else. It's the equivalent of the factory that bags the sugar using the same five-pound label as before, but actually increasing the weight of the bag (or mixing in something else that is cheaper than sugar), and reducing the weight of the sugar. Cocaine offers another analogy: a dealer acquires five ounces of pure cocaine, mixes it with some other white powder, and then sells ten ounces of "pure" cocaine.

Now, the contamination of the coins may not initially seem to be as great a crime as the contamination of sugar. After all, there is no "consumer" where money is concerned, and thus there is nobody eating cake which has sand in it along with sugar, or running out before they should. The gold is just a trade medium, something you accept because someone else will in turn accept it from you. The act of passing an ounce of 90% pure gold as 95% pure gold (100% being too soft to retain coin form), while clearly fraudulent, just doesn't seem to harm the fooled in the same manner theft does.

The problem, however, is that markets respond to increases in supply by reducing the value of the coin. When less is presented as more, people eventually figure out that there is "more" gold out there than there was previously. Every body's money loses value. It's as if the debaser, rather than stealing from an individual, stole a little bit from every person in the community. The biggest losers are the people who are living off savings (like those among the elderly who saved for their retirement). Their money simply ends up running out faster than expected.

Today, of course, we don't really use coins any more. Heck, we don't even use paper for most transactions any more, but I'll move on to the history of paper.

The legend goes that paper money began as little more than receipts given by bankers indicating that the holder of the paper had gold stored at the bank. People started trading in the receipts rather than the gold itself, which lent itself to all new ways of debasing currency.

The criminal method, of course, is what we call counterfeiting. Basically, an individual who is not the bank (or the government, in the case of government-issued notes) prints his own notes and passes them as if they were genuine. This is considerably more economical for the private debaser than coin-clipping was, since paper is much cheaper than the coins. The result, once again, is that people start trading the metal as if there is more than there actually is. Assuming the counterfeits pass into circulation unchecked, no individual is stolen from, but rather the whole community is. This lasts until people realize there are more notes than there is gold on deposit, and everybody scrambles to get to the bank first. The slow ones lose, as their paper becomes worthless--all their money disappears.

Of course, banks did their own "counterfeiting," although it isn't called that, rather it is called "fracional reserve banking." The bank accepts gold and issues notes in its place. They then turn around and issue more notes, lending them out at interest. So long as there isn't a run on the bank, the bank turns a profit, very likely passing some of that onto their depositors. However, the impact on the general market for the metal is the same as it is when counterfeiters are passing their notes: people behave as if there is more gold in the system than there actually is, and thus prices rise.

However, the effect goes beyond that. Fractional reserve banking creates a pyramid of dishonest wealth transfer. At the top of the heap are the bankers themselves, who not only profit off the interest paid on loans, but likely maintain their own reserves, on which they earn interest like any other depositors. The next tier is the depositors, depending on how much they have on deposit. Whoever has more money in the bank is earning more interest; the rich get richer while the middle class does not. And in an unstable banking system, it is probably the richer depositors who get the news of an impending collapse earliest. At the bottom of this system is the debtors. They are the ones paying the interest that profits the people above them. The rich get richer; the poor get poorer.

The lower on the pyramid a person is, the worse position they are in. If they're not socially tied to the top, they are likely to be the ones that end up with nothing when a collapse happens. However, any money they do not store in the bank does not earn interest, and thus they are fully exposed to inflation.

The greatest coup for the banking industry, however, is the present state of affairs. Understand that the Federal Reserve System is not a government-owned central bank, but rather a government-sanctioned cartel of private bankers. The road to today's unbacked fiat currency was a long and gradual one. First came the setting of a government standard conversion rate between paper and gold. The next was to periodically stop conversions into gold during wartime, enabling the government to pay for war expenses in unbacked certificates. Third was to stop conversions altogether for private citizens, while a gold standard was maintained in international currency trading. The final step, realized during the Nixon administration, was to sever that last link. Today, the dollar has no guaranteed value whatsoever, and its value continually drops against the goods and services we are expected to exchange them for.

So, if dollars are not created through the deposit of actual objects of value, how are they created? Does it even occur to anyone to ask?

Very simply put, they are created by loan. The Federal Reserve Banks have the authority to create dollars out of thin air, which they loan out to other banks at the rate specified by the Federal Open Market Committee. The FOMC is a group of twelve men, consisting of of the seven members of the Board of Governors for the Federal Reserve System, and five of the twelve presidents of the Federal Reserve Banks, one of which is always the president of the New York branch. And that's it. All the money in the economy represents somebody else's debt, plus the interest. Where does the interest go?

The bank that loaned it to the individual or corporation takes a part of it. Part of that is used to cover the expenses of the banks. Buildings need to be maintained, staff needs to be paid. The rest is profit, given to the owners of the bank. This profit does not serve as reward for the wise management of financial capital, resulting in the creation of jobs, goods, or services, but rather is a reward for buying oneself a place in the pyramid.

The other part goes to the Federal Reserve Bank that loaned the money to the bank that loaned the money to you. Their profits go into the U.S. Treasury.

So what has occurred is that the prior system of multiple competing unstable pyramid's has been stabilized. The Federal Reserve System ensures that banks no longer fail. The elimination of convertibility into gold removes any remaining limitation on the creation of new dollars. The pyramid has been unified, with the federal government benefiting and protecting it, and the owners of banks also benefiting, far more than they did before the Federal Reserve was established. The rich get richer via interest payments. The poor get poorer via inflation (at the very least). Value is thus extracted from the economy in an unjust fashion, being continually siphoned upward.

What is the solution to this? One thing we can be sure of is that the government is not going to come to our rescue on this. Congress benefits directly from the interest paid to the Federal Reserve System, and those with money to offer for elections benefit from the system as well, to a degree directly proportional to how much they have to offer. The monetary pyramid results in a political pyramid. Politics cannot be the answer.

What can work is if people are educated as to the nature of our monetary system, and begin to seek an alternative system... begin to use money other than Federal Reserve Notes (aka U.S. Dollars). There are a few competing potential models out there already. My preference is the Liberty Dollar, which have been around since 1998. It's the only alternative currency I am aware of, based upon a standardized weight and purity of a precious metal (silver, in this case), that attempts to emulate the dollar quite so completely, having both paper certificates (100% silver backed--no fractional reserve here!) and a digital currency (also 100% backed; for every non-silver Liberty Dollar in circulation, there is silver stored in their warehouse), they will also ship the base coin at any time (not too long ago, I was carrying around a half-ounce silver coin stamped with a suggested value of $10.00. I spent it as part payment on Aikido lessons).

The primary base coin is one ounce of .999 pure silver. When the price of silver rises (and it must over time, given inflation), the price of the base coin also rises. They issue a recall of the dollars, reminting the coins with the new suggested price, replacing the bills and digital currency with more new bills and electronic currency. For example, suppose in 2004, I acquired a $10/1 oz certificate. Due to the rising price of silver, the base was switched from $10 to $20 on Nov 24, 2005. I could have sent the $10 certificate in, and received a $20 certificate in return. The attempt to follow the U.S. dollar means the company has to do this (if they didn't folks would be selling their $10 1 ounce coins for approximately $12 on the open market today, rather than circulating them at their stamped value), and the holders of Liberty Dollars are protected from inflation.

There are a few other models. Several local currencies circulate in various towns and cities (such as the Ithica Hour, one of the more successful ones since there is actually a bank that accepts them). There is also e-gold, a company that enables their customers to trade with each other in gold, either by weight or in its current estimated value in any currency worldwide. However, it is for online transactions only, and gold is of such high value that it isn't suited for everyday transactions... at least not in quantities you can hold in your hand. Indeed, competing currency systems is probably the only real way to blunt the pyramidal wealth transfer scheme that is the U.S. Dollar.

If people got used to trying these alternative currencies out, the competition alone could even improve the U.S. Dollar, since its benefactors would not want to see the dollar lose against these new currencies. Less value would be extracted unjustly; the worker would get his wages in full, assuming something can be done about the other two unjust drains of value.

Note: I now realize that the mechanism of money creation I described above isn't the actual method used to create money. It has something to do with the Fed buying Treasury bonds. The money they use to do so is still created out of nothing, but the system is different from what I thought.