The History and The Creation of Money
Alright, it’s time for our annual dive into philosophy, into the deep of the why and what, an exercise needed to cleanse our curious palettes and open our eyes a bit wider.
I have been touching this subject quite often here, but not full heartedly, not head-on as it begs to be dealt with. In fact, this subject is the cornerstone of the philosophy of Penury Street and should be known by many, I am talking of the Creation of Money and how’s that fucking us over really hard.
So let’s begin with the easiest question: How is money created?
Suppose I have 10 tons of Gold in my bunker. I would like to open a bank and let people borrow and save their money. It would be awfully unpractical and stupid of me to divide my huge, 1 kilo lumps of gold into usable blocks, so I begin to print paper with the promise of a certain amount of gold, a currency traded for this piece of paper.
When people deposit their gold for safe keeping in my safe, secured, massive vault, I give them my printed token, the currency an IOU for their amount of Gold. When people want to borrow money, I give them the token. Soon everyone who had gold has converted it into my paper, and everyone else conducts their transaction with my printed paper. Why? Because everyone has confidence in me, and therefore in my paper.
People begin to trade their lumps of gold for easy to use paper, and in one year’s time my gold supply doubles. Everyone who wishes to trade their paper for my gold does it without any concern or trepidation, and a veil of confidence covers the common man.
Soon I begin to realize that people don’t know the actual contents of my vault, they know it’s secure and that my word is as solid as gold. I begin to print more paper than that of the actual Gold in my vault, and loan it to people who want to borrow. No one notices. I begin printing more and more, reaching a ration of 1:2, 1:3 and then 1:10, yet no one gives a flying fuck. What does happen, however, is inflation.
Because I increased the money supply by lowering my rates, people borrow more and more, therefore increasing the amount of my paper circulating my small nation. Everyone seems to have the money, everyone begins to buy houses, expensive rugs and spices, soon merchants begin to increase their prices to keep up with the trend.
Yet I don’t stop, I keep on printing my paper, until the ration of paper to gold reaches 100:1.
Inflation soars, soon, a loaf of bread increases a hundred times in price, people cannot keep up with the inflation, a panic ensues.
One day every able man and woman come to my bank demanding their gold. I, of course, don’t have as much gold as there is paper in circulation, I, therefore, go bankrupt. I run down to the nearest government office and plead my case before the kings and queens of my nation.
The Central Bank
After begging the wealthy and the powerful on my knees, the government allows me to live and protects my person from the angry mob outside, under one condition of course, I give up my mischievous enterprise entirely to the government. Left without a choice I sign the papers and flee the country into obscurity, but the story does not end there, my dear reader.
We follow now a Government Employee who is tasked with operating the bankrupt bank. Guarded by an army of guards he goes in front of the angry mob and pleads for their confidence, as the bank is now under the wealthy, the powerful king, and of course is able to fulfill every obligation in requires. Some people don’t believe this and successfully take their gold out of the bank, yet most have forgotten their fears and worries, and went to sleep that night happier because the government now safeguards their money.
Business goes as usual for a year or two, inflation calms down, people begin to borrow and deposit their money again. But soon worrying news spread throughout the country: A War is coming. Yes, the small country is beginning to wage a war for territory and dominance.
A war, as you might have guessed is a costly affair, and after a year of such war, the King feels his pockets and treasury begin to dry up. Yet the war is now in full swing and cannot be stopped by a lack of funds. To the King’s rescue comes the Treasury Secretary, the Government Employee tasked with managing the once bankrupt bank, now the Bank of The King. His offer is simple and once tested before: Print more currency than that of the amount of gold in our treasury. That way you can pay all your obligations and win the war.
The King likes this idea and signs and official decree letting the ratio of Gold to Currency be raised to 1:2. Now, the amount of money Doubles as the Central bank begins to print and pay for the horses, the arrows, the swords and the spies it desperately needs.
King eventually wins the war but with a price, another inflation. All that printing of money hurt his kingdom by making the prices on every good soar. What can be done?
The King stops lending money. This leads to deflation as people have less and less money on hand and cannot borrow from the bank. Because people have less money, the merchants begin to lower prices significantly to stay afloat. Eventually inflation ends. The King is really happy with this since now he can create as much money as he wishes without bad outcomes such as inflation.
He commissions cathedrals, new government palaces and statues of himself, to pay for this; he raises the currency to gold ration to 5:1. He dies, and the next king continues this, raising the ration to 10:1, then 20:1. Centuries go by, financial instruments such as Government Bonds and other banks get invented, all under the pretense of controlling inflation and the money supply, the kryptonite of Fiat currency.
The Fiat Currency
Soon, after many wars, many inventions and skyscrapers, many government changes and statues, the gold standard becomes obsolete. Other governments caught up with this system and now every country on Earth uses a ration of 100:1, meaning for every 100 bills in circulation there has to be one ounce of gold in the treasury.
Our Kingdom, now a Democracy comes off the gold standard all together, unto a new system, where the amount of money controlled is determined by the Central bank and the “demand” for currency.
Without a ratio to limit the money supply and borrowing, there is a huge boom in the economy. People borrow to buy a new car, a better house. Money is created as soon as there is a demand for it, meaning when you borrow 10,000$, the money is created on your account for you to use and displayed on the balance sheet of the bank.
Business open, new bridges are built, buildings higher than the sky appear in the landscape. All are built and made for paper.
So, now, as we know how money transformed from a limited resource into an unlimited one, what can we conclude?
Well, like it or not, the elimination of the gold standard has fueled massive growth since there were no constraints on progress. Think about it, if we had the gold standard, even with a ration of 100:1, there still would be a finite amount of money, and therefore, finite amount of progress.
This debate revolves around a core philosophy and question: What is the purpose of life? Is it progress, better cars, higher building and bigger TV’s? If yes, then we sure are achieving that with lightning fast speeds. Or is it conservation of resources? Then we are failing miserably at that. This race for progress is resulting in horrible environmental catastrophes, it leads us down a path of slavery to debt, a slavery in poverty in a polluted environment.
Or is our life purpose cyclical? First we progress, then we decade, and it goes on and on. Only future will tell.