Sacred Economics: Money, Gift, and Society in the Age of Transition (57 page)

What is money? In this book I have played with different definitions: it is a medium of exchange, a store of value, and a unit of account; it is a story or agreement; it is a token of gratitude; it is a ritual talisman for the direction of human creativity. All of these definitions are useful, depending on how we are trying to understand money. Ultimately, the conviction that money
is
something, something objective and discrete among a universe of other objective, discrete objects, is a false conviction, part of the story of separation that is ending in our time.

That is why I favor a more fluid, “multi-jective” approach to understanding money. The axiomatic method of understanding, which starts with definitions and reasons from there, is bound to be incomplete. It creates an internally consistent and intellectually comforting system that leaves out important truths. Such is always the case with fundamentalism, economic as well as religious.

It might behoove us, then, to be very cautious in accepting any authoritative statement about what money is and, by extension, about how money is created or should be created. There have been many times that I thought I finally understood money, only to come across new contradictions, sometimes subtle and sometimes flagrant, that showed me that, as in Gödelian logic, the realm of truth is always vaster than my framework for understanding it.

None of the revelations of “what money
really
is” were wrong; they were just partial, useful for certain kinds of reasoning. This is true even of the latest understanding about money to sweep the
avant-garde consciousness: that money today is pure credit, created out of nothing—a mere accounting entry—by banks when they write a loan. Upon close examination, however, this definition breaks down. I would like to explore these subtleties of money and credit so that my vision of sacred economy doesn’t carry forward the inevitable flaws lurking within any variety of monetary fundamentalism. Some immediate and, to me, surprising conclusions bear on the issue of bank reserve requirements. Fractional? One hundred percent? Zero? Each has its very bright, knowledgeable advocates. As we shall see, much of that debate is based on false (or at least conditionally true) premises.

First, consider the equation of credit with money, as is taught in innumerable explanations today, from the
Zeitgeist
movies to Chris Martenson’s
Crash Course
to the Federal Reserve’s own manual,
Modern Money Mechanics
. A bank (Bank A) loans John a million dollars, creating it with a few keystrokes. No one’s account is debited by a million dollars to do that; it is new money. Now, John probably took out that loan because he wanted to use the million dollars, so it won’t stay in his account at the originating bank. Probably he’ll spend it, say on a home, and the million dollars will end up deposited in Mary’s account at another bank (Bank B). There is still a million new dollars in the system, only now it is in Mary’s account, not John’s.

However, this is not the only thing that goes on when Mary deposits John’s check. The check must also “clear,” meaning that Bank A’s account at the Federal Reserve (or, more likely, at an intermediate clearing organization, but let’s keep things simple) is debited by $1 million and Bank B’s account is credited by the same. Typically, though, Bank A will also be receiving checks drawn on Bank B or other banks, so at the end of the day, when
all the transactions are settled, it is possible that Bank A’s reserve account won’t need to be debited at all. It is also possible, especially if Bank A is writing some big loans, that its reserves will fall below zero. That’s OK, though—its checks won’t bounce. It can simply borrow the necessary reserves from other banks (in the Fed Funds market) or from the Fed itself (from the discount window). These are short-term loans of bank reserves. To meet a longer-term deficit, Bank A would have to attract more deposits or, alternatively, borrow longer term from other banks or sell the loans on the repo markets. If it can show that the loans it has been making are sound, it should normally have no problem acquiring the necessary funds at a favorable rate. This borrowing is fundamentally different from credit creation. When a bank borrows on the interbank lending market, no new money is created. One bank’s gain of reserves is another bank’s loss. When it comes to reserves, new money can only be created by the central bank (e.g., the Federal Reserve). So already we have two types of money, reserves and credit, corresponding in economic statistics to M0 (or “base money”), M1, M2, and so on.

Something else is going on
when bank-created credit is used as a medium of exchange. Keep this in mind over the next few paragraphs as we investigate the idea of full-reserve banking, advocated by many reformers as the key to a sound money system. Full-reserve banking has an illustrious pedigree, supported by thinkers as disparate as Frederick Soddy in the 1920s, Irving Fisher in the 1930s, and numerous reformers today such as Ron Paul, Stephen Zarlenga, Dennis Kucinich, and many economists of the Austrian School. Full-reserve banking eliminates the distinction between credit and reserves. Banks would only be able to lend their own money, or they could lend depositors’ money (with their agreement), but that
money would be gone until repaid. There would be no lending of demand deposits.

At first glance this system would seem radically different from what we have today. With fractional-reserve banking, a bank can “borrow short and lend long”; that is, it can hold demand deposits, which could be withdrawn anytime, and lend most of them out as long-term loans. With full-reserve banking this is not allowed. Banks could still lend money, but only if that money has been given to them in the form of time deposits. For example, if a depositor buys a six-month certificate of deposit (CD), those funds could be lent out for a term of six months.

One of the main criticisms of full-reserve banking is that it makes financial intermediation—the connection of lenders and borrowers—much more difficult. Instead of issuing loans based purely on creditworthiness, the bank would have to find a depositor willing to commit his money for the term of the loan. However, closer examination reveals this criticism to be for the most part invalid. In fact, banking would be almost the same as it is today.

Let’s think about bank deposits first. In a full-reserve system, there would be no interest offered on demand deposits because the bank would gain no benefit from holding them (indeed, there would be a fee). It would only offer interest on time deposits, which it could lend at even higher interest—the longer the time period, the higher it would be. Depositors would do their best to deposit their money for the longest term they could, depending on their projected liquidity needs. A given depositor might put some of his money in a thirty-day CD, knowing he had to pay his bills at the end of the month; some in a six-month CD, anticipating a big purchase then; and the rest in a ten-year CD, planning to save it for college tuition. Taken across all depositors, the bank would have
a wide, near-continuous distribution of terms for which it could lend funds. More funds would be available for short-term lending, which would carry a lower interest rate; less would be available for long-term lending.

The main difference is that banks would be limited in making very long-term loans, which today go toward real estate and large capital projects. People might still need a twenty- or thirty-year loan to buy a house, but few savers are willing to part with their money for that long. In fact, this problem is easily avoided, simply by issuing a short-term loan, say one year, and refinancing it every year thereafter. This is basically the equivalent of an adjustable-rate mortgage. I suppose the refinancing rate could be contractually fixed to mimic a fixed-term loan as well.

In principle, all loans could be financed in this way, obviating the need for fixed-term deposits of any specific length at all. One question, then, is, “What constraints on lending would exist in a full-reserve system?” Just as today, a bank could lend any amount (up to its total reserves) for any term, to any borrower. What if a bank had an attractive lending opportunity and wanted to lend beyond its current reserves? It would do exactly the same thing it does today—borrow the necessary reserves from other banks or financial markets.

Now, of course, we must face the very same problem that motivated full-reserve banking proposals to begin with: runs on banks. Even though in theory the full value of short-term deposits would be covered by loans of even shorter term, in practice many of these short-term loans would be intended for periodic refinancing, and thus based on assets that are not very liquid. Just as today, if a bank makes too many of these (de facto) long-term loans from short-term deposits that are indeed quickly withdrawn, the bank will face
a liquidity crisis. It could solve that crisis in the same ways banks do today; for example, if its loan portfolio is solid, it could probably find other banks from whom to borrow liquidity. Alternatively, given sufficient lead time, it could issue stock or bonds to investors. In general, liquidity would be no more a restraint on lending than it is today. Random fluctuations in the level of deposits happen every day and are no big deal because banks can cover any shortfall in reserves by borrowing from the Fed Funds market or the Fed’s own overdraft facility. Equivalent mechanisms could easily operate in a full-reserve system.

Besides financial intermediation, another apparent difference between the two systems is that in a full-reserve system, banks would supposedly have no capacity to alter the money supply, which would be dependent on the monetary authority. However, this difference too is an illusion. In the present system, the money supply increases when banks lend more, such as during an economic expansion when there are lots of safe lending opportunities. In a full-reserve system, again banks will lend more under such conditions. The total number of dollars won’t increase,
but the number of dollars in the hands of people who want to spend them will
. In times of recession, banks won’t want to lend, and money will languish in the savings accounts of people who don’t need to spend it. Thus, the amount of money actually available to the economy will decrease. It is exactly as it is today.

Proponents of full-reserve banking claim that it would prevent the boom and bust cycle that arises through the excessive expansion of credit. I hope the foregoing makes it clear that this is not the case. The effective money supply depends not on the number of dollars but on the number of dollars being
used as money
, being used as a medium of exchange. No matter whether fractional-reserve
banking is allowed, if too many dollars are in the hands of people who don’t want or need to spend them, then aggregate demand can collapse, creating a deflationary spiral.

When banks are lending in a full-reserve system, you might say, “The money supply isn’t increasing at all—it is the same money in different hands.” But what is money? Is it possible that the same thing, in the hands of one person, is not money, while in the hands of another it is? In the hands of one who will never spend it, is money still money? This conundrum has been with us since ancient times. Is the miser’s hoard of coins buried under the apple tree money? What is the difference between the Fed decreasing the money supply by selling securities to remove money from the system, and a bank removing money from circulation by hoarding excess reserves? The effect is the same, and the physical reality—bits in computers—is the same too. Richard Seaford, echoing Marx, notes the essential paradox: “Although valuable only in payment or exchange, it [money] can paradoxically only be possessed … by being
withheld
from payment and exchange, as a ‘mere phantom of real wealth.’ ”
¹

Standard economics attempts to resolve this paradox by distinguishing between the supply of money and the velocity of money—how much there is and how fast it circulates. Multiplied together, these two factors determine price levels in the equations. The math works, but do these mathematical formulas truly model reality? So often we see the world through the lens of our symbolic representation of it. The mathematical distinction between the supply and velocity of money conditions and echoes a perception that money is a discrete, objective
thing
existing independently of transactions
between human beings. But there is another, post-Cartesian way to view money: as a relationship and not a thing.

I came to this realization thinking about my dear ex-wife, Patsy, who, shall we say, does not count frugality among her many fine qualities. Her motto is, “Money is not yours until you spend it!” From the point of view of an economy, it is the same: money has little effect on economic activity if it is not being used for transactions. In a fractional-reserve system, one way to view what happens is that banks are not creating new money at all, but simply allowing existing money to be
in two places at once
. It is at once in the depositor’s savings account and also in the borrower’s checking account (and soon thereafter in someone else’s savings account, and so on). The same base money (reserves) is in many places at once, yet it can only be used in one of those places at a time: whenever a transaction occurs and a check clears, reserves move from one account to another in the Federal Reserve. When there is high demand for this same amount of money, when it has to be in too many places at once, then interest rates rise unless the Fed provides more of it through open-market operations.