The Evolution of Money

by David Orrell

  The latter appears to have been the case in the United States and Great Britain (so far), though the long-term effects have yet to be seen. A more damaging critique, as discussed in chapter 6, was that the banks ended up hoarding much of the money or channeled it into unproductive activities such as boosting house prices and paying themselves bonuses. This is why some suggested circumnavigating commercial banks—the middlemen who benefited from central bank easing en masse—and give money directly to the people. Australia, for instance, sent every taxpayer a paycheck of AU$900 in December 2008. The aim was to prevent contagion at the very early stage of the unfolding global crisis caused by the collapse of Lehman Brothers in September of the same year. This bet on the consumer rather than the financial industry paid off, as Australia was the only big, high-income country that did not experience a recession in the aftermath of the collapse of 2008.

  In fact, Australia approximated a scheme suggested earlier by Bernanke, back when he was a professor of economics at Princeton, as a way to treat the chronic malaise of the Japanese economy in 1998. And it is a variant of a much older idea, known as basic income, that has been around for some time and has been tested on a small scale in a number of countries but has never caught on.

  QE for the People

  Unlike QE, the idea behind unconditional basic income can be divined from its title—give people an income, without conditions. Amounts vary depending on the proposal, but a typical sum is in the range of $10,000 per year. People wouldn’t have to work (or not much as they do now) unless they truly wanted to. The government could also avoid micromanaging tax allowances and different benefits for housing, food, and other basics. Although it is often presented as socialist, its appeal is broad based. Even Milton Friedman thought it was a good idea (though his version was called negative taxation), since he thought it would shrink the size of government and therefore pay for itself. It would have the largest impact on low-income people, who tend to spend their money rather than hoard it, and therefore boost economic activity directly. Of course, they might spend it on things like drink, drugs, gambling, socially inappropriate body piercings, or whatever, but empirical evidence from a number of pilot studies shows that the money is usually spent quite sensibly.3 And how much of the QE money was spent on champagne?

  Current benefit systems tend to stigmatize the poor while incentivizing them to not seek paid work, because if they get jobs their benefits are cut. This makes it hard to wean them off state support (rather like certain banks). A basic income, in contrast, could boost risk taking and entrepreneurship by giving people the time and space to experiment and potential customers some money to spend. As record label owner Alan McGee has pointed out, the unemployment benefit system in England certainly helped to incubate the music industry until it was cut back—most musicians in the 1980s and 1990s seem to have honed their skills while on the “dole.”4 The author Geoff Dyer wrote: “I couldn’t have learned my trade (if one can dignify writing with that word) and become a respectable tax-paying citizen without the support of the dole.”5

  At the time of this writing, the idea appears to be gaining widespread interest: Switzerland is planning a referendum on the subject; Finland is considering it; the Dutch city of Utrecht is launching an experimental version; and in the Canadian province of Alberta, the mayors of Edmonton and Calgary have spoken in favor of the idea.6 Perhaps the biggest impediment to a basic income is psychological, our aforementioned obsession with scarcity and competition. But much of the wealth in the economy is generated from public goods such as natural resources or land values, and what the father of Social Credit, the British engineer C. H. Douglas, called the “cultural inheritance” of society, which today would include inventions such as the Internet or mobile communications.7 So it makes sense that some of these proceeds be considered a birthright rather than something that can be captured by a small group (e.g., Facebook shareholders).

  The fact that central banks have been willing to take a huge risk on QE, but not on something like basic income, points to a fundamental contradiction in our attitude toward money (and of course is not unrelated to the fact discussed in chapter 6 that banks are powerful). As shown earlier, financial systems have historically oscillated between the twin poles of credit and physical money, and we are still currently experiencing a transition between a gold standard system and a fiat system. Our gold standard economic ideas have not caught up, and neither have our financial institutions. To use McLuhan’s words, we are “trying to do today’s job with yesterday’s tools—with yesterday’s concepts.”8 But being in a virtual currency phase opens up a number of possibilities.

  QE for the State

  For example, if we continue the QE thread a little further, could we not have QE for the state as well? If the government can print money to give to banks, could it not print money to give to itself?

  In our current monetary system, governments borrow money at interest from quasi-private central banks, which sell bonds via private banks to the public. This model is based on the gold standard system and originated when the private Bank of England lent gold to the sovereign. But today, if the government wants to add money, it could in principle just produce it afresh—after all, it’s not gold. For example, the U.S. government could revive Lincoln’s greenbacks. Would that not be quantitatively easier on future generations than burdening them with massive debt payments?

  For example, after the financial crisis, the United States and other countries chose to boost demand by lowering interest rates. The net effect was to soften the recession but also to create a credit bubble as households and companies leveraged themselves up. But another way to boost the economy, instead of borrowing money and paying interest on it, would be to just create the money as a permanent addition to the supply. As Adair Turner points out, “Money-financed deficits would increase demand without creating debts that have to be serviced. This would lift either real output or inflation and allow interest rates to return to normal more quickly. True, banks might amplify the stimulus by creating additional private credit, but they can be restrained with higher reserve requirements. There are no technical reasons to reject this option, only the fear that once we break the taboo, money-financed deficits will be used on too large a scale.”9

  Indeed, with a fiat currency, the entire role of the private sector in the money creation process becomes less clear. The Bank of England originally rescued the king because the king was too big to fail. But now the roles seem to have reversed: the state has to rescue the banks, because the banks are too big to fail. As Nicolas Oresme pointed out centuries ago, there are dangers in leaving control of the money supply to the state. There will always be a temptation for the government to print too much money and generate inflation. But as shown in figure 7.1, the private sector can do a good job of printing massive amounts of money as well, with little risk to itself, because it can always rely on a bailout. And we trust the state with other important and dangerous things, including nuclear weapons. Moreover, in democracies, there is a safety mechanism in the form of elections, meaning that should the mismanagement of a particular issue become perceived as gross the electorate has a power to act.

  The other main function of private banks is to scale up the money supply through the mechanism of “fractional reserve” banking. Again, this made a certain amount of sense under the gold standard. But today banks are free to generate pretty much as much money as they like. This pivotal role is very well compensated; and as discussed in chapter 6, the banks end up with undue influence over government decision making, so rather than checking it, they are directing it.10 A 2014 Princeton study claimed that the United States, for example, was essentially run by an economic elite, with the general public wielding “near-zero” influence over policy decisions (which rather undercuts the aforementioned advantage of democracies).11

  An alternative system, known as 100 percent banking, or full-reserve banking, has been proposed (for different reasons) by people including Fred
erick Soddy, Henry Simons, Irving Fisher, Milton Friedman, Herman Daly, and Frank Knight. In a 1927 review of Soddy’s Wealth, Virtual Wealth, and Debt, Knight wrote: “In the abstract it is absurd and monstrous for society to pay the commercial banking system interest for multiplying severalfold the quantity of the medium of exchange when a) a public agency could do it all at negligible cost, b) there is no sense in having it done at all, since the effect is merely to raise the price level, and c) important evils result, notably the frightful instability of the whole economic system.”12 To avoid deflation during the transition, new money would be created by the government and lent to the banks to bring their reserves up to par. Full-reserve banking would create a new separation of powers between the state and the private sector: the former in charge of money creation, and the latter responsible only for arranging finance through loans of the existing supply.13 Because banks would be out of the business of money creation and would only recycle existing funds, seigniorage profits from the creation of new money would go directly to the government. As Martin Wolf explained in the Financial Times, the amounts are significant: the British government, for example, could potentially “run a fiscal deficit of 4 per cent of GDP without borrowing or taxing.”14 In Iceland—where the GFC led to the complete collapse of the banking sector—the prime minister recently commissioned a plan for monetary reform along these lines.15 The Swiss are also planning a referendum on it (though they do that a lot). From the viewpoint of complexity science, another advantage of 100 percent banking is that it would simplify the monetary system and remove some of the positive-feedback loops that destabilize the economy.

  Why One Currency?

  As discussed in chapter 2, money has an inbuilt tendency to unify, just as power has a tendency to try and become absolute. The government, with its private sector partners, has therefore long enjoyed a monopoly over money creation. But would a number of complementary currencies be more resilient and help to address problems such as scarcity of the main currency? Ecosystems tend to be broken into separate modules, rather than a single highly connected network, and a similar structure may also be useful in finance.

  Parallel currencies have been called upon repetitively as possible saviors throughout periods of financial turmoil. Given that, according to the IMF, the world has experienced an average of about ten systemic financial crises—including banking crises, monetary crashes, and sovereign debt crises—per year since the floating exchange regime was introduced in the early 1970s, it is clear that the system needs some fine-tuning.16 As complexity scientists point out, in complex systems there is a trade-off between efficiency and resilience.17 Today, the financial system—or its guardians, the apostles of efficiency, to employ Joris Luyendijk’s rhetoric introduced in chapter 6—stresses too much of the former and neglects the latter, which explains the system’s fragility and volatility.

  To have but one currency might seem simplifying and thus “right,” especially given the rather chaotic transition of the world order we are living through. However, such a one-dimensional approach corresponds with neither the demands of a complex, globalized economy fueled by mutual dependencies and exposures nor the opportunities the current state of affairs offers. By giving up on the possibility of mixing and matching existing problems with multiple monetary solutions we deprive ourselves of what is called the edge effect in nature: one can find the most diversity as well as the greatest new life-forms in the transition zone where two ecological communities meet and influence each other. The same should be expected of a monetary order that forgoes the one-size-fits-all paradigm.

  History, after all, delivers multiple examples of economies that benefited greatly from the introduction of a parallel legal tender. Some of these supporting pillars that propped up collapsing monetary regimes were created in a bottom-up fashion, as we shall see, meaning that they were community driven and often tolerated rather than accepted by the currency monopoly centers. Some of the parallel currencies were constructed in a top-down manner and were considered solid albeit temporary scaffolding by the representatives of respective governments and central banks.

  In Russia, for instance, the golden chervonet was reintroduced by the government as a parallel to the floating fiat ruble in 1922. Both currencies were part of the system until the ruble was pegged to gold, at which time the second currency lost its meaning and was retired in 1947. Until then, the chervonet did its job quite well, stabilizing the economy and thus a society disturbed, among other things, by rampant inflation. Once the faith in the dominant currency—its stability and thus its future—is lost, the introduction of a trustworthy supplement can either provide for a stabilization of the original monetary order or for an ultimate orderly opt out.

  The euro was founded on the idea that a single currency would make Europe stronger. However, the GFC led some to question this premise and suggest that the best way to ease monetary stress would be to have more currencies, old or new. One such proposal, suggested by former Deutsche Bank chief economist Thomas Mayer, was the creation of the geuro. The idea worked with the premise that Greece does not want to leave the eurozone and does not have the means to quickly put its fiscal house in order. The Greek government should thus issue IOUs to its creditors who—short of cash—would have to use them to settle their own bills. As a result, geuros would start circulating within the domestic economy, settling at a rate of circa two geuros to one euro, Mayer said, adding that this would give Greece both a chance to recapitalize domestic banks and to devalue with a second boosting of its competitiveness and thus its economy.

  Bernd Lucke, a founding member of the Alternative for Germany political party and a professor of economics at the University of Hamburg, suggested that the countries of highly indebted southern Europe should bring back the drachma, the peseta, the lira, and so on. This would allow them either to leave the currency union without a bang or to stabilize and regain full membership in the club. Of course, it is difficult to unscramble the scrambled egg, says Parag Khanna, a global strategist, summing up all the technical as well as psychological issues tied to a possible eurozone breakup or split.18 But as history shows there are a number of exceptions that prove that it is difficult, yet not impossible. Great empires collapse, and big (and small) currencies disappear. The demise of the Soviet Union, for instance, brought about a messy albeit brief, in some instances, transitory period with fifteen new currencies—including the Russian ruble, a successor to the Soviet ruble—at the end. Similarly, the Czechoslovakian koruna split into two tenders after the breakup of the country, causing only minor turbulence and proving that it is possible to have an egg where once there was a scramble. What is needed is political will to drive the change—or, alternatively, a lack of will to stop it.

  Corporate Money 101: In Ones and Zeros We Trust

  A return to the drachma or lira would represent a return to traditional currencies. However, these are not the only choices available. As mentioned earlier, since the time of the gold standard, money creation has conventionally been managed by a public–private consortium involving private banks and a centralized state. But just as modern virtual currencies don’t necessarily need the private banking system to prosper, so there may be less need for the state, there is no rule to say that the only way to create money is to monetize government debt. And politicians, when willing, can enable potent parallel monetary schemes not only to exist but also to thrive. One of the oldest and certainly most successful examples is the Swiss WIR Bank, formerly the Swiss Economic Circle, which was founded in 1934 by two businessmen, Werner Zimmermann and Paul Enz, as a direct response to issues faced by small and medium-sized businesses.

  A typical problem for such businesses is that they are pressured to pay quickly, within a month or so, even though the delivery horizon might be three to four times longer than that. The resulting cash-flow problems complicate their development, operations, and—during crises such as the Great Depression—existence. Commercial banks are mostly disinterested i
n helping and of course charge interest on loans. This creates bureaucratic obstacles and financially burdens the borrowing firm.

  WIR is short for Wirtschaftsring (economic circle), but is also the German word for “we,” which symbolizes the sense of community. The system solves the cash-flow problem by creating a mutual credit network of businesses, suppliers, and clients, which eliminates the need for financial middlemen. The WIR currency has a value equal to the Swiss franc (CHF), but mutual loans are arranged at zero interest. The currency can also be borrowed directly at a low interest rate. It is therefore a mix between a mutual credit system (which just keeps track of who owes what to whom) and a fiat currency system (where money can be created by loans). The loans must be repaid in WIR, and if a company wishes to leave the system, then its surplus WIR must be spent within the system. These measures protect the currency by making it more difficult to switch out of.

  What started with only 16 members is now a network of some 62,000 small and medium-size enterprises (large corporations are not allowed to join) that announced a turnover of almost 2 billion WIR in 2012. Moreover, since the transactions typically involve both WIR and CHF, the real turnover generated by this currency might be up to three times higher. Companies experience an average 5 percent increase in business when they join the network, due to loyalty effects.19 The system has also proven to be quite countercyclical, and helps to fill in for the national currency during times of economic stress.20