Money. It’s quite likely the most mis-used term in economics and finance, so much so that it’s conflation with credit pervades just about every textbook, the media, and the even the banking and finance industry itself. Even the dictionary no longer defines money in a way that clearly distinguishes it from credit. So, what’s the difference?
Money is a medium of exchange, a portable, durable, divisible and fungible unit of account, and a store of value. Credit on the other hand serves all the aforementioned functions, aside form the last one. Credit is unlimited and therefore is not a store of value.
For the vast majority of recorded history, gold was money. That all ended in 1971 when President Nixon unilaterally withdrew gold from the international monetary system by defaulting on its repayment obligations. Since then we’ve been left with an international credit system based purely on fiat currency, backed by nothing but the illusion of confidence.
Around 600 fiat currencies have existed in the past, and every single one has failed, typically within 40 years. We’re now into the 48th year of the current fiat system and the clock is ticking. If history is anything to go by, it’s only a matter of when, not if, this one fails too.
As for gold, it’s still money. The majority of bankers, economists and finance professionals will tell you otherwise as it’s no longer legal tender, and while that may be true, it’s also true that today’s legal tender is credit, not money. Why else would every major economy and even the IMF (which incidentally should be renamed the ICF, International Credit Fund) keep gold reserves?
Further evidence that gold is money (a store of value), distinct from credit, is the fact that you can save it. Credit cannot be saved. When you deposit fiat currency in a bank, you are actually lending it to the bank, not saving. The currency is legally theirs, not yours, and you are compensated for your loan by receiving interest in the same way any currency you borrow is legally yours and you compensate the lender by repaying with interest. There is no way to preserve the value of credit without risk, as credit is an inherent risk itself!
Conversely, gold is an asset. It is one of only ninety-four elements known to man that can be found in its natural state on earth. Elements cannot be broken down into simpler components so gold can neither be created nor destroyed, making it impossible to counterfeit. Unlike many of the other elements, it exists in solid form at room temperature, does not corrode, and is malleable which enables it to be easily minted into standard units such as coins or ingots. In other words, it satisfies all the properties of money in a way that no other material can, and it’s done so since the Lydians first minted gold coins in the 6th Century BC.
So what happened? Why was gold abandoned after more than 25 centuries? Utility, for the most part. The limited supply of gold means that as the economy grows, gold becomes more valuable (its purchasing power increases) since the relatively fixed pool of money can now purchase more goods. People were therefore incentivized to hoard gold as a spate of 20th century innovations spurred unprecedented growth. But as money is saved, less of it is available for the very thing that spurs innovation in the first place – spending and consumption. So the unintended consequence of saving money is that it cannibalises the benefit of saving it in the first place!
Now if a limited supply of gold (money) cannot adequately serve a growing economy, and an unlimited supply of credit cannot adequately store value to serve the function of savings, what should a modern economy adopt to facilitate transactions? The answer is profoundly obvious yet never tried in the history of mankind: both. A fair and efficient monetary system needs both money and credit. And how would these two “competing” units of account and media of exchange coexist? Simple: float the credit supply against the money supply and allow either to be used to transact in goods and services. Let’s call it the Quasi-Gold Standard.
In practice, this would mean a complete overhaul of the current (failing) monetary system, the abolishment of central banking, and a return to government issued fiat currency with a twist: government created credit would float against the global supply of gold, giving us consumers the choice of holding money (gold) or credit (government issued fiat). According to the World Gold Council, there is approximately 187,200 metric tons of mined gold in existence. That’s around 6.7 billion ounces. So, if a government issued credits of 25 trillion, gold would be priced at 3,731 credits per ounce (25 trillion divided by 6.7 billion). If the government wanted to increase the credit supply to 27.5 trillion (a 10% increase), gold would be priced at 4,104 credits per ounce.
The “credits” themselves could be named dollars, yen, euros, yuan or whatever each sovereign nation decides to call them. What’s important here is that they are issued exclusively by the government, not the banking system. Crucially, the Quasi-Gold Standard would address virtually all the structural deficiencies of our current monetary system:
Firstly, gold would regain its mantle as global money, facilitating cross-border transactions, and limiting the ability of strong economies to exploit weaker ones by printing credit to engage in predatory lending (China) or over-consumption (United States).
Secondly, it would enable genuine saving for the first time in over a century: consumers could maintain purchasing power (save) as the credit supply increases by acquiring gold. And because gold isn’t fixed to the credit supply, it wouldn’t impede the economy’s ability to grow.
Thirdly, as part of a dual money + credit system, gold would act as an automatic stabilizer over the economy: when the economy is growing faster than the credit supply, consumers would be encouraged to invest rather than save (e.g. they would sell private gold holdings to the government, and as the government accumulates gold, more credit flows through the economy and government spending is constrained. Conversely, if the economy is growing slower than the credit supply, consumers would increasingly flock to gold to maintain purchasing power. In doing so, they swap credit for gold, providing the government with additional credit to stimulate the economy with good old-fashioned Keynesian spending!
Fourth, the absence of a Central Bank means no centrally controlled interest rates, allowing money to be traded (borrowed and lent) at real, market-determined rates. This raises the question of how retail and commercial banks will operate, and furthermore how will they avoid financial panics, which (conspiracy theories aside) was the key purpose behind the establishment of modern central banking. The real question, is why do we need banks?
Banks don’t provide the food we eat, the clothes we wear, or the goods and services we consume. The fundamental role of the entire industry is to store, consolidate and distribute credit, and facilitate transactions. The banking system also performs another role: credit creation. We’ll expand on this in Part 2, but for now what’s important to know is that this is bad. Very bad. So bad that I’d say it’s fundamentally the real cause of the 2008 financial crisis, and the anaemic state of today’s global economy.
The first and last of these functions (storage of credit and facilitation of transactions) can be performed far more efficiently, and at a fraction of the cost, by distributed ledger technologies such as hashgraph (a faster, cheaper and more reliable alternative to blockchain). Yes, given this is “A Truly Modern Monetary System”, what I am advocating here is government-backed cryptocurrencies.
Now if you’re an anarchist, conservative or libertarian, you’re probably losing your mind right now at the thought of politicians having direct control over the money supply. At least in the current system, the supply of money (credit) is controlled by an “independent” Central Bank. On the other side of the fence, socialists and “progressives” are likely frothing at the mouth in favour of this idea as it would allow them to re-distribute credit as they see fit.
What if a government-backed cryptocurrency could satisfy both camps? It can (to the extent this is possible) and can do so quite simply: mandate that all new credit is distributed equally among the citizenship. For example, if the government of a country with 320 million citizens wanted to increase the credit supply by 10% from 25 trillion to 27.5 trillion, it could do so simply by issuing 7,812.50 credits (2.5 trillion divided by 320 million) to each registered citizen via the distributed ledger. Equally, this could be done incrementally with instalments of 150.24 credits per week over 52 weeks.
At this point, the government-backed cryptocurrency described above replaces three of the four functions of a bank; credit creation, credit storage and transaction facilitation. That leaves consolidation and distribution of credit (e.g. the accumulation of “savings” and onward lending of those savings to borrowers who need credit). In our current financial system, consumers have no choice – excess credit must be invested in a bank or speculative assets, with no guarantee that their purchasing power will be maintained – since there is no monetary “anchor” to store value.
Under a quasi-gold standard, consumers could choose between saving (purchasing gold) or investing. Those that choose to invest would presumably do so only if they thought they could improve their purchasing power (e.g. earn returns that exceed the rate of government credit creation). To do this, they could: 1) start a business; 2) invest in a business; or 3) lend their credit for a return that exceeds the expected rate of government credit creation. Option 3 is essentially the last function of today’s banking system that isn’t replaced by the quasi-gold standard’s government-backed cryptocurrency.
This could remain a function of banks, but if banks can no longer create loans out of thin air, their supply of credit would be constrained by deposits, and in a competitive interest rate environment, banks as we know them would not survive. Instead, smaller investment funds, co-operatives and other vehicles would compete for the limited pool of available funds, and those that are best at maximizing their risk and return profile would attract more and more funds until they get too big to sustain high returns. This eliminates the “too big to fail” problem of our current financial system, ensures resource allocation is optimized, and encourages grassroots-level financing.
Taxes. Another game-changing feature of the Quasi-Gold Standard is the way in which taxes could be implemented. On a distributed ledger system, taxes could be collected on a transaction basis, so rather than the multitude of tax rates, allowances, deductibles, loopholes and other complexities, a simple transaction tax could automatically recoup enough credit to fund government services and eliminate virtually all forms of fraud and tax evasion. To ensure the “billionaire class” are paying their fair share, the transaction tax could scale according to transaction size (e.g. larger transactions may be subject to higher rates).
The benefits of a Quasi-Gold Standard are enormous. Giving the simple power of saving back to the individual, removing the power of credit creation from the banking system, and distributing credit from the bottom-up rather than top-down, would be a quantum leap forward from the current system.