Showing posts with label Debt: The First 5000 Years. Show all posts
Showing posts with label Debt: The First 5000 Years. Show all posts

Tuesday 8 August 2017

What Is Money?

The system runs on borrowed money

The cliché that “The system runs on borrowed money” is well known.  You might imagine that you are somehow removed from that “system.”  Whether you are aware or not, your country, state or province, your school, your job, your church, your city, and your household are all run on borrowed money.  Nonetheless, “borrowed money” is a funny/peculiar expression because it is redundant.  There is no other kind of money.

What is money?  Experts aren't sure.

Reading Graeber’s Debt:  The First 5000 Years I was bemused to discover that there is no consensus among the experts on what exactly money is.  (See   When Should You Repay Your Student Loan? ) Of course, we all know what money is, but it is one of those obvious, everyday concepts that makes perfect common sense until you start to think about it.

IOU or Commodity?

Historically, the debate has been between seeing money as a commodity like gold or silver (something that has a value) or viewing it as an IOU, a promise to pay issued by the government of a particular country.  These days money is either paper or, more likely, pixels on someone’s computer screen—nothing of value in itself.

Money:  Without the gold standard, a debt that can never be paid.

However, if money is an IOU, it is a very strange kind of debt because no-one ever expects it to be paid.  (In the old days, countries were expected to have a supply of gold in storage—the “gold standard”—to back up their currency and, in theory, you could request an exchange of paper money for gold.  Those days are long gone.  (See   When Should You Repay Your Student Loan? .)

Money is simply a system of measurement

If money isn’t a commodity and it isn’t an IOU, what is it?  Graeber points out that the dominant theory in major economies like those of the USA and Germany—and I must confess it has taken me a long time to get my head around this idea—is that money is just a measurement system like feet and inches or litres and cubic centimetres. 

“Credit Theorists insisted that money is not a commodity but an accounting tool.  In other words, it is not a ‘thing’ at all. You can no more touch a dollar or a Deutschmark than you can touch an hour or a cubic centimetre.”

Money is a measurement of debt.

This is where the idea of “borrowing money” starts to get strange.  If money is just a measuring tool, imagine that you owe your buddy Georges 100 yards or you borrowed 300 miles from the bank to buy a house.  A hundred yards of what? Three hundred miles of what?  

Graeber writes:

"The obvious next question is:  If money is just a yardstick, what then does it measure?  The answer was simple:  debt."

The leverage ratio:  Why money doesn't really exist

“Borrowed money,” then, is just a way of saying “borrowed debt” or, more precisely, "a borrowed quantity of borrowing."  Once you’ve grasped this concept everything else in the financial and banking system begins to make sense—sort of.  As I’ve pointed out a couple of times, the mainstream, conservative banking system uses a leverage ratio of 4%; that is, 1 to 25,  meaning if the bank has 1 million dollars, it can lend out 25 million or 25 times more than it actually has.  “Actually has” (in the previous sentence) doesn’t mean to possess in a physical sense because as we have just learned money is “not a thing at all” so “has” does not apply in a physical sense.

When you borrow, you create money, which is the measurement of your debt

To trace the chain of “borrowed money” backward:  if you get a mortgage from the bank for $300,000, you will never get to see or touch or smell that money, but it is understood that you now have 300,000 dollars (i.e., money = debt).  You don’t have the money in an ontological sense (that is, in the sense that it actually exists), but you and the banks have an understanding.  

The more we “follow the money” the more imaginary and less real money becomes.  Following the leverage rules, it is understood that the bank does not have (in any sense of the word "have") the money it is lending you.  It is even understood that the bank has no understanding with anyone about the $300,000 you are borrowing prior to you borrowing it. Your $300,000 mortgage debt is created out of nothing, out of pure imagination.  It is a debt which you now owe to the bank.  It only exists as a piece of paper which you signed, meaning you created it for the bank's benefit out of nothing and which, by the way, the bank can turn around and sell or keep and claim as an asset in its bookkeeping. 

Synthetic leverage: how $1 becomes $40

In After the Music Stopped:  The Financial Crisis, the Response and the Work Ahead, Alan S. Blinder, an economist and former vice-president at the Federal Reserve, is adamant that “We need a financial system with much less leverage” (his italics, page 55).  Banks may give the impression on their books that they are leveraged to a conservative ratio of 1 to 10 but, as Blinder points out, the largest investment banks in the USA were creating “synthetic leverage” (using leverage to invest in something that is also leveraged; therefore leverage on top of leverage) to create leverage ratios of up to 1 to 40. 

Leverage and bankruptcy

If you want to understand what people are saying when they claim that the financial system was near collapse in 2008, consider a couple of salient facts.  The five companies that Blinder is talking about above—Bear Stearns, Lehman Brothers, Merrill Lynch, Morgan Stanley and Goldman Sachs—were the five largest in the USA.  Goldman Sachs, according to a French documentary I watched recently, has greater assets than the country of France (Goldman Sachs had $1.12 trillion in assets in 2007 according to Blinder).  Lehman Brothers, with assets of $691 billion, was allowed to go bankrupt.  To avoid bankruptcy, Merrill Lynch, with assets of $1.02 trillion, was forced to merge into the Bank of America.  As bankruptcy approached, Bear Sterns, with assets of 395 billion, was bought up, under government pressure, by JP Morgan Chase.  With these kinds of assets, how is it possible that these companies faced bankruptcy and needed government bailouts? 

The simplest answer is that no matter how rich you are if you are lending 40 times more than you have on paper (or in pixels, if you prefer) then a 2.5% mishap can send you spiralling into bankruptcy.  Think about it.  You have a billion dollars on paper, so you lend 20 of your friends 2 billion each.  One of those friends screws up and comes to tell you that he can’t pay you the 2 billion.  He’s bankrupt.  Guess what, so are you now.  Remember you only had a billion dollars on paper (in pixels), so now you can’t claim that you have those pixels anymore.   But are you really bankrupt now?  Sure you can’t say you “have” a billion dollars anymore (whatever “have” means in this context), in fact, you are a billion dollars in the hole.  According to the banking rules, you can’t lend out any more money because you don’t “have” any money to leverage—which is a problem if you are a bank because lending money is what banks do.  However, since money is just a measurement of debt, you still “have” the other 38 billion that you lent to your other 19 friends—don’t you?

Zombie Banks [Updated Nov. 3, 2018]

Listening to Yanis Varoufakis, former Greek Finance Minister, I learned there is an expression for what I described [above] a year ago:  Zombie Banks.  When banks no longer have the cash, the liquidity, the seed money, the "pixel dust," or whatever you want to call the million dollars that allows them to lend out 25 million, they stop lending money.  "Lending money" is the only reason for a bank to exist.  The bank is dead, insolvent, bankrupt, a zombie, but it continues to exist by receiving money from the national treasury, from taxpayers, which it hoards to itself to preserve the illusion that it is still a functioning bank.

High finance is like musical chairs until the music stops

The money game is a game of pretend.  The game only works if everyone believes or, as we say in literary studies, “suspends disbelief.” The game starts to fall apart when too many people start to notice that a billion-dollar or a trillion-dollar company doesn’t seem to have any money. You win the game by pretending that you “have” the money, even when it becomes obvious that no-one “has” the money.  All we have is the understanding that we all owe each other and the debt is measured in dollars or pesos or euros, etc, which is fine as long as we all understand the game and follow the same rules.


In my previous post, I described money as “pixy dust”—the magic stuff that Tinker Bell spreads with her wand in Peter Pan.  It wasn’t a metaphor that I thought about very much, but on second thought I’m a bit shocked by how accurate, how close to reality, that metaphor is.  Realizing that money is a kind of strange fiction that we have been convinced is the ultimate reality answers some of the questions I have asked in the past.  How is it possible that the USA is 17 trillion dollars in debt?  That the USA owes more American dollars than actually exist in circulation?  That every country in the world is in debt?  That the unregulated “derivatives” market is said to be between 700 trillion and 1.2 quadrillion dollars?  Since all these numbers are measurements of something that doesn’t really exist, they have no limits.  Nonetheless, I shouldn’t have called money “pixy dust.”  I really wish I had called it “pixel dust” the first time.  "Money is pixel dust!"  Spread it around!

Tuesday 18 March 2014

When Should You Repay Your Student Loan? How about . . . Never!

  To Owe Is to Own

Do you remember this line:  “So Romeo would, were he not Romeo called, / Retain that dear perfection which he owes / Without that title.”?  “Owes” used to mean “owns.”? 

I’ve been reading David Graeber’s book Debt:  The First 5000 Years.  It begins with the American proverb:  “If you owe the bank a hundred thousand dollars, the bank owns you.  If you owe the bank a hundred million dollars, you own the bank.”  I can remember my father telling me this.  I thought he made it up.  

Avoiding Debt

I’ve always had an aversion to debt.  I think it has something to do with when I was five and my mother, as she was leaving to go to work, telling me, “If there is a knock at the door, just sit on the floor and be quiet.  Don’t answer the door; they might be bailiffs.”  Of course, like everyone else, I’ve understood that it is impossible to get on in the world without a car loan, a mortgage, a credit card and a line of credit.  Nonetheless, I’ve always been fairly obsessive about paying my debts and as soon as possible.  You too I imagine.

Why Must Debts Be Paid?

Graeber is an anthropologist and he must have been a good teacher because the book is full of those “dumb questions” that a student might ask which turn out to be really profound, epiphanic, inspiring and unanswerable.  For example:  “Why should we pay our debts?”  And the corollary:  “Why are we so absolutely convinced that we should pay our debts?” Or, “What is money?” 

Is Barter Really the Root of Economics?

Graeber’s ambition in the book is to dispel all those preconceived notions that come to us through the study of economics--that discipline created by Adam Smith in 1776 at the University of Glasgow--like that “barter,” people exchanging one commodity or service for another, is a primordial, primeval human activity as well as the historical basis of economics, and that we are morally obliged to pay debts.  It intrigued and amused me to learn that economists (and anthropologists) are unable to trace the historical origins of money or agree upon a definition of what it is.  The camps divide into those who think of money as a commodity (meaning that it is worth something, like gold and silver coins) and those who think money is an IOU (a way to contract and measure debt).  These days it seems obvious that money is either paper or pixels, and not worth anything in itself.  Graeber argues that money and debt are pretty much the same things:  money is a measuring system (like meters and feet) and debt is what money measures.  If you have a twenty-dollar bill on you, it means that the government of the country that issued it owes you twenty dollars worth of something.  The problem these days is “of what?”  

The "Yellow-Brick Road":  The Gold Standard

In the old days, the government was supposed to have enough gold in storage so that all the money it issued could, in theory if not practice, be exchanged for gold--what was known as the “the gold standard.”  It was interesting for me (I’m a lit prof remember) to discover that L. Frank Baum’s The Wonderful Wizard of Oz, published in 1900, was an allegory in opposition to the gold standard.  Farmers in Kansas needed government loans, but the treasury refused them because the USA didn’t have sufficient gold reserves.   The “yellow-brick road” was the illusion of the gold standard leading to a fraud, the Wizard of Oz, who was just an ordinary old man (Oz is the abbreviation for ounce, the typical way gold was measured).  The gold standard came to an absolute end in the USA in 1971 when Richard Nixon announced that American dollars could no longer be redeemed for gold.  

Money Is a Debt that Can Never Be Paid

Even today there are people who believe that gold is the only real money.  However, according to a CBC documentary I watched not so long ago, a lot of individuals and countries hold papers that say they own gold, but the gold doesn’t actually exist. So if you have an American twenty, the American government owes you twenty dollars worth of something, but not gold.  No need to worry about gold, because it is fairly obvious that the American government has no intention of paying its IOUs period.  Economics really does become the purview of literary critics, I mean people skilled in analyzing works of fantasy and imagination, when you consider that the USA currently has a debt of over 17 and a half-trillion dollars.  That’s American dollars, so it owes trillions of its own IOUs.  

You Can Create Your Own Money

Think about it.  You’re out having a beer with your friend George and he runs out of money.  You pay the bar bill and George gives you an IOU.  The same thing happens a week later and the week after that.  Instead of getting George to pay, when you go out to dinner with Rosemary, you pay your half of the bill by giving her a couple of George’s IOUs.  George keeps writing IOUs and pretty soon everyone in your and George’s circle of friends has George’s IOUs.  When does it end?  It would end when people start refusing to accept George’s IOUs, but why would they?  If they keep getting what they want (beer and meals; maybe they can even get the bar and restaurant owners to start using George IOUs), what motivation is there to stop accepting George’s IOUs?  At a certain point, everyone knows that George is never going to pay off all his IOUs, but it is in everyone’s interest to pretend that he can and will.  It will all end when George has given out so many IOUs (like say 17 trillion) that people can no longer pretend to believe in them or George himself refuses to write any more IOUs, even though he is only being asked to write IOUs to pay a debt that he owes in his own IOUs (because at a certain point George began to receive and repay in his own IOUs).

USA:  The Most Indebted Country in the World

Both of these scenarios have taken place in the US government recently.  The USA has the biggest debt in the world at 17 and a half-trillion dollars, or over $55,000 per citizen, but every single country in the world is doing the same thing and is in debt.  The only debate is about those countries that we know will never be able to pay off their debts. Even in these cases, it seems like they "own” the banks and the countries that they owe money to, and we hear constantly that they can’t be allowed to go bankrupt.  Governments are considered conservative and fiscally responsible if they announce the intention to balance their budgets and eliminate deficits, meaning to stop going further into debt, some year in the future.

Canadian and Québécois Debt Levels

In this context, should a recent university graduate pay back her student loan?  Jeez, I don’t know!  But here are some of the facts of the Canadian/Quebec case.  The Canadian debt is currently approaching 700 billion, which means we each (every man, woman and child) owe over 20,000.  (Yep, if you were born yesterday, you are already in hock for $20,000.)  The Quebec debt is at 265 billion.

History of Non-repayment of Canadian Student Loans

Beginning in the 1990s Canadian students started to borrow a lot more money and were having increasing difficulty in paying back their loans when they graduated.  In 1980 around 9% of graduates were unable to repay their student loans; by 1990 the level of non-payment was at 17%.  By 1997, non-payment of student loans reached a total of 70 million dollars.  The federal government passed a law making it illegal for a student to declare bankruptcy until 10 years after graduation.  The Canadian Federation of Students took the government to court claiming discrimination under the Canadian Charter of Rights but lost the case on the grounds that student borrowers were not considered a social group.  The government later reduced the length of time before a student could declare bankruptcy to 7 years (thereby falling into line with what Graeber identifies as the ancient Judaic tradition of forgiving loans after the sabbath--or seventh--year).  

In 2003-2004 Canadian student loans amounted to $1.63 billion.  The same year, 28% of student borrowers (43,600 former students) defaulted on their loans totaling 331 million dollars. The government’s solution to the student debt crisis has been to create a Repayment Assistance Plan whereby students’ loan payments will be tapered to a maximum of 20% of their gross family income and the maximum repayment period will be 15 years.  For 15 years (or until the loan is paid) you will have to fill out a form every 6 months requesting permission to only pay one-fifth of your gross family income toward your student loan.  I’m not sure that I would find myself jumping for joy at these conditions, and it seems clear that the real objective is to ensure that the government gets its money back (or at least more than it was getting when 28% of former students were defaulting).

Canadian Student Debt Is Equivalent to a Small Country

The Federation of Canadian Students has begun to maintain its own “debt clock” showing how much Canadian students owe in Canada Student Loans.  The amount is now over 15 billion.  If they keep going, eventually they will be able to declare themselves a country (they are currently between Jamaica and Guatemala in debt size), or maybe the Federation will come to the realization that it’s members own this one.

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