In this piece, we’ll discuss and explore money and how it has shaped our understanding of value and trust. We’ll outline the definition and functions of money; how money is created; money as a social construct; money as a system of trust; and money as we view it today.
Money is one of the oldest technologies of human civilisation and is prevalent in its application throughout our lives. We use it on a day to day basis for transacting in commerce, so what is it?
Money is, and functions as a:
Medium of exchange – used as a medium to be able to buy goods and service;
Unit of account – a common standard for measuring relative worth; and as a
Store of value – it holds value over time.
Anything that fulfils these three functions can be considered to be money.
In today’s world, we typically transact in fiat money and bank money. Fiat money is the physical currency that is issued and backed by the government and is what you have in your wallets and pockets. Bank money is what you have in your bank account, and is a form of privatised money, which is commonly referred to as deposits or credits.
Historically we had operated off a monetary system that was backed by gold (the gold standard). The gold standard limited the issuance and quantity of commodity money to the amount of gold that was held in reserves. Commodity money is paper money that is backed by something scarce and of value such as gold and silver.
Sound Money: Although the world has evolved immensely in the last two thousand years, what we would consider to be sound money is in line with the Greeks and Aristotle who listed 4 attributes, which to the current day, have essentially remained the same:
It is Durable – not easily destroyed and is able to stand the test of time;
It is Divisible – when divided into its parts would be interchangeable;
It is Portable – can be easily transported and carried around; and
It is Intrinsically Valuable & Scarce – holding value within itself that is independent from any other object and is scarce.
Now, ‘intrinsically valuable’ is a debatable point when evaluating money throughout history. Fiat currency could not be said to have intrinsic value, considering that we had moved from monetary systems that had been backed by gold, to systems backed by the full faith and credit of the government that issues it.
Gold has traditionally been labeled as intrinsically valuable, due to its scarcity, it’s geological composition and its 5000-year history of accepted value par excellence. Yet, we could also say that it is historically valuable, for value whether it is intrinsic or not is dependent on consensus, or in the words of Bettina Greaves, “gold’s physical properties are the product of nature, its value is the product of acting men”. If we value something, it has value, if we don’t, then it does not. Value all comes down to how society constructs it.
Money as a Social Construct
Money is an individual’s expression of value that is accepted by a collective. We collectively agree that ‘something’ is of value or not, and without this the individual is left to either find something of collective value to participate with others, or convince the others that their ‘something’ is valuable and demands participation. Governments are experts at influencing (coercing) public participation in monetary systems of value.
Marbles as Money: Outside of external intervention or governing decree, our society naturally orientates itself around the transacting of value as defined by the free-market’s decisions. As a child (in a pre-internet era), even though the principles of money were cognitively beyond our understanding, marbles were one of the primary objects of value and repute (in a time before Pokemon cards). For some reason, children would naturally shape their economic desires towards the pursuit of marble empires through rudimentary wealth accumulation strategies, ranging from barter to gambling through to payments for services and other goods, for example, trading marbles for lunch.
As children, there were even loose valuation systems for the marbles. Rare marbles were ascribed a higher value, and the common ones, a lower value. Without understanding the monetary policies of the society they lived in, the children created their own, as will other groups within the human genome who participate in a shared economy. Shared economies provide the foundations for collective belief systems that then define the expression of value that is shared by other market participants in an economy.
One of the fascinating considerations of money is that the physical fiat money we use is not actually worth the cost to make it, or is substantially worth more than the cost. Due to economies of scale, printing a $100 bill would cost a fraction of a dollar, yet minting coins, particularly the lower denominations would cost more than the value. The value of the $100 note is established by legal decree, collective agreement and societal acceptance that regardless of its inherent worth and cost of production, $100 will always be $100 (in a healthy economy). This acceptance is granted on legal tender, whereby transacting entities within society are required by law to accept it as payment. Money is not inherently valuable, until we allocate it value as a social construct.
How Money is Created
What we view as traditional money today can basically be broken down into physical currency – in the form of fiat (government-issued legal tender) notes and coins, and bank deposits through double entry accounting i.e. credits and debits.
Central banks and mints are responsible for the creation of the physical currency that we call cash. Cash is private and permissionless and can be transacted outside the purview of the government. For this reason, this type of money has been, and is still undergoing a prolonged global war on cash, waged by governments to transition their population into a digital monetary system. Beyond the issuance of the nation’s physical currency, the Central Bank is also responsible for the nation’s monetary policy; price stability and economic growth; regulation and control of liquidity in the economy through the expansion and contraction of the money supply; and are responsible for setting the reserve ratio requirements, holding the reserves, and acting as a clearing house for commercial banks. As a final note, the Central Bank also acts as the Lender of Last Resort to financial institutions and banks experiencing liquidity issues, as we saw in the 2008 global financial crisis.
The banking system has privatised the creation of money (commonly referred to as deposits, credit or bank money) by increasing the money supply through lending excess reserves. Banks are held to reserve requirements or capital adequacy requirements, where liquid deposits (cash) are held in reserve as dictated by the Central Bank i.e. 10% reserve requirement to ensure that it can meet liabilities in the case of customer withdrawals. Any excess reserves may be lent out. Through double entry accounting, each new loan that is recorded as an asset, a corresponding deposit is created in their liabilities. With each loan that is lent out, new money is created.
Although banks seemingly create money out of thin air, they are not able to create unlimited money. The money they can create comes down to the money multiplier as measured against the reserve requirement.
If the reserve requirement is 10% then the money multiplier will be 10, then the money created will in theory be 10 times the original amount deposited. Simplified example: Tom deposits $100 in Bank A | Bank A keeps 10% = $10 in reserves | Bank A lends out $90 to Masha | Masha deposits $90 into Bank B | Bank B keeps 10% = $9 in reserves | Bank B lends out $81 to Polly | and so on and so on. From the original deposit of $100, theoretically, the total money created in the banking system through deposits would equal $1,000.
*NOTE: if customers hold it in physical cash and don’t deposit back into the banking system, or the banks don’t lend out all the excess reserve then the money obviously does not multiply 10 times.
Bank lending increases the money supply. Customer loan repayments decrease the money supply.
As money is created and assigned a value for us to trust and transact within the traditional sense, other forms of money are also being created on a daily basis that serve as an alternative to the modern monetary system. These forms are always completely dependent on your personal situation, geographical and political location, and the community willing to validate its function as money.
One of the most notable monetary innovations of the last millennia came in 2008 through a pseudonymous entity called Satoshi Nakamoto, who launched Bitcoin to the world through the Bitcoin white paper and then in January of 2009, the genesis block that gave life to the world’s first trustless, permissionless, decentralised, open-source peer to peer digital currency, Bitcoin. Please refer to our Bitcoin Primer for more information. Bitcoin was the first of many decentralised digital/crypto currencies that have since emerged that are changing the way we understand money, value and trust.
Money as a System of Trust
Trust underpins much of how we walk through the world on a day to day basis. We trust that when riding a bike to work that a car is not going hit us, that they will keep to their lane; we trust that the food we eat is not going to poison us; we trust that our friends and loved ones will stand by our sides through thick and thin; we trust that the people tell us the truth when we listen to them; we trust our employers to pay us for our services.
Commerce is no different. The commerce lifecycle is based on systems of trust – trust that the currency transacted will have value tomorrow; trust that the goods and services received or delivered will have and continue to hold their value; trust that your money in the bank will still be there tomorrow (well not in the case of Cyprus); trust that your bank will still be around tomorrow; trust that your government will continue to maintain relative value of the national currency; and trust that you are able to spend your money on what you want, which is not always the case.
In the modern world we trust the government and we trust the fiat system of money. Fiat dollars that have flooded the markets through inflation, exuberance and unchecked bank lending, are considered to be money and of value, not because they have intrinsic value, but because of the trust in the issuing government – In State we Trust. This is a devolution from what has been the money par excellence over the ages, that is, the value and trust in the precious metals of gold and silver. Gold is created by supernovas and when two neutron stars collide and gold particles are released into space, which find their way to earth. The rarity of its geological composition and the 5000-year-old history of trust in its value ensures that it earns its place at the table of intrinsic value – which is why throughout the ages – In Gold we Trusted.
With the proliferation of the internet and information, the world is undergoing an awakening of value. State trust is becoming increasingly displaced in the fiat monetary system of money, led by uncertain supply dynamics (QE) at best, and at worst, abuse of State trust from governments in Zimbabwe and Venezuela leading to hyperinflation and the decimation of the people’s wealth. There is now an increased focus for individuals and families to be able to build and preserve their wealth outside of traditional financial systems to be able to live, survive, and thrive.
There has been a continued erosion of trust in financial institutions and the governments that were and are supposed to be regulating them – 2008 taught us a lot about trust. A $700 billion dollar US government bailout was deemed necessary to stop the collapse of the global financial system, which resulted in the gamblers getting paid and the public left holding the tax bill.
Even trust in the physical cash in our pockets is currently under assault. The global war on cash is escalating, as governments seek to remove physical cash from circulation to replace it with digital bank currency and money. From the removal of high denominations of cash, through to the outright removal of all cash payments, there is little hope of protection from banking bail-ins should we live in a cashless society. Unless there are alternatives in how we understand money today.
What is Money Today?
When we think of money we think of the ‘currency’ / ‘fiat’ that we use on a day to day basis, yet this is merely a form of money. Notably, it is the form of money that we as citizens of a nation are legally required to use for goods and services.
The US dollar has value because the US and the rest of the world each subscribe to and put faith in the belief that the dollar today will be worth a dollar tomorrow. It also holds value due to the ‘full faith and credit’ backing by the US government, and that the government through trade or war will continue to ensure it retains relative value. The US dollar and the Federal Reserve has redefined our understanding of money over the last century.
The US dollar went Alpha in 1944 when representatives of 44 countries met in Bretton Woods, New Hampshire to establish a new global monetary system – the Bretton Woods Agreement. It essentially replaced the gold standard, and pegged the participating nation’s currencies to the US Dollar, which was pegged to gold at an exchange rate of $35 USD per ounce. Pre-Bretton Woods, most countries followed the gold standard which due to its nature (currency supply can only increase if gold supplies are increased) held inflation and government over-spending in check. However due to the fact that military wars took place every year of the 20th century meant that governments had to abandon the gold standard to be able to print enough to pay for their military spend, thereby blowing out their debt and creating increased levels of inflation.
The Bretton-Woods Agreement collapsed in 1971 when Nixon and the US abandoned the gold standard due to Europe and the rest of the world losing faith in the US being able to honour the convertibility from US dollars into gold. The charge was led by France, where De Gaulle in favour of international monetary reform, and a return to the gold standard, exchanged their US dollars for US gold reserves, and thereby reclaiming their monetary rights as affirmed by the Agreement.
Continuing Thoughts on Money
Money is what allows us to express our needs and our desires. It is a financial representation of where we have chosen to spend our time, energy and productivity. It is the means by which we buy and sell goods and services and attain wealth. It is a communication of value and is a system of trust. There are many forms of money and financial instruments in which to accumulate wealth, and we believe in having the freedom, education, and available access to be able to create our own individual financial expressions.
We believe that alternative forms of money have a place in the modern world, complementing the existing system. Traditional money and financial systems will continue to operate as they have, making incremental innovations to enrichen the existing system that has been in place for the last 400 years, and yet is struggling to keep pace with the digital age that is breaking down borders and opening access to billions of people globally that until now, were never invited into the club of financial exclusion. This digital age has ushered in the convenience of having not only the world’s information at your fingertips but also, a global system of digital finance that everyone on a network can participate in. The digital age has awakened us to how we view and express value and trust.
Money is a social construct and a consensus of what constitutes value. We either choose to continue buying into the existing construct of financial reality, or we choose to transform it, change it or use one of the greatest weapons in our own personal arsenal, we can choose to exit it. One of the most liberating truths in life, is that we have choice. And so it is with this choice that we can choose a multitude of financial realities to buy into, be that fiat money, physical cash, bank money, Bitcoin and digital currencies, gold, barter systems and so on. We believe in alternatives and choices.