Steve KelseyIt all began with a move
In 1991 I had found a house in Ealing for my wife and our two beautiful young daughters and my son, who was due to arrive soon after the move. I had created some capital with the growth in value of my flat in the East End of London, a stones throw from Hackney where my mum had been born. I needed a mortgage for the rest of the cost of the house in Ealing. I had been with the NatWest bank since I had moved to London to study design, so I put in a call to the Bloomsbury Parr branch and the mortgage was arranged.
What is Money? The question popped into my head as I was shifting boxes while the girls helped by sitting on the stairs crayoning the walls. As a designer I had learnt to trust those moments. Design often happens at a subconscious level where a great deal of associative activity goes on until, pop, there it is, the unique combination of observations that solves the problem. Although it was a question rather than an answer, it had the same qualitative heft to it, the same solid impact that an inspiration has. It was a question that I had never asked before. What is money? Where does it come from? Who invented it?
This is what happens when you buy a house. The bank buys it. Although you might think you have just bought a house, the bank owns it. What you own is a contract with the bank to spend the next 25 years handing over a significant portion of your income to pay the bank back, with interest. Only then do you get to own the house. Not a day before.
Now you have to spend 25 years toil earning the money to pay the bank. Where did the bank get the money to pay for the house? The bank created it out of thin air. That’s what banks do. Create money. This money is not called money of course, its called debt. And your contract, the mortgage, binds you to pay down the debt.
Let’s unpack this a little more, just as I unpacked All those boxes, a piece at a time. On Monday morning your bank writes a number and a lot of zero’s into the sellers solicitors bank account, lets say 200k. The bank receives the deeds to the property which has just been proven by the sale to be worth 200k. The bank also receives a contract with you worth somewhere north of 200k because of the interest part of the contract.This interest element can be higher than the market value of the house, but as its spread out over 25 years you probably don’t worry about that as you can pay it in instalments.
So at this point in time, say 10.30 on Monday morning, the bank has invented some numbers to put into the sellers solicitors account at a cost to the bank of some admin time and a trickle of electricity. For that heady expenditure, lets be generous and say it cost them £200, they have an asset worth £200k and a contract with you, which is another form of asset, for £200k plus the interest. That’s more than £400k for £200 of cost. It’s been a good Monday morning for the bank.
Tuesday gets better. On Tuesday the bank sells one of their new assets, your contract with them, which you call a mortgage. They sell the asset because they can get money now rather than wait 25 years and there is the added benefit of relieving themselves of the risks associated with a mortgage, e.g. your inability to pay. But Tuesday is about to get even better for the bank.
The bank has increased the assets it can count towards its capital account by at least £200k. Your house is not worth £200k to them, its worth £2M assuming a multiple of 10. This is a low multiple. Before the banking crisis of 2007/8 some banks were using a multiple of 33.
So on that happy day shifting boxes I had thought I had bought a house in leafy Ealing for £200k. The bank knew they owned new assets worth more than £400k and had increased their loan capability by £2M. All for the cost of some admin time and a trickle of electricity.
Funny stuff money.
But, you might ask, doesn’t the bank go to a big vault and shovel gold into a sack to send to the solicitor? No, that’s Gringott’s Bank Established 1474, Diagon Alley, London, which isn’t a real bank! In the modern world it’s all done by numbers on a spreadsheet. But doesn’t the money come from deposits at the bank?No, the money really is created out of thin air and it always has been.
But how can the bank do that? Your bank, any bank, has an operating licence granted by the Bank of England. That means your bank has permission to operate, stunning how that works. The bank’s licence includes the ability to create money, which everyone in financial services insists is called debt. Your bank has to keep reserves at the Bank of England to cover its day to day operation so the BOE is the banks bank. The BOE has many tasks to perform but the big one is acting as the lender of last resort to the banks.
So, the BOE has all the money which it lends to the banks? No, the BOE creates money out of thin air as well, in just the same way that the bank created the money for the house purchase. So when the BOE needs to provide support to a bank, it writes numbers into the banks reserves at the BOE which supports the money the bank wishes to create. When I finally collapsed on my sofa in my new living room at the end of moving day, all around the country banks were reconciling their reserve balances with the BOE. This happens every working day.
One of the subtle but important things to note as I drink my mug of tea, is that in a very real sense all the money created is government money. Banks are owned by their shareholders, but the money itself, whether that is credit, or debt or currency or any of the names we use for money, ultimately comes from or is authorised by the BOE. Hold onto that thought, we will come back to it latter
Funny stuff money.
But, as any reasonable, if slightly old fashioned person might claim, doesn’t gold provide the backing for money?, I mean I have seen pictures of the Queen counting it on TV. In Britain. “ I promisee to pay the barer on demand five pounds” appears on the good old fiver, meaning once it could be converted into five pounds in weight of the shiny stuff. But, before you sprint to the bank and make foolish demands, gold convertibility was abandoned during the first world war.
This was to solve a serious liquidity crisis. With a gold backed currency the number of pounds in circulation was8 limited to the nation’s gold reserve. If you are fighting a continental war, and you need to spend more than you own, this limitation is frightfully inconvenient.
Technically, Britain was bankrupt at the end of the first world war, and the value of the pound had diminished against currencies like the dollar. In an effort to counteract this problem the pound was put back onto the gold standard. After five very painful years, in 1931, the pound’s gold convertibility was abandoned for good. The pound hasn’t been backed by gold for over 89 years, the same age as my Cockney mother, although she insists she had nothing to do with it.
What is our money backed by then? Our money is backed by the state. This is a polite way of saying the pound is backed by force. The currency that we use for our money is legal tender, and the only currency the state will accept for the payment of taxes. The British pound’s status as the national currency is enforced by law. If you doubt this is true then please by all means set up a printing press and try your luck.
This is how money has always been, right from the very start. Of course there will still be some who suck on a cigar are say “you are confusing currency with money foolish boy” although they may use more acerbic terms than ‘foolish boy”, to which I reply balderdash! Currency is money. So is Debt, Credit, Bonds, T-bills, Stock, Gilts and any other term invented by the financial services to describe money. But for now let’s focus on the origins of money.
Ancient stuff, money.
Thousands of years ago, at the dawn of civilisation, there was money and there was wealth. It didn’t look like money. It didn’t look like wealth. It looked like mud. Imagine a marshlands filled with reeds under a terrible sun. It’s hot, so hot you can barely breath. Your life is hard, you exist on fishing and course bread made from grain. You are working on the land, digging ditches to drain the marshland to make more arable land, hot back breaking work under a fierce sun, with temperatures at midday rarely falling below 40C degrees. But you know it is worth it. Generation by generation your tribe has stolen more farmland from the marsh. Generation by generation there has been more food. If only the ditches you dug did not erode so quickly.
We don’t know who was the first to notice that dried clay resisted erosion more effectively than soil. We don’t know who noticed that as clay dries it cracks into blocks, and extended that idea to make blocks of sun dried clay to line the ditches. But somebody did, and the brick lined ditches of the plains of the Euphrates turned marshland into cultivated plains and food became abundant. So wealth, bricks, clean water, plentiful food, came before money, as it aways has.
Sumer is, as far as archeologists and anthropologists can tell, the worlds first civilisation. The Sumeric civilisation, its irrigation canals, walls and cities, were built from clay and clay became its money also. If you have a workforce that toils on the land, or makes bricks, or builds walls and temples, palaces and tombs, they have to be fed and quartered. They need to be rewarded for their labour or who will work on anything but feeding their own family?
Which leaves the question how do you reward labour in a way that is functional useful? I am going to ignore the deviation into barter economies invented by economists, there is no anthropological evidence that a civilisation was ever built on barter. It’s a nonsensical idea. You reward workers with more mud.
Clay tablets were made for each worker and the reward for their labour inscribed in the clay, a bowl of rice, a sheaf of corn, depending on their work. The worker could take this tablet to market and exchange it for what they needed. The vendor in the marketplace knew they could take the tablet and use it themselves to purchase labour or produce at some time in the future.
Excavations have uncovered tens of thousands of these tablets which would circulate from worker to vendor and then back again, the symbols inscribed into them becoming more abstract as a new class of worker, the scribe, emerged from the need to keep account of all the transactions made. Money had arrived, as had writing, which evolved from the marks used by scribes to keep accounts.
We have a lot to unpack from that brief history. Firstly, wealth comes before money, and always does. Secondly, wealth and money are two fundamentally different things. Wealth lies in the creative act, applying intelligence to base matter. bricks from mud, canals and cities from brick. So let’s call that act of applying intelligence to base matter building civilisational wealth.
So what is Money? Money is an abstract symbol which is used to keep account of the labor that creates civilisational wealth. Money has no intrinsic value of any form. And money is incomplete at a fundamental level, a component in a system. That system is based on a transactional framework. Users of money trust that the money is ‘good’ That it will be accepted by others, That it can be converted into civilisational wealth.
Money requires cooperation, from people outside your family, your tribe, your city. Money is dependent on universally accepted standards. The mark for a sheath of corn can be exchanged for the same size, weight and quality sheath of corn in Nineveh or Babylon. These standards have to be agreed and then, because people are people, enforced. Money needs an authority and sanctions to function.
These social tools, trust, cooperation, authority and sanctions are all prerequisites before money can function. These social tools were not invented for money, they were in place before money could emerge. They were essential tools for a civilisation to be built, and are as fundamental as applying intelligence to base matter in the creation of wealth.
So money is a peculiar thing, an abstraction, having no functionality without trust, cooperation and authority. It has no intrinsic value in itself, it is merely a means of obtaining civilisational wealth.