I heard this on NPR’s This American Life, and for the first time in my life, my eyes did not glaze over. Three stories explaining the deliberate fantasy that is money:
There was an island in the South Pacific called Yap. They had an impractical method of currency—gigantic stone disks, some taller than a person. They only used them for big purchases, like for a dowry or to ransom a warrior captured in battle. I‘m sure you can see where this is going: Pretty soon, the actual giant stone circles did not need to be physically transferred between parties; it became understood who the owner was. That was an innovation! The stone that was quarried for these giant circles was on another island, and one time, during a storm, the raft used to carry the stone was overturned. The crew survived but the stone was at the bottom of the Pacific. When they arrived on Yap, it turned out to be no problem. The islanders said, Look, we believe you. There is a giant stone at the bottom of the ocean and it still belongs to So-and-so.
That is not so different from what we do today. Since 1933, there is no gold behind our dollars, and even if there were, what good is gold? It’s only worth something because everyone agrees it is. We agree on the idea of money. Today, even currency itself is essentially gone—there are only computers firing impulses between parties. And those transfers represent…nothing tangible at all.
Brazil is a poor country, and so, most everything is bought on installments, from sunglasses to cars. This is a very recent development for that country—since 1994 to be exact. Buying on installments would have been impossible previously. Before then, there was terrible inflation—80% a MONTH. It started in the 1950’s when the president of Brazil wanted to build the capital, Brazilia, in the middle of the jungle but didn’t have enough money, so he printed a bunch. 80% inflation a month means that a pair of sunglasses that costs $10 today will sell for more than $10,000 in one year.
For decades, Brazilians lived with high inflation like this, and could not figure out how to fix it. Prices changed daily. There were people who worked in large stores whose only job was to change the prices on all items every day. Housewives would go to the supermarket and run ahead of the guy changing the prices to get yesterday’s cheaper prices. You couldn’t save any money either—it would be worth less every day. And you wouldn’t want to produce anything that took too long to get to market because the raw materials would be worth less than they cost you to buy.
They tried several things. First, a price freeze, but no one wanted to sell anything and merchants held back goods, thinking the prices would go up. They tried confiscating everybody’s money—you can imagine how well that went over! There was almost an insurrection, and the government was impeached. Then, in 1994 the government asked four economists to help them fix this problem.
These guys understood that the very nature of money is a fiction, and they used that mass delusion to fix inflation. The government stopped printing so much money and cut spending, but every bit as important was to gain the publics’ trust in the money. People had to be tricked into thinking money had value. They invented a new currency, one that was stable, trustworthy. But this currency would not be real, would not have coins or bills. They called it “a virtual currency,” or a Unit of Real Value—a URV. People would still carry cruceros, tangible money in their pockets, but when they got their paychecks it was in URV’s, taxes were in URV’s and prices of goods and services were in URV’s. And the URV’s were stable.
When you asked how much a quart of milk was it was always One URV. Now, you still had to pay for the milk with the cruceros in your pocket. But every day, the newspapers would print the value of the URV’s relative to the crucero. Yesterday, the price of milk was One URV, which equaled 7 cruceros. Today, the price of milk was still One URV, but it took 14 cruceros from your pocket. The idea was, people would start thinking in URV’s. You were always paid your same salary in URV’s, say, 1000 URV’s. The price of milk was always One URV, regardless of the inflation of the crucero. Amazingly, people accepted that. After a while, once people trusted the URV, inflation came down and prices were in synchrony, they did away with the old currency. The “Real” (pronounced Ree-AL) became the new currency—it was the URV. The Brazilian real is equal to One URV and one US Dollar.
Everyone in Brazil tricked themselves on purpose into believing this fake currency was real. Everyone was happy—inflation was solved! BRzillIANT!
WEEKEND AT BERNANKE’S
When the US was on the gold standard, it was clear how much money we had and what it was worth. Each dollar corresponded to a dollar’s worth of gold in a vault somewhere. (Which, as I mentioned, is still a construct.) When we went off the gold standard, someone had to be entrusted to figure out how much that dollar was now worth. The Central Bank was created to do that: The Federal Reserve.
The Fed is the only institution empowered to create money. It controls the amount of money in our economy and it controls interest rates, among other things. Yet most don’t realize it is not a part of the Federal government—and this will become immensely significant. The Chairman of the Fed is appointed by the President and Congress has oversight, but it is an independent body.
The Fed conjures money out of a void. Every 6 weeks, at the Federal Reserve in DC, there’s a meeting at which there is no press, no Congress and not even the President is allowed. Members of the Fed make presentations about the economy. And then, they take a vote—should there be more, or less, money in the US economy? The ramifications are who can get loans to start businesses, create jobs, or if there is too much money, create inflation and hurt the economy. The fate of the US economy rests on these decisions made every six weeks. Since 2008, when the economy deteriorated, the Central Bank did some unprecedented stuff. The danger is that if the Fed screws up, the fiction that we call the US Dollar loses value.
How do they create money out of nothing? It’s not just about printing it although they tell the Treasury to do that too. They need to get vast amounts of money on the street fast, so they need banks. They put money into the banks’ hands by buying something from them—something safe: US Treasury Bonds. Big banks have billions of dollars of these bonds. This transaction, of course, does not involve cash; it’s all done via computer. When the banks lend that new money out, that’s how money enters our economy. And that is also the way the Fed raises or lowers interest rates—more money to banks equals lower interest rates.
What I just described was the way it had always been done—boring and safe…until 2007, when the banks had all these investments that were plunging in value and they needed someone to lend them money.
The Fed has always had special emergency powers that it can use when the banking system is on the verge of collapse. They can create a bunch of money and lend it to the banks. In 2008 they did just that and it was revolutionary. Revolutionary because, for one, these banks were no longer the traditional, previously regulated banks the Fed was designed to deal with. The Fed created over a TRILLION dollars that they loaned to Wall St—GS, Morgan Stanley, Bear Sterns and the like, as well as to Citigroup, B of A, and even to regular companies like Verizon and Harley Davidson. The second radical thing the Fed did was to depart from their boring, safe buying of Treasury bonds, and instead they accepted all sorts of assets for collateral—toxic assets. Mortgages on resort hotels, and malls in Oklahoma, for example.
In 2008 the economy was still on the verge, so the Fed did something else unprecedented. Remember, they wanted to get money out there on the street as fast as possible. They created more money than ever before and made the single biggest purchase they had ever made: Home mortgages. But not the sub-prime ones the banks had on their books—the safe, high quality types in the form of mortgage-backed securities. But how many to buy? How much money needed to get circulated through these purchases? There was no economic theory to fall back on and they were guessing. They literally picked a big, round number, according to one member of the Fed who was there. They decided on $1.25 trillion. (I have to remind myself: A trillion is to a million dollars what a million is to one dollar.)
It took the four employees of the Fed, sitting in grey cubicles at PC’s, weeks and weeks to buy those mortgage-backed securities. Where did the $1.25 trillion come from? They made it. That is the nature of Central Banking around the world. Alchemy.
This is part of the story that I think very, very few people understand: That $1.25 trillion does NOT get added to the deficit. The federal deficit occurs when the government spends more money than it takes in via taxes. The Federal Reserve is not part of the federal government and thus has nothing to do with the deficit. But if the Fed loses money from all the toxic assets they bought from Goldman Sachs, et al, is that somehow going to come out of our taxes? No. Again, it’s not part of the federal government but mostly, the Fed, every single year, makes a profit. It creates money out of thin air and uses that money to buy bonds—which pay interest. (In 2009, at the height of the crisis, it made $47 billion.) And their profit is always turned over to the government so it actually reduces the deficit. The money created by the Fed has nothing to do with the TARP; it has nothing to do with the stimulus. Most economists would say, Thank God the Fed used their powers to do this– it kept us out of soup lines.
We have heard the opposite from the Right, and especially people like crazy Ron Paul. He thinks the Congress should be responsible for monetary policy. Can you imagine that!? His abolish-the-Fed campaign used to be ignored as whacky. Now he chairs the Committee which oversees the Fed. True, there is some truth to the claim that the Fed got us in to trouble through their policies—Greenspan is infamous for helping create the housing bubble with low interest rates. But I would take a bunch of eggheads at the Fed any day over the frothing Congress.
We are now in unchartered territories. If too many people stop trusting the Fed, they lose trust in money itself (see Brazil). Simply, we trust the Fed and other countries trust the Fed, and therefore we all trust our money. The value of our money is based on that trust—not gold, or tulips. The magic of Central Banking is it works SOLELY on trust. It is an agreed-upon fiction. Once that trust is gone, our money becomes just another stone on the bottom of the ocean.
I think that’s both very cool and very strange. Like saying to Tinker Bell, “We DO believe in fairies!”