Money is debt. Yes, I know that sounds weird, but the tenner in your wallet may be an asset to you, but it’s a liability to the Central Bank of whatever country you happen to live in. Now it used to be in some countries you could swap your banknotes for a fixed amount of gold. There are reasons, that I’ll tell you about in a minute, why you can’t do that any more. So what makes our money……..money? The simple answer is that it’s money because the government says it is. The whole game is played with mirrors. Remember a few years back the banknotes used to say “Promise to pay the bearer on demand…….” If you take in your tenner they’ll give you another one in exchange. Eventually someone realised it was a bit silly so they don’t say that anymore. Money has value because of 1) its general acceptability and 2) its relative scarcity compared to the demand for it.
Now about the gold standard. It used to worry people that paper currency had value just because somebody said so. What was to stop governments printing and spending money at will, creating runaway inflation? The gold standard required governments to keep a reasonable fraction of their currency liabilities as gold. The central banks could create currency liabilities (ie print money) up to a certain multiple of its gold reserves. Gold coins used to circulate as part of the money stock.
But the gold standard had two huge unintended consequences. Firstly, it removed exchange rate risk across national boundaries (of the countries using the gold standard), facilitating massive lending based on the confidence that the debts would always be repaid because they were backed with gold. Secondly, any variations in the quantity of gold held by the central banks had an exponential effect on the money supply. This was ok when confidence was high and people were happy to hold bank deposits and paper currency. But during the Great Depression people became frightened. and tried to switch their assets into safer forms. Foreign holders of US dollars were particularly anxious to swap them out for gold, especially after Britain suspended the convertability of the pound into gold in 1931. As the gold reserves declined, the monetary system came under strong contractionary pressures, exactly what it didn’t need at that time. The gold standard was abandoned soon thereafter. In the words of British economist DH Robertson: The value of a yellow metal, originally chosen as money because it tickled the fancy of savages, is clearly a chancy and irrelevant thing on which to base the value of our money and the stability of our industrial system.
What I’m taking a long time to get to here is that we find ourselves in an eerily similar situation today. We have a strong creditor nation lending across national boundaries with no exchange rate risk, with the expectation that the loans will be repaid because, even if there was a crisis, the euro would be sacred in the minds of European politicians. The “credibility” of the system has to be maintained at all costs. So as our debts mount, we are lent even more money so we can pay back the earlier loans. At the same time, we are being told to cut back on spending at the very time when we should be doing the opposite.
Let’s be clear on something. These bailouts are not bailouts of the Irish people, or the Greek people. They are bailouts of the French and German banks who lent recklessly to us during the boom. Now you, the people, are being asked to shoulder the burden of the risk that should belong to the banks. At the same time you are being told you have to do this to maintain the credibility of the system, which all the while becomes more and more incredible.