The Story of the Community with No Money

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Imagine you live in a community with no money and you make furniture for living. Every time you want to buy something you need to exchange an appropriate amount of furniture directly or indirectly for those goods. This has a number of obvious problems.

A Mr B comes along and says he has the solution. He has produced large numbers of tokens which he has got the powers that be in the community to set as a legal tender; that is they legally have to be accepted in exchange for goods and services. It sounds great. The tokens are small and easy to carry and also unlike your furniture, everyone will accept them in exchange for their goods and or services.

You ask how do I get these tokens and Mr B explains that because you have your own place and produce something useful that can be exchanged for other things of real value that he will be happy to lend you 100 tokens. However because there is a risk that you won’t be able to pay him back when the tokens are due back in a years time he asks that you make a legally binding promise to pay him back 110 tokens when the year is up.

He explains that provided you make and sell enough furniture you should easily be able to pay him back at the end of the year. “People always need furniture” he says “and because everyone else in the community will also have borrowed tokens from me there will be plenty of tokens to go around”.

You think about this and ask the following question: “If each person in the community borrows 100 tokens and has to pay back 110 where do the extra 10 tokens each come from?

“That’s easy”, he replies “Most of the tokens you pay to me in interest, I’ll pay to the people who work for me administering the loans, and they’ll spend them into the economy. So all you have to do is produce something that they want to get the extra tokens from the people who work for me…”

You stop and think again and ask “So what stops you from producing tokens for yourself and buying up all the stuff in the community?”

“Don’t worry” says Mr B, “I can’t produce the tokens for my own use. The powers that be only allow me to lend them out. It is also of course illegal for anyone to copy them. When I get the tokens back they are out of circulation again. I can only spend the extra tokens. Well and of course the tokens I’ve lent to my wife.”

 

You have a number of other questions you want to ask, including the following:

“How do you decide whether or not you will lend out tokens to someone?”

“What happens if you suddenly decide to stop lending?”

“What happens if someone can’t pay you back?”

“What happens if you don’t spend all the extra tokens back into the community?”

“Do you lend tokens to your wife under the same conditions you lend to us?”

“Is there any way the community as a whole won’t always owe you tokens?”

 

But two other questions seem more important so you let the other questions wait.

The first is: “What determines the value of these tokens?”

“Well that’s determined by two things.” Mr B replies, “The number of tokens in circulation in the community and the number of things the tokens can be spent on, i.e. the amount of goods and services available in the community.”

“Surely Mr B,” you begin “you are incentivised to lend as many tokens as possible because you can spend the extra tokens you get back. But with more tokens circulating in the community the value of each one must decrease”

“Well,” replies Mr B “that would be the case if the number of things to buy in the community didn’t also increase. Because people have to pay back more tokens than they borrowed they are incentivised to use the tokens to improve their productivity, increasing the available goods and services. As such the tokens should only lose a little bit of their value.”

“But I want to use my tokens to make my furniture more sustainably” you say, “The number of nearby trees is falling rapidly and it seems right and sensible to spend my tokens on replanting them so the community and I have a source of wood for the foreseeable future”

“That’s absolutely fine” says Mr B “but you’ll still have to sell enough furniture to make up the 110 tokens”.

 

Not sure if Mr B has understood your concern you proceed straight to the second question: “Why do you get to control the tokens?”

Mr B seems particularly annoyed by this and responds curtly, “Because I set this up, I produce the tokens and I am the one who made the arrangements with the powers that be!”

And then you hit upon a really key question:

Why can’t the powers that be allocate tokens to projects that the community needs such as a new road? The people that build the new road will get the tokens and be able to spend them into the community. To stop the tokens losing value we can limit the number allocated according to the growth of the goods and services in the community. That way nobody owes anybody anything and we get to produce things the community needs.”

“Hah, you’ll never be able to convince people to do that” Mr B laughs, “it sounds too much like communism!”

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  • John Morrison

    I like this kind of analysis

  • RJ

    But why would people ever INITIALLY accept the tokens.

    People initially accepted tokens for a reason (and its not just because someone was persuasive or used force). What was it (people in England for example did not accept tally sticks in exchange for real goods just because the tally stick looked nice).

    These tally sticks had real value. What was it. (and there is evidence of similar systems to tally sticks using various items in many cultures including the NZ Maori).

    • John Morrison

      Simple really, human culture. You keep your eyes and ears open to what everybody else is doing. You see that they all happily accept a currency, so you accept it too. It really helps to get it started if a government can declare it the legal tender. It is like the government declaring which side of the road you should drive on, leaving the people to figure it out amongst themselves wouldn’t have been so good.

    • Dhavar

      RJ:
      You circle and circle all over again and again.You insist in a confusing term, “real value”.In a barter exchange, the value of my apples is two loads of bread. VALUE=TWO LOADS of bread.( all together the “two” and the “loads”, you can´t have value without both)
      Then apples, may be eaten or may be exchanged agaisnt two loads of bread.The first one feature let us call it “usefulnes”. And the second , “value”.
      And they both are incompatible.Either I eat my apples or exchange them.I can not do both.
      This is very important to understand.It is the cornerstone of the issue.For a merchant, all of his commodties have ONLY “value”, not usefulness.
      Then, If you agree to have a universal thing exchangeable agaisnt ALL of the other things, its very nature requires that its only purpose is being exhangeable universally (and without time limits, as theatre ticket).
      Then, it follows by necessity, since exchangeability is incompatible with “usefulness”, than such item, no matter the usefulness of the material is made of, has NO USEFULNESS,otherways it woul ceased to be money, its circulation and so its universality would cease “ipso facto”.
      It is exactly the opposite as Von Mises and other liars have presented the issue.Money requires, as “conditio sine qua non”to exist NOT TO HAVE ANY USEFULNESS, but only UNIVERSAL EXCHANGEABILITY in the society it is using it, or it would simply cease to exist.
      There has never been “commodity money”, that is an oximoron and a phallacy and a lie.A thing either is a commodity, here and now, or is money, never can be both at once.
      Example: The Austrians so much praised gold.In some communities gold was used as money and afterwards ceased to be.In others, like Rome, for the majority of its history, they use copper – and invented the expression “fiat nummus”, let money be issued by this decree-.Taken together the history of humanity, gold has played a minority role compared with other substances.
      In short: A Traffic sign derives all of is usefullness out of their meaning, conveyed in their shape, absolutely regardless of wht is made of.

    • Richard

      Should Mr B find that despite the fact that the tokens are set as legal tender by the government and accepted for tax payments people are still not persuaded to borrow them from him there is a simple option open to him. All he has to do is give a few tokens away to everyone in the community for free. Once people start using them and realise how useful they are as a means of exchange then a demand will be created for them. At this point he will have plenty of people coming to him for loans of tokens.

  • Peter J. Morgan

    One very good reason is that government made them legal tender, and also announced that it would accept them in payment of taxes.
    People in the UK may not be aware of the fact that in 1936 the New Zealand government used state credit to build state houses. This is all detailed in the book State Houses in New Zealand, by Cedric Firth. It is available on the Internet at https://docs.google.com/viewer?url=http%3A%2F%2Fwww.hnzc.co.nz%2Fresearch-and-policy%2Four-archives%2Fbooks%2Fstate-housing-in-new-zealand-section-1.pdf

    • http://www.thecommongood.info/ Dick Rodgers

      Peter
      Thanks very much for this. I would be glad to know more of this sort of thinking as you have it in NZ. Who creates our money suply is crucial and I am working on this issue and other things in the UK. Best wishes Dick

  • Dhavar

    RJ:
    Tally sticks did not have any other real value than to serve as “tokens” or money.They were not fit for any other thing, the y did not serve to be eaten, or a dresses, or to build houses.
    They have another utility, ie, serving a medium of payments and exchanges in that nice community.
    Simbols, signs – traffic signs, for example, documents of any kind – are perhaps the most useful thing created by human civilization. Wihtout signs and symbols no civilization may emerge.
    And, of course, symbols are THINGS we use to signify other things. Adn, as things, are made out on the material better suit for its specific purpose.
    For example, a token-money may fabricated in plastic, caly GOLD,SILVER,PAPER… it does not matter, such is just a technical issue (For example, vegetables do not look a fine material for making the money tokens.
    And regarding paper: Paper as we now today has been one of the greatest technical achievements humanity has been able to create.It cost hundreds of years and efforts to develop such a great material to inscribe on it the symbols of writing.
    It is of course a much more valuable material than gold or siver that only serve to produce ornaments (and fake teeth).

  • Dhavar

    Great story! Stories are much better to discuss this money issue than abstract arguments.

    But such community of the story is a bit different from ours, namely: In our societies Mr B is allowed to produce tokens NOT ONLY FOR LOANS, BUT ALSO TO ACQUIRE THINGS (Assets they call them), which is an issue that is overlooked too much frequently.
    Mr B, in our world, is entitled to produce tokens and give them to the Furniture man in exchange for a piece of his furniture business.

    • DozyHole

      Can banks really create money to buy assets for themselves?

      I would like more information on this and perhaps information about the justification, if it is true.

      • Dhavar

        Dozy:

        I can not produce the exact piece of legislation.It is a fact they are allowed to do so. And not only using the “Extra tokens”, but by producing new ones.
        But, for example, you may check a book edited by USA FED called Modern Money Mechanics, devoted to explain step by step – accounting included – the procees of banking and moeny creation.
        In such book, you will see that when they go through a concret example of the moeny creation process, they use both the loan example and the “buying assets example”.
        Is downloable in many sites on the web.For example, you may ge it on http://www.scribd.com

      • Graham Hodgson

        I think this is partly a statistical quirk. Banks’ internal operational accounts are not included in official measures of the money supply. When customers make payments to their banks for fees, charges and interest (but not for debt repayment), the payment is transferred from their deposits to the banks’ income/expenditure accounts. Their deposits, which are included in the measure of the money supply, go down, the banks’ internal accounts, which aren’t, go up. The net effect is that the measure of money shrinks. Conversely, when banks spend that interest back into circulation their internal accounts diminish (which has no effect on the money supply measure) but the accounts of the recipients of that spending increase, increasing the measure of the money supply. It appears therefore that bank spending creates money, and according to the official measure it does, but if the full accounting treatment is considered (which it must be if we are to be successful in changing this) then the money is just recirculated.

        However, that’s banks’ own-account expenditure. If a customer walks into a bank with £10,000 of UK government stock and asks to open an account, if the bank agrees to buy the stock outright (say for £9,750) then it would create a deposit for the customer of £9,750, increasing its deposit liabilities by that amount and record a matching increase in its assets. With no reduction of deposit liabilities involved, the money stock increases by the £9,750 credited. Money has been created since both the assets and the liabilities of the bank have expanded. If the bank bought the gilts from a money market institution, another bank or a bond dealer, then it would settle with BoE reserves and not by creating a deposit, so no money is created in that instance. It would merely be exchanging one asset, reserves, for another, gilts, with no effect on its liabilities.

        In general therefore, when a bank buys a pre-existing asset, if the sales proceeds are paid into a bank account held by the seller (at the same or any other bank) then money is created. If the seller’s account is with the Bank of England, then payment is with reserves and no money is created. The rule of thumb is that if a transaction increases both liabilities and assets of a bank (or of the banking system as a whole) then money is created. If it only swaps one liability for another, or one asset for another, then money is not created.

  • Matt

    RJ, I don’t believe that tally-sticks ever had real value (certainly not the ones used in England). They were a book of records, both the borrower and the lender keeping half of each tally (being identical, it ensured that the lender and borrower always agreed on the amount each lent/owed). They were used to record transaction made in the coin of the realm, which was gold. That was a token that had a real value, so the money supply could only be increased by mining or buying more gold. I believe that the story above is illistrative of what happens when you use fiat currency (e.g. a currency, like promissory notes, that has no substance like gold or silver backing it).

    • Dhavar

      What is the “real value of gold”? A material to produce ornaments.
      Everything is “real”.A sign or symbol or owrd is a real thing, much, much, much, much valuable than a mere ornament.
      Besides, whenever a piece of gold IS CHOSEN – as in the story, as the material out of which the tokens will be made ceases entirely of being just a material or an ornament. It becomnes, by virtue of a HUMAN WILL, a symbol, whose accorded meaning is: Usable as mean of payments and exhanges.There is nothing neither in gold, silver, plastic, paper, clay or whatever, that makes them naturally money.What makes anything money is the acceptance or agreement of a human group to use something, whatever it is, as the universal mean for all payments and exchanges within suc society.
      To give a thing a use and then to forget YOU gave it to such thing and start believing that is something such things posseses naturally in itself is, strcitly speaking, the mistake called in ancient times idolatry.

    • DozyHole

      “I believe that the story above is illistrative
      of what happens when you use fiat currency”

      I’m not so sure about that, the story above illustrates what happens when a private organisation is responsible for the money supply, everyone ends up indebted to that organisation.

      I believe we could have a public fiat currency which would be better for society than the current situation.

      • Dhavar

        You are right. Besides, ALL MONEY IS FIAT MONEY.Any human institution is created by a FIAT (let be).
        Paper is a commodity
        Clay is a commodity
        Plastic is a commodity
        Gold is a commodity.
        Computers are a commodity.
        Every thing is a commodity, save the “res nullius” such as the open sea and the air and strict public goods that are held by a community.
        Whta makes any commodity, whit a special form or not, MONEY, is the accorded FIAT given to that commodity by a society.
        Let us all end up with the interested Gold Phallacy or “real money phallacy!
        Which is disseminated by our dear Mr. B of the post story because he will be and is the owner and controller of such commodity.

      • RJ

        “everyone ends up indebted to that organisation”

        Everyone (or those with debt) are indebted to the holders of the credit NOT the banks.

        The banks simple managing the matching process between debt holders and the money (credit) holders.

        And this is how money started. By a seller of real goods accepting a IOU promise from the buyer to pay back the same or equivalent in the future. This promise then has value. This is why tally sticks had value. One party sold goods and held the asset half of the tally stick. The other the liability half.

        Tokens (notes and coins today) just allowed the easy exchange of credit. But credit always comes first. Even today.

        We exchange credit for notes and coins. Without the link to credit (which is always supported by debt) notes and coins would have no value.

        If a bank loans carelessly. Then the debt asset held by the bank becomes insufficient to support cash deposits. Without Govt support the deposits in this bank would become worthless or reduced in value.

      • RJ

        Dozyhole

        But that is the whole point of money.

        Barter includes exchanging one physical asset (like gold or silver etc) for another asset, goods or services.

        Money is an IOU. It comes into existence when one party does not have an asset to exchange for goods etc but another party trusts them to make good in the future. So the buyer gives an IOU promise.

        Money is called a financial asset. It has value like all financial assets because it is backed by another parties promise to make good (or accept this financial asset / liability) in the future.

        Notes and coins only have value because they can be used to wipe out a future Govt tax obligation, or can be used to buy Govt bonds. If a Govt collapses and a new Govt refuses to recognise the old notes and coins as legal tender and they refuse to allow then to offset a tax obligation. Then they will have no value. But if they can still be used to pay future tax they will have value. Maybe slightly discounted in the market but full value when paying tax.

        • RJ

          One further point

          The definition of money today is restricted to bank credit (deposits) and notes and coins. (BoE credit is the commercial banks or treasuries money. No one else can open an account with the BoE so the Govt needs to exchange BoE credit for commercial bank credit to trade with anyone else).

          But companies can sell goods for a promise to exchange for bank money in the future. This has a similar property to money but is managed by a company that sells good not the banks. (this is non bank credit).

        • Dhavar

          Dozy:
          It is astounding how the Anglo Saxon world is so much confused about basic juridical concepts, and ends up being able to tell the difference between property, credit, debt and faculty.
          Any thing may be credited to someone, i.e, a thing has to be given to another person.Romans call credit simply “res credita”(Thing given to some one that has to be given back)
          CREDIT is NOTHING in itself.
          You all think as credit as if it were a substance in itself, and IT IS NOT.THINGS CREDIT OR OWED is the real thing, with the stress, of course, upon the word THING, which is, after all, what matters.
          Next time the Bank asks you to pay 100 pounds because he has a “100 pounds credit”(right to claim the transfer of such 100 pounds property from your wallet to his wallet), agaisnt you,tell you are going to give him only THE CREDIT, BUT NOT THE 100 POUNDS.
          It is not strange, though.Our current system of private money power, was definitively set up in England by the foundation of the BoE in 1694.Since then, they, the controllers of education among other things, have done all they can to confuse and obscure as possible this monetary issue.So, you are tauhgt since childhood that there exist a credit in itsef, dettached form the the thing that is credited, and they tell you that such logical magical monster is money.

  • John Morrison

    The story, like history, leaves fiat currency and bank credit rolled together as if one could not exist without the other. That does leave the door open to confusing them with each other.

    Perhaps it should have started with the happy story of a nation that issues its own fiat currency to fund its public infrastructure. This creates an asset for the nation ( public infrastructure) and a liability on its people to pay for it (the obligation to accept the money in exchange for anything they wish to trade). This way the money is earned into existence and can circulate permanently. The obligation is fair and its is that obligation (legal tender) that ensures that it will continue circulating yet not be felt as an obligation.. Its beautiful !

    Unfortunately fractional reserve banking intruded and muddied the waters while our national currencies were severely disabled by the mistaken but almost universal belief that they should be backed by gold, even if only partially. What a mess that has made! We should never again allow those that hold gold to convince us that we have such a need for their commodity.

  • RJ

    “This creates an asset for the nation ( public infrastructure) and a liability on its people to pay for it (the obligation to accept the money in exchange for anything they wish to trade).”

    The asset is money too. If John builds a Govt building and sells it for £1 million.

    The Govt pays John for the building. So John ends up with money in the bank (£1 million). The Govt gets a new building.

    • John Morrison

      ..and now John can hold the nation to its obligation to exchange the  £1 million for goods and services – he can spend it into the economy. The nation ends up paying for its own asset. There debt side of money creation is fully expressed by the obligation of its people to accept the currency in trade.

      • Rick

        Hi John,
        It seems to me that this debt obligation is met by the taxation that occurs at every step that this initial £1 million is transacted (in VAT and business/income tax) and in consequence that initial sum is returned in total to the Government eventually in small increments. Tax is the way that the citizens of the UK meet the debt obligations of their Government spending – whether it be by bonds issue or issued/spent free of interest. It remains as a debt until such times as as the full sum is returned to the government in tax – at which point the debt is cancelled out.

        The taxes paid by each citizen/business are a deduction from their surplus production – this of course leaves them with less discretional spending power. The more we have to pay in tax to meet the government spending on our behalf, the less we have to spend on beer, fags and cinema etc. The tax rate in % dictates the speed/velocity at which the £1 million is returned to to the issuer – the Government. The lower the tax rate, the longer it remains in circulation to facilitate trade.
        This could of course be a load of cobblers ???

        • Graham Hodgson

          I find it more useful to consider that the obligation placed on the nation by the state issue of money is not an obligation to accept that money in payment but an obligation to maintain conditions such that people within the nation remain prepared to produce goods and provide services for sale, purchasable with that money. It’s a political obligation, so to organise society that the money retains its purchasing power. Taxation and debt can play a part in compelling people to engage in commodity production, in order to service their onerous demands, but there remains also just the faintest possiblity that a social order might arise in which it was pleasurable to all to produce for sale or hire. At the national level, the asset corresponding to the issued money liability is value of the future production of the nation.

      • Rick

        I might add that the Government could instead of taxing us all, they could send out the Impress Men (Press Gang) to gather up a bunch of unfortunate souls to labour as slaves on behalf of us all for the holders of the £1 million who would then pay the Government and in doing so cancel out our outstanding liability. The Government do not take this route, they just take a little from all(most ?) of us by taxation.

        • RJ

          The Govt does not have to tax

          They can fund the money to buy the £1 million building by

          -Using central bank credit as NZ DID IN THE 1940S and 1950S for example

          -Issuing Govt bonds

          Neither ever have to be paid back unless the Govt wants to for whatever reason

          Both Govt bonds and central bank credit create a new asset for the banks to hold to offset the banks customer depsoit liability.

          • Rick

            I was trying to look at the issue of Governemnt spending in a simplified form, in isolation from the rest of the money system – from that angle it appears as a closed loop as I have suggested. My aim was to try to understand how this public liability is settled and if currency debasement occurs.

            The way I see it, if tax take per month say is less than the Government spending, then the money supply will increase – to me it appears that currency dilution does occur but is of a temporary nature – it will be reversed if the tax take increases above spending (which rarely happens). It will only become debasement if the supply of resources/labour/goods is restricted – all additional money in circulation must facilitate trade additional to that which previously existed. Public liability remains until the money finally returns as tax ?

            Sorry if this complicates the real way it all works – I am just trying to get my head around it.

          • John Morrison

            Rick and RJ – The obligation of the people to accept a national currency in trade is the entirety of the debt side of the equation that facilitates its spending power to those that hold it. It is an nationally autonomous arrangement between a government and its people and does not need the involvement of private investors.

            Bonds have nothing to do with the proper issue of a national currency. For a government to issue bonds is essentially evil. It gives the government some money to spend by putting the country in debt to private investors. It is only excusable if a nation needs foreign resources in time of war or similar existential crisis.

            Taxation is an essential part of any nation that has public infrastructure. When there is a shortage of currency, taxation can be kept low or even none existent because public services can be entirely funded with the required issue of new money. As the money in circulation reaches the required quantity the issue of new money must be slowed and the funding of public services must be increasingly covered by taxation. If there is too much money in circulation and it must be reduced then some of the tax revenue can be simply annihilated.

            Rick you are right in one sense that the contract between a government to share the cost of public infrastructure through money issue eventually must become a contract of taxation once enough money has been issued. But be careful about what this means, we are only talking about a shift in how public services are funded.

          • RJ

            “For a government to issue bonds is essentially evil”.

            Govt bonds = a non Govt financial asset. These assets are held by pension funds and other investors

            Govt intereat expense = non Govt interest revenue

            So why is non Govt interest revenue and an essential asset held in large part by pension funds evil.

            For me Govt bonds are good as they are the ONLY way to generate NET non Govt financial assets desperately needed by the population as a country ages.

            And what’s more the bonds are created by the Govt at no cost. And the Govt (people) receive real goods and services in exchange for a piece of paper (a Govt bond). Without paying tax.

          • RJ

            One further comment John. Don’t believe anything deficit hawks say. They are not on the side of the average person.

            So we have the disgraceful unemployment situation (and low retirement savings) that could easily be solved with more bank credit funded by Govt debt. Preferably by large tax cuts for the lower income and higher unemployment and pensions etc.

          • RJ

            “The way I see it, if tax take per month say is less than the Government spending, then the money supply will increase – to me it appears that currency dilution does occur but is of a temporary nature – it will be reversed if the tax take increases above spending”

            Correct. More debt (Govt or non Govt)= more money. Less debt equals less money

            But also see the impact of Govt bonds below

            The easiest way to follow this is by simple double sided journals entries. Every company, bank, central bank and Govt (treasury) must produce accounts based on millions of journal entries.

            Do the journal entries for a company, bank central bank and treasury for

            Govt spending. (for one transaction)
            New bond issue purchased by a bank
            New bond issue purchased by a non bank

            For example if a Govt pays Bob £1000 for work done. Bobs banks journal entry is

            Debit BoE reserves £1000 (a bank asset / BoE liability)
            Credit Bobs cheque account £1000 (Bobs money asset / banks liability)

            I will let you do the rest. The result is surprising and very easy to follow and understand.

            And beyond dispute.

            By the way bonds purchased by a non bank decreases money (bank deposits = a bank liability) at the commercial bank and bank reserves (a bank asset). If however bonds are purchased by a commercial bank it only decreases bank reserves.

          • Rick

            RJ: I can see no problem in Pension Funds or indeed charitable institutions holding Govt bonds as that is, as I think you suggest, part of the way the future pension provision is funded – my only reservation is that it tends to benefit the higher paid who can better afford the private pension schemes. Those on low or minimum wages tend not to contribute to private schemes and have to hope that a state scheme will still exist in years to come.

            I remain to be convinced that a proportion of the productivity of the UK citizen (earned wealth) should go to banks, private investors, hedge funds etc just to make the function of Government and it’s services possible.

  • Rick

    John: “…we are only talking about a shift in how public services are funded.” Good point – the PM campaign is about changing the way Govt raises money – not how it is used after that creation. However,I believe it would be helpful – for me anyway – to have a basic understanding of the subsequent processes.

    RJ; Having thought about the requirement for taxation the following comes to mind:
    1) Taxation is a way of recycling money previously spent into circulation by Govt thus making it available again for Govt spending.
    2) This reduces the requirement to borrow new money.
    3) This must take some of the wealth of every tax payer to fund the process.
    4) Without taxation, the money supply would rise very rapidly as all Govt spending would require the issue of new bonds.

    • RJ

      1 Yes but it recycles BoE reserves. And bonds do the same thing.

      4 NO. Bonds also REDUCE or drain reserves. Do the various journal entries. It makes a difficult subject very simple to understand.

      Govt spending increase BoE reserves held by commercial banks (it is the banks asset / BoE liability) NB The BoE reserves offset the customer deposit

      Bonds and tax REDUCE BoE reserves held by commercial banks. In effect the bank either

      Swap one asset (BoE reserves) for another asset (bonds) if the bank buys bonds
      Use BoE reserves to settle with treaury if say a company or pension fund buys bonds. The bank

      Reduces (debits) the customer deposit balance (bank liability)
      Reduce (credits) the banks asset BoE holding

      • Rick

        I will have to look back at some earlier posts to get my thoughts/understanding on this asset/liability thing sorted – sorry no economics education !

        The way bonds operate within the system is I accept an important aspect of this but the main issue is the payment of interest to the bond holders. It is perhaps acceptable to some that pension funds should be able to profit from this but the idea that the private sector should gain is debatable.

        Of course, if we stick with the current system, those self same pension funds may lose much of their value anyway – depending on how this Holy Grail of GDP plays out. It appears that the Greek pension funds are about to take a “haircut” as I believe the expression goes?

      • John Morrison

        RJ – A monetary sovereign nation can, and properly should, simply spend its currency into circulation. When there is enough in circulation it must then fund its spending through taxation (recycling existing currency). No bonds required. Positive Money recognises the impact of this on pensions, a whole section is devoted to it, and recommends phasing bonds out slowly to give them time to adjust. It would be better to guarantee everyone a good state pension, we should not condemn our old people to living off the proceeds of usury.

        • Dhavar

          John:
          That is exactly the point.I think that it would clarify things very much if we stop talking about “bonds” and always talk about government borrowing money or private sector lending to the government.
          Its is a subtlety, but very important. Or, for example, reverse the wording, and, when you go to a bank to ask for a loan, say: “Hey, I´m going to issue a collateralized bond on my home.I´m here to offer you to buy it.It´s a pretty nice asset, with a 7% yield.Hurry up or you´ll miss this opportunity.

          • John Morrison

            Dhavar – I agree, you have put it very nicely.

        • RJ

          I don’t agree re higher state pension and no bonds (do both)

          It leaves people in a vulnerable position where they need to depend on taxpayers after they retire. They won’t anyway so you end up with a dog eats dog situation that we have now (some have lots of money to be secure in retirement, other lots of non Govt debt)

          It is much better for Govts to lower tax and then people can instead invest this money is Govt retirement bonds

          Simple. It gives people dignity in retirement

          More Govt bonds (from higher Govt deficits)are critically important to solve our current problems.

          Without them the future is grim.

          It’s ignorance about Govt bonds and debt that is causing all our current problems.

          Govt debt is not = to non Govt debt. They are completely and utterly different.

          One is essential and the more the better. One is OK but not too much

          We currently have too much non Govt debt. And far too little Govt debt

          • John Morrison

            You don’t want to trust your country and its people so instead you put your trust in private financial arrangements that bond your country and its people ?

            Where is the dignity in living off the proceeds of usury ?

          • RJ

            People do not trust the Govt. And maybe with good reason especially the Euro countries. But by holding Govt bonds they have a legal asset holding that hopefully the Govt will not walk away from (the disgraceful attitude of the Euro countries re Greece is not good though).

            And what is the problem with living off interest income.

            Your solution means more of the same. Many will be smashed by non Govt debt to offset the credit (money) invested in pension funds.

            Mine means dignity for people in retirement. And higher living standards for people right now due to tax decreases and higher unemployment and pensions payments. Funded by Govt bonds that pension funds can hold as hopefully a safe asset that countries will not disgracefully walk away from (as Greece might do).

  • Dhavar

    RJ:

    “Funded by Government Bonds” means: Someone lends money to the Gvt.So, in the next future, Gvt, will have to give it back plus interest.”
    There are two instances:
    a) RJ lends money to the Gvt.
    b) He who has the power to issue new money (Banks)lends money to the government.
    In both cases, since the source of money for the Gvt, is Taxes, the taxes we are avoiding today will have to met tomorrow, plus interest.

    All of this is a ludicrous situation. Because the original power to issue money lies in the society, exercised through its Gvt.
    THERE is ABSOLUTELY NO NEED to borrow, exactly like, today, any central Bank has absolutely no need to borrow money, because he is the original issuer of money.
    Why should I borrow money if I may create it?
    So, if a society regains it monetary sovereignity:
    -There is no need to borrow money at all.
    -The money created stay in the society and has not to be given back.
    -There is no need to tax a society to fund the annual payment of interests.

    We live under such a idiotic structure that is hard to believe.

    • Dhavar

      RJ:

      Then, you have to choose and cut all the sophistry and gobbledygook:

      -The State is the sole issuer of money
      -The Banks are the sole issuer of money.

      “Tertium non datur”

  • John Morrison

    RJ – To quote yourself: “Greece gave away their monetary sovereignty when they joined the Euro. And are basically stuffed now ”.

    So your pensioners made a bad bet and will now have to live on the neglected residual state pension allowance. I would like to see that allowance taken seriously and increased so that there is no need for them to gamble with their savings to extract income.

    Maybe buying bonds from a state that doesn’t have monetary sovereignty wasn’t very smart.

    • Dhavar

      John:

      No modern western State has monetary sovereignity.Period.(Well , by the way, Lybia had it )
      And, precisely, the first one that fully set up the system of giving away such sovereignity of sovereignities to a band of crooks and rogues was England in 1694, when BoE was established.
      And, unfortunately, all countries have ended up following that fraudulent system.

      • RJ

        This is not true. Any country with their own central bank must be monetary sovereign

        The BoE is the Govts own bank. The Uk Govt can spend using either BoE credit (called reserves) or Govt bonds (which are purchased using reserves) to support these Govt payments.

        Both bonds and BoE credits are created out of thin air. Both bonds and BoE reserves are held by the banks (or bonds by non banks as well) as an asset in exchange for real goods and services.

        So the people (Govt) get real goods and services in exchange for an entry on a computer screen.

        People find it hard to grasp the significance of this (although slowly more and more and waking up). The Uk Govt has all the power not the banks. They may not exercise this power fully but they clearly have it.

        The Euro countries gave away this power. And are now paying the price.

      • RJ

        it is actually a serious misunderstandings about Govt debt that cause the problems today NOT the BoE

        UK Govt debt is just a journal entry. Created as required When required

        The treasury JE is

        Debit Govt expenses
        Credit Govt debt (bonds or BoE aaa)

        This Govt debt is used by the banks initially to offset the bank deposit

        The banks journal entry is

        Debit Govt debt or BoE reserves (offsets the above aaa)
        Credit Customer deposit account (Govts pays expense)

        The BoE was set up so Govts do NOT need to get money to spend from the commercial banks. Rather Govt can get all the money they need from the BoE using BoE reserves. These bank reserves created from thin air are exchanged for commercial bank credit. These reserves are then used to buy Govt bonds

        The Euro has returned power to the commercial banks. These countries can no longer spend using central bank credit. They have given away their prosperity to bankers.

      • John Morrison

        Dhavar – You’re right. Buying bonds in general isn’t smart and issuing them is worse.

        A bond is a kind of sacred paper that says “Whatever your misfortune, you owe me, in full, with interest and on time!”. Deals with such a harsh bottom line that firmly insulate one party from the misfortune of the other belong to the criminal world. They are not honourable or practical in a society that respects human dignity and are sure to be defaulted or repudiated when misfortune strikes. A nations people are sure to cry “Allow us what we need to live first before you pay those rich bond holders, in full, with interest and on time!”. That is where we are now.

        Basing pensions on holding current and future working generations in bond bondage has been a bad adventure born of social distrust. Taxing current workers to provide good pensions for the current retired population would have been less of a burden, socially responsible and more dignified.

        • RJ

          Is this a serious post.

          Govts bonds can set people free. Without bonds Govts must always (or close to) balance their books (otherwise asset inflation will take off). This will destroy the West as the euro countries are now finding out (even Euro countries fall back on ECB credit to stop a collapse)

          Deficit hawks like you John who will not open their eyes are causing the current economic problems not the banks.

          • John Morrison

            What part do you not think is serious ?

            RJ – Deficit Hawk? I do not think we should suffer austerity to avoid borrowing. I think the nation should directly issue its own money to the extent that is necessary for the internal trading of the nation.

            RJ – Get this! When an actively monetary sovereign nation directly ussues its own money it can create it from nothing. It does not have to borrow it. It is the issuer. This kind of honest national currency does not need bonds, banks or reserves in order to be effective money.

          • Dhavar

            John:

            Yes, but not from “nothing”.Ex nihilo nihil.But from the will and acceptance of each and all the members in a society, expressed in the law, and representing all the strenght,ingenuity,human force, energy, goods and services of such society, now and in the future.Then, it is the bond that ties all that things together and make them a body politic, i.e., a human society with self governance, sopvereignity and liberty, and not a Pharaonic slave one, all servants to the caste of usurpers and robbers of the heart´s heart power of the community, the institution of money.

          • RJ

            Two points

            1 The Uk does issue its own money (BoE reserves). All monetary sovereign countries do. In effect the Govt exchanges BoE reserves for bank credit. This is done because only the banks and treasury have an account at the BoE. (If everyone had an account at the BoE the treasury would just pay people direct using BoE reserves created from thin air. But as we don’t the banks accept BoE reserves created from thin air (as their asset) in exchange for bank credit (the banks liability).

            2 Bonds are issued to stop inflation. And to pay the holders of bonds (often pension funds) a small return.

            I will post the relevant journal entries again. You can see that bonds drain either reserves or deposits ad reserves. Without bonds (a new asset) increased money from Govt spending would chase the same amount of assets = inflation.

            I can not make it any clearer. (but don’t let facts stand in the way)

            Example

            Spending of £1 million by the govt has this impact on a commercial banks balance sheet

            COMMERCIAL BANK ASSET
            BoE reserves £1 million (new BoE and GOVT debt)

            BANK LIABILITY
            Customer deposit £1 million (new money)

            ———————————————-

            Bonds then purchased by the BANK has this impact

            COMMERCIAL BANK ASSET
            BoE reserves £0 million
            Govt bonds £1 million

            BANK LIABILITY
            Customer deposit £1 million

            The bank uses BoE reserves to buy bonds

            ———————————————-

            Or if a non bank pension funds ourchases the Govt bonds instead

            COMMERCIAL BANK ASSET
            BoE reserves £0 million

            BANK LIABILITY
            Customer deposit £0 million

            The pension fund uses bank deposits to buy bonds. The bank settles with treasury suing BoE reserves

            I can’t make it any clearer.

          • RJ

            Dhavar

            “Then, it is the bond that ties all that things together”

            This is exactly what Govt bonds do. It allows Govt to spend using BoE reserves created from thin air (the Govt exchange real goods and services for BoE credit). But then issues a bond to prevent inflation (as spending increases bank deposits)and give the holders of the bond (often pension funds) a small return.

        • Dhavar

          John:

          Yes. But this another question, that affects the essence of the lending contract, any lending contract.In old times, even in the so much mercantil Geneva, to isolated one party from risk at the expense of the other was what was called properly, “Usury”, and so it was banned.
          This is an abuse, of course, and a practical derogation of one of the main juridical principles, the “rebus sic stantibus” one.
          Today, that is the system of the muslim world, by the way.A lender in a business, is also subject to risk, and so is like a preferred stock holder.

          • RJ

            Usury is excessive interest. Interest on Govt bonds are low at present

            And because Govt debt is low non Govt borrowers have been forced to take on non Govt debt due to the credit required (and not therefore available for consumption) pension savings

            So by being against Govt debt you are

            Anti non Govt financial ASSETS (bonds)
            Anti non Govt interest REVENUE (interest on bonds)
            Pro non Govt debt (often at high interest rates)

            This is great for bankers on financiers but no one else

          • Dhavar

            RJ:

            When the government receives a loan, it is not for Mr.Cameron private spending.Is money received by all the society, through Govt.Then, society also is the one that has to pay it back plus interest to the particular group within society that has been granted the power to issue money.
            Of course I am agaisnt such idiotic system.
            If a society, through Gvt, wants to create money to pay for a new road, there is no need to borrowing to nobody.It simply issues the new money.
            But if you are an idolater of the ideology that thinks that only private groups should be allowed to benefit from issuing national money, than I can not help you.
            I would understand it a bit if you were one of those persons because if the greatest privilege anybody may get on earth.But if you are not,then you have a serious problem.

          • RJ

            “It simply issues the new money.”

            It does at present. But don’t let facts stand in the way of your flawed beliefs.

            Bonds simple drain reserves. And it is the Uk Govts decision to do this and not run a BoE overdraft.

            In part to stop inflation. If you understood how everything tied together you would see why bonds are issued. (banks do not force the UK Govt to issue bonds rather than finance using reserves. But bonds are issued for sound reasons)

  • Dhavar

    Dear RJ:

    “The BoE is the Govts own bank”.
    Two meanings:

    a) BoE is just a technical department of the GvT-The State, better said- that obeys and issue Money when Gvt asks him to do it.:Hey.BoE, print 1000 thousand pounds I need to pay for a new road.
    b) BoE decides if he is going to print more money to do “open purchases” or lend or not lend to the gvt.

    If a), then your phrase is true.And then, the Gvt needs not to borrow anything, he is the original issuer.THIS IS NOT OUR CURRENT SYSTEM.
    If b) the Gvt is just a poor begger, asking for money to the true SOVEREIGN, THE BoE.And why the BoE has such original power to issue money?
    Because the stupid Gvt has donated to him his own original power and now needs to beg for money instead of simply ripping of from the hands of the Bank such absolutely undue power.

    You really have such a mess!

    • RJ

      The UK Govt is the initial issuer. The govt has made a decision to issue bonds and not run a negative BoE balance

      But all this does is exchange BoE credit (reserves) resulting from Govt spending for Govt bonds

      Example

      Spending of £1 million by the govt has this impact on a commercial banks balance sheet

      COMMERCIAL BANK ASSET
      BoE reserves £1 million (new BoE and GOVT debt)

      BANK LIABILITY
      Customer deposit £1 million (new money)

      ———————————————-

      Bonds then purchased by the BANK has this impact

      COMMERCIAL BANK ASSET
      BoE reserves £0 million
      Govt bonds £1 million

      BANK LIABILITY
      Customer deposit £1 million

      The bank uses BoE reserves to buy bonds

      ———————————————-

      Or if a non bank pension funds ourchases the Govt bonds instead

      COMMERCIAL BANK ASSET
      BoE reserves £0 million

      BANK LIABILITY
      Customer deposit £0 million

      The pension fund uses bank deposits to buy bonds. The bank settles with treasury suing BoE reserves

      I can’t make it any clearer.

  • Dhavar

    “The UK Govt is the initial issuer. The govt has made a decision to issue bonds”.JA,Ja,JA…this is great indeed!

    Next time I go the bank to ask for a morgage I´m going to tell them:
    See guys, don´t you get it wrong.I AM – and not you poor folks- the one who is issuing this money, because I am writing this marvellous mortgage Deed that give you the right to claim back agaisnt me the money received today plu the interests on that money.
    And folks, Of course I am not going to pay you back neither the principal nor the interest because I am giving you today this great “asset”, this fantastic “bond” of my mortgage Deed.Who needs money when it can hace such a great document “promising money”?

    Whta a nice idea you have gave us poor indebted folks!

    RJ: I think you should better understnad first what a loan contract is before trying to grasp this issue.

    • RJ

      You are confusing Govt debt with NON GOVT DEBT

      GOVT DEBT IS COMPLETELY DIFFERENT TO NON GOVT DEBT

      But only for a monetary sovereign nation. The Euro countries have given away their most valuable asset and is now on a similar position to a US state. Or a company. Or an individual.

      They must now get money from the banks or market. The bansk control these countries now and can charge high interest rates on Govt borrowing

      Until you understand the difference you will continue to form badly flawed opinions about Govt bonds and the banking system and how it all fit together.

  • Dhavar

    RJ:

    Please enlighten us: What is exactly the difference between a loan to the government and a loan to …whomever different than the State?
    You should notice that both are loans, by the way…

    • RJ

      Look at the journal entry above

      The banks must accept BoE reserves when the Uk Govt spends money. They have no choice

      Reserves pay 0% interest

      With anyone else in the UK THE BANK DECIDES IF THEY LOAN MONEY OR NOT. AND AT WHAT INTEREST RATE

      The Govt is the top dog in the Uk not the banks. Central bansk give the Govt the power whereas without a central banks the banks (and markets) call the shots.

      And it has been this way especially since 1971 when the gold standard was removed.

  • Dhavar

    What a stupid “top dog”! That needs to beg for money that could issue himself with out having to give it back plus interest to the lender!
    I´m not going to insist.I know this the dirtiest little secret of England history, that required to put in the throne of England a foreign dinasty – the Orange house-, to allow a bunch of “financiers” aristocrats -rogues and crooks indeed-allied with the Venetians – they were called in fact the Venetian Party -,to be the real masters of the nation making a mockery of the English liberties and rapidly engaging in the “Empire” expansion.
    It is so funny that the first modern nation that surrender its sovereignity to the “banks” now looks in disdain to the EU nations saying, Oh, they have surrender their sovereignity to the European Central Bank. Marvellous! Fog in the Channel! The Continent isolated!

    • RJ

      But they do not have to beg for money. The UK Govt pay their expenses using BoE reserves
      (banks must accept BoE reserves as an asset and pay people or companies which is the banks liability).

      The banks then use these SAME reserves to buy Govt bonds. We could argue about what comes first (spending or bonds) but it is irrelevant.

      I know you want to believe evil bankers rule the world and Govts must kiss bankers feet to get money.

      And for Euro countries it does work a bit this way. But not for monetary sovereign countries like the UK.

      Sorry to disappoint you. The current problems are due to Govt incompetence (especially countries that joined the Euro) not the banks.

      • Dhavar

        RJ:
        It is so much curious.You always ommit the crucial step, that of money creation.BoE Govt Reserves is simply a bank account whose holder is the Government, hence the whole nation, and government acts as the manager.
        How do money enter this account? (Let us put aside now taxes, etc. because that is money passing from one hand to another, and what we are interested in is in the creation process)

        You say that when Gvt. “issues bonds”.That means the the Gvt writes on a piece of paper a promise to give back in the future a certain amount he now receives FROM THE BOE, plus annual interests.That is simply a loan contract. Then, the BOE, writes, by clicking in their PC Enter Key XXX pounds to the Gvt account.
        You are implying that the BOE can not refuse to lend to the GVT. I do not know if that is the case in UK, allthough I doubt it a lot.
        But the important thing is:
        a) It is the BOE the one that creates the entry on the GvT account in the BOE.
        b) The Gvt is in a very strange situation, he may oblige always – you said it- the BOE to lend him – that is to lend to the whole nation.
        c) Then all reserves, ie, Gvt Account in the BOE, since they are created by issuing bond, are created by a loan contract.That reserves will have to be give bak, and annually interests should be paid.

        Then we do agree on the structure of the process.But I find it idiotic that the BOE , a supposed part of the State, is the only one able to originally make the “enters” in the GVT account.By lending to “himself”,through another Gvt Branch, such stupid Gvt , by such a system produces a situation in which:
        a) Each pound created of the national money held in the BOE Gvt account (reserves)should be given back to the BOE.
        b) Each year interests should be paid to the BOE.
        c) Then the GVT must tax aditionally its own people to get the principal and the interests, whic cause such a drain of national resources.

        It is simply idiotic, because it was founded by a trick, namely when a group of whigs loaned to William III of Orange Nasau 1,200,000 pounds to finance wars agaisnt France,with 100,000 pounds interests annually, they received in exchange something that hitherto had not existed before in no part of the world, namely:
        -The right to issue legal tender notes
        -The setting up as collateral to assure the payment of interests and principal the WHOLE required TAXES of the English Kigndom.

        By the way, that same group of whigs were the same that helped to bring William III to the English Throne, in a coupd d´etat called so humorously “Glorious Revolution”.

        • RJ

          “c) Then all reserves, ie, Gvt Account in the BOE, since they are created by issuing bond, are created by a loan contract.That reserves will have to be give bak, and annually interests should be paid.”

          No. Reserves are created by the Govt spending money. Or the banks going into overdraft with the BoE

          For the banks to buy bonds. They must have reserves first

          So reserves equals the BoE’S LIABILITY which is the banks or treasuries ASSET (banks use this asset to buy bonds which si another asset).

          Just like the bank and us

          Our MONEY is our asset. But it is always the banks liability

          Money is just a financial asset. A financial asset is always supported by a financial LIABILITY.

          The BoE is the commercial banks and treasuries bank. If we all had an account at the BoE then commercial banks would be unneccesary

          In some ways the BoE is just a clearing house between the banks, treasury (and the mint)

          -If the treasury spend money

          The banks reserves increase
          The treasuries reserves decrease

          -If the treasury collect tax

          The banks reserves decrease
          The treasuries reserves increase

          -If the treasury sells bonds

          The banks reserves decrease
          The treasuries reserves increase

          -if the mint issues cash to a bank
          The mints reserves increase
          The banks reserve decreases (they hold notes and coins as an asset instead)

      • John Morrison

        I think the problem is an unholy alliance between corrupt incompetent government and the evil side of banking.

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  • Mr M Dawson

    When we talk of the banks creating money we ignore the mortgage payers who are creating money they don’t have to pay for their house on a promise to pay in the future. In doing this they are getting possession of an asset which will appreciate to many multiples of it’s present value.One solution might be to tax on house sale or inheritance after taking normal depreciation into account.
    A government bond which is not repayable would gain by being continually eroded in its value by depreciation but still desireable in giving a reasonable income. For pension purposes government bonds paid for by pension contributions which represent only a small share of present income could not fund up to 40 years of pension as a percentage of fnal salary and certainly not index linked pension.
    .

    • SilverSmith

      Do explain to me why the house asset will “appreciate to many multiples of its present value”.

      …and the mortgage payers do not create the money, the lender creates the money (albeit at the payer’s request) and the payer borrows it.

  • T.H.I.K.

    The Aztecs had the, at the time, most advanced civilization of the American continent, with a national system of defense, education, health care, infrastructure, etc. Still, they had no money, as we know it. Just saying.

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