A look at the way money runs our lives.
I'm writing this article deliberately from the point of view of someone living in the UK. There will be a piece appearing in the near future talking about the content of the film “Zeitgeist: Addendum”, which is mainly about the monetary system in America.
My investigation begins with the recent story from Mervyn King that inflation is likely to stay at 2% or above for at least another two years. You can read the BBC's account of the story here: http://www.bbc.co.uk/news/business-21440080.
Now, what exactly is inflation?
Well, as far as I can tell, inflation is a measure of the rate of increase in prices. The internet tends to give the system the benefit of the doubt by calling it the rate of change but let's be honest: prices never go down, do they?
So, essentially, studies are done to find the most commonly bought day-to-day items and their prices are compared to what they were a year ago. The average increase on last year's prices are approximately the rate of inflation. The Bank of England likes to keep it to below 2% but lately it's been closer to 3% and is likely to stay there.
But why do prices go up? Well, the business world is run on growth. Whether you've heard it put this way before or not, I hope you'll recognise the truth of it: if your business isn't growing, it's dying.
Businesses can 'grow' in any number of ways: size of factory, number of staff, number of customers, output and so on. In any one of these cases, money is needed to accomplish that growth.
Just as a brief insert: why do businesses have to grow? Well, businesses have to grow so that profits can go up so people can be paid more each year because of inflation.
Now, where do businesses get this money to invest in future growth? Well, there are two ways: the money they already have, or a loan. Most times, businesses have their money tied up in the business already – their 'assets' tend to be things they already own, rather than loose cash, so to speak. In theory they could free up cash by selling their assets but that would more than likely impede growth in and of itself.
Either way, sooner or later the economic climate or industry trends dictate that a loan will be needed in order to fuel continued growth.
This is where it gets especially interesting.
There are plans in the ether to require banks to hold a minimum of 60% of their outstanding loans in cash. I haven't gone to the trouble of finding out what the previously stipulated amount was, but let's look at it logically.
No matter what the amount is, the system allows for banks to lend money that they don't actually have. If you've watched the film, “Zeitgeist: Addendum”, you will know that in 1969 a US citizen named Jerome Daly won the right to keep his house despite not being able to keep up the payments on it because the money used to buy it had not existed until the bank loaned it to him.
There's a gaping great hole in the system right here, an unbelievable paradox.
Based on my investigation so far, it seems that the creation of money from thin air is perfectly acceptable, but its destruction is not. i.e. Banks and governments can create money from nothing, but if they suddenly find themselves in need of money and enough of their customers/people cannot repay their loans, there is an enormous problem.
Even with the amended requisite level of 60%, there may well come another time when banks are suddenly without money and so are their customers, leaving the banks (and from thence, the economy as a whole) in free-fall.
Additionally, of course, banks charge interest on this non-existent money. That stands to reason, after a fashion. Within the scope of loans only, a bank has to charge interest in order to make money on that line of business. The base rate of interest is set by the Bank of England again, but there is no upper limit (hence the 4000% APR of Wonga.com!)
That brings us approximately up to date, except for one thing: quantitative easing.
In a recessionary phase, such as we are currently in, the goal of the system is to start rebuilding the economy through the kind of buying that is monitored to calculate inflation – that is, the day-to-day shopping activities of the general public.
The most effective way of doing this, generally, is to lower interest rates. This way, people don't have to pay so much interest on their loans and this frees up more money for them to spend.
However, in a particularly bad recession, like the current one, this isn't enough to get the upward trend going again so the Bank of England uses quantitative easing.
Quantitative easing basically means adding more money to the system – usually to buy assets like government bonds. In other words, the Bank of England creates money out of thin air in order to invest in the government (via the selling institutions, who initially gain from QE).
The problem is – and this point has been made by experts despite arguments to the contrary – QE is basically like printing money (even though it is done electronically). Anyone that has studied history will know that this is what was done in Germany in 1923, resulting in hyperinflation (to the extent that the cost of a cup of coffee, for example, would double between ordering it and paying for it).
To my mind, printing new money must account for some inflation anyway since more of it is printed each year because loans and interest demand it. To be clear: at least some loans represent previously non-existent money and the interest to be paid on them represents further 'new' money.
As it pertains to the UK at the moment, QE seems like a glaring paradox to me.
In terms of money markets (i.e. buying and selling currencies) the relative price of a currency is dependent on demand, not supply. But as with any commodity (whether it's money or a bag of crisps), the more of it there is, the less it is worth – that's why the diamond market is so strictly controlled: if all the diamonds in the world suddenly flooded the market, they would become worthless and a number of sickeningly rich Belgian diamond traders would be bankrupt.
If the same rule applies, then QE actually devalues the currency it's applied to, whether it's electronic or not.
Moreover, according to the simple guide here: http://www.bbc.co.uk/news/business-15198789, the Bank of England creates this money simply by crediting its own account.
The money the Bank of England disperses into the economy through buying bonds, for example, is in turn used by the other institutions for further investment or to lend to individuals.
In other words, the money that we ultimately end up owing back to the bank has come from nowhere.
In the long-term (the seriously long-term, perhaps), the Bank of England will sell the government bonds back to the original seller and destroy the money it created, thus rebalancing the system.
In the shorter-term, however, QE has already been cited as one of the major reasons for the pensions crisis.
Final-salary pension schemes are calculated on the assumption that all the money was invested in government bonds (because they are so safe – governments very rarely go bankrupt). But because the Bank of England has bought up so many bonds for the purposes of QE, the return on such bonds has significantly decreased.
This means that more is needed to make up the shortfall for the pension payouts. If this problem can't be corrected, employers will have to make up the shortfall (peaking in May 2012 at over £300bn). In the meantime, pension payouts will be much lower than planned/needed by those going into retirement and in certain circumstances they will not get the money back at all since a number of private pension schemes have collapsed entirely.
Incidentally, as of September 2012, £375bn was the amount committed to QE by the Bank of England – an interesting correlation with the pensions shortfall.
So the situation, it seems to me, is that we pay interest on loans made up of money that doesn't exist in order to normalise an economy that has robbed us of any financial security at every stage of life between the cradle and the grave.