What is money? Or why bankers handing out cash makes us poorer

English this week. And a note in advance. All English posts will deal with broad macro, airy fairy thinking that I can’t do in Italian. Be warned and don’t expect precision.
So this is my attempt to try to clarify what money is and how playing around with it will have an effect on our lives. Well, obviously it will because we all need money. But, importantly, not like we need food and shelter. Since even without money we can all survive if we use a form of barter to exchange goods and services directly. So far, so very medieval. So how does bartering work and why is money better?
Let’s barter. I produce carrots, you produce chickens. We swap 20 carrots for 1 chicken. I’m happy, but you actually only want the carrots to swap with the shop to buy fertiliser and milk. Where 1 bag of fertiliser costs 40 carrots and a pint of milk costs 3 carrots. But you can also exchange chickens. And the shopkeeper is willing to give you 1 bag of fertiliser and 1 pint of milk for 2 chickens because, while we were trading, he’s discovered he doesn’t need the carrots for the post office’s horse as he doesn’t need to send a letter anymore. So you’re left with the 40 carrots, which now need to find a home otherwise they’ll go mouldy. Is this rapidly becoming complicated? I hope so. In such a situation, there are multiple exchange rates and there’s also the problem of dealing with, for example, chickens being indivisible into smaller units of exchange (at least while they’re alive) and the fact that carrots go mouldy if you don’t eat them fast enough. Money overcomes these problems by being accepted as a recognised medium of exchange and providing a store of value. Why was gold used as the original form of money? Because it doesn’t change or rust, unlike iron, so you can be sure that in a year’s time your gold will be as it is now. And the person who accepts your gold can also be sure of this.
(This is a link to an article on stone money - http://en.wikipedia.org/wiki/Rai_stones the history part is very informative)
Importantly, for money to be a store of value, it also needs to be difficult to create, which is why gold, and stone in the example above, has always been useful since mining for gold requires considerable effort.
Unlike now when we have a fiat currency. Fiat is a Latin word and means let it be and in this case the value of the currency derives from the fact that a Government or Central Bank decrees it has a value. Here the problem begins. Because the banks have no limit on how much money they can print if they so desire. Zimbabwe recently is a very good example of what can happen when the central bank prints so much money that everybody becomes a multi-trillionaire. Everyone’s so much richer, yet so much poorer. The actions of the Bank of England, Federal Reserve, Bank of Japan and European Central Bank over the course of the last year are the same as those of the central bank of Zimbabwe, though on a lesser scale. Lowering interest rates, quantitative easing and lowering collateral requirements for lending to the central bank all serve to increase the amount of money in circulation, ceteris paribus. The idea is that a bank which is earning a return of 0 on its cash holdings will do something with the money and a saver who has cash in the bank will spend it since it is providing no return.
(Quantitative easing is the creation of money by a central bank and then using it to buy bonds held on a normal bank’s balance sheet. The bank now has cash instead of assets and can use this cash to make more loans or buy other assets.)
So what’s the effect so far? Well, the banks are doing something with the money. They’re buying any liquid asset in existence. Commodities, bonds, stocks, anything that will provide a return and whose value is not dependent on decisions taken by the central banks. But broadly they’re not lending to businesses or consumers. Because consumers aren’t taking their cash out of the bank and businesses aren’t looking to invest.
Because there’s a point which the central banks have overlooked which is that flooding the system with money as happened in Zimbabwe makes certain assumptions about the health of the system, its ability to invest that money productively and the desires of the consumer which have not been satiated. I want to emphasise productively and not satiated. The policies we’re seeing now come at the tail end of a bubble that has lasted 11 years, if not longer. The response by the Federal Reserve at every juncture (and the British and European Central Banks at quite a few) has been to lower interest rates and encourage the status quo to continue. This means the system has been increasingly biased towards consumer spending in general, and particularly on cars and housing as well as on goods of increasing luxury and decreasing necessity. In part the reason the central banks are not having any success is that the consumer realises that there is little more to buy, that more debt is unsupportable and that the businesses which have grown up around this consumer need to rebalance in favour of… What? This is partly the problem. Nobody seems to be quite sure where they should be investing next. Only that there are more than enough houses in the world, more than enough capacity for cars, luxury shoes, TVs and electronic goods, but not enough capacity for…
My theory, working on a elaboration of something I read on a site (www.minyanville.com not bad for an overview of US markets) is not just that we’ll become more interested in the immaterial pleasures rather than the material, but that this also involves a focus more on the local than the global and more on education and the community than has been the case in the past few years. This is likely to happen partly as a function of necessity as people become relatively well off as the rise of the emerging markets means there will be more competition for material resources and the system we have created suffers from the dislocation necessary to rebalance. This dislocation is necessary to change people’s perception of success and the material rewards inherent from that success. Because the brain drain to the banking, finance and associated sectors that has been created by the central banks and governments continually emphasising the success of these sectors is most likely what will be very damaging for our future prospects. And sure the governments and central bankers have resolved the short term problem of do we have enough money, but they haven’t solved the long term problem of what we do with it, whether it is productively invested or not and therefore whether it makes us richer and better off. It’s not the amount of money we have that makes us wealthy but how much we have spare. Banking, law and finance currently seem to be the best places to invest for one’s future success which, as a contrarian play, probably means the best thing to do at the moment is to become a farmer. Just about the least sexy job there is, so probably where there’s most money to be made.
And where does one invest in this scenario? In oneself is one answer, though, as above maybe not in the skills the world currently thinks are most rewarding, in cash is another and then I think I’m looking at companies that enhance efficiency and that will help with delivering the immaterial. Which is why I’m still fairly keen on the long telecoms companies/ short motorways and airlines trade, for a world that’s delivering more bytes and fewer goods over a long distance.