Articles in Monetary Literacy 101 by Bernard Lietaer

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What is money?

Most people tend to regard money as “a thing” because that is usually the way it appears to us (as paper, coins, checks, credit cards etc).  And yet, stranded on a desert island, we would quickly discover that while our knife remains useful as a knife, whatever cash or checks we carried would now be totally useless.  It would remain paper, but it would no longer be “money.”  For any “thing” to act as money, it requires a community to agree that a particular object has a certain value in an exchange.

Money can be defined as an agreement, within a community, to use something as a medium of exchange.  As an agreement, money lives in the same space as other social constructs like marriage or lease agreements.  These constructs are real, even if they only exist in people’s minds.  The money agreement can be made formally or informally, freely or by coercion, consciously or unconsciously.  Most of us do not consciously agree to use U.S. dollars, euros, or yens, for instance, nor do we consider their nature.  We just use them, unconsciously entering into an unspoken agreement with our banking system.   Any monetary agreement is only valid within a given community. Some monetary agreements are operational only among a small group of friends, like chips used in card games; for certain periods, like the cigarette medium of exchange among front-line soldiers during world war II; or within a larger community, like the citizens of one particular nation.   A community can be geographically disparate, such as Internet users, or can include large segments of the global community, as in the case of the U.S. dollar in its role as international reference currency.

The key function that transforms the chosen object into money is its role as medium of exchange.  There are other functions that today’s money tends to perform, such as unit of account, store of value, tool of speculation, and so on.   However, these other functions may be considered secondary, as there have been effective and functional currencies that did not perform some or any of these other roles.

In summary, the magic of money is bestowed on something as soon as a community can agree to use it as a medium of exchange.  Our money and monetary system are, therefore, not de facto realities like air or water, but are choices, like social contracts or business agreements.

“Money” is used throughout this work as a generic, overarching term.  Specific types of money are referred to by the term “currency.”   There are two general subcategories of currencies: national currencies and complementary currencies.  We are accustomed to considering only our national currencies as ‘real’ money.   However, national currencies have been designed for specific purposes only, and cannot fulfill certain social objectives (such as fostering trade and cooperation, or ecological sustainability). Some currencies already operational today or being proposed for the future are designed to fulfill such objectives, and operate best when they are used in tandem with the national currencies.

Why is it important to understand that money is not a thing, but an agreement?

If we regard money as a thing,  it becomes a given, and we lose our ability to change it in any way.  We are treating money as if it is God-given, like rain or the number of planets in the solar system.   But it is not a given.  If you don’t like the quality of rain, you cannot do much about it. If you don’t like your money system, on the other hand, you can do something about it.   When we understand that money is created by a set of understandings and practices, we can begin examining the terms of these agreements to see whether they actually serve our collective aspirations and objectives.  Currencies can be redesigned to better meet our needs.

Bernard Lietaer on the definition of money

Who creates money?

Contrary to popular belief, governments do not create money in our current system.   As a matter of fact, whenever the revenues generated by taxes are inferior to their outlays, governments have to borrow money from the general public through the bond market, or through the banking system.

Money is actually created by the banking system. A country’s banking system includes the banks themselves and the central bank that supervises the banks incorporated in its jurisdiction.   In the case of the US, the central bank is the Federal Reserve Bank.

In essence, new money is produced each time a new loan is approved by the banking system either for the private or the public sector.  It is called fiat money because it is money created “out of nothing”. Since only a small part of the money is drawn from bank deposits (typically less than 10%), the balance (more than 90%) is created through the fractional reserve system.  This means that only a small part of the money lent originates from the reserves of the bank.

What are the main characteristics of modern national currencies?

National currencies

  • are geographically attached to a nation-state
  • are chosen by a central authority when it declares that something is the only medium of exchange acceptable in payment of taxes (the only valid “legal tender” for all private and public debts)
  • are “fiat currencies,” created by bank debt, and issued in scarce supply as “debt money derives its value from its scarcity relative to its usefulness” (Jackson & McConnell Economics.  Sydney: McGraw-Hill, 1988.)
  • and bear interest, a feature which in turns:
    • creates structural competition between participants (see the story of The Eleventh Round) and
    • encourages short-term planning via “discounted cash flow”

Effects of national currencies:

  • they bolster national consciousness by facilitating economic interactions with fellow citizens rather than with foreigners;
  • they encourage competition and facilitate concentration of wealth (which was key to catalyzing the industrial revolution)
  • they have proven flexible enough to be adopted by all countries (including “communist” ones), independently of political context;
  • they have attracted sophisticated financial services and institutions; and
  • they are legal tender for all debts public and private.

Shortcomings: here is an overview explanation of the problem with modern national currencies.

What are the three main effects of interest-based currencies?

Until the 16th Century, Western Civilization prohibited the practice of charging interest on money on both moral and legal grounds.   In our modern monetary system, however, money is created by banks through loans issued with interest.   Though the full implications of the loans that create our money are seldom understood, their effects upon society are pervasive and powerful.  Three consequences of interest as a built-in feature of our monetary system are that (1) it encourages systematic competition among the participants in the system; (2) it continually fuels the need for endless economic growth; and (3) it concentrates wealth by transferring money from the vast majority to a small minority.

  • Encouragement of Competition –  When a bank creates money by providing you with, say, a $100,000 mortgage loan, it creates only the principal when it credits your account.  However, it expects a return of some $200,000 over the next 20 years or so.   The bank does not create the interest; it requires you to earn this second $100,000 through your interactions with others.  So, how does a loan, whose interest is never created get repaid?  Essentially, to pay back interest on a loan, someone else’s principal must be used.  In other words, not creating the money to pay interest is the device used to generate the scarcity necessary for a bank-debt monetary system to function.  It forces people to compete with each other for money that was never created, and penalizes them with bankruptcy should they not succeed.   The story of the 11th round illustrates the way interest is woven into the fabric of our monetary system and how it stimulates competition amongst its users.
  • The Need for Endless Growth – The main simplifying assumption of the “eleventh round” story  is that everything remains the same from one year to the next.  In reality, we do not live in a world of zero growth in population, output, or money supply.  The real process involves growth of all three.  The monetary system just takes the first slice of that growth to pay for interest.  In agrarian societies, one customarily sacrificed to the gods the first fruits of the harvest.  Now, instead, we give the first fruits of our toils to the financial system. In real life, population, production, and money supply all grow at different rates from year to year, making it much more difficult than in our eleventh round story to notice what is actually happening.  The monetary system acts like a treadmill, requiring continuous economic growth, even if the average real standard of living were to remain stagnant.  In short, the interest rate determines the average rate of economic growth needed to remain at the same place. This supposed need for perpetual growth is another fact of life in our modern societies.   This monetary system was created during a time in which nobody recognized any ecological or other constraints for indefinite and compulsory growth.
  • Concentration of Wealth – A third systematic effect of interest is its continual transfer of wealth from the vast majority to a small minority.  The wealthiest receive an uninterrupted rent from whoever needs to borrow to obtain the medium of exchange.   Interest by definition is a process that transfers money from people who don’t have enough of it (and therefore have to borrow it) to those who have more than they need (and who are therefore able  lend it).

Conclusion: The three main effects of interest (competition, the need for perpetual growth, and unrelenting wealth concentration) have been the hidden engines that have propelled us into and through the Industrial Revolution.  Both the best and the worst of what the Modern Age has achieved can be directly and indirectly attributed to these hidden effects of interest — the apparently benign feature of our prevailing monetary system.

What are complementary currencies?

Complementary currencies are agreements within a community to accept something else than national currencies as a means of payment.  They are sometimes called community currencies, local currencies or “common tender.”   Not all these common tender currencies are local, however, and some have purposes other than community building.   Because they are designed to function in parallel with conventional money — not replacing but complementing national currencies–we will use the terminology of “complementary” to describe them.

New monetary innovations are now being crafted and used by an ever-growing number of communities worldwide to address a wide array of different social and economic mandates: from effectively caring for the elderly in Japan, to urban renewal in communities like Curitiba or Palmeiras in Brazil, providing new jobs and significantly raising the standard of living in communities, all without incurring costs to government or industry.   The potential and adaptability of social currency innovations are part of the shift from the Industrial Age to a Post-Industrial or Information Age.  Most of them would not have appeared without cheap computing power becoming available. This also explains their impressive growth from a handful to thousands such currency systems worldwide in the past two decades.

Mounting evidence from these practical experiments in diverse communities around the globe demonstrates that complementary currencies can have significant positive impacts on communities that use them.   These new kinds of currencies are addressing critical social problems for which conventional money has proven inadequate such as the erosion of community, ecological deterioration, the need for elderly care, and much more.

What is the Problem with our Current Money System?

Our modern monetary systems share in common the fact that they consist of a nationwide, government-enforced monopoly of a single type of currency, created by banks through loans attached to positive interest rates, and naturally or artificially kept scarce.   While these particular features of our money system have permitted the accumulation of capital that enabled rapid industrialization during the modern era, they also have a number of hidden but far-reaching counterproductive side effects.

The use of positive interest alone is responsible for driving (1) the short-term thinking that drives our economic decisions, (2) the relentless pressure for economic growth which feeds hyper-consumerism; (3) growing inequities; (4) the greed and rampant speculation which regularly make the front page of our media, (5) and the weakening of social ties and erosion of community.   I have written more at length about these dynamics in my books, articles, and interviews, but I invite you to read a brief overview of the main effects of interest to understand how our national currencies generate competition and erodes community.

From Monopoly to Monetary Ecology.  To be clear, the problem is neither our national currencies nor the use of interest per se, but the monopolistic use of these types of currencies which are only well-suited for certain purposes but not for others.   The fundamental problem with our current monetary system is that it is not sufficiently diverse, and as a result it dams and bottlenecks our creative energies, and keeps us trapped in a world of scarcity and suffering, when we actually have the capacity to create a very different reality.   Our conventional money facilitates particular types of (commercial) flows but does not adequately support other types of flows within communities.   When a broader spectrum of currencies is in place, people can complete more transactions, enabling more people to meet their needs and enter into exchange relationships.  Because complementary currencies do not bear interests and are issued in sufficient supply, they encourage cooperation amongst participants, and can counterbalance some of the side-effects of conventional money.

Biologist Elizabeth Sahtouris once asked: “How would a body survive if we decided that all the blood should go to the brain or the liver, or certain organs should only be irrigated with blood on certain conditions?” This is precisely what is happening to our world economy under a monoculture of national currencies that are distributed based on a centralized decision making system controlled by a few financial institutions.  All the blood (dollars, euros etc.) is being sent to specific organs that are supplied while others (communities and regions) are often starved to death.  When they are not properly counterbalanced by complementary currencies, national currencies promote embolism (which is the accumulation of blood in one place).

Adopting a diversity of currencies is just as important to human survival as bio-diversity is to the fate of the earth.  This is not a metaphor. Our peer-reviewed scientific research on the conditions under which  complex flow networks are sustainable demonstrates that money systems share with natural ecosystems the need for a higher diversity and interconnectivity.  The conclusion: to ensure such diversity, we need to actively support the circulation of different types of currencies for different types of purposes.    Promoting a healthier monetary system requires the use of three different kinds of currencies alongside our national currencies: (1) an inflation-proof global complementary currency designed to stabilize the world economy;  (2)  business-to-business currencies designed to counteract the effects of conventional money shortages during periods of economic crises and  contraction; and (3) community currencies that address a variety of social problems and strengthen the fabric of society.

Revising our agreements around money.  Most of the fundamental rules and agreements we have around money were created centuries ago, at a time that was widely different from ours, and by a small group of stakeholders concerned with a narrow set of interests.  As a consequence, they are ill-equipped to serve the challenges and objectives of our current world.   As long as our monetary system remains a blind spot to us, we remain unable to alter its powerful influence on the way we think and act.  As soon as we gain monetary literacy, we can begin examining the nature and implications of the monetary agreements in which we unconsciously participate.  We can start identifying the conditions under which they serve or do not serve the needs of our times, and begin create agreements that better serve our needs.

The Story of the 11th Round

The story of the 11th round illustrates how the introduction of interest in a monetary system forces artificial competition amongst its users beyond what would naturally occur.

Once upon a time, there was a small village where people knew nothing about money or interest. Each market day, people would bring their chickens, eggs, hams, and breads to the marketplace and enter into the time-honored ritual of negotiations and exchange for what they needed. At harvests, or whenever someone’s barn needed repairs after a storm, the villagers simply exercised another age-old tradition of helping one another, knowing that if they themselves had a problem one day, others would surely come to their aid in turn.

One market day, a stranger with shiny black shoes and an elegant white hat came by and observed the whole process with a knowing smile. When one farmer who wanted a big ham ran around to corral the six chickens needed in exchange, the stranger could not refrain from laughing.  “Poor people,” he said. “So primitive.” Overhearing this, the farmer’s wife challenged him: “Do you think you can do a better job handling chickens?” The stranger responded: “Chickens, no. But I have a much better way to eliminate all the hassles. Bring me one large cowhide and gather the families. I will then explain this better way.”

As requested, the families gathered, and the stranger took the cowhide, cut perfect leather rounds in it and put an elaborate stamp on each round.

He then gave ten rounds to each family, stating that each round represented the value of one chicken. “Now you can trade and bargain with the rounds instead of those unwieldy chickens,” He said. It seemed to make sense and everybody was quite impressed with the stranger.

“One more thing,” the stranger added. “In one year’s time, I will return and I want each of you to bring me back an extra round, an eleventh round. That eleventh round is a token of appreciation for the improvement I made possible in your lives.”

“But where will that round come from?” asked the wife.

“You’ll see,” replied the stranger, with a knowing look.

Assuming that the population and its annual production remained exactly the same during that year, what do you think happened? Remember, that eleventh round was never created; it was never cut from the cowhide.

As the stranger had suggested, it was far more convenient to exchange rounds instead of chickens on market days. But this convenience had a hidden cost: the demanded eleventh round generated a systemic undertow of competition among all the participants. One out of every 11 families would have to lose the equivalent of all its rounds, even if everybody managed their affairs well, in order to provide the eleventh round to the stranger.

The following year, when a storm threatened some of the farmers, there was an atypical reluctance to assist neighbors. Families were now wrestling one another over that eleventh round. The introduction of interest-bearing money actively discouraged the long-standing village tradition of spontaneous cooperation.

The Eleventh Round is a simplified illustration for non-economists. The impact of interest was isolated from other variables by making the assumption of a zero-growth society: no population increase and no production or increases in the money supply. In practice, of course, all three variables (population, output and money supplies) grow over time, further obscuring the impact of interest.

The point of the Eleventh Round is that, all other things being equal, the artificial competition to obtain the money necessary to pay the interest is structurally embedded into the current system.

So how does a loan, whose interest is never created, get repaid?    In a static or declining system, it requires someone else’s principal being used. In other words, not creating the money to pay interest is the device used to generate the scarcity necessary for a bank-debt monetary system to function. It forces people to compete with each other for money that was never created, and penalizes them with bankruptcy should they not succeed. When the bank checks creditworthiness, it is really verifying their customers’ ability to compete successfully in the market place– that is to say, to obtain the money that is required to reimburse the principal and interest. Ultimately, someone must always lose.

In the current national currency paradigm, one reason why so much attention is paid to central bank decisions is that increased interest rates necessitate more bankruptcies in the future. The economic pie must grow that much faster just to break even. The monetary system obliges us to incur debt and compete with others in order to perform exchanges and pay the resulting interest to the banks or lenders. No wonder “it is a tough world out there,” and that those who live within a competitive monetary system so readily accept Darwin’s supposed “survival of the fittest.”    Excerpt from Of Human Wealth (Forthcoming).

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