I recently read a blog post about the coming catastrophic collapse of the U.S. economy and the destruction of all our wealth. This genre of writing is familiar, but it author’s errors are nonetheless instructive. While the author may be what Keynes called a “monetary crank,” his errors highlight some of challenges we face in understanding what money actually is. In this post I hypothesize that a folk psychology underlies our theory of money; a psychology based on anxieties about our interdependence, and the conditions of contingency that shape our experience.
The post’s author writes, “You see that 300 percent increase in the money supply we've experienced . . Much of it is sitting in excess reserves at the Fed and with the big banks. These funds haven't made it into the markets and the economy yet. But it's a mathematical certainty that once this dam breaks, and this money passes through the reserves and hits the markets, inflation will surge.” (http://www.moneynews.com/MKTNews/billionaires-dump-economist-stock/2012/08/29/id/450265?PROMO_CODE=110D8-1)
The metaphor of the dam breaking suggests that money is a physical force, not unlike a raging river, which operates under its own mathematical laws, much as a gravitational field exerts an inexorable pull on objects in its field. But nothing could be farther from the truth. It is useful to ask if this misconception is simply a question of ignorance, or is it motivated? Does it serve any purpose?
It is useful to look at the numbers behind the metaphor. Banks are required to hold a minimum amount of reserves in their own checking deposits with the Federal Reserve Bank (“the Fed”). The following chart traces the amount of excess reserves that banks held in these checking deposits with the Fed since 2009. It has grown by the astounding amount of $1.8 trillion.
As the post we quoted suggests, the bank system has been flooded with money. But how did the money get there and what does it consist of? The Fed buys treasury bonds, bills and mortgage-backed securities from mutual, hedge and pension funds and deposits the money in sellers’ bank accounts. This means that this money is now available to a seller’s bank as the basis for lending to borrowers, and thus counts as its reserves. (Recall that banks can lend out far more than their reserves because it is unlikely that all the depositors will demand their money at the same time. When this happens, we say that there is a “run on the bank.”)
But where did this money and the subsequent reserves come from? The answer is from nowhere. The Fed created it with keystrokes. Reserves are like points in a football game. The Fed bought the bills and bonds and credited the seller by adding points to both the seller’s account and to the bank’s “score,” or the amount of its recorded reserves. When game officials add points on the scoreboard in a baseball stadium, we never wonder where the points came from. We should not in this case either. Moreover, in the first instance this does not change the money available to the public. Bonds and Treasury bills are ways in which institutions, non-profits, households and mutual funds can earn interest on the money they own, much as individuals do with a savings account. When a pension fund sells bonds to the Fed for money, it is in effect moving its money from a savings account to a checking account. The amount of an individual and institution’s financial assets, at least initially, remains unchanged.
There is a common misconception, held even by some economists, that banks are intermediaries, linking people with money to lend, to people needing money to borrow. This is called the “loanable funds doctrine.” This is not right. Instead, banks create money whenever they make a loan. This is why the process is called credit creation. In this of way of thinking, as modern monetary theory emphasizes, loans create deposits, deposits don’t create loans. (See Modern Money Theory, by Randall Wray, Palgrave, 2012). If a bank gives me a loan it does not give me a barrel full of cash. It simply creates an account on its spreadsheet and marks down the requisite “points” in dollars. Keystrokes again. This also means that when the Fed increases a member bank’s score – the measure of its reserves—the banks do not automatically give out more loans. The money is not sitting there creating pressure. It is denominated in keystrokes. Instead, banks lend only when they can identify credit worthy borrowers. One reason that banks had so much excess reserves in the years after the Great Recession is that they were wary of extending credit. This is also why the Fed’s program of “quantitative easing’ – buying bonds and bills and crediting member banks with reserves, has not caused inflation.
The seeming mystery of how money can come from nothing is resolved by recognizing that economic life is lived forwardly. Businesses have to spend money, before they earn it, and credit, or what is sometimes called “working capital,” makes this possible. This is why sometimes a fast growing company goes out of business. It cannot get enough credit to finance its growing expenses in advance of its hoped for revenues. Credit in this sense is a measure of a bank’s and business owner’s shared conception of the future, which by definition does not yet exist. It is a signal from the future, as the bank and borrowers imagine it together. Money instantiates this signal.
In this sense credit represents a victory of abstraction. Human culture has found a way of representing numerically something that does not exist materially. It is not unlike, the way in which Newton’s theory of gravity accounted for the observed motion of objects, by abstracting from its physical manifestations and positing a force that could only be described mathematically. We can’t “touch” gravity. Instead, it is instantiated only in the numerical relationship between objects.
So one question is why do people persist in thinking about money as a “thing,” as a force that can break through a dam, or as an object that is passed like a tennis ball from a lender to a borrower. I can think of two hypotheses that draw on psychoanalytic thinking. Both presume that human culture creates “social defenses” against anxiety, which if experienced directly would be distressing and discomfiting.
Consider the extreme case of “gold bugs.” These are people who believe that the only basis for a national currency is gold, and that the Central Banks of all countries should promise to redeem their national currency into gold upon demand. This was in fact the basis for the historic but now defunct international gold standard. The conviction underlying this idea is that states and their representatives cannot be trusted, that left to their own devices they will “print money” in order to confiscate our real resources; our houses, cars, televisions, coal and gas. If political and economic elites are foresworn to redeem paper into gold they will be constrained by the amount of extant gold and the amount that can be mined. Never mind that the amount of gold available as backing is in some degree arbitrary. Never mind as well that if there is insufficient gold, countries will experience deflation because there is too little paper currency to support the desired volume of exchange. Gold bugs discount the salience of these likely problems partly because their larger vision is tinged with paranoia. They worry that a cabal of unseen forces, call them Jewish bankers or Freemasons, controls us, and that only gold will free us.
I suggest that we can generalize from this extreme case. The gold bug has a fantasy of a social relationship, albeit a paranoiac one. Once we understand that money is nothing but the expression of our relatedness, we must recognize the ways in which we are interdependent in world wide circuit of exchange. So one hypothesis is that we want to see money as thing, as a defense against the anxiety we feel when we see how interdependent we really are. Karl Marx’s conception of “commodity fetishism” is helpful here. He argued that we tend to see an economic exchange as the relationship between money and goods, rather than what it ultimately is, a relationship between people. We treat money as magical, as if it can conjure up objects without considering the underlying social organization that money sets into motion. Thus for example, we buy cheap clothing from Bangladesh imagining that we are exchanging money for clothing. But in fact we are setting in motion a social process through which poor people work under unsafe and sometime life threatening conditions. It could very well be anxiety provoking to acknowledge our personal connection to this social fact. That is why of course activists insist that trade be fair as well as free.
Marx’s use of the term, “fetishism” is also suggestive to the psychoanalytic listener, and may provide some additional insight. For example, many men are comfortable in a sexual situation, at least initially, only if they can focus on a body part, for example, a woman’s breast, leg, buttocks or foot. This is very common, as is evident in most commercial pornography. In the extreme, a male fetishist may need a prop, for example a shoe, in order to become sexually excited. He endows the fetish or shoe with magical properties. One hypothesis is that the this focus on a part, rather than the whole, and on a material object, rather than on the relationship with the woman, enables the man to exercise control over the conditions that excite him. Absent the fetish his excitement would turn into anxiety. The conception that money is a physical object, that is separate from the complicated relationships it sets into motion, and from the relationships it exposes, shares some of these features. (Note to my skeptical reader. Invoking sexuality does not mean that people's relationship to money is sexualized Rather, by drawing on sexual experience in its vividness and specificity we gain insight into motivation and its constituents more generally. This is one way to interpret psychoanalysis' privileging of sex as a key to motivation.)
The term “magical” points to another and perhaps more speculative hypothesis. I came across the following video, which gives a coherent presentation of credit creation, emphasizing for example the creation of credit out of nothing and the system of account settlement and clearing. (http://www.youtube.com/watch?v=KyDU4X8GSmE) Yet the tone and import of the video suggests conspiracy. It is introduced with dark sounding music, and images of a grim reaper type of figure chained to a rock of “debt” and swinging a mallet to break the chain. The video scrolls through a quote by Woodrow Wilson, the 28th president of the United States, “Some of the biggest men in the United States, in the field of commerce and manufacture, are afraid of somebody. They know that there is a power somewhere so organized, so subtle, so watchful, so interlocked, so complete, so pervasive that they had better not speak above their breath when they speak in condemnation of it.” The video’s central message is that there is something nefarious about the fact that credit is created “ex-nihilo,” or to translate the Latin, “out of nothing.”
The phrase “ex-nihilo” is in fact linked to the idea of credit creation (http://en.wikipedia.org/wiki/Ex_nihilo), but was originally a theological description of God’s powers. In Judeo-Christian theology only God can create ex-nihilo. This is why the Old Testament counsels the Israelites to avoid magic and magicians, “No witch shall you let live,” (Exodus, 22: 17). Moreover, the economist Fredrick Hayek argues that in the early stages of capitalism, “Activities that appear to add to available wealth ‘out of nothing,’ without physical re-creation and by merely rearranging what already exists, stink of sorcery.” As David Hawkes notes this was one basis for the revulsion against usury in Renaissance England; not that it was simply unjust but that it was supernatural. Money “procreated” so to speak, in the form of interest payments added to capital. Yet it was lifeless. As he writes, “Usury was magic perfected by other means.” (The Culture of Usury in Renaissance England, Palgrave, 2010)
Today most of us do not believe in magic. Instead we enjoy magic shows in which stage magicians makes objects appear out of nothing -- ex-nihilo -- but only in fun, though we are often astonished. I want to suggest nonetheless that there is an experiential basis for our anxieties about "ex-nihilo," particularly in a secular age. If we think seriously about our own existence, it must seem that we came into the world, ex-nihilo. Of course we understand how babies are born, but our own existence is so arbitrary. After all, none of us have existed since the beginning of the universe and yet here we are now, suddenly! How can that be?
The arbitrary can be frightening. It is a portal to chaos. But we should also remember that the other side of arbitrary is “contingency.” Our world is not determined, and this becomes the basis for creative work of all kinds. That is why credit creation can support entrepreneurship, which is, after all, the creative arrangement of resources in new ways.
One speculative hypothesis is that that we project these existential anxieties onto a “folk-theory” about money. At the extreme, some people develop a theory of money in which “hidden forces,” who create credit out of nothing, use this power to enslave us, in other words to eliminate contingency and the capacity for creative work. This fantasy paradoxically provides relief because it suggests that someone, some shadowy network, is actually in control. All is not chaos, and if we are smart enough, we can control the controllers. A larger number of people, less likely to be drawn to conspiratorial thinking, persists in thinking of money as a physical object that operates mechanically, as a way of avoiding the uncomfortable idea that the course of our lives, like our birth, is entirely contingent and unpredictable. The laws of money like the laws of physics provide scaffolding, an “invisible hand.” This may be one reason why economists did not anticipate the financial crisis that led to the Great Recession. This sense of contingency is also the basis for the criticism that George Soros, the famous investor, has of modern economic theory. His name for it is "reflexivity." The challenge then, is to accept the arbitrary, and then see the creative opportunities in contingency, both in our individual lives and in the social world we create together. We can use credit and money creatively.