The free people of Switzerland have been asked to vote on the most “damaging” question, according to an economist, in a binding referendum this June 10th. That is, what should money be?
A question that for the first time in generations illuminates what money currently actually is. Unsurprisingly, money is nothing like what textbooks say. More interestingly, there is not one money, there are three.
Thomas J. Jordan, current Chairman of the Governing Board of the Swiss National Bank (SNB) reveals in a speech a complicated web that we’ll try to elucidate here.
“When speaking about money, we need to distinguish between various types of money. Especially important with regard to our topic is the distinction between central bank money on the one hand and commercial bank money – i.e. deposits with commercial banks – on the other. The two differ in terms of characteristics and risks, as well as in the way they are created,” Jordan says.
Since these different types of money have different characteristics, we’ll give them different names. We’ll call central bank money SNBmoney or just senbi. We’ll call commercial bank money as bankmoney. And then we’ll call deposits, or what everyone thinks as money, peoplesmoney. Accordingly, we’ll modify the quotes from Jordan’s speech to make it more clear and easier to follow.
“Central bank money comprises banknotes in circulation and the senbi held by commercial banks at the central bank. Both are legal tender, which means that no restriction may be imposed on their acceptance. Central bank money, like all nominally denominated money, is subject to the risk of inflation, in other words to the risk of losing in value as a result of rising prices for goods and services. Apart from this, however, central bank money is practically risk-free.
In Switzerland, central bank money is created by the Swiss National Bank. Whenever, for example, the SNB purchases foreign currency or Swiss franc denominated securities from a commercial bank, it credits the amount paid to the senbi account of the bank concerned in Swiss francs. If the SNB wants to reduce the amount of central bank money, also known as the monetary base, it can conduct transactions in the opposite direction. It then sells foreign currency or Swiss franc denominated securities to banks and charges the corresponding amount to their senbi accounts. The SNB is thus in a position to either increase or decrease the monetary base in accordance with its monetary policy goals.”
Banknotes are of course the actual paper money, a tiny fraction of money. They are printed by the central bank and any change in amount is insignificant.
Because money printing today, or as they like to obfuscatingly call it quantitative easing, happens digitally. That is, commercial banks have an account with the central bank which we have called a senbi account. To give money to the bank, the central bank can simply buy a portion of their mortgages or other securities by just increasing the number on the senbi account.
That is in effect creating money out of nothing, but rather than randomly increasing or decreasing the amount in the senbi account, they do so by buying something, such as bad loans held by the bank, with money created from nothing.
This money can also be extinguished. If the commercial bank wants to buy something from the central bank, instead of moving money around it is just burned by the senbi account amount being lowered.
“Banks can, through the SNB, exchange banknotes against senbi and vice versa. They thus have access to both banknotes and a senbi account at the SNB, while the public has access to banknotes only, since private individuals cannot hold an account with the SNB.”
This is very much the crux of the matter, but we’ll get to it later. What we’ve called senbi is basically digital cash, real money if you like. You can not move this money, only commercial banks can.
As such, the public currently does not really have an independent payment system. They must rely on banks, but here is where things get a bit murky.
“Senbis are used by banks for cashless interbank payment transactions. Payments between banks – or their customers – are effected via the Swiss Interbank Clearing (SIC) system and result in the reallocation of senbis across the participating banks’ accounts at the SNB. Moreover, banks are obliged to fulfil the minimum reserve requirements of the National Bank Act, i.e. to hold sufficient reserves either in the form of banknotes or as senbis with the SNB.”
In effect banknotes, or their digital equivalent senbis, are like gold. As in real money. Banks must hold some of it, primarily to ensure people can withdraw banknotes when they need to.
Anyone can move their cash around, but for the digital equivalent of senbis, only banks can do so, and they have their own centralized database of sorts that keeps account of what bank has how much senbi.
“Deposits with commercial banks are distinct from central bank money. When speaking of these deposits in my remarks today, I will be referring to the peoplesmoney – also known as demand deposits – of their customers. Customers also hold savings and time deposits with banks. These cannot be directly drawn on for transaction purposes, but they are cash equivalents and are therefore included in broader definitions of money.”
By deposits he is basically referring to the numbers in your digital bank account, such as in your debit card. That being what everyone thinks as money, or the digital equivalent of cash, which we have called peoplesmoney. But they’re actually not money at all:
“Bank customers can use their peoplesmoney to make payments. Unlike central bank money, the peoplesmoney are not legal tender, but they do represent a claim on central bank money. Bank customers can withdraw peoplesmoney in the form of banknotes, i.e. central bank money, or instruct their bank to make a cashless payment. The latter leads to a reallocation of senbi from the customer’s bank to the payment recipient’s bank.”
This is a heavy paragraph because there is a lot happening. What’s most astonishing is that your money held in the bank, which most see as the digital equivalent of cash, is actually not even legal tender. As in, it’s not money at all legally speaking.
You can of course turn the debit card/digital money into cash, or you can make a digital payment. Since this is real money when looking at the whole financial system, but not where your relationship with the bank is concerned, when you make a digital payment with it the senbi accounts of the banks involved adjust accordingly.
In effect, peoplesmoney are senbi, but only when banks transact between themselves. When their relationship to the public is concerned, they are not even legal tender and you do not even have to accept this digital money for payment.
The reason for that, and we’re speculating now, might be because no one knows whether the bank’s statement you have x in your digital account is true or not. This is only verified when it goes through the centralized payment system where the database knows the entire senbi money in circulation, and therefore whether you are cheating or not.
It could also be because once you deposit in the bank, your money becomes a debt owed to you by the bank. They could of course spend this money frivolously and be unable to pay you the debt. But let’s get to the interesting bit:
“How do deposits at commercial banks, i.e. peoplesmoney in Swiss francs, come into existence?
In our present-day financial system, the creation of deposits by banks is closely linked to the granting of loans. When a bank provides a loan, it credits the amount in question to the borrower in the form of a deposit to his or her account. This leads to an increase in credits on the assets side and in customer deposits on the liabilities side of the bank’s balance sheet.”
Credit here is used from the bank’s point of view. That being money you owe to the bank. While deposits are liabilities because the bank owes you your money.
What Jordan is saying here is that when a bank makes a loan, they create money effectively out of thin air. Just as the central bank simply increases the amount in the senbi account of the bank they buy something from, here too the commercial bank simply increases the amount in the account of say a property seller.
No real money has moved hands. No one goes around with $100,000 banknotes to buy a house and no senbi has moved. Instead bankmoney has been created with the seller’s account increased by +100k, which at this point is fake or fictitious money, while the buyer’s account has a -100k.
Then, something interesting happens because this -100k is gradually paid off and eventually goes to 0. At that point, the +100k becomes a senbi of sorts or real money from a wholistic perspective of the entire system.
Yet there’s a problem. A 100k mortgage over 20 years means someone has to pay interest of around 100k. That is, the buyer eventually pays the bank 200k in total. So 100k has been created from somewhere. To distinguish, let’s say the interest is 50k.
The first question is, where does this 50k come from? Jordan’s question was where do deposits come from, as in how does money actually get in your hand or enters circulation. And his answer was from loans. But the loan creates only 100k. So how is interest created?
From that derive a million more questions. Such as what happens to this 50k? Does it become a senbi? Wouldn’t that then create more loans, as in more new money, leading to more interest, in a constant loop of sorts?
As things stand, we have no idea whatever what role interest plays because neither the Bank of England nor Jordan touch on it. Presumably because that’s the key problem with bank money, so they’d perhaps rather everyone ignores it.
“As a rule, borrowers will immediately use their new deposit to acquire the goods or services for which they requested and received the loan. They thereby trigger a payment that reduces their deposits while increasing the deposits on the payment recipient’s account. By far the most common form of loan in Switzerland is a mortgage. When a mortgage is taken out for the purchase of a house or an apartment, the deposit does not normally even appear on the borrower’s account, since the bank remits the loan amount directly to the seller of the house or apartment in exchange for the mortgage certificate.
To execute the payment, the bank needs to have senbi with the SNB. If it holds enough liquidity in the form of central bank money, the payment can be made without delay. If not, the bank needs to obtain liquidity on the interbank market or via credit facilities at the SNB, which only works if the bank has sufficient collateral in the form of securities or if it is prepared to pay a premium.
Our example illustrates the following key points: An individual commercial bank cannot use the granting of loans to ensure a lasting increase in the deposits it holds. Due to payment transfers, the deposit created by a loan flows out and disappears from the books of the lending bank. For the banking system as a whole, however, things look different. The payment transfer creates a new deposit at another bank. While the total volume of central bank money remains unchanged, lending by an individual bank increases deposits in the banking system and hence also the overall money supply.”
Jordan here is saying that banks do not deal with each other in fake money. They only accept senbi, or digital cash. So when the bank gives you this fake 100,000, if you want to transfer it to another bank they have to transfer real senbi in the amount of 100,000.
This is where complexity reaches incomprehensible proportions even ignoring derivatives (fake money) on top of loans (fake money).
Because all of this fake money does have a base, like the gold standard, and that base is digital payments between bank accounts held at different banks, payments that need to be made in senbi.
In most nations banks are a cartel of sorts. There’s only around five of them that account for probably around 90% of the entire market.
So most of the home buyers and sellers will probably be from the same bank. Thus senbi does not need to move at all. Then just as Alpha bank seller might buy a house from Beta bank buyer, another beta seller might buy a house from alpha buyer.
That is, the senbi does not circulate one way. Alpha sends it to beta, then beta sends it back to buyer, while each time creating different loans.
Of course there are constrains, there is some base in reality, but a lot of bankmoney is being created, and often too much is created which usually leads to a crash and an economic collapse because eventually they don’t have enough senbi to pay each other.
At that point commercial banks threaten with cutting off ATMs. So politicians rush to give our senbi to the banks. While the central bank gets busy with senbi printing. So the music continues and the cycle repeats.
“The sovereign money system would lead us to a sustainable society once again,” Katharina Serafimova, a lecturer at the Institute for Banking and Finance at the University of Zurich, says.
The Sovereign Money movement wants these senbi accounts to be open to all, rather than just limited to banks. One could then have a digital cash payment system, rather than being forced to use bank IOUs if you want to move money online or conveniently.
They go further and require that banks no longer create money through loans. They must instead lend actual senbi. That’s a very radical proposal, but it’s sufficiently popular to gather the required signatures for a binding referendum which could give the world a bigger shock than Trump and Brexit combined.
It’s not a light decision to take, even if we might quite like crypto-money as an alternative. But the fact that this is now up to a binding vote does put the topic of money very much on the political table.
And somewhat uniquely perhaps, the sovereign money framing of it is neither right nor left. The left of course would see that punishing interest payments requirement on top of fake money as exploitation and perhaps one of the root causes of ever increasing inequality.
While the right would see fake money itself as a hocuspocus make believe nonsense with no ground in reality.
Yet there are arguments in favor of this debt based system, with the main one being that rather than the central bank making all these decisions, commercial banks can make them instead.
But the strongest argument against it is that rather than this interest payment, this out of nothing 50k, going to ever richer bankers, it goes to the taxpayer through the government coffers.
A government that can then actually make it possible for people to buy homes, rather than chaining a generation to rent out of those the banks have decided are worthier of land ownership. So creating an ever richer and richer class, and a landed gentry, from fake money.