What is the Money Illusion?

The current concept of the Money Illusion means that people think in terms of the nominal value of money, rather than its real value.  However, the truth of the Money Illusion goes much deeper than that.  The truth of the matter is that real value of money is nothing at all.  In short, the illusion is that money has any value at all. 

Seeing beyond the Money Illusion, we realize that money is nothing but a trick to gets us to cooperate.  Money is both the stick and the carrott, in that it inspires both the fear and the greed to get us motivated.

The existence of money is not even necessary to the function of the economy.  Just imagine what would happen if all money disappeared tomorrow: all cash, all plastic, all bank balances, everything, just magically erased.  What would happen if everyone's wallet was completely empty, and every bank vanished?   Most people agree, if it happened in the real world, human civilization would pretty much end rapidly in a violent conflagration.   

But... what if.... instead of going Mad Max in collapsing economy... what if everyone just PRETENDED they were exchanging money.  You go to the store, the cashier pretended to ring you up.... and you pretended to giver her money.  You buy items from your vendors, and pretend to pay their invoices...  Your clients pretend to pay you...  so on and so on. 

In other words, what if everyone just went on doing what they normally do, but WITHOUT the MONEY???  Viola, Mad Max apocalypse averted!  If everyone would just fulfil their role in the economy as if money didn't matter, in truth, money wouldn't matter, and the economy would go on quite nicely without it. 

Of course, the average listener objects, if you could just "pretend" to pay for stuff, why would you work?  Well, yeah, that is the rub, human nature.   Stands to reason, some people would shirk off and refuse to work, and if enough people did it, the economy would collapse. 

But my point is not to suggest a model for a real-world working "cashless" economy.  Rather, I just wanted to give a concrete example of the true depth of the Money Illusion.   The fact is, money is totally unnecessary to the function of a real economy. 

If people could just be trusted to do something productive everyday and give it away, we could totally dispense with money.  THAT is the Money Illusion, the idea that money is anything necessary or worthwhile at all.  In reality, it is just a big trick to get us to work together and limit our consumption.   If we could agree to work together and limit our greed CONSCIOUSLY, we wouldn't need money. 

Arguments about the Type of Money

The Money Illusion also manifests in our arguments about what TYPE of money to use, especially among the Austrians, who have an irrational attachment to the use of gold as money.   What really matters when it comes to defining our standard of living is our overall level of PRODUCTIVITY.  The type of money we use is complete incidental, and the only argument we should have about money is how to make it facilitate the highest level of communal wealth. 

This is where the Austrian gold-fetish is revealed at its most primitive.   A solid, stable, tangible FORM for money is all-important to this strange mindset.   Whether it is most condusive to the creation of social wealth is totally irrelevant to the Austrian; the most important thing is its constancy, its permanency.

Ironically, it was the rise of the limited Money Illusion that proved the death knell of the modern gold standard.   Modern workers in the early 20th century fought hard for union power, higher wages, and guaranteed contracts.   All of these were totally incompatible with the operation of the gold standard, which required constant deflation of wages and prices (as greater productivity was piggy-backed into the static supply of money).  Workers, however, would not be contented with falling nominal wages, even if they were assured that it was part of the natural process of economic balancing under the iron discipline of the gold standard!  Deflation and mass unemployment are not a good combination in the modern, urban, industrial economy, and thus ended the gold standard era.

This is why Austrians are viewed as kooks and cranks in the modern economic milieu.   Everyone ELSE sees through the Money Illusion and is discussing the advanced theories of wealth creation and social stability, EXCEPT the Austrians.  It is like trying to make Christmas plans with someone who insists you have to be in bed at midnight for when Santa arrives.  Or trying to make travel plans with someone who insists you can't travel too far across the ocean because the earth is flat and you don't want to go off the edge, do you???   I mean, really, there is nothing you can do with such a person but ignore them and go about your normal plans despite their irrational beliefs.   Which is exactly how Austrians are treated. 

In the end, Austrians are left alone in the corner, muttering about hyperinflation causing the collapse of the economy.   We just pity the poor chaps, totally locked in to their irrational beliefs, unable to see through the Money Illusion.    They honestly can't separate the collapse of a currency with the collapse of the economy itself, and are totally flummoxed trying to imagine that money is just a tool to be used for the social good.  The very idea is offensive to them!

Mainstream economics is hardly better.  In fact, it is probably even more odious, being used to obfuscate, beguile, and confuse the public, through a massive smoke screen of jargon and faux-complexity, serving only to mask the exploitation of the masses by the parasitic Money Elite. 

Gold Standard Institute admits: gold useless w/o paper trading money -- What are Real Bills?

The latest issue of the Gold Standard Institute (http://www.goldstandardinstitute.net/GSI/wp-content/uploads/2010/06/TheGoldStandard15.pdf) helps the average confused member of the alt-economics community get to the heart of the matter.     Obviously, the GSI is devoted to the idea of money based on the gold standard.   Naive, Austrian-influenced, amature economists need to understand GSI's position before spouting off about gold as "the only sound money". 

For, you see, the GSI is perfectly upfront about the fact that direct trade in gold is not practical.  As they put it, for example: "Gold on its own cannot support international trade; Bill circulation is essential for a viable Gold Standard." 

The gold standard only works, then admit, when actual trade is in paper.   The paper, which they call Real Bills, is backed by gold, but the paper is essential. 

Real Bills vs Money

Now, the question becomes, what are Real Bills???    Unlike a paper money supply backed by gold, real bills are not issued by a central bank and are not permanent.  Rather, they are issued by private parties, and they have an expiration date. 

They are most like a personal check with an expiration date.  They would say something like "Redeem this bill of sale for $100 worth of gold on July 31st 2012 at XXX Bank".  In practice, that bill could then trade hands among various people right up until the redemption date.    

This is the meaning of Real Bills being "self liquidating".   Unlike a permanent paper money supply, Real Bills are created in response to real economic activity, and are liquidated at the commencement of that activity.  Here is how they describe it: "Bills are drawn against real goods, the goods are delivered, the Bills net out the trade. Then, after doing their job, after being paid off on their due date, the Bills disappear."

The Necessity of a Clearing House

The only thing they left out of their description is the necessary role of a clearing house.  The clearing house keeps track of accounts upon expiration of the bills.  If necessary, on the date when accounts are settled, actually physical gold would then trade hands.  But the whole point of Real Bills is to allow multilateral trades in paper certificates, rather than actual gold. 

The clearning house has to function as the gold storage vault, as well as an accounting service, to clear and pay accounts of settling day.  If Real Bills are drawn on multiple banks, the individual banks would have need of a central clearing house to clear their accounts.  In practice, that would work like the way cheques are cleared by multiple banks. 

Advantages of Real Bills

Because they aren't permanent, Real Bills can't be used to fund speculation.  It is also nice because they don't disrupt the productive economy with the inflationary or deflationary effects of a permanent money supply.   Real Bills are always matched perfectly to the real productive economy. 

Nor are they centrally-controlled.  Real Bills are like a democratically-issued money supply.   People issue Real Bills on the wealth they possess.  Under this system, the function of banks is simply accounting and wealth transfer.   Presumably, the banks are funded on a fee-for-service basis. 

International Gold Standard Era begins (again) - India-Iran gold for oil trade agreement

India (and reportedly soon, China) will be buying Iranian oil with gold. I would expect Russian to join them as well. This truly marks the beginning of the new international gold standard.

Of course, that is assuming Iran isn't destroyed by US-Anglo-Israeli weapons in the next 6 months....

It is interesting to note that the latest EU sanctions on Iran prohibit EU contries from selling gold or other precious metals to Iran, either. In other words, it specifically closes down the possibility of trading on the gold standard with Iran to avoid the central bank clearing prohibition. (see: http://www.presstv.ir/detail/223260.html)

As reported on the PressTV website:

'India to buy Iran oil in gold not dollars'

India has agreed to pay the price of crude oil it imports from Iran in gold, which makes it the first country to drop the US dollar for purchasing the Iranian oil.

According to a report published by DEBKAfile news website, unnamed sources have stressed that China is also expected to follow suit.

India and China take about one million barrels per day (bpd), or 40 percent of Iran's total exports of 2.5 million bpd and both of them have huge reserves of gold.

The report added that by trading in gold, New Delhi and Beijing enable Tehran to bypass the upcoming freeze on its Central Bank's assets and the oil embargo which the European Union's foreign ministers agreed to impose on Monday, January 23. The EU currently buys around 20 percent of Iran's oil exports.

On the other hand, experts say the vast sums involved in these transactions are expected to boost the price of gold and depress the value of the dollar on world markets.

“An Indian delegation visited Tehran last week to discuss payment options in view of the new sanctions. The two sides were reported to have agreed that payment for the oil purchased would be partly in yen and partly in rupees. The switch to gold was kept [in the] dark,” the report stated.

India is Iran's second largest customer after China, and purchases around USD 12-billion-a-year worth of Iranian crude, or about 12 percent of its consumption. Delhi is to execute its transactions, the report said, through two state-owned banks: the Calcutta-based UCO Bank, whose board of directors is made up of the Indian government, the Reserve Bank of India representatives, and Halk Bankasi (Peoples Bank) -- Turkey's seventh largest bank which is owned by the government.



http://www.presstv.ir/detail/222857.html

Non-USD trade block grows - Iran with Japan, China, Russia, India

The non-USD/FRN trade block continues to grow and expland. We are used to seeing Russia and Iran linked, sometimes with China. But now the non-dollar group includes Japan and India as well, and, you know, I thought they were allies.

Just read that list, wow. China, Japan (all of east Asia really), India, Russia, Iran.

All avoiding the dollar.

For now, they are expanding bilateral and trilateral trade swaps, but it is only a matter of time before a common currency unites them. Given their cultures of corruption and non-transparency, such a common tradting currency will almost certainly be based upon a gold standard.

news reports:
http://english.farsnews.com/newstext.php?nn=9007275648
Iran, Russia Replace Dollar with National Currencies in Trade Exchanges

"During the last two years, Iran has been replacing dollar with other currencies in its trade with the outside world. Iran has replaced dollar in its oil trade with India, China and Japan."

Tokens as Alternative Money and Problems with Metallic Coins

What exactly is the difference between tokens and money? In many ways, none at all. Tokens are money. However, they are privately issued money. What we normally think of as money is just publicly-issued and government-controlled tokens.

For those wishing to start their own alternative currencies, keep in mind, there is nothing illegal about issuing your own private money supply, as long as your money does not look like government money (which would leave you open to charges of counterfeiting).

Tokens can also be seen as a subset of metalic money. When used for general trade, tokens were characterized by their composition from common metals like copper, rather than the standard precious metals used for official money like gold or silver.

The problem with using gold or silver for coins is that the metal itself has a value, and that value can change over time. Thus, if the value of the metal goes up, people will hoard the coin for its metal, rather than use the coin as money.

When people hoard coins for their valuable metal, the trade economy is affected by a shortage of money. As strange as it sounds, money shortages have plagued humankind since the dawn of history up into the modern era. Sometimes, when shortages of gold or silver money occur, people have often resorted to tokens (such as the fascinating case described here of privately-issued token usage in early modern England).

The use of multiple types of metal coins, such as in the system of bimetalism (using gold and silver) brings up the further problem of convertability. That is, in a multi-metal system, the coins have to be fixed in relation to each other (one gold piece equaling 17 silver pieces, for example). When one metal rises in price against the other, coins made of that metal will be hoarded, since their market ratio no longer equals their official exchange ratio.

Now, the advantage of tokens lies in their production from cheap and abundant metal. Tokens are also often stamped with money-denomination values below their metal value. That is, 100 dollars worth of copper might be used to create 200 dollars worth of tokens. This mass-production of cheap tokens helps meet the needs of daily commerce, alleviating the problems of money shortage.

A critical thinking question for the reader arises: what problem is created when coins are stamped with a greater value than their metal is worth?

The answer is: counterfeiting! If you can turn 100 dollars of metal into 200 dollars worth of coin, you can make a great profit by creating money. The production of paper money represents the ultimate spread between the cost of materials versus the value of the money produced, and so counterfeiting of paper money is a perpetual problem when it is used. Given our modern printing technology, the ability today to counterfeit paper money is much more widespread than the ability to counterfeit metal money.

The critical balance point which thwarts counterfeiting is when the cost of materials is exactly equal to the value of the money. Why counterfeit money, if the cost of the materials is equal to the value of money you'd produce? In that case, you wouldn't be making any money by counterfeiting, so why bother.

For anyone today considering the issue of an alternative currency, this balance point is key, since there is essentially no way to stop or punish counterfeiters when a private money supply is issued. The value of any currency issued should be carefully tied to the value of its underlying metal, thereby avoiding the twin problems of counterfeiting and hoarding.

Local artists can make tokens, like the Phoenix bux (pictured here). Or tokens can also be ordered from a number of private mints today, such as this one, which promises tokens of the same quality as government issued coins. The list of advantages of using tokens are parallel in many cases to the arguments made for using local alternative currencies, including promotion/advertisement/publicity, price discounting, seignorage (i.e. souvenir value), and captured/circulated/repeated business encouragment.

Global Trade, Debt, and Stimulus: a short Explanation

The Chinese run a large trade surplus with the US. This leads them to have a huge stockpile of dollars. This allows them to peg their own currency to whatever dollar value they want. Since they do all their foreign trade in dollars, there is simply no international market for their domestic currency, so international traders are simply shut out. (For other countries who do trade their currencies on the international market, lacking a supply of dollars means that currency traders could make runs on their currency, and the buying and selling of it would be out of their control.)

The surplus of extra dollars leaves the Chinese with a question of what to do with those dollars. In the past, they were content to invest in US debt securities, in effect, expanding their supply of dollars. However, stockpiling dollars is good for the Chinese in absolute terms, because dollars are the international trade currency. Thus, with extra dollars, they can buy anything else in the world.

When the international collapse in trade happened last year, many analysts thought China would be hit hard, because they are so export-dependent. However, they responded to the collapse in export trade with an almost unbelievably large dose of domestic spending. This is where their dollar stockpile came in, because they were able to stimulate their own economy by spending all the dollars they had stockpiled buying raw materials.

Oil, copper, rare elements, whatever they wanted, they were able to buy, using their dollars. They have also been investing heavily in gold, although not for use in industrial stimulus, but as a hedge against dollar collapse.

They could then pay their citizens in their own currency to do the work. Printing out their own money for domestic projects was not necessarily inflationary. For one, it was partially just holding the line, fighting deflation and unemployment from the collapse in international trade. For another, it can’t cause a currency devaluation, because their currency is not traded internationally.

The same process, printing out your own money, does not work for making international payments. Foreigners will see that you are diluting your money, and the exchange rate will fall. This defeats the purpose of printing more money in the first place, since it now costs more for the same trade.

For this reason, many times throughout world history, two types of money are used, one for domestic trade, one for international trade. For example, the US went off the gold standard for domestic dollars in 1933, but didn’t go off the gold standard for international dollars until 1971. It is also the reason why the world is clamoring for a new international trade currency now. International trade needs an absolute standard of measure, to prevent countries from screwing the system by printing more of their own currency (such as they see the US doing now).

So, with their stimulus money, the Chinese have been stockpiling raw materials and using them to put their people to work on infrastructure projects. This is true capital investment, and increases their wealth-creating capacity for the future, as well as putting people to work today.

Our stimulus money is not based on a trade surplus, but is simply based on diluting the dollar through deficit spending and monetization of government debt. Nor is our stimulus money providing the basis for future wealth creation or even repairing old infrastructure. Our stimulus money is simply covering budget shortfalls and continuing welfare payments. Thus, we will be in a worse position when the stimulus ends, having the same economic condition, but then with a higher debt load.

Looking forward, the US economy is in between a rock and a hard place. Keeping the dollar as the international reserve currency means that the US will continue to have its industrial base undercut by cheaper foreign competition and be the target for mass immigration because of the overvalued dollar. When the change finally happens, and the dollar is removed as international reserve, the US faces a massive inflation, from the return of dollars to domestic use and currency devaluation. The longer we wait, the worse the economic collapse will be when it does happen, since we will have to rebuild our industrial economy from scratch.

The only solution to that guaranteed eventuality is to take aggressive proactive steps, sooner rather than later. For example, the US should take decisive steps to safeguard its industrial base now, while the dollar is strong, rather than later, after currency collapse. The US should also cease all inflationary policies (such as deficit spending and monetization of debt), which are literally driving the world away from the dollar reserve standard. An even more radical approach would involve repudiation of the national debt, leaving the rest of the world holding the bag of worthless paper, and reinvesting in America’s industrial powerbase through protection from imports and outsourcing/off shoring.

In short, Americans should start thinking of themselves a people, rather than just as expendable units of profit manipulation in an international economy.

Father of Legal Tender - Elbridge Gerry Spaulding

Article in today's NY Times (http://www.nytimes.com/2009/09/04/business/economy/04norris.htm) attempts to equate Bernanke to E.G. Spaulding, the man who financed the US government during the Civil War by firing up the printing presses. In funny part is, Spaulding didn't even support his own actions, except for the necessity of specifically WAR TIME funding, and to say he was a proponent of fiat paper money is completely false.

The Times article is basically a propaganda piece suggesting that money printing by government is not bad. Well, I guess it’s all relative, right? The article presents some of the doom and gloom statements of that debate that did not pan out, even flatly dismissing the inflation problem, which as predicted, did occur. By suggesting by extension that today’s naysayers are equally wrong, that Bernanke has a chance at historical vindication when this is all said and done, the Times produces a lame pro-Bernanke publicity piece. [As for Bernanke, it has been proven conclusively that he is an intellectual idiot who completely fails in every prediction he makes, demonstrating his lack of mastery of what is really going on with the economy. His only successful function is enriching the banking class at the public’s expense, so it is no surprise that the Times, the voice of that banking class, lauds him.]

The article pays homage to Spaulding, an important factor in the victory of the Union in the War for Southern Independence (what he called the Great Rebellion and we call the Civil War), while totally misleading us about what Spaulding really did and what he stood for. The article calls him the father of fiat currency, a man who was willing to throw out the economic orthodoxy of his day. He article falsely states: “Contrary to the expectations, paper money did not set off sharp inflation over time, and when the paper money eventually was made convertible into gold, there were no lines of people wanting to trade in paper for bullion.”

The facts of history debunk this. In fact, the greenbacks were indirectly backed by gold for the first half of the war. When its gold backing wavered in the first half of 1864, inflation spiked over 100%, and in the end, the dollar went back on gold, which was used to pay off all wartime debts including the redemption of the war time greenbacks! Such blatant and easily verified factual errors calls into question both the competence and honesty of the Times.

After it was all said and done, Spaulding wrote a book documenting it all for posterity, and God bless him for it. Spaulding’s book, History of the Legal Tender Paper Money Issued During the Great Rebellion, published in 1869, is an absolute treasure trove of speeches and letters, the very substance of the money argument at the time. It is full of weighty economic theorizing on matters of money, economics, and government finance. Some of the language is a bit archaic, as we no longer use some of their financial terms, but it is always elegant, and merely sampling the book pays off intellectual gold.

One thing that may surprise the average reader today is that the central terms of the debate were not whether the government should issue lots of paper money to pay for the war effort. That was generally granted by all, save the northern banking class of the day, which wanted the government to pay for the war through bonds sold on the open market (a scheme roundly denounced as most assuredly designed for the enrichment of the bankers, not for the good of the Union).

Rather, the most tendentious issue of the day was the establishment of the newly issued federal script as legal tender. At the time, there was no legal tender, no money that you had to accept in payment by force of law. Regional notes competed in an open market, and inferior notes would suffer discounting. Greenback advocates like Spaulding did not want their federal notes to suffer competition, while holders of solid regional notes did not want to have honor these obviously inflationary greenbacks at face value, which legal tender laws would require.

Another fascinating aspect of the war-time greenback effort was an ingenious bond conversion program they developed. For the first year of their issue, each newly issued federal note had the following statement engraved on it: “This note is a legal tender for all debts, public and private, except duties on imports and interest on public debt, and is exchangeable for US six percent bonds, redeemable at the pleasure of the United States after a period of five years.”

On the one hand, this bond conversion option was seen as a compensation for people forced to accept the notes. It was openly acknowledged that the legal tender issuance of federal notes was a loan to the federal government forced on the public. The bond conversion option was like a bonus to offset the rightful discounting that could have been taken in the absence of legal tender law.

The bond conversion option was also intended, in modern terms, to soak up liquidity. This convertibility would prevent any great inflation, as Spaulding wrote, “for the reason that as soon as this currency became redundant in the hands of the people, and not bearing interest, they would invest it in the six percent bonds” (pg 188).

The interest on those government bonds was to be paid in coin, meaning gold, every six months, while the bond’s principle would be paid in gold within 20 years. In other words, these greenabacks were not really debt-free fiat money, as Ellen Brown would have them. They were still on the gold standard!

Spaulding stated explicitly on this matter: “There was no very great danger that the currency would become excessively inflated so long as every person holding greenbacks, not bearing interest, could exchange them at his own will into gold-bearing bonds at six per cent interest per annum” (pg 192).

The bond conversion aspect of federal notes was, however, suspended after the first year of their issuance, in March 1863. Spaulding does not explain why, although presumably, the government simply no longer wanted to pay interest on their forced loan. After that time, it was up to the discretion of the Treasury Secretary how much interest he would pay, if any at all. After that change in the greenback, after it had been removed from the gold anchor, inflation kicked in. Spaulding was against giving that power to the Secretary, calling it a mistake, and blamed it for “the inflations, fluctuations, and changes now so apparent” (pg 194). An inflation spike of 100% took hold in the first six months of 1864. By mid July, these US notes were worth only 35 cents on the dollar.

After the war was over, Spaulding was an enthusiastic proponent of paying back the national debt in gold and silver. The way he saw it, abandonment of the gold standard during war was necessary because those war loans paid for destruction, meaning an unproductive purpose. As he put it, “Every dollar expended took out of existence a dollar of value for which the Government gave its promise to pay. Every dollar of property thus destroyed led us farther and farther away from the specie standard, and has to be produced again by labor before the value is restored” (211-2). Eventually, the debt was paid back in gold, as Spaulding called for.

To cite this man as anything but a gold-standard enthusiast is completely dishonest.