by Bill Sharon
We live in a world where the means of exchange (money) has become vastly more important than what we exchange (goods and services). We have moved from a time when money or profit was one of several metrics by which a company could be judged to the only metric and more recently in many cases, to becoming the product of a company – buy our stock because we make money. How did we get here?
The history of money apparently has its origins in China around 1200 BCE where cowry shells were used as a means of exchange. If we fast forward to the Middle Ages in Europe we can find the origins of the modern banking system when people took their gold and silver coins and deposited them with the local goldsmith. The goldsmith found that only 10% of his deposits were ever withdrawn at any one time and he began what become known as fractional reserve lending (keep a fraction in reserve and lend the rest).
There are some fundamentals of that old system that are still in play today. We have a debt based monetary system. Banking and the creation of money is a private business. Someday NY Times columnists like Tom Friedman will understand that the loans from the Federal Reserve to IAG were not taxpayer bailouts. There is not way for dollars paid in taxes to get into the Federal Reserve unless they are used to pay interest on the money created by the Fed and loaned to the US government. Taxpayer dollars are not at risk in the AIG transaction; all the dollars are at risk. But I digress.
For centuries human beings have debased themselves in one way or another to accumulate money. Money was and is power. With it you could not only provide yourself with the basics, but have some toys as well – like big armies or iPods. Over the past fifty years we have elevated the accumulation of toys to an art form in the United States. So much so that over 60% of our economy is based on people buying things. Most of us believe that acquisition is the purpose of money.
A recent Wiki article (http://en.wikipedia.org/wiki/Stock_market
) states that as of October of 2008 the total value of all stocks in the world was $36.6 trillion and the total face value of all derivatives in the world was $791 trillion. Given that these numbers reflect the values shortly after the financial crash I’m sure that they have moved around a bit since then. But the ratio is likely the same – roughly 22:1. Derivatives are contracts to pay based on the performance of something else. It’s pretty clear that more than one contract has been written for each underlying asset. When things go south it’s no wonder that these contracts can’t be paid and it’s no wonder that there have major efforts to save the financial system; a system that is so abstract that no one really understands it.
Another number that is useful to think about is global GDP which is roughly $65 trillion – that’s the value of all the goods and services produced in the world.
So it is fairly easy to see that wealth or money has been decoupled from its ability to buy goods and services. There simply isn’t enough available to buy given all the wealth in the system. Economists will tell you that derivatives only have nominal value; that the vast number of derivatives cancel each other out because they are “bets” on whether something will happen – or not.
But let’s leave that discussion to the economists (they seem to be the only ones who want to talk about financial systems as though they are separate from the human experience and have a life of their own) and get back to thinking about money. If money is not a means of exchange, if it is not something that we can use to make our lives better or someone else’s life better – what is it? The more I look at the numbers the more I have come to conclude that I don’t know what it is any more. The only thing that seems clear is that we are tenuously hanging on to the idea that somehow all allegedly sophisticated financial instruments have value – an idea that is under constant daily attack.
The story of what is said to be the world’s first large economic bubble may provide some clues as to where we go from here. In 1593 tulip bulbs were brought from Turkey to the Netherlands. Initially these flowers were prized for their relative rarity but then a non-fatal virus caused the bulbs to produce very unusual flowers – they appeared to have “flames” of different colors and their value increased exponentially. Many citizens mortgaged their homes and businesses to invest. The resulting crash seems obvious in retrospect. One can imagine how the collective unconscious tapped the Dutch on the shoulder one day and said, “Dude, it’s just a tulip bulb.” Seems like a quaint story until we remember all the websites that had no product, service or functionality that were so valuable ten years ago.
I would suggest that we consider the following:
- Debts are not going to get paid back. Not the personal debts that are close to $2.5 trillion that Americans owe or the mortgages on properties that are not worth the loans or the national debt – in our country or in others. Some of this will take the form of tax payer revolts and some will take the form of people going on YouTube and challenging the banks but mostly it will occur by people simply no longer paying the loans.
- The endgame for all the derivative assets and worthless loans on the books of financial institutions is nearer than we think. What is worth nothing will be acknowledged as being worth nothing.
- Alternative ideas about money will begin to appear. There have been systems in the past were the value of money declined the longer it was held. There are systems now that derive value from time – time banks. What seem like wacky ideas will begin to seem sane as the wacky ideas that have passed for sanity are revealed as wacky.
So have I traded in my risk management bona fides to become a fortune teller? I’m not psychic and I don’t see dead people. All three of these events are occurring now. The tulip moment is upon us.