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  • Martin Schmalzried

The REAL Value of Money


In mainstream economics, typically, money is defined as having 3 major characteristics: a means of exchange, a unit of account, and a store of value. I won’t waste time explaining these components, because the most important part, often missing, is how money acquires these characteristics in the first place. Some economists more radically declare that money has no intrinsic value and that its value is simply based on a form of collective trust, a sort of “collective hallucination” where everybody believes that money has value and expect to be able to redeem the money they hold for a certain number of goods and services, and this collective belief then gives value to what otherwise is just a bunch of numbers on a piece of paper. Of course, there are some features which help in maintaining this belief, such as the fact that no one (except perhaps central banks, more on that later) owns a “magic money” printer at home, enabling a form of “artificial scarcity” for money, which, in a similar way to gold, makes it eligible as a “store of value”.


But the elephant in the room, the major factor behind what gives money its value, is mostly ignored. In short, the value of money is directly linked to the way it enters into the economy: via debt. Since the financial system is a debt based monetary system, any money comes into existence as a loan. This means, in very simple terms, that when you open your bank account and look at your balance, you’re actually owning someone else’s debt. If a large number of people decided to stop spending money (left it to be eaten by inflation and fees on their bank accounts), grew food in their gardens, lived in a self-sufficient cottage disconnected from all utility, then a large number of economic actors (mostly businesses, but also private individuals) would inevitably default on their debt.


What are the implications of this reality? That money does have an intrinsic value via the fact that there are millions of indebted actors who are in demand for the money people have on their bank accounts or in their wallets. Thus, one could actually reverse the relationship of offer and demand, where businesses selling goods/services are considered to be the offer and consumers are considered to be the demand. In fact, consumers represent the offer of money, and businesses/privately indebted individuals/indebted states, represent the demand (for money). And so the reason why people believe that the money they hold will buy them some good or service, is thanks to the fact that most businesses have a debt to pay, and thus need to find someone to sell their goods/services to (a sort of “forced” selling to service costs, which include debt, but also rent, salaries etc). For privately indebted individuals, they are under pressure to find a job (typically in the very business which is itself under pressure for repaying debt), in order to get a salary to repay their debt. So in fact, it is debt which keeps this whole system from imploding. And it all relies on a delicate balance where ideally, money flows smoothly through the economy in the following ways:

  • A business gets a loan, invests the money, the productivity gains allows it to produce more or more efficiently (cutting costs), which allows the business to maintain price levels all the while producing more or even lower prices. Productivity gains must always be higher than the level of interest on the debt, otherwise inevitably, over a longer period, this situation would lead either to higher and higher debt levels or high inflation (a rise in prices to offset the cost of servicing debt or a transfer to society of the failure to achieve higher productivity while still remaining solvent/being able to repay the debt).

  • The business then pays its workers decent salaries, which allows those workers to purchase the goods produced, and thus enables the business from repaying its debt. Basic Fordism, nothing new really…

  • And so money enters into existence via the creation of a loan, it allows to produce a certain number of goods/services, and enables a certain limited number of exchanges to take place before it is repaid/destroyed. The interest on debt serves as the main driver putting pressure on businesses to innovate and increase their productivity, otherwise the economy could enter a deflationary spiral, much like the one we are experiencing now. NOTE: I highly encourage you to read my article on inflation, as this also is a concept which is completely misunderstood by most economists.

There are many things that can go wrong in this cycle. For instance, as already mentioned, the lack of productivity growth which means that while businesses become more and more indebted, there is no meaningful increase in the quantity/quality or a decrease in cost of the goods produced, except maybe from cutting on the one expense which is risky from an economic perspective: cutting on labour costs. If all businesses resort to that sort of strategy to artificially increase productivity, then there needs to be the creation of new businesses to absorb the excess unemployment. Failure to do so has a negative repercussion on demand: a lower number of consumers to purchase the goods/services available. This can be jacked up artificially via wealth transfer mechanisms (social benefits) and personal credit, but both are a short term fix.


Another wrench thrown into this system, is when the cost of servicing labour dwarfs the cost of servicing capital. When businesses compress wages to pay higher dividends, they are also shooting the economy in the foot. Within the investment landscape, the ultra-rich, who own most of the wealth, don’t spend their money in goods/services that actually support the economy. No ultra-rich person eats 1000 meals a day, or buys 400 retail cars. This gap between ultra-rich and the rest creates two parallel economies: one economy which is targeted for the “demand” of the ultra-rich, with flourishing industries in yacht building, or super luxury villas/cars, which may experience very high inflation due to very high demand, and then the rest of the “real” economy which is on the border of deflation. And the “permeation” of one economy to the other is too minimal to prop up the failing one (for instance, compensating the loss of demand from compressed wages in businesses selling “mainstream” goods by the demand from workers manufacturing yachts or building luxury villas/cars).


Of course, you’ll note that both of the problems mentioned above currently plague our economic and financial system. Looking at the graph below, it can be seen quite explicitly. The inflation for the “ultra rich” or the CLEWI (see below) is about double that of the consumer price index. Yet the net worth of the top 400 richest people has skyrocketed, notably via the mechanism identified above (servicing capital to the detriment of labour) and also thanks to the explosion of the value of asset prices thanks to government and central banks actions in artificially propping up markets following the 2008 financial crisis.




https://www.forbes.com/sites/andreamurphy/2019/11/26/what-it-costs-to-live-like-the-richest-people-in-the-world/?sh=22bd205b3aae


On top of that, we are experiencing unprecedented economic and financial strains due to the coronavirus pandemic, which only exacerbates the problems above. What could possibly go wrong?


Well, to put it simply, once a borrower who uses a lot of “flexibility” for his repayment conditions enters massively into the market, it can create wild distortions. As I have said earlier, whenever you open your bank account, the balance you see represents debt that someone owes to the bank. These debtors will chase after you, begging for your money, to make sure they don’t miss a payment for fear of banks sending debt collectors to their homes/businesses.


Or they will simply create a consumerist society and assail you with a ton of advertisement every way they can to make sure that you willingly and happily part with your money without thinking too much about it: be a nice, stable and predictable consumer. Anything else would be a liability for our present debt based system. Repayment of debt is steady and predictable, so should consumption of course, since consumption translates into revenue which allows for steady repayment. That’s why the “consumer confidence” index is highly regarded and observed by the smartest economists: they know that whenever consumers act like squirrels rather than spendthrifts, it’s a highly bearish signal for the economy.

So back on topic: imagine a simplified version of our economy, where you have 10 businesses each producing 10 goods. The bank lends each business 1000€ at 10% interest to be paid in full the next year. Thanks to the 1000€, the businesses invest in newer technology, or anything else increasing their productivity, which results in enabling them to produce 12 goods instead of 10. They have to pay 10% interest on 1000€, which means 1100€. Let’s just assume that those 1000€ covered all of the businesses’ costs, including wages (ultimately, every euro spent is turned into a wage down the line). This means that before the loan, if the price of each good was 100€ a pop, after the loan and investment, the price of each individual good will be 1100€/12 to be able to cover the interest on the loan (let’s ignore profit and just make sure that the business breaks even, it makes it simpler to understand). So that’s about 91€. Prices have dropped about 10% and there are more goods around. Well, that being said, that’s without understanding that basically, since there is only 10000€ (10x1000€) in circulation in the economy, the businesses or consumers need to take out a new loan to pay for the interest on the older loan, which means that in most cases, the businesses will take out a new loan of say 1200€ each this time, to pay for the interest of the previous loan (100€), invest again and make (hopefully) extra productivity gains. So the prices may actually remain stable since there is more money in the economy, but since there are more goods available, it’s still to the benefit of consumers.


Now, imagine what happens if suddenly, one of the businesses starts borrowing massively, and yet producing nothing. That is the case for governments today, borrowing massively just to prop up markets and businesses which would otherwise sink (airlines, SMEs selling non essential goods, car makers etc). In that case, the effect on price stability may be disastrous, since it breaks the stability of this cat and mouse game of a roll-over of debt into infinity, where loans push for productivity and innovation to counterbalance the effect that interest has on the cost of capital. Of course, like I said earlier, this cycle has already been broken on many accounts, on top of other factors such as the impending resource scarcity and climate change, but the last nail in the coffin certainly is the massive borrowing and money printing of governments/central banks. Neither are very efficient producers of goods, sometimes they are good producers of services, but the mere fact that they can much more easily roll over their debt (most rich states are too big to fail) creates a disincentive to increase their own productivity. So inevitably, we will land in a situation where:

  • the debt levels overall increase (which will invariably fall on tax payers one way or another),

  • a misallocation of capital (most of that borrowed money doesn’t help the “real” economy, and even when it does, it’s not for increasing productivity, but merely preventing businesses from defaulting on loans and file for bankruptcy),

  • a strain on individual workers/consumers who are fired to help businesses cut costs to survive months without any sales,

  • and yet a lot of money splashing around which represents debt that isn’t tied to some business which creates a “demand” for that money in exchange for a good/service.

The current situation basically greatly lowers the demand for consumer money in two ways:

  • SMEs because they receive government aid or simply because they go bankrupt and stop chasing after you to get your money because they have given up on remaining solvent;

  • Big (zombie) corporations or other too big to fail businesses because they know they will be able to roll over their existing debt at no or even sometimes negative interest rates.

And of course, as you should have understood from this paper, since what gives actual real value to the money on your bank account is the fact that you have a number of indebted people who are proactively chasing after you to take it from you in exchange for a good/service, once you are in a situation where:

  • Governments don’t really care that much about providing a good/service to lower their debt because they can simply increase taxes and take that money away from you without compensation in the form of a good/service, only a vague “promise” that the money is going to be used in the “public interest” and will eventually, theoretically, maybe translate into a service (like the current understaffed underfunded public healthcare services);

  • Businesses don’t really care about providing a good/service either because they count on roll-over of their debt or they are bankrupt;

  • You should really start to be concerned about the value of your money since the demand for it is falling at a break neck pace.

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