How Money and Banking Works, Supposedly

June 26, 2014

Now, When I start to discuss money, what I refer to like most people, is fiat money. The first question to ask should really be: What is money, and more to the point, what isn’t money? There are several accepted definitions of what constitutes money; I’m going for a simple one:

“Money is any object or verifiable record that is generally accepted as payment for goods and services and repayment of debts in a particular country or in a particular socio-economic context.”


So, Money is a good that acts as a medium of exchange in transactions, it is simply a facilitator of trade. Money, at its simplest has two functions, it is a store of value, and it is a means of exchange. If this is a bit too straightforward then The Federal Reserve Bank of New York provides the following:

“The Federal Reserve publishes weekly and monthly data on three money supply measures — M1, M2, and M3 — as well as data on the total amount of debt of the nonfinancial sectors of the U.S. economy. The money supply measures reflect the different degrees of liquidity — or spendability – that different types of money have. The narrowest measure, M1, is restricted to the most liquid forms of money; it consists of currency in the hands of the public; travelers checks; demand deposits, and other deposits against which checks can be written. M2 includes M1, plus savings accounts, time deposits of under $100,000, and balances in retail money market mutual funds. M3 includes M2 plus large-denomination ($100,000 or more) time deposits, balances in institutional money funds, repurchase liabilities issued by depository institutions, and Eurodollars held by U.S. residents at foreign branches of U.S. banks and at all banks in the United Kingdom and Canada.”

By the way, Credit Cards are not a form of money. Also, it can be reasonably inferred that anything that is acceptable to both parties can be loosely termed money. In 2007, the collapse in the level of trust in paper money in Iraq led contracts to be written in values of sheep. Now, If I withdraw a fifty Euro note from the ATM, I get a piece of paper. That paper assures me that the bank will honour it. But, honor it with what? Gold, silver, precious gemstones, no! They will honor it by giving me five €10 pieces of paper or ten €5 pieces of paper. The paper itself is worthless, but people maintain enough trust to give me goods to the value of that note. Money is a system that works on mutual trust. I trust the state to honor their currency, the state trusts me to accept their currency in payment. Bitcoin also works on trust; trust in so much, as it works on mutual distrust. I buy an item and pay with bitcoins, my peers confirm the transaction, the transaction is confirmed and therefore completed. Bitcoin is a store of value (That is why people hoard it!) and acceptable as a means of exchange.  Bitcoin is therefore money. Now we hit a problem! The simple definition of money will clearly include Bitcoin, but the more complex, and complete, definition is stymied.

Now, let us look at the noble industry of banking. Banking operates, like money, on trust. I trust the bank so I give them my money to  hold. They lend out most of it to a customer that they trust, either by their credit history and/or by the presence of collateral. Banks tend to be very good at accounting; they know how much everybody has and how much everybody owes, at a point in time. Now, Bitcoin is really M0 money. It is that money that can be instantly spent; like the dollar bills in your pocket and under the mattress, as well as those coins trapped in the couch. All bitcoins can be spent; instantly. There are none held in deposit accounts, none held in mutual funds, no repurchase liabilities and no Bitcoin complex derivatives. There is no government controlled element whatever.  We can store bitcoins, we can even lend bitcoins, but we cannot impose central banking restrictions onto a decentralized currency, and both banks and governments hate this.

“The level of imports is too high! What will we do? Let’s devalue our currency, oh wait! We’re using Bitcoin!”

“People are spending too much and not saving enough and the economy is overheating, raise deposit rates, oh, Bitcoin!”

“People are making the wrong decisions, buying alcohol and cigarettes, lets tax them! They’ll import them using bitcoins!”

That’s the problem, Bitcoin removes choice from Banks and Governments and places it firmly in the hands of the market. Owning our own money system causes states problems. The more closely managed states have the most to lose and they regulate the most severely; just look at China. The secret about banking, the thing they don’t want us to know, is that it’s a numbers game. Money has absolutely no morality, it possesses no loyalty and banks are the same. Remember the quote from Gordon Gekko in Wall Street‘It’s a zero sum game, somebody wins, somebody loses. Money itself isn’t lost or made, it’s simply transferred from one perception to another.’

As Bitcoin goes from strength to strength perhaps it is time for us to define the laws we want to protect us and then to tell them the level of banking we are prepared to accept. There may well turn out to be a compromise but let us at least define our starting position.

Images by Shutterstock.

PJ Delaney @P.J. Delaney@delboyir

Masters in Public Administration, Bachelors in Mgt., I live in Ireland, I have a bit of a background in Economics and lots of opinions on everything else.