A Challenge to Banking

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SECTION ONE - Dishonest Money

Invalid Claims Made Legitimate

A man in New Jersey once tried to corner the soybean oil market using a practice not dissimilar to that employed in the normal course of banking. He bought and paid for a storage tank of soybean oil. He then asked his bankers to test it for quantity and quality. He borrowed against it and bought a futures contract for the delivery of an equal amount of oil to him at some future date. He then shifted the oil to another tank and filled the first tank with water so that it would continue to appear full. He was not concerned about his borrowings, they had been covered by the futures contract.

He then had his bankers test the new tank for quality and quantity and borrowed against the new tank. He bought a further futures contract. He kept repeating the process in the hope of gaining control of the market and driving up its price to his advantage.

In each case, he had removed the real oil, and had effectively replaced it with a legal promise to deliver an equal amount of oil at some stage in the future. This is what the banking system does with our deposits. They are removed. Loan agreements are held in their stead. Loan agreements are agreements to deliver a specific amount of money to the lender at some future date.

The soybean oil man was eventually exposed. He was tried and convicted. He went to jail for fraud. Yet bankers, who in essence do the same thing with money, continue to function as legitimate businessmen - and, in fact, they are. Their misrepresentation has been legitimised. The legitimisation occurred so long ago that most, if not all, current bankers and customers have no knowledge of it. Today, bankers are seen as the pillars of the community. No reputable economist or financial expert of whom I am aware has questioned the validity of the money-lending mechanism of the banking system. To each it is a "given".

One of the most odious effects of this misrepresentation occurs when bankers voice their objections to wage rises, arguing that such rises are inflationary. Such comments are an insult to working people. Wage earners request a wage increase to claw back the purchasing power which has been removed from their pay packets. For reasons they do not fully understand, their wages can no longer adequately support their standard of living. Demands for higher pay lead to conflict and industrial dispute. Once again we can see how dishonest money divides decent people and sets man against man.

Then we hear financiers and bankers weigh in with arguments about the workers' greed. Yet we can now see that it is not workers' greed. It is the actions of bankers themselves that are causing the losses. The injustice of their comments is appalling.

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Inverted logic

As we saw with the gold coin in the previous chapter, the system produced by superimposing the mechanism of money-lending onto the system for storing and distributing money is dishonest. It ought not to have the support of the legal system. Giving legal respectability to misrepresentation turns logic on its head. The widespread use and acceptance of institutionalised money-lending leads us to believe it is a sound practice. But it is based upon misrepresentation. It is dishonest. It certainly ought not to have the support of the legal system.

Nevertheless, it does have the support of the legal system, and the amount of the misrepresentation continues to grow. The amount can be measured. In a given banking system, it will equal the amount of loans outstanding on the books of all branches of all the banks in that particular system, less the paid-up capital of those banks. Each time the banking system as a whole produces a net increase in loans, the amount of misrepresentation will increase, and the real exchange value of each previously existing unit of money will decrease proportionately.

This decrease should become immediately apparent in the market-place - but it doesn't. Under the gold standard, for instance, prices remained stable during periods when misrepresentation was continually occurring. Hidden from public view, a gap was opening between the amount of gold available to honour claims and the amount of those claims. With each new misrepresentation the gap widened. Holders of claims were unaware of it. They believed that the claims which they held could be exchanged at any time for the amount of gold stated. So long as this view held, each claim was treated as if it were the amount of gold stated.

Confidence then became the key to successful banking. It was irrelevant that a bank could not meet all its issued claims if presented for payment at the same time. What mattered was that individual claims could be met when presented. Systems were put in place to assure depositors that their deposits were safe. The presence of these systems allowed lenders to increase their misrepresentation with impunity. Nevertheless, with the increased misrepresentation, prices remained stable.

Gold had a minimum exchange value. It was in demand as the principal medium of exchange and store of value for future exchanges; it was rare: it was hard to find: it required a considerable amount of expenditure of human energy for both its discovery and its production. People would not produce it for less than the effort to produce it was worth. If demand fell and its value in exchanges fell, less would be produced. As less was produced, less would be available to service the needs of the market-place, and its exchange value would begin to increase. These factors helped to provide a minimum level below which even massive misrepresentation could not push the exchange value of gold.

As a result, there was also a minimum exchange value below which claims on gold could not be pushed unless and until holders recognised that each claim could not be exchanged for the amount of gold stated on its face. Only then would the exchange value of paper claims collapse.

This prospect faced the Western monetary and banking system in the 1930's. Had the invalid claims then been declared illegitimate, the exchange value of gold would have risen as the market recognised that there was not nearly as large a supply as had been represented. As the exchange value of gold, or money as it was then, increased less of it would have been needed in exchanges for the same previous value of goods and services. Prices would have fallen. The holders of gold and valid claims would have found their purchasing power increased. The existing amount of gold would then have been able to support an increased volume of exchanges. This was not allowed to happen. Instead, the invalid claims were legitimised, and gold was removed as a form of money.

The problems faced by the monetary authorities and banking systems in the late 1920's and 1930's were a direct result of the practice of money-lending. In the United Kingdom, for instance, up to that time, a pound was the name given to a note which had a legal claim upon one quarter of an ounce of gold. Pound notes were issued both by private banks and the Bank of England. Each accepted pound notes as deposits as if they were gold itself. Each loaned both. The acceptance of pound notes as deposits, the issuance of receipts against them, and their eventual use for loans, merely served to compound the rate of misrepresentation. The mechanics of money-lending were misrepresenting both the amount of gold in the market-place and the amount of valid claims which were issued against gold.

It took a long time before a sufficient number of individuals began to suspect that they might not be able to exchange their claims for the exact amount of gold stated. During that long period, the exchange rate of both gold and claims remained very stable at, or near, the minimum level below which gold could not be pushed. When sufficient individuals did suspect the truth of the matter, they acted with natural self-interest. The suspicious preferred not to hold notes for future exchanges: they asked for gold. The British banking system had to face the truth: it held insufficient gold to honour all the claims issued. In Great Britain, monetary collapse became imminent.

The situation was similar in North America. But it was exacerbated by the acceptance of shares on the stock market as collateral for loans. Through the provision of up to 90 per cent of the purchase price of shares in the form of loans, "bidding power" was provided which drove the share market higher and higher. At each higher level, lenders remained willing to advance 90 per cent. The value of shares soon became unsupportable. Yet "bidding power" continued to drive them higher. In due course even the most optimistic investor began to suspect that share prices had far exceeded their actual value, and would no longer invest. The market collapsed. The inflated value of collateral disappeared. Individuals and institutional borrowers were unable to sell their shares to cover loans. Lenders found much of their collateral valueless. Lending stockbrokers and their supporting banks began to fall like tenpins.

So, by the early 1930's, monetary collapse in Great Britain and the United States of America as imminent. The monetary authorities of both countries ought to have recognised misrepresentation as the cause of the impending collapse. They ought to have exposed if and thereby helped the system to heal. Instead, they reasoned that if individuals had been willing to accept paper claims at a given value on one day, they ought to be able to accept them at a similar value the following day. Confidence in the exchange value of the invalid claims had to be created. Both governments therefore chose to legitimise the claims. They made them the only legal medium of exchange. They cancelled the convertibility of these claims to gold by other than governments. They banned the use of gold itself as a medium of exchange.

Thus the prudent and the careful, who had chosen to hold gold rather than paper, paid the penalty and the careless and the fraudulent were let off the hook. Dishonesty was rewarded and integrity penalised.

Nevertheless, the validation of paper money might have solved the governments' monetary problems had action been taken to stop the continuing production of invalid receipts. But nothing was done to stop the banking practice of money-lending.

Therefore the issuance of invalid receipts continued. Now, however, it was worse: the deposit looked just like the paper receipt. Both were simply statements about pounds or dollars. It is and it remains difficult to differentiate between them. Today, in the absence of a clear understanding of how the mechanism actually works, the money supply appears to grow organically. Some would even say mysteriously. Yet there is nothing mysterious about it. By allowing the superimposition of the mechanism of money-lending onto the system for storing and distributing money we have both legitimised and institutionalised misrepresentation. Thereby we have allowed the emergence of a monetary and banking system which continues to debase the currency by its own natural action.

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