Mining the Future
Many people will tell you that banks are a better investment than gold mines. But what they won’t tell you is that banks are also mines. The commodity that they mine though is far more abstract than mineral ores. What they are mining is future value. They are tunnelling into the future, extracting the value added to society by a certain person or company (the borrower), and bringing it into the present, where that value is represented by a fiat currency, added to the bank’s balance sheet, and lent to the borrower.
In a banking system where fractional reserve is not permitted, any lending activity must make use of current savings as the only source of funds. This, by definition, restricts the supply of money for lending and therefore restricts economic growth. But contrary to what you have been conditioned to believe, this is not necessarily a bad thing. The economy may not leap forward in huge steps, but it is absolutely certain that the rate of development will be sustainable.
With a fractional reserve system however, banks are able to give credit to a multiple of the cash they have on deposit. In this way they are inflating the current money supply by issuing notes on deposits that don’t exist. Or more specifically don’t exist YET. The important thing to remember is that the loan is issued on the premise that it will be repaid from future earnings. So in essence it is a loan, not of current money, but of future money. In this way, the banks are reaching into the future and bringing back the projected earnings of a person, and allowing that person to use those earnings in the present.
People often say that in a fractional reserve system, money can be created from thin air. That is not really true, it is just the understandable reaction of people who are concerned for the value of their own currency, who don’t understand the basis for the value of credit created in a fiat monetary system. It is important to note that currency is never just indiscriminately printed and added to balance sheets; any money added to the money supply through fractional reserve banking is in the form of a loan to a debtor (borrower), and that loan is backed by the promise to repay the loan from the future earnings of the debtor.
There is potential here for feedback – either positive or negative, and this feedback is what makes banking magical. If the borrowed money is used to finance productive capacity, it will increase the borrower’s future earning power, thus filling the future “value gap” created by mining the future, and even increasing the value present in the borrower’s future. On the other hand, using the mined future value for pure consumption leaves the “value gap” in place, making the borrower poorer in his future. If we apply the positive feedback scenario to all borrowings, the value of the future will increase exponentially. This is what allows you to develop at the rate you have done.
I will not make a judgement on which is the best system, or which is the correct system. My purpose is only to lay out in a simple way the mechanisms of value in each so that you may better judge the dangers of each, and make decisions with a better knowledge base.
The dangers of the 100% reserve system, or a gold standard, are only in the limits imposed on development. Whether these limits are really dangers, or if they are safeguards is not known to me. We cannot judge the future accurately – it may be that only technology can save the human race from a looming external threat, in which case fast development is preferred, or it may be that technology that develops faster than it can be fully considered and understood will create its own threat to the human race, or even the earth (I gather the possibility of “anthropogenic global warming” is the current fashionable threat; a case of technology – even such a primitive one - being implemented without full consideration and understanding of its effects). Nevertheless, slow development must be considered a threat as much as fast development.
Fractional reserve banking, or “future mining”, has it own dangers – and here we finally get to the current global economic crisis. As with any form of mining, there are skills involved – principally knowing where to find the richest seams of value and being able to assess the value of the seam, as well as its surrounding strata, to determine how much value can safely be extracted without the danger of a cave-in. This is the skill of a banker. Being able to assess the borrower in terms of his understanding of the debt, the proposed use of the debt and its contribution to future value, his ability to repay the debt, his future prospects and his lifestyle. All of these factors and more should be important to the banker, because his bank is acting as facilitator to the borrower, allowing him to borrow from his future by providing surety for the debt. If the borrower defaults, the value gap in the future is never filled, it simply sits there on the bank’s balance sheet. What has happened in the world economy is that there has been too much borrowing for pure consumption, which adds no value to the future, in conjunction with lending to people who have no hope of repaying the debt (sub-prime mortgages). I also believe that third world state borrowing has a large part in this equation, because it is often used simply for consumption, and new loans are frequently used to service interest payments on old loans. These factors have created a massive hole in the value of the future. For a long time now, banks have simply been mining deeper and deeper into the future to fill the holes left open. It has reached (or will soon reach) a point where banks can no longer mine any deeper into the future. Beyond a certain time span – significantly less than a generation, there is no way of determining the ability of a person to repay a loan. This is the depth limit of the future mines. When this point is reached, we will have to simply wait until seams of future value collapse in on one another, creating a more homogenous mass to mine. This is the financial meltdown.
How do you avoid this in the future? It is simple, literally! Just simplify. Remember simplicity, teach simplicity, use simplicity. By creating abstract complex financial instruments, and pyramiding one on top of another, by hiding bad debts in “black boxes”, by believing that complexity can overcome the basic principles of value, you have created a culture that allows, and even encourages, unwise banking practices. It is not the system that is at fault, it is the people.
You will probably be saying, “we need stronger regulation”. It is a natural reaction, but not necessarily the best. This is a subject for another study. In the meantime, best of luck to all of you all, and remember to simplify.