Gold News

Money vs Capital

Few countries seem interested in treating capital well these days...

THE OLD ADAGE says 'Capital goes to where it is treated best', writes Greg Canavan for the Daily Reckoning Australia.

In this age of currency wars, no one is particularly interested in treating capital well. If too much of it shows up on our doorstep, we turn it away. We're not interested in housing and nurturing it. If only we'd get to know it better...let it stay and grow of its own accord, it could do us so much good.

Instead, we shun it. We think capital is the problem. It's makes currencies too strong and weakens nations' ability to export, create jobs and earn foreign income.

But the world is confusing capital with money.

Money is the problem, not capital. Too much money makes capital less productive. It can't settle down and get to work. It takes flight and constantly looks for shelter instead of generating wealth.

But where does money come from? Who makes it?

This was the rather lengthy subject of our latest issue of Sound Money. Sound Investments. We traced the history of 'money' – as in the concept of it, not the bland history of coinage – to get an idea of where we stand today.

And history shows that people create money through building and earning credit. Banks grant credit, which is 'money', to creditworthy individuals and businesses. These individuals and businesses spend this 'money' (by consuming or investing it) and it flows throughout the economy generating income, sales, taxes and profits.

The money though, is really just an abstract concept. It's a unit of measurement and exchange, with its value limited to this utility. The wealth...the in the 'stuff' that the money obtains. Human ingenuity and innovation then combine with this stuff to grow wealth and capital.

Money is just the vehicle for this wealth to pass through in a standardized 'unit of account'. Throughout history money has been many things...seashells, rocks, cigarettes, paper, gold and silver, copper, bronze etc. But it's not wealth and never has been. Wealth is something that takes sweat, brains, perseverance and failure. Money is none of these things.

In the era of the 'modern monetary system' we utilize paper as our money. More precisely, we use government produced paper, which uses the collective credit and credibility of nations' resources and people to in turn give the paper money 'credibility'. Nothing tangible backs our modern money, only intangible qualities like the goodwill of men (yes, mostly men) and nations.

It's probably the most efficient form of money society has ever used. But unfortunately, the management of it is in the hands of humans, which makes it inherently unstable.

Ever since this modern system arose, breaking free from the 'shackles' of gold in 1971 (we'd call it cutting the golden safety net), the managers of the system have attempted to create more and more 'money' by creating more and more creditworthy borrowers.

Lowering interest rates, cutting banks' reserve requirements and myriad other regulatory changes have all bestowed credit upon people who in a more disciplined system would have been denied it. As a result, credit, and therefore money, is easy to get.

But just as credit creates money, discredit takes it away. And so the great US housing bubble created trillions in money when it had 'credibility'. But by 2008, with the credibility of the bubble destroyed, trillions in 'money' went along with it.

That's why the Fed stepped in. It didn't 'print' money. It monetized previously created money that was rapidly turning bad and disappearing from sight. It did this by buying bad mortgage debt for a price well above what the private market was prepared to pay. In effect, it swapped Fed produced 'money' for market produced money that was rapidly falling in value. Money and credit are intangible concepts, here one day and gone the next...

The Fed's job is to make sure it is never gone. It stands ready to monetize all the debt ever created. It has to. The system cannot handle the disappearance of money...the discrediting of previously credited accounts. If it did it would collapse.

The market knows this. And it's just not the Fed, it's all the central banks. By monetizing discredited credit, central banks give the green light to rampant speculation, the most discredited form of 'wealth creation' in history!

That it's getting out of hand is obvious to most people. You're seeing it in asset markets all over the world. But there's now rumblings at the Fed that all is not well in the bowels of the world's monetary system. They're very faint rumblings, to be honest, but all stampedes start that way, don't they?

Time to Buy Gold?...

Greg Canavan is editorial director of Fat Tail Investment Research and has been a regular guest on CNBC, ABC and BoardRoomRadio, as well as a contributor to publications as diverse as and the Sydney Morning Herald.

See the full archive of Greg Canavan.

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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