On Monday, I talked about bitcoin and the real estate cycle. It’s the first part of a series, explaining how money is the accepted means of settling credit balances.

Today, we’ll get to part two and talk about banks and how they fit into this sophisticated system.

(Make sure to  check out part one if you haven’t yet.)

Let’s get back to the example of writing an article and getting paid for it…

It could be that my publisher, too, had a credit balance if, for example, it was yet to collect payment from its customers.

In other words, it might not have the funds available to pay me yet.

But it would still need to pay me soon, so it could secure an advance from its bank to achieve the same effect.

It doesn’t matter that the publisher hasn’t settled its balance with customers. That will happen in time.

Enter the Bank

The bank advances the needed credit to the publisher, the publisher settles with me, and then once its customers have settled with the publisher, it will address the debt it owes to the bank.

I hope that you’re starting to see that credit, money, and debt are connected.

The role of a bank is to advance credit for this exchange… and for many, many others that take place every day.

And it does so by creating – out of nothing – the means of settling those balances…

Yes… that’s money creation.

Don’t be fooled by erroneous thinking: banks don’t channel pre-existing money from savers to borrowers.

They create money by advancing credit to whomever needs it to support the chain of exchanges which a productive economy depends on.

For a time, some of those credits, after exchanges have been made and payments have been settled, appear to get “deposited” back into the bank awaiting use at some future date.

First comes the credit, then comes the deposits (the term deposit is actually misleading, but we can leave that for another day).

A bank’s job is to properly assess whether someone needing an advance can do what they say they will (produce a good) and that they’re trustworthy.

Banks are at the center of the capitalist economy for this reason. If banks weren’t there, some other means of creating credit (money) and assessing creditworthiness would emerge.

In the modern economy, banks fill this function.

I hope you’re starting to see that much of the discourse around money is actually quite misleading.

This includes the conversation about money in relation to bitcoin.

The Decentralized Bank?

The idea of decentralized finance rests upon this assumption: you can bypass the intermediary function provided by banks.

But have you heard an advocate of decentralized finance articulate what money is or the role of a bank in this way? I haven’t.

Creating money in this way is not inflationary if what the banks do is advance credit against increased future production.

Credit is advanced, new goods are produced, they are sold, and that initial debt is repaid. More money is available to facilitate the increased number of exchanges taking place as the economy grows.

In fact, the origin of all money begins this way – with someone using a token created out of nothing or which had some unrelated use to settle a balance.

The tokens may or may not be inherently valuable… whether they are is irrelevant to their function as money.

Their utility derives from the trust that people have that they can be used in exchange for settling their own credit balances. This is why the tokens issued by a central authority typically work best as money because it can be mandated that all credit balances are settled in this way.

And besides, we all need to pay our taxes – and so it makes sense to use tokens stamped in the same way.

How Money Creation Leads to the Real Estate Cycle

Some of you may find that a controversial statement, but the worst thing to have is money that you can’t use in exchange. Exchanges have to be settled by something that everyone accepts.

So wherein lies the problem with money in the economy?

Earlier, I said that money creation led to increased production.

That’s the ideal, but in reality, our system has become distorted.

Most of the money created by the banking system is for the acquisition of land rather than advancing credit for businesses.

This is inherently inflationary because the money so created does not directly lead to increased production (it may do in part, but it may not).

Worse, it drives economies through cycles of booms and busts, and at the end of it, banks collapse, and their money-creating function for genuinely productive businesses is significantly impaired.

Hence we get the dark moments at the end of every real estate cycle, where the economy, starved of credit, sinks into an economic depression.

A Built-In Flaw in the Banking System

Frantic governments then attempt to bail out the system…. but what they’re really trying to do is preserve the credit creation process and fill the gap in the money supply that is lost as banks stop lending.

Incidentally, the size of each bailout is always directly linked to the fall in land values – and as land values get higher with each passing cycle, the size of the bailout gets bigger.

So to recap…

Money is created out of nothing.

It is given its value by the fact that it is a generally accepted means of payment.

How do we agree on what is to be accepted and trusted?

Well, that’s the issue. This depends on the context. Nowadays, it is a government decree. In medieval times it was often a precious metal, generally imposed on people by violence (see David Graeber’s research on this in Debt: The First Five Thousand Years).

At other times, people have used rocks, such as some indigenous peoples who had highly evolved systems of credit. Or it can be cigarettes, as in some prisons. Or paper. Or even a digital token.

The key requirement is that when you are in possession of it, you can settle a balance. Once bitcoin can play this role, it can be money.

At the moment, its most important feature is the fact that it is limited in supply, which makes it a highly speculative asset.

This excess demand against limited supply makes it a little like a piece of land (albeit that land, unlike bitcoin, has some inherent value because you can grow something on it).

Bitcoin’s link to speculation brings me to its next link to the cycle: economic rent.

I’ll discuss economic rent and put the whole picture together in our next issue.

For now, if you have read this series carefully, you’re ahead of the vast majority of investors in terms of understanding money, both fiat and digital.



Phil Anderson

Editor, Cycles Trading with Phil Anderson