Wednesday, December 12, 2007

Organization of Debt into Currency by Charles Holt Carroll

Sounds like a dry book to me, but it's strikingly similar to the current situation with CDOs, SIVs, and other derivative products. 

But the difference is that it was first brought up around 1858. 

Although both borrower and lender cannot have the same dollar at the same time, both are privileged to check upon it, and may offer it for purchases; thus it produces the same effect upon market prices, by degrading the exchange value of money, as double the amount of gold and silver in the hands of individuals. A sum thus available at sight by a check on the bank is as much currency as the bank note deposited in one's pocket.

Source: Organization of Debt into Currency by Charles Holt Carroll

Ever wonder why it takes a day to get your savings transferred to your chequing?  Perhaps it's because savings accounts don't really have any money in there.  You are loaning the bank money, which it "sweeps" out of your account on a regular basis, lends out, bundles into derivative products, gambles on the markets, or pays its employees & shareholders.  Your bank balance is just a computer printout until you sweep the money back into your hand from an ATM.  It duplicates, triplicates, fabricates the currency until it is many times leveraged. 

A similar thing happens to your chequing account, though on a smaller scale, since some reserves are sometimes required.

What if the money you're depositing isn't really anything either? 

"The term "deposit," as applied to the amount at the credit of a borrower, is in truth a misnomer, for the borrower deposits nothing—there is no money in the transaction; it is simply an exchange of debt. Yet it is effectually currency to be used as equivalent to coin at any moment. In event of a bank contraction, however, it is apt to become a most embarrassing claim upon both bank and borrower, for real dollars that are nowhere—that never existed."

This is another situation currently happening in the markets.  Lack of liquidity in derivative instruments has forced some financial institutions to write off their "mark to model" assets at a heavy discount.  Because they need a certain amount of capital or assets to maintain their credit worthiness or to stay within loan limits, this is causing some serious crunches.

"But the effect upon the general commerce and the individual prosperity and happiness of the people of this country is our concern in this matter. Nothing will prevent the precious metals from going where there is an effective demand for them, and nothing will prevent them from leaving the country where such demand does not exist. If we do not use them for currency they will go where they have that use in addition to other uses; for, like all other commodities, where they possess the highest utility they possess the highest value, and under the keen instincts of commerce they are as obedient to the law of value as matter to the law of gravitation. They only are money; a promise to pay them is debt, and that debt is not equivalent to money, unless coin is exchanged for or remains deposited and pledged to meet it."

This is a bit antiquated, as currency has really become a psychological gold.  Because so many instruments, assets, and debt are traded with currency, gold is forgotten in many circles.  It is only when there is a crisis in the markets that the gold factor is really hyped.  The key reason?  Maybe it's to sell more debt to dig for more gold... and use the debt and assets raised to purchase other things.  Really it's all in your head, as is the concept of money.

The other thing that was found when analyzing these complex financial instruments, was that the bundles they had of debt were sometimes duplicated or triplicated, or worse.  Your mortgage was sold to one party, then bundled and sold to another.  They both paid for the same virtual good, and will expect to hold title to that good.  When things will get interesting is when they decide to pick up their purchase, or audit their books to figure out what the heck it was they actually paid for.

The auditing is what happened in August.  Inventory didn't go so well that month.

"We cannot eat our cake and have it too; this truth was settled to the satisfaction of each one of us in the nursery; nevertheless, we try the same absurdity in principle in our currency, and the consequences are demonstrated in financial revulsions, such as that which befell the country last fall. We must accept money or debt for currency; we cannot have them both for the same sum at the same time."

Again, this was the 1850s.

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