Before relativity, time was considered to be a separate entity to space. Relativity made clear that they belong to the same entity, and they are related by energy. The same way, credit belongs to the essential function of money as medium of exchange, and they are related by the socially assigned reputation of the lender.
I will make early my heretic statement: FRACTIONAL RESERVE BANKING, AND THE CREATION OF MONEY OUT OF THE NOTHING IS THE MOST BRILLIANT FINANCIAL INVENTION OF OUR ERA.
Sure, combined with interest, it has evolved to the tumor of the debt monster bubble of today. At speaking about debt, we tend to put it at the negative corner. We are so terrified, that at speaking about debt, we prefer to stay at the safe land where there is not actually debt, because there is a collateral or a monetary asset, like in mutual credit. But we should not kill the patient to heal the cancer. Unless we are able to propose something more advanced than fractional reserve banking, and not something more primitive, we will not succeed.
What is credit
One of the essential functions of money is Medium of Exchange. It is more related as a way of issuing it, compared to other means like commodity, acknowledgment and fiat.
As a medium of exchange, money is supposed to solve the “double coincidence of wants” problem in a given market. Somebody puts some tickets into circulation in that market, tickets accepted by everybody as a measure of value, decoupling the problem of the “double coincidence of wants” (of products to be exchanged) into a simple coincidence of wants of a product against the number of tickets representing a value.
Credit is also supposed to solve the “double coincidence of wants” problem in a given market, but in the time dimension. Somebody needs some money now to buy something that he wants now, and no later, but he will get the money only later when he makes another future transaction, a transaction that cannot be done now (he wants to attend and pay a course in spring. To earn his income, he runs an hotel, but customers only will come later in summer).
Credit is needed to be able to increase temporarily and locally the monetary mass with money there where it is needed. The money will arrive later (this is what solvency means) but the chain of transactions has not brought it there jet. However, the money is needed now to generate a new transaction demanded by the economy.
Money solves the “double coincidence of wants” creating a chain of transactions where the money flows. This circuit has a huge essential synchronization problem we tend not to be aware of, now that we are used to large commercial surfaces where we have products from all over the world, all seasons and all obsolescences. It has been the fractional reserve banking, by creating money out of the nothing, to take care of the synchronization.
In old times, the saturday market at the village square took care of space and time coincidence. The “bakers money” was issued in the morning and redeemed in the afternoon.
Without the possibility of this type of credit the economy gets stuck. We all know, without credit most SME's would not survive. SME's are responsible for the largest part of the economy. By nature, SME's arrive at cashflow problems. Every sale only randomly adjusts to the planned cycle from offer to delivery to payment. For large corporations with huge number operations this becomes a moderated noise. SME's, with few sales in relation to total sales (like in the Bangla-Pesa example), need to ride the random shaking of incomes and payments in their balance sheet. The credit financial tool provides this flexibility to smooth the peaks with credit, with out of the nothing money.
Money out of the nothing
Physics analogy comes for help again. Quantum mechanics allows a particle to appear there where or when it is not supposed to be, across an energy (time or space) barrier. So to say, out of the nothing. The condition is that only for a very short period until all conservation laws are fulfilled.
Credit is a kind of monetary tunnel effect. The equivalent monetary mass conservation law is the famous equation of exchange:
M x V = P x Q
It means that, in order to create credit money out of the nothing, it has to be guaranteed that it is given back. Each credit contributes to the average monetary mass at a pace where other credits are returned, so that the level remains stable.
The solution proposed by the International Movement for Monetary Reform, with positivemoney.org as the lead, of a 100% backed credit is not satisfactory for modern economy.
You cannot state that 97% of the monetary mass is banks issued debt money, and then minimize the amount of the need for credit. Taking the example of Spain, the total debt is around 3 billion. Out of it, 1 billion may be mortgages. Mortgages, as Paul Grignon explains (Mortgages in the Credit Coin System, Paul Grignon, 2012) can be solved by an exchange of commodity currencies of long and short cycles (long lasting goods against perishable goods). State budget, equivalent to the sovereign money issuing, is around 0,5 billion. There is a remaining 1,5 billion need in credit. Family savings are around 2 billion, but most of it is investment and what remains available for liquid credit, as positivemoney.org proposes is hardly 0,5 billion.
Still, we have an additional need of 1 billion, essential for the economy, to be crated out of the nothing.
They recognize it at “Would there be enough credit in a sovereign money system?”
“In the future, the increasingly significant role of peer-to-peer finance in debt markets is likely to further reduce the importance of bank lending to business”
We have to get rid of the “horror vacui” and moral rejection of money created out of the nothing as credit.
An additional analysis to be maid is on what kind of money credit out of the nothing can be made. Some short not elaborated statements:
- Credit out of the nothing does not make sense on commodity money. Commodity money is already a self issued credit by the producers expressed through a Ricardian contract commitment. Only the producer has the power.
- Credit out of the nothing makes sense in fiat money, the one to manage the commons budget, and agreed socially. The monetary governance body can socially agree on a mechanism to authorize the credit. In a post-Transition scenario (Rob Hopkins, The Transition Handbook: From Oil Dependency to Local Resilience), at an economy where subsidiarity is a strong factor due to transport (energy cost and local generation), fiat money will be related to local, public services. In this scenario, the risk of the debt tumor explosion is mitigated.
- Interest can be left out. It plays no role any more, in the times where the limit of resources has been reached.
Solvency analysis is a human activity
The very good news is that the solvency analysis of the borrower, to authorize a credit, is made by humans, cannot be automated. The extremely good news is that the monopoly of the solvency analysis can be taken from the banks, once we use the block-chain to register the transactions in contract based crypto-currencies (on ethereum financial infrastructure, doug project, etc.), with no fixed monetary mass.
Every day, hundreds of thousands of local branch bank agents, authorize, in the name of the bank, with hierarchically established criteria and tools, and after analyzing the borrowers solvency, a credit, not necessarily linked to a collateral, but to the credibility and chances of a future income flow shown by the user, which is what solvency means.
This is a human activity that cannot be automated.
Far from a blind monstruous money machinery, our monetary system consists in a layer of mechanic transactions, with a myriad of spots of human interventions gearing the necessary tunnel effect of issuing temporary money.
The sovereign fiat money governance can foresee a vast variety of money lending reputation assignment mechanisms to nominate its own credit agents, thus giving ample opportunity to make customized designs of local fiat. Banks have seniority grades. LETS give a certain amount of credit to all members by default, a short circuit to nominating agents. In SoNantes (FR), credit lines can be authorized by the currency administrators. The project Eurocat (ES) nominates specialists after a selection process. Reputation as moneylender could be gained from the scratch by any citizen, starting with a LET level capacity, by a good record of successful credit authorizations.
The monetary system dominated by banks consists of:
- Having a monopoly of keeping the transaction records
- Analyzing the solvency to issue money to give credits
- Profiting from interest
Once we have the transaction ledger in our hands on the blockchain, the monetary reform creativity has to concentrate in the gearing/governance of money issuing as credit.
The sovereign money needed for the State Budget could be created the same way, as a credit authorized by the people to the State.