The Fatal Flaw Of Centrally-Issued Money

A Thought Experiment on Money

Let’s imagine a small mountain kingdom with only ten very scarce and thus highly valued seashells in circulation.  These few shells are certainly valuable in terms of scarcity, but there aren’t enough of them to act as a means of exchange.

One solution to this innate problem of scarcity—money has to be scarce enough to retain value but not so scarce that there isn’t enough of it in circulation to grease trade—is for the kingdom to issue 100 slips of paper for each shell, each slip of paper representing 1/100th of the shell’s value. Now there is enough money in circulation to facilitate trade and each slip retains a store of value equal to 1/100th of a shell. The slips are paper money, i.e. currency.

This system works well, but the rulers of the kingdom aspire to consume goods and services in excess of what their share of the shell-backed money can buy in the open market.  The kingdom’s leaders print another 100 slips of paper without acquiring a shell to back the new slips with intrinsic value. Nobody seems to notice, and so the leaders print another 100 slips. Note that the kingdom didn’t produce more goods and services; its leaders simply produced more money.

Eventually this excess of paper slips reduces the value of each slip in circulation. What once cost 10 slips now costs 20 slips. This reduction in the purchasing power of money is called inflation, as the price of goods inflates as the money supply is increased while the production of goods and services remains unchanged.

Let’s assume the kingdom’s leaders avoid the temptation to expand their consumption by printing money rather than first increasing the production of goods and services.

As the kingdom expands its production of goods and services and its population, the original 1,000 slips of paper are no longer enough to facilitate trade: lacking money, people revert to the clumsy alternative of bartering goods and services or issuing letters of credit.  The purchasing power of the existing money might well increase due to the imbalance between the demand for money (high) and the supply (limited); what once cost 10 slips now costs only five slips.

The value of each slip has now detached from the underlying value of the shell. It’s not the scarcity of the shell that is creating the paper’s value—it’s the scarcity of paper money itself which is creating the paper money’s store of value.

The kingdom can respond to this shortage by issuing more slips of paper.  If the kingdom only issues a sum of money that is equal to the increase in goods and services produced, demand will remain high (as trade in the expanded supply of goods and services expands) and the value of the money will remain stable as well.

This detachment of the value of the paper money from the underlying value of the scarce shells worries some in the kingdom, and they propose that the kingdom borrow ten shells from others and pay them interest for the loan of the shells. In effect, money is being loaned into existence: the kingdom borrows ten shells and issues 1,000 new slips of paper that is fully backed by the new shells.  But the kingdom has to pay interest on the loan.

One advisor has an insight: rather than actually borrow the shells, why not just borrow the money into existence by selling the kingdom’s promise of paying interest?  Why bother with the shells when the only transaction that’s needed is payment of interest on the newly created money?

And so the kingdom sells ten promises to pay interest—what we call a bond—and the buyers receive interest, just as if they’d loaned the kingdom a valuable shell.

The new money isn’t backed by shells at all; it’s backed by the interest paid on the bonds.  The kingdom sells off the original ten shells and issues ten more bonds. Now the kingdom’s money is not backed by any intrinsic store of value; it is backed entirely by the kingdom’s promise to pay interest on the bonds.

If the kingdom is prudent and only issues enough money to match an increase in the production and exchange of goods and services, the demand for money will remain in line with the supply, and the money will retain its value.

On the face of it, the kingdom’s money has no intrinsic value at all; but if we follow the example closely, we see that the money is both a store of value and a means of exchange, and its value (when priced in shells, goods or services) fluctuates with supply and demand.

The kingdom’s slips of paper fulfill all the requirements of money.

When the kingdom loaned the money into existence, the money retained its value as long as the kingdom only issued new money to match the demand for money from the expansion of production and exchange.  In other words, the supply of money rose in tandem with the expansion of the real economy’s production of goods and services.

The fact that the kingdom had to pay interest on newly issued money created a cost to issuing new money that eventually limited how much new money could be created.  Creating too much money would not only reduce its purchasing power, but the treasury of the kingdom would be drained by the interest paid on new bonds.

This raises a very interesting point: when the kingdom created new money only to match the expanding production of real-world goods and services, it didn’t matter that the new money was not backed by either shells or bonds; demand for the money alone maintained purchasing power. There was no need to back the newly issued money with scarce shells or interest-bearing bonds.

Economist Paul Samuelson observed that “money is a social contrivance.”  In other words, money exists to serve a social function—to facilitate exchange and the real-world production of goods and services to the benefit of all participants in the economy. If the supply of money is connected to the demand generated by the production and trade of goods and services, it needs no backing nor does it need to be backed by interest-bearing bonds.

Let’s now turn to the way money is issued in the present: by central banks.

Money Issued by the Central Bank Benefits the Few at the Expense of the Many

Let’s imagine that we have a $1 billion line of credit with our central bank at an interest rate of .25%--one-quarter of 1%. We don’t need to post any collateral, and the central bank has given us whispered assurances that should we lose the money in risky gambles, the losses will be made good by the taxpayers. This is called moral hazard: the risks have been disconnected from the consequences.

If we make a profit with the borrowed money, it’s ours to keep. If we lose the borrowed money, the taxpayers will foot the bill.

It’s difficult to imagine a better deal: near-zero interest rate, no collateral, and no risk of having to suffer the consequences of losing the borrowed money.

But our advantages are even better than this already astonishing deal: with the magic of fractional reserve banking, we get to create $19 billion of new money with our $1 billion of borrowed central bank money.

Our options to make low-risk profits are nearly limitless.  Anything we earn beyond the annual interest of $2.5 million is ours to keep. We could invest the $1 billion in Treasury bonds yielding 2%. That would yield us an annual gain of $17.5 million for doing absolutely nothing beyond clicking a few keys to buy $1 billion Treasury bonds.

If we are willing to take on higher risk, we could buy stocks that pay dividends of 3% or more annually. If the stocks rose in value, then we’d also earn capital gains.  An annual gain of $30 million or more is easily possible in the relatively low-risk investment.

If we wanted even higher yields, we could seek out bonds in other countries that are paying 6%. If those currencies are strengthening versus the U.S. dollar, then this foreign-exchange gain could boost our total gain to 10% annually—a cool $100 million, out of which we only have to pay the central bank a modest $2.5 million in interest.

Or we could set up a bank that issues auto loans and credit cards with the $1 billion. Thanks to fractional reserve lending, our $1 billion in cash (never mind it was borrowed from the central bank—to the rest of the world, it’s cash) can leverage $19 billion in high-interest consumer loans.  If the average interest paid on our loan portfolio is 10%, we are earning $1.9 billion in gross revenues. If operating the bank costs $900 million, we net a cool $1 billion annually from the $1 billion line of credit: 100% annual return.

This is precisely how the banking system works, and it illustrates how central banks enable private banks to accrue vast profits.  Those closest to the central bank money-spigot are given an opportunity to leverage up astounding profits.

In theory, central banks claim the noble task of providing credit to the private banking sector to facilitate increased production of goods and services, but in reality central banks benefit the few with access to their credit at the expense of the many. The few can generate immense profits without producing any goods and services.

Imagine if we each had a relatively tiny $1 million line of credit at .25% interest from a central bank that we could use to issue loans of $19 million. Let’s say we issued $19 million in home loans with an annual interest rate of 4%. The gross revenue (before expenses) of our leveraged $1 million is $760,000 annually.  Since the accounting of the $19 million in loans is highly automated, our expenses are modest.  Let’s assume we net $600,000 per year after annual expenses of $160,000. Recall that the interest due on the $1 million line of credit is a paltry $2,500 annually.

Median income for workers in the U.S. is around $30,000 annually.  Thus a modest $1 million line of credit at .25% interest from the central bank enables us to net 20 years of a typical worker’s earnings every single year.

But central banks don’t offer this largesse to individuals or communities; these profoundly profitable privileges are only available to private banks.

Today's Money Regimes Are Doomed To Failure

I hope you now understand that the current system of issuing money and credit intrinsically benefits the few at the expense of the many. This vast privilege and the equally vast inequality that is the only possible output of the system cannot be reformed away; it is intrinsic to centrally issued money and private banking.

The problem isn’t fiat money—currency that isn’t backed by scarce commodities; it’s centrally issued money that is distributed to the few at the expense of the many. This centrally created money is issued not to facilitate the production of goods and services and the demand that naturally arises from the expansion of the real economy, but to serve the state and its cronies.

Centrally issued money centralizes wealth and generates systemic inequality. This is equally true of all centrally issued currencies.  But the inequity that is intrinsic to this system is politically, socially and financially destabilizing, and so this system is unsustainable.

In Part II: The Future Of Money, we consider what the landscape will look like once the current system of central bank-issued credit-money implodes. Which new form(s) of money are most likely to rise from the ashes?

Click here to read Part 2 of this report (free executive summary, enrollment required for full access)

This is a companion discussion topic for the original entry at

Hi Charles,
Great Article. I like the historical perspective. The Trade Fair example clearly shows the difference between money to enable commerce and money to store wealth. I think we often forget that these 2 are different requirements.

Lately, I have become convinced that attempting to store excess wealth in the form of currency undermines the good functioning of the money system by withholding crucial liquidity, and is ineffective in the face of inevitable money supply expansion.

Thanks for the effort Charles. I lost the tread towards the end.
All I saw was a bull in a labyrinth. I suspect that there is a bear in there too?

Arthur, I had to read my own Part 1 a couple of times–it reminded me of the old Star Trek episode where "Bones" takes a drug which gives him super-human surgical skills. Then as the drug wears off, he's facing an open skull, and an immensely complicated operation he no longer knows how to complete…
What really struck me as I dug into the topic of "money" is how mysterious it is, despite our confidence we know exactly what it is…

What is Money, Alex?

I don't think the problem stems simply from a centrally issued money supply. The problem is that the public purse has long been taken over and owned by a private banking institution (The Fed and all the commercial banks that it supports / are supported by it). If the government was able to issue money, which it hasn't done for 100 years I believe, then the whole interest issue would disappear. The money could be issued to the people via government expenditures as debt-free, interest-free currency that would retain its value simply because of the demand for money by people "producing" "goods" and "services" and needing a medium of exchange, as explained in the shell money analogy. No need for debt -- a nice stable money supply that doesn't expand or contract with every levered breath from some banker. No credit money, no fractional reserve banking, no interest, no need for growth to satisfy interest on the money, heck, no banks even, just like I believe the Bible advised (note: I'm not an expert on the Bible). We wouldn't need banks since the entire monetary system would re-adjust so that the average person would be able to buy a house outright after working and saving for a few years -- not a lifetime -- due to simple supply and demand! It would be a major shift of wealth back into the hands of average people.
Of course there's always the problem that politicians would like to please their populace and in order to boost their popularity would promise too many public expenditures on health care, new infrastructure etc. that would cost too much to fund with a stable money supply. They would have to issue more money to fund those things. So... the currency experiences some depreciation because the government spends too much on its citizens. The problem being...?? Isn't that what we're aiming for here? The increased laziness that people would now be able to enjoy from increased medical and welfare expenditures from the government would be the perfect solution to go hand in hand with the increases in productivity we have experienced due to technological automation that makes the average worker 5 times more productive now than 50 years ago.
OK OK, yes, a depreciating currency would push savers out of paper money and into hard assets and possibly spark some kind of confidence-induced, velocity-driven hyperinflation. But there would be no need or reason for savers to be in paper money in the first place since it returns no interest; it would simply be a medium of exchange. Savers would instead be in hard assets. Again ... the problem being? Isn't that what we are aiming for? Individual savers putting their assets into real things, not paper currencies that can be manipulated by whatever authority is in control? Isn't that yet another shift of wealth back to average people? If inflation becomes a problem then just back the government money issuance with the noble handcuffs of gold -- I mean we have 8,000 tonnes of it gathering dust in storage! Oh wait, didn't they used to do that until privately owned banks took over the government, stole the gold and sold it to China to extend their ponzi scheme just a little longer?
What is the alternative to centrally issued money, I ask? A bunch of small private banks offering safekeeping for individual peoples' personal gold hoards? Wait a minute, isn't that how this whole centuries-long banking scam began? The friendly little neighbourhood banks got more and more centralized, invented fractional reserve lending, then bribed / killed enough politicians to take over the government and steal the public's gold and Treasury? What's to stop all that from happening again? Is this all just a multi-century cycle that repeats, facilitated by the ability of the real economy to grow and provide value to the paper ponzi scheme? What happens when the economy can no longer grow and a new ponzi scheme cannot be inflated?

It is a claim on ecological production (carbohydrates, proteins and oils), and specifically on how humans and our technology can lever the natural world to use that production and resulting energy flows to 1) provide enjoyment to us or 2) to perform / provide useful activities / things that increase the fitness of our children. It can be further broken down into the more traditional definition of "medium of exchange, store of value, etc. etc." but those all ultimately boil down to ecological production since 97% of all economic activity is powered by burning dead things that used to be alive and which were created through ecological production.

I disagree.  I think the problem is not a private banking institution nor the government.  I view these as symptoms.  The problem is a spiritual one, and the problem is in each and every one of us.

Withdraw your consent, every day, in any way you can.

I'm usually all in for a trip into a difficult hallway of mirrors. However this hallway is a trap, and I have yet to be able to balance feelings, thoughts and actions, in any recognizable way. I always leave with the inescapable aspect of manipulation on all fronts. I prefer to skip this adventure, yet I'm hopefully others might be more adept and skilled and bring back something useful. I wait patiently while the beast continues it's consumption. Can you sense it's effects?

Good comments all, thank you. History suggests we need some sort of money, and perhaps the "answer" is a variety of currencies that offer different aspects of "money" that can be selected by users of money rather than a central state/bank.
I think we can safely say the Fed and all central banks are simply arms of the central state. Issuing money is the core power of states/central banks, but history shows that "money" does not have to be issued by the state to be useful.

What I am suggesting is that perhaps there are new models for "money" that harken back to historical models. For example, if GLD (or some other repository of gold) issued its own currency backed by its reserves, would this currency be in demand? I suspect it would–partly because it couldn't be depreciated by politicos the moment they needed more cash to fund their cronies. 


Exactly my point.


I am looking forward to jumping in to this thread because I love talking about money but just don't have the time to do it justice right now.  Can you or Rosehip please expound upon your feelings more… What is it about money, or the discussion of money, that is creating a trap? 
I get the point about taking personal responsibility… about fixing ourselves inside, or spiritually, as being the core mission.  I have heard enough Chris Duane to get this : )  I am not clear though why trying to think about how a better money system might work, i.e. the externality, is either mutually exclusive of the important internal work, or a trap of sorts?  Chris Duane makes nice Silver rounds, right?

Thanks, Jim       

The problem with shells is not their scarcity, but rather their lack of divisibility and homogeneity. Gold is also very scarce: it is its divisibility and homogeneity that make it a better form of money. So paper money cannot have evolved to make its represented money (gold) more divisible since the divisibility of gold has always been enough.

My impression is that what was a simple and transparent country fair accounting of who owes whom what, and the balance paid in gold at sundown, has become a monster.
The cunning ape has obfuscated and coplexified everything to the point where no-one knows what is going on, for fun and profit.

Unless one takes the sward to this Gordian knot money will sink into its own cesspool and die. It is losing its only value, that of a trusted medium of exchange. Every year we see it becoming more abstract and opaque. Soon the folding stuff in your wallet will become irrelevant and illegal by design.

To become a servant of the people again it has to be wrested back from some very naughty boys.


The Thing / Peak Oil / $atan. Going to be quite the matchup I think. 
Godzilla ain't got nothin' on the mess that's coming.

It's the look I see in the eyes of others as they deepen their pockets. They (me also) don't seem to be able to emotionally feel out how much is enough before I (they) refocus on the other much more entertaining and fulfilling forms of capital. You know there are some that revel in the collection of those other forms, they mostly go unnoticed and under appreciated. I have noticed a certain discomfort arising from those adept at financial capital gains, if you blow on them they fall right over. Seriously, try it. Our human interconnectedness, our being is nearing retirement and we'd best think about what hobbies we value. Although we will still use money, we should remember the grandchildren, as for the adults our bed is made.

At this point the monetary system is complete artifice, unhinged from reality and weaponized to boot.  The masses are so numb from the constant mindf@#$ that is our "society" that I'm unsure they would have the emotional bandwidth to care if they were to suddenly understand it. I do hope I'm wrong here. 

Zombie apocalypse indeed.


Jim wrote

I get the point about taking personal responsibility… about fixing ourselves inside, or spiritually, as being the core mission.  I have heard enough Chris Duane to get this : )  I am not clear though why trying to think about how a better money system might work, i.e. the externality, is either mutually exclusive of the important internal work, or a trap of sorts? 

no kid ever that played and lost at monopoly, at their next opportunity suggested, hey wanna play monopoly? Instead they played games with many winners, where the rules are easy to learn and change if they increase the enjoyment. Jim (metaphorical Jim) when was the last time you allowed your inner child out to REALLY play? I mean full on forget the clock, personal responsibility or any other distraction your clever mind has invented… Have you become overly rational without increasing your ridiculousness to compensate? 

We are headed to a place where the center is everywhere and the edge is nowhere with diffuse and integrated technologies.  Where cause and effect are linked, everyone is required to deal with the consequences of their own actions, both in the present moment and in the future.  
Our current model of reality is flawed and outdated: the centralized brain, top down, competitive, command and control systems, are all misunderstandings.  The intelligence of the cell in not located in the nucleolus, but in the membrane.  The most productive parts of an ecosystem are the edges where they meet other systems.  The intelligence of the nervous system is distributed throughout our bodies, it does not reside only in the physical head.

Unconsciousness is built into our system now, we purchase products that are made in remote locations, in god knows what conditions, with both unknown economic, ecological, and human impacts.  Shadow banks, black budgets, secrete services dominate our systems now.  The lack of transparency is justified by the word secrecy, which is justified by "national security".  And all of that is justified by Terror(ism). Fear, fear and more fear.  Actions and the resultant consequences have been disconnected, both in time and space.  The body has outgrown the connecting nervous system, we have become dismembered.  So we, the world, is dying.

Central planners, both in the private and public sector, have become parasites living off of a dying body, functioning under the old illusions.  The attempts to maintain control are doomed to failure because they are at variance with what is.  The information technological revolution is not something entirely new, but an attempt for the world to balance itself again in a new context, it is the resurrection, the creation of a new body.

But those parasites of the old system will not be able to see the light because they love the darkness, because their actions are unconscious, the arrogantly love their own power and control.  They will die with the old body.  We must live in the resurrected body, where consciousness is universal, but the material body is local, food production is local, currencies are local, governance is local.  We will become fractured materially (in a sense - in the old way of thinking) and connected spiritually. Perhaps individuated is a better way of saying it.  We will become unique, shedding death and monotony of mass production and be connected in the vibrancy of our own perfection. The confusion between the description and the thing described will disappear.

As someone who has recently lived in several parts of the US, (AZ, IL, TX) the difference in local communities is startling in terms of everyday life, but the common denominator is increasing disconnection from the national consciousness and focus on the local here and now. While some oldsters still listen to MSM and parts of their thinking may be connected to some kind of national narrative, most are not. The 2016 election will see very low voter turnout, I suspect, especially among youth, EXCEPT from those being paid to care for one reason or another, i.e. with $3 billion being spent some of that may sprinkle around.