Thursday, July 7, 2016

Money Series: difference between credit and money - Is there any?



This post is part of the money series.

Last time, I explained my position about money, that is there are currently three types of money, namely cash, bitcoin and gold.
Cash is legal tender currency, that is it is backed by the government. If the government collapses, between toilet paper and cash I would prefer toilet paper because toilet paper would be much more useful. In any case, no government will crash overnight, so this is simple academia.
Bitcoin is digital cash and, differently from ordinary cash, its issuing is decentralized. It is not very much diffused, ​it is extreme volatile with respect to other currencies, and its main use is still speculative.
Gold is the ultimate form of money, and it is used especially as the store of value of last resort, since it is physical, atomic number 79. That's why, even if mondern Keynesian economists look at gold as a barbarous relic, it is jelously stored in super guarded vaults and countries like China and Russia are piling it up.
NOTE: There are many reasons why gold has been used as a form of money for centuries in the western countries, and it is not only because it is beautiful and shiny. I will talk about this in one of my next posts. 

Why I consider these three types of "entities" like money? Is your debit card money? what about your credit card? what about your savings deposit? What about cheques? What about the securities that you have in your portfolio -if you have any-, like bonds, stocks, stock options, futures etc?

Well, I consider all the aforementioned examples of money as, indeed and more correctly, instruments of credit or debt.

The difference is the following: 

1. money does not bring interest or commission costs when you use it. 
2. Credit brings interest and commission cost when you use it
3. Debt is the other face of Credit, ie, for every credit, there is a debt. For every creditor, there is a debtor. 

Let's make some examples taken from real life:

1. You go to the local market and you buy a sack of potatoes which costs you 5€. You pay cash. You get your sack of potatoes. The shopkeeper takes your cash. End of the story. There is an exchange of cash for goods, ie potatoes.

2. You go to the local market and you buy a sack of potatoes which costs you 5€. You have run out of cash and you pay with your debit card (bank card). You take your sack of potatoes. Your bank account is decreased by 5 €. The shopkeeper's bank account is increased by 5€. This is not the end of the story. To use your debit card, you need a bank account. This costs you in terms of commissions. To have the right for using the bank card reader, the shopkeeper needs a bank account, plus she pays extra cost for using the card reader. It is less money for you and the shopkeeper, more money for the bank.

3.  You go to the local market and you buy a sack of potatoes which costs you 5€. You have run out of cash and you pay with your credit card . You take your sack of potatoes. Your bank account is not decreased by 5 €. The shopkeeper's bank account is not increased by 5€. To use your credit card, you need a bank account. This costs you in terms of commissions. Plus, you need a contract with, for example, Mastercard. Each time you use your credit card, you are paid a commission for the transaction. At the end of the month, 5 € are subtracted to your bank account. 
Let's come to the shopkeeper, for her the situation is worse: to have the right for using the bank card reader, the shopkeeper needs a bank account, plus she pays extra cost for using the card reader. Plus, for each transition, part of the 5 € are kept by Mastercard, let's say 2%. At the end of the month, on the bank account of the shopkeeper ony 98% of the 5€ are transferred, ie 5*0.98=4,9 €. Ten cents less. 
If the shopkeeper 1  uses 4.9 euros to buy another thing by means of her credit card at another shopkeeper 2, and shopkeeper 2 goes to buy something at shopkeeper 3, and again and again, after 10 transactions, the original 5€ have become 4.1 euro. 0,9 € of the street guy's purchasing power have been destroyed or, which is the same, have been transferred to the types of Mastercard. 


4. You go on internet. You buy an antivirus license for 30 dollars. You pay with paypal. Paypal takes 2.9% + 0.3 dollars for each transaction from the seller's account. The principle is the same as example 3.

5. You go on internet. You buy an antivirus license for 30 dollars. You pay with bitcoin. 30 USD in bitcoin are 0.0465 BTC. You transfer 0.0465 BTC from your wallet to the seller's wallet. End of the story. 
NOTE: In some cases, a minimum fee may be required, a few USD cents, but the larger the pool of users, the less the fees will become.

With cash, after 10 transitions, 5€ are still 5€. With bitcoin, after 10 transitions, 0,01 bitcoin are still 0,01 bitcoin, with gold, after ten transitions, one ounce of gold is still one ounce of gold. No hidden costs. No commission cost, no interest.

6. You go to the bank and you ask for a mortgage, let's say 300 thousand dollars. The commercial bank, out of thin air, creates 300 thousand dollars, in your bank account. Now you have 300000 dollars of purchasing power. Of course, this comes at a cost. Firstly, you need to open an account, and, secondly, you have to pay an interest on that money. This interest is higher than the interest the bank pays you keep your money. So, it is not "real" money, it is CREDIT. You know how three hundred euros look like in the ledger of the bank? They look like this: "1001001001111100000". 
Now, let's suppose that you get out of the bank and withdraw 250 dollars from the cash machine. Your bank account has decreased to  299750 dollars. Now you have 250 dollars in cash and you can buy lots of sacks of potatoes. Is it real money? Yes it is, you can use it whatever you please. The problem is that you are paying interest on the original 300000 thousand, not on the remaining 299750! 

So, can we conclude that all money nowadays is in reality credit?

Yes, we can. The key point to understand here is how money is created, because money is created by commercial banks and each time a bank creates money, it creates an instrument of credit (for the bank), and an instrument of debt (for us, because we have to pay the original sum PLUS an interest).
NOTE: also Central Banks create money, but this money does not intervene directly in the economy of average Joe. We will talk about this in future posts.

The main difference is that, once credit has become cash, because you have withdrawn your money from a cash machine, the banks have no possibility to track it and to ask for extra commision costs or interest for each transition.  

So, in a nut shell:
  1. Banks create money
  2. Money is credit for the bank, debt for you
  3. Money always come with an interest
  4. When money becomes cash, or bitcoin, it can be transferred without extra commissioning or interest costs. Nevertheless, you still pay interest on the original creation of the money that you have withdrawn from the cash machine. You cannot escape from this.


I hope these examples have made things a bit more clear about the difference between money, credit and debt today. 
I will come back to these points many times in the future. 
Money is not related AT ALL with the effort that you make to do something. Not any longer, not in the present world

In most of the situations we only use the word money, even if what is behind it is actually credit. 
No problem. The important thing to understand is that nowadays money is credit, since it is created by commercial banks. 

So, in my future posts, unless I want to stress the difference between the three, I will use the term money, credit and debt interchangebly. And I will also explain why Credit is essential, and why Debt can be a good thing.

See you back in August.






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