Saturday, 6 September 2008

The Promissory Note Standard

A promissory note is a type of contract that agrees to provide an item in the future (gold, wheat, a picture of Britney Spears naked etc) in exchange for something right now. So, for example, a promissory note would be accepted in exchange for doing a days work and later on the labourer would come and exchange the promissory note for the item he had been promised.

At the start of bankings meteoric rise to economic dominance, people would place their gold in the bank, and the banker would issue a promissory note against that gold which the depositor could redeem at any time. This was an "on demand" claim form for his gold. Eventually people started to exchange the promissory notes amongst themselves as though they were the actual gold itself.

Eventually, the banker noticed he could make more promissory notes than gold he held, but this didn't matter as long as people didn't all come for their gold at once. This story usually ended in ruin for the banker as the inevitable happened, everyone turned up at once and his fraud was discovered......the bank run, the fear of all bankers.

The last time the bankers did this and were discovered, something else happened, instead of the bankers ruin. Allied with the government, the bankers both refused (or were unable to honour) their promises and managed to stay in operation. Laws were passed outlawing the holding of gold, the paper money was fixed by law at certain levels and prices for goods and the promises were said to be as good as gold in and of themselves.

In short, we went onto a promissory note standard. Money these days is an unbacked promise, an empty note. Nothing can be bought with it, only debts can be dismissed as far as a court is concerned using legal tender.

Fascinating, but what does this mean?

It means that promises are money. When you go and "borrow" from a bank, you sign a promissory note, which the bank records as valuable in and of itself. Then you are paid for your asset in an equal amount of bank credit. if you were to borrow £10,000 or $10,000 then you will first give the banker a promise worth £10,000 and then be handed back those promises in an equal amount.

The value for this money comes from the holders of all other holders of the currency you have just created more of. It does not come from the bankers. It does not come from deposits. The money is created by the borrowers signature.

To "borrow" £10,000 from a bank these days means that you give them an asset worth £10,000 and then they pay you for it. The total amount of money the bank has goes up when you sign the form and then back down when you are given your payment.

That's right folks, you funded your own loans.

As much as the banker would like you to think that he would be out of pocket or his depositors would be out of pocket if you do not "repay" him, this is a myth. His books were balanced the moment you took the money back from him and nothing further need happen. it might have said "loan form" on the top of the piece of paper you signed but I have a friend who called his cat "doggy" and it's still not barked. I don't think it ever will do, either. (Small aside, mortgage means grip of death in french. French people rent more than most other nations..perhaps this explains why. )

Of course, the banker only did this because he figured you don't know how the system works and you will be a good little boy or girl and run around working hard to "repay" your debts to him, at which point he gets to keep the money for himself. Or you might try hard and fail, in which case he can take you to court and seize your assets for himself.

So..erm...if this is the case how come banks can go out of business?

If bankers and customers and everyone else can make promises and promises are money, then it doesn't seem to make much sense that they can go out of business. Anyone can promise anything, in unlimited amounts. We are all good for it, honest! The trouble the bankers (and everyone else for that matter) have is that no one has to accept their promises. The law only requires that people accept legal tender, the central banks promissory notes if offered as settlement.

When a bank runs out of people willing to accept it's own promises in payment and it runs out of legal tender, then it will go bust. The central bank can and sometimes does turn the franchise banks promises into legal tender, but this is inflationary and harms the overall integrity of the system so isn't usually done. It's normally better to collapse the bank in an orderly fashion, tell the depositors they aren't going to be getting all their money (not that it matters, they are only going to be putting it in another franchise bank anyway) back and keep the people who think they are in debt working away.

Whatdoes this mean if you have a "debt"?

You don't have a debt. You owe nothing. In fact, if you made any repayments, the banks owe you. Good luck getting them to pay you back though.

What does this mean if you are a depositor?

Nothing. Your deposit is fine. It just probably wasn't made in legal tender like you thought it was and was just someone elses bankers promises.

What does this mean if you are a banker?

Life on easy street until people wake up or you cut your own throat through greed.

This does leave some options for those who are in debt and being chased by the bankers, which I will be covering in future.


eye2i2 said...

"(Small aside, mortgage means grip of death in french. French people rent more than most other nations..perhaps this explains why. )"

Continuing the aside, I still remember the first time someone pointed out to me that mortgage and mortuary (and mortician) have the same root word! (both having the old French/Latin words mort, which means "dead" ie mortal ie bound to death)
Etymology dictionaries I've checked state that the mort in mortgage was originally meant to convey that the debt dies at payment. It rings in my ear as saying more of the honor many men held: when they gave their word (witnessed by a signature), they'd die before dishonoring it. In the case of a loan, they'd pay it back as promised or die trying.

Too bad that among today's Bankgsters their is so little (if any) honor.

Injin said...

I think one of the main problems the bankers have is that of "system creep."

The old immoral acts are todays normal. And then they get a it more immoral. Which quickly becomes normal.

Until the system breaks and reality comes crashing in on them, it's hard to see any change in their nbehaviour. Even then, someone else will be probably paying the bill.

Anonymous said...

Good post inJin

Followed your sig here from HPC

'Justice' who will soon vanish from the HPC and other sites but i will be watching.

J said...

The system was never faultless in the first place; it was always broken. We exist only within degrees of dissonance. As to the evolution of the word 'mortgage', there is a french children's book that depicts mort as the grim reaper. Naturally, most living souls like to avoid him. This he finds perplexing. He is surprised therefore to find a mortal (a girl) who looks forward to seeing him. After a wonderful time dancing with death, the girl moves on. Mort comes to realize that he will be forever alone.

Personally, I like Neil Gaiman's version of death. A nice looking goth!

ps. Injin, respect for living the dream!

pps. what's injin mean? Long been intrigued.

Mastiff said...

There is a logical flaw in your argument. The promissory note you give the bank, in exchange for the loan, is only valuable if the holder can reasonably expect that you will honor the note.

If you issue a promissory note with the manifest intent not to honor it with currency, it becomes worthless. Ergo, you have not exchanged anything of value for the loan.

That governments' finances essentially work this way with fiat currencies is only possible because they have more guns than we do. I strongly suggest you not try to emulate them.

If you are interested in learning how fractional-reserve banking would work in a free society, may I suggest this book from the Mises Institute.