Financial system basics

Well, right now we are in the middle of an economic crisis, a credit crunch, the start of the next depression, a housing bubble going pop and a whole lot of other economic difficulties that I will have a look at going forward.

This time, however, I am going to talk about the basics of the financial system, specifically the answer to this question -

What gives pieces of paper with dead presidents, monarchs and other various famous people any value?

When you think about it, the trading of bits of paper with people printed upon them (they aren't even naked!) shouldn't really have all that much value. You can't eat them, you can't write on them all that well, you cannot do very much with them at all.

So..why so valuable?

First of all- taxes.

You have to pay your taxes or some rather nasty things will happen to you (assuming you are caught of course.) You have to pay your taxes using the "legal tender" banknotes of the country that you are living in.

The simple act of threatening people gives fiat money, legal tender, paper currency or whatever you want to call them their value. They are, in effect, "get out of jail free cards." Without taxation paper currency has no value.

A simple analogy is this -

A large, heavily armed group of men are demanding that you provide them with pictures of someone who used to lead their gang. Luckily for you, there is another group of men called "bankers" (who apparently have nothing to do with the first group) who are willing to loan you the pictures (at interest) if you provide them with collateral in the form of promised future labour, your assets such as cars, houses and so forth. There is also a third group of men who are giving out pictures of ex-gangleaders in exchange for a days work, these people also seem to be an entirely different group to the gang which is threatening you.

So...you pledge your assets or work for a day to acquire the pictures of old gang leaders and give them to the heavily armed gang, who seem pleased and tell you they will leave you alone for the rest of this year but will be back next year for another payment of pictures and every year after that.

As soon as the heavily armed gang leave you, pictures in hand, they drive straight around to the workmaster and give him some of the pictures, and then drive to the banker to give them some of the pictures so that when you need some more you can pledge more of your assets or do more work for yet more pictures. This is happening to all of your neighbours, all of your friends, to your family all at the same time and so it seems kind of ..well..normal. People trade the "get out of jail free cards" amongst themselves even, because they have value - what's more important than your liberty and your unmolested health?

Now, I don't know about you, but this looks a lot like slavery to me. It's more complicated than an outright master/slave relationship but it pretty much amounts to the same thing.

The second thing you can do with the paper is to cancel debts as far as the heavily armed gang is concerned. They have a court system where one of their number settles disputes by using the gangs might on one party in a disagreement (usually the one who has least to offer the gang.) If you offer the gangleader pictures to pay a debt, then the courts will back you up even if the other person wants some other substance instead. All legal means of restitution are lost if the paper currency is refused.

So, people accept them for this reason.

Again, I don't know about you, but this doesnt seem to me to be the most equitable arrangement. it looks a lot like one man getting another to work for him for free by using force.....which is again a kind of slavery. It's almost an embarassed slavery though, not the old, open kind - a veneer of legitmacy has been placed over it and the obvious coercion has given way to a game of plausible deniability where it could even be argued that one hand really doesn't know what the other is doing.

I doubt that the average worker in any of these spheres (or the average tax/debt payer) has this global view of events. Higher up the food chain the truth will be known of course.

And so we have this blog, within which I shall aim to put how our systems work as simply as possible, without terminology or jargon as far as possible and hopefully by using easy to understand analogies and stories to illustrate what actually goes on.

Thank you for reading and have a good one!