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Thursday, January 26, 2012

Guest Post - What's in a Trillion?

Sanni KrugerSanni Kruger, of Holistic Money Manager, is a finance coach helping people to become competent and confident money managers who live within their means without stressful money concerns. She assists her clients in reducing their debts whilst building up savings, as well as clarifying their desired long term vision and learning how to expand their resources to reach it. Her self-help book “Making Friends with Money – How to start feeling wealthy without waiting till you’re rich” is available from Sanni is also a motivational speaker with over 30 years experience of speaking to groups of any size on a variety of subjects.

In the “good old days”, actually not all that long ago, money was something we could experience or visualise in a tangible form, such as coins and banknotes in our purse.  Even cheques feel more real than the virtual electronic money most of us have got used to.

I still remember when, as a small child, I learned that having one silver coin is more valuable than a handful of coppers, and that a single banknote would be more valuable still.  I learned to distinguish their weight and size, their appearance and their different sounds and thus create associations in my brain.

Gillian Tett of the Financial Times  quotes Satyajit Das, author of Extreme Money as saying that it is now “endless, capable of infinite multiplications and completely unreal”.  She writes further that he “likens it to an object in a room of mirrors, that keeps refracting into numerous new forms, so dizzying that our brains are simply not equipped to understand”.

Gillian Tett goes on to say that this has at least two implications.  Firstly, “the abstraction makes it surprisingly hard, even for financiers, to keep track of where those zeros are going, or if anything tangible lies behind them.” And that the second implication is “that it is hard to spot how debts are piling up – or how to cut them when they do.”  She goes on to say that “the sheer ease of using electronic money removes any sense of constraint (or shame).”

I recently bought the brand new book Where Does Money Come From? The authors argue that “private banks can really create money by simply making an entry in a ledger”.  And that there is no common understanding about this fact even among bankers, economists, and policymakers.  Most seem to wrongly assume that the central bank; i.e. the Bank of England, has significant control over the amount of reserves banks hold with it.  In fact, at the time of the financial crisis banks held just £1.25 for every £100 issued as credit.

This is pretty much akin to the mental process that get a lot people into debt.  Many of them wrongly assume that if the bank or credit card company preapproved their overdraft or credit that “the powers that be” know what they are doing and are certain they would be able to service the debt and pay it back.

The recognition how new money is created is not new.  The economist J.K. Galbraith wrote in 1975: “The process … is so simple that the mind is repelled.  When something so important is involved, a deeper mystery seems only decent.”  When I read this it reminded me of an interview I had with the Admissions Tutor of the physiology department at Bristol University back in the 1990’s.  I blew it because I rejected the first answer that popped into my mind to the question what happens in the body during exercise as too simple.  After all, this was The University and the answer had to be somewhat more complicated!

When I saw the graphs at a recent lecture by Ben Dyson of Positive Money it seems that the only restraining influence on the creation of new money through credit has been the lack of technology.  But since the electronic means have become more sophisticated that has shot up enormously.  Add to that the way in which the credits have been carved up and re-packaged in ever more complicated and sophisticated “instruments” so that not even financiers understood it anymore, it was only a question of time that the whole house of cards would collapse sooner or later – and is likely to do so again.

I imagine the creation of credit is like blowing up a balloon.  Whenever more credit is created the balloon gets bigger and whenever money is repaid, the balloon gets smaller as the money vanishes back into thin air.  The same happens when debts cannot be repaid either by a significant number of people, as happened when a lot of mortgage holders, mostly in the US, defaulted on their payments, or one large debtor, e.g. a country like Greece.  The once shiny balloon ends up as just a piece of rubber.

So what is the solution? Detailed proposals for relevant policy changes are laid out on the Positive Money website (  Gillian Tett describes in her article how at a recent meeting of the IFM and World Bank Group “the more zeros I heard the more desensitized I felt.”  This describes pretty much what I observe amongst my clients. Therefore, I do advocate a return to cash, especially for those clients who are struggling with debt.  I actually encourage them to cut up their credit cards, use cash for everyday purchases, and only use a debit card for online transactions or those where cash would be impractical.

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