Savings, capital formation and the monetary system

You all of course remember the tale of the grasshopper and the ant that has variously been interpreted to teach the virtues of hard work, saving and dedication.

Although “saving” is an integral part of the interpretation of this fable, narrators and interpreters do not nearly spend enough time on this point considering the ramifications of this deceptively simple concept.

For example, in economics capital formation can only take place in the presence of savings.

Think about that.

Salting a little something away can only happen if and only if an individual produces more than what he consumes. In other words, you can only “save” if you spend less than what you earn.

The reasons individuals may want to save are varied. But the one underlying common theme is that saving is supposed to, at the very least, hold its original exchange value. In other words salting away your excess salary or your excess production only makes sense if you know that in the future the money or items you have set aside can be exchanged for at least the same quality and quantity of goods as today if not allow you to exchange them for more items of better quality.


In ideal circumstances therefore, savings allow you to front unforeseen future circumstances or to provide you with a source of income when you should no longer be able to work.

But the most important function of saving excess production is that it allows investment (Pool of real funding). Thus savings allow the formation of capital thus the expansion of the economy.


In a healthy economy, banks would be mere storage and distribution centers where individuals would store savings and the banks would then distribute them to entrepreneurs for a fee. In this hypothetical construct, savers and banks would become partners in sourcing new investment opportunities in order to maintain or enhance the quality and quantity of savings. In this construct too, both banks and savers would share in the profits or losses of new investments.

Enter Debt Based Fiat Money.

Fiat Money is a brilliant concept. It is flexible, it is easy to create, it is easy to store, transport and to account. It is a truly brilliant concept. Debt Based Fiat Money on the other hand, not so much. Readers of this blog will know DBFM is predicated on inflation and that inflation conforms to the law of diminishing marginal utility.

Thus, the choice made, DBFM can only exist in an environment of expanding monetary base and credit. In other words, the DBFM construct can only exist for as long as the currency can be debased. In turn, currency debasement is anathema to saving because in a context of currency devaluation, savings no longer perform their supposed role.


Now pay attention because this is subtle.

Having opted for DBFM, the governing elite must move quickly to pre-empt resistance to the use of same. Thankfully, the arithmetic underpinning DBFM is such that dissenters can be brought to heel through a rich mix of what appear to be politically and ideologically driven policies: subsidies, social programs, incentives, government programs requiring the creation and staffing of new departments, preferential accounting treatment or preferential legal treatment that are all magically made possible by the not so subtle expansion of credit and the monetary base.  Simultaneously, the monetary authority must also pre-empt the emergence of future more structured critics so that study of DBFM must be expunged from the academic curriculum.

And this is where it gets subtle.

The whole DBFM construct holds for as long as society can be convinced that not only is saving of no use but that spending in excess of one’s capabilities is what constitutes wealth (in this regard, social programs help the governing elite convince the electorate that their future needs are secured by the state).  If the GDP of a country increases nominally, the governing elite will declare that wealth is growing.  In other words, consumption is wealth. The greater your consumption capacity, the wealthier you are. Thus government’s long term need to manipulate the  interest rate lower to sustain the illusion.

You may think this is a trite explanation. But get this. In this transition from a society that saves and provides the basis for capital formation for a fee, the monetary authority now sidelines the individual and usurps the role of “capital” provider thus cutting out the original partner.

In the context of DBFM, banks gradually do away with the original capital provider by progressively turning him into a capital consumer. This is achieved by the gradual debasement of the currency till the point at which saving no longer makes sense.

And here is the absurdity of the entire construct.

Not only is the original capital provider (the individual) subverted into a capital consumer but banks are left as the only entities ostensibly providing capital. But the type of capital provided by the banks is produced out of thin air and, through the magic of fractional reserve banking, is boosted … at virtually zero cost.

The difference is this. The capital provided by an individual has a cost structure that involves time, labor and capital equipment. Ergo, the production or excess production of an individual helps to expand the wider economy. On the other hand, the capital provided by a bank has no similar labor, capital or temporal input. It is purely conjured by decree. Nobody is employed, no resources are extracted, processed or delivered. No transactions have resulted in excess capital. A bank merely creates a sum at no cost.

But although the bank has no cost of production, it is allowed to sell its capital at a substantial premium to economic actors whom, under penalty of incarceration, are not only obligated to make use of said capital but must by law promise to pay it all back plus more.

It is clear in this construct that the relationship between economic actors and capital provider is skewed in favor of the bank. From an arithmetical point of view, pushing DBFM to its logical conclusion results in the transfer of the productive capacity of society to the banks.

In other words. Towards the conclusion of the DBFM induced credit cycle, the economy of a country is predominantly a consumer based economy. In other words, it is an economy that by definition does not set aside a little something that can be sold onwards for equal or greater value than its original cost of production. At the same time, banks become the last and only pillar of the system and the only providers of credit (I mean credit here as opposed to capital which the bank does not create).

As the DBFM induced credit cycle reaches its mathematical limit, economic actors are heavily burdened by debt and credit will no longer be sought from banks.  In turn this situation precipitates a crisis that is thought to be due to lack of liquidity. As by this stage the banks are proclaimed to be the one and only pillar of the system and despite the obvious lack of demand for credit, the monetary authorities will pump the banks full of liquidity. This is done ostensibly in the hope that fractional reserve banking can translate these gargantuan sums in a quantity of credit that is many folds the original amount, thus helping to maintain credit expansion on a positive trajectory.

At this point the situation is as follows. Individuals are out of the credit market trying to repair their balance sheet by attempting to cut down on their debt load because despite preferential accounting treatment for the banks, the monetary authority is not assisting the individual. Corporations are out of the bank credit market because as interest rates are the lowest in generations they prefer to turn directly to institutional funds. Banks on the other hand are stuffed full of reserves that are not and cannot be disbursed to economic actors because, on one hand, of the lack of credit worthy borrowers and, on the other hand, of the mountain of bad debt that has piled up over the years and that will at some point need to be written off thus requiring substantial reserves to compensate the hit.

There is only one way this ship can be righted.


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7 Responses to “Savings, capital formation and the monetary system”

  1. pat00donnelly Says:

    There are many who know that there will be a boom and they try not to allow others to warn of the dangers. In view of the money to be made on the way up and down, buying cheap, this is organized over centuries. Read Thos Jefferson!

  2. Manor Mouse Says:

    I agree that the situation may be as you describe, but what I don’t understand is why the elite “opted for DBFM” in the first place, if it must ultimately end in the destruction of society. Sure they make a few quid on the way, but what use is that if they end up in a Mad Max world? They could surely have made pots of money some other way? Who are the elite, and are they the descendants of the people who originally got us into this mess? Are there people employed by the elite whose job it is to actively expunge any mention of DBFM from the school curriculum?

    Presumably anyone looking at the DBFM system from the outside over the last few years might have been forgiven for thinking it worked. People did appear to be supported in their old age by their pensions (savings?). To me, though, it was ‘working’ in the same way as a Ponzi scheme. Would non-DB FM have avoided the Ponzi nature of the economy?

    (I am also confused by the role of effectively free resources in the economy – are we sure that we’re not ascribing complex economic concepts to a one-off windfall of free oil and other resources that will never be repeated?)

    Thanks for a great blog, by the way.

    • guidoamm Says:

      Hi Manormouse,

      Politicians are by definition people that want to lead other people. Thus, politicians are naturally inclined to expediency. You can accuse politicians of many things but one thing you cannot accuse them of is to be well versed in history and/or economics.
      DBFM is a construct sponsored by the banks. When politicians asked why they should impose DBFM upon society, the short answer was that in so doing they could freely spend money on pet projects; pet projects that would help them garner votes.
      Considering that most professionals in the banking and finance industries are not aware of what monetary system we employ and, of those that do, even fewer may be able to calculate the ramifications of the use of one system instead of another, I can tell you that the proportion of politicians that may be aware of the characteristics of DBFM is statistically insignificant if it registers at all.

      Politicians were sold the system as an expedient way to win votes. Was there ever a debate anywhere in the democratic West as to what monetary system we should adopt? Of course not. It was just adopted and imposed upon society for good reason.

      On the other hand, the sponsors of the system that today are the Primary Dealers, stand to gain first by inflation and then by deflation. During the inflationary cycle economic actors pledge their assets in order to obtain loans. During the deflationary bust the follows, the collateral that had been pledged is appropriated by the banks.

      In a manner of speaking, all politicians descend from all politicians before them. They all seek power over other people or else they wouldn’t be politicians.

      During the inflationary cycle, the state must perforce gradually become the largest actor in the economy. As this dynamic evolves, the state must create champions that are worthy of its munificence. Entities like GM or GE or, indeed, Citibank or Goldman Sachs or Boeing for example. Similarly, entities that are protected and favored by the state eventually go on to absorb media and academic assets ensuring a certain type of information is filtered to the masses.

      DBFM appears to work for as long as the credit markets can be expanded. Even though people run faster just to stay in place, most feel empowered by a new sense of economic ability that is only brought about by low interest rates and deliberately shoddy appraisals of one’s economic abilities. This is not new. It has happened before as far back as the Tulip mania for example.

      There are no free resources mate. The only free thing that exist is not available to the great unwashed. The Primary Dealers are the only entities that have privileged access to the only free resource in existence today: DBFM. The banks are the only entity that can create something out of nothing and sell it at a premium. Everyone else is obligated by law to make use of DBFM and pay it back to the Primary Dealers plus more.

      And before you might think that the Primary Dealers are only concerned with the US$ or the USA, think again. In our world of Floating Exchange Rates where the US$ is the reserve currency of the world, the Primary Dealers are supplying DBFM to every other country in the world… collecting fees at several stages of the circulation of the currency.

      The Primary Dealers are the enemy. A real, clear and present enemy.

      • Manor Mouse Says:

        Many thanks for such a lightning fast reply and clear explanation. Yes, it makes perfect sense that it is not a ‘conspiracy’ as such, but mutual ignorance and expediency that has led to the adoption of such a flawed and unstable system.

        So how does non-DB FM work on a day-to-day basis? (You might want to save such a huge question for another post!?)

        • guidoamm Says:

          I’m going to disappoint you on this one. Honest money is deceptively simple.

          Let me premise that there is no full proof system. The mere existence of politics ensures that eventually the perceived raison d’etat will prevail over sensible policies.

          That said, the important thing is to do away with DBFM. Without necessarily going back to a gold standard, we could make do with a fixed amount of fiat money. In this hypothetical construct, the value of money would increase or decrease according to people’s preference in holding money or purchasing goods. But this system greatly constrains political rhetoric.

          Similarly, in a gold and/or silver based monetary system, expanding the money supply is tempered by the fact that you first need to find, extract, convey, refine and distribute the metal. Thus expanding the monetary system means expanding the economy because you need time, labor and resources to do so. And, anyway, even gold based monetary systems can be gamed as the Romans have proven during the decline of that empire.

          DBFM is particularly pernicious because of the inherent leverage it allows.

          The important thing in whatever monetary system is employed is that it should be managed transparently. In other words, it should be made part of the democratic system and the study of the system should be re-integrated into the curriculum.

  3. Patrick Donnelly Says:

    Perfectly correct.

    The reserves of course, are also created out of fiat. The taxpayer, the slave that can be compelled to pay the state, is saddled with the expense of funding the very engine of economic destruction!

    The gall of it! Inflation of course is the darling of the politician as it enables the sale of votes for promises of unequal allocation of resources magically created by banks!

    The ants are raped by the grasshoppers and then sent the bill for their hotel stay as they have no home or food!

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