This is just a rational explanation of money and rates. If you need an alternative Zen approach regarding emotions, read Happy Money from Ken Honda.

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Copyright© Schmied Enterprises LLC, 2023.

My approach is the invisible hand of Adam Smith. If people stick to accounting and exchanging value for money, it should make the economy working.

Humankind has dealt with money for a long time. There are many definitions of money. My favorite one is the present value of a future payment, or present value of a past payment. Money is travel in time.

There are two implications. It is not possible to explain money without interest rates. Interest rates set the aging of money across time periods.

It is also not possible to explain money without inflation. It is the loss of value of cash in hand or loss of fungible assets it can be exchanged to. Eroding coins make people keep less of them. Drought makes less likely to buy much grain after harvest.

This explanation is from the point of view of a historian. Inflation represents the risk of keeping money for longer. You may not be able to exchange it later.

The first mentions of money dealt with salt. Salt was an ultimate currency, easy to measure and easy to verify. It does not perish. Verifying it by taste also appeared as an early example of monetary tightening. Dare to hoard too much salt? Taste yours to verify them all.

Still it was a good way to stimulate the economy. You did not need to collect three or more parties in a farmers market to do the barter, who gets the chicken, the rice, and the fruits. You could negotiate separately and use salt accepted as an ultimate currency.

As civilization evolved people learnt how to do metal casting. This allowed the use of precious metals to replace salt. Metals are hard to find and gold and silver do not react easily with anything else. They could be verified by biting, or submerging in water and weighting. This allowed coins to be kept longer. This lowered the risk of carrying them reducing inflation.

Gold allowed them to collect more, leading to more advanced forms of civilization collecting taxes and spending the gold on weapons in need, when there was a threat to the local community. It allowed merchants to use it throughout the Silk Road.

Problem. The fixed amount of a monetary instrument limits its power to innovate.

Solution. Inventions make society more efficient. Societies grow better with inventions. Still, a fixed amount of monetary instruments limits the opportunity to grow. Holding money is riskier in change. Holders of money will want to deter and limit growth and efficiency increases.

Problem. The fixed amount of monetary instrument limits its power to grow.

Solution. The amount of money is fixed in a gold standard. Manufacturers will optimize costs to save. Lowering prices will make them pile up cash. They will be reluctant to increase salaries thus they limit consumption.

This issue of fixed currencies makes their use cases limited and increases their variety for different purposes. Medieval rulers all had their unique currencies printed. It was pointless not to build a castle in Europe, if a warlord piles up gold in Korea. Enforcing coins with the face of the ruler kept money in the realm. It was expensive to collect wood to melt and recast coins.

Similarly, Bitcoin, the ultimate press & marketing currency, was quickly followed by other cryptocurrencies with different user bases. Is Bitcoin too expensive? They just created yet another one. Protectionism that was made famous by King Louis XIV of France is about limiting the loss of local currency in exchange for producing things locally.

Soon a demand emerged to replace the heavy metals. Paper money was used in the densely populated area of China, and Europe as well. This eased the need to carry money for the wealthy and for the merchants.

Mercantilism allows better flow of money building trust lowering risks across regions. Paper money helped merchants and sailors on long trips overseas.

Paper money was still bound by the produce it could be exchanged to, and a warehouse of precious metals. This was land, and gold and paper money represented a portion of the produce, it could grow. Titles such as the Prince Of Wales or the Duke Of Edinburgh still show how ordinary people could connect the income to the value represented by the coins or paper money issued.

Paper money was still bound to a warehouse of precious metals. The dollar bills issued by local banks were liquid, replaced with gold in the United States upon request. This duality stayed with us for a long time. People learned that a thick stack of paper dollars, or checks are to be protected by a thick gun of the Second Amendment.

It was the industrial revolution and the scientific method that changed this duality forever. Mercantilism was replaced by industrialization.

Problem: Scientific achievements will cause inflation.

Solution: Remember the long lines in front of Apple stores, when the iPhone was introduced. Products such as a shiny Tesla or iPhone make existing assets look less valuable. They will attract the savings of the wealthy. It is not accidental that highly priced products will cause hypes. The product strengthens the perceived status in society.

The new inflow of free cash increases prices elsewhere, unless central banks fill the gap. This is the standard monetary cycle of excess investment and return to a normal output.

The industry limiting feature of gold backed currencies led to the introduction of credit money. Credit money can be issued by central banks in unlimited quantities as needed. Each bank has an account at the reserve bank, and they can borrow at a common rate.

Many of the successful economies of the 2010s like Taiwan or Korea were built on smart decisions of local bankers. If credit money supports local builders, they can invest in machinery and keep building towers or semiconductor factories. If foreign competitors have less access to credit money, local semiconductor makers can even get ahead internationally.

Problem. Inventions and destruction generated inflation.

Solution. Wars generated inflation spreading new value such as radar, jet engines, and overseas travel making old assets obsolete. Old buildings were destroyed at scale reducing the number of assets existing money could be exchanged to. A famous example was the Hungarian billion bill.

Problem. The iPhone did not generate inflation.

Solution. Indeed. Quantitative easing allowed enough liquidity to avoid inflation in case the iPhone and cloud. Money piled up at tech companies in cash reserves, and in manufacturing hubs such as Taiwan, Korea, and China. This was a smart use of credit money.

Problem. The invisible hand of the economy can solve money supply without central banks.

Solution. Sometimes technology speeds up the circulation making the same amount of money sufficient. Paper money and checks ensured liquidity for the growth of the frontier in the United States and Australia in the 1800s. Railways, dwellings were manufactured.

Factories, trucks, bulldozers all needed financing. The cash flow generated helped to pay the loans back. They detached the economy from the classic wealth model proportional to land mass.

The credit card was invented allowing a stable flow of revenue. This strengthened franchises and construction. There was a need of more flexible money supply that followed the product supply.

The currencies today are floating currencies. They are not strict credit money. Their liquidity is driven by statistics and international exchange rates.

The liquidity requirement suggests a divergence from the credit money model. Why would the central bank issue an unbound amount of money to random people? Why do not they borrow from smart wealthy individuals at home and abroad?

Government bonds were to be paid back. Central banks were tied to the government and the statistics it enforces. They reduced risks instead to lower their own rates. They give money to those who are more likely to pay back with a rate aligning well to the risk. Should they issue more money than value produced, inflation will build up.

Problem. The primary law of companies is to generate cash flow.

Solution. If companies did not generate cash flow every year, they would cease to exist. Cash flow prevents default, loss of assets, and inflation. This is taught in most accredited MBA courses.

The governments enforce statistical limits, how much asset banks need pile up by their owners in capital and retained earnings. This allows them to have access to credits. They operate lending the money they borrow and generate cash flow.

Search for Basel standards to read more about the statistics behind floating currencies. They enforce arbitrary 3-6% requirements on assets to debt, and cash flow to debt based on statistics. Basel rules ensure that the depositors can always get to their money. The system is liquid. This means that banks will generate cash flow, they cannot default.

Crisis situations sometimes make people more likely to withdraw their money. Central banks keep tightening the Basel standards after every recession. The Basel standards have a tendency of becoming stricter. The reason? It is unknown, but it is likely related to job security and information technology of the past twenty years.

Why is a floating currency not clear credit money? There is a monopoly of the central bank. They set the limits based on statistics of inflation, growth, and unemployment. Sometimes these numbers are questionable or contradictory.

Central bank leaders are usually elected to keep inflation and rates at bay for the government. Targeting inflation as an indicator protects the assets of a strong voter base of owners and earners. They were enough to elect a government that sets the rules for the central bank and financial regulators.

Lowering inflation requires lowering risks. Lowering risk usually requires a good insurance and subsidy system. Risks across geographical regions can be limited as a result, so they can share the same currency. The Empire State is formed. Two examples are the United States, or European Union.

The Empire grows until it can provide growth to a joining region by sharing risks with a unified currency. Once this is reached the Empire loses its power. If a region can solve the problem of risks itself, it remains neutral and independent such as Switzerland.

Imagine the peak of the British Empire. HMS Prince Of Wales battleship and HMS Repulse battlecruiser of the Royal Navy were sunk by land based bombers of the Japanese Empire in 1941. The battle took place close to Singapore far from London and Tokyo. Risks set by bankers in London reached their limits. The two battleships were not enough to protect the edge.

The same risks set the limit of the other side. The Japanese Empire surrendered in Tokyo Bay in 1945 to the Allied Command led by the United States. Many of the ships of the Japanese Empire were actually built in British shipyards before WWI, when they were allies. The empire could not keep up with the efficiency of US manufacturing.

Provinces of the Roman Empire was defended by thirty ever moving legions from Gallia Narbobensis to Africa of the current Tunisia. Most of them were assembled with free citizens of Italia.

Problem. Empire=Equality.

Solution. Empires are built on lowering risks by diversification, free markets spreading equality naturally. Dictatorships increase risks. Inequality eventually sets the limit. I will address this in another article, but the more an empire supports equality the bigger it can grow. Equality simplifies the calculations of risks and interest rates.

Empires that build on inequality are set to fail just like the empires of the two battleships and the bombers thousands of miles away from the center mentioned above. They were not efficient enough to build enough bombers and battleships. Higher risks and rates limited the supply.

What followed was the liquid money of the United States dollar that still lasts today. The United States can lower the risks in our trade network making the dollar a low risk currency. The Basel standards ensure this liquidity.

The dollar stays in parity with countries where transparency, equality, and free speech can lower the risks to trade efficiently. This keeps the risks and currency on par with the United Kingdom or the Euro Area.

Regions that have higher risks like those close to China must keep their own floating currencies. The United States can lower their risks by providing a promise of military support to South Korea or Taiwan. Sometimes the risks and currencies need to be kept stable by promises of military support in exchange for enforcing monopolies in industries like semiconductors. This is called a subsidy like in the European Union. These currencies stay in parity by exporting the monopoly back to the United States.

The European Union provides subsidies in the form of structural funds more transparently to states with lower domestic products to keep risks and rates in parity. The stabilisation of Greek GDP was a remarkable example.

Floating currencies are still not a credit money by academic definition. Interest rates are set by following indicators such as the consumer price index and its inflation, unemployment rate, new jobs created, domestic product growth, etc. It is a statistical money requiring to be liquid. The currency fluctuates more compared to fixed gold as a result. It is still set by the monopoly of the central bank elected by the majority of asset holders.

The system created challengers in the form of cryptocurrencies. The market of cryptocurrencies showed demand in GDP growth. Complexity made it difficult to maintain them. Executives of FTX or Binance face legal trouble as of 2023. Cryptocurrencies usually have limited amounts but the barrier to entry is small to issue new types of coins.

A more invisible hand driven approach became wealth coming back to the US from the Middle East and Asia with Vision fund and similar investments. The Federal Reserve simply gives away the monopoly power with quantitative easing. The money is influenced by foreign corporations and governments. This shows the problem with fluctuating currencies that are not clear credit money.

The fixed gold standard limited scientific growth, and manufacturing. Fluctuating central bank money tied to statistics was good for industrialization, but it limited general welfare. Cryptocurrencies and crowdfunding filled the gap for minorities, but they lack the leverage of access to central bank funds.

Individuals not getting access to credit will eventually rely on the social government accepting less fulfilling jobs, subsidies, or do everything themselves. This limits the Empire. The US government was downgraded in 2023.

Problem. Experiments like cryptocurrencies are carried out because there is a demand.

Solution. There is sufficient money for all needs in a system with credit money. The amount of money just follows the cash flow demand. Statistical money limits this following a few indicators favoring the majority. Minority will carry out experiments such as the partnership, common law contacts, state crowdfunding laws, or cryptocurrencies to do business.

Federative fluctuating money is influenced by central banks, investment banks, local wealth, foreign trade, foreign wealth.

Credit money is set by citizens borrowing freely from the local central bank. Credit money is not a federation of wealth anymore, it is a Union of the people.

Let’s return back to the farmer’s market of a tribe with salt as their currency. It allowed them to trade with each other. Credit money does nothing else but the same. The purpose circles back.

A central bank that treats lowering unemployment rate than inflation as a target will address the unfortunate, not just the wealthy. A central bank that favors the employment to population ratio instead of the unemployment rate addresses the vast majority of the population. This may be behind the success of governments of Hungary or Poland. A central bank that puts the per capita domestic product as its primary goal lets nobody suffer. It is the perfect union.

A central bank focusing on GDP counts the retired and the disabled as full-time consumers. Such a bank lowers inflation, unemployment, and increases employment by providing meaningful work for many. Such an approach reduces rates by allowing exporting the excess. Any trade balance allows reducing risks importing anything that falls short of the supply chain temporarily, spending the rest on traveling. This is probably the real credit money by definition.

Central bank focus on GDP allows saving extensively, allowing the super rich, if they are frugal and become the central bank themselves, to remove the excess from the system. The system showed in the 2010s that such money is accumulated in unrealized gains of stock accounts. Such funds are sometimes never realized and inherited to the next generation.

Push to invest in fixed income such as certificate of deposits in 2022 and 2023 lowered the gap by realizing the value of such assets lowering the gaps between stock and bond returns. Bonds are paid at the end of the term.

Stocks are valued using a few recent transactions negligible to the whole market capitalization. This is why assets are taxed, when income is realized. This allows to build wealth without affecting supply chains and generating inflation.

Money supply tied to per capita domestic product is the ultimate credit money. Rates are still set by a central bank focusing a different metric. It allows building wealth without affecting supply chains. However, it also allows better access to credit to the retired, individuals and small businesses. This removes the emotions from the system. Diversification, free markets and equal treatment reduces risks and interest rates.

It also allows a more stable interest rate providing liquidity not limited to an oligopoly of investment banks but millions of traders. Equal access to credit lowers interest rates by lowering risks.

It will not exist for a long time because it requires citizens to apply for a loan from the central bank directly. This requires extensive education, so that the excess does not affect supply chains and fuel inflation.

Stay green.

This article was revised on Dec 2, 2023.