Tuesday, May 28, 2013

The Accounting System #10: The Federal Reserve and Accounting Money

previous: Checking and Credit Cards as Virtualization

Before going on to the use of computer devices, in particular smartphones, to de-coin and virtualize the economy, it would be good to consider the accounting system from the point of view of the government and the Federal Reserve System.

As pointed out in Chapter 1, the economy of the 19th century changed so fast that the arts of banking and governance were inadequate to prevent a series of cyclical booms and depressions, cumulating in the Great Depression that kicked off at the end of 1929. The accounting system of the time was thought to be adequate to the task, but it was unable to give clear indications of coming financial disasters. In fact, the system and its interpretation by humans contributed to the boom-bust cycle. Nevertheless, The Accounting System can be said to have been born out of ordinary accounting and other developments that came in quick succession after 1929.

At the beginning of 1929 a number of past problems were considered solved by economists, politicians, business executives, capitalists, and even ordinary people.

Paper money had solved a lot of problems. It had become standardized. Banks could no longer issue circulating bank notes; only the U.S. Treasury could issue paper money. This was something of a revolution. While counterfeiting existed, for the most part American paper money was self-proving. Unlike a paper check, you did not have to worry if there was money in a deposit account to back it. The government backed it. Compared to coin it was much lighter and much more portable. You still needed coin in 1929 only because a one-dollar bill bought so much. With a briefcase full of $100 bills you could buy a mansion or a boat load of bootleg whiskey.

Critics of paper currency were suspicious of substituting paper and ink, which were almost valueless, for metal coins they thought had intrinsic value. They pointed to past trouble with governments printing so much money that it lost much of its value, including during the Revolutionary War. The hyper-inflation in Germany in the 1920s, which resulted from massive money printing not backed by economic activity, was also a fair caution.

But the U.S. did not print too much money. The asset inflation (high prices for stocks and real estate) of the 1920s resulted from money (not cash, but accounting money) being focused on those assets. People bought stocks and real estate because they thought they would keep going up. They spent money to make more money.

What is accounting money? Recall our late Middle Ages Italian city-state banker, and in 1929 the first thing you should note is that only a few things had changed. Reserves were now set by law, and were spread over the Federal Reserve System. But each bank had very little cash in its vaults compared to the amount of money it carried on its accounting books. The depositors' money was simply some numbers kept on a ledger, and the creditors' debt in money was kept on a ledger. In normal times that was fine. The creditors had used the loans they took to buy things of value, like houses and business assets (and, unfortunately, stocks they had bought at inflated prices).  As they paid them back, accounting entries were made that gave the bank more money, which would then be available to pay out to depositors, to take as profit, and to cover the normal costs of running a bank.

This is a key point that most people don't get. Already, by 1929, almost all money, the count of what people held to be of material value, was in the accounting system. It was not paper money; it was ledger entries on paper. The Crash and Depression did not happen because there was too much or too little paper money or gold. It happened because of a combination of human folly (buying overpriced stocks, followed by panic) and the nature of the accounting system.

Next: #11, The Great Unraveling of 1930

[The Accounting System, Your Fate is in the Cloud, is a work in progress by William P. Meyers, ©2013]

Tuesday, May 21, 2013

The Accounting System #9: Checking and Credit Card Virtualization

Previous: The Accounting System #8

It is really not much of a leap from letters of credit and a system of loans and deposits backed by a reserve of coin or cash to a checking system. Checking accounts did not become common until the 20th century, but they extended the accounting system in a very convenient way. Most people, most of the time, did not write checks for more money than they had on deposit. Merchants had ways of deciding whether or not to trust the check writer. Long before the advent of credit cards it was possible to make do with almost no cash or coin, if you were willing to use a check book for purchases.

This again added portability to the accounting system. Many people kept a careful record of the checks they wrote, the deposits they made, and their balances, thus manually doing their own accounting. That helped the banks and merchants by reducing the number of bad checks that had to be dealt with. At the same time, with checks being written all the time by millions of people, the number of transactions banks had to process became a major factor in the cost of banking. First adding machines, then tabulating machines, and finally computers were used to speed up the accounting process. At the national level the Federal Reserve System facilitated the transfer of checks so that you could send a check to anywhere in the nation and eventually it would be turned into your bank for collection.

With a systematic, universal checking system it would have been possible to eliminate coin and cash from the economy. The accounting system would have been universal, at least for monetary transactions. A dollar would have been whatever the central bankers at the Fed said it was, unrelated to the antiquated silver dollars of yesteryear. But many people did not have checking accounts. The banks did not want to deal with untrustworthy or unprofitable customers, so the cash system remained in use.

People who are used to modern credit cards, which are used to make transactions through point of sale terminals, personal computers, and smartphones, may not realize that for years credit cards were part of a system that still relied on paper. While a card could be checked for available credit by telephone, a credit card purchase was made on a receipt with a copy for the purchaser, one for the merchant, and one for the bank. The receiving bank then debited the card holders account and credited the merchants account. By the time credit cards were coming into general use, so were computers (mainframe computers). Again the accounting system extended its tentacles. A credit transaction was a small loan. If not paid off immediately it carried a high rate of interest. But it meant that the customer need do no bookkeeping: if there was no credit left, the merchant would decline the card. Shop 'till you drop took on a new meaning.

Again, with credit cards you did not need coins or cash, at least until your credit limit was reached.

Next: #10: The Federal Reserve and Accounting Money

Sunday, May 19, 2013

Persecuting the Cannabis Community is a Crime Against Humanity

Rather than reposting here, I'll just give you the link:

Persecution of Cannabis Community is a Crime Against Humanity Which is at Mendoday, my Mendocino County web site.

Of course crimes against humanity come in shades of gray, ugly shades of gray. In Roman Catholic, Francoist Spain (1936-1975) they shot people with no or minimalist trials just for not being a good Catholic supporter of the General. It is not that bad for marijuana users in the U.S., though millions have been put in prisons with serious detrimental effects on their lives. It means they are on record as being criminals, which makes it hard to find employment, and as felons they may lose the right to vote. The black market also means the stakes are high enough in the trade to result in deaths inflicted by fighting over profits.

Wednesday, May 15, 2013

#8. Eureka: Reserve Banking

previous: #7: Virtualization in Early Banking

Consider a small city served by a single banker-merchant. He has built a safe room to store coins and has a clerk to keep accounts. He has lent out all his own money and, it being a prosperous era, in the past his loans have always been paid back on time and with interest. There are all these coins, really a lot of the coins of this city, sitting in his safe. He can't help thinking that if he could lend them out not only could he earn interest on them, but it would be good for the community. One client wanted a loan for a second fishing boat, which would surely be paid back, since the demand for fresh fish is high. The banker thinks of other clients who would be helped if only he could make loans to them.

Then it strikes him! Like a jolt of lighting, like a burning bush, like Christ speaking to him from the crucifix of the local church. Every day a client or two comes in and deposits or withdraws money. Over time the pile of coins has grown. On no one day do enough clients come in to withdraw all the coins. Eureka! He calls his clerk Big Data and says: go back through the ledgers and find out what the lowest count of coins we've had on deposit in the last five years.

A week later Big Data says: in the last five years we have never had less than 4,000 gold coins on deposit. And how many are on deposit today, our banker asks. 5,282, says Big Data. The banker sends out his clerk to get another blank accounting book.

The new account will record loans to clients that are made using the coin in client deposits. The fisherman borrows 50 coins to buy a new boat. He takes it to the boat builder, who is worried about having 50 gold coins sitting in his workshop or house. So … he takes the coins to the banker and deposits them. The banker will make, perhaps, two gold coins in interest on the loan. The same number of coins are back in the safe as there were at the start. The two gold coins paid in interest along with the original fifty are not even new coins. They are from the banker's stash of depositors' coins. The fisherman has a new boat, the boat builder a small profit, the men who cut timber for the boat have made wages, and the banker is richer.

The banker sees that the system is a closed loop. Most of the coins he loans out come back as deposits. As long as the town is prospering, as long as the total goods owned and services provided continue to grow (as they did in many Italian towns during this period, until the Turks cut off the trade routes to the East and the Portuguese and Spaniards gained monopolies in the West), the Banker can loan out the same coins over and over again. Sometimes coins are traded to outside his loop, but other times coins come in trade from other regions. The coins left in the vault, the ones that are not loaned out because they may be demanded by their owners, are what we call a reserve.

The accounting system is now critical to the banker's success. He has to know who owes him principle and interest, as well as how much he owes depositors. He sees that while he does not have coins to pay all the depositors at once, he does have loans out that will cover the deposits.

Of course, sooner or later, the banker will find that due to a series of withdrawals, he is running out of coins. He knows he'll be okay over time because the loans are still good, and he expects them to be paid in coin. Perhaps his friend who started as a fisherman comes in wanting to make a large withdrawal of coins that will break the bank.

The banker enquires why such a large sum of money is required. The depositor is buying an estate so that he can retire from managing his fishing fleet, leaving it to his son, and enjoy life as the owner of a country estate known for its fine grapes and wines. It so happens that the current possessor of the estate, Luciano,  has borrowed a sizable sum from the bank. The banker suggests that it is dangerous to carry such large sums around. He can facilitate the transaction by giving Luciano a note cancelling his debt along with the coin needed to make up the difference. The fisherman accepts this, and the bank is saved.

Of course in reality the system evolved over time and with many participants, but the idea of the reserve system was a major extension of the accounting system and the beginning of the end for coins. Over the centuries large numbers of banks have failed, some because of fraud but most because they did not keep sufficient reserves. It happened to a few American banks last year and it will happen again next year, and continue as long as the system is used. But on the whole the system of keeping small reserves of coin, and later paper money, and now electronic money, to back a larger accounting of loans and deposits, has worked rather well.

Next: #9: Virtualization with Checking and Credit Cards

[The Accounting System, Your Fate is in the Cloud, is a work in progress by William P. Meyers, ©2013]

Sunday, May 12, 2013

Bad Mothers Day

As a refreshing change from the high-fructose corn-syrupy Mothers Day of greeting cards and Call Your Mother Internet ads, I offer a reminder that a lot of us have Bad Mothers. Calling them is not a good idea. Trying not to imitate them is about as good as it gets on Mothers Day.

There are all sorts of bad mothers out there, and there are a lot of them, so of course there are a lot of people who don't want to be reminded of Mother. It just puts salt in wounds.

Mothers who abandon their children should be high on many people's lists of bad mothers.

Mothers who delight in physical and psychological abuse of children are bad mothers. Reminder: hitting a child is assault. It is a crime. Sure, their are difficult children out there, but there are other ways of controlling them besides hitting.

Alcoholic and drug addicted moms are classic and common examples of bad moms. Some are nice drunks and some are mean drunks, but none deserve a Mothers Day celebration.

There are a lot of shades of gray out there in the bad-to-good mom spectrum. Strictness and permissiveness are on a spectrum, as are protectiveness and carelessness. Moderation in all things is a good maxim for moms and everyone else. Exactly how far and in which direction from moderate you have to go to become a bad mother is a fair question. Err on the side of moderate.

Egocentric and cold mothers are probably the most common type of bad mother we encounter out in the real world. There are mothers with gambling addictions, obsessive-compulsive moms, and autistic-spectrum moms. Just plain crazy moms often qualify as bad mothers.

Mothers with bad values are bad mothers, but the world is full of people who argue about which values are good and which are bad. Joining a crazy religious sect definitely makes you a bad mother, no matter what else you do.

Of course every bad mother can point to worse mothers. Mothers who encourage their daughters to have sex with their fathers, or who pimp their daughters out for money. Mothers who actually kill their children. Mothers who drive their children to killing them. Mothers who drive away perfectly good fathers. Mothers who encourage their children to be criminals or soldiers or terrorists. Mothers who date men who abuse children. Mothers who have too many children for this overburdened earth to take care of.

So, here's a shout out to all of you children of Bad Mothers who are feeling a bit miserable today. I am with you. I understand.

Here is a tip: Don't Call. Don't be intimidated. You have a right to live your life and to pursue liberty, and happiness without being hounded by a bunch of people who did not grow up in your shoes.

On the other hand, don't be grumpy about people who have good mothers and love them. That is the way things should be.

Leave Feedback! Did I leave out a type of bad mother? Care to mention some particular examples of bad mothering? Favorite film about a bad mother?

Monday, May 6, 2013

The Accounting System #6: Coin, Counting, and Crashes

previous: Physical Money as Portable Accounting

If the money value bids for a particular set of assets can crash in a bubble, then if almost everyone decides to cling to their money, all asset classes can crash. That is what happened in the depressions of the 1800s and the Great Depression between 1930 and 1932, and came close to happening in the Great Recession of 2008-2010.

Cash and coin are not magical stores of idealized value. Nor is gold. The sense they created during the Coin Age was due to their countability and their portability. Coins are easy to count. You don't need any higher math to do it. Countability also equates to accountability. Is the bank's accounting right? Then the count of the coins in the safe should match the cash balance in the ledger.

Portability, however, was not exactly perfect. Gold is heavy. Paying for a chicken and some turnips in a local market is not a weight issue, but what if you want to buy a shipload of silk in China? The coin required would be heavy, but at least it went by ship. Overland transfers of large sums required pack animals and soldiers to guard them.

During the great expansion of global trade between 1400 and 1900 a lot of gold ended up at the bottom of the sea. Better systems were already available. They were extensions of the commercial accounting systems of that era, and they would evolve into The Accounting System.

Keep in mind that physical money, either coins or cash, amounted to a local, physical, and (except in cases of fraud, like gold-plated lead coins and counterfeit notes) undeniable accounting. If you had cash you could buy whatever was for sale despite your credit rating, criminal record, or cultural preferences.

During the Coin Age, the coins were the key physical part of accounting system.  People could forget that the ultimate basis of human economy is real goods and services. Accounting systems track who has rights to real goods and services. Coins were a primitive accounting system. Today they are disappearing along with paper money. They have lost their utility for accounting. But accounting has grown, evolved, and absorbed many new functions, to become The Accounting System.

next: Virtualization in early banking

[The Accounting System, Your Fate is in the Cloud, is a work in progress by William P. Meyers, ©2013]

The Accounting System #7: Virtualization in early Banking

previous: #6, Coin, Counting and Crashes

We know that credit and debt are early historical phenomenon because they were recorded in ancient documents. The Bible requires the returning of borrowed land and goods, as well as the liberation of slaves, every 50th year [Leviticus chapter 25]: "ye shall return every man unto his possession, and shall return every man unto his family." Laws regulating loans may pre-date writing.

Credit requires a tracking system, which of course is an accounting. A written record had considerable merit over human memory.

Trade, as indicated earlier, is facilitated by an accounting system. The portable accounting system that used coins came to be supplemented at a very early date (certainly by the time of the Roman Republic) by systems based on the letter of credit.

It was a simple enough system. A wealthy Roman, wanting to send his son to receive an education in Athens, could go to a merchant banker who would write a letter of credit. This light, paper document would be taken to Athens and presented to an associate of the Roman banker, who would issue coin, up to the amount stated in the letter, to the travelling student. Because citizens of Athens often travelled to Rome carrying letters of credit, to a large extent the two-way flow of credit might cancel out. Each of the banking associates kept careful records. At intervals, if flows were lopsided, then could even up their mutual accounts by shipping coin or by sending desirable merchandise.

Letters of credit are an early example of the portability of accounting combined with its virtualization. A letter of credit, in the coin age, would be thought of as virtual coin. In fact, once we drop the coin blinders from our eyes, we see that it accounted for goods and services up to the point when coin was issued.

The most remarkable discovery that allowed accounting systems and trade in real goods and services) to escape the limitations of coin systems probably evolved among Italian city-state proto-bankers in the late middle ages. No, not double-entry bookkeeping (we'll get to that in Chapter 3). They discovered that they only needed a small reserve of coins to do business and make a profit through loans.

Next: To be continued

[The Accounting System, Your Fate is in the Cloud, is a work in progress by William P. Meyers, ©2013]