Regimes of Currency

Money is one of those things we take for granted. Not money in the abstract, but money in the concrete: dollars and cents (over in Europe where I live, it’s euros and euro-cents). Money seems to be just there; and in thinking this way, we fall into the trap Ortega y Gasset spoke of, when he castigated those who similarly believe “that civilization is there in just the same way as the earth’s crust and the forest primeval.”[1] For if you believe it is just there, you will do nothing to maintain its existence, an existence which, truth be told, is fraught with contingencies of the human-factor variety. For money is a reflection of human action, and its functioning is contingent upon decisions made by human beings, economic decisions to be sure, but political decisions as well. Citizen, be aware.

Money, then, is not just there. Many exponents of the free market would have it so: a mere commodity pressed into service out of the need for smoother circulation, in existence prior to all legal or civil institutions.

Nor, on the other hand, is money a fiat creation of government, mere paper that can be printed whenever the government decides it wants more, and does not wish to raise the money in an honest way (i.e., taxation with representation).

Money is the product of contract, and property in the service of contract; it is the natural, necessary by-product of these <44> institutions of law. It is created through a specific form of contract – the credit contract – by special institutions called banks. The total amount of money in circulation is backed by the total asset base of the jurisdiction of a particular legal system, to the degree that those assets have been harnessed to the money economy. Dead capital has come to life. This harnessing – “monetization” – of the asset base also has the effect of bringing those assets out into the open. In turn, it enables them to be taxed. It creates the tax base of that jurisdiction. Therefore, through legal institutions, sovereignty creates for itself the means by which it feeds itself.

Recall that the common-law order is a function of sovereignty: it is the product of binding adjudication (see p. 9), whereby the sovereign lays out the law in a manner which neither is imposed from above (by a dictator) nor is merely arbitration (whereby adherence is voluntary). Binding adjudication sets out the law in a sovereign manner, but it sets out such law as lives among the people, adjusting their interactions, coordinating their disparate activities. It is both top-down – maintained by an overarching supreme authority, the state – and bottom-up – reflecting the will, customs, and mores of the people.

Therefore the law is a function of sovereignty – established in sovereign manner, which is to say, in a manner that cannot be gainsaid. But it is also “discovered,” not created; it is the result of the establishment of practices and customs alive among the participants in the social process, sifted and weighed, sanctioned by higher authority. Such law evolved through the process of binding adjudication.

Money is the product of a similar process. It likewise is discovered, not created, in the sense that it represents real value which is there, but which gains recognition only through a process of open-market operations. Thus the courtroom here is not <45> a literal courtroom, but the bar of the marketplace. Money is the product of a process of valuation. Property is valued, and money is issued against that value. The property is security for the repayment of the money. And the money thus issued is subsequently used as the measure of value in other market transactions.

Money and Metal

Part of the confusion surrounding the concept of money has to do with the fact that in less secure conditions, money is issued in the form of tangible assets, mainly precious metals. But that only had to do with the weakness of the legal system. Where legal tender can be enforced, paper money shows its advantages.

Early on in the development of money, public powers (princes, sovereign or semi-sovereign cities) took on the task of minting coins, by which means they supplied money to the economies within their orbits, and pocketed a certain percentage, called “seigniorage,” which, in lieu of interest, made it worth their while to do so. They used these coins to pay their bills – in the case of princes, mainly outlays to and for their armies. This had the effect of setting up a so-called “money of account,” the unit of value in terms of which they did business. In England, for instance, this was the pound sterling; in Holland, the guilder; in France, the franc. As the state grew, and the need to do business with it grew apace (specifically to pay taxes), its unit of account came to displace all others. It became standard also among other issuers of money, such as private banks, whose discount and deposit activities were conducted using this received money of ac <46> count.[2] As each country consolidated its sovereignty, it not only consolidated its legal system but also its currency.

Money and Central Banking

In the 20th century, the system of central banking came to displace all others. This system put into place once and for all the sovereign as final arbiter of economic as well as legal value, for it established the state bank as the sole issuer of currency. The central bank is a state institution even when privately held, for its role, tasks, and management are all dictated (in one way or another) by government. It holds in its hands, through this capacity to issue currency, control of basic money-market interest rates. And this, as we shall see, anchors the entire monetary system. Central banking has a bad name among some, because it smacks of a government printing press, creating fiat currency at the whim of whoever is in charge – but that is to mistake its function entirely. In fact, an independent yet publicly established – state-established – banking system is as necessary to a sound economy as is an independent yet publicly established judiciary. For they both serve to translate sovereign power into practice, through the binding adjudication of value. The legal system establishes value in terms of what is right and what is wrong, while the monetary system establishes value in terms of what is scarce and what is abundant.

In former days, paper currencies were redeemable in precious metals upon demand; as the legal system became more ro <47> bust, the need for this diminished. The need for money with intrinsic value is tied to the lack of trust, a lack of confidence in the enforcement of contracts (see p. 19). Nowadays, currencies are either paper, metal, or simply bits and bytes on a computer server. This does not change the basic nature of money as standard and store of value.

Competing Sovereignties, Competing Currencies

Multiple sovereignties, multiple currencies. There are as many currencies as there are sovereign nations maintaining legal and monetary institutions. The key here is to recognize that these various currencies have value relative to each other. One must be able to evaluate these currencies against each other, as they reflect the comparative soundness of sovereignties as they compete for investment. This, of course, is done every day on the foreign exchanges. In the long run, the factors of sound policy we have already elucidated lie behind the changes in value of one currency to another.

The chief factor is the terms by which loans are obtained, thus, against which currency can be issued. Are only sound securities accepted, i.e., property as collateral? The red flag goes up when one gets wind of funds being obtained in exchange for IOUs. An independent monetary system ensures that such contagion will not enter the money base.

The chief criterion of sound security is marketability. A government IOU given directly to the central bank in exchange for funding, without first having its value assessed by being floated on the market, is a sure sign of a currency being debauched, for in this case the central bank truly is simply “printing money” – it is no central bank at all, but a branch of the Treasury Department or Ministry of Finance. Only those securities ob <48> tained by the central bank through open-market operations can be acknowledged as sound security, and so contributory to a stable currency.[3] The same holds true all the way down the line to the level of consumer lending. The subprime-mortgage debacle never would have occurred if bank regulations had not been loosened irresponsibly (to accommodate uncreditworthy borrowers), and, in fact, if implicit guarantees had not been given by quasi-government agencies (Freddie Mac, Fannie Mae) regarding the risk inherent to such loans. Credit ratings agencies should also have been on their guard, instead of passing off as investment-grade the mortgage-backed securities containing those loans, which is what in fact happened. This was truly a perfect storm of quasi-conspiratorial collusion.[4]

<49> In assessing the relative value and stability of a currency, one first should keep in mind the criterion of a sound currency: good securities. From top to bottom, loans as well as asset purchases – hence, the lenders’ balance sheets – should be solid.

How is this to be assessed? Not easily. Central banks have among their chartered tasks the establishment of regulations regarding collateral requirements. But, as noted above, pressures to admit substandard security as collateral – whether market-oriented (i.e., in a boom market, by reselling the loan before the security goes sour) or political (i.e., “encouraging” banks to lend to less-creditworthy borrowers, as with the Community Reinvestment Act) become difficult to withstand. But with the recent financial crisis, the necessity to tighten up lending criteria has been realized on all sides, which eventually will lead to a renewed strengthening of currency fundamentals.[5]

Building on the methodology of Heinsohn and Steiger, Lehmbecker has devised a framework for ranking central banks in terms of the quality of collateral used in implementing monetary policy – the Index on Central Banks’ Quality of Eligible Collateral (IQEC). To build the index, Lehmbecker devised a questionnaire and distributed it to the 148 central banks listed as such by the Bank for International Settlements as of November 2006. The survey was returned by 62 central banks. The results indicated “a significant correlation between index values and mone <50> tary stability as measured by inflation rates.”[6] Such an index is precisely what is needed to guide investment decisions, for given such a correlation between central-bank balance sheets and inflation, it would be an excellent indicator of inflation prospects. It is to be hoped that the initiative will be continued and expanded.[7]

All these various parameters factor into the health of an economy and its attendant currency. The most direct, most visible way to assess the condition of an economy is to look to interest rates, the basic thermometer of risk. This, in turn, brings up the subject of interest per se.

Interest and the Law

Here as well, common-law economics must part company with traditional economics, which, in line with its state-of-nature, Robinson-Crusoe approach, disconnects interest from money. Traditional economics views interest as a function of time preference – a bird in the hand is worth two in the bush, so that if one lends something, one should be compensated for the period of time in which he has to do without. Or, it views interest as a function of productivity, which makes it to be the same thing as profit. But these explanations miss the bigger picture, which is, what makes a certain rate attach to borrowing money? Aristotle <51> was quick to deny the productivity theory of interest, when he argued that money does not produce anything, it being inert, which is why charging interest is immoral.[8] Traditional free-market economics did not get much farther than this. Although the ban on usury was eventually dismissed, interest still remained something for which to apologize. It was adverted that because money could be used to finance productive activity, interest is analogous to a form of profit, hence, it is derived from productivity. But how exactly this connection could be made was never satisfactorily explained.[9]

These explanations beg more questions than they answer. If we have recourse to the explanation given earlier in this book as to where money came from – the process of contracting based on property – the riddle of interest is likewise answered.[10]

<52> Property versus Possession

Recall that the concept of property is a direct result of the commitments involved in borrowing and lending. People needed money, and lenders, to provide that money, needed collateral.  Thus, possessions are used to create property in order to bridge the gap and allow the engagement of credit/debt relations. Property, as distinguished from mere possession, arose from the need to borrow. It is possession put up as security, by the debtor, in order to obtain money from the creditor. Property, then,  is encumbered, for which money is issued. The interest attached to money stems from property, not possession.

Property is something other than possession. Possession concerns the physical productivity or profitability of the resource. It belongs to a physical category. Property, by contrast, belongs to a legal category – it exists only in the mind – i.e., the collective mind of the society, which is the law.[11]

Therefore interest, being a function of property not possession, is something fundamentally different from productivity. Which is why investing in interest-bearing instruments is one category, and investing in productive activity is another. Of course, interest rates profoundly affect productivity and thus rates of profit. But profit in itself is something entirely other. Profit can be zero even in a very safe environment, for it depends not sim <53> ply on security but on positive generation, on creative activity, on human action to generate some good or service, which of course depends greatly upon a secure environment but which cannot be confused with that environment.

Interest, then, as a function of a legal institution, is the rate asked by the creditor to act as guarantor of the money issued. The money issued by the creditor is not simply the debtor’s but the society’s, in the sense that it translates the value of hitherto isolated possession into group-external, socially recognized, common value – it is currency.[12] The value of the currency is the sum of the value of the property against which it is issued. Money makes general and objective what otherwise would remain particular and subjective – the disparate conditions of individual economic actors and their resources.

Interest and Risk

The rate that the creditor asks in return for lending is a reflection of the risk he takes in underwriting the issue of money. This risk involves the likelihood of being paid back, or alternatively the likelihood that the value of the property put up as collateral will answer to the original issue. These, in turn, depend on the broader condition of the security of property in civil society. To what degree are the institutions of property and contract protected and enforced? To what degree are they circumvented and nullified, through impotence, corruption, etc.? The factors involved in the International Property Rights Index, and those <54> affecting property and contract in the Index of Economic Freedom, therefore feed into the interest rate. Interest is a function of all these factors regarding security and enforcement of rights. It is a function of the legal regime.

The Bond Market – Barometer of Risk

This being so, the most secure forms of investment in the contemporary investment scene are government bonds, the interest of which is guaranteed by the very sovereign which guarantees the stability and security of the whole. The rationale of interest is recognized as being the product of protection, of soundness, of security of expectations, and governments have learned to use their sovereign power to guarantee interest payments on their own loans, recognizing that this is the anchor of the attendant money and capital markets (for more on this, see pp. 76 below).

In modern central-bank oriented economies, the trade in government bonds is the core activity by which interest rates are determined. The basic interest rate here is the rate at which the central bank deals in open-market operations with its so-called primary dealers. By targeting a certain interest rate level, the central bank provides the floor for the entire interest-rate regime of the economy.

Governments issue a range of bonds with various maturities, ranging from very short-term to long-term, each of which bears its own interest rate. This results in a yield curve, which is a graph comparing the yields –  interest rates combined with bond prices – of the various bond maturities. Yield curves range from steep – low short-term rates, high long-term rates – to flat – no great differential between short- and long-term rates – to reverse, which is when short-term rates exceed long-term rates.

<55> There is much scholarly debate as to the significance of various shapes taken by the yield curve. In general, it can be stated that a flat yield curve is an indication of a low inflationary environment, while a steep yield curve indicates the opposite. This is because the lower the long-term rates – a flatter curve – the lower are long-term inflation expectations. In other words, the markets believe that inflation is under control. Which means that the sovereign – the treasury and the central bank – are maintaining restraint. Governments are not overborrowing, and central banks are not accepting non-marketable assets as collateral for the currency issue.

In addition, the lower the interest rate, generally speaking, the more stable the currency. Governments like to see low interest rates in their own countries because they make it easier to float government bonds and cheaper to finance government activity. Low interest rates also spur investment by making it more attractive for businesses and consumers to borrow. All of this makes for a more dynamic economy and so a more attractive destination for investor capital.

Additionally, interest rates give a good indication as to the long-term prospects of an economy. The lower the interest rate, the more confidence investors have in the sustainability of the given economic climate.

Low interest rates can only be gained through sustained fiscal and monetary discipline over time. This has to be the focus both of the government and of the monetary authority. In this manner they build up a track record of responsibility. This is a key element in assessing investment suitability. What kind of budget deficits has the government been running? What level of government debt as a percentage of GDP? Can the debt be sustained <56> by the level of economic output? Or will repayment eventually have to occur through currency debauching?

It is common knowledge that one of the main differences between the developed and the developing world is the fiscal and monetary discipline maintained by the respective authorities. In the former, discipline is the hallmark; in the latter, it is the holy grail, unattainable even as it beckons from afar. At least, such is the received wisdom. But are matters still in such a state? Or has there been a fundamental shift, a transformation, under way here, the evidence of which abounds, but which is nevertheless hidden to us? In other words: what is this “New Normal” of which we have been hearing so much lately?

[Adapted from Investing in the New Normal: Beyond the Keynesian Endpoint, ch. 3.]

[1]Highly recommended: José Ortega y Gasset, Revolt of the Masses (New York: W.W. Norton & Co., 1932), p. 126.

[2]But it must also be kept in mind that the money of account was developed within the context of open-market operations. It was not simply imposed, but rather had the effect of fixing valuation already arrived at on the open market.

[3]This is, in Heinsohn and Steiger’s terminology, “creditor’s money,” as opposed to “debtor’s money,” which is the kind of money a fiscally irresponsible government may foist upon its citizenry. “To function as genuine money, money proper has to be a creditor’s money; that is, the central bank is not allowed to accept assets as collateral in the loan contract issued by its eligible counterparty, the commercial bank, or by any other entity with which the counterparty has close links. Otherwise, the money issued would be a debtor’s money, like Keynes’s “Government printing money”, which today is forbidden…. If debtors were allowed to go directly to the central bank with their own IOUs, the money handed over to them would be an instrument discouraging investors and destroying the economy.” Heinsohn and Steiger,  “Collateral and Own Capital: The Missing Links in the Theory of the Rate of Interest and of Money,” in Steiger, Property Economics, p. 196.

[4]Mason, Joseph R. and Rosner, Josh, Where Did the Risk Go? How Misapplied Bond Ratings Cause Mortgage Backed Securities and Collateralized Debt Obligation Market Disruptions (May 3, 2007). Available at SSRN: Heinsohn and Steiger archly remark that “These instruments [i.e., collateralized debt obligations, collateralized loan obligations] do not deserve the term ‘collateral’ in their names. Yet, insufficiently collateralised debt obligations (ICDOs) would not have been an easy sell.” “Collateral and Own Capital” in Steiger, Property Economics, p. 217.

[5]Although not without going through a rough patch initially. The Fed will have to find a way to refloat all the mortgage-backed securities it took on in its bid to stabilize mortgage markets. And the Eurozone will have to find a way to survive the fiscal irresponsibility of many of its member countries, e.g., Greece.

[6]Philipp Lehmbecker and Martin Missong, Measuring the Quality of Eligible Collateral, Research on Money in the Economy Discussion Paper Series No. 2008-3, June 2008, p. 13.

[7]See also Lehmbecker, The Quality of Eligible Collateral and Monetary Stability: An Empirical Analysis, Research on Money in the Economy Discussion Paper Series No. 2008-04, June 2008; Lehmbecker, The Quality of Eligible Collateral, Central Bank Losses and Monetary Stability: An Empirical Analysis, Frankfurt am Main: Peter Lang, 2008.

[8]“The most hated sort [of wealth-getting], and with the greatest reason, is usury, which makes a gain out of money itself, and not from the natural object of it. For money was intended to be used in exchange, but not to increase at interest. And this term interest, which means the birth of money from money, is applied to the breeding of money because the offspring resembles the parent. Wherefore of all modes of getting wealth this is the most unnatural.” Benjamin Jowett (trans.), Aristotle’s Politics (Oxford: At the Clarendon Press, 1905), p. 46.

[9]The discussion in Heinsohn and Steiger (see n. ), pp. 56-63, provides sufficient evidence for this conclusion.

[10]This riddle was first solved by Heinsohn and Steiger in their pathbreaking book, Eigentum, Zins, und Geld: Ungelöste Rätsel der Wirtschaftswissenschaft [Property, Interest, and Money: Unsolved Riddles of Economic Science] (Marburg, Germany: Metropolis-Verlag, 2006 [1996]).

[11]There is a dictum of Roman law which highlights this distinction: “Nihil commune habet proprietas cum possessione” (Ulpian, in the Digest, 41.2), property has nothing in common with possession. Stahl (Private Law, pp. 86ff.) criticized the drastic separation of property and possession in Roman law, and argued that their inner unity needed to be recognized. Nevertheless, the distinction holds firm (which distinction Stahl did not deny), and must be used, as Heinsohn and Steiger have done, as the basis for real-world economic theory.

[12]The Merriam-Webster Dictionary ( provides as one definition of currency, “general use, acceptance, or prevalence: ‘a story gaining currency.’” Thus, currency is recognized social acceptance.