What is the role of Money in Innovation?

“Too big to fail” might be a necessary maxim in order to keep the banking infrastructure from blowing itself up but there are unintended consequences that could be hurting us, especially when it comes to innovation. Remember - banks create money, not the Fed (or your own central bank wherever you may be). By some measures, banks create over 95% of all the money in our economic system; leaving a tiny fraction to our respective Treasury. And the more the banking system gets concentrated into bigger banks, the more inequitable the situation becomes and the worse off our economy.

Richard Werner can sometimes ride the loopy train (such as when he cautions us against a future of microchips embedded in our bodies) but he is a very good resource when it comes to certain macroeconomic and monetary issues (such as where does money come from). In this particular interview, he makes a number of important points.

The first is that increasing the money supply doesn’t automatically cause inflation, at least not the type of price inflation that people are used to. For example, if banks are creating money by making loans for the purchases of assets (e.g. real estate) then you see asset price inflation but not necessarily consumer price inflation. The latter happens when banks make loans for consumer purchases. The best use of new money is when it’s used for new business creation.

The US has been very good at this in the past but for the past couple of cycles they have not; they have been fueling asset bubbles, instead of investing in economic growth and increasing productivity. It is possible, however, that the Fed raising rates as high and as quickly as they have is intended to starve speculators of excess money and prevent them from putting it into non-productive things (e.g. crypto). However, they cannot force people to make better investment decisions, so that may be magical thinking. And the interest payments that they are now making on government debt must be pretty big given that we are at a short-term rate of 5% with the GDP to debt ratio at 120%. The longer this runs, the higher the interest payments, sowing the seeds of inflation. So, thwarting inflation is not the aim of the Fed no matter what they are saying in public.

The second observation that Werner makes (39 mins into the video) is that Germany has the highest amount of Hidden Champions in the world - SMEs that are a total global leader (top three) in their particular niche. Germany has 1500 Hidden Champions; the US comes second with 320. He also says that Germany has the same absolute amount of exports as China does, despite having a much smaller population, and half of these exports comes from these Hidden Champions. You can only do this if you are very competitive and highly productive. Why are these firms able to successfully implement the latest technology? They get the finance they need from small, local banks (not the big banks). Germany has 1,500 small community banks out of 1,800 overall, most of which are not for profit. They only lend to companies in their footprint area and not lend outside their geographical area. Lots of small banks > lots of high growth.

The US is going in the opposite direction. Every time there is a financial crisis - like the one we are going through now - more and more small banks go out of business and are not replaced. And big banks, like JP Morgan, get to buy the assets of the busted banks for cents on the dollar and eventually drop the assets that they don’t like. There used to be 30,000 banks in the US and now there are 5,000 and declining (over 5,000 banks lost in the last 25 years). We don’t have productive allocations in the US. Instead, we are getting creative accounting, share buybacks, and other ‘clever’ tricks but not what we need for innovation (except in accounting and legal).

In future, when we create a mass collaboration community of any kind, we should heed the warning of leaving investment decisions to central authorities. Instead, these should be micro decisions made at a local level in order to maximize proximity to innovation.

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Great insights here David – and I’m wondering if in summary, you’re suggesting that we take a page from what the Germans are doing here in the US where more (smaller, regional) banks invest in innovation at the community level. If so, do we consider Silicon Valley Bank as part of that equation as they’re re-inventing their brand (based on our recent interaction with them in Miami)? Again, I think this could make great fodder for a JAM session…

I think that is probably correct; we do not want to see increasing consolidation in the banking industry which is also why Werner is so worried about CBDC. I think the DeFi experiment is, also, a valuable one because it is a microcosm of small bank lending operations with their own proprietary tokenizations that can settle on a common ledger and feed into one another’s economic activities. We may need this someday to help us, especially if CBDCs take up all the oxygen of economic activity. We may need DeFi projects to do what small and local banks do for us today.

I am not an economist, obviously, so I am spitballing here (as they say). It is just another reminder that central authorities can really get things done but they can really screw things up, too.

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rightly or wrongly I’ve only used my local credit union for my business for over 25 years. It’s been a wonderful relationship; I have nothing but praise & gratitude.

Werner would applaud you, there. He is setting up non-profit and community banks in England to help bolster the economy. Decentralization has many advantages, as the Soviets can tell you.

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I just listened to an interview with Warren Mosley in which he gave more accurate numbers about the debt than I had realized. He said that the public debt outstanding (excluding debt instruments held by the government itself) is about 100% of GDP and that current short term interest rates put the interest payments at about $1.25 trillion per year.

He points out that this automatically adds $1.25t to the deficit every 12 months without any political debate about deficit spending (unlike other spending discussions regarding safety nets, healthcare, etc) and that it functions as an extremely regressive tax because it is income that only goes to wealthy people in proportion to the wealth that they already have and nothing to people who don’t hold government debt. Furthermore, for the Fed to suggest that it is fighting inflation by pumping an extra $1.25t into the economy for wealthy people is absurd. It’s fascinating to me how ass-backwards our economic debates are but, again, I think it comes down to terminology and false narrative making. Words matter.

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The positive/optimistic thing is that money only has the power human society gives to currency. In theory we could wake up today and all collectively decide to change money to Pokémon cards or anything else as a new currency, or just do the old-fashioned barter system of goods and services which I have used on several occasions by trading things and has worked tremendously in my personal experience. Imagine being an Alien trying to figure out how this all works :blush: There is an extremely fun film called F is for fake which is basically about a guy who sells fake Picassos and Matisse paintings. If we could make a fake Dollar bill as an art piece so good that nobody could tell its fake, would that make it real?

You’re right that society gives money power as currency in the economy but only through force - whether that is through a democratically elected or an autocratic government. For instance, you wouldn’t be able to pay your taxes with Pokemon cards. Failure to pay in fiat ultimately ends in jail time. That’s the coercive power of the State and why we don’t use alternative forms of currency for most of our economy. Witness the recent crackdown on crypto and you’ll see why we cannot just collectively decide to create new money in our day-to-day operations outside of State sanctioned fiat.

Banks create digital dollars all the time that are indistinguishable from real dollars in the global economy even though they are really just ledger tokens specific to each bank. Every time a bank extends credit by making a loan to someone, they create a new digital ‘dollar’. Is it a real dollar? Well, it’s not the same as fiat created by the treasury but it serves the same function, so it’s neither real nor fake. When the bank creates an offshore dollar derivative, we call them Eurodollars and they operate exactly the same as a fiat dollar does. Are those real dollars with a capital ‘D’? No, not really, but they operate as such. They serve the same function.

I find that the more I learn about money the more fascinating it becomes.

I haven’t seen that Welles movie but it does look like fun. I remember reading about a professional master-fake painter that used their talent to paint famous paintings with your pet featured in them.