As the Fixed income markets continue to crumble, all eyes in Finance are now on a summit of European leaders that will take place next Sunday, when many persons will be watching sporting events, enjoying the outdoors, protesting, or toiling to eke out a meager existence on this earth.
What happens in Europe next Sunday may be simply another act in the game of extend and pretend that until now has been the only strategy employed by Western governments and their Central Banks in response to the bankruptcy of the world’s largest banks and governments.
Since we do not know what will befall mankind this coming Sunday, we must endeavor to understand how the Western world has arrived at this critical juncture in history. We began last week, by exploring the often underestimated contribution of Luca Pacioli to the commonwealth of society: The dissemination of Dual Entry Accounting methods used in Genoa, Florence, and Venice circa 1492.
Today, we will explore the great irony that Dual Entry Accounting – what we call man’s greatest innovation, has made possible what we are calling man’s greatest catastrophe, Modern Central Banking.
In order to do this, we begin with a brief history and explanation of the concept of Central Banking and its relationship to government.
The concept of Central Banking is rooted in man’s need for security as well as his recognition of his co-dependence on his fellow man to increase his well being through trade. It takes time and energy to obtain and protect wealth. It also takes time and energy to barter with counterparties while trading differing goods without a suitable means of exchange.
A bank, in its simplest form, provides a secure place to store wealth. A natural extension of this activity is for the banker to extend credit and act as a clearing house for commerce by assuming a de facto role as an issuer of currency in the form of banknotes which represent a claim on wealth held at their bank. The existence and circulation of these banknotes greatly facilitated trade.
As trade and consequently the wealth of mankind increased both in volume and geographical reach, there was increasingly a need for a larger banking interest to store the excess wealth of the individual banks and to honor the banknotes emitted by the individual banks. This larger banking interest, formed by and for the benefit of the individual banks, is what we today call a Central Bank.
The complexity of maintaining banking accounts was greatly facilitated and made possible on a large scale by the use of dual entry accounting. The ability for individual banks to maintain accounts on a larger scale made possible the existence of a Central Bank to act as a clearing house amongst banks. Hence, our premise that Dual entry accounting enabled Central banking.
Now, on to the role of Government in relation to Central Banking. If Central Banks arose because man needed someone to look after his wealth, governments arose because man needed someone to look after his life. Governments were formed in response to the natural human need for a common defense.
It is not hard, then, to imagine that Governments, in whatever form, relied heavily upon and supported the formation of both individual banks and Central Banks. Why would Governments need banks and Central banks?
Governments are generally given license by the members of society to use whatever means necessary to preserve their lives. As such, they assume the role as the apparatus of compulsion and coercion in that society.
As the apparatus of compulsion and coercion, the government, by definition, cannot generate wealth. At best, it can only create the conditions under which individuals may create wealth, but the activities of government as a provider of security never directly create wealth. Because they cannot create wealth, they must either borrow from or tax the populace in order to fund their activities of compulsion and coercion.
The Central Bank, as the ultimate repository of wealth, offers a convenient source of both credit and, in a later wave of Central Banks of which the Federal Reserve is a prime example, tax collection services.
As you can see, a Central Bank is an indispensible institution both for individuals in terms of storing wealth and facilitating trade, as well as for Governments who have an insatiable need for tax revenues and credit.
The existence of a Central Bank, for all of the benefits that it may bestow, unwittingly makes the wealth of those it serves a natural target for those who are anxious to obtain that wealth through unjust means.
Central Banking, like alcohol and socialism, may be a good idea when used in moderation. However, each one of these also represents a catastrophe waiting to happen. For if the circumstances under which they are created or used take an unfavorable turn, the wealth and lives of many may be lost in a very short period of time.
Needless to say, the scale of modern Central Banking is beyond what would be advisable, and the potential for catastrophe is unprecedented.
How, when, and most importantly why will this catastrophe take place? We can only answer the why, and we will tackle it tomorrow as we are spent.