When Money Becomes Numbers in Computers

Economic boom-bust cycles have been known for millennia and they continued in different forms throughout history. One of the first cycles was recorded in the Bible, in the book of Genesis, when Joseph interpreted Pharaoh’s dream about seven years of abundance followed by seven years of famine.


While the phenomenon is not new, during the last two decades, first after the year 2000 market crash and especially after the 2008 crash, we were presented (and later accustomed to) new concepts and terms – like for instance “global crisis”, “systemic risk”, and “too big to fail institutions”. As we now know, the global financial system is so interconnected nowadays that collapse of one of the important institutions can take down the entire financial system.


The common-sense question is – how can this be possible?


In this article, I will reveal what I think is the root cause of this problem. There may be different causes that triggered the entire system to collapse in 2008, but I believe any of the possible explanations can be traced back to the root cause, which is: ‘money’, called ‘currencies’, are nothing but numbers in computers.


Before delving into the facts, let us review a couple basic principle about how an economy works.


Understanding the importance of material resources and labor in the economy


If we imagine economy as a big area for exchanges, we can observe that there are only two elements that bring value into the economy: (1) natural resources – these are all those materials that we have available from the earth; and (2) human labor – these are the billions of hours that people around the world spend working every single day.

To make this clear, let’s look at a couple of examples.

Let’s imagine a regular evening when, on the way home from your job, you stop by the store to get some groceries.


You are driving in a car. How did you get the car? It was first designed by a designer who put his idea and labor together with paper and crayons (material resources). The paper was produced in a paper mill, where workers put their labor to transform wood pulp, which is a material resource, into paper. They used machines designed by engineers (that’s labor) made of steel – a material resource that, in its turn, was produced in a steel mill where other workers put their labor to transform iron ore into steel. The crayons were made using wax and color pigments – material resources produced in chemical plants out of oil and other different natural materials. A chemical plant is normally very complex and in order to build and operate it, it takes human work hours and materials. The oil had to be extracted using sophisticated techniques and equipment– that also involved labor and raw materials.

Going back to the car designer, after he finished his idea, engineers started to work on the detailed design. They used computers made by other people using computer chips, steel frame and plastic covers. The engine, the frame, the seats, the steering wheel, the electrical wires, pipes, and hoses – all are the result of human labor combined with different materials.

The road you were driving on is also the result of materials and labor. Road planners made their plans, land surveyors did their measurements and workers laid out gravel, cement and asphalt.


The grocery store was also built of materials and labor. The groceries you are buying were produced by farmers who spent their time and labored in the fields. Some of the goods are packaged in cardboard made like paper, out of wood pulp, in factories where people labor. Other goods are packaged in plastic –made out of oil… natural resource, using labor in a chemical plant. The goods are on the shelves because some people spent their time arranging them; that’s labor. Someone is standing at the cash register to help you check out – that’s labor.


As we can continue to split hairs looking into every single activity we can think of, we will discover that every product or service used in the economy, regardless of its complexity, can be boiled down to only two type of elements that were used to produce it: natural resources and labor.The first conclusion we can draw is that every goods and service that has value in the economy derives its value from natural resources and labor.


Understanding the importance of human needs in the economy


Another observation is that there is only one reason why an economic system exists -and that is to satisfy human needs. Seen as an entire group, the billions of people who put their labor into the economy, are also the consumers of goods and services offered by the economy.

What happens in between, what we normally call “economy” or “marketplace”, the place where we find businesses and corporations, is nothing but an arena for exchange of goods and services, where businesses and corporations show up due to the division of labor.


No business is ever started with the purpose of selling goods or services to itself. Depending on their activity, a business may sell goods and services directly to individual consumers (B2C) or to other corporations (B2B). When the buyer is a corporation, it does not consume goods and services as an end user; a company purchases goods and services because these are needed in the process to provide its own products and services to its customers. In fact, if we take any business and follow the sales chain, we never stop with another business; we always find a human need at the end.


For instance, a company selling office supplies (paper, binders, staplers, scotch tape etc…) will sell these to other companies, but a company buying those office supplies does not need them for itself; it uses them to sell its own goods and services.

If the buyer of office supplies is a grocery store, it uses them to support its own activity which is selling groceries – satisfying people’s need for food. If the buyer of office supplies is a building company, it uses them to support their own activity, which is building – it may be homes (satisfying people’s need for shelter); it may be a clinic (satisfying people’s need for healthcare); it may be a cinema theater (satisfying people’s need for leisure and entertainment); or maybe a gym (satisfying people’s need for wellness). If the buyer of office supplies is an automotive repair shop, it uses them to support its own activity, which is to fix cars – satisfying people’s need for reliable transportation.


In all these examples, the consumers don’t care about the office supplies used by the businesses they interact with; when they interact with these businesses, they are focusing on their own need – the food, the house they are going to live in, the quality of the medical services at the clinic, the movie experience, the gym, or the trustworthiness of the mechanic.


The theories about human needs are pretty complex; so, in order to keep things simple, we will divide them into two layers.

The first layer consists of needs that are essential for physical existence and survival – for instance: shelter, food and drinks, hygiene, clothing, health, safety and stability, rest / sleep. For simplicity, we will call them “basic needs”. There are other needs, beyond the survival level, that all humans have, needs that are not necessary for the physical existence of the individual. We can call these ‘psychological & self-fulfillment needs’ and in this category we can include: connection (that means family, community, social groups), something that gives us a sense of belonging; autonomy – this is about freedom of choice and independence; significance – this is about the need to be important, to know that we mean something to people around us; recognition – to be acknowledged for the things we do; growth – to always expand our boundaries; contribution and purpose – to have the feeling that we are making other’s lives better.


In a normal functioning society, the basic needs are not difficult to meet. Working an average job will provide enough to live in a small apartment and buy basic groceries – and your physical well-being is ensured because you have basic shelter and food supply.


The other needs, the non-existential needs are reflected by the choices we make to meet the basic needs. That’s called life style.


While a small apartment may still provide shelter and protection, we buy a larger house because we want comfort and privacy. Hopefully, it is in the right neighborhood because this gives us recognition. The same applies to buying food, when we choose the exclusive grocery store instead of shopping at the Big Box discount store. Dining out is not about getting food, it is all about socializing. Then it becomes a question of where do we go out? A regular diner will do it, but a high-end restaurant gives both socializing and recognition. Grabbing a morning latte at Starbucks is not about coffee; it is about being seen with the right cup in your hand when you get to the office. The multi-billion haute-couture fashion industry is not about clothes, it is about belonging to an exclusive club.


In this article, I am not presenting and argument over right or wrong choices when it comes to our consumer habits. The point I am making is following: the real and the only driver of the economy is the aggregate volume of the needs, both existential and non-existential, of individual consumers.


The office supply company has its very important role, but it is the individual consumers and their needs that make this role possible. If the consumers do not buy a new house, if they don’t go to the cinema or the gym or if they don’t even have car, none of the companies that provide those services have a reason to exist. In other words, an office supply company will provide office supplies to a builder, a theater, a clinic, a gym or a car repair shop only when some people will buy goods and services from them.


All the so-called B2Bs, companies selling goods and services to other businesses, exist only because somewhere down the chain, there is a group of individuals willing to pay a price to have their needs met.


The second conclusion to be drawn from here is that only the individual needs of the people of a nation will make the economy move.


Understanding the importance of fair exchanges


Understanding the importance of material resources, human labor and human needs, where does money come into the picture? Without going into economic jargon and theories, we will just observe that money is used to facilitate the exchanges of goods and services. Every time we have a transaction, goods or services go from seller to buyer and money goes from buyer to seller.


Understanding that only human individual needs make the economy move, it is easy to conclude that an economy does not become strong because it has a large amount of money available for transactions, but because of a high volume of goods and services available to individual users.


Looking throughout history, the first forms of money were precious metals – because of rarity and desirability. Silver was used for everyday transactions and gold was used for high value transactions or wealth preservation. It all started with small pieces of metal that were not uniform in size and purity. Then, kings of the old days started to issue coins that had a determined weight and purity; being recognizable, precious metal coins were acceptable as payment and it made easier to trade.


Later, people who accumulated larger quantities of coins chose to deposit them into goldsmiths’ vaults, for safety reasons. The goldsmiths gave depositors personal certificates for the deposited gold and silver – basically a claim check, allowing the depositor to redeem his metal at any time. After a while, goldsmiths noticed that people don’t really come to get back their gold unless they do large purchases; in most cases, the gold never left the vault, it was just a matter of recording a change in ownership and reissuing new claim checks. Also, people did not necessarily want exactly the same pieces they deposited. Other coins were acceptable as long as they had the same weight and purity.


That lead goldsmiths to issue generic certificates for the deposited metals. These became banknotes and the goldsmiths became bankers. Using banknotes stimulated the trade further, because people could just pass the banknotes from one to another well knowing that they could take the notes anytime back to the bank to redeem the gold. At that stage, money was nothing but certificates for gold and silver deposited in the banks’ vaults.

This lasted for a while. In 1971, the connection between money and gold and silver was completely removed.


The question is… why would we care about the nature of money, when we actually are more interested in what can be done with money?


When we get a paycheck, we get a number printed on a piece of paper. That number is transferred to a bank account; then, we go happy to buy our groceries, pay our mortgage, pay our car note, go out to dinner, and so on. When we pay, we just move some numbers from one bank computer into another bank computer. We started with giving our time and labor to our employer, and ended up receiving the goods and services we wanted. As long as we do not touch the money anyway, what difference does it make if the money used in these transactions is linked to a precious metal or not?


As I will demonstrate here, it makes a huge difference.


In order for the economy to function on a basis of fair exchanges, every transaction must represent an exchange of values that have the same nature on both sides.


We already understand that economic value is represented by two elements – material resources and labor. That is why, when somebody sells a good or a service that consist of accumulated material resources and labor, it is a fair exchange only if that seller, be it individual or business receives a compensation of the same nature – meaning material resources and labor.


When money is linked to some form of material commodity, it is a fair exchange because both seller and buyer receive things of the same nature. When money loses these components, it becomes a currency and has no backing, except for authorities’ decree that make currencies legal tenders. Even when we carry banknotes in our wallets, there is no real value because the paper patch and the drop of ink used to print it has a real value much lower than the number printed on the banknote. The modern money, currencies, are just an image of perceived value.The value is not real, it is imaginary, and the banknote or the screen of the ATM or bank’s computer is just an image of that perception.


When the material component and labor are removed and money becomes nothing else but numbers in computers, all transactions become unfair because all sellers are giving away goods and services (material resources and accumulated labor) and receive in exchange just numbers in computers with no real value. If this is the case, why does the economy continue to move anyway? This is because the same sellers who sold valuable goods and services in exchange for numbers in computers with no real value, are also buyers; they are confident that at any given moment they can give away those numbers in computers in exchange for real goods and services (containing both material resources and accumulated labor).


This game can go on for a long time, as long as there is nothing that disturbs these exchanges. Both corporations and individuals have no problem accepting valueless numbers in computers as long as they are confident that someone else will accept the same valueless numbers for the goods and services they will buy in the future.


But this also shows the vulnerability of a financial system based on currencies – it is based on one single factor: confidence. If, for some reason that confidence evaporates, the whole game collapses. And this is what happened many times in history, especially during the financial crisis of 2008. Loss of confidence is contagious and when a critical mass of market participants lose confidence, the event accelerates in a cascade-like manner.


Math Rules…


Once we understood that monies are nowadays nothing but numbers in computers, let us go back to the math classes in school and look at some facts. (By the way, if you hated math in school, do not worry, we will keep things at a very basic level).


Math Fact #1. Numbers can be combined in unlimited manners in mathematical formulas.


Let’s take two numbers for instance, 5 and 6 and a few basic operations. We can add them, 5+6 equals 11. We can subtract 5 from 6 and get 1. We can subtract 6 from 5 and get negative 1. We can multiply them, 5*6 = 30. We can divide 6 into 5 and get 1.2. We can divide 5 into 6 and get 0.833. We can take 5 to the 6th power and get 15,625. We can take 6 to the 5th power and get 7,776.


We can even build more sophisticated formulas, where we combine two operations with the same two numbers. We can multiply 5 and 6 and then add the result of division of 6 to 5. Or we can divide 5 into 6 and take it to the 5th power. Many other examples can be given and, so far, we have seen only a few examples using just basic math operations. Can you imagine the countless possibilities of combining numbers into more and more sophisticated formulas, like going into advanced algebra or calculus?


The obvious conclusion is that, whenever numbers are available, there are unlimited ways of combining them into mathematical formulas.


Math Fact #2 – when labels are attached to input numbers of a formula, those labels are transferred to the number resulting from computation.


In order to illustrate this fact, let’s take the same two numbers, for inst. 5 and 6, and use multiplication as mathematical formula.


“6 * 5 = 30” is a simple, abstract mathematical formula: 6 times 5 equals 30.


Now let us attach labels and see what happens.


If the number 6 represents, for instance, “beverage bottles” in a pack and we have 5 packs, the number 30 represents beverage bottles, because the label “beverage bottles” was attached to the input number. If the number “6” represents apples in a basket and there are 5 baskets, the result “30” represents apples, because the label “apples” was attached to the input number. If there are 6 books on a shelf and there are 5 shelves, the 30 are “books” because the 6 elements on each shelf are “books”.


So, Math fact#2 tells us that whatever label we attach to the input numbers, the same label is carried through the formula and will be attached to the number resulting from calculation.


Math Fact #3 – for a math formula to have applicability in real (tangible) life, the labels attached to the numbers have to be real (tangible).


This means that the examples we listed above are valid in real life only if those objects we used in formulas are real. In other words, we will have 30 bottles if we have 5 packs and there are 6 bottles in each pack. We will have 30 apples if we have 5 baskets and there are 6 apples in each basket. And we will have 30 books only if we have 5 shelves with 6 real books on each of them. If the 6 units (bottles, apples, or books) are not real but imaginary, the 30 units will not be real either!


In other words, if the input labels attached to a number in a formula represents real objects, the results of computation are also real objects. Unfortunately, the dire reverse is also true – if input labels are imaginary, the outcome is also imaginary.


Applying the three Math Facts to money and currencies


Now you are probably asking yourself… what does all this have to do with money and how does this translate into the world of finances? Well, this is what we need to understand… Whenever currency labels (USD, EUR, GBP, CHF etc.) are attached to input numbers in mathematical formulas, whatever number comes out as result of that formula automatically becomes . . . currency!


Looking back at history, the first formula applied to money was the so-called “Fractional Reserve Banking”. This was a method developed by the goldsmiths turned into bankers. As they printed generic certificates for gold deposited in their vaults, they found out that people would not come back to redeem gold coins; people would just pass the bills from one to another while carrying out daily transactions.


So they, the bankers, had an idea: “Why don’t we print more certificates than we have gold? We will just take a chance that we will never face a situation when everybody will bring their certificates to redeem the gold. Then we can lend out these newly printed banknotes and charge interest and people will have no idea that some of the banknotes have no gold backing.” And so they did… and the result is the “Fractional Reserve Mechanism”. Also called “Money Multiplier”, this method allows the bank to lend out in form of credit much larger amounts than it has in deposits.


This is basically a formula that allows for the money you have deposited in the bank to be replaced by a promise that the bank will give you the money whenever you ask for it. And of course, the banker’s hope is that they will never face a situation when all depositors will come at the same time to withdraw their money.


Over time, as technology advanced, things got more sophisticated; when we keep money in our bank accounts and that money is just numbers in the bank’s computers, the banks can take those numbers and combine it with other numbers in someone else’s accounts using a mathematical formula. My savings and your savings go together with the savings of other thousands of people into sophisticated mathematical formulas that carry fancy names - like “financial product”, “commercial paper”, “security”, “investment vehicle”, “financial instrument”, “collateralize debt obligations” or “derivative”. In their essence, all these fancy names used by the financial industry are nothing more but sophisticated mathematical formulas. And because the numbers used as inputs represent currency units, like dollars, euro, yen, pounds, the number resulting from computation carries the same label, exactly like we have seen with bottles, apples or books.


Depending on the formula used for any particular financial product, the result of the computation becomes the value of that particular financial product, expressed in the same monetary terms as the input number. Now, the financial institution that used the mathematical formula can claim that it created a “financial product” and record it as an “asset” in its balance sheet. It is just a number with a currency label attached to it, with no real value behind it; still, in a financial world of currencies, this became an “asset”.


But it doesn’t stop here. Further, these “new assets” with monetary labels attached to them can be combined into other sophisticated formulas, creating layers upon layers of financial products - a game that keeps going because there is never a lack of mathematical formulas.


So, if we wonder why the financial industry has become so over sized compared to the overall economy and why the “value” of derivative financial products exceeds many times the value of the global GDP, here we may find an answer – because there is no limit to numbers and mathematical formulas!


A not so happy ending


Unfortunately, the strength of this system is also its main vulnerability. The first fundamental problem is that these financial assets do not contain material resources and labor that support their value expressed in monetary terms. While it is true that the financial instruments are created in office buildings, where people labor in front of their computers, these assets are valued at hundreds of trillions of dollars – a value that does not reflect the correct amount of material resources and labor put into them. In other words, the value given to these products is many times larger than the value of the material resources and labor employed.


The second fundamental problem is that those financial products do not satisfy a specific basic need for individuals. And as we established, it is only the needs of the individuals that are the driving force of an economy. It is true that individuals need savings as protection for difficult times and also to leave a legacy to their heirs. It is also true that individuals expect a decent return on their savings and, if they are willing to take some risks, to expect a decent return on their investments. But there is hardly any need for more than that. The financial industry is supposed to grow up to the limits of meeting these needs and not more.


So, currently, these are the two fundamental problems of the financial industry: (1) the value of the assets is too large compared to the material resources and labor employed and (2) those sophisticated financial instruments do not really satisfy any human need.


The moment of truth comes when some sort of event (called a “black swan”) forces these financial products to confront the real world. Since they do not meet a real market need, their true value will be revealed – they are simply immaterial numbers in computers. Whatever once were “great assets” have now become “toxic assets” – which is in fact another fancy name to disguise huge liabilities. As nobody needs these products, there are no buyers and they get destroyed even faster than they were created, always returning to their true value – zero.


Summa summarum? As long as we continue to implement monetary systems based on imaginary values, we will not have fair economic exchange systems; whoever has the power (given by law, by force, or both) to generate those imaginary values, will always have an advantage.


And that “whoever” is not you and me…

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