The total value of the world’s derivatives is estimated at $791T. That’s not only almost 100 times the currencies, it is also about 14 times the global GDP. Derivative instruments are by far the world’s largest pool of instruments of value. Few people understand them, they are not regulated in any meaningful way, and it is impossible to know what they are truly worth, not only because their value is contingent on future conditions but also because factors such as the risks associated with the counterparties of each instrument are utterly opaque.

Other than derivatives, the total value of securities in the world today includes approximately $82.2T in worldwide debt securities and $36.6T in equity value (the total value of all the world’s stock markets combined). Not only does the total value of these securities dwarf all the currencies of the world, but al these securities have something in common. They were conceived, issued, and valued by the market, and they will be settled, or undone, by the market. The lifeblood of the world’s markets, the repositories of all the world’s value, are financial instruments — often complex, certainly stateless, constantly swirling above and beyond the reach and comprehension of virtually any government officials, all created, controlled, and influenced by a comparatively small group of private actors.


Money is money after all. But we don’t see it that way. Depending on how we get it, we treat it differently. Money is not naked; it is wrapped in an emotional shroud.


If we strive for money, it is because it offers us the widest choice in enjoying the fruits of our efforts. Because in modern society it is through the limitation of our money incomes that we are made to feel the restrictions which our relative poverty still imposes upon us, many have come to hate money as the symbol of these restrictions. But this is to mistake for the cause the medium through which a force makes itself felt. It would be much truer to say that money is one of the greatest instruments of freedom ever invented by man. It is money which in existing society opens an astonishing range of choice to the poor man — a range greater than that which not many generations ago was open to the wealthy. We shall better understand the significance of this service of money if we consider what it would really mean if, as so many socialists characteristically propose, the “pecuniary motive” were largely displaced by “noneconomic incentives.” If all rewards, instead of being offered in money, were offered in the form of public distinctions or privileges, positions of power over other men, or better housing or better food, opportunities for travel or education, this would merely mean that the recipient would no longer be allowed to choose and whoever fixed the reward determined not only its size but also the particular form in which it should be enjoyed.


Powerful people judge everything by what it costs, not just in money, but in time, dignity, and peace of mind.


The story shows, first, an essential aspect of money: That it is humans who have created it and humans who instill it with meaning and value. Second, with objects as with money, what the courtier most values are the sentiments and emotions embedded in them — these are what make them worth having.


Suốt 5000 năm lịch sử, vàng không bao giờ mất giá.


Tỷ giá cưỡng chế được thiết lập. Một khi các tờ bạc đã có dấu chứng nhận chính thức, dân chúng được lệnh tới kho bạc nhà nước đổi tiền bằng kim loại lấy tiền giấy theo tỉ lệ 1 quan tiền kim loại lấy 1 quan hai tiền giấy. Việc đổi tiền có tính bắt buộc vì có lệnh cấm sử dụng và cất giữ tiền bằng kim loại. Kẻ vi phạm sẽ phải chịu cùng hình phạt dành cho kẻ làm tiền giả, nghĩa là tử hình và tịch thu tài sản sung quỹ nhà nước. Hành động này nhằm hai mục đích: tạo phương tiện chi trả và gom kim loại để đúc súng.


Once you have enough for beans and rice and taking care of your family and a few other things, money is a story. You can tell yourself any story you want about money, and it’s better to tell yourself a story about money that you can happily live with.


The entire economic system is based on trust. It’s not based on a particular investment model, price-earnings ratio, income statement, or balance sheet. It’s not based on any of these rational concepts. It’s based on whether people believe in the numbers and in the people who are supplying them. If people don’t trust those who handle their money, their livelihoods, and their lives, they’ll just refuse to participate.


The highest form of wealth is the ability to wake up every morning and say, “I can do whatever I want today.”

People want to become wealthier to make them happier. Happiness is a complicated subject because everyone’s different. But if there’s a common denominator in happiness — a universal fuel of joy — it’s that people want to control their lives.

The ability to do what you want, when you want, with who you want, for as long as you want, is priceless. It is the highest dividend money pays.


The prevalence of the gold standard meant that there was, in effect, a single world money called by different names in different countries.


For instance, a cash-back rebate invokes a very different psychology from simply saving the money in the first place. Studies show that they tend to spend it like a lottery winning — an unexpected windfall, even though it’s really just a loan against future payments. Guys buy golf clubs their wives would never normally let them purchase, and their wives don’t stand in their way, despite the fact that they know they’ll be paying that money back over the years to come, just like a credit card debt.


Even after most cultures established monetary economies, day-to-day transactions within close-knit social groups, from families to tribes, was still mostly without price. The currencies of generosity, trust, goodwill, reputation, and equitable exchange still dominate the goods and services of the family, the neighborhood, and even within the workplace. In general, no cash is required among friends.


Just as in Darwin’s description of nature, competition was at the heart of this emerging science of commerce. Money was how we kept score. Charging for things was simply the most efficient way to ensure that they would continue to be produced — the profit motive is as strong in economics as the “selfish gene” is in nature.


The value of anything was best determined by the price people would pay for it — it was as simple as that. Utopian dreams of alternative systems based on gifts, barter, or social obligation were reserved for fringe experiments. In the world of commerce, “free” took on its primary modern meaning: a marketing tool.


People often don’t care as much about things they don’t pay for, and as a result they don’t think as much about how they consume them. Free can encourage gluttony, hoarding, thoughtless consumption, waste, guilt, and greed. We take stuff because it’s there, not necessarily because we want it. Charging a price, even a very low price, can encourage much more responsible behavior.


Finance epitomizes indefinite thinking because it’s the only way to make money when you have no idea how to create wealth. If they don’t go to law school, bright college graduates head to Wall Street precisely because they have no real plan for their careers. And once they arrive at Goldman, they find that even inside finance, everything is indefinite. It’s still optimistic — you wouldn’t play in the markets if you expected to lose — but the fundamental tenet is that the market is random; you can’t know anything specific or substantive; diversification becomes supremely important.


At no point does anyone in the chain know what to do with the money in the real economy. But in an indefinite world, people actually prefer unlimited optionality; money is more valuable than anything you could possibly do with it. Only a definite future is money a means to an end, not the end itself.


Money make money. Compound interest is the eighth wonder of the world. Never underestimate exponential growth.


Cash is attractive. It offers pure optionality: once you get your paycheck, you can do anything you want with it. However, high cash compensation teaches workers to claim value from the company as it already exists instead of investing their time to create new value in the future. Even so-called incentive pay encourages short-term thinking and value grabbing. Any kind of cash is more about the present than the future.


Why work with a group of people who don’t even like each other? Many seem to think it’s a sacrifice necessary for making money. But taking a merely professional view of the workplace, in which free agents check in and out on a transactional basis, is worse than cold: it’s not even rational. Since time is your most valuable asset, it’s odd to spend it working with people who don’t envision any long-term future together. If you can’t count durable relationships among the fruits of your time at work, you haven’t invested your time well — even in purely financial terms.


At that time, following the Bretton Woods agreement, which aimed to ensure global financial stability by making the dollar the backbone of the global economy, the greenback was the unit of international trade, widely available, and backed by gold. But there was not enough gold being mined to keep up with the number of dollars in circulation. The Bretton Woods agreement collapsed and the dollar’s position and reputation were in jeopardy.

To help re-establish the dollar’s global credibility, the USA made a deal with Saudi Arabia in 1973 to price and trade all petroleum products in dollars. So the dollar held on to its leading role in commerce, and its value was supported by the insatiable thirst for hydrocarbons. In return, the Saudis got America’s influence and backing to maintain security, particularly in holding Iran and Iraq at bay — a valuable development for them in such a volatile region.


By far the simplest method of avoiding income taxes — at least for someone who has a large amount of capital at his disposal — is to invest in the bonds of states, municipalities, port authorities, and toll roads; the interest paid on all such bonds is unequivocally tax-exempt. Since the interest on high-grade tax-exempt bonds in recent years has run from 3-5%, a man who invested $10M in them can collect $300K-$500K a year tax-free without putting himself or his tax lawyer to the slightest trouble; if he had been foolish enough to sink the money in ordinary investments yielding, say, 5%, he would have a taxable income of $500K, and if he did not avail himself of any dodges, he would have to pay taxes of almost $367K.


A collector who donates a work of art to a museum may deduct on his income-tax return the fair value of the work at the time of the donation, and need to pay no capital-gains tax on any increase in its value since the time he bought it. If the increase in value has been great and the collector’s tax bracket is very high, he may actually come out ahead on the deal.


Moreover, until quite recently, the propriety of the use of inside dope for their own enrichment by those fortunate enough to possess it went largely unquestioned. Nathan Rothschild’s judicious use of advance news of Wellington’s victory at Waterloo was the chief basis of the Rothschild fortune in England, and no Royal commission or enraged public rose to protest.

In the post-Civil War era in the US the members of the investing public, such as it was, still docilely accepted the right of the insider to trade on his privileged knowledge, and were content to pick up any crumbs that he might drop along the way.


In Washington, it had been development of natural resources, atomic energy, or the like — world-shaking things. Now it turns out to be some little business to make money. It all seems a bit petty.

Then there’s the matter of money itself. In the government, our hypothetical man didn’t need it so badly. He had all these services and the basic comforts supplied him at no personal cost, and besides he had a great sense of moral superiority. He was able to sneer at people who were out making money. He could think of somebody in his law-school class who was making a pile in the Street, and say, “He’s sold out.” Then our man leaves government and goes to the Wall Street fleshpots himself, and he says, “Boy, am I going to make these guys pay for my services!” They do pay, too. He get big fees for consulting. Then he finds out about big income taxes, how he has to pay most of his income to the government now instead of getting his livelihood from it. The shoe is on the other foot. He may begin to scream “Confiscation!” just like any old Wall Streeter.


In a larger sense, it was an expression of an age-old tendency to distrust all paper currencies in times of crisis, but more specifically it was the long-feared sequel to sterling devaluation, and — perhaps most specifically of all — it was a vote of no confidence in the determination of the US to keep its economic affairs in order, with particular reference to a level of civilian consumption beyond the dreams of avarice at a time when ever-increasing billions were being sent abroad to support a war with no end in sight. The money in which the world was supposed to be putting its trust looked to the gold speculators like that of the most reckless and improvident spendthrift.


The success of the plan in achieving its end — averting dollar devaluation, overcoming the world shortage of monetary gold, and thus postponing indefinitely the threatened mess — will depend on whether or not men and nations can somehow at last, in a triumph of reason, achieve what they have failed to achieve in almost 4 centuries of paper money: that is, to overcome one of the oldest and least rational of human traits, the lust for the look and feel of gold itself, and come to give truly equal value to a pledge written on a piece of paper. The answer to that question will come in the last act, and the outcome for a happy ending is not bright.


The line separating investment and speculation is never bright and clear.


In the NDCs, banks only became professional lending institutions after the early 20th century. Before then, personal connections strongly influenced bank lending decisions. For example, throughout the 19th century, US banks lent the bulk of their money to their directors, their relatives, and those they knew. Scottish banks in the 18th century and English banks in the 19th century were basically self-help associations for merchants wanting credit rather than banks in the modern sense.


Bank-issued credit makes up the largest proportion of credit in existence. The traditional view of banks as intermediaries between savers and borrowers is incorrect. Modern banking is about credit creation. Credit is made up of 2 parts, the credit (money) and its corresponding debt, which requires repayment with interest. The majority (97% as of December 2013) of the money in the UK economy is created as credit.

When a bank creates credit, it effectively owes money to itself. If a bank issues too much bad credit, the bank will become insolvent; having more liabilities than assets. That the bank never had the money to lend in the first place is immaterial — the banking license affords bank to create credit — what matters is that a bank’s total assets are greater than its total liabilities and that it is holding sufficient liquid assets — such as cash — to meet its obligations to its debtors. If it fails to do this it risks bankruptcy or banking license withdrawal.


You must know the difference between an asset and a liability, and buy assets.

If you want to be rich, this is all you need to know. It is rule number one. It is the only rule.


A corporation can do many things that an employee cannot, like pay expenses before paying taxes. Employees earn and get taxed, and they try to live on what is left. A corporation earns, spends everything it can, and is taxed on anything that is left. It’s one of the biggest legal tax loopholes that the rich use.


It is not the nature of the activity itself that matters but the possibility of making profit out of it. Indeed, it is typical of a capitalist society that virtually all economic activities that go on within it are driven by the opportunity to make profit out of capital invested in them.

Capital is money that is invested in order to earn more money. By extension the term capital is often used to refer money that is available for investment or, indeed, any asset that can be readily turned into money for it. A characteristic feature of the development of capitalist societies is the emergence of institutions that enable the conversion of assets of all kinds into capital. Hernando de Soto has argued persuasively that it is the absence of these institutions, above all functioning systems of property law, that frustrates the emergence of local capitalisms in the Third World. He claims that an enormous amount of value that is locked up in property cannot therefore be realized and put by entrepreneurs to productive use.


This money thing is driving me crazy. Just the waiting for the lock-up period to end. It’s like having lots of money but not having lots of money. It’s on my mind constantly.


When the money rolls in, people get convinced.


Do you know when you’re making too much money? When you need someone else to manage it for you.


Still, as recently as the late 1980s, McKinsey’s fee arrangement with clients remained shockingly informal. The firm did not deign to explain to clients like Federated Department Stores how it arrived at a fee of $200,000 a month plus expenses — it was a take-it-or-leave-it proposition. In an interview with Fortune, Amsterdam office manager Mickey Huibregtsen said that the high fees were in the best interests of the company’s clients as well as McKinsey, because “they protect us from not being taken seriously by the client and that protects the client from having the wrong studies done. It also protects the quality of the work. When you charge that much, the quality has to be there.”


The more I studied and wrote about the financial crisis, the more I realized that you could understand it better through the lenses of psychology and history, not finance.

To grasp why people bury themselves in debt you don’t need to study interest rates; you need to study the history of greed, insecurity, and optimism.


“Our findings suggest that individual investors’ willingness to bear risk depends on personal history.”

Not intelligence, or education, or sophistication. 


Few people make financial decisions purely with a spreadsheet. They make them at the dinner table, or in a company meeting. Places where personal history, your own unique view of the world, ego, pride, marketing, and odd incentives are scrambled together into a narrative that works for you.


$81B of Warren Buffett’s $84B net worth came after his 65th birthday. Our minds are not built to handle such absurdities.


Controlling your time is the highest dividend money pays.


More than your salary. More than the size of your house. More than the prestige of your job. Control over doing what you want, when you want to, with the people you want to, is the broadest lifestyle variable that makes people happy.


Part of what’s happened here is that we’ve used our greater wealth to buy bigger and better stuff. But we’ve simultaneously given up more control over our time. At best, those things cancel each other out.


No one is impressed with your possessions as much as you are.


You might think you want an expensive car, a fancy watch, and a huge house. But I’m telling you, you don’t. What you want is respect and admiration from other people, and you think having expensive stuff will bring it. It almost never does — especially from the people you want to respect and admire you.


Savings in the banks that earn 0% interest might actually generate an extraordinary return if they give you the flexibility to take a job with a lower salary but more purpose, or wait for investment opportunities that come when those without flexibility turn desperate.


My own theory is that, in the real world, people do not want the mathematically optimal strategy. They want the strategy that maximizes for how well they sleep at night.


I have pledged — to you, the rating agencies and myself — to always run Berkshire with more than ample cash. When forced to choose, I will not trade even a night’s sleep for the chance of extra profit.


It is easy to underestimate what a 30% decline does to your psyche. Your confidence may become shot at the very moment opportunity is at its highest. You — or your spouse — may decide it’s time for a new plan, or new career. I know several investors who quit after losses because they were exhausted. Physically exhausted.


You have to survive to succeed. To repeat a point we’ve made a few times in this book: The ability to do what you want, when you want, for as long as you want, has an infinite ROI.


But do you know how hard it is to maintain a long-term outlook when stocks are collapsing?

Like everything else worthwhile, successful investing demands a price. But its currency is not dollars and cents. It’s volatility, fear, doubt, uncertainty, and regret — all of which are easy to overlook until you’re dealing with them in real time.

The inability to recognize that investing has a price can tempt us to try to get something for nothing. Which, like shoplifting, rarely ends well.


An idea exists in finance that seems innocent but has done incalculable damage.

It’s the notion that assets have one rational price in a world where investors have different goals and time horizons.

When investors have different goals and time horizons — and they do in every asset class — prices that look ridiculous to one person can make sense to another, because the factors those investors pay attention to are different.


Bubbles form when the momentum of short-term returns attracts enough money that the makeup of investors shifts from mostly long term to mostly short term.

Bubbles aren’t so much about valuation rising. That’s just a symptom of something else: time horizons shrinking as more short-term traders enter the playing field.


Rising prices persuade all investors in ways the best marketers envy. They are a drug that can turn value-conscious investors into dewy-eyed optimists, detached from their own reality by the actions of someone playing a different game than they are.


But while we can see how much money other people spend on cars, homes, clothes, and vacations, we don’t get to see their goals, worries, and aspirations. A young lawyer aiming to be a partner at a prestigious law firm might need to maintain an appearance that I, a writer who can work in sweatpants, have no need for. But when his purchases set my own expectations, I’m wandering down a path of potential disappointment because I’m spending the money without the career boost he’s getting. We might not even have different styles. We’re just playing a different game. It took me years to figure this out.


But the foundation of, “does this help me sleep at night?” is the best universal guidepost for all financial decisions.

If you want to do better as an investor, the single most powerful thing you can do is increase your time horizon. Time is the most powerful force in investing. It makes little things grow big and big mistakes fade away. It can’t neutralize luck and risk, but it pushes results closer towards what people deserve.


Individuals and companies just about anywhere in the world have the opportunity to undertake what might be described as “tax planning” within the law of the territory in which they live or operate. For the vast majority of the world’s population, the concept of “tax planning” is largely meaningless: tax is normally deducted at source from earnings, and that is more or less that with regard to the settlement of tax liabilities.


Among the most significant tax havens of the world, Switzerland, Luxembourg, and Singapore claim that they are not low-tax jurisdictions. Strictly speaking, they are correct: they are certainly not low-tax jurisdictions for their own citizens. Yet through a complex set of loopholes and formal and informal rules they can serve as low-tax jurisdictions to nonresidents. In addition, all 3 offer very strict secrecy provisions and relatively easy and cheap mechanisms to set up nonresident companies.


In 1957 the BoE created, perhaps unwittingly, the regulatory concept of offshore when it accepted that transactions that took place in London but were undertaken between 2 parties resident outside the UK were not subjects to UK financial regulation. They were deemed to take place “elsewhere” and not London, even though it was obvious to all involved that this was a fiction.

Albeit modified and reduced in scope in April 2008, the UK domicile rule states that any person who immigrates to the UK but declares their wish to return to their country of origin at some point in the future, is not liable to pay local tax on their worldwide earnings. Note that the person need not actually return to their country but only declare that this is their intention. This law is exploited by a horde of Russian oligarchs, Arab sheiks, US corporate raiders, and European magnates, who flock to London, declaring their intention to return home one day, and use the UK as a tax haven.


82 of the 275 top US corporations paid no taxes between 2001 and 2003, although they declared $102B in pre-tax profits. 46 companies with a combined profit of $42.6B paid no federal income taxes in 2003 alone. Instead, they received rebates totaling $5.4B.


All the evidence suggests that the main vehicle of tax avoidance/evasion and capital flight through tax havens is the mundane practice of transfer pricing. Transfer pricing is the price companies charge for intra-group, cross-border sales of goods and services. About 70% of all capital flight is conducted by means of transfer pricing. Multinationals placed transfer pricing at the heart of their tax strategy.

Transfer pricing is a legitimate practice so long as it is undertaken under what is called an “arm’s length principle” — that is, companies charge for their goods and services at prices equivalent to those that unrelated entities would charge in an open market.

In practice prices based on the arm’s length principle are often difficult to establish within highly complex international production networks, where companies use trademarks, patents, brands, logos, and a variety of company-specific intangible assets. The technique, therefore, is open to abuse.


Relocation to tax haven may be a drastic move for an individual to undertake, but companies can relocate by the simple expedient of creating new subsidiaries in tax havens. Their presence is easily disguised, first by the secrecy to which we have referred elsewhere, and second because corporations are allowed to present one set of accounts. These accounts are, however, prepared on a consolidated basis. “Consolidated” means that all transactions between different parts of the corporation are eliminated from the accounts. There may be hundreds or even thousands of such constituent companies, which can be hidden from the public eye because of this accounting convention.

The convention has some other benefits. The accounts presented to a stock exchange and to shareholders might make it look as if there is a single multinational entity but in reality, when it comes to taxation, there is no such thing as an MNE. Companies can legally maintain economic ties between their subsidiaries, but every single subsidiary is deemed a separate entity when it comes to taxation. Consequently, multinational corporation is an economic but not a legal concept. A parent company usually owns all or most of the other entities in a group, and controls them all because ownership of a company’s shares provides that right under company law. However, the companies remain legally distinct and entirely separate for tax purposes.


Foundations are another method to conceal assets. Foundations are a form of trust that is recognized as having separate legal existence akin to a limited company. The foundation’s success arises from its combination of secrecy with a legal existence separating it from the lawyer who manages it and from the settlor and its non-taxable status.

Foundations have no owners or shareholders. They are set up to manage assets whose income must serve a specific goal. Many tax havens demand only minimal disclosure from foundations. In one extreme case, Panama, no approval is needed to create a foundation.


Swiss law demands “absolute silence in respect to a professional secret,” that is, absolute silence in respect to any accounts held in Swiss banks — “absolute” here means protection from any government, including the Swiss. The law labels inquiry or research into the “trade secrets” of banks and other organizations a criminal offence. Not surprisingly, ver few academics and journalists have been prepared to risk jail for their research. The law ensured that once past the borders, capital entered an inviolable legal sanctuary guaranteed by the criminal code and back by the might of the Swiss state.


In 2001, Lee Hsien Loong, then DPM, finance minister, and chairman of the MAS all rolled into one, met with international bankers to discuss how Singapore could tailor its laws to gain primacy. Following these consultations, he introduced amendments to the Banking Act to revise the secrecy provisions, including stringent laws that are far more robust than Switzerland’s. The penalty for breaking Singapore’s bank secrecy laws were raised: a fine of up to $125K or 3 years in jail, or both. Swiss banks are now moving much of their client business to Singapore to exploit this fact given that banking secrecy in Switzerland has now proved to be permeable.

There are 2 other reasons why Singapore is considered a tax haven. First, as an English common law country, Singapore still permits nonresidents to form limited companies but manage them from elsewhere. Neither the UK nor Ireland do so, and Singapore has emerged as the leader in this field. Despite a notional tax rate of 22% on income originating in Singapore, foreign corporate income is not taxed at all. Second, due to a complex arrangement of subsidies and deferred payments, Singapore is considered a low-tax country. Sullivan puts effective tax rates of US subsidiaries in Singapore at 11%, which is at the high end of taxation among intermediate tax havens.


Not all the capital that flees developing countries stays out. Some of it comes back disguised as FDI. This process is called “round tripping.” Preferential treatment accorded to many foreign investors provides an incentive to engage in this process. In the case of China, foreign investors typically enjoy lower tax rates, favorable land use rights, convenient administrative supports, and even favorable financial services. They also enjoy superior protection of their property rights.


There are several conflicting ways to describe what banks do. The simplest version is that banks take in money from savers and lend this money out to borrowers. However, this is not actually how the process works. Banks do not need to wait for a customer to deposit money before they can make a new loan to someone else. In fact, it is exactly the opposite: the making of a loan creates a new deposit in the borrower’s account.

More sophisticated versions bring in the concept of “fractional reserve banking.” This description recognizes that the banking system can lend out amounts that are many times greater than the cash and reserves held at the BoE. This is a more accurate picture, but it is still incomplete and misleading, since each bank is still considered a mere “financial intermediary” passing on deposits as loans. It also implies a strong link between the amount of money that banks create and the amount held at the central bank. In this version it is also commonly assumed that the central bank has significant control over the amount of reserves that banks hold with it.

In fact, the ability of banks to create new money is only very weakly linked to the amount of reserves they hold at the central bank. At the time of the financial crisis, for example, banks held just $1.25 in reserves for every $100 issued as credit. Banks operate within an electronic clearing system that nets out multilateral payments at the end of each day, requiring them to hold only a tiny proportion of central bank money to meet their payment requirements.

Furthermore, we argue that rather than the central bank controlling the amount of credit that commercial banks can issue, it is the commercial banks that determine the quantity of central bank reserves that the BoE must lend to them to be sure of keeping the system functioning.


  1. Although possibly useful in other ways, capital adequacy requirements have not and do not constrain money creation and therefore do not necessarily serve to restrict the expansion of banks’ balance sheets in aggregate. In other words, they are mainly ineffective in preventing credit booms and their associated asset price bubbles.
  2. In a world of imperfect information, credit is rationed by banks and the primary determinant of how much they lend is not interest rates, but confidence that the loan will be repaid and confidence in the liquidity and solvency of other banks and the system as a whole.
  3. Banks decide where to allocate credit in the economy. The incentives that they face often lead them to favor lending against collateral, or existing assets, rather than lending to investment in production. As a result, new money is often more likely to be channelled into property and financial speculation than to small businesses and manufacturing, with associated profound economic consequences for society.
  4. Fiscal policy does not in itself result in an expansion of the money supply. Indeed, in practice the Government has no direct involvement in the money creation and allocation process. This is little known but has an important impact on the effectiveness of fiscal policy and the role of the Government in the economy.

We do not own the money we have put in the bank. The custodial role that one third of the public assume banks play is something of an illusion. 77% of people believed that the money they deposited in banks legally belonged to them. In fact, the money that they deposited legally belongs to the bank. Instead, the bank takes legal ownership of the cash deposited and records that they owe the customer the money. In the bank’s accounting, this is recorded as a liability of the bank to the customer. It is a liability because at some point in the future, it may have to be repaid.

The balance of your bank account, and indeed the bank account of all members of the public and all businesses, is the bank’s IOU, and shows that they have a legal obligation (i.e. liability) to pay the money at some point in the future. Whether they will actually have that money at the time you need it is a different issue.


In fact, not all deposits with the banks were actually deposited by the public. When banks do what is commonly, and somewhat incorrectly, called “lend money” or “extend loans,” they simply credit the borrower’s deposit account, thus creating the illusion that the borrower have made deposits. This focus on bank deposit, including deposits with the central bank, distract from the money creation process. We can learn more about credit creation — when banks lend or make payments — from other parts of their balance sheet.


The textbook model of banking implies that banks need depositors to start the money creation process. The reality, however, is that when a bank makes a loan it does not require anyone else’s money to do so. Banks do not wait for deposits in order to make loans. Bank deposits are created by banks purely on the basis of their own confidence in the capacity of the borrower to repay the loan.


One reason that banks’s confidence may be volatile is the fact that, despite their ability to create money, they can nevertheless go bust. Banks can create deposits for their customers, but they cannot create capital directly for themselves. Banks must ensure at all times that the value of their assets are greater than or at least match their liabilities. If the value of their assets falls, and they do not have enough of their own capital to absorb the losses, they will become insolvent. Once a bank is insolvent, it is illegal for them to continue trading. Equally, while banks can create deposits for their customers, they cannot create central bank reserves. Therefore, they can still suffer a liquidity crisis if they run out of central bank reserves and other banks are unwilling to lend to them.


When banks create credit, and hence expand the money supply, whether the money is used for GDP or non-GDP transactions is crucial for determining the impact on the economy. Unproductive credit creation (for non-GDP transactions) will result in asset price inflation, bursting bubbles and banking crises as well as resource misallocation and dislocation. In contrast credit used for the production of new goods and services, or to enhance productivity, is productive credit creation that will deliver non-inflationary growth.

Historical evidence suggests that left unregulated, banks will prefer to create credit for non-productive financial or speculative credit, which often maximizes short-term profits. This may explain why the BoE, like most central banks, used to impose credit growth quotas on banks. However, such credit controls were abolished in the early 1970s.


Money is not metal. It is trust inscribed. And it does not seem to matter much where it is inscribed: on sliver, on clay, on paper, or on a LCD.


Soon goldsmiths further realized that as the real deposit receipts were being used as a means of exchange as opposed to the metal itself, they could equally issue deposit receipts instead of actual metal for their loans. And this meant they could issue more gold deposit receipts than they had actual gold deposited with them. Goldsmiths chose to keep just a fraction of their total loan value in the form of gold in their vaults. Thus they created new money and fractional reserve banking was born.

From a legal perspective, the goldsmiths were committing fraud. The receipts were fictitious — they were pure credit and had nothing to do with gold. But no-one could tell the difference between a real deposit receipt and a fictitious one.


We have seen how fractional reserve banking allowed banks to lend multiples of the amount of gold in their vaults. Similarly, they could create new bank deposits through lending or purchasing assets, which were multiples of the amount of now restricted banknotes. Because these account balances were technically a promise by the bank to pay the depositor, they were not restricted by the Act in the same way that banknotes were. This meant that the country banks were able to create them without breaking counterfeiting laws.


In France, the Bretton Woods system was called “America’s exorbitant privilege” as it resulted in an “asymmetric financial system” where non-US citizens “see themselves supporting American living standards and subsidizing American multinationals”. It costs only a few cents for the Bureau of Engraving and Printing to produce a $100 bill, but other countries had to pony up $100 of actual goods in order to obtain one.


Commercial banks are in a rather privileged position compared with ordinary businesses. Not only are they allowed to create money and allocate purchasing power, but someone else guarantees to pay their liabilities for them if they are unable to. That someone else is you, the taxpayer, via the Government. The Financial Services Compensation Scheme guarantees that the first $85K of any money deposited in UK licensed banks will be repaid in the event the banks are unable to make the payment. This $85K is risk-free. It has been transformed by the state from an IOU issued by a bank to an IOU issued by the Government. For any deposit above $85K, if the bank went into liquidation you would join the queue of general, unsecured creditors (behind the secured and senior creditors) hoping to get some of their money back.


The implications of the credit model of money are profound. Rather than being neutral or a veil over the “real” activities of the economy (trade, exchange, the use of land and labor), it becomes clear that money — as an abstract, impersonal claim on future resources — is a social and political construct. As such, its impact is determined by whoever decides what it is (the unit of account), who issues it, how much of it is issued to whom and for what purpose.


While money is really nothing more than a promise to pay, what distinguishes money from, say, an IOU note, is its general acceptability.


Anyone can create money, the problem is getting it accepted. Since banks are the accountants of the economy, through whose computers the vast majority of all transactions are booked, they are uniquely placed to get their money — created through granting credit — accepted.


People accept and hold money not because of its intrinsic value as a commodity but because of guarantees regarding its future re-exchangeability; the “satisfaction of the holder does not depend on possession per se, but on possession with a view to future use for payment.”


The best that Western civilization has been able to achieve — which is, as far as we can see, the best that any civilization can achieve — has been to mitigate the struggle for power on the domestic scene, to civilize its means, and to direct it toward objectives, which, if attained, minimize the extent to which life, liberty, and the pursuit of happiness of the individual members of society are involved in the struggle for power. More particular, the crude methods of personal combat have been replaced by the refined instruments of social, commercial, and professional competition. The struggle for power is being fought, rather than with deadly weapons, with competitive examinations, with competition for social distinctions, with periodical elections for public and private offices, and, above all, with competition for the possession of money and of things measurable in money.

In the domestic societies of Western civilization the possession of money has become the outstanding symbol of the possession of power. Through the competition for the acquisition of money the power aspirations of the individual find a civilized outlet in harmony with the rules of conduct laid down by society.The pursuit of luxury among early modern rulers and their retinue was predicated around the acquisition of enormously expensive artefacts, but experience of the mind and body was also valued: “The things which can make life enjoyable remain the same. They are, now as before, reading, music , fine arts, travel, the enjoyment of nature, sports, fashion, social vanity and the intoxication of the senses.”


These wars were fought primarily by mercenaries who, their interests being in the main financial, were not eager to die in battle or to invite that risk by killing too many of their enemies.


It rejects a prevalent but mistaken mind-set that equates price with value. On the contrary, Graham held that price is what you pay and value is what you get. These two things are rarely identical, but most people rarely notice any difference.


The difference also shows that the term “value investing” is a redundancy. All true investing must be based on an assessment of the relationship between price and value. Strategies that do not employ this comparison of price and value do not amount to investing at all, but to speculation — the hope that price will rise, rather than the conviction that the price being paid is lower than the value being obtained.


The financial calculus that Charlie and I employ would never permit our trading a good night’s sleep for a short at a few extra percentage points of return. I’ve never believed in risking what my family and friends have and need in order to pursue what they don’t have and don’t need.


First, we participate in only a few, and usually very large, transactions each year. Most practitioners buy into a great many deals — perhaps 50 or more per year. With that many irons in the fire, they must spend most of their time monitoring both the progress of deals and the market movements of the related stocks. This is not how Charlie and I wish to spend our lives. (What’s the sense in getting rich just to stare at a ticker tape all day?)


You have 2 types of career assets to keep track of: soft and hard. Soft assets are things you can’t trade directly for money. They’re the intangible contributors to career success: the knowledge and information in your brain; professional connections and the trust you’ve built up with them; skills you’ve mastered; your reputation and personal brand; your strengths.

Hard assets are what you’d typically list on a balance sheet: the cash in your wallet; the stocks you own; physical possessions like your desk and laptop. These matter because when you have an economic cushion, you can more aggressively make moves that entail downside financial risk.

Soft assets are more difficult to tally than cash in a bank account, but assuming your basic economic needs are taken care of, soft assets are ultimately more important. Dominating a professional project at work has little to do with how much dough you’ve socked away in a savings account; what matters are skills, connections, experiences.

One of the best ways to remember how rich you are in intangible wealth — that is, the value of your soft assets — is to go to a networking event and ask people about their professional problems or needs. You’ll be surprised how many times you have a helpful idea, know somebody relevant, or think to yourself, “I could solve that pretty easily.”