Money’s Mostly Digital, So Why Is Moving It So Hard?
Let’s say I had an apple, and you had an orange, and I wanted an orange, and you wanted an apple. We could trade, and both of us would end up happier than when we started. But now let’s say I had an apple tree, and you had an orange tree, and the apples from the apple tree were ready, but the oranges wouldn’t ripen for another month. I could give you an apple now, and you could promise to give me an orange in a month, when they’re ready, and both of us would end up happier than when we started. Although, maybe you didn’t want an apple. Maybe you wanted a pear.
But all I had to give was my apple, and I still wanted your orange. Well, maybe there was a third guy, a pear-laden guy, and he wanted an apple. So I give him my apple, he gives you his pear, and you promise to give me your orange in a month, and we all end up happier than when we started. But then maybe we start to trade bigger quantities and maybe we add more people with different fruits on different harvest schedules and maybe we decide that certain popular fruits are worth more and two of one equals one of the other and one of the other equals three of the third and… it all starts to get just a little bit complicated.
So, we simplify: instead of trading physical fruit for physical fruit, we trade physical fruit for fruit credits—clay balls with a generic fruit symbol carved into them. If I trade an apple into the system, I get a credit, and when I want that orange, I trade the credit in—nobody has to keep track of what I’m owed. Now that we have this system going, we might as well add vegetables into the mix—sure, it’s not fruit, but we want veggies sometimes, and the veggie farmers want fruit too, so the system still works. Naturally, as the system develops and develops with more and more items and more and more complexity, we start to feel that these fruit credits have value, even though they merely represent theoretical value. But that theoretical value can be turned into real value, and so in a way, the clay balls, the representation of theoretical value that translates into real value, hold real value in and of themselves. So, someone starts a business where they’ll keep your fruit credits safe for you, free of charge.
Better yet, they’ll pay you to keep your credits safe. It sounds like a scam, and maybe it is, but you take the risk and deposit a thousand credits. Elsewhere, in order to grow more watermelons this year, and therefore earn more fruit credits, a watermelon farmer needs more credits than she has to exchange for an irrigation system. So, this new credit storage business offers to give her 7,500 credits if she promises to give 9,000 back in a year. This seems like a safe bet since she’s already a successful watermelon farmer, and it’s worth it for her since she’ll get the new irrigation system, and worth it to this new fruit credit safeguarding business since they’ll get more credits, and everyone ends up happier than when they started. Meanwhile, you’re told you can take your credits out at any time, and you can, even if they only kept 250 of them on hand.
That’s because there are nine more farmers that deposited their thousand credits too, and even if the safe-guarding business only kept a quarter of them, a quarter of all deposits is much more than your 1,000, and the chances of everyone wanting all their credits at the same time is negligibly low. So, this is a free money machine—you make money, the bank makes money, and the watermelon farmer makes money. Everyone makes money. But, wait… everyone makes money? You, the bank, and the watermelon farmer end up with more money than when you started so… where did it come from? If we turn this into a closed loop, where no money enters or exits the system, we can track down the source. So, ten people with 10,000 credits each deposit 1,000, meaning the bank now has 10,000. The bank lends those 7,500 out to the watermelon farmer, meaning it now holds 2,500.
She pays that 7,500 to one of the ten depositors for an irrigation system they’re selling. One growing season later, the farmer has 9,000 watermelons that she brings to the market, and sells 900 of them to each of the same group of ten that put their money into the bank. They now each have 9,100 credits—1,000 of which sit in the bank. Meanwhile, the farmer has 9,000 which she gives to the bank, meaning it now holds 11,500 credits.
So, the farmer has nothing, the ten individuals have 98,500 total, and the bank has 11,500, meaning there are now 110,000 credits in the system—once again, money has appeared out of thin air. So, its source: in the very first step, ten thousand-credit deposits go into the bank, but the ten individuals still each have 10,000—it’s just that 1,000 of it’s in the bank. That’s not the bank’s money, so the 10,000 sitting in their vault isn’t theirs, which means the money is created exactly… now.
The moment that loan goes out, new money has appeared. The original depositors still have their 100,000 credits, because with the way the fractional-reserve banking system works, they can all, on an individual level, withdraw their 10,000. But simultaneously, the watermelon farmer has 7,500 very real credits.
If you have a roommate that you agree to share your blender with, only one blender physically exists. But two blender’s worth of value is being extracted from it, because you’re both using it just as much as you’d use your own, dedicated blender. That’s essentially what’s happening with money, except that with money, we track the per-person value, rather than per-blender value. Now, it’d be easy to argue that we can’t consider the bank to have created 10,000 credits—and that’s fair, because the system wouldn’t work if it lent 10,000, because it couldn’t give the original depositors their money back. But it does work when they give away 7,500—a 25% reserve ratio is very typical in a fractional-reserve banking system—so we can at least say 7,500 was created. You could still argue that that 7,500 isn’t actually money since it’s eventually owed back to the depositors—except that, if you trust and engage in the global financial system, that’s not what you believe.
When you receive a loan, you can take out that money in cash, and when you deposit money in a bank account, you can take out that money in cash—it is very real money representing very real value. This is exactly why answering the question of how much money exists is so tough—there are at least six different commonly-accepted definitions incorporating different combinations of currency, demand deposits, traveler’s checks, time deposits, and more—and this means of money creation is one of the primary activities that central banks like the Federal Reserve, Bank of England, or Bank of Japan seek to administer and regulate. They’re in charge of telling banks how much money they have to keep in reserves, which throttles how much money appears out of thin air through banks’ lending process. Of course, the aspect to take note of is the fact that money is created when it moves—money is never created while it’s sitting still. So, back in 1867, when moving money was tough and banks were rudimentary, physical currency still pretty well correlated to the total supply of money—most dollars were represented by a physical bill or coin.
But since then, well, things have changed. Abstraction helps money move—adding paper stand-ins for precious, rare minerals speeds up the transportation of funds and transactions. Abstraction helps money grow too—as a bank’s ability to loan money provides its customers the assets to then create value. Abstraction, however, doesn’t alone move money from one bank to the next, one town to the next, one state to the next, or one country to the next like it does today—that required standardization. Before the Civil War there were thousands of different types of paper money backed by all sorts of private and public institutions in the US. Say, for example, a watchmaker from Waltham, Massachusetts in 1857 went into their bank to withdraw this $20 bill to buy some machinery down in Brookline.
This isn’t the $20 bill anyone today is used to, this is a Waltham Bank $20 bill, redeemable in gold at only the Waltham bank but of uncertain value to anyone outside of the Waltham bank. Now, while the watchmaker’s not taking on the risk or inconvenience of carrying $20 Waltham dollars worth of gold, there’s also no guarantee that the merchant in Brookline will take the note from a bank so far out of their way. Perhaps, because of the distance, they’ll tack on a fee for the inconvenience of cashing the note and say the machinery is now $23 Waltham dollars. Or, perhaps the watchmaker gets lucky and they are only one of the many business relations the Brookline merchant keeps in the Waltham area, then maybe the merchant will accept the Waltham dollars knowing they’ll be able to use the bill in the future. Regardless of the fate of the Waltham watchmaker, what their predicament underscores is that money, when in many different forms from many different places, was hard to move, hard to transact with, and hard to transfer outside of one’s immediate community. All this changed with the National Currency Acts of the 1860s.
Out went thousands of separately backed private banknotes, in came nationally chartered banks, and so began a new era of money moving with a new means with which to do it: the modern check. Under the new rules, all nationally chartered banks had to carry about 25% of their liabilities in reserves—in other words, of all the money they were good for, a quarter of that needed to be held in gold in the basement. Crucially though, the smaller banks, or country banks, could hold these reserves in the central reserve cities, or the few big banks.
Effectively, the two banks were now connected—someone could now take a check from their local bank, head into the city and buy supplies, and that check could then be settled at the larger, correspondent bank without any gold having to move outside the vault. And not only were these two banks connected, countless small banks were now all linked together through that correspondent bank functioning as a hub. This simple connection had major consequences—it allowed a customer to move money regionally without the hassle of navigating a maze of domestic exchange rates, thus stimulating growth, and without the slow and risky necessity of moving actual coins or cash from bank to bank, making the process quicker. In this environment, armed with a Waltham check rather than Waltham dollars, our watchmaker could pay for their supplies, the merchant could deposit the check at their Brookline bank, and the Brookline bank, in turn—assuming because of their proximity, they share a correspondent bank—would send the check to the correspondent which then would balance each bank’s funds by moving money across the basement. Now, this process at the time was far from efficient, especially when banks didn’t share immediate correspondent banks.
When a check moved money between banks without a direct link, they had to find a third party bank, or in some cases multiple banks, to bridge the gap and connect them with a correspondent, racking up fees, delays, and postage all along the way. Take, for example, this check from 1898 for $43.56 which was deposited at the Second National Bank of Hoboken, N.J. before Second National then sent it to Harvey Fisk & Sons, who sent it to the The Globe National Bank of Boston, who sent it to the First National Bank of Tonawanda, who sent it to the National Exchange Bank of Albany, who then sent it to a bank in Port Jefferson, who then sent it here, who then sent it here, who then sent it here, who then sent it here, who then sent it here, where it was finally drawn.
Still, while inefficient, these early checks were a critical stepping stone in standardizing and moving an increasingly abstract form of money—bank account totals denoted in dollars, not gold. The use of checks, and the ease of their accounting took a major step forward with the Federal Reserve Act of 1913, which split the nation into 12 separate regions and tasked each regional federal reserve bank with filling the role of clearing house for all regional checks. This centralization streamlined processing, as a bank could now credit a merchant’s account and know exactly which federal reserve bank to send it to—and it also codified a critically important function that would allow money to move farther, and become increasingly abstract in the decades to come: rigorous accounting.
In the early 1900s, checks were still rather rare, and their use remained mostly regional. Then came the ‘50s. Now, Americans were making more money than ever, spending more money than ever, and had more bank accounts than ever. From 1943 to 1952, national check use doubled from four to eight billion a year, and through multistep proofing and processing, American banks were wading through some 69 million checks every day.
Banks were drowning under the pressure—branches closed at two in the afternoon to shift all work to matching signatures, running the adding machine, double-checking the math, and packaging the checks for shipping to the Federal Reserve. The work was grueling, most clerical staff at banks quit within a year, but it was absolutely necessary. With more money passing through their hands than ever before, they had to be as accurate as humanly possible. Relief, though, came in the form of a computer the size of a room designed by the Stanford Research Institute, funded by the Bank of America, and built by IBM.
They called it the Electronic Recording Machine, Accounting—or ERMA—and it transformed banking. Before ERMA, checks were processed at every bank branch, they came in all sizes, and they weren’t identified by bank account numbers. To move the process of sorting checks to the computer, they’d need to be the same size and they’d need numbers rather than names to be organized by.
Once those standards were adopted, checks were entered into the computer, which read the magnetic ink, and if the account belonged to a Bank of America branch, ERMA would access the account stored in its 16-by-20 inch magnetic-drum memory, check for any account holds, make sure the balance in the account was positive, draw the amount, tally the total, save the new balance, and print the new record. Where human eyes misread, and human hands mistyped, ERMA didn’t, as the computer even went so far as to check the routing number by plugging the digits into this algorithm to ensure the check’s legitimacy. Now the paper processing crisis that began in the 1950s was not solely a Bank of America problem, it was structural.
From monthly insurance bills to tax returns to social security checks, no matter how many sorting computers were added to the system, if every transaction took the form of a flimsy paper check that needed to physically pass from person to bank to Fed to bank, then the paper avalanche simply couldn’t be contained. So payment systems went electronic, and the Automated Clearing House Network revolutionized the domestic movement of money when adopted in the 1970s. Where thousands of checks once poured into reserve banks and private clearinghouses everyday, the ACH network now allowed for direct deposits, automatic payments, and ATM transactions. Now someone looking to pay their insurance premium could hand over their bank account information to the insurance company, the company’s bank would then create an ACH entry requesting to withdraw money, the request would be processed by the ACH’s operator and the money would be debited from one account and credited to the other, no check required. Of course, security and the ability to uphold accurate accounting were of paramount concern in an era before the internet.
Companies adopted micro-deposits as a means to verify bank accounts, federal reserve officials helped form a regulatory body called NACHA, and in 1978 congress passed the Electronic Fund Transfer Act to limit customer liability and protect them against wrong or fraudulent charges. The measures successfully eased consumer fears. Today, the ACH Network moves over $50 trillion dollars across 23 billion transfers a year.
While ACH securely moves mountains of money stateside, its role ends where the US does. For international transfers, there’s the society for worldwide interbank financial telecommunications, or SWIFT, which, like ACH, was established in the 70s to streamline payments but at the international scale. SWIFT doesn't actually move money, but instead provides its 11,000 member banks a secure network and a standardized messaging format to send payment orders. Prior to SWIFT, international transfers lacked standardization, security, and accuracy.
So SWIFT started from scratch, organizing its member banks in a manner similar to the routing number on a check, assigning each an 8 to 11 character code that denotes bank name, country, location, and branch. The program also standardized how payments were communicated. They start with a bank code, but the payment instructions are outlined in an MT103 document which, as they’re processed, can be tracked by the bank, and, once the transaction is complete, will function as a receipt. Now if someone’s wiring money from the US, through, say Bank of America, to Germany through Deutsche Bank, rather than actually sending money, the MT103 will tell Deutsche Bank how many dollars to pull from Bank of America’s Nostro account held at Deutsche Bank, and convert them to euros to be deposited into the recipient’s account. Like correspondent banks settling checks in the early 1900s without taking on the risk of shipping gold coins in the mail, SWIFT members are able to fulfill international transactions without actually moving money across oceans.
Through its simplicity relative to programs before it, once a SWIFT transfer is initiated and then communicated through SWIFTNets’ encrypted message system, a transfer is usually completed within 24 to 48 hours with more complicated, multi-bank transactions accounting for some transfers taking longer. Still, even though SWIFT functions as a member-owned cooperative and therefore doesn’t maximize profit, it’s neither cheap nor easy to manage a global network capable of securely passing along more than 40 million messages a day. This cost is felt by member banks who pay to enter SWIFT, then pay SWIFT by the message—costs that add up, and costs that trickle down too. Today, each international transfer, beit part of everyday business or someone sending money to their family back home, usually gets tagged with a fee likely starting in the $40 range. Considering the cost and complexity of transferring money, some have identified the opportunity of layering a simpler system on top of it. Wise, for example, is one of the world’s hottest fintech startups, focusing primarily on remittances—there are loads of low to medium-income people working outside their home country who pay those huge fees to send money to their families back home—but Wise designed a system that almost entirely circumvents those intermediaries.
Essentially, if someone in the US is sending $1,000 to someone in Australia, they actually transfer money into Wise’s American account, then the company instructs its Australian account to send the equivalent amount, minus fees, to the recipient. They’re essentially a private-market equivalent of SWIFT. It’s a dead-simple system that leads to the same end result, but with far less cost and complexity. Banks can’t do this.
You see, if Wise messes up and sends the recipient money without debiting the sender, the company is out $1,000. If a bank messes up and gives the recipient $1,000 without the sender being debited, $1,000 just appeared out of nowhere. So that can’t happen—it just simply can’t. If it does, money breaks. Our trust breaks. The system breaks.
If money erroneously appears, outside of the contexts in which we allow it to appear, then it’s not functioning like its physical counterpart would. Money really is just a means of accounting. It’s accounting for the fact that you owe me an orange. But if you give me the orange and I don’t give you the fruit credit, then the system didn’t work—the accounting failed. For the modern, digital financial system to function at all, the process of transfer has to be as infallible as the process of handing a clay ball from one person to the next. Simulating physicality in a digital network as vast and distributed as the global financial system is incredibly complex, considering how complex the system itself is.
These expensive, burdensome middlemen are the institutions that protect that simulated physicality, so without them, money is worthless. Alternatives are arising, most notably the blockchain, and central banks like the Federal Reserve are studying whether to introduce blockchain-based digital-currencies, but for now, the world still runs on money, and money’s value is all in the system’s ability to account for it. Few things in the digital world are as finite as money, with one notable exception—domains.
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