On the ‘Impossibility’ of Paying Interest

I note a considerable amount of interest in some ideas by Chris Martenson – who has a website and offers tutorials entitled ‘The Crash Course’. He suggests that the current way we are living is unsustainable and we’d better start preparing for when it all goes pear-shaped (which will be pretty soon according to him). There are three pointers to this alarming turn of events – two fairly genuine, I think, and one based on a misunderstanding.

The two issues I would share his concern about are Climate Change and so-called ‘Peak Oil’ – the impact of the likely future decline in oil production as reserves are exhausted. Their exact impact is, of course, open to ongoing debate.

His misunderstanding involves the impact of interest payments on the monetary system. Now Dr Martenson is a neuro-toxicologist by training, rather than an economist. Otherwise he would probably be aware that the problem of how interest can be paid when all money is created through lending is one that has troubled many economists, particularly those of the monetary circuit school, to which I would describe myself as loosely attached. But in fact it has a very simple solution, once one learns to distinguish between money stocks and money flows.

Martenson’s concerns about debt and interest are summarised in the following quote from his site (which he attributes to a Steven Lachance):

A debt-based monetary system has a lifespan-limiting Achilles heel: as debt is created through loan origination, an obligation above and beyond this sum is also created in the form of interest. As a result, there can never be enough money to repay principal and pay interest unless debt is continually expanded.

Martenson makes it sound even worse by suggesting an exponential growth in debt that results from the need for more debt creation to pay the interest. Now this seems alarming, and it is in some ways, but not quite in the way described.

The quantity of debt, and the money created by it, is at any instant in time a fixed stock. But, over a period of time, this fixed stock of money can be used to carry out a much greater monetary value of transactions. If the rate of circulation of money (the technical term is the ‘velocity of money’) were infinite, the value of total transactions carried out with any quantity of money would also be infinite! Obviously it isn’t infinite, but the point remains that the quantity of money is not on its own an absolute limit to the value of transactions in a time period. This is because transactions are a flow, not a stock.

As an analogy consider a pond, out of which water flows and is then pumped back in. If we measured the capacity of the pond as 100 litres, does this say anything about the possible rate of flow out of and back into the pond? In fact even if the water flowed out at 100 litres every second, as long as it was pumped back in at the same rate then the flow could continue at 6000 litres/minute – 60 times the capacity of the pond every minute – indefinitely! If, on the other hand, 100 l/s were pumped out, but only 90 l/s pumped back in, the pond would be empty in 10 seconds and the process would come to a halt. So the ‘sustainability’ of a flow depends not on its absolute rate, but on the differences between flows in and out of stocks.

Interest payment is a transaction, so it is a flow. What matters therefore is not the absolute quantity of interest, but whether the flow of interest payments from the borrower back to the bank is matched by a flow of payments to the borrower. Since the money paid as interest does not disappear after being paid to the bank, but is spent by the bank – as wages or dividends, or on physical capital, it returns to the rest of the economy. As long as it finds its way back to the original borrower, it can then be used once more to repay the loan.

Let’s go through this process step-by-step using some diagrams.

Interest Diagram 1

Here the bank makes a loan of £100 to a firm, and the firm immediately makes a wage payment of £100 to households. The interest charge is 10% of the loan. The stock position of each economic unit is indicated. I treat the debt as ‘negative money’ for the bank, but this is not important to the analysis. The important thing to note is the net money stock position of the non-bank economy, which is now +100.

Interest Diagram 2

The firm sells its initial output to households for £10, and then pays this to the bank to discharge its interest obligation. The net non-bank stock position is now +90.

Interest Diagram 3

The bank now uses the money it has received as interest to pay wages, dividends or to purchase physical capital. The net non-bank stock position is again +100.

Interest Diagram 4

The firm now sells the rest of its output to households for £100. The net non-bank stock position remains +100.

Interest Diagram 5

The firm now repays its loan to the bank. The net non-bank stock position returns to 0.

In summary, the firm has managed to match its flow of money back to the bank of £110, with a flow of £110 in sales revenue. But at no time has the non-bank sector had a total stock of money exceeding £100. This model of the monetary economy is simplified in various respects, in particular by suggesting that interest is paid in a lump sum, and by suggesting the existence of only one firm. Interest is normally a continuous flow over the lifetime of a loan, but as long as the total interest plus repayment and the revenue flows match over the time of the loan, the picture is essentially as shown. The presence of multiple firms (some of them providing goods to other firms) complicates the flow, and produces uncertainty for firms, but it has no impact on the feasibility of loan and interest repayment.

None of what I have said should be taken to mean that a monetary economy is trouble-free. Far from it, as I have pointed out in several other pieces on this site, Understanding Money (pdf 83.9Kb) in particular. But there is no urgent inevitability about the collapse of the monetary system. In a sense, this perhaps makes it more important to understand what is needed to tackle the real problems of our monetary economy. These are primarily the periodic tendency for large quantities of money to be held (saved) instead of spent, the fact that money issue is increasingly divorced from real value creation, and that the significance of money flows and stocks for real human and social welfare is very poorly understood.

Professor Steve Keen of the University of Western Sydney has also investigated this issue, and comes to the same conclusion using a dynamic mathematical technique. You can see a video of his discussion.

31 thoughts on “On the ‘Impossibility’ of Paying Interest”

  1. Hi Diarmid,

    Thanks for putting this page together.

    As a non-economist who recently viewed Chris Martenson’s material this page is a must read, and begs the question what other misunderstandings have been raised by Chris. Is his statement that money growth is exponential also flawed?

    Unfortunately I don’t see such an easy way out of the concerns related to ‘peak’ oil and resources!

  2. validation doesn’t like brackets

    A. The debt-based nature of money

    Most of the money supply in OECD countries – all but about 3%, the value of the coins and notes – is issued as debt. In these countries, the total of all the bank accounts in credit is balanced exactly by all the accounts on which money is owed. This makes the economies basically unstable because if insufficient new loans are taken out in any year to cover the principal and the net interest being paid into the banks on the previous years’ loans, the money supply will contract. A smaller money supply makes it impossible to carry on the same level of business as in the previous year. People lose their jobs and surplus capacity appears, further inhibiting borrowing and investment. A downward spiral could develop with one set of job losses leading to others.

    So, if the economies of these countries are not to become depressed, the amount borrowed in any year has to be at least equal to the amount being paid to reduce old loans plus the banks’ retained earnings. And, assuming that the banks are not distributing all their profits, this means that the amount borrowed has to grow year by year. But since a steadily increasing amount of borrowing cannot be supported by a stationary or declining economy, this means that the economy has to grow too to prevent the level of indebtedness rising continually in relation to national income. This is a small effect compared with the second reason why growth is required.

  3. DavidL

    Chris Martenson is quite correct that money growth is exponential. I actually noted this and its significance in 1998. See http://www.futureeconomics.org/2010/05/money-and-inequality But ‘economic activity’ has also increased exponentially, so it becomes a question of what is cause and what is effect. My view is that it is the greed and recklessness of the wealthy and powerful that is the primary cause, rather than any logical flaw with the monetary system.

    Perhaps it isn’t that important whether the economy is physically unsustainable or logically unsustainable. I can’t say for certain – but it might be, either because any reasoning flaw will be picked on by deniers or because the outcome and solutions of the unsustainability might be different.

    I’m going to try and look at all the empirical evidence, and see what it adds to the debate – so watch this space! In the meantime there is an active debate now going on the Chris Martenson site about this issue – see http://www.chrismartenson.com/forum/interest-payment-not-problem/41544

    Tom

    if insufficient new loans are taken out in any year to cover the principal and the net interest being paid into the banks on the previous years’ loans, the money supply will contract.

    Well, that’s just what I am saying is not correct. When the principal is repaid, it ‘disappears’ and cannot recirculate. This is not necessarily true for interest payments however, since they represent revenue for the bank and can be re-entered into circulation.

  4. Diarmid,

    Thankyou for the pointer to the ChrisMartenson debate – I am now following that.

    The main take-away for me is that it is money flow that makes the dfiference between a sustainable and non-sustainable monetary system.

    I also note your alternative economic model in which an investor is penalised for withtholding money over a period of time and recall reading something similar in ‘Dr Strangegloves Game’ several years ago. At the time it struck me as an interesting model, but in light of the economic stresses and economic failure of the last couple of years it may be the sort of big thinking that is required for future stability.

  5. Hi Diarmid,

    Came across your blog via a link on a board I frequent and had some questions I’d like to run past you.

    I am not an economist but, like you, I too feel the monetary system should be a subject of debate and study and, crucially, should be ratified by society rather than being imposed and managed by decree.

    By way of premise, my position is that as opposed to either a value based Monetary System or a Fiat Monetary system based on a fixed amount of money (FM), not only does a Debt Based Fiat Monetary system (DBFM) not offer safeguards thus is inherently inflationary but the asymmetry in the cost structure of the creator of the currency vs. the user of the currency must result in the productive capacity of society to become concentrated in the hands of the monetary authority and the entities that gravitate around it.

    That’s a mouthful I know.

    But on to my question.

    What is your opinion on the purpose of Fractional Reserve Banking?

    Tia
    g

  6. Hi Guido,

    Thanks for your question.

    I’m not convinced of the usefulness of the term ‘Fractional Reserve Banking’ (FRB), but I guess what we are talking about is a banking system where there are two sorts of money – one which is somehow more ‘properly’ money but is more or less interchangeable at par with some slightly ‘less proper’ money.

    The relationship in a modern monetary system is between money issued by the state to pay for the goods and services it requires and to fulfil payment obligations to its citizens, and money issued by private banks as a liability in the form of deposits and matched by an asset in the form of a loan.

    The state money exists as accounts at the central bank held as assets by the private banks, and as notes and coin (‘cash’) held in private bank vaults and by citizens. The banks can freely exchange these accounts and the notes and coin. This means that they can fulfil demands from their deposit-holders for cash up to limit of their state money accounts with the central bank. The prediction of these demands is going to be some ‘fraction’ of total private bank deposits – thus the concept of the private banks having a ‘fractional reserve’. But this fraction is not fixed, and depends on the banking environment. Moreover the FRB concept implies that movements of deposit money are potentially autonomous of those of ‘proper’ money. In fact this is not so – any movement between banks (or between citizens and state) of private deposits must always be accompanied by movement of the same quantity of ‘proper’ money. The size of these movements is usually masked, however, by the netting out of many of these movements over any interval of a day or more. Again the ‘fraction’ of reserves required to be held to cover these movements is variable and depends on the banking environment.

    What is more – the standard arrangement in modern systems is to allow private banks access to further state money (at a cost) as they need it. So the restriction on the money-creating activities of private banks is not related directly to any particular reserve ratio, but to a profitability calculation.

    What is the purpose of such a system? Well, as I see it, it’s probably a reasonable compromise between stability and security, and flexibility of public and private action. A solely state money would always be 100% backed by the state (instead of limited guarantees on private retail deposits) and its issue under democratic control, but it would take time and effort to weigh up the correct quantity to issue. Private money is issued according to an assessment of risk by parties to a loan agreement for some ‘productive’ purpose. These parties also bear most (although not all) of that risk. This seems likely to produce more efficient matching of money with its local requirement.

    So the problems that you mention in your comment are not, I think, inherent in the system. They are a consequence of too narrow a focus of the ownership and purpose of banks (as indeed of most business power). Banks are looking purely to short-term monetary flow gains for their executives and shareholders, and this is frequently at the expense of human, social and environmental capital.

  7. “The relationship in a modern monetary system is between money issued by the state to pay for the goods and services it requires and to fulfil payment obligations to its citizens, and money issued by private banks as a liability in the form of deposits and matched by an asset in the form of a loan.”

    I take it you refer here to the difference between money issued by the central bank (the Fed in the USA) and the multiplied amount of said money issued by the Primary Dealers and Commercial Banks yes?

    If that is indeed the case, here are two observations:

    In a world of Floating Exchange Rates as we have since 1971, participants to the system are allowed to keep the name of their respective currencies but in actual fact our economies have been Dollarised.

    This means that we effectively evolve in a monetary framework that is dictated by the Federal Reserve (hence the swap lines that have been opened by necessity and in secret every time insolvency stalks the banks of any member to the system).

    That being the case, empirical evidence shows that the Federal Reserve is not “government”. The Federal Reserve is in fact a third party driven by the Primary Dealers that get paid a fee for creating the currency.

    As you point out: “So the restriction on the money-creating activities of private banks is not related directly to any particular reserve ratio, but to a profitability calculation.”

    Hence, PDs and CBs have an incentive to always create more proper currency which will give rise to multiples of its less proper cousin at vast profit for no cost. Incidentally, this dynamic is borne out empirically by the rate of progression of money (whether base money or true money supply or any other parameter one chooses).

    In this construct, the asymmetry in the cost structure of the creator of the currency vs the cost structure of the users of the currency (who under penalty of incarceration must make use of the currency produced by the Fed) must arithmetically lead to a transfer of wealth brought about by inflation, when credit markets are expanding and then by deflation, when credit markets can no longer be expanded – (inflation is a dynamic that conforms to the law of diminishing marginal utility thus there is an arithmetical limit to the expansion of credit markets).

    If the above is true, then we must recognize that DBFM is a construct that can only result in wealth transfer from economic actors that are productive to the sponsors of the monetary system…. no?

  8. Hi Guido,

    I take it you refer here to the difference between money issued by the central bank (the Fed in the USA) and the multiplied amount of said money issued by the Primary Dealers and Commercial Banks yes?

    Now, my detailed knowledge covers the UK system, but my understanding is that these ‘primary dealers’ (who in fact are usually subsidiaries of commercial banks) do not issue money, but purchase Fed securities with pre-existing Fed-issued money. In this role they are actually reducing the money supply. If you can direct me to any documentation that their role is different, glad to see it.

    In a world of Floating Exchange Rates as we have since 1971, participants to the system are allowed to keep the name of their respective currencies but in actual fact our economies have been Dollarised.

    I’m not quite sure what you mean here. Clearly if exchange rates are floating, local conditions will play at least some part in the value of non-dollar currencies. Of course the US is a big economy and there are a lot of dollars around, so what happens there makes a big difference to everyone else…

    The Federal Reserve is in fact a third party driven by the Primary Dealers that get paid a fee for creating the currency.

    To some extent the Fed is independent (as is the BofE), but why you think it’s driven by the Primary Dealers I’m not sure. They make money not from creating the currency as far as I can see, but for ensuring a ready market in Fed securities.

    Hence, PDs and CBs have an incentive to always create more proper currency which will give rise to multiples of its less proper cousin at vast profit for no cost.

    Assuming CBs here are commercial banks, they have an incentive to create more deposit money only if the costs (of having adequate reserves and of default risk) are exceeded by the interest they earn on the loan that creates that money. In the sense that CBs can borrow at base rate from the central bank there is no direct limit either on base money or on deposit money, but at some point interest minus costs is maximised.

    Incidentally, this dynamic is borne out empirically by the rate of progression of money (whether base money or true money supply or any other parameter one chooses).

    You would expect the money stock (the snapshot gap between creation and destruction of money) to grow with economic activity and be affected by many other factors. So I think it is difficult to use any particular growth pattern to positively support any particular monetary theory.

    In this construct, the asymmetry in the cost structure of the creator of the currency vs the cost structure of the users of the currency (who under penalty of incarceration must make use of the currency produced by the Fed) must arithmetically lead to a transfer of wealth brought about by inflation, when credit markets are expanding and then by deflation, when credit markets can no longer be expanded…

    Well, there is a whole set of gains and losses in this sort of cycle. As the expansion starts, real incomes will rise with economic activity. Then inflation will start to erode the value of money savings. On the downturn real incomes then fall, followed by a decrease in the value of real capital. For banks, they increase loans and interest revenue on the upturn and suffer defaults on the downturn. Their other costs are difficult to predict relative to the cycle. Everyone loses and gains at some point.

    As a result, I would suggest that any persistent transfers of wealth are not a structural phenomenon of the monetary system, but due to an excessive concentration of the power over capital (including money).

    If the above is true, then we must recognize that DBFM is a construct that can only result in wealth transfer from economic actors that are productive to the sponsors of the monetary system…. no?

    It depends how the power of the ‘sponsors of the monetary system’ is spread. If it were spread more widely (and actually this goes for the power of ‘economic actors’ in general), I believe not only would we see a more equitable spread of wealth but we would see an economy that was more efficient in creating human welfare.

  9. “You would expect the money stock (the snapshot gap between creation and destruction of money) to grow with economic activity and be affected by many other factors. So I think it is difficult to use any particular growth pattern to positively support any particular monetary theory.”

    You must admit that when Federal debt progressed from US$1Trillion in 1980 to US$14Trillion today whilst GDP barely doubled during the same period of time (from 6 to 14 Trillion)…. I’d say this is one particular growth pattern that clearly supports the absurdity of DBFM.

  10. “but my understanding is that these ‘primary dealers’ (who in fact are usually subsidiaries of commercial banks) do not issue money, but purchase Fed securities with pre-existing Fed-issued money.”

    Once again, I am not an economist. But in looking at the board of the Federal Reserve, Bank of America, JPMorgan, Goldman Sachs e tutti quanti feature prominently. To my eyes, the Fed is the Primary Dealers’ club. And yes, they purchase Treasury securities that, currently thanks to the magic of Quantitative EAsing, are palmed back off to the Fed (ergo themselves but with the use of public funds thank you very much).

    Now, I may be banging on about the Dollar and the Fed. But empirically, Western monetary systems are one and the same and are driven by the Fed… once again… proof is to be found in the need for secret swap lines between the Fed and every other member of the Floating Exchange Rate club (last count was US$16Trillion).

    http://www.scribd.com/doc/60553686/GAO-Fed-Investigation

    The U.S. Federal Reserve gave out $16.1 trillion in emergency loans to U.S. and foreign financial institutions between Dec. 1, 2007 and July 21, 2010, according to figures produced by the government’s first-ever audit of the central bank.

    Last year, the gross domestic product of the entire U.S. economy was $14.5 trillion.

    Of the $16.1 trillion loaned out, $3.08 trillion went to financial institutions in the U.K., Germany, Switzerland, France and Belgium, the Government Accountability Office’s (GAO) analysis shows.

    Additionally, asset swap arrangements were opened with banks in the U.K., Canada, Brazil, Japan, South Korea, Norway, Mexico, Singapore and Switzerland. Twelve of those arrangements are still ongoing, having been extended through August 2012.

    Considering the USA upon the abrogation of Bretton Woods in 1971 have imposed on the West this particular form of Debt Based Fiat Monetary system, I’d say that not only have we been sold down the river by our respective politicians but, empirically, I can only conclude that DBFM is inherently and deliberately skewed to favor the sponsors of the system… i.e. the Primary Dealers…

  11. “It depends how the power of the ‘sponsors of the monetary system’ is spread. If it were spread more widely (and actually this goes for the power of ‘economic actors’ in general), I believe not only would we see a more equitable spread of wealth but we would see an economy that was more efficient in creating human welfare.”

    Once again, you’ll forgive my obtuseness, but to my eyes the power of the sponsors is absolutely concentrated and arbitrary.

    In presumably open societies predicated on the principles of democracies as we have in the West, the choice of monetary system was neither debated nor ratified by society. Worse still, management of the monetary system occurs by decree behind closed doors. To wit: setting of interest rates, need for quantitative easing, need for bailouts, need for appropriation of public funds … and so on and so forth… can power get any more concentrated in the hands of a very restricted circle?

    I’m not a trained economist but what I see paints a dark picture… and the numbers and their progression tell me the majority of the great unwashed are getting penetrated at the base of their back…

  12. Guido seems to have some good points.

    The problem with any sytem that is unfair, is that those who make money out of it will deny or diminish that unfairness?

    The more so in view of the massive credit expansion. These money makers are distorting the economy and while technically correct to say that correction will occur, these also cause suicide, investment distortion and delay in implementing new technology.

    These prices are too much to pay, simply to allow privateers to profit. They clearly lost control of the system and their platitudes about light regulation should be read by those who enjoy a hearty belly laugh occasionally!

    The constitution of a state such as Iceland currently being altered by crowd sourcing, should provide limits on banking and allow every citizen/resident a bank account in a state bank. The only banks that do not go crawling on their belly for state support are state banks: irony?

    Steve Keen has solved the prediction of bank bust with his formulae. It is clearly inherent in any chain letter that the later subscribers run out of subsequent subscribers, greater fools as they are termed, as everyone is already subscribed! In an asset based economy, this means that those who dispose of the assets obtained by means of cheap credit make out like bandits and those who suddenly realize they are those greater fools get to tell their children why things are no longer so rosy.

    Ideal for those who thrive on division in society but not for the rest of us.

  13. At ponit 11 above, you describe the role of primary dealers. But like all trained economists, you neglect what goes on in practice!

    There has been too much money, credit, created. Now those assets that are directly related to loans will drop and overshoot.Those that are not, like commodities will soar, affected by the purchasing power possessed by those who came out on top in the chain letter banking system!

    I speak as someone who saw this coming and left Ireland, Europe and went to Australia. If only I could sell my Irish civil service pension! It is going to diminish for the next few decades.

    The depression was baked in until the Republicans called for a PNAC and we got 9/11 and ZIRP. Now it is going to be worse and last longer!

    How would a trained economist term that sleight of hand? HAHAHAHAHAHA!

  14. We\re all Bernankes Bitches now!
    The truth is both darker and stranger than fiction.
    The founding fathers of the USA will be turning in their graves.

  15. Guido #12

    The growth of Federal Debt is primarily a consequence of spending and taxation policy decisions rather than the structure of the monetary system.

    Guido #13

    I’m not sure why the Fed’s role in providing liquidity (whatever its merits) should automatically mean it controls all non-dollar currencies. It may be that it tends to act to support certain institutions – but again that is not a structural issue, but an issue of the distribution of power within the structure.

    Guido #14

    the majority of the great unwashed are getting penetrated at the base of their back…

    With that I most certainly agree – but I don’t it’s primarily a (macro)structural issue.

  16. Diarmid,

    What then is the utility or need to adopt a Debt Based Fiat Monetary system if the constant expansion of money and credit is, as you claim, not a structural issue but, rather, a policy issue?

    If that were so, then any other monetary system would do…. no?

  17. Guido,

    The term ‘Debt Based Fiat Monetary System’ is not really a good one as it conflates two different types of money. ‘Fiat’ money is money that has little or no intrinsic or value or any ultimate demand, but is sustained in circulation by some form of authority or convention. It’s not really clear that such a money has ever truly existed (some work on this by Dror Goldberg). Debt-based money, on the other hand, comes into existence with an obligation to accept the money in repayment of the contemporaneously created debt. I would class central bank money supported by a state that is capable of collecting taxes and has a reasonable fiscal reputation as essentially the same sort of money.

    The advantage of debt-based money is that the quantity of money varies with the quantity of loans, and the quantity of loans should vary with the level of economic activity. The part of the system that is decentralised (private bank deposit creation) should respond automatically without the need for complex calculation.

    Note the ‘shoulds‘, because clearly the system is not working as it ought, but I would contend that it could do if the identity of the deposit-creators was changed. Moreover, I’m not sure what monetary system would be an improvement (although in Money and Credit in 2050 I proposed a greater role for barter). What would you propose to replace the current system?

  18. I read what you are saying the distinction is and it still looks to me like you described exactly the variety of money that is imposed upon us.

    What is our monetary system then?

    As far as what I would propose, let me premise that it is clear that any monetary system can be gamed given political will. History is replete of examples. That said, it is empirically clear that our current set up is geared towards the transfer of wealth from the get go. The arithmetic says so.

    Not only have our politicians tasked a third party to create a currency that society must make use of to the exclusion of any other, under penalty of incarceration. But the creator of the currency is also compensated to create something that has no cost structure.

    So the creator of the currency has a vested interest in creating as much currency as possible for virtually 100% profit. On the other hand, society must employ labor, resources and capital in order to repay the creator of the currency and potentially make a profit. This relationship is completely skewed in favor of the monetary authority. Thus in the long run, the productive capacity of society is concentrated in the hands of the monetary authority and the entities that gravitate around it.

    A more equitable system would be to have either a value based monetary system or even a fiat monetary system based on a fixed amount of currency. Whatever the system, it seems to me that the important thing is to cut out the third party creator of the currency at interest.

  19. The advantage of a value based monetary system, is that if politicians were tempted to expand the money supply, they would have to first prospect, collect, convey, refine and distribute whatever material constituted the basis of the system. Ergo, in wishing to expand the money supply they would contribute to expand the economy.

    But a better system would be to do away with politicians all together.

    As an occupation, politician should not exist or should be banned. Politicians should not be a career. The combination of professional politicians and electoral politics is a dynamic that must inherently and necessarily result in the concentration of power and the creation of aberrant interest groups.

    We can dream eh?

  20. Guido,

    In what sense are national currencies imposed? You repeat the line ‘a currency that society must make use of to the exclusion of any other, under penalty of incarceration’ but this doesn’t appear to be true, since in the US and other countries people make use of local currencies without any apparent sanction by the state.

    Therefore it seems pretty clear to me that national currencies are backed by the tax-raising power of the state and that the deposit money that uses them as reserves are backed by the loans with which it is issued. It’s true that most of the time we don’t think about this backing – we just know we can use our cash and deposits to make our next and future purchases – but I don’t think the system would be sustainable in the long term without it. So if we regard tax liability as a sort of redistributed debt, then what we have is a purely debt-based system of money, and for the reasons I gave in my previous response I don’t see any problem with that in itself.

    It is certainly true that banks are a ‘third party’ creating deposit money, but no-one is forced to accept (or use) deposit money – it is accepted because many people and businesses have debts to banks that they need deposit money to repay (and because it is exchangeable 1:1 with central bank money if desired). Moreover in a competitive banking system there are multiple sources of deposit money. (My problem is that despite being multiple, these sources are all playing the same wrong-headed game.)

    Banks earn interest on deposit-money loans, but they also incur costs because any transfer of deposit money has to be accompanied by a transfer of central bank money which is costly to acquire, and because any loan carries a risk of default that the bank is responsible for making good. Therefore it is not true for deposit money that the creator…is also compensated to create something that has no cost structure’, that there is ‘100% profit’, or that its creator has a ‘vested interest in creating as much currency as possible’, since only a finite quantity of loans will be viable.

    As for the creator of base money (cash and reserve accounts) it would seem that you believe this to be other than the central bank on behalf of the state (or you believe there to be some profit-earning intermediary). I’m not clear of your grounds for believing this. As far as I see it, the central bank allows the government to spend, with the quantity spent being accounted for in the reserve accounts (held at the central bank) of the banks in which recipients of government spending hold their deposit accounts. To the extent that the central bank makes any gain in their role here, this gain goes to the government. Clearly if that’s all that happens then each new issue of central bank money adds to the total in circulation, but in fact most of the created base money is removed from circulation in the reverse process of its creation, as tax is paid. The slight wrinkle is that money can be temporarily removed and added again through the process of bond sales and purchases, and I guess the ‘primary dealers’ do have some advantage in having first access to trading in these bonds – but it’s not clear to me that they will make a profit that exceeds by any unusual margin the advantage that an orderly bond market brings – as long as they are not allowed to form a cartel anyway. It’s also true that the QE process appears to have allowed the (wrong-headed!) financial institutions to make additional profits instead of increasing economic activity as intended – but the QE process is not in any case the normal mechanism by which the base money creation system works.

    The government may have an incentive to create and spend too much money under this system (at least in relation to its tax revenue), and corrupt central bank and government officials can certainly gain from this. But in a properly informed democracy the inflationary and other economically damaging effects of this should be a strong disincentive.

    I don’t think a pure fiat system is sustainable. A value-based (by which I assume you mean commodity-backed) monetary system might mean a more stable value for money, but it would also be inflexible, resource wasteful and potentially deflationary. It would give excessive power to whoever controlled the commodities with which it was backed. So unless all the claims you make against the present system are true I don’t see any grounds for replacing it rather than reforming the way in which its components are operated.

  21. It is not the currencies that are imposed.

    It is the system that manages the currency that is imposed. If is the US$ Based Debt Fiat Monetary System.

    Regarding the penalty for not using the currency predilected by the state you could do worse than see what happens when you try to barter a big ticket item like a house or a car for example (I am Italian and barter is not contemplated by law… some form of transaction must be recorded in order to tax it). But I suppose a better case in point is the recent and ongoing saga of Mr. Von Nothaus:

    http://www.nysun.com/editorials/a-unique-form-of-terrorism/87269/

  22. By the way. I really appreciate your taking the time to debate this back and forth with me… it is immensely useful for me…

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