Home > Main > Ellen Brown’s Web of Debt

Ellen Brown’s Web of Debt

October 31, 2011

I am going through Ellen Brown’s “Web of Debt” book, and page 46 really jumped out at me.

One of my major problems with monetary policy is that it must end in either a bust, or lots of little, horrible human miseries.  This isn’t even debated by the supporters of Monetary policy.  It’s just assumed its natural and desirable.

Monetary Policy is about creating human misery, over and over again.  I think the idea behind line is simply handwaved away by fans of monetary policy, as though defaults are’t a big deal:

“But the premise still applies: in a system in which money comes into existence only by borrowing at interest, the system as a whole is always short of funds, and somebody has to default.”

Usually, these defaults come at a steady stream, so we just hear about stories of some second hand person who lost it all.  Every few generations, massive amounts of people default.

Monentary Policy is all about the central bank deciding that someone needs to go bankrupt, that someone needs to get fired, that some couple should fight about money for the next year.  It’s all about pushing thriving companies into a spiral of debt.

Compound interest cannot be eternal, because it grows exponentially.  But we’ve created a such a good system of record keeping that we’re seeing it on the book for decades and decades, so we are seeing the end game of this exponential growth.

Here is Ellen Brown, talking about planet sized hunks of gold:

The Importance of Usury Laws, a writer named John Whipple did the math. He wrote:

If 5 English pennies . . . had been [lent] at 5 per cent compound interest from the beginning of the Christian era until the present time (say 1850), it would amount in gold of standard fineness to 32,366,648,157 spheres of gold each eight thousand miles in diameter, or as large as the earth.18

Thirty-two billion earth-sized spheres! Such is the nature of compound interest — interest calculated not only on the initial principal but on the accumulated interest of prior payment periods. The interest “compounds” in a parabolic curve that is virtually flat at first but goes nearly vertical after 100 years. Debts don’t usually grow to these extremes because most loans are for 30 years or less, when the curve remains relatively flat. But the premise still applies: in a system in which money comes into existence only by borrowing at interest, the system as a whole is always short of funds, and somebody has to default.

Bernard Lietaer helped design the single currency system (the Euro) and has written several books on monetary reform. He explains the interest problem like this:

When a bank provides you with a $100,000 mortgage, it creates only the principal, which you spend and which then circulates in the economy. The bank expects you to pay back $200,000 over the next 20 years, but it doesn’t create the second $100,000 — the interest. Instead, the bank sends you out into the tough world to battle against everybody else to bring back the second $100,000.

The problem is that all money except coins now comes from banker- created loans, so the only way to get the interest owed on old loans is to take out new loans, continually inflating the money supply; either that, or some borrowers have to default. Lietaer concluded:

[G]reed and competition are not a result of immutable human temperament . . . . [G]reed and fear of scarcity are in fact being continuously created and amplified as a direct result of the kind of money we are using. . . . [W]e can produce more than enough food to feed everybody, and there is definitely enough work for everybody in the world, but there is clearly not enough money to pay for it all. The scarcity is in our national currencies. In fact, the job of central banks is to create and maintain that currency scarcity. The direct consequence is that we have to fight with each other in order to survive.

I’ve heard ideas like this before from Ed Seykota (penny at 3% from the time of Christ), and there was recently a post somewhere about how really high rates of return are impossible to sustain much longer than a few decades.

Even very, very small rates of money capture by banks end up swamping the entire system.

[Update: A Summary Here – this comments section is getting very long]

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  1. October 31, 2011 at 9:04 am

    I believe this is called the Debt Virus theory.

    I think it’s bogus. It’s perfectly possible to have a system running completely on such debt-money.

    Steve Keen shows that in his models. If Neil Wilson shows up in the comment field here, I’m sure he’ll confirm..? (Hi Neil!)

    Somebody has to default? No, not necessarily.

    I do understand how one can come to that conclusion though. “How can those interest payments possibly be made in addition to the principal? Where is that extra money going to come from?”

    The answer is this: An interest payment made to the bank does not disappear from the total bulk of circulating money. It is still “circulating money”, although booked (at that particular point in time) on the balance sheet of the bank (rather than any of the other agents in the economy).

    That money is likely to be paid out in wages to workers, as profits to shareholders or as payments for other services. It is not taken out of circulation.

    “Oh, but it is taken out of circulation” you say. “That’s how I think it should be thought of”.

    Ok, but then you have incorporated an interesting aspect in your model: The bank is holding on to some of its income. It is “net saving”. But I would argue then that this net saving behaviour is not something that only banks do. Anyone that has an income could do that.

    Do you see what I mean? The problem is not banks collecting interest but rather agents in general doing net saving.

    And sure, if you have “net saving” in your model (a “leakage”) without an inflow (“injection”) as well, then money supply problems will obviously follow.

  2. October 31, 2011 at 9:23 am

    Example of a debt-money economy that works without anyone defaulting:

    There is this small economy with one banker and one … other guy.. a worker. The banker lends 120 buckaroos to the worker. It all has to be paid back a year later, plus an interest of 10 buckaroos.

    Oh dear, this can’t go well, can it?

    After a month, a first 10 buckaroo payment is made by the worker. But simultaneously, the worker has worked — doing practical stuff for the banker. So the 10 buckaroo payment pretty much immediately goes back to the worker as a wage payment.

    That same thing happens every month that year.

    The last month the worker also makes a 10 buckaroo interest payment.

    The hardworking worker ends up with 110 buckaroos and no debt. The banker has made 10 buckaroos.

    Only 120 buckaroos were ever issued, and yet it could handle the initial liability of 130 buckaroos without exploding in anyones face.

    • October 31, 2011 at 11:06 am

      While this example is sort of correct (I hope) it has a pedagogical flaw: Most Post-Keynesians note that when a repayment on a loan is made, the money “disappears”. It’s “destroyed”. (The money was created when the loan was created, and it disappears as the loan is repaid.)

      (Steve Keen disagrees though, but he’s wrong 🙂 )

      So, I should probably have created an example is consistent with that.

      • TC
        October 31, 2011 at 12:01 pm

        No it was a good example. And I am not sure that Steve K is wrong. I just think that the system he supports runs into real world problems.

        And don’t get me wrong – I like lending and debt. it’s just that lending and debt are all we use today, and we don’t recognize the huge power of fiscal spending. There are limits of how we should use each. NGDP targeting doesn’t recognize the limits to debt based stimulus, or that it chooses winners and losers more directly than just giving money to people.

        What we never get answered is why the financial crisis happened from the monetary guys. The market was moving down, but something happened that caused the entire debt market to freeze. They wave their hands about the fed, but lets face it, the fed was there with liquidity.

      • October 31, 2011 at 12:13 pm

        Absolutely agree with Hugo – it is the savings desires that cause the problem! It is also why all the “fixed money supply” regimes are doomed – because with fixed money any one agents desire to save out of income immediately causes some other agent to be deprived of income (see this post by Winterspeak: http://www.winterspeak.com/2011/01/why-government-must-run-right-size.html for a nice illustration. A much longer but even more illuminating version is from heteconomist: http://heteconomist.com/?p=658)

        Which all ties nicely into Warren’s comment I posted the other day: “the reason the govt can deficit spend in the first place without causing ‘inflation’ via excess demand is because the economy has a net savings desire for whatever reason.” (beowulf, I am reading the paper you linked too!)

        Regarding whether the money gets destroyed when the loans are repaid, we just recently had a discussion on Lord Keynes’ blog:
        http://socialdemocracy21stcentury.blogspot.com/2011/10/steve-keen-on-capital-account.html?showComment=1319693977174#c1860735401023821763

        Neil Wilson came up with a credit stock idea and I expect him to have a detail blog post about it sometime soon. To me, since bank capital is freed up when loan is repaid (as loans are some multiples of bank capital), in that sense the money is not “destroyed” but is freed for further “recycling”.
        (This all discussion, by the way, was about the fallacy of “for each debtor there is a creditor” critique of balance sheet recession theory of crisis, such as can be heard even from smart people like Krugman. Totally missing that propensities to save are vastly different between those debtors and creditors.)

        • TC
          October 31, 2011 at 12:23 pm

          I’ve been so dang busy on other projects I haven’t had a way to work on stuff lately.

          I was thinking about a fixed money simple back forth model that adds population over time. It’s a recipe for deflation. Then add banks, it is clear there will be defaults.

      • Clonal Antibody
        October 31, 2011 at 3:36 pm

        Hugo,

        You are incorrect in your thinking. You have just made the compound interest go away!. To have compound interest the debt has to accumulate. And the debt does accumulate, at both an individual level (when a person in debt becomes jobless and cannot find work) and at a societal level, as shown in the exponentially increasing debt figures – see http://tinyurl.com/3f2ltts

        The other error you make is in assuming that work can always be monetized. Remember, the loan is due in buckaroos, and not in the kangaroos that you are trying to sell.

        Yes the model does work, but it requires continuous growth of GDP. The rate of growth of the GDP then becomes the bankers profit, and if saved and “reinvested”, it accumulates, leading to income inequality, and finally to increasing bankruptcies in society, a transfer of accumulated assets from the defaulters to the bankers, and finally leads to economic collapse. This pattern has been observed at least since Babylonian times – see Michael Hudson’s “The Mathematical Economics of Compound Rates of Interest: A Four-Thousand Year Overview” Part 1 and Part 2

        At a societal level, the model works only if there is “real” gdp growth — nominal gdp growth coupled with zero or negative “real” growth will lead to income inequality and finally to collapse. This is not to say that collapse will not occur even if there is real gdp growth — real growth can still be accompanied by increasing impoverishment of the 99%

      • TC
        October 31, 2011 at 4:08 pm

        I agree with Clonal on this.

        The small rate of interest capture adds up – and because it accrues to one segment of the economy, that segment comes to dominate the other sectors.

        Over long periods, this effect is huge and comes to cause the imbalances we see today.

        But it’s funny because everything we bring up here is all part of the problem and the solution.

        We need debt, but not too much.
        Usury is bad for many reasons.
        Growing populations require more money
        Savings desires have huge effects

        We haven’t talked much about this little thought experiment:

        You get to flip a coin – and you get to set the payout! That’s right, you set the odds! Just set the odds before the flip, and then if you win, you get those odds! 100 to 1 – sure! 1000 to 1 – yes we are takers!

        Here’s the catch – the wager must be your entire net worth. You win, you get a huge payout. You lose, you lose everything.

        I think this thought experiment says a ton about savings desires.

      • October 31, 2011 at 4:32 pm

        Hugo,

        Steve isn’t wrong, and neither are most Post-Keynesians. It both disappears and doesn’t depending upon your point of view.

        It’s the models that both sides use that are incomplete.

        And I think I have a solution for that one, so stay tuned.

      • November 3, 2011 at 2:00 am

        Steve is not wrong. He just has a very slightly different point of view that is actually quite important (as it determines the ‘hunger’ of the bank to lend).

        It’s his double entry that’s wrong.

    • Clonal Antibody
      October 31, 2011 at 3:57 pm

      My reply with links seems to be stuck in moderation.

      • TC
        October 31, 2011 at 4:00 pm

        Hi Clonal,

        For some reason this happens to your comments all the time. I can’t figure out the reason why it happens. It might be that your “handle” trips the wordpress spam filter. It’s supposed to go through once I approve one comment from an email address! But yours – and sometimes beowulf – get stuck all the time.

        And…it’s intermittent, as you can see. Your one comment went through, even after the one got stuck.

        🙂

      • Clonal Antibody
        October 31, 2011 at 4:09 pm

        It is because most of my comments have links. Multiple links in a comment is a sure way to go to spam hell.

  3. PaulJ
    October 31, 2011 at 9:35 am

    I see what you mean but I can’t envision an economy without net savings, so isn’t your point moot. Sure it’s mathematically possible but so unlikely that it may as well be impossible.

    Plus what about growth in the money supply? In a debt-based private economy the aggregate is zero-sum, i.e. For every person/persons that gains financial assets some other person/persons must go negative, leading to default.

    Thus, the Eurozone cannot succeed as currently configured except by the longest of long-shots.

    • October 31, 2011 at 10:05 am

      I see what you mean but I can’t envision an economy without net savings, so isn’t your point moot. Sure it’s mathematically possible but so unlikely that it may as well be impossible.

      Agree completely.

      My point is just that the Debt Virus theory is misleading. The theory makes it sound like there is some paradox there: “How can that debt possibly be repaid — both principal and interest? Debt money is impossible, it can’t work without people defaulting!” It gives the impression that there is something special with the net saving that banks do, and I would argue that it is not.

  4. Dan Kervick
    October 31, 2011 at 9:52 am

    Something seems missing in this web of debt nightmare picture: the real economy.
    It seems to me that in a growing economy we would like the broad money supply – including bank-created debt liabilities denominated in money terms – to grow in sync with the growth in the exchange of real goods and services. In that way we get price stability, but no unnecessary frictions in exchange. The fact that the total money-denominated debt at any given time exceeds the total amount of money that has been created at that time is only a problem if the time schedule for the growing volume of debt payments and the time schedule for expected volume of real exchange are out of whack. As the real economy creates more goods and services in every cycle, its demand for monetary capital leads to the creation of additional money, and that new money as it circulates is used to pay off the debts of the previous cycle.

    So there is no reason that the money supply cannot continuously inflate along with the real economy.

    But I agree that in the real world we seem to have a persistent problem: Human avarice, dishonesty, division of responsibility and the passionate pursuit of profit are such as to lead people constantly into making loans that cooler reason would tell them are unlikely to be repaid, and into taking on debts that cooler reason would tell them they are unlikely to be able to pay. Human beings, left to their own laissez faire devices, tend to pile up huge liability surpluses of promises that run way ahead of the potential of the real economy to fulfill those promises. Eventually they can’t roll them over with new promises because even the most reckless of lenders come to the point where they say, “This is nuts. I’m out” So the whole business needs to be very well-regulated.

    I take it this is Minsky’s great lesson.

    • TC
      October 31, 2011 at 12:35 pm

      I’d agree with this “kinda”. This is the old “Natural rate of interest” argument. We can and inflate the money supply at the natural rate of interest and we’ll get no inflation.

      The problem with this rate is we can’t really observe it in real time. It exists as a mental construction. But we can’t see it in real time with enough precision to be able to help us.

      So it’s like aiming at a moving target from the deck of a ship at night, and then cursing our stupidity afterwords when we miss it.

      It would be much easier to choose things we can easily see to use as our guides.

      Also, there is something else. Real growth rates are all that matters. It’s the be-all, end-all of the point.

      If we had 70% inflation and 8% real growth, this would be awesome. Anyone who says different isn’t thinking through the consequences and how this would play out.

      Inflation isn’t the problem. With 70% inflation, you’d have 77% 10 year rates.

      The problem is unexpected inflation. And it’s way easier to run policy at high interest rates than low interest rates.

  5. Anthony
    October 31, 2011 at 10:01 am

    Keen argues that it is mathematically possible for an economy to run indefinitely with interest (contra Ellen Brown), but it has never happened and almost certainly never will. The reason is because the financial industry has a short-term incentive to load everyone else up with more debt than can be serviced long-term.

    I think he would say the error Brown makes is confusing a stock (the money supply) for a flow (income). Interest comes out of income, not the money supply. At least, that’s how I understand it.

  6. TC
    October 31, 2011 at 10:07 am

    Hi Hugo,

    I didn’t see a first comment from you – so it must have vanished. I don’t toss comments unless they are spam. Plus, your comment is great – why in the world would I toss something like that?

    I don’t agree that credit money is sustainable. Steve Keen – and i really, really like his work – assumes a flow of money.

    I’ve found money doesn’t have a guarantee it will flow. The old story about the town, the wealthy stranger who rents a room but doesn’t stay but magically allows everyone to pay off the debts misses the point.

    For me, the point of that story was that money was stuck before that dude showed up. This happens all the time in the real world.

    It’s like musical chairs but in the real world, and it happens all the time. You’ll have industries hit by this kind of effect.

    The problem then becomes if this effect cascades enough to force a system-wide margin call. Sometimes, this happens, and we’re absolutely screwed when it does.

    It’s not that Steve K is wrong. He isn’t wrong in an absolute sense. And I find his work to be essential to understanding how economies work.

    I just think he misses something very important – that the real world is very messy and isn’t clockwork at all. So there are times when there are no problems, but other times that force the system to take a snapshot. During those times, it becomes obvious that there will be forced defaults.

    That’s what we are seeing now.

    • October 31, 2011 at 10:53 am

      (Oh, I didn’t think you tossed the comment — it just never showed up.. It works better when I’m logged in to my wordpress account)

      Oh well, it’s pretty much a theoretical argument that I’m making, and no, it’s not super important for the real world.

  7. October 31, 2011 at 12:17 pm

    TC :
    NGDP targeting doesn’t recognize the limits to debt based stimulus, or that it chooses winners and losers more directly than just giving money to people.

    Or that it would only really work by employing a de facto fiscal stimulus!

    • TC
      October 31, 2011 at 12:21 pm

      Exactly. It’s fiscal stimulus through debt-based asset holders.

      Your comment was exactly what I was thinking when I wrote those.

  8. October 31, 2011 at 12:26 pm

    TC :
    I was thinking about a fixed money simple back forth model that adds population over time. It’s a recipe for deflation. Then add banks, it is clear there will be defaults.

    Exactly, you have to have deflation for a fixed money supply regime to be sustainable (or 0 savings desires). To which Austrians say “amen, that the whole point”. To which Keynesians reply “prices and wages are sticky”. To which Austrians reply “only because the gubmint made them so…”

    • November 1, 2011 at 4:21 am

      Perhaps I shouldn’t be too hard on Krugman, maybe he’s more post-Keynesian than I realized: http://neweconomicperspectives.blogspot.com/2009/08/keyness-relevance-and-krugmans.html

    • Peter D
      November 1, 2011 at 11:05 pm

      Hugo, this is important stuff, thank you! I will try and find time to check your references out. It makes intuitive sense that even without price stickiness you could have depressions but I want to see the logic more closely.

      • Hugo Heden
        November 2, 2011 at 8:19 am

        Oh, you should really check this stuff with peterc heteconomist.com — (I know you’re a regular commenter there) I think that this is the main thrust of what the capital debates was about?

        In any case, again: For Keynes, unemployment could *not* be guaranteed to be resolved by removing price stickiness. (By New Keynesians forgotten wisdom). It’s could possibly increase employment numbers — or not. Could go either way.

        One reason was given above — the classical deflationary trap.

        Another reason:

        Decreasing wages would mean decreasing incomes (for employed workers). Of course there would also be increasing profits for firms (and increased income for those who were unemployed that possibly would get a job).

        So what is the result on aggregate demand: Hmm — decreasing wages — that would mean decreased spending out of wages. (Although there would also be increased spending out of profits). The resulting effect on aggregate demand is unclear — it could go either way.

        Assuming that spending propensities from wages are higher that from profits (workers spend more of their income than capitalists), decreasing wages would result in decreased aggregate, and thus higher unemployment — contrary to the expected (by some) effect that wage cuts would clear the labor market.

  9. beowulf
    October 31, 2011 at 2:33 pm

    A bit off topic but it seems to me the best way to make clear to everyone that the govt doesn’t need to borrow to spend and that the govt only borrows to control interest rates is to make form follow function:
    Change the law so Tsy can create and deposit US Notes into TGA a millisecond before it spends them and the Fed can issue its own bonds and buy them back to adjust interest rates (it could always use its de facto taxing authority– Board-levied transaction fees– to pay debt service, but I can’t imagine a circumstance where that’d be necessary).

  10. October 31, 2011 at 4:39 pm

    Technically interest charged on loans is seigniorage. The bank earns it before the punter pays it and it comes from created money that the bank appropriates for its own use. The punter just gets his loan extended by the amount of the interest.

    So the banks pay their own interest.

    That isn’t in Steve Keen’s model either – because his double entry is wrong.

    • beowulf
      October 31, 2011 at 4:59 pm

      Yup, and on public debt the govt pays interest to borrow the money that it alone creates. Like RSJ says:
      All seignorage income should flow to the government, not banks. In the current system, the government is granting almost all seignorage income to banks. That is why it cannot seize more seignorage income for itself.
      http://windyanabasis.wordpress.com/2011/03/28/leaving-modern-money-theory-on-the-table/

      • TC
        November 1, 2011 at 8:38 pm

        We didn’t even get to this, beo.

        This isn’t even monetary policy. This is just granting banks free money, for no reason at all.

        I am finding Ellen Brown’s work to be useful in providing historical context. The Cross of gold…

  11. Jorge
    October 31, 2011 at 5:04 pm

    every time a bank reduces its equity, the non-financial private sector increases its net worth in the same amount. That is the source of the payment of interest. The bank is also an issuer of currency. In the same way that the government can always repay its debts, banks can always feed the circuit .

  12. October 31, 2011 at 5:15 pm

    Clonal Antibody :
    Hugo,
    You are incorrect in your thinking.

    That was obviously what triggered the spam filter 🙂

    Yes, yes, in the real world there is a ton of arguments supporting TC and you.

    I’m just arguing against the “where is the interest going to come from — mathematically somebody has to default”-idea, which is false.

    It’s not really about the real world, rather just a toy economy — a very simple model — and it does not depict the real world very well. But if you’re going to make arguments using that simple model, you’d better get it right.

    So, let’s consider the toy model. The mistake I think is being made there is that the banking system is understood as a closed system, separated from the rest of the economy, like this: “At the beginning of the year, a loan of $100 is being made. But then, over the course of the year, there is an extra $12 (say) of interest payments that has to be paid back in addition to the principal. $100 comes of of that closed system, and then later $112 is going back into it. Impossible! Somebody must be forced into default!”

    This is only correct if the bank refuses to spend what it earns in interest payments.

    But the bank may very well spend its income. One can think about the bank as any other firm within the economy: It could spend some of its income into circulation again. There can be wages, profits etc. And if it does spend, then nobody has to default.

    Yes the model does work, but it requires continuous growth of GDP.

    No, I will argue that it does not require growth. You can have a steady state economy based on “debt money”, with a constant circular flow of income and expenditure. (Yes, yes, it is a toy model, not a real world depiction.)

    Look: A bank makes a loan of $100, and expects interest payments of $1 a month, and repayment of the principal a year later. Ok, that $100 circulates around in the economy. After a month, the borrower can hopefully make the first interest payment of $1. So, now there will only be $99 left circulating in the economy? No! Because the bank spends that $1 into the economy again! This is key to what I’m saying here. The bank pays wages and stuff. There will still be $100 circulating in the economy!

    This will be repeated the next 11 months. And finally the principal is repaid. Nobody defaults.

    Yes, yes, it’s just a toy economy etc — in the real world agents are net saving! The bank may indeed be holding on to some of its income! But that is true for any other agent as well. If somebody — anybody — is net saving, then it won’t be this smooth. Somebody will have to re-borrow for original loan to be repaid.

    • Clonal Antibody
      October 31, 2011 at 5:24 pm

      Ah! But in your toy economy, the GDP is growing, and I would argue that it is exactly at the rate of interest charged by the bank. And if the real (CPI adjusted) GDP is stagant, I would also argue that there is a net shift of wealth (in the form of either an asset shift, or in the use of debt slavery labor) to the banker.

      • October 31, 2011 at 5:53 pm

        In my toy economy, GDP is not growing. The economy hums along nicely, with the exact same amounts of milk and chocolate produced every year. Actually the whole procedure with the $100 is repeated year after year as well 🙂

        • Clonal Antibody
          October 31, 2011 at 6:25 pm

          In your toy economy, the real gdp is constant, but not the nominal gdp – the nominal gdp is growing at the rate of interest, and inflation is impacting everybody other than the banker. This is because the banker is not producing any real goods and services, but is consuming those.

          Before the loan was made, the banker was unable to consume because he had no interest income coming to him. Now he can consume, but as you say, the real goods and services have remained unchanged. So there is one more mouth to feed on the same societal production. So the banker is richer on the backs of everybody else!

          If the banker was loaning out saved “money”, the story could be spun differently. But not on money created by fiat by the banker and lent out on interest.

        • November 1, 2011 at 2:47 am

          Clonal,

          Have you looked at Steve Keen’s constant private circuit model? It is stable where there is a capital limit on the bank.

          The bank takes its slice of the profit share – which makes sense since the capital part is debt funded.

          http://www.youtube.com/user/ProfSteveKeen#grid/user/0A21A329D01D0CFE

          Lecture 08.

    • TC
      October 31, 2011 at 6:24 pm

      “Hugo,
      You are incorrect in your thinking.

      That was obviously what triggered the spam filter . lol!

      But I don’t think that model works…

  13. October 31, 2011 at 5:36 pm

    Peter D :

    TC :
    I was thinking about a fixed money simple back forth model that adds population over time. It’s a recipe for deflation. Then add banks, it is clear there will be defaults.

    Exactly, you have to have deflation for a fixed money supply regime to be sustainable (or 0 savings desires). To which Austrians say “amen, that the whole point”. To which Keynesians reply “prices and wages are sticky”. To which Austrians reply “only because the gubmint made them so…”

    At which point the real Keynesians, the post-Keynesians, step in and tell those bleak Krugmanesque New Keynesians to go away.

    Post-Keynesians argue that it wouldn’t work even if prices were not sticky. Deflation (in the real world, as opposed to toy models) has a peculiar dynamic: As the real value of money increases, one would expect increased spending — there’s a lot more cool stuff you can buy with the money — stuff has gotten cheaper. But instead, people stop spending, and hold on to their money even harder..

    There is currently a humongous piece of text on this here: http://mmtwiki.org/wiki/The_Role_of_Government_Deficits — excerpt:

    If firms can cut wage costs they should also be able to cut prices, wage cut proponents argue. Lower wages and prices would imply that the value of “money” is stronger. More goods, services and investment could be obtained for the same amount of money. This could restore consumption and investment propensities, so that any desires to net accumulate financial assets would ultimately disappear — the decreasing prices would induce agents to spend all income. This could restore aggregate demand to a full employment level, it is suggested.

    There are however theoretical concerns to this argument as well, and whether such an economy would work is uncertain. Classical deflationary traps could occur. Due to the increasing value of the currency during deflationary episodes, agents tend to desire to increase their hoarding of net financial assets instead of spending and investing all income. This would cause sales to drop, thereby adding further deflationary pressure, resulting in an unstable spiral. The result could be the economy grinding to a halt.

    But see also Steven Fazzari’s excellent paper (very layman style): “A Penny Saved May Not Be a Penny Earned: Thinking Hard About Saving and the Creation of Wealth”; http://artsci.wustl.edu/~fazz/saving.pdf

  14. October 31, 2011 at 10:36 pm

    Hugo

    I dont think your story captures the essence of what is really happening in our economy. Your story makes it sound like banks are just intermediaries between people who are saving and those who are borrowing. This isnt strictly true. Banks are third parties that everyone owes money to.

    That story that was on the web the other day describing a guy coming into a hotel, leaving a hundred dollar bill on the desk while he goes up to inspect the rooms and the hundred dollar bill being circulated around town to pay off debts before ending up back on the desk, was a quaint somewhat illuminating story, but it was horribly deficient in describing our current debt predicament.

    When enough people owe more money to banks than they can possibly earn in the next ten years, the system comes to a halt and financial crises ensue. Its not unlike the govt doubling tax rates on everyone tomorrow. If everyones disposable income is cut in half due to tax increases the fact that the govt is in “surplus” is no help to the private sector. It will still be in deep recession.

  15. November 1, 2011 at 1:39 am

    Clonal Antibody :
    In your toy economy, the real gdp is constant, but not the nominal gdp – the nominal gdp is growing at the rate of interest, and inflation is impacting everybody other than the banker. This is because the banker is not producing any real goods and services, but is consuming those.

    Nominal GDP does not need to grow either.

    As discussed above: At the beginning of the year, the loan is made. At the end of the year, the loan is repaid. At that point, there are no financial assets or financial liabilities remaining. It’s all back to zero. Exactly the same state as the beginning of the year.

    The second year could then be an exact copy of the first year. And so on. Every year that follows could be identical. Ergo: No GDP growth necessary.

    It is true that the banker does not produce any real goods and services. So, if there was no banker before the “first” year, then there would have been one mouth less to feed. (There would also have been no monetary transactions without the banker — so no “nominal GDP” to compare with really, but whatever). And then, at the beginning of the first year when the banker emerged, there would have been one mouth more to feed. That would perhaps be akin to an increase in nominal GDP, I don’t know.

    But the following years could all be exactly equal to the “first” year. It would therefore be a steady state economy. No growth necessary.

    Before the loan was made, the banker was unable to consume because he had no interest income coming to him. Now he can consume, but as you say, the real goods and services have remained unchanged. So there is one more mouth to feed on the same societal production. So the banker is richer on the backs of everybody else!

    Agreed. In my toy economy, the banker seems pretty useless. Doesn’t to much good really… That’s an aspect of the model that — in spite of its simplicity — reflects the recent real world events pretty well 🙂

    • Clonal Antibody
      November 1, 2011 at 4:16 pm

      Hugo and JKH,

      No quibbles on what you said. Credit creation and charging of interest is quite sustainable. Sustained and compounding interest is not. Both of your models do not involve compound interest, or even an accumulating simple interest. In your models, interest is always paid back, and all interest income is always spent back into the economy. This model by its very nature does not engender growth.

      The problem occurs, if there is leakage because of saving of interest income, or because of the non payment of interest.

      In a compound interest scenario, every skipped interest payment means a further reduction in future income on part of the debtor, and saving of interest income has to be compensated for by growth for the model to function correctly and indefinitely.

      One of the shortcomings of Steve Keen’s model has been (correct me if I am wrong) that his models do not address income and wealth inequalities.

      My contention is that the private creation of credit money (without adequate taxation on banker incomes) inevitably leads to increasing income and wealth disparities. This problem goes away if banking becomes a government function. In that case, interest income is no different than government taxation

      • November 1, 2011 at 5:42 pm

        @Clonal, maybe you’d like the ideas depicted here: http://wfhummel.cnchost.com/nationaldepository.html
        “The Case for a Single National Depository” by William F. Hummel.

        (I’m not sure I understand it, but maybe you will)

      • JKH
        November 1, 2011 at 6:53 pm

        CA,

        In what I described, you can have compound interest just by increasing loans by the amount of the interest due, and increasing equity by the same amount (instead of debiting deposits and increasing equity). It’s still not an issue in terms of the basic question of the money being available in the system – in aggregate – in order to be able to pay the interest in cash at any point. It’s always there in the system. Distribution and ability of individual debtors to pay in cash is a separate issue.

  16. TC
    November 1, 2011 at 10:36 am

    Neil,

    I sure hope it involves balance sheet treatment of bank loans.

  17. JKH
    November 1, 2011 at 3:05 pm

    I’m late on this interesting topic, but here’s my two cents:

    “In a system in which money comes into existence only by borrowing at interest, the system as a whole is always short of funds, and somebody has to default”.

    This is false. I think it’s originally Marx’s idea. The Circuitists adopted it, and Steve Keen set out to prove them wrong as well. He developed an elaborate model of equations of stocks and flows.

    But an elaborate model isn’t necessary. You can show its wrong by simple double entry bookkeeping:

    First, treat the banking system as if it’s a single bank –

    So, as we know, loans create deposits.

    There are two sides of the question at hand – borrowers must have the money to pay interest on their loans, and the bank must have the money to pay interest on deposits.

    (The case of DEFAULTS is left to the end, for reasons to be apparent.)

    So, first assume the extreme INTEREST MARGIN CASE – where banks charge interest on loans but pay no interest on deposits. (Other cases that include interest on deposits will be seen as offshoots of this one.) Then assume away other bank expenses, and we have bank earnings equal to interest on loans. (Again, the base case is easily extended to other expenses such as wages.) Also, assume away the problem of distribution – i.e. the issue at hand is the question of borrowers in aggregate having the money to pay interest – not how they find the money as individuals.

    To start, borrowers in aggregate pay interest on loans with money in their deposit accounts. That is not a problem at the outset, since loans created deposits in the first place.

    So the bank is paid interest on loans by debiting deposit accounts of borrowers.

    At the same time, by elementary accounting, the bank credits its equity account by the amount of the interest earned.

    So bank deposits have declined; and bank equity has increased by the same amount.

    (Again, assume away all other bank expenses – they are just sideline details around the main question.)

    So the process over time is that the bank earns interest, reduces deposits, and increases equity.

    An extension on that basic interest margin case is that where the bank pays non-zero interest on deposits. But the overall dynamic remains the same – bank deposits decline (so long as interest earned on loans exceeds interest paid on deposits) and bank equity increases by an equal amount – the rate of movement from deposits to bank equity just occurs at a slower pace than the first case, other things equal.

    Now consider this type of bank interest margin dynamic in the context of 3 ECONOMIC GROWTH CASES – no growth (steady state), contracting, and growing.

    In a NO GROWTH CASE, borrowers continue to pay interest on their loans and therefore deposits shrink continuously and equity grows, reflecting the accumulation of bank earnings as equity. Assume in conjunction with this that in the no growth economic case there is no change in the size of the balance sheet – i.e. any loans that are repaid are replaced with new loans.

    As this process continues, bank equity continues to grow while assets remain the same size, so the bank becomes over-capitalized with too much equity.

    So the bank pays a dividend, or buys back its stock. That’s what banks do when they’re over-capitalized.

    Accordingly, it debits it equity account and credits deposits.

    That replenishes deposits from which more interest can be paid. It’s just a matter of distribution, not aggregate supply of deposits. It’s assumed that borrowers are capturing their share of deposits from their investments, etc.

    And so on.

    This process in theory can go indefinitely in the steady state case. The bank will keep paying dividends or doing stock buybacks as it accumulates excess capital. If the process were perfectly continuous, the asset/deposit/equity mix of the balance sheet would be constant (assuming constant asset risk levels and capital requirements).

    That’s steady state.

    Moreover, it doesn’t matter what the interest rate is.

    A 20 per cent interest rate just bloats the bank’s equity position that much more quickly, but it pays dividends or buys back stock to restore deposits. Compound interest is not an issue per se. There is nothing in this process that precludes a high interest rate per se.

    (As a special case, in the case of stock buybacks, at the theoretical limit, the bank may be down to one shareholder. And it will have done a whole lot of stock splits, reflecting the increase in value of the last shares remaining. Alternatively, that shareholder may already have started selling some of his stock in the market, which restores a more balanced distribution of stock across individuals. And none of this is an issue in the case of dividend payments, which are more the norm.)

    Now assume the economic CONTRACTING CASE where everybody wants to pay off loans.

    Borrowers will repay loans from deposits. Deposits will shrink. This will also result in bank over-capitalization, since an equity position that isn’t necessarily declining will become large relative to a declining asset base. Again, the bank will pay dividends or buy back stock in order to restore capital ratios.

    At the ultimate theoretical limit, the bank balance sheet will shrink down to virtually nothing. Then both loans and deposits decline and the bank buys back its stock until both sides of the balance sheet hit zero (in theory). The final transaction will move the last remaining asset, which will be a reserve balance, to another bank (banking system?) as a result of the final stock buyback. This is a very theoretical outcome, obviously, and not important in a practical sense anyway.

    The third case is a normal expanding economy, which is not a problem. It’s just a steady growth in the proportions of loans, deposits, and equity. There’s no problem sourcing interest payments from deposits, no matter what the interest rate.

    DEFAULTS and LOSSES are relevant to all cases above – most obviously, to that of the contracting economy.

    Defaults and losses just slice off sections of the bank balance sheet – assets and equity. If the bank’s asset loses value, it writes down the value of its equity by the same amount. The effect at the margin again is a decline in the equity capital ratio. In a simple model, that is resolvable through new bank equity capital issues, in which equity is credited and deposits are debited. That will restore equity capital ratios. It can also happen gradually through retained earnings – i.e. slowing down the process of dividends or stock buybacks.

    So defaults and losses are just a layer of activity over the basic model, and not a problematic issue in terms of the question of where interest comes from.

    In practice, the experience of banks in economic cycles is characterized by all the elements of equity accumulation, dividends, stock buy backs, and losses at different points in time.

    So, compound interest is not a problem per se.

    Compound growth of bank balance sheets is a separate issue. It is not the same issue as compound interest. Unlike compound interest, compound growth of bank balance sheets might be a problem, at least in theory:

    Economic cycles include losses that slow down the effect of compound growth of assets and balance sheets. The result is reflected ultimately in the growth rate of the equity capital account of the banking system, which hasn’t exactly exploded to infinity over the past few millennia. That in itself is evidence that compounding has never amounted to some nightmarish mathematical problem in practice.

    But the fact that defaults and losses slow down the pace of compounding of growth in the size of banking is not at all the same thing at all as the contention that payment of interest requires such defaults and losses. The latter point is wrong, as explained.

    As noted earlier, Steve Keen has an elaborate model on this topic – one that really isn’t necessary to analyze this issue, but one that is necessary for him, because he avoids the methodology of normal double entry book keeping, which is all that’s really required, and much easier.

    It’s always about accounting.

    Those who believe there is a structural banking problem of having enough money to pay interest are basically confused on stocks and flows. The description above (e.g. steady state) shows how a given stock (deposits plus equity) can generate flows that continue indefinitely.

    If this problem did arise out of Marx, it is ironic that the response involves some basic bookkeeping that demonstrates the resilience and flexibility of the core account of capitalism – equity capital.

    (BTW, this general issue of sourcing interest payments has nothing to do with any unusual complication arising from vertical money or MMT. Interest paid on NFA is interest earned on NFA. That’s just a transfer. And if banks own bonds or have reserve balances, there is an offsetting liability on the bank balance sheet, which reduces to the general framework of interest margins, deposits, equity, etc. described above.)

    • November 2, 2011 at 3:37 am

      That’s not quite accurate though. A bank can charge interest without requiring anybody to pay it.

      All that happens then is that the borrowers loan account expands at the same rate as the bank equity account. Deposits aren’t necessarily touched.

      It’s the payment of interest by borrowers that keeps the system stable.

      • JKH
        November 2, 2011 at 6:30 am

        Right; I qualified that above: November 1, 2011 at 6:53 pm

      • JKH
        November 2, 2011 at 6:57 am

        Apart from that, I’m not sure why compound interest is a big issue in the larger scheme of things. If you look at the “average duration” of compounding in the financial system, its probably pretty short. It certainly is in the banking system – instruments don’t normally compound very long until the cash is due, and banks don’t normally compound non-performing loans indefinitely, before writing them off.

  18. Clonal Antibody
    November 1, 2011 at 7:37 pm

    JKH :
    Distribution and ability of individual debtors to pay in cash is a separate issue.

    But that is the real issue, isn’t it? Interest is paid by individual debtors and not by the system. Take for example the glut of reserves in the banks today. If nobody is willing to borrow, because they are unable to pay the interest and principal, that money isn’t any good, is it?

    The problem can always be, and has always been resolved by a debt jubilee. See the Michael Hudson references. However, private bankers will always be unwilling, and perhaps unable to declare debt jubilees. The government however always can, particularly in a fiat currency regime.

    This is another reason for banking to be a public undertaking and not a private one.

    • JKH
      November 1, 2011 at 8:01 pm

      CA,

      As I noted, I was responding to this:

      “in a system in which money comes into existence only by borrowing at interest, the system as a whole is always short of funds, and somebody has to default”

      That’s just false.

      The issues you raise about individual distribution, etc. are separate from that – anything goes.

      • TC
        November 1, 2011 at 8:29 pm

        I was wrong about this – I need to remember to think of unit of account instead of money, and it will help me along.

        The system as a whole is not short of funds. Banks are magical entities we allow to make money out of nothing, so any system that involves banking can’t be short of funds. Going through the accounting proves it.

        But this system brings a horrible moral calculation into people’s lives. The desire for savings – something that can be “good” – becomes twisted into an act of ill will and even violence against your neighbors.

        • JKH
          November 1, 2011 at 8:52 pm

          Maybe two different themes here.

          One is just the stock/flow hydraulics of the monetary system. I haven’t checked back here to look at Steve Keen’s work on this, but its in the same general area as what I discussed, although he used an elaborate, somewhat artificial model where normal accounting would have sufficed. I believe he used a model where banks were actually using physical bank notes to do most of their own transactions, instead of simply recording them as electronic accounting entries.

          The other theme has to do with the kinds of savings issues you mention, which is another level of analysis. I think that’s an important theme, but I didn’t attempt to address that here.

        • November 2, 2011 at 4:47 am

          JKH,

          The physical bank notes is there because Steve wants to maintain a notion of ‘relending’ – which allows him to maintain a link with what Keynes wrote about circulation.

          I think he’s right to do that, but the notion he uses is incorrect. If he was an accountant he’d know what is missing.

        • JKH
          November 2, 2011 at 6:33 am

          Neil,

          Right. That’s also what allows him to claim money isn’t destroyed when loans are repaid.

    • TC
      November 1, 2011 at 8:05 pm

      I’d agree with this assessment, clonal.

      The question isn’t “Is the system solvent?” The question is “how much does the system wants to save?” In this system, the savings desire causes insolvency to the penny, right? It can all get paid back until someone wants to save a bit. Then, the loan can’t get paid back, and will default to the exact level of the savings desire.

      This is all the Sector balance stuff we love so dearly.

      This is a bit more interesting question than I originally thought, and I was wrong about the “someone must default” idea. There is no requirement of default.

      Default only needs to happen to the extent that someone desires to save. Saving then becomes a virtue where you must cause misery to exercise that virtue.

      This is ugly stuff. Ebenezer Scrooge pops into my mind…

  19. John Hermann
    November 1, 2011 at 8:37 pm

    “However, private bankers will always be unwilling, and perhaps unable to declare debt jubilees. The government however always can, particularly in a fiat currency regime.”

    Good point Clonal. And this is a powerful argument for having public banks.

    I agree with the main thrust of Hugh’s arguments. However it should be noted that commercial banks direct a small portion of their interest income to deposits in other banks, which lies outside the money supply and acts as a small (although limiting) drain on the money supply. So the debt virus hypothesis has a very small degree of validity.

    Nevertheless the debt-virus idea — that money necessarily needs to be created (by future bank lending) specifically in order to accommodate the interest portion of bank loans — is absurd, and has been thoroughly debunked and disposed of by those who have a good understanding of financial economics.

    Neil Wilson also makes a good point in saying that — in regard to the repayment of money loaned by banks — it “both disappears and doesn’t depending upon your point of view”. The bank credit money disappears in the repayment process (as indeed does any payment of credit money to a bank) however the associated reserves are retained. Reserves are the form of money that banks use in all of their transactions within the financial system.

  20. November 1, 2011 at 9:00 pm

    Long thread! I couldn’t read it all, but I’ll just say on the debt virus — I agree that it’s possible to have a sustainable system that includes interest. It works if the bank is publicly owned and the interest returns to the public and the local economy (as roads and bridges, reduced taxes, etc.). But in a private system, it doesn’t work that way. Bankers have far more money than they can spend on shoes or food. It gets REINVESTED — money making money. The banker can only hire so many people to scrub his floors. The rest is LENT back into the economy — at interest. Or it goes to wealthy CEOs who reinvest it — again money making money, in what amounts to a pyramid scheme, because more is always taken out of the system than is put in.

  21. November 1, 2011 at 9:01 pm

    Margrit Kennedy shows that 40% of everything we buy is INTEREST. Pretty shocking. There has to be a better way to design a trading system.

    • TC
      November 1, 2011 at 9:21 pm

      That’s a huge number. I tried to find something on this – any links?

      • Clonal Antibody
        November 1, 2011 at 9:38 pm

        TC,

        Margrit Kennedy’s publications can be found here

        I will try do dig up the specific reference that Ellen just referred you to.

        • TC
          November 1, 2011 at 9:41 pm

          I was poking around there and couldn’t find anything for that exact number. Good site.

        • Clonal Antibody
          November 1, 2011 at 9:43 pm

          The specific reference to the 40% can be seen in Kennedy’s Why do we need monetary innovation? on page 3 “The transparency misconception”

  22. John Hermann
    November 1, 2011 at 10:27 pm

    I agree with much of what Ellen has said, but strictly speaking she is not talking about the debt-virus hypothesis. The issues of (a) the debt-virus explanation of the need for debt growth, and (b) the impact of the effective withdrawal of purchasing power from transaction money via various saving and investment options, are quite different explanations of the debt growth imperative. They should not be conflated.

  23. Clonal Antibody
    November 2, 2011 at 8:24 am

    JKH :
    Neil,
    Right. That’s also what allows him to claim money isn’t destroyed when loans are repaid.

    That is where the original issue of the “problem” of interest crops up.

    1) Money is created when a loan is made.
    2) Money is destroyed when a loan is repaid

    Assume
    3) All money is created only through loans(monetary policy.) No government or banker money created by spending (fiscal policy.)
    4) Money plus interest is due at maturity. No intermediate payments of interest or principal allowed. No compound interest.

    Question: In the above scenario, where is the money to pay interest coming from?

    This I believe is the conundrum of a monetary policy without a fiscal policy

    • JKH
      November 2, 2011 at 9:19 am

      “Question: In the above scenario, where is the money to pay interest coming from?”

      I answered that in my original comment.

      The bank debits deposits for the interest, and then pays a dividend. That restores deposits to the original level.

      What remains is enough money in the system to repay the loan.

      • Clonal Antibody
        November 2, 2011 at 9:45 am

        Exactly my point

        100 dollars has been loaned, 110 dollars is due. Only 100 dollars exist in the economy.

        Therefore a new loan for a 10 dollars has to be made.

        So the banker loans himself the money at no interest, gives it to you for services performed, and then you give it to the bank. Loan and interest repaid

        Bank issues a $10 dividend, Banker repays the loan.

        In other words fiscal policy,

        So should banking be privately owned, or publicly owned?

        In one case you are providing services to the “Lord of the Manor” (Private Banker) and in the other, services to the community (Government)

        • JKH
          November 2, 2011 at 10:23 am

          Sorry, exactly not your point:

          “The bank debits deposits for the interest, and then pays a dividend. That restores deposits to the original level.”

          There’s no loan. The amount of money required to pay the interest already exists as part of the deposit created by the original loan.

          The dividend then restores original deposit levels, and drive on from there.

          I fear you’re not understanding the accounting.

        • JKH
          November 2, 2011 at 10:42 am

          Scratch what I said.

          I see your point on the repayment of the 110.

          My point is that the 10 in interest can be repaid with the dividend. In your terms, a bridge loan may be required, but the dividend naturally provides the money to extinguish it. The money is temporarily trapped as bank equity, but it exists in that form only pending the dividend payment. And things are smoother than that at the macro level, where such micro matching isn’t usually necessary.

  24. Peter D
    November 2, 2011 at 9:47 am

    Hugo Heden :
    Oh, you should really check this stuff with peterc heteconomist.com — (I know you’re a regular commenter there) I think that this is the main thrust of what the capital debates was about?

    You must be right, but I never managed to wrap my head around what the Capital Debates were about. I thought they were more about interest rates, but I really need to sit and read and think about those things. One of the downsides of not having an economics education is that even lucid posts like the ones from heteconomist still use language that is foreign to me – I might read a sentence and while I would understand it on some basic level, I would not catch all the implications or hidden meanings.

    In any case, again: For Keynes, unemployment could *not* be guaranteed to be resolved by removing price stickiness. (By New Keynesians forgotten wisdom). It’s could possibly increase employment numbers — or not. Could go either way.

    Assuming that spending propensities from wages are higher that from profits (workers spend more of their income than capitalists), decreasing wages would result in decreased aggregate, and thus higher unemployment — contrary to the expected (by some) effect that wage cuts would clear the labor market.

    This makes sense. I wonder whether Austrians have any counterargument to this, except for saying “let the market figure it all out – if there is unemployment, then it is the right decision on a “cosmic” level”…

  25. Clonal Antibody
    November 2, 2011 at 10:46 am

    JKH :
    Sorry, exactly not your point:

    There’s no loan. The amount of money required to pay the interest already exists as part of the deposit created by the original loan.
    The dividend then restores original deposit levels, and drive on from there.
    I fear you’re not understanding the accounting.

    My original premise was the money can only be created as a loan. $100 I borrow – who borrows the $10, that you say the bank created?

    How did I as a borrower of the $100 get the remaining $10? So that I could pay the interest? When I borrowed $100, I did not get $110. I got $100. Explain the flow and the timing of the flow.

    Day 0 I go to the bank to borrow 100
    I get $100
    I rent land from the banker for $100, Banker has $100 – produce lettuce that I eat, and the banker buys for $100 – I get back the $100

    Day 10 I have to return $110

    There is only the bank, the banker (who owns the bank in total) and me

    Fill in the intermediate events and times.

    • JKH
      November 2, 2011 at 10:49 am

      I had amended above just before you posted.

      • Clonal Antibody
        November 2, 2011 at 11:00 am

        Thanks.

        But I hope you noticed that I sneaked in a little bit of “Georgism” in my response!

        • JKH
          November 2, 2011 at 11:17 am

          Unless you’re referring to Seinfeld, I’m probably not smart enough just yet to know what that means.

          However, I think we’ve stumbled together on an interesting distinction here. My reading of the general concern about availability of money to pay interest is that it seems to infer an assumption that permanent loan growth is required to lend the amount of interest that must be paid. That’s basically what I’m rejecting at the core. If you noticed, I qualified the lending requirement as a “bridge loan”. That is to say that the interest loan liquidates according to the natural operation of the banking system and its balance sheet. It is a matter of timing of mismatched cash flows which the system will make available – not a matter of a permanent shortfall in the money that is required to pay interest. To make that point, in the limit, for example, the borrower could micro match a dividend payment date to an interest payment date, where not even the bridge loan would be required. And there’s all sorts of other stuff happening at micro and macro levels to produce a more continuous version of liquidity in the payment of interest on loans.

          I.e. I don’t see that type of qualification made in the general explanation of the case for a shortfall in money required to pay interest, and I think its an important qualification. Indeed, I totally assumed it away in my initial comment, and until just now, because I think that the mere mismatch of cash flow timing is not the core point that the general population of objectors would like to make.

    • November 3, 2011 at 1:58 am

      Day 5

      Banker charges you interest. Your loan account increased by $10 but crucially not your deposit account. Bank equity increased by $10 instead

      Day 9

      Bank buys lettuces just in time . $10 ends up in your deposit account from the bank equity account.

      You have two accounts. A loan account and a deposit account. You payment of interest and principal causes the bank to reduce those accounts by the amount of the payment.

      The charging of interest and the paying of interest are separated in time.

  26. Hugo Heden
    November 2, 2011 at 11:30 am

    Clonal Antibody :

    JKH :
    Neil,
    Right. That’s also what allows him to claim money isn’t destroyed when loans are repaid.

    That is where the original issue of the “problem” of interest crops up.
    1) Money is created when a loan is made.
    2) Money is destroyed when a loan is repaid
    Assume
    3) All money is created only through loans(monetary policy.) No government or banker money created by spending (fiscal policy.)
    4) Money plus interest is due at maturity. No intermediate payments of interest or principal allowed. No compound interest.
    Question: In the above scenario, where is the money to pay interest coming from?
    This I believe is the conundrum of a monetary policy without a fiscal policy

    I think I understand what you’re saying. There is no “fiscal policy” in your toy economy. No money circulates back out from the bank into the economy in the form of dividends. Nor does the bank spend anything on wages. Right?

    As far as I can tell, the total debt outstanding will grow exponentially with compound interest (unless/until someone “defaults”)? So, eventually, the non-banking sector will be heavily indebted to the bank. This sounds like the debt virus hypothesis.

    Note that one of the assumptions you’ve made is that there are no dividends from the bank, no wages, no purchases, no spending whatsoever. So it’s not like the banker will gain anything in real terms in your economy. The guy will starve to death. What’s the incentive to run a bank like that? It’s absurd.

    At some point, the banker is going to start spending (i.e what you call “fiscal policy”, right?) — to assume anything else would just be absurd.

    Or am I just being confused?

    • TC
      November 2, 2011 at 11:35 am

      The bank can create units of account forever. In the toy economy, there is nobody to force a margin call except the bank.

      It can just have “equity” on the books in the unit of account that people can’t pay until it makes another loan, right?

      I think the point was to show the math first, then move to what a real world might look like.

      I’d say this toy economy doesn’t account for the implied put of real estate, but that’s another issue entirely.

    • Clonal Antibody
      November 2, 2011 at 12:34 pm

      Hugo,

      I do not think you are being confused. The question that is really being addressed in the guise of a discussion on interest is the question about the value of rent seeking. Hence the little Georgist” sentence that I sneaked in in response to JKH

      Historically, in Feudal society, the Government, the Banker, and the Land Owner were all the same person – namely the King, or the “Lord of the Manor” and all other individuals were his subjects.

      By ceding the ownership of the main productive asset to an individual (probably in return for “protection”) members of that society became slaves, or at best serfs.

      In today’s society, the power to create money has been ceded to the bank owners. Increasingly so, with banking deregulation. The impact of banking deregulation has been immense in terms of increasing income and wealth inequities. It has also resulted in a ballooning of private sector debt. Two graphs below from FRED will show the impact of deregulation on private debt

      TCMDO and GDP
      TCMDO/GDP

      Both of the above graphs are on a log scale and GDP is nominal GDP
      1st is ln(TCMDO) and ln(GDP)
      2nd is ln(TCMDO) minus ln(GDP)

  27. BrianK
    November 2, 2011 at 3:22 pm

    What was happening in Pennsylvania between the years of 1720 and 1750, was the road to Shambala…
    Read the 2003 Alvin Rabushka ( Senior Fellow at the Hoover Institute ) article, entitled ” Representation without Taxation ”
    to see the reality of the system that Ellen B advocates…
    the link is on the page you can access here…

    http://www.stanford.edu/~rabushka/articles.htm

  28. Jason
    November 4, 2011 at 8:27 am

    Doesn’t the government spend money into existence that is interest free?

    • Clonal Antibody
      November 4, 2011 at 9:25 am

      Yes. But that is a much smaller part of the money supply. Hence the need for public banking. With public banking, interest can either be considered a tax (combat inflation) or considered to be revenue to be spent for public (as opposed to private) purposes.

      Private Banking, with a high degree of regulation, along with high marginal tax rates (for the rich) coupled with deductions for charitable contributions will act in a similar way (though without government legislated counter cyclical automatic stabilizers.)

  1. November 2, 2011 at 12:13 pm
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