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Money Creation: The Fed - Crash Course Chapter 8

Creating money out of thin air since 1913...
Friday, August 8, 2014, 8:49 PM

Chapter 8 of the Crash Course is now publicly available and ready for watching below.

As a follow-on to the two previous chapters -- one explaining the nature of fiat money, the other showing how money is loaned into existence through our fractional reserve banking system -- this week's video details the Fed's near-magical ability to create money out of thin air (literally!).

We've devoted these past three chapters of the Crash Course to the process of money creation in order to understand this key question: What does the future look like for fiat currencies? (e.g. the dollar, the euro, the yen, the pound...)

In the case of the dollar (which operates similarly to the other major world currencies), we've learned that -- since all are "loaned into existence" -- all dollars are backed by an equivalent amount of debt. Debt upon which interest must be paid. As all outstanding debt must compound over time at the rate of its interest (at least), we come to this important conclusion: Our money system is designed to grow exponentially. And it requires ever more debt in order to do so.

Is this good? Is this bad? At this point, we're not here to cast judgment (yet). But, it does raise some important questions:

  • If the money supply must always increase over time, isn't the purchasing power of each unit of currency (e.g., each dollar) destined to speed its way towards zero?
  • What happens when hard limits prevent the system from expanding at the rate it needs to? (see: 2008 liquidity crisis)
  • Are those responsible for the rate of increase in the money supply doing a responsible job? (see: central bank quantitative easing programs since 2008)

Most of the people holding the majority of their wealth in fiat currency have little clue how it is created or managed. This leaves them very vulnerable to what happens to it over their lifetime.

How vulnerable are you?

For the best viewing experience, watch the above video in hi-definition (HD) and in expanded screen mode

Coming next Friday: Chapter 9: A Brief History of US Money

For those who simply don't want to wait until the end of the year to view the entire new series, you can indulge your binge-watching craving by enrolling to PeakProsperity.com. The entire full new series, all 27 chapters of it, is available -- now-- to our enrolled users.

The full suite of chapters in this new Crash Course series can be found at www.peakprosperity.com/crashcourse

And for those who have yet to view it, be sure to watch the 'Accelerated' Crash Course -- the under-1-hour condensation of the new 4.5-hour series. It's a great vehicle for introducing new eyes to this material.

Transcript: 

Now we’re going to travel to the headwaters to discover where money is actually created. 

The process works like this.

Suppose congress needs more money than it has.  I know, that’s a stretch!  Perhaps it’s done something really historically foolish, like cutting taxes while conducting two wars at the same time.   

Now, Congress doesn’t actually have any money so the request for additional spending gets passed over to the Treasury department. 

You may be surprised or dismayed or perhaps neither to learn that the Treasury department essentially lives hand-to-mouth and rarely has more than a couple of weeks of cash on hand, if that. 

So the Treasury department, in order to raise cash, will print up a stack of Treasury bonds which are the means by which the US government borrows money. 

A bond always has a face value which is the amount it will be sold for. And it has a stated rate of interest that it will pay the holder. 

So if you bought a bond with $100 of face value and paying a rate of interest of 5%, then you’d pay $100 for this bond and in a year you'd get $105 back.

Treasury bonds are sold in regularly scheduled auctions and it is safe to say that the majority of these bonds are bought by big banks and by sovereign nations such as China and Japan. 

The money that is used to purchase these bonds gets sent to the Treasury Department's coffers where is can be disbursed for the usual array of government programs. 

I promised you that I’d show you how money first comes into being and so far that hasn’t happened, has it?    The bonds are being bought with money that already exists. 

So where does money come from?

Money is created by this next mechanism where the Federal Reserve buys a Treasury bond from a bank. 

If you've been wondering what the so-called "Quantitative Easing" - or QE - programs are, this next bit describes them.

When the Fed buys a bond from a bank or other financial institution, they simply transfer money sufficient to cover the cost of the bond to the other bank and then they take possession of the bond. 

It's that simple.  A bond is swapped for money. The Fed has the money, the bank has the bond. 

Now, where did the Fed get the money to buy the bond? 

I'm glad you asked.  It literally comes out of thin air as the Fed simply creates money when ‘buys’ this debt. 

Such newly created Fed money is always exchanged for a debt instrument, be that a Treasury bond, a mortgage backed security (or MBS), or even corporate debt on rare occasions, so we can now put the title on this page.

Don’t believe me?  Here’s a quote from a Federal Reserve publication entitled “Putting it Simply”

"When you or I write a check there must be sufficient funds in our account to cover the check, but when the Federal Reserve writes a check there is no bank deposit on which that check is drawn.  When the Federal Reserve writes a check, it is creating money."

Wow.  That is an extraordinary power.  Whereas you or I need to work to obtain money, and place it at risk in the markets to have it grow, the Federal Reserve simply prints up as much as it wishes, whenever it wants, and then loans it to us all via the US government, with interest.

Given the fact that over 3,800 paper currencies (and a few metallic ones) have been rendered worthless due to mismanagement, wouldn’t it make sense to keep a very close eye on whether or not the Federal Reserve is acting responsibly with our own monetary unit?

What if they are overdoing it and printing too much?  Because this is such an extraordinary power to have, we should really pay close attention to what they are up to.

So now we know that there are two kinds of money out there.

The first is bank credit, which is money that is loaned into existence as we saw here.  Bank credit is a type of money that comes with an equal and offsetting amount of debt associated with it.  Debt upon which interest must be paid.

The second type is money printed out of thin air and that is what we see here at this stage.

The process by which money is created is so simple that the mind is repelled, so don’t worry if you need to review this chapter several more times.  I’ve had some people tell me that they've reviewed this section four or more times before it really began to sink in.

However, if you understood all that, and ‘get it’ congratulations, give yourself a hand, because it’s not easy.

These monetary learnings allow us to formulate 2 more extremely important Key Concepts.

The first is that “All dollars are backed by debt”. 

At the local bank level, all new money is loaned into existence. 

At the Federal Reserve level money is simply manufactured out of thin air and then mostly exchanged for interest paying government debt. 

In both cases, the money is backed by debt.  Debt that pays interest.  From this Key Concept we can formulate a truly profound statement which is that “At a minimum, each year enough new money must be loaned into existence to cover the interest payments on all of the past outstanding debt”. 

If we flip this slightly, we can say that each year all the outstanding debt must compound by at least the rate of the interest on that debt.  Each and every year it must grow by some percentage.  Because our debt based money system is growing by some percentage over time, it is an exponential system by its very design.   

A corollary of this is that the amount of debt in the system will always exceed the amount of money in the system. 

So...if there's always more debt in the system than money, and the interest to pay off the debt must be loaned into existence...well...that too deserves at least a few minutes of your careful attention.

It is not my role here to cast judgment on this system and say if it is good or if it's bad.  It simply is what it is.   By understanding its design, though, you will be better equipped to understand that the potential range of future outcomes for our economy are not limitless, but rather bounded by the rules of the system.   

And that system is one that is designed to increase by some percentage, in this case the rate of interest on all the outstanding debt, over time.

That is, our money system is designed to expand exponentially.  That is a feature of our money system.  Whether we happen to believe this is a good thing or a bad thing does not change the fact that this is simply how our money system is designed. 

All of which leads us to the fourth Key Concept, which is that Perpetual Expansion is a requirement of modern banking.  Not a legal requirement, but a systemic requirement-- like your body, as a system, requires oxygen.

In fact we can make a rule; to avoid cascading disruption, each year new credit (loans) must be made that AT LEAST equal the amount of all the outstanding interest payments that year. 

Without a continuous expansion of the money supply, past debts would not be able to be serviced and defaults would ripple through, and possibly ruin, the entire system.

Defaults are the Achilles heel of a debt-based money system, which we saw in our local banking example in the previous chapter.

Because of this, all the institutional and political forces in our society are geared towards avoiding this outcome. 

So the banking system MUST continually expand – not necessarily because it is the right (or wrong) thing to do but rather simply because that is how it was designed. 

It is a feature of the system just like using gasoline is a feature of my car’s engine.  I might wish and hope that my car would run on straw, or water, but I’d be wasting my time because that’s just not how it was designed.

By understanding the requirement for continual expansion we will be in a better position to assess whether that's even possible and, if we think that it's not, then we're free to imagine what might come next.

More philosophically, we might wonder about the long-term viability of a system that must expand exponentially forever but which ultimately lays claim to the resources of a finite planet. 

So the question is this: what happens when a human contrived money system that must expand by its very design runs headlong into the physical limits of a spherical planet That only has so much to offer?

Someday sooner or later, our monetary and economic models will collide with physical realities.

One more belief I happen to hold is that I will witness this collision in my adult lifetime and in fact it has already started, and I am extremely interested to see how this is all going to turn out.

Now this is, admittedly a truly gigantic proposition to consider, and some would say that this is not very interesting at all, but rather frightening. 

Well, if you want the future to look just like the past, then I suppose it is frightening. 

But if you are flexible in your view of the future then you have an opportunity to make the most of whatever future actually arrives. 

These are fascinating, invigorating and truly unprecedented times and I, for one, am thrilled to be living right now, right here, with you.

In the next section we’ll be looking at some very important historical context about our money system where you’ll learn that our money system could be viewed as a masterpiece of sophisticated evolution, or as a historically brief experiment that is just over 40 years old.

In order to better appreciate just how remarkable this truly is, please join me for Chapter 9: A Very Brief History of US Money.

Thank you for listening.

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48 Comments

Merle2's picture
Merle2
Status: Bronze Member (Offline)
Joined: May 4 2014
Posts: 34
Is perpetual expansion a requirement

Thank you, Chris, for sharing this excellent Crash course series. You present a very important perspective that we should all be aware of.

That being said, I must admit that I take exception to your concept #4 in the money creation video ("Perpetual expansion is a requirement of modern banking"). I do understand that money is created as it is loaned into existance, and that this money remains in the system until the principal is paid. And I see that, when the principal is paid, banks would then need to create more money to maintain the money supply. But what about the interest? Do they then need to loan out more money to account that the previous loans were paid back with both principal and interest payments? I don't  think so.The interest payments don't disappear from the system. They are simply the payments that the borrower makes to the banks or the Fed for the service they render. The bank or Fed in turn uses the interest payment to pay its costs for labor, building, heat, etc. Paying interest to a bank for the services they supply is no different from paying money to a lawyer for the services he supplies. The money stays in the system, and floats from one hand to another. It is not being destroyed.

So I have no problem imagining our modern banking system working with the stipulation that the total amount of money created will never exceed x trillion dollars. Once that money is created, no more could be created until some loans are paid off. When loans are paid off, the federal government can auction the right to create new money in loans.The highest bidding member bank (or the Fed) can then create money for more loans, and the profit from the auction goes to the federal government. So we always have x trillion dollars loaned into existence, and there is no need for perpetual expansion.

Actually accomplishing that in real life would not be easy, but if the people are informed and make their voice heard, I see no physical reason to believe that the U.S. dollar could not continue to exist indefinitely without perpetual growth.So though I agree that perpetual expansion is happening, I don't agree that it must happen.

My bet is that the money supply will continue to expand perpetually. My bet is the Federal reserve will continue to print money, and make ever expanding loans. But I see no reason to think this is a requirement of modern banking.

 

I

 

climber99's picture
climber99
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Money is destroyed as well.

Let me start by saying that the Crash Course is brilliant and it was my way into the topics of Energy and Money a few years back.  However now that I have studied money creation a lot more since, I am going to point out some very important omissions.

1. Money can be destroyed   (ie. can go back into thin air)

When Treasury bonds become due, the Federal Reserve receives the money from the Treasury equal to the face value and this money gets destroyed.  In addition, all the interest is also destroyed. 

2. There is an equilibrium at any one time between money being created and money being destroyed. Between new treasury bonds being issued and old treasury bonds becoming due.

When    money created > money destroyed = an increase in money supply

When    money created < money destroyed = an decrease in money supply

(All other variables such as velocity kept constant)

3. It is the Federal Reserve's job to make sure the money supply is at the correct level. (It is not the purpose of this post to make a judgment on whether it is getting this correct or not. I only want to comment on the mechanics)

Ed

climber99's picture
climber99
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Correct.

Correct, Hertzler.  It is one of the most annoying misconceptions in the blogosphere about money creation. Banks create money when they pay for services, purchase assets, pay dividends to shareholders, pay wages and bonuses to workers.  This gets spent into the economy and circulates until it comes back to the banks as 'interest'.  To summarise

1.  Money gets created in loans and any services or assets the bank purchases.

2.  Money gets destroyed when loans get repaid together with the interest.

When  money created > money destroyed  = increased money supply.  You are correct again when you say that this is not a requirement of modern banking.   (but beneficial if you are a banker wanting big bonuses when interest rates are low !!)

Ed

Merle2's picture
Merle2
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I agree that the money gets

I agree that the money gets destroyed when the principal is repaid, but is it being destroyed when interest is repaid? It seems to me that interest is just payment for services, and is no different from other payment for services. Payment for services is part of the flow of money around the system, that does not involve money creation or destruction. It is just money transfer.

It is this statement in the transcript above that I question:

At a minimum, each year enough new money must be loaned into existence to cover the interest payments on all of the past outstanding debt.

And my question is whether this indeed must happen. Why cannot there simply be a fixed supply of money in existence, without having to increase it at least by the amount of the past interest payments every year? I see no reason to believe this is so.

Again, I strongly support most of what is said at this site, including the problems with running low in cheap oil and mineral supplies, and the danger of  inflating skyrocketing bubbles when the economy cannot possibly increase fast enough to pay it all off. Those are huge issues.

But I don't see that there is a need to create enough new money to pay for past interest payments, and I don't believe this is nearly the concern that the other issues create.

 

 

 

climber99's picture
climber99
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Creation and destruction

The act of creating and destroying money can be conceptually confusing. 

Creating money.

1. A loan is agreed.

2. A credit appears in the account of the borrower

3. A liability appears on the ledger of the bank.

Destroying money

1. A loan is repay

2. money disappears from the account of the borrower

3. The bank liability disappears

There is no transfer of money. The money doesn't have to already exist before the loan is made. The bank can create as much as it likes up to its reserve requirements.

Interest is indeed also destroyed in the same way. Money created in the process of purchasing assets or services by the bank appear as a liability on the ledger of the bank and all interest that comes in gets subtracted from the bank's liabilities.

The key conceptual element is that no money is transferred. Money created and destroyed at any instant of time does not need to be equal.  This is a very important aspect of the economy because this enables the money supply to expand/contract in response to government policy or in response to the underlying state of the economy like its resource base.

Ed

 

climber99's picture
climber99
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Money supply can't be held constant.

The money supply can't be held constant.  It has to respond to the economy. You will get higher prices if the money supply is too high for the resource base and visa versa.

funglestrumpet's picture
funglestrumpet
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interest

Perhaps the question of the role interest plays in the money supply could be clarified if a closed system as used in chapter 7 by way of example of how banks loan money into existence were expanded to include what happens to the interest that the loan attracts. I would make the suggestion that the example should limit itself to the primary deposit of $1000 and the first loan without the complication of endless loans of diminishing value.

Perhaps it is because I am not a finance expert and am deluding myself, but I find no problem in seeing that all interest payments on all loans must themselves be loaned into existence, where else is the money to pay them going to come from? They are thus different from all other payments for services etc., which are, if I have understood it correctly, funded by money already in circulation and which must therefore already have been loaned into existence at some point in the past.

 

Merle2's picture
Merle2
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Thanks for your response,

Thanks for your response, Climber99. We will probably just have to agree to disagree on whether interest money paid to the banks is destroyed. I contend it is not. 

 

I have now found that this topic has been discussed before here. I cannot link to those threads for some reason, but if you will click on "discuss" - "forums" - "chapter 8" above you will be able to find them. In particular I found the thread, "Interest is not the key" to be helpful.

Why would bankers destroy the interest money that is paid them for their services? Doctors and lawyers don't destroy the money that is paid them for their services. It seems to me that doctors, lawyers, and bankers all recirculate the money we pay them for their services. As far as I can tell, none of it is destroyed.

But anyway, I didn't come to argue but to clarify this issue in my mind. I have found those other threads to be helpful, and suggest others who are curious about this issue also go to those threads. They have helped me.

Again the Crash Course is brilliant, and I highly recommend it. I just think the part I mentioned above needs to be reviewed further.

 

 

 

 

Merle2's picture
Merle2
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Thanks for your response,

Thanks for your response, funglestrumpet. I have seen this illustration before. The claim is that, if there is no money in existence, and we create $1000 out of thin air as a loan that gets paid back with interest, then there needs to be in the future another creation of money larger than the first so the borrower can pay back both the principal and the interest.

I think the problem here is that this illustration oversimplifies the problem. Let's modify it a little. Say the first loan is created for $1000 and given to me, with the stipulation that I will pay it back at $100 principal per year plus 5% interest on the outstanding balance until it is paid off. This $1000 now circulates around the economy as the only cash in the world. At the end of the first year I pay $150 to the bank, $100 in prinicipal and $50 in interest. The bank takes the $50 in interest, and uses it to pay their bills, and the money goes back into the economy. But the $100 I paid in principal reduces the net amount that is currently loaned into existence. There is now only $900 in the world. No problem. The bank still exists and creates another $100 out of nothing to give to someone else, and the world is back to a steady state of $1000 total money supply. I continue to participate in the economy and earn money for my services. The next year I and the other borrower make payments back to the bank. The bank retires debt with the principal payments we make, and creates new debt exactly equal to the principal it was paid. The process continues, with the bank continuing to loan out exactly enough to make the total money supply equal to $1000. I borrowed $1000 at the start of the process, and was over time able to pay it back with interest, without the bank ever having to increase the net money supply higher than $1000.

So yes, our simplified example requires the bank to continue to make loans so we have money in the system. But in no case is the bank ever required to increase the instantaneous money supply in existence.

But although the bank in our example is not required to increase the money in existence, they could desire to do it, because they would get more interest payments if they loan out more.

This is the real world issue. Banks are not required to make ever increasing loans. They desire to do it. And it is this desire for ever increasing loans, and ever increasing money, and ever increasing luxuries, and ever increasing stuff, even beyond the peak, that will cause problems. The peak in a finite world is inevitable. The only debate is when it will occur. If later history records that the peak in prosperity occurred in the year 2015 +/- 10 years, then we all need to address this issue now. In spite of our desire for more stuff, we need to be happy with less.

Hence the Peak Prosperity website.

 

 

 

theordore's picture
theordore
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What will happen when the system gets re-booted?

     The explanation of where money comes from should be taught to all of us who eventually become voting citizens.  We should also learn some of the basic implications of the process since those implications should influence how we think about personal asset management.  Thanks to Peak Prosperity for contributing to public knowledge on this vital subject.  
     I support the view that the source of money to pay interest is the same source that created the money upon which interest has to be paid. Thus, from my point of view, unless there is a well supported collective agreement as regards the maximum amount of money that should be in existence, there will be a tendency for that amount to increase indefinitely, though the rate of increase will vary a lot over historical periods. 
     A fascinating question is the following: if money is created out of thin air why do we have any confidence in that money? Looking at this question from the perspective of a citizen, it becomes important in two contexts.
     First, some decades after you start to use the system the same unit of money inevitably purchases far less hard assets that it did at your entry date. Thus if you do your financial planning on the assumption of the retention of purchasing power of that unit at a particular point in time you need to go back to square one and think again.  This issue arises from the design of the system.
     Second, if the total quantity of money in existence is much larger by big multiple than the comparable value of hard assets and real production, what are we going to do when something happens that forces us to reboot the monetary system and we find that we must then anchor a new system to the existing hard assets and real production?  I feel there will be some very big winners and losers coming out of that anchoring process, and that for a  proportion of losers the scale of loss might make them wonder why they should bother to soldier on.
 

climber99's picture
climber99
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Doctors and lawyers can't



Doctors and lawyers can't create money so it is logical that can't destroy it either. Only Banks have the power to change the money supply by creating and destroying money. Interest is just like any other money that the bank handles.

Perhaps it is the word 'destroy' this is the block here. When money is handled by the bank, be it a loan repayment or interest, a number is just deleted from liabilities column on a ledger held somewhere on the bank's computer. Deleted. Gone.  This is just the same as when someone takes out a loan. Money just appears in the borrowers account. From thin air.  It is a number created on some computer in the borrowers name and a corresponding liability created on the bank's computer. 

Remember only 3 to 5% of money in circulation is in physical form such as notes and coins. 95% or so are just numbers on ledgers held on computers.

It's hard to get your head around, I know.

An interesting case is when two individuals transfer money between themselves. Again numbers disappear from one account and appear on the other's.  The difference between this and what the bank does, is that these numbers must be equal.  Therefore it is indistinguishable from a 'transfer'. 

climber99's picture
climber99
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Thing of beauty

Our monetary system is a thing of Beauty. It doesn't create wealth inequality in itself.  We humans did that.

It has facilitated a huge expansion of resource extraction and population growth but will equally cope with a contraction of resource extraction and a reduction of world GDP.   

Fossil fuels will run out within 100 years and there will be probably be less than 1 billion people on Earth.  If you are waiting for our monetary system to collapse and/or a magical source of energy to be found, I think you are going to be disappointed. 

Enjoy your energy abundance now. It won't last for much longer.

Merle2's picture
Merle2
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climber99 wrote: Fossil fuels
climber99 wrote:

Fossil fuels will run out within 100 years and there will be probably be less than 1 billion people on Earth. 

And how are we going to get from 7 billion people to 1 billion in 100 years? You seem to be describing a massive die-off of unimaginable proportions.

I certainly hope things will not get this bad.

 

Merle2's picture
Merle2
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theordore wrote: Thus, from
theordore wrote:

Thus, from my point of view, unless there is a well supported collective agreement as regards the maximum amount of money that should be in existence, there will be a tendency for that amount to increase indefinitely, though the rate of increase will vary a lot over historical periods.

Absolutely. That has been a problem with any fiat currency throughout history.

The question here is whether a well supported collective agreement could limit the amount of money in circulation. I think it could. But getting that "well supported collective agreement" would be very, very difficult. 

 

Merle2's picture
Merle2
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climber99 wrote: . When money
climber99 wrote:

 

. When money is handled by the bank, be it a loan repayment or interest, a number is just deleted from liabilities column on a ledger held somewhere on the bank's computer. Deleted. Gone. 

Oh dear. Everything? Deleted? Gone? Then I should keep my money out of the bank, huh?

 

 

 

Merle2's picture
Merle2
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climber99 wrote: Perhaps it
climber99 wrote:

Perhaps it is the word 'destroy' this is the block here. When money is handled by the bank, be it a loan repayment or interest, a number is just deleted from liabilities column on a ledger held somewhere on the bank's computer. Deleted. Gone.

If that is true, then how do bankers earn a living? Here I thought they ran their business off the interest they collect from loans. If all the money they collect in interest is deleted, gone, then what do bankers live off of?

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funglestrumpet
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Response to Merle2

Having spent some considerable  time constructing a reply to your detailed comment about my earlier post, I lost it when I selected preview, All very annoying! So, in short (I cannot summon up the will to try and do it all over again), I suggest that we wait and see what future chapters provide on the key notion of the Crash Course i.e. that all money is loaned into existence. I am wondering if there are some challenges to be found in GDP growth and resource extraction (around chapter 20 and later. Until then, I cannot see how it is possible to avoid the fact that interest is physically linked to the principal and that it must at some point be loaned into existence to enable it to be paid. Seeing as all loans are backed by a debt instrument, the national debt must continue to grow.

So, let's pick up the cudgels when we are nearer the end of the Crash Course.

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theordore
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Maximum size to money supply

     Thanks!  As you will recall, another commentator in this thread has noted that certain interests would not go along with movement toward an agreement.  So, whether or not there is a system design factor driving the growth of the "mountain", it will just keep growing until there is an "accident".  As I read the experts, some feel the accident is inevitable, others doubt that it is.  All seem to agree that when it will happen is unpredictable.

    One thing I find astonishing is an estimate by some prof's that the aggregate "value" of derivatives is already 120-odd times as large as the estimated world GDP, and the money in the FX market is over 1,000 times as large as world GDP.  I can't say this is right or wrong; but if it is only half right, we know that the mountain has already become humongous.  God help us if a consortium of billionaires decide to convert in concert their money into real assets!   God help them too; because they will quickly learn that as those billions will not get them very far.

    The good news in all of this is that being a billionaire is no big deal any more (i.e. not worth striving to achieve) , and what we can build with our brains may be far more worthy of being called wealth than these piles of computer bytes we call "money".

climber99's picture
climber99
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Worse than that.

It's actually worse than that. World population will probably go beyond 9 billion before fossil fuel depletion starts to bite.  (It is called overshoot)

We may be able to build out our renewable energy or nuclear infrastructure before then. However, they need so much fossil fuel in their manufacture that you have to regard these technologies as what I call 'fossil fuel extenders'.  If we do manage to do this in time, all we will do with out extra time given us is to increase world population to over 10 billion.  Good plan !  No plan !  Who cares !

On the plus side, I may have underestimated how many humans the world can support post oil age. It may support 5 billion, optimistically.

Ed

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climber99
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Real values

You may be a billionaire but you can only drive one car at a time, live in one house at a time and eat so many calories. What matters is your health,  having an active mind and living within a self-supporting community like a family.

Paper wealth can disappear very quickly and real assets in excess to the people around you need defending !

Ed

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climber99 wrote: It's
climber99 wrote:

It's actually worse than that. World population will probably go beyond 9 billion before fossil fuel depletion starts to bite.  (It is called overshoot)

...

On the plus side, I may have underestimated how many humans the world can support post oil age. It may support 5 billion, optimistically.

Right, I understand overshoot. And yes, 9 billion is a number that is commonly given as the point where population will level off, and yes, 5 billion is the number some have given as the sustainable carrying capacity of the planet. But getting the population down to 5 billion in any kind of humane fashion is a huge task. But, of course, getting population to 5 billion would be a lot easier than getting it down to 1 billion humanely.  So I was curious how you thought the world population would reduce itself to those levels. Through Darwinian starvation?

 

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theordore wrote:   One thing
theordore wrote:

   One thing I find astonishing is an estimate by some prof's that the aggregate "value" of derivatives is already 120-odd times as large as the estimated world GDP, and the money in the FX market is over 1,000 times as large as world GDP.

I agree that the paper claims on the world's wealth are astonishing, and that if the economy peaks and declines as most people here expect, many of those claims on wealth cannot be paid off as many people expect. I understand that. 

Again the question is whether an increase in the money supply is required by modern banking due to interest payments on loans. I don't think interest payments require the money supply to expand, and based on previous discussions I now see here, it looks like many agree with me.

 

 

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funglestrumpet wrote:Until
funglestrumpet wrote:

Until then, I cannot see how it is possible to avoid the fact that interest is physically linked to the principal and that it must at some point be loaned into existence to enable it to be paid. Seeing as all loans are backed by a debt instrument, the national debt must continue to grow.

The problem is that it is claimed in the video above that interest payments force the banking system to increase the money supply.

And you say this must happen because interest payments are linked to principal. So if we were to unlink interest from the principal, will the problem go away? If instead of charging "interest" for their loans, banks start charging "annual fees" for their loans, could they then charge those annual fees without those annual fees forcing the Fed to expand the money supply?

If I pay a fee to a doctor, nobody says that fee forces the system to expand the money supply. If I pay a fee to a plumber, nobody says that fee forces the system to expand the money supply. And if I pay a fee to a banker for a safe deposit box, surely that must not force the system to expand the money supply. But if I pay the banker a fee (called "interest") for the services he provided in giving me a loan, people start claiming that this payment forces the system to increase the money supply. Sorry, but I just don't get it. 

 

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Good discussion about money...

In order to understand money, you really do need to sit back and just think about it.  The fact that the system creates money as debt, but does not simultaneously create the money necessary to pay interest, is a source of dynamic instability in the system.  Because of this, total debt will always run away from total money.  It would be my contention, and I think Chris' as well, that our central banking planners target positive inflation (odd when their charter is price stability, no?) in part to mute the effects of this dynamic.  

One of the best illustrations of how our central planning central bankers have been running the show, with a bias toward money expansion, is this chart from Doug Short;

       If the value of money is fairly constant, one would expect natural cycles of inflation and deflation.  This can be seen happening in the 1800's.  Since the mid-1950's though, there have been no extended periods of deflation.  In fact there has been almost no deflation... how magical, right?  Not magic... it's an intentional bias.  

My own idea to fix the system is this;  Create out of thin air the money that represents the interest on all of the new debt created - pass this out periodically (helicopter drop analogy fits here) in equal portions to all citizens... this way the "benefits" of inflation are democratized.  Bankers no longer need to fear deflation as much, and they don't need to run the system in a purposefully inflationary manner.  It's a pipe dream, sure.. but I think discussing it helps us to understand how our current system works and who benefits. 

Next up to discuss;  Derivatives:  A huge deflationary vacuum of money demands that were created as side bets on a system that does not have enough money to pay them.  

   

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Inflation and fiat currency

Once you understand debt based fiat currency.... you can really appreciate better what Bitcoin is.  Bitcoin is free market money that is not created as debt.  If I had to define the creation mechanism, I might explain it like this; 

"Owners of specialized computers, or groups of owners working together, run software that both creates new units of cryptocurrency, as well as maintaining an image of the ever-updating, public historical record of all transactions called the Blockchain.  Their inducement for employing their computers and internet connections in service to Bitcoin's decentralized network is... Bitcoins."

Some good reading;

http://bitcoinmagazine.com/15403/arrogance-dollars/

One sentence perfectly summarizes the problems with modern finance, and you can find it in your pocket. Open up your wallet and take out a US bill of any denomination. On its front, you’ll find these words:

“THIS NOTE IS LEGAL TENDER FOR ALL DEBTS, PUBLIC AND PRIVATE”

This simple sentence encapsulates Old-World finance, where central bankers make intimidating commandments, and governments try to manage commerce from a central point. Contrast this with bitcoin, which represents New-World finance. Several points:

1. There’s a reason why fiat currency needs special clauses. Never in history has a fiat currency maintained its value over time. Whoever controls the printing press has always inflated the money supply. Thus, fiat money, our dollar, comes with intimidating commandments: “You must accept this paper as money – or else!”

2. Bitcoin needs no special commandment. Nobody is forced to use it; nobody controls the printing press. If it came with a declaration, it would read: “This bitcoin is completely worthless unless you choose to value it.”

3. Consider the extraordinary hubris of central planners. Some distant, far away bankers declare that their special currency will be legal tender for all debts, public and private. Excuse me? Who do these people think they are? Imagine a regular person demanded you accept whatever currency he created, just because he said so. You’d probably think he was deluded.

4. Bitcoin proves that money doesn’t require government decree. Good economists understand that money emerges from a free market. It doesn’t depend on some authoritative declaration or mystical process. A growing number of individuals choose to trade with each other using something they find valuable. It’s no more complicated than that.

The new emerging financial system has no room for lofty commandments, and we mustn’t tolerate attempts to force people into one particular way of doing commerce. Believe it or not, people can figure out by themselves what currency they want to use. (Usually, they don’t want to use junk.)

We can expect the old, failing financial system to get even worse – historically, the closer a currency edges to collapse, the stricter the financial controls become. Be prepared for a flurry of new laws, rules, regulations, and threats regarding your freedom to use money.

Fortunately, bitcoin presents an opportunity to break free from this coercive system and its inflationary, fiat currency. No matter how hard they try, governments and central banks can’t create bitcoin out of thin air, and no matter how many laws they write, it’s going to be difficult to prevent people from using it. I only hope bitcoin will be able to withstand the onslaught from all the arrogant rule-makers attempting to control a new financial world.

      

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My own idea to fix the system
Jim H wrote:

My own idea to fix the system is this;  Create out of thin air the money that represents the interest on all of the new debt created - pass this out periodically (helicopter drop analogy fits here) in equal portions to all citizens... this way the "benefits" of inflation are democratized.  Bankers no longer need to fear deflation as much, and they don't need to run the system in a purposefully inflationary manner.  It's a pipe dream, sure.. but I think discussing it helps us to understand how our current system works and who benefits. 

I agree. If they are going to print money, then give it out to the people. $65 billion QE a month equals over $200 being printed per person per month. Gosh, why don't we adopt your plan and give that money to the people? My family could use the $800 they would get each month with your plan. and we would surely find something to do with it to stimulate the economy.

But I too dream.

 

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Jim H wrote: Once you
Jim H wrote:

Once you understand debt based fiat currency.... you can really appreciate better what Bitcoin is.  Bitcoin is free market money that is not created as debt.  If I had to define the creation mechanism, I might explain it like this; 

"Owners of specialized computers, or groups of owners working together, run software that both creates new units of cryptocurrency, as well as maintaining an image of the ever-updating, public historical record of all transactions called the Blockchain.  Their inducement for employing their computers and internet connections in service to Bitcoin's decentralized network is... Bitcoins."

Well yes, but I hear most of the bitcoins that will ever be found have already been found, so there isn't much to be made in mining bitcoins.

Those that started at the beginning got masses of free bitcoins. Those that get in late are turning over millions of good money to get bitcoins from those that got in early. Surely we can come up with a system that is more fair.

So you like that bitcoin is created out of nothing and not based on debt? We can do the same thing with united states dollars. Just print dollars whenever anybody mines a virtual dollar on the computer. Same thing. I don't see how that fixes anything.

And it would be possible to loan out bitcoins and collect interest, yes? And if that happened, would the bitcoin system then be required to increase the supply of bitcoins by the amount of interest paid? If we are going to make the rule that whenever dollars are loaned out we are forced to make more dollars equal to the dollars paid in interest, why is there not a similar rule saying that whenever bitcoins are loaned out we are forced to make more bitcoins equal to the bitcoins paid in interest?

 

 

 

 

 

 

 

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Jim H wrote: The fact that
Jim H wrote:

 The fact that the system creates money as debt, but does not simultaneously create the money necessary to pay interest, is a source of dynamic instability in the system. 

Can you tell me how you know this statement is true?

If the banks make thousands of loans to thousands of people who then spread that money around the economy as part of business transactions, why cannot we then use that money that is spreading around to pay the interest? We can use that money to pay the plumbers. We can use that money to pay the farmers for food. Why, oh why, can we not use that money to pay bankers interest?

 

 

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Instability
Merle2 wrote:

If the banks make thousands of loans to thousands of people who then spread that money around the economy as part of business transactions, why cannot we then use that money that is spreading around to pay the interest? We can use that money to pay the plumbers. We can use that money to pay the farmers for food. Why, oh why, can we not use that money to pay bankers interest?

Merle, I think that you have missed the point. If you have a debt and someone also owes you money, you can use what you are paid to pay the interest on your debt. Everyone with some income can use part of their money to pay the bankers' interest. It is just that in aggregate, there is not enough money in existence at any given time to pay all of the interest owed on all of the debt in existence. To get the interest money, net new debt must be taken on by someone. That delays the onset of instability only so long as there is either real economic growth or as long as the central banks will print money that ultimately goes to the other bankers.

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Hello Merle

All money is created as debt... as the principle of the loan.  Money is debt in our system.  But as you know, when you, say, get a car loan check from the bank to take to the car dealer... you are going to have to pay back that amount, plus interest.  It is that extra increment of money.. the interest, that is not created.  Thinking in terms of the entire system, and all the money, it is easy to see how total debt runs away from total money.  Total debt = all the principle + all the interest.  This system of debt money therefore thrives on growth, be it good, organic growth, or bad, inflationary (nominal) growth.  Growth, growth, growth.. we gotta get back to growth, right?  Why do you think our leaders say that?  Why can't we just have steady state?  Why growth?  Why does the FED target 2% inflation when their charter is, "price stability"?  The bankers have their fangs in us way deeper than we think.  Instead of thinking to question why the imperative for growth is so hard wired, you instead question how do I know that a debt-based money system is inherently, dynamically unstable.  The imperative for growth, the demonization of deflation, is all about what is good for the banks.  We have been taught to subjugate our own good, the yield on our savings, and the future buying power of our money, so that banks can be healthier.               

Inflation always benefits those with first access to the money.. deflation, on the other hand, benefits the saver, because his saved dollars will buy more in the future.  Today we have brutal financial repression, which is all about saving the banks.  Who gets punished?  The saver, of course.  Bitcoin is designed to be deflationary... just like Gold.  Bitcoin does away with the need for parasitic banks and their ability to abuse us via control of the money system.  You can have sour grapes over not seeing this earlier when Bitcoins were pennies each, but it does not take away from the truly revolutionary nature of this new free market money.      

None of this makes sense until you understand the nature of a debt money system.  I get a kick out of this guy, who, after calculating that there was much more debt than money, actually bumped into the fact that money is being created by the banks to lend (vs. the common idea that banks are lending you someone else's money).  

    http://simonthorpesideas.blogspot.com/2013/04/total-global-debt-and-mone...

DebtMoneySupplyRatio.png

Of course, we do use that money to pay interest.  There is only that money.. that which has been previously created as debt.  That is the entire pool of money, excepting for a small amount of actual paper currency that is created to lubricate the cash part of the economy.      

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Stan Robertson wrote: To get
Stan Robertson wrote:

To get the interest money, net new debt must be taken on by someone.

Yes, If all fiat money is loaned into existence, and if those loans are all paid off without new fiat money being created, then yes, of course, there will be no more fiat money left in existence. And yes, if there are no dollars left in existence, then there will be no dollars left to pay interest payments. Of course! And if there are no dollars left in existence, then there will be no dollars to pay grocery bills. Of course! And if there are no dollars in existence, then there will be no dollars to pay taxes. Yes. Yes. Yes. I agree.

Absolutely! Undeniably true. If there are no dollars in existence, and all American transactions take place in dollars, then commerce will grind to a halt.

Nobody is suggesting that we retire all money that was loaned into existence without somehow bringing more money into existence to replace it.

My point is that the instantaneous supply of money in the system does not necessarily need to increase exponentially. Simply maintaining the existing supply of money or adjusting it up or down as needed might be sufficient.

 

 

 

 

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Gold, bitcoins,and the Merle2 system.
Jim H wrote:

Growth, growth, growth.. we gotta get back to growth, right?  Why do you think our leaders say that?  Why can't we just have steady state?  Why growth?  Why does the FED target 2% inflation when their charter is, "price stability"?  The bankers have their fangs in us way deeper than we think.  Instead of thinking to question why the imperative for growth is so hard wired, you instead question how do I know that a debt-based money system is inherently, dynamically unstable.  The imperative for growth, the demonization of deflation, is all about what is good for the banks.  We have been taught to subjugate our own good, the yield on our savings, and the future buying power of our money, so that banks can be healthier.               

Inflation always benefits those with first access to the money.. deflation, on the other hand, benefits the saver, because his saved dollars will buy more in the future.  Today we have brutal financial repression, which is all about saving the banks.  Who gets punished?  The saver, of course. 

You seem to be making my point. Why does there need to be inflation? Why does the money supply need to increase? Why not keep the supply of money nearly constant, and let prices fluctuate up and down slightly, but not changing significantly over an extended period of time?

And yes, the Fed policy of inflating the money supply helps those who have connections to take advantage of the easy liquidity, and hurts those who save. So maybe we should not be inflating the money supply.

Quote:

Bitcoin is designed to be deflationary... just like Gold.  Bitcoin does away with the need for parasitic banks and their ability to abuse us via control of the money system. 

The system I proposed in my first post above is also designed to be non-inflationary. What is wrong with the system I proposed? Why doesn't your list of non-inflationary systems include gold, bitcoin, and the Merle2 system? Could you include the Merle2 system in your list, please? :) 

Quote:

You can have sour grapes over not seeing this earlier when Bitcoins were pennies each, but it does not take away from the truly revolutionary nature of this new free market money.      

No sour grapes. I am just stating that the way bitcoin is designed, those who got in early got their bitcoins for practically free, and now own much of the bitcoin total. If everybody were to move to bitcoins, then those few who got in early could easily earn half of the world's wealth. That is not fair.

It would be easy to create thousands of other bitcoin-like money systems. Should I invest in every single one of those, just in case one takes off and becomes a world reserve currency? Or should I gamble and pick one or two bitcoin-like systems, in hopes I pick the right one? If everybody starts gambling millions of dollars on which bitcoin-like system will take off, and only one of those bitcoin-like systems takes off, how can that possibly have a happy ending?

It just seems to me that it would be more fair to fix the current system, to end QE, to stabilize the money supply, to perhaps bring in some gold backing of the dollar, and thus to reward those who have worked hard all their lives and saved dollars hoping to retire.

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What are we going to tell our children about saving?

This last comment brings us to one of the bottom lines for us as citizens.  Tons of us worked hard and saved in the belief that in old age what we saved would have value that made the saving effort worthwhile.  And most of us were told to trust savings in the form of financial market instruments!  But now these instruments are looking more and more like Monopoly Money.  What are we going to tell our children about how and where to save for the future?

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That word again.

It is that word 'delete' again. A major block for you. It is only a word to describe a process.  Just think of it as 'interest' coming into the bank pays for the bankers wages.  Ok  

 

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That life

That is inevitable. I'm afraid, as net energy per capita declines.  The cost of energy increases with time. 

Saving is just 'deferred spending'.  The longer you wait to spend your money, the less energy you get for your money.

Example. Buy an iphone now for say $500  OR save this money to spend in 10 years time. In 10 years time the equivalent iphone might cost $800 because the energy and resources that have to go into that phone is now rarer and hence more expensive.

When net energy per capita was increasing, it makes sense to save or borrow for the future.

When net energy per capita is declining, saving or borrowing no longer is an automatic good thing to do.

 

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Edit out of time

I tried to edit my last comment but was out of time.

Decreasing purchasing power of your saving is not inevitable like I said.  If the money supply decreases during this 10 year period then you can maintain your purchasing power.  Like I said in previous comments; the money supply must be adjusted to match the resource base of the economy for stable prices.

Sorry for the correction

Ed

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climber99 wrote: It is that
climber99 wrote:

It is that word 'delete' again. A major block for you. It is only a word to describe a process.  Just think of it as 'interest' coming into the bank pays for the bankers wages.  Ok  

 

Delete" is a block, only if you claim that "delete" means the money is deleted. As long as you don't think the money is deleted, we are on the same page.

 

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Credit is not 'money'

All money is currency but not all currency is money

 
Fiat Currency:
Section 31 U.S.C. 5103, defines legal tender as "United States coins and currency (including Federal reserve notes and circulating notes of Federal reserve banks and national banks) are legal tender for all debts, public charges, taxes, and dues."
 
Federal Reserve notes are legal tender currency notes. The twelve Federal Reserve Banks issue them into circulation pursuant to the Federal Reserve Act of 1913. A commercial bank belonging to the Federal Reserve System can obtain Federal Reserve notes from the Federal Reserve Bank in its district whenever it wishes. It must pay for them in full, dollar for dollar, by drawing down its account with its district Federal Reserve Bank.
 
Congress has specified that a Federal Reserve Bank must hold collateral equal in value to the Federal Reserve notes that the Bank receives. This collateral is chiefly gold certificates and United States securities. This provides backing for the note issue. The idea was that if the Congress dissolved the Federal Reserve System, the United States would take over the notes (liabilities). This would meet the requirements of Section 411, but the government would also take over the assets, which would be of equal value. Federal Reserve notes represent a first lien on all the assets of the Federal Reserve Banks, and on the collateral specifically held against them.
 
By law, Federal Reserve Notes (FRNs) are money, a tightly controlled, tangible product with severe penalties for their unauthorized reproduction and if the Federal Reserve's (Fed) balance sheet is to be believed, there are about $1,040 billion accounted FRNs in circulation worldwide, the majority of which are held overseas.
 
FRN's (a.k.a. Dollars) are the primary unit of account by which all public/private debt can be extinguished.  They are also a medium of exchange and are assumed to be a store of wealth.
 
Fractionally Reserved Currency:
Commercial banks do not create money as defined by law.  They create a "money substitute" a.k.a. "book keeping money", a.k.a. "electronic digits", a.k.a. "Credit", a derivative of the primary money, Federal Reserve Notes, that is measured in dollars.  This practice is known as Fractional Reserve Banking (a practice that has been destroying economies, countries and lives for over 600 years).
 
Fractionally Reserved means that a portion of demand deposits are backed by cash FRNs.  Currently, the reserve requirement is 3% of demand deposits.
 
Credit is a debt generated currency that is denominated by a unit of account (FRNs). Unlike money (by a strict definition), credit itself cannot act as a unit of account. However, many forms of credit can readily act as a medium of exchange. As such, various forms of credit are frequently referred to as money and are included in estimates of the money supply.
 
Credit as currency is, quite simply, a promise to pay FRN's (dollars) upon demand as well as over time.  The everyday physical representation of that promise is the debit/credit card, which is the hallmark of modern computerized, fractionalized, debt driven commercial/investment banking.  Literally billions of dollars' worth of transactions are conducted in credit currency each and every day without any thought given to the un-fulfill-able promise that backs its use or the inevitable consequences of its failure.
Our economy is totally dependent upon the continuing flow of digits, which necessitates the continued expansion of public/private debt as well as the continued expansion of assets and asset values, for its survival.  To put it bluntly, It's a debt based pyramid scheme.
 
Unlike FRNs, which are an obligation of the government, credit currency is not, thus the need for the FDIC, which is as "Federal" as the Federal Reserve, a congressionally chartered consortium of private banks, the FDIC is a congressionally chartered subsidiary of the Federal Reserve that is funded primarily by member banks with allowance to borrow from the Treasury.  The objective of the FDIC is to re-digitize credited deposits (positive credit) that have reverted to their natural state of bank debt upon its failure.  In other words; the FDIC's function is to keep the illusion of "credit is money", and the fractionally reserved banking system that issues and administers this "money substitute", alive. 
 
 

 

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how can we repay the interest: the secret is flow

We are making an error in assuming that the system in aggregate needs to have enough money to repay all principal and interest in the system at any given moment, or the system is doomed to fail.

From a "system design" viewpoint, the amount of money needed to provide satisfactory liquidity for the total economy is vastly less than the total indebtedness + annual interest due.  Example:

You are a worker at google.  You make $250k/year, and you owe $1M @ 6% on your silicon valley home, but due to your massive spending on toys, you live paycheck to paycheck.  How much liquidity do you demand from the system for your life to function smoothly?  $1M + 6%?  $250k?  No.  You only require $20k, since that's the maximum amount you ever see in your bank account.  Your entire paycheck flows through that account each month, and the period - clearly is monthly - and so your maximum liquidty requirement ends up being your monthly paycheck, even though your annual interest payment alone might be $50k in year 1.

And the good news is, over time, you'll repay that $1M debt easily.  Your payments of $5k/month are no problem at all.  Even though "not enough money was created to pay the interest" on your debt.  That's because you are adding a heck of a lot of value at google, which gets you that $20k/month paycheck.

Flow is how interest payments are made.  Not even our google employee could make even his annual interest payments if he had to make them all at once, but its a piece of cake spread over 30 years.

What happens to those interest payments our google employee makes?  Do they just vanish into money heaven, sucked out of the system never to be seen again?  No, they get paid to bankers as salaries, paid as rent on buildings, and taxes, and sent out as dividends to shareholders.  All the recipients then spend their chunk of the interest payment flow on things they want to buy, perhaps even buying ad words at google which eventually helps to pay the salary of our google employee!  The interest flow is all recycled.

What's more, in practice, aggregate debt remains constant over time.  People in aggregate always seem to want to buy more than what they can afford at any given moment.  Houses, cars, factory equipment, you name it.  Debt remains largely the same, overall liquidity requirements remain the same, and profit + flow enables payment of the interest.

Its not to say interest has no effect.  Interest does - the higher the aggregate debt, the higher the interest flow (paid from worker or business "value add") to the banking sector.  More debt = a bigger slice of the "value added" flow sent to banking.

Here's another thought experiment.  People use 100 gallons of water per day, yet nobody is worried that the aggregate capacity of the water pipes in our cities cannot supply 36,500 gallons of water to each person at any given moment.  That's because we understand "liquidity requirements" (!) when it comes to water.  We just don't need 36k gallons all at once per person.  All we really need is 100 gallons a day in flow.

Therefore, I contend that the debt-based money system doesn't need to construct enough liquidity to pay the aggregate principal plus annual interest, because the liquidity required to pay the interest (assuming aggregate debt remains the same) comes from the flow through the system - money earned in excess of costs for people and businesses.

Of course, if people save money (and we assume for a moment that savings are not re-lent - cash stored in the mattress) then the system does need to create enough liquidity for that purpose as well.  But if the saved money is re-lent, then the system need not create any new liquidity for either the principal or the interest.

The secret of how interest payments get made is recycled flow - and the secret inside that is "value added".  Apple takes a collection of $100 chips, and creates an iphone that sells for $600.  Value add.  Value add + recycled interest payment flow allows for interest payments to be made in aggregate without requiring a large enough money supply to pay it all off at once.  And the other secret - interest payment flow is the skim off aggregate profits that goes to banking and savers; or these days, just bankers, not savers.

So after that long-winded presentation, why then is our money supply so clearly growing exponentially?  (Any chart of money supply will show this).  I claim its not some systemic design flaw.  It's simpler than that.

Its just greed.

It is the built-in motivation of banking to lend as much as possible, to push the envelope wherever possible, to maximize profits by getting everyone into as much debt as possible.  And since they can create money, they have the power to make it happen.  But they need a partner in crime.  So when you marry this intrinsic banking motivation to push debt to the apparently insatiable desire of humans to participate in ponzi schemes using borrowed money ("housing prices never go down"), you get a perfect, exponential money growth over time.  I'd call this the pusher/addict model but using money rather than heroin.

Its also called "the business cycle" - but attempts at "the great moderation" through rate manipulation means that the Fed has successfully prevented the system from really cleansing the ponzi from each previous cycle before it launches a new ponzi all over again, that just ratchets up over time, and we get that lovely exponential growth curve.

I do think population growth (also exponential) contributes, as does energy production growth (larger economy needs more liquidity to function), but I believe the vast majority of money growth since the 70s is just greed + ponzi, rinse, repeat.

Here's a % change chart of Bank Credit that shows that repeated Fed-rate-driven ponzi, with money growth oscillating around a steady growth over time - resulting in an exponential curve when looked at as an absolute value.  I posted it before:

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we know where it goes, but where does it come from

Merle2

Your observation that interest payments go into the bank and pay for paper clips and the cleaning lady, let alone banker profits is spot on.

But all of those - the money stays in circulation - answers miss the question.

If tomorrow you take out a loan for 10K that requires 12K repayment within 5 years, then from where does that 2K ORIGINATE?   Sorry, but what happens to it after you pay it is simply irrelevant.

As all money is created as a debt, and as no new money is created for the purpose of paying your 2K, then it must come from 'someone else's" debt 'proceeds'..... in reality creating a shortage of, and demand for, additional new money......and thus more debt. It works OK during monetary expansions. But its the musical chairs game from Zeitgeist on the downturn.

Chris has finally scratched the surface on this issue. But 'understanding' money still lies a bit down the road.

I suggest a reading of Soddy's The Role of Money for a look at the foundation of the system.

 https://archive.org/details/roleofmoney032861mbp

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Yes, 'money' is destroyed, but....

Climber99

In your first example, "the Federal Reserve receives the money from the Treasury", so, the Treasury HAD the money already, your taxes, and paid it over to the holder of the Treasury.....in this example, the Fed.

The Fed takes those payments as income, and at the end of the year, or more often, it pays its excess net income back to Treasury.....who uses it to pay the public's Bills. so, no, anything that comes from the Treasury's use of already existing money, is not destroyed in that process.

In your second example, beyond a couple of axiomatic truths caused by 'greater' and 'less' than symbol usage, I'm not sure what you mean by "equilibrium". There is obviously an ever-changing relationship, but beyond that, what are you saying?

On the third point, it is the FR's job to

"" maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.""

The Fed has zero control over either monetary(M-1 and M-2) or credit aggregates, as all are in control of the private banks.

That's the problem.

Thanks.

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But, how ?

Climber

Money (M-1) is created when banks issue credit balances upon receipt of your Promissory Note for repayment of THAT bank credit, PLUS the interest that is unearned.

With EACH principal payment, the M-1 money supply is reduced, destroyed, extinguished, or however you want to think of it. When the loan is fully repaid, all of that M-1 money does not exist.

But that debt-money paradigm creates either a reduction in the money supply, which would cause 'deflation', or a NEED for more new money creation to achieve monetary 'equilibrium'.....enough money to achieve economic potential....a.k.a., another debt-issuing opportunity for another bank.

Milton Friedman correctly opined that fractional-reserve banking "creates and destroys capital", all day long, every day.......and for this reason was a reform advocate when it comes to sovereign fiat money. As am I.

Thanks.

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That Statement is the ultimate truth.

Maybe Google "When Debt Money Goes Broke" by Stephen LaChance for the inside scoop on the 'end of tmes' cascading cross-defaults that will certainly erupt whenever there is not enough new money created to cover that year's interest costs.

You say 'past' interest payments.....but it is 'current' interest payments that requires 'current' money creation.

Thanks.

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The bank's liability is NOT destroyed.

There are separate paths that are operative here. One with you, and one with the payments system.

The bank's liability is to have money to pay for whatever demand is created, whenever that demand is created, and has nothing to do with loan repayments.

THAT is the 'work' of the bank. It needs reserves to settle the payments made from your account.

If you borrow 10k today and buy a car, the 10k is the liability of the bank TODAY to pay the seller. You have not made a single payment on your loan. But the bank's 'liability-management' people must pay attention and ensure the payment system functions.

It may take years for you to pony up your P&I payments, and destroy the bank-credit's "money"(M-1) balance. But the bank had to manage its real liabilities on Day One.

The solution is debt-free money issuance, BTW.

Thanks.

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bodies incorporated as collateral for the credit of a nation

Our birth certificates are bonds floated on the money markets and worth unlimited amounts of credit to the nation state. 

Every newborn child when bonded in this manner becomes the future repayment collateral for the credit that was just raised in its name. 

Check out the name on all you govt documentation. All caps letters indicates a body incorporated, not a man or a woman but now a legal entity called a person.

Now go to any cemetery and check out how the names on the tombstones are formed...in all capital letters. Here lies the body incorporated, a dead entity. We were only living men and women for the moments that existed prior to BC bonding into servitude.

And that is where all the obligatory debt promissory note paper originates! Sinister eh!

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Must be, but are not....

""I find no problem in seeing that all interest payments on all loans must themselves be loaned into existence,""

Actually, here the trumpeter approaches the conundrum of debt-based money.

But, it is a problem.

It is not possible for the banker to lend you the interest payment money....or he would not make any profit.

This is also true for the banking system as a whole.

Yet, correctly, YOUR interest payment money MUST originate from MY loan......but I spend my loan money for my car.....  and we're still short the interest money. riddle.  conundrum.   enigma.

Sorry, but the solution is not to try to figure out how to make this pig fly, but to install a sovereign fiat money system, issued without debt and interest payments due on the money created.

Are we ready for that discussion here?

http://sovereignmoney.eu/what-would-a-sovereign-money-system-look-like

Thanks.

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Sorry, that is not the issue.

""on whether interest money paid to the banks is destroyed""

How about on whether the non-interest money I pay to the grocer is destroyed or not?

Your following the wrong end of the transaction.

The only issue is from where the interest payment COMES, and not on where it GOES.

It could be said that ALL money remains in circulation (my grocery payment) and interest paid to the bank is just as 'real'.

That's not the issue.

The issue is where it comes from.

Like I said, it comes from the principal of MY (The Restofus) loan proceeds.

But I use my loan proceeds for another purpose, which shows where the interest payments really come FROM.

Nowhere.

This debt-based system of "bankers school" money has run its course.

It is broke, broken and insolvent........existing on outside life-support.

Time to shitcan it in favor a a sovereign money system.

sovereignmoney.eu

Thanks.

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""So yes, our simplified

""So yes, our simplified example requires the bank to continue to make loans so we have money in the system. But in no case is the bank ever required to increase the instantaneous money supply in existence.""

First, again, all of these simplifications completely miss the real issue. Is this an "instantaneous money supply" issue?

Sorry, the bank IS required to increase the debt supply (a.k.a. money) which they are glad to do because debt servitude(*) is the purpose of debt-based money. You (the Restofus) are here(*)

The result of 'not' increasing the 'debt' supply will be less money in existence and deflation. In a deflation, there is not enough money to repay the debts already in existence, which would endanger liability management for any and all banks. "Man the debt-issuing guns!".

There is an "imperative" in the debt-based money system. The imperative is for more debt.

If anyone cares to break that cycle, then the solution is debt-free money of government issue.

Because it's OUR money system.

Thanks.

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