Fatal Flaw in Logic of the Crash Course?

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Fatal Flaw in Logic of the Crash Course?

http://home.hiwaay.net/~becraft/FRS-myth.htm#hd25

"there is no force causing debt to grow continuously relative to the available
money supply. The current system is not inherently unstable."

Anyone care to comment on this article?

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Re: Fatal Flaw in Logic of the Crash Course?

.

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Re: Fatal Flaw in Logic of the Crash Course?

Excuse me, hefferdust.

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Re: Fatal Flaw in Logic of the Crash Course?
ds wrote:

http://home.hiwaay.net/~becraft/FRS-myth.htm#hd25

"there is no force causing debt to grow continuously relative to the available money supply. The current system is not inherently unstable."(from the link, above)

Anyone care to comment on this article?

I found another quote (below) that I found interesting.  Below explains -I think- that if there are $3 dollars in circulation it doesn't necessarily mean that there are three dollars circulating simultaneously.

"An economy only needs enough money to complete the transactions that occur in the course of normal business -- not a sum related to total debt. And the total amount of money needed is less than the total value of the transactions because the money is used more than once."

 

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Re: Fatal Flaw in Logic of the Crash Course?

      If I have a credit card, the debt via interest continues to grow unless I pay it off.  Therefore, in a very simple example, everyones debt increases independent of the available money.

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Re: Fatal Flaw in Logic of the Crash Course?

This is the title of the article

Money and the Federal Reserve System:

Myth and Reality

G. Thomas Woodward
Specialist in Macroeconomics
Economics Division

July 31, 1996

Congressional Research Service Library
of Congress

CRS Report for Congress, No. 96-672
E

 

The following is G. Thomas Woodward's current job:

 

Assistant Director for Tax Analysis

Photograph of G. Thomas WoodwardG.
Thomas Woodward joined CBO [congressional budget office] in 1998. He was previously with the
Congressional Research Service (CRS), where he specialized in fiscal,
monetary, and macroeconomic issues. Most recently, he headed the
Income, Financing, and Housing Section of CRS's Economics Division. He
has also served as Chief Economist for the minority staff of the House
Budget Committee and as an economist with the General Accounting Office
(now the Government Accountability Office).

 

Can we safely assume he is a stooge writing what he is being told to write and getting paid a handsome sum for doing so?

 

here is another short biographical:

 

 

Biographical Profile
G. Thomas Woodward

Dr. Woodward is Specialist in Macroeconomics and Head of the
Income, Finance, and Housing Section of the Economics Division
of the Congressional Research Service, The Library of Congress,
where he has worked on issues related to macroeconomic policy
and financial institutions since 1982.

 

He received a B.A. from the College of Wooster (1974), and M.A.
(1976) and Ph.D. (1979) from Brown University.

From 1979 through 1982, he was an Economist in the Program Analysis
Division of the U.S. General Accounting Office. And during 1991-92
he was Chief Economist of the minority staff of the Committee
on the Budget, U.S. House of Representatives.

He has published papers on aspects of productivity growth, hyperinflation,
inflation-indexed securities, interest-bearing currency, debt
management, and government sponsored enterprises.

 

Am I being too harsh, only it doesn't sound like he is too independant. Am I being too cynical in thinking that you don't get to be Chief Economist of the minority staff of the Committee on the Budget by going against the grain of one's superiors.

 

what a title anyway!

 

crash 

 

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Re: Fatal Flaw in Logic of the Crash Course?
Sandman3369 wrote:

      If I have a credit card, the debt via interest continues to grow unless I pay it off.  Therefore, in a very simple example, everyones debt increases independent of the available money.

True-  but that is different from saying that debt MUST grow in order to maintain a functioning economy.

He's not saying that lending doesn't create money. Everyone agrees that it does. He's saying that this creation of money through lending isn't a fatal flaw that's going to crash the whole system eventually.

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Re: Fatal Flaw in Logic of the Crash Course?

Economics is not my strength but..is it possible for 2/3 of the U.S. economy to be financed by consumer purchases without requiring an increase in debt?

 

SG

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Re: Fatal Flaw in Logic of the Crash Course?
capesurvivor wrote:

Economics is not my strength but..is it possible for 2/3 of the U.S. economy to be financed by consumer purchases without requiring an increase in debt?

 

SG

I don't see why that would REQUIRE an increase in debt (although in practice it certainly means there's an increase in consumer debt). Our GDP must continue to grow, but it can also grow through consumers putting their money in savings (where the savings are then lent for investment and increased production). I don't know that our economic system requires consumer purchases to constitute 2/3's of the GDP, either, that's just what is.

The argument that this guy is making is not that things are completely fubared, which they are, but whether that fubaredness is inherent in a particular critical aspect of our economic system, specifically, whether our system requires that debt continually increase to the point where it all must collapse, or whether the system would continue just fine if we stopped this insane love affair with increasing debt.

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Re: Fatal Flaw in Logic of the Crash Course?

It is a long article and I didn't have the patience to read it thoroughly. By skipping and skimming, I could get an idea where he is coming. Basically, he is saying we should trust the government and the Federal Reserve; they know what they are doing. Given his attitude and his credentials, I take that as a warning of what is to come. No matter how bad things get, they cannot be persuaded they are the problem.

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Re: Fatal Flaw in Logic of the Crash Course?

The author's argument hinges on the statement that when a bank pays a salary (or whatever cost of operations) it "spends the money into existence". This is patently false and absurd. A bank will not "spend money into existence" anymore than I can when I buy a piece of chewing gum. Whenever a loan payment is made to a bank, the principal part of the payment disappears, while the interest part continues to be part of the circulating money stock, and the bank spends it like anyone else. As long as a dollar is not repaid as a repayment of principal, it simply continues to circulate and accrue interest. Since all money stock is accruing interest, it must continue to grow to avoid a chain of defaults. Since no money is created unless as debt, then there you have your requirement of perpetual growth of total debt. Show me where money is created not as debt and I'll retract my statements. But that is going to be hard as 100% debt-based money is how the system has been designed.

The same argument applies at the level of repayments to the Fed. 

One could have a field day demolishing the article, like with the stuff about the Fed being partly a government agency. That is a front, and a card that they play when it is convenient, like in this case. But when, say, Bloomberg put the FOIA request to find out about TARP recipients, then the Fed's defense was simply: "we don't need to comply, we are not a government agency." Just know this: The Fed is private in what matters: the collection of dividends by stockholders due to its day-to-day operations.

As they say: "it is difficult to understand something when one's salary depends on not understanding it"

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Re: Fatal Flaw in Logic of the Crash Course?

“Fatal Flaw?  I don’t think so.  This way too long article targets only one element of the “Crash Course” and even if there were any truth to any of it and it wasn’t written by a biased source, I would question its truth and accuracy.  Regarding this Central Bank as well as all of the previous ones, I find the opinions of Thomas Jefferson, Alexander Hamilton, and many others to be less suspicious and biased.

 

It is encouraging to see that the Fed is at last, at least recognizing the need to defend itself against mounting public opinion of its illegitimacy and fraudulent nature.  I didn’t have time to read the entire article, but I did see a defense of fractional reserve banking, but I didn’t see anything about fiat currency.  The problems arising from the issuance of fiat currency seems like a more important issue to address.  The money supply and the debt that backs that money appears to be the next crises looming on the horizon.  The history of all fiat currencies has been well recorded and documented and its eventual demise is not even up for debate.       

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Re: Fatal Flaw in Logic of the Crash Course?

mred, how would your arguments apply to say the bank of england or bank of japan? These entities are publically owned.

Also, as I said in reply to the Keen article thread, government debt should not be thought of as simply an interest bearing loan since they have the ability to simply monetise it. It's not debt - it is something else - but how to classify it? Clearly we can classify it as robbery since the monetisation is basically a flat tax on most of the population, but it would still be nice to place it in more academic/macroeconomic terms. 

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Fatal Flaw in Logic of the Crash Course?

The Mathematical Flaw is NOT a Myth

Chris Martenson has used mathematics to fully explain the exponential growth of interest/debt - which is irreversible - and terminal.  This is not just a "theory" or a "myth" it is a mathematical certainty.   Your source never endorses or refutes the math but instead suggests that it's effects are compensated for elsewhere. 

So what is he, or you saying - is Chris's math wrong?  Or is his math correct, but through some double shuffling of money the exponential growth of debt/interest doesn't matter?

The author contends that the banks and various other lenders spend the interest charges collected back into circulation implying that in some way this makes the math a "myth."  No doubt some of the interest charges collected will end up back in circulation - but that misses the point and the logic of the math.

Let me give an example; a $100,000, 30 year, 7.5% amortized home mortgage will end up costing the home owner $251,717 to fully retire the loan.  $100,000 in principal and $151,717 in interest.  So, you say the interest collected will be spent back into circulation - ok, let's see how that works out.

The principal amount, $100,000 is retired from circulation as it is repaid - that's fine.  And the interest, $151,717 will be spent back into circulation.  What a deal, we borrow $100,000 principal and repay it, and we get a bonus $151,717 put into circulation!  We will all be rich in no time!

But as you can see, only $100,000 was ever created (and retired) - the interest payments must come from future debt - this is the point and the math! 

I hope this helps clear up the matter.  I'm glad you are skeptical and asking questions and I think It is good you took the Crash Course - you will find through further investigation that Chris is on the mark with many very important issues.

One other quick suggestion - check sources carefully - the source of your
linked page - Woodard was a paid apologist in writing a complimentary
view of his employer.  And, more to the substance, his long list of
apologies and rationalizations are laughable at best.

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Re: Fatal Flaw in Logic of the Crash Course?
DrKrbyLuv wrote:

The principal amount, $100,000 is retired from circulation as it is repaid - that's fine.  And the interest, $151,717 will be spent back into circulation.  What a deal, we borrow $100,000 principal and repay it, and we get a bonus $151,717 put into circulation!  We will all be rich in no time!

But as you can see, only $100,000 was ever created (and retired) - the interest payments must come from future debt - this is the point and the math! 

I might be really stupid... but, I still don't understand.

The $151,717 gets put into circulation. I don't see how it can't get put into circulation. It goes to the mortgage company, and they use it to pay salaries and expenses. People getting their salaries use it to pay THEIR expenses and buy stuff. And so on. Its money created by lending, and I just don't see how it doesn't go back into circulation.

You say the $100,000 was the only money created, yet, as far as my dorky brain can see, that's the money that WASN'T created. Its the money actually lent (well, not counting fractional lending). The bank got it from people making deposits. Then when it was repaid it went back to the bank and was lent again. Its the interest that created new money, not the principle. I think. The bank had to have the money to lend the $100,000, so they didn't create the principle. But they DID create money in the form of the interest.

I also don't know what it means that the $100,000 was retired. Does that mean that it goes back to the feds and is burned? Taken out of circulation somehow? I don't think it does. It gets spent just like the interest money got spent. Keeps going around, as far as I can see.

I don't know why this is so hard for me to understand. I'd appreciate it if you would keep trying to explain it, because I really do want to understand this concept.

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Re: Fatal Flaw in Logic of the Crash Course?
SkylightMT wrote:

The bank got it from people making deposits. Then when it was repaid it went back to the bank and was lent again.

NO! This is the part many folks don't get. Banks create money when they lend it - they don't use customer deposits. Think of it this way: The bank has $1,000,000.00 in customer deposits. It makes home loans totaling $10,000,000.00 - where does it get the other $9,000,000.00 from? It lends it into existence.

When you repay the loan with interest - you have to get the interest money from somewhere. Where does it come from? Someone else's debt.

I leave it to the brighter minds on this site to expand on my simplistic comments.

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Re: Fatal Flaw in Logic of the Crash Course?
SamLinder wrote:

NO! This is the part many folks don't get. Banks create money when they lend it - they don't use customer deposits. Think of it this way: The bank has $1,000,000.00 in customer deposits. It makes home loans totaling $10,000,000.00 - where does it get the other $9,000,000.00 from? It lends it into existence.

Oh, okay! I get it. Due to fractional reserve lending, banks create money by lending money that they only actually have a small percentage of.

But... if we simply eliminated fractional reserve lending, couldn't we still have the same economy that we have now? I mean, fractional reserve lending is a relatively recent phenomenon... at least, to the extent that its being used now. Fractional reserve lending is the problem... and not a fatal flaw in our whole economic system. They should just eliminate fractional reserve lending, or at least, increase the percentage that must actually be held in cash.

How does fractional reserve lending cause it to be a requirement that our economic system must continue to lend increasingly to be stable?

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Re: Fatal Flaw in Logic of the Crash Course?

SkylightMT wrote:
The $151,717 gets put into circulation. I don't see how it can't get put into circulation. It goes to the mortgage company, and they use it to pay salaries and expenses. People getting their salaries use it to pay THEIR expenses and buy stuff. And so on. Its money created by lending, and I just don't see how it doesn't go back into circulation.

Sorry if I wasn't clear - yes, some of the interest payments will be spent into circulation.  My point is that even if 100% were, the problem would still remain.  And, by the way, not all of the interest is spent back into circulation which may accelerate the problem.  For example, we owe over a trillion dollars to China alone.  We cannot guarantee that any part of the interest will be spent into OUR circulation.

 

This is a big reason why countries like China and Japan make sure that they always export more than they import. When we buy their products, we help diffuse the growth of interest debt by pouring money into their circulation. 

SkylightMT wrote:
How does fractional reserve lending cause it to be a requirement that our economic system must continue to lend increasingly to be stable?

Fractional lending doesn't cause the problem and no matter what reserve percentage you use, it can't solve the problem. And, currency specie doesn't matter, you may have gold backed, fiat, or even coconuts as dollars - the problem will remain.

 

 

 

 

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Re: Fatal Flaw in Logic of the Crash Course?

Scepticus, mate, it just dawned on me that you are writing from the UK.

The argument goes unchanged. Note that the process of (high-powered) money creation is (nominally) the same: governments sell their debt in public bond auctions; whatever they can't sell, the central bank picks up the tab with brand new money. The inflationary requirement of the debt-based system is the same. I don't quite understand your comment about direct debt monetization, that is after all another example of debt-based money. What did I miss? But I see where you are coming from now; and the following is my take on it. You make the observation that in the British case, the government would be selling a debt to itself and therefore, in principle it could write it off, so it is really no big deal. Is that a fair representation of what you think?

Assuming that it is, what must be considered is not only the government-central bank tandem, but also the rest of the players. Let me make a roundabout argument:

In a different time, competing banks would issue their own gold certificates to depositors. As competing entities, they could not afford to issue more certificates than the amount of gold in reserve, lest when the certificates ended up in competing banks, these would in turn ask for certificate redemption and deplete the fraudulent bank of its gold. However, the temptation for all banks to over-issue certificates was simply too big. The solution: form a cartel that would issue a common certificate for all competing banks, and furthermore, have a centralized provider of reserves in case that any bank fell short. The end result: competition was minimized and all banks could then inflate in unison. Since their profits are the interests, their previous profits would now be multiplied by the reserve ratio. I'm sure you knew this, but I need this to be kept in mind.

For the system to work, the minimal reserves of the banks must be sound. The reserves are composed mainly of deposits by the public and the high-powered money in the commercial banks' accounts at the central bank. This is the main connection of the CB-government tandem with the outside. The CB's role is to support (if you want, subsidize) the local banking cartel. When the CB purchases government securities, the value of those securities ends up increasing the cartel's reserves. It is for this reason that even though at the level of the government/CB one could say that the government owes money to itself and thus may ignore the obligation, the fact is that such act would decapitalize the commercial banks. The obligation of the government is thus ultimately to the commercial banks under this scheme.

The depths of the present crisis are manifested in the desperate measures to save the commercial banks even at the cost of loading the CBs with crap assets. They know what they are protecting: the biggest cash cow is the commercial banking sector. That is the first line of defense, even if the CB is weakened to the possible point of becoming insolvent itself (which they are already).

The elites in other countries may not be as shameless as the American ones, in terms of openly having a CB that directly stands to benefit when the government's deficit spending increases. That the regional banks' stocks can't be traded, or that the profit rate is capped at 6% is a smokescreen. It is the whole concept of central banking that is tailored to serve the interests of a particular sector. The only case in which this would not be true would be the case in which the government owned both the central bank and all the banks that collect demand deposits from the public. There have been successful instances of these that I know about. In any other scheme,  whether public or private, the CB is an instrument of control and a means to subsidize a local banking cartel. As a side comment, the Bank of Japan is not fully public, about 40% of its shares are privately owned and also privately traded. The Bank of England may very well be fully government owned, but the interests/families that once owned it have frequently staffed the board of governors since its "nationalization." In conclusion, other elites know better about how to guard against negative perceptions than the American ones. But if you understand the system as a whole, you'll see that it is a scam that was not set up to serve the public, but rather to be served by it.

 

 

 

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Re: Fatal Flaw in Logic of the Crash Course?
DrKrbyLuv wrote:

Fractional lending doesn't cause the problem and no matter what reserve percentage you use, it can't solve the problem. And, currency specie doesn't matter, you may have gold backed, fiat, or even coconuts as dollars - the problem will remain. 

Would you mind expanding on this? The nature of money is all-important. What particular problem are you referring to?

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Re: Fatal Flaw in Logic of the Crash Course?

mred: "Scepticus, mate, it just dawned on me that you are writing from the UK."

Yes. 


"You make the observation that
in the British case, the government would be selling a debt to itself
and therefore, in principle it could write it off, so it is really no
big deal. Is that a fair representation of what you think?"

yes. 

"Since their profits are the interests, their
previous profits would now be multiplied by the reserve ratio. I'm sure
you knew this, but I need this to be kept in mind."

Agreed. I was aware of this. 

"For the system to work, the minimal reserves of the banks must be
sound.... [snip] ... one
could say that the government owes money to itself and thus may ignore
the obligation, the fact is that such act would decapitalize the
commercial banks. The obligation of the government is thus ultimately
to the commercial banks under this scheme."

By decapitalising the banks somewhat, the government can both write off its own debt and clip their wings with regards to future credit expansion.Would this not achieve the same thing as an increase in the reserve ratio?i.e. keep reserveratio the same but make sure the banks have less high powered money.

"the biggest
cash cow is the commercial banking sector. That is the first line of
defense, even if the CB is weakened to the possible point of becoming
insolvent itself (which they are already)."

That is only the case when people wish to borrow money, and have a reason to do so. My whole line of reasoning on this site and others has been that this era in which borrowing against future growth makes sense, is coming to and end. If the banking system has ceased to be a cash cow, why prop it up? The elites would be better off dashing for whatever the next gravy train is. If they knew what that train was and where it would be leaving from, you can guarantee that there would be little political appetite for propping up banking and a rush of pigs onto the new train. The fact that they are trying to prop up a doomed system leads me to believe the elite have no more idea what is gonig to happen than we do. There is no conspiracy, just greed so short term that they did not even consider what they'd do for an encore.

"The elites in other countries may not be as shameless as the
American ones,"

The old eurpoean elite are much more widely distributed accross industry than in the US. In the US the elite are all FIRE sector. Over here, and especially in mainland europe the elite are normally a political/industrial/media/old money tycoon hybrids - like Silvio Berlusconi and Murdoch.

"In any other scheme,  whether
public or private, the CB is an instrument of control and a means to
subsidize a local banking cartel."

Agreed. I also agree it does not serve the public. I am speculating mostly about how the powers that be will attempt to modify the system to mollify the public,  which they are going to have to do to stay in power as the depression deepens.

People won't tolerate the kind of poverty seen during the depression this time around - you can be sure of it. I suspect change will come in europe first due to the different character of the elite over here - france, germany and UK may lead the way. Eventually other nations like japan and the US will be forced to follow their lead, if the reforms in europe prove successful.  

 

 

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Re: Fatal Flaw in Logic of the Crash Course?

mred - the problem I was referring to is the "exponential growth" of interest as described by Chris Martenson. Since only the principal of debt is issued, any subsequent interest payments must be taken from the future circulation.  Of course, the circulation must also support principal debt obligations and commerce. 

As the interest debt accumulates, or grows exponentially as Chris says, the circulation quickly becomes inadequate.  So, we enter into a dangerous paradox - future debt must continually grow.  This is not sustainable as sooner or later, there simply won't be enough willing and worthy borrowers to support constant debt growth.

This is where we are right now - near the end of any real ability to grow the circulation sufficiently.  This is a very dangerous time in our economy as we are beginning to crash and burn but yet, our politicians and policy makers, deny the problem exists.

Why would they lie about such a huge problem?  And I mean lie as they have known about this mathematical flaw for at least 30 years, probably much longer.  My opinion is that they would rather save the system than the people.  If people understood this phenomenon, they would demand the system be changed which would put the federal reserve thugs out of business.

Interest is the problem - and my earlier point was that you may change the currency, or you may eliminate fractional lending, but those two things have nothing to do with interest - this is the key.

This is why they have been pouring 0% interest money into the system; it is an attempt to quench the "exponentially growing" interest debt.  That won't work either, but it buys a little more time and makes the final crash that much more damaging.  

 

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Can Defaulted Loans Create the Money for Interest Payments

What if the loan default rate in a society was high enough to create enough money from loans that would not be paid back for there to be enough money in the system to equal the interest that the performing loans needed to pay?  In that situation you could solve the problem, no?

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Re: Fatal Flaw in Logic of the Crash Course?
DrKrbyLuv wrote:

mred - the problem I was referring to is the "exponential growth" of interest as described by Chris Martenson. Since only the principal of debt is issued, any subsequent interest payments must be taken from the future circulation.  Of course, the circulation must also support principal debt obligations and commerce. 

 

DrKrbyLuv,

I cannot agree with you and Chris here as I replied in the thread where Chris gave his answer: Is perpeptual expansion really a requirement for modern banking?

Stating that "perpetual expansion is a requirement of modern banking" is just a fallacy for me.

The interests are profits for banks. They are not "frozen" (taken from the future circulation), but continue to circulate in the economy. Like any other business, banks have expenses, they pay their employees, suppliers, taxes, dividends... which ultimatly are all recycled in the economy. This is also applicable to the Fed.

Just a simple example. Assume a total money supply of $36,500 sufficient for economy to function properly. Each and every day someone borrows $100 for 1 year with 10% interest. Let the economy turn for some time. Each and every day someone pays its debt contracted the previous year: $110 = $100 principal (money destroyed) + $10 interest (profit for bank) and someone else borrows $100 (money created). So each and every day, the money created equals exaclty the money destroyed, there is no expansion. Each and every day the bank makes $10 profit, which it uses to pays its employees, suppliers, taxes, shareholders... which will spend they money. And so on forever. There is no shortage of money since each and every day, there is $36,500 in the system. Of course this is over simplified, sometimes more or fewer loans are made, bearing different interests, having different maturities, GPD varies from year to year... but on average, this how it could work. So modern banking does NOT require perpetual expansion.

The banking system does not require money expansion, but the Fed and other Central Banks are indeed expanding money supply at a (much) higher rate the GDP grows. Which induce price inflation soon or later. In fact these days, they "pray" for some inflation, because they fear for deflationary spiral.

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Re: Fatal Flaw in Logic of the Crash Course?

fujisan,can we rework your example such that all 365 debtors pay back their loans on the same day each year? Your example should still work yes?

In this case, our debtors must each find 365x$110=40,150. Oh dear, there is only 36,500 in the money supply. Cue bankruptcy.

Note that in the real world, interest is calculated daily or monthly.

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Re: Fatal Flaw in Logic of the Crash Course?

DavidLachman wrote:
What if the loan default rate in a society was high enough to create enough money from loans that would not be paid back for there to be enough money in the system to equal the interest that the performing loans needed to pay?  In that situation you could solve the problem, no?

You make an excellent point.  Yes, this is the solution that Austrian Economics reccomends, there will always be some debt that cannot be paid as a function of the system.  They accept that some loans must allowed to default without any government intervention.  The Kenysians on the other hand are more proactive in attempting to get money into the system through government intervention.

 

I think both of these strategies are terribly wrong as at the core, our system is not sustainable.  There are other solutions, for example, the Mathematically Perfected Economy suggests that all interest be eliminated.  The logic being that money is simply created through debt, why should any bank be rewarded with interest since they are not lending their money or their depositors money, they are charging interest because they have a monoploly to do so. 

The other big problem we have is that as the government intervenes through added debt - the problem just gets worse.  We have hit the point that in order to extinguish enough debt (through defaults) many many defaults will occur.  This is how depressions are built and this will be a long one.

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fujisan
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Re: Fatal Flaw in Logic of the Crash Course?

scepticus, it does not make sense since it's totally different the way it works in the real world.

The delay between payments do not change anything. If everyone should pay 1/12th every month, then each day, 12 persons will pay 1/12th of $110, so in total $110 is payed back each day.

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Reuben Bailey
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Re: Fatal Flaw in Logic of the Crash Course?

For the interest to be paid, the money required must be created somewhere along the line.  If it is not, then when the principle of all loans is paid off, there will be no money left in the system. The only way for the sytem to continue is for new loans to be made all the time, at least equal to the principle paid.

under the original example, each day someone takes out a loan for $100, with 10% annual interest, due in one year's time, after 365 days, there is now $36,500 in the system.

Lets start with no new money being created each day and the loans being repaid as they come due. Each day, the money supply will shrink by $100 dollars, but each day the amount in circulation will shrink by $110 dollars.

If you want to factor in the banks expenses, let's say that they total $5/day - that is, $5 per day is spent back into circulation.  The money in circulation still shrinks by $105 per day.  On day 348 there is no longer enough money in circulation to repay the loan that is due that day.  I would guess that the defaults would have come into play earlier, because the money moving through this model is not just going to those who have a debt to repay, and the bank is not going to be buying supplies from everyone, nor is everyone going to be collecting dividends.  Of those who are getting the money from the bank as it is re-spent into circulation, if they are not going to get new loans to live on, they are likely going to be saving some of the money that they receive to spend later.

So, where does this leave us...

Lets change this so that the $100 loans continue to be made each day and see where we end up.

day 365 total money supply = $36,500, total money in circulation = $36,500

day 366 total money supply = $36,500, total money in circulation = $36,495

day 367 total money supply = $36,500, total money in circulation = $36,490

day 730 total money supply = $36,500, total money in circulation = $34,675

Where did that $1825  go that is no longer in circulation? Well, it is in the bank - profits that have been taken and are either being used by the bank to aquire other assets, going to shareholders, or sitting there on the balance sheet.  In order for this to not take the system down, that money must be redistributed somehow, otherwise it will all end up in a few peoples' hands - those of the shareholders.  After a certain point, they will have much of the wealth - the system will become very lobsided and will cease to function when those taking out the loans no longer have the money to repay them.

On paper, this example looks fairly stable - it will be a long time before the money in circulation is too low for the system to function, but look at what MUST happen for this to remain stable

the same amount of money must be loaned into existance for each day as is destroyed by the repayment of principle

no money can be saved, or taken out of circulation in any manner - it must all be spent, including dividends and money from asset sales.

But what about the profits, you ask?  Don't they stay in the system?  Yes, they do still exist, and can still circulate.  On paper, the system will always have enough money to pay off all debt.  The reason that debt must expand with the current system is that the interest does not recirculate evenly, and usually not back to the borrowers, to the degree necessary for the system to function smoothly.  This also brings up the transfer of wealth that occurs through interest payment - for the interest to continue to circulate, it must be paid to someone for something - therefore the wealth within the system is constantly moved away from the borrowers and to the lenders.

 

Having laid this out this way, I come to the conclusion that enough money must be loaned into existance to replace the principle that is paid off each year.  The exponential growth comes when new loans are made to pay interest on existing loans.

 

Please feel free to poke any holes in this that you find, and lets see where the debate takes us.

All the best,

Reuben

Edited to add my conclusion

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pleaseremoveme
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Re: Fatal Flaw in Logic of the Crash Course?

I loan $100 000 to buy a new house. The interest is 0.5% per month, so I pay the bank $1 000 each month part interest part payment. Now I happen to be a window cleaner cleaning the windows of the same bank, and they pay me $2 000 every month. So taken together, the bank pays me $1 000 every month, while reducing my debt at the same time: after only 11 years and 7 months I'll have payed my mortgage, earning money from the bank the whole time.

So you see: it is not necessary for you to go deeper in debt because of interest. It was necessary for the banks that you went deeper into debt, so that they earned enough money in interest to pay for expensive window cleaners like me.

 (It would be more realistic if I had said I was a plumber: a bank needs good plumbing, since bankers produce so much crap!)

 

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sucker4lush
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Re: Can Defaulted Loans Create the Money for Interest ...
DavidLachman wrote:

What if the loan default rate in a society was high enough to create enough money from loans that would not be paid back for there to be enough money in the system to equal the interest that the performing loans needed to pay? In that situation you could solve the problem, no?

I think that would be called "Great Depression 2". There's plenty of ways to "solve the problem": What if the loan default rate was 100%? What if humans went extinct?...

I think we all know the proper, and healthiest way to solve the problem: Sound money... or at least nonprofit-ize the ab initio creation of money. 0% interest.

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sucker4lush
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Re: Fatal Flaw in Logic of the Crash Course?
reubenmp3 wrote:

...Where did that $1825 go that is no longer in circulation? Well, it is in the bank - profits that have been taken...

What? Banks dont profit from making loans! Everybody knows the money is "destroyed" when banks are paid back.Tongue out

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