Interest payment is not the problem

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diarmidw's picture
diarmidw
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Interest payment is not the problem

The concern about the repayment of debt interest is actually based on a confusion of stocks and flows of money. The money issued in a loan contract is a stock, which can support a theoretically unlimited flow of transactions, including interest payments, over time.

Since the money collected by a bank as interest flows out again in the form of wages, dividends and payment for physical capital, it can return to borrowers and form part of the final repayment. No further loan is necessarily required. I've explained this in more detail with some diagrams at http://www.diarmidweirphotography.co.uk/wealth_without_money/2010/07/on-the-impossibility-of-paying-interest Please visit and comment.

Of course the money stock does grow exponentially, because transactions are increasing exponentially, but this doesn't in itself mean that debt can never be repaid. The real problem is that loans are increasingly made for projects of little real value. This means that to capture the revenue (a flow) that will replenish the borrower's stock enough to allow him or her to repay the loan and interest, and make his/her own profit, involves resource exhaustion, human exploitation and frequently outright fraud.

You might think this is just a semantic difference from Chris Martenson's arguments, but I think that without the prospect of the 'automatic collapse' he is predicting there is much more scope and necessity for collective and co-operative action to put things right. This is rather different from the individualistic 'survivalist' approach that seems to be advocated on this site.

Dr Diarmid Weir

http:/diarmidweirphotography.co.uk/wealth_without_money/

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Re: Interest payment is not the problem
diarmidw wrote:

You might think this is just a semantic difference from Chris Martenson's arguments, but I think that without the prospect of the 'automatic collapse' he is predicting there is much more scope and necessity for collective and co-operative action to put things right. This is rather different from the individualistic 'survivalist' approach that seems to be advocated on this site.

Actually, CM's approach seems to be far more along the lines of building community, rather than the individualist survivor method.

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Re: Interest payment is not the problem

I hope this important thread is given some thorough review and commentary by some of the more experienced posters on CM.com.

Like many, I find the constant debate and lack of a commonly accepted definition on exactly how money is created and the impact and  overall feasibility of debt based currency to be extremely frustrating. These events are occurring around us every day, are not necessarily abstract in that they are observable, yet we can get no consensus among some very smart people as to exactly how this works. Much of the Crash Course is based on the fallacy of debt based currency, we need to continue to validate this core belief, and if it needs modification based on demonstrable evidence, then that bridge will need to be crossed.

I have made several posts questioning the concept of debt based currency and it’s role as a root cause failure in a monetary economy, and I do not feel that his has been adequately addressed. The responses tend to be both ideological in content and in the abstract. In the category of “related but different” concerns, I am also unconvinced that any alternatives that have been posited in response to debt based currency are consistent with the overarching theory of basic capitalism, which at its core uses borrowed money to fund business which in turn fuels the basic economy.

That said, the material and thesis proposed by poster “diarmidiw” clearly show major holes in the debt based currency construct as outlined in the Crash Course, and perhaps unsurprisingly, review of his web site shows reference to the work of Steve Keens’, who I have also reviewed and noted his conclusions using mathematical models that have full transparency, also show that debt based currency is feasible and sustainable.

I’d like very much for some rigorous debate to surround this issue, and perhaps even for some conclusions to be drawn that can move toward putting this matter (on determining whether debt based currency is in fact an irreconcilable root cause failure) to rest once and for all.

What say you?

Note: Dr. Weir’s link does not load. This one does.

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Re: Interest payment is not the problem

Darbikrash,

The debt currency we use isn't the problem, because Federal Reserve Notes do not increase nor decrease the money supply and have nothing to do with the actual creation of money.  Money is only created as a book entry (numbers in a checking account) and this is where the true root cause of the problem lays.

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Re: Interest payment is not the problem
diarmidw wrote:

Since the money collected by a bank as interest flows out again in the form of wages, dividends and payment for physical capital, it can return to borrowers and form part of the final repayment. No further loan is necessarily required.

Or as Dr. Weir, a PhD in monetary economics, states on his website:

 http://www.diarmidweirphotography.co.uk/wealth_without_money/2010/07/on-the-impossibility-of-paying-interest

 

Quote:

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

While this argument and the illustrative diagrams are seductive they can readily be dispelled by the real world activities of banks. Typically banks pay 50%-60% of their net earnings (net of wages, capital expenditures, and allowance for non-performing loans) as stock dividends. The rest goes into retained earnings, is used to increase the working capital of the bank that is then used to support more fractional lending. In Dr. Weir's terms the flow interest payments from the borrower back to the bank is not matched by a flow of payments to the borrower.

In simple terms a bank that paid no dividends would grow faster since the doubling time for its compounding interest would be shorter than if it did pay dividends. Thus any retention of interest by the bank will compound and the argument simply reduces to the exact doubling time of the exponential growth of debt.

 

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Re: Interest payment is not the problem

Every so often we need to revisit this conversation because somebody concocts a spreadsheet that shows that if a bank pays out all the interest to the right people at the right time that it's theoretically possible for debt based money to work.  The problem with this approach is that it utterly fails to address how the world and banking actually works.

So let's get back to the basics to assure that we're working from the same map.

Here are the basics:

  • It is undeniably true that there is less money than principal and interest combined from the very first minute after a loan is made. This is not debatable it is a design element of our system of money.  It simply exists as a condition.  You could argue that if the bankers only make loans to people who work for them this will all balance out and, while technically true, this is not relevant from a real-world standpoint point since banks and bankers do not produce anything that people need to live upon.  They produce no products, no food, and no useful services besides money management.  So a society that entirely consists of bankers making loans but then paying people to work for them out of interest payments is very quickly a starving, cold, and homeless society.  Hopefully we can agree that there's not a lot of useful insights to be gained from following this line of reasoning too far because it is not realistic.  From a wider perspective we might note that total interest payments on $52 trillion of debt are in the vicinity of $3 trillion and it's a preposterous notion to suggest that even a skinny fraction of that is performed as direct work for banks.  If it were, services performed for banks would be fully 25% of the economy.
  • Since we hopefully now agree that the world cannot live by the actions of bankers and people working for them alone, we have to introduce outside agents who are working in other industries and professions but who are required to use bank money (see also; legal tender and tax laws).  Now we have people who are taking loans but not having any other relationship with the banks besides paying them interest.   Here's where some people get confused because they make the critical mistake of assuming that just because someone works outside the bank, and earns some money there by creating value somehow, and uses that money to pay off the bank loan (which the bank may or may not "recirculate") that somehow the interest money has been accounted for.  It has not.  Money did not magically come into existence through the actions of the person working.   ALL MONEY IS LOANED INTO EXISTENCE.  That's the system we have.  There is no other mechanism.  None.  Because we know this to be true, we know that the money the person magically obtained 'on the outside' has a corresponding amount of debt elsewhere in the system.  A debt that has an interest payment attached to it.   Because of this condition, there is always more debt outstanding than money in circulation and  new money MUST continuously be loaned into existence to cover the difference.   Otherwise debts will go into default and the banking model will become extremely unhappy, or even collapse.

So, here's where we are from a reductionist standpoint.

We know that all money is loaned into existence with interest.  This means that there is a percentage rate of growth baked right into the system.  Barring some sort of a deflationary impulse that will destroy outstanding debt (and defer growth for a while), exponential growth will result from this system based on its design.

We know that there is always more debt than money in existence UNLESS debt defaults are exceeding new loan/money creation in which case banks are being destroyed (see also: today)

We know that it is not possible for everybody to apply all of their productive effort towards banks.

Taken together we can conclude that we have a system that is designed to expand and that will suffer greatly if and when it cannot. That's exactly what I see around me today.

From a larger perspective there is unarguably more debt than money and we can back test both money and debt growth and see nearly perfect exponential fits to those curves. When I see such strong evidence I begin with the hypothesis that there is an exponential driver underpinning the system(s) involved.

So I stand by my statements as they were made in the Crash Course.  We have an exponential money system which we can either detect in the aggregate data or from a realistic understanding of how the banking system operates.   either way, same result.   This is a useful way to analyze and understand the banking system, our economy, our monetary system, and the world we see around us.

While I am sure that someone can concoct a spreadsheet to prove a theoretically different outcome, I have been well served by the marriage of real-world observation and a fundamental understanding of how the banking system actually operates.   It's  been both predictive and matches up with history pretty well.

Saying that interest payments must flow out of the banking system and therefore everything balances is completely out of line with the data spanning many decades, does not comport with what I see in the real world, and does not match my theoretical understanding of the mechanisms of banking and debt-based money.

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Re: Interest payment is not the problem

 

 We know that all money is loaned into existence with interest.

 Are you certain ?

 

 Assuming the Fed keeps honest (unaudited) books and doesn't type a few extra billion into the treasury's account without mentioning anything..

 What are the rules on Fed purchases.. it can only purchase securities backed by the full faith and credit .... (I'd be interested to know what the definitions of "securities" "backed" and "full faith and credit" are.. )

 Perhaps as malleable as "dollar".. ?

 

 If Timmy Geithner was to offer pet rocks signed by obama at a giveaway price of 100 Billion per rock.. would the Fed be barred from bidding ?

 If JP Morgan decided to do so instead, and then found itself squeezed.. could congress pass emergency legislation authorising the buying of "Troubled Autographed Rock Pets" at full value..

 

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Interest payment is precisely the problem

The logic is irrefutable: If all money is loaned into existence (with interest), then, at any given moment, total debt exceeds the amount of money available to repay all debts.  From the moment the first unit of debt-based money is brought into existence, it is absolutely, unequivocally impossible for all debts to be repaid ever again.

The only two ways an individual debtor can cancel his debt is by repaying it with money that someone else has borrowed or by defaulting.

The reason Diarmid and Steve Keen are able to show the system perpetuates is by introducing time into the process.  Time allows more people to take out loans, so that more money can be infused into the system, so that those who took out their loans first can repay.  This is a Ponzi scheme.  It only works as long as people agree to play and as long as we don't run into hard, physical limits that prevent it from continuing.

Diarmid, the illustration on your website breaks down in the very first diagram when you show the Firm paying out wages to the Households before the work is done.  This essentially amounts to an interest-free advance from the Firm to Households before production.  This is not a situation to be found in real life.  In reality, the firm would use the initial loan to produce something and then pay out wages.  So, in order for the Households to buy the Firm's product, they would have to get the money from somewhere else first.  And in a debt-based currency system, the money would have to come from the bank.  So, in reality the Households would also be carrying debt to the bank.  And how would the Households be able to clear their debt?  They simply cannot, because at any given moment there is more debt than money.  While your diagrams are clear and easy to follow, THEY ARE NOT BASED ON REAL LIFE.

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Re: Interest payment is not the problem

diarmidw http://www.diarmidweirphotography.co.uk/wealth_without_money/2010/07/on-the-impossibility-of-paying-interest

Here the bank makes a loan of £100 to a firm, and the firm immediately makes a wage payment of £100 to households. The interest charge is 10% of the loan."

Hello diarmidw,

If you are making the argument that many will be able to repay their debt then I agree.  But collectively, we cannot all repay our debt.  I think you may be looking at the microeconomics view while Chris Martenson is looking towards the bigger macroeconomic picture.

In your example, £100 is created but £110 must be repaid.  The debt can be repaid if the holder is able to capture the extra £10 from the economy.  If you look at the entire economy, then it becomes impossible for everyone to repay their debt as the economy will always have more debt than money. Hundreds of millions of £100 loans are used to create our money supply and individually and collectively, the interest will ultimately be taken from defaults and liquidations unless the economy can grow forever at an increasing rate.        

Virtually all of our money is temporary.  The principal of all of the combined loans is created as debt and when it is repaid, it is extinguished (destroyed).  You mentioned the velocity of money which is the ability of money to be used over and over within a given time frame.  But, money can only pay principal once to the original bank that created the money. 

In your example, the 10% interest, applied across the economy, means only 90% of the loans may be repaid.  The day of reckoning can be put off, even while showing growth, if enough new loans are taken to stay ahead of the scheduled payments.  Eventually, the ever growing need for new debt simply cannot be sustained.

In your flow charts you assumed that the interest repaid goes directly back in circulation and that it finds its way to the needy:

diarmidw http://www.diarmidweirphotography.co.uk/wealth_without_money/2010/07/on-the-impossibility-of-paying-interest

"What matters therefore is not the absolute quantity of interest, but whether the flow of interest payments from the borrower back to the bank is matched by a flow of payments to the borrower."

Of course, this doesn't happen which makes things all the worse.  Much of the interest collected ends up in savings vehicles which are accounted for in the close to $15 trillion M3.  Most of that money is not available for people to repay their debts.  We can see this as M1 is only around $1.7 trillion and M2 is around $8.6 trillion.

Wiki Definitions:

  • M1: The total of all physical currency part of bank reserves + the amount in demand accounts ("checking" or "current" accounts)
  • M2: M1 + most savings accounts, money market accounts, retail money market mutual funds,and small denomination time deposits (certificates of deposit of under $100,000)
  • M3: M2 + all other CDs (large time deposits, institutional money market mutual fund balances), deposits of eurodollars and repurchase agreements

Empirical evidence: 

  • Total private and public debt hovers around $57 trillion (not including future liabilities)
  • M3; total money supply is less than $15 trillion - where will we get the needed  $42 trillion to repay our combined debt?
  • M1; the amount of money available (currency and checking accounts) is only around $1.7 trillion
  • M2 is around $8.6 trillion but to become fully available; savings accounts, money market accounts, retail money market mutual funds and small denomination time deposits must be sold.

Larry

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Re: Interest payment is not the problem

 

 I put it to you.. Isn't life itself a ponzi scheme ?

 Dependent on the influx of new borrowers (of time..)

 

 http://www.youtube.com/watch?v=KLHFdduVDVg

 

 

 

 

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Re: Interest payment is precisely the problem
penski wrote:

The reason Diarmid and Steve Keen are able to show the system perpetuates is by introducing time into the process.  Time allows more people to take out loans, so that more money can be infused into the system, so that those who took out their loans first can repay.  This is a Ponzi scheme.  It only works as long as people agree to play and as long as we don't run into hard, physical limits that prevent it from continuing.

Just to piggyback on this, I have read many of Steve Keen's works and I never got the impression that he believed a debt-based money system was sustainable. In fact, he follows Hyman Minsky's Financial Instability Hypothesis (FIH) which predicts financially-driven asset bubbles as an endogenous, inevitable outcome in a capitalist economy with a developed financial sector. Once these inevitable debt deflations occur, the government may mitigate or even counter-act them with fiscal deficits/loose monetary policy, but the debt dynamics of the private sector should apply equally to the public sector IMO, which makes counter-cyclical government intervention unsustainable in the long run (which it appears we have now reached).

Also, Keen points out the contribution of debt to aggregate demand (AD) in our economy (AD=GDP + change in debt). As debt grows to become an increasingly higher % of AD, a small reduction in the (change in) debt will exact a disproportionate reduction in the AD, especially when positive feedback dynamics are factored in. I guess you could argue, theoretically, that if all debt issued is used for self-liquidating productive investment (such as technological innovation) and all interest payments are re-circulated back to borrowers, then the debt money system will be sustainable in the long run. However, those assumptions are completely unrealistic for several reasons, including: 1) As Minsky's FIH suggests, human behavior in a debt money system simply does not follow that route (completely productive rather than speculative) and 2) A complex economy within a planet of finite resources cannot fund its own productive capacity at a level which supports an exponentially increasing debt burden forever.

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Re: Interest payment is not the problem

Saffron says:

CM's approach seems to be far more along the lines of building community, rather than the individualist survivor method.

I apologise if a fairly brief perusal of the publicly available material here has led me to a faulty conclusion. I just worry that the idea that 'there is absolutely certain to be a non-survivable (for the economy that is) crash' can lead to that sort of thinking. Because I think it is rather more likely that things will just steadily get worse for those of us not among the super-rich in gated communities - and frankly not really much fun for them either in the long run.

And I also strongly believe that there is plenty we can do to stop this happening - short of blowing up the system of monetary exchange. So I wouldn't want the concern and energy evident here to go to waste.

darbikrash

determining whether debt based currency is in fact an irreconcilable root cause failure

This is the question I was trying to address, and I think it is problematic because, strange to say, the vast majority of economists have no interest in (studying) money. It doesn't actually fit with the models they use, so they simply ignore it.

There is no intrinsic reason why there should be a problem with a debt-based currency - as long as the purpose is to mobilise resources to create genuine future value.

Thomas Hedin refers to debt-based currency and opposes it to 'checking-account 'money. In fact government-created money, which includes both notes and coin and the reserves held by banks with the Fed, is in effect just as much debt-created as the rest of it. In this case the 'repayment' of the debt requires us to pay our taxes in exchange for the services provided by government. The only money that is not debt-money is commodity money, whose value is exactly given by its intrinsic properties.

The other point I would make about getting 'the problem with money' wrong, is that it puts the blame for current problems in the wrong place. If we think that a debt-based monetary system is fraudulent and self-destructive in itself, then we tend to think it is the government and ourselves (for believing them) who are at fault. In fact, the real culprits are a wealthy elite that have captured the banks and the corporations that are the beneficiaries of most loans (directly or indirectly), and have made a perfectly workable system into a tool for their own greed and recklessness.

If we want a system in which sophisticated goods and services continue to be produced, then there has to be some way in which future production potential can be 'securitised', whether in the non-specific form of money or in some more specific way involving multilateral barter. If we are going to continue to use a money system, then we certainly will see the winding down of a lot of current debt - not because the money doesn't exist, but because the debtors have no realistic chance of accessing it. Along with that, we need to 'socialise' banking in some (preferably decentralised) way that marries the issue of debt and money with real human welfare enhancement.

This post was meant to come yesterday - but I think there were server problems! I will try to address some of the other points made in a further post.

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Re: Interest payment is not the problem

Diarmidw said "I also strongly believe that there is plenty we can do to stop this happening - short of blowing up the system of monetary exchange. So I wouldn't want the concern and energy evident here to go to waste."

Welcome Diarmidw!  THANK YOU for this one comment.  To me, its the singularly most important opinion that is lacking in the vast majority of threads on this site.  The chances of the world getting through this without economic end times is FAR higher than many on this site predict.  We are not doomed to disaster.  In fact, that is exactly what drew me to Chris - his realistic forecasts coupled with optimism.  Its easy to get on the fear monger wagon when you read as much as many of us do.  However, people adapt and will adapt as do economic systems.

Thanks for the optimistic slant to your comment.  A breathe of fresh air.  Let me note that you will be bombarded with end time comments and "good luck with that" comments for your optimism.  But, know that I love it and think there is good reason to be optimistic longer term if we can simply make small changes on a consistent basis!

 

 

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Re: Interest payment is not the problem

darbikrash wrote in Post #2:

"I hope this important thread is given some thorough review and commentary by some of the more experienced posters on CM.com.

Like many, I find the constant debate and lack of a commonly accepted definition on exactly how money is created and the impact and  overall feasibility of debt based currency to be extremely frustrating. These events are occurring around us every day, are not necessarily abstract in that they are observable, yet we can get no consensus among some very smart people as to exactly how this works. Much of the Crash Course is based on the fallacy of debt based currency, we need to continue to validate this core belief, and if it needs modification based on demonstrable evidence, then that bridge will need to be crossed."

I totally agree with your well worded post that the bridge of understanding the inherent and terminal problems from our private debt based must be crossed.  Fortunately there have been some very good posts in this thread that firmly establish the debt money system as the unequivocal root cause of our current failure.

For example, Chris Martenson's Post #5 will go a long way towards gaining this understanding:

"It is undeniably true that there is less money than principal and interest combined from the very first minute after a loan is made. This is not debatable it is a design element of our system of money. It simply exists as a condition.

Money did not magically come into existence through the actions of the person working. ALL MONEY IS LOANED INTO EXISTENCE. That's the system we have. There is no other mechanism. None. Because we know this to be true, we know that the money the person magically obtained 'on the outside' has a corresponding amount of debt elsewhere in the system. A debt that has an interest payment attached to it. Because of this condition, there is always more debt outstanding than money in circulation and new money MUST continuously be loaned into existence to cover the difference. Otherwise debts will go into default and the banking model will become extremely unhappy, or even collapse.

We know that all money is loaned into existence with interest.  This means that there is a percentage rate of growth baked right into the system.  Barring some sort of a deflationary impulse that will destroy outstanding debt (and defer growth for a while), exponential growth will result from this system based on its design.

We know that there is always more debt than money in existence UNLESS debt defaults are exceeding new loan/money creation in which case banks are being destroyed (see also: today)

We know that it is not possible for everybody to apply all of their productive effort towards banks.

Taken together we can conclude that we have a system that is designed to expand and that will suffer greatly if and when it cannot. That's exactly what I see around me today.

Saying that interest payments must flow out of the banking system and therefore everything balances is completely out of line with the data spanning many decades, does not comport with what I see in the real world, and does not match my theoretical understanding of the mechanisms of banking and debt-based money."

From penski's Post #7:

"The logic is irrefutable: If all money is loaned into existence (with interest), then, at any given moment, total debt exceeds the amount of money available to repay all debts. From the moment the first unit of debt-based money is brought into existence, it is absolutely, unequivocally impossible for all debts to be repaid ever again."

In addition, I provided some empirical evidence in my Post #8:

Empirical evidence: 

  • Total private and public debt hovers around $57 trillion (not including future liabilities)
  • M3; total money supply is less than $15 trillion - where will we get the needed  $42 trillion to repay our combined debt?
  • M1; the amount of money available (currency and checking accounts) is only around $1.7 trillion
  • M2 is around $8.6 trillion but to become fully available; savings accounts, money market accounts, retail money market mutual funds and small denomination time deposits must be sold.

I think it has been adequately demonstrated that Chris Martenson's Crash Course content regarding our private debt based money system is absolutely correct in articulating the terminal flaw that comes as a mathematical certainty.

diarmidw wrote in Post #11:

"I apologise if a fairly brief perusal of the publicly available material here has led me to a faulty conclusion. I just worry that the idea that 'there is absolutely certain to be a non-survivable (for the economy that is) crash' can lead to that sort of thinking....There is no intrinsic reason why there should be a problem with a debt-based currency - as long as the purpose is to mobilise resources to create genuine future value.

diarmidw It is a credit to you that you admit when you are wrong and I understand your worry.  But then you go back and state that there is "no intrinsic reason why there should be a problem with a debt-based currency" which looks like denial.  You are incorrect as it has been well established as there are terminal "intrinsic" problems within the debt based system.

You are presenting misinformation at this point as your premise has been corrected.  It is important that we understand the system and you can see in rickets Post #12 that you are leading others to misunderstand what is happening and to draw flawed conclusions.

Larry

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Re: Interest payment is not the problem

Thomas Hedin refers to debt-based currency and opposes it to 'checking-account 'money.

I'm not quite sure what you're saying here.  Are you trying to say that you disagree with me or agree with me on the fact that checking account money and currency are two totally and completely different things?

In fact government-created money, which includes both notes and coin and the reserves held by banks with the Fed, is in effect just as much debt-created as the rest of it.

I partially agree here, that the Fed notes printed by the government and the Coins are only moved into circulation as a debt, but where I disagree is that government creates money, because the government creates no money at all.  The actual creation of money always involves an extension of credit by a private commerical bank.

The only money that is not debt-money is commodity money, whose value is exactly given by its intrinsic properties.

The only money that is not debt money is wealth money.  Commodity money can either be debt money or wealth money.  It all just depends on how it moves into circulation.  If it is spent into circulation it would represent wealth.  If it is loaned into ciculation it would represent debt.

The other point I would make about getting 'the problem with money' wrong, is that it puts the blame for current problems in the wrong place. If we think that a debt-based monetary system is fraudulent and self-destructive in itself, then we tend to think it is the government and ourselves (for believing them) who are at fault. In fact, the real culprits are a wealthy elite that have captured the banks and the corporations that are the beneficiaries of most loans (directly or indirectly), and have made a perfectly workable system into a tool for their own greed and recklessness.

Basically I agree.

If we want a system in which sophisticated goods and services continue to be produced, then there has to be some way in which future production potential can be 'securitised', whether in the non-specific form of money or in some more specific way involving multilateral barter.

How about we apply the benifits of barter to a medium of exchange?

If we are going to continue to use a money system, then we certainly will see the winding down of a lot of current debt - not because the money doesn't exist, but because the debtors have no realistic chance of accessing it.

There is no question that the money does not exsist to pay off the debt.  The idea that the debt can be paid is a complete lie.

Along with that, we need to 'socialise' banking in some (preferably decentralised) way that marries the issue of debt and money with real human welfare enhancement.

We can all clearly see that having money created as a debt gives the illusion of greater human proserity but real world life experience proves this to be untrue.  A debt money system always drives increasing money shortages for the bulk of the people, and an ever decreasing standard of living.  Though it's true we may accumulate more pyhsical wealth, this only comes at the expense of the people going deeper into debt.

We do not need to socialise the banking system, what we need to do is switch the money system over to a wealth based money system that represents the peoples production with no debt.  This would give the producers the benifits of their production without having to in time turn over everything they own to a fraudulent banking system.

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Re: Interest payment is not the problem

Diarmidw,

Thank you for recasting doubts that have been raised and expressed previously by others on this topic, but in a fresh and easier-to-understand light than they might have been expressed before.

I believe Chris is too quick to dismiss this topic.  It is the one area of all his work that in my opinion, I find his reaction to questioning in to be both impatient and inconclusive.  Please note I say that with all respect, which should be obvious as I’ve now been a paying member of this site for 18 months and plan on continuing due to Chris’s ongoing excellent analysis and the contributions of many on this site.

As for the issue itself, I find both your analysis and Chris’s to be inconclusive, and the topic too important to leave unaddressed.

You have logically shown (as have others but not as elegantly) that interest payments can be made using the same money stock; while Chris correctly points out that this is not what is observed in reality.

I believe you are both right and therefore the answer must lie not in whether interest can flow back to borrowers for repeated use, because we know it can, but rather why it doesn’t.  I am pretty sure Chris has concluded that because the system is inherently broken and behaves exponentially, then damn the torpedoes, let’s get on with business we can take action about and stop quibbling about theoretical constructs. 

That is all well and good, and everyone who hasn’t figured out how they will get through the next 20 years, should probably focus on that before worrying about what the real problem with our money is.

I however, not only enjoy these discussions but also think it is worth finding the real reasons for what we see and why it is not as we would expect.  If we do not get to the heart of the problem, nothing will be solved, or we will “solve” the wrong thing which will have unintended consequences on the ”real” thing.

I have a number of objections to Chris’s reasoning above, but I do not claim to have answers that would satisfy what he attempts to explain.  That does not make his explanations good or acceptable, much less “right”.  Sometimes it is better to say, “we don’t know yet”, instead of to believe something explained by a well-respected and obviously very smart person just because there is nothing better to explain the situation.

So, for the sake of opening some minds around here on the topic at hand, the following is my devil’s advocate-style rebuttal of what Dr. M stated above.  The point of this is to help reopen the topic under question for further study, for we will never solve a problem if we do not even know it exists or if we treat a different problem entirely.  Ascribing the wrong cause to a set of factual and correct observations, will keep us from ever finding the true cause, and so in that spirit, I hope to show why Chris’s reasoning is simply not satisfactory:

 

 

Chris Martenson wrote:

It is undeniably true that there is less money than principal and interest combined from the very first minute after a loan is made. This is not debatable it is a design element of our system of money.  It simply exists as a condition. 

Yes, but that would be true of any system in any society that allows promises (i.e., loans) in the first place.  Anybody could – could, promise to buy my house or anything else from me,  in installments, with interest, with money that “does not exist”.  It does not exist because I am personally going to hold the mortgage on the property.  So in a sense, I am “creating money out of thin air”, and lending it to the borrower, am I not?  And would it make any difference if we are talking about fiat money, gold money, or any other kind of money, or if a banking system even existed?  In the sense that I personally just “introduced” however much money my home sold for into the economy, no it doesn’t.  A promise for future payment was made.  The entire point of a promise is to deliver tomorrow what DOES NOT EXIST today!!!!!  So yes, in ANY society, using ANY monetary system, principal plus interest will ALWAYS be greater than the existing money stock.  It is not something inherent to our fiat money system, inherent to our Central Banking system, or to our Fractional-Reserve-Banking system.  It is inherent to the NATURE of promises and the HUMAN condition!  This was written about extensively in

http://www.peakprosperity.com/forum/how-i-learned-stop-worrying-about-fractional-reserve-banking-and-start-hating-fed-even-more-ev 

And, the reason it works, is because INTEREST, as Diarmidw has pointed out, is a FLOW, not a stock of money. 

So, there is obviously something else wrong with our system.  It is not that principal and interest are greater than the money stock.  That would be true in ANY human society because humans make and accept promises which by their very definition, are pledges to deliver tomorrow that which does not exist today, and is therefore greater than what exists today.  Otherwise, the promise and the loan would not be necessary, would it?

Chris Martenson wrote:

You could argue that if the bankers only make loans to people who work for them this will all balance out and,

I suppose someone could argue that, but Diarmidw is not, and nobody I know of on this site or anywhere else that is taken seriously is arguing that.  I suppose it is OK to cover this possibility for the sake of logical order, but it would be a ridiculous argument for anyone to try to make so I’m not sure why you bother addressing it.  It is not necessary for money to return to the economy through wages.  It could return through dividends, taxes, capital investment, or through more loans.    

Continuing…

Chris Martenson wrote:

while technically true, this is not relevant from a real-world standpoint point since banks and bankers do not produce anything that people need to live upon.  They produce no products, no food, and no useful services besides money management. 

So “money management” is not a useful service?  Why does anyone have bank accounts then?  I do not want to quibble, and this excerpt is really not very important, but just thought I’d get my two cents in on that one!  And no, I am not a banker for anyone that is wondering why I’d defend banks.  The point is, they do perform a useful service, or the industry would not have been born hundreds of years ago as it was.

Chris Martenson wrote:

 So a society that entirely consists of bankers making loans but then paying people to work for them out of interest payments is very quickly a starving, cold, and homeless society.  Hopefully we can agree that there's not a lot of useful insights to be gained from following this line of reasoning too far because it is not realistic. 

Again, nobody has made this argument.  Totally agree this argument is not worth pursuing as nobody has made or is making the counter-argument.

Chris Martenson wrote:

From a wider perspective we might note that total interest payments on $52 trillion of debt are in the vicinity of $3 trillion and it's a preposterous notion to suggest that even a skinny fraction of that is performed as direct work for banks.  If it were, services performed for banks would be fully 25% of the economy.

Again, nobody is suggesting that all the interest be reintroduced out as wages.  There are other ways, much more important ways, for it to be reintroduced into the economy.  Keep in mind also that that $52 trillion is total debt – public and private, and so many of those loan-holders are not just banks but include private individuals, pension funds, insurance companies, and institutional investors holding government debt, corporate bonds, home and commercial mortgages, and so forth. 

 

Chris Martenson wrote:

Since we hopefully now agree that the world cannot live by the actions of bankers and people working for them alone,

I don’t think anyone would disagree with this.  Just like the world could not consist of JUST bricklayers, JUST potatoe farmers, or JUST anything else, it could not work with JUST Bankers.

Chris Martenson wrote:

we have to introduce outside agents who are working in other industries and professions but who are required to use bank money (see also; legal tender and tax laws).  Now we have people who are taking loans but not having any other relationship with the banks besides paying them interest.  

I am not sure what is meant by “no other relationship” with the bank.  Is that relevant?  What we are trying to figure out is whether or not interest on principal gets re-introduced, behaves as a money FLOW, and thereby does NOT require exponential debt growth, is it not?  I am at a loss as to what the meaning or purpose of this statement is.

Chris Martenson wrote:

Here's where some people get confused because they make the critical mistake of assuming that just because someone works outside the bank, and earns some money there by creating value somehow, and uses that money to pay off the bank loan (which the bank may or may not "recirculate") that somehow the interest money has been accounted for.  It has not. 

I am still not following what is being said here.  The issue of people working outside a bank and paying their loans is not the confusing part.  The confusing part is whether, and why or why not, interest payments are reintroduced back into the economy in ways that borrowers can reutilize to pay off debt, thereby rendering further aggregate debt creation unecessary.

Chris Martenson wrote:

Money did not magically come into existence through the actions of the person working.   ALL MONEY IS LOANED INTO EXISTENCE.  That's the system we have.  There is no other mechanism.  None. 

I think both Dr. M and Diarmedw, and certainly I, are in 100% agreement here.  But again, that is not the point.  No matter how money is created, or if we even use debt-based money or not, principal plus interest in ANY society, ANY economy, and in ANY money system, will ALWAYS be bigger than the money stock.  THAT is one of the points.  The other, maybe more important point, is that it is possible for all interest to flow back into the economy to re-service debt because interest is a flow, not a stock, so exactly WHY is it that we are not observing that???!!!!  THAT is the question that must be answered satisfactorily if we want to correctly and permanently put this issue to rest.

Chris Martenson wrote:

Because we know this to be true, we know that the money the person magically obtained 'on the outside' has a corresponding amount of debt elsewhere in the system.  A debt that has an interest payment attached to it.   Because of this condition, there is always more debt outstanding than money in circulation

No argument here either, but as I pointed out above, there will always be more debt than money in any system.  That’s how promises work.  It has nothing to do with our monetary or banking systems.  As long as humans are allowed to make promises to each other, there will ALWAYS be more debt than money under any banking, monetary and even legal system on Earth and there always has been.  That’s simply what a promise is in the first place.

Chris Martenson wrote:

and  new money MUST continuously be loaned into existence to cover the difference.   Otherwise debts will go into default and the banking model will become extremely unhappy, or even collapse.

And here is the cruz of the matter again.  No, new money must NOT necessarily be loaned into existence.  That is simply not true because interest due is a flow, not a stock (to use Diarmedw’s terms).  It would be like saying that GDP cannot be bigger than the money stock when in fact it always (thankfully) has been several multiple of it. 

Obviously, Dr. M’s observations about the actual behavior of our debt and money supply are facts that cannot be argued with.  However, I do not agree with the conclusions he has drawn.

If we really want to know what is wrong with our system, we must ascertain why our debt has/is growing exponentially faster than the population or the economy.  It is NOT because of the nature of our banking or even monetary system.  I do not have the answers, but Diarmedw and many others have shown over and over again why it is not simply due to our monetary system as it can support many more times the interest flows due than there is money stock in the system.

Chris Martenson wrote:

So, here's where we are from a reductionist standpoint.

We know that all money is loaned into existence with interest.  This means that there is a percentage rate of growth baked right into the system. 

No, it does not bake a percentage rate of growth (of the money stock) right into the system.  It does bake a percentage rate of production or flow into the system.  Growth (of the money stock) itself is not required for this system to work, though it certainly makes things easier (in the short run).  A minimal rate of production, call it GDP, is required, since borrowers have to receive enough dollars throughout the year to service their loans.  A minimal rate of wages, dividends, capital investment or new loans, or a combination thereof, on part of the banks, is also required.  But again, growth of the money stock is not required.

Chris Martenson wrote:

Barring some sort of a deflationary impulse that will destroy outstanding debt (and defer growth for a while), exponential growth will result from this system based on its design.

  Obviously I cannot agree with this either since it is derived from the prior statement.  It’s design does not require exponential growth of the money stock.  It does require a minimal state of production.


Chris Martenson wrote:

We know that there is always more debt than money in existence UNLESS debt defaults are exceeding new loan/money creation in which case banks are being destroyed (see also: today)

One does not preclude the other.  Banks are being destroyed today, but debt is still bigger than money.  The important part is the flow, which is essentially what the second part of your statement is about, and I agree with.


Chris Martenson wrote:

We know that it is not possible for everybody to apply all of their productive effort towards banks.

Taken together we can conclude that we have a system that is designed to expand and that will suffer greatly if and when it cannot. That's exactly what I see around me today.

From a larger perspective there is unarguably more debt than money and we can back test both money and debt growth and see nearly perfect exponential fits to those curves. When I see such strong evidence I begin with the hypothesis that there is an exponential driver underpinning the system(s) involved.

Chris, I have no doubt, and I do not think anyone else does either, that there is an exponential driver behind the data you observe.  However, I do not agree that you have proven that it is inherently tied to our debt-based money and banking system. 

It is a logical and mathematical fact that money/debt growth is NOT required for debt-based money to work.  It is also a mathematical and logical fact that the condition of having more debt than money stock is true of ANY economic, monetary, banking, legal system or combination thereof because ALL promises, by their very nature, pledge to deliver TOMORROW what is NOT AVAILABLE TODAY.

For the record, I have all sorts of problems with our debt based monetary and banking medusa system, and I am not trying to defend either.  What I am hoping to do is to help show that things are not nearly as simple as Dr. M would have them be, at least not in this case.  Whatever the true problem with our system, it is not as simple as it requiring exponential growth by design, because its design simply does not require it. 

 

Chris Martenson wrote:

So I stand by my statements as they were made in the Crash Course.  We have an exponential money system which we can either detect in the aggregate data or from a realistic understanding of how the banking system operates.   either way, same result.   This is a useful way to analyze and understand the banking system, our economy, our monetary system, and the world we see around us.

While I am sure that someone can concoct a spreadsheet to prove a theoretically different outcome, I have been well served by the marriage of real-world observation and a fundamental understanding of how the banking system actually operates.   It's  been both predictive and matches up with history pretty well.

Saying that interest payments must flow out of the banking system and therefore everything balances is completely out of line with the data spanning many decades, does not comport with what I see in the real world, and does not match my theoretical understanding of the mechanisms of banking and debt-based money.

What we do know is it behaves exponentially, but nobody, including Dr. M, can explain why.  If simply knowing it behaves the way it does is enough for people to make decisions, there is nothing wrong with that, and I myself have and will continue to act on what we know from observation, even though I may not understand what is causing the behavior.     

I hope Diarmidw’s opening of this “can of worms”, along with Dr. M’s response to it, leads to some spirited and intelligent discussion.  We are all here to learn after all, even as we prepare.

FB

 

 

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Baywork
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Re: Interest payment is not the problem
DrKrbyLuv wrote:

You are presenting misinformation at this point as your premise has been corrected.  It is important that we understand the system and you can see in rickets Post #12 that you are leading others to misunderstand what is happening and to draw flawed conclusions.

Larry

Larry-

it looks like these posts, stating that a sustainable credit money system is theoretically possible, are dead sure revenants on this site.

Shoudn’t we be able to theoretically dismantle a theory that doesn’t coincide with evidence?

My take is that Keen and alike fool people by disguising the deposit quality of a credit transaction.

A bank money credit is a bank money deposit. Instant and inevitable. To make their theory work, they presume that any deposit interest must fully be consumed rather than reinvested. After paying the depositors, the bank must fully consume the remaining credit interest. All interest money must enter instantaneous recirculation to avoid any compound interest.

However, compound interest is exactly the problem.

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Baywork
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Re: Interest payment is not the problem

Farmer,
(I didn’t read your answer before posting above because the site or my browser or whatever was hiding it beforehand.)

100% agreement with your post here.

If you look at Diarmidw’s logic, you could simplify the sample transactions:

Banker gives a winemaker credit.
Winemaker transfers deposit to others in exchange for labour and resources and makes wine.
Winemaker retracts deposit by selling wine.
Winemaker repays credit and deposit is extinguished. Terrific.

Winemaker owes interest to banker, thus gives a bottle of wine to banker.
And, banker owes interest to depositors, thus holds a wine fest with his depositors.

Thus, we must just dictate a 100% dissipation rate of any interest payments in the banking system by law to make the system work perfectlySurprised

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Baywork
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Re: Interest payment is not the problem

duplicate, cleared

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darbikrash
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Re: Interest payment is not the problem

I’d like to try and capture my reaction to the dialogue so far, and hope that it continues in a productive fashion. Several posters expressed some sentiments that really hit home for me.

In carefully reading and re-reading the posts, and especially Dr Martenson’s post, I feel that one of the most important observations I can make concerning the unending debate of debt based currency is the (faulty) co-mingling of the subject of the current state of the economy, with the subject of a “clean sheet of paper” economy. They are two very different subjects and conclusions drawn from one do not necessarily scale to the other. We are after all, talking about the extreme ends of the scale with respect to debt based currency. It has been called “macroeconomic economics” vs. “microeconomics” but we have to get past the labels and really create a profound separation between these disparate conditions.

We cannot segue from a discussion with one bank and one loan and in the very next sentence introduce a scale in the current economy wherein we are looking at 52 trillion in debt. This is a non-sequiter and the two cases are as different a night and day.

Look, the basics Dr. Martenson’s laid out are not in question as far as I am concerned. However, the conclusion that debt based currency is inherently predestined to create a failure is suspect in my mind. This is an important distinction- a very important distinction, because as Diamidw alluded, this goes to assigning blame, and ultimately corrective action.

You cannot repair what you do not understand. You cannot win a fight if you do not know the correct enemy .

It is critically important that this controversy of intrinsic failure of debt based currency be settled. I cannot settle this or really even contribute, but I can comment.

The statement that ‘the facts are irrefutable” insinuating that truth of the failure of debt based currency is self evident is not a plausible argument. If one takes the time to peruse Diamidws’ website, referring to his pond capacity analogy, it can be readily seen that the occurrence of debt in excess of the currency in circulation does not necessarily denote a catastrophic outcome. As a layman, I will try and explain why I believe this is so:

1.)    Velocity of money (or dynamic equilibrium) The system works because it is always in motion. As mentioned by others, time is indeed a factor. The element of time is a critical component of the debt calculus. It is not disingenuous to introduce time into the discussion of economies. Economies are inherently dynamic, they can almost never be measured statically with any degree of accuracy. Sure, if you freeze time, and contemplate an instantaneous debt value in excess of the money supply, red flags go up. So what? If everyone tries to withdraw their savings from the bank at the same instant what happens? Broad statements specifying the (artificially) static case of more debt than currency totally miss the point. This is not a realistic assessment and an unfair metric. Some reverse logic may apply here. If debt never exceeds currency supply, than it may well be impossible to have a debt based crisis but even if true, one can most certainly not conclude the opposite, that having debt in excess of currency absolutely indicates a crisis is forthcoming. It just means that those making these statements likely either do not understand the dynamic component of economies, or do not have the tools the analyze such a system with many moving parts.

2.)    Purpose of debt/type of debt- qualitative measures. Another red flag around broad statements predicting failure is the absence of discussion around the quality and types of debt being introduced into the economy. You cannot lump consumerist debt into the same basket of conclusions as the type of business to business debt which creates highly leveraged future value into the economy. They are not the same, and broad statements predicting debt failure are subservient to the types and quantities of debt. As Minsky was referenced earlier, perhaps a quote outlining some of his theories on the subject would be useful:

Wikipedia wrote:

Understanding Minsky's financial instability hypothesis

Hyman Minsky's theories about debt accumulation received revived attention in the media during the subprime mortgage crisis of the late 2000s.[9]

Minsky argued that a key mechanism that pushes an economy towards a crisis is the accumulation of debt. He identified three types of borrowers that contribute to the accumulation of insolvent debt: hedge borrowers, speculative borrowers, and Ponzi borrowers.

The "hedge borrower" can make debt payments (covering interest and principal) from current cash flows from investments. For the "speculative borrower", the cash flow from investments can service the debt, i.e., cover the interest due, but the borrower must regularly roll over, or re-borrow, the principal. The "Ponzi borrower" (named for Charles Ponzi, see also Ponzi scheme) borrows based on the belief that the appreciation of the value of the asset will be sufficient to refinance the debt but could not make sufficient payments on interest or principal with the cash flow from investments; only the appreciating asset value can keep the Ponzi borrower afloat. Because of the unlikelihood of most investments' capital gains being enough to pay interest and principal, much of this type of finance is fraudulent.

If the use of Ponzi finance is general enough in the financial system, then the inevitable disillusionment of the Ponzi borrower can cause the system to seize up: when the bubble pops, i.e., when the asset prices stop increasing, the speculative borrower can no longer refinance (roll over) the principal even if able to cover interest payments. As with a line of dominoes, collapse of the speculative borrowers can then bring down even hedge borrowers, who are unable to find loans despite the apparent soundness of the underlying investments.[10]

How can broad statements predicting imminent failure of a debt based currency be practically issued without identification of which type of debt, and which type of borrower we are discussing? Are we saying that even using Minsky’s definition of a interest laden “hedge” borrower, that collapse is inherent? Really?

3.)    Credit Defaults. Just as it is unrealistic to frame a dedicated capital flow from borrower to bank in an N=3 diagram, it is a unrealsitic to portray a debt based economy as unsustainable just because the time zero debt exceeds the time zero currency. All that is needed to rectify this disparity is a simple credit default. Problem solved. But this is never mentioned on these pages, even when I have explicitly brought this up. So is this just an exercise on my part to hair split and jigger some type of unrealistic, one in ten million case study to try and justify an implausible and illogical premise? Or does this need to be realistically assessed, quantified and woven into the basic theory of how (debt based) economies really operate? I’ll say this, in the history of the world, there is likely never have been a significant economy wherein all monies loaned were paid back with no defaults. This is a virtual impossibility and though it may be convenient to ignore the effects of a borrower defaulting to advance a belief system, it hardly seems realistic. A “real” study of real effects must factor the inevitability of sporadic (and not catastrophic) defaults and the effect of said defaults on the debt/currency ratio.

Another observation that I would add is that to some degree, this topic is misplaced. What we are really discussing here is a component of capitalism, and a central component at that. The way to think of this predicament is to think about it not as a monetary issue, but as a constituent effect of capitalism. Nowhere is it written that when interest bearing money is loaned out that it all comes back to the lenders. Nowhere is it written that everyone that borrows interest bearing capital is able to efficiently and effectively leverage this money into a condition described by Minsky as a “hedged” transaction. Some will fail. In fact, and here it comes, the system does in fact contain a failure based design element as Dr. Martenson suggests, but I suggest that this failure is not systemic, it is isolated to individual entities. Not everyone who borrows money will succeed. In fact, it is not be possible for everyone to succeed, as this is the design element. Those that do not, default. There just are not enough chairs for everyone when the music stops playing.

Somehow, we have morphed this reality into a systemic blame game with debt based currency indicted and convicted.

Some of the other reply comments seemed a little off. It looked like Diamidw went to some trouble to indicate that his diagram was not dependent on the simplified case presented, but rather extended to include a more realistic economy with more than just one bank and one borrower. This does not seem to have been absorbed, so perhaps some additional clarification from Diamidw on this subject (scale up) would be helpful.

I also took the apologetic discussion from Diamidws’ second post to be in reference to his earlier survivalist comment, and not to the larger claims regarding interest flow. It seemed to me that this (interest flow topic) was reaffirmed, not retracted.

I disagree that the premise of “unequivocal root cause failure of debt based currency has been established”. To the contrary, I view this as very much an open debate.

It is important to understand that for me anyway, this is not idle trivia. This is not “stump the teacher” day. If incorrect conclusions are drawn as to the root cause of what we are seeing- today- in our world, we cannot react properly and cannot respond properly with any type of rebuilding effort if we do not understand the problem. If a significant initiative is put forth to ban debt based currency going forward, I would hope and agree that this provides better results that we observe now. But I doubt it. I doubt it because in  my mind exigent circumstances are the root cause problem, not debt based currency. Exigent as in manipulation of markets. Does wealth based currency (or any alternative for that matter) stop financial derivatives? Aren’t derivatives proximally closer to insurance polices that currency instruments? Are not the derivative components of our financial system several log orders larger than private sector debt? Is focusing on debt based currency not “mowing the lawn when the house is on fire”

Perhaps the root cause of what we observe is regulatory capture, runaway corporatism,  persistent and caustic influence on our democracy by special interest groups. I don’t know the answer, but I do know this- to get this wrong and identify an incorrect root cause is a major risk.

I do hope this discussion continues.

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ashvinp
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Re: Interest payment is not the problem

Given the fact that Minsky and Keen have been brought up several times in this thread, I think this post by Keen on his blog is timely - http://www.debtdeflation.com/blogs/2010/07/07/naked-capitalism-and-my-scary-minsky-model/

Quote:

Yves found the model [of Minsky's FIH] scary, not because it revealed anything about the economy that she didn’t already know, but because it so easily reproduced the Ponzi features of the economy she knows so well.

I have yet to attempt to fit the model to data–and given its nonlinearity, that won’t be easy–but its qualitative behavior is very close to what we’ve experienced. As in the real world, a series of booms and busts give the superficial appearance of an economy entering a “Great Moderation”–just before it collapses.

I think the key point here is that Minsky and Keen view(ed) these ponzi debt dynamics as an inherent feature of finance-based economies, which certainly includes economies in which all money is created as debt. If all people were perfect utility-maximizing rational beings when it came to making economic or other decisions, then a lot of unsustainable systems we currently have [mainly the 3 Es] could be theoretically sustainable, but unfortunately that is not reality. Failures will happen and should happen, but why should we operate under a debt-based money system that inevitably makes these failures absolutely devastating and is so prone to exploitation?

 

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Re: Interest payment is not the problem
darbikrash wrote:

ILook, the basics Dr. Martenson’s laid out are not in question as far as I am concerned. However, the conclusion that debt based currency is inherently predestined to create a failure is suspect in my mind. This is an important distinction- a very important distinction, because as Diamidw alluded, this goes to assigning blame, and ultimately corrective action.

I apologize in advance for not having read the extensive forum discussions of this topic before offering comment, but it seems to me that there is a simple example that gets to the heart of this matter. Consider an economy in which the only legal currency is gold coin that exists in a finite, definite, unchanging quantity. Economic growth (obviously not measured via quantity of money!) can come from human endeavor and an environment that supplies food, fuel and raw materials. If there is economic growth, then prices can drop as more goods become available to the same stock of money. If there are droughts, natural disasters or human errors that reduce goods, prices can rise and the economy can shrink.  If lending occurs and interest is charged by lenders then it is necssary that there be growth in the economy so that less coin is needed to purchase essentials and thus becomes available for payment to lenders. Without growth, the coin to pay the lenders can be obtained only by borrowers reducing their purchases of other things. If things get bad enough, the lenders might not get paid at all, which is default. If defaults are never to be allowed, then there must be economic growth sufficient to liberate the coin needed for interest payments. If lending is involved in a fraction, f, of the economy, at interest rate i, then in steady state the resources provided by the environment to the economy must grow exponentially at an approximate rate of f*i.

Stan Robertson

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Farmer Brown
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Re: Interest payment is not the problem
ashvimp wrote:

I think the key point here is that Minsky and Keen view(ed) these ponzi debt dynamics as an inherent feature of finance-based economies, which certainly includes economies in which all money is created as debt. If all people were perfect utility-maximizing rational beings when it came to making economic or other decisions, then a lot of unsustainable systems we currently have [mainly the 3 Es] could be theoretically sustainable, but unfortunately that is not reality. Failures will happen and should happen, but why should we operate under a debt-based money system that inevitably makes these failures absolutely devastating and is so prone to exploitation?

So  are you saying that because some loans default, some banks make bad loans, and because humans simply do not behave like mathematical abstractions, that that is the reason why a debt-based system does not work?

I suppose that could be the reason, but I can think of many ways to disprove that theory.  But if it is the reason, then the statement that our debt based economy requires perpetual exponential growth is not true.  What would be true (if you're right) would be, debt defaults and bad loans, and Ponzi borrowers require exponential growth in the money supply.

I do not think that conclusion is correct because bad loans and bad banks could just be allowed to fail, extinguishing loans both for the borrower and the lender.  

Maybe that's what;s wrong with our system:  failure is not allowed, so bad debt piles up forever.  In that case, we could say that the inability for politicians to allow failure, requires an exponential increase in the money supply in order to compensate for the cash flows lost on servicing loans that produce nothning.  

LOL, that was tongue and cheeck, of course.  Smile

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Farmer Brown
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Re: Interest payment is not the problem
Stan Robertson wrote:
darbikrash wrote:

ILook, the basics Dr. Martenson’s laid out are not in question as far as I am concerned. However, the conclusion that debt based currency is inherently predestined to create a failure is suspect in my mind. This is an important distinction- a very important distinction, because as Diamidw alluded, this goes to assigning blame, and ultimately corrective action.

I apologize in advance for not having read the extensive forum discussions of this topic before offering comment, but it seems to me that there is a simple example that gets to the heart of this matter. Consider an economy in which the only legal currency is gold coin that exists in a finite, definite, unchanging quantity. Economic growth (obviously not measured via quantity of money!) can come from human endeavor and an environment that supplies food, fuel and raw materials. If there is economic growth, then prices can drop as more goods become available to the same stock of money. If there are droughts, natural disasters or human errors that reduce goods, prices can rise and the economy can shrink.  If lending occurs and interest is charged by lenders then it is necssary that there be growth in the economy so that less coin is needed to purchase essentials and thus becomes available for payment to lenders. Without growth, the coin to pay the lenders can be obtained only by borrowers reducing their purchases of other things. If things get bad enough, the lenders might not get paid at all, which is default. If defaults are never to be allowed, then there must be economic growth sufficient to liberate the coin needed for interest payments. If lending is involved in a fraction, f, of the economy, at interest rate i, then in steady state the resources provided by the environment to the economy must grow exponentially at an approximate rate of f*i.

Stan Robertson

Sorry, but this misses the point entirely.  The issue at hand  is whether and why or why not, interest paid back from loans gets reintroduced into the economy, thereby rendering perpetual debt-based growth unecessary.

I did enjoy the trip down into my fantasy economy though!

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Baywork
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Re: Interest payment is not the problem
Farmer Brown wrote:

Sorry, but this misses the point entirely.  The issue at hand  is whether and why or why not, interest paid back from loans gets reintroduced into the economy, thereby rendering perpetual debt-based growth unecessary.

I did enjoy the trip down into my fantasy economy though!

Because money paid as interest won’t have zero lifetimes in the system, thus the system must grow forever. It's very simple.

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Farmer Brown
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Re: Interest payment is not the problem
Baywork wrote:
Farmer Brown wrote:

Sorry, but this misses the point entirely.  The issue at hand  is whether and why or why not, interest paid back from loans gets reintroduced into the economy, thereby rendering perpetual debt-based growth unecessary.

I did enjoy the trip down into my fantasy economy though!

Because money paid as interest won’t have zero lifetimes in the system, thus the system must grow forever. It's very simple.

You might want to revisit Diarmidw's site or read his posts again.  Interest can flow back into the system and be used over and over again.  The queston is why doesn't it, or if it is, then what else is causing the exponential growth beyond our exponential population growth in our money stock.

PS:  What does, "won't have zero lifetimes in the system" even mean?  That would seem to imply that it has multiple lifetimes, in which case you are in agreement with Diarmidw.

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Stan Robertson
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Re: Interest payment is not the problem
Farmer Brown wrote:
Stan Robertson wrote:
darbikrash wrote:

ILook, the basics Dr. Martenson’s laid out are not in question as far as I am concerned. However, the conclusion that debt based currency is inherently predestined to create a failure is suspect in my mind. This is an important distinction- a very important distinction, because as Diamidw alluded, this goes to assigning blame, and ultimately corrective action.

I apologize in advance for not having read the extensive forum discussions of this topic before offering comment, but it seems to me that there is a simple example that gets to the heart of this matter. Consider an economy in which the only legal currency is gold coin that exists in a finite, definite, unchanging quantity. Economic growth (obviously not measured via quantity of money!) can come from human endeavor and an environment that supplies food, fuel and raw materials. If there is economic growth, then prices can drop as more goods become available to the same stock of money. If there are droughts, natural disasters or human errors that reduce goods, prices can rise and the economy can shrink.  If lending occurs and interest is charged by lenders then it is necssary that there be growth in the economy so that less coin is needed to purchase essentials and thus becomes available for payment to lenders. Without growth, the coin to pay the lenders can be obtained only by borrowers reducing their purchases of other things. If things get bad enough, the lenders might not get paid at all, which is default. If defaults are never to be allowed, then there must be economic growth sufficient to liberate the coin needed for interest payments. If lending is involved in a fraction, f, of the economy, at interest rate i, then in steady state the resources provided by the environment to the economy must grow exponentially at an approximate rate of f*i.

Stan Robertson

Sorry, but this misses the point entirely.  The issue at hand  is whether and why or why not, interest paid back from loans gets reintroduced into the economy, thereby rendering perpetual debt-based growth unecessary.

I did enjoy the trip down into my fantasy economy though!

In the fantasy economy, the bankers can stop exponential growth (of resource consumption) by putting the interest they earn into a vault. Their steady state economy can remain fixed in "size" and operating on progressively fewer coins. I suspect that our real debt based money economy would work the same way because if all of the interest is spent, then it is actually equal to the amount of growth required.

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Baywork
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Re: Interest payment is not the problem
Farmer Brown wrote:

You might want to revisit Diarmidw's site or read his posts again.  Interest can flow back into the system and be used over and over again.  The queston is why doesn't it, or if it is, then what else is causing the exponential growth beyond our exponential population growth in our money stock.

PS:  What does, "won't have zero lifetimes in the system" even mean?  That would seem to imply that it has multiple lifetimes, in which case you are in agreement with Diarmidw.

Farmer,

when existing money gets paid back as interest, it doesn’t get extinguished like a principal repayment. It continues to require additional service, i.e. interest, although it’s already ‘contaminated’ with debt service through it is existing money.

Zero money life cycle refers to the concept that money must not exist to not require interest service because it is debt. Yes, if you manage to establish infinite velocity in the system, it can be used over and over again without generating compound interest. However, if interest money is allowed to show up as deposit balances, you’ll end up with compound interest. Compound interest in turn constitutes exponential growth.

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DrKrbyLuv
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Re: Interest payment is not the problem

The fact is that a private debt based system like ours cannot be sustained as it requires infinite growth.  This can be proven with mathematical certainty and the predicted results may be witnessed in our economy.  

"Our present monetary system was established by legislation, without any reference to the mathematical science of numbers.

To make entirely sure that our reasoning upon the impossibility of paying interest when the principal is all loaned without the production or coining of money is logically and mathematically true, we will apply to our problem the test of higher mathematics. In examining the credit system we find that it must be composed of a definite number of interest-bearing contracts. By analyzing one of these contracts we shall find two parties are concerned in them, the borrower and the loaner. The loaner loans a stipulated sum of money called the principal; the borrower receives it and agrees to return a like sum together with a premium called the interest, which is estimated at a legal rate per cent on the sum loaned for a given time. Failure of the borrower to comply with these conditions calls for the forfeiture of his securities. This comprises all the quantities and considerations of an interest-bearing contract. It may be algebraically expressed thus:

Let a = the amount of a contract (which is the sum of the principal and interest)
p = the principal
r = the rate per cent
t = the time

Now p = a at the date the contract is drawn, and p+prt/100 = a at the time the contract expires. Quantities that are equal to like quantities are equal to each other. Hence p = p+prt/100 which is impossible

This formula shows that the contract is impossible, that prt/100 calls for a production of money and cannot be canceled by a production of values. Neither can it be eliminated by a contraction of t, which constantly increases pr/100. This being true of one contract it must be true of any number of contracts with the credit system may contain. This formula solves one of the important problems of the age and is presented to the scientific people of America for inspection.

The mathematical conclusion which must be drawn from this formula is that the interest on our circulating medium is imaginary and impossible, and under our present system must be satisfied by securities, which is legalized robbery."  - Mary E. Hobart, A Scientific Exposure of the Errors in Our Monetary System, Published in 1891

Others have offered the following:

P + I > P

Let P = the principal
I = interest

The equation cannot be balanced as P + I will always be greater than P.  If you started a debt based system tomorrow and created 100 1 year loans at 10%, and no other money is created, then at least 10% of the loans would default by the end of the year.  If 100 loans for $1,000 was made, there would be $100,000 created but $110,000 is owed.  The $100,000 (principal) would be destroyed as principal repayments are made.  There would be no money at the end of the year making it impossible for people to collectively repay the full $110,000 - they would be $10,000 short and without any money.

The alternative is for people to continue borrowing at an ever accelerating rate until peak debt is reached.  The life of the system may be extended through bubbles and irresponsible lending but eventually it will collapse.  Every time the economy hits a recession, many defaults occur as a function of the math as the money supply is reduced.  The liquidations help reset the system but only constant growth can keep it tenable.

1) Money supply growth (see chart above). It took us from 1620 until 1973 to create the first $1trillion of US money stock (measured by adding up every bank account, CD, money market fund, etc). Every road, factory, bridge, school, and house built, together with every war fought and every other economic transaction that ever took place over those first 350 years, resulted in the creation of $1 trillion in money stock [1].

The most recent $1 trillion? That has been created in only 4.5 months. The dotted line in the chart is an idealized exponential curve, while the solid line is actual monetary data. The fit is nearly perfect (with a correlation of 0.98, for those interested). Data from the Federal Reserve.

3) Total credit market debt (that’s all debt) had finally exceeded $5 trillion by 1975, but has recently increased by $5 trillion in just the past 2 years (from 2006 - 2008), and now stands at nearly $50 trillion. In order for the next twenty years to resemble the last twenty years, debt would have to expand by another 3 to 4 times, to somewhere between $150 trillion and $200 trillion. How likely do you think this is? Data from the Federal Reserve.

How do we make sense of money numbers this large and growing this fast? Why is this happening? Could it be that the US economy is so robust that it requires monetary and credit growth to double every 6-7 years? Are US households expecting a huge surge in wages, to be able to pay off all that debt? If not, then what’s going on? The key to understanding all three of the above money and debt charts was snuck in a few paragraphs ago; every single dollar in circulation is loaned into existence by a bank, with interest.

That little statement contains the entire mystery. As improbable as it may sound to you that all money is backed by debt, it is precisely correct, and while many of you are going to struggle with the concept, you’ll be in good company. John Kenneth Galbraith, the world-famous Harvard economist, said, “The process by which banks create money is so simple that the mind is repelled.” [2]

Here’s how money (and debt) creation works: Suppose we wipe the entire system clean and start over, so that we can more easily understand the process. Say you enter the first (and only) bank and receive the very first loan for $1000. At this point the bank has an asset (your loan) on the books, and you have $1000 in cash and a $1000 liability owed to the bank. After a month passes, and the first interest accrues, we peek into the system and observe that the $1000 in money still exists, but that your debt has grown by the size of the interest (let’s call that $10). Now your total debt to the bank is $1000 plus the $10 interest or $1010 in total.

Since there’s only $1000 floating around, and that’s all there is, clearly there’s not enough money to settle the whole debt. So where will the required $10 come from? In our system it must be loaned into existence, taking the form of $10 of new money plus $10 of new debt that must also be paid back with interest.

But if our system requires new and larger loans to enable the repayment of old loans, aren’t we actually just compounding the total amount of debt (and resulting money) with every passing year? Yes, that is precisely what is happening, and the three money/debt charts supplied above all provide confirmation of that dynamic.

In other words, our monetary system, and by extension our entire economy, are textbook examples of exponential systems. Yeast in a vat of sugar water, predator-free lemming populations, and algal blooms are natural examples of exponential growth. Plotted on graph paper, the lines tracking these populations start out slowly, begin to rise more quickly, and then, suddenly, shoot almost straight up, yielding a shape that resembles a hockey stick.

This is clearly an unsustainable arrangement. Someday soon, it will cease to be.

Repeating an opening sentence, our choices now are to either evolve a new economic model that is compatible with limited physical resources, or risk a catastrophic failure of our monetary system, and with it the basis for civilization as we know it today. I wish this collision between a finite planet and an exponential money system was far off in the future. Alas, it is certainly within the lifetime of people alive today, and likely already upon us.

This is a fundamental and catastrophic problem that should concern us all and I fully agree with CM, "our choices now are to either evolve a new economic model that is compatible with limited physical resources, or risk a catastrophic failure of our monetary system."

This is the key to our current dilemma.  The solution is for the people to figure out that our system is terminally flawed and then to demand a fair and sustainable alternative.

I'll leave you with a final question...how do we repay $57 trillion (private and public debt) with a total money supply (M3) of only around $15 trillion?   

Larry

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diarmidw
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Re: Interest payment is not the problem

DrKrbyLuv

diarmidw It is a credit to you that you admit when you are wrong and I understand your worry.  But then you go back and state that there is "no intrinsic reason why there should be a problem with a debt-based currency" which looks like denial.  You are incorrect as it has been well established as there are terminal "intrinsic" problems within the debt based system.

You are presenting misinformation at this point as your premise has been corrected...

I admitted that I might have been wrong about Chris Martenson having an individualist survivalist approach. I do not believe I am wrong about my criticism of his analysis of the monetary system. I could be, of course! But I'm not admitting that just yet!

SteveW said yesterday

Typically banks pay 50%-60% of their net earnings (net of wages, capital expenditures, and allowance for non-performing loans) as stock dividends. The rest goes into retained earnings, is used to increase the working capital of the bank that is then used to support more fractional lending.

Now, this may well be true - but it doesn't actually affect the argument. If some of the interest payments are being used as the basis for new loans, then the system is certainly expanding - but not necessarily in an unsustainable way. Consider what happens if economic activity reduces. More loans are repaid than are issued, so less reserves are needed. These reserves can now be released to shareholders (the ultimate owners of the bank's capital) who spend it back into the economy, making it available to borrowers once more. Of course if borrowers do not take account of the possibility of money recirculation being delayed in this way, then they are in trouble - but such is business!

penski also yesterday

the illustration on your website breaks down in the very first diagram when you show the Firm paying out wages to the Households before the work is done.  This essentially amounts to an interest-free advance from the Firm to Households before production.

It doesn't matter whether the wages are paid out before or after any work is done, as long as some goods are purchased before the interest is paid to the bank.

This is not a situation to be found in real life.  In reality, the firm would use the initial loan to produce something and then pay out wages.  So, in order for the Households to buy the Firm's product, they would have to get the money from somewhere else first. 

No, they got it from their wages from the firm.

 While your diagrams are clear and easy to follow, THEY ARE NOT BASED ON REAL LIFE.

No, they aren't, but not, I think, in ways that invalidate my point. They are unrealistic because of course there are lots of households and lots of firms, and all these flows (wages, purchases, interest payments) are going on more or less simultaneously. (There are also lots of banks but that adds additional complications!) The absolutely vital point of the diagrams is that interest is a flow arising from debt, not an addition to the stock of debt.

Farmer Brown is quite correct when he says today

The entire point of a promise is to deliver tomorrow what DOES NOT EXIST today!!!!!

and that is precisely the purpose of a monetary system like the one we have. It is to allow us to promise to share the greater output we will get tomorrow, from combining labour and raw materials today. If we can actually achieve that then of course we can benefit and share some of the enhanced output with the guys that run the 'promise network' (the bankers). The system allows this to be expressed in the form of monetary profit and bank interest.

As for there always being more bank debt than money - I would say that logically this cannot be true, and for the UK it doesn't seem to be. As for the US, the oft-quoted total debt figure of $35 trillion (from D3, Z1) is misleading. It simply lumps together all debt, without netting it out between sectors. For example, federal govt debt was $7.8 trillion at end of 2009. To whom is most of this debt owed? US citizens and institutions - as govt bond-holders! What the exact US money supply that corresponds to the actual level of debt is, I am not sure, but I shall try to work on this.

Having said all that - I would strongly agree that the exponential growth of debt and money does suggest a problem, particularly when capacities of various sorts are finite. But it suggests it - it isn't actually it. Because if we really were able to increase our living standards exponentially, even without inflation, we would probably need exponential debt and money growth to make it possible.

But we almost certainly don't have exponentially growing real living standards now, and even if we do it is unlikely to continue for much longer if we rely on the same physical and social techniques. One of the reasons that we do see exponential money growth despite this, is because there is much profit to be made simply from creating new money and moving it about - the more created and moved, the more profit. And the 'percentage fee' culture of finance no doubt drives exponentiality here.

The reason this is a problem is not, I believe, because of a logical inability to pay interest on the money that creates these loans, but the practical impossibility of creating enough real new value to justify the currently observed transfer of wealth claims in the form of profits (including bank interest minus costs).

To illustrate: if Warren Buffett raised a $1 billion loan to buy a chunk of  Microsoft from Bill Gates (this isn't a stock tip, by the way!), and Warren Buffett reckoned that this chunk of MS was worth $1.1 billion to him, he's going to be quite happy to pay a bank $50,000 (5% interest) to take on the (small!) default risk, effort of documenting, contract arranging, finding deposits etc etc. Now assuming Buffett realises his additional valuation in revenue (thanks to his more efficient business methods), he can repay his loan and have $100,000 left over, giving him $50,000 in profit. This transaction has created $100,000 of new real value (because Warren Buffet valued what he gained more than Bill Gates did), shared between Buffett and the bank.

While the $1 billion was in circulation, there was an additional debt obligation and additional money in the economy of $1 billion, and there was an interest obligation of $50,000, but the ultimate effect of this was to produce real additional value of $100,000. Here the monetary system is doing exactly as it should, and assuming I am right about interest being a flow rather than an addition to a stock, all obligations and all new money have been cleared from the system by the end of the process.

If, however, the loan was made for some activity that did not lead to any real benefit (a failed corporate acquisition, say), then additional debt and money, and an interest obligation would have been created with no real benefit that can be realised. If the banks, lawyers and executives get their usual cut based on the size of the transaction rather than its real success, then the burden of debt and interest does indeed fall on us.

So, my point is that it is not the money system in itself that is the problem, but the way it is abused by a wealthy and powerful elite.

Thomas Hedin suggested a solution

The only money that is not debt money is wealth money.  Commodity money can either be debt money or wealth money.  It all just depends on how it moves into circulation.  If it is spent into circulation it would represent wealth.  If it is loaned into ciculation it would represent debt.

I am assuming that by 'wealth money' you mean money created by government spending, that is not then required to be repaid as taxes or to purchase govt bonds.

If so, there are two problems with this. Firstly, since money is continuously entering the economy but never leaving it, it will eventually lead to significant inflation.

Secondly, what happens when a firm wants to start a viable production process that will take time to produce output? How does it pay for labour and raw materials before production is available to be sold? Does it get free money from the government? If so, what are the criteria for getting this money, who assesses if they are met, and how does the govt make sure the money is spent as proposed?

 

 


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Farmer Brown
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Re: Interest payment is not the problem
DrKrbyLuv wrote:

If you started a debt based system tomorrow and created 100 1 year loans at 10%, and no other money is created, then at least 10% of the loans would default by the end of the year.

If banks did not have to pay wages, other expenses, make capital investments, and if their shareholders for some odd reason did not want to receive dividends, yes, that would be true.  The point is, banks do not work that way.  Shareholders demand and receive dividends and/or those dividens are reinvested or kept in the bank for more loans.  Obviously, if there were no loan demand, the shareholders would demand it as dividends and reintroduce it into the economy through spending or other investments.

Larry wrote:

I'll leave you with a final question...how do we repay $57 trillion (private and public debt) with a total money supply (M3) of only around $15 trillion?   

If you review Diarmidw's presentation again, you will see how it is certainly possible for an amount of money stock to pay off an amount of debt that is larger, even much larger, than it is.  

As for whether that can be done with the US example, I highly doubt it, but it is not because of the reasons cited in Larry's argument.  

If we allow loans which result in no productive value to pile up in the system by outlawing failure, then it becomes acceleratingly more difficult for the base money stock to support the payment flows necessary to service the debt. I believe this is what Diarmedw was saying above.  

This is because non-productive loans do not grow GDP and do not contribute to an increased money velocity at a sufficiently high rate to service the flows demanded by the debt.  In a capitalist society, such failures would be allowed to fail, with both borrowers and lenders punished.  But, when the can gets kicked down the road, and the market's self-regulating mechanism (known as failure) is not allowed to operate, these loans do not get purged from the system and we must all live with them for considerable more time.  

The algebraic formulas above are a clever trick that whoever the author is used with language that is meant solely to confuse the subject, or the author himself is confused.  Of course P cannot equal P+I without taking t (time) into account.  The author tries to suggest that since P (before time has passed) does not equal P+I (after time has passed), that somehow that makes the concept mathematically inconsitent.  This is really so below my expectations I will not comment further on it.

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