Is perpetual expansion a requirement of modern banking?

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Fr. Fessio S.J.'s picture
Fr. Fessio S.J.
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Is perpetual expansion a requirement of modern banking?

I offer the following as a possible minor revision to one of the principles expressed in “The Crash Course”. I’m new to this forum  and don’t know if what follows has already been said. I found the book to be persuasive and this criticism, if correct, would not materially alter the book’s conclusions.

                Chris Martenson states that debt which pays interest must always grow by some percentage, and that therefore “perpetual expansion is a requirement of modern banking” (emphasis in original). He discounts the “theory of perfect interest flows” because in practice it would mean that no one could ever “take out a purely consumptive loan, undertake a failed business venture, or save money without spending it”. (This would be therefore an “unstable equilibrium”, like balancing a pyramid on its apex.)

                However, I submit that there can be an economy that is based on modern banking, that doesn’t grow, and is in stable equilibrium.

                I’ll take the publishing house of which I’m the editor as an example. For the past few years our total revenues (and expenses) have been more or less flat (adjusted for inflation). But our biggest selling season is the fall and we have to produce the books we sell then in the summer. So every June we borrow several hundred thousand dollars at interest, and repay it by the end of the year. In economic terms: our GDP has remained constant and we have no annual change in our debt. There has been no expansion.

                Could this “local economy” be generalized? It could. What’s happening is that we are creating wealth by transforming resources into more useful or desirable forms (which is what “creating wealth” means). Another way of describing it: we’re adding value. For a large economy to be in stable equilibrium, it would suffice for its producers, on average, to add enough value each year to cover interest payments and the negative effects of consumptive loans and failed businesses. Neither the GNP nor total debt would have to increase. In principle they could even decrease, say from population loss.

                This of course does not account for resource depletion, population changes, etc. But I think it shows that it is not the banking system as such which requires expansion. It is rather an excess of unproductive or non-self-liquidating debt which requires it.

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Travlin
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See if this helps
Fr. Fessio S.J. wrote:

                Chris Martenson states that debt which pays interest must always grow by some percentage, and that therefore “perpetual expansion is a requirement of modern banking” (emphasis in original). He discounts the “theory of perfect interest flows” because in practice it would mean that no one could ever “take out a purely consumptive loan, undertake a failed business venture, or save money without spending it”. (This would be therefore an “unstable equilibrium”, like balancing a pyramid on its apex.) <snip>

For a large economy to be in stable equilibrium, it would suffice for its producers, on average, to add enough value each year to cover interest payments and the negative effects of consumptive loans and failed businesses. Neither the GNP nor total debt would have to increase. In principle they could even decrease, say from population loss.

FrFessioSJ

Welcome to the forums.  You have posed a subtle but tough question I have wrestled with as well.  I’m can’t give you a definitive answer, but let me point out a couple of things that may be helpful.

I think you have essentially answered your own question in the section I changed to bold print.  That extra value you produced has to use money to pay the interest.  When the consumptive loans are repaid, and the failed business loans written off, that money is extinguished, since money is created by debt.  That still leaves the question of where does the new money come from to pay your interest, since it didn’t exist at the time of your loan?

In practice the central bank creates new money out of thin air to expand the money supply so interest can be paid.  As long as this is in rough equilibrium with increased production it is not inflationary.  When money is destroyed too quickly we have deflation and loans cannot be paid, which leads to economic destruction like the Great Depression.

I was dubious of the concept that our financial system requires perpetual growth because money must be created to pay the interest.  However, every advanced nation seems to bear this out with constantly growing levels of aggregate debt, so it appears to be true.  Chris has expounded on this at length and in detail in many places in this site.  Here is a link where he explained it particularly well.  http://www.peakprosperity.com/blog/exponential-money-finite-world/29744

Travlin 

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markt2p
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continue

I believe the end game must always be considered when talking about this subject. What is the end game and who are the players and what are their motives?

The goal is to create wealth. The players have to first create the means to do this. How do they do this? The create a privately held central bank which has been given the monopoly power to create credit/debt by the government. The government and/or people must repay the debt plus interest to the central bank and it's cartel. It is as simple as that. They have no inherent reason to have balance. That system wants nothing other than growth of credit/debt.

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let's go one more step

Travlin wrote: "I was dubious of the concept that our financial system requires perpetual growth because money must be created to pay the interest.  However, every advanced nation seems to bear this out with constantly growing levels of aggregate debt, so it appears to be true." [How do you get quotes of a previous post in that white box?]

I accept the fact that there are "constantly growing levels of aggregate debt", but I question whether that is an inherent necessity of the present banking syster (fractional reserve, fiat currency). I tried to give an example of how it would not be necessary. You replied that more money would be needed to pay the interest on the loan. Here's the next step I'd like to take. (I'm not trying to instruct. I'm trying to learn.)

Suppose in year 1 we borrow $100,000 and create $110,000 worth of goods. The buyers have to have the money to pay, so there needs to be another $10,000 in the money supply. It's all right if the Fed creates this because it corresponds to a real increase in wealth. We're able to use that $10,000 to pay the interest on the loan. (That's paid for a valuable service performed by the bank; and that additional $10,000 is now in the system.)

Now in year 2 we do the same thing. We borrow $100,000 and create $110,000 worth of goods which we sell. GDP has not increased. And there 's no need to increase the money supply for us to pay the interest on this second loan. 

In this scenario, the money supply only expands once to the extent that additonal wealth is created. That should be non-inflationary: money supply is just tracking increased wealth. In a static economy no more money needs to be created to pay interest, once it has been done the first time.

If this logic is sound, then the banking system doesn't require perpetual expansion. Q.E.D.

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Fr. Fessio S.J.
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let's look at the goal

I agree with markt2p: the goal is to create wealth. (Although there's a more ultimate goal: human flourishing.) And that motivates the players. But that doesn't mean the "game" itself (in this case the banking system) requires perpetual growth. Some players (I'm one) don't seek continual growth. And some (I'm also one) don't think it's possible on a finite planet. If my original post is correct, the desire for perpetual GNP growth is an abuse of the game, one that will sooner or later be self-correcting.

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Fr. Fessio S.J.
Fr. Fessio S.J. wrote:

 [How do you get quotes of a previous post in that white box?]

 

Insert your cursor into the paragraph or sentence that you want contained in the white box ( I think that you can also highlight the desired text) then click on the quotation mark icon (the one to the left of the smiley face) on the toolbar at the top of the window where you are generating your reply.

Dominus vobiscum

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Travlin
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Off the map
Fr. Fessio S.J. wrote:

Now in year 2 we do the same thing. We borrow $100,000 and create $110,000 worth of goods which we sell. GDP has not increased. And there 's no need to increase the money supply for us to pay the interest on this second loan. 

You were at the frontier of my knowledge with your first question.  Now you just drove off the map!  Wink.  That’s fine because that’s how I learn.  I suspect it has something to do with the fact that when you paid off your loan $100,000 was extinguished and only $10,000 remained, but I can’t explain it.  Theoretically we should be able to have a stable system without growth, but I can’t explain how that would work either.  I do know that the mantra of business is growth at all costs.  If you are static you are dying.  There seems to be a fundamental reason for that imperative that jibes with Chris’ explanation.

I can answer your question about quotes.  Just click the "quote" button in the lower right corner of any post.  You can edit the results.  If you copy the HTML codes at the beginning and end you can quote material from other sources.  So I am not a complete loss!  Cool

Travlin

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Travlin
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Welcome
markt2p wrote:

I believe the end game must always be considered when talking about this subject. What is the end game and who are the players and what are their motives?

Markt2p

Welcome to the forums.  We've waited a long time to hear from you - December 2008!

Travlin 

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