It’s been a while since my last post, but I thought I’d throw out another interesting idea I’ve been studying. I’ve made posts about monetary reform here, and talked about the idea of debt-free money, as advocated by the American Monetary Institute. However, while that proposal tackles the debt problem, it still takes interest as a given. It’s come to my attention recently that interest needn’t be an essential part of the monetary system.
Under the current monetary system, most of the money supply is created as debt. When banks create loans, they take a fraction of their deposits to loan out. But after they loan the money out, that money stays in their ledger as money to lend out further. Essentially, that money has been duplicated – created out of nothing but debt. But banks only create the principal for the loan, while charging interest on it. Where does the money come from to pay off the interest? It has to come from other loans. Thus, we have a game of musical chairs in which debt must be paid off with more debt. So long as the music keeps playing, the cycle can continue. But if a shock occurs in the system, as it inevitably does with the 18-year land cycle, money is literally destroyed as people default on their debts. Wealth is then transferred to the lenders as people who default on their debts have their wealth repossessed.
Furthermore, the system requires unlimited growth in order to sustain itself. More and more debt means more and more consumption of natural resources. It means ever-increasing throughput. As Herman Daly has correctly pointed out, the economy is a subsystem within a larger system called the biosphere, and a subsystem cannot outgrow the larger system. The biosphere has natural limits to how big it can get. Logically, so must the economy. Yet current economic theory necessitates that the economy continue to grow in perpetuity.
Debt-free money solves the first problem. Unlike bank credit, debt-free money does not get destroyed from systemic shocks. It also solves the false dilemma between the need for economic stimulus and the need for deficit reduction, while lowering the cost of infrastructure and allowing for the government to be more responsive to public needs.
However, the problem of interest remains. Banks will no longer have the ability to create money out of debt, but they will still charge interest. The money to pay off the interest, instead of coming from more debt, will instead have to come from government. There are two problems with this. First of all, money is used not only for the exchange of goods and services, but also for savings. It is difficult to determine the proper amount of money when it is split between these two functions. Second, we still have the problem of an economy that continues to require growth. New money is spent on wealth-creating infrastructure, and a portion of that money goes to pay off the interest on debts. But the continuation of interest means that new debts require the further increase of money and therefore the further expansion of economic activity. Thus, we still run the risk of running up against ecological limits.
A major part of the problem comes from money’s dual purpose. As the German economist Silvio Gesell noted in his book The Natural Economic Order, the function of money as a means of exchange and a means of savings contradict one another. To hold money out of circulation as savings means that it can’t be used for the exchange of goods and services. When people and institutions feel financially insecure, they will hold onto money rather than spend it. However, when everyone is holding onto their money, this reduction in demand causes the economy to further contract, as businesses are no longer able to find consumers for their products. John Maynard Keynes referred to this as the paradox of thrift. Demand is shifted to liquidity preference, and effectively reduces the money supply in the real economy.
Another issue is that money doesn’t really behave like the goods and services for which it is exchanged. Real goods, for the most part, have a negative interest rate. They don’t grow in value. Instead, as physical entities, they are subject to entropy. Food rots, machines break down, and even durable goods have a cost of storage. Services may not seem entropic, but they are performed by people who need to eat, sleep, and pay their bills. In other words, goods and services have a cost when they are not put to use. Money, on the other hand, earns interest when it is held out of use. The difference is compensated for by vendors by including the cost of maintenance into the price of goods. Thus, prices are artificially inflated by a hidden interest rate.
Those who say we should return to the gold standard have it exactly backwards: They assume that a good monetary system is one defined by scarcity and appreciation of value. In this, they mistake a good investment with a good money system. Money should behave like the goods and services that it purchases. It should have a cost associated with holding onto it. This would plug the leak in the economy in which circulating money gets caught in a liquidity trap.
Keynes believed that maintaining a modest level of inflation would be effective in keeping the money circulating. However, such inflation is insufficient for this purpose because it affects circulating and saved money alike. It also fails to put hoarded money into circulation since hoarding works against inflation. If hoarded money is suddenly spent, then it can mean that the money supply exceeds the planned amount, resulting in excess inflation.
Gesell proposed an alternative idea known as demurrage. In his system, currency would have to be periodically given a stamp worth a certain percentage of its value. The stamp might be required weekly, monthly, or annually, but the point is that it would enact a cost associated with holding onto that money, and encourage its holder to spend it, lest they be stuck with the cost of the stamp. They could still keep it in the bank as before, but the bank would have an incentive to continue circulating the money through loans. One way or another, the money would continue circulating. Since the money would have a negative interest rate, the banks would have an incentive to lend it out at zero interest.
Given that most money today is digital and therefore cannot actually have a physical stamp applied to it, but the principle is sound. Perhaps there could be a way to apply a sort of “digital stamp” to bank ledgers, or a kind of monthly tax on banks for holding onto money that they should be lending. Banks often charge their customers an inactivity fee, so why not do the same to banks?
Some may be concerned that demurrage would exacerbate the rampant consumerism we see today. But that would only be true if the supply of money is kept above the level of demand. With high-velocity money, the actual amount of money needed would be greatly reduced. When its function as a means of savings is eliminated, money becomes the embodiment of demand. Whatever the demand for goods and services, there should be a corresponding amount of money in circulation. Those who wish to maintain economic security through savings can instead invest their money, preferably in companies with long-term potential, but also in precious metals like gold and silver.
However, such fears for the future would be much ado about nothing in such an economy. With land value taxation to prevent the rise of speculative bubbles, and high-velocity money preventing liquidity traps, the likelihood of financial collapse would be largely eliminated. A few more tweaks in taxes and regulation to further reduce other forms of speculation would ensure a stable, sustainable economy.
