Debt Based Money: Can Money Exist Without Debt?

[chiro]

If money circulates perfectly it's possible. For example: Alice borrows 1 dollar from Bob on the understanding that she will pay him back 1 dollar a week for a year. Problem is there is only 1 dollar in existence. After the first week she's stuck right? Unless Bob pays her 1 dollar for a task which she can then immediately give back. So week 2 she mows the lawn, get's paid, and immediately gives it back. Week 3 she paints the lounge, get's paid...etc.

Essentially any amount of money can be paid back in a finite economy so long as the time it takes for the instalment money to circulate back to the debtor is less than the instalment.

All the money is created from interest bearing debt: how can you pay debt off with debt?

 

[Ryan_m_b]

All the money is created from interest bearing debt: how can you pay debt off with debt?

In the manner I described; in our two person economy the debtor ends up working directly for the creditor to pay off the interest by doing an equivalent amount of work. In a real economy there are more actors but the principle is the same, to eliminate debt and interest work must be done and taken in payment.

 

[Jim Kata]

The basic question is why must interest be charged in the issuance of money? I understand why it can be charged in the loaning of money as a kind of convenience charge, being charged interest for the right to get the loan, but not at the point of issuance. If the first dollar was borrowed into existence and the second dollar was borrowed into existence to pay off the first dollar you do not have the situation where money = debt as in if all debts were paid there would be no money because of the interest charged at the point of creation. Simply put, to pay off debt you need more debt. The argument that John has made for interest at issuance, if I understood him correctly, is that the interest serves as kind of a manufacturing cost. Gold required labour to produce and so it has some kind of intrinsic value but i think this misses the point. The point is not the intrinsic value of gold or the cost of its manufacturing it, the point is that gold is finite. Fiat currency doesn't have a finite constraint, and as such it seems that inflation is inevitable. There are only two outcomes I can see to inevitable inflation one is destruction of the currency or two is the writing off of debts at some point, a jubilee.

 

[chiro]

In the manner I described; in our two person economy the debtor ends up working directly for the creditor to pay off the interest by doing an equivalent amount of work. In a real economy there are more actors but the principle is the same, to eliminate debt and interest work must be done and taken in payment.

Doesn't work that way in the real world with the real central banks.

The system is set up so that debt is payed back through debt based instruments just like someone trying to pay a credit card with another credit card.

You really should try and understand these instruments and how money is created and what it represents which is debt and all that exists is an endless cycle where debt only compounds and never decreases or ever gets paid off: in fact if there were no debt there would be not one dollar in existence.

How can one pay debt off if they the only thing they have is debt themselves? The simple answer is that they can't.

This is how the world works and this is what modern slavery is all about: it's not shackles and chains, it's debt.

It's done to everyone from entire countries to the simple citizens: you get economic hitmen to go into countries like Mr. Perkins did (see confessions of an economic hitman) and what they do is they sign people on to debt that they know can never ever be paid off.

The only difference between this form of slavery and the ones of shackles and chains is that this form of debt is often backed by the stroke of pen and is in a way, based on a form of consent even though that consent is mostly based on deceptive means.

Banks don't want people or countries out of debt and they certainly don't want them independent enough.

Your utopian idea of the world is nice, but it isn't that way: the world has adopted a system where everyone is becoming a debt slave in every single possible way.

You think you own that house after you have paid off your mortgage, then stop paying your property taxes and see what happens. Look at the wonderful state of the student loan and home loan systems you have? Want to start a business? Finding a way to get some interest on your deposits lately?

The whole thing is structured so that none of you will ever get out of it unless the system as it is right now is abolished.

 

[Czcibor]

Somehow I consider it as quite interesting how bizarre views Americans can have on monetary policy...

The basic question is why must interest be charged in the issuance of money? I understand why it can be charged in the loaning of money as a kind of convenience charge, being charged interest for the right to get the loan, but not at the point of issuance.

In a simplification you can have as source of money a gov which took a loan from the central bank. Any interest rates that are paid to the bank would return to the gov as income of the central bank. If only gov was entitled to take such loans (and there was some mechanism to keep that amount in check) then indeed no interest rate were needed.

In real world (still in great simplification) we have banks which buy bonds from the gov, and later use them (when needed) as collateral for a loan from central bank. However, if private agents are allowed to take these loans too, then there should be some kind of price to limit the demand for money... which is the interest rate.

Fiat currency doesn't have a finite constraint, and as such it seems that inflation is inevitable. There are only two outcomes I can see to inevitable inflation one is destruction of the currency or two is the writing off of debts at some point, a jubilee.

Couldn't just the amount of money in the economy be controlled by changes in the interest rates? (Yes, a bit rhetorical question)

 

[Czcibor]

How can one pay debt off if they the only thing they have is debt themselves? The simple answer is that they can't.

Maybe you ask a wrong question. Do you ask about an individual agent? He can pay his debt.

Or do you ask about whole system? Does everyone within the system want to pay his debt immediately? No one would like to take a loan for ex. a house or an investment? No one?

We can face, however when there is a clear surplus of people wanting to pay off their debts to face a paradox of thrift. However, it can be solved by gov taking active role - either by issuing gov debt or by central bank reducing interest rates.

http://en.wikipedia.org/wiki/Paradox_of_thrift

 

[Jim Kata]

Somehow I consider it as quite interesting how bizarre views Americans can have on monetary policy...

Well, Americans are uncomfortable with the idea of a private institution having the power to issue their currency, and even more uncomfortable with the idea that they might be profiting from doing so.

Your explanation for the needing of interest at the point of issuance as a means of controlling how much can be borrowed I believe is the right one, where the interest acts like the finite constraint in the place of some finite commodity such as gold.

The whole point of giving capital to a government is to spur GDP growth, but giving too much is inflationary, but i don't know if interest is needed to maintain this balance if government's could stay within an allotted budget.

My follow up questions are what does the Federal Reserve do with the interest they earn on the loans give out? If the Federal Reserve were nationalized like the Bank of England and Bank of France were after WWII how would this make the situation different?

 

[Jim Kata]

One real problem with people that spout inflation from official sources is that these figures do not include food and energy.

I mean cmon, how the hell can anyone take that figure seriously? Of all things you don't include food and energy?

You need food to live and you need energy for any kind of economic activity period.

One reason for this I heard is that social security payment adjustments are adjusted to inflation , and if they were adjusted to real inflation, including energy and food, which is closer to 10 -15% rather than 2% the social security trust would go bust quicker than it already is.

 

[Czcibor]

Your explanation for the needing of interest at the point of issuance as a means of controlling how much can be borrowed I believe is the right one, where the interest acts like the finite constraint in the place of some finite commodity such as gold.

Actually interests are a bit more flexible and you can adjust them to smoother the economic cycle. With fixed amount of money economics tend to fluctuate intensively.

The whole point of giving capital to a government is to spur GDP growth, but giving too much is inflationary, but i don't know if interest is needed to maintain this balance if government's could stay within an allotted budget.

From theoretical perspective - not needed. However, actually quite a few countries learned that gov tend to overspent such easy money, thus for example in my country constitution there is a partial ban for central bank to even buy gov debt directly. (Yes, interest rates in this case serve more as psychological safeguard)

My follow up questions are what does the Federal Reserve do with the interest they earn on the loans give out? If the Federal Reserve were nationalized like the Bank of England and Bank of France were after WWII how would this make the situation different?

"In 2009, the Federal Reserve Banks distributed $1.4 billion in dividends to member banks and returned $47 billion to the U.S. Treasury."
http://en.wikipedia.org/wiki/Federal_Reserve_System#Board_of_Governors

Except that you would have to pay some kind of compensative for your banks, but no longer pay them fixed dividend? The move would be practically neutral, but system would be easier to understand.

EDIT: If FED is anyway trying to flood markets with cash maybe such buyback of shares might be a thing worth doing.

 

[Czcibor]

One reason for this I heard is that social security payment adjustments are adjusted to inflation , and if they were adjusted to real inflation, including energy and food, which is closer to 10 -15% rather than 2% the social security trust would go bust quicker than it already is.

Are you sure about those numbers for the US? I mean in my country CPI is 3,8%,(August 2012 in comparison to August 2011) while CPI after excluding energy and food is 2,1%. The gap that you mentioned sounds somewhat high.

 

[ImaLooser]

Somehow I consider it as quite interesting how bizarre views Americans can have on monetary policy...

It is a strange country. The media is owned by the rich and is basically propaganda. Many people realize this and through the Internet have a created an alternative communal view which has a rather oblique relation to reality. Everything outside of this communal view is rejected, so there is no point in discussing anything with these people.

Economics is simple but counterintuitive so very few people understand it. Alan Greenspan wrote that it was quite difficult to communicate even the most basic concepts to US senators and congressmen.

The US economic systems is the product of a history of trial and error. Very few people know this history. Almost all of the recommendations for reform that I have read are for return to systems of the past that were worse than what we have now. It is very unlikely that such a return will ever occur unless there is a complete change in the basic goals of the system to a low or no growth model.

 

[chiro]

The US economic systems is the product of a history of trial and error. Very few people know this history. Almost all of the recommendations for reform that I have read are for return to systems of the past that were worse than what we have now. It is very unlikely that such a return will ever occur unless there is a complete change in the basic goals of the system to a low or no growth model.

That is a great point about the growth attribute.

All these people are obsessed with growth and it's actually worse because people are expecting continual growth on shorter and shorter time intervals.

These idiots that want this have become so obsessed that it's almost like a video game where people become obsessed with getting the highest rank they can, only in this situation this is not a game and this affects everybody, often most people in a detrimental manner.

The sooner we abandon the growth paradigm as you have suggested, the better off we will all be.

 

[John Creighto]

The basic question is why must interest be charged in the issuance of money? I understand why it can be charged in the loaning of money as a kind of convenience charge, being charged interest for the right to get the loan, but not at the point of issuance.

What do you mean by "but not at the point of issuance"?

If the first dollar was borrowed into existence and the second dollar was borrowed into existence to pay off the first dollar you do not have the situation where money = debt as in if all debts were paid there would be no money because of the interest charged at the point of creation.

If the person charging the interest spends the money they earn then that money is circulated back into the economy and can be used to pay off the interest. Of course if people hoard their wealth, then it is true that either new money must enter the economy as it does through borrowing money or the debt must be written off as people won't be able to pay which will lead to a default. The stock of money (stagnant supply) is much less relevant to the real economy then the dynamic supply of money [supply of money times velocity (my phraseology)] because if money was traded fast enough one could imagine one single dollar sufficing for all transactions -- yet because there is a delay between when a given dollar is spent and a given dollar is received it is necessary that there be a greater stock of money in-order to make up for all the delays in transactions.
The fact that the money supply is a debt is unavoidable as the whole concept of money is that it can be redeemed for something of equal value at a later date. If you are yet unconvinced that money, is by its essence a debt, then ask your self the following question: "What is a debt but an obligation to repay, the value given, with something of approximately equivalent value?". Or an even better question would be "What is debt but an obligation to repay?" -- for a debt is one side of a contract while the amount given is only part of the basis which is used for any expectations for the quantity of value expected in return. Usually one measures the return expected or negotiated in proportion to the value which was given and the rate of proportionality is called the rate of return or is called specifically in cases of monetary transactions the interest rate.

Simply put, to pay off debt you need more debt.

A basic observation popular in modern monetary theory is one person's debt is another persons asset. This is basic double entry accounting. If a group of entities in the economy accumulate indefinitely then yes -- either new money must be created or some of it must be written off. However, unlimited accumulation is impossible because there are finite resources. People cannot become arbitrarily indebted to the extent where their debt vastly exceeds their ability to repay -- without the contradiction eventually causing a correction. I know there must be a better way than the boom bust cycle. My solution to these contradictions would be to propose a wealth tax as they have in such places as France and the Netherlands. However, if such a concept was proposed it would unfortunately be difficult to implement effectively -- as people will both constantly bring up the boogieman of capital flight and also, established interests will fight aggressively to protect themselves from the tax by using whatever influence they have in-order to manipulate the legislation to their advantage.

The argument that John has made for interest at issuance, if I understood him correctly, is that the interest serves as kind of a manufacturing cost.

Yes. The discount window is the interest rates banks must pay to borrow from the central bank. This is the cost which banks face to add new base money (M0) into the economy. Banks would prefer not to do this because they usually can borrow cheaper from other banks at a lower rate. Banks set they rates they lend to other banks based on their equity which is determined by the difference between the value of their assets and liabilities. There is a particular regulatory formula for measuring their relative quantity and quality of equity based on the perceived risk of various types of assets. This is called capital adequacy. Adequate capital adequacy is important in determining the credit risk of a bank because a bank must have adequate capital adequacy to have access to the discount window. Access to the discount window is important as it guarantees the banks liquidity which significantly reduces the short term risk of lending to such banks and consequently guarantees them a lower rate.

The quantity and quality of equity is not only important to banks but is strongly tied to the borrowing costs of any actor in the economy. Because of this relationship between both the quality and quantity of equity; it is the case that the supply of money is tied to wealth (real or perceived). Consequently the supply of money is to a degree constrained by value or is as a minimum a weak function thereof.

 

[alan2]

There is a widespread misconception that the government can create money by printing it, or that to repurchase bonds they just print money. This is not true. The only way that the money supply is increased is by fractional banking. Money is created when the government borrows money (or when anyone does), but in order to repurchase their debt they must have an existing balance. The currency is nothing more than a token representation of debt. There is also a common misconception that increasing the money supply always decreases the value of money and leads to inflation. That notion is based on the long dispelled assumption that the velocity of money is constant (thank you Milton Friedman). Data shows that this is not true. In fact, the velocity of money fluctuates and has slowed considerably since the beginning of the recession. The increase in money supply can actually serve to prevent deflation in that case.

 

[chiro]

A few points for you John Creighto.

The first thing is about debts and assets: this is not true in general.

Firstly value can get wiped out: this is what happened in the sub-prime crash and it also happens in many other value-wiping scenarios like stock-marketing crashes, government currency defaults, and other kinds of default scenarios.

The sub-prime one showed what happens when you have mass defaults, and a collective effect of these on a market: it's one thing to have a few defaults but its another thing to have a entire market based default at work.

The other thing that you need to look at is that the person with the debt is not necessarily in the worse position.

If you owe the bank a little bit, the bank has the iron grip: if you owe the bank a lot then you have the grip on the bank. If you owe the bank billions of dollars you are the one that can have some say at the table.

The other thing is that with your comment, if all debt based instruments have the same creditor, then what does that imply about who is the creditor and the debtor? How can any debtor in this situation become a creditor?

In the real world, so called "value" gets wiped out all the time and the reason relates to the situations you find in this stock market crashes, various bubbles, defaults that have a tonne of other related catastrophes (all the "risks" you hear like systemic risk), and all the stuff where the so called valuation is out of proportion.

Another thing relates to what is known as leverage: nowadays financial institutions are leveraged up to ridiculous levels.

So if a bank says that they have so much in one accounting term, if they are leveraged then they don't and this is how they all operate nowadays.

It also means that if these morons make a bad bet to get a price move of 2% when they are leveraged around 50:1, they can become insolvent unless they get a "bailout" which is basically a euphismism for "lets take money from people who aren't stupid and give it people who are" or basically some kind of anti Robin-Hood kind of thing.

The other thing is this principle: people will waste what they do not value.

This principle is said in a lot of different ways in many parables including the "don't throw pearls before swine" and other similar phrases but the idea is the same as the above.

Governments don't value money: they can create it when they want and they do create it when they want. They don't have any valuation of how debt affects their citizens or anyone else for that matter because they don't have to feel the effects themselves since they can just get money whenever they want through their cozy relationship with the central banks.

When you give people everything, they don't value anything. Most people value the money they get because it requires time and energy on their own part to get it, hence why they value it in the first place.

If you give someone a power to do something where they don't have to directly feel the consequences of their actions, they won't have kind of real evaluation and valuation for what they do.

You let a murderer kill people and consistently walk, they won't have a deterrant and will probably just do it since they know they can get away with it. All people value their time and the point of jail (even though this whole thing doesn't work anyway) is to deprive people of their time to do other things and this creates an incentive (again, even though this system is largely useless since jails provide ways to bring "like minded" people together to hone their own skills, knowledge, and craft) to not do said things by a way that has been "socially" (if you can even call it that) agreed on.

You give people power where they are able to deflect consequences in any significant means and they will do whatever the hell they want even if it screws the rest of the country or most of the world.

Unfortunately when you put most people in a situation they don't stop and think that what they are doing may be stupid and most people unfortunately just do whatever the hell they are told as long as they think the other person has authority (yes there have been clinically controlled experiments validating this effect if you are interested) and when you shield them from the consequences, it is just a recipe for disaster that is waiting to happen.

 

[Czcibor]

It is a strange country. The media is owned by the rich and is basically propaganda. Many people realize this and through the Internet have a created an alternative communal view which has a rather oblique relation to reality. Everything outside of this communal view is rejected, so there is no point in discussing anything with these people.

In my country we have no such talks concerning monetary policy... but after our president crashed in terrible mist, at a poorly equipped Russian airport in a plane lead by pilots whom he tried to prosecute for disobedience and cowardliness when the last time were unwilling to take excessive risk... let's say that Polish part of internet become filled with self proclaimed air crash experts, able to prove that everything was covered up assassination. (thanks to such experts we can learn on internet how to produce artificial mist or how to use gigantic electromagnets)

But you know, monetary policy (even though I had a postgraduate course in it) sound for me less cool than air crash, thus I'm still impressed that's so many Americans are so willing to express unconventional ideas on that subject.

 

[Czcibor]

Another thing relates to what is known as leverage: nowadays financial institutions are leveraged up to ridiculous levels.

So if a bank says that they have so much in one accounting term, if they are leveraged then they don't and this is how they all operate nowadays.

It also means that if these morons make a bad bet to get a price move of 2% when they are leveraged around 50:1, they can become insolvent unless they get a "bailout" which is basically a euphismism for "lets take money from people who aren't stupid and give it people who are" or basically some kind of anti Robin-Hood kind of thing.

Technical question - where did you get that 50:1? May you link the source? I mean I found for US banks something like average capital ratio of round 10%, which means rather 10:1 and efforts to increase the buffer effectiveness (and size) by regulations prescribed by Basel accords.

http://seekingalpha.com/article/701...ctive-compared-to-european-and-japanese-banks

Governments don't value money: they can create it when they want and they do create it when they want. They don't have any valuation of how debt affects their citizens or anyone else for that matter because they don't have to feel the effects themselves since they can just get money whenever they want through their cozy relationship with the central banks.

Actually such risk is the reason why quite many countries have prescribed in their constitution independence of central banks. (effectively just one more branch like ex. judiciary) Regardless of any friendships, the main limitation is risk of inflation increase. Does any first world country has elevated inflation now - let's say two digit inflation? (for argument sake you might count mine as first world ;) ) If not - it seems that you somewhat overestimate practical use of that limitless money creation possibility.