Debt Myths

[Traktion]

The thought about countries and borders being just lines on a map, feeds my thoughts about money transcending such boundaries. If banks were to be free to use their own currencies backed (or not) by whatever people decided was trustworthy, there would be no need for such discussion. No sovereign risk. No inflation that you can't escape from (competition would surely seal the coffin on debasement).

This talk of central bankers, base rates, sovereign currencies and such all seem rather abstract. Why not free the world to discover its own money issued by anyone who wants to? Why tie it to or guarantee it by a country? Why the need for the state to price fix and control?

As far as I can see, money just needs to be a conduit for trade. Nothing more. Nothing less. People seem to get caught up in financial jargon, making something simple very complex. It is like a mountain of obfuscation, lies and trust.

I see no problem with sovereign currencies competing for peoples affections, but it need not be forced upon us. While people may need it to pay taxes, they may chose alternatives monies to store/invest their wealth in. Indeed, people talk of money being transient and of no value, with wealth being in the things you buy - if the bank is using the money to invest in "things" and well as people/businesses, then it could be argued that the currency is backed by some inherent value. There is no need to back by just gold or some other standard - let the banks diversify and the markets decide the value. Good investments would lead to more buying power in one bank currency of another (bank or sovereign) currency. It would lead banks away from debasement and towards good investment, which would surely be virtuous for all.

Of course, it would be beyond state control*; their influence would be restrained by what they can tax and spend. Debasement would just lead to people holding sterling (or other state money) like a hot potato - just long enough to pay the tax man. Alternatively, if banks make unwise investments, people may move to a state currency (or other easily exchangeable commodity). Freedom of choice and a genuinely free market for money would take the power away from those who seek to exploit their monopoly of money (both the governments and the banks who secure easy profits).

*EDIT: although if they were restrained, they could influence the market - banks making poor investments, thus debasing their currency, would face competition from sovereign currencies.

Edited October 9, 2009 by Traktion

[Stars]

I think you need also to think in terms of tax policy (or pay/profit policy) to re-introduce balance...not just money policy. So that people can save and trust in the value of their money - without having to risk it or expand the economy and the use of resources exponentially.

Expanding the economy does not do any damage

The damage comes when people can expand their wallets or pay back credit without expanding the economy.

[Traktion]

To add, in a world of bank or sovereign currencies, are the states then not simply competing with the private sector to bring forward good investments?

Thinking about it, if the state made wise investments, their money would appreciate in value. Similarly, it would be the same if a bank made wise investments. We would be free to back whichever horse we deemed would do the best job. If the state proved ineffective, maybe they would stick to making rules and providing services which banks deemed unprofitable, but were wanted by the electorate collectively still.

[Injin]

To add, in a world of bank or sovereign currencies, are the states then not simply competing with the private sector to bring forward good investments?

Thinking about it, if the state made wise investments, their money would appreciate in value. Similarly, it would be the same if a bank made wise investments. We would be free to back whichever horse we deemed would do the best job. If the state proved ineffective, maybe they would stick to making rules and providing services which banks deemed unprofitable, but were wanted by the electorate collectively still.

The state can never match the private sector, it doesn't have the same nifty feedback mechanism of the price signal. That's why they push for monopoly all the time, because they simply cannot compete.

[scepticus]

Go back and read assertion no. 1 of septicbugs original post. He suggested that the money supply does not have to inflate in order to pay interest. In my scenareo I fixed the money amount in my example to show how ridiculous that assertion is and why it doesn't work. Please keep up at the back.

mr bullcrap, your simple minded example is not only completely inadequate to begin to describe the monetary circuit, it is entirely spurious and betrays such a base misunderstanding of elementary economics that only other similarly deluded commenters could possibly find any value in it.

If you wanted to you could find confirmation of my assertions independantly on the internet, however I confidently predict you will continue to rabidly spout this nonsense without the slightest attempt to educate yourself further, either because you are incapable or more likely because you are scared that you will find that my assertions are entirely correct.

The underachiever at the back of the class is you sir, while I take questions from the front.

[Injin]

He is right.

It depends on whether you believe that debt repayment involves cancellation or circulation.

If the borrower has managed to find the money to service their debt including all interest payments - the loan and interest liability is cancelled. But whilst the loan went out the front door to the borrower, the interest liability went out the back - as wages, profits, tax, paying for default (and as Alan B'Stard say) pencil sharpeners.

The bit you are missing si that in a FRB syste, debt repayment means the bankers get their money back at least twice.

I borrow £10, spend it at Daves shop.

Dave gives it to the bank to look after - which should then cancel my debt.

[Injin]

mr bullcrap, your simple minded example is not only completely inadequate to begin to describe the monetary circuit, it is entirely spurious and betrays such a base misunderstanding of elementary economics that only other similarly deluded commenters could possibly find any value in it.

If you wanted to you could find confirmation of my assertions independantly on the internet, however I confidently predict you will continue to rabidly spout this nonsense without the slightest attempt to educate yourself further, either because you are incapable or more likely because you are scared that you will find that my assertions are entirely correct.

The underachiever at the back of the class is you sir, while I take questions from the front.

Can you validate your credential a little please?

A quick basic description of how the banking system works without using any jargon would help. Most people here have had a go at a it.

J. Smith goes to a bank to borrow £100 annnnd... (your wisdom goes here)

[Traktion]

The state can never match the private sector, it doesn't have the same nifty feedback mechanism of the price signal. That's why they push for monopoly all the time, because they simply cannot compete.

This would be my suspicion too, but then they would either give up trying to compete or try harder. It would be pretty clear who was doing a better job and encourage all to search for the best investments.

[JustYield]

Indeed. If the future has less people than today, which it will within our lifetimes -

What makes you think global population will decline in our lifetime? Link?

Otherwise, excellent thread, please carry on.

[Injin]

This would be my suspicion too, but then they would either give up trying to compete or try harder. It would be pretty clear who was doing a better job and encourage all to search for the best investments.

The whole point about the state is it's an agency where the no-marks can go and get a place in society they don't merit by using collective action and violence.

While it's clear that the state is utter shit, most people have a profound moral attachment to it "who woudl feed the roads??? Old people wouldn't get built!!!"

[Injin]

And the thing is that a depositor only gets one times the benefit of what they've lent the bank - whilst the bank takes as much as 10 slices of the pie.

I would like a bank that paid me interest on the basis they were going to lend my money out 10 times - because that could well be the risk I'm taking.

it's not just that, they can spend the ******er and it'll be back in the bank by teatime.

So all their spending does is create yet another deposit, but this time with no matching liability.

[erat_forte]

Expanding the economy does not do any damage

The damage comes when people can expand their wallets or pay back credit without expanding the economy.

Only to a point - resource use cannot continue to expand exponentially.

[CokeSnortingTory]

The very fact that it is possible to debate the circulation of debt and interest in the FRB system, and not come to a conclusion satisfactory to all, tends to suggest that the whole process is opaque, and therefore a fraud.

N'est pas?

[scepticus]

First of all I think you are right to pursue money reform as a way of untying the gordion knot.

However, how do you stop money issued being concentrated in fewer hands?

Guys, the answers you are looking for can IMO be found here:

http://bilbo.economicoutlook.net/blog/?p=332

Please read through the deficit spending 101 parts 1 and 2. After that if you have questions ask me and I'll point you to further material on modern monetary theory as required. Hopefully after reading enough of this material you will realise we don't need monetary reform, we need political reform. If you come to different conclusions after reading this I shall be very interested to discuss them.

Just to be clear I don't agree with all of the ideas advocated in these links - what I do agree with is their characterisation of our monetary system and therefore what the 'dashboard' of the economy looks like. You hopefully can then see how to employ the various levers and buttons, to extend the analogy, to achieve your goals.

[bogbrush]

This would be my suspicion too, but then they would either give up trying to compete or try harder. It would be pretty clear who was doing a better job and encourage all to search for the best investments.

Isn't their more usual form to pass some laws threatening to lock you up if you compete with them?

[Injin]

The very fact that it is possible to debate the circulation of debt and interest in the FRB system, and not come to a conclusion satisfactory to all, tends to suggest that the whole process is opaque, and therefore a fraud.

N'est pas?

Mus tbe.

If no one understands it, how can any contracts regarding it be valid?

[Injin]

Guys, the answers you are looking for can IMO be found here:

http://bilbo.economicoutlook.net/blog/?p=332

Please read through the deficit spending 101 parts 1 and 2. After that if you have questions ask me and I'll point you to further material on modern monetary theory as required. Hopefully after reading enough of this material you will realise we don't need monetary reform, we need political reform. If you come to different conclusions after reading this I shall be very interested to discuss them.

Just to be clear I don't agree with all of the ideas advocated in these links - what I do agree with is their characterisation of our monetary system and therefore what the 'dashboard' of the economy looks like. You hopefully can then see how to employ the various levers and buttons, to extend the analogy, to achieve your goals.

hmm central planning gooodness.

[scepticus]

This would be my suspicion too, but then they would either give up trying to compete or try harder. It would be pretty clear who was doing a better job and encourage all to search for the best investments.

I agree with injin here too. whocuddathought?

In the ideal circumstances, the private sector dominates but the public sector is sufficiently strong to ensure unsustauinable wealth inequality does not accumulate, and that bankers cannot dominate the political process and thereby give themselves the freedom to run off the cliff like lemmings every 10 years.

I advocate a balance. If it ever got to the point where the public sector was going past the 30-40% of teh economy mark because the private sector is totally FUBAR, we'd need to consider more radical changes to shift the balance back towards the private sector again.

However, we have some way to go before we reach that point.

[bogbrush]

I agree with injin here too. whocuddathought?

In the ideal circumstances, the private sector dominates but the public sector is sufficiently strong to ensure unsustauinable wealth inequality does not accumulate, and that bankers cannot dominate the political process and thereby give themselves the freedom to run off the cliff like lemmings every 10 years.

I advocate a balance. If it ever got to the point where the public sector was going past the 30-40% of teh economy mark because the private sector is totally FUBAR, we'd need to consider more radical changes to shift the balance back towards the private sector again.

However, we have some way to go before we reach that point.

The state is the reason the bankers have the opportunity to screw everyone and be bailed out when they fail, it's no form of control whatsoever. In case you hadn't noticed, we have a large state/public sector and the bankers run the place.

Your solution is inherently unbalanced because it has no naturally functioning checks, or as Injin puts it, no price signals. Just your arbitary numbers.

[scepticus]

What makes you think global population will decline in our lifetime? Link?

Reviewing the UN population division reports, coupled with reading literature on the demographic transition and the causes behind it. Then on top of that you can extrapolate the effects of the GFC on birth rates in highly indebted nations suffering form high unemployment.

I'll try and address demographics in more dtail at some point in the future.

[scepticus]

Can you validate your credential a little please?

A quick basic description of how the banking system works without using any jargon would help. Most people here have had a go at a it.

J. Smith goes to a bank to borrow £100 annnnd... (your wisdom goes here)

Injin, I shall return shortly with a written description of what I am claiming about the money circuit, but written by another, since my explaination is clearly inadequate for you.

Stay tuned.

[CokeSnortingTory]

I think the tendency for human beings, (who are, let's face it, nothing more than a species of sophisticated monkey) to grab money in the short-term and then malinvest it in gratification or delusions, is pretty much a part of their animal nature and is therefore unreformable.

This tendency has been with humanity throughout history, and was recognised from Sumerian times. The ancients had a way for dealing with debt - with the arrival of a new king, all debts would be cancelled in a jubilee, and then the system would be reset.

I don't see any reform of the banking system that would work for any length of time, because as the system becomes more stable, the monkeys will start to wonder why they have to delay their gratification when there's been so much stability for such a long time, and so the siren voices will ask, and get, reform of the system to increase "risk".

Expecting the state to come up with a mechanism to curtail adult monkey-humans from indulging in speculative greed is like expecting the state to come up with a mechanism to curtail teenage monkey-humans from having sex. You can see how well that has turned out......

[scepticus]

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

A popular theory about the Fed and money creation in the United States is built around the notion of a "mathematical flaw" inherent in introducing money by means of "lending" as opposed to "spending." This theory starts with the observation that money in the United States (and most other countries) is placed into circulation through the purchase of interest-bearing debt.

To inject money into the economy, the Fed buys federal securities, thereby acquiring an asset that pays interest. In the second round of money creation, banks, S&Ls, and credit unions, through the fractional reserve banking system, earn interest on the loans they hold as a consequence of creating checking account money.

This means that for every dollar of money, there is a corresponding dollar of interest-bearing debt. As a consequence of this arrangement, the argument goes, there is only enough money to pay off the principal of existing debt; there can never be enough to pay the interest that accrues on that principal. If there is to be enough money to handle interest payments in the economy, the theory continues, more borrowing must occur to generate the extra money. Of course, additional borrowing under this arrangement would mean even more interest that cannot be paid out of the existing money supply.

Just to keep the money supply constant under the system, according to this line of reasoning, debt must grow by the rate of interest. Since the economy grows over time, debt must grow at even a higher rate. As compounding occurs, the result is an explosive growth of debt. Thus, the argument is, policy must actually encourage households and businesses to take on new debt just to keep the money supply from shrinking.

Allowing debt to expand is a problem, these theorists argue, because interest costs are a -- if not the -- principal cause of inflation. When the banks make loans, they charge interest. Interest represents a cost of doing business for borrowers which they pass along to consumers in the prices they charge for goods and services. Hence, it is reasoned, the more interest paid, the higher prices must be.

If debt must mushroom over time in order to keep the money supply from shrinking, according to this line of thinking, then the cost of doing business must rise faster each year, and so must prices. In short, it is argued, the money supply process demands that debt grow exponentially. As debt grows as a proportion of total production, so do interest payments. And as interest payments grow relative to the rest of real income, it is claimed, prices must rise faster as well.

This dilemma, the proponents argue, is the inherent problem that causes instability in the current banking system -- an instability that the authors believe to be responsible for the business cycle.

Most of those who advance this view believe that to correct the inherent instability in the current monetary system and simultaneously reduce inflation, the system of "debt" money must end. They argue that money must be spent into existence, or at least issued without charging interest.

This analysis is deficient on four counts. First, the banking system does not behave as presented above. The payment of interest on debts that arise through the money creation process will neither contract the money supply nor result in the growth of debt relative to the money supply. Second, there is no reason for the money supply to equal the sum of debt and interest. Third, debt is such a common and essential part of an economy, there is always plenty of it available for money creation without any need to encourage the creation of more. (The fourth reason, that interest costs are not the cause of inflation, is discussed in another section).

The crucial error made by the above arguments lies in the proposition that once interest is paid by the government to the Fed, money is "extinguished". If the interest earnings were simply put away into a vault until they were lent out again, the authors would be correct. But in fact, the money is spent back into existence.

The part of the Fed's income used for its own expenses and the dividend paid to member banks is, of course, spent back into existence. The rest the overwhelming majority of all of the income earned by the Federal Reserve -- that which is remitted back to the U.S. Treasury, is also spent. Thus, "lending money" into existence does not mean that debt has to constantly increase to make up for the money that is paid in interest and removed from circulation. It is not removed from circulation; interest payments to the Fed re-enter circulation as they are paid for expenses, as they are paid in dividends, and most significantly as they are paid over to and spent by the Treasury.

The argument has similar problems with its claim that money disappears from circulation as interest is paid back to commercial banks. Like the Fed, commercial banks have expenses. They must pay these out of their earnings -- spending them into existence. They also must pay dividends to their stockholders -- again spending them into existence. Most important among their expenses is interest on their deposits. Whether in the form of explicit interest paid to depositors or implicitly paid as free services (such as check-clearing, balance reporting, etc.), these funds are also spent into existence. Even those sums retained to increase the capital of the bank do not have to be lent, but can be used to purchase expansion of the facilities. There is no requirement in the system that interest earnings must be lent back into existence through new loans.

Since the amount of dollars represented by the interest payment is returned to the spending stream and the money supply, there is no need for banks to lend continuously a sum equal to the interest payment to keep the money supply constant. Hence, there is no force causing debt to grow continuously relative to the available money supply. The current system is not inherently unstable.

Nor is there any reason why there must be enough money outstanding to pay off all outstanding debt. The money needs of the economy are much smaller than an economy's total debt. Money circulates; it gets used repeatedly in the course of a year. Transactions take little time. As soon as money is used in one transaction, it is available for use in another. Consequently, the money stock need only be a fraction of the total transactions that take place in a year.

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

Finally, debt is not created because of a need for money. Every economy - even those without money -- has debt. Debt is a necessity in any modern economy. Indeed, debt pre-dates money in that it exists even in barter economies. It comes in a variety of forms and does not consist exclusively of bank loans. It exists because some people do not consume all that they produce, and are in the position to place some of their goods temporarily in the hands of those who need more goods than they have. Resources are not always in the hands of those who can best employ them. Hence, the lending of resources is common and even necessary for economic progress.

Consequently, debt is always present in private affairs. Healthy economies can always be expected to have private debt equal to many times the amount of money that they need. Even as some borrowers repay their loans, still others are ready to borrow. Money creation, therefore, does not drive the creation of debt; the debt is already there regardless of how money is created. It is always there. There is plenty of debt to be used by the banking system for the purpose of money creation with plenty more left over. This is true everywhere there are market systems. Debt does not exist because of a need to create money.

In short, there is no mathematical flaw. And paying money directly out of the Treasury would have exactly the same economic effect as having the Fed create it by "lending."

[scepticus]

The state is the reason the bankers have the opportunity to screw everyone and be bailed out when they fail, it's no form of control whatsoever. In case you hadn't noticed, we have a large state/public sector and the bankers run the place.

Your solution is inherently unbalanced because it has no naturally functioning checks, or as Injin puts it, no price signals. Just your arbitary numbers.

The price signal theory is entirely fallacious. It relies upon a thouroughly debunked concept termed 'says law' which holds that money is just a veil over barter andd hence prices will always adjust to supply and demand.

But how can money just be a veil over barter when the objective of those who hold the most money is to aquire more money, not to simply to facilitate exchanges in the real economy?

This money hoarding tendency leads always to deficient demand in the economy due to lack of money in the hands of those who would like to transact.

The whole price theory stuff that comes from neo-classical and particularly that most deluded of economic schools of thought, the austrians, is based on deeply flawed notions of equilibrium, and equilibrium that is exibithed nowhere in the economy either now or in the past.

[Tired of Waiting]

The International Monetary Fund has just published its "World Economic Outlook - October 2009", part of its series "World Economic and Financial Surveys". A few relevant quotes:

"Consumption will be particularly weak in advanced economies, especially those that experienced credit booms, housing bubbles, and large current account deficits, such as the United States and the United Kingdom"

“Households struggling with lower pay and job losses and facing weak labor markets will constrain their consumption of durables and their demand for housing.(...) This is particularly true in the United States and the United Kingdom, where household debt is relatively high, house prices have fallen considerably, (...)”

"many economies that have followed export-led growth strategies and have run current account surpluses (Asia) will need to rely more on domestic demand and imports. This will help offset subdued domestic demand in economies that have typically run current account deficits and have experienced asset price (stock or housing) busts, including the United States, the United Kingdom (...)"

- - -

People, yes, in 2007 our national debt was below international average. But the properties/debt bubble happened mainly in 2 countries: the USA (properties around 20% ovrevalued) and Britain (around 30% overvalued). But the USA has the most dynamic economy in the world. They will recover.

Our bubble was bigger than the others. And all that extra money was fuelling the whole economy. Not only house prices. That's why we are having now the biggest annual deficit in the world, of around 14% of GDP. And what makes it very serious is that our deficit is "structural". It won't disappear after the recession, because this is not the normal business cycle recession, and then "back up". This is a landing after an artificial bubble. 90 billion of this annual deficit will have to be plugged by cuts or tax rises. (Osborne's list cut only 7 billion.) This is the worst case in the world.

I'm sorry, but... it was a bubble.

You must accept reality. It will be better for you in the long term - if you prepare yourselves for what is coming.

Edited October 10, 2009 by Tired of waiting