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Felix

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For this bankruptcy (which would be bad for both the bank and the debtor) not to happen, you seem to agree with me here, one would need new currency. According to debitism this new currency can be created by someone else borrowing money before you have to pay yours back. Then there is enough money in the market for you to pay back your interest. And since you worked for your money, the money (which was previously nothing but fake) is now backed by values.

Does all this not assume that the bank is some kind of Feudal Lord who owns all the money? The fact that both I as the debtor and another person (who also lends money from the bank thereby creating the money that I can earn to pay back my interest) are both free to work and trade, why do we not simply refuse to deal with this Feudal Lord and instead create our own currency and trade our values with that instead?

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I'd say that banks don't own all the money. They just manage it for their customers. I don't understand why you would want to create a new currency. The problem would stay the same: Time costs money that isn't there.

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The banks increase the money supply by the value of the extra goods that are being produced. No inflation is created. They do this by lowering the interest rate.

Therefore A borrows $100 @ 5%. He invests his $100 and only gets $100 back because no other money exists yet. But then B comes along and borrows $100 @ 4%, pays A for some good allowing A to pay off his 5%.

This continues until interest rates becomes 0%. Remember, this is still in the banks interest as they need to keep the money supply high in order for people to pay back their loans. Remember, also that no inflation is being created either.

Now Y comes along and borrows at 0%. He doesn't have to pay any interest back and so the system has enough money to go around.

Banks start increasing interest rates when people start borrowing and investing in things that pay no return (ie think of the technology bubble) and can't pay back their loan and become bankrupt. This is basically a business cycle. There is no significance in the 0% number above. People could start going bankrupt at 2% or 3%.

At the moment though, things don't work like this because central banks impose a minimum reserve level. Therefore they force banks to borrow from the central bank (so the central bank can set interest rates) at the end of each day to meet the level. The central bank does this so it can try and smooth out the economic cycle. But the above business cycle still happens, albeit with central bankers having control over the business cycle.

I know some people point to Japan to show why monetary policy doesn't work but I don't know enough about the economics to say. I know though that there are quite a few competing theories to explain that puzzle.

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The banks themselves don't increase the money supply. Basically that's the debtors' job.

As far as I see it, the interest rate reflects the banks' anticipation of future indebtedness. It is, to a large degree, an anticipation of future productivity. But things like speculation bubbles, government debt and things like the introduction of the credit card also come into play.

I doubt, however, that anyone is willing to lend his money at 0%. There's still risk involved. Just because there is theoretically enough money to go around now, the business-plan can still fail in the market.

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Exactly and when enough business plans fail, the bank will start increasing interest rates, reflecting the fact that they don't want to supply to people who are investing in worthless ventures.

(Btw, interest rates can be zero:

http://news.bbc.co.uk/1/hi/business/4788376.stm)

If most businesses fail, it would suggest a deflation. Then borrowing money becomes extremely risky. And then it is nearly impossible to pay back even a 0% debt, because prices are falling over time - rapidly. Which would be why a mass-failure of businesses would occur in the first place. I doubt that banks would raise interest rates. They would be happy if someone would actually borrow at least something. I think that banks don't lend money to people without a sound business-plan no matter what the current interest rate is. Because without a sound business-plan you lose independent of the current "monetary climate".

Lending money at 0% is usually a poor attempt to keep an economy from collapsing into depression. It can work for quite a time, but it is only a way of buying time.

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Moderator's Note: Trudy Cool has just joined the forum; this is his first post. I deleted it first, but from a subsequent PM it seems like he might be a well-intentioned poster after all, so to give him the benefit of the doubt, I'm provisionally reinstating his post and asking him to substantiate the data shown in his diagrams. - CF

--------

Hi Everyone

Intro :I just now joined this forum in order to jump into this thread. Is it dead? I hope not because I have a number of things I would like to contribute.

I've studied the whole preceding discussion and commend Felix on his valiant (but inadequately informed) defense of a very difficult line of reasoning. The root of the difficulty is the willy-nilly superimposition of models that always crop up when the issue is raised. This thread has been completely characteristic of that tendency.

I won't go into the problem of superimposition of models, just yet. First, I'd like to completely recast Felix's central argument, as I think he intends it to be. To do so I need to indulge your patience and state which model I am referring to, without yet clarifying the full set of possible models.

For this problem description I will be referring only to the reigning fiat dollar financial system. If you respond to me, please don't "mode hop" to barter, gold or any of the other models.

Body: The core point that Felix wishes to make is not really that there is not enough money to pay off debt. It's a key factor, but not the main issue. The main issue (I expect he'll agree), is to determine whether "money" genuinely serves value creation. I'd like to show how it doesn't with some simple graphs.

g1.JPG

The first graph has three segments, representing the three principal sectors of the economy: public, productive and financial.

The bottom scale is "a time span". (As far as I have been able to determine the proportions for the year 1900 aren't far wrong. The other end I fear is grossly optimistic, the "pinch-off" is long past in the third world, and imminent for "The West".)

The left-hand scale needs a bit of explanation. Consider the "family basket" of basic goods. Every item in the basket arrives at the end of a supply chain that connects all the way back to an original producer: a mine, a farm/forest, a fishery or a professional. That typical family basket has some price; the left hand scale shows the 100% of that price whatever it may be over time.

To enable the forward flow of goods and services, there is a counter-flow from consumer to producer of the medium of exchange.

Each node along the reverse pipeline suffers two significant leakages of money: one to the public sector in taxation and the other to the financial sector in debt service.

The graph contends that both are increasing as a percentage of the price of the family basket. It is a very frightening thing indeed. In short, the public and financial sectors are using their political and contractual (credit agreement) power to reduce to zero the profitability of the productive sector on which they depend for their very existence. Scarcely anyone is fighting to roll back these tendencies.

Having proposed that scenario, I need to relate it to the central problem, that "money" does not genuinely serve value creation. To do so I need to show another graph, more or less the one Felix tried to describe.

g2.JPG

I expect no one in this forum disputes the reality of the public sector (top segment in the first graph) eating ever further into the profitability of value production (middle segment). I contend that the financial sector (bottom segment) is eating even more powerfully into the profitability of creating value, by the mechanism shown in the second graph.

The volume of the money stock is closely proportional to the original capital of all unpaid debts. The amount owing however exceeds the original capital, and hence the money stock, by an ever increasing amount. Credit bubbles such as the current real estate bubble or the earlier dot com bubble, serve both to accelerate the velocity of money, and to make more money generally available, both of which ease debt service over the short-run; but they're bubbles in any case, and much new debt is incurred during these bubbles, to pay down accumulating unpaid interest from earlier recessionary phases everywhere along the various supply chains. This results in a total debt curve that increases much more swiftly than the money stock. (Markets are living systems. No living system can contain within it an exponential function ... if you wish to experiment, try jumping from a rooftop!)

Having posed these models I can get to the main point.

Money has numerous functions. The three main ones are :

1) Medium of exchange

2) Measure of value

3) Store of value

The first two serve the productive sector directly, the third, less so.

The third function is predominantly interesting to the financial sector, the first and second, less so.

Our reigning money system, the Federal Reserve dollar and the mechanism by which it is created, was designed by the financial sector to serve the financial sector first, the public sector second and the productive sector last of all. I'm sure historical facts can be brought forward to support and to refute this. Nevertheless, if you can accept the truth of the graphs (I have real data that supports the theoretical results) then I think you must accept that, over the long term, our "money" has subjugated the public sector to the financial sector and subjugated the productive sector to both. And now, 93 years on, we are now poised to reap, in horrible direct experience, the inevitable harvest.

In the preceding posts, I have seen repeated the stock arguments for the virtues of this system as propounded during the early periods of the graphs, when interest due was small in proportion to the money stock. Felix has been arguing the case for the dangers of the "end-game" when the "chickens come home to roost", when we've "made our bed and must sleep in it" and "somebody's got to pay the piper" (and all the other fun clichées).

Money created by interest bearing debt, whether by central banks or "Free Banking", is an artificial stimulant, an economic steroid that generates greater power than the host can sustain indefinitely. Unfortunately the host, like a frog in a pot of cool water being brought to a boil, has a miserable time deciding at what point should it jump to safety?

I think that Felix is right in his suspicion that Ayn Rand never understood the issues I raise above.

Comments eagerly anticipated,

TC

P.S. This thread has been dead for over a week. Is anyone interested in it? Shall I proceed to describe the other models?

Edited by Capitalism Forever
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Each node along the reverse pipeline suffers two significant leakages of money: one to the public sector in taxation and the other to the financial sector in debt service.

Your premise here is that the "financial sector" is not itself productive--as if a banker were just a different kind of taxman, who took away your money without offering anything in exchange. This premise is completely false. No bank will ever get a cent of yours unless you sign a contract with them and agree to pay them for the services they provide. If the bank gets money from you, it's because you think it's money well spent; it's a voluntary, mutually beneficial trade--a transaction that creates wealth for both parties--in other words, a productive act.

You cannot compare a productive trader to an armed robber. And I contend that your claim about the proportion of money going into debt service is completely bogus. It certainly isn't true for me ; while the government filches a substantial portion of my earnings, my bank adds to my income, since I have a credit balance on my account. What's more, my credit card allows me to buy goods and pay for them a month later interest free. And I doubt I'm unique in my position!

Sure, if you buy something like a car or a home on credit, you're going to have "debt service" exbursements for quite some time, but you're getting a car or a home in exchange, and you're getting it now. What do you want the bank to do, build you a home for free?

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Your premise here is that the "financial sector" is not itself productive--as if a banker were just a different kind of taxman, who took away your money without offering anything in exchange. This premise is completely false.
That is not my premise. My premise is simply that debt of the productive sector to the financial sector is rising as a percentage of profits.

On the other hand, I do indeed make a distinction between productive and financial. As I mention in the explanation of the first graph, there is a forward flow of tens of thousands of *kinds* of concrete goods and services produced for sale. The aggregate characteristics of those flows is controlled by a counter-flow of exactly one kind of "good" -- the medium of exchange. The financial sector exercises that control, and ultimately the Fed controls the financial sector.

That central planning and control, and the manner in which the productive sector is subject to it, is something which must be understood very clearly.

No bank will ever get a cent of yours unless you sign a contract with them and agree to pay them for the services they provide. If the bank gets money from you, it's because you think it's money well spent; it's a voluntary, mutually beneficial trade--a transaction that creates wealth for both parties--in other words, a productive act.
Yes, correct. Well, almost correct. When examining the contractual agreements one by one, we see the obvious ... a deal between consenting adults; a way for the one party to gain immediate liquidity to which he might not otherwise have access.

I'm not concerned with that aspect. It is a minor detail in a system of vast reach and vast consequences. I'm concerned with the aggregate behaviour across the entire system and over extended periods of time.

The point Felix was trying to make, and I'm trying to reinforce, is that your statement "a transaction that creates wealth for both parties" is not wholly accurate. I contend that there is a slight imbalance in favour of the lender that increases, in an accelerating manner, over time.

You cannot compare a productive trader to an armed robber.
By "armed robber" you evidently mean the public sector, and I completely agree. I live in a third world country that ranks in the worst 10% of corrupt countries in the world. We see here clearly a phenomena that is far better hidden in "The West" -- that supposedly democratic governments are simply heatshields for bankers who can, and do, purchase any legislation they require. (The cronies of Wesley Mouch, if you will). In turn, those bankers rise or decline in power and influence according to the strength of their relations with the IMF, World Bank, Interamerican Development Bank and other trans-governmental organizations. A large part of my concern is that those institutions are not merely statist, but meta-statist (if I may coin a term), frighteningly powerful and accountable to no one..

And I contend that your claim about the proportion of money going into debt service is completely bogus.

Here follows the substantiating data for the two curves of the "pincers":

img00003.gif

-- Public Sector Pincer --

business-debt-to-networth.gif

-- Financial Sector Pnicer --

It certainly isn't true for me ; while the government filches a substantial portion of my earnings, my bank adds to my income, since I have a credit balance on my account. What's more, my credit card allows me to buy goods and pay for them a month later interest free. And I doubt I'm unique in my position!
I propose that arguing from the specific to the general is not applicable here.

Sure, if you buy something like a car or a home on credit, you're going to have "debt service" exbursements for quite some time, but you're getting a car or a home in exchange, and you're getting it now.
My concerns are more towards the commercial debtor than the consumer debtor, mainly to keep the discussion from difusing in too many directions.

What do you want the bank to do, build you a home for free?
Do you really think I deserve to be jeered at?
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Trudy Cool:

These are more floating abstractions heaped on top of Felix's floating abstractions.

You offer no definition or description of what you are graphing. What exactly is being measured in this "financial sector"? What is a "family basket"?

There are no citations for where the alleged historical data come from, nor whose forecasts are being presented.

If people and governments are borrowing beyond their means to repay, then that's a problem. But don't blame it on money as such. And don't arbitrarily assert that money under central banking is the same as money under free banking, or that Ayn Rand somehow didn't understand the topic. One thing Ayn Rand did do was concretize and ground in reality what she talked about - something I'm not seeing a lot of here.

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Dear Mr. West

It's taken me considerable effort to get my posts past this community's first rank troll filters. It seems you are putting up a second line of defense.

The objections you raise are unjust and show (in my opinion) a troll-filter unwillingness to genuinely think about what I'm saying. I'm concerned that by the time my intentions are accepted as honest and genuine, my original points will be lost, my arguments appear fragmentary, and your objections appear legitimate. If that's the case I might just as well quit now, and go away. Is that what you want?

These are more floating abstractions heaped on top of Felix's floating abstractions.
This is false. I'm referring to a theoretical model (my own) which refers directly to concretes. If I haven't been concrete enough I can nail each one of them down exactly -- given a fair hearing.

You offer no definition or description of what you are graphing.
This is also false. There is enough definition for those willing to understand. If further clarifications are needed I'll respond to each item you raise. Is the following a complete list of these supposedly floating abstractions or merely a sampling? If the latter, supply me with a complete list and I'll clarify every one. But I must say, that it is easy, if you so intend, to stonewall any logical presentation of ideas with an endless stream of demands for definitions and explanations. Is that your intent?

What exactly is being measured in this "financial sector"?
In the tightest terms I can come up with. Public sector: Every person (individual or corporate) who lives off taxation. Financial sector: Every person (individual or corporate) who lives off interest on money or trading in financial instruments. Productive sector: Those who produce non-financial marketable value and live off the proceeds.

Only slightly more abstractly, (and as already explained), the two private sectors represent the flow and counter flow that constitute the fundamental elements of the marketplace. Reiterating (with new terms) -- the flow is where "something" exits the inventory of B and enters the inventory of A and the counter-flow is where "something" leaves accounts payable of A and enters accounts receivable of B. The productive sector dedicates itself to the flow and the financial sector dedicates itself to the counterflow.

What exactly is being measured in this "financial sector"? The financial sector represents costs to the productive sector. Those costs are increasing dramatically as a proportion of profits (as I said), and of net worth (as in the graph). The relative proportions over time is what is being "measured". I was NOT unclear about that.

I draw attention to a danger and theorize a cause. Please tell me what is wrong with that.

What is a "family basket"?
It's the generally accepted economics term in the region where I live. It's also pretty darned obvious and concrete. "Canasta Familiar", is a set of retail comodities used to calculate a consumer price index. In my theoretical model it is the terminus of the set of all flows of the productive sector, but not (interestingly) the source of all money flows.

There are no citations for where the alleged historical data come from, nor whose forecasts are being presented.
False yet again. The first does have the citation. http://mwhodges.home.att.net/ The second is from the same site. The Grandfather Economic Report assembles all its graphs from generally available public data. As you can easily see, there are no "forecasts", merely a statement of a theoretical possibility.

If people and governments are borrowing beyond their means to repay, then that's a problem. But don't blame it on money as such.
Now you are using floating abstractions and pushing opinions without substantiation.

Why should I not blame it on "money as such"? The entire preceding thread since Felix began it has been about "money as such". That the discussion has no merit is merely your opinion and, as a consequence, I'd be interested to know how you justify your involvement.

"Money" is an immensely complicated tool, with a considerable number of overlaid functions. For that reason, it is preposterous to talk about "money as such". It is a ridiculous floating abstraction, and a disingenuous trivialization of the entire discussion. Which money are you referring to??? Which of its functions?

The entire point has been that some manifestations of money serve poorly the exchange of value, (e.g. straight barter) while others serve it better, (eg, durable commodities) and some serve it very well, (e.g. precious metals).

I am very, very obviously not trying to come at this community with a dissumulated "Money is the root of all evil" evangelism, as you are hinting. Far closer to the truth of my position would be, "Money issued without backing is the root of all evil". However, that is already well understood among Objectivists. One of the points I want to discuss is, indeed, controversial. That not even Gold is the ideal medium of exchange. I seek serious discussion to clarify my own thinking. If you're interested, then discuss it honestly. If not, I have no interest in endlessly fending off hecklers.

And don't arbitrarily assert that money under central banking is the same as money under free banking,...
The arbitrary assertions are yours. There are many manifestations of money. Without any justification, you are attributing to me, a dopey confusion of functions and manifestations. To what purpose?

... or that Ayn Rand somehow didn't understand the topic. One thing Ayn Rand did do was concretize and ground in reality what she talked about...
I am thoroughly aware of that. It is exactly the reason I have sought out an Objectivist forum to test my theory, as opposed to a forum of fiat economists, or preaching to the choir in a forum on community currencies. It is exactly the reason I striven to find a stable measure (the "canasta familiar") and found the entire discussion in terms of relative proportions within that stable measure. Felix failed to do that and got hmiself shredded for it. My first objective has been to nail the discussion to indisputable basics. I have done so ... and any genuinely objective observer will either agree or collaborate to fix it. What will you do?

... something I'm not seeing a lot of here.
Are you seeing what is there, or what you are pre-disposed to see?
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My problem is this: If you borrow a certain amount of money at 5% interest, you have to get that money plus interest back from the market in, say, one year. Now if this sort of lending/borrowing is done on a consistent basis with compound interest it results in a concentration of money.
Comparative advantage says that there is some service/good that Jim benefits paying Alex for, so concentration of money isn't a problem if the islanders are rational.

With paper money the problem is similar. There is only so much money in circulation right now. New money can now not be mined like gold (which at some point can't be mined anymore, too), it has to be created by a corresponding rise in debt. There is no other way out of this as far as I see it.
Isn't the way out the fact that in a real-life situation, a person has the capacity to pay off a debt by earning money instead of Ponzi schemes?

The problem is not that additional value can't be created. It can. I seriously believe that a 5% rise in this product/benefit-wealth is possible. But what is missing is the currency that corresponds to that 5% rise. Where does that come from? If the world economy is rising by 5% in product/benefit-wealth, where does the additional currency come from that pays for it?
There is no additional currency. Each existent unit of currency simply buys 5% more than it did previously. What's the problem, particularly since an increase in purchasing power leads to lower interest rates?
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Comparative advantage says that there is some service/good that Jim benefits paying Alex for, so concentration of money isn't a problem if the islanders are rational.

I don't attack trade on moral grounds. I don't even attack the concept of trade. It's fine. The aim of my attack is the currency-system.

Isn't the way out the fact that in a real-life situation, a person has the capacity to pay off a debt by earning money instead of Ponzi schemes?

Actually it's not. You need a constant rise in debt to provide enough corresponding money to pay the interest on the old debt. This is the basic problem of the current system.

There is no additional currency. Each existent unit of currency simply buys 5% more than it did previously. What's the problem, particularly since an increase in purchasing power leads to lower intert est rates?

You need to carry 5% more currency back to the bank to pay the debt you have.

Please wait a little bit more. I'm currently researching to write my treatise.

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I think the main point of dissent comes from the fact that most people here (me included) are talking about how an economy should properly work, rather than how it is working today (with our fiat currency, and all that). Felix, on the other hand, is only talking about how the situation currently is, and what is wrong with that. We had a very long discussion last night about this subject, and I think we have managed to reach a good resolution. I will leave it to him to post his final treatise on this, though.

To summarize some of the discussion, I agree with him that if interest rates are higher than the amount of growth in production and currency (real currency, not paper money) that compensates for it, then you would have a problem.

At a certain point there wouldn't be enough money floating around in the economy to pay for all the debt, which is a very strange scenario. Rather than condemning the economy for this reason, however, I think it is more fair to say that it is irrational for banks to ask more interest than the economy can properly support.

If there were only 100 gold coins in existance, then it would be utter madness for the banks to ask for more than a total of 100 coins in return. Instead, however if they loaned money to someone, and that person used it to become much more productive, the bank owners also profit because the coins they get in return (at 0% interest) now buy more than they did previously. This is mainly to show that interest is not necessarily needed in an economy if productivity rises.

This is another reason why it is so important for money to be linked by goods, something which hasn't really been the case since we switched to a fiat currency. If you divorce the two, then the only way to keep up with interest rates would be to print more money, which makes the money have less buying power, which in turn further causes interest rates (and inflation) to rise, and etcetera.

As far as we could tell, however, if you have actual goods backing your currency, rather than the promise of a future claim to something (whether it be taxes or future production), you inherently limit the abuse the system can take.

If gold was the only currency in use, then the interest rate could equal the amount of gold entering the economy that compensates for it without any trouble. If the amount of gold starts running low, you could easily switch to another type of valuable metal to use as a medium of exchange, and I think this could go on indefinately.

In conclusion, I think this thread shows yet another problem with the concept of fiat currency, which would be more motivation to change back to a gold-standard.

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Actually it's not. You need a constant rise in debt to provide enough corresponding money to pay the interest on the old debt. This is the basic problem of the current system.

You need to carry 5% more currency back to the bank to pay the debt you have.

Okay, I agree that if more money than exists is due to debtors, if lenders are so myopic as to engage in such a losing proposition, if potential lenders ignore their capacity to pay back loans, if the due date is so short that some debts be paid off and then more money be earned to pay the rest is impossible, or if debtors don't earn sufficient money to pay off debts in time, then your situation could exist.

We don't need a constant rise in debt because the sum of all debts is not for a nonexistent sum of money, and not due before some could pay off their individual debts. Worst case scenario, some pay off their debts and others can't earn enough to pay off theirs... in time. Any such system still balances out without relying on ever increasing debt.

Besides that, all of these ifs don't coincide anywhere, certainly not in America. What does this stuff then apply to? One could make a theory as to what happens if everyone destroys every unit of currency. In such a theory, catastrophe occurs because no one has the currency to purchase anything, but like your example, it wouldn't matter, because 1) it doesn't pertain to any realistic scenario and 2) to the extent that it could, it could be easily remedied.

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Hi Maarten

At a certain point there wouldn't be enough money floating around in the economy to pay for all the debt, which is a very strange scenario. Rather than condemning the economy for this reason, however, I think it is more fair to say that it is irrational for banks to ask more interest than the economy can properly support.
It is not a strange scenario. It is a continuous and inevitable consequence of a medium of exchange created on the basis of interest bearing debt. That was the point of the second graph in my first post. In a fiat currency the charging of interest and taxation are absolutely essential to maintaining the scarcity of the currency that gives it its apparent value. (It's no coincidence that the Fed and the IRS were created within months of each other.)

In a gold-only economy, Galt's Gulch for example, Midas Mulligan would have to spend every ounce of the interest he received to maintain the currency stable. If he decided to increase his reserves (not spend all the interest), he would reduce the "money stock", increasing its value, lowering the prices his debtors could obtain for their products, and (possibly) cause some of them to default. If he elected to do so in mid-summer, he'd clobber farmers who have yet to harvest and get to market. If he chose mid-December, he'd clobber retailers (if they celebrate Christmas in Galt's Gulch? heh!)

If he remained the only financier, he'd exercise a subtle but dangerous "central planning" authority over the rest of the valley.

As far as we could tell, however, if you have actual goods backing your currency, rather than the promise of a future claim to something (whether it be taxes or future production), you inherently limit the abuse the system can take.
You are correct about this, but actual goods are not so necessary as you assume. If the goods are the issuer's stock in trade, and he/she invariably redeems them at face value out of production, what's the problem? The key to the whole thing is the quality of the contract. Pull out an $1 FRN and try to find the contract. It's there, honest. It says, "This note is legal tender for all debts public and private." Just what are they committing themselves to with a contract like that? It's an obscenity worse than kiddie-porn once you really stare it in the face.

If gold was the only currency in use, then the interest rate could equal the amount of gold entering the economy that compensates for it without any trouble. If the amount of gold starts running low, you could easily switch to another type of valuable metal to use as a medium of exchange, and I think this could go on indefinately.
Unfortunately, it's not so easy. The anguish and desperation of the deflation, the foreclosures, and the unmerited impoverishment of the unprepared during the transition is not an extraneous cost. This is the reason I give so much importance to the need for numerous simultaneous currencies.

Rgds,

TC

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Okay, I agree that if more money than exists is due to debtors, ...

This is true for all interest.

..., if lenders are so myopic as to engage in such a losing proposition, ...

They do it.

..., if potential lenders ignore their capacity to pay back loans, ...

They do it, too.

... if the due date is so short that some debts be paid off and then more money be earned to pay the rest is impossible, ...

To have enough new money in the market you would need new debt, the paid-off debt usually enters the market again as new debt. It is not just spent.

... , or if debtors don't earn sufficient money to pay off debts in time, then your situation could exist.

This can always happen, no matter if my theory is correct or not, as it is dependent on the debtor's performance.

We don't need a constant rise in debt because the sum of all debts is not for a nonexistent sum of money, and not due before some could pay off their individual debts. Worst case scenario, some pay off their debts and others can't earn enough to pay off theirs... in time. Any such system still balances out without relying on ever increasing debt.

Some can only pay off their individual debt with interest with other people's debt. The problem is that it can't "balance out". It's a constant falling forward, a constant struggle against bankruptcy. There is no balance.

Also note that what we were describing was nothing but just breaking even. We haven't even started talking about making a profit, yet.

Besides that, all of these ifs don't coincide anywhere, certainly not in America. What does this stuff then apply to? One could make a theory as to what happens if everyone destroys every unit of currency. In such a theory, catastrophe occurs because no one has the currency to purchase anything, but like your example, it wouldn't matter, because 1) it doesn't pertain to any realistic scenario and 2) to the extent that it could, it could be easily remedied.

Yes it does coincide everywhere. It's a description of the current system. I'm the first one to describe it as on the verge of sheer insanity. But still it is true. The problem I am having describing this is that everyone tries to argue that this is insane and could therefore not be. My point is that it is insane and will therefore end in a crash. It should not be, I agree with that completely. I am not arguing for it. I am arguing against it. But I am certain that "my" theory which describes it is right.

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While quite unusual, I don't really disagree that it could happen. My argument is that it wouldn't lead to a crash. Let's say there are $100 dollars in a system, every penny of it is loaned out, and $105 dollars are due to the debtors in a short enough amount of time that no one can earn their interest via a transaction. There are only two things that I believe could happen:

1) legal action - the loaners prosecute debtors for not paying in time. They get their original money back, and the only interest they can possibly gain is products from the debtors - which they could have accepted in lieu of dollars for interest in the first place! The debtors essentially sell goods/services to the debtors to pay off their debt, and things are balanced debt-free.

2) The loaners grant time extensions, which allow the most able persons to earn some of the loaned money from others and pay their debts. What happens to those less able? The loaners are again faced (again) with only two solutions - accept goods/services from the debtors in place of currency interest, or grant another extension.

The loaner could perpetuate this system, sure, by again loaning out the money the able people pay back - but what? If they wish to keep their capital infinitely loaned out and unusable, that's their perogative, and it doesn't affect the able (who can pay back their loans, and without taking on more debt) or the unable (who either pay interests with non-currency goods, get an extension, or clear their debts via bankruptcy - in any case, nothing requires they take on more debt to balance out.) The only one harmed by such a system is the loaner who continually loans out money without regard to when or if it'll be paid back. The only one who doesn't balance out is the negligent loaner.

Where's the crash?

Edited by hunterrose
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I think the main point of dissent comes from the fact that most people here (me included) are talking about how an economy should properly work, rather than how it is working today (with our fiat currency, and all that).
Agreed. I'd put it as how people can or must act within our given system vs. how they have acted within the system.

The point Felix was trying to make, and I'm trying to reinforce, is that your statement "a transaction that creates wealth for both parties" is not wholly accurate. I contend that there is a slight imbalance in favour of the lender that increases, in an accelerating manner, over time.
My bank adds to my income, since I have a credit balance on my account. What's more, my credit card allows me to buy goods and pay for them a month later interest free. And I doubt I'm unique in my position!
I propose that arguing from the specific to the general is not applicable here.
Depends on what's the application. I believe CF would say that, even if some particular businessmen were reducing their profits from taking on bad debts, this proves neither that some people aren't increasing profits by borrowing nor that modern business requires indulging in an increasing spiral of debt. I don't particularly dispute the graphs you posted, but if(?) they don't apply how an individual businessman can act within our system, wouldn't this simply be a case of many (perhaps even most) businesses taking on bad debts?

P.S. I'd like to get your response, so don't get caught up in anti-trolling, regardless of whether it's a valid response to others or not :worry:

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Hi folks,

I began to reply to hunterrose and found myself up against the same confusion that has plagued this thread from the beginning. Which "money" are we talking about?

To fix that, I'd like to take a single scenario and apply several economic systems to it. I'll name the scenarios, and hopefully others will retain the terminology.

The scenario is simple enough -- a dinner for Dagny at John Galt's house in Galt's Gulch. John supplies the space and the cooking facilities. In one way or another everyone contributes; cutting vegetables, bringing wine or whatever.

Tribal Economy: John assigns duties to each member. Once the meal is prepared, quantities are allocated in proportion to compliance to John's wishes.

Gift Economy: Everyone brings roughly what they expect to consume, plus a bit. Everyone participates as they please, and consumes as they please. Status in the community is directly proportional to net contribution.

Feudal Economy: John assigns duties to several of the burliest invitees. These in turn assign to weaker ones. Those assign to the weakest. John eats first, then the next echelon, and so on.

Communist Economy: A committee of the burliest, citing the idyllic plenitud of the gift economy, decide the gifts to be given by each invitee. What the committee does not consume or take home, is allocated in proportion to the degree of enthusiasm of obedience to the committee.

Owned Gold Economy: Each participant arrives with a pocketful of gold coins. They haggle out rental contracts for table and stove burner space with John. Once the parts of the meal are prepared, participants rove around purchasing what they want. Everyone strives to leave with at least as much gold as they brought.

Borrowed Gold Economy: At the outset, neither John nor any participant has any gold coins. They wait for Midas Mulligan to arrive. Midas lends out gold coins by taking signed title to the wristwatches of each participant. For the first hour everything progresses more or less as in the Owned Gold Economy above. However, every fifteen minutes, during the party every participant visits Midas, to pay a gold coin of interest, and John to pay a gold coin of rent. As owner of the "rental spaces" John has no need to borrow, and like Midas receives a steady income from beginning to end. As, the number of coins in circulation declines with each period, some are obligated to return to borrow more, also prices decline as competition heats up for the fewer and fewer remaining coins. Those with outstanding debts find it more and more difficult to sell enough to make payments. This is partially mitigated by Midas' and John's occasional purchase of drinks. Towards the end, Midas & John are the only ones with cash. Those who offer the food and drink preferred by Midas and John are able to meet the final payment on their loan. Those who don't -- lose their watches.

Fiat Paper Economy: Same as Borrowed Gold Economy above, except that Midas arrives with an impressive looking locked strong box. As each invitee comes for a loan of gold coins, they receive a fistful of paper certificates. At the end of the day a few request their coins to take home. Midas convinces most of them to leave their certificates with him, because he'll redeem them with many more coins at the next party. Those he can't persuade, he pays from a few coins in his pocket. No one ever sees the contents of the strong box.

Mixed Economy: Same as Fiat Paper Economy but, citing the idyllic plenitud of the gift economy, a committee is organized to institute an "opportunity equalization" scheme to distribute the remaining coins "more fairly".

Central Banking Mixed Economy: Same as Mixed Economy but the committee sells interest bearing bonds that commit the contributors to the equalization scheme to pay up later. Midas purchases most of these bonds and, declaring them "as good as gold", substitutes them for the gold he claims to have in the strong box. From this point on, he "burns the candle at both ends", using interest-bearing bonds from the committee as backing for interest-bearing debt. The creation of the medium of exchange without reference to any objective equilibrium of supply and demand causes unpredictable price fluctuations on an upward trend.

Clearing Economy: Midas maintains an accounting book. As each pair of participants negotiates a firm trade, they ask Midas to debit the buyer and credit the seller. Midas charges a percentage on each transaction. Everyone starts with zero. The net value of all accounts is always zero. Negative closing balances are settled up by some form of contractual agreement, perhaps involving interest.

Private Paper Economy: Each invitee brings to the party self-printed paper notes denominated in the products/services they offer. They provide, for public viewing, a "To The Bearer" contract that defines the exact meaning of their notes. Participants deposit a portion of their notes with Midas. Also, they pay him a periodic auditing and maintenance fee. On this income Midas audits their conformance to contract. Should one of them suddenly die, holders of the deceased's notes can redeem them for a basket of notes of various issuers, or Midas' own notes. Should Midas determine through audit that an issuer is spending in excess of contract he will increase their periodic maintenance fee by that amount, and publish this decision. Seeing his informed decision, all sellers will demand a similarly increased price for the notes, and the the issuer will find everyone reluctant to accept his notes at all.

Final note: The various types above are obviously schematic, and biased towards highlighting the issues under discussion in this thread.

I deliberately chose to make a dinner party the context, rather than Galt's Gulch in general, in order to highlight a vitally important aspect of "the exchange paradigm" -- Trust. In the trusting environment of a party a great deal of productive exchange takes place with no need of a medium of exchange at all; a gift economy.

A molecule of H2O has a certain dynamic behaviour. So does a drop of water. So does a snowflake. A glass of water. A puddle. A lake. An ocean. You don't tsunamis in glasses of water and you don't get oceans hanging from kitchen taps. Nevertheless, it's all the same stuff. The difference is all in the strength of binding across the mass under discussion. One binding -- surface tension, for example -- permits a droplet to maintain its integrity without a container.

Where the exchange paradigm is concerned, Trust is a binding factor that weakens as the size of the marketplace increases. Above I show a variety of ways that the financial sector executes their role of mediators of trust. I'm convinced the mechanisms in use are sub-optimal.

In my view, the issue on the table is not so much which is best as which is best at different scales

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That is not my premise. [...] On the other hand, I do indeed make a distinction between productive and financial. [...] The financial sector exercises that control

So just what is the difference between your view and the premise I cited?

The aggregate characteristics of those flows is controlled by a counter-flow of exactly one kind of "good" -- the medium of exchange. The financial sector exercises that control, and ultimately the Fed controls the financial sector.

Would you be so kind as to translate this to English?

As far as I understand, what you are saying is: "I would like you to think that your lives are in the hands of the banks. I don't want to give you a clear picture of the exact mechanism by which the banks control you; instead, I want you to believe that it is a complicated and nebulous machinery that can only be figured out by people who can understand phrases like 'the aggregate charactersitics of these flows.'" Did I get it about right?

The point Felix was trying to make, and I'm trying to reinforce, is that your statement "a transaction that creates wealth for both parties" is not wholly accurate. I contend that there is a slight imbalance in favour of the lender that increases, in an accelerating manner, over time.

It either does create wealth for both parties, or it doesn't. If it does, what's the problem? If it does not, why would the client sign the contract?

By "armed robber" you evidently mean the public sector, and I completely agree. I live in a third world country that ranks in the worst 10% of corrupt countries in the world. We see here clearly a phenomena that is far better hidden in "The West" -- that supposedly democratic governments are simply heatshields for bankers who can, and do, purchase any legislation they require. (The cronies of Wesley Mouch, if you will). In turn, those bankers rise or decline in power and influence according to the strength of their relations with the IMF, World Bank, Interamerican Development Bank and other trans-governmental organizations. A large part of my concern is that those institutions are not merely statist, but meta-statist (if I may coin a term), frighteningly powerful and accountable to no one..

The solution is a free market, including a free financial market, and a government that enforces individual rights. Which means that banks should be able to make as many loans as they see fit, and charge whatever interest they think will profit them best.

business-debt-to-networth.gif

This graph relates the amount of debt to the businesses' net worth. We need a graph relating debt service payments to profits.

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It is a continuous and inevitable consequence of a medium of exchange created on the basis of interest bearing debt.

I don't know about how it works in your third-world rathole, but in all of the countries I am familiar with, the forms of money used as a medium of exchange do NOT bear any interest.

  • Coins? No interest.
  • Notes? No interest.
  • Checks? No interest.
  • Money orders? No interest.
  • Credit cards? No interest if repaid soon enough.

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Okay, I'm starting to see Felix's/your argument, though I'm not sure it applies to our system yet.

I'd like to take a single scenario and apply several economic systems to it. I'll name the scenarios, and hopefully others will retain the terminology.
Sounds good to me.

I deliberately chose to make a dinner party the context, rather than Galt's Gulch in general, in order to highlight a vitally important aspect of "the exchange paradigm" -- Trust. In the trusting environment of a party a great deal of productive exchange takes place with no need of a medium of exchange at all; a gift economy.
What do you mean by trust, particularly as applied to the Borrowed Gold Economy model?

Borrowed Gold Economy:
I'll use this one for the moment, as the Fiat and Mixed Economy examples are derivatives of this one (if there are important differences, I "trust" :) they'll be pointed out when necessary.)

I believe this system has the necessary factors of the discussion:

  1. having currency within the system unavoidably requires making payments to an entity
  2. the money circulating within the system decreases subject to the debt-collector's unwillingness to spend the interest he obtains

I understand that you mean any system with interest contually paid and not put back into the system, regardless of whether the debts are "bad" or proportionately large to the supply of money, will suffer a diminishing ability to pay the interest?

To the extent that such systems are avoidable subsystems within our own (i.e. personal transactions between willing individuals,) I'd fault the fool who partakes in such a debt and leave it at that. But I believe you are saying that we all are taking on such a "debt," regardless of whether we actively/consciously wish to or not?

If such debt-spiral systems are not merely avoidable subsystems within our larger one, but representative of the system (as is) as a whole, what makes it unavoidable (gov't/the Fed?)

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So just what is the difference between your view and the premise I cited?

My premise, if you would be willing to study each of the scenarios in my last post, is that the financial sector has imposed upon the productive sector one of numerous possible money creation mechanisms. The one they have chosen is the one that maximizes their profits. I don't dispute the logic of their doing so.

The point I want to raise is that the technical mechanism itself, MUST lead to a collapse. It is an inescapable inherent characteristic of a money created on the basis of debt. This is not my opinion. It is an objective fact, and I am trying to lay out the groundwork to make it possible to explain how it works.

Have you seen those Magic Eye pictures in which a 3D object only becomes visible if you set the binocular focus of your eyes to a point beyond the lens focus of each individual eye? There is no disputing the presence of the object once you see it. Unfortunately there is no possible way of showing it to persons unable to make their eyes adjust correctly.

You can suspend your disbelief and make an effort to understand me, or you can continue to scoff at me. Which will it be?

Would you be so kind as to translate this to English?

Gladly. The flow of goods and service towards the final consumer involves thousands of different kinds of items. During booms the flow increases. During busts, it declines.

Why? Because it responds to the behaviour of the counter-flow of a single "good" (the medium-of-exchange) from consumer back to original producer. If the financial sector eases credit, consumers have more liquidity and the resulting generalized increase in demand flows all the way back to original producers. If it tightens credit, the reverse occurs.

That is how the financial sector exercises control over the productive sector.

W.r.t. the phrase 'the aggregate charactersitics of these flows.' -- 'Aggregate' means the sum of all flows. 'Characteristics' refers to the volume and velocity of those flows. During monetary inflation for example, the velocity tends to increase ('coz people don't want to hold cash), while volume tends to decline ('coz prices are higher).

Would you be so kind as to translate this to English?

As far as I understand, what you are saying is: "I would like you to think that your lives are in the hands of the banks. I don't want to give you a clear picture of the exact mechanism by which the banks control you; instead, I want you to believe that it is a complicated and nebulous machinery that can only be figured out by people who can understand phrases like 'the aggregate charactersitics of these flows.'" Did I get it about right?

You have totally missed the point. I came here to explain the "exact mechanism by which the banks control you", in as much detail, and with as much patience as may be required, in order to encounter informed criticism. To date I have encountered plenty of criticism, but all of it disappointingly ill-informed.

You have only to examine with an open mind the scenarios in my last post, to see that I am making a sincere effort to clarify the confusions and bring the discussion onto a sound footing.

It either does create wealth for both parties, or it doesn't. If it does, what's the problem? If it does not, why would the client sign the contract?
As already stated, I don't dispute the validity of the individual contracts.

My professional speciality is the macro-behaviour of systems. Please recognize that the localized detailed behaviour of a system is not a sound basis for assessing the system as a whole. In aggregate, over time, the financial sector gains (ratchets towards itself) an ever-increasing amount of real wealth (property) at the expense of the productive sector. Please permit me to explain the entire case, rather than nipping it in the bud, or jumping to unwarranted conclusions.

The solution is a free market, including a free financial market, and a government that enforces individual rights. Which means that banks should be able to make as many loans as they see fit, and charge whatever interest they think will profit them best.
I totally defend the concept of a free-market, and defend the right of lenders to lend at interest. My argument is that lending at interest must not be the mechanism by which the medium of exchange is created. I do not propose that lenders be forcibly impeded from creating a medium of exchange in this way. Instead, I'm proposing that the productive sector choose to create a medium of exchange that principally serves its needs, rather than naively and passively accepting the financial sector's preferred mechanism. I believe it is urgent that this happen.

This graph relates the amount of debt to the businesses' net worth. We need a graph relating debt service payments to profits.
You would only want that if you believe that a graph of debt service payments to profits, would have something other than a close correlation to debt as a percentage of networth. If you can explain how such a thing could happen, I'll take seriously your request. If a graph of debt service payments to profits is available, I'd be glad to see it, but it too would be subject to a host of objections in any case, and not a fruitful direction to take.

Instead, my intention is demonstrate the validity of the theory, by reference to a simple objective model that anyone can understand and replicate -- as described in the Borrowed Gold Economy scenario.

I don't know about how it works in your third-world rathole, but in all of the countries I am familiar with, the forms of money used as a medium of exchange do NOT bear any interest.
Then you simply don't understand the mechanism of money issuance. It's not a matter of opinion. It works in a very specific way. I've made an effort of several years to understand the mechanism.

Since you are not well-disposed towards believing me -- try this quote from a Federal Reserve official.

If all the bank loans were paid, no one could have a bank deposit, and there would not be a dollar of coin or currency in circulation. This is a staggering thought. We are completely dependent on the commercial banks. Someone has to borrow every dollar we have in circulation, cash, or credit. If the banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless situation is almost incredible -- but there it is.

Robert Hemphill was the Credit Manager of the Federal Reserve Bank in Atlanta

To understand what he means please work through the Borrowed Gold Economy scenario in my last post.

Rgds,

TC

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Wow, there's been a lot of activity since the last time I've been here. Sorry for the late answer, but I only had limited computer access over the weekend.

Where's the crash?

Well, here it is. You named two scenarios:

1) legal action - the loaners prosecute debtors for not paying in time. They get their original money back, and the only interest they can possibly gain is products from the debtors - which they could have accepted in lieu of dollars for interest in the first place! The debtors essentially sell goods/services to the debtors to pay off their debt, and things are balanced debt-free.

This legal action ends in bankruptcy. If you are piled in debt and are unable to pay it off, you go bankrupt and your goods are sold, usually at a loss. Now remember: What we talked about was an entire economy where there wasn't enough money to pay off all the debt. This means that for everyone who can pay off his debt with interest, there's in average someone who can't, i.e. who goes bankrupt. Again, remember that we actually have to include profit in addition to interest, which makes this even more likely.

Now picture an economy where a large group of businesses and people go bankrupt. That's a crash, isn't it? And if you think that's not enough, this is just the beginning.

What's worse is that this initial crash results in debt unpaid. If you are bankrupt, you usually don't only owe money to the bank, but to lots of other businesses as well. If this happens on a big enough scale, and if there's not enough money around it does, then this initial crash will drive other businesses into bankruptcy, because suddenly they can't pay their bills, because the money they expected to get from the bankrupt business doesn't come. This drives prices down because money that was accounted before (the debt which remains unpaid) doesn't come, and has to be deleted, lowering the actual sum of accounted money. This alone has to result in lower prices, as the total amount of money in the economy is going down.

This sudden lack of liquidity puts additional pressure on the remaining businesses, forcing them, who are trying to do the impossible under time pressure already, to lower their prices to speed up the sales process and even to minimize losses.

This, of course, drives other businesses into bankruptcy and so on and so forth until new debt is issued to pay off the interest of the remaining old debt which has survived the crash, which is when the whole thing starts anew, waiting for the next crash to come in the future.

2) The loaners grant time extensions, which allow the most able persons to earn some of the loaned money from others and pay their debts. What happens to those less able? The loaners are again faced (again) with only two solutions - accept goods/services from the debtors in place of currency interest, or grant another extension.

This extension, as you said it yourself, only extends and in the end worsens the problem.

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