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Debt Free Money alone does not solve Compound Interest

by on January 5, 2012

Debt free money in a full reserve banking system can still be subverted by the Money Power through Compound Interest. This is a vital issue for all Debt Free currency activists and theorists. It also is relevant for Gold and even Bitcoin.

An important model to finance national economies without the Money Power is debt free currency. It is printed by Government and spent into circulation. Either by Government itself, a la the Greenback, or by the People, Social Credit, which is preferable.

The key reason why this method is better than the current ways is because it allows an interest free money supply: the money in circulation is not burdened with interest. Considering the fact that trillions of dollars are now circulating, each costing 5 to 10 cents per year in debt service, this is a major improvement.

However, there are a few limitations to debt free money. I discussed them here, but there is a crucial problem that merits independent analysis.

As we know, debt free money does not completely eradicate interest. For credit a banking system is needed and these banks would require capitalization: deposits by savers that can be lent out. To attract these deposits, interest is necessary.

The interest payed over credit in this system will continue to be a wealth transfer to the rich. Because also in this system it will be the poor who borrow and the rich who lend.

Worse, the risk is very real the Money Power would be able to subvert a debt free money supply.

Consider this:

Compound Interest
Let’s say we implement Social Credit. The Government prints money and the People spend it. The Money Power would open a number of banks on a full reserve basis, all credit backed by deposits.
During the first year it would acquire a fair bit of the new money. They would easily be able to do so: they could sell some of their Gold or other assets. And they would have major income through for instance Big Business. It would use that income for their loan shark operation.

Let’s say, for argument’s sake, they obtain 10% of it’s supply.

They start lending at say 5%. Of this 5% they use 2% for cost. The remaining 3% is profit, new capital, new deposits for their banks.
After 1 year of lending they control 13% of the money supply. After two years 16.09%. After three years 19.28.
After 10 years of lending they would control 34 percent and after 20 years 81% of the money supply.

Compound interest in operation.

Of course, the exact numbers are not important here, it’s the process that matters.

Yes, Government could print ever more money, but this would mean unstable prices. And the idea that the Money Power is still raking in so much interest is unacceptable.

Solutions
There are two ways of combating this. The first is to combine debt free money with Mutual Credit, preferably in a free market environment.

The second is approach is known as ‘demurrage’.

Demurrage is interest on holding money instead of credit. It means that if you have money in your account, you will be paying interest over it. It was invented by Silvio Gesell. Demurrage is the secret behind the famous ‘Wörgl Freigeld‘. I recommend everyone not familiar with it to take note of it. It is the basic model of the German Regional Currencies, that circulate in dozens of Germany’s towns and cities.

The effect of demurrage is predictable: people start dumping their cash. The velocity of circulation is massively increased. Wörgl vouchers circulated up 140 times in the 13 months they were allowed to finance the local economy. A dollar or euro would typically go round maybe 8 or 10 times.

Because of higher velocity, far less money is required. That’s also a notable aspect. This explains why it is so useful in a depressed economy: depressions are caused by scarce capital.

But the key is that people, in order to get rid of their cash, start paying up front. This has been confirmed in Wörgl, so its not just an idea. They even pay taxes up front, just to avoid the penalty of holding cash.

If we pay our supplier up front, we basically give him an interest free loan.
In this way businesses and commonwealths would be able to finance many big projects interest free.

Concluding
Debt free money, especially Social Credit, is vastly superior to our current system. It does have a major limitation: the Money Power, through compound interest, would be able to control the money supply.

This problem exists both under fractional reserve banking and full reserve banking. It does not matter whether it’s Gold or debt free money.

Two easy solutions are available: a combination with Mutual Credit, allowing interest free credit, or demurrage.

Perhaps other ways are imaginable.

This shows just how nefarious the implications of interest really are. It is a good reminder to not stop until we completely get rid of it.

I’d be interested in any comments, as I believe this is a serious issue.

Afterthought:
This is also discussed in Ellen Brown’s Web of Debt, the chapter on the Goldbugs vs Greenbackers.

Further reading:
Reassessing the Greenback and other Alternative Monetary Systems
Mutual Credit, the Astonishingly Simple Truth about Money Creation
the Power of Demurrage: the Wörgl Phenomenon

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42 Comments
  1. Ronnie White permalink

    Long before we had banking systems, we had the ability to work, produce wealth and trade it among ourselves. Commerce requires no debt. If you had a debt free money system or wealth money system where the money is spent into circulation based on labor and raw materials, true production, and it’s run correctly money should not lose it’s purchasing power. People with that much wealth would not need to loan out there money. Money should only be final payment. Interest, usury should be probhibited. Otherwise what’s the point, Under the monetary principle of Debt-free monetization or wealth, the people get the benefit of owning the production they produce and the benefit of owning, not owing, the money they earn as payment for their production.

    “A monetary system can exist without a banking system but a banking system cannot exist without a monetary system.” The only real solution is to monetize the production of the people as wealth to the people with debt to no one! When the production is done first and the money supply is increased as a payment to pay for the production there is no inflation. There would be no loaning of money and promising production in the future. You wouldn’t need any taxes. No one should be in debt. Money should mean only one thing. final payment for production done. True money. You can only increase the money supply based on production done. Otherwise you’re thinking under the old way of doing things. You gotta get out of this way of thinking that we need credit and loans. We don’t and we would be more prosperous than anytime in history, individually and as a nation.

  2. I would like to add another solution to your toolbox.

    Land Value Tax efficiently extracts the economic rent and works as a incentive to use the land more efficiently. It reduces the total amount of debt needed in society. Georgists want to remove all other taxes. Then tax the economic rent for land at close to 100%. This way the state tax the people at a rate the people choose themselves by living in a high/low-valued location. LVT also reduces urban-sprawl. This leads to improvement of the land and environment everywhere. This because people move to locations with the lowest tax and improves the area with any earnings.

    http://earthsharing.ca/

    I would love to see full reserve banking with the central bank as the main/only lender in the economy (financing the state with lots of seigniorage), demurrage to speed up the market, reducing the need for debt, and LVT as an incentive to improve the land to its fullest potential and further reduce the need for debt and other taxes.

    A mutual credit network (i.e. Ripplepay) would complement this system and provide an efficient alternative for payments.

    • Thanks much.

      It was only recently that Georgist landreform came to my attention. Landreform is absolutely crucial and Georgism seems to offer a lot of answers!

      • Dark Dirk permalink

        Anthony, have you actually read Silvio Gesell’s book Natural Economic Order ? It first part is about land reform. Without land reform there cannot be money reform, because land is scarce and landowners get rent from land. There is two possible way of doing that reform: private ownership of the land and land value tax or state ownership of the land and rent payed to state. With taxes collected that way, state can make social payments and public investments.

        • Dark Dirk permalink

          Sorry,
          I have commented on old article. My mistake.

  3. Keith Gardner permalink

    inflation is a demurrage. the government printing money in excess of monetary demand with a debt-free monetary system would cause inflation. citizen dividend (social credit) should be sufficient to pay for the cost of inflation for most people, though it is already a minimum amount for most people (multiple inflation rate by the average amount you have in your wallet, that is your yearly inflation tax). if you sit on a lot of cash without putting it to work, you pay for the cost of inflation.

    inflation is an ideal progressive tax under a public debt-free monetary system. there are no forms. the more you sit on monetary units without putting it to productive use, the more tax you pay. i’d like to add that inflation is interest…. interest on not completing an economic transaction. under our current system, inflation isn’t even a tax, it is interest owed to bond holders and bankers, since we have a debt-based monetary system.

    • I agree, but the middle classes must be educated not to hoard the cash and look for alternative stores of value.
      I also agree that Gold is probably far from the best choice. I just use that as an example for the Austrians who are so enthralled by it.
      But Gold is only appreciating because of speculation it will be currency again. And if it will, it will become very expensive (http://realcurrencies.wordpress.com/2011/12/22/why-is-gold-appreciating/).
      Without this driver Gold would be just another commodity.

      With a demmurage paying up front becomes a viable store of value. Or paying of debts, investing in education or your own business. All these things save future cost or provide (more) future income.

    • REN permalink

      Actually, NO. With demurrage, the unit is made whole. Think of it like a bucket which has fixed volume; the demurrage fills the bucket when the tax is paid. The bucket is filled with a fraction of the holders labor output. The unit of money, or bucket has a a nearly constant volume.

      Inflation is radically different. The shape of the bucket diminishes over time. The unit itself shrinks. The holder of inflation money holds a diminishing quantity.

      The holder of a demurrage ticket must make the money ticket whole in order to spend it. When the ticket (bucket) is spent, it is filled and the volume did not diminish.

      In a demurrage world, there may be some small inflation going on simultaneously.

      • Dark Dirk permalink

        I agree with REN. Inflation is totally different from demurrage. You still can hoard inflated money and charge interest on them. And money loses value with exponentially increasing speed. All such system had hyper-inflated, because there is only positive feedback to the system: 1. Inflation 2. Interest. Demurrage is negative feedback to the system: 1. Demurrage extracts money from system. 2. Interest hardly can be charged. So you need central money authority witch have the power to inflate money supply or leave it deflated after extracting the demurrage tax.

  4. Nik permalink

    Interest is not the problem.

    If people want to participate in a system with no interest, they of course should have that right.

    Just as there are two ways of having a means of exchange come into circulation, via debt or Credit, there are two roots of interest, earnt or unearnt.

    Earnt interest is just another commodity, and can serve a valuable function in an economy. Unearnt interest, on the other hand, is destructive and harmful. It is the Unearnt interest on the unjust Debt that results from value exceeding cost in the co-operation of factors in wealth production, that is the problem of interest – not interest itself.

    But the the best absolute will always be CHOICE :)

  5. Summer permalink

    Excellent article.

    As a new law graduate I chose to study the IMF viz.., Human Rights. This led me to discover what an exploitative weapon interest is. I am happy to have been made aware of your work and share your views on interest and appreciate all your hard work.

    Here’s a film I came across on this topic:

    Thanks again – we are indeed one!

  6. Liam B Allone permalink

    There is a third option. IMO the error starts with the assumptions. You assume credit needs to be issued by private banks… at interest. Check out http://www.economiccures.com/WealthPump for a better mousetrap and the third option fully articulated. Loans are made to producers interest-free, the gap is covered by a minimal national dividend (ND) that will eliminate welfare and the rest of the gap is covered by a compensated price (CP – think sales rebate/credit) so that everything the producer makes can be liquidated. There is no income or sales taxation. The model is pure math and can be mathematically modeled/proven.

    That being said, there is a flaw in peoples’ reasoning about compound interest because they look at it from the wrong perspective. If you look only at the banking system as it is, you see the root cause as interest – a mistaken perspective. If you look at the economy from the perspective of the gap and flawed accounting principles that fail to address it, you realize that the reason banksters hold onto the flawed system so ferociously is that they know they lose all leverage if the gap gets addressed successfully. That is why they won’t let go and why they fight against social credit (SC) so viciously.

    In summary, the real problem is the gap, the apparent problem is usury and the proof that usury is not really the root problem is that as every student of social credit well knows, interest is just bank profit that could be funded by CP or ND. The best reason for castrating bankers and their ability to issue credit is simply because they are fighting the implementation of SC because they want to control us by controling the means of our bread, and therefore are not worthy of our trust. The second reason is that there is nothing that can be done with usury that cannot be done without it. This begs the question why have it at all?

    • Bankers charge interest on other peoples debt and that is absolute fraud. Who are the Nazis in your model that decide who gets loans? There can only be so much currency(debt) in circulation before it’s apparent that inflation is out of control. Would there be a lottery or something? Do I get a huge loan because I say I’m used to living a lavish lifestyle?

    • a_reader permalink

      “In summary, the real problem is the gap, the apparent problem is usury and the proof that usury is not really the root problem is that as every student of social credit well knows, interest is just bank profit that could be funded by CP or ND.”

      Can you explain what you mean by “gap”? This is not clear from your comment.

    • Thanks Liam!

      “The second reason is that there is nothing that can be done with usury that cannot be done without it. This begs the question why have it at all?”

      Since, in the end, interest means the poor pay the rich, I think your quote is exactly what it all boils down to.

      We can easily do without interest.

      Let’s just forget about the whole thing.

      • I meant to express wholehearted agreement!

    • Bankers charge interest on other peoples debt and that is absolute fraud. Who are the N*z*s in your model that decide who gets loans? There can only be so much currency(debt) in circulation before it’s apparent that inflation is out of control. Would there be a lottery or something? Do I get a huge loan because I say I’m used to living a lavish lifestyle?

  7. If I’m not mistaken, what you are essentially doing is facilitating debt. The person or firm issued the currency is debited on a balance sheet the amount that is issued and signs a promissory obligation note. The credit(represented by a note) is spent by the obligor creating debt between him and the holder of the currency note.
    If you formed a brokerage facilitating the creation of stock that traded using your currency, that would eliminate the issue of unevenly distributed public currency obligations and transfer it to stock obligation which is a totally different thing. The trick is to destroy your banking industry by replacing it.
    I think what you’re asking about taxation is why can’t the government pre-tax(which is what they do now – spend now{creating debt}, tax later {extinguishing debt}). The only reason the masses tolerate that now(along with going to a private banker to be issued public currency), is because of constant conditioning from youth to be apathetic.

  8. A “bank” that loans out the depositors money is called a brokerage. The depositors are risking their money. If the book entry IOU currency is issued directly to the individuals in the community by a publically appointed bookkeeper(as it should be), the individuals can choose to invest their excess earnings or not. In other words, they don’t have to use the brokerage at all. If everyone never required investors, there would be no need for the local brokerages at all, but pooling of resources is necessary to coordinate large construction projects and developing higher technologies. Ultimately, it would be the people that build the product owning the company stock.
    The “rich” of this world are that way because they are directly or indirectly taking advantage of their understanding of the fraud that is banking. They don’t actually have a lot of money. They have dividend producing financial instruments gained by fraudulent means, and deeds to property purchased conducting fraud.

    • Why can’t large projects not be financed with the same IOU currency?

      I’d say making available credit for infrastructure is a way of pooling REAL resources. Sand, stone, iron, all we need.

      • I think what you are suggesting is having some benevolent central authority decide what is constructed as opposed to the free market deciding what it wants constructed. Of course you could argue that government construction of common use infrastructure is necessary, but that should definitely only be done with funds that were previously raised by taxation. This is the issue I’ve debated supporters of “Mathematically Perfected Economy”. Who decides who is financed? The only fair way to introduce a circulatory public currency is to issue it directly to the public evenly as possible. The free market decides how fast the currency circulates through a person’s hands and who they are going to trust with their earnings by the transaction of stock.

        • You’re on target with your ‘who decides who is financed’ philo, no doubt about it.
          In my own system, the Gelre, credit is assigned through a function with these parameters:
          – How much credit can be assigned over the total network
          – How much does the person wanting the credit pay with the unit (ie: people and firms paying a lot with it can get more credit)
          – How much credit has this person received in the past?

          The amount of credit that can be assigned I call ‘credit space’.

          Why do you believe infrastructure can only be financed with taxation, and not with credit?

          • Mauro permalink

            First, I believe the banking system is not a normal commercial system, it is some sort of “medium”, comparable with “transportation.”
            Both ought to be owned by the state, the profits of which are to be measured with the money spent into circulation.

            I know, it sounds sort of harsh saying: “oughtg the state command whom to fionance and whom not.”
            But compared to the status quo, that is having an international satanic cabal control whom to finance and before all WHAT to finance, the state option is surely preferable.

            In a post world war 3 time this is I believe the way it is to be done.
            Money control in the hands of individuals is simply too strong, too enormous a power to delegate to individuals comparable to making atomic weapons legal to possess as a 2nd amandment right.

            Gretings,
            M

  9. Hi Ed,
    Thanks, I’m happy you like the articles and the new look.

    Yes of course, I don’t know why I didn’t realize this before.

    It’s basically the same kind of process which forces the eternal growth of the money supply in our current system.

    MPE worked all this out long ago, but I didn’t notice it’s relevance for full reserve banking for a debt free unit.

  10. EdGe permalink

    Great post.

    It’s easy to see for anyone that any amount of interest leads to unsustainable debt when all money is borrowed. You can prove that with simple math.

    When you put the logic from your article in math, you can prove that any amount of interest will lead to a situation where all money is interest bearing debt. Slowly all debt free currency is replaced by debt money.

    It’s undeniable….math cannot lie.
    Any amount of interest will lead to endless debt.

    I think many persons don’t see it because they are trained to think as individuals.
    And that is not by accident.

    btw.: i like the new ( more professional ) look of this site. Your articles deserve it.

    Cheers,
    Ed.

    • Btw Ed, thanks for this reminder:
      I think many persons don’t see it because they are trained to think as individuals.
      And that is not by accident.

      We are One!

    • REN permalink

      Debt free currency circulates and does not drain easily. It can only be drained with taxation. The usury component does allow money to accumulate toward those who have it available toloan. Since taxation is the only drain, then taxation needs to be the mode to prevent unnatural accumulations. The usury component can be minimized with demurrage or limiting loan principle to a small maturation amount. For example, loan maturation can mean only a doubling such that usury cannot exceed principle. Example: Loan of 1K plus maximum of usury = 1K, therfore total is 2K. This limits compounding behavior to one cycle. Only the law can control money, as the definitions and system design determine behavior.

      Like most things there are good and bad aspects. Debt free currency does not come with debt contracts attached. That means it circulates without the usury burden, hence it can become an excellent means for settling/transacting accounts. That is, the divisibility of money allows transactions, which is its main purpose; money should not be a store of value. The ideal is money as an accounting device with low usury burden, and moving at maximum velocity so supply is not drained by hoarding. The second ideal is to think of monetary policy and fiscal policy as flip sides of the same coin. Taxation is an element of money, they are reflections of each other. Sorry, gravity makes us fall down, and money has law and force elements.

      Credit on the other hand, stands in for money, and then disappears readily from the supply, sometimes draining supply unnecessarily. Meanwhile credit can drag usury behind it, allowing debt contracts to drive society. Credit also is good and bad. If we use credit right it can be very good; for example to surge and retreat with the needs of a flexing economy. Credit can also bypass the time element of usury by using fees. Holders of money on the other hand will want their “time element cost- lost” to be replaced with usury. Holders of money cannot help it, their money represents past wealth accumulation, and they will want to loan it out and get a return.

      This basic human behavior is why I favor demuarrage (sp?) instead of inflation. People need to understand that money is a ticket and not a store of value. Inflation as a faux tax skews this needed understanding. Inflation doesn’t deal well with the store of value problem.

      We need both credit and money, and we need to discern the rules underlying both types of mediums.

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