Is there enough money to pay off debt plus interest? A closer look
The elegant P<P+I equation points in the right direction but it is incomplete and needs further analysis. Not only does it ignore the velocity of circulation, but also the question whether the interest is spent back into circulation. The issue is important, both in terms of truth-seeking and Austrians and the Mainstream subverting the argument.
Can all debt be repaid in a usurious credit system? The P<P+I (P=Principal, I=Interest) equation suggests it cannot. For the longest time we have been maintaining that the principal is created, but not the interest and thus eternal indebtedness is part of the system. A closer look shows the problem is more complicated and the original proposition not per se correct.
Interest-Free Economics has always assumed that P=Money Supply (MS) if the money supply is debt-based. This ignores the crucial factor of velocity, the number of times the money supply changes hands in a given time span. The effective money supply (r(eal)MS) is Principal x Velocity: rMS = P x V.
Another vital issue is the question whether the interest is spent back into circulation. If it is not, it is bound to cause problems.
Here’s an analysis of the implications of these two overlooked factors:
A: slow circulation.
Let’s say P=100 and I=10 and velocity is 1. We are in an economy of two players. Let’s say the loan is for a year and that it has to be repaid at the end of the year. My partner gives me the loan so we don’t need a third party.
We pay the other participant 100 at the beginning of the year. Velocity is 1 and P=MS, so he’ll buy something worth 100 from us at the end of it. It’s easy to see that at the end of the year we will have 100 income to pay off the principal, but we will have to borrow an extra 10 to pay off P + I.
So in this example the original proposition is correct.
B: Good circulation, interest not spent into circulation.
Now let’s see what happens if velocity is 20. I go into debt, pay my supplier and he buys with me. I save 1 because I know I need to pay interest at the end of the year, so I buy 99 worth with him. He buys 99 with me and I save another 1 for the interest payment. In the final transaction, I have saved 9, my partner buys 91 with me and I collect the remaining 1 for the interest payment. I have the interest, but only 90 for the principal.
It matters not, whether I save to settle the interest payment at the end of the year, or whether I pay the interest immediately, while the lender does not spend it. If the interest is not immediately circulated, no matter the speed of circulation of the remaining money supply, there will be a shortage of money. I will not have enough to pay off P + I.
Again: P < P + I still stands.
C: Good circulation, interest spent into circulation.
Now let’s say I pay the interest immediately and my partner spends the received interest back into circulation. Velocity is again 20.
So I buy 99 worth + I pay 1 interest. He buys back 100 worth of goods. I again buy 99 worth + 1 interest. Etc.
In this example, after 20 (10 buys and sells each) transactions, I will have paid off the interest during the year and at the end of the period, I will have 100 to pay off the principal.
The conclusion is, that if velocity is high enough and the interest is immediately spent into circulation, the P + I > P equation does not mean that debt plus interest cannot be settled with only P as the money supply.
However, these are two big ifs. In fact: they both don’t fly.
Getting to the bottom of the issue
In the first place, velocity. As it happens, Usury is a key factor in destroying velocity of money. It greatly encourages hoarding, especially in the current banking system. Postponing paying your bills nets you income through interest. So Here’s a graph, courtesy of wiki, the green line shows velocity, the left axis shows the relevant scale:
As we can see, velocity is very low in the economy, money changes hands a little more than once every two years. It went down even further during the last few years, because of the depression. Considering the the example above, it is clear that velocity is far from sufficient to allow interest payments on the money supply, meaning we have serious deflationary pressures because of interest payments.
Then the other issue: is the interest spent back into circulation? The answer is: far from all the interest payments are spent back into circulation. Sure, the banks pay their people massively bloated bribes (‘bonuses’) for their handiwork and to control their conscience, and they build major citadels (‘office buildings) everywhere, but banking is an incredibly profitable business and this profit is not spent back into circulation.
In the first place, banks use profit as capital reserve requirements for more lending. Basically this means the money is lent back into circulation, not spent. Because it is lent back into circulation, even more money is needed for interest payments, aggravating an already grim situation.
Secondly, there is the two loop economy. I discussed it in an article on stagflation. There are two economies. The real one, where we operate, actually producing all sorts of stuff. Then there is the financial economy. A large part of it is accessible only to insiders and the financial industry. Normal people can access it only via the Stock Exchange, where their assets are disowned through insider trading. Turnover in the financial economy dwarfs that of the real one. Most of the money out there is in the financial economy. This, I venture to suggest, is another reason why velocity is so slow: in the real economy money circulates much quicker, but most money is in the financial economy which is not counted in the GDP figures. Meaning only a small percentage of our money supply is used to finance the real economy. Here’s a graph of the financial economy:
Make no mistake: the two loop economy is real. Recently insider Mark Faber actually mentioned it, it’s the first time I ever saw it mentioned in the media.
The financial economy is where the big bucks are being made by the vampire class. Their derivatives, forex, insider trading. It’s where all their gains from the stock market and other fleecing of the non-sophisticated investors is going. Unfortunately for them they cannot really use this money in the real economy, because it would cause an immediate hyperinflation, but it does give them full control over the real economy and it is an important part of their domination. It also explains why QE1, 2, 3, x have not led to rising prices: There was a massive deflation in the financial economy as a result of the busted Mortgage Backed Securities hoax and Bernanke slyly fixed only that, while not adding any money to the real economy, which needs to be strangled with austerity, sequestration, the fiscal cliff and whatever tool they have to aggravate the depression.
The point is: much of the interest is siphoned off to the financial economy. Meaning it is not circulated back into the real one. Meaning usury does deflate the money supply and interest + debt can never be settled.
It’s an important issue. The Mainstream and the Austrians have been getting to terms with the original P + I > P equation. The argument in its original form is no longer operable. More importantly: we owe it to ourselves and the people we talk with to get to the heart of the matter and take both truth and their arguments seriously, if they have merit.
In an ideal scenario, when velocity is sufficient and the interest is spent back into circulation, principal plus interest can be repaid.
But for other reasons, the basic problem still is the same: velocity is very low in practice, making it impossible to pay for both and the leaking of money to the financial economy, the ‘upper loop’ is probably even worse.
I hope this article can lead to further discussion, perhaps the experts can shoot a hole in it, making it irrelevant or better. I’m not a mathematician, and I’m pretty sure people like Gauvin, Turmel or Montagne would put it more elegantly, but I hope to have made the point clear.
Please comment if you have anything to add and share this article with those you know are into this line of thinking.
Dick Eastman is the main thinker on the two loop economy, a phrase he coined. Unfortunately he does not operate a website, so he cannot be found on the web and there are no archives of his previous work to be searched. But Dick is one of the most outstanding economists out there, and he sends out emails on a daily basis, you can contact him at oldickeastman(at)q.com if you want to get to know his work.