Currency: interest, sources and sinks

Vorlath recently wrote:
I think you need to re-evaluate your reality. The money system is a failure. It's a joke. Lump all the loan agencies together. Everyone else has to borrow from these organisation (yes, if these people so choose). Where exactly do you propose the borrowers get MORE money than they borrowed to pay the interest if there's none available? You can't pay back what doesn't exist. The system is made so that at least some MUST fail. Even if you do everything right, you may still fail because there's a process of elimination at work. I know that's a simplistic view, but it doesn't make it any less true. So if you have more money than others, you too can loan it out and do nothing except for one fact that you have more money. That's BS and is why no money system will ever work. No system that requires failure will ever get my support. I find it funny how much suffering and failures there are around the world because of money, yet there are still people that claim everything is peachy.
Vorlath, I'm not sure that you understand how money is created.

There isn't a single fixed amount of money around. Money is created dynamically and destroyed dynamically, essentially on demand. Banks create money by loaning out their float. The task of the central bank is to control this dynamic creation and destruction of money to make sure there's just the right amount to keep the economy stable. No one gets screwed.

There are problems with how currency is issued, but they are not problems with interest.

One problem is that currency has a fixed number of sources and sinks. Because currency is issued by a central bank, there's more currency the closer you get to the central bank, which makes the financial landscape non-homogenous. Consequently places that are not near the central bank are poorly supplied with money, so prices in Alabama are by necessity lower because dollars are scarcer than in New York. The central source/sink issuance system forces everyone to do business with the issuer of the money if they want to have any money in the first place. That is unfair.

However, regarding interest rates, the only risk-free way to loan out your money is to be a big bank and "loan it out" to the central bank, which of course can always pay you their published interest rates simply because they can always print money. However, in the long term, you will earn no real value this way because their interest rates will, in the long term, match the inflation. If you want to earn money by lending, then you have to accept your portion of risk and lend it to people and businesses, and then the amount of money you earn will be determined by how wisely you choose the businesses and people in which to invest. And there's nothing unfair about that.

Perhaps you might want to read a book like "The Future of Money" by Bernard Lietaer. I found it an easy read, quite entertaining and illuminating. It does a decent job explaining how currency works (more or less) and it paints a picture of the possible futures of currency.

A book I also found _very_ interesting was "The Future of Capitalism" by Lester C. Thurow, but that warrants a whole separate topic. :)

Comments

Anonymous said…
From Vorlath:

Why don't you want to lump all lending institutions together? Try it. Lump them together. You have lenders and borrowers. The lenders are asking for more money back than they are lending out. Where exactly does this money come from? You say it is created dynamically. Sorry, but this is not so. You cannot extract more money than what exists. No one is allowed to print money, but the Federal reserve or whichever national bank. And newly issued money is lent out, not injected. So the problems compound.

Your refusal to see a problem with the money system stems only from your reluctance to accept facts.
denis bider said…
I would prefer to say that my refusal to see a problem with the money system stems from my reluctance to accept misleadingly framed arguments.

New money is not lent out, it is injected. New money comes into the economy by way of the government paying for things. People who receive that new money are people who have sold products and services to the government.

Subsequently created money is created through lending. But creation of this money is a process that never stops. When you spend the money you have been lent, people who earned it will put it in their banks, who will loan it out again as a 3rd, 4th, 5th, ... generation money.

Your argument requires a faulty assumption that the money with which the lenders' money needs to be repaid is the same money that was issued by those lenders. But you can pay back your debt with any money from any stage of money creation, including a subsequent or previous stage.

And if you cannot earn that money from anywhere else, you could still make a deal with the lender to work off the debt. In a well-run economy, this is usually never necessary since there's always money around, so, if you're providing something of value, you can always sell your products and services to someone else.

All of the money that's in existence is just a huge IOU note issued by... no one in particular. It is backed merely by everyone's belief that the money will still be good for something at some point in the future. That people will still be willing to trade for this money. That the government will force them to if they don't. The value of money is based entirely on the future.

Of course if all of the lending institutions got together and did as you say - "give us all our money back right now, and with interest!" - this would be impossible. But the money would stop being worth anything if they did. Money is worth something only as long as it's flowing, spreading, being created.

Governments continuously make sure that everyone can theoretically repay their debts simply by targetting a positive, non-zero inflation rate. Inflation reflects that the amount of money in circulation is increasing slightly faster than the productivity of the country.

If lenders did as you propose - all at the same time asking for their money back with interest - this would cause withdrawal of money from circulation, which causes deflation, which is what people who run the economy generally try to avoid.

In summary, you are incorrect because your arguments are based on a mind experiment which is never actually reflected in practice. Not in a well-run economy, at least. It did happen in 1929 in the United States, but recurrence of such phenomena is something the world is trying to avoid.

I'm not saying that money cannot be designed better so as to be resistant against 1929-like phenomena. Certainly it can be, but the drawbacks of money as we currently have it are not in its every day use, as you imply, but in its potential for catastrophic vulnerability.
denis bider said…
Actually, what you are proposing - all lenders at the same time asking for all their money back - is what's generally known as a run on the banks. This is because the original lender is, in fact, everyone who has money deposited in banks. When everyone decides simultaneously that they want their money back in cash, this is a vote of no confidence on the banking system, which triggers recursive destruction of all of the higher generation money out there, of course leaving not enough of 0 generation money to go around, because most of the money people thought they had was in fact not 0 generation money but money of a higher generation that can't exist any more if everyone wants their money back from the banks. The result is of course economic catastrophe.

I have some systems in mind that would solve this essential vulnerability by giving clear meaning to what money is and what it stands for, however this is beyond the scope of my reply at this time. Right now, I'm just trying to state clearly how the interest thing - creation of money via lending - does not lead to unfairness of the money system as Vorlath implied, but rather causes a different problem altogether - and that is the potential for catastrophic failure if people lose confidence in the banks.
Anonymous said…
Vorlath says:

Sorry for responding so late. I didn't know this was here.

Anyhow money is lent out. It isn't injected. Look it up. Also, where do you think governments get money from? They get it from taxes and my borrowing money borrowed from the Federal Reserve. This is part of your national debt. Sometimes they borrow from other countries too.

Ok, so if the government doesn't pay it back, there's more money with the extra cost of interest and taxes. Fine. What is the government actually paid off their loans? What if they did what companies do. Either pay your bills or go bankrupt. How long do you suppose your economy would last?

And where's this notion about lending creating money? It doesn't create money. The scenario you describe is even worse than what I was talking about because the banks lend out the very same money they previously lent out. The people who borrowed this money must all pay it back. Where is this money coming from?

Hey, if you're a bank, all the best to ya. You've got the power and are doing everything to make the most profit. But there's still no money created as much as the lenders are sucking the money out from everyone else. The banks are just smart enough to keep it in circulation. But not one penny has been created. All it's done is shift the ownership of money from the borrowers to the lenders through interest. The system you describe is where everyone grows a debt like the government. Only problem is that regular people can't have infinite loans.

BTW, this is stuff everyone knows about. Just look it up. PLEASE! It's not like I'm making this up out of nowhere.
denis bider said…
I find that you're an interesting phenomenon as you are aware of the technical specifics of the process, but you misinterpret the big picture. Statements like "no money is being created" are just plain false. The whole purpose of interest rates controlled by central banks is to control how large a proportion of their float banks will lend out, and thus to indirectly control how much money is in the economy. The system is controlled such that the total mass of money in the system is increasing a bit faster than GDP grows, the difference being inflation. If the total money mass contracts, then yes, a situation is being created where even theoretically not everyone will be able to repay their loans. But such a situation is called deflation and is generally the thing that central banks most want to avoid.

Your exhortations for me to look things up are unappreciated when you clearly have problems grasping the principles the economic system is built on. And, no, the mechanisms of macroeconomy are not something that is widely known. Even more significantly, knowing about the mechanisms is not sufficient to understand the process, and true understanding of the process is something that is actually quite rare. It is something that you clearly don't possess, which puts you in no position to exhort others to look things up.

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