According to the rationale of the GNP, monetary transactions are considered a gain, and anything that does not involve the direct exchange of money is disregarded. Barter exchanges, for example, are not tracked. Domestic care, such as someone taking care of an aged parent or a young child, and volunteer work are likewise not taken into account. Yet the same work performed by someone paid in conventional money, like a nurse or a firefighter, is measurable in bank-debt money and, therefore, does count.
The consequences of not taking into account such activities are both unfortunate and deeply significant. The decline of a nonmarket economy, such as the social breakdown of a family or community, has a negative impact on society. But from a strictly monetized economic perspective, services rendered without payment are considered to have no value. Worse, if individual decline gets to the point where paid intervention is needed, the costs of social decay then register as an improvement.
Costs associated with psychological counseling, social work, and addiction treatment, which arise from the neglect of the nonmarket realm, are tallied as economic gains. Crime adds billions to the GNP due to the need for legal services, prisons, increased police and private security protection, and repair of property damage. Similarly, the depletion of our natural resources, the cleanup and medical treatments associated with industry’s toxic by-products, the costs of ecological disasters such as the oil spills in the Gulf of Mexico and Alaska’s Prudhoe Bay, relief efforts following the Haitian and Japanese earthquakes and subsequent nuclear meltdown, the devastation caused by wars, and the hundreds of billions of dollars allocated in emergency stimulus packages all register as improvements to a nation’s economy by the curious standards of the GNP.
As economists Clifford Cobb, Ted Halstead, and Jonathan Rowe point out, “The GDP not only masks the breakdown of the social structure and the natural habitat upon which the economy—and life itself—ultimately depend; worse, it actually portrays such breakdown as economic gain.”10 Herman Daly put it this way: “The current national accounting system treats the earth as a business in liquidation.”11
Gross domestic product (GDP) replaced gross national product (GNP) as the primary measure of U.S. production in 1991, without correcting the flaws just described. Yet, despite its obvious limitation, it endures today, warping and distorting the collective worldview. It persists precisely because of the myopic focus on monetary exchanges regardless of the broader-term consequences for society at large.
The devastation of the Great Depression and the dramatic economic ramifications of the 1930s forced economists and nations to reexamine their assumptions regarding the economy, particularly the then-dominant view that a free market, unfettered by government interference, would naturally bring about full employment equilibrium.
This debate still rages, almost a century later. Without needing to parse the theories, ideas from three iconic schools of thought shape current economic and political debates: John Maynard Keynes, Friedrich Hayek, and Milton Friedman and their respective Keynesian, Austrian, and Chicago schools of economics. Their viewpoints, together with those of another once-prominent economist, Irving Fisher, not only show how the views of prominent economists diverge but also highlight what is almost entirely lacking from traditional economic thought.
WHAT’S NOT CONSIDERED
Challenging a paradigm in any field and moving thought and action forward beyond it is always a risky business. In particular, challenging the monetary paradigm can be interpreted as violating an academic taboo. It somehow gets in the way of being invited to the “important” conferences or getting published in prestigious peer-reviewed journals. For example, consider the most prestigious award of all, the Nobel Prize in Economics. Many people overlook the fact that there is a significant difference between the economics prize and the other five awards that were established in 1901: the awards in physics, chemistry, physiology or medicine, literature, and peace. The economics prize is the only one that wasn’t created by the will of Alfred Nobel, nor is it funded by the Nobel Foundation. Its technical name is the “Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel,” and it was first awarded in 1969. It is funded by the Swedish central bank. Is it any wonder that none of the 69 Nobel laureates in economics, so far, have dared to challenge the monetary paradigm?12
New York Times columnist Paul Krugman told one of the authors in Seoul, South Korea, a decade ago that he has always followed one piece of advice that his MIT professors had given him: “Never touch the money system.” Krugman was awarded the Nobel Prize for Economics in 2008.
Perhaps Keynes said it best: “The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back … sooner or later, it is ideas, not vested interests, which are dangerous for good or evil.”13
Chapter Three
A FATE WORSE THAN DEBT
Interest’s Hidden Consequences
It may sometimes be expedient for a man
to heat the stove with his furniture.
But he should not delude himself by
believing that he has discovered a
wonderful new method of heating his
premises.
LUDWIG VON MISES, Austrian economist
The small village was bustling with locals proudly displaying their wares, chickens, eggs, cheeses, and bread as they entered into the time-honored ritual of negotiations and trade for what they needed. At harvests, or whenever someone’s barn needed repair after a storm, the village-dwellers simply exercised another age-old tradition of helping one another, knowing that if they themselves had a problem one day, others would come to their aid in turn. No coins ever exchanged hands.
One market day, a stranger with shiny black shoes and an elegant white hat came by and observed with a knowing smile. When one farmer who wanted a big ham ran around to corral the six chickens needed in exchange, the stranger could not refrain from laughing. “Poor people,” he said, “so primitive.”
Overhearing this, a farmer’s wife challenged him: “Do you think you can do a better job handling chickens?”
The stranger responded: “Chickens, no. But, I do know a way to eliminate the hassles. Bring me one large cowhide and gather the families. There’s a better way.”
As requested, the families gathered, and the stranger took the cowhide, cut perfect leather rounds and put an elaborate stamp on each. He then gave ten rounds to every family, stating that each one represented the value of a chicken. “Now you can trade and bargain with the rounds instead of those unwieldy chickens.”
It seemed to make sense, and everybody was quite impressed.
“One more thing,” the stranger added. “In one year’s time, I’ll return and I want all the families to bring me back an extra round—an eleventh round. That eleventh round is a token of appreciation for the improvements I made possible in your lives.”
“But where will that round come from?” asked another woman.
“You’ll see,” replied the stranger, with a knowing look.
A year passes and on another market day the stranger with the stylish hat returns, and from his vantage point he observes the village below. While sitting under the broad-limbed oak tree, he reaches into his knapsack and pulls out a silver canteen filled with a single-malt whiskey, takes a swig, savoring its peaty warmth at the back of his throat, and waits for the village folk to file past him with each family’s repayment of the eleventh round.
Below on the village outskirts, a family begs for alms, having lost everything in a fire. Focused on their obligations, the villagers pass by without as much as a glance.
The elusive eleventh round like interest its
elf was not created, but payment for the development of the upgrade in efficiency does seem reasonable to his mind and is exacted nonetheless. The stranger sits and watches the scene below, completely oblivious and unaware of the impact his innovation has caused.
The eleventh round is a very simplified illustration of an important principle regarding money. The point of the anecdote is that, with all other things being equal, the competition to obtain the money necessary to pay the interest is structurally embedded in the current money system. Somebody will have to be without the eleventh round for payment for somebody else to have it and make the interest payment.
So how does a loan, whose interest is not created, get repaid?
Essentially, to pay back interest on a loan requires using someone else’s principal. In other words, not creating the money to pay interest is the device used to generate the scarcity necessary for a bank-debt monetary system to function. It forces people to compete with each other for money that was never created, and it penalizes them with bankruptcy, should they not succeed. When a bank checks a customer’s creditworthiness, it is really verifying his or her ability to compete successfully against the other players—that is to say, assessing the customer’s ability to extract from others the money that is required to reimburse the interest payment. One is obliged in the current monetary system to incur debt and compete with others in order to perform exchanges and pay the resulting interest to the banks or lenders.
HOW IT REALLY WORKS
For each deposit that any bank receives, it is entitled to create new money, specifically in the form of a loan to a customer of up to 90 percent (a fraction) of the value of the deposit (held in reserve), hence the name fractional reserve system.1 Indeed, a bank is supposed to lend out only the money it has on deposit while keeping 10 percent of it in reserves with the central bank. In practice, however, banks do not wait for excess reserves before making loans. Rather, if faced with a creditworthy customer and a request for a loan, a bank makes the loan. It then operates to obtain reserves as necessary to meet legal requirements. If banks in the aggregate are short of required reserves, the central bank must supply them. Indeed, if a bank is short on reserves, this shortage is, in fact, accounted as an overdraft on its reserve account with the central bank. This overdraft is an automatic loan from the central bank. So there is no way that a central bank could deny credit to a bank.
Furthermore, when a new loan is made—for instance, a mortgage to buy a house, financing for a car, or a student loan—this usually results in someone making a new deposit somewhere else in the banking system, for example, by the seller of the house. In turn, the bank receiving that deposit is entitled to create another loan for 90 percent of that new deposit. Then that loan is deposited in another account, that bank is permitted to make yet another loan, and the cascade continues from deposit to loan down through the banking system. Although new loans are being created, the interest on the principal is not. Nowhere in the system is this additional money created. This gives rise to scarcity, which, in turn, creates competition to acquire the extra money to cover the loans’ interest. This magic, where one person’s loan becomes another’s deposit, and whereby when you pay interest you are using someone else’s principal, is really monetary alchemy. This monetary alchemy is one of the esoteric secrets of the monetary system.
This fractional reserve multiplier, as it is technically known, starts with the injection, for example, of 10 million units of high-powered money from the central bank directly into the reserve account of a bank. This 10 million makes it possible for that bank to make loans for 100 million. These 100 million end up being deposited somewhere in the banking system by the recipients of these funds, which enables the banks that receive these new deposits to provide a new loan for 90 million to someone else (the other 10 million becoming “sterile reserves,” meaning they remain in deposit in the reserve accounts with the central bank). The new loan for 90 million will, in turn, lead to another deposit for that amount somewhere else, enabling the next bank to provide another loan for 81 million (i.e., 90 percent of 90 million), and so on. This is how what started off as 10 million units of high-powered money can create up to 200 million units in credit money as it trickles down the banking system.
A key point to keep in mind is that this entire money-creation process hinges on loans. If all debts were repaid, money would simply disappear, because the entire process of money creation would reverse itself. Reimbursing all loans would automatically use up all the deposits. Even the central bank’s high-powered money would evaporate if the banks were able to repay their debts. There would even be a remaining financial hole, a negative balance reflecting the unpaid interest on all those loans.
In the conventional currency paradigm, one important reason that so much weight is given to decisions made by central banks is that increased interest rates automatically imply a larger proportion of bankruptcies in the future.
Also remember the eleventh round story: When a banker checks a customer’s credit score, it is to assess how successful or aggressive that individual or business will be in contending with others to obtain funds that are not created in sufficiency to pay back the interest on the loan.
In a manner of speaking, it’s like a game of musical chairs in that there are never enough seats for everyone. Someone will end up getting squeezed out. There isn’t enough money to pay the interest on all the loans, just like the missing chair. Both are highly competitive games. In the money game, however, the stakes are elevated, as it means grappling with certain poverty or, worse still, having to declare bankruptcy.
The dynamics of today’s conventional money system have led to a number of problems in addition to systematized bankruptcy. These negative consequences not only are misunderstood but also were unintended and, for the most part, have their roots in the application of interest.
INTEREST
Undoubtedly, there are solid reasons for applying interest to a loan. It protects against default and works as a fair precaution by the lender to ensure that he receives back at least the amount he lent out. For instance, if a lender expects 10 percent of his borrowers to default on their loans, then 10 percent interest is charged to ensure that the entire principal is paid back. Furthermore, by providing a borrower with money, the lender forgoes the opportunity to make a profit by investing the money. A lender charges interest as compensation for the missed opportunity to make additional earnings.
Interest, however, has hidden dynamics that result in detrimental costs not only to personal relationships, commerce, and society at large, but also to the sustainability of our fragile planetary home, Earth. The effects are so well concealed, in addition to being so deeply embedded in the money system, that they go, for the most part, utterly unnoticed.
COMPULSORY GROWTH PRESSURE
Debt-based money requires endless growth because borrowers must find additional money to pay back the interest on their debt. For the better-rated debtors (e.g., in normal times, government debt), the interest is simply covered through additional debt, resulting in compound interest: paying interest on interest. Compound interest implies exponential growth in the long run, something mathematically impossible in a finite world.
There’s a famous metaphorical tale about the Persian emperor who was so pleased with a new game called chess that he offered its inventor a reward for his idea. The nameless inventor knew something about mathematics, so he asked for a grain of rice for the first square, twice as much for the second square, and doubling again for each square until all 64 squares on the board had been accounted for.
It seemed innocuous enough to the emperor, and he quickly agreed. On the eighth square, the inventor collected 128 grains of rice. On the 16th, he brought home 32,768 grains of rice. By the time half of the chessboard was accounted for, the emperor was in debtors’ prison because he defaulted on his debt to the game’s creator because he owed more rice than was produced.
Here’s another way to visualize this con
cept of exponential growth. Let us assume that every week water lilies double the surface they cover in a lake. Initially, their growth may seem quite reasonable. For example, after a year, a quarter of the pond is covered with lilies. How much time will it take for the lilies to cover the entire pond? If the growth were linear, it would take another four years. If the growth is exponential, as is the case in compound interest, however, it will take merely one week to cover a second quarter of the pool of water, and by the second week, the entire pond will be covered!
Stories aside, the exponential growth of money through interest rates has shattering real-life consequences in which entire nations of people are marginalized and stuck in debt forever. For instance, after a G8 summit former President Obasanjo of Nigeria stated: “All that we had borrowed up to 1985 or 1986 was around $5 billion and we have paid back so far about $16 billion. Yet, we are being told that we still owe about $28 billion. That $28 billion came about because of the foreign creditors’ interest rates. If you ask me, ‘What is the worst thing in the world,’ I will say, ‘It is compound interest.’”
The Nigerian government by 2006 had paid almost $20 billion to settle its foreign debts to two international bank syndicates, the Paris Club and the London Club of Creditors, and became the first African nation to settle with its official lenders. This was one of the largest transfers of wealth by a third world nation to first world nations.2
It is alarming to note that back in the 1990s the developing world was spending $13 on debt repayment for every dollar it received in foreign aid and grants. By 2004, that number had grown to $20 on debt repayment for each dollar of foreign aid. Today the ratio is 25:1.3
Sadly, Nigeria’s cycle of debt was not absolved with its massive settlement less than a decade ago. With an outstanding debt profile of about $5 billion after the debt pardon was secured by then President Olusegun Obasanjo, the progression of arrears and liabilities has now risen to a staggering $37 billion.4
Rethinking Money Page 5
