Hi everyone,
This is my first post here. I'm puzzled by the problem of interest. It seems to me that since money comes about through the creation of debt plus interest, there is always a greater amount of debt in the system than there is money. This creates an organic need in the system for defaults, and gives excessive power to the holders of money, not because they are productive, but simply because they hold money. As a system founded on this basis expands, it inevitably creates an unequal distribution of wealth. I raised these concerns to Tom Woods and he recommended this article by Robert P. Murphy - http://mises.org/daily/4569 .
In the article, he states that "my modest point in this article was to correct the widespread misconception that in a system of 'debt-based money,' further rounds of inflation are mathematically necessary to avoid default on previous loans. In general, this simply isn't true, because the bankers can spend their interest payments on real goods and services, thereby returning that money to the public, which can then use it again for further debt payments." But isn't it extremely unlikely that bankers would spend 100% of their interest payments back into the economy? They are more likely to save a large amount, or re-invest in some interest-bearing asset. So this doesn't really address the basic problem. Am I missing something here?
Thanks for your help,
Joe
This was kind of also addressed here:
Where does interest come from?
In that thread I quoted from G. Edward Griffin's book The Creature From Jekyll Island (pp. 191-192) where he describes the same kind of scenario. But if you go through that thread that may help clarify some things as well. One thing to keep in mind is they don't have to spend 100% of their interest payments back out every payment period...debtors could get paid from the holdings of other people in the economy who do not have to make interest payments of their own. Yes, eventually if the central bank never spent any money, it would come to reduce the money supply and at some point hold all the money in the economy...but that doesn't even work in theory, as the bank would have to constantly be spending money just to remain functioning. Bank employees, janitorial services, electricity, paper, ink, groundskeeping, building maintenence...the myriad of things necessary to keep a central bank running mean constant costs, and constant outflows of payments of the money. And the bigger the bank gets, the more of these costs there will be.
But even still, this "one entity controlling money supply" is part of the reason people like Ron Paul argue in favor of competing currencies, so that you never have to worry about any real influence...because unless there are laws forcing everyone to transact in the one currency (legal tender laws), if one entity or group acquires enough to manipulate the market, people will just use something else.
(But in reality, it won't ever even get close to that point because people will constantly be using something else...and as more of the supply gets concentrated with one group some other kind of money will more and more gradually come into use...meaning there would be no point to try and gain all the money in the system, because by the time you did it, the economy would be already functioning without it...meaning it wouldn't be worth anything near as much as you paid to acquire it.)
Thanks for your reply. It is just fantastic to live in the internet age and have immediate access to resources like this. So even though it is true that if all loans were due at the same time, there would not be enough money to pay them off - the fact that the maturities of loans are spread out over time means that this theoretical problem never becomes a reality? I guess my problem is just that banking and finance are so removed from the real world these days - making money from making money from making money. So although the original concept of charging interest on money that has been earned from productive work may be sound, the idea of charging interest on money that has come from money that has come from money... seems deeply unethical to me. And this applies to the average individual as well - the idea that people should be able to plop their money in a savings account or mutual fund, forget about it, and expect a steady stream of interest just for the use of their money... it just doesn't seem right. I guess economics doesn't traditionally enter into value judgements... money is money and we just assume that it represents real value? The more I read, especially about the recent crisis, the more I feel that many of our economic problems can be boiled down to two words: moral hazard. There was this naive idea that by inventing all these financial instruments to spread risk across the world, that you could eliminate risk from the system. Then, we find out that the risk was just placed on the back of the taxpayer. So I think the more we can do to connect lenders with the fate of the lendee, the better. After all, people are supposed to lend money because they believe in the prospects of the lendee, right? That's why this quote by Smiling Dave from the thread you recommended bothered me: "The only difference is the insistence on the banker's part that win or lose, he gets his money plus his profit. The justification for this insistence is that the banker has to defer enjoyment and use of his tools until he gets his tools back." Banking is about allocating capital in the most productive way for society, and since this necessarily involves risk, it is a skill that deserves to be rewarded. But to say that "win or lose, he gets his money plus his profit" is an attempt to take risk out of the equation, and reward bankers whether they do their job well or not.
The idea that all money is debt is just a rabbit-trail to distract you from the real point: when they print new money or loan non-existent money, they are stealing from you. The details of how they steal are irrelevant except as a matter of curiosity.
Clayton -
charging interest on money that has come from money that has come from money... seems deeply unethical to me.
No. Charging interest on money that did not previously exist is unethical.
Scenario 1: A banker loans out 100 gold coins, earns 10 gold coins in interest. Next year, he loans out 110 gold coins, earning 11. Ad infinitum. There is nothing unethical about this anymore than if he had been a sword-maker instead who made 10 gold coins in income one year and 11 gold coins of income the next year.
Scenario 2: Counterfeiter drafts up 100 gold banknotes, loans them out, "earning" 10 genuine gold notes in interest.
The second scenario is unethical because the counterfeiter is stealing from the other holders of the counterfeited banknote, even though he is "merely" giving a loan of the counterfeited money rather than simply disbursing it. This is the Fed's bullshit game. It says, "Oh, all the money we create is merely a loan and must be repaid so bada-bing, bada-boom, our asset sheet stays value-neutral which means we can't possibly be creating new money!" But this is a charade. A loan of counterfeited money is stealing in just the same way as directly spending the counterfeited money, it just occurs at a more gradual rate.
Yeah, you're right about that first scenario. I'm referring more to the Wall St. casino of today, where profits are generated from moving money around without producing anything of value. Would you agree that that is unethical? I suppose I'm trying to square the idea of minimal regulation that Austrians promote with the realities of today. I assume the Austrian perspective would be that if we didn't have all this funny money created by the FED and banking system than none of this casino-economy would even be possible, and money would more fully represent real value?
-Joe-:to say that "win or lose, he gets his money plus his profit" is an attempt to take risk out of the equation, and reward bankers whether they do their job well or not.
In certain ways, that's true. I'm not completely sure what Dave means by "win" and "lose", but yes, moral hazard is created when you remove risk but allow the potential to profit to remain. There are things the individual can do to minimize risk on his own, but of course these come with costs. The unethical part comes in when force is involved...such as the bailouts. When the government takes your money under threat of force (i.e. you have no choice) and then hands it over to someone else, obviously that is wrong. (See "George Ought to Help").
-Joe-:I'm referring more to the Wall St. casino of today, where profits are generated from moving money around without producing anything of value.
Not so fast. As Thomas Sowell has pointed out (I think in this interview actually, and elsewhere) people believed the same thing about the Jews in the past...that they were just useless middlemen who provided no value at all...they just shoved themselves in the middle of transactions and took a piece of the action withtout adding anything...but when all these money merchants were shoved out of town, the economies fell apart. There is a social function of stock speculators, as well as insurance, futures markets, credit default swaps, and banks.
The tough part comes in when you have to account for gains made by money being printed out of thin air...and then, not only that, but money being printed and then "lent" to an organization with the monopoly power of force, which then uses that power to steal money from a bunch of other people to pay back its debt. That's where it gets hard to really talk legitimacy of profit, because at the root of the whole system lies illegitimacy.
the idea of charging interest on money that has come from money that has come from money... seems deeply unethical to me.
You're close. As Clayton points out, it's not the fact that you're charging interest...it's the fact that money has been created out of thin air to begin with. That's when it became unethical...
-Joe-: I assume the Austrian perspective would be that if we didn't have all this funny money created by the FED and banking system than none of this casino-economy would even be possible, and money would more fully represent real value?
Basically, yeah. You can definitely get into more detail and specifics, but that's basically it...
(unfortunately that is more than likely the only part of the "Four Horsemen" film worth watching. So if you're interested in a documentary, we can recommend quite a few.)
P.S.
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I'm not arguing that there is no place for Wall St. in our society. And obviously traditional banks play a vital role in the healthy functioning of an economy. But don't you think it has gone way overboard? Sure, speculators provide some useful information to investors, but rampant speculation also leads to huge price distortions, like the oil spike in 2008, which as far as I know had nothing to do with supply and demand and everything to do with speculation in the futures market. Credit default swaps tie into what I said in the previous post - a futile attempt to spread risk in order to justify reckless behavior. And what about people using credit default swaps to ensure assets they didn't even own? You can't possibly argue this has a social function, it is pure gambling. There may be a legitimate limited use for CDS (and if you know of a resource that explains this I'd like to read it), but clearly they were abused in the run up to the crisis in 2008.
Thanks for the links you provided, I'll check them out.
I'm not arguing that there is no place for Wall St. in our society. And obviously traditional banks play a vital role in the healthy functioning of an economy. But don't you think it has gone way overboard? Sure, speculators provide some useful information to investors, but rampant speculation also leads to huge price distortions, like the oil spike in 2008, which as far as I know had nothing to do with supply and demand and everything to do with speculation in the futures market.
Incorrect speculations by definition hurt only the incorrect speculator if you have sound money. The problem is that institutional Wall St. speculators can borrow at sub-market rates from commercial banks (who borrow at sub-market rates from the Fed) and then use this artificially cheap money to engage in speculation they could never have afforded to engage in if they had to put only their own money and true credit rating on the line. With the end of Glass-Steagal, this was made 10x worse because now you didn't even have to borrow from a bank to speculate, the banks themselves could directly engage in speculative investments.
The problem is not speculation and there is no such thing as "rampant speculation" in a sound money economy because there is no way for the speculator to force others to pay for his mistakes. It's only with this funny-money economy where profits are privatized while losses are socialized that you can have such a thing as excessive speculation.
Credit default swaps tie into what I said in the previous post - a futile attempt to spread risk in order to justify reckless behavior. And what about people using credit default swaps to ensure assets they didn't even own? You can't possibly argue this has a social function, it is pure gambling. There may be a legitimate limited use for CDS (and if you know of a resource that explains this I'd like to read it), but clearly they were abused in the run up to the crisis in 2008.
The problem is not CDS or MBS or any of these instruments... the instruments are precisely what the word says: instruments. Means to an end. The end is to monetize the cheap credit available from the Fed. Schmuckety-schuck Joe Wall St. Investor has access to a sub-market line of credit from the Fed (whether directly or indirectly doesn't matter) and he wants to take that spread and turn it into cash in his bank account. To do this, he needs something to invest in... the riskier the better because he's not even putting his own money on the line, particularly with the Fannie Mae/Freddie Mac MBS crap. Joe Wall St. had already crunched the political numbers and realized that there's no way the Federal government could allow America to go bankrupt. Why do you think a bank with the name "Bank of America" was bailed out while another with the name "Lehman Brothers" was not. It really is that juvenile.
-Joe-:Thanks for the links you provided, I'll check them out.
Yeah, definitely do that. Those articles on the social functions of those industries will address the concerns you just raised. But as Clayton points out, all the problems stem back to money being printed out of thin air, and people being forced to use it (i.e. legal tender laws, and taxes). Definitely watch that video.
Thanks for that explanation, that makes a lot of sense. I feel like if Ron Paul was more articulate in explaining these positions he'd have a lot more support. So why do you think there is such strong resistance to sound money? Among those who have access to the cheap money the reason is obvious, but what about everyone else? How did mainstream economists become so clueless? Are they all just bought and paid for by the establishment - i.e. speaking fees, consulting fees, etc. Is there a worry that lending would get too tight under a sound money system, and economic growth would stagnate?
In terms of Lehman not being bailed out - I wouldn't be surprised if that had something to do with Goldman's political influence.
-Joe-:Thanks for that explanation, that makes a lot of sense. I feel like if Ron Paul was more articulate in explaining these positions he'd have a lot more support. So why do you think there is such strong resistance to sound money? Among those who have access to the cheap money the reason is obvious, but what about everyone else? How did mainstream economists become so clueless? Are they all just bought and paid for by the establishment - i.e. speaking fees, consulting fees, etc. Is there a worry that lending would get too tight under a sound money system, and economic growth would stagnate?
My understanding is that most economists work in academia, big business (particularly the financial variety), or the government. Take that how you will.
I think the resistance to sound money concerns people wanting to have their cake and eat it too. In other words, sound money would reveal to them that things are actually scarcer in many ways than they want to believe.
The event that led to the creation of the Federal Reserve System was the Panic of 1907. Looking at the history of this event, it seems that the banks involved were technically already insolvent before the panic erupted. "A shortage of money and credit" was blamed for the panic, but what did people mean by that? Based on subsequent events, apparently they meant that banks weren't able to get away with printing even more bank notes (not backed by real money, i.e. gold) and make even more loans using those bank notes.
Also keep in mind that, while there was no central bank in the United States between 1836 and 1913, banks were regulated by some level of government during the entire intervening period. See this Wikipedia article for some good background information.
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That's an interesting point. So how would you see this playing out? Our natural resources and skills/human capital would be unchanged, so how would this change of mindset affect society? Do you imagine that the overall standard of living would drop in a sound money system due to this scarcity no longer being masked by artificial credit creation? Trying to wrap my head around the psychology of it. I'm always amazed when people talk about a "crisis of confidence" as if our economy was more about psychology than anything concrete. But in our current system, if this confidence stalls for even a moment, the whole thing comes crashing down.
Hmm meant to quote your sentence "I think the resistance to sound money concerns people wanting to have their cake and eat it too. In other words, sound money would reveal to them that things are actually scarcer in many ways than they want to believe." at the beginning of my last post, didn't work. How do you quote from someone's msg in your post, I can't figure it out. I hit reply on that person's post but that didnt work.
-Joe-:Am I missing something here?
1) you are assuming that inflation is automatically bad.
Inflation is not any more bad than a bird crapping on your head is bad. It just is. Whereas, theft and fraud are bad. A lot of the inflation we experience is directly attributable to theft and fraud.
In a truly free market, there can be inflation and if it comes about through completely voluntary transactions, be they risky or not, then there is no reason to point it out as something that we libertarians must stop.
We should be stopping taxation and legal tender laws. It just logically follows that most inflation would also disappear as a result.
2) you are assuming that the money markets will operate the same way in anarchy as they do now. That is not likely to be the case.
In a truly free market, people will probably have no choice but to research and closely examine the practices of their banks.