There has been some conflict over the idea that, since the
majority of money (95%) is created as debt, the problem is that while what money
is owed is principal plus interest, (P +
I) and what money exists is merely the principal (P), it is always impossible to pay back the total, (since P < (P + I),) and so there will
always be default.
Paul Grignon, from whose excellent movie “Money as Debt II” http://www.youtube.com/watch?v=jQuEOUzA9P8
I originally gained this idea, now says the primary cause of default is
secondary lending.
http://peemconference2013.worldeconomicsassociation.org/?paper=proposed-new-metric-the-perpetual-debt-level
If I understand him right.
We examine this.
WE consider a steady state economy, one which is neither
growing nor contracting. The velocity of
money V we consider constant. Banks lend
out $100 at the beginning of the year.
This is all the money there is in the economy. All money is debt. At 6% interest.
All loans are to be paid in full at the end of the
year. Otherwise, there is no interaction
between the banks and the rest of the economy.
$106 is required at the end of the year, but only $100 exists. If we look at all of the actions internal to
the economy, that is, the economy separate from the banks, none change the money
supply. Only the paying back of loans, which extinguishes the money, or
creating new loans, which creates money, changes the money supply. If loans are paid early, the interest is
collected. Paying early extinguishes the money, whether on principal or
interest. If the money supply is to be
maintained, the loans are lent out again.
In this case $106 is still required at the end of year. Of course, the
next year, $106 can be lent out, thus allowing the $6 in interest to be rolled
over, along with the rest of the money in the economy, the debt compounding. But see below.
Internal lenders, (secondary non-bank lenders,) who must
first borrow the money from the banks at the beginning of the year, before they
lend it, do not change the money supply.
They may sell the loan, for money, but that doesn’t change the total supply of
money. Neither do they change the default rate to the banks. In this sense: Default to secondary lenders is
passed on as default to the banks. They
transmit, but do not originate.
But this is the basic point.
If we keep secondary lenders separate from banks, the net default rate
to banks does not change. The default rate is still just a consequence of the
original shortage of money to pay the interest, unless the money supply is
expanded. Anyway, if the default rate is greater than the 6% interest rate,
then there is money retained in the economy by other actors. If the default rate is 8%, then 2% is
retained as cash by the economy for the next year. Indeed, we would expect a certain amount of
this kind of default in an economy in any year.
Call this distributional, as opposed to secular, default. Roughly, the
distributional default rate would be a constant, although this might depend on the
growth rate or inflation. We will ignore this, as it is not brought about by a shortage of money, but by the distribution of money in the
economy. Because of distribution, some
people will have more than enough to pay back their loans, some people will not
have enough, and this will even out. But
because P < P + I, there will in
addition always be some who will not
have enough money to pay back their loans.
Suppose now instead the banks spend $6 throughout the year. (Interest
to savers may be some of this.) Essentially
they are giving away this money, although they may demand real services for it.
Then there would be $106 at end of year.
There would be no secular default, but there would be 6% inflation, with
constant velocity, as the money supply has expanded by 6%, while the economy
has, by assumption, remained at a steady state. The same result would happen if
the banks were just to lend out $106 at the beginning of the second year, as
above, thus covering what would otherwise be defaulted upon at the end of the
first year.
Suppose the banks spend $10 throughout the year. Then there would be $110 at the end of the
year, and 10% inflation, with $4 remaining in circulation at end of year, when
all loans were called due, and $106 collected.
But $106 would still have to be lent out, at the next cycle, as the
required base money supply is now $110, and anything less, (or more,) would
change the money supply, and if less, cause deflation, from $110, and if more,
inflation.
Suppose the banks spend just $3 through out the year. Then the money supply increases by 3%, and
there is 3% default. This suggests an
equation: rate of Money added + Default rate = mean interest Rate. (Rate of
Money added in a steady state economy will equal the inflation rate, but it
will not equal the inflation rate in a growing economy.)
Let’s look at this some more. The increase in the money supply need not be
just the banks spending money. It could
also be the government issuing money.
And this increase in the money supply could be greater than the interest rate. Then default would be ‘negative,’ (by which we
mean there would be net cash at beginning of the next cycle,) and inflation
greater than the interest rate.
Another thing that could happen is the banks could increase
the rate of loaning money above $100, the first cycle. But this would just set the base at say $110.
Thus the increase in bank lending
would also contribute to inflation.
Suppose now an economy growing at 3%. Then if the banks put in $6, 6%, we would
have 3% inflation: Rate of Inflation = rate
of Money added – Growth rate. As before,
zero secular defaults. But suppose
instead the banks just spend nothing. This
will lead to 3% deflation. The default rate would still be at 6%, though, because
there is the 6% shortage of money. So in a growing economy, our first equation still
is: rate of Money added + Default rate = mean interest Rate. These terms are
the purely monetary terms. Inflation and
the Growth rate are the terms involving the real economy. Substituting for rate of Money added, from one
equation to the other, we have: rate of Inflation + Growth rate + Default rate
= mean interest Rate. Note we allow the default rate to be ‘negative’ if there
is a sufficient increase in the money supply.
(Note also that if we include the distributional cause of default, we
actually have: rate of Inflation +
Growth rate + Default rate > mean
interest Rate. But distributional default is a complication
we are ignoring. I think it averages out as roughly a constant over time, and so
does not affect the secular default rate.)
Back to a steady state economy. Instead of all money being
created by loans, we are told that there is $5 in the economy, not created by
the banks as loans. Banks lend out $100
at 6% interest at the beginning of the year.
So there is $105 at the beginning of the year. All loans to be paid in full at the end of
the year. No other interaction between
the banks and the economy. So $106 is
required at the end of the year, but only $105 exists. All internal actions, in particular the
actions of internal lenders, add to zero.
Paying early extinguishes the money.
However, unless $5 is put into the economy the next year, then the banks
will have all the money. ($105) Then the next year all the money which is in the
economy will be lent, that is, all the money
will be created as debt. Which the banks loan out at 6%, requiring
$111.30, or default to the amount $6.30.
So we see an amount equal to the interest on all money must be pumped
into the economy each year to avoid defaults.
This leads to inflation, at the rate of interest.
So we see that, in a steady state economy, unless new money
is created each year, at the mean rate of interest, there will be default. If new money is created each year, there will be inflation.
Consider instead overlapping periods of loans. Banks lend out $100 at beginning of year: $50
for a year; $50 for 6 months. Then the banks loan out the $50 again at mid
year, for a year, etc. Assume as before the
velocity of money V is constant. Then
$51.50 is taken out of the economy at the end of 6 months. If then only $50 is
lent back in, the banks keeping the $1.50 interest, then only $98.50 will
remain in circulation. But if we assume
business as usual, and that the money will be distributed throughout the
economy, then the $1.50 interest due after 6 months will be defaulted on. This default is required to maintain the
money supply, in the economy. If it is not defaulted, the money supply will
contract by $150, unless the banks now lend out $51.50.
Suppose instead the banks will lend just the $50 out
again. After 1 year, then, on the first
year loan $53 will be taken out, so only $95.50 will remain in circulation. So
we see that with overlapping loans, the result will still be some combination
of deflation, default, or increasing indebtedness with inflation.
What about with deflation?
Indebtedness can still compound.
The banks keep all interest to themselves. Then after one year, $100 is
owed on $94 in circulation, and after two years $100 is owed on just $88 in
circulation, etc. This is a cumulative
6%, or $6 on the $100 which is owed.
This is constant, so the reduction in circulation each year is constant,
although the percentage decrease in money in circulation increases. 6.38% decrease in the 2nd year, 6.82%
decrease in the 3rd year, 10.35% the 7th year, when $100
will be owed on just $52 in circulation.
This is independent of any growth, or contraction, in the in the real
economy.
In this toy economy, we have either default or compounding
debt, just because P < P+I.
Finally, we note again the odd consequence of distributional
default, which is that the economy retains cash not owned by the banks. Peculiarly, except for this small percentage,
plus any money issued by government each year, or given away by banks, each
year, all money is effectively owned
by the banks.
