23 Aug 2010

What Does “Debt-Based Money” Imply for Interest Payments?

Shameless Self-Promotion 8 Comments

Not as much as some think:

In a previous article, I explained the sense in which our fractional-reserve, fiat financial system is built upon debt-based money. In this perverse arrangement, new dollars come into existence through the creation of government and private debt. Going the other way, if the private sector and the federal government ever began seriously paying down their debts, the supply of US dollars would shrink.

These observations are not common in Austrian economics, but they are discussed quite frequently in radical critiques of banking and “money-changing” per se. (For a great presentation, watch this video from 3:00 to 18:00.) Such critics claim that the charging of interest itself is unnatural. In the context of our present, admittedly perverse, system, these reformers argue that the people have to take on more debt, because “there’s not enough money in the economy” to pay back the principal and interest from their previous loans.

Although there is a grain of truth in this claim, in its crudest form it confuses stocks with flows. Although the critics are right to castigate our current system, they are wrong when they say that interest payments require a constantly growing supply of money.

8 Responses to “What Does “Debt-Based Money” Imply for Interest Payments?”

  1. Troy in India says:

    I just wanted to make an observation. While in an evenly rotating, hard money, central bank-less economy, yes, you do not need new money creation to pay off loans.

    However, with the increasing amounts of malinvestments in the system due to monetary expansion, it does become necessary to increase the money supply to help marginal businesses to pay off their loans. That’s the reason for the money supply expansion even when governments ran balanced budgets like in the early 50s and 60s. Or at least money supply growth was faster than the deficit.

    I’m assuming this is what Mises meant when he said an ever increasing cupply of money is then required to keep the system solvent.


  2. NOTAL says:

    Good article. I’ve always had a hard time explaining this ideas to those who make the claim that there is not enough money to repay interest on loans.

    The extension of the “not-enough-money-to-repay-interest” argument is that, if the interest rate is 5%, then it’s mathematically necessary that 5% of people will default on their loans for the others to be able to repay their own loans (at least if there is a constant money supply). I like to point out that if this is the case, then banks would never be able to collect any interest on net, and therefore wouldn’t make any money.

  3. Sean Duffy says:

    Zetgeist? Seriously, Bob? Crazy talk. Oh wait, I think it’s crazy because I’m enslaved. And I’m enslaved because I mistakenly believe I’m free. Used to be the only people who thought like Mr.Joseph spent most of their time smoking pot in black light lit college dorm rooms listening to the Moody Blues. Now it’s mainstream?

    • bobmurphy says:

      I don’t care if you mock me or the documentary, but leave the Moody Blues out of this.

  4. Sean Duffy says:

    I will retract the implied slur against the Moody Blues as long as you concede that, for someone to take the Zetgeist conspiracy business seriously, sustained drug use may be helpful.

    • bobmurphy says:

      You saw how I confined my endorsement to a certain portion of the documentary, right? So what claim do they make in that portion that you think is wrong?

  5. Sean Duffy says:

    I thought the section you pointed to, minutes 3-18, was informative insofar as it treated the mechanics of money creation. The teleological wrinkle, that it’s all part of a grand design to enslave mankind and compromise third world governments, is a bit thin, to put it charitably. The Federal Reserve segment runs about 15 minutes in a 2 hour movie. Few viewers, I think it fair to suppose, having viewed the movie in its entirety, would conclude that the FED section is the diamond hidden under a pile of BS. More likely they would conclude that it’s all BS.

  6. Toms debt advice says:

    At the end of the day it is a form of bullying that will never stop unless the public unite and over throw them.