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Money of the Natural Economic Order


7 October 2008 - 23 August 2014




Introduction




The dual nature of interest


The buildup of capital made it possible to improve living standards for most people around the globe. Capital accumulates through the mechanism of interest. Interest is also the main cause of wealth disparity. The wealthy mostly increase their wealth by investing. Between 1980 and 2014 the S&P 500 Index rose from 100 to 1,900, while in the US average real income for the working class declined. Poor people mostly do not invest at all and pay interest either directly on loans or indirectly via the products they buy [1]. Capital needs a return in order to be employed and to improve overall living standards so banning interest on capital makes no economic sense.

Interest on money is a different issue. Money is not the same as capital and here the problem lurks. Money is an accounting unit that does not depreciate or grow by itself. Economic crises as well as inflation can be traced back to interest on money. Making interest on money illegal will solve those issues but also poses challenges. Whether or not certain economic activities or distributions of wealth are desirable or efficient, and what to do about it, is a political question. The theory of Natural Money does not address these issues directly as it primarily focuses on interest on money.



Interest on money


There are two major issues related to interest on money. The first issue is that when people borrow money for consumption, the interest paid does not reflect interest on capital, but a reduction in future consumption, and an overall decline in living standard as the loan has to be repaid with interest. This is the most troublesome when poor people borrow money for consumption at high interest rates. Borrowing for consumption also contributes to economic cycles as people tend to borrow and consume more in times of optimism and tend to pay off and consume less in times of pessimism.

The second major issue is the arithmetical problem that interest poses if there is a limited amount of currency units. This is the most clear under a gold standard. The following example demonstrates that interest on money is unsustainable in the long run. If someone brought a 1/10 oz gold coin to the bank in the year 1 AD, and the money remained there until the year 2000 AD, collecting a yearly interest of 4%, the amount of gold in the account would have weighing 6,000,000 times the complete mass of the Earth. The yearly interest would have been 240,000 times the complete mass of the Earth.

Lenders can corner the market for money just by charging interest on money, and by doing so ruin the economy. Long before the owner of the account accummulated all the available gold, a severe depression would set in as there would be a shortage of currency. The account holder could then buy up all existing businesses and homes at firesale prices. Many people would then become his servants. US President Thomas Jefferson did see what might happen, even though he did identify private banking institutions and not interest on money as the primary cause of economic crises, when he stated:

I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around them, will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered.


Lenders can demand interest on money as long as money can be withheld from the economy without losing value. This is the most clear when the money is gold. Lenders desire a compensation for the risks involved in lending out money. As a consequence there is a minimum interest rate. Below that rate there will be no money available for borrowing. This may not be an equilibrium interest rate where savings equal investments, and savings can remain outside the economy. This in its turn can cause deflation. The prevalent solution is inducing inflation, either by more government borrowing and spending or printing money outright.

When interest is charged on a limited scale or over a short timeframe then the problems seem limited. Interest is an insidious process. Over time interest can reduce large numbers of debt burdened people to a state of servitude. This is a long term development that transcends the life span of a human. It is often assumed that a prosperous economy depends on free people that make their own decisions, so interest on money may have been a reason why a number of civilisations have failed. Natural Money is an alternative for interest on money that can help to bring a flourising economy for centuries to come.



How banks create money


The video Money as Debt (3:30 - 8:50) explains how banks create money by issuing credit. The current banking system emerged from the business of the goldsmiths. In the late middle ages, the goldsmiths had secure vaults to store their gold. Other people entrusted their gold to them for safekeeping. In return they paid a storage fee and received claim checks for the gold they deposited. The claim checks issued by the goldsmiths were used on the marketplace as if they were money. The paper money was more convenient so hardly ever did someone return the claim checks and demand gold.

The goldsmiths had another line of business, which was lending out gold at interest. When the paper money of the goldsmiths became widely accepted, borrowers also preferred paper money. As trade expanded, more people came to the goldsmiths for loans. Only a few depositors wanted to exchange their claim checks for gold so the goldsmiths came to the conclusion that they could issue claim checks against the gold of the depositors. As long as the loans were repaid, the depositors would not lose any money, while the goldsmiths could make a greater profit.

The source of those extra profits became known and depositors started to demand interest on their deposits. That was the beginning of banking. The bank paid a low interest rate on deposits that were lent out at a higher interest rate. As all issued claim checks were covered by gold, this is full reserve banking.

The demand for loans was rising fast but the amount of loans remained limited by the amount of gold in the vault. It then emerged to some goldsmiths that they could issue claim checks for gold that did not exist. As long as the claim check holders did not demand gold for their checks all at once, the scheme would work, and the goldsmiths could make even greater profits. This is fractional reserve banking. When the people realised that the goldsmiths had created claims on gold that did not exist, depositors started to demand their gold. In this way many goldsmiths ran out of gold and the claims they issued became worthless. This is called a bank run.

To make the system more stable, the practise of banking became regulated and central banks were instituted. If there was a bank run, then the central bank could come up with gold, and restore confidence. Over time the amount of credit expanded enormously because of economic growth, and the gold convertibility was ended. This provided more flexibility to central banks to issue more currency when banks needed this, and in this way bank runs became largely an item of the past. This flexibility however provided an incentive to build up more debt as savers only demanded interest and did not take their money out of the banks.

In a way fractional reserve banking can accelerate debt expansion, which is a reason why the practise is controversial in some economic and monetary views. As soon as a new debt has been created, the credit becomes money which then can end up in another deposit account accumulating interest. Fractional reserve banking can make those problems worse as new debts can create new interest bearing deposits. Accumulated interest can make savings and debts go out of control and fractional reserve banking can speed up this process.



Interest and economic cycles


Boom and bust

Banks create money when a new loan is made. The money is destroyed when interest is paid or the loan is paid back. As long as the loan is not repaid, the borrower pays interest to the banks and the holders of deposits. If the holders of deposits do not liquidate their accounts, there will never be enough money to repay the debts with interest, so not everybody can fulfil his or her obligations unless new debts are created. Periodically this can lead to an economic crises when debts have to be written off, which contributes to economic cycles.

During a boom phase more credit is available based on rosy expectations of the future. During a bust phase less credit is available because of grim expectations of the future. The availability of credit can intensify the boom while the unavailability of credit can intensify the bust. During a boom phase interest rates rise, which sows the seeds for the bust as there is only a limited amount of currency units in circulation, while higher interest rates take more money away from debtors.

During a boom phase consumers are more willing to spend and to borrow, while investors are more willing add leverage using credit. This can intensify the boom, creating shortages of materials and labour resulting in rising prices. Interest on money is an incentive for banks to lend money to leveraged investors during the boom. When the cycle turns into bust, investors start to reduce their leverage, which intensifies the bust, creating surpluses of materials and labour, resulting in lower prices.


The usury economic cycle

Debts as well as interest on those debts are a potential cause of economic cycles. On the other hand, economic cycles can also contribute to the buildup and contraction of debt. Periodically interest charged on debts can cause a reduction in demand as debtors have less free income to spend because they have to pay interest on their debts. This is the most clear if it is assumed that the amount of currency is fixed. The usury element is the increase in debts due to interest relative to the number of currency units, making it impossible to repay all the debts or even to pay the interest as long as savers accumulate balances on their accounts.

The usury economic cycle, as an economic cycle caused by interest on money thus may be called, may favour large scale operations. This can work as follows:
- If businesses use interest bearing debt, they need larger scale operations to achieve the same income level for the business owners because a part of the business income is going to the money lenders. In good times businesses can borrow money to expand their operations and there is a tendency to over invest.
- When a recession sets in, some businesses fail because demand falters or because there is no credit available. If a larger scale operation fails then it is often not liquidated but taken over at a lower price, which makes it cheaper for the new owners to operate.
- Smaller businesses that are more conservatively financed are at a disadvantage as a larger low cost competitor has arrived so more of them may fail than otherwise would have happened. The cycle may thus lead to an increase in scale that is not based on a real cost advantage but from a financial cost advantage.
- When the economy recovers a smaller number of larger scale businesses have survived. The usury economic cycle may then repeat again.

To some extent the functioning of markets seems to be perverted by cycles of leverage and liquidation. During the boom phase excess capital is created that may destroy capital that could otherwise be useful. This development can also be seen as innovation or creative destruction, but if it is not real innovation leading to better products or lower prices, there may be no real economic benefits on the aggregate. If jobs are eliminated and replaced by capital without creating a real cost advantage or product improvement, this may be a zero sum game or even a negative sum game.


Making society vulnerable

The usury economic cycle can be repeated over and over again so interest on money may favour large scale operations. The usury economic cycle may have caused the division of labour to go further than it otherwise would have done. It is a speculative proposition and it is contestable as many other issues also influence the economy of scale and business profitability. The effect of the usury economic cycle favouring large scale operations may have been amplified by the free flow of capital and free trade as this created a competition of everybody against everybody on a world wide scale.

As a consequence dependencies may have escalated and people may have become less self sufficient. Before the middle of the twentieth century most people lived in villages that were largely self dependent. Henceforth more and more people live in cities and societies may have become more complex than they would have been without interest on money. Specialisation and economies of scale, which are important elements of economic development, have made human civilisation vulnerable, as many people may not be able to survive a collapse of the system.



The competition element


Money can bring out the worst in people and the love of money is seen as a root of all kinds of evil. Money tends to make people less compassionate [2]. Money can cause unethical behaviour and crime. Interest increases competition for money as there is not enough money to repay debts with interest. It is a game of musical chairs and the ensuing shortage of money increases competition. Everybody has to work harder or has to be smarter than others in order not to be left out in the money game. Being smarter often implies deceiving others, while working harder often equals to destroying the living conditions humans depend on.



Correction mechanisms


As long as economic growth can keep up with the debt expansion, it is unlikely that the problems will grow out of control. In the current financial system there are a number of correction mechanisms that are operated by government and central bank bureaucrats. Those correction mechanisms are government spending, central banks setting interest rates, regulation of the banking sector and printing currency.

Government spending can be used to increase spending when the economy falters. Because there is interest on money, economic growth can depend on the expansion of debt. Governments may need to go further into debt when consumers and businesses are reluctant to take on more debt.

If the economy is faltering, because too little debt is added, central banks lower interest rates for consumers and businesses to encourage them to go further into debt. If the economy does well new debt is created in a faster pace, and central banks raise interest rates to curb debt growth, because money is created with the expansion of debt and an increase in money supply can result in higher prices.

There is also regulation aiming to stabilise the banking system, such as solvability and liquidity requirements. In recent decades a less regulated shadow banking system emerged that needed government assistance during the financial crisis.

When there is just too much debt in the banking system to get the economy back on track, central banks can print currency to buy up government debt and debts owned by the banks, so the government has more money to spend and banks have more room to create new debts.



The dilemma of government intervention


If the government did not interfere with the economy and interest rates, markets could correct harshly with businesses going bankrupt, economic recessions and even economic depressions. In this process capital could be destroyed which could be useful if there was demand. The destruction of capital is a destruction of wealth. Since we live a democratic society, people may elect officials that promise to solve this issue and there may be a call for government intervention and regulation.

Government intervention may reduce the severity of economic recessions and economic depressions in the short term, but this can create bigger problems long term, namely expanding debt on which interest must be paid. The economist Keynes, who promoted government intervention only considered the short run, and he noted that in the long run we are all dead.

Government intervention can help inefficient politically connected businesses to remain in operation. The demand created by the government often does not reflect the preferences of market participants. The expansion of government and the welfare state are to some extent caused by interest on money. Interest on money can increase poverty so the poor may become the majority. They may then elect people that look after their interests and many poor can become dependent on the state.



The financial system promotes senseless economic activities


The share of the financial sector in the economy has increased significantly in recent decades. Although the financial sector is useful, it does not produce real goods and services, while the interest and credit cause financial instability. Financial instability and the perceived need for government and central bank interventions, generate opportunities for politically connected and informed people. Interest payments, and unproductive activities in the financial sector may have contributed to a reduction in the living standard. The US financial sector comprised only 10% of total non-farm business profits in 1947, but grew to 50% by 2010 [3].

For most people the living standard in the US has declined after 1970. Many people did get into trouble due to predatory lending practises. Even in good economic times, there are a million personal bankruptcies per year in the US alone [4]. Companies can get into trouble due to financing structures that may cause them to lay off people. These companies may have been viable if they had been more conservatively financed. To deal with the consequences of economic cycles caused by credit and interest, governments try to manage the economy and help the unemployed.



Economic growth


The way economic growth is measured ignores long term consequences such as the depletion of natural resources and the degradation of the planet. The current economic system based on exponential growth of human activities can lead to a collective suicide of humanity. Economic growth may not help most people In the United States the living standard declined after 1970 despite economic growth. Most of the new wealth has ended up in the hands a few oligarchs, while many activities in the financial sector are not beneficial to the real economy.

Interest on money makes debts increase over time. As a consequence, the economy needs to grow to support those debts. Many economic activities make little sense, and economic growth often equals to more resource consumption for non-essential activities. It may not be surprising that this did not bring more happiness. In 1950 per capita GDP in the United States was smaller than today, yet surveys of happiness and life satisfaction and other indicators of well-being have declined over the years [5].



The current financial system causes many problems


Interest on money causes a number of problems. The book Poor Because of Money from the Strohalm Foundation identifies a number of consequences of interest on money [6]:
- There is a constant shortage of money because every euro put into circulation bears interest. Money is created under the agreement that more money is returned. Each individual may try not to be the victim of this game of musical chairs. This can result in a stiff competition, as well as looting of natural resources and human labour.
- Interest flows from the poorest people and areas of the world into the ever increasing financial sector. Many people are left behind impoverished and robbed from their means of exchange necessary to trade. Some money returns in the form of development aid, which offers an opportunity for corruption and this contributes to social dislocation.
- Interest represents a percentage of the borrowed amount that the borrower must pay to borrow the money. In the current monetary system additional debt must be created to pay for the interest and therefore debt increases exponentially like the amount of interest that must be paid. The opposite happens for credit. Savings accounts earn interest on top of interest.
- Currently more people live as slaves than in Roman times. Twenty seven million men, women and children currently are slaves. When people can no longer pay the interest on debts they end up as slaves. Entire families have become the property of a money lender. In many villages in India the only house made out of stone belongs to the money lender.
- In Western nations a new class of debt slaves is emerging. There is an entire industry that specialises in the art of tempting people to buy on credit. Often they have been lured into debt for unnecessary expenses they could not afford to pay. Now their houses are being foreclosed and they often have to pay high rates on their credit card debts.

The problems are compounding like interest and they may cause a massive financial catastrophe. Easy solutions appear not to be available as interest is needed to employ capital. Productive labour and enterprise should be rewarded and parasiting should be discouraged. There is no simple solution for all economic woes, but it may be possible to solve the problem of compound interest on money, spur economic growth, distribute wealth more evenly and make the economy more sustainable.




Money of the Natural Economic Order




Examples of interest-free money


Wörgl stamp scrip

On July 5, 1932, in the middle of the Great Depression, the Austrian town of Wörgl introduced a complementary currency. Wörgl was in trouble and was prepared to try anything. Of its population of 4,500, a total of 1,500 people were without a job and 200 families were penniless. The mayor Michael Unterguggenberger had a long list of projects he wanted to accomplish, but there was hardly any money to carry them out. These projects included paving roads, streetlights, extending water distribution across the whole town, and planting trees along the streets.

Rather than spending the 40,000 Austrian schillings in the town’s coffers to start these projects off, he deposited them in a local savings bank as a guarantee to back the issue of a type of complimentary currency known as stamp scrip. The Wörgl money required a monthly stamp to be stuck on all the circulating notes for them to remain valid, amounting to 1% of the each note’s value. The money raised was used to run a soup kitchen that fed 220 families.

Nobody wanted to pay the monthly stamps so everyone receiving the notes would spend them as fast as possible. The 40,000 schilling deposit allowed anyone to exchange scrip for 98 per cent of its value in schillings but this offer was rarely taken up. Of all the businesses in town, only the railway station and the post office refused to accept the local money. Over the 13-month period the project ran, the council not only carried out all the intended works projects, but also built new houses, a reservoir, a ski jump and a bridge.

The key to its success was the fast circulation of the scrip money within the local economy, 14 times higher than the Schilling. This in turn increased trade, creating extra employment. At the time of the project, unemployment in Wörgl dropped while it rose in the rest of Austria. Six neighbouring villages copied the system successfully. The French Prime Minister, Édouard Daladier, made a special visit to see the 'miracle of Wörgl'.

In January 1933, the project was replicated in the neighbouring city of Kitzbühel, and in June 1933, Unterguggenberger addressed a meeting with representatives from 170 different towns and villages. Two hundred Austrian townships were interested in adopting the idea. At this point the central bank panicked and decided to assert its monopoly rights by banning complementary currencies [7].

A significant part of the success of the Wörgl stamp scrip can be attributed to one-time effects, such as payment of taxes in arrears. This provided a short term stimulus, and it is unlikely that this effect would have been sustained in the long term [8]. On the other hand, the Wörgl stamp scrip caused taxes to be paid that otherwise would not have been paid, and this part of the stimulus would have been sustainable. There have been other experiments with free money but few were as successful as Wörgl.


The Schwanenkirchen Wara

In the town of Schwanenkirchen in Bavaria the owner of a small bankrupt coal mine started to pay his workers in coal instead of Reichsmark. He issued a local script which he called the Wara that was redeemable in coal. The bill was only valid if a stamp for the current month was applied to the back of the note. This demurrage charge prevented hoarding and workers paid for their food and local services with the Wara.

Coal was a necessity and German Marks were in short supply so the currency became widely accepted. The use of this currency was so successful that by 1931 the so-called Freiwirtschaft (free economy) movement had spread through all of Germany. It involved more than 2,000 corporations and a variety of commodities backed the Wara. In November 1931 the German Central bank prohibited the use of the Wara [9].


The United States

In the United States Irving Fisher analysed the Wörgl case and published various articles about its success. More than 400 cities and thousands of communities all over the US started to issue emergency currencies, and many of them were stamp scrip. There was a movement to issue a stamp scrip currency nationwide. Senator Bankhead from Alabama presented a bill to the Senate on February 18, 1933 and Representative Petenhill from Indiana presented a bill to the House of Representatives on February 22, 1933.

The stamp scrips in the United States often had a high tax rate, sometimes 1 to 2% per week instead of 1% per month like in Wörgl. This undermined the confidence in the stamp scrip currencies. Irving Fisher approached the Undersecretary of the Treasury, Dean Acheson, to obtain support from the Executive branch for issuing stamp scrip. Acheson asked the opinion of one of his Harvard professors, who advised him that the system would work but that it would imply strongly decentralised decision making. President Roosevelt later prohibited any use of stamp scrip [9].


Lignières-en-Berry

In 1956 a few people in Lignières-en-Berry started a revolutionary experiment. They issued vouchers of 100 French francs for 95 French francs. After four months the vouchers could be returned for 98 French francs. A notary saw to it that for each voucher 98 French francs were deposited into a bank account. If the vouchers were not returned, a stamp of 1 franc had to be bought to keep the voucher valid.

The money was attractive because there was three francs of profit to be made by buying vouchers for 95 French francs and returning them for 98 French francs four months later. By spending the vouchers for 100 Francs it was even possible to make a profit of five francs. People tried to spend the vouchers in the shops and the shopkeepers liked the currency because it brought them additional customers, while it never did cost them more than 2% because the vouchers could be returned for 98 French francs. The shopkeepers also preferred to use the vouchers for their own payments.

Many people did not return the vouchers but bought the stamps to keep them valid. From the income of the stamps the cost of buying returned vouchers for 98 French francs could be covered. It did not take long before the currency of Lignières-en-Berry had replaced the French francs. The vouchers spread quickly and the French authorities were alarmed. The vouchers were prohibited [10].


Guernsey

The British island of Guernsey has issued its own currency, and by doing so, Guernsey has demonstrated that inflation is caused by banks charging interest on money. In her book Web of Debt, Ellen Brown wrote the following [11]:

In 1816 its sea walls were crumbling, its roads were muddy and only 4 1/2 feet wide. Guernsey's debt was 19,000 pounds. The island's annual income was 3,000 pounds of which 2,400 had to be used to pay interest on its debt. Not surprisingly, people were leaving Guernsey and there was little employment. Then the government created and loaned new, interest-free state notes worth 6,000 pounds. Some 4,000 pounds were used to start the repairs of the sea walls. In 1820, another 4,500 pounds was issued, again interest-free.

In 1821, another 10,000; 1824, 5,000; 1826, 20,000. By 1837, 50,000 pounds had been issued interest free for the primary use of projects like sea walls, roads, the marketplace, churches, and colleges. This sum more than doubled the island's money supply during this thirteen year period, but there was no inflation. In the year 1914, as the British restricted the expansion of their money supply due to World War I, the people of Guernsey commenced to issue another 142,000 pounds over the next four years and never looked back. By 1958, over 542,000 pounds had been issued, all without inflation.




Defining Natural Money


Money

It is not easy to define money by its properties because there are many forms of money. It is more easy to define money by its use. Aristotle already saw the dual nature of money: money is a medium of exchange and a store of wealth. Those are conflicting uses. The store of wealth role can obstruct the medium of exchange use. If money does not function properly as a medium of exchange then the economy can suffer and capital may be destroyed. If money is hoarded because as a store of wealth, this may lead to the destruction of capital, which is real wealth.

For practical purposes it can be useful to make a distinction between currency and debt. Currency is money that has been put into circulation by the government. Coins and bank notes are currency. The central bank may also have created digital currency. However, most money is created by banks as a debt. This money is created when a loan is made, and it disappears when the loan is repaid. Also interest payments make money disappear, which is an important cause of monetary instability, as new debts are often needed to pay for the interest.


Natural Money

Natural Money is an attempt at finding the the most optimal form of money in terms of systemic efficiency. Natural Money is derived from the Natural Economic Order of Silvio Gesell [12]. Money based on the Natural Economic Order is called free money, and Natural Money is a specific type of free money. Because of its alleged systemic efficiency, Natural Money may become the dominant type of money in the future, and nothing may stop this from happening, as it may lead to higher real interest rates.

The idea that restricting interest on money could lead to higher real interest rates is the most remarkable feature of Natural Money. If this claims holds, there is no way of stopping the spread of Natural Money and Natural Money will replace the current interest based financial system.
- there is a fixed amount of currency, making Natural Money inflation free;
- the issuing government issues a holding tax on Natural Money currencies, which may be 0.5% to 1.0% per month;
- it is not allowed to charge interest on loans denominated in Natural Money currencies;
- it may still be attractive to lend out money without interest, as the lender does not have to pay the holding tax;
- governments are not allowed to have deficits or debts as they may undermine the value of the currency or push up interest rates;
- banking, which is creating credit that can be used like money, should be a clearly separated and regulated type of business;
- banks can charge an intermediary fee to savers, resulting in negative interest rates on deposits that are better than the holding tax;
- central banks can provide credit to banks at an interest rate of zero, making it attractive for banks to hold reserves or borrow from other banks;
- other financial institutions can issue shares that reflect the value of their investments;
- local governments can issue local currencies that supplement national currencies to support the local economy.


Valuation of the Natural Money unit

Money must be exchangeable for goods, services and other money units. In other words, money must be accepted. The amount of money in circulation (money supply) and how often the money is used (velocity) influence the price level. Changes in the amount of money in circulation may affect prices. Prices can adapt to the amount of money in circulation so there may be no need to change the money supply. A government can only determine the amount of currency in circulation. Keeping the amount of currency constant may be important to make interest free Natural Money a competitive.

Additional provisions may be needed to guarantee the value of loans, for example a clause guaranteeing the value of the loan as a fraction of the amount of currency in circulation in case more currency is issued. An alternative may be a price quoted in a basket of goods and services. This basket could also be a price index.
 
Loesje comment
 

It may be possible to keep the amount of currency constant because the holding tax can provide a constant stimulus. The holding tax makes it unattractive to be liquid in the currency. Consequently there is little or no risk for a downward spiral of the economy, even when financial institutions fail. Consequently there is no need for governments and central banks to print currency or influence interest rates. This makes it possible to make such questions subject to a referendum. With interest on money, a fixed amount of currency can contribute to economic crises because compound interest is infinite.

It is not a good idea to back the money with gold or any other commodity. This introduces the need to purchase gold or commodities, creating an excess reserve of gold or commodities. The value of the Natural Money currency should not be fixed to an interest bearing currency, such as the euro or the dollar. The value of Natural Money is primarily based on legal tender laws. The exchange rate should be determined by the market like any other fiat currency. Economic growth can lower prices if the amount of currency remains the same so the currency may rise in value.

During a transition period, most notably when there are only local initiatives, it may be a good idea to have a fixed exchange rate between the Natural Money currency and an interest bearing currency. This requires the Natural Money currency to be backed by a reserve of interest bearing currency like it has been done in Wörgl, Austria [7].

When there is a national Natural Money currency, it is possible to use it as backing for municipal, state and provincial currencies. If a municipality, state or province issues currency, their currency units must be backed by a reserve of national currency units so it will always be possible to exchange their currencies for national currency at a fixed rate. The proceeds of the holding tax will go to the municipality, state or province. In this way all currency units in the nation can have the same value, but if the national currency is badly managed, this will also affect municipal, state and provincial currencies.

If an interest bearing currency is to be converted into Natural Money, then the value of those currency units is likely to drop in value initially, and this drop may be quite severe. Natural Money will circulate faster, so less money is needed to sustain the same level of economic activities. The excess money can produce a one time price and wage inflationary effect. After some time the value of the currency probably will stabilise and it may start to rise if there is economic growth.



Systemic risk


Natural Money is likely to reduce systemic risk in the financial system for the following reasons:
- the holding tax is likely to produce a constant flow of money, reducing the risk of economic downturns;
- a restriction on charging interest will reduce the risk that lenders are willing to take;
- debts cannot grow out of control because of interest charges;
- the cycle of debt creation and liquidation will be attenuated.

When money stops flowing and liquidity dries up, systemic risk increases. In the current financial system it is not expensive to be liquid, at least in the short term. With a holding tax on money, this could change. Investors have to weigh the cost of going liquid against the potential losses they can make by investing. Those potential losses are subdued in the first place as the holding tax provides a constant stimulus that may prevent significant economic downturns from happening.

The economy can be seen as a system like the human body. All parts of the system need each other to operate properly. Imagine that money flowing in the economy is like blood flowing in the body. It does not make sense that a kidney is saying to the liver: "This is my blood you may borrow it at interest." It also does not make sense for body parts to rake a hoard of blood because there might be no blood flowing in the future. It can become a harmful self fulfilling prophecy.

Interest is an allowance for risk so interest allows for risk in the financial system. People, organisations and countries that have troublesome debt levels can borrow more if they are willing to pay higher interest rates, which further erodes their capacity to repay. If there was no interest on money, creditors are less willing to lend money to risky debtors so debtors will be forced to reorganise their finances in an earlier stage.

Compound interest is infinite and most money is put into circulation by banks at interest in the form of a debt. As a consequence more and more debt is needed to keep the economy afloat. Without interest on money, debts cannot grow because of interest, while every down payment reduces the principal. As a consequence, debts are less likely to grow out of control.

To some extent economic cycles are caused by interest on money. During the boom phase, individuals and corporations can take on more debt, which further fuels the boom, while the bust phase debts are liquidated, which further intensifies the bust. Without interest on money, it is not attractive to invest in debt during an economic boom as investment in equity promises better returns. In that case the risks are offloaded to equity holders so during a bust there will be less debt liquidation.



Natural Money promotes sustainable investment choices


When interest on money is charged, money in the future is worth less than money now. This has a major impact on investment choices. Interest promotes short term thinking. If no interest was charged, long-term investments would be more attractive [13]. The following example comes from Poor Because Of Money [6]:

Suppose that a cheap house will last 33 years and costs € 200,000 to build. The yearly cost of the house will be € 6,060 (€ 200,000 divided by 33). A more expensive house costs € 400,000 but will last a hundred years. This house will cost only € 4,000 per year. For two thousand euro per year less, it is possible to build a house that is not only more pleasant to live in, but will also cost less in energy use.

After going to the bank for a mortgage application the math changes. If the interest rate is 10% then the expensive house will not only cost € 4,000 per year on write-offs, but during the first year there will be an additional interest charge of € 40,000 (10% of € 400,000).

The long lasting house now costs € 44,000 in the first year. The cheaper house now appears less expensive again. There is the yearly write off of € 6,060 but during the first year there is only € 20,000 in interest charges. Total costs for the first year are only € 26,060. During the following years, interest charges are lower, but they still make the less durable house cheaper.


The example shows that without interest charges there is a tendency to select long-term solutions, so interest makes long-term solutions less economical. If interest rates are negative, future income would be preferred even more. Interest promotes a short term bias in economic decisions. This must also be true on a larger scale. It may help to explain why natural resources, such as rainforests are squandered for short term profits.



Natural Money can stabilise the economy


With Natural Money governments levy a holding tax on the money and return this money into circulation by spending. Any form of cash, both in accounts and in the form of bank notes and coins, is subject to the holding tax. Bank notes and coins can be discounted, but it this is a cumbersome process, so Natural Money currencies most likely will be digital currencies. Money cannot be lent at interest, but the money keeps its value and the holding tax can be evaded by lending out money.

There will be money available for borrowing by credit worthy companies and people. There is no interest on money so there is no reward for taking risks that exceed the reward of evading the holding tax. This will curb unwise lending and borrowing that could destabilise the economy. People who are unable to pay back a loan will not get a loan. This is in their own interest and in the interest of society at large. It is better to assist needy people in other ways than lending money at interest.

The optimal holding tax rate is around 0,5% to 1% a month. Lower holding tax rates may not give a good stimulus or give to little incentive for lending without interest. Higher holding tax rates can undermine the confidence in the currency.

The effect of a stable economy is that risks in the financial system are reduced. Risk perceptions depend on available information, and traders tend to exploit any information advantages they may have over others. Reduced overall risk means that informed traders may have less opportunities to prey on the public, and may be forced to look for productive jobs instead. This may improve economic efficiency as less people can make money by parasiting on others.


 
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Employment


Natural Money can help to reduce cyclical unemployment as the holding tax can provide a constant stimulus [14]. The issue of structural unemployment is more difficult to solve as it is caused by a quality mismatch between the supply and demand for labour. This means that the labour offered does not meet the requirements of potential employers. Often there is a surplus of low skilled labour. There may also be a demand for technical skills, while social skills are offered. People with psychological disorders or physical disabilities are often not able to be competitive in the labour market.

The constant stimulus from the holding tax may offer an opportunity for more people to enter the workforce and find a job, thus reducing structural unemployment. Local currencies can help to create local markets, which can make it more easy for less competitive people to find a way of acquiring an income. It may be a good idea that local governments pay a significant part of the benefits for people that are not in the workforce. This may create an incentive to come up with local solutions. With Natural Money local governments have additional tax income from their local currencies.

When benefits are paid from local taxes, people may have stronger incentive to find a job as the benefits are paid for by their neighbours instead of a distant national government. Local employers may start to work together to employ less competitive people at a reasonable wage because their effort can lower local taxes. Local production may be more labour intensive as there are less economies of scale to pay for investments in mechanisation and automation. Most notably, if taxes on labour are reduced while taxes on fossil fuels are increased, energy use may be substituted by labour.



Balancing trade


The holding fee on money can help to correct trade imbalances. An exporting country will be inclined to spend the foreign currencies it received. This means that for each import, a matching export will be found. A country that lacks exports will need to replace imports with locally produced goods and services. In the current financial system imbalances can persist, and those imbalances tend to escalate over time because countries in deficit have to pay interest on their debts in foreign currencies.

A holding tax on money may stimulate international trade based on comparative cost advantages. A relative cost advantage between countries can result in balanced trade when currencies are not kept as a reserve. A country that has a trade deficit may find it easier to export as exporting nations do not like to keep currency reserves. Currently some countries have large current account deficits for a long period of time because of exporting nations hoarding reserve currencies such as the US dollar.

Complete industries have been wiped out in the United States because the US dollar was propped up by currency hoarding by exporting nations like China and Japan. This is a process of reverse economic development resulting in a third world economy. On the other hand, this may have created useless capital in China and Japan. Those countries produced goods and services for US dollars that may prove to be worth less in the future as the United States has too little productive capital to support the value of the US dollar.

In the past tariffs have been used to defend national industries. There is no magic formula for determining what tariffs on what products are needed or justified, so decisions on tariffs tend to be arbitrary and political. The consequence may be that the advantages of trade between nations diminish, and that people will be paying more for foreign products than needed, and that employment may not improve because higher prices reduce demand for other goods and services. Tariffs may also be an incentive for fraud and smuggling.



Natural Money can increase the reward for labour


Profits tend to reflect the risk of doing business and it seems that reducing the risk of doing business will increase the overall level of wealth as well as wealth equality. Unless there is a monopoly, excess profits tend to lead to more competition and a higher demand for labour, which lowers the price of products or increases the price of labour. As profits tend to reflect the cost of doing business, the reward for labour could rise when the risk of doing business is lower. For this to happen, a country must be politically stable and property rights must be respected.

Natural money may help to reduce the risk of doing business, and hence reduce the cost of capital. Because the economy will be more stable with Natural Money, the risk of doing business can also be lower. Consequently the reward that capital requires to be employed can be lower. Local currencies and more employment may also reduce international wage competition, especially if it is combined with a basic income that provides some income security. As a consequence the portion of national income paid out to labour can rise.



Natural Money may need less regulation and government intervention


In a stable economy less useful capital is destroyed by a lack of demand for products and services. More people can have work so there is less need for government assistance for people without income. With Natural Money sustainable investment choices can become rational economic decisions, so the government may not need to encourage them. The economy may do well by itself so the government may not need to interfere. Less government regulation in the financial system may be needed because a restriction on charging interest on money can reduce risk taking in the financial system.

At least it seems that fiscal policies and monetary policies are less needed with Natural Money. Those policies can distort markets. Fiscal policies are government policies that use the government budget to influence the economy. With Natural Money there may be no need to influence aggregate demand so the government can have a balanced budget. Monetary policies are central bank policies to influence interest rates and money supply. With Natural Money the economy may do well without monetary policies. Both fiscal and monetary policies counteract the effects of compound interest by pumping money in the economy.



Stimulating local development


One of the core elements of economic development is specialisation and division of labour, often accompanied by the economies of scale. To some extent those developments can be attributed to interest on money because of the usury economic cycle. It seems likely that a certain reduction in the division of labour can enhance the efficiency of the economy as there may be diminishing returns on investments in social complexity [15].

A small producer such as a farmer only gets a small portion of the price for which a product is sold in a supermarket. Small producers such as farmers have little bargaining power versus large supermarket chains. If products could be produced and sold locally then both producers and consumers may be able to get a better price.

It is possible to issue local and regional Natural Money currencies to support local and regional development. States and municipalities can issue their own currencies that circulate along with the national currency. If they come into existence, those currencies can be used for payments within the state or the municipality. People will be inclined to spend the local currencies first because they can only be used locally. This can stimulate local trade at the expense of long distance trade [16].

Local currencies can give local communities more possibilities to handle their own affairs as those currencies produce income. There are limitations to this concept and it may have undesired consequences. Most countries have wealthyr regions and poor regions. In order to have a uniform level of government service, a central government may be needed.

Local and regional currencies can cause currency confusion as there may be many of them. Most people will only use the currency of their own community, state and country and will use not more than three to five. Still, this can be confusing. Over time people may become accustomed to multiple currencies. Fixed exchange rates and a requirement to back local and regional currencies with the national currency can solve this issue.



Role of the banks with Natural Money


With Natural Money banks operate like commercial banks. Only banks can offer deposit accounts. Banks can guarantee deposits at face value and offer fixed rates to savers. This is possible because the central bank can lend money to banks at an interest rate of zero when they cannot borrow elsewhere. Governments may choose to guarantee deposits at banks to a certain maximum. Banks can only borrow money from depositors and make loans at a maximum interest rate of zero. Banks can only invest in assets that have a fixed yield of zero or less.

Banks have to comply to the following rules:
- Banks can not invest money that has been entrusted to them. They can only lend money without charging interest.
- It is possible to have administrative accounts. Those accounts are similar to cash and not subject to the risk of banking.
- Money in administrative accounts cannot be used for lending so the money in those accounts is subject to the holding tax.
- It is possible to have deposit accounts, such as savings accounts. The money in those accounts is not subject to the holding tax.
- Depositors pay a fee to the bank for mediation costs. Banks can offer different types of deposit accounts.
- Banks can only charge mediation costs to the saver and not to the borrower as fees on loans are interest.
- Banks can charge a maximum interest rate of zero on loans so they tend to select the least risky borrowers.
- Deposits at banks can have a government guarantee and banks can borrow from the central bank.

Non-banks cannot guarantee deposits at face value and cannot offer fixed rates to savers. Non-banks may offer similar services as banks and offer administrative accounts, but their desposits are converted into shares that have a price risk attached to them. Those shares can be converted back into money in an administrative account and used for payment. Non-banks cannot charge interest on money, but they can make investments and offer better returns than banks. In times of emergency, non-banks may temporarily limit withdrawals or opt to become closed-end.



The soundness of Natural Money


Governments can be tempted to issue additional currency. With Natural Money there will be less incentive to do so as there is no case for creating additional currency. Tax income may increase as Natural Money improves the economy. Should the economy slow, which is unlikely to happen, then raising the holding tax has the same effect as issuing additional currency. To boost confidence, savings and loans can be guaranteed as a percentage of money supply.

A restriction on charging interest means that there is no compensation for high risks and only people that are trustworthy will be able to borrow money. People that cannot afford to pay for their necessities and are not able to borrow money can better be helped in another way. The maximum risk compensation is avoiding the holding tax by lending out money at zero interest so banks tend to choose the best borrowers for their loans.

If the economy is booming, it may not be possible to satisfy the demand for loans. The maximum interest rate on money is zero, so it becomes more attractive to invest directly in equity. Promising business projects may be financed at the expense of consumer borrowing. In this way the overheating of the economy may never materialise. If the economy is slowing, interest rates can go negative, inducing people to consume and businesses to invest. In this way a recession may never materialise.

If the amount of money in circulation is stable, economic growth can lower the prices of goods and services, as more goods and services are offered against the same amount of money. The value of loans can increase in real terms, which is interest based on the economic growth of a currency area. A positive return on lending money without interest is possible. An economy with Natural Money may be stronger than an economy based on interest so returns with Natural Money can be higher.



Economic growth


Introducing Natural Money may lead to more economic growth, but it probably will be economic growth of a different kind. Growth in the Natural Economy may be sustainable and increase overall wellbeing if social needs are better addressed. Researchers of the interest free economy like Strohalm, think that economic growth without interest may follow a natural curve instead of an exponential curve. At the same time there will be a higher level of prosperity and well-being [17].

The exponential growth in materials consumption may end. Production means such as machines may be used longer, thus creating those production means may bring more prosperity. Products may be recycled more, creating more purchasing power. An item that is recycled five times can have the same value as five produced items. More prosperity can be created with fewer resources. People may have to work less but extra leisure time can be seen as prosperity.



Periodic debt forgiveness


In The Bible once in seven years a Sabbath Year was introduced in which debts were forgiven (Deut. 15:1-18). Once in the fifty years there was a Jubilee (Lev. 25:8-55). In the Jubilee every man could return to his possession while the land had to be redeemed. The Bible also banned interest [18]. The periodic debt forgiveness in The Bible was not unique as Mesopotamian royal edicts cancelled debts, freed debt-servants and restored land to cultivators who had lost it under economic duress [19].

It is often argued that periodic debt forgiveness and a ban on interest charges will deprive people from needed credit. When there is a holding tax on money this is less likely to happen. The absence of a risk premium in the form of interest and periodical debt forgiveness can refrain potential creditors from letting debtors go too far into debt. It is also in the interest of the borrowers not to borrow more than they are able to repay.

The freedom advocated by the Covenant Code of Exodus, the septennial year of release in Deuteronomy and the Jubilee Year of Leviticus were concrete legal practises freeing rural populations from debt servitude and the land from appropriation by foreclosures [19]. It is reasonable to assume that those concepts can work well today. The creation of debt under a system of interest can be seen as fraud because new debts are needed to pay off the interest on existing debts, making debts grow further.




Interest in history




Joseph in Egypt


The Bible contains a story about the Pharaoh having dreams that he could not explain. The Pharaoh dreamt about seven fat cows being eaten by seven lean cows and seven full ears of grain being devoured by seven thin and blasted ears of grain. Joseph was able to explain those dreams to the pharaoh. He told the Pharaoh that seven good years would come and after that seven bad years would follow. Joseph advised the Egyptians to store food in large storehouses. They followed his advice and built storehouses for food. In this way Egypt survived the seven years of scarcity (Gen. 41:1-45).

What is less known, because it is not recorded in The Bible, is that the storing of food resulted in a financial system. The historian Friedrich Preisigke discovered that the Egyptians used grain receipts for money and had built a sophisticated banking system based on this money [20]. Farmers bringing in the food received receipts for grain. Bakers who wanted to make bread, brought in the receipts which could be exchanged for grain. According to the Bible, Joseph took all the money from the Egyptians (Gen. 47:14-15). This may have prompted them to invent an alternative currency.

As a consequence the grain receipts may have been accepted as money. The degradation of the grain and storage cost caused the value of the receipts to decrease steadily over time. This stimulated people to spend the money. There was credit in this banking system, and most likely it was interest free. The grain receipt system lasted for many centuries. The actions of Joseph may have created this system as he allegedly proposed the grain storage and took all the money from the Egyptians. When Joseph came to Egypt, the country had already passed its zenith and the time of the building of the great pyramids was centuries earlier.

A few centuries later, during the reign of Ramesses the Great, Egypt became again a leading power [21]. Some historians suggested that the wealth of Egypt during the reign of Ramesses the Great was built upon the grain financial system [22]. The grain money remained in function in Egypt after the introduction of coined money around 400 BC until it was finally replaced by the Roman currency. The money and banking system were stable and survived for more than a thousand years. It seems therefore possible to have a sophisticated banking system with Natural Money.



Solon's economic reforms


Around 500 BC agricultural output in Greece was not able to keep up with increasing population. Because of interest charges, mostly paid to city people, the debt load for farmers had gotten out of hand so that many of them could no longer pay their debts and were forced into slavery. Farms became the property of rich city people who did not understand farm work, while slavery did not contribute to the productivity of agriculture [23].

Harvests declined and the people in the cities were threatened by famine. Solon realised that a healthy countryside is a countryside without debts. Farmers who understand the business of farming must make their own decisions. The farmer's ambition to improve himself is indispensable for a vital countryside. Solon introduced drastic measures eliminating all existing debts. To avoid the expansion of new debts, a limit was also set to the rate of interest and the accumulation of land [23].

Solon's reforms were concentrated on the constitution and the economy and his reforms on debt and interest are just one of them [24]. Solon also set a moral example. He identified greed as having negative consequences for society. The modesty and frugality of the rich and powerful men of Athens may have contributed to the city's subsequent golden age. Solon, by being an example and by reforming legislation, may have established a moral precedent [24].



The decline of Rome


A number of historians and economist investigated the decline of Rome and consequently a number of theories have been proposed to explain this historic event [25]. For the Natural Money research, economic theories are the most relevant. In the fifth century the Roman historian Vegetius pleaded for a reform of the weakened army. The Roman Empire, and particularly the military, declined largely as a result of an influx of Germanic mercenaries into the ranks of the legions. This led not only to a deterioration of the standard of drill and overall military preparedness within the Empire, but also to a decline of loyalty to the Roman government in favour of loyalty to commanders.

There was a slump in agriculture and land was withdrawn from cultivation. High taxation on cultivated land was probably to blame. Another factor may have been the debasement of the currency that led to inflation. Apart from an expansion of the state, the debasement could also have been caused by interest on money as usurers may have amassed most of the gold and silver in the Roman Empire. Price control laws resulted in prices that were significantly below their free-market levels. The artificially low prices led to a scarcity of food. Together with increased taxation and oppressive laws, this led to a decrease in prosperity. In the Decline and Fall of the Roman Empire Edward Gibbon wrote:

Unable to protect their subjects against the public enemy, unwilling to trust them with arms for their own defence; the intolerable weight of taxes, rendered still more oppressive by the intricate or arbitrary modes of collection; the obscurity of numerous and contradictory laws; the tedious and expensive forms of judicial proceedings; the partial administration of justice; and the universal corruption, which increased the influence of the rich, and aggravated the misfortunes of the poor. A sentiment of patriotic sympathy was at length revived in the breast of the fortunate exile; and he lamented, with a flood of tears, the guilt or weakness of those magistrates who had perverted the wisest and most salutary institutions.


Taxation was spurred by the expanding military budget, which was the result of the barbarian invasions and the use of mercenaries. Two centuries later the Eastern Roman Empire managed to survive the invasion of Arabs by introducing local militia that were not paid from the treasury but from local revenues [26]. Over time the ranks of the militia were filled with local people that had an interest in defending their own land.

Roman money was based on gold and silver. Contrary to the Egyptian corn receipts, this money could be hoarded and moved abroad. This meant that when the Roman Empire started to decline, money may have disappeared from circulation. This may have reduced trade and impaired the economy. Because of this, the expansion of government and the barbarian invasions, the government was permanently short of funds, causing a debasement of the currency and a rise of taxes that further burdened the Roman economy. In the end the invading barbarians may have been considered liberators.



Western Europe in the Middle Ages


Restrictions on charging interest

After the Roman Empire collapsed, feudalism became the predominant political and economic system in Western Europe. The power in Western Europe became fragmented, so trade diminished and money became less important. Gold disappeared from circulation. Most transactions however were done as barter while taxes were mostly paid in kind. There were metal coins as well as promises [27]. From around 1100, money became increasingly important as both trade and cities grew at a steady pace and gold reappeared in Western Europe.

From the year 300 onwards, the church restricted charging interest. Rates above 1% per month where considered to be usurious and evil. There was no enforcement of the restrictions and charging interest remained common practise in trade [28]. In 784 the Council of Aachen forbade charging interest altogether. In Western Europe this rule was more strictly enforced during the subsequent centuries [29]. In the Byzantine Empire, restrictions on interest remained less strict, possibly because economic life was more developed, which made it more difficult to enforce a full ban on charging interest [29].

The restrictions on charging interest did not hamper economic development in Western Europe. When the ban on usury was first imposed, Western Europe was backwards compared to the Byzantine Empire and the Arab world, but during the centuries that the ban on charging interest was in force, Western Europe managed to become a dominant power. By the year 1100 when the Crusades started, Western Europe had enough resources to spend on a long war that lasted two centuries. The crusaders maintained long supply lines of thousands of kilometres, while the conquered land was not profitable.

When economic life in Western Europe became more developed, the ban on charging interest became more and more difficult to enforce. In the 14th century partnerships emerged where creditors received a share of the profits from a business venture. As long as the share in the profits was not fixed, this was not considered to be usury [30]. Over time contracts were devised to evade the restrictions on charging interest. Rents on property were allowed so the definitions of rent and property were extended. During the 15th and 16th century, the restrictions on charging interest became untenable and were gradually lifted [31].


Fiat and scrip currencies

In the second half of the Middle Ages some lords started to issue fiat and scrip money. The fiat money had a value because they could be used to pay taxes. Apart from making money legal tender, taxes can give value to money issued by governments. The scrip money was valid for a limited period of time. After that period the the money had to be returned to the ruler who exchanged it for new money that also was valid for a limited period of time. During the exchange a tax was levied. The actual value of the scrip currency decreased slowly during the period it was valid and was the lowest just before the tax was due.

An example of a fiat currency is the tally stick introduced by King Henry the First around 1100. Henry introduced sticks of polished wood, with notches cut along one edge to signify the denominations. The stick was then split full length so each piece still had a record of the notches. The King kept one half for proof against counterfeiting and spent the other half so it could circulate as money. Only tally sticks were accepted by Henry for payment of taxes so there was a demand for them. This gave people confidence to accept tally sticks as money. The tally sticks remained in use until the early nineteenth century [32].

An example of a scrip currency is the brakteaten. The brakteaten was used in Europe between 1150 and 1350 and brought a lot of prosperity. Brakteaten coins were silver plaques called back by the local authorities from time to time and then reissued with a new image. During reissuing a tax was levied that amounted to a holding tax. At first the currency was only reissued when a new ruler came to power. Later on the silver plaques were called back on a regular basis. Rulers started to abuse the currency and holding taxes reached 6% per month. This burden became so heavy that the brakteaten currencies were shunned [20].



The business of goldsmiths


The goldsmiths of seventeenth-century London developed banking in its modern form. The goldsmiths united into one business activity functions such as: maintaining safe storage of gold, silver, and deposits of money, loaning out deposits of money (as well as their own money), transferring money holdings from town to town or person to person; trading in foreign exchange and bullion, and discounting bills of exchange. Before the goldsmith bankers these activities were often by-products of other trading activities [32].

The goldsmiths invented fractional reserve banking, which is the practise of creating money out of nothing. People stored their gold in the secure safes of the goldsmiths in exchange of receipts declaring gold ownership. The name of the owner did not appear on those receipts, so they could be used as money. Most of the gold never left the safe so the deposited gold could be used to cover loans. The goldsmiths then discovered that they could also issue loans for which there was no gold in the safe [33]. The goldsmiths caused an increase in money supply that spurred economic growth in England and this may have ignited the Industrial Revolution.

Fractional reserve banking is a cause of financial instability. There were more claims on gold circulating than there was gold in the vaults of the goldsmiths. As long as the claims were trusted, this was not a problem. As soon as the owners of the receipts started to question the gold backing of the receipts and reclaimed their gold, there was not enough gold in the vaults. This is called a bank run. For that reason, the practise of fractional reserve banking became regulated, and central banks were created to deal with bank runs. Fractional reserve banking first appeared in England and in 1694 England did get the first central bank.

Fractional reserve banking and central banks are considered with distrust as there is a kind of fraud involved that requires a centralisation of power in the hands of governments and banks. The fraud is creating money out of nothing and charging interest on this money. This produced the need for central banks and a greater involvement of governments in the economy. With fractional reserve banking, money is created under the agreement that more money is returned, resulting in a constant shortage of money. This shortage can only be resolved with new loans and more debt until debt reaches infinity [33].



Socialism and Communism

 
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During the Industrial Revolution the world's average per capita income increased but in the nineteenth century most people did not feel that they profited from those developments. Many independent artisans lost their job and income. There was resistance, such as the Luddites. The Luddites were a social movement of British textile artisans in the nineteenth century who protested, often by destroying mechanised looms, against the changes enforced by the Industrial Revolution, which were leaving them without work and destroying their way of life.

Factory owners became rich but workers remained poor. The social conditions of the nineteenth century gave rise to Marxism. According to Marxist theory, workers were exploited because the value of their work was higher than the wages they received from the factory owners. Marxists thought that the surplus value of the labour turned up as profit for the factory owners. The Marxist analysis lead to the conclusion that capitalism oppresses the proletariat, the inevitable result being a proletarian revolution.

Marxism has not been able create a society that suited the needs of workers better. Socialism eliminates markets and takes away the incentive to adapt economic output to demand, which is the primary function of markets. The end result is often that most people remain poor, which another way of saying that there is no supply to meet demand. Over time the conditions of workers in the capitalist societies improved while those in communist countries lagged behind. It turned out that planned economies without markets were a failure.

The Marxist analysis still points at the fact that the accumulation of capital results in an unequal distribution of wealth, which is a tendency that is still prevalent in developed economies. At some point a few people possess most means of production while the impoverished masses have no money to buy the products they make. If demand collapses, factories close and capital is destroyed. Marxists view this development as the crisis of Capitalism. This crisis may have been postponed by the expansion of debt and de lowering of interest rates in recent decades.

This development cannot not only be attributed to interest on money, but also to the expansion of capital in general. Interest on money may be the most harmful component as interest on money destabilises the financial system. The expansion of capital makes the economy productive, so mechanisms have to be invented to stop this development from becoming destructive. The problem may be aggravated by big businesses buying politicians. Governments redistribute income, but this did not prevent the emergence of large estates, so more may be needed.



Nazi-Germany


After Adolf Hitler rose to power, Germany issued new debt free government money called MEFO bills to finance rearmament and public works. By 1938, Germany had a stable currency and unemployment was practically extinct. Wages increased by 10.9% in real terms during this period. However, nationalisation and a cutting off of trade meant rationing in key resources like poultry, fruit, and clothing for many Germans [34].

On the surface, the recovery appears to be a miracle. The German project was Keynesian experiment before Keynes first wrote down his theory in 1936. Inflation was kept in by check government controls of the capital markets, a rationing of imports and a reliance on foreign credit. Foreign credit was available as some countries were eager to export their surplus products during the Great Depression [35].

By 1936 Germany ran out of foreign currency reserves and this proved to be a turning point for the German trade policy. Hjalmar Schacht was replaced by Hitler's lieutenant Hermann Göring, with a mandate to make Germany self-sufficient to fight a war within four years. Under Göring imports were slashed, wages and prices were controlled and dividends were restricted [34]. The Nazi government tried to limit the number of its trade partners, and, when possible, only trade with countries within the German sphere of influence [34].

The German economic miracle still attracts attention because the Nazis seemed to have found a way to achieve full employment during the Great Depression. Nazi Germany is an example of a successful implementation of Keynesian thinking. Adolf Hitler identified international finance and interest charges as causes of economic suffering, which gave Adolf Hitler a few admirers in alternative circles that are critical about banking and interest. Henry C.K. Liu wrote the following [36]:

The Nazis came to power in Germany in 1933, at a time when its economy was in total collapse, with ruinous war-reparation obligations and zero prospects for foreign investment or credit. Yet through an independent monetary policy of sovereign credit and a full-employment public-works programme, the Third Reich was able to turn a bankrupt Germany, stripped of overseas colonies it could exploit, into the strongest economy in Europe within four years, even before armament spending began.




Interest and war


World War I

World War I has been caused by a number of factors, such as the rise of nationalism, the system of alliances, arms races and military planning, imperial and colonial rivalry for wealth and power and economic rivalry in industry and trade. Most historians agree that economic factors played a significant role in the rivalry between nations before World War I. In the years before 1914 the final conquests in Africa were made and further colonial expansion had become impossible. European colonial expansion started around 1450. Its main driver had been the lure of profits and interest from economic adventures.

It may not be a coincidence that World War I started just after further colonial expansion became impossible. The tensions that were building before 1914 probably could have been fuelled by economic stress caused by the need for economic expansion imposed by interest on money. With fractional reserve banking, money is created under the agreement that more money is returned, resulting in a constant shortage of money. This shortage can only be resolved with new loans and more debt. To pay the ever increasing interest, more and more economic activities are needed. This may have and important underlying cause for World War I.

According to G. Edward Griffin and Rothbard, bankers have played an important role in the entry of the United States in World War I. European governments started issuing war bonds. England and France selected the House of Morgan in the U.S. to act as their sales agent for the bonds while American big business started to work for the Allied cause. If the allies would lose then the allied bonds were going into default. The US Treasury could make direct grants to the Allies but only if the U.S. entered the war. After the United States entered the war, the Allies credits were extended so the loans to Morgan could be to paid off. In this way the Morgan was saved.


World War II

Interest on money and fractional reserve banking have also been important underlying causes for World War II. World War II had not been possible if Adolf Hitler had not risen to power. This happened for a number of reasons. They can be summarised as follows:
- The Peace Treaty of Versailles was humiliating for Germany and a direct consequence of World War I. Interest on money and fractional reserve banking may have been important underlying causes for World War I.
- The economic hardship and the Great Depression are often seen as important causes for the rise of Adolf Hitler. Economic cycles and economic depressions are caused by interest on money and fractional reserve banking system.
- Anti-Semitism in Germany helped Adolf Hitler. This can be traced back to the Middle Ages when charging interest was forbidden in for Christians in Western Europe. Only the Jews were allowed to charge interest on Christians. As a consequence Jews have had a predominant position in money lending and banking. Economic suffering caused by banking and charging interest have been important causes of anti-Semitism.


Petrodollar warfare

As the United States had a negative trade balance for decades it became impossible to keep the US dollar on the gold standard. In 1971 the United States terminated convertibility of the US dollar into gold. The US dollar could keep its reserve status, partially because oil was traded in US dollars. The American Empire depends on the US dollar being accepted as a reserve currency. It is sometimes argued that the United States is waging wars in the Middle East to support the reserve status of the US dollar [37]. For example, it caused suspicion that the Iraq war started after Saddam Hussein had made the move to accept euros instead of US dollars for oil [38].

The Central Bank of Libya was 100% state owned. Gaddafi was ousted at a time he was planning an all-African currency for conducting trade. He also planned to quit selling Libyan oil in US dollars, demanding payment instead in gold-backed dinars. France was the first country to support the Libyan rebels and its leader Nicholas Sarkozy called Libya a threat to the financial security of mankind [38]. One of the first acts of the Libyan rebels was to create a new central bank [38]. According to Ellen Brown, Libya challenged the supremacy of the dollar and the Western banks like Iraq under Saddam Hussein [38].

The Clash of Civilizations is sometimes seen as a war against Islam, but can also be seen as an example of petrodollar warfare. Coincidentally, or probably not so, Islam is the only remaining religion opposing interest on money. Historically Christianity was opposed to charging interest and Judaism taught Jews not to charge interest to their fellow Jews. The Clash of Civilisations can be seen as a consequence of forced economic expansion caused by interest bearing. Tens of millions of people were killed in the process, such as the indigenous people of America. The quest for a better social model has killed tens of millions of people more.




Will it work?




Superior efficiency can enforce the change


Natural Money can improve the performance of the economy. The holding tax can provide a constant stimulus. There may be less need for government and central bank intervention that can distort markets. Debts cannot grow out of control as there are no interest charges. There is a limited reward for risk on debts, so risky lending will be curbed. As a consequence the economy may perform better and there may be fewer economic crises.

The holding tax on Natural Money is an incentive to use the money for investment, consumption or lending without interest. As the economy performs better, while no additional currency is created, money supply can stabilise. When there is economic growth, more goods and services are offered against the same amount of money, and prices can fall. If prices fall, the value of the currency rises and zero interest loans can have positive real returns.

If economic growth improves, which seems likely given the performance enhancements embedded in the design of Natural Money, real returns on capital can also improve. This implies that real interest rates on Natural Money deposits can also be higher. This implies that, as soon as Natural Money is applied somewhere, there can be a capital flight to the interest free economy. This can force the rest of the world to adopt Natural Money.



Uncovering the prequisites


The complementary currency of Wörgl was a stunning succes, but other experiments with free money did not yield similar results. It was a fluke, but it highlighted a hidden potential. At least in theory, it seems possible to have stable economic growth without unemployment, or something close to that. The ideas of Silvio Gesell have fallen out of grace as they seem impractical to work with. To get it right seems to be a major challenge.

It seems important that the currency is legal tender and the only payment for taxes the goverment accepts. The existence of competing currencies, such as Bitcoin does not seem to be such a problem, as they often do not have a holding tax. As a consequence the Natural Money currency will be used for transactions. Investing in Natural Money deposits can also be more profitable. It seems that Natural Money can work under the same conditions as existing fiat currencies.

People are not familiar with the concept of Natural Money. It requires a new way of thinking. People are used to receiving interest on deposits and may object to paying for having deposits in the bank. The idea that the money may be worth more in the future, may not be very appealing unless they can see that they are better off. Educating people about Natural Money before implementing it seems an imperative.

Money illusion can be a serious problem with Natural Money. People may find it difficult to accept lower wages or selling their house at a lower price, even when all other prices drop. Price inflation is more easy to cope with as price inflation makes it appear that people have more to spend even when this is not true. Natural Money may make it appear that people have less to spend even when real incomes rise.



Maximum interest rate


Maximum interest rates have caused trouble in the past. If market interest rates exceed the maximum interest rate then investors will seek alternative investments and banks can become short of funds. In the United States there have been maximum interest rates on bank deposits for decades. The system came under stress because alternatives were offered, such as money market funds. As a consequence, maximum interest rates were phased out in the 1980s [39].

With Natural Money, banking is separated from other types of business, and only banks are able to guarantee the value of their deposits as there is a central bank to guarantee liquidity and a government to insure deposits. Other financial institutions must issue shares that have a price risk attached to them, but people may find the higher rates they offer more attractive and withdraw deposits from the banking system. This can cause a liquidity crisis in the banking sector.

The question is whether or not market interest rates will exceed the interest rates banks can offer on their deposits. The maximum interest rates in the United States did not cause any trouble when market interest rates were low. The maximum interest rate on Natural Money can be a positive real return. In a mature economies with stable political systems and respected property rights, interest rates may remain low enough for Natural Money to succeed.

In Japan near zero interest rates have existed for decades. Japan could be a harbinger of what is to come for the rest of the world. Because of compound interest, debts tend to go to infinity. When debts reach infinity, they can only be sustained by zero or negative interest rates. The alternatives to zero or negative interest rates are widespread defaults and destroying the currency. This leads to a destruction of money and creates new room for positive interest rates.



Fractional reserve banking


The current financial system is based on fractional reserve banking. Banks are required to keep a certain amount of cash to meet demands from depositors. This cash is called reserves and the amount of reserves is a fraction of the total deposits. Fractional reserve banking is criticised because banks have not enough cash to cope with a large amount of depositors withdrawing their deposits.

With fractional reserve banking money is created as a debt on which interest must be paid. When there is a limited amount of currency units or gold this scheme must run into trouble in the long run as the amount of debt tends to grow because of interest. At some point there may not be enough currency or gold to stabilise the system. With Natural Money there is no interest on money, so this will not happen.

In theory banks can create an unlimited amount of money as Natural Money does not specify a reserve requirement. Borrowing money from the central bank is expensive so banks will be encouraged to keep adequate reserves. As interest is also a reward for risk, a maximum interest rate could make banks more conservative.




Frequently asked questions


 
Monopoly 1935
 


Questions about money supply and debt


Can the economy grow with a stable money supply?

Prices can adapt to the available amount of money. This can be demonstrated by the game of Monopoly. In the sandard version bank notes have denominations ranging from 1 to 500. There are also games with bank notes that have denominations ranging from 100 to 50,000 and all prices are multiplied by 100. Still, the game is exactly the same. Economists often assume that if there is economic growth, more money is needed to support it. However, the quantity of money is not the same as the denomination on the bank note. If prices drop, the amount of money buys more goods and services.

With Natural Money the economy may grow while the amount of currency is stable. As there is a maximum interest rate, direct investments may be preferred to loans, so the amount of credit can also stabilise. Economic growth implies that more goods and services become available, so prices can drop and the value of the money can rise. This can be explained with the equation M*V = P*T. If the amount of money M is constant, and the rate at which money circulates in the economy V remains stable over time, then economic growth will reduce the price level P because it increases the value of economic transactions T.

Money illusion can be a serious problem with Natural Money. People may find it difficult to accept lower wages or selling their house at a lower price, even when all other prices drop. Price inflation is more easy to cope with as price inflation makes it appear that people have more to spend even when this is not true. Natural Money may make it appear that people have less to spend even when real incomes rise.


Can the economy collapse if debt is not increasing?

The following example demonstrates that interest on money is unsustainable in the long run. If someone brought a 1/10 oz gold coin to the bank in the year 1 AD, and the money remained there until the year 2000 AD, collecting a yearly interest of 4%, the amount of gold in the account would have weighing 6,000,000 times the complete mass of the Earth. The yearly interest would have been 240,000 times the complete mass of the Earth.

As interest must be paid from debts, the scheme would have collapsed long before that. At some point people would not be able to repay their debts. There is not enough gold to sustain the scheme. Some ways to avoid or postpone a collapse are lowering interest rates, printing currency and thus inlflating debts away and encouraging people to go further into debt. This has happened in recent decades.


Is it not better to introduce a gold standard to curb the growth of debt?

The gold standard had been in force throughout the 19th century. Between 1815 and 1914 there was no major war in Europe while the Industrial Revolution increased overall living standards. Proponents of the gold standard think that it may still work well today. Gold and silver can be stored in a safe so it is not possible to levy a holding tax under the gold standard. As a consequence there will be no incentive to lend out money without interest.

The gold standard can enforce monetary discipline but it may be a harsh form of discipline. There may be depressions from time to time as bank runs can cause financial crises. The creation of central banks did alleviate that problem, but this also allowed for a centralisation of power in the hands of central banks. A renewed gold standard may eventually revert back into fiat currencies like we have now because interest on money is unsustainable in the long run. At some point there may not be enough gold to stabilise the financial system and the gold standard will be defaulted upon.


Why is it that the problems in the interest based financial system come to light right now?

If economies grow then leverage can make interest work positively for the economic development, because the extra growth above the interest adds to prosperity. That we see in emerging economies, but also in many European countries in middle of the last century. Once the economy turns into a mature phase, economic growth becomes a mere statistical fiction. The growing debt will become a drag on the economy.

In 1971 the link between gold and money, which over the years had become increasingly detached, was completely deserted. Financial innovations have since then created the possibilities for debt to grow further. This did not seem a problem for a long time. Now debts have become so large that many people get into financial trouble and the interest based financial system is at risk.



Questions about money without interest


May capital earn interest?

Capital should earn interest otherwise there will be no incentive to employ it. Only interest on money should be forbidden and money should not be capital. Gold and silver are capital because it takes effort to mine precious metals so gold and silver cannot be lent without interest. Fiat money is not capital as it requires little effort to produce. For this reason fiat money is not capital and does not need interest.


Is money without interest money for free?

In the current financial system banks and governments can create money with little effort. This is money for nothing. The value of loans reduces over time because of price inflation. Natural Money is not for free because the money supply is constant. The borrower has to pay back the same value. If the economy grows then the value of the loan increases. The interest based financial system penalises savers when interest rates are low and borrowers when interest rates are high.


How does a ban on interest reduce excessive risk taking?

Since there is no allowance for risk money will only be lent money to credit worthy people and businesses. Without interest payments the credit worthiness of borrowers will not be eroded. Because of the holding tax on money, there are no booms and busts. It is less likely that borrowers get into trouble because changing economic conditions.


Is a saver worse off without interest?

The interest rate the bank pays to savers is often lower than the price inflation rate, and nearly always lower than the growth of money supply. When the value of money is not eroded by printing of money, savers will be better off with zero percent interest in most cases. In the Natural Economy economic growth increases the value of money so there is often a real return on money without interest.


Is a borrower worse off without interest?

If the interest rate on the loan is lower than the inflation rate, a borrower will be worse off without interest. This is usually not the case as most loan rates are higher. In recent years interest rates for high quality mortgages have been low. Often they have been lower than the increase in money supply.


Interest rates in Japan are near zero percent. Does Japan have Natural Money?

The interest rates in Japan are low but this is not Natural Money. About 20 years ago, the banking system in Japan had been inflated by credit. Since then interest rates have been around zero percent to prevent a collapse of the monetary system. For the same reason interest rates in the United States and Europe have been low in recent years.


Do Islamic countries have Natural Money?

Charging interest is forbidden for Muslims, like it was for Christians. Islamic banks take a share of the profit of the companies they invest in and depositors get a share in the profit of the bank. Islamic banks do not lend money at interest but invest in the operations of their customers. Islamic banks do not provide loans at zero interest.



Questions about banking with Natural Money


Should banks be nationalised?

Banks have a special role in society because they are keepers of the financial system. With Natural Money banks must not be able to use money entrusted to them for investing. They must use all funds to make loans without interest. Banks can do this for their own risk. Banks should get an compensation for the risk of loans not being repaid. Depositors will pay for this compensation. Banking for profit is possible with Natural Money so banks can be private companies.


Are savings safe with Natural Money?

The Natural Economy will be stable. Bankruptcies and bad debt are rare. When certain loans cannot be repaid, depositors may loose some of their money. As there are less economic crises with Natural Money, it is less likely that a bank will become insolvent. Liquidity issues may occur more often when banks are smaller. This may mean that deposited money can be locked in a savings account until loans are repaid.



Economic questions


Should a government protect national businesses and employment from international competition?

Competition from abroad is not the cause of the financial crisis nor is it the true cause of unemployment. The free flow of money in international financial markets is causing crisis and unemployment as countries can manipulate currency rates in order to sustain unbalanced trade. With Natural Money international trade will be balanced as the holding tax on money will make it unattractive to hold currency reserves.

When trade is balanced then the stimulus of the holding tax will remain within the borders of the country. It is also possible to have a basic income as countries do not have to fear international competition. Consequently there will be sufficient employment and income security for the citizens.


Will Natural Money make international trade more difficult?

It is more difficult to have deficits or surpluses on the current account for a longer period of time. When a country pays another country in Natural Money for goods or services, the other country is encouraged to lend out the money or use the money for investment or consumption in the issuing country.

It is possible to have an international currency unit, which can be based on all Natural Money currencies in circulation. The holding tax rate of the international currency unit can be a weighed average of the holding tax rates of the underlying Natural Money currency units. The proceeds of the holding tax will go to the governments issuing the Natural Money currencies. There may be a surcharge on the international currency unit for international organisations like the United Nations.



Questions about the transition to Natural Money


Is a transition to Natural Money possible?

It is possible to start up local Natural Money currencies. If they are a success then more local Natural Money currencies will be set up and countries will become interested in introducing Natural Money on a national scale. Change will come when the problems are serious and when successful examples have demonstrated that Natural Money is the way out of the current crisis. The stakes are high so the power that be will try to block the reform.


How can a transition to Natural Money take place?

There are two approaches to the transition to Natural Money: gradual and big bang. During a big bang approach all balances are converted to Natural Money currencies after a political decision. A big bang will require a large effort in a short period of time. People have to be informed and businesses have to adapt their administrative systems in this short period. A big bang is risky as it is difficult to address issues that emerge during the transition.

In a gradual approach Natural Money currencies spread and replace interest bearing currencies for payment. During the initial phase Natural Money currencies are backed by interest bearing currencies and there is a fixed exchange rate between them. During the gradual approach issues can be addressed when they emerge and this provides the flexibility to make the process of transition as little disruptive as possible.

The introduction of Natural Money may undermine confidence in the interest based financial system and consequently banks may fail. The government may be forced to take over the administrative systems of the banks in order to let payments continue without disruption. The government may also be forced give a guarantee on deposits. A debt forgiveness may also be executed but this issue may also be addressed after the transition.


How can deposits and debts be converted into Natural Money?

All debt denominated in fiat currency is not worth more than the currency itself. As money is converted to Natural Money, deposits and debts will also be converted to Natural Money. After the conversion debts will be interest free while depositors will pay a compensation to the bank. Deposits are not subject to the holding tax and the compensation paid to the bank will be a fraction of the holding tax so deposits will still be attractive. If the transition is gradual then debts and deposits must be transferred to Natural Money in the same pace.



Political questions


Why do governments encourage debts of consumers and businesses?

To keep the economy growing, debts have to grow. Deposits grow because rich people can save money and receive interest on this money. If deposits grow while now new debts are made then the money supply decreases and this weakens the economy. Debts have to grow otherwise the economy collapses and the interest on the debts cannot be repaid.


Is a holding tax on money a tax on the rich?

The holding tax on money is not a tax on capital. Stocks, real estate and money lent are not subject to this tax. The holding tax on money is aimed at keeping the money in circulation, so the economy will not falter. The purpose of the holding tax is not to redistribute money.


Is inflation not a holding tax on money?

Inflation is not the same as a holding tax on money. Apart from fluctuation in supply and demand for goods and services, inflation is caused by increasing the money supply, even though this link is not always directly visible. Inflation is a stealth tax on money and many people are not aware of this.

With Natural Money the money supply does not grow but money is taxed directly, which makes the taxing visible. The holding tax will also stimulate people to circulate the money. Inflation does not have the same effect unless the inflation rate is high. High inflation can undermine the confidence in the money.


Why do religions condemn interest on money?

The Bible and the Quran state that interest on money is forbidden [+]. The Jews wrote this rule down in the Old Testament. In Islam interest is forbidden. Christianity also condemned charging interest on money. Based on the evidence it is likely that God sees charging interest as one of the most gravest sins.


What is the relation between interest and mass migration?

Economic refugees are coming to rich countries in increasing numbers. The driver behind mass migration is the difference in wealth between rich nations and poor nations. Interest on debts made it difficult for poor countries to reduce their debt burden. Poor countries have lured into debts to create profits for the oligarchs [+].

In his book War Cycles Peace Cycles Richard Hoskins argues that interest on money causes migration. According to Hoskins the consequence of having a debt/usury-based monetary system is a declining birth rate. When interest compounds debt over time, due to the lack of enough money to pay the existing debts, the debt-plagued native population stops reproducing due to the high cost of living.

This in its turn leads to the influx of foreign peoples. Hoskins states that mass immigration is an absolute necessity for any interest based system since new money must always be borrowed into existence. Immigrants represent new debt-free borrowers and bank customers [+].


What is the relation between interest and war?

When an economy collapses because the interest on debt can no longer be paid, the following scenarios can unfold:
- A war can be started to obtain access to new markets so the economy can grow to sustain more debt and interest payments.
- It is possible that a war will be started to ensure that the financial collapse will be attributed to the war and not to the banking system and interest payments.
- It is possible that a war is started to increase inflation by printing money. This eliminates debt and generates new economic activities.
- A chain reaction of bankruptcies may emerge as the economy goes into a depression. Many people will become dissatisfied. The leaders of a country may then look for an enemy to draw away the attention of the public from the economy.

In his book War Cycles Peace Cycles Richard Hoskins argues that a consequence of having a interest based economy is war. According to Hoskins wars are typically fought as a desperation measure to stimulate an economy suffering from the effects of deflation, which is a consequence of interest on money. Wars tend to have the effect of providing a short-term stimulus to the economy since new money has to be borrowed into existence in order to fight the expensive battles while industry is provided an excuse to begin operating at full capacity again. This is followed by a "peace" phase of non-aggression, completing an idealised cycle of approximately 50 years. Hoskins identifies his War/Peace Cycle with the 50-year "Jubilee Cycle" mentioned in the biblical book of Leviticus. Without interest bearing debt there could be no such cycle [+].




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