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An Overview of Economic History


 
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Compounding interest


A new financial and economic crisis may be coming. A major cause of financial crises is interest. Interest compounds, and in the long run this compounding amounts to infinite. When there is a limited amount of money or wealth this could become a really big problem. I will now explain why.

Assume that Jesus' mother had put a small gold coin weighing 3 grammes in Jesus' account at 4% interest in the year 1 AD. Suppose now that the account was kept for Jesus' return. How much gold would there be in the account in 2015? The answer is an amount of gold weighing 10 million times the mass of the Earth.

Bankers promise to pay back the money in deposit accounts but their promise depends on the borrowers paying back their loans. And if Jesus really had come back in 2015, and if there really had been such an account, this certainly would have been a day of reckoning. Bankers and governments have been busy to come up with solutions.



Becoming more flexible


The problem of compounding interest caused financial crises and so that central banks have been invented to help banks in trouble because of people wanting to have their deposits paid out in gold. Central banks could provide this gold if needed. This worked for a while but interest kept on compounding. In 1929, after a major financial crisis, the Great Depression began. A solution was to reduce the value of money so that some of the compounding was reversed.

Reducing the value of money worked for a while, and as a side-benefit, governments could spend more than they received in taxes, and set up welfare states. Most economists in the aftermath of World War II thought that this idea helped to spur economic growth. It certainly countered the effects of compounding interest. After some time inflation began to become a more serious problem, and it could only be curbed with high interest rates and reducing welfare spending.



Ending inflation


Central banks then pledged to control inflation by raising interest rates if needed, and the expectation that they would do this, became a self-fulfilling prophecy. In the meantime, central banks printed money when there was a crisis, and depositors wanted to take out their deposits. Because the money wasn't gold, central banks banks could create as much money as needed, and there was no real limit to the amount of debts that could be created.

But interest kept on compounding and there was a steady flow of money to the wealthy from the rest of us. The neoliberal policies that started in the 1980s implied that there was less room for governments to redistribute income and to counter the effects of compounding via welfare spending. And as most people didn't see their incomes rise, they had less money to spend, so that business profits were lagging, and interest rates had to go down.



The age of financial engineering


There is no real limit to the amount of debts that can be created so these lower interest rates could be used to let the rest of us to go deeper into debt. Many new financial products with fancy names where invented, but they were all just means to increase the amount of debt in the financial system, so that people could buy more stuff and corporations could make more profits. Most profits ended up in the financial sector.

And it all worked great for a while. Most notably in the 1990s everything looked fine. There wasn't so much inflation in real stuff such as food and clothing that the rest of us buy, but only in financial stuff such as stocks and real estate, that the richest people buy. In the 2000s people were increasing their mortgages to buy stuff that they couldn't afford. Not surprisingly, it didn't end well. In 2008 there was a serious financial crisis.



What happened?


Despite lower interest rates, there had been more compounding than ever before, because there was far more debt than ever before, so that a situation emerged in which the top 10% richest people own most of the money, stocks, and real estate. And this is how a game of Monopoly often ends. In many ways capitalism is like this game, because the compounding of interest causes everything to end up in the hands of a few wealthy people.

Interest on capital cannot exceed the rate of economic growth indefinitely, at least if most interest income is reinvested, which often happens when wealth is distributed unevenly. Wealthy people tend to invest more than they consume because that was the reason why they became wealthy in the first place. It is in their nature to do so. This problem has always been obscured because wars destroyed a lot of capital and because of welfare spending and inflation.



And now for a solution


A solution is to induce the richest people to spend more so that growth doesn't have to come from the rest of us going deeper into debt. How can we make that happen? You can't expect rich people to spend more because it is better for the rest of us. It is not in their nature to do so. But there is a way, which is inducing them to spend using negative interest rates. There is a problem. Lower interest rates allow the rest of us to go deeper into debt.

There is a solution for that too, which is setting the maximum interest rate on loans to zero. First, interest is partially a reward for risk, so that you cannot borrow more at a maximum interest rate of zero when you already have borrowed a lot. There is no reward for the lender to take too much risk. Second, there is no compounding, so that borrowing will not eat away the future income from the rest of us, so that in the end, we have more money to spend.



Natural Money


Natural Money means that there is a holding tax on cash of about 10% per year. If you put your money in a bank account, you may only pay around 2% per year because the bank lends out the money. The maximum interest rate on loans is zero. There is no inflation and prices may even drop because there is no need to print more money to counter the effects of compounding interest. In this way a negative interest of 2% may be an acceptable yield.

Natural Money can be implemented only if most lending is already done at interest rates below zero. Currently, that is not yet the case, so that the compounding of interest continues, and in the end will cripple the economy. There probably will be no inflation because the rest of us don't have enough money to spend, so that in the end, there will be no other option than to start implementing negative interest rates.



Benefits


There are a number of benefits to Natural Money, which are explained on this website, such as:
- Natural Money will help to create economic growth without the need for more debts because negative interest rates can induce rich people to spend more or otherwise sponsor the spending of the rest of us;
- Natural Money will mitigate economic cycles because the holding tax can provide a stimulus while the maximum interest rate can curb debt creation;
- With lower interest rates, most people will have more money to spend, because most people pay more in interest than they receive;
- With lower interest rates, there will be more employment because lower interest rates make more projects feasible;
- With lower interest rates, it is possible to make the economy sustainable because long-term investments are more attractive when interest rates are lower.



The money for the future


The economy could perform better with Natural Money so that better returns on investments become possible. This also affects bank deposits, and because the maximum interest rate is zero, the value of the currency must rise faster than interest can accrue on interest bearing deposits so that people will prefer Natural Money. This is the secret of success that may cause Natural Money to become the money of the future.