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A Short Introduction to Natural Money


4 November 2008 - 22 April 2017



 
 

The problem of interest


Suppose that Jesus' mother had put a small gold coin weighing 3 grammes in Jesus' retirement account at 4% interest in the year 1 AD. Jesus never retired but he promised to return. Suppose that the account was kept for this eventuality. 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. The yearly interest would be an amount of gold weighing 400,000 times the mass of the Earth.

A mere 4% yields an insane amount of gold after 2015 years. Someone has to pay for the interest, in this case the people who borrowed money from the bank. If Jesus doesn't come back to spend some of his money, that's impossible. At some point the debtors can't pay the interest, let alone repay their debts. They can only borrow more or default. And if they default, there will be a financial crisis. A financial crisis means that borrowers can't repay their debts with interest.

Now you know why financial crises happen. How are they solved? Our money isn't gold and central banks can print as much new money out of thin air as they see fit. With this newly printed money the banks were bailed out. In this way the financial crisis of 2008 was contained. But bailing out banks has downsides. Interest is an incentive for banks to create new debts. And higher interest rates mean greater profits for the banks but also more risks for the taxpayers.

You might have figured out that interest is the root cause of financial and economic crises. This is so obvious that it was already known more than 3,000 years ago. Interest pushes people into poverty. They are crushed by growing debt burdens and interest payments. Interest was called usury and considered evil. It was forbidden by some major religions like Christianity and Islam. So why do we have interest? The answer is that lending and borrowing wouldn't be possible without it.

If you lend out money, you can't use it yourself. Most people want a compensation for this inconvenience. Furthermore, the borrower may not repay, or the money may be worth less in the future because of inflation. Most people want a compensation for these risks too. Finally, if you can make a profit by investing, then why lend out money without interest? The interest rate on borrowed money must be attractive compared to other investments. As most investments have been made with borrowed money, it would have been impossible to build the capitalist economy without interest.

Research has shown that the 80% poorest people pay interest to the 10% richest people. Interest is everywhere. It is hidden in rents, taxes, and the price of everything we buy. Products on average cost 25% more because of interest charges. And the poorest people often pay the highest interest rates when they borrow money. Interest is therefore sometimes called a tax on the poor for the benefit of the rich [1]. But if the poor don't have enough money because they pay interest to the rich, they can't buy the stuff to make the investments of the rich profitable.


 
Year 0
Year 25
Year 75
 

The end of usury


A few things have changed over the years. You can lend out your money to a bank but you can still use it anytime. This is very convenient. Banks check the financial condition of borrowers and lend out money to many different people. This reduced risk. Central banks can help out banks if there is no money to pay the interest. There are even government guarantees on bank deposits. This reduced the risk of losing money to the point that bank deposits are considered to be safer than cash.

So what about the returns on investments? In the past, returns on investments on average have been higher than the rate of economic growth. Because most of those returns have been invested again, the amount of capital has grown faster than the economy, and a growing share of total income was not for wage earners but for investors. This cannot go on forever, because who is going to buy all the stuff the corporations make if wages keep on lagging?

To the left you see how total income and interest income develop with a rate of economic growth of 2% and an interest rate of 5% when interest income starts out as 10% of total income and all interest income is reinvested. After 25 years the economic pie has grown faster than interest income so that wages have risen. At some point interest income starts to rise faster than total income, and wages go down. After 80 years there's nothing left for wages.

This is the main reason why interest rates have gone down in recent years. In the short run, it was possible to prop up business profits by using the lower interest rates to let people go further in to debt to buy the stuff corporations make. In the long run, the growth rate of capital income cannot exceed the rate of economic growth. Furthermore, in the long run the amount of debts cannot grow faster than the economy. That is what the example demonstrates us.

If interest rates go down even further then it may be possible to abolish interest on money and loans altogether. This will be the end of usury. In that case we do not need more and more debts to pay for the interest on existing debts. That may be the end of financial and economic crises. And so central banks do not need to print more money. In this way inflation will end. Products and services can become cheaper because interest costs will go down. So how can it be done? And is it really possible?



The miracle of Wörgl

 
 a plan so cunning
you could put a tail on it
and call it a weasel
(Blackadder)
 
 

In 1932, in the middle of the Great Depression, the Austrian town of Wörgl was in trouble and 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. The mayor came up with a cunning plan.

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 complementary 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.

 
Wörgl stamp scrip
Wörgl stamp scrip with some stamps
Source: Mises.org
 
Nobody wanted to pay for the monthly stamps so everyone receiving the notes would spend them. 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. That was because it could be spent as one schilling after buying a stamp.

Of all the businesses in town, only the railway station and the post office refused to accept the 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 increased trade and created 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 [2]. One can only imagine what had happened if communities all over the world had been free to copy the idea. The Great Depression may have ended in 1933 and World War II may never have taken place.



Joseph in Egypt

 
Joseph and the Pharaoh
Joseph and the Pharaoh
Source: Doré English Bible
 

The Bible features 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. 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 on a large scale. They followed his advice and built storehouses for food. In this way Egypt survived the seven years of scarcity.

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 [3]. 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. This may have prompted them to look for an alternative.

In this way the grain receipts may have become money. The degradation of the grain and storage cost caused the value of the receipts to decrease steadily over time. The effect was similar to buying stamps to keep the money valid as happened in Wörgl. This stimulated people to spend the money. It is unclear whether there was credit in this banking system. The actions of Joseph may have created this system as he allegedly proposed the grain storage and took all the money from the Egyptians.

A few centuries later, during the reign of Ramesses the Great, Egypt was again a leading power [4]. Some historians suggested that the wealth of Egypt during the reign of Ramesses the Great was built upon the grain financial system [5]. The grain money remained in operation after the introduction of coins around 400 BC, until it was finally replaced by Roman money. The money and banking system were stable and survived for more than a thousand years, probably because there weren't any financial crises caused by interest payments.



Natural Money


Interest rates will probably remain low and may go even lower because the trend towards lower interest rates is sustained by structural developments. Most notably, capital income cannot grow because of wealth inequality and lagging labour incomes. This may get worse when machines take over more jobs from humans. There are two main ways in which the returns of capital can be redistributed. The first way is via taxing and entitlements. This may imply introducing a wealth tax and a basic income. The second option is via the market for money and capital. And this could mean negative interest rates.

If interest rates go negative then interest-free money with a holding tax, or Natural Money, is the best way to go. Interest-free means that the maximum nominal interest rate on loans is zero. The demurrage is a tax on holding cash that may range from 0.5% to 1% per month. You don't have to pay the holding tax on money lent and other investments, which can make it attractive to lend out money at interest rates below zero. The holding tax doesn’t apply on bank accounts either because it is money lent. And so it can be attractive to put money in a bank account, even when the interest rate is negative, for example -2% or -3%.

The German business man Silvio Gesell was the first to propose a holding tax on money in his work The Natural Economic Order [6]. The money is named Natural Money to honour his legacy. The following points highlight some of the consequences of implementing Natural Money:
• Natural Money doesn't change the business of banks. Banks borrow money from depositors at a lower rate to lend it out at a higher rate. There is little difference between borrowing money at 2% to lend it at 4% and borrowing money at -2% to lend it at 0%.
• Stamps on paper money like those in Wörgl are cumbersome. Instead cash and digital money can become separate currencies, for example digital euro and paper euro. The tax can then be implemented by gradually lowering the exchange rate of paper money relative to the digital currency unit.
• Most money is in bank accounts nowadays, and because the holding tax doesn't apply on bank accounts, most people don't pay a lot in holding tax, while the people who still rely on cash will be encouraged to make more use of digital money.
• People who want to make more on their investments have to accept that higher yields mean more risk. The maximum interest rate will make investments in equity more attractive relative to debt so that businesses will become less leveraged, and 'financial engineering' is curtailed.
• A maximum interest rate limits the risks lenders are willing to take so that people and businesses in financial trouble need to reorganise their finances, while the maximum interest rate also prevents financial problems from escalating because of interest payments.
• In order to have negative interest rates, people should be able to trust the currency, which means that government finances need to be in order. This doesn't mean austerity because governments can receive interest on their debts.

If interest rates can go lower, more projects can become economical, and we can be wealthier. With lower interest rates it may be possible to end poverty and to make the economy sustainable. Products and services can be cheaper because of lower interest costs. The maximum interest rate of zero can curb reckless lending because it removes the reward for taking excessive risks. Debts can't grow out of control because of interest payments. Governments must have their finances in order, because you need trust in the currency to have negative interest rates. As governments receive interest on their debts that doesn't mean austerity.

Natural Money can stabilise the economy. If the economy is about to boom, returns on investments rise, and it becomes less attractive to lend out money at an interest rate of zero. And so people cannot borrow more money to buy stuff and the economy will not overheat. The holding tax provides a stimulus so that the economy will not cool down either. In this way the economy can do well without crises. In that case, returns on investments will be higher, and interest rates rise. If interest rates cannot exceed zero, the currency must rise in value, and at such a pace that interest-free money yields more than interest-bearing money.

The implications are profound. Natural Money can improve the efficiency of the economy. The higher yields on Natural Money can cause a capital flight to the interest-free economies at the expense of economies allowing interest on money. And so Natural Money can become the money of the future.


This is the core idea behind Natural Money. Nobody else sees this potential, not even the people who promote interest-free money and money with a holding tax, so I started this website in 2008. The lack of awareness appears to be the only obstacle in the way of Natural Money becoming the money of the future. Maybe a new crisis is going to change that. Maybe people need to be really desperate and ready to try anything, just like the people of Wörgl were during the Great Depression. Only then different experiments may be undertaken, and if Natural Money is one of them, Natural Money will come out on top. It is the best option.



Research


"Yeah right", you may think, "If Natural Money is so great then why doesn't everyone use it already?" After the Great Depression interest rates never came near zero again, until very recently, so other local currencies weren't as successful as the one in Wörgl. And the success of the Wörgl currency was inflated by the payment of taxes in arrears that generated additional revenues to the town council [7]. The council could spend this money, which provided a stimulus that would have petered out if the money hadn't been banned so soon. Maybe it is too good to be true after all, but there are good reasons to think otherwise.

 
US real interest rate versus natural interest rate
US real interest rate versus natural interest rate
Source: FED
 

Most economists and central bankers can't grasp that negative interest rates can become the new normal. Yet, the graph tells a different story. It shows the interest rates in the United States between 1961 and 2016. The green line is the market interest rate. The red line is the natural interest rate, which is the ideal interest rate for optimal economic growth. The trend is clear, but most economists and central bankers expect it to reverse, so that interest rates will go up again. But the factors that drove interest rates down will probably not go away. So why can't they see what is coming, even when it is so obvious?

That is because economists, like everyone else, are programmed to think that interest rates need to be positive. Negative interest rates go against some of the most basic tenets of economics, such as scarcity and, by extension time preference, as positive interest rates follow from them. Yet, economists should question these concepts at a time when more people are dangerously overweight than underfed. The law of diminishing marginal utility counteracts scarcity and time preference. Scarcity certainly doesn’t apply to the wealthy top 1% of people who own most capital and determine interest rates. They are running out of things to invest in.

Negative interest rates are likely to become the new normal. It isn't possible to force interest rates down. A holding tax will only allow interest rates to go lower when market conditions justify lower rates. A holding tax will have little effect on the economy when interest rates are well above zero. Furthermore, if a lot of lending and borrowing takes place at higher interest rates, then a maximum interest rate of zero will disturb the markets for money and capital so that the economy will suffer. A maximum interest rate can nevertheless be beneficial if it mainly affects dubious or usurious lending such as sub-prime credit and credit card debt.

Negative interest rates are likely to become the new normal so that Natural Money can be implemented successfully. The holding tax can best be implemented when interest rates are near zero as this measure would have little effect otherwise. The maximum interest rate of zero should only be implemented when most interest rates in the financial markets are already negative as it could cause disaster otherwise.


This website is frequently updated and reflects the current state of the project. If you only have limited knowledge of the economy and the financial system, you could read Explaining Natural Money to Non-Economists. This document explains what money is, what the role of banks is, why the financial system is the way it is, what the problem of interest is, and why Natural Money can solve it. It is easy to understand and I have done my best to make it an entertaining read. The economic theory of Natural Money is laid out in Money of the Natural Economic Order.



References


1. Poor Because of Money: Our theory on interest, Henk van Arkel and Camilo Ramada, Strohalm, 2001: http://www.naturalmoney.org/ poorbecauseofmoney.html
2. The Future of Money: Creating New Wealth, Work and a Wiser World, pp. 153-155, Bernhard Lietaer, Random House, 2001
3. A Strategy for a Convertible Currency, Bernard A. Lietaer, ICIS Forum, Vol. 20, No.3, 1990: http://www.itk.ntnu.no/...; backup copy: http://www.naturalmoney.org/convertiblecurrency.html
4. Ramesses II - Wikipedia (as on September 3, 2013): http://www.naturalmoney.org/ramesses2.html; current version: http://en.wikipedia.org/wiki/Ramesses_II
5. This was mentioned on Discovery Channel or National Geographic but I was unable to recover the source
6. The Natural Economic Order, Silvio Gesell, Translated by Philip Pye, Peter Owen Ltd, 1958: http://www.silvio-gesell.de/neo_index1.htm
7. A Free Money Miracle?, Jonathan Goodwin, Mises.org, 2013: http://www.mises.org/daily/6336/A-Free-Money-Miracle; backup copy: http://www.naturalmoney.org/freemoneymiracle.html