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A Short Introduction to Natural Money


4 November 2008 (latest update: 22 June 2020)
 
 


Author: Bart klein Ikink


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 now that the account was kept for this eventuality. How much gold would there be in the account in 2018? The answer is an amount of weighing 11 million times the mass of the Earth.

A mere 4% yields an insane amount of gold after 2018 years. Someone has to pay the interest, in this case the people who borrowed money from the bank. If Jesus doesn't come back to spend 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 is a financial crisis.

Financial crises happen when people can't pay the interest or when depositors want their gold. But our money isn't gold so central banks can print new money out of thin air. With this newly printed money debts can be repaid. If someone comes to the bank and wants 'real' euros, the central bank just prints them, uses these euros to buy the debt from the bank so that depositors can get 'real' euros if they want to.

In 2008 some people couldn't pay the interest on their loans after banks had been lending money to questionable borrowers. Interest is a reward for risk so questionable borrowers pay more. Higher interest rates mean bigger profits for banks, and more importantly, bigger bonuses for bankers. If things go wrong we all may end up paying the bill if banks have to be bailed out. So it made perfect economic for bankers. They make the profit and we pay for the loss.

Interest causes financial and economic crises. This was already known more than 3,000 years ago. Interest can push people into poverty when they are crushed by debt burdens and interest payments. Interest was called usury and considered evil. It was forbidden by some major religions like Christianity and Islam. But without interest, there would be very little lending and borrowing, and a modern economy would not be possible. So why is that?

 
Figure 1: Interest versus total income
Figure 1: Interest
versus total income
 
If you lend out money, you can't use it yourself. This is inconvenient. Furthermore, the borrower may not repay or the money may be worth less in the future because of inflation. So, lending out money is risky. A reward in the form of interest can compensate for inconvenience and risk. 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.

Interest has serious downsides. 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. And the poorest people often pay the highest interest rates. Interest is therefore sometimes called a tax on the poor for the benefit of the rich.1

A few things have changed over the years. You can lend out money to a bank and still use it anytime. This is 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 for 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. Most of those returns have been invested again so 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?

Figure 1 shows 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 and 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. That won't happen because the economy would have crashed long before that.

It is a reason why interest rates have gone down in recent years. In the short run it was possible to prop up business profits by lowering 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 can't exceed the rate of economic growth. Furthermore, in the long run the amount of debts cannot grow faster than the economy. And make no mistake, this is a serious problem.

There is another equally serious problem. Incomes fluctuate while interest payments are fixed. Interest causes financial and economic instability by escalating existing fluctuations in the economy. If the economy slows down, the burden of interest-bearing debt can aggravate a recession and even cause an economic depression. In recent decades the amount of debt has escalated and at some point this may collapse the financial system and end human civilisation as we know it. This nearly happened in 2008.

If interest rates go down further 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 debt to pay for the interest on existing debt and there will be no incentive to take excessive risk because there is no reward for doing that. It may be the end of financial and economic crises too. And it could be the end of inflation. Products and services can become cheaper because interest costs will go down. So can it be done? And how?

 
Monetary Revolution
 


The miracle of Wörgl


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.

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.

 
Wörgl stamp scrip
Wörgl stamp scrip with some stamps
 
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 asserted 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 has a story about a Pharaoh how had bad dreams that his advisors couldn't explain. He 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 explained those dreams. He told the Pharaoh that seven years with good harvests would come followed by seven years with poor harvests. He advised the Egyptians to store food. They followed his advice and built storehouses for grain. In this way Egypt survived the seven years of scarcity.

The food storage resulted in a financial system. The historian Friedrich Preisigke discovered that the Egyptians used grain receipts for 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 made the Egyptians look for another form of money.

As a consequence the grain receipts may have become money instead. The storage costs were settled when the receipts were exchanged for grain so the receipts lost value over time. The effect was similar to buying stamps to keep the money valid as happened in Wörgl. The actions of Joseph may have created this money as he allegedly proposed the grain storage and took all the money from the Egyptians.

During the reign of Ramesses the Great, Egypt became a leading power again.4 Some historians have suggested that Egypt's wealth during the reign of Ramesses was built upon the grain money.5 The money remained in circulation after the introduction of coins around 400 BC, until the Romans conquered Egypt. The grain money was stable and survived for more than a thousand years, probably because there were no financial crises caused by interest payments.



The only way out?


And so it appears that interest causes most of the problems in the financial system. The miracle of Wörgl suggests that money with a holding fee could have prevented the Great Depression or ended it once it had started. The Egyptian financial system based on grain storage suggests that money with a holding fee can be stable. The only way out of the current predicament may be negative interest rates as the economy can't support positive interest rates any more. To see why, you can imagine the economy to be like a game of Monopoly.

If you have ever played this game then you know that nearly everyone is doing great in the beginning of the game. Money is coming in and capital is built in the form of houses and hotels. At some point some people can't pay their bills any more. To keep the game going, the winners can lend money to the losers. It doesn't take long before the losers can't pay the interest on their loans. So to keep the game going, interest rates must go down, and the bank must be funded with new money to keep on paying out the reward for every round.

In this way the losers can remain in the game. But the bills are mounting and at some point the losers can't pay the interest again. It seems pointless to go on. In a game of Monopoly we can start all over again from nothing. In the real economy that's not an option as it would mean destroying houses (everyone will be homeless) and closing factories (shops will be empty). It will be a crisis much worse than the Great Depression. To continue the game debts must be written off.

That could cause a financial crisis and soon the same situation emerges that the losers can't pay their bills. It will not remedy the underlying problem, which is that the capitalists own the means of production (streets, houses and hotels), so that the losers run out of money soon. It may be better to have negative interest rates on their debts. And so the game can continue and debts won't grow any more. In the real economy it means that the capitalists hand out money to the rest of us in order to keep us buying so their capital isn't destroyed to the benefit of all of us.



Natural Money


As the game of Monopoly suggests, lower interest rates are caused by structural developments in the economy like wealth inequality, and not central banks setting interest rates. Capital can't grow faster than the economy in the long run. Wealth inequality and lagging labour income limit capital growth and interest rates. Machines may take over jobs from humans or measures may need to be taken to deal with the limits of the planet. These measures may result in lower returns on capital, and therefore low or even negative interest rates.

Capitalism is great in providing us with things like housing and consumer goods but at some point wealth inequality caused by interest becomes destructive. The economy may do better if there is a redistribution of some of the returns of capital from capital owners to people with little or no capital. There are two ways in which that can be accomplished. The first way is via taxing and entitlements, for example via a wealth tax and a basic income. The second option is via the markets for money and capital, for example via negative interest rates, so that people and governments have more money to spend.

Natural Money is a comprehensive solution for a financial system with negative interest rates. Natural Money is interest-free money with a holding fee. There is a maximum interest rate on money and loans of zero and there is a holding fee ranging from 0.5% to 1% per month on central bank currency, which currently is cash and accounts at the central bank held by commercial banks. The holding fee doesn't apply on money lent, bank accounts held at commercial banks and investments. And so it can be attractive to put money in a bank account, even when the interest rate is negative.

If cash remains central bank currency then it would cost 0.5% to 1% to hold on to it, which makes cash unattractive to hold. Natural Money therefore has a new form of cash backed by short-term government loans issued by the treasury instead of the central bank, which means that the holding fee doesn't apply. Instead the interest rate on short-term government loans applies to cash, which is a far better rate and it might be -3% per year.

There will be an exchange rate between cash and digital money. Cash and digital money will become different currencies. Cash will depreciate in terms of digital money. There will probably be no inflation and there might even be price deflation so the value of cash is likely to remain fairly stable. It is possible to have cash bank accounts, which means that a bank isn't allowed to lend out the money in this account so if the bank goes bankrupt, this money is safe.

The German business man Silvio Gesell was the first to propose a holding fee on money in his book The Natural Economic Order.6 The money is named Natural Money to honour his legacy. The following points summarise the idea of 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%.
  • Cash and digital money will become separate currencies, for example digital euro and cash euro. Cash is backed by short-term government loans. The negative yield can be implemented by gradually lowering the exchange rate of cash relative to the digital money.
  • It is possible to have safe bank accounts where you can hold cash outside the banking system.
  • Most money is in bank accounts nowadays, and because the holding fee doesn't apply on bank accounts either, no-one ends up paying the holding fee. The holding fee only defines how low interest rates can go based on market conditions.
  • Investors seeking higher yields can achieve this by providing equity. This lowers systemic risk. The maximum interest rate can make investments in debt less attractive and cause a deleveraging of balance sheets.
  • 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.

  • Natural Money has the following benefits:
  • Natural Money allows interest rates to go as low as the state of the economy requires.
  • When interest rates go lower, more capital remains economical (houses and factories), so we can be wealthier, so it can help to reduce poverty.
  • With lower interest rates the financial value of future income increases so that it may be possible to make the economy sustainable.
  • Most people pay interest to the wealthiest, so with lower interest rates income inequality can reduce.
  • Products and services can be cheaper because of lower interest costs.
  • Natural Money can curb reckless lending because there is no reward for taking excessive risks in the form of interest.
  • Debts can't grow out of control because of interest payments.
  • Natural money promotes financial discipline with governments because negative interest rates require trust in the currency.
  • Financial discipline doesn't mean austerity because governments receive interest on their debts.
  • If the economy is to slow down then the holding fee allows interest rates to go as low as needed to provide sufficient stimulus so that the economy will recover.
  • If economic activity picks up, interest rates rise and the amount of credit diminishes because of the maximum interest rate of zero, so that the economy will not overheat because of a debt-fuelled boom.

  • Natural Money can improve the economy so returns on investments can be better and real interest rates can rise. With Natural Money interest rates cannot exceed zero, so digital money could rise in value, perhaps at such a pace that interest-free money provides better yields than interest-bearing money.

    The implications are profound. Natural Money might improve the efficiency of the economy so that 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 may become the money of the future.


    If Natural Money becomes the money of the future, it may help to deal with some serious challenges humanity is facing. These were the reasons to start this website in 2008. A lack of awareness may be the main obstacle standing in the way of Natural Money becoming the money of the future. Perhaps the next financial crisis is going to change that. Perhaps people may need to become desperate and ready to try anything, just like the people in Wörgl during the Great Depression. Natural Money may be the best solution. So if there is a good plan ready, it may be adopted.



    Research


    "Yeah right", you may think, "If the Wörgl currency was so great then why is this ignored?" After the Great Depression interest rates never came near zero again, until very recently, so similar 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. If interest rates near zero, the markets for money and capital cease to operate, and this can cause an economic depression.

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

    Economists and central bankers think that low and negative interest rates will be temporary but the graph above tells a different story. It shows the interest rates in the United States between 1961 and 2016. The green line is the real interest rate in the market. The real interest rate is the inflation free interest rate. So if the interest rate of your mortgage is 5% and the inflation rate is 2%, the real interest rate on the mortgage is 3%.

    The red line is the natural interest rate. This is the ideal interest rate for optimal economic growth. The natural interest rate is not an interest rate in the market. It is estimated by economists using models. Central banks use the natural interest rate to set the interest rate. If the central bank believes that the economy is overheating, it sets the interest rate above the natural rate. If it believes that the economy is in a slump, it sets the interest rate below the natural rate.

    The trend is clear but most economists and central bankers expect that interest rates will go up again. Only, the developments that drove interest rates down may not go away and interest rates may remain low and may even go lower. 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 economists see what's coming?

    Negative interest rates go against one of the most basic assumptions of economics, the idea of scarcity. It states that we can never have enough stuff and need positive interest rates so that people will save money to finance investments. Yet, we should question this assumption because it is destroying the planet. And scarcity doesn’t apply to the wealthy top 1% of people who own most capital. They can't spend all their money and are running out of things to invest in.

    Proponents of interest-free money ignored basic economic laws. They opposed interest as a way of making money without a useful contribution to the economy. They complained that projects are feasible only if they yield more than the interest rate on money, so that many projects are not executed and people are unemployed. This goes back to Silvio Gesell who saw interest on money as inefficient6 But positive interest rates are a sign of scarcity and lack of capital. It is the accumulation of capital by saving and investing that brings interest rates down.

     
    Questions?
     
    Negative interest rates are likely to become normal but it isn't possible bring interest rates down by force. Savers must be willing to accept these rates. A holding fee only allows interest rates to go lower if supply and demand for money and capital justify that. If interest rates are above zero then a maximum interest rate of zero can cause problems and the economy may suffer. Yet, a maximum interest rate can be beneficial if it mainly affects dubious or usurious lending such as sub-prime credit and credit card debt.

    Negative interest rates may become the new normal so Natural Money may be implemented successfully. The holding fee 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 financial distress otherwise.


    Once interest rates are negative and positive interest rates are not allowed the economy may do well by itself so governments and central banks do not have to interfere to ensure stability of the financial system and the economy. It may be the end of fiscal and monetary policies. This is not to say that governments and central banks shouldn't interfere when markets fail. The advice is limited to ensuring financial and economic stability insofar usury is a primary cause. Indeed, economic cycles may often be avoidable and without usury the economy may be self-correcting.

    Two papers have been presented at the IV International Conference on Social and Complementary Currencies: Money, Consciousness and Values for Social Change in Barcelona in 2017. The first paper named The End of Usury explains why interest rates are likely to go lower and become negative and that this may remain so for the foreseeable future. The second paper named Feasibility Of Interest-Free Demurrage Currency clarifies how Natural Money might be implemented world wide and what the possible consequences will be.

    This website is frequently updated and reflects the current state of the Natural Money project. The research is still in progress. If you have limited knowledge of the economy and the financial system, you could read Natural Money For Dummies. 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 made some effort to make it an entertaining read. If you have knowledge of economics you could read Natural Money Theory. In the Natural Money Blog some individual aspects are highlighted.



    References


    1. Poor Because of Money: Our theory on interest, Henk van Arkel and Camilo Ramada, Strohalm, 2001: https://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: https://www.naturalmoney.org/convertiblecurrency.html
    4. Ramesses II - Wikipedia (as on September 3, 2013): https://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: https://www.naturalmoney.org/ NaturalEconomicOrder.pdf
    7. A Free Money Miracle?, Jonathan Goodwin, Mises.org, 2013: http://www.mises.org/daily/6336/A-Free-Money-Miracle; backup copy: https://www.naturalmoney.org/freemoneymiracle.html