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A Short Introduction to Natural Money


4 November 2008 (latest revision: 3 July 2024)


Author: Bart klein Ikink



The problem with interest


When borrowers couldn't repay their debts with interest in the past, they became the serfs of money lenders. That is why religions like Christianity and Islam forbade interest on money or debts and deemed it usury. Nowadays, most money is a debt on which debtors pay interest. That is why debt levels increase, inflation is permanent, and the financial system becomes unstable. We have central banks to manage these problems.

Incomes can fluctuate, but borrowers pay fixed interest charges, which can get them into trouble. The less a debtor can afford to pay interest, the higher the interest rate will be, while a lower rate would improve the borrower's situation. The lender demands a higher interest rate to take risks, thereby increasing the risk and making the financial system less stable. And interest on top of interest causes trouble. An example shows why.

Suppose Jesus' mother had opened a retirement account for Jesus just after he was born in 1 AD at a bank next to the Temple in Jerusalem. Suppose she had put a small gold coin weighing 3 grammes in Jesus' retirement account at 4% interest. Jesus never retired, but he promised to return. Suppose now that the bank held the money for this eventuality. How much gold would there be in the account in the year 2020?

It is an amount of gold weighing 12 million times as much as the Earth. If Jesus returns, the gold will not be there. You don't need to be a genius to see something is wrong. A few eventually own everything, and the rest are in debt. The only thing the rich have to do is keep the money in the account, making money while they sleep and reaping the fruits of the toil of others. People have already known this for over 3,000 years.

There isn't enough gold to repay our debts, so gold isn't money today. When interest charges cause trouble, central banks print money to cope with the shortfall and prevent the scheme from collapsing. And so, debts continue to increase. Inflation reduces the debt burden by lowering the value of money and debts. But if inflation is too high, we lose trust in our money. That is why central banks aim for some inflation but not too much.



How the financial system operates


Money and finance may seem mysterious, but the basics are simple. When you go to a bank and take out a loan, for instance, a car loan, you get money and a debt. The bank creates this money on the spot. This money becomes someone else's deposit once you purchase the car. When you pay back the loan, the money disappears. It may seem like magic, but it is just accounting. You must repay the loan with interest. If the interest rate is 5% and you have borrowed € 100 for a year, you must return € 105.

Nearly all the money we use are deposits created from loans that borrowers must return with interest. Banks might pay interest on these deposits, but the interest rate is lower than the rate on the debt. The bank pockets the difference. Borrowers must return more than they borrowed. If they have borrowed € 100 at 5% interest, they must return € 105 after a year. So, where does that money come from? Here are the options:

  • Borrowers borrow more.
  • Depositors spend some of their balance.
  • Borrowers don't pay back their loans.
  • The government borrows the money.
  • The central bank prints the money.

  • That also happens in reality. Problems arise when borrowers don't borrow, and depositors don't spend their money. In that case, borrowers are € 5 short, and some can't repay their loans. If many borrowers can't repay their debts, you have a financial crisis, and an economic crisis will follow. It is why governments have deficits and central banks print money. With interest on debts, these things are hard to avoid.

    The financial crisis of 2008 nearly brought down civilisation. If you were familiar with the problems caused by interest, the crisis didn't come as a surprise. Central banks succeeded in ending the crisis by printing trillions of US dollars. The shortfall was as enormous as that. It also demonstrated we are the usurers' hostages.

    It has not always been like that because there were fewer debts. In the nineteenth century, mortgages were hard to come by, and there were no car loans. People and businesses were less deeply in debt, so most money wasn't in debt but gold coins or paper money backed by gold in a government or central bank vault. Even then, there were financial crises and economic slumps caused by debtors who couldn't repay their debts.

     
    Figure 1: Interest versus total income
    Figure 1: Interest
    versus total income
     
    That is why there are central banks. They can halt or prevent financial crises, but in doing so, they allow the creation of far more debt as central banks can print money to fix the shortfalls caused by interest charges. And that is what happened after the nineteenth century. With interest charges on debts and money, governments can't balance their budgets, and central banks can't stop printing money without collapsing the economy.

    Ending interest on money and debts has been impossible until now because lenders didn't lend without interest so that we wouldn't have had a modern capitalist economy. Lenders demand interest because:

  • When you lend out money, you can't use it yourself. That is inconvenient, so you desire compensation for the use of your money.
  • The borrower may not repay, so you desire compensation for that risk.
  • You can use your money to invest and earn a return. However, to lend, the interest rate must be attractive compared to other investments.

  • Lending and borrowing are essential for the functioning of a modern capitalist economy. We take interest for granted. However, economic and financial system changes may make it possible to end interest on money and debts. Innovations in finance may make it feasible to stop charging interest on debts. And so, the end of usury might be at hand.



    The end of usury


    A few things have changed. You can lend money to a bank and still use it at any time. That is convenient. Banks check the financial condition of their borrowers and lend money to many different people and businesses. If a few debtors run into trouble, the bank can stil fulfil its obligations. This reduced risk. Central banks can help out banks if needed. And governments guarantee bank deposits. That reduced the risk of lending money so bank deposits are often 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. Investors have reinvested most of those returns, so the amount of capital has grown faster than the economy, and a growing share of total income was not for wage earners but investors. That cannot go on forever because who will buy the things the corporations make if wages keep on lagging? An example can demonstrate why that is so.

    Figure 1 shows how total income, wages and capital income develop with an economic growth rate of 2% and an interest rate of 5% when capital revenues start as 10% of total income and investors reinvest all their capital income. After 25 years, the economic pie has grown more than capital revenues, and wages have risen. At some point, capital income starts to increase more than total income, and wage income goes down. After 80 years, there is nothing left for wages. The economy would have collapsed long before that.

    Wealthy people reinvest most of their capital income. Saving and investing often made them rich in the first place. In recent decades, we have seen economic growth slowing in advanced economies. Several factors affect economic growth, such as population growth and technological innovation. One is available capital and profitability. If growing capital income comes at the expense of labour income, this capital's products will have fewer buyers. As a result, capital returns decline, and as a result, interest rates.

    When interest rates are negative, debtors don't return more than they borrow. And if the maximum interest rate is zero, lenders don't lend to borrowers they don't trust. From then on, there is no excuse for financial mismanagement. Governments don't need to run deficits and central banks don't need to print money. A fully negative-interest financial system has never existed, but it seems possible. Two examples from history can show us how we might do it.



    The miracle of Wörgl


    In 1932, during the Great Depression, the Austrian town of Wörgl was in trouble. 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 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 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 hardly anyone took this offer as the note was worth one schilling again 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. The local money circulated for thirteen months. The council carried out the intended public works and also built new houses, a reservoir, a ski jump and a bridge.

    The key to this success was the fast circulation of the scrip money within the local economy. Townspeople spent the money to avoid paying for the stamps. This increased trade and 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 witness the 'miracle of Wörgl'.

    In January 1933, the neighbouring city of Kitzbühel copied the plan. 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 asserted its monopoly rights on issuing money by banning scrip currencies.1 One can imagine what had happened if communities all over the world had copied the idea. The Great Depression may have ended sooner.



    Joseph in Egypt

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

    The Bible contains a story about a Pharaoh who had some 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. A guy named Joseph explained those dreams. He told the Pharaoh that seven years with good harvests would come, followed by seven years of crop failures. 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.2 Farmers bringing in grain received vouchers. And bakers who wanted to make bread exchanged these vouchers for grain. According to the Bible, Joseph took all the money from the Egyptians. That may have made the Egyptians look for another form of money.

    As a consequence, the grain receipts may have become money instead. There were storage costs so the vouchers lost value over time. Paying a storage fee is 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.3 Some historians have suggested that grain money was a source of Egypt's wealth during the reign of Ramesses.4 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 there were no financial crises caused by interest payments.



    Natural Money


    The miracle of Wörgl demonstrates that money with a holding fee might have ended the Great Depression. The grain money in ancient Egypt provided a stable financial system for over 1,000 years. The holding fee can make it attractive to lend money at an interest rate of zero or even lower. Lending at an interest rate of -2% to a reliable borrower is better than paying a holding fee of 10%.

    At present, cash has an interest rate of zero. With negative interest rates, taking your money from the bank and storing it in a safe deposit box can be attractive. A steep holding fee, like in Wörgl, disadvantages people who use cash. That is not needed. An interest rate close to that of bank accounts will be sufficient to keep people from hoarding cash.

    The solution is cash with a negative interest rate, so that banknotes and coins become separate from central bank currency. Short-term government loans could back it, and the interest rate on cash would be close to that on short-term government debt. If the cash interest rate is -3%, one euro cash will be worth 0.97 euro currency after a year. Cash thus stops being a currency and becomes government debt.

    And now, we arrive at a definition of Natural Money:

  • Natural Money currencies carries a holding fee in the vicinity of 10% per year.
  • Loans, including bank loans, have negative interest rates. Zero is the maximum.
  • Cash becomes money with a negative interest rate backed by government debt.

  • Natural Money doesn't change the nature of the business of banking. Banks borrow money from depositors at a lower rate to lend it at a higher rate. They may borrow money at -2% to lend it at 0% instead of borrowing it at 2% to lend it at 4%. A maximum interest rate of zero will favour equity financing over lending and borrowing at interest, and equity finance may often replace traditional banking. Thus:

  • Borrowing for consumption will be restricted. Car loans and credit card debt may disappear. Consumers will be better off because they don't pay interest.
  • Leveraged financing will become constrained. Businesses need to reduce their debts and attract more equity.

  • The role of governments and central banks changes. Government and central bank interventions kept the usury scheme afloat. Without usury, these things would be unnecessary or even undesirable, as there would be no financial crises. The financial system would be stable, as the maximum interest rate promotes responsible lending, and there is no reward for taking excessive risks.

    The miracle of Wörgl indicates that negative interest rates can lift the economy from a depression. If the economy does better with Natural Money, interest rates could rise. That probably is not a problem, as the currency's value may increase, and yields on interest-free money could be better than on interest-bearing money. When the usury scheme collapses, Natural Money currencies might become a haven.



    Research


    Other local currencies with a holding fee weren't as successful as the one in Wörgl. The payment of taxes in arrears inflated the success of Wörgl. It generated additional revenues for the town, which the council could spend. It provided a stimulus that might have petered out once the citizens had paid their taxes.6 Maybe it is too good to be true, but there are reasons to think otherwise. Once interest rates are near zero, the markets for money and capital cease to function, and central bank interventions become ineffective.

    To prevent the 2008 financial crisis from escalating, central banks took extraordinary measures, like printing trillions of dollars, to keep the usury financial system afloat. A holding fee could have kept the markets functioning without such measures. A maximum interest rate of zero could have impeded irresponsible lending, preventing the financial crisis from occurring in the first place.

    Implementing a usury-free global financial system is a profound change with far-reaching consequences. Is it possible? And under which circumstances? What are the benefits and drawbacks? What are the implications for individuals, businesses and governments? How does it affect banks and the financial system? These questions need answering. History provides us with few examples, but there are many economic theories.

    This research uses available knowledge to (1) discover the prerequisites for a usury-free financial system, (2) uncover how it works best in practice, and (3) what the consequences are for individuals, businesses, governments and financial institutions. It seems feasible, and the design of Natural Money is more robust than the current financial system. Still, unanticipated issues may appear once a Natural Money financial system is operational.

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

    Economists and central bankers believe 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, which 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 rise in interest rates in the early 2020s is not a rise in the real interest rate. It merely tracks a pickup in inflation.

    It could be a structural development. Once an economy matures, it has little room to grow, and interest rates remain low. And if we intend to live within the planet's boundaries, we may even need negative growth. Low growth rates are a problem for the usury financial system as it only operates smoothly with high enough interest rates. And so, the future world might do well with a global usury-free financial system.

    At the 2017 IV International Conference on Social and Complementary Currencies: Money, Consciousness and Values for Social Change in Barcelona, I presented two papers about Natural Money. The first paper, 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, Feasibility Of Interest-Free Demurrage Currency, clarifies how to implement Natural Money in the global financial system and what the consequences are likely to be.

    Natural Money is a theory about money, the financial system, including banks and central banks, and interest. It describes how the financial markets and the economy might operate with negative interest rates and the prerequisites for negative interest rates to work. Unless they are relevant, there is little consideration for subjects beyond money, banking and finance. Natural Money is a design for the financial system, not the economy itself. Presumably, it can work in a developed economy. Natural Money comes with benefits and drawbacks. I have tried to describe and address them.

    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. It explains what money is, what the role of banks is, why financial markets are the way they are, 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 entertaining. If you know about economics, you could read Natural Money Theory. The Natural Money Blog highlights individual aspects of Natural Money.



    References


    1. The Future of Money: Creating New Wealth, Work and a Wiser World, pp. 153-155, Bernhard Lietaer, Random House, 2001
    2. 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
    3. Ramesses II - Wikipedia (as on September 3, 2013): https://www.naturalmoney.org/ramesses2.html; current version: http://en.wikipedia.org/wiki/Ramesses_II
    4. This was mentioned on Discovery Channel or National Geographic but I was unable to recover the source
    5. The Natural Economic Order, Silvio Gesell, Translated by Philip Pye, Peter Owen Ltd, 1958: https://www.naturalmoney.org/ NaturalEconomicOrder.pdf
    6. 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