This article discusses the effect of using interest free loans as an additional method of increasing the money supply. It does not propose changing the existing system. It is a proposal that only adds a new method of creating money tokens.
The monetary system is an information system where entities communicate with each other according to a set of rules. These rules determine the outputs from the system and the internal states of the system. Because the outputs of the system are difficult to predict they are often called emergent properties.
Changing the underlying rules in any complex system – even in small ways – will often produce radically different emergent properties.
The monetary system consists of the exchange of tokens that represent “value” of goods or service that are exchanged for the tokens.
Tokens “at rest” in accounts represent dormant value that can be used at some later time to purchase goods or services for some purpose. People deposit money with institutions with the understanding that the institution will invest the money to create more money. Because it is expected that the money will be invested people expect to get part of the value from the investments. This return of value can be in the form of interest on money. The expectation has grown so that we expect most money in bank accounts to earn interest.
When goods or services are “consumed” then the value has gone but the tokens remain. If goods or services are “invested” then they create more value which can be represented as new tokens. Consumption destroys value while investment increases value.
With our present monetary system tokens are created by monetising existing assets. This makes sense because assets produce value. It is believed that this limits the number of tokens created because there is a limit to the value of existing assets.
Unfortunately the system fails because, in practice, there is NO LIMIT to the number of tokens that can be created because of two flaws in the system. The first is that money itself is deemed an asset and more money can be created than there is value in the world. This would not seem to matter because the money that is created through monetising assets is destroyed when the loan to create the money is repaid. Unfortunately because dormant money that is not used to create new assets pays interest and hence causes monetary inflation. The other reason it is assumed the system will work is that the amount of money created is limited by the fractional reserve requirements. However, the fractional reserve requirement clearly fails if there is no limit on the loans (and hence money tokens) created. It also fails if too many assets are inflated beyond their underlying productive value and we monetize those inflated assets.
It is INEVITABLE with the current system that more money will always be created than is needed for commerce and investment. This need not matter if money at rest was interest free because we could simply leave it at rest until it was repaid. Unfortunately people will not leave money in interest free accounts but will try to deposit it so it will earn interest.
When too much money is created then the system adjusts. One way is through inflation which reduces the value of money and the other is stopping the creation of extra money by reducing new loans and getting old loans paid off. Both these methods are undesirable because they lead to a reduction in productive activity and a reduction in the creation of new productive assets. The also lead to a concentration of new wealth in the hands of those who already possess wealth.
The solution to the problem is to stop the creation of new tokens by monetizing existing assets. That is, a loan that is created by monetizing existing assets should use existing money rather than creating new money. This will stop the creation of excessive tokens. Unfortunately it leaves the problem of how to create new tokens.
If we discourage the monetizing of existing assets as the way to create new tokens we will still need a way of creating new tokens. One way this can be done is to monetizing new assets by building them with interest free loans. This reverses the current system where new assets are created with savings (or old tokens) while old assets are monetized with new tokens.
If we change the way we create some new tokens then the money market on existing money will inform us when we need to produce extra tokens. This will happen when interest rates increase to high values because there are not enough tokens available to fund desired investments. In this case we increase the number of interest free loans. When interest rates drop it will discourage savings and so we reduce the number of interest free loans which will encourage people to save rather than consume.
We should be selective in the investments which are funded by interest free loans. Most investments will still occur from savings and only a small percentage of investments will be needed to create new tokens. A particular use can be those cases where we have finite resources. In those cases we give interest free loans for investments in ways to increase the utilisation of those resources or to find substitutes. The effect can be amplified by giving interest free loans to people in inverse proportion to their consumption of the finite resource. This means that the less wealthy will tend to get more of the new wealth created from the use of the particular resource.
It is critical for the success of interest free loans to invest them efficiently and to prevent the funds “leaking” to other uses and/or being used for immediate consumption. This can be achieved in different ways depending on the area of investment. All the different ways depend on openness and transparency of market places for investment and on ensuring compliance by banning those who abuse the system from further participation for a period and of losing the advantages from the interest free loans they have previously received.
If we start increasing the money supply by giving interest free loans for investment purposes we will find that the system will adjust so that it becomes unprofitable to create new money by monetizing existing assets. That is, the monetization of existing assets to create new tokens will be less profitable than using existing tokens to monetize existing assets because of the interest payable immediately on the new tokens which increases the risk of investment failure. Without the need for interest payments on capital most investments are profitable and the investment risk of new ventures is significantly reduced.
If we distribute the right to interest free loans broadly throughout the population we will find the system will exhibit new emergent properties. It is likely that these will include.
1. New assets or wealth will be more widely distributed throughout society leading to a flatter distribution of wealth.
2. Society will be able to tackle difficult problems like climate change in ways that guarantee success.
3. There will be no monetary inflation.
4. Wealth will increase at a compound rate without exhausting finite resources. That is we will build a sustainable growing economic system in a finite world.
This addition to the way we create monetary tokens can be tried without the need for new legislation or the need to disrupt the existing financial system. It can be started in one community at a time and it does not depend on coercion for implementation. This means there is no need for any international or national agreements to fix the economic system. The creation of interest free loans can start independently in different societies and in different sectors of the economy and by disparate groups.
However, because societies that implement the system effectively will gain a competitive advantage over societies that don’t, the approach will spread rapidly.