Credit as a Tragedy of the Commons

The way we issue credit is an example of a “Tragedy of the Commons”.  The Commons in this case is a communities credit or trust in each other.  The way we issue credit is such that we each try to get as much of it as we can for our own purposes even though we know that if we issue too much overall there will be a tragedy (like a global financial crisis or depression).

An illustrated description along with a solution can be found at http://www.youtube.com/watch?v=wXqHSZOg3VA

The text of the talk is at

https://cscoxk.wordpress.com/2011/01/26/the-global-financial-crisis-is-a-tragedy-of-the-commons/

The solution is a variation of the general solution to the Tragedy of the Commons which is:

  1. Give people who consume less of the commons a reward of interest free credit.
  2. Require the interest free credit to be invested in ways to increase the commons.

The Global Financial Crisis is a Tragedy of the Commons.

The tragedy of the commons is a dilemma arising from the situation in which multiple individuals, acting independently, and solely and rationally consulting their own self-interest, will ultimately deplete a shared limited resource even when it is clear that it is not in anyone’s long-term interest for this to happen.

The total amount of credit in society is a Commons.

We create new money by issuing credit. That is, governments create money by giving loans. Banks are also allowed to do this. Not all loans result in an increase in money because we can use existing money and loan it – and the majority of loans do not end up increasing the total money supply.  Unfortunately the way the monetary system works it is not possible to distinguish which loans increase the total money supply and which ones don’t.

To try to control the total amount of credit in Society we restrict the amount of new money by only giving credit to people who already have money (or assets they can sell to get money).

So our system of credit creation is one where those who have money can get new money by getting interest bearing loans.  They can then use this new money to get more loans. So it ends up that the people who have assets keep getting more credit and so reduce the amount of credit available to those who do not have assets.  The problem with this system is that if we create too much money then the value of the money drops because we have more money than there are things to buy and so we get inflation. Also rich people start to run out of things to buy and so they spend their money on bigger and bigger houses and other forms of conspicuous consumption.  The other problem is that the money and assets ownership gets skewed so that some people end up owning most things because they are the only ones who can get credit and so get their hands on the new money that the banks and governments create. A more subtle problem is that people with assets tend to spend the extra credit protecting the value of their existing assets and this stifles innovation and creates monopolies and oligopolies.

The Tragedy of this system is that the monetary system causes booms and busts as it causes too much credit to be issued.  This causes inflation and the so called business which sometimes becomes recessions and depressions.

The solution to the problem is to give interest free loans to those who do not have assets – but require them to invest the loans to create new assets that will repay the loans.  That is we create new money with interest free loans that must be spent building productive assets. The income from the new productive assets will repay the loans.

Rich people can still get credit but we do not create new money when we give credit but use money that already exists.  So the principle is

  1. Create new money by giving interest free loans to the poor and require them to invest the money to create new assets that will repay the loans.
  2. If we make a loan secured against an existing asset then we should use existing money and we should pay interest on the loan.

This will fix the GFC, stop the business cycle, and stop inflation.

If the interest free money is used as Rewards for consuming less energy and the Rewards are used to build renewable energy plants then we will rapidly replace our fossil burning energy plants and start to reduce the levels of greenhouse gases in the atmosphere.

Early Infrastructure Replacement

The headlines and comment about the Queensland floods are focused on the cost to reconstruct what was destroyed.  We get headlines (CT Monday 24th) “Massive cost of floods to hit us all”. Instead of that headline we could have one that reads “Replacement of Queensland infrastructure brought forward”.

All Queensland houses that were destroyed and damaged had a use by date.  All roads and other infrastructure had to be maintained and replaced.  Using this point of view the floods have not cost us anything, but have made us replace some infrastructure many years earlier than expected.

When viewed in this light the problem becomes the cost of earlier expenditure on something we were going to do anyway.  This only becomes a problem if we consider time in our accounting calculations.  We can remove time by removing the need to pay interest on the funds used to rebuild infrastructure.

The question to ask is what value is there in paying interest on infrastructure funds? The answer is none.  Time cost is used to account for what is called opportunity cost. It gives us a way of evaluating whether we should do project A before project B.  It doesn’t change the real cost of construction of A or B.  If we are going to build infrastructure anyway why should we worry about whether it would be better to use the money on building something else?

The recent disasters has given the government an opportunity to change the way we fund infrastructure so that the monetary cost of rebuilding is reduced. The real cost of rebuilding will be the same but the monetary cost will drop.

Funding Health Care

Headlines such as “Ageing Boomers to cost us nearly $1.8 b” (CT Sat 22nd) are misleading and incorrect.  The headline should say, “Older People may spend more on health care”.

The headline arise from antiquated accounting practises – not the likely cost of future health care.  Our current health accounting procedures, used by Health and Treasury planners, assumes we have to save money for our future health care before we need the care.

Rather than trying to save an unknown amount of money for health care we can use “just in time” financing.  When an old person (or a young person) needs medical help then they can get an interest free loan that they pay back from their future income when they are well again. If the person dies the loans are paid back from their estate.  We can control the amount of funds by giving everyone – depending on age and health – a yearly accumulating amount of health credits.

Infrastructure can be built before the facilities are needed by people buying priority access with some of health credits.

Doing things this way removes the need for most health insurance. People can still take it out for queue jumping if they wish.  Governments do not have to collect taxes up front to build infrastructure and importantly we do not have to pay the rent seekers unnecessary interest.

Funds for Queensland Flood Relief

Gillard suggests a Levy, Abbott suggests stopping the NBN, and Brown suggests that the miners stump up the money.

There is another way.  The government can give flood victims credit to rebuild their homes and businesses and the victims can repay from their future taxes.  We are already familiar with the idea with the Higher Education Contribution Scheme invented by Prof Bruce Chapman of the ANU. Commercialisation Australia uses it to encourage innovation in industry.

Whether victims have to pay extra tax to repay the loan, whether there is interest on the loan, and how large we make the loans are all political decisions not economic ones. Loans whose repayment are contingent on future earnings are the most economically efficient method to provide assistance for disaster victims.

This approach lets victims rebuild using their future income rather than the current approach which rebuilds using the whole communities past taxes and savings. The approach does not affect the government’s balance sheet because the loans are given to taxpayers.  While it might appear inflationary it will not be inflationary if there are no restrictions on where the money is spent and when it is spent – as long as it is spent on rebuilding the equivalent lost assets.

The same approach can be used with Councils and with the Queensland State Government rebuilding efforts. Give them credit and expect it to be repaid from future taxes.

Creating money tokens

There are many descriptions of how the money supply increases.  There are even more theories on why the money supply increases.  By money supply we mean all the money tokens in the monetary system. The following describes how the money supply increases and outlines a method of increasing the money supply to meet the money needs for investment and trading.

Money is a token of a promise. The promise is that the money token can be exchanged for something of value.

If we have money tokens – bank accounts with deposits – then we can lend those tokens to others and in return we expect to get back more tokens than we lend.  If we do not get back more tokens then we require the borrower to sell an assets they have mortgaged and to use that money to repay the loan.  This is called monetizing assets.

Banks are allowed to create new money tokens if they can find a borrower who has an asset they can monetize.

If we lend exactly the same amount of money as is repaid then the money supply will stay the same and we will not increase the amount of money tokens in the system. If there are more loans made than repayments then the number of money tokens will increase.

As we only make loans by monetizing assets then we would expect that the total amount of loans in an economy could not be greater than the total amount of assets because banks can only make loans by monetizing assets.

However, the way our system works we make a lot more loans than we have assets.  This comes about because we can monetize the same assets more than once.  This happens because we can make a loan that monetizes a loan. This means there is an infinite amount of money that can be created.

We can stop this spiral of debt by making sure we have enough money tokens in the system to monetize all the assets that are in existence.  We can do this, without changing the existing system, by increasing the number of money tokens in a way that ensures we will create an asset at the same time as increasing the number of money tokens.

We do this by creating interest free loans that must be used to create a new asset. If we have enough money tokens in the system then there will little profit in creating new money tokens by monetizing loans.

Investing for Sustainability

The world’s monetary system is an amazing invention and it has enabled society to develop and advance.  It has done this by creating a system that turns natural and human resources into things of value to society. The monetary system drives the consumption of resources because it creates money that is then invested in ways to turn raw materials into things of value.

This system works well when there are abundant raw materials but it fails when there are limited raw materials.

The monetary system needs to be adjusted so that it expands value while at the same time using fewer raw materials.  We need a system where consumption of consumables can expand but consumption of raw materials will drop.  We need a system where we do more with less.

The secret to such a system lies with our monetary system as it is the enabler of investment.

The current monetary system expands the money supply by monetizing assets. That is, money increases when credit is granted.  Loans of money are granted if someone has an asset of some sort that can be sold if the money is not repaid.  The monetizing of assets is meant to control the amount of money that is created.  Loans are meant to be used to create new assets so that the loan can be repaid.

The reason the monetary system is failing us is that the money supply has increased way beyond the value of productive assets created with the new money.  We have many times more money than we have productive assets. This excess of money is accommodated in various ways. In a period of expansion it happens by monetizing many raw resources not currently in use.   This is the labour of the population, water, land and all the naturally occurring minerals, plants and animals. What happens is these natural resources are monetized through the use of loans.

We also create non productive asset value through asset bubbles.  We create assets that are derivatives of other assets. Monetizing non productive assets is the main way the money supply is increased.

The excess money is also accommodated by the system slowing down the rate at which money circulates.  This has the effect of moving money from those who use money for trade to those who already have assets because new money is only given to those who already possess assets.

Other excess money is absorbed by making each unit of money lower in value.

We need to change our monetary system so that the money supply more closely matches the productive assets in existence.  We also need to change our monetary system so that an increase in the money supply increases productive assets while consuming fewer naturally occurring resources.

We can do this by making any increase in money supply, that consumes less resources, less expensive than increasing the money supply that turns finite resources into money.  Such a monetary engine can drive society towards sustainability with increased consumption of goods and services of value.  Such a system will increase the rate of circulation of money and with it the spreading of assets throughout society and such a system can stop inflation of the money supply.

These objectives can be achieved by increasing the money supply by investing in productive assets that reduces the consumption of natural resources to achieve the same consumable output.  We can do this by issuing interest free loans to those in society who agree to invest money in such assets.

The current system increases the money supply by the difference between loans granted and loans repaid.  Money created this way earns interest the moment it is created.  It is thus more expensive than interest free money.

By having an adequate supply of money created with interest free loans we will reduce the amount of money created by monetizing natural resources and with it the exploitation of natural resources.  Of more importance to the excess of money supply it makes it unprofitable for creators of derivatives to increase the money supply. Derivatives can still operate using existing money tokens but they will find it less attractive to create expensive new money.

The Credit Commons – A Tragedy

The Global Financial Crisis is a Tragedy of the Commons.

The tragedy of the commons is a dilemma arising from the situation in which multiple individuals, acting independently, and solely and rationally consulting their own self-interest, will ultimately deplete a shared limited resource even when it is clear that it is not in anyone’s long-term interest for this to happen.

The total amount of credit in society is a Commons.

We create new money by issuing credit. That is, governments create money by giving loans. Banks are also allowed to do this. Not all loans result in an increase in money because we can use existing money and loan it – and the majority of loans do not end up increasing the total money supply.  Unfortunately the way the monetary system works it is not possible to distinguish which loans increase the total money supply and which ones don’t.

To try to control the total amount of credit in Society we restrict the amount of new money by only giving credit to people who already have money (or assets they can sell to get money).

So our system of credit creation is one where those who have money can get new money by getting interest bearing loans.  They can then use this new money to get more loans. So it ends up that the people who have assets keep getting more credit and so reduce the amount of credit available to those who do not have assets.  The problem with this system is that if we create too much money then the value of the money drops because we have more money than there are things to buy and so we get inflation. Also rich people start to run out of things to buy and so they spend their money on bigger and bigger houses and other forms of conspicuous consumption.  The other problem is that the money and assets ownership gets skewed so that some people end up owning most things because they are the only ones who can get credit and so get their hands on the new money that the banks and governments create. A more subtle problem is that people with assets tend to spend the extra credit protecting the value of their existing assets and this stifles innovation and creates monopolies and oligopolies.

The Tragedy of this system is that the monetary system causes booms and busts as it causes too much credit to be issued.  This causes inflation and the so called business cycle with its recessions and depressions.

The solution to the problem is to give interest free loans to those who do have fewer assets – but require them to invest the loans to create new assets that will repay the loans.  That is we increase the money supply with interest free loans that must be spent building productive assets. The income from the new productive assets is used to repay the loans.

Rich people can still get credit but we do not create new money when we give credit but use money that already exists.  So the principle is

Create new money by giving interest free loans to the asset poor and require them to invest the money to create new assets that will repay the loans.

If we make a loan secured against an existing asset then we use existing money and we pay interest on the loan.

This will fix the GFC, stop the business cycle, and stop inflation.

Most new assets are profitable if they are financed by interest free loans.  For example if we Reward people who consume less energy and require the Rewards to be used to build renewable energy plants then we will rapidly replace our fossil burning energy plants and start to reduce the levels of greenhouse gases in the atmosphere.

Why we have a Dysfunctional Banking System and What to do About it

The existing banking system seems to be sound yet we have a banking crisis that does not seem to be going away.

The banking system works in the following way.

Each day a bank makes loans and receives repayments.  It only makes loans if it can find a borrower who has assets that can be used as collateral for the loan.  At the end of the day it taillies up its loans and repayments and if it has more loans than repayments it goes to another bank and gets a loan that is backed by its loan portfolio.

This all makes perfect sense.  The amount of money increases – or decreases – depending on the demand for loans.

What can possibly go wrong?

Well something goes wrong because there is now many times more loans in existence than there are assets to back the loans. How can that be?

It comes back to what happens at the end of the day and the cumulative effect of doing this for many years.   When a loan is made that is backed by another loan then money is created that does not have a real asset backing it.  The asset backing has already been used to back the original loans so we have loans being created without the backing of real assets.  Again this would not matter if there was only a small amount of extra money in the system but over the years we have increased the amount of money so that it is now many times the value of existing assets.

The real problem becomes how to get rid of these excess loans.  Governments have run up huge deficits and governments take on the job of servicing those loans.  The way we try to get rid of the loans is to inflate the currencies of the world or to make the loans so that they do not matter. They become interest free or they are written off.

In a global economy writing off government deficits means transferring wealth from one country to another and this is what the IMF tries to do with some countries.  It says to a country like Ireland.  “You have to repay your debts and the way to do that is for you to reduce your spending and sell off the assets of your country to repay your debts”.

This appeared to work when the countries “going broke” were small but it is not working when the country “going broke” is the USA.

But countries don’t go broke.  It is all monetary mirage.  The loans should not have been created in the first place but because of the way the system works it is inevitable that this will happen.  The assets of the country still exist – it is just that there are too many loans written against them.

There is a solution and that is to stop the way this extra money is introduced into the system and to replace it with a different method.

Instead of banks getting an interest bearing loan from another bank if it has shortfall the bank could give interest free loans to its depositors.  These interest free loans would create interest free deposits and the bank would require that the loans be invested to create new productive assets.

However, this mechanism would be cumbersome and too open to abuse. Rather let us have Public Banks whose job it is, is to increase the money supply with interest free loans to the general population to satisfy the monetary needs of the other banks.  If Public Banks took on this role then it would supply the money needed for the rest of the system.  It has created extra money – not as a loan on top of another loan – but as a loan against a future asset.

If this was done then the banking system would get rid of the excess loans as it is too expensive to create extra money as interest bearing money when the money can be created as interest free money.  This means that as existing loans get repaid then we would not get new money being created with interest bearing money but we would get new money created with the cheaper money.

The system will rapidly return to equilibrium.

The good thing about this approach is that individual countries can do it with or without a public bank.  All it requires is a government willing to give interest free loans to its citizens – if they will invest the money to build public infrastructure.  Most citizens in most countries would be only too willing to take up the challenge.