Economic Myth and Transformation

Here’s an English translation of an article by our supporter in Greece, financial analyst Jason Ghionis, published in the Efsyn newspaper on 17th September.

With the following article you will familiarize yourselves quickly and in absence of technical terminology with new economic theory. It includes basic arguments why borrowing, interest and older systems such as linking currency to gold were and are problematic. Finally, it examines a currency issuance mechanism by an independent, state authority in accordance with Positive Money’s proposal and suggests adaptations that are in line with Greek reality.

The article is concise and constitutes a synopsis of thousands of pages of personal study and correspondence with people from a number of countries, associated with national and international monetary reform and transformation initiatives. Without resorting to citation of countless technical references and sources you will capture the essence!

Media of exchange throughout history

In the past various objects and systems have been employed to facilitate exchange. Among others, metallic rods (Mesopotamia, Ancient Greece), blocks of salt and seashells (various parts of the world), clothes weaved by tribesmen (Africa), large multi-ton circular stones carved out of limestone (Micronesia), human skulls in Borneo (!) among others. One can only imagine what happened in Borneo in 1800 when the time to settle accounts came due. Moreover, these were cannibal tribes. So they viewed their fellow man as currency and food simultaneously.

The issue at hand here is that the contemporary western standard is “cannibalistic” albeit with a civilized veneer. It is simply the case that this cannibalism (to the extent that a human construct negates, i.e. “cannibalizes” human essence) is more indiscernible. As you read on you will understand precisely why. Τhe current system (the western monetary standard) if viewed as a system among countless systems that have operated throughout the depths of time, is a parenthesis. Our very system has been reformed on multiple occasions over the past 3 centuries, where its contemporary form is traced. The last major reform took place in 1971 when the gold standard was abandoned following the decoupling of the dollar’s exchange rate from the precious metal.

As such, by looking at the greater picture one becomes aware that all we have experienced throughout our short personal journeys, is part of a much broader history that has undergone countless changes in the monetary (and not only) domain. It is just natural to believe that everything somehow magically has to be the way it was, as it was when we were children. Each generation however, sooner or later arrives at a junction.

The gold standard

Many up to this day claim that we must return to the gold standard or a precious metal standard. To support this idea, they bring up the period from ~1865 to 1914 (a variant of which was revived between 1944 and 1971)during which an international monetary system based on gold was in place (including silver in certain countries, known as the bimetallic standard) which was stable (Greece for instance was a member of the Latin Monetary Union which initially was based on a bimetallic standard). This system had a basic self-regulating mechanism: A country minted coins (and printed paper notes) in direct proportion to its gold reserves. When it had a deficit (e.g. owing to more imports than exports) it shipped gold to the other countries which lead to a decrease in domestic currency. This in turn would cause a decline in domestic prices (less gold => less currency => lower prices). The end result was that exports would increase due to lower prices, gold would flow back into the country and the domestic currency supply would increase. As such a sustainable cycle would repeat. There were however, three major problems with this system:

1) With the discovery of new gold deposits or with the improvement of mining techniques, the amount of currency could increase in one or more countries, without this being linked to actual economic output. In other words, the available quantity of a precious metal would arbitrarily determine the [monetary] size of a given economy, leading to destabilization (more gold from the discovery of a large new deposit => more currency =>price level increase => inflation => destabilization).

2) In times of uncertainty, a mere absence of confidence was capable of causing a lack in willingness to permit outflows of gold, leading to the system’s degradation and/or collapse

3) During periods of extreme phenomena or events (natural disasters, war), large outflows of gold owing to sizable, unanticipated expenses destabilized the economy and the entire mechanism collapsed.

In other words, this self-regulating property only worked during very mild changes (“normal” outflows and inflows of gold). This is precisely why new economic theory focuses on “non-arbitrary” regulating standards.

The economy as an ecosystem and new economic theory

An economy’s operation is characterised by complexity. An intricate system of flows and interactions just like those taking place in an ecosystem. The corollary of the exchanges that take place in an economy is the recycling of matter (biomass) within a natural ecosystem. It is for this reason that new economic theory focuses on better understanding how an ecosystem functions and how to emulate such functional behaviour in the realeconomy. As such, the notion of self-regulation remains topical since it is a defining, characteristic element of a healthy ecosystem (as long as it can adapt and recover even after being exposed to phenomena that lie outside the “ordinary” – i.e. to possess adequate levels of resilience).

On the other hand, a healthy ecosystem is governed by additional principles. It functions within a state of continuous flow, recycling matter in order to perpetuate a sustainable cycle. Birth, development, aging, death,recycling and repetition thereof. In today’s economy however, the medium of exchange, currency, is not governed by this principle. It is born, grows and continues to grow without end. This occurs because currencyowes its existence to debt.

Currency as interest bearing debt and fractional reserve banking

Today, the predominant currency issuance mechanism is in the form of private bank lending. Contrary to what most people believe, the currency in circulation is not the notes and coins printed and minted by a central bank. Indicatively, only 8% of euros in circulation are in coins and notes, much of which are not even exchanged (they are stored in bank vaults, safe-deposit boxes and under mattresses). The vast proportion of currency is created spontaneously in electronic form, when a private bank extends a loan. A private bank loan is not a transfer of existing currency from savers to borrowers. A private bank lends according to a practice known as “fractional reserve banking”. In plain English, for each unit of currency a bank in a eurozone member state holds in reserve, it may loan up to one hundred (unlike the UK where there is no reserve requirement whatsoever.)

This practice is better understood with an example from the past. Centuries ago goldsmiths operated as bankers. People took their gold to them and received a certificate in return, quoting the amount they had deposited. After a certain point the goldsmiths became aware of the fact that they could issue certificates in multiples of the gold they had on deposit. This occurred because they considered it highly unlikely that their depositors would simultaneously withdraw all their gold. In doing this, they started operating as present day banks.

The main problem with this practice is twofold:

1) During periods of crisis, people lost faith in the certificates and rushed to withdraw their gold. An older version of what is known today as a bank run. Since the certificates issued were many multiples of the gold deposited, the entire system would quickly collapse.

2) In present day apart from the creation of more currency than actually exists in reserve, we have the additional problem created by interest (remember, new currency = interest bearing debt). This interest has to be paid from somewhere. However, since currency is created predominantly through lending, an ever increasing level of lending is required to cover interest on older loans. This serves to propagate more and more cycles of lending. And this is why debts derail. And this is why everyone owes everyone and the sum total of the economy owes the banks. And not only are the banks owed currency but they must be recapitalized (at least the larger banks) when they go bankrupt because banks = currency. If a large bank fails then its failure spreads throughout the financial sector and the entire system collapses.

The growth imperative

The only way in which this system can sustain itself is when the rate of economic growth is equal to or greater than the interest that must be paid [on the sum total of debt outstanding]. In essence this means that economic growth is called upon to match and overcompensate for interest. In reality however, this has not been the case for a number of decades (interest charges accumulate faster with growth trailing in the distance). By way of example, when consumer credit carries an interest rate of 17%, precisely what kind of growth can offset it? The end result is a debt bubble (in all countries in the private and public sectors) which equates to an attempt to sweep this systemic dysfunction under the rug.

The system’s deficiency in sustainable self-regulation/recycling consistently stumbles on 5 points, each of equal importance:

a) in that time available to us is finite

b) in that natural resources are finite

c) in that the natural environment’s capacity to recover from its constant degradation is finite

e) in that the vital energy we can expend to propel this growth is finite

f) in that it takes for granted that an economy can grow indefinitely without accounting for factors that lie beyond the ordinary (natural disasters and other contingencies).

From a certain point onwards we reach a natural limit just like a 100m dash runner. He will improve his time as far as his physical limitations permit. The system however, requires of him not only to improve his time but to improve it without end and, at an increasing rate. Furthermore, all this without allowing any leeway for contingencies (e.g. a period of absence due to a cold).

In light of the above we become aware of the distorted nature of this entire premise which presents us with the following dilemma: Either we have to comply with the “growth imperative” at all cost in an attempt to prop up the system (without mathematical prospect of success). To “generously” sacrifice the sum total of our free time (and of our sleep beyond a certain point) while simultaneously draining the planet’s natural resources beyond its self-regulating regenerative capacity. Either on the other hand, to reconsider the entire construct’s functional principles. As such, we logically come to the conclusion that for the system to function we have to:

a) examine anew and revise the logic of currency issuance “out of thin air” (i.e. the practice of fractional reserve banking)

b) examine the role of interest as a destabilizing factor

Economic simulation of the ecosystem and negative interest

For the economy to simulate the natural ecosystem, to align with the organic needs of man and the natural environment and to enter a sustainable cycle it has to be inextricably linked to:

1) our vital energy and the time available to us

2) the self-regulating regenerative capacity of the natural environment

Point 1) does not imply that we must devote the sum total of our vital energy to the economy. On the contrary, we must limit our engagement in lower order pursuits and devote much more time towards personal development, creative endeavours, personal relationships. Those things that have always fueled meaningful development and prosperity.

For point 2), the predominant proposal with historical precedents * (1) is the notion of negative interest. As an introduction to this notion, the words of Fīnau Fangupō , chief of the Tonga islands, in 1806, following a bloody confrontation with European colonialists strike one as relevant within a contemporary context:

“If money were made of iron and could be converted into knives, axes and chisels there would be some sense in placing a value on it; but as it is, I see none. If a man has more yams than he wants, let him exchange some of them away for pork. […] Certainly money is much handier and more convenient but then, as it will not rot by being kept, people will store it up instead of sharing it out as a chief ought to do, and thus become selfish. […] I understand now very well what it is that makes the papālangi [white men] so selfish — it is this money!“ 

Following this line of reasoning, should not currency perhaps “rot” at some point, in line with the same principles that govern the natural organic? Birth, development, decay, death, recycling.

Birth (currency creation), development (generation and exchange of value in the real economy), decay (negative interest), death (cancellation of currency owing to old age – accumulation of negative interest), recycling(redistribution of currency with the proceeds of negative interest to society and the economy by extension). In this way the natural function of the ecosystem is simulated in the economic domain. Moreover, a framework is simultaneously created whereby environmental preservation, not degradation is financially beneficial.

Why negative interest contributes to environmental preservation

Let us examine the following scenario. A company purchases a woodland for the purpose of timber harvesting. It examines two competing scenarios:

1) Clear-cutting the entire forest.

2) Timber harvesting in line with the forest’s rate of replenishment.

In an environment of positive interest rates, 1) is more beneficial financially. This holds true because the company earns one large sum upfront vis-à-vis option 2) which it can in turn park in a bank account not only preserving its value but earning interest over time. When it examines the 2nd option, it not only considers the upfront revenue foregone by not engaging in clear-cutting but in addition, the interest it would have earned.

In a negative interest rate environment everything reverses. Option 2) is more beneficial financially.

The aforementioned example is clearly an oversimplification. Generally speaking though, negative interest sets a financial barrier to unsound environmental practice. This occurs because currency is subjected to decay as is every natural organism. The end result is that what becomes preferable is a steady flow of currency over a long period of time (in perpetuity to be more precise) in lieu of ongoing destruction and collection of large sums upfront.

Conditions under which negative interest can function

The rationale for introducing negative interest can only function properly when it constitutes the norm for all major, hard currencies. Imagine a country with a moderately competitive currency introducing a policy of negative interest rates. What would happen? As soon as someone earned this particular currency, they would have an incentive to immediately convert it to a foreign currency whose interest is equal to or greater than zero.

With respect to negative interest rates currently observed in certain countries (Switzerland for example), this occurs because the currency in question is considered more “secure” and more likely to appreciate vis-à-vis other currencies. As such, strong demand for this currency empowers its banking sector to charge deposits instead of paying interest on them. The impetus here is definitely not a product of ecological sensitivity.

An international regime of negative interest rates albeit desirable for environmental reasons and beyond, will take time to become the norm* (2). On one hand because the public will require time to adapt to the notion that modes of saving will radically change and on the other because the adaptation of all currencies to align with such rationale will be a time consuming process. This however, does not mean that we must remain complacent.

No single economy can function without a healthy natural environment. Irrespective of how many technical improvements are made to the “growth” model and of how much pro-environmental legislation is passed, if preserving the environment is not financially beneficial loopholes will always be discovered and exploited. What is required is a systemic input such as negative interest that will render environmental preservation “profitable”. For the time being, what needs to be done is for the benefits of this practice to be communicated to as many people as possible. If anything, we are already very close to negative interest rates since a number of large economies have interests rates very close to 0 * (3).

From currency as fractional reserve private bank debt to sovereign currency

At the core of the most popular monetary reform movement in the world – Positive Money – rests the notion that every sovereign nation (or economic zone) must rely on a sovereign authority to issue its currency. Specifically, it proposes the abolition of the privilege bestowed upon private banks to issue currency through fractional reserve lending.

Instead of private banks, a central authority such as a Monetary Committee accountable to a second committee will decide on the sum total of currency issued. Once currency is issued it will be transferred to the government which will decide how it will circulate with parliamentary approval. Three authorities, each independent of the other.

The creation of currency can be directed towards the funding of public projects, reducing taxation, providing private banks with loans on condition that these funds are directed towards the real economy, or directly distributed to the population. In other words, the state will distribute (spend) new currency directly or indirectly, in the real economy. The Monetary Committee’s prime mandate will be to issue currency in quantity that will not cause instability (destabilizing inflation) and of the state to favour distribution which is most beneficial to the population in its entirety.

Within a purely Greek (or European) framework now, if we are to assume that the Monetary Committee, the overseeing committee and the government (or commission) will operate truly independently in accordance with the nation’s (or economic zone’s) best interests as a whole and with auspicious, sustainable long term objectives in mind, all is well.

Since it would be infelicitous to express an opinion for other countries, let us focus on Greece. Throughout the country’s recent history, whenever a central authority has been responsible for the issuance of currency (in its entirety or of a large proportion thereof), major problems have ensued. Inflation, devaluations, issuance of paper notes without corresponding value in precious metals (during the bimetallic standard) and so forth.

To consider this specific proposal now, we will entertain the following scenario: Let us assume that our nation has adopted a system whereby currency is issued by a sovereign authority which receives permission by a supervisory committee to transfer a specific monetary sum to a given government to be made available in the economy. What will happen during a pre-election period? The likeliest outcome will be for political pressures to be applied towards excessive, inflationary issuance of currency. To create an artificial sense of prosperity thus influencing the electoral body. This is a natural concomitant since the framework is susceptible to manipulation under specific conditions, especially when dealing with domestic monopolies or oligopolies (oligopoly in currency issuance and monopoly in its distribution). Even if we are to assume that the committees are not influenced by a given government or lobbying, it is almost certain that during a pre-election period, any given government will choose to distribute currency directly to the population (since it will have the right to do so) as a pure exercise in electioneering. All this irrespective of whether the economy and the population have other needs. For instance it might be imperative that currency is invested directly in sustainable farming so as to avert a future food shortage and not to be distributed to the population directly just to satisfy a need for ephemeral consumption.

A competitive mechanism would be capable of automatically regulating the entire process. For instance there could be multiple committees responsible for currency issuance, multiple supervisory committees and a corresponding number of authorities responsible for its circulation. All possible combinations that result from this structure generate a more creative framework, limiting the scope of abusive behaviour. Even from an intuitive standpoint, creative polyphony is preferable to concentrated administration. It is more likely that one, two or three authorities will commit major errors and / or be manipulated than all the possible combinations that result under the second scenario. By way of illustration, there could be the following authorities that will propose currency issuance: Environmental, commercial, healthcare, cultural, sporting, social, agricultural, R&D, educational and a unified entity representing local governments. In turn there could be multiple supervisory committees which will evaluate each of the former authorities’ proposals and will collectively decide on the amount that will be approved for each proposal on their merit. Following that, a corresponding number of authorities will carry out the distribution of currency in the economy* (4).

Synopsis

• Our current monetary system is but a small stage within a broader evolutionary monetary framework

• Gold and silver comprise arbitrary regulating standards with innate shortcomings and as such have proven severely deficient whenever adopted

• Private banks today create in excess of 90% of currency in the economy, through interest bearing loans

• 92% of the sum total of euros are in electronic form and only 8% in cash

• Private banks in the eurozone have the right to lend up to 100 times their reserves (unlike the UK where there is no such limit) – under certain conditions even more (via interbank lending)

• Issuance of currency through lending creates an unstable system; on one hand because it is not 100% connected to actual currency (this is what creates the possibility of a bank run) and on the other because interest creates an unsustainable growth imperative (finite natural resources, finite environmental capacity for absorption of waste and pollution, unanticipated events, finite human time and vital energy)

• Negative interest rates align the monetary modus operandi with the environment – an idea however that will require a bit of time to mature in public conscience

• Positive Money‘s proposal eradicates the pathogens associated with the private banks’ problematic practice of fractional reserve banking

  • Currency is issued directly by national, public organizations (or supranational in the case of the eurozone – it applies to both cases)

  • There will always be sufficient cash (the possibility of a bank run is eliminated)

  • Currency is directed towards the real economy

  • As far as Greek reality goes, multiple authorities of currency issuance, supervision and distribution will be required

Finally, the Greek proposal is inextricably linked with the writing down of the proportion of debt towards private banks which is the result of interest and compound interest. At the same time, it is imperative that private banks are maintained and begin focusing on the real economy. Either which way we examine this, the fact of the matter is that the private banks are essentially bankrupt, first and foremost because they have required billions in recapitalizations and state guarantees (by extension constant support by the Greek taxpayer) and additionally because a large percentage of loans is no longer being serviced. In essence we are referring to an accounting reset.

The most important element though is that with such monetary reform, the emphasis shifts from the quantitative to the qualitative and from the virtual to the actual. At all levels.

1. https://en.wikipedia.org/wiki/Demurrage_%28currency%29#History

2. As far as private banks are concerned one reasonably can ask oneself how can they manage to survive in a negative interest rate environment? The answer to this is simple: what is of importance here is not whether interest rates are positive or negative. The latter can also be profitable as long as there is a differential between the rate that applies to the bank and the rate charged by the bank itself.

3. http://www.cbrates.com/

4. In addition, for SMEs, a subbranch of the system could operate employing the rationale of a mutual credit network. There are countless resources online on mutual credit networks and they could be adapted to serve this specific model (e.g. by enabling overdraft limits for SMEs and issuing or destroying currency spontaneously depending on the aggregate amount of overdraft balances outstanding).

Original article in Greek here.