Imagine you live in a community with no money and you make furniture for living. Every time you want to buy something you need to exchange an appropriate amount of furniture directly or indirectly for those goods. This has a number of obvious problems.
A Mr B comes along and says he has the solution. He has produced large numbers of tokens which he has got the powers that be in the community to set as a legal tender; that is they legally have to be accepted in exchange for goods and services. It sounds great. The tokens are small and easy to carry and also unlike your furniture, everyone will accept them in exchange for their goods and or services.
You ask how do I get these tokens and Mr B explains that because you have your own place and produce something useful that can be exchanged for other things of real value that he will be happy to lend you 100 tokens. However because there is a risk that you won’t be able to pay him back when the tokens are due back in a years time he asks that you make a legally binding promise to pay him back 110 tokens when the year is up.
He explains that provided you make and sell enough furniture you should easily be able to pay him back at the end of the year. “People always need furniture” he says “and because everyone else in the community will also have borrowed tokens from me there will be plenty of tokens to go around”.
You think about this and ask the following question: “If each person in the community borrows 100 tokens and has to pay back 110 where do the extra 10 tokens each come from?”
“That’s easy”, he replies “Most of the tokens you pay to me in interest, I’ll pay to the people who work for me administering the loans, and they’ll spend them into the economy. So all you have to do is produce something that they want to get the extra tokens from the people who work for me…”
You stop and think again and ask “So what stops you from producing tokens for yourself and buying up all the stuff in the community?”
“Don’t worry” says Mr B, “I can’t produce the tokens for my own use. The powers that be only allow me to lend them out. It is also of course illegal for anyone to copy them. When I get the tokens back they are out of circulation again. I can only spend the extra tokens. Well and of course the tokens I’ve lent to my wife.”
You have a number of other questions you want to ask, including the following:
“How do you decide whether or not you will lend out tokens to someone?”
“What happens if you suddenly decide to stop lending?”
“What happens if someone can’t pay you back?”
“What happens if you don’t spend all the extra tokens back into the community?”
“Do you lend tokens to your wife under the same conditions you lend to us?”
“Is there any way the community as a whole won’t always owe you tokens?”
But two other questions seem more important so you let the other questions wait.
The first is: “What determines the value of these tokens?”
“Well that’s determined by two things.” Mr B replies, “The number of tokens in circulation in the community and the number of things the tokens can be spent on, i.e. the amount of goods and services available in the community.”
“Surely Mr B,” you begin “you are incentivised to lend as many tokens as possible because you can spend the extra tokens you get back. But with more tokens circulating in the community the value of each one must decrease”
“Well,” replies Mr B “that would be the case if the number of things to buy in the community didn’t also increase. Because people have to pay back more tokens than they borrowed they are incentivised to use the tokens to improve their productivity, increasing the available goods and services. As such the tokens should only lose a little bit of their value.”
“But I want to use my tokens to make my furniture more sustainably” you say, “The number of nearby trees is falling rapidly and it seems right and sensible to spend my tokens on replanting them so the community and I have a source of wood for the foreseeable future”
“That’s absolutely fine” says Mr B “but you’ll still have to sell enough furniture to make up the 110 tokens”.
Not sure if Mr B has understood your concern you proceed straight to the second question: “Why do you get to control the tokens?”
Mr B seems particularly annoyed by this and responds curtly, “Because I set this up, I produce the tokens and I am the one who made the arrangements with the powers that be!”
And then you hit upon a really key question:
“Why can’t the powers that be allocate tokens to projects that the community needs such as a new road? The people that build the new road will get the tokens and be able to spend them into the community. To stop the tokens losing value we can limit the number allocated according to the growth of the goods and services in the community. That way nobody owes anybody anything and we get to produce things the community needs.”
“Hah, you’ll never be able to convince people to do that” Mr B laughs, “it sounds too much like communism!”