Article : why debt growth must exceed interest payments

[gnk]

Re: Article : why debt growth must exceed interest payments

However I am surprised you state that the debt behind a dollar is never extinguished.

If I understand correctly, the Treasury debt behind Dollars is created when the Treasury issues Bills, Notes and Bonds which it sells at auction in exchange for Dollars. The Fed puts more Dollars into circulation by engaging in Open Market Operations with its banks, exchanging Treasury debt back and forth for Dollars.

Treasury debt can be (though, granted, infrequently is) extinguished by the Treasury buying back its debt paper. More commonly of course, old expiring debt is rolled over, and new additional debt is added.

What you refer to above is a line from a prior post of mine:

It's all debt, and never truly extinguished, but transferred.

How are debts settled? With dollars, which themselves represent debt. These dollars are created not just between the Fed and Treasury, but thru the private banking system - so long as they have reserves. All of these dollars are loaned into existence. That's how the system works.

So that's why I say debt is transferred. New money/New debt, is used to pay off old money/old debt.

Simply put, let's call dollars IOUs:

We are merely exchanging IOUs amongst eachother. Some are owed IOUs, others have to earn IOUs to pay off someone else. But the IOUs continue... the interest grows in the aggregate, and more IOUs are therefore needed to be created to handle that interest growth.

You'll hear Austrian economists frequently say things like:

"Gold is the ultimate extinguisher of debt"

"Gold has no counterparty"

These are based on the fact that gold used to be exchanged for dollars at banks - it was money. Anyone could go to a bank and get gold, or vice versa. The gold itself was not debt, it was something tangible. When you hold gold money, you do not rely on the solvency of a government or individual for your gold to maintain its value.

I think that's why JP Morgan said to Congress once:

"Gold is money, and nothing else."

That's not the case today. Today, money is backed by debt because it is created by debt. Either by government or private banks, it is loaned into existence. As it is loaned into existence, interest accumulates.... more needs to be loaned into existence.

If fiat debt-based money is loaned into existence at one shot - and never again - like your example... the economy would crash. Why? Because the original lender, let's say the government, would need to collect interest - money. Meanwhile, the private sector will be creating lenders and debtors, and they too would be competing for the same money to pay the interest on their own loans.

This is very Alice in Wonderland type stuff... but, that's how I unfortunately think it works.

[Glenn Black]

Re: Article : why debt growth must exceed interest payments

"Exponential", another word like "mathematical" used to glaze over the listener's mind, so as to cover up an insufficient precision of thought with an imposing layer of language.

If tomorrow I go out and sign a mortgage for a $3 million dollar McMansion, with monthly payments of perhaps 200% of my income, that's not exponential growth in my debt load. Presently I have zero debt and quite modest income. Signing that note would be financial suicide, taken all in a single step function. Nothing exponential about it.

On the other hand, if the rent on my trailer lot increases by 1% per-annum forever, I'll easily be able to handle that increase on my current quite modest income, even if my income remains exactly fixed. I doubt I'll be here more than another 30 or so years, during which time a 1%/yr increase, compounded annually, totals out to just a 35% increase. No problem.

Debt becomes a problem to the debtor when the repayments exceed the cash flow available for repayment. Debt becomes a problem for the lender when the debtor defaults. When that happens depends on future events which cannot be entirely predicted, and which certainly cannot be computed using some particular form mathematical equation.

If SAC accidentally drops a live nuke on Denton, Texas tomorrow morning then even a $1 debt at zero interest that I might owe someone defaults .. is vaporized ... instantly.

I'm not exactly sure of your point.

Did you watch the video? The good Dr. describes how any exponential will eventually destroy the system that creates it; it's only a matter of time. He also states that "7% growth" is often used to hide the ugly truth. He suggests using "doubling times", in what duration is the quantity doubled. In our 7% example, it is calculated as 70/7%= 10 years, which means a 7% growth rate double the quantity every 10 years. You can imagine what would happen to a city that had to double the water, sewer, houses, etc. every 10 years. Doesn't take a rocket scientist to figure out this is a huge change, and can only occur for so long before disaster strikes.

[charliebrown]

Re: Article : why debt growth must exceed interest payments

I am replying to your point about a loan repayment being made in partial payments.
It really makes no difference whether paid in full at the term of the loan, or paid over time.

When I give $10 to the bank it sits in the bank vault, or if I pay with check, it is just an accounting entry.
The notes principle is reduced, which means the bank can lend more because it has a little more capital.
Note that a loan must be made to create the money again.

Banks create money making a loan, and destroy money when the loan is repaid, either destroyed bit by bit, or whole hog if paid in full.
Still the $5.00 in the above example never exists, unless someone else takes out another loan.

========
If I am thinking about this conundrum correctly, the issue with a fiat debt based currency system is only banks can create and destroy money.

If we lived in society where timber was the medium of exchange, each citizen could grow their own trees, thus creating there own money. Yes they could borrow from a timber bank, with interest, but the payment of the interest could be made by the borrower growing their own trees, and using it to pay the interest.

Rajiv, do I have it? Oh my brain hurts.

[ThePythonicCow]

Re: Article : why debt growth must exceed interest payments

I'm not exactly sure of your point.

My point is that it is incorrect to claim the problem is due to exponential growth. We could have the same problems with linear or other growth curves; we could not have the same problems with exponential growth; we probably don't even have exactly an exponential growth anyway (real world messy curves seldom fit any particular analytic function perfectly.)

I'm not denying we have a problem with mushrooming debt. I'm not denying that one way to (approximately) model mushrooming debt is with exponential curves. But focusing on the word "exponential", with examples of such functions, is a distraction from the real causes of our economic problems. For example, your 7% example becomes less scary if I just adjust the exponent or its time scale. A growth of 7% per billion years is no problem; the sun turns into a red giant destroying all life on earth before that growth gets out of hand.

Exponents don't kill economies. Mushrooming fraud in an economies major institutions kills economies... or something like that.

Did you watch the video? The good Dr. ...

Which Doctor, which video, do you refer to?

[ThePythonicCow]

Re: Article : why debt growth must exceed interest payments

I am replying to your point about a loan repayment being made in partial payments.
It really makes no difference whether paid in full at the term of the loan, or paid over time.

Hmm... this time I guess you're responding to my query above:

To what are you responding?

I should ask not for whom the bell tolls; it tolls for me.

Whether the loan is paid in full all at once, or over time, does not matter much to many aspects of this discussion. You are correct there.

But this detail does matter to one point. Trivial monetary systems created using a single monetized, interest bearing, debt instrument (P) and one single repayment (P + I) lack sufficient money afloat to fund that single repayment (P < P + I.)

Other posters presented such simple examples to show that a debt-based monetary system mathematically required an exponentially growing money supply. I introduced the "multiple payment" variant to demonstrate that debt-based monetary systems did not mathematically require a growing money supply.

For the larger picture and more important matters, yes, you're right. The number and size of payments of any particular loan doesn't matter.

When I give $10 to the bank it sits in the bank vault, or if I pay with check, it is just an accounting entry. The notes principle is reduced, which means the bank can lend more because it has a little more capital. Note that a loan must be made to create the money again.

Banks create money making a loan, and destroy money when the loan is repaid, either destroyed bit by bit, or whole hog if paid in full. Still the $5.00 in the above example never exists, unless someone else takes out another loan.

I'll agree with what you say here, yes.

If I am thinking about this conundrum correctly, the issue with a fiat debt based currency system is only banks can create and destroy money.

Yes. In such systems, banks make money from interest and fees. Anytime one grants a monopoly for a critical resource to a few large institutions who are rewarded as that resource is used more, there is great risk that those institutions will become increasingly powerful and corrupt, as they find more ways to increase our use of that resource.

The premier example of this is banks, money and debt.

If we lived in society where timber was the medium of exchange, each citizen could grow their own trees, thus creating there own money. Yes they could borrow from a timber bank, with interest, but the payment of the interest could be made by the borrower growing their own trees, and using it to pay the interest.

Yes. In your timber example, control of money creation is dispersed and requires labor. This keeps a lid on massive fraud. The risk in your timber example might be that a few large timber companies gained control over massive areas of timber growing land, perhaps facilitated by their increasingly corrupt control of the government. This could lead to cynics claiming that "Big Wood" funded and drove the invasion of other nations that happened to be timber rich, or through which logging roads were needed to get timber to seaports.

[Rajiv]

Re: Article : why debt growth must exceed interest payments

Banks create money making a loan, and destroy money when the loan is repaid, either destroyed bit by bit, or whole hog if paid in full.
Still the $5.00 in the above example never exists, unless someone else takes out another loan.

========
If I am thinking about this conundrum correctly, the issue with a fiat debt based currency system is only banks can create and destroy money.

If we lived in society where timber was the medium of exchange, each citizen could grow their own trees, thus creating there own money. Yes they could borrow from a timber bank, with interest, but the payment of the interest could be made by the borrower growing their own trees, and using it to pay the interest.

Rajiv, do I have it? Oh my brain hurts.

You have that partly correct. The loan a bank makes to you is an asset to the bank. The deposits in the bank are its liabilities. Also, there is the banks capitalization.

When a bank makes you a loan of $500, it opens a bank account for you, and credits that bank account with $500 - it now has an asset of $500 in the form of a loan to you. It also has a liability of $500 in the form of the new deposit. So $500 of new money has now been created, that can now flow into the economy when you withdraw money from that bank account. When you pay the loan back, the asset and the liability disappear, and that $500 is destroyed. The payments back to the bank consist of the principal plus the interest.

What happens to the interest is interesting. The interest exists either in the form of monetary payments, or in the form of barter payments. In both cases, the bank has a new asset. Either a new monetary asset (which of course would be a new loan) or a physical asset in the form of the fruits of your labor. If it is in the form of a new loan, then it relies on the creation of new money (or an increase in money supply) -- This could potentially be inflationary, if no new physical assets were created in the economy due to new loans.

However, what happens if the loan is not paid back? Now the bank's books no longer balance, and the loss has to be written off. This loss comes out of the bank's capitalization.

If all loans were being paid back, things are fine nominally. There are still issues of ownership of the newly created assets. Let us take two cases. In one case the bank is owned by private individuals, and in the other, it is a nationalized bank owned either by the community, or by the government (the decision maker for the community)

So the additional assets that you created by utilizing the loan in your business, are shared by you and the bank. In one case the fruits of the loan went to small group of people. In the other the assets created by the fruit of your labor were shared between you and your community.

The problems arise, when the loan results in no new assets being formed. In that case, if the loans are paid back, an asset moves from you to the banker. If the asset is inflationary (new money) than you are impoverished because of inflation. If it is a barter asset, you are impoverished by losing that asset.

However, on the other other side of the equation, in the inflationary scenario, the whole community is impoverished when the bank is private, while the banker is enriched. In the case of the community owned bank, the community is not impoverished, but rather, the assets go from the individual to the community. But even in the case of the private bankers, the community has one more tool - taxation - to avoid the impoverishment of the community. (This I believe was the reason for institution of the income tax at the same time as the creation of the FED)

However if loans are defaulted upon, then bankers lose to the defaulter, and there is a reverse transfer of assets. In one case, the private bankers lose, and in the other case, the community loses wealth to the defaulter.

Indiscriminate creation of new money leads to a much higher chance of default, and therefore financial crashes.

When there are new resources to be exploited, this process results in "economic growth." However unless one has a Cornucopia, these "new" resources are invariably used up, and lead inevitably to the "Four Horsemen"

A steady state economy is not very compatible with the current financial system, because of the nature of debt based money.

[ThePythonicCow]

Re: Article : why debt growth must exceed interest payments

How are debts settled? With dollars, which themselves represent debt. These dollars are created not just between the Fed and Treasury, but thru the private banking system - so long as they have reserves. All of these dollars are loaned into existence. That's how the system works

But, but ... what happens when the debt against which some particular dollar was issued is extinguished by paying the debt off with that self-same dollar?

You seem to be saying that debt can be extinguished, but that the corresponding money that was issued (or credited to a bank account) to fund that debt cannot be extinguished. You seem to be saying that the money supply must always and inexorably increase. If that's so, how is it possible that the money supply statistics from http://www.shadowstats.com sometimes decrease:

Let's consider an example in which the correlation between debt and money is clear. Let's say tomorrow morning my bank extends me a $10,000 signature loan. I sign a note saying I owe them $10,000 and they add $10,000 to my checking account with them. Then let's say tomorrow afternoon I change my mind and go by the bank again to cancel the loan. Let's say there were no loan fees and I had not yet accrued any interest. The bank tears up my note and deducts $10,000 from my checking account. I claim that these events did not increase the nations money supply one whit at the end of the day.

You and I are like a couple of passengers on the Titanic, just after it hit the iceberg. You're saying we should never have built ships out of steel because it's heavier than water, so will always and inexorably sink. I'm saying that's not the problem. You're looking at me a bit incredulously, crying out for me to notice the seawater lapping at my feet. I'm telling you I agree the ship is sinking, and indeed I am scrambling as frantically as you are for a life preserver or a seat on a life boat. You are invoking the wise words of old sailors who recommend sailing only in boats made of wood.

[gnk]

Re: Article : why debt growth must exceed interest payments

But, but ... what happens when the debt against which some particular dollar was issued is extinguished by paying the debt off with that self-same dollar?

You seem to be saying that debt can be extinguished, but that the corresponding money that was issued (or credited to a bank account) to fund that debt cannot be extinguished. You seem to be saying that the money supply must always and inexorably increase. If that's so, how is it possible that the money supply statistics from http://www.shadowstats.com sometimes decrease:

Yes, but that chart does not show the amount of money (supply), but the rate of growth in supply. The rate of growth can fluctuate - true. But over a longer period of time, supply always grows. The M3 that John Williams uses is a projection - but keep in mind, M3 includes dollars held by US residents abroad as well as Canadian and the UK banks. I'm focusing on money in our domestic economy.


Let's look at MZM, M1, and M2:

MZM_Max_630_378.png

M1_Max_630_378.png

M2_Max_630_378.png


Overall, there is growth. No flatlines or extended periods of contraction.

But yes, the money supply can contract - for a brief period. But that's highly unstable for an economy... it causes deflation (money and wealth destruction)... hence, the recent 23.7 Trillion in Government bailouts/guarantees/ commitments/ purchases/ swaps... The government will fight this tooth and nail.

The debt based money supply will grow... it must grow... and government, be it Republican or Democrat, will ensure it will grow, regardless of what they say on the campaign trail. It will grow until it no longer can grow. And then we find out what happens - because I'm really curious, as no one really has an answer.

During the Great Depression, the US was both the Saudi Arabia and China of the world - the largest oil exporter and largest creditor nation. We also had over 25% of the population living on farms, and our debt prior to the depression was very manageable. We are missing all those factors today.

Never in the history of the world has the entire global marketplace relied on fiat-debt based paper - energized and optimized by computers no less. It is but a 40 year experiment, yet 99% of the population thinks that's how it has always been.

I'm probably one of the most pessimistic people on this site. I believe that most people have not fully grasped just how really, really bad this will turn out - or how fragile and susceptible our system is. Most people think - hey, I have a job, my boss likes me... I'm fine. They don't realize how entire industries will be wiped out - and it will affect them whether they are good at what they do or not. But I digress...

[ThePythonicCow]

Re: Article : why debt growth must exceed interest payments

Yes, but that chart does not show the amount of money (supply), but the rate of growth in supply.

True - good catch. Only the blue SGS M3 goes more than a hair below zero (actual shrinkage) and that for just this year.

Back to the top ... I quite agree that our fiat money supply has been growing without significant letup and that our monetary, financial, regulatory, economic, political, medical, ... systems are seriously borked.

And while I may be less certain than you are that this is going to turn out really badly, I won't be much surprised either. I've moved to a much cheaper area (from an upscale neighborhood in Silicon Valley to a trailer park in North Texas), quit my job (a good software management and development career of 30 years), sold my California and Florida real estate, paid off all my debts and downsized to 5 or 10% of the run rate of what it was two years ago. I've moved most of my remaining liquid assets into gold and silver and stocked up on enough supplies to last me many months without a single shred of our economy (stores, water, gas, banks, ...) functioning at all.

We both figure this ship has some good chance of sinking.

On this thread, we were just trying to analyze the failures in bulkheads and rivets that led to our Titanic's structural failures, even as we scramble for life boat seating.

[jacobdcoates]

Re: Article : why debt growth must exceed interest payments

No, I don't think so. That 100 $GNK$ was created through debt. It was created in exchange for the note I gave you, good for 11 payments of 10 $GNK$ each, from me to you, one payment per week, for 11 weeks.

My scenario is quite simplified, yes. But that detail at least is captured, I believe.

Our real dollar bills in our wallet are, as you note, also debt-based money. However I am surprised you state that the debt behind a dollar is never extinguished.

If I understand correctly, the Treasury debt behind Dollars is created when the Treasury issues Bills, Notes and Bonds which it sells at auction in exchange for Dollars. The Fed puts more Dollars into circulation by engaging in Open Market Operations with its banks, exchanging Treasury debt back and forth for Dollars.

Treasury debt can be (though, granted, infrequently is) extinguished by the Treasury buying back its debt paper. More commonly of course, old expiring debt is rolled over, and new additional debt is added.

TPC,

The sum total of the your money supply in this scenario is 100 $GNK, that you loaned into existence to your servant. The servants total repayment is 110 $GNK. You only have a couple of options at this point. 1) is to loan yourself 1 $GNK per week to pay him his wage. But then you have a debt repayment obligation to repay and then must charge him rent to cover you debt cost(total indebtedness increased(you)). 2) Issue a new loan to the servant for 10$GNK on the 11th week to repay the loan in full(total indebtness increased(him)) or 3) print 10 $GNK and give him a raise to 1.10 $GNK per week so that he can repay the loan in full(runaway inflation for any time period > 11weeks). Please choose 1,2 or 3 carefully.

[ThePythonicCow]

Re: Article : why debt growth must exceed interest payments

The sum total of the your money supply in this scenario is 100 $GNK, that you loaned into existence to your servant. The servants total repayment is 110 $GNK. You only have a couple of options at this point. ... Please choose 1,2 or 3 carefully.

I spelled out exactly what happened each week. The total money in the system was always exactly that initial 100 $GNK$. I choose none of the above options you offer. There is no need for some additional 10 $GNK$. Here's a spreadsheet that I just prepared in Google Documents showing who pays what to whom (gnk is the master, tpc the servant) for what purpose each week, the balance sheet of each party, and the total (always 100) $GNK$ in the economy:

. week \ amount gnk -> tpc lent gnk -> tpc wage tpc -> gnk repay tpc -> gnk rent gnk balance tpc balance total $GNK$ . 1 100 1 10 0 9 91 100 . 2 0 1 10 0 18 82 100 . 3 0 1 10 0 27 73 100 . 4 0 1 10 0 36 64 100 . 5 0 1 10 0 45 55 100 . 6 0 1 10 0 54 46 100 . 7 0 1 10 0 63 37 100 . 8 0 1 10 0 72 28 100 . 9 0 1 10 0 81 19 100 . 10 0 1 10 0 90 10 100 . 11 0 1 10 1 100 0 100 . 12 and beyond 0 1 0 1 100 0 100

I will repeat a point that I have tried to make several times in this thread. The total money in the system can be less than the total Principle + Interest due on all debt, so long as cash flows allow partial payments to work their way back to the debtor, to fund additional payments.

[Nivelles]

Re: Article : why debt growth must exceed interest payments

I spelled out exactly what happened each week. The total money in the system was always exactly that initial 100 $GNK$. ...

That's wrong. The total of money in the system is equal to the loan balance. The loan balance drops as the loan is paid back. When the loan principal is paid back, there will be no more money in the system (under this simple borrowed-money scenario.)

Since the loan balance is the amount of money in the system, the right-hand column is wrong. It should be 100, 90, 80, etc.

The basic "accounting" problem is that you haven't balanced the books for the various accounts. Also, you've confused the banker with the bank, but they are two different entities.

There are three accounts in that scenario: tpc, gnk, and the bank, call it B.

Here are the initial entries for those three accounts, when gnk makes the loan to tpc:

tpc, 100;
gnk, 0;
B, -100.

Observe that the bank entry is negative. Add them up, and you'll see that the books are balanced, that is, the total is zero, as it must be. Every credit must have a corresponding debit. (Otherwise, somebody is going to jail.)

The loan repayments do not become the banker's personal money. The repayments are used to retire the loan on the bank's own account. The repayments are entered on the account B, not on the account gnk.

[ThePythonicCow]

Re: Article : why debt growth must exceed interest payments

That's wrong.

Well, I did make one mistake. I used the word "balance" to mean the total number of scraps of those $GNK$ scraps of paper in the possession of gnk, tpc and in total.

That was an misleading and "unconventional" of that word "balance", as I did not account for the value of debts owed, which would usually be of the same magnitude, opposite sign.

The basic "accounting" problem is that you haven't balanced the books for the various accounts. Also, you've confused the banker with the bank, but they are two different entities.

Wrong. I have balanced books. I understand double entry accounting. Also, there are only two entities in this scenario, gnk and tpc. There is no bank in my scenario.

You have substantially misunderstood my scenario and overlaid something else on it then presumed I was wrong six ways from Sunday, wherever your scenario differed from mine.

In my scenario there are always, from the initial event, exactly 100 scraps of $GNK$ paper in the system, either in gnk's or tpc's possession. No new paper is ever created; none of those original 100 scraps of paper are ever destroyed. There are only two parties in my scenario, not three. There is no Bank.

Perhaps my original telling of this scenario, back in Post #8 above, will be clearer to you. Try reading that.

[Rajiv]

Re: Article : why debt growth must exceed interest payments

You are correct in what you have said.

There remains the issue of how gnk gets the interest from tpc.

If tpc used the loan to create or purchase some new assets, then the interest will come out as a share of the new assets created or purchased by tpc. However, if tpc sold his services to some other entrepreneur who borrowed money from the bank to purchase those services (in other words, tpc sold his services to someone for bills of credit (cash,)) then the interest comes from an increasing money supply.

Ultimately, if the loan is used to produce new assets, this results in economic growth, which is then used to pay the financiers. If there is no economic growth, then the interest payments come as transfer payments from the community to the banker. This appears to be what is happening in the world today. Enrich the bankers at the expense of the rest of society.

This also explains why the CPI figures are fiddled with. If there is no percieved real growth, and the interest payments to the bankers persist, then the game is exposed. Thus a perception of real economic growth is essential to keep the game going.

Also this real economic growth may come at the expense of the well being of essential systems that are often outside the purview of the economic/financial system,

[Rajiv]

Re: Article : why debt growth must exceed interest payments

TPC

The system that you are talking about is not a system of fiat currency, but rather a system defined by fixed coinage (e.g. gold) in this case the paper takes place of gold -- in other words, the paper cannot be created out of thin air by either party (or also known as counterfeiting)