Article : why debt growth must exceed interest payments

[metalman]

Re: Article : why debt growth must exceed interest payments

Dear TPC - I have been watching this little train wreck for days, in utter amazement. You are a very patient person. I'd like to add my thanks for your example, which forced me to actually work through what were previously only somewhat hazy generalities. Best wishes.

wish i were more like tpc... much to learn from him.

[ThePythonicCow]

Re: Article : why debt growth must exceed interest payments

Thanks for the kind words, MLM and metalman.

[unlucky]

Re: Article : why debt growth must exceed interest payments

Yes, whether it was rocks, or slave labour, is immaterial. Something exchanged hands. TPC had $10 worth of something to give him ...

The issue of varying defintions of monetary aggregates is probably very relevant then.

I think most people would agree that in TPC's model, all "money" ultimately comes from gnk, since gnk is the provider of financial services in this model whereas tpc is more of "real economy" operator.

One view is that the "money" in the system consists solely of the $100 cash that gnk loans to tpc. Under that view, it seems clear (to me, at least!) that the loan plus interest (total $110) can be repaid in the model without creating any new loans.

Another possible view is that is that the total "money" consists of the $100 cash, plus an additional $10 to account for the value that gnk assigns to the 10 rocks that tpc has in the beginning. This $10 never exists in the form of cash, nevertheless it exists as a net balance sheet value determined by gnk (the financial services provider) and therefore arguably deserves to be consider as a form of money.

If the total "money" is $110 (cash + rocks) then I guess there is no argument about how the interest gets repaid, without the need to create more loans.

Personally I would lean towards the view that the financial money in the system is $100, not $110. But to avoid argument we can simply define (in this model)

M0 = cash
M1 = cash + balance sheet value assigned to rocks

and conclude that the loan+interest can be repaid without requiring M0 to ever exceed the loan principle, $100.

[Rajiv]

Re: Article : why debt growth must exceed interest payments

TPC,

Money, and particularly gold or fiat money has no place in a two person economy. In your example why would you ever take out a monetary loan. There is no place to spend that money.

However, if you had been able to spend those chits of paper that gnk gave tpc, then you would have to buy them all back if you were to pay back gnk. You would be able to pay back gnk the original principal. However, now that there is no more money in the system, and you accept the fact that gnk (being able to create that money out of thin air) has plenty of it, then gnk has you over a barrel -- you are now a debt slave of gnk for life. There is no market value for your labor, other than what gnk decrees.

So gnk's "money out of thin air commodity" really has no value, unless the community as a whole accepts that. Money at its core is an accounting system, tracking and extinguishing mutual debt obligations through the community. This is particularly so with fiat money. If this is indeed the case, then the ability to create that money is at the same time a tremendous responsibility, and requires utter honesty. Having stated the above, banking also at the same time offers many temptations -- the motivation to cheat can be high. That is the reason why regulations on the banking system become essential.

If there were dishonesty in the system, the system breaks down, as is happening today. The only commodity a banker can sell you on is honesty in transactions. This was the firm belief held by Sapiens (God bless him) who was an old school banker, and was horrified with where the system had gone.

However, that said, the mathematics of interest bearing instruments still remains the same. Requirements of interest payment in debt instruments require BOTH an increasing money supply, as well as real growth in the economy. Compounding the interest just increases the speed at which it is required.

When the monetary supply is fixed, this invariably leads to boom bust scenarios (that is the origin of business cycles.)

If physical resources start hitting limits, and society is unable to increase carrying capacity of the ecosystem, then growth is no longer possible, and first the financial system collapses, followed by the society. See William Catton's work in "Overshoot." Systemic thinking is imperative if we are to face the future wisely (Extracts from Catton's work linked)

You may wonder what the financial system has to do with "Overshoot." The reason it is important, is that the current financial system (via the medium of interest payments) requires continual growth. Continual growth inevitably leads to "Overshoot", and that inevitably leads to societal collapse (see also Jarred Diamond's work)

From the above linked extractfrom Bill Catton

Facing the Future Wisely

Perilously Persistent Cargoism

It is essential to see the profound peril in continued flagrant misperception of the very nature of the human situation. That peril compelled me to write this book. Misperception is the problem to be overcome by a paradigm shift, and only a paradigm shift can overcome it. Misperception will tend to motivate efforts to pursue ostensible "solutions" that will, when the circumstances are so much different from what people suppose them to be, make matters worse instead of better. In this concluding chapter, therefore, I want to highlight the contrast between prevalent presuppositions about our situation (and about our options) and the actual ecological circumstances that need to be recognized and with which we must do our best to cope.

During the debate on energy policy, one ominous sign of the prevalence of mistaken assumptions was the fact that Cargoist expectations could pass for Realism. [Realism: recognition that the Age of Exuberance is over and that overpopulation and resource depletion must inexorably change human organization and human behavior. Age of Exhuberance: the centuries of growth and progress that followed the enlargement of habit available to Europeans as a result of voyages of discovery: a period of expansion when a species takes exhuberant advantage of the abundant opportunities in an eminently suitable but previously inaccessible habitat. Cargoism: faith that technolgical progress will stave off major institutional change even in a post-exhuberant world; the equivalent among people of industrial nations to the cargo cults of the Melanesian islanders.] As we saw in Chapter 4, Realism and Cargoism are importantly different. This difference has been obscured during public debate by exaggeration of a lesser difference—between Cargoist expectation that "tech fixes" will overcome our problems, and the more exuberant former expectation that problems would naturally vanish with passage of time.

In referring to Cargoist thoughtways I am not now merely speaking of particular technological proposals—of domestic solar water heaters or other "soft energy paths," of the breeder reactor, stepped-up oil exploration, better carburetors or smaller cars, gasification of coal, geothermal power generation, etc. At this point I have in mind the general background belief that carrying capacity can "always" be raised anew by further technological breakthroughs. [Carrying capacity: the maximum population of a given species which a particular habitat can support indefinitely (under specified technology and organization, in the case of human species).] As we saw in Chapter 2, major technological achievements did in past ages repeatedly raise the ceiling for human population. Modern Cargoism naively supposes this picture of the past must also be a valid picture of the future. It may not be.

Figure 1:

In Figure 1, three images are compared. Image A schematically depicts a curve of exponential growth in a situation where there is no ceiling. That image represents the expectations nurtured by the Age of Exuberance. Only the outright Ostrich can hold that view of the human situation today.[Ostrichism: obstinately persistent belief in the myth of limitlessness: the unrealistic supposition that nothing basic has changed; refusal to face facts.] Image B (if taken as a picture of the past) shows that Image A was once plausible because the ceiling sometimes was raised before the growth curve had quite bumped against it. The Cargoist way of thinking takes Image B as a picture of the future. Image C, a schematic way of reflecting the fact that prosthetic man's resource appetite has grown larger and larger, shows that carrying capacity can be considered a diminishing quantity rather than an ever-enlargeable quantity. [Prosthetic device: in medical practice, an artificial substitute for a part of the body(as, for example, an artificial limb; by extension; any artificial device or any other thing that either serves a function some organ would otherwise serve, or enables an organism to do something it could not otherwise so without having devloped a special organ for the purpose.] Technological advances can reduce carrying capacity, even if historically their function was to raise it. Image C is much more different from Image B than the latter is from Image A. Insofar as Image C is applicable to mankind's situation in the real world of post-exuberant times, then Image B is not sufficiently more realistic than Image A to serve in charting our way into a post-exuberant future.

Despite this, there are persistent temptations toward Cargoist thinking.

[ThePythonicCow]

Re: Article : why debt growth must exceed interest payments

Money, and particularly gold or fiat money has no place in a two person economy. In your example why would you ever take out a monetary loan. There is no place to spend that money.

Sure ... it was rather silly to have a currency system in the two person economy in my simple scenario.

I never suggested that the world should be run like my scenario, or even that a real world two person interaction should be run that way.

However, if you had ...

Whatever ... I readily grant the real world irrelevance of my simple scenario.

So gnk's "money out of thin air commodity" really has no value,

That's for sure.

Sapiens (God bless him)

Yes.

However, that said, the mathematics of interest bearing instruments still remains the same. Requirements of interest payment in debt instruments require BOTH an increasing money supply, as well as real growth in the economy. Compounding the interest just increases the speed at which it is required.

Now there we disagree.

When you lend me money, I typically don't contract to return that principle plus interest all at once. Rather I contract to pay back an income stream.

When you extend credit, you typically trade the principle cash you have on hand for a future income stream of payments, whose aggregate value is you hope will be worth more to you than that present money you had in hand. So long as my repayments (or someone else's repayments) to you can flow back into the community where I can earn an income in trade for my future goods, services or appreciation of assets I hold, then I may be able make all my payments in full without any increase in the monetary base.

In other words, an increase of either the volume or velocity of the monetary base can support the repayment with interest.

Debt is most commonly a trade, of present value for future income streams. That's the key concept; that's the key reason that there is no mathematical necessity for a constantly increasing monetary base in a debt-based system.

When the monetary supply is fixed, this invariably leads to boom bust scenarios (that is the origin of business cycles.)

This was one of the classic and most successful arguments for a more flexible monetary supply, for going from gold to fiat money. Presently I am skeptical of this argument, however I have not studied my history well enough to have an informed view either way.

If physical resources start hitting limits, and society is unable to increase carrying capacity of the ecosystem, then growth is no longer possible, and first the financial system collapses, followed by the society.

This observation may apply to physical resources, such as food and energy, required to run an economy of a given size, technology and activity. However this observation does not apply to the monetary base. So long as there is no impediment to "money becoming more valuable", then the same dollars can chase more goods and services easily enough.

You may wonder what the financial system has to do with "Overshoot." The reason it is important, is that the current financial system (via the medium of interest payments) requires continual growth. Continual growth inevitably leads to "Overshoot", and that inevitably leads to societal collapse (see also Jarred Diamond's work)

Ah now you've shifted from the question of whether or not a debt-based monetary system is mathematically required to keep expanding, to the question of whether our current system is locked into expansion by any mechanism, and whether any such system can endure.

I entirely agree that our current system is locked into such expansion, and that this cannot end well.

[Rajiv]

Re: Article : why debt growth must exceed interest payments

Now there we disagree.

When you lend me money, I typically don't contract to return that principle plus interest all at once. Rather I contract to pay back an income stream.

When you extend credit, you typically trade the principle cash you have on hand for a future income stream of payments, whose aggregate value is you hope will be worth more to you than that present money you had in hand. So long as my repayments (or someone else's repayments) to you can flow back into the community where I can earn an income in trade for my future goods, services or appreciation of assets I hold, then I may be able make all my payments in full without any increase in the monetary base.

In other words, an increase of either the volume or velocity of the monetary base can support the repayment with interest.

Debt is most commonly a trade, of present value for future income streams. That's the key concept; that's the key reason that there is no mathematical necessity for a constantly increasing monetary base in a debt-based system.

Keen it appears, seems to agree with your point

See Keen - The Dynamics of the Monetary Circuit
(warning: the paper uses non elementary mathematics in its modelling)

As is well known, Keynes (1936) asserted that a monetary economy differs fundamentally from a barter economy. However, he provided no a priori foundation for his analysis that clearly ruled out a barter framework, which left the way open for Hicks’s Walrasian interpretation of The General Theory, and the ultimate decline of Keynesian economics.

It is an undoubted strength of the monetary circuit approach to have improved upon Keynes’s analysis in this regard, by giving a definitive basis on which a monetary economy cannot be analysed from a barter perspective. This is that, in a truly monetary economy, a token – and not a commodity – is accepted as the final means of payment. From this it also follows that banks are an essential component of a monetary economy (they cannot be simply subsumed within the firm sector); and that transactions are not bilateral – that is, an exchange of two commodities between two agents at a price that is fundamentally relative – but tripartite, with a buyer A purchasing a commodity from a seller B by directing the bank C to transfer money ‘tokens’ from the buyer’s account to the seller’s. This is an exchange of one commodity between two agents, mediated by a third, at a price that is fundamentally monetary. All payments are, in essence, transfers between bank accounts.

Unfortunately, this substantial conceptual advance appeared to lead to an impasse. Attempts by many (though not all) authors to put Graziani’s (1989) insights into a mathematical model reached the conclusion that net profit was zero in a monetary production economy. Rochon’s (2005) thoughtful survey of this literature put the dilemma nicely:

The existence of monetary profits at the macroeconomic (aggregate) level has always been a conundrum for theoreticians of the monetary circuit. […] Indeed, not only are firms unable to create profits, they also cannot raise sufficient funds to cover the payment of interest. In other words, how can M become M'? (Rochon, 2005, p. 125)

This is a paradoxical result, since, as Rochon (2005) makes evident, Marx also looms large in the monetary circuit tradition. In Marx’s schema, net profits are positive and represent the surplus from production. Howcould it be that the attempt to give Marx’s analysis an explicitly monetary flavour could end up destroying one of Marx’s key insights, that profit emanates from the surplus generated in production?1

In this chapter, we show that this paradox is in fact an illusion, which results mainly from the use of inappropriate modelling techniques – and also, we argue, from a misspecification of the nature of debt. With an appropriate dynamic framework, and an appropriate understanding of debt, it is easily shown that positive profits are compatible with the monetary circuit in a pure credit economy – so long as that economy generates a physical surplus in Marx’s sense. Many other currently accepted circuitist impressions about the monetary circuit – such as the need for continuous injections of money to sustain constant economic activity, and the destruction of money by the repayment of debt – are also shown to be erroneous. The correction of these errors substantially strengthens monetary circuit analysis, even though it requires the abandonment of several established circuitist conventions.
.
.
.
.
.
.
.
Debt as a data record versus ‘negative money’

One crucial way in which our analysis differs from the norm for researchers in the endogenous-money tradition is that we treat debt, not as a bank account as such, nor as ‘negative money’, but as a data record of the legal obligations of a borrower to a bank. The argument that repaying debt destroys money – and therefore that debt is, in effect, ‘negative money’ – is commonplace in the endogenous-money literature, with writers routinely surmising that money is destroyed when debt is repaid:

As soon as firms repay their debt to the banks, the money initially created is destroyed (Graziani, 1989, p. 5).

If debts are to banks, then the payments which fulfill commitments on debts destroy ‘money’. In a normally functioning capitalist economy, in which money is mainly debts to banks, money is constantly being created and destroyed (Minsky, 1980, p. 506).

This implies that money used to repay a debt goes into a debt account, and negates the equivalent sum of debt. While this is intuitively appealing, we believe that it is a fundamental misspecification of the nature of debt.

First, one of the essential differences between commodities and money is that the former are destroyed – or at least depreciated – in use, whereas money does not depreciate by use. To treat money as effectively indestructible when used in transactions, and yet destroyed when used to repay debt, is incongruous.

Second, though the apt framework for considering the models below is a purely electronic payments system, consider, as a thought experiment, a pure credit banking system using an entirely paper money, and issuing its own notes as money.3 If a debt to a bank were repaid, would it make sense for the bank to duly destroy the returned notes? Of course not: the bank would instead record that the outstanding debt has been reduced, and store the returned notes in its vault, ready for relending. The one stricture, to avoid the problem of seigniorage identified by Graziani (1989), is that the notes that repay debt must be treated differently from those that represent the bank’s income from the spread between its loan and deposit rates of interest. The latter can be used by the bank to finance the purchase of goods (whether as intermediate inputs or consumption expenditure by bankers); the former cannot.

This same stricture applies to electronically generated and stored money today. Repayments must be treated differently from interest payments: the latter can be used to finance bank expenditure, the former cannot.

Finally, if debt were truly an account holding ‘negative money’, then the only way it could be reduced would be by paying ‘positive money’ into it – in other words, by repaying the debt. Debt, however, can also be reduced by bankruptcy, when a lender is forced to write off a debt that the borrower is unable to repay. Equally, as illustrated later in this chapter, debt can grow via compound interest if the borrower (or, more correctly, the borrowing sector) does not meet all of its debt-servicing obligations – and this growth of debt is not matched by any corresponding growth in money. These manifest realities of debt emphasize that the debt account is not a repository for money – negative or otherwise – as are other accounts in the system, but a data record of the amount owed.

He ends with some interesting conclusions in this paper.

However, what he appears to be saying is that "not all debt is money" -- However, that statement does not imply that more money does not have to be created in order to service the increasing debt.

However even his model does not imply that it is possible to service debt without growth. In fact growth is essential to service the growing debt load.

[Jay]

Re: Article : why debt growth must exceed interest payments

It is not mathematically unsustainable. By mathematics I refer to that body of proofs, definitions and theorems derived from some specified set theory such as Zermelo-Fraenkel following the rules of a second order predicate calculus.

Here's a (very very very brief) sketch of a proof by counter-example: I believe I could code a simulation of say 100 automatons operating in a stimulated "perfect" economic system, funded by a single issuance of debt-based money, such that that economic system was stable and sustainable forever, during and following the payback of that one initial debt, where the initial principle amount of money issued in the single loan funding the system remains forever and always exactly the amount of money available to the system.

The original lender in this simulated system must spend some of (*) the loan payments (P+I) he receives back into the system for goods and services. The original borrower works, providing some service and receiving a cash flow income from which those loan payments can be made. Actually the other 98 automatons are inessential to this "proof"; they're just there to make this simulation more "realistic."

A quite simple example. Let's say you hire me as a servant. You lend me 100 $GNK$ (100 pieces of paper you scribbled your initials on.) I work for a wage of 1 $GNK$ per week, and I pay you back 10 $GNK$ principle plus interest for 11 weeks to extinguish the debt. Beginning the 12th week, I begin paying you 1 $GNK$ for rent of the shack I built the first 11 weeks for you on the back of your property, in which you now let me live. You continue to pay me 1 $GNK$ wages. My job is now to guard and maintain that precious ;) shack.

Each week thereafter, in perptuity, I give you 1 $GNK$ (rent) and you give me 1 $GNK$ (wages.) You keep the other 99 $BNK$ locked up in your safe, for you are a wealthy man.

My best guess is that the word "mathematics" has different meaning for me than it does for yourself and most other people. I still treasure my volume one of Nicolas Bourbaki's Elements of Mathematics and my first edition of Set Theory and its Logic by Willard Van Orman Quine. My early edition of Quine's Mathematical Logic fell apart and was apparently discarded in some move I made in the past.

(*) "some of" -- meaning sufficient to provide the cash flow required to fund future loan repayments.

Your example is very clear to me cow and makes perfect sense. So do the clear explanations of its purpose and limitations, especially how it was not intended to be an exact model of the banking system as it exists today. We have gone through this exercise at itulip multiple times before with the same results: interest just means that the banks end up with tons of cash and immense power. Everyone else has to work in the system at the banks behest to keep from falling off the treadmill. They work in order to obtain enough money back from the banks to pay the same bankers interest. Essentially, the banks trickle money, created from thin air and given back to them with interest bit by bit every month, back through the economy, hopefully fast enough to cover interest payments. That is the punchline. There is no reason inherent in and specific to this process that it is not sustainable as long as the banks and the people who are paid the money don't hoard it. Those are sure nice bank buildings in major cities and those banker bonuses have been real sweet. The wealth gap is due to the fact that most bankers don't enjoy paying back that cash and have tight giant wallets. And that is part of the problem, capital has been accumulated by a few and not let back out into economy. Another part of the problem, depending on your want, would be the nature of this system in the first place.

[ThePythonicCow]

Re: Article : why debt growth must exceed interest payments

Essentially, the banks trickle money, created from thin air and given back to them with interest bit by bit every month, back through the economy, hopefully fast enough to cover interest payments. That is the punchline.

It seems that anytime one trades present value for futures, then whichever party has greater control over the future values has an advantage. This advantage tends to compound exponentially, until systemic collapse.

The locus of control in institutions larger than a small village is often not well understood by all participants, hence long term contracts between larger institutions, be they loans, monetary reserves, treaties, constitutions, laws, contracts, or whatever, are frequently unstable.

We often cannot see grave imbalances in our larger institutions and their contracts; hence the stronger party leverages these imbalances to their advantage until it blows up on them.

Being neither a borrower nor a lender, engaging only in bartering of present value for present value, and otherwise avoiding long term contracts, constitutions, treaties and other arrangements would be a cure ... as starvation unto death is a "cure" for medical problems.

Human civilization is not yet sufficiently well developed to include the healthy feedback loops required for sustainable, less catastrophic laced, existence. Any history as written by the losers remains quite horrific.

Hopefully the web and other recent increases in the world-wide connectivity of humans will provide the fabric required for developing more refined feedback loops in our civilization.

[ThePythonicCow]

Re: Article : why debt growth must exceed interest payments

See Keen - The Dynamics of the Monetary Circuit

Ah great ... another paper to read ... thanks ;).

[Jay]

Re: Article : why debt growth must exceed interest payments

It seems that anytime one trades present value for futures, then whichever party has greater control over the future values has an advantage. This advantage tends to compound exponentially, until systemic collapse.

The locus of control in institutions larger than a small village is often not well understood by all participants, hence long term contracts between larger institutions, be they loans, monetary reserves, treaties, constitutions, laws, contracts, or whatever, are frequently unstable.

We often cannot see grave imbalances in our larger institutions and their contracts; hence the stronger party leverages these imbalances to their advantage until it blows up on them.

Being neither a borrower nor a lender, engaging only in bartering of present value for present value, and otherwise avoiding long term contracts, constitutions, treaties and other arrangements would be a cure ... as starvation unto death is a "cure" for medical problems.

Human civilization is not yet sufficiently well developed to include the healthy feedback loops required for sustainable, less catastrophic laced, existence. Any history as written by the losers remains quite horrific.

Hopefully the web and other recent increases in the world-wide connectivity of humans will provide the fabric required for developing more refined feedback loops in our civilization.

Well said TPC.

[unlucky]

Re: Article : why debt growth must exceed interest payments

We have gone through this exercise at itulip multiple times before with the same results: interest just means that the banks end up with tons of cash and immense power. Everyone else has to work in the system at the banks behest to keep from falling off the treadmill. They work in order to obtain enough money back from the banks to pay the same bankers interest. Essentially, the banks trickle money, created from thin air and given back to them with interest bit by bit every month, back through the economy, hopefully fast enough to cover interest payments. That is the punchline. There is no reason inherent in and specific to this process that it is not sustainable as long as the banks and the people who are paid the money don't hoard it. Those are sure nice bank buildings in major cities and those banker bonuses have been real sweet. The wealth gap is due to the fact that most bankers don't enjoy paying back that cash and have tight giant wallets. And that is part of the problem, capital has been accumulated by a few and not let back out into economy. Another part of the problem, depending on your want, would be the nature of this system in the first place.

I would certainly agree with these points, although it isn't clear to me now how much is the fault of "interest" and how much is the fault of other broken things in the system. In TPC's model, tpc provides labour to the bank and the bank provides financial services to tpc. One can quibble about the relative value of these services, but if the transaction is freely entered into by two knowledgeable parties, then it's hard to argue that it is "unfair". The original argument that "interest" is inherently a bad way for the economy to reward bankers, because it necessarily begets the creation of further loans and further interest, isn't clear to me either now.

In practice there are multiple other things that are broken, as you mention: the bankers use political influence and asymmetric information to create an unfair playing field; the bankers distribute too much of the banks' earning to themselves, hoarding it and preventing it from flowing back into the real economy; the government manipulates interest rates and will put you in jail if you refuse to accept its notes to settle a debt; etc etc.

[Debt-freeTICer]

Re: Article : why debt growth must exceed interest payments

You really do need to pay attention to what others are trying to tell you. The fact is that you are wrong.

You might also go back to your own Google docs post, and observe that you left out the loan balance.

Your basic error was in failing to treat the loan as a loan. You overlooked that necessity. You treated the loan as if it was a gift, with no need for repayment.

Taking the loan repayment into account would require a column with 100 at the top, and 0 at the bottom, of course. If you will examine your own doc, you'll see that you did not include any such column.

You didn't show the loan being repaid. Where that would properly appear, of course, is the far right column, as you had things set up.

And that far right column is the amount of money in the system.

As I understand this scenario the "Loan Balance Column" is the "tpc Balance Column". TPC's only mistake was to start the chart with week one as the first entry line. It would be more clear to me if it started with week zero to indicate the moment of transfer of the $GNK$ and a balance in "tpc Balance Column" of 100. The chart would then continue with week one indicating the transactions after passage of one week's time.

I am a simple man and i am willing to accept the fact that GNK placed value (if only in his own mind) on the slips of paper when he affixed his mark. I can also accept the fact that as repayment was made he would not destroy the $GNK$, But would hold them as valuable.