In Part One we discussed interest
rates as an increasingly problematic aspect of the globalizing economy. We saw
that interest is connected to increasing competition; the concentration of
wealth effect; compulsive, endless growth; and discounting the future.
While perhaps the world’s major
religions had less conscious understanding of money and economics than we do
today, given the above side effects it can be no surprise that they unanimously
treated interest unfavorably. Nevertheless, on the other hand, it is vital to
remember that history is full of examples where forbidding interest outright has
been far more damaging to economies than letting it be.
And this brings us to the crux of
the challenge. If interest is at least significantly responsible for an economic
paradigm which is proving inadequate for meeting the challenges of the 21st
Century, and banning interest is certainly undesirable, is there a free-market
solution that could transcend this problem and make interest obsolete?
To be successful, such a solution would need to encourage competition and cooperation, encourage long-term thinking and decision making, while reducing the compulsion to grow at any cost. It would also have to be a voluntary decision rather than imposed, for we have seen that imposing a ban on interest destroys liquidity and the willingness to lend. Furthermore, it would have to enhance free market spontaneity and resiliency while simultaneously reward market players for including vital global concerns such as the environment, poverty, and future generations in their decision making process.
Sound impossible? Before writing off the possibility, keep in mind that the modern economy as we know it today was utterly unthinkable before the industrial revolution. We all too readily take for granted the profound shift that occurred, where capital became exponentially more accessible to the Average Joe. Combined with the emergence of individual rights and revolutionary scientific discoveries, the economy was utterly transformed into something far more powerful and liberating than anything humanity had previously known.
Economic transformations of this
magnitude are certainly infrequent, yet entirely possible and probable in the
long run. There are sporadic times when they even become necessary in order to
avert a collapse. And today’s world is increasingly looking like such an
occasion.
Could it be that a deeper understanding about interest and how money works could be at the heart of enabling further economic evolution? If so, what would it look like? Let’s look a little closer.
If I have money, no matter how good your credit, there is an element of risk to lend it to you. There is a chance I may never get it back. Given that risk it may be preferable to spend or save it rather than lend it. It would seem fair to be given a reward for undertaking this risk. For this reason it seems strange to us that Christianity, Islam and Judaism have all forbidden interest on money.
Money is widely recognized to carry two essential functions: it acts as a medium of exchange that makes trade exponentially easier than barter and it is a commodity where we may store wealth. More precisely we could call money an abstract representation of natural goods and commodities. This abstraction allows it to function as a medium of exchange.
Seeing money in this light, it is clearly a product of human invention and creativity. Money doesn’t grow on trees, it is born in our minds. It is from our collective agreement of its value and worth that lend it currency. Therefore, it also carries a third function of grounding cultural values and meaning into society and its social structures.
Naturally, we should expect that
if money is a representation of things, it ought to represent them accurately.
Money, being the primary unit of economic exchange, would certainly have to
serve this function accurately for economics to be legitimately considered a
science. But if we examine it closely, we will find that this is not so.
Let’s consider commodities: wheat, gold, oil, soy, steel, salt, sugar, diamonds, paper and so on. All of these goods have a common property: if they are not on the market, they must be stored. Failure to store these commodities safely will result in theft, decay, rust, and so on. The primary force at play here is what scientists refer to as the second law of thermodynamics, namely, that the universe is moving from a state of low entropy to a state of high entropy.
As Eric Beinhocker points out in the The Origin of Wealth “every organism needs a source of energy to maintain and grow its complex internal order, and all life gives off heat and waste materials as entropy is paid back to the universe. When that process stops, the organism’s molecules are returned to the disorder of the environment – death is a surrender to the Second Law.” Beinhocker also notes that this law is remarkably absent from modern economic theory. This leads him to rightly call the field “half-baked.”
The second law of thermodynamics (decay, rust, etc.) creates a compulsion for the holder of goods to sell. When one brings goods to market there is incentive to sell as quickly as possible to avoid incurring future storage expenses which of course are necessary to protect goods from the Second Law. The holder of money on the other hand has no such concern. Money will not decay or rust. In fact, one can easily yield a return from storing money. Interest. Thus, it might be said that our money is designed to defy the second law rather than represent it.
Here we can also begin to see the imbalance in exchanges between the seller and buyer (money holder). If you want to sell me your bushels of wheat for $1,000 what is my incentive to buy right away? Why not wait. I know that I am able to let the interest accumulate on my money while you want to sell immediately in order to avoid paying for storage and inventory. Certainly, this situation confers advantages to the buyer.
If money were some sort of natural phenomenon, we might say well, so what? That’s how it is. But it’s not. It is a human creation and how we hold it is determined by the meaning and values we give it. Our present form of money existed long before the second law of thermodynamics was even discovered. Thus, it can be no surprise that it does not reflect it. Nevertheless, it fails the function of accurately mirroring the goods and commodities it represents. And this in turn makes it worse as a medium of exchange.
In this light, we can see our present form of money as unconscious, unscientific and a source of arbitrary power in free market exchanges. This arbitrary power is the ability to withhold it from the marketplace to gain advantage over suppliers and borrowers. It is the sole unit in economic transactions to be exempt from the second law.
In order to resolve this problem,
let’s consider a scientific approach that would enable a money design that
accurately reflected goods, life and the second law of thermodynamics:
- Determine the basket of commodities that are used in the global economy: x bushels of wheat, y barrels of oil and so on. Then determine the average storage costs for this global basket of goods needed to maintain them. Say, for example, we find that we find the average storage costs of this global basket are 5% per annum. We could then apply a 5% storage charge per annum for withholding money from the marketplace.
- This, in turn, would create level footing for exchanges as both money holders and suppliers of goods have equal compulsion to meet at the market. As a result, velocity of exchanges and liquidity would increase and in the long run most of the money supply will enter into circulation. This is because the fee would encourage the constant infusion of energy into money while acting as a penalty for money’s idleness.
- The increasing velocity and
circulation of money would make it exponentially easier to manage money supply
than today. Today, downturns in the economy lead to hoarding, which worsen the
problems. In this new case, money would almost always equal demand leading to
unprecedented economic resiliency.
- Because of the 5% charge for idleness, money in the future will take on greater value than the present. This would reverse the current trend, where money in the future is discounted in favor of the present. This would make interest free loans attractive to the lender as a means of planning for retirement. It would also create an economic orientation favoring longer term planning and projects that integrate the concerns of society as a whole. Such projects might include developing alternative energy sources, protecting rainforests, improving infrastructures, international development and providing outstanding education for our children.
- This storage fee, which originator Silvio Gesell called demurrage, would encourage everyone to spend what they need, and find other ways to ensure storage of wealth, such as capital investments, loans, etc. The money holder will now have total incentive to lend money for future return. In the long run this fee would internalize the incentive to lend and lead to the voluntary, long-term evaporation of interest. This in turn would release our compulsion for growth and over-competitiveness that interest propagates.
- The reward for long-term thinking would encourage the resurgence of quality and products built to last. This would make planned obsolescence inconceivable. Yet it would improve the position of producers and sellers because of the radical shift in the market dynamics. For the first time in history, buyers would have as much incentive to buy as they have to sell, meaning their position is considerably more secure and predictable.
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While perhaps no one knows exactly what demurrage would look like in practice today or how it would be implemented, this kind of thinking reflects how the economic system could transform organically into a system that rewarded long-term thinking and sustainability while also removed some of the more toxic side-effects of our current economic paradigm. We could think of it as a plan to make free markets freer. It certainly beats central planning and bureaucratizing sustainability.
While it is a path just now
starting to garner broader attention, it is important to note this idea has been
out there for about a century. It was even successfully implemented in Austria and
Of course, the twentieth century
was largely a period where politicians were more concerned with World Wars and
the Cold War, and emerging global problems were on the periphery of human
consciousness. Demurrage, too, has remained largely on the periphery of
economic thought.
Now that the old ways of doing things just isn’t working and global challenges are coming to center stage, perhaps it is time for a dramatic shift in thinking about money and free-market economics while reevaluating even our most basic assumptions.
[This article was originally published on InsideMoney.org, 25 December 2007.]
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