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Overview of Natural Money




Interest: what's the problem?


Interest compounds

Suppose that Jesus' mother had put a small gold coin weighing 3 grammes in Jesus' retirement account at 4% interest in the year 1 AD. Jesus never retired but he promised to return. Suppose that the account was kept for this eventuality. How much gold would there be in the account in 2018? The answer is an amount of gold weighing 11 million times the mass of the Earth. The yearly interest would be an amount of gold weighing 440,000 times the mass of the Earth.

A mere 4% yields an insane amount of gold after 2017 years. Someone has to pay for the interest, in this case the people who borrowed money from the bank. If Jesus doesn't come back to spend his money, that's impossible. At some point the debtors can't pay the interest, let alone repay their debts. They can only borrow more or default. And if they default, there will be a financial crisis. A financial crisis means that borrowers can't repay their debts with interest.

Interest promotes risk taking

The financial system nearly blew up in 2008 because of irresponsible lending. Interest is a reward for risk, and lenders are willing to take more risk if they are rewarded with a higher interest rate. Questionable lenders can only borrow at high interest rates but borrowing at high interest rates only makes their financial condition worse. It would be better if they can't borrow at all so that they have to reorganise their finances.

A stable and trustworthy financial system is a key public interest so governments and central banks guarantee its integrity and step in if things go wrong. Banks are rewarded with interest to take risk and the taxpayer is on the hook when things go wrong. The guarantees of governments and central banks are needed. Without them the financial system would get into serious trouble. Hence, the problem is that banks are rewarded with interest to take risk.



Banning interest: the market must allow it


Banning interest has been tried before and it failed every time. Interest was needed for the economy to operate. Lending and borrowing wouldn’t be possible without interest. If you lend money, you can't use it yourself. People want a compensation for this inconvenience. And if you lend out money, the borrower may not repay. People want a compensation for this risk. Finally, if you can make a profit by investing, then why lend money without interest?

In the meantime a few things have changed. You can lend money to a bank but still use it any time. This is convenient. Banks check the financial condition of borrowers and lend to many different people. This reduces the risk of borrowers not repaying their debts. Central banks and governments can help out banks if needed. And so bank deposits are now considered safer than cash.

But what about the returns on investments? Throughout history these returns were mostly higher than the rate of economic growth. Most of these returns have been reinvested so a growing share of total income was for investors. The wealthy have now amassed a lot of capital but the rest of the people doesn't have the money to spend on the stuff produced by the corporations the wealthy invested in.