the plan for the future

The Coming Monetary Revolution

7 February 2015

Paper for the 32nd International Symposium on Money, Banking and Finance, annual meeting of the European Research Group in Nice, France.

Author: Bart klein Ikink


A monetary revolution may be coming. Interest-free money with a holding tax appears to be a sound monetary concept that could become the dominant type of money in the future as it could improve the efficiency of the economy and therefore provide better real returns. This may entail a capital flight to the interest-free economy, which could force the entire world to adopt this concept.

Structural developments, such as a diminishing growth perspective of mature economies, a global savings glut as well as more free and reliable money and capital markets, may have pushed the equilibrium interest rate down to negative territory. Furthermore, interest on money may contribute to financial instability and economic cycles, so that negative interest rates may help to improve financial stability and increase economic growth.

A holding tax on money could provide a constant stimulus and give room for negative nominal interest rates if people can evade the holding tax by lending out money. The real interest rate at which intended savings and intended investments are equal, might be close to zero or even in negative territory in advanced economies with well-developed money and capital markets. If the experience of Japan is to be a guide, this condition is likely to persist for the indefinite future.

A maximum interest rate of zero on money could eliminate the adverse consequences of compounding interest on debts. It could also to curb risk taking in the financial system so that the economy is less likely to overheat. Lending out money at zero or even negative rates can only be attractive when there is little risk in lending out money. If the holding tax can be evaded by lending out money, and the currency is inflation free, then this might be an attractive proposition.

The holding tax is a mechanism that provides a constant stimulus. The maximum interest rate of zero prevents the economy from overheating because the available amount of credit will reduce during an economic boom when there are better investment opportunities elsewhere. As a consequence the economy could operate close to its maximum potential with more employment and less pronounced economic cycles. Under those conditions, real interest rates are likely to be higher or risk/reward ratios are likely to be more favourable.

If the amount of currency is constant then the amount of credit cannot grow indefinitely so that it is likely to stabilise at some point. In this way economic growth is likely to reduce the price level so that a nominal interest rate of zero implies a real return. Real returns on interest-free money could be better than returns in the current financial system, which may imply that introducing this concept could cause a capital flight from the interest-bearing economy towards the interest-free economy. This may force the whole world to adopt interest-free money with a holding tax.


A simple explanation

Our current monetary system has a feature that causes trouble. Most of the money we currently use is created by banks as a debt on which interest must be paid. This may seem a rather uninteresting circumstance, but it has far reaching implications. Economic theory tends to mystify this, so I will simplify matters and take a limited perspective. The example is a bit controversial, but it shows the mechanism of interest on money at work.

Assume that there is a small self-sufficient village that does not trade with other villages. This village only needs € 1,000 to operate its entire economy. The local bank is happy to lend the € 1,000 at a reasonable interest rate of 5%. The lender could also be a wealthy village dweller. That does not matter for the purpose of explaining the problematic nature of interest on money.

What happens? After a year the € 1,000 has to be returned, but also a petty € 50 in interest must be paid. There is a slight difficulty, a fly in the ointment so to say. The required € 1,050 simply is not there as there is only € 1,000 to begin with. Then the bank comes up with a clever solution. The economy needs € 1,000 to operate and the € 50 is non-existent money that cannot be repaid, so the bank offers to lend the villagers € 1,050 at the same reasonable interest rate of 5%.

It is now clear what will take place next. At the end of the next year the debt has grown to € 1,102,50. This may not seem much but it cannot be repaid as there is only € 1,000. After 10 years the debt has grown to € 1,628,89. After 100 years it amounts to the considerable sum of € 131,501,26. There is no way of repaying this debt as there is still only € 1,000 in the economy. Long before that time, the debt level may already have become a cause of some concern, at least by people that can make proper use of a pocket calculator.

If the villagers are quite dexterous with their pocket calculators and fear the consequences of compounding interest, then nobody in the village may be willing to borrow the extra € 50 in the first year. Then there would be only € 950 in the economy in the second year, while the debt remains € 1000. After two years there would be just € 900 in the economy as another € 50 in interest had to be paid. Because there is less money available, the economy could enter into a crisis. After twenty years, there is no money left at all, only € 1000 of debt. Long before that the economy would have collapsed.

Of course reality is more complicated. A village is unlikely to be self-sufficient. Banks make expenses, the money that banks lend may come from deposits, depositors can spend their money, and debts do not have to be repaid in one year. Still, the underlying mechanism of interest lets debts grow and makes it impossible to pay them off. This means that we continuously need more debt to keep the economy from collapsing. This is why the people in charge are trying to convince us to go deeper into debt to buy more stuff we do not need or cannot afford. This is why governments have to go into debt when nobody else is willing to do so. And this is why economies seem to need inflation.

A possible solution

There are a few ideas that may help to reduce the fallout. Central banks can print new money so that there is more money available to keep the scheme going. This money can be given to banks in exchange for existing debts. This happened during the financial crisis. A problem is that rescuing banks can make bankers careless. They can make some handsome profits and hence make big bonuses for themselves and let the taxpayers foot the bill if their scheme fails. And the scheme of interest on money is likely to fail again as the € 1,000 village economy example has demonstrated.

Banning interest has been tried in the past and it did not work. There are two main reasons for this. First, people can store money instead of lending it out at zero interest. Second, there is a link between interest on money and the return on other investments. Business people only invest when they expect to end up with more than they invested. If there is no reward for doing business then nobody will do business and the economy will come to a standstill. If investments require a reward then so does money, otherwise only a few people will lend out money at an interest rate of zero when there are better returns on other investments.

If a fix can be found then this might entail a great reward. Success could mean that the economy might operate with fewer crises so that there will be more employment as well as better investment opportunities. The design of a new financial system needs to reconcile two requirements that apparently conflict. Charging interest on money must be forbidden but money needs to be an attractive investment too. The key is the realisation that interest is also a compensation for inflation and a reward for risk. If lending out money is risk free then interest rates could be zero or even lower if there is no price inflation or even price deflation.

To make it attractive to lend out money at zero interest, there must be a tax on money, and people must be able to evade the tax by lending out the money. The tax on money could also provide a constant stimulus in the economy, which might reduce the risk of lending out money as there are fewer economic crises. The maximum interest rate of zero could curb risky lending. To make the money an attractive investment, the amount of money must remain the same, so that there is no inflation. Prices may even drop as the economy grows and more goods and services become available.

Natural Money

Natural Money is currency with a holding tax, a maximum nominal interest rate of zero and a fixed amount of currency units. Natural Money is named after the Natural Economic Order of Silvio Gesell, in which he proposed a holding tax on money [1]. A holding tax, also called demurrage, means that all currency in circulation is taxed, mostly at a rate of 0.5% to 1.0% per month by the issuing government and spent back into circulation by the issuing government. The holding tax does not apply on investments and loans. The holding tax should provide a constant stimulus so that the economy tends to operate at its maximum potential.

It is not allowed to charge interest on Natural Money currencies. It should be attractive to lend out money at zero interest because the holding tax can be evaded in this way. The maximum interest rate of zero should also prevent excessive risk taking in the financial system as there is no reward in the form of interest to take such risk. There could be more investment in equity at the expense of debt because higher returns on equity are possible while returns on debts are capped at zero. Consequently, businesses are likely to become less leveraged, and debts are less likely to grow out of control because of interest charges.

The fixed number of currency units limits the growth of credit. A contraction of credit does not harm the economy as the holding tax provides a constant stimulus, so that there is little reason to print more currency. The existence of a constant stimulus might reduce the need for government and central bank interventions. If the amount of money is relatively constant then economic growth could result in lower prices as more goods and services are offered for the same amount of money. This means that the price level could drop so that an interest rate of zero is a positive real return.

The example of the € 1000 village economy shows that interest on money can squeeze the juice out of the real economy. Interest on money differs from interest on capital as capital takes effort to create, while currency can be created at zero cost. From this perspective it might seem inefficient to print currency to match capital growth. If Natural Money could make the economy perform better, then the value of Natural Money currencies could rise faster than the value interest bearing deposits in the current financial system. This might cause a capital flight that will force the rest of the world to adopt Natural Money. This seems an idea that can produce a monetary revolution. But is it?

The miracle of Wörgl

On July 5, 1932, in the middle of the Great Depression, the Austrian town of Wörgl introduced a complementary currency. Wörgl was in trouble and was prepared to try anything. Of its population of 4,500, a total of 1,500 people were without a job and 200 families were penniless. The mayor Michael Unterguggenberger had a long list of projects he wanted to accomplish, but there was hardly any money to carry them out. These projects included paving roads, streetlights, extending water distribution across the whole town, and planting trees along the streets.

Rather than spending the 40,000 Austrian schillings in the town’s coffers to start these projects off, he deposited them in a local savings bank as a guarantee to back the issue of a type of complementary currency known as stamp scrip. The Wörgl money required a monthly stamp to be stuck on all the circulating notes for them to remain valid, amounting to 1% of the each note’s value. The money raised was used to run a soup kitchen that fed 220 families.

Nobody wanted to pay the monthly stamps so everyone receiving the notes would spend them as fast as possible. The 40,000 schilling deposit allowed anyone to exchange scrip for 98 per cent of its value in schillings but this offer was rarely taken up. Of all the businesses in town, only the railway station and the post office refused to accept the complementary currency. Over the 13-month period the project ran, the council not only carried out all the intended works projects, but also built new houses, a reservoir, a ski jump and a bridge.

The key to its success was the fast circulation of the scrip money within the local economy, 14 times higher than the Schilling. This in turn increased trade, creating extra employment. At the time of the project, unemployment in Wörgl dropped while it rose in the rest of Austria. Six neighbouring villages copied the system successfully. The French Prime Minister, Édouard Daladier, made a special visit to see the 'miracle of Wörgl'.

In January 1933, the project was replicated in the neighbouring city of Kitzbühel, and in June 1933, Unterguggenberger addressed a meeting with representatives from 170 different towns and villages. Two hundred Austrian townships were interested in adopting the idea. At this point the central bank panicked and decided to assert its monopoly rights by banning complementary currencies [2].

Joseph in Egypt

The Bible contains a story about the Pharaoh having dreams that he could not explain. The Pharaoh dreamt about seven fat cows being eaten by seven lean cows and seven full ears of grain being devoured by seven thin and blasted ears of grain. Joseph was able to explain those dreams to the pharaoh. He told the Pharaoh that seven good years would come and after that seven bad years would follow. Joseph advised the Egyptians to store food on a large scale. They followed his advice and built storehouses for food. In this way Egypt survived the seven years of scarcity.

What is less known, because it is not recorded in The Bible, is that the storing of food resulted in a financial system. The historian Friedrich Preisigke discovered that the Egyptians used grain receipts for money and had built a sophisticated banking system based on this money [3]. Farmers bringing in the food received receipts for grain. Bakers who wanted to make bread, brought in the receipts which could be exchanged for grain. According to the Bible, Joseph took all the money from the Egyptians. This may have prompted them to invent an alternative currency.

As a consequence the grain receipts may have become accepted as money. The degradation of the grain and storage cost caused the value of the receipts to decrease steadily over time. This stimulated people to spend the money. There was credit in this banking system, and most likely it was interest free. The grain receipt system lasted for many centuries. The actions of Joseph may have created this system as he allegedly proposed the grain storage and took all the money from the Egyptians. When Joseph came to Egypt, the country had already passed its zenith as the time of the building of the great pyramids was centuries earlier.

A few centuries later, during the reign of Ramesses the Great, Egypt became again a leading power [4]. Some historians suggested that the wealth of Egypt during the reign of Ramesses the Great was built upon the grain financial system [5]. The grain money remained in function in Egypt after the introduction of coined money around 400 BC until it was finally replaced by Roman money. The money and banking system were stable and survived for more than a thousand years without collapsing, possibly because the storage fee made people more willing to lend out money without charging interest. It seems therefore possible to have a sophisticated banking system with Natural Money.


So why does this supposedly efficient money with a holding tax not dominate the world already? Similar experiments like the one in Wörgl did not produce similar results. The success of the Wörgl currency may have been inflated by the payment of taxes in arrears that could be spent by the town council [6]. Maybe it is too good to be true after all, but the theory suggests that it is not. Natural Money could become a success as it promises to provide higher real returns or at least better risk/reward ratios. The major challenge is making the idea work in practise.

The theory of interest-free money is not well-developed. The field of interest-free money and community currencies is dominated by people who aim to improve the living conditions of the poor. Their focus is not on economic theory. As a consequence many assumptions behind complementary currencies and interest-free money conflict with widely accepted economic theories on interest and money. On the other hand, most economists think that interest-free money will never work, so they never seriously investigated the idea.

Still, the logic behind the example of the € 1000 village economy remains compelling. It shows that interest on money can cause economic crises that may need to be countered with monetary inflation. From a political perspective one could argue that interest on capital is needed to promote economic welfare, but that interest on money is a mechanism of exploitation as there is never enough money to pay for the interest. This is a reason why governments and central banks print money and influence interest rates as more currency and lower interest rates can help to alleviate this issue.

In the past there was sufficient economic growth and new debts were made in a sufficient pace to pay off the old debts with interest, but now most mature economies are burdened with debt. The time for Natural Money may be approaching as mature economies with ageing populations could follow the example of Japan and enter a steady state where interest rates remain near zero. If interest rates could go negative, then intended savings and investments could match, which could give a boost to the economy. A holding tax on money may make this possible.

If interest-free money is more efficient then it must be possible to discover the preconditions that need to be satisfied for interest-free money to become a success. Real interest rates need to be low already and the currency needs to be strong, otherwise interest free money is likely to fail. Natural Money currencies need to float freely against interest bearing currencies so that they can rise in value. If the Natural Money currencies are somehow pegged to interest bearing currencies, the scheme will never work as people could borrow Natural Money at zero interest, buy interest bearing currencies with the proceeds, and lend this money at a higher interest rate.

Natural Money currencies may need to become legal tender in order to make them work properly. People need a currency because it can be used to make payments. The rules for banking with Natural Money currencies need to be worked out. There is a lot of research that needs to be done. It may take a long time before the idea is first put into practise, unless an economic crisis occurs. During a crisis people may be willing to try out new ideas out of pure desperation as happened in the Austrian town of Wörgl. Out of the experiments, the most efficient system may emerge. Most likely this will be Natural Money.

Economic Theory

Common ideas about interest

The consequences of interest on money and the influence of demurrage are both not mainstream economics. There is little thought on the influence of interest on money on risk taking within the financial sector and the effects of interest on money on the stability of the financial system, which are both core issues in the theory of Natural Money. As a consequence there is some ground breaking theory making in the economic model of Natural Money.

Many theories about interest-free money do not consider arbitrage. Interest exists independent of the monetary system. If an interest-free currency can be used to buy assets with a yield, there will be free money for those who engage in this trade. Abundant interest-free money can harm the economy and destroy the currency. An interest-free currency must provide a competitive return in order to be a viable alternative.

Another issue with many ideas about interest-free money is the idea that charging interest is morally wrong. This requires an explanation. It is not wrong to be rewarded for lending out money as there is risk involved and opportunity forgone. Still, it might be a bad idea to desire more and more of something that is in limited supply, such as gold or currency, most notably if other people need that something to survive or to have a meaningful role in society.

A common misconception is that a restriction on charging interest on money is a restriction on business profits. Capital needs a reward to be employed and restricting interest on money does not change that. Others might worry that credit will not be available when charging interest on money is restricted, or they may fear the opposite, that abundant credit will destroy the currency. That is not meant to happen with Natural Money.

It may seem strange that a restriction on charging interest on money can result in higher real interest rates. On closer inspection this makes sense. After all, if Natural Money is to improve economic efficiency, then this will somehow affect real interest rates. This is likely to be reflected in a rising value of the currency. This counterintuitive idea is the reason why Natural Money could be a success that might surprise most economists.

The rationale of having interest on money

Reasons for interest to exist

Many of the reasons for interest to exist are standard economics, but some are not, so that a more comprehensive view on interest rates might be possible. Those reasons are:
- returns on capital;
- the risks associated with lending out money (default and inflation);
- time preference and marginal utility, where marginal utility counterbalances time preference;
- money itself not depreciating in nominal terms, which puts a floor on interest rates.

Economists see interest as a payment for deferred consumption. By deferring consumption, resources can be used for production. This can facilitate future consumption. As a general rule, it is assumed that a certain amount of savings makes a greater amount of future consumption possible. This is the return on capital, which exists independent of money.

In a competitive free market, interest rates on money tend to reflect the productivity of capital. If they did not, and the risk/reward ratio of capital was better or worse, interest rates would adjust until they do reflect the productivity of capital. For example, if interest rates on money are low and the return on capital is high, then more people would be willing to invest in capital directly. Therefore interest rates on money tend to reflect the expected future return on capital.

Interest rates may reflect the expected rate of price inflation and the risks associated with the borrower. Default and price inflation are both risks associated with lending out money. It is often assumed that there is a risk free interest rate, for example on government bonds. Governments may not default outright but they can create money to pay off their debt, thereby lowering the value of the currency.

Time preference versus marginal utility

There is time preference because on average people prefer to have a good or service sooner rather than later. In this way time preference contributes to positive nominal interest rates. Interest may have another cause too. Money does not depreciate like capital or other goods, so nobody accepts negative nominal interest rates as money can be put away in a safe. If there is a holding tax on money, people may be more willing to accept zero or negative nominal interest rates. The law of marginal utility also counteracts time preference.

When there is a choice between 10,000 loaves of bread now or one loaf of bread each day for the next 10,000 days, most people prefer one loaf of bread every day for the next 10,000 days. Most people will even prefer one loaf of bread each day for the next 1,000 days above 10,000 loaves of bread now, which implies a steep negative real interest rate. This is because bread spoils in a short time so no one can use 10,000 loaves of bread. It also applies on durable goods. Most people would prefer to have a new car now and a new car in ten years’ time instead of having two new cars now.

The predominance of time preference for goods and services above the law of marginal utility is therefore questionable, most notably in affluent societies. For affluent people long term security becomes more important than short term needs. The time preference is predominant when you are hungry and have the choice between one loaf of bread now or one tomorrow. Time preference may also be predominant when you can sell the 10,000 loaves of bread and put the money on the bank at interest. In this way interest itself promotes time preference.

Effect of a holding tax

The money we currently use evolved from gold. It makes no sense to lend out gold at zero interest because gold does not decay. Money inherited this property from gold. Below a certain threshold there is no incentive to lend out gold because of the risks associated with lending. John Maynard Keynes thought that a liquidity trap can occur, which is a floor under which nominal interest rates cannot fall [7]. Similarly it makes no sense to lend out euros at negative interest rates if you can put euro bank notes in a safe deposit box. This is why interest rates cannot meaningfully drop below zero.

If money depreciates over time like capital and other goods, for example by applying a holding tax, the picture may alter dramatically. People may prefer to have money at the time they need it in the same way they desire a loaf of bread when they need it. Under those conditions they may be willing to lend at zero or negative nominal interest rates. Whether or not that might happen also depends on other conditions such as the return on capital and the level of risk associated with lending out money, as well as the value development of the currency over time. Only strong currencies allow for negative interest rates.

A holding tax might affect real interest rates, but only if risk free interest rates are already near zero. An interest rate near zero might imply that there is no real equilibrium between the supply and demand of money. This equilibrium might be at an interest rate below zero. Central banks try to induce inflation by printing money and lowering interest rates, but until now they had little success. If the experience of Japan is to be a guide, they will not succeed. A holding tax on money could make it possible to achieve this equilibrium without much effort.

Effect of a maximum interest rate

Restricting interest on money poses constraints on the funds available for borrowing. If the risk/reward ratio of capital is more favourable, interest rates on money may not be able to adjust upwards and direct investments may be preferred. There may be less borrowing for consumption so the economy may not overheat because of unsustainable accelerated consumption. The value of money may increase as economic output increases and in this way the real interest rate on money can reflect the return on capital. Consequently it may be possible to sustain borrowing and lending at a maximum nominal interest rate of zero.

Borrowers with a high risk profile may not be able to borrow at a nominal interest rate of zero. They may be better off because they have to postpone consumption instead of paying high interest rates, so they will end up having more purchasing power. It is likely that financial innovators will try to chisel on any interest restriction. Loan sharks may try to fill in the gap and black markets may emerge. Making interest on money illegal and nullifying loans with interest may help to alleviate this issue as it makes the risk of doing business for loan sharks prohibitively high, so that black market interest rates are prohibitively high for most prospective borrowers.

For centuries usury laws have been enacted to protect the poor from unscrupulous lending practises by setting a maximum interest level. Economists contend that usury laws in the past failed because the interest ceiling was set below the equilibrium market interest rate. The effect of the interest rate ceiling may have been that only wealthy people could borrow money and that the poor had to manage themselves. Insofar the poor could not borrow at all they may have been better off in the end, but many poor may have become victims of loan sharks.

It follows that any feasible maximum interest rate should be near or above the market interest rate. A maximum interest rate of zero might seem a serious obstacle, but it might not be. First of all, real interest rates in developed nations might remain zero bound for the foreseeable future. Second, the risks associated with lending money are reduced when the financial system is more stable because only the best borrowers get a loan. Third, and finally, with Natural Money a nominal interest rate of zero might imply a real interest rate close to the trend growth rate as the interest rate might reflect the level of economic growth.

Causes of economic cycles


Interest on money can contribute to economic cycles but interest on money is not the only cause of economic cycles. In general economic cycles are caused by mismatches between supply and demand. Those mismatches can concern the supply and demand of money, capital, labour or consumer products. Interest reflects the market for money and capital. If all markets were perfect, and supply could adapt to demand instantly, then there might be no economic cycles.

Economic cycles occur because mismatches between supply and demand emerge from time to time and are resolved after some time. Fluctuations in demand and supply cause fluctuations in prices, stocks and employment. There are a number of theories and explanations regarding those mismatches, economic cycles and their effects. Some of them identify banking and interest rates as causes. The ideas that are relevant for Natural Money are discussed here.

Expectations about the future and money hoarding

Expectations are important in economics. If people feel secure and have a good feeling about their future, they could be more willing to spend. A positive or negative feeling about the economy can become a self-fulfilling prophecy. For example, if people expect a bank to collapse then this could happen because there might be a bank run. Therefore many policy makers tend to give a rosy picture of the economy or the state of the banking system.

According to Say's law supply creates its own demand because goods and services are produced to acquire an equal value of other goods and services. This applies to a barter economy. If money is used as a medium of exchange, people can hold on to money and postpone their purchases. In this way producers can be left with overproduction, and a reduction in economic activity could be the result.

Money hoarding can be caused by bleak expectations about the future. Money hoarding can reinforce itself as a decline in economic activity can make people more cautious. They may start to save more and economic activity may decline even more. As a consequence, more people may expect that times get worse and start to save more. This cycle can reinforce itself and become destructive.


During good economic times, businesses and individuals tend to be confident. Credit is often available because future income projections of businesses and individuals are the basis for banks to lend money. Therefore businesses and individuals tend to increase their leverage during good times. When the economy slows down and their incomes reduce, they can get into trouble. People would have more disposable income when they were out of debt and did not have to pay interest. Similarly, businesses can go bankrupt even when they are profitable overall because of interest charges.

For example, a business may expect a return on investment of 8% and can borrow at 6%. It makes sense to use leverage and the business may have liabilities equalling two thirds of total assets. If the return on capital turns out to be 3%, the business operates at a loss because of interest payments. If there was no leverage then the business would still operate at a profit. Leverage can add to economic instability as it fuels the boom as well as the bust.

Often businesses are not liquidated but taken over at a lower price. In that case competitors that are more conservatively financed suffer as the overinvestment has created a new competitor with a lower cost base. Some of those more conservatively financed competitors can go bankrupt as a consequence. Leverage can be an accelerator of economic change as it reduces the value of the capital of the leveraged business as well as the capital of the more conservatively financed businesses.

Leverage also contributes to the overall risk in financial markets. Liquid financial markets make it easier to enter and exit positions, making it appear that it is safer to operate with leverage. If markets were not liquid then leverage appears more dangerous as it is more difficult to exit a position. In times of crisis liquidity may suddenly disappear. Liquidity makes it possible to take on more risk so the overall level of risk in the financial system might increase as a consequence of liquidity. This may become apparent during a crisis.

Credit cycle

Banks create money by issuing bank credit that can be used for payments. From time to time a bank cannot meet the demand for money of its depositors and then the bank goes bankrupt. Such a situation can have different causes, such as reckless lending, unexpected withdrawals, economic cycles or seasonal factors. Because banks hold deposits at other banks, one bank's financial troubles can cascade through the banking system. As a consequence, people can lose their confidence in the banking system and bank runs may ensue.

Banks may stop lending money because they need to meet the demand from depositors for money. This can cause an economic recession or even a depression because a reduction in lending causes a reduction in spending and investments. During a depression business incomes drop in money terms so many businesses and people experience difficulty to repay their debts. This causes more businesses to go bankrupt and more people to become unemployed. More loans will then not be repaid and consequently more banks can get into trouble. In this way a credit cycle can reinforce itself.

Usury and debt slavery

Ancient societies observed the adverse consequences of interest. Interest contributed to the concentration of money in the hands of a few people, while on the other hand many people were in debt or had become serfs of the money lenders. For that reason debts were forgiven from time to time [7]. This may have produced economic cycles. The Bible has provisions to forgive debts such as the Jubilee Year. Compound interest is infinite in the long run. This is a problem when the money lenders do not spend the interest on their money but accumulate it.

When money becomes concentrated into the hands of a few, less money remains in circulation and prices may drop. It becomes difficult to repay debts with interest because the debts and interest are fixed in money terms. Interest payments further reduce the available money in the hands of the public. Money lenders can then take possession of the belongings of the borrowers and demand their labour as repayment. In this way many people became serfs of the money lenders. This phenomenon is called debt slavery.

From this one could conclude that any interest rate on debts above the change in the monetary base, which could be currency or gold, contributes to this problem and can henceforth be called usurious. For example, if there is two percent more currency in circulation every year, then an interest rate of two percent on debts does not contribute to the concentration of money into the hands of a few, but higher interest rates do. It also follows that if the monetary base remains stable, interest rates above zero could be called usurious.


Fiscal and monetary policies

Interest on money is a possible cause of economic cycles and the expansion of debt as the example of the € 1000 village economy demonstrates. There will not be enough money in circulation to pay off debts with interest. If new debts are made at a faster pace than old debts are repaid with interest, the amount of money in circulation increases, which is monetary inflation. Under those conditions the economy tends to perform well and there could be price inflation. If new debts are made at a slower pace than old debts are repaid with interest, then the amount of money in circulation decreases, which is monetary deflation. Under those conditions the economy tends to perform poorly and there could be price deflation. This is why many economists think that there should be some monetary inflation.

To deal with economic cycles and to deal with economic crises, monetary policies and fiscal policies have been introduced to manage interest rates, money supply and aggregate demand. Those instruments have turned out to be awkward because the best course of action is difficult to know in advance, but also because policy actions can distort markets and favour politically connected people and businesses. Most notably, those policies may foster moral hazard if market participants expect governments and central banks to help them out in times of trouble.

Economists often assume that there is a natural interest rate at which the economy is growing at its trend rate and inflation is stable. The natural interest rate may differ from the actual interest rate in the market because the market is influenced by the creation of bank credit. Deviations from this natural rate of interest could trigger booms and busts. If the market rate of interest is pushed below the natural rate of interest, for example through monetary expansion caused by bank credit during times of optimism, then people might receive a false signal to invest in more interest-sensitive projects. During an economic bust, useful capital might be destroyed that might have to be rebuilt during the next economic boom.

The market interest rate may therefore differ from the natural interest rate so economists often assume that it must be set by monetary policies. One of the intentions of central bankers is to keep the market interest rate near the natural interest rate. By setting short term interest rates, and in this way indirectly targeting long term interest rates, central banks can influence the creation of bank credit. If they perceive the natural interest rate to be above the market interest rate, they will raise short term interest rates or sell bonds, and if they perceive the natural interest rate to be below the market interest rate, they will lower short term interest rates or buy bonds.

The biggest problem here is that the natural interest rate is a theoretical construct. It cannot be measured or calculated. Economists and central bankers therefore have to rely on estimates. During an economic boom the natural interest rate is above the market interest rate because economic growth is above the trend rate, while during an economic bust the market interest rate is below the natural interest rate because economic growth is below the trend rate. Monetary policies may be too easy during the boom phase as high interest rates could produce a bust and policy makers prefer not to be responsible for economic downturns.

Policy makers therefore tend to extend booms and mitigate busts so money supply as well as debts continue to expand. Often the growth rate of the money supply exceeds nominal interest rates. The scheme of compounding interest contributes to this as it needs new money to pay off the interest on old debts. Debt expansion also seems to require lower interest rates because otherwise people might not have adequate income to service a higher debt level. If no-one is willing to take on more debt, then the last resort of central bankers is printing new currency. This can have unforeseen inflationary consequences in the long run.

Fiscal policies and monetary policies are driven by a fear of economic cycles, most notably economic crises and monetary deflation. When there is price deflation, debts and interest payments grow in real terms, which may become a further drag on economic growth. People may postpone purchases when they expect lower prices and an uncertain future. A holding tax on money could solve this issue as the holding tax makes keeping money idle expensive. It allows for negative interest rates when the equilibrium of intended savings and investments is at a negative interest rate.

Diminishing growth perspective

Economic growth comes from capital deepening and technological change. Capital deepening is increasing the amount of capital per worker, such as machines, infrastructure and software. At some point adding more capital to a worker starts to yield less because of the law of diminishing returns. Mature economies have large capital bases and adding more capital may lead to lower returns on capital and a downward pressure on interest rates.

In the past technological change helped to overcome this problem as technological change destroys capital and offers opportunities for new capital to grow. Even though technological development seems to continue unabated, new innovations may have less economic value as further improvements in living standards are subject to the law of diminishing marginal utility. This also may put a downward pressure on interest rates.

There might be a global savings glut, often identified as excess savings in Asian economies invested in the United States and the European Union. A global savings glut, if it exists, could push interest rates downwards. An uneven distribution of wealth may also contribute to lower interest rates. Capital not only produces wealth, but it also requires wealth to exist, because supply must equal demand. When the richest people do not have meaningful ways to spend their wealth, they can only invest, which produces a downwards pressure on interest rates.

Many mature economies have a low population growth or their population might even decline. They may enter a steady state where interest rates might remain low. Japan with its advanced economy and ageing population could be a precursor for what will be happening in other mature economies like Europe and the United States. In Japan interest rates have been near zero for more than two decades despite massive monetary and fiscal stimulus.


There is a relation between the risk associated with the borrower and the interest rate the borrower has to pay. But interest on loans is a double-edged sword. Borrowing at high interest rates tends to make the condition of the borrower worse. It might be better that borrowers in trouble have to adjust their finances in an early stage in order to create a more healthy perspective for the future. It might also be better that borrowing does not deteriorate the financial position of the borrower. A maximum interest rate could help to achieve this.

If there was a maximum interest rate then there is no incentive to take risk above a certain threshold. Under those conditions economic agents that see their prospects deteriorating have to adjust in an earlier stage because no money will be lent to them otherwise. Risky projects will be funded outside the traditional banking system, which reduces risk inside the banking system. A holding tax on money can provide an incentive to lend out money at zero or negative nominal interest rates.

Interest-free money requires reliable money markets and capital markets with low transaction costs. Free and reliable capital markets tend to drive down interest rates as they reduce the level of risk. The removal of restrictions on capital markets may have contributed to the conditions that make it possible to implement interest-free money. For that reason interest-free money might not succeed in developing nations where money and capital markets are less developed.

Fiscal and monetary policies might have created a false sense of security. This could entail a moral hazard as a perceived low risk level enables market participants to increase their leverage. Leverage tends to be extended because there is an incentive to do so in the form of interest on money and because of expected government and central bank support. In this way, the instruments of policy makers may have increased the overall level of risk. If the fall-out of debt defaults can be reduced, then it might be possible to reduce the need for government and central bank support and eliminate this type of moral hazard.

The Natural Money proposal


Natural Money is currency with a holding tax and a maximum nominal interest rate of zero. The amount of currency is fixed. Apart from that there is bank credit that can be used as money. There is a constraint on government deficits and government debts. Government deficits and government debts could push up interest rates, making it difficult to maintain a maximum nominal interest rate of zero. With Natural Money, central banks have a more limited and passive role and do not target interest rates or money supply.

By putting money in a deposit account, depositors accept the risks of banking and are rewarded with not having to pay the holding tax. Interest is a reward for risk so a restriction on charging interest on money may curb risk taking in the financial sector so that more risk may be taken directly by investors, and bank deposits are near risk-free. A restriction on charging interest on money could also mitigate economic cycles. Fiscal policies and monetary policies may be needed less, and this could reduce moral hazard.

Currently, monetary issues are decided undemocratically by central banks. Natural Money can go together with full democracy, which implies free elections but also referendums in which the citizens can enact or retract any law by a majority of votes. Monetary issues may also be subject to full democratic control. The board of a central bank may be elected. Citizens can make mistakes, but over time they may learn to make better choices as this is in their best interest.


Natural Money is assumed to have the following features:
- national governments as well as local and regional governments can issue Natural Money currencies;
- on the currency in circulation, a holding tax is levied by the issuing government;
- lending out money at a nominal interest rate of above zero is not allowed;
- the holding tax is spent back into circulation by the issuing government;
- the currency is legal tender in the realm of the issuing government and the issuing government requires taxes to be paid in its own currency;
- the amount of currency is fixed and can only be changed after a referendum;
- if the amount of currency is altered, the nominal value of deposits and loans should be altered with the same percentage.

Within the context of Natural Money the following interest rates can be distinguished:
- the reward for capital or business profits, which is often named interest on capital;
- the nominal interest rate, which is the rate of interest expressed in currency terms;
- the real interest rate, which is the rate of interest after accounting for changes in the price level;
- a usurious interest rate, which is a nominal interest rate on money greater than the change rate of the money supply.

Banking principles

Institutional arrangements

The Natural Financial System, which is the financial system based on Natural Money, is assumed to have at least the following principles:
- banks can lend money at a maximum nominal interest rate of zero;
- no holding tax is charged on money in deposit accounts;
- banks can charge an intermediary fee to depositors, which amounts to a negative nominal interest rate on deposit accounts.

The financial system facilitates all other types of business. A disruption of the financial system could mean a disruption of the entire economy. For that reason, there is an implied government support for the financial system. Governments support the financial system by declaring that bank credit is a means of payment so that it can be used as if it is money. Moreover, currencies are backed by the credit worthiness of the governments issuing them.

Taxpayers could thus be backing the profits of banks but it does not seem a good idea to turn banks into public institutions. If credit is issued based on bureaucratic considerations instead of a business rationale, this can severely harm the economy. Still, there might be a good reason to make banks a separate type of business that cannot be mixed with other types of business, because there is an implied government guarantee or central bank backing.

Types of services

There can be two types of accounts with regard to risk. Money in a deposit account is part of the bank's capital available for lending. This money is subject to the risk of banking but depositors do not have to pay the holding tax. Money in an administrative account is similar to cash outside the banking system and it is not available for lending. This money is not subject to the risk of banking but a holding tax must be paid on this money. Because banks do not earn revenue from lending against administrative accounts, account holders might pay fees for the services associated with administrative accounts.

There can be two types of accounts with regard to availability. Money in current accounts is readily available and can be used for payments. Money in savings accounts is not directly available for payment. Depending on the conditions of the savings account, this money can at some point in time be transferred to a current account and then used for payment. Current accounts could be administrative accounts while savings accounts are always deposit accounts.

Apart from banks there might be financial service providers that make investments instead of loans. They could for example offer lease contracts on cars and houses similar to car loans and mortgages. This implies a shared ownership of a property, and therefore a shared risk taking. The lessee may not only pay rent but may also pay to gradually become the owner of the property. Those financial service providers cannot offer deposit accounts with fixed rates but they can offer shares in a closed-ended or open-ended structure. The value of those shares and their dividend can fluctuate.

Properties of the financial system

Inside the core financial system, which consists of the banks and the central bank, fixed or flexible rates on deposits and loans could be agreed as long as they do not exceed zero. Central bank support might be needed to guarantee those agreements as fixed rates and a return of the principle amount are promised. Outside the core financial system there is no central bank support and yields exceeding zero are possible. The absence of central bank support implies a higher risk for investments in financial service providers relative to banks.

Based on these considerations, the following properties might be implemented in the Natural Financial System:
- only banks can offer deposit accounts and other financial service providers can only offer administrative accounts;
- banks should only provide payment, borrowing and lending services;
- banks cannot invest directly in securities, except bonds that yield less than the maximum nominal interest rate of zero;
- financial service providers can make other investments and make loans at a maximum nominal interest rate of zero;
- only banks can receive central bank credit and central banks could discount bonds for banks at an implied interest rate of zero;
- banks need to adhere to solvency requirements and reserve requirements that might not apply fully on other financial service providers;
- government guarantees may only apply on bank deposits;
- only banks can receive central bank credit.

Wholesale banking system

Fischer Black realised in 1970 that a long term bond could be sold in three separate parts to three different investors. One could supply the money for the bond, one could bear the interest rate risk, and one could bear the risk of default. The last two would not have to put up any capital for the bonds, although they may have to post some sort of collateral [9]. This idea became the basis for the development of wholesale banking and derivatives in recent decades. The wholesale banking system is more commonly known as the shadow banking system.

The emergence of the wholesale banking system and derivatives is often seen as a dangerous development because it is not well understood, and because the regulation systems of the wholesale banking system as well as the derivatives have been immature. Many derivatives cannot be traded in transparent liquid markets so that their true value is not known. On the other hand, the emergence of the wholesale banking system probably helped to spread risk and thus contributed to the drop in interest rates in recent decades.

A well-developed wholesale banking system might improve the efficiency of markets. Economic stability and a maximum interest rate of zero could help to diminish risk in the wholesale banking system. Default risk might be reduced significantly with Natural Money. Combined with adequate regulation that includes solvability and liquidity requirements, as well as transparent liquid markets for derivatives, this could help to develop a mature and stable wholesale banking system.

Governments and central banks

On the one hand, Natural Money requires more discipline from governments with regard to their budgets. Government borrowing can crowd out private borrowing and can make it difficult or even impossible to keep nominal interest rates below zero. On the other hand, Natural Money may offer more opportunities for governments to enforce budget discipline. There might be no need for deficit spending because the holding tax could provide a constant stimulus so that budget cuts or tax increases will have fewer adverse effects on the economy.

With Natural Money central banks do no set interest rates and do not manage the money supply. Central banks are needed to provide temporary credit to banks to cope with fluctuations in demand for money. This should be done at a nominal interest rate of zero to discourage the use of central bank credit and to encourage banks to keep adequate reserves. When a bank is on central bank credit, this might be a reason to put the bank on increased central bank supervision. Central banks should be public institutions in order to have democratic control.

Natural Money currencies might be issued on the international, national, regional as well as the local level. With Natural Money it may be possible to support national as well as regional and local economies, and to decentralise economic decision making to some extent. Regional and local currencies introduce exchange costs that may make it profitable to localise production when the benefits of the economies of scale are relatively small. There are limitations to the use of local currencies. Experiments have shown that at most 20% of the currency in circulation could consist of local currencies.

Reserve requirements

Banks have a maturity transformation function so it is difficult to make a clear distinction between fractional reserve banking, which is making loans out of any deposits, versus full reserve banking, which is making loans out of savings only. It is possible to have savings accounts with deposits available for immediate withdrawal. The creation of bank credit that can be used as money can cause monetary instability via credit growth and contraction, but credit is inherently dynamic.

Full reserve banking is not a real solution to the problematic nature of compounding interest on money. Also with full reserve banking the amount of currency relative to the amount of credit tends to decline because of compounding interest, albeit at a slower pace than with fractional reserve banking. Natural Money does not have positive nominal interest rates, so these considerations do not apply.

There might be a reserve requirement with Natural Money, which is a ratio between the amount of currency in the banking system and the amount of credit outstanding. There are two options. The first option is to have fixed reserve requirements based on the type of deposits. The second option is to base reserve requirements on a moving average of the daily transactions between accounts, including transactions within the same bank. Banks pay a holding tax on the currency in their vaults, but they can pass on those costs to account holders via the intermediary fee.

A fixed reserve requirement seems less appropriate as it does not adapt to the velocity of money. A high velocity of money tends to be price inflationary while a low velocity of money tends to be price deflationary. If the reserve requirement changes with the velocity of money, it could counteract price inflation and deflation. In order not do disadvantage small banks, transactions between current accounts within the same bank could be included in the reserve requirement calculation.

With Natural Money, banks can receive temporary central bank credit, which can be used as reserves. This may be needed if there are sudden withdrawals from savings accounts in the case of full reserve banking or when there is a sudden surge in the turnover of money in current accounts in the case of a fractional reserve system. The central bank currency is subject to the same holding tax as regular Natural Money currency.

Central bank credit with Natural Money is expensive because it is available at a nominal interest rate of zero. Under normal conditions a bank can borrow at better rates from other banks and depositors. Because they cannot make money from central bank credit, banks will have little appetite for central bank credit and curb lending when they are on it.


The holding tax provides a constant stimulus by making liquidity expensive. If an economic downturn is about to occur, then the economy is likely to recover quickly. It seems unlikely that the government or the central bank have reason to intervene to support the economy. A reduction in debt levels and price deflation might not harm the economy so governments and central banks may have no reason to take measures to counteract such developments. There seems to be no need for increasing debt levels over time so a constant monetary base over time might suffice. If there is economic growth then price deflation is a likely consequence.

If intended savings exceed intended investment then the real interest rate could drop below zero because of the holding tax. The maximum interest rate of zero could curb consumer spending when the economy is poised to overheat. The reason is that people are less inclined to deposit money at a maximum interest rate of zero when other investment opportunities provide better risk/reward ratios. The adaptive reserve requirement could have a similar effect. If the economy is doing well then the velocity of money increases and thus the reserve requirement so that fewer funds are available for lending.

Because there is a maximum interest rate, there could be a cap on the risk lenders are willing to take. Consequently risky projects will be financed with more equity and less debt. People and businesses in financial trouble may have to adjust their finances in an earlier stage. Their troubles cannot be increased by interest payments. The stable economic picture could also diminish the likelihood of people getting in financial trouble. Natural Money could discipline governments as low interest rates require sound government finances.


If the economy is stable and operating at or near the trend growth rate at full employment then the maximum economic potential appears to be achievable. Under those circumstances real interest rates could be near their maximum. It seems that Natural Money helps to realise a stable economy and that Natural Money reduces risk in the financial system. It therefore follows that real interest rates with Natural Money could be higher. This could then be reflected by a strong currency that is rising in value. An interest rate of zero might then be a positive real return.

A tentative calculation can be made to support such a view. There is a link between the amount of money and money substitutes (M) in circulation and prices in the equation Money Stock (M) * Velocity (V) = Price (P) * Quantity (Q). Prices are not only determined by the money stock (M) but are also affected by the quantity of economic production (Q) and velocity of money (V). From M*V = P*Q it follows that P = M*V/Q, so that P+ΔP = (M+ΔM)(V+ΔV)/(Q+ΔQ), where ΔP is the change in price level, ΔM is the change in money stock, ΔV is the change in money velocity and ΔQ is the change in quantity of production.

If ΔP, ΔM, ΔV and ΔQ are sufficiently small, it is possible to approximate this equation with %ΔP = %ΔM + %ΔV - %ΔQ, where %ΔP is the percentage change in price level, %ΔM is the percentage change in money stock, %ΔV is the percentage change in money velocity and %ΔQ is the percentage change in the quantity of production. To simplify matters, we assume that the velocity of money (V) is fairly constant over time so that %ΔP = %ΔM - %ΔQ.

Even though the velocity of money (V) for Natural Money might be higher than the velocity of money (V) for interest bearing currency, it is even more likely to remain constant as the economic picture is more likely to remain constant. Now it is possible to make a calculation of the real interest rate (r), which is the the nominal interest rate (i) minus the inflation rate (%ΔP) so that r = i - %ΔM + %ΔQ.

Suppose that for interest-bearing money the long-term average economic growth is 2%, but for Natural Money it might be 3% because the economy is more often performing at its maximum potential. Assume that the long-term average money supply increase for interest-bearing money is 6% per year, but for Natural Money it is 0%. The long-term price inflation rate could then be 4% for interest-bearing money, but for Natural Money there could be a price deflation rate of 3% as the economy grows 3% on a stable money supply. Then the following calculation can be made:

 situation  interest on money   Natural Money 
 nominal interest rate (i)+3% -2%
 change in amount of money (ΔM) +6% 0%
 economic growth (ΔQ)+2% +3%
 real interest rate (r = i - ΔM + ΔQ)-1% +1%

Economic growth is likely to be higher with Natural Money, so real interest rates are likely to be higher. Furthermore, because the design has a number of stabilisers that tend to reduce risk in the financial system, the level of risk is likely to be lower in the Natural Financial System. It seems therefore likely that the risk/reward ratios in the Natural Financial System are better than in the current financial system. This suggests that the design of Natural Money is more efficient so that there might be a capital flight from the interest economy to the interest-free economy as soon as Natural Money is implemented somewhere.

The real interest rate improvement may be higher than the improvement in the economic growth rate as there might a reduction in financial sector profits. Economic and financial stability might imply a reduction in the risks of investing so that investments could be made with less financial sector intermediation. The financial instability and the perceived need for government and central bank interventions in the interest-based financial system may have produced opportunities for politically connected and informed people to enrich themselves at the expense of the general public.

Non-productive activities in the financial sector may have harmed the real economy and may have contributed to a reduction in living standards. It might not be a coincidence that despite economic growth, real wages in the United States have remained stagnant for decades, while the US financial sector comprised only 10% of total non-farm business profits in 1947, but grew to 50% by 2010 [10]. This development seems to have benefited the top 1% of extremely rich people. Natural Money might help to reverse this development.

Further explanation

figure 1: quantity sold and general price level
figure 1: quantity sold and general price level

The classical perspective


According to classical economists, the economy tends to be in equilibrium at full employment because the desires of consumers exceed the capacity of the businesses to satisfy them. People produce in order to consume what they have produced or have acquired by exchanging what they have produced for what others have produced. This is reflected in Say's Law, which states that supply creates its own demand. When the economy is not in equilibrium at full employment, classical economists think that this is caused by a lack of price flexibility.

Classical economics suggests that everything will work out fine when markets are competitive and flexible so that prices can adapt fairly quickly. According to classical economics it is better that governments do not interfere with the economy, except for making markets more flexible and competitive. Unemployment is a consequence of inflexibility of the labour market. If markets have price flexibility then problems will resolve themselves quickly and recessions will be short lived.

figure 2: labour supply and demand
figure 2: labour supply and demand

Demand for goods and services

Classical economics assumes that if there is a surplus of goods or services, they will drop in price until they are consumed (see figure 1). Lower prices will make it more attractive to buy those goods and services while it will be less attractive to produce them. Consumption will rise and production will drop and a new equilibrium will be achieved.

If the demand for goods and services drops from D1 to D2, there will be a surplus at a general price level P1 and only Q2 products will be consumed. As long as prices have not dropped to P2, there will be a surplus of products. After some time there will be a new equilibrium at a general price level of P2 and a quantity of Q3. This may create a surplus of labour.

Labour supply and demand

Classical economics assumes that if there is a surplus of labour, it will drop in price until there is full employment (see figure 2). At lower wages, working is less attractive so there will be less people willing to work. At lower wages, it will be more attractive to hire people so there will be more employment at lower wages.

If the demand for labour drops from D1 to D2, the number of people employed drops from N1 to N2 if the real wage level remains W1. As long as the real wage level has not dropped to W2, there will be some unemployment. After some time a new equilibrium has arrived at a real wage of W2 and a number of people employed of N3.

Money value

When prices drop the value of money rises. This means that the money stock increases in the equation Money Stock (M) * Velocity (V) = Price (P) * Quantity (Q). According to classical economics, people will feel richer as a consequence and start to spend more and save less. Even if they do not spend more in money terms and velocity does not change, they spend more in real terms. Demand will rise again as will employment.

figure 3: savings supply and investment demand
figure 3: savings supply and investment demand

Interest rates

National income is consumption plus investment, which is reflected in the equation National Income (Y) = Consumption (C) + Investment (I). If consumption drops, there is more money in the form of savings available for investment. At the same time businesses need to reduce production so the investment demand for money will also drop (see figure 3).

According to classical economists people save money in order to have more money in the future. Because people have a time preference and prefer present consumption above future consumption, they only postpone consumption if real interest rates are high enough. A lower real interest rate makes saving less attractive while more projects become feasible, which produces a higher investment demand for money.

If the supply of savings increases from S1 to S2 (a lower line means more supply at a given price) then the real interest rate will drop from R1 to R2 while the quantity of investments and savings will increase from IS1 to IS2. If investment demand then drops from I1 to I2, then the real interest rate will drop further from R2 to R3 while the quantity of investments and savings will decrease from IS2 to IS3.


There are some issues with the assumptions of classical economics. Businesses may continue production as long as the price exceeds the variable costs of making the product so overproduction may persist for a longer period of time. If prices drop, people may not start to spend more. They may wait until prices drop further. Because employment and incomes are dropping, people may become more cautious. This can cause a deflationary spiral.

If labour drops in price, its supply may increase rather than decrease because people may try to make up for the income lost. This could create a race to the bottom in wages. To deal with this issue, labour unions have tried to corner the market for labour and governments have introduced minimum wages. Because there are labour unions and minimum wage laws, the market for labour is not efficient, making it difficult to adjust prices downward when there is lack of demand for labour.

Most people save for a specific purpose, for example retirement. Those savings depend little on real interest rates. Savings may even reduce when the real interest rate is high as the perceived objectives can be achieved with less effort. A lower real interest rate may therefore increase savings. If people are cautious because they are unsure about their future, they may start to save more regardless of real interest rates.

Natural Money view

If banks can create money then not all loans are made out of savings so investments (I) may not equal savings (S) and the market interest rate may not be the natural interest rate. The market interest rate may be lower than the natural interest rate when the economy is booming. As a consequence bad investments may be made during the boom phase. The market interest may be higher than the natural interest rate during the bust phase so that useful capital could be destroyed during a bust.

Nominal interest rates cannot go negative, even when the market equilibrium for savings and investments is at a negative interest rate. People may prefer to keep savings in cash below a certain rate of interest. During an economic crisis depositors may demand higher interest rates to compensate for the risk of default while lower interest rates may be needed to sustain the economy and reduce the risk of default.

This could be seen as an inflexibility of the markets for money and capital. Natural Money could help to solve this issue by allowing negative interest rates. The stabilising mechanisms of the design can help to reduce the risks in the financial system so that crises are less likely to occur and people are less likely to demand high interest rates. With Natural Money it is also less likely that bad investments will be made or that useful capital will be destroyed.

Natural Money introduces another type of inflexibility, which is that nominal interest rates cannot exceed zero. Assuming that the velocity of money (V) is constant over time, this means that real interest rates cannot exceed the rate of economic growth. It should be noted that such a limitation can act as a brake on an economy that is about to overheat as the amount of available credit will reduce under this condition because people prefer equity investments to debt investments.

figure 4: circular flow model
figure 4: circular flow model

The Keynesian perspective

Economic cycles, recessions and depressions

Keynesians see low demand combined with excess savings as the primary cause of economic depressions, often called general glut. The circular flow of money (figure 4) is an important element in Keynesianism as is the equation National Income (Y) = Consumption (C) + Investment (I). If Consumption (C) reduces then Investment (I) must rise. If demand is lower than anticipated, excess investments are made in unsold inventory. As a consequence production will be lowered as will subsequent investments. This may cause a downward spiral that ends at a lower equilibrium national income with a considerable level of unemployment.

The following example may illustrate this. Suppose that there is equilibrium at a national income (Y) of 100 where consumption (C) is 90 and investment (I) is 10, which is equal to planned investment (Ip). Then consumption (C) drops to 80 and investment (I) rises to 20, of which 10 is planned (Ip) and 10 is an unplanned increase in inventory (Iu). Suppose that production will be scaled down by 15 to 75 to anticipate lower demand and to reduce inventory. Unemployment will then rise and consumption (C) drops to 75.

Businesses do not see a reduction in inventory and scale down production 10 more to 65. Employment reduces again and consumption (C) drops to 70. The next time consumption remains 70 but production remains 65 to sell inventory. Suppose that businesses then reduce planned investments (Ip) to 5 because there is less demand and national income (Y) will stabilise at 75 with a consumption (C) of 70 and planned investments (Ip) of 5.

Price stickiness and deflationary spiral

An interesting observation can be drawn from this calculation. Because people wanted to save more, they ended up saving less because incomes dropped. Households intended to save 20 but ended up saving only 5 at the new equilibrium. This phenomenon is called the Paradox of Thrift. The Paradox of Thrift depends on prices being sticky. If all prices including real interest rates could adapt immediately to market conditions then this would not happen.

figure 5: liquidity trap
figure 5: liquidity trap
Keynesians assume that prices are sticky. Most notably wages do not adjust quickly downwards while interest rates cannot go below zero. Because of money illusion employees will resist lower wages even when prices are lower. Real interest rates will not fall as much as is required to make savings (S) match investments (I). According to Keynes, people will hold on to cash and not lend out money, hoping to fetch better interest rates in the future. There is not much downward risk when nominal interest rates are low.

According to Keynesian analysis cutting wages is a bad idea as it will reduce aggregate demand even further while insufficient aggregate demand is the cause of recessions in the first place. Furthermore, if wages and prices were falling, people would start to expect them to fall. This could make the economy spiral downward as those who have money would postpone spending as falling prices makes their money more valuable. Price deflation can make a depression deeper as falling prices and wages can make pre-existing nominal debts more valuable in real terms.

Interest and liquidity trap

Keynes thought that planned savings (S) do not depend on real interest rates and that planned investments (I) depend on long term profit estimates that are somewhat influenced by real interest rates. Lower real interest rates make more projects feasible (see figure 5). Assume that there is equilibrium at planned savings and investment of IS1 and a real interest rate of R1. If planned savings increase significantly to S1' then equilibrium could only be achieved at a negative real interest rate. This does not happen so the economy will contract until a new equilibrium is reached, possibly at planned savings and investment of IS2 and a real interest rate of R2.

Prices and wages can adapt downwards but nominal interest rates cannot go below zero. Keynes thought that a liquidity trap can occur, which is a floor under which nominal interest rates cannot fall. He suspected that in this trap any increase in the money supply will cause bond holders to sell bonds to obtain liquidity. This may be because nominal interest rates cannot go below zero so that there is little downward risk when nominal interest rates are low. The liquidity trap is also known as the Zero Lower Bound Problem.


Government intervention could make markets less efficient. Fiscal policies such as government spending tend to favour politically connected businesses. There is also a time lag between the occurrence of the problem and the effects of increased spending taking hold. At that time the recession may be over and the increased government spending could even help to overheat the economy.

Keynesian thinking tends to undermine fiscal discipline and government deficits have become the norm in recent decades. When the economy is overheating, Keynesian economics prescribes that governments decrease spending or increase taxes, but this rarely happens. Government spending tends to increase year over year and government deficits have become a problematic issue.

Natural Money view

To Keynes, stickiness of prices was a problem, but by increasing aggregate demand prices are less likely to correct. Keynesian policy actions might increase the stickiness of prices, but stickiness of prices was an important reason to implement those policy actions in the first place. Keynesian policies, in the way they are mostly implemented, could make problems worse because they do not allow the general price level to adjust downwards.

Keynes and his followers identified the inflexibility of interest rates as a problem, but they did not provide a real solution, except for monetary inflation and price inflation. Nominal interest rates seem to be the inflexible during times of crises and in mature stationary economies like Japan. In those situations equilibrium appears to be below zero but nominal interest rates cannot go below zero. This restriction appears to be a drag on economic development.

The chartalist perspective

Accounting perspective

An important chartalist idea is the accounting perspective, which implies that one agent's financial asset is another agent's financial liability and one agent's financial deficit is another agent's financial surplus. In the aggregate net financial balances as well as financial flows must equal zero. It follows that if one economic sector runs a financial surplus then all other sectors together must experience a financial deficit. Financial balances do not equal wealth. At the aggregate level real wealth does not equal zero [11].


To chartalists it is important that a country is sovereign and has its own currency. Only the sovereign government has the power to issue a currency and to determine that this currency it will be recognised for official accounts. Pegging the currency to another currency or gold, or entering a currency union with other nations, limits the policy options of the government. Throughout history, money has often been a legal construction of a state, even though coins often had a precious metal content to inspire confidence.

Taxation establishes fiat money as currency, giving it value by creating demand for it in the form of a tax obligation that must be met using the government's currency. A continuing tax obligation, together with private confidence and acceptance of the currency, maintains its value [11]. Taxes create a demand for the currency while government spending produces the supply of the currency.


Minsky thought that borrowing and lending is done on expectations of future cash flows. This gives rise to a certain pattern of cash commitments. At the same time, there are cash flows emerging from the real economy. If these two patterns match then debt is serviced and there are no problems. If the people who are receiving cash do not need it, there is no problem because they will lend it. The consequence is an expansion of credit. This is what happens in a boom. A boom is a credit expansion, which is a delay of settlement on the basis of expectations about the future [12].

The problem comes on the reverse side of this expansion, when there are demands to delay settlement and no supply, or demands to make payment and no matching cash flows. This shows up as pressure in the money market, because it requires an expansion of credit. What could make the problem worse is that the cash commitments of each agent depend on the cash commitments of every other agent [12]. Minsky observed swings between robustness and fragility in the financial system that are part of the process that generates business cycles [13].

Minsky argued that these swings, and the booms and busts that can accompany them, are inevitable in a free market economy, unless the government steps in to control them through regulation, central bank action and other tools. He also thought that a key mechanism that pushes an economy towards a crisis is the accumulation of debt by the private sector [13]. An important chartalist idea is that private sector cannot print currency so that the government may need to do this in times of crisis.

Natural Money view

The accounting perspective suggests that expansion of private debt could be a problem because the private sector cannot print currency. For that reason chartalists tend to think that government spending and printing currency can help to solve economic crises. An important underlying problem is the compounding of interest on money. With Natural Money there is no compounding of interest on money and Natural Money provides a more stable economic picture so that economic swings between robustness and fragility are less likely to occur.

The chartalist view on sovereignty is important. Legal tender laws and tax obligations can give value to a currency. Governments issuing Natural Money currencies must require taxes to be paid in their own currency. Competitiveness as well as fiscal and monetary policies can be reflected in currency valuations and interest rates. If fiscal and monetary issues are to be decided democratically, which is the part of the Natural Money proposal, then the people making up a currency area might need to be under the same government. This is often the case within a nation state.

This is often not the case within multinational currency areas like the Eurozone. On the other hand, Natural Money requires monetary and fiscal discipline, which limits the policy options of governments, so that a national Natural Money currency seems not to have same benefits as a national interest-bearing currency. With Natural Money there appears to be less need for fiscal and monetary policy options to deal with economic crises. This could give the euro a better perspective, even though differences in development of competitiveness between nation states might still be a cause of concern.

With Natural Money, fiscal issues in the Eurozone could be decided on the national level because government borrowing is restricted by the maximum interest rate of zero, and because fiscal discipline has fewer adverse effects. Monetary issues could be decided on the Eurozone level by the central bank, which has a more restricted mandate because it cannot print additional currency or set interest rates. In this way the euro could survive, even though it might be supplemented with local, regional and national Natural Money currencies.

Austrian School of Economics

Austrian Business Cycle Theory

The Austrian Business Cycle Theory views economic cycles as the consequence of excessive growth in bank credit, exacerbated by central bank policies which cause real interest rates to remain too low for too long, resulting in excessive credit creation, speculative economic bubbles and lowered savings [14]. According to the theory, economic cycles are caused by credit creation that is not backed by savings. Fractional reserve banking makes more funds available for lending. This lowers the real interest rate and facilitates a boom.

Austrians argue that the monetary boom ends when no further investments can be found which provide adequate returns for speculative borrowers at prevailing interest rates and bank credit creation stops. They further argue that the longer the artificial monetary boom goes on, the bigger and more speculative the borrowing, and the more wasteful the errors committed, the longer and more severe will be the necessary readjustment consisting of bankruptcies, foreclosures, and depression [14].

Gold standard

Many proponents of the Austrian School of Economics favour a gold standard to enforce fiscal and monetary discipline because the availability of gold limits the creation of money. The value of gold depends on its rarity, attraction and monetary qualities. Its value does not depend on the trustworthiness of an issuer. Over the ages gold has retained its value while other currencies did not. Between 1815 and 1914 there was a global gold standard. During this century there was relative peace, monetary stability, often combined with robust economic growth. Most notably in the United States there were some serious depressions.


Mainstream economists contend that financial innovations such as fractional reserve banking can improve the efficiency of financial markets. Banks have a maturity transformation function because savings and loans tend to have different maturities. On average savings with a shorter maturity are transformed into loans with a longer maturity, which might be inflationary insofar savings more liquid than the underlying assets.

In theory it is possible move any positive balance on a current account to a savings account and supplement any negative balance on this current account with money from the same savings account. This shows that the difference between full reserve banking and fractional reserve banking is arbitrary. Furthermore, economic cycles would still exist when loans are made out of savings only, partially because compound interest is infinite in the long run.

Natural Money view

The Austrian School of Economics focuses on fiscal monetary discipline, which is also a core idea behind Natural Money. Strict monetary discipline seems only possible if nominal interest rates do not exceed zero as this eliminates the need to print additional currency to make up for the shortfall caused by interest on money.

The Austrian School of Economics does not consider compounding interest on debts as a cause of financial instability and economic crises. This might be a consequence of their free-market views, which state that any interference with markets, such as setting a maximum interest rate, will cause more harm than do good.

This perspective is important, because it shows that Natural Money may only work when market interest rates are already near zero, so that most economic agents are able to borrow at this rate or even lower. If the equilibrium interest rate is near zero or even negative, then the holding tax could help to make achieve equilibrium with minimal interference with markets, so that interest-free money could succeed.

Steady State Economics and De-Growth

The de-growth movement is based on ecological economics and it advocates for the downscaling of production and consumption, arguing that overconsumption lies at the root of long term environmental issues. It appears that economic growth has limits, given its consequences such as climate disruption, widespread habitat loss and species extinction, consumption of natural resources, pollution, urban congestion and an intensifying competition for remaining resources.

It is likely that the exponential growth of economic activities is about to hit the limits of the planet, unless new sources of virtually unlimited energy can be tapped. Keynes thought that at the limits to growth investing for economic expansion becomes unprofitable for all [15]. This could be reflected in lower interest rates. It seems that low or negative real interest rates go together with a transition to a steady state economy without exponential growth of economic activities.

Possible consequences of Natural Money

Introduction phase

The conditions under which Natural Money might be implemented are not clear at this time, but if Natural Money is able to improve the efficiency of the economy, then it is likely that Natural Money will be implemented when this knowledge becomes more widespread. One could imagine that a local or regional currency based on this design emerges during an economic crisis or a monetary crisis. It seems also possible that a nation or currency block implements the Natural Money design on its currency.

If an existing currency is to be transformed to a Natural Money currency, then the first phase might be to gradually implement the holding tax. This requires an overhaul of all banking software to implement the holding tax and to allow for negative interest rates. Bank notes may need to decommissioned. Another option is to have issue dates and bar codes on bank notes so that the accrued holding tax can be calculated instantly. In that case coins might only be available in small denominations so that keeping coins to evade the holding tax is not an attractive option.

After the holding tax is implemented, most interest rates are likely to go negative, most notably if the emergence of inflation is suppressed. As the velocity of money is likely to rise because of the holding tax, some of the proceeds of the holding tax might at first be used to decommission currency. Another option is to have central banks undo quantative easing and to sell their debt holdings in order to retire currency units. There may be a market for those debt holdings as holding cash is unattractive. There is a constraint on undoing quantative easing as it might produce an upward pressure on interest rates.

At some point in time after the introduction of the holding tax, nominal interest rates may have dropped to the point that the maximum nominal interest rate of zero could be introduced. There must be some time for market participants to adapt to the new situation so that they can adjust their balance sheets. It needs to be determined whether or not existing interest payment obligations are to honoured. Honouring them might mean that the transition to Natural Money could be gradual without breaking existing contract obligations.

Sustainable investment choices

When interest on money is charged, money in the future is worth less than money now. This has a major impact on investment choices. Interest promotes short term thinking. If no interest was charged, long-term investments would be more attractive [3]. The following example comes from Poor Because Of Money of Strohalm [16].

Suppose that a cheap house will last 33 years and costs € 200,000 to build. The yearly cost of the house will be € 6,060 (€ 200,000 divided by 33). A more expensive house costs € 400,000 but will last a hundred years. This house will cost only € 4,000 per year. For two thousand euro per year less, it is possible to build a house that is not only more pleasant to live in, but will also cost less in energy use.

After going to the bank for a mortgage application the math changes. If the interest rate is 10% then the expensive house will not only cost € 4,000 per year on write-offs, but during the first year there will be an additional interest charge of € 40,000 (10% of € 400,000).

The long lasting house now costs € 44,000 in the first year. The cheaper house now appears less expensive again. There is the yearly write off of € 6,060 but during the first year there is only € 20,000 in interest charges. Total costs for the first year are only € 26,060. During the following years, interest charges are lower, but they still make the less durable house cheaper.

The example shows that without interest charges there is a tendency to select long-term solutions, so interest makes long-term solutions less economical. If interest rates are negative, future income would be preferred even more. Interest promotes a short term bias in economic decisions. This might also apply on a larger scale. It may help to explain why natural resources, such as rainforests are squandered for short term profits.

Employment and the reward for labour

The best way to improve the reward for labour is full employment because this gives labour more pricing power. Natural Money can help to reduce cyclical unemployment as the holding tax can provide a constant stimulus. The issue of structural unemployment is more difficult to solve as it is caused by a quality mismatch between the supply and demand for labour. The stimulus from the holding tax may offer an opportunity for more people to enter the workforce and find a job. Local currencies can help to create local markets for labour intensive production, which can make it more easy for less competitive people to find a way of acquiring an income.

Profits, and therefore interest rates, tend to reflect the risk of doing business and it seems that reducing the risk of doing business tends to increase the overall level of wealth as well as wealth equality. Unless there is a monopoly, excess profits tend to lead to more competition or a higher demand for labour, which lowers the price of products or increases the price of labour. As profits tend to reflect the cost of doing business, the reward for labour could rise when the risk of doing business is lower. For this to happen, a country must be politically stable and property rights must be respected.

Natural money may help to reduce the risk of doing business, and hence reduce the cost of capital, but Natural Money seems to require political stability and respect for property rights. Because the economy will be more stable with Natural Money, the risk of doing business might be even lower. Consequently the reward that capital requires to be employed could be lower. Local currencies and more employment may also reduce international wage competition. As a consequence the portion of national income paid out to labour could rise with Natural Money.

Government and central bank intervention

In a stable economy less useful capital is destroyed by a lack of demand for products and services. More people can have work so there is less need for government assistance for people without income. With Natural Money sustainable investment choices can become rational economic decisions, so the government may not need to encourage them. The economy may do well by itself so the government may not need to interfere. Less government regulation in the financial system may be needed because a restriction on charging interest on money can reduce risk in the financial system.

At least it seems that fiscal policies and monetary policies are less needed with Natural Money. Those policies can distort markets. Fiscal policies are government policies that use the government budget to influence the economy. With Natural Money there may be no need to influence aggregate demand so the government can have a balanced budget. Monetary policies are central bank policies to influence interest rates and money supply. With Natural Money the economy may do well without monetary policies. Both fiscal and monetary policies counteract the effects of compound interest by pumping money in the economy.

International trade

An important development in recent decades was currency hoarding by central banks in China and Japan in order to manipulate exchange rates. The imbalances helped those countries to build an industrial base for exports. Most notably in the United States, and to a lesser extent in the European Union, this caused a decline in industrial jobs. If those imbalances persist, the surplus nations may end up with large losses on their currency hoards. From a broader perspective, their peoples may have been better off by working less hard or spending more.

Natural Money currencies seem not attractive as to use as currency reserves because of the holding tax. Exporting nations are more likely to dispose of received currency balances by matching exports with imports. Making high risk loans to countries in deficit is not attractive if the maximum interest rate is zero. In this way comparative cost advantages can become a more predominant driver of international trade. Most economists think that trade is the most beneficial when it is based on comparative cost advantages. Hoarding currency reserves can prevent this from happening.


1. The Natural Economic Order, Silvio Gesell, Translated by Philip Pye, Peter Owen Ltd, 1958:
2. Laboratory readings: Wörgl's Stamp Scrip – The Threat of a Good Example?, Martin Oliver,, 2002:
3. A Strategy for a Convertible Currency, Bernard A. Lietaer, ICIS Forum, Vol. 20, No.3, 1990:
4. Ramesses II - Wikipedia (as on September 3, 2013):
5. This was mentioned on Discovery Channel or National Geographic but I was unable to recover the source
6. A Free Money Miracle?, Jonathan Goodwin,, 2013:
7. Liquidity trap - Wikipedia:
8. The lost tradition of Biblical debt cancellations, Michael Hudson, 1993:
9. Economics of Money and Banking Part Two, Redacted Lecture Notes, Perry G. Mehrling, 2013, chapter 20 paragraph 1,
10. Financial services - Wikipedia (as on 28 October 2013):
11. Chartalism - Wikipedia:
12. Economics of Money and Banking Part One, Redacted Lecture Notes, Perry G. Mehrling, 2013, chapter 12 paragraph 7,
13. Hyman Minsky - Wikipedia:
14. Austrian business cycle theory - Wikipedia:
15. Steady state economy - Wikipedia:
16. Poor Because of Money: The consequences of interest, Henk van Arkel and Camilo Ramada, Strohalm, 2001: