the plan for the future
16 August 2016 - 3 February 2018
Natural Money is interest-free money with a holding tax. This means that the maximum interest rate on money and loans is zero and that there is a tax on currency, which includes cash. The tax may range from 0.5% to 1% per month. You don't have to pay the holding tax on money lent and that includes bank accounts. In this way it can be attractive to lend out money at slightly negative interest rates, for example -2%. The business of banks doesn't change much. Silvio Gesell was the first to propose a holding tax on money in 1916 in The Natural Economic Order. That is why this money is named Natural Money.
In order not to disturb financial markets, the holding tax as well as the maximum interest rate can best be implemented gradually. When interest rates are near zero the holding tax can be introduced so that interest rates can go lower when market conditions justify such rates. At first the holding tax can be set at a small value, for example 2% per year. The maximum interest rate should be high enough in order not harm the economy. The maximum interest rate can first be set at a large value, for example 7% per year. As interest rates are destined to go lower, these values can be adjusted over time.
Natural Money can improve the economy in the following ways:
• Removing the zero lower bound allows interest rates to go below zero if market conditions justify such rates. In this way the markets for money and capital can balance at the equilibrium rate.
• The maximum interest rate curbs the risks lenders are willing to take. This promotes financial discipline. The integrity of the financial system is a public interest that is guaranteed by governments and central banks so it also reduces moral hazard.
• The business cycle can be mitigated. The holding tax provides stimulus while the maximum interest rate provides austerity.
• The economy can do well by itself so that fewer government and central bank interventions may be needed. Interventions can cause market distortions such as political business cycles and the mispricing of risk.
For those reasons, the economy can do better with Natural Money. Returns on investments can improve and real interest rates can rise. The maximum interest rate on money and loans is zero so the currency will rise in value as prices go down. The improved economic efficiency of Natural Money can cause a monetary revolution. Investments in economies using Natural Money might provide better risk/reward ratios. This can cause a capital flight so that Natural Money can become the money of the future.
Feasibility of Interest-Free Demurrage Currency was one of two papers presented at the IV International Conference on Social and Complementary Currencies in Barcelona in 2017. The other one was The End Of Usury that deals with the future direction of interest rates. It is expected that interest rates will remain low and may even go lower because of structural developments in the economy. This is Thesis One.
Money doesn't have a lot of nutritious value but that hasn't always been the case. As a matter of fact, wheat and barley were amongst the first forms of money about 5,000 years ago. People accepted grain as payment because you could eat it. Natural Money is a very old concept based on a form of grain money that existed in Egypt for about 1,500 years. Coins and bank notes were introduced much later. So, how did Natural Money emerge?
That is a peculiar story. Some 3,500 years ago there was a Pharaoh who had a few strange dreams, at least that is what the Bible tells us. A fellow named Joseph could explain these dreams to the Pharaoh. He predicted that there would be seven years of abundant harvests followed by seven years of famine. Joseph therefore advised to store grain to weather the bad times. And so it was done. Egypt introduced grain storage facilities.
Farmers who brought their grain to the storage facility did get a receipt stating how much they brought in. And these receipts became used as money. There was a storage fee because of the costs attached to the grain storage. This worked like a holding tax. The money based on grain storage existed for 1,500 years. It probably was a very stable form of money without financial crises because there was no interest.
The grain money was terminated by the Romans after they conquered Egypt 2,000 years ago. The existence of the grain money administration in Egypt was discovered by archaeologists around the same time when Silvio Gesell was busy writing the Natural Economic Order. The storage fee of the grain money holds the solution to the economic predicament we are facing because interest rates are going negative.
Negative interest rates are not on the mind of economists and central bankers, at least not as a long term solution or a permanent state. They only think of it as a temporary policy measure to cope with a crisis. Economists and central bankers can’t imagine that negative interest rates will become the new normal. And that could be a serious mistake. If the zero lower bound is not removed, the economy may enter a deflationary collapse, and if efforts to halt the deflation succeed, this could end in hyperinflation. It could, it might, it is not certain, and central bankers are on it, but they are running out of options. And so Natural Money could be an idea whose time has come.
Lower interest rates are wonderful for a number of reasons:
• We can all be wealthier with lower interest rates because more capital will be profitable. Wealthy countries like Switzerland have negative interest rates while poor countries like Venezuela have high interest rates.
• Lower interest rates can help to make the economy sustainable. Future income is discounted at the prevailing interest rate. With positive interest rates future revenues have a lower value than present income. With negative interest rates, future revenues have a higher value than income in the present.
• Lower interest rates can reduce income inequality. Wealthy people make money with their capital. If interest rates go lower, their share of total income can drop.
• Low interest rates require trust and promote financial discipline because it is attractive to borrow at negative interest rates. For example, Germany can borrow at negative interest rates because creditors trust Germany.
Natural Money consists of two basic elements. First, there is a holding tax on currency ranging from 0.5% to 1% per month. In order to keep the amount of currency stable, the government spends the taxed currency back into circulation. Cash and central bank deposits are currency and subject to the tax. Regular bank deposits, bonds, stocks, real estate, and other investments are not currency, hence the tax doesn’t apply on them. Second, there is a maximum interest rate of zero on money and debts. It can be attractive to lend out money at negative interest rates because the holding tax doesn’t apply on money lent, and that includes bank accounts.
To successfully implement Natural Money, interest rates must be low or negative already, and remain low or negative in the future. It is not possible to force interest rates down because they emerge in the money and capital markets. It is assumed that interest rates will remain low or negative because the factors that contribute to lower interest rates will probably remain in place. This is Thesis One, which is investigated in The End Of Usury. The introduction of Natural Money needs to be a gradual process in order not to disrupt financial markets. Financial turmoil engenders a risk premium that causes interest rates to rise.
Natural Money is expected to bring efficiency improvements in the following major ways:
• The removal of the zero lower bound allows interest rates to go negative if market conditions justify such rates. This means that the operation of money and capital markets is not hindered by the liquidity preference.
• The maximum interest rate curbs the risks lenders are willing to take. This promotes financial discipline. The integrity of the financial system is a public interest that is guaranteed by governments and central banks so it also reduces moral hazard.
• Natural Money can mitigate the business cycle. The holding tax can provide a stimulus because interest rates can go as low as needed while the maximum interest rate can provide austerity because the amount of credit at a maximum interest rate of zero reduces when the economy improves.
• The economy can do well by itself so that government and central bank interventions are not needed. This can bring improvement because these interventions can cause market distortions such as political business cycles and the mispricing of risk.
In this way Natural Money can enhance economic growth so that real interest rates rise. The amount of currency and debt are expected to remain stable over time so that prices can deflate. The maximum interest rate of zero can become a positive real return close to the economic growth rate. Interest rates on money and loans not exceeding the economic growth rate is a requirement for a stable economy. The improved economic stability can reduce the risk premium so that investments in Natural Money currencies can be more attractive. This improved efficiency can promote a worldwide introduction of Natural Money.
Thesis Two states that interest-free demurrage money, also called Natural Money, can improve the economy and reduce risk in the financial system so that the risk reward ratio of investing becomes more attractive. This is the efficiency argument that stands at the core of the thesis. Natural Money might defeat other forms of money in competition and this can cause it to be adopted worldwide. The research in this paper aims to demonstrate that Natural Money is more efficient and that it will become the money of the future if the knowledge is widely available.
There is a lack of data and theory as to how an economy with Natural Money will operate. This paper centres on examining the consequences of implementing Natural Money in order to predict whether Natural Money is a feasible option for the regular financial system, and under which conditions that may be so. This paper is laying out a vision for economists to research upon.
The following issues are investigated:
• implementing Natural Money;
• removing the zero lower bound;
• maximum interest rate;
• moral hazard and problematic debts;
• business cycles;
• fiscal and monetary policies;
• position of the wealthy;
• efficiency improvements.
To implement Natural Money, interest rates must be low to begin with. There is no point in trying to force interest rates down as it would only scare investors and drive up interest rates, which is the opposite of the intent. Low interest rates require financial discipline, most notably from governments, but this doesn't mean austerity because governments can receive interest on their debts. It is expected that interest rates will probably remain low and may go even lower in the future, so that it becomes feasible to implement Natural Money. This is Thesis One, which is investigated in The End Of Usury.
A sudden introduction of Natural Money can cause financial turmoil. The transition preferably is a gradual process that is well communicated in advance. Financial markets can remain in operation. The trend towards lower interest rates is expected to pave the way for Natural Money. The first step is the introduction of the holding tax when interest rates near the zero lower bound. This should be done in small steps so that market participants have ample time to adjust. Introducing a tax on currency is going to affect the liquidity preference, so that currency needs to be decommissioned in order to rein in inflation.
Introducing the holding tax is complicated because of the existence of cash. Many people still use cash. Cash is currency and therefore subject to the holding tax. The most practical way of implementing the holding tax on cash is via an exchange rate between cash and digital currency. Cash can then depreciate relative to digital currency at a rate of 6% to 13% per year. For example, a person who holds € 150 euro in cash on average will pay € 9 to € 19 per year in holding tax. Alternatively, a consortium of banks can introduce cash that isn't currency but bank money backed by loans. In this way better rates on cash may be possible.
A tax on cash and negative interest rates can arouse negative sentiments. People are accustomed to a zero interest on cash and positive interest rates on money and debts. The general public may accept Natural Money if the benefits of lower interest rates are well known. The market conditions causing lower interest rates, and the advantages of negative interest rates, as well as a maximum interest rate need to be explained. Yet, many people may oppose the idea unless they are desperate and willing to try anything, and that may be in a time of crisis.
After the removal of the zero lower bound, a maximum interest rate can be introduced. The initial maximum interest rate must be sufficiently high in order not to disrupt financial markets. This could happen when a significant portion of lending takes place at higher interest rates than the maximum. At first, the maximum interest rate may be set between 5% and 10% annually. It is assumed that interest rates will go down further in the future, and that sub-prime credit needs to be phased out, so that the maximum interest rate can be lowered over time until it reaches zero.
The zero lower bound is a minimum interest rate. Like a price control it prevents interest rates from moving freely to where supply and demand for money and capital balance. This can obstruct an economic recovery because of the liquidity preference where market participants prefer holding cash to consumption and investments. The holding tax brings down the lower bound to the holding tax rate so that negative interest rates become possible when market conditions justify them.
Removing the zero lower bound allows interest rates to go lower than otherwise would be possible. Lower interest rates are expected to foster capital formation and prosperity. The lower interest rates go, the more projects become economical, and the more capital and wealth can exist. As capital costs go down, products and services can become cheaper. The additional wealth created by lower interest rates can help to combat poverty and to make the economy sustainable.
Removing the zero lower bound only affects interest rates when the zero lower bound has already been reached. When interest rates are higher, a holding tax on currency is unlikely to have a major impact on interest rates. The holding tax is not much more than a lower bound, just like zero currently is the lower bound because of the existence of cash. The lower bound only comes into play when interest rates are near it. And if it wasn’t for the existence of cash, removing the zero lower bound wouldn’t be such a big issue.
Negative interest rates don’t alter the business of banks. There isn’t much difference between borrowing money at 2% to lend it at 4% and borrowing money at -2% to lend it at 0%. A concern sometimes expressed is that people may shun the currency because of the holding tax. Indeed, few people are willing to lose 6% to 13% per year on money balances, but that isn’t going to happen as most money is in bank accounts and other investments that provide better yields. Money is the most liquid asset so people will probably accept slightly negative interest rates on money in bank accounts.
The holding tax will therefore not adversely affect the economy. It can contribute to an improvement when interest rates are near the zero lower bound. There is not much historic evidence to support these claims. Yet money with a holding tax existed in ancient Egypt for more than 1,000 years. This suggests that a currency system with a holding tax can be stable and last a long time. In 1933, when interest rates were at the zero lower bound, a local currency with a holding tax resulted in a remarkable economic recovery in the Austrian town of Wörgl. This suggests that removing the zero lower bound can promote an economic recovery.
After the removal of the zero lower bound central banks can stop printing currency to satisfy the demand caused by the liquidity preference. They can stop buying assets such as government bonds and end unconventional measures like quantitative easing. Removing the zero lower bound reduces the demand for currency and can make investors look for many of the assets that central banks have piled up on their balance sheets. In this way quantitative easing can be undone at a profit for the central banks. Removing the zero lower bound may turn out to be the only viable way to undo quantitative easing.
A maximum interest rate is a price control and it can distort money and capital markets by hampering lending and borrowing. It caps the risk lenders are willing to take and causes a deleveraging of balance sheets. Insofar the maximum interest rate affects questionable segments of credit like sub-prime lending, this may be beneficial overall. More troubles can be expected in the arena of business finance. Private equity and partnership schemes like Islamic finance can fill in the gap, but maybe this is not enough. Hence, the most contentious questions will probably arise in this area.
And even though there may be objections against the limits Natural Money will impose on consumer credit, there is little doubt that a maximum interest rate can improve the economy because borrowers won't pay interest so that the purchasing power of consumers will improve. In some way the beneficial effects and the adverse consequences should be weighed against each other. There is also the possibility that black markets arise. In order to make illegal schemes unattractive for lenders, lenders who charge interest would be liable to forfeit the money lent.
There is little historic data on the subject of maximum interest rates. In the Middle Ages charging interest was illegal in Western Europe. When economic life became more developed, the ban on interest became difficult to enforce. In the 14th century partnerships emerged where creditors received a share of the profits from a business venture. As long as this share was not fixed, this was not illegal as it was considered a share in business profits rather than interest. Islamic finance is based on similar principles.
In the 17th and 18th century interest bans were often replaced by interest rate ceilings. To circumvent the interest ceiling, creditors and debtors sometimes agreed that less money was handed over to the borrower than stated in the loan contract so that more interest was paid in reality. More recent experiences with Regulation Q in the Unites States, which amounted to maximum interest rates on bank accounts, indicate that a maximum interest rate is enforceable only if it doesn't affect the bulk of borrowing and lending.
A maximum interest rate seems feasible if it is above the rate at which most borrowing and lending takes place so that the effects on liquidity in the fixed income market are marginal at best. A maximum interest rate creates room for alternatives like private equity and partnership schemes like Islamic finance. These alternatives can supplement the fixed income market and mitigate the consequences of the maximum interest rate. A maximum interest rate can be beneficial overall if it mainly affects questionable segments of credit like sub-prime lending while leaving beneficial segments of credit largely untouched.
Interest contributes to moral hazard and financial instability as interest is a reward for taking risk. This idea underpins Islamic finance as Islam forbids gambling and excessive risk taking. Extracting a fixed income out of a variable income source can be seen as a form of gambling. Fixed interest payments on debts can bankrupt a corporation even when it is profitable overall. The more uncertain the source of income is, the higher the fixed interest rate needs to be to compensate for the risk of lending, but the higher the fixed interest rate is, the more likely the scheme will fail. This resembles a Catch 22 situation.
All parts of the financial system are intertwined so these risks can enter the financial system. The financial system is a key public interest so it is backed by governments and central banks. Banks can take risks and reap the rewards in the form of interest while public guarantees back up the financial system. This arrangement can lead to moral hazard, a mispricing of risk and private profits at the expense of the public. The approach so far has been to use regulations to deal with these issues, but regulations can be cumbersome and subject to politics. An alternative is to finance risky ventures with equity instead of debt.
A maximum interest rate on money and debts can help to bring about this outcome. If the maximum interest rate offers too little compensation for the risk of lending, lenders will refrain from lending, and prefer equity investments. This deleveraging can have a stabilising effect. Maximum interest rates can distort money and capital markets. Most notably, there will be fewer options for businesses to borrow. Schemes similar to Islamic finance can partially fill in the void. An Islamic bank is more like a partner in business than a lender. The bank and its depositors share in the profits as well as the losses of the ventures they participate in.
People and businesses with problematic debts often pay the highest interest rates and this affects their spending power. These people and businesses might be better off if they can borrow at an interest rate of zero or cannot borrow at all. A maximum interest rate discourages the creation of problematic debts as it caps the risks lenders tolerate. Borrowers then have no other option than to adjust their finances before their debts become problematic. The increased spending power of debtors as well as a reduction of problematic debts can improve economic conditions.
Regular economics doesn’t provide a satisfactory solution for the business cycle. The main stream view is that central banks should increase interest rates during economic booms to curb investment and spending in order to prevent the economy from overheating. A problem is that a rosy view of the future often prevails during boom times, so that higher interest rates seem justified, and the borrowing continues for some time. When the bust sets in, the picture suddenly alters, and an overhang of debts at high interest rates worsens the woes. It would have been better if these debts hadn’t been made in the first place.
The main stream view also holds that central banks should lower interest rates to stimulate investment and spending when the economy is slowing down. Most notably economists fear deflation and the zero lower bound because of the liquidity preference. Deflation can make people hold on to their cash and postpone their spending. Many investments are halted when the equilibrium interest rate is below zero because cash at an interest rate of zero is deemed more attractive from a risk/reward perspective. In the aftermath of the financial crisis, central banks have printed a lot of currency to cope with the liquidity preference.
Keynesian economists think that governments should curb spending during economic booms in order to slow down the economy and should increase spending during slumps in order to stimulate the economy. It is often difficult to plot the best course of action so Keynesian interventions are not always well-timed. Political considerations also affect government spending. This can result in a political business cycle, for example if politicians increase spending to stimulate the economy to get re-elected. The alternative view is that governments shouldn’t interfere with the economy but this may worsen slumps and make them last longer.
Natural Money has a different dynamic. When the economy improves, equity becomes a more attractive investment compared to debt because of the maximum interest rate. The funds available for lending will then reduce so that the economy is less likely to overheat. Even if the economy overheats, there is less likely to be a debt overhang afterwards. When the economy slows down, the zero lower bound will no longer be an obstacle so that negative interest rates can provide a stimulus. And in the absence of a debt overhang the economy is poised to recover soon. This dynamic can mitigate the business cycle.
It seems unlikely that there will be inflation with Natural Money because the maximum interest rate of zero doesn't provide a compensation for the loss of purchasing power. This means that the funds available for lending will dry up as soon as inflation picks up. Inflation is then suppressed because there will be no expansion of the the monetary aggregates. On the other hand deflation will not be suppressed. That isn't a problem because interest rates can go as low as needed so that deflation can be accompanied by a flourishing economy.
The holding tax removes the zero lower bound. This provides a stimulus during economic slumps. The maximum interest rate curbs lending during economic booms. In this way business cycles can be mitigated. And so there might be fewer debt overhangs and financial crises. The economy will probably do well by itself and doesn't require interventions. So what about the darlings of many main stream economists, the fiscal and monetary policies? They are meant to deal with the business cycles and economic crises. Natural Money can make these policies obsolete.
The amount of monetary aggregates such as bank debt and currency are expected to remain fairly stable. Central banks don’t lend money to banks which implies that central banks also don’t set interest rates. This is possible because the economy will do well by itself. Instead, interest rates are expected to float freely between the holding tax rate and zero. The holding tax provides a stimulus so deficit spending by governments isn’t needed. On the contrary, negative interest rates require fiscal discipline.
This can be the end of fiscal and monetary policies as we know them. Central banks and governments may still need to step in if there is a crisis to ensure trust within the financial system, but with Natural Money fewer interventions are needed, and possibly none at all, because there will be fewer crises, and none of them probably very serious. This can bring further economic improvement because government and central bank interventions entail market distortions such as political business cycles and mispricing of risk.
Reserve requirements are probably not required to keep inflation in check. The maximum interest rate should prevent inflation. As soon as inflation picks up, lending at zero interest becomes an unattractive proposition, so that the monetary aggregates will not expand and inflation is reined in. Some flexibility may be needed to deal with temporary fluctuations in the demand for funds. For that reason central banks may lend money to banks at an interest rate of zero. This is an unattractive proposition for banks as they cannot lend this money at a higher rate, so that they will use this facility as little as possible.
This can take a controversial issue of the table as it entails a reduction in the policy discretion of central banks. Central banks are technocratic institutions that wield enormous power. The boards of central banks are not democratically elected while they often operate independent of elected governments. The independence of central banks exists for good reason but it is becoming an increasingly contentious issue that most notably affects the FED as it supports the world financial system because the US Dollar is the primary reserve currency and the ECB because it is a transnational entity.
It is sometimes argued that the wealthy are going to oppose a scheme like Natural Money and that Natural Money will fail because they are going to obstruct it. That may not be the case. The alternatives amount to a destruction of capital, possibly in a depression or a war. This is not in their interest. The best they can hope for is stagflation, but even then a lot of financial capital will be destroyed just like happened in the 1970s. The core problem is the lack of room for capital to grow so that interest rates need to be negative in order to let their capital flourish.
The current situation resembles a game of Monopoly in its final stage where the winner owns more than half the streets, houses and hotels and other players are running out of money. The options for the winner are ending the game, which is a kind of great reset, or handing out money to the other players to keep the game going, and enjoy being rich. And the winner might not be so lucky next time. A great reset in the real economy is not really an option because it could mean depression or war. Enjoying being rich is an attractive alternative for the wealthy.
Natural Money can help to improve the economy. The improvement is expected to come in the following ways:
• Removing the zero lower bound allows the markets for money and capital to clear at the equilibrium rate so that markets can function better.
• Interest rates can go lower if market conditions justify these rates, which can promote capital formation and bring more prosperity.
• The maximum nominal interest rate can reduce the appetite for risk with lenders so that there will be fewer problematic debts and risk is transferred out of the financial system into the hands of investors, which curtails moral hazard.
• The business cycle can be mitigated so that there will be more stable economic growth with fewer crises.
• The market distortions caused by fiscal and monetary policies can disappear.
• With lower interest rates income inequality can be reduced because the wealthiest people mostly receive income from their capital. This can promote social stability and lower risks for investors.
Suppose that with Natural Money the average growth rate in mature economies improves from 1.5% to 2.5% per year, which doesn’t seem unreasonable given the expected efficiency improvements, then a nominal interest rate of zero can be 2.5% in real terms. Even deposits with a nominal yield of -2% can have a positive real return that betters the yields on euro and dollar deposits nowadays. From a risk/reward point of view, the improvement could even be greater as the economy will be less prone to instability. The improved risk/reward picture may cause a capital flight to economies based on Natural Money. In this way Natural Money can become the money of the future.
It appears that income inequality is hampering economic growth. This is reflected in the trend towards lower interest rates. The zero lower bound hinders the operation of money and capital markets while the financial system is at risk because of the quest for yield combined with the moral hazard attached to public guarantees for the financial system. The predicament can be summarised as follows:
• Structural developments in money an capital markets cause interest rates to remain low and quite possibly to go even lower.
• At the zero lower bound the markets for money and capital become dysfunctional because supply and demand cannot clear at the equilibrium rate.
• Low interest rates allow for more capital and debt to exist, which means that debtors have less room to pay interest while creditors are faced with an excess of capital, and this puts a constraint on future interest rates.
• Business cycles cause debt overhangs because in times of optimism interest rates are above their natural level so that debts are made at high interest rates.
• The financial system is a key public interest guaranteed by governments and central banks so that the quest for yield promotes moral hazard.
• Debt fuelled spending to promote economic growth will probably not be an option any more in the future.
Natural Money can deal with this predicament and improve financial stability as well as economic growth in mature economies. The feasibility of Natural Money primarily depends on low interest rates. If irresponsible actions that push up the risk premium remain absent, interest rates will probably remain low and may go even lower. Low interest rates reflect a trust in the financial system and money. Low interest rates require financial discipline, most notably from governments. Governments can still spend more than they receive in taxes, but only to the extent of the interest they receive on their debts.
Economists should be inspired by this potential and get busy. Natural Money can help to end financial and economic crises. World War II wasn’t possible without the Great Depression so the importance of a possible solution doesn’t need further clarification. If the experiment in Wörgl hadn’t been halted, and communities around the world had been free to copy it, World War II may not have happened. The alternative to new financial and economic crises can be unparalleled prosperity and social stability. This was the vision of Silvio Gesell. Hopefully he was only one century ahead of his time.
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