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A Short Introduction to Natural Money


4 November 2008 - 27 July 2019
 
 


Author: Bart klein Ikink


The problem of interest


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

A mere 4% yields an insane amount of gold after 2018 years. Someone pays the interest, in this case the people who borrowed money from the bank. If Jesus doesn't come back to spend his money, that's impossible. At some point the debtors can't pay the interest, let alone repay their debts. They can only borrow more or default. And if they default, there will be a financial crisis.

Financial crises happen when people can't pay the interest or when depositors want their gold. But our money isn't gold so central banks can print new money out of thin air. With this newly printed money the banks can be rescued. If someone comes to the bank and wants 'real' euros, the central bank just prints them. In this way the financial crises can be contained. So what went wrong in 2008?

Some people couldn't pay the interest on their loans because banks took too much risk by accepting questionable borrowers. Interest is an incentive for banks to lend out money. Interest is a reward for risk so questionable borrowers pay more. Higher interest rates mean bigger profits for banks, and more importantly, bigger bonuses for bankers. Other people pay the bill when banks have to be bailed out with newly printed money as money is becoming worth less.

Interest causes financial and economic crises. This was already known more than 3,000 years ago. Interest can push people into poverty when they are crushed by growing debt burdens and interest payments. Interest was called usury and considered evil. It was forbidden by some major religions like Christianity and Islam. But without interest, there would be very little lending and borrowing, and the economy would collapse. But why is that?

 
Figure 1: Interest versus total income
Figure 1: Interest
versus total income
 
If you lend out money, you can't use it yourself. This is inconvenient. Furthermore, the borrower may not repay or the money may be worth less in the future because of inflation. So, lending money is risky. A reward in the form of interest can compensate for inconvenience and risk. Finally, if you can make a profit by investing, then why lend out money without interest? The interest rate on borrowed money must be attractive compared to other investments.

Interest has some serious downsides. The 80% poorest people pay interest to the 10% richest people. Interest is everywhere. It is hidden in rents, taxes, and the price of everything we buy. Products on average cost 25% more because of interest. And the poorest people often pay the highest interest rates. Interest is therefore sometimes called a tax on the poor for the benefit of the rich.[1]

A few things have changed over the years. You can lend out money to a bank and still use it anytime. This is convenient. Banks check the financial condition of borrowers and lend out money to many different people. This reduced risk. Central banks can help out banks if there is no money to pay for the interest. There are even government guarantees on bank deposits. This reduced the risk of losing money to the point that bank deposits are considered to be safer than cash.

So what about the returns on investments? In the past, returns on investments on average have been higher than the rate of economic growth. Most of those returns have been invested again so the amount of capital has grown faster than the economy, and a growing share of total income was not for wage earners but for investors. This cannot go on forever, because who is going to buy all the stuff the corporations make if wages keep on lagging?

Figure 1 shows how total income and interest income develop with a rate of economic growth of 2% and an interest rate of 5% when interest income starts out as 10% of total income and all interest income is reinvested. After 25 years the economic pie has grown faster than interest income so that wages have risen. At some point interest income starts to rise faster than total income, and wages go down. After 80 years there's nothing left for wages. That won't happen because the economy will crash long before that

It is also the reason why interest rates have gone down in recent years. In the short run, it was possible to prop up business profits by using the lower interest rates to let people go further in to debt to buy the stuff corporations make. In the long run, the growth rate of capital income cannot exceed the rate of economic growth. Furthermore, in the long run the amount of debts cannot grow faster than the economy. And make no mistake, this is a serious problem.

If interest rates go down further, it may be possible to abolish interest on money and loans altogether. This will be the end of usury. In that case we do not need more debt to pay for the interest on existing debt and there will be no incentive to take excessive risk because there is no reward for doing that. It may be the end of financial and economic crises too. And it could be the end of inflation. Products and services can become cheaper because interest costs will go down. So can it be done? And how?

 
Monetary Revolution
 


The miracle of Wörgl


In 1932, in the middle of the Great Depression, the Austrian town of Wörgl was in trouble and 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. The mayor came up with a cunning plan.

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 for the monthly stamps so everyone receiving the notes would spend them. 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. That was because it could be spent as one schilling after buying a stamp.

 
Wörgl stamp scrip
Wörgl stamp scrip with some stamps
 
Of all the businesses in town, only the railway station and the post office refused to accept the money. 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 increased trade and created 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 asserted its monopoly rights by banning complementary currencies.[2] One can only imagine what had happened if communities all over the world had been free to copy the idea. The Great Depression may have ended in 1933 and World War II may never have taken place.



Joseph in Egypt

 
Joseph and the Pharaoh
Joseph and the Pharaoh
Source: Doré English Bible
 

There is a story in the Bible about a Pharaoh having bad dreams his advisors could not explain. He 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 explained those dreams. He told the Pharaoh that seven years with good harvests would come followed by seven years with poor harvests. He advised the Egyptians to store food. They followed his advice and built storehouses for grain. In this way Egypt survived the seven years of scarcity.

The food storage resulted in a financial system. The historian Friedrich Preisigke discovered that the Egyptians used grain receipts for 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 made the Egyptians look for another form of money.

As a consequence the grain receipts may have become money instead. The storage costs were settled when the receipts were exchanged for grain so the receipts lost value over time. The effect was similar to buying stamps to keep the money valid as happened in Wörgl. The actions of Joseph may have created this money as he allegedly proposed the grain storage and took all the money from the Egyptians.

During the reign of Ramesses the Great, Egypt became a leading power again.[4] Some historians have suggested that Egypt's wealth during the reign of Ramesses was built upon the grain money.[5] The money remained in circulation after the introduction of coins around 400 BC, until the Romans conquered Egypt. The grain money was stable and survived for more than a thousand years, probably because there were no financial crises caused by interest payments.



Natural Money


Lower interest rates are caused by structural developments. Capital can't grow faster than the economy in the long run. Wealth inequality and lagging labour income limit capital growth and interest rates. Machines may take over jobs from humans or measures may need to be taken to deal with the limits of the planet. These measures may result in low returns on capital, and therefore low and negative interest rates.

The economy may do better if there is a redistribution of some of the returns of capital from capital owners to people with little or no capital. There are two ways in which that can be accomplished. The first way is via taxing and entitlements, for example via a wealth tax and a basic income. The second option is via the markets for money and capital, for example via negative interest rates, so that people and governments have more money to spend.

Natural Money can deal with these challenges. Natural Money is interest-free money with a holding tax. This means that thee maximum interest rate on money and loans is zero and that there is a holding tax on central bank currency ranging from 0.5% to 1% per month. The holding tax does not apply on money lent, bank accounts and investments. And so it can be attractive to put money in a bank account, even when the interest rate is negative.

Natural Money includes a new form of cash backed by short-term government loans issued by the treasury instead of the central bank. Currently, cash is issued by the central bank. With Natural Money there will be a holding tax on central bank currency. This new type of cash is not central bank currency but money lent to the government so that the holding tax does not apply.

Instead of a holding tax, there will be a negative interest rate on cash reflecting the yield on the loans. There will be an exchange rate between cash and digital money. In this way cash and digital money will become different currencies. Cash will depreciate in terms of digital money. There will probably be no inflation and there might even be price deflation so the value of cash is likely to remain as stable as it is now.

The German business man Silvio Gesell was the first to propose a holding tax on money in his book The Natural Economic Order.[6] The money is named Natural Money to honour his legacy. The following points summarise the idea of Natural Money:
  • Natural Money doesn't change the business of banks. Banks borrow money from depositors at a lower rate to lend it out at a higher rate. There is little difference between borrowing money at 2% to lend it at 4% and borrowing money at -2% to lend it at 0%.
  • Cash and digital money will become separate currencies, for example digital euro and cash euro. Cash is backed by short-term government loans. The negative yield can be implemented by gradually lowering the exchange rate of cash relative to the digital money.
  • Most money is in bank accounts nowadays, and because the holding tax doesn't apply on bank accounts either, no-one ends up paying the holding tax. The holding tax only defines how low interest rates can go based on market conditions.
  • Investors who want higher yields than zero have to accept that higher yields mean more risk. Investors taking more risk means lowering systemic risk. The maximum interest rate will make investments in equity more attractive relative to debt so that balance sheets will deleverage.
  • A maximum interest rate limits the risks lenders are willing to take so that people and businesses in financial trouble need to reorganise their finances, while the maximum interest rate also prevents financial problems from escalating because of interest payments.
  • In order to have negative interest rates, people should be able to trust the currency, which means that government finances need to be in order. This doesn't mean austerity because governments can receive interest on their debts.

  • Natural Money has the following benefits:
  • Natural Money allows interest rates to go lower if economic conditions justify lower interest rates.
  • When interest rates go lower, more projects become economical, and we can be wealthier, so it may be possible to end poverty.
  • With lower interest rates the financial value of the future increases so that it may be possible to make the economy sustainable.
  • Most people pay interest to the wealthiest, so with lower interest rates income inequality can reduce.
  • Products and services can be cheaper because of lower interest costs.
  • Natural Money can curb reckless lending because there is no reward for taking excessive risks in the form of interest.
  • Debts can't grow out of control because of interest payments.
  • Natural money promotes financial discipline with governments because negative interest rates require trust in the currency.
  • Financial discipline doesn't mean austerity because governments receive interest on their debts.
  • Business cycles will be mitigated. The holding tax provides a stimulus while the maximum interest rates promotes discipline.

  • Natural Money can improve the economy so returns on investments will be better and interest rates will rise. With Natural Money interest rates cannot exceed zero, so digital money must rise in value, perhaps at such a pace that interest-free money provides better yields than interest-bearing money.

    The implications are profound. Natural Money can improve the efficiency of the economy. The higher yields on Natural Money can cause a capital flight to the interest-free economies at the expense of economies allowing interest on money. And so Natural Money can become the money of the future.


    Natural Money can become the money of the future. And Natural Money can help to solve some serious problems humanity is facing. These were the reasons to start this website in 2008. A lack of awareness appears to be the main obstacle standing in the way of Natural Money becoming the money of the future. Perhaps the next financial crisis is going to change that. Perhaps people may need to become desperate and ready to try anything, just like the people in Wörgl during the Great Depression. Natural Money appears to be the best solution. So if there is a good plan ready, it may be adopted.



    Research


    "Yeah right", you may think, "If the Wörgl currency was so great then why is this ignored?" After the Great Depression interest rates never came near zero again, until very recently, so similar currencies weren't as successful as the one in Wörgl. And the success of the Wörgl currency was inflated by the payment of taxes in arrears that generated additional revenues to the town council.[7] The council could spend this money, which provided a stimulus that would have petered out if the money hadn't been banned so soon. Maybe it is too good to be true after all, but there are good reasons to think otherwise. If interest rates near zero, the markets for money and capital cease to operate, and this can cause an economic depression.

     
    US real interest rate versus natural interest rate
    US real interest rate versus natural interest rate
    Source: FED
     

    Economists and central bankers think that low and negative interest rates will be temporary but the graph above tells a different story. It shows the interest rates in the United States between 1961 and 2016. The green line is the real interest rate in the market. The real interest rate is the inflation free interest rate. So if the interest rate of your mortgage is 5% and the inflation rate is 2%, the real interest rate on the mortgage is 3%.

    The red line is the natural interest rate. This is the ideal interest rate for optimal economic growth. The natural interest rate is not an interest rate in the market. It is estimated by economists using models. Central banks use the natural interest rate to set the interest rate. If the central bank believes that the economy is overheating, it sets the interest rate above the natural rate. If it believes that the economy is in a slump, it sets the interest rate below the natural rate.

    The trend is clear but most economists and central bankers expect that interest rates will go up again. Only, the developments that drove interest rates down may not go away and interest rates may remain low and may even go lower. The trend is clear, but most economists and central bankers expect it to reverse, so that interest rates will go up again. But the factors that drove interest rates down will probably not go away. So why can't economists see what's coming?

    Negative interest rates go against the most basic tenet of economics, the idea of scarcity. It states that we can never have enough stuff and need positive interest rates so that people will save money to finance investments. Yet, we should question this assumption because it is destroying the planet. And scarcity doesn’t apply to the wealthy top 1% of people who own most capital. They can't spend all their money and are running out of things to invest in.

    Proponents of interest-free money ignored basic economic laws. They opposed interest as a way of making money without a useful contribution to the economy. They complained that projects are feasible only if they yield more than the interest rate on money, so that many projects are not executed and people are unemployed. This goes back to Silvio Gesell who saw interest on money as inefficient [6] But positive interest rates are a sign of scarcity and lack of capital. It is the accumulation of capital by saving and investing that brings interest rates down.

     
    Questions?
     
    Negative interest rates are likely to become normal but it isn't possible bring interest rates down by force. Savers must be willing to accept these rates. A holding tax only allows interest rates to go lower if supply and demand for money justify that. A maximum interest rate of zero can cause problems and the economy will suffer when a lot of lending and borrowing takes place at higher interest rates. Yet, a maximum interest rate can be beneficial if it mainly affects dubious or usurious lending such as sub-prime credit and credit card debt.

    Negative interest rates are likely to become the new normal so that Natural Money can be implemented successfully. The holding tax can best be implemented when interest rates are near zero as this measure would have little effect otherwise. The maximum interest rate of zero should only be implemented when most interest rates in the financial markets are already negative as it could cause a financial disaster otherwise.


    Two papers have been presented at the IV International Conference on Social and Complementary Currencies: Money, Consciousness and Values for Social Change in Barcelona in 2017. The first paper named The End of Usury explains why interest rates are likely to go lower and become negative and that this may remain so for the foreseeable future. The second paper named Feasibility Of Interest-Free Demurrage Currency clarifies how Natural Money might be implemented world wide and what the possible consequences will be.

    This website is frequently updated and reflects the current state of the Natural Money project. The reseach is still in progress. If you have limited knowledge of the economy and the financial system, you could read Natural Money For Dummies. This document explains what money is, what the role of banks is, why the financial system is the way it is, what the problem of interest is, and why Natural Money can solve it. It is easy to understand and I made some effort to make it an entertaining read. If you have knowledge of economics you could read Natural Money Theory.



    References


    1. Poor Because of Money: Our theory on interest, Henk van Arkel and Camilo Ramada, Strohalm, 2001: https://www.naturalmoney.org/ poorbecauseofmoney.html
    2. The Future of Money: Creating New Wealth, Work and a Wiser World, pp. 153-155, Bernhard Lietaer, Random House, 2001
    3. A Strategy for a Convertible Currency, Bernard A. Lietaer, ICIS Forum, Vol. 20, No.3, 1990: http://www.itk.ntnu.no/...; backup copy: https://www.naturalmoney.org/convertiblecurrency.html
    4. Ramesses II - Wikipedia (as on September 3, 2013): https://www.naturalmoney.org/ramesses2.html; current version: http://en.wikipedia.org/wiki/Ramesses_II
    5. This was mentioned on Discovery Channel or National Geographic but I was unable to recover the source
    6. The Natural Economic Order, Silvio Gesell, Translated by Philip Pye, Peter Owen Ltd, 1958: https://www.naturalmoney.org/ NaturalEconomicOrder.pdf
    7. A Free Money Miracle?, Jonathan Goodwin, Mises.org, 2013: http://www.mises.org/daily/6336/A-Free-Money-Miracle; backup copy: https://www.naturalmoney.org/freemoneymiracle.html