On the desirability of Debt Based Fiat Money

Recently, I had a discussion on another blog with someone who asked why Debt Based Fiat Money (DBFM) should be such an evil construct and how it is that it should be better or worse than any other monetary system.

As expected, I launched in my usual rant about exponentiality, diminishing marginal utility, transfer of productive capital yada, yada, yada till, I thought, I had defined the issue in its entirety. Whether she was being kind or whether she just wanted me to stop, my interlocutor acknowledged she now understood the mechanics of DBFM. However, she wondered, how much worse can DBFM be than any other variety of money?

It is only some time later I thought of something that should finally clarify the evil of DBFM.

In a non debt based monetary system (that could be either value based or predicated on a fixed amount of fiat money), an individual may choose to work less and, provided he at the same time chooses to consume less, said individual could still be able to save a portion of his earnings.

On the other hand, DBFM does not allow this choice. In a DBFM system, the same individual could not choose to work less because even assuming he decided to consume less, government would overspend on his behalf thus not only devaluing the little income the individual may have saved, but also saddling him with public debt which he is going to have to pay through taxes and/or through an increase in the cost of living.

March 1st, 2012 addendum

In the case of individuals that cannot or do not want to work, DBFM allows politicians to promise all sorts of state aid under the guise of social safety nets and safe in the knowledge that outlays can always be covered by newly minted currency. A cursory look at the creation of credit and currency over the past forty years will readily evidence the profligacy of our expedient political/monetary system. And, by the way, we ain’t seen nothing yet. The diminishing marginal utility of debt ensures that as the mathematical limit of the construct is reached, credit and money creation must go exponential:

FRED Graph
This picture requires little comment me thinks.

So even though, given political will, either monetary system can be subverted, a non debt based monetary system has the virtue to at least allow a 50% chance that the system can be managed properly ensuring fiduciary duty, true free markets, true freedom of choice and true democracy. Not so DBFM which from the get go is geared towards statism via the debasement of the currency and which is set up to transfer the productive capital of society into the hands of a financial elite and its cronies.

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17 Responses to “On the desirability of Debt Based Fiat Money”

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  5. Manor Mouse Says:

    OK, showing my profound ignorance… In a non-DBFM world, if money is not created when a loan is taken out, then when and why is it created? Or do we start out with a fixed pool of currency, and prices drop as the economy expands? I genuinely don’t know!

    But my main question is about economic growth. At the moment, growth seems to be written into the very DNA of the monetary system. And in the non-DBFM world it seems to be too (your comment about savers getting interest on their savings). The thing I can’t work out, is how any sort of system would work if growth stopped. The way I see it, there are savings, and there are savings. In the most literal sense, when saving we would put by some corn or pots or flint arrowheads to draw upon later. Instead, in the modern world we ‘save’ money, but in reality we merely free up some resources for entrepreneurs to use in their own bids to grow the economy, and we are given a certificate to reclaim our share of the then expanded economy at a later date. But what if the economy can expand no more? What if the oil supply levels off, for example? You may have some idea that prices will rise and that therefore man’s greed and ingenuity will always find a way around such an obstacle, but what if that’s just not true? What if our economy is now 100 times bigger than it would have been without the windfall of oil (probably about right) and that when we say ‘price’ we mean ‘economic activity enabled by oil’? When the price of oil goes up, we mean that in exchange for a barrel of oil we demand more fruits of economic activity only possible by using more oil. Supply and demand disappears up its own fundament. (It probably did when oil was discovered bubbling out of the ground, but we thought that economic laws were universal and still applicable even with supplies of virtually free energy.)

    A shrinking economy shouldn’t be anything to worry about. Life wasn’t too bad in 1986, so I wouldn’t worry if my standard of living dropped back to those levels over the rest of my lifetime, but that’s not how it would work is it? Instead, the economy would implode and cease to function. Even if the initial mess was cleared up, there would no longer be the same incentive to ‘save’ and ‘invest’ would there? Would non-DBFM be much better than the current system in a world of no growth? I don’t see how it could be. Or is such a world literally unthinkable to you? The invisible hand will always solve such problems even after ‘the last tree is chopped down’..? (The story being that on Easter Island, in a society without the evils of DBFM or socialism, someone did actually chop the last tree down thus condemning the people to starvation and death).

    In one of your posts you suggested that a man could choose to work less, and make less income but that the government would spend the money on his behalf (because they can with DBFM) in order to ‘stimulate’ the economy. In the non-DBFM world I would imagine that the government would have to do something very similar in order to maintain growth. How could they not? They may not be able to do it so stealthily as they do with DBFM, so they might resort to something more drastic, but do something they would!

    • guidoamm Says:

      Manor, you start from the assumption that it is government that drives growth…. ?

      The overarching rationale for the abandonment of DBFM is that the arithmetic that underpins the system results in criminal negligence as a necessity to keep the system going. Criminal negligence on the part of the enablers of the system (government) is preordained.

      That, in and of itself, is, or at the very least should be, sufficient grounds for doing away with DBFM.

      Leaving aside a value based monetary system for the time being, in a purely Fiat Monetary (FM) system too money is created by decree. But it would be a fixed amount of money. In this construct FM is created by government at no interest. Meaning it is purely a tool for exchanged which is sanctioned, made available and monitored by government. Individuals will still charge each other interest for the use of each other’s savings but, crucially, this cost does not result in a transfer to a third party that stands outside society. In other words, wealth will still be accumulated by individuals but it will not be transferred outside of society as is contemplated in DBFM. In this context “prices” fluctuate according to people’s preference for spending or holding cash. If the trend is towards spending, goods and services are more desirable than cash which translates in a higher cost for goods and services and lower cost of money and vice versa.

      How would FM behave in a context of no growth? I really don’t know other than to say that like anything else, a mechanism must be found whereby government is forced to forego the temptation of gaming the system for political gain. Sometimes the best thing to do is to do nothing. But the nature of government is such that it must be seen to be ,doing something. When the Roman empire became too big to be sustained by the revenue it was generating, rather than reducing the size of the empire, debasement of the currency became the preferred solution. Eventually corruption, waste and social pressures at home drained so much of the state coffers that provinces and legions overseas were left to fend for themselves resulting in mayhem, chaos and great blood shed and, eventually, the demise of the empire. History rhymes; look up “secret America” on my blog. See how myriad secret security agencies are left to run amok with no supervision. If there is no supervision where does funding come from? And this is where things like the Opium Wars, Air America in the 60s, the Contra scandal or currently the current Fast & Furious investigation may tie in.

      The only growth written in the DNA of DBFM is inflationary growth; i.e. financial growth. In other words, not intrinsic growth but apparent growth. That’s exactly what a CDO is. It is perceived value rather than intrinsic value. A CDO like any number of its bretheren is the ultimate product of DBFM. Hence the reason DBFM concentrates profits in the finance industry.

      Regarding oil, my personal opinion is that oil is way too cheap for what it is and what it does. Everything you can see and/or touch around you requires oil either as a direct input or as an energy input. That being the case, here is a thought exercise.

      It costs billions of Dollars to prospect for oil
      Once it is located it costs hundreds of millions more to extract (deep water extraction costs billions)
      Once extracted it costs hundreds of millions to convey
      Once it is conveyed it costs hundreds of millions to refine
      Then it costs hundreds of millions to distribute

      … now… how much does a liter of gasoline retail for?

      Now think about this. How much does one liter of sugar and water otherwise known as Coca Cola costs?

      And people rile against the profits of oil companies?

    • guidoamm Says:

      Regarding the potential implosion of the economy.

      In an FM world, the economy would not be allowed to get so far out of kilter that an inflationary stall would result in global devastation. Nothing in our universe continues along the same path uninterruptedly for ever. The same goes for the economy. There will be times of expansion and times of contraction. The problem is that DBFM cannot contemplate contraction so that it is perceived that government must intervene. From there, cronyism, corruption, waste and expediency are perceived to be justified means to an end.

      A pause in economic growth is not the end of the world. It is natural. It must be allowed in order to establish a sound base for future growth. A pause will always result from sound investment because as economic actors invest for future growth, they plan for expanded growth. Once the investment is complete, it is designed to service demand from many years to come so that in the short term it must inherently constitute overcapacity. What matters, it is not to corrupt the system whereby money is spent for the sake of spending money because the monetary system must be propped up.

      Economic expansion is not and must not be thought to be the direct result of finacialization. Economic expansion must be based on real needs and intrinsic value. If we could achieve that, then a stalling economy would not spell doom for society.

  6. Manor Mouse Says:

    What you say about DBFM vs. other kinds of money also reminds me of ‘Jevons’ Paradox’.

    http://en.wikipedia.org/wiki/Jevons_paradox

    Are the two in any way related?

    • guidoamm Says:

      Wasn’t familiar with Jevons’ Paradox. Efficiency that leads to higher consumption… dunno… have to think about it… Certainly efficiency minimizes waste so that for any given finite resource an increase in efficiency of use will result in satisfying more consumer demand.

      Just off the top of my head; efficiency must be a direct function of demand (need). For example, if something is plentiful and/or useless, we would not be inclined to make efficient use of it. Water comes to mind as even though it is very useful, the perceived infinity of water supplies leads to great waste of the resource. Most households globally do not make efficient use of water. Not even here in the Middle East where water should cost multiples of what it does. But costing so little, despite the scarcity of it, few are inclined to make efficient use of water. Would more efficient use of water lead to greater consumption?… I dunno… we already consume it liberally and thoughtlessly… how much more water could be wasted realistically if our use became more efficient?

      As to a comparison with the efficiency of the currency… DBFM is inherently inefficient thus great quantities of dosh must be expended to keep the sponsors of the system alive… conversely, sound money gets you a greater bang for your buck so that less of it needs to be expended for any given desired result…

      … will have a think…

      • Manor Mouse Says:

        I was listening to some internet radio programme the other night, about energy and the environment, and someone was saying how he had ditched his 4×4 and was now cycling and using public transport. It had occurred to him, though, that with all the money he was saving, he would have to spend it on something – possibly something as frivolous as a trip to Australia or whatever, undoing all the good work (a good example of Jevons’ Paradox wouldn’t you say?). Therefore, he had decided to work one day a week less, thereby allowing him to genuinely save the environment and enjoy life more. To him, that was the end of the story.

        What you are pointing out, though, is that if he does this, the government will only go and make up for it by borrowing or printing money on his behalf, and using it to consume the energy for him, anyway.

        Is that a reasonable way to look at it?

        • guidoamm Says:

          I don’t see how foregoing an activity to save money relates to Jevons’ Paradox. From what I understand JP’s Paradox holds that a more efficient use of something leads to greater consumption of this something. The gentleman on the radio is foregoing driving a car. On the other hand, had he invented something that would make the engine in his car burn more efficiently that would fall under JP imo.

          Government has already gone ahead and spent in excess thus negating any savings individuals may undertake. That’s what a budget deficit and runaway government borrowing mean. Individuals, and laborers in particular, are the last in line to receive DBFM thus they get the least benefit out of the purchasing power of the currency (more later).

          In the short term, the gentleman on the radio may find he can save something. But next year and the year after the gentleman will notice that his savings will have been eroded by higher taxes or higher energy prices or higher food prices or any combination thereof.

          Once DBFM is created, it must be injected into the economy. DBFM enters the economy through well defined and exclusive gates. Essentially, every new unit of currency goes from the Fed, to the Treasury, to the Primary Dealers (PD), to Commercial Banks (CM) (in the US and overseas) and on to corporations and individuals. At every stage, DBFM is devalued by the prevailing rate of interest so that by the time it reaches the pocket of the salaried laborer, it is at its lowest purchasing power. You will notice that in this construct, the PDs whom are also members of the Fed, get paid twice in the first three steps. These are the entities that benefit the most out of each new unit of currency and, by doing the bidding of government, they get paid even more.

          Governments adopt DBFM just because it allows them to spend excessively far ahead of any presumed savings they may achieve. Anyway, DBFM cannot contemplate savings because if it did, then we would not need DBFM but could instead make do with any of the other varieties of monetary systems.

          • Manor Mouse Says:

            I would suggest that the man has simply found a more efficient way of going to work. Maybe he was able to do it because the internet made bus schedules more reliable, and new materials allowed the design of lighter bikes. Maybe his company installed showers at work. A combination of factors, some of them undoubtedly efficiencies, allowed him to ditch his 4×4.

            What I do begin to see, I think, is that even in your ideal world without DBFM, success would still be measured in terms of economic growth, just as it is now. ‘Saving’ i.e. foregoing consumption would not ‘leave the oil in the ground’, but would merely free it up for someone else to make musical birthday cards with, or whatever. Just as it is now. Or are you saying that the economy would not literally need to grow as it does at the moment? Would the non-DBFM economy have the concept of compound interest? Pension schemes?

            • guidoamm Says:

              In the real world, real economic expansion can only happen in the presence of savings which give rise to capital formation. Savings are directly correlated with the pool of real funding.

              DBFM supplants capital formation with debt.

              In a world of value based money, when someone produces something the entire economic chain is nourished. Raw materials are prospected for, extracted, transported, transformed, packaged, distributed, warehoused, sold. The entire chain employs a variety of economic actors. All the entities that participate to the process will be able to save a portion of their earnings. This saving will then be employed to expand a business or will be lent out to other economic actors to expand the economy and the saver will get interest on the loan thus earning a little something on his savings thus encouraging more savings (expansion of the pool of funding) whilst participating to the expansion of the overall economy.

              In a DBFM world, government mandates that you should not save because it has mandated a third party (The Central Bank) to be the provider of capital. But the capital provided by the central bank does not feed an economic chain. The capital provided by a central bank is purely financial and does not need to employ anything or anyone. It is conjured and has no cost structure. It has no cost.

              Thus, whereas the profit potential of your garden variety economic actor is limited by his/her cost structure, a central bank and the entities that gravitate around it have no such limitations thus their profit potential is unlimited. This results in the transfer of wealth and productive capital outside of society.

              The point at which DBFM begins to lose traction is evidenced by chart number 130 and 135 on page one of my charts. The charade of DBFM is exposed for what it is at the point when financial value starts running away from intrinsic value. In our case that would be about the year 2000. Since then, the monetary authority must shift financial gimmicks into overdrive in order to keep up appearances.

              In a non DBFM world, over-consumption is not something that could be induced by the monetary authority. Thus waste and devastation of natural resources would be greatly reduced. The corollary to this rant is that Green Parties all over the world should be the staunchest supporters of the abrogation of DBFM.

  7. Patrick Donnelly Says:

    As we all know, this is too late!

    How do we and others, prevent DBFM in the coming decades?
    a) eradicate all bankers and their bonuses (low probability)
    b) establish non-profit banks and savings based institutions (that will never be able to compete once the credit boom begins)
    c) other?

    • guidoamm Says:

      Technically it is not too late. I mean, technically we could still quite easily bring about the demise of DBFM.

      On the other hand, the real obstacle is how to get the masses to understand the mechanics, the ramifications and the fact that we are in the final denouement thus we are about to be plunged into the final crisis.

      Effectively, nothing short of the full assimilation of the Chinese currency would allow us to once again postpone the logical consequence of DBFM or something of that import like a global currency… failing that, this is it. The final crisis is upon us and I personally believe a conflict is very likely.

  8. guidoamm Says:

    That’s catchy!
    Here’s to hoping… against hope…

  9. Roger Glyndwr Lewis Says:

    Guido,
    I hope your Blogs and my Tweets of the same do not fall on deaf ears. The revolving doors of Corporate Government spin on, in fact it may be the answer to free energy perpetual motion?

    And so to work to sate the state not to slake my own modest Thirst!
    In planet Corporation we know which appetite comes First.
    Hope and Wish for the best yet fear the Worst.
    for FIAT decree is surely the Curse.

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