Is Interest a Scam?

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Gumby
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Is Interest a Scam?

Post by Gumby » Tue Nov 15, 2011 2:07 pm

When our country was on a Gold Standard, our money was a paper representation of our gold reserves. And if the country didn't ever have enough gold, we issued bonds to borrow money — and we would owe a debt.

Makes sense.

Since 1972, the US Dollar has been a purely fiat currency with a free-floating exchange rate. However, Congress never changed the laws for issuing currency and Treasury Bonds are still, to this day, necessary if the U.S. Treasury wants to spend or create money it doesn't have.

In other words, as the laws are currently written, the only money that the United States Treasury can freely issue are coins. But, other than coins, the U.S. Treasury may not create or spend any new money that isn't offset by the issuance of Treasury Bonds.

The Fed, on the other hand, can print money out of thin air, but each dollar it prints is entered as a liability on its balance sheet — and every liability is offset by higher reserve holding requirements with excess bank reserves at the Fed.

Therefore, every dollar issued by the government — other than coins — must originate from either a Treasury Debt or a sterilized Federal Reserve liability. Since coins make up a tiny amount of our monetary base, it stands to reason that the overwhelming majority of our monetary base wouldn't exist without corresponding Federal debt.

But as we all know, the majority of our money supply doesn't come from the government. Most of the money supply comes from banks that create loans — what we call the fractional reserve banking system.

Unless anyone can think of another way that money is created, it would seem that 99% of our money supply would simply not exist without public and private debt.

Now, here's the problem.

With every loan issued by a bank, the banks require the loan plus interest to be paid back. So... How do we pay the interest on all of this debt-based money if the money to pay the loans doesn't exist?

Without more dollars being issued (from either more public or private debt) it would be impossible to pay back the interest on every loan. So, in order to pay off interest on all future loans, more public or private debt is needed.

I've been thinking about this for awhile and can't find an answer.

Mind you, I didn't make this up. This is actually the #1 argument against the Fractional Reserve Banking system:
Critics of fractional reserve banking claim that since money creation requires loans from the banking system, people are required to go into debt in order for any new money to be created. They assert that this can debase the means of exchange. While there is no controversy over the fact that the commercial banking system expands the money supply, critics find it problematic that banks "create money out of nothing."

One criticism posits that since debt and the interest on the debt can only be paid in the same form of money, the total debt (principal plus interest) can never be paid in a debt-based monetary system unless more money is created through the same process. For example: if 100 credits are created and loaned into the economy at 10% per year, at the end of the year 110 credits will be needed to pay the loan and extinguish the debt. However, since the additional 10 credits does not yet exist, it too must be borrowed. This implies that debt must grow exponentially in order for the monetary system to remain solvent. This was the argument of the Social Credit movement of the 1930s, who proposed to remove the job of money creation from banks and give it to governments.

Source: http://en.wikipedia.org/wiki/Criticism_ ... criticisms
This leads me to believe that interest is really a scam designed to generate profits for private banks with money that doesn't actually exist in the money supply yet — causing a never-ending public and private debt cycle to emerge.

And, if banks won't lend money, then it would seem to be mathematically impossible for people not to default without more debt-based money being issued. This seems like a simple balance-sheet issue. But, maybe others can point out something that I'm missing.

Would love to hear your thoughts. Thanks.

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GregLee
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Re: Is Interest a Scam?

Post by GregLee » Tue Nov 15, 2011 2:52 pm

Gumby wrote: Now, here's the problem.

With every loan issued by a bank, the banks require the loan plus interest to be paid back. So... How do we pay the interest on all of this debt-based money if the money to pay the loans doesn't exist?

Without more dollars being issued (from either more public or private debt) it would be impossible to pay back the interest on every loan. So, in order to pay off interest on all future loans, more public or private debt is needed.

I've been thinking about this for awhile and can't find an answer.
I don't understand the problem. You ask "how do we pay the interest?" and then provide the answer "more public or private debt is needed." Asked and answered.
Greg, retired 8/10.

Gumby
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Re: Is Interest a Scam?

Post by Gumby » Tue Nov 15, 2011 3:08 pm

GregLee wrote:I don't understand the problem. You ask "how do we pay the interest?" and then provide the answer "more public or private debt is needed." Asked and answered.
Then I suppose the only "problem" is that most people don't understand that the money supply is entirely composed of debt and that more debt is constantly required to pay every loan. At the moment, the people who issue the public/private debt don't want to issue more of it.

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neurosphere
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Re: Is Interest a Scam?

Post by neurosphere » Tue Nov 15, 2011 3:22 pm

Suppose I cut down a large tree, and try to sell it. I will get very little for it. Who wants a dead tree.

Now suppose I spend a year of my life fashioning the wood from that tree, together with some metal I found, shaped and polished, into hundreds of high-quality tools which have significant value, and people are willing to pay me lots of money for them.

Do these tools have a value? Are they worth anything? Are they 'money'? In your example of with the credits: last year there were 100 credits and nothing else. This year there are 100 credits and hundreds of tools. And people are willing to pay me a credit for each tool. How many credits are really available? Can I pay back the interest on borrowed credits with the original credits and a tool? What if I sell all of my tools to another country, and they pay me in 'eurocredits'. How many credits are now in this country? Do the eurocredits count for anything? What if someone is willing to pay me one credit for each eurocredit? Or willing to take a eurocredit as payment on interest. How much 'money' is there NOW?

Maybe this is a silly example. I am far from a macro-economist, and know squat about monetary policy. But it seems that terms such as 'money supply' and 'debt' and highly context specific. But 'value' and 'goods' can be created 'out of thin air', with a some resources, human labor and time. And then one can loan these goods to others. Does that mean that one 'created' more debt?

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Oicuryy
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Re: Is Interest a Scam?

Post by Oicuryy » Tue Nov 15, 2011 3:27 pm

I must be missing something.

I can see how continuously borrowing and repaying with interest would require continuously producing more wealth. But I can't see why that would require continuously creating more money. The same quantity of money could be used over and over to facilitate the exchange of non-money forms of wealth back and forth between lenders and borrowers.

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dmcmahon
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Re: Is Interest a Scam?

Post by dmcmahon » Tue Nov 15, 2011 3:41 pm

I agree with Olcuryy. It only seems as if an ever-expanding "money supply" and ever-expanding debt is needed for "interest" to be paid, whereas in reality only an ever-expanding amount of wealth is needed.

It's hard to see this when considering familiar examples involving consumer debt, because in these cases the debt is being incurred to finance consumption. For example, borrowing money on a credit card to take a vacation. Even here, we know that eventually the consumer will have to work enough (produce enough wealth) to pay for the consumption, plus a bit more to pay for the interest. It's easier to see the value in productive investments, viewing the debt as simply another component in the capital structure financing a project. For example, suppose a utility constructs a power plant, with some equity investment and a lot of borrowed money. Once it's built, we expect that it will produce wealth in the form of generated power, net of any expenses of running the plant, that exceeds the cost of constructing it. In this example, those getting "interest" are simply accepting a lower-risk, lower-return position in the overall financing of a project, but what really "pays" the interest is the value inherent in the project. Money isn't needed per se - interest might be paid in the form of rights to units of power to be produced, which could then be traded for other things.

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Re: Is Interest a Scam?

Post by john94549 » Tue Nov 15, 2011 3:50 pm

Boy, howdy. Looking at what I'm getting on my CDs.

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GregLee
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Re: Is Interest a Scam?

Post by GregLee » Tue Nov 15, 2011 4:10 pm

dmcmahon wrote:I agree with Olcuryy. It only seems as if an ever-expanding "money supply" and ever-expanding debt is needed for "interest" to be paid, whereas in reality only an ever-expanding amount of wealth is needed.
Isn't that a distinction without a difference? We customarily measure wealth in dollars. If wealth increased without money increasing correspondingly, the money's value would be greater, since each dollar would buy more stuff. I.e., there would be deflation. Adjusting for inflation or deflation, as wealth increases or decreases, so will money.
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Culture
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Re: Is Interest a Scam?

Post by Culture » Tue Nov 15, 2011 4:11 pm

This is one of those arguments that drives me nuts. Let's assume that we are all on a hard gold standard (all money is 100% back by physical gold, and the monetary unit is grams of gold), and I loan you 100 grams of gold at 50% interest. You are going to have to pay me back 150 grams in 365 days. Did I just make 50 grams of gold? No, of course not.

Thus, the same "problem" that you are discussing also exist with a gold standard. Where is the extra gold going to come from to pay interest under a gold standard? Will I collapse the world economy by charging interest that does not exist in the system, the gold standard equivalent of dividing by zero? Does this mean that it is logically or physically impossible to charge interest under a gold standard? No, of course not.

What happens when my start up company is all of a sudden worth $5Billions grams of gold? Where is this gold going to come from? Does this mean my business is suddenly worthless because this gold does not exist?

Money (paper, gold, silver or otherwise) is an imaginary concept that depends on a shared delusion. However, it works pretty well.

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FNK
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Re: Is Interest a Scam?

Post by FNK » Tue Nov 15, 2011 4:23 pm

john94549 wrote:Boy, howdy. Looking at what I'm getting on my CDs.
By the way, this is the answer for the original question. The interest does not go to the big bank in the sky. It's paid out to depositors, investors, employees. In the case of the Fed, excess interest is paid to the Treasury. So all that interest money is recycled back into the economy.

So the net transfer of dollars is not from everybody to banks, but from the borrowers to the lenders.

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Re: Is Interest a Scam?

Post by john94549 » Tue Nov 15, 2011 4:28 pm

FNK wrote:
john94549 wrote:Boy, howdy. Looking at what I'm getting on my CDs.
By the way, this is the answer for the original question. The interest does not go to the big bank in the sky. It's paid out to depositors, investors, employees. In the case of the Fed, excess interest is paid to the Treasury. So all that interest money is recycled back into the economy.

So the net transfer of dollars is not from everybody to banks, but from the borrowers to the lenders.
My net transfer is so tiny these days.

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Re: Is Interest a Scam?

Post by learning_head » Tue Nov 15, 2011 4:35 pm

Gumby wrote:Now, here's the problem.

With every loan issued by a bank, the banks require the loan plus interest to be paid back. So... How do we pay the interest on all of this debt-based money if the money to pay the loans doesn't exist?
Maybe I am missing something, but to pay off loan + interest, you could sell some of you possessions or you could go without food for a week and accumulate more money in that way. Neither of these require money printing. You will just have less of other stuff...

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Oicuryy
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Re: Is Interest a Scam?

Post by Oicuryy » Tue Nov 15, 2011 4:36 pm

GregLee wrote:We customarily measure wealth in dollars. If wealth increased without money increasing correspondingly, the money's value would be greater, since each dollar would buy more stuff. I.e., there would be deflation. Adjusting for inflation or deflation, as wealth increases or decreases, so will money.
And we customarily measure height in inches. If a tree's height increased without the supply of inches increasing correspondingly, the inch's length would be greater, since each inch would measure more stuff. I.e., we would all be a little shorter.

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GregLee
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Re: Is Interest a Scam?

Post by GregLee » Tue Nov 15, 2011 5:56 pm

Oicuryy wrote: And we customarily measure height in inches. If a tree's height increased without the supply of inches increasing correspondingly, the inch's length would be greater, since each inch would measure more stuff. I.e., we would all be a little shorter.
Yes, given your assumption. So, since we'd prefer not to undergo such shrinkage, it behooves us to keep plenty of inches on hand.
Greg, retired 8/10.

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Re: Is Interest a Scam?

Post by Gumby » Tue Nov 15, 2011 9:06 pm

neurosphere wrote:Do these tools have a value? Are they worth anything?
Yes
neurosphere wrote:Are they 'money'?
No, they are just valuable tools.
neurosphere wrote:In your example of with the credits: last year there were 100 credits and nothing else. This year there are 100 credits and hundreds of tools. And people are willing to pay me a credit for each tool. How many credits are really available?
Is this supposed to be a trick question? There are still 100 credits.
neurosphere wrote:Can I pay back the interest on borrowed credits with the original credits and a tool?
No. Only 100 credits exist. Where are you going to find more credits?
neurosphere wrote:What if I sell all of my tools to another country, and they pay me in 'eurocredits'. How many credits are now in this country?
100 credits and some Eurocredits. What's your point?
neurosphere wrote:Do the eurocredits count for anything?
No. They aren't "credits"
neurosphere wrote:What if someone is willing to pay me one credit for each eurocredit?
It wouldn't make a difference. There would still only be 100 credits in existence. You haven't changed the money supply in any way.
neurosphere wrote:Or willing to take a eurocredit as payment on interest. How much 'money' is there NOW?
That doesn't make any sense. Domestic banks wouldn't be able to accept eurocredits as interest payments. And, besides, there would still only be 100 credits in existence. None of your examples have ever changed the number of credits in existence.
neurosphere wrote:But it seems that terms such as 'money supply' and 'debt' and highly context specific. But 'value' and 'goods' can be created 'out of thin air', with a some resources, human labor and time. And then one can loan these goods to others. Does that mean that one 'created' more debt?
I'm not sure how you've managed to confuse goods with money, but you have. You can make as many valuable products as you want, but you aren't going to change the money supply. You don't create more credits by making something valuable.

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Re: Is Interest a Scam?

Post by rmelvey » Tue Nov 15, 2011 9:34 pm

I think the biggest scam is the ignorance about this truth you bring up. The United States needs to maintain deficit spending if it hopes have net private sector saving and a growing economy.

Government surplus are not sustainable. It is disgusting for me to hear politicians talk about our "debt problem." They just haven't had a serious philosophical introspection for longer than 5 minutes in their life...

If they just thought about our system, how it actually functions, they would realize that surpluses should only be used very sparingly and are neither "good" nor "bad."

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Re: Is Interest a Scam?

Post by mas » Tue Nov 15, 2011 9:41 pm

Gumby wrote:...
This leads me to believe that interest is really a scam designed to generate profits for private banks...
I'm not sure whether it is a scam or not, but of course interest is designed to generate profit for private banks lenders.
If this bothers you, then its pretty easy to avoid. Just don't borrow money.
And if you find yourself in a position to lend money, then maybe you can help end the scam by not charging interest.

I think that the concept of interest is much more general than (and unrelated to) your discussion of money supply, and factional reserve banking.

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Re: Is Interest a Scam?

Post by Gumby » Tue Nov 15, 2011 9:59 pm

Oicuryy wrote:I must be missing something.

I can see how continuously borrowing and repaying with interest would require continuously producing more wealth. But I can't see why that would require continuously creating more money. The same quantity of money could be used over and over to facilitate the exchange of non-money forms of wealth back and forth between lenders and borrowers.
But that's not how loans work. We are talking about a fractional-reserve banking system — where money is created out of thin air. Every loan that's ever been procured by a bank is money being added to the money supply that didn't previously exist. Not only did that money not exist previously, but that loan must be paid back with money plus interest. So, how do you pay back the money that didn't previously exist, plus interest, without more money being added to the monetary supply?

It's impossible.

"Wealth" is not money. You can't pay back the loan with wealth, unless you liquidate that wealth into actual money. Every dollar, in every bank (except for coins and Fed liabilities) can be traced back to either a loan from a bank or government debt spending. Without debt, our money supply wouldn't exist.

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Re: Is Interest a Scam?

Post by investomajic » Tue Nov 15, 2011 10:46 pm

It seems like there is a lot of confusion on this thread, probably due to the fact that the fractional reserve banking system is a very confusing topic.

Maybe a different way to pose the problem / question with slightly more clarity...

Consider:
If the assumption is all money is debt - which is what the fractional reserve banking system gives us - what happens if everone paid off their debt at the exact same time. By definition, there would be no money. What would be left to make their final interest payment?


Actuality:
Now, with the cycle of money, cycle of loans and labor to procur more money, this will never happen, but never-the-less, here we are, in a system dependent upon people being in debt. Debt won't go away, it can't.

My thoughts:
A large part of the reason our entire economy almost came to a stand-still in 2008 is because the banks wouldn't lend. We are entirely dependant upon banks lending (FAR more important than most people think) and, really, we can't improve until that gets back to normal.

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Re: Is Interest a Scam?

Post by NERD777 » Tue Nov 15, 2011 11:15 pm

investomajic wrote:It seems like there is a lot of confusion on this thread, probably due to the fact that the fractional reserve banking system is a very confusing topic.

Maybe a different way to pose the problem / question with slightly more clarity...

Consider:
If the assumption is all money is debt - which is what the fractional reserve banking system gives us - what happens if everone paid off their debt at the exact same time. By definition, there would be no money. What would be left to make their final interest payment?


Actuality:
Now, with the cycle of money, cycle of loans and labor to procur more money, this will never happen, but never-the-less, here we are, in a system dependent upon people being in debt. Debt won't go away, it can't.

My thoughts:
A large part of the reason our entire economy almost came to a stand-still in 2008 is because the banks wouldn't lend. We are entirely dependant upon banks lending (FAR more important than most people think) and, really, we can't improve until that gets back to normal.
Pretty much this^^^. Debt is money. What happened in 2008 was similar to what started the great depression, their was little credit available anywhere. This is what quantitative easing is supposed to combat. Problem is two-fold. Interest rates are very low, making locking in long term loans unattractive for banks. Also, the economic environment still seems risky to lend. In 2008 central banks basically had two options in my opinion. Massive defaults and subsequent deflation & economic contraction (this goes to your money supply theory, when debts are erased you will see deflation), or stalled economic growth and hopefully a controlled inflationary environment in order to slowly but surely monetize the debt every single person/entity owes. Wages tend to lag inflation so you see an economic standstill and a pinch on the lower and middle classes.

Remember the housing industry is an integral part of any domestic economy. Central banks have virtually no control over supply+demand of housing so the best way to combat falling housing prices is via inflation. If you have a loan on a house for 500,000 with littler to no equity but it's now worth 400,000 you are underwater. 6 years of 4% inflation makes that 400,000 into 506,000. Now again the central banks can't control where exactly inflation hits, but eventually it should come full circle and should impact all types of goods & services.

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Re: Is Interest a Scam?

Post by FNK » Wed Nov 16, 2011 12:23 am

Gumby wrote:But that's not how loans work. We are talking about a fractional-reserve banking system — where money is created out of thin air. Every loan that's ever been procured by a bank is money being added to the money supply that didn't previously exist.
Is this actually true? Fractional reserve banking is loaning out a fraction of the money that somebody else deposited. So it's not money created out of thin air, it's money repeatedly deposited and lent out. Each borrower pays interest, but each lender receives interest.

If everyone pays off their debt, we'll be left with M0, the "high-powered money".

The reason M0 is so much smaller than M3 is that there is a lot of debt in the economy. The reason there is a lot of debt is that it's apparently more effective to borrow somebody else's delayed consumption than to wait for your own wealth to reach the levels you want to consume or invest.

We may dislike the system, it may be confusing, even broken, but it is not broken the way you described.

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Oicuryy
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Re: Is Interest a Scam?

Post by Oicuryy » Wed Nov 16, 2011 12:24 am

Gumby wrote:"Wealth" is not money.
Wealth is what we produce, store and consume. Wealth is what we borrow and pay back -- with interest. Money is just the medium of exchange. Banks create and uncreate money as needed to facilitate the exchange of wealth.

Ron
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Re: Is Interest a Scam?

Post by dumbmoney » Wed Nov 16, 2011 1:12 am

Gumby wrote: With every loan issued by a bank, the banks require the loan plus interest to be paid back. So... How do we pay the interest on all of this debt-based money if the money to pay the loans doesn't exist?
The interest goes into the salaries of bankers, and the profits of the shareholders, which after being spent provides the money to pay interest. So it's a fallacy that increasing debt (or economic growth) is mathematically required. (It may be required in practice but that's another argument).
I am pleased to report that the invisible forces of destruction have been unmasked, marking a turning point chapter when the fraudulent and speculative winds are cast into the inferno of extinction.

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Re: Is Interest a Scam?

Post by patrick » Wed Nov 16, 2011 3:37 am

Gumby wrote:This leads me to believe that interest is really a scam designed to generate profits for private banks with money that doesn't actually exist in the money supply yet — causing a never-ending public and private debt cycle to emerge.

And, if banks won't lend money, then it would seem to be mathematically impossible for people not to default without more debt-based money being issued. This seems like a simple balance-sheet issue. But, maybe others can point out something that I'm missing.
It's only impossible to pay off the debts if you assume additional conditions, such as that all the debt must be paid off at once, or the debtor does not have and cannot produce anything that someone with money will pay for. The latter case would be a problem even without interest if the debtor spends any of the borrowed money on something the debtor then consumes.

Here is how I can repay 110 credits when only 100 credits exist (and you start out holding all of them), without anyone else or any other money supply being involved:

Step 1: You lend me 100 credits (now I have 100 credits, you have 0 credits, and with interest I owe 110 credits)
Step 2: I buy some bright lights from you for 45 credits (now I have 55 credits, you have 45 credits, and I owe 110 credits)
Step 3: I repay 55 credits of my debt to you (now I have 0 credits, you have 100 credits, and I owe 55 credits)
Step 4: I use the lights to grow some marijuana
Step 5: I sell the marijuana to you for 55 credits (now I have 55 credit, you have 45 credits, and I owe 55 credits)
Step 6: I repay the remaining 55 credits (now I have 0 credits, you have 100 credits, and I owe nothing)

Of course, this exact scenario would not work if you don't like marijuana. But in a real economy with other people this isn't a problem. Perhaps you'd like a bicycle instead -- then for step 5 some other guy could sell you a bicycle for your 55 credits, then I could sell the marijuana to the other guy to get the 55 credits I'd need to repay the rest of the debt,

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Re: Is Interest a Scam?

Post by QuirkyYogini » Wed Nov 16, 2011 3:59 am

rmelvey wrote:I think the biggest scam is the ignorance about this truth you bring up. The United States needs to maintain deficit spending if it hopes have net private sector saving and a growing economy.

Government surplus are not sustainable. It is disgusting for me to hear politicians talk about our "debt problem." They just haven't had a serious philosophical introspection for longer than 5 minutes in their life...

If they just thought about our system, how it actually functions, they would realize that surpluses should only be used very sparingly and are neither "good" nor "bad."
Honestly, I've been wondering the same thing. I just finished my macroeconomics class several weeks ago and it seems that when there is a recession, we need a defecit. That is the way it's supposed to work. So I don't understand all this talk of the debt problem either. Why aren't economists rallying in the streets? Am I missing something? I thought this was just basic economics?

Edited to Add:

Also, just as new loans create money, paying off the loans destroy money. So what's all the fuss about? It all evens out. Again, I'm no economist and I have a very limited understanding of how things work, but this was in my textbook. I'm sure there is much more to this than what we covered in Macro, but since it's supposed to lay the groundwork for future courses, I don't think it's outright wrong, is it?

Feel free to educate me!

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Re: Is Interest a Scam?

Post by jimkinny » Wed Nov 16, 2011 6:15 am

QuirkyYogini wrote:
rmelvey wrote:I think the biggest scam is the ignorance about this truth you bring up. The United States needs to maintain deficit spending if it hopes have net private sector saving and a growing economy.

Government surplus are not sustainable. It is disgusting for me to hear politicians talk about our "debt problem." They just haven't had a serious philosophical introspection for longer than 5 minutes in their life...

If they just thought about our system, how it actually functions, they would realize that surpluses should only be used very sparingly and are neither "good" nor "bad."
Honestly, I've been wondering the same thing. I just finished my macroeconomics class several weeks ago and it seems that when there is a recession, we need a defecit. That is the way it's supposed to work. So I don't understand all this talk of the debt problem either. Why aren't economists rallying in the streets? Am I missing something? I thought this was just basic economics?

Edited to Add:

Also, just as new loans create money, paying off the loans destroy money. So what's all the fuss about? It all evens out. Again, I'm no economist and I have a very limited understanding of how things work, but this was in my textbook. I'm sure there is much more to this than what we covered in Macro, but since it's supposed to lay the groundwork for future courses, I don't think it's outright wrong, is it?

Feel free to educate me!
I have been reading a lot of economics stuff recently and it seems to me that as far as macroeconomics is concerned, one group of economist will say what needs to be done is just the opposite of what another group will say. Lot of opinions, less knowledge, than one would think. Important stuff though, I suppose.

But then, really, is the money supply really important. The universe is about 13-14 billion years old and about 100 billion light years in size, so maybe thinking about that is more important than thinking about interest and money supply. :beer


Jim

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Re: Is Interest a Scam?

Post by zeugmite » Wed Nov 16, 2011 6:58 am

patrick wrote:
Gumby wrote:This leads me to believe that interest is really a scam designed to generate profits for private banks with money that doesn't actually exist in the money supply yet — causing a never-ending public and private debt cycle to emerge.

And, if banks won't lend money, then it would seem to be mathematically impossible for people not to default without more debt-based money being issued. This seems like a simple balance-sheet issue. But, maybe others can point out something that I'm missing.
It's only impossible to pay off the debts if you assume additional conditions, such as that all the debt must be paid off at once, or the debtor does not have and cannot produce anything that someone with money will pay for. The latter case would be a problem even without interest if the debtor spends any of the borrowed money on something the debtor then consumes.

Here is how I can repay 110 credits when only 100 credits exist (and you start out holding all of them), without anyone else or any other money supply being involved:

Step 1: You lend me 100 credits (now I have 100 credits, you have 0 credits, and with interest I owe 110 credits)
Step 2: I buy some bright lights from you for 45 credits (now I have 55 credits, you have 45 credits, and I owe 110 credits)
Step 3: I repay 55 credits of my debt to you (now I have 0 credits, you have 100 credits, and I owe 55 credits)
Step 4: I use the lights to grow some marijuana
Step 5: I sell the marijuana to you for 55 credits (now I have 55 credit, you have 45 credits, and I owe 55 credits)
Step 6: I repay the remaining 55 credits (now I have 0 credits, you have 100 credits, and I owe nothing)

Of course, this exact scenario would not work if you don't like marijuana. But in a real economy with other people this isn't a problem. Perhaps you'd like a bicycle instead -- then for step 5 some other guy could sell you a bicycle for your 55 credits, then I could sell the marijuana to the other guy to get the 55 credits I'd need to repay the rest of the debt,
Perfect. This is actually quite simple. Money is created whenever the lender issues the interest-bearing bond. It's just a piece of paper -- a contract, really -- and now it has value. As time goes on, the same piece of paper -- the bond -- grows in value according to the agreed-upon Interest. Note that the money for the interest is being created by the bond itself without anybody needing to do anything. The additional value of the bond is presumably backed up by the additional wealth created by the borrower. At any point, the lender can simply exchange the accrued interest of the bond for the created wealth from the borrower and extinguish that portion of the debt. The borrower doesn't need to get more debt to pay the interest. In real life, the "lender" in this example isn't the bank, but anybody down the chain who actually provided the funds for the loan (depositors, investors) that the bank can match up with the borrower, i.e., everybody else in the world.

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Re: Is Interest a Scam?

Post by investomajic » Wed Nov 16, 2011 9:21 am

FNK wrote:
Gumby wrote:But that's not how loans work. We are talking about a fractional-reserve banking system — where money is created out of thin air. Every loan that's ever been procured by a bank is money being added to the money supply that didn't previously exist.
Is this actually true? Fractional reserve banking is loaning out a fraction of the money that somebody else deposited. So it's not money created out of thin air, it's money repeatedly deposited and lent out. Each borrower pays interest, but each lender receives interest.

If everyone pays off their debt, we'll be left with M0, the "high-powered money".

The reason M0 is so much smaller than M3 is that there is a lot of debt in the economy. The reason there is a lot of debt is that it's apparently more effective to borrow somebody else's delayed consumption than to wait for your own wealth to reach the levels you want to consume or invest.

We may dislike the system, it may be confusing, even broken, but it is not broken the way you described.
Yes, this is true for the very reason you mention "fractional reserve banking". Your definition is correct, but you are only thinking of the first deposit / loan ... you are forgetting that the money that is lent out is deposited yet again and the cycle repeats itself. This point is key.

If you deposit $100 into Bank A and the reserve requirement is 10%, that bank can lend out $90. Someone else gets that $90 as a loan and deposits it into another bank: Bank B. Bank B hangs onto 10% of that and creates another loan for $81 ... this can repeat many times.

Wikipedia has a nice explantion:
http://en.wikipedia.org/wiki/Fractional ... iplication

Now, M0 is a more confusing subject and gets into how the Fed and Treasury lend to each other. Grumpy actually had a fairly good overview of it (the original post to this thread).

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Re: Is Interest a Scam?

Post by Gumby » Wed Nov 16, 2011 10:02 am

patrick wrote:Here is how I can repay 110 credits when only 100 credits exist (and you start out holding all of them), without anyone else or any other money supply being involved:

Step 1: You lend me 100 credits (now I have 100 credits, you have 0 credits, and with interest I owe 110 credits)
Step 2: I buy some bright lights from you for 45 credits (now I have 55 credits, you have 45 credits, and I owe 110 credits)
Step 3: I repay 55 credits of my debt to you (now I have 0 credits, you have 100 credits, and I owe 55 credits)
Step 4: I use the lights to grow some marijuana
Step 5: I sell the marijuana to you for 55 credits (now I have 55 credit, you have 45 credits, and I owe 55 credits)
Step 6: I repay the remaining 55 credits (now I have 0 credits, you have 100 credits, and I owe nothing)
Excellent example. Thank you.

Now, suppose that millions of new loans — equalling 1 Trillion in new credits — are created, plus interest. But, due to a slowdown in the economy, marijuana becomes massively overpriced and people are unable to sell enough marijuana to pay off all the loans and interest within the timeframe of the loans. What then? Doesn't it stand to reason that there isn't enough money moving around to pay off all the loans in time, before the clock runs out?

It would seem that the money supply would have to increase in order for people to be able to pay back their loans and interest in time. The only way to create more money would be with more federal debt or more private debt. If, at that point, private debt were difficult to come by (i.e. banks not loaning), marijuana sales had plummeted (i.e. no marijuana jobs), and there was no more appetite for public debt (i.e. debt ceilings not being raised), it would seem that the money supply would simply be inadequate to support the looming timeframe of the outstanding loans.

By the way... I don't have any problem with more public or private "debt" — after all, our money wouldn't exist without debt. I just think that the interest on every loan is a significant drag on the creation of wealth for most of the population — particularly when times get tough and there is no more appetite for more loans or debt. Furthermore, when all of the loans needed to run an economy are considered, studies have shown that interest makes up more than 40% of the cost of all goods:

http://www.converge.org.nz/evcnz/resources/money.pdf

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Re: Is Interest a Scam?

Post by FNK » Wed Nov 16, 2011 1:25 pm

investomajic wrote:Yes, this is true for the very reason you mention "fractional reserve banking". Your definition is correct, but you are only thinking of the first deposit / loan ... you are forgetting that the money that is lent out is deposited yet again and the cycle repeats itself. This point is key.

If you deposit $100 into Bank A and the reserve requirement is 10%, that bank can lend out $90. Someone else gets that $90 as a loan and deposits it into another bank: Bank B. Bank B hangs onto 10% of that and creates another loan for $81 ... this can repeat many times.
No, I'm not forgetting that. The point that is being forgotten is that every iteration of the cycle has a borrower and a lender. The borrower pays interest, the lender receives interest.

Also note that the bank pays interest on 100% of the deposit, but receives interest on 90% (well, that's not true now that fed started paying interest on reserves, but now is a strange time). This is, of course, compensated by the spread between deposits and loans. So if the cycle runs to completion, all high-powered money is kept as reserves and not earning interest (not significant interest and not from the economy anyway).

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Re: Is Interest a Scam?

Post by Gumby » Wed Nov 16, 2011 2:30 pm

FNK wrote:
Gumby wrote:But that's not how loans work. We are talking about a fractional-reserve banking system — where money is created out of thin air. Every loan that's ever been procured by a bank is money being added to the money supply that didn't previously exist.
Is this actually true? Fractional reserve banking is loaning out a fraction of the money that somebody else deposited. So it's not money created out of thin air, it's money repeatedly deposited and lent out. Each borrower pays interest, but each lender receives interest.
Are you arguing that the fractional reserve banking system doesn't increase the money supply?

In the following example, $357.05 in new loans are created from an initial $100 deposit. (i.e. banks created $357.05 in M1, from a single $100 deposit). For simplicity, a new bank is used for every deposit that came from the initial $100 deposit:

Image
Source: http://en.wikipedia.org/wiki/Fractional_reserve_banking

The "problem" is...

If there is a slowdown in the economy — and these loans can't produce the wealth that borrowers hoped they would — many of these loans will be impossible to pay back in time without new bank loans or new federal debt being issued to cover the $357.05, plus interest.

As I have said. More debt doesn't bother me, since that's where our money comes from. But, if there isn't an appetite to provide more bank loans or federal debt-based money to the public, it prevents a very big balance sheet problem for the borrowers.
Last edited by Gumby on Wed Nov 16, 2011 2:54 pm, edited 10 times in total.

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Re: Is Interest a Scam?

Post by magician » Wed Nov 16, 2011 2:36 pm

investomajic wrote:We are entirely dependent upon banks lending (FAR more important than most people think) and, really, we can't improve until that gets back to normal.
What, exactly, is "normal"?

(And why is it, and not something else, normal?)
Simplify the complicated side; don't complify the simplicated side.

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Re: Is Interest a Scam?

Post by FNK » Wed Nov 16, 2011 4:03 pm

Gumby wrote:Are you arguing that the fractional reserve banking system doesn't increase the money supply?
Not at all! Once we consider both cash and checking account balances as money (basically, M1), lending certainly increases the supply.

What I'm saying is that "money is created from thin air by banks who then charge interest on all of it and necessarily destroy the economy" is fundamentally different from "money is lent through banks and interest is channeled from borrowers to lenders".
Gumby wrote:The "problem" is...

If there is a slowdown in the economy — and these loans can't produce the wealth that borrowers hoped they would — many of these loans will be impossible to pay back in time without new bank loans or new federal debt being issued to cover the $357.05, plus interest.
Agreed. "When", not "If", because a deleveraging is exactly what we are dealing with right now.

Disregarding the "perfect storm" of illiquidity and government response, what are the fundamental, intrinsic problems with debt-based economy? I mean, on the other hand, that interest feeds the retirees...

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Re: Is Interest a Scam?

Post by rmelvey » Thu Nov 17, 2011 12:06 am

Gumby,

I think it is important to note the difference between bank money and state money. The introduction of state money increases net financial assets. Banks leverage this state money (reserves) creating bank money. The creation of bank money does not create net financial assets. For every bank dollar that is created there is an asset matched with a liability, netting out to zero. The increase in the money supply stemming from bank loans is quite different from an increase in the money supply coming from deficit spending.

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Re: Is Interest a Scam?

Post by TheEternalVortex » Thu Nov 17, 2011 3:42 am

Gumby wrote:
patrick wrote:Here is how I can repay 110 credits when only 100 credits exist (and you start out holding all of them), without anyone else or any other money supply being involved:

Step 1: You lend me 100 credits (now I have 100 credits, you have 0 credits, and with interest I owe 110 credits)
Step 2: I buy some bright lights from you for 45 credits (now I have 55 credits, you have 45 credits, and I owe 110 credits)
Step 3: I repay 55 credits of my debt to you (now I have 0 credits, you have 100 credits, and I owe 55 credits)
Step 4: I use the lights to grow some marijuana
Step 5: I sell the marijuana to you for 55 credits (now I have 55 credit, you have 45 credits, and I owe 55 credits)
Step 6: I repay the remaining 55 credits (now I have 0 credits, you have 100 credits, and I owe nothing)
Excellent example. Thank you.

Now, suppose that millions of new loans — equalling 1 Trillion in new credits — are created, plus interest. But, due to a slowdown in the economy, marijuana becomes massively overpriced and people are unable to sell enough marijuana to pay off all the loans and interest within the timeframe of the loans. What then? Doesn't it stand to reason that there isn't enough money moving around to pay off all the loans in time, before the clock runs out?
If marijuana isn't the only good, then you can always sell other goods/services to get money. If you want to say that the price of all goods drops, then you require deflation, which a monetarist view would say is impossible if the money supply hasn't decreased (which would require the amount of debt to decrease in your scenario).

(Of course if you had invested all the money into marijuana plants and now can't pay anything, then you would be screwed, but that's microeconomics now and I don't think anyone finds that situation unusual. It would be no different without fractional reserve banking.)

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Re: Is Interest a Scam?

Post by tadamsmar » Thu Nov 17, 2011 8:11 am

Isn't money always like an IOU?

If we did not have a formal system of money we could still trade IOUs.

So what if the IOU specified interest? Assuming it was not paid off in goods, then another IOU would have to be created to pay the interest. Some poor schmuck would have to get off his bottom and create something of value and then trade it for an IOU, or his goods just would have to increase in value so he could trade some for an IOU.

Now, back to the topic of government debt. If the government is gaining value then there is no problem with it writing additional IOUs. The value of a government is it's actual or potential tax base, I think.

An IOU might or might not be a scam. Depends on the issuer's ability to cover IOUs as needed.

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Re: Is Interest a Scam?

Post by zeugmite » Fri Nov 18, 2011 4:28 pm

rmelvey wrote:Gumby,

I think it is important to note the difference between bank money and state money. The introduction of state money increases net financial assets. Banks leverage this state money (reserves) creating bank money. The creation of bank money does not create net financial assets. For every bank dollar that is created there is an asset matched with a liability, netting out to zero. The increase in the money supply stemming from bank loans is quite different from an increase in the money supply coming from deficit spending.
Sure it does. Every financial asset is new money, or else how would leverage work? Given 1x in deposits, how did 9x worth of bank bonds additionally come into existence? Central bank money is not fundamentally different, it's just that the central bank is not subject to its own reserve requirement so it can be leveraged arbitrarily from the deposits of member banks.

And Gumby's point regarding the relationship between interest payments and money supply causing bankruptcies during deflation, well that's why the response has been to cut interest rates and increase central bank leverage. Interest itself isn't special or separate, it's the value of the bonds declining. If it declines too much, esp. below the original loan amount, then you need negative interest rates to "get to" its value for them to be "paid off."

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Re: Is Interest a Scam?

Post by Specialized » Fri Nov 18, 2011 5:47 pm

rmelvey wrote:I think the biggest scam is the ignorance about this truth you bring up. The United States needs to maintain deficit spending if it hopes have net private sector saving and a growing economy.

Government surplus are not sustainable. It is disgusting for me to hear politicians talk about our "debt problem." They just haven't had a serious philosophical introspection for longer than 5 minutes in their life...

If they just thought about our system, how it actually functions, they would realize that surpluses should only be used very sparingly and are neither "good" nor "bad."
Hmmm, Greek debt-to-GDP is about 170%, at least before their "voluntary" default. Why isn't their economy doing great? They've had massive deficit spending for a decade.

Japan's debt-to-GDP is well over 200%. They've been running huge deficits since about 1990, yet they haven't had much luck in the "net private sector saving and a growing economy" department.

Prior to the Great Depression, the US Federal deficit was tiny except during wartime. Yet, the US experienced massive economic growth from its inception to the 1930s.

This didn't take me five minutes, and it might not qualify as serious philosophical introspection, but it's quite obvious that deficit spending doesn't guarantee a growing economy and a balanced budget doesn't result in a stagnant economy.

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Re: Is Interest a Scam?

Post by FNK » Fri Nov 18, 2011 9:03 pm

zeugmite wrote:Sure it does. Every financial asset is new money, or else how would leverage work? Given 1x in deposits, how did 9x worth of bank bonds additionally come into existence?
Are we going "I can't hear you la la la"? Given 1x in deposits, you get 0.9x in loans. To get 9x in loans, you need 10x in deposits.

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Re: Is Interest a Scam?

Post by Gumby » Fri Nov 18, 2011 10:13 pm

Specialized wrote:
rmelvey wrote:I think the biggest scam is the ignorance about this truth you bring up. The United States needs to maintain deficit spending if it hopes have net private sector saving and a growing economy.

Government surplus are not sustainable. It is disgusting for me to hear politicians talk about our "debt problem." They just haven't had a serious philosophical introspection for longer than 5 minutes in their life...

If they just thought about our system, how it actually functions, they would realize that surpluses should only be used very sparingly and are neither "good" nor "bad."
Hmmm, Greek debt-to-GDP is about 170%, at least before their "voluntary" default. Why isn't their economy doing great? They've had massive deficit spending for a decade.

Japan's debt-to-GDP is well over 200%. They've been running huge deficits since about 1990, yet they haven't had much luck in the "net private sector saving and a growing economy" department.

Prior to the Great Depression, the US Federal deficit was tiny except during wartime. Yet, the US experienced massive economic growth from its inception to the 1930s.

This didn't take me five minutes, and it might not qualify as serious philosophical introspection, but it's quite obvious that deficit spending doesn't guarantee a growing economy and a balanced budget doesn't result in a stagnant economy.
rmelvey is actually correct. He is referring to MMT (Modern Monetary Theory), which takes far longer than 5 minutes to fully comprehend. As much as MMT makes absolutely no sense the first time you hear it...the more time you spend trying to refute it, the more it the fiat world seems to support its theories.

The best example of MMT I can give you is the following analogy (which I didn't write):
"MMT (Modern Monetary Theory) focuses on the way monetary systems such as ours operate and the implications from this knowledge.

Is MMT advocating a free lunch? Is it saying that we can simply spend our way to prosperity? No! It instead identifies the real as opposed to imaginary constraints on economic growth.

Think about our economy as of a car that needs to get from where we're now to its destination – Prosperity! MMT recognizes that the car has a gas pedal and a brake pedal and a steering wheel that if used right can get us to our destination. Think of the gas pedal as injection of money into the economy (also known as "spending"), the brake as removal of money from the economy (also known as "taxation") The driver is the government and it can steer the car in various directions. Other countries have their own economies, so, think of other cars sharing the roads with yours.

The "deficit-hawks" believe that big deficits are always bad. Deficit is the difference between spending and taxation. So, their position is similar to a belief that too much pressing on gas (without counterbalancing by braking) causes crashes. While it is true that if you go too fast you are more likely to crash, pressing on gas and going too fast are two separate things. For example, when the car is going uphill or stalling, you really need to step on the gas to get it moving. So, deficit hawks in their myopia ignore the road conditions. They concentrate on numbers that are meaningless without a context. Additionally, their fear of spending prevents the economy from realizing its potential. Either they'd have you press on the gas very gently (spend less) or brake too often (tax more), without realizing that they might be causing the car to move too slowly and by the time you'd get to the destination Prosperity – if you got there – the rest of the world was there long ago and left to even further destinations.

The deficit hawks don't know how the car really works. They don't even understand that the deficit should be automatically adjusted to road conditions. Imagine if somebody told you you should never press on gas continuously without braking for more than, say, 1 mile. You'd laugh and say: this depends on where you drive and a myriad of other things!

What MMT is saying, is that you should not be shy to press on the gas when needed, to press on the brakes when needed and to steer the wheel as needed. MMT allows you to take the full potential of the car, without imposing arbitrary constraints (such as "pressing on the gas is bad" or "pressing on the brakes is bad"). Is there a fool-proof way to get to the destination? No, there is always an risk and sometimes the driver will make a mistake and sometimes crashes can even occur because of other driver's actions. But have you ever seen a fool-proof system?"
Much like a US State or local government, Eurozone nations owe debt in a currency they can't print more of, so they can't take part in these MMT rules of a true fiat currency. In other words, States, local governments, and Eurozone nations have to be careful, because they can all run out of money. A true fiat currency is one where the governing body is sole producer of its own currency, maintains a free-floating exchange rate (i.e. no pegs to another currency), and does not owe any debt in a foreign currency. If those three conditions are met, and the military is strong, it is very easy for a country to maintain a very high deficit when unemployment is high. Japan, the US and the UK meet those conditions. Eurozone nations, US States and local governments do not meet those conditions (and they can run out of money).

For more information about MMT, see: http://pragcap.com/mmt-101-the-very-basics

Believe me when I tell you that MMT does a very thorough job of explaining why Japan can run high deficits and Greece cannot.

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Re: Is Interest a Scam?

Post by FNK » Fri Nov 18, 2011 11:02 pm

That's a very good analogy!

It also explains the risk that politicians will "press the gas" even when the car is going at a pretty good clip, just to keep the passengers entertained. E.g. 2001-2003 tax cuts that had very little economic justification, but a lot of ideology.

OK, OK, no talking politics.

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Re: Is Interest a Scam?

Post by CaliJim » Fri Nov 18, 2011 11:17 pm

patrick wrote: Step 1: You lend me 100 credits
Step 2: I buy some bright lights
Step 3: I repay 55 credits
Step 4: I use the lights to grow some marijuana
Step 5: I sell the marijuana to you for 55
Step 6: I repay the remaining 55 credits
LOL.

OK so... you have made a few mistakes here:
0) You took on a big risk for a 0 credit return
1) Grow the pot outside so you dont' have to buy lights. Savings=45 credits.
2) You are selling the dope too cheap. Increase your price to 100 credits. Increased profits=45 credits.
3) Net increase is business profits=90 credits.
You are of course conducting business in Peru, Urugauy, or Bangladesh?

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Re: Is Interest a Scam?

Post by CaliJim » Fri Nov 18, 2011 11:33 pm

On a more serious note:

Interest is simply the usage fee borrowers pay to lenders for the use of legal tender.

It is the fee paid for the value added by those who provide 'legal tender'

Without 'legal tender' we would have to barter our goods. Very inefficient. So we happily borrow and pay the fee (give up some of our profit) so that we can more easily conduct commerce.

It is easy to get tangled up in your shorts thinking about the money supply, the velocity of money, how it is created, government spending, supluses, deficits, taxation, etc etc.

While linked and manipulated by politicians, the mechanics of banking and money is really separate from the efficiency of government.

One could imagine an honest and compassionate society where there is a banking system, vibrant commerce, and no government at all. Government spending, surplus or deficit, is not a fundamental requirement to sustain banking and commerce.

Is this thread heading anywhere productive?

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Re: Is Interest a Scam?

Post by zeugmite » Fri Nov 18, 2011 11:43 pm

FNK wrote:
zeugmite wrote:Sure it does. Every financial asset is new money, or else how would leverage work? Given 1x in deposits, how did 9x worth of bank bonds additionally come into existence?
Are we going "I can't hear you la la la"? Given 1x in deposits, you get 0.9x in loans. To get 9x in loans, you need 10x in deposits.
I was talking about the money that comes out of one person making 1x in deposits. The first bank makes 0.9x in loans, meaning they created 0.9x worth of bonds. The 0.9x in loan money gets deposited again no matter what, then a second bank makes 0.81x in loans off of that, creating 0.81x worth of bonds, the loan money also getting deposited, off of which a third bank makes 0.729x in loans, creating 0.729x worth of bonds, and so on. Add it all up and you get 9x worth of bonds. Sure, the 10x of liabilities in the system is backed up by "assets", but 9x are financial assets in the form of these created bonds, and only 1x are the original cash deposits. If you read what I was replying to I'm saying it's not different at all from the central bank, with the exception of the leverage that is allowed.

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Re: Is Interest a Scam?

Post by zeugmite » Fri Nov 18, 2011 11:50 pm

CaliJim wrote:On a more serious note:
Interest is simply the usage fee borrowers pay to lenders for the use of legal tender.
It is the fee paid for the value added by those who provide 'legal tender'.
It is just profit (and loss) sharing. Borrowers want to make some investment, then the profit is shared with lender in the form of agreed-upon interest if successful, or the loss is shared with the lender in the form of defaulting if not.

It's borrowing to consume that becomes the problem, for both the borrower and the lender.

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Re: Is Interest a Scam?

Post by CaliJim » Fri Nov 18, 2011 11:56 pm

zeugmite wrote:
CaliJim wrote:On a more serious note:
Interest is simply the usage fee borrowers pay to lenders for the use of legal tender.
It is the fee paid for the value added by those who provide 'legal tender'.
It is just profit (and loss) sharing. Borrowers want to make some investment, then the profit is shared with lender in the form of agreed-upon interest if successful, or the loss is shared with the lender in the form of defaulting if not.
exactly.

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Re: Is Interest a Scam?

Post by zeugmite » Sat Nov 19, 2011 1:56 am

CaliJim wrote:
zeugmite wrote:
CaliJim wrote:On a more serious note:
Interest is simply the usage fee borrowers pay to lenders for the use of legal tender.
It is the fee paid for the value added by those who provide 'legal tender'.
It is just profit (and loss) sharing. Borrowers want to make some investment, then the profit is shared with lender in the form of agreed-upon interest if successful, or the loss is shared with the lender in the form of defaulting if not.
exactly.
Yeah, on a tangent -- since we sometimes discuss not going for junk bonds rather than equity -- interest, at least high interest, might still be a "scam" but for another reason than what OP says.

Something about high credit risk in bonds really bothers me. What could a high credit risk loan be used for? It's not going to be for normal investment growth since rarely do investments grow at that rate, but it's to pay off something, consume, or gamble, none of which a rational lender would want to participate in personally -- the first two have negative expected return, and the third, if it does indeed have positive expected return, is still ruled out since the lender is opting for a *bond*, rather than equity, which would make more sense for someone with a high risk/return profile. So the loan is flawed to start with. The only reason the lender would make such a loan is in the hopes that the loan itself shields the bad investment decision from the lender's own responsibility, in that a borrower could, if there are other assets, transfer those to pay off the high value of the loan (due to high interest), or if those assets are secured against the loan, relinquish them to the lender upon default.

So high credit risk bonds, if they were to work out, might just be a form of contractual asset transfer with little economic value. Maybe usury laws aren't such a bad thing after all... hmm, just some random thoughts.

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Re: Is Interest a Scam?

Post by sommerfeld » Sat Nov 19, 2011 3:25 am

Oicuryy wrote:
Gumby wrote:"Wealth" is not money.
Banks create and uncreate money as needed to facilitate the exchange of wealth.
In a fractional reserve banking system, new "money" is created not by banks but by the combined action of borrowers and lenders.

In the most basic form, a borrower signs a note promising to pay back the lender in the future; in exchange for the note, the lender gives cash to the borrower.

The note is itself an asset -- a thing of value; the lender can trade it to others in exchange for other things of value. The note's continuing value depends on the borrower's continued ability to repay. In short, the note is itself a type of money.

So in some sense it is not banks who create money, but borrowers.

zeugmite
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Joined: Tue Jul 22, 2008 11:48 pm

Re: Is Interest a Scam?

Post by zeugmite » Sat Nov 19, 2011 6:41 am

sommerfeld wrote:
Oicuryy wrote:
Gumby wrote:"Wealth" is not money.
Banks create and uncreate money as needed to facilitate the exchange of wealth.
In a fractional reserve banking system, new "money" is created not by banks but by the combined action of borrowers and lenders.

In the most basic form, a borrower signs a note promising to pay back the lender in the future; in exchange for the note, the lender gives cash to the borrower.

The note is itself an asset -- a thing of value; the lender can trade it to others in exchange for other things of value. The note's continuing value depends on the borrower's continued ability to repay. In short, the note is itself a type of money.

So in some sense it is not banks who create money, but borrowers.
True, in this view, banks are just middlemen and gatekeepers. If it were merely consumption stream exchanges it would be fine. Some people don't want to consume now, and some people don't want to save now, so they swap. A bank merely facilitates this by monetizing the latter's payment stream and doing stream matching. Technically, money has been created but the wealth was always there. It was just hidden and not put to good use without a loan being made. This is all fine and legit.

The problem arises when banks also price and sell risk. Often risk is packaged into the payment stream by the nature of the instrument but conceptually it's separate, and in fact, nowadays get factored out by derivatives. In the old days banks would try to make get rid of risk by making relatively safe loans, perhaps as it should be. More recently, they figured out they could make unsafe loans, if they just accounted for the price of risk. Some people apparently want to buy risk, amazingly. So the secondary business of risk matching has been quite profitable, because risk often *doesn't show up* until much later and so can be sold for more than it's worth! This is where the "scam" potentially lies -- again, not in the part of the interest relating to enterprise gains, but the part relating to credit risk.

The conceptual reason why buying and selling risk shouldn't work without a downside is because, while some people (e.g. insurance companies) have more resources to absorb losses from risk and so they might buy it for a price, such spreading out of risk still doesn't change the fact that, once risk is a product, it *will* get mined from everywhere to be sold, and the overall risk in the economy goes up. You hope that more risk is in exchange for higher expected growth (just as in a portfolio), but you never know, because risk is much harder to price than payment streams, and despite using fancy models banks have totally, and I mean, totally failed to give the right price on this.

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CaliJim
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Re: Is Interest a Scam?

Post by CaliJim » Sat Nov 19, 2011 12:54 pm

zeugmite wrote:risk is a product, it *will* get mined from everywhere to be sold
interesting way of looking at it

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