The Interest Myth Exploded
May 18, 2009 by Paul McKeever
I recently received a question from a reader concerning my post of October 20, 2008, entitled “Banking and Morality: 100% Reserve versus “Fractional” Reserves“. It reads as follows:
Take any Base money supply amount.
With FRBanking any increase in the money supply, and therefrom all money in circulation, is lent into existence, securing a loan amount (A) with a contract and [Promissory Note].
Between the loan contract and [Promissory Note] is an obligation to repay the interest on that loan along with the principal (A + B).
If ALL money in a debt-money system comes into existence as a debt, and if all loans require the repayment of a sum greater then the principal amount, then from where does the interest payment money come into existence?
This is partly covered in the Zeitgeist Addendum video, Part 1 [Note from PM: actually, the reader is referring to Part 2 of that video, at this point in the video].
Steven Lachance identifies the unpayable interest as the achilles heel of the debt money system, if you check it out here.
Your thoughts, please, if you are still posting on this subject?
The reader is referring to one of the oldest, yet most persistent, myths in the history of modern banking: what I’ll here call the “Interest Myth”. Essentially, as with all persistent myths, the Interest Myth consists of a mixture of facts and falsehood. The facts are:
1. All money is debt issued by banks (whether currency issued by a central bank, or credit issued by a chartered private bank).
2. Banks charge interest on every dollar of debt they issue.
3. Therefore, if the money supply (M) is equal only to the principal that must be repaid (P), such that M=P, then – at all times – there is not enough money in existence to repay all of the interest (I) in addition to all of the principal. In other words, at any point in time, M < P+I .
The falsehoods are:
4. Therefore, if P+I is to be repaid, additional money, equal to the amount of interest owing, has to be created by the banks. In other words, M has to be increased by at least as much as I.
5. However, because all money is debt, when you increase the money supply (M), you also increase the principal that must be repaid (P).
6. And, because banks charge interest on all principal, interest is also owing on the additional principal.
7. Therefore, the use of debt as money results in a situation in which the principal can never be repaid.
Upon this mix of fact and falsehood, any number of conspiracy theories has been founded for decades. What they have in common is the idea that: there has been a conspiracy, by bankers, to empower themselves – financially and politically – by making us all dependent upon a money system that turns us into indentured servants.
Who are the conspirators? That depends upon who is promoting the myth and who is their intended victim. The usual suspects are:
- Christians blaming “Mammon” (a devil) and warning that the world is doomed if we do not start praying the Rosary on a daily basis.
- “New World Order” conspiracy theorists, some of whom target one or more of the following: the Trilateral Commission, The Council on Foreign Relations, the Bilderbergers, Jews, Freemasons, “the Rothschilds”, “the Rockefellers”, Capitalists, Communists, (and on and on), or any mixture of any of the above.
- Other people who want something for nothing and believe, after reading about Clifford Hugh Douglas‘ “Social Credit” monetary system, that everyone could have something for nothing if we just adopted the Social Credit system (or one of its variants). See, as an example, the history of William “Bible Bill” Aberhart and the “Social Credit” party of Alberta (interesting note: the first student of Bible Bill’s bible school was Ernest Manning, who later became the Premier of Alberta. His son, Preston Manning, formed the Reform Party of Canada, which eventually morphed into the current, governing, Conservative Party of Canada).
A classic example of the use of the Interest Myth to found a conspiracy theory is a little comic book titled “The Money Myth Exploded” the story for which was written by Louis Even, one of the founders of the Pilgrims of St. Michael. The story is simple. A bunch of productive people are stranded on an island with no medium of exchange. A banker among them suggests that they borrow his paper money and repay it with interest. A while later, they figure out that the banker has tricked them by getting them involved in a collectively un-repayable debt. The comic book lays out the myth, roughly as described in 1-7, above.
I refer to “The Money Myth Exploded” not because I think it is a worthy read, but because the story actually demonstrates why the Interest Myth is a myth. There are two main problems with the Interest Myth, and each is illustrated by the facts of the story.
First, in the story, the banker does not participate in the economy except to lend money and to expect its repayment with interest; he is not trading. He buys nothing and consumes nothing. The key line is this: “And it’s money you’re asking for, not our products.” The banker might just as well be visiting from Saturn when he drops of the money, disappearing, and visiting again when he comes to collect it all plus interest. But, of course, that’s not how things work in the real world. Bankers are human beings, just like everyone else: they need food, shelter, clothing etc.. They don’t just lend out money: they trade the interest they receive for the goods and services offered by the very people to whom they lend money, and those people use their profits to pay others for goods and services (which others, similarly, profit), to pay interest to the banker, and to pay down principal they owe to the banker, over time. Bankers lend money to grocers, and clothing retailers…but they also buy groceries and clothing with the interest that they earn on the dollars they loan out. They use some of the interest to pay employees – – receptionists, secretaries, tellers, cleaners, security, etc. – who buy groceries and clothes. They pay some of the interest to power companies to light and cool the bank; to natural gas companies to heat the bank…and those power and gas companies pay employees…who buy groceries, and clothing, and gas, and electricity, etc. Yet, in the story, the banker somehow – without producing anything all year long, and without obtaining anything other than a shelter from his borrowers – eats, stays warm, gets from one place to another etc.
Second, in the story, the banker is expected to demand the simultaneous repayment of the entire money supply at some point. That is never the case in a real economy. People generally pay in installments of interest and principle but, more importantly, they do not repay all of their loans simultaneously. As some people pay-down principal, others take on debt. Old debt (i.e., money) is cancelled by way of repayment, as new debt (i.e., money) is issued by the banks to other borrowers. Note that, if all of the money were repaid: there would be no more money, because debt ceases to exist when it is repaid. Nobody, not even the banker, would have money if the banker called in all of his loans. Therefore, there would be no medium of exchange with which to satisfy/pay outstanding debts (such as interest, rent, etc.).
The entire story is silly. However, that which is wrong about the story is essentially that which is wrong about the Interest Myth itself. The Interest Myth rests on the implicit assumption that banks are not trading in the economy; that they exist and survive independently of the economy.
Now, all of that said, I know for a fact that the essential Interest Myth argument – that “there can never be enough money to repay the principal plus the interest when the money supply is debt” – can be a compelling one when it is first encountered. The argument is so easy to understand, yet so offensive, that ‘discovering’ it leaves one ready to believe that those who set up the debt-based money system did it precisely because “the principal plus the interest debt can never be repaid”, and because they wanted to enslave a nation. For that reason, I thought it might be helpful to my readers – including the reader who asked the question at the beginning of this post – to “explode” the Interest Myth, as follows.
On February 20, 2001, on Jon Chevreau’s now defunct wealthyboomer.com discussion forum, I was challenged to demonstrate how it would be possible for a person to borrow money and repay both the principal and the interest without any additional money being created. I gave a number of examples. The following excerpt includes just one:
Paul, if you wish please repost your example which you say proves that X can pay X+i.
Here is just one of the several examples I’ve posted, each of which demonstrate that $X+interest can be paid with $X. In this example, repayments of principal are not destroyed because your thesis is not that the elimination or reduction of the money supply makes it impossible to pay interest (that would be an easily supported thesis). Rather, your thesis is that $X+interest cannot be paid with $X, so we must always leave $X in supply to determine whether or not you are correct. Here we go:
Step 1: W = $0; M = $0; B = $0.
Because there is no money, there is no price system. No snow is expected for 10 weeks, so W (who shovels snow and cuts grass for a living) has nothing to exchange for M’s housekeeping services (one service per week) or B’s bread (one loaf per week).
Let’s see if W can repay $20 principal plus $2 interest in a system where all of the money supply – $20 – is issued by B to W as debt. Let’s make the following reasonable assumption: B doesn’t ask for all of the money to be paid at the end of one year. Instead, he asks to be paid in installments. Usually, they are monthly, but for ease of computation we’ll assume that B wants weekly installments of $22/52. Let’s again add-in person M.
Step 2: W=$20, M=$0, B=$0
Step 3: For 10 weeks after borrowing money from B, W does no work but buys bread ($0.50 per week) and maid services ($0.50 per week) for 10 weeks.
At the end of 10 weeks:
Over the next 42 weeks, the banker will receive $42 for his bread. He will also receive $17.77 from W as repayment of principle plus interest. W has $5.77 on hand. So both parties have to raise their prices enough that W can pay the remaining $12.00: each party has to raise his/her price by about $0.30. So, W and M will now charge $0.80 each per week for their respective services.
Step 5: At the end of the 52nd week, things look like this:
If my math is correct (and I’m quite willing to accept demonstrated proof that it is not), W has repaid both the $20 principle and the $2 interest on the $20 debt, and no extra money had to be created.
Now, you may argue that, because B is putting repayments of principal back into circulation without loaning them to anyone, the supply of debt money in my example is being converted into non-debt money, and that is correct. But it is entirely irrelevant. Were the repayments of principal simply re-loaned out to other persons by B, what was true for W (possibly at a later date) would be true for everyone else who rented notes from B: all, over time (and at differing times) would eventually be able to repay both their principal plus interest without B increasing the money supply.
Let the inevitable refrain of “but what you fail to realize, Mr. McKeever” begin…as it always has with this topic.