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Home » Blog Updates, Monetary Literacy 101

What are the three main effects of interest-based currencies?

Submitted by on September 17, 2010 – 4:00 amNo Comment

Until the 16th Century, Western Civilization prohibited the practice of charging interest on money on both moral and legal grounds.   In our modern monetary system, however, money is created by banks through loans issued with interest.   Though the full implications of the loans that create our money are seldom understood, their effects upon society are pervasive and powerful.  Three consequences of interest as a built-in feature of our monetary system are that (1) it encourages systematic competition among the participants in the system; (2) it continually fuels the need for endless economic growth; and (3) it concentrates wealth by transferring money from the vast majority to a small minority.

  • Encouragement of Competition –  When a bank creates money by providing you with, say, a $100,000 mortgage loan, it creates only the principal when it credits your account.  However, it expects a return of some $200,000 over the next 20 years or so.   The bank does not create the interest; it requires you to earn this second $100,000 through your interactions with others.  So, how does a loan, whose interest is never created get repaid?  Essentially, to pay back interest on a loan, someone else’s principal must be used.  In other words, not creating the money to pay interest is the device used to generate the scarcity necessary for a bank-debt monetary system to function.  It forces people to compete with each other for money that was never created, and penalizes them with bankruptcy should they not succeed.   The story of the 11th round illustrates the way interest is woven into the fabric of our monetary system and how it stimulates competition amongst its users.
  • The Need for Endless Growth – The main simplifying assumption of the “eleventh round” story  is that everything remains the same from one year to the next.  In reality, we do not live in a world of zero growth in population, output, or money supply.  The real process involves growth of all three.  The monetary system just takes the first slice of that growth to pay for interest.  In agrarian societies, one customarily sacrificed to the gods the first fruits of the harvest.  Now, instead, we give the first fruits of our toils to the financial system. In real life, population, production, and money supply all grow at different rates from year to year, making it much more difficult than in our eleventh round story to notice what is actually happening.  The monetary system acts like a treadmill, requiring continuous economic growth, even if the average real standard of living were to remain stagnant.  In short, the interest rate determines the average rate of economic growth needed to remain at the same place. This supposed need for perpetual growth is another fact of life in our modern societies.   This monetary system was created during a time in which nobody recognized any ecological or other constraints for indefinite and compulsory growth.
  • Concentration of Wealth – A third systematic effect of interest is its continual transfer of wealth from the vast majority to a small minority.  The wealthiest receive an uninterrupted rent from whoever needs to borrow to obtain the medium of exchange.   Interest by definition is a process that transfers money from people who don’t have enough of it (and therefore have to borrow it) to those who have more than they need (and who are therefore able  lend it). Conclusion: The three main effects of interest (competition, the need for perpetual growth, and unrelenting wealth concentration) have been the hidden engines that have propelled us into and through the Industrial Revolution.  Both the best and the worst of what the Modern Age has achieved can be directly and indirectly attributed to these hidden effects of interest — the apparently benign feature of our prevailing monetary system.