This is a very good point. Monte seems to believe that lending/borrowing at interest is unsustainable, and yet people have been doing just that since the earliest civilizations in Mesopotamia, even prior to the invention of writing. If the system collapses due to too much bad debt, it will just regroup itself in a slimmed down form.

My mistake. Therefore, as long as the population is growing, we do need economic growth to maintain a tolerable standard of living.

No, I don't. Never have said that. JD, if I wasn't a moderator, you would be on my ignore list. You muddy the threads you post on.

<Cough> <splutter>
If it collapses! Do you know what you're saying there?! Yeah no problem if it collapses, no problem at all. The world's financial systems collapse but it's no problem.

I don't understand how this condition (businesses having a 50% chance of failing to make money) is equivalent to a condition of no growth. That is, in a stagnant economy, production still occurs and businesses are still making money: they're just not making more money than last year.

If a completely stagnant economy seems to far-fetched to imagine, think of one in which some years the economy gets a little bigger, some years it gets a little smaller but over the long term (decades) it stays the same size.

Yes I agree I didn't make that point very well.

What I was trying to demonstrate is how in a recession, money is taken out of the economy. Ignore my rather clumsy paragraph above, but the central argument - that money can only be removed up to a point - still stands.

spot5050, if I bought a house for $100k with $10k down and the market dropped by 5%, I wouldn't care. It's a house. I'm not selling it today, tomorrow, or the next day. I don't understand how this is analogous to the entire economy and growth.

I'm not being purposely obtuse here. I think we're narrowing in on a very important question about peak oil. That is, if you accept the scientific arguments about oil depletion, what are the economic implications? As we understand that better, we can begin to address the critical question of how best to structure an economy in a world of diminishing natural resources. It's a continuation of MonteQuest's original question in this thread. Anyway, the whole thing seems to hang on this question that, for many participants in this thread, is still open. That is, is there some inherent quality in the money system that renders it unsustainable or unstable under a condition of no economic growth?

It is possible that under this condition, the debt burden continually increases to the point at which interest can no longer be paid. However, I have not yet seen an illustration of this assertion that convinces me it is true.

As a banker I think I would be quite leary of lending to a business that doesn't have any equity. The equity provides a buffer in case the business fails to make a profit. The loss is taken up by the equity and the bank still receives it's money +interest (unless the business makes so great a loss that it loses all it's equity and goes bankrupt)



As the banker I usually borrow from my depositors, as a bank I usually keep my reserves in the central bank ("the bank's banker") I lend out money based on the guarrantee of the reserves held by the central bank. But again as a business the bank also has to have some equity to buffer any losses associated with making bad loans. This requirement is set by the CAR (capital adequacy ratio).



Yes you may lend him money as long as the business man is taking most of the risk by having a large equity stake in the business. The equity stake is your guarantee that the loan isn't too risky. Similarly the CAR is the central bank's guarantee that you are not abusing your privledge to take in depositor's savings (with an implied guarantee that they will be bailed out by the central bank if the bank goes bust.).

Problems do arise in this system when the economy doesn't grow as quickly as expected but this is mainly because the risk of the loans and the size of the required equity positions wasn't estimated acurately. In other words there wouldn't be a problem with a shrinking economy as long as it is expected. The bankers could just change their capital adequacy requirements and continue banking.



This is sometimes the wrong thing to do. It was the course followed in the great depression and was the main reason the great depression was so "great". The current paradigm is to try and reflate the economy by pumping up the money supply. And Smiley has it right there that this may not be the correct course of action in response to a recession caused by resource depletion and so we probably should be more worried about the human control of the monetary system rather than the system itself.



I think I understand you here. You are talking about the equity buffer to the system being wiped out. But what happens if in response to the recession the banks increase their equity requirements for loans. This may increase the severity of the recession in one sense (being a sort of self fulfilling prophesy) but if the self fulfilling prophesy is avoided with some luck the new regime of higher equity stakes can compensate for the higher probability of the business failing to make money on the new venture and therefore leave the bank at the same level of risk.

Can the gearing be changed while in an extended depression? I believe it can as long as the central bank pumps money into the system to counteract the decrease in money supply inherent in changing the capital adequacy ratio. In other words while reducing the multiplier effect you increase the quantity of money the two elements may balance out, leaving your banking system on a sounder footing while not increasing the severity of the depression. If it was recognized that this depression was permanent it certainly would be a shock to our society that is accustomed to growth but the banking system may be able to handle the new situation if handled correctly.

There will still be opportunities to lend money. For example in home equity loans the bank would simply increase the downpayment required to insure that they would get their profit even if you lose your job and have to default on the loan. Bank lending doesn't have to be inherently riskier while the economy is shrinking.

GDP growth is an overall increase in the level of economic activity that creates monetary value.

What happens if your job disappears? Can you pay your car off then? What if 20-50 million or more lose their jobs can their loans be repaid?

When a whole bunch of people lose their jobs or have their incomes decreasing what does that do to the housing, car, food, clothing et el.. industries? In a worst case scenario it leads to a depression.

Well the system collapsing is a catastrophic event that has occured many times in the past. I wouldn't say that the banking system has a great track record of being stable. But I do think my point is valid that growth can't have been a requirement for the fraction reserve lending of money in the middle ages because people back then (including the money lenders) didn't even have the concept of progress let alone that the economy is expected to grow year after year. Yet they lent money to people and expected to (and did) make a profit.

Nero,

Let's take this one step at a time. Answer this question.

In a debt-based monetary system, if money can only get into circulation by borrowing it, then how can enough other money get into circulation to pay the interest on these loans if it is not borrowed as well?

Say, for instance, the money supply is currently zero. If a bank loans Person A and Person B $100 each and charges them 10% interest, the money supply increases to $200, yet total indebtedness increases to $220. As a result, the only way either one can pay the interest he owes is to capture a portion of the other person's loan principal through the process of commerce.

Thus, if Person A captures enough of Person B's loan principal to repay his loan plus interest, the money supply is reduced to $90. Of the $110 it receives from Person A, the only portion the bank can spend back into the economy is the $10 it receives as interest. Doing so increases the money supply to $100, leaving Person B with $10 of unpayable interest debt. At that point, the only way Person B can avoid bankruptcy is for someone else to obtain an interest-bearing loan from a bank, making it possible for Person B to capture the necessary portion of that someone else's loan principal to get out of debt.

Now, I have heard your polite fiction argument. Doesn't fly. Money the goverment spends into existence is from the sale of bonds or securites that they owe interest on, payable at a certain return on a certain date. And since these are mostly short-term bonds, I see no way that the bond yields are not paid. Polite fiction? NOT. This would require the government to sell bonds and go into debt equal to the entire outstanding interest on dollar denominated assets and do it for free!

In order to understand the basics of how the ecomomy works, it's necessary to understand a few terms like money supply, debt and gearing. The above was just an example to explain gearing in a way that everyone can relate to.

Take the principle of gearing and instead of thinking of a person buying a house, think of a business borrowing to expand itself eg. an airline borrowing to buy planes, or a manufacturing company borrowing to build a new factory, or a bank borrowing to finance it's lending.

Do you see now how borrowing to finance expansion can only work in an expanding economy?

You are talking about reserves as if they are fixed. They are not.


What do you mean "change their capital adequacy requirements"?


No it isn't. Pumping money into a shrinking economy causes inflation. Are you thinking of when goverments spend their way out of recession?


They will lend even less money.



That's gobbledygook! How can a central bank "pump money into the system to counteract the decrease in money supply"? Is that what you meant to say? Either central banks are releasing money into the system or they're taking money out, or they're doing neither. They can't be in both situations at the same time.


Great example. Lets use it: A bank gives you a 90% mortgage. The value of your house drops 20%. You lose your job and default on the loan. How does the bank get it's 90% back when the house is only worth 80% of what it was? Take it further: the banks realise that house prices are falling (temporarily they assume) and decide start only lending a maximum of 80%. However the recession continues and the value of your house drops by 30%. It never ends.

Well think back to my long lost Bob, Dick, the Bank Manager and Mary story. The status quo there was that with an intial start of 20 dollars the system was at steady state every month Mary borrowed 100 dollars paying 20 dollars interest. You didn't have to find a new 20 dollars every month you just had to get that initail twenty dollars into the system and it continued indefinitely. Similarly if the economy/money supply is not growing we can continue indefinitely loaning out money and paying interest on that money with the current money we have in the system. The key is that the interest received by the bank is spent on goods and services provided by other individuals in the economy.



Only the money from the sale of bonds to the Feds is new money. Other investors buy the bonds as well.
Here is link to an
2000 Announcement from the Fed reserve bank of New York on SOMA. SOMA stands for System Open Market Account and is the account the fed uses to buy and sell securities. The announcement deals with the problems that were to occur because of the future Federal government surpuses that were anticipated at the time. Here are some relevant excerpts:



This is explicitly saying they routinely roll over the government debt held by the FED.



Here is a good description of what SOMA is used for and describes the fact that the SOMA account increases in step with the money supply.

Forget your Bob, Dick, story. It is not reality and is confusing and doesn't hold water when the interest compounds anyway. This is reality:

Say, for instance, the money supply is currently zero. If a bank loans Person A and Person B $100 each and charges them 10% interest, the money supply increases to $200, yet total indebtedness increases to $220. As a result, the only way either one can pay the interest he owes is to capture a portion of the other person's loan principal through the process of commerce.

Thus, if Person A captures enough of Person B's loan principal to repay his loan plus interest, the money supply is reduced to $90. Of the $110 it receives from Person A, the only portion the bank can spend back into the economy is the $10 it receives as interest. Doing so increases the money supply to $100, leaving Person B with $10 of unpayable interest debt. At that point, the only way Person B can avoid bankruptcy is for someone else to obtain an interest-bearing loan from a bank, making it possible for Person B to capture the necessary portion of that someone else's loan principal to get out of debt.