Some thoughts on usury, money and the banking industry.

nesf

This is some very basic economic thinking and reasoning, but I thought it might be of interest to a few people. Feel free to tear my arguments apart! I love debate

On a different website I was asked this question:


Isn't it true that the federal reserve is not even a government agency,
but rather an international group of wealthy bankers. If the Fed
reserve is printing money for our gov't to use, and we are paying them
back with interest.. then who are the people who are benefitting from
this interest payment? doesn't seem right to me. Am i oversimplifying
the picture? is there much more to it? please help me out here or point
me to where i can get some better answers on this topic. thx



Ok. Where to start! First off, what is money, and what does it mean in our present day society?

Ok, I'm going to keep things simple and just outline the main points. To start with throw away the inbuilt reaction that money has some inherent value. It doesn't anymore. It used to have one though, just not in the past 30 years. In the past 30 years (and longer) the majority of currencies of developed economies have become unfettered. That meaning that they are no longer tied to a physical quantity of precious metal. Now this concept is quite important and I'm going to take a few moments to explain it fully.

First off, lets look at the concept of a currency pegged to a "gold standard". This was what modern currencies were like before "modern" revisions. What this meant was that each dollar/pound/euro/whatever had an intrinsic value that was measured by a set quantity of gold. Each dollar was worth a specific quantity of gold and this relationship was immutable. This meant that money was merely a handy way of carrying around quantities of precious metal. If you want you can view money that is pegged as a refinement of the barter system. When you were paid for work with a pegged currency, what effectively happened was you were paid an amount of currency equivilant to a certain weight of gold. For all intents and purposes, you job "earned" you a certain amount of gold each week and the currency was just a convenient way of handling this transaction without the need for carrying around quantities of gold on your back. If you wanted to, you could go to a central bank and exchange your quantity of local currency for gold (not really but conceptually at least). The currency had a real, intrinsic value to it measured in terms of it's fixed worth in physical goods. A dollar literally was a representation of "gold in the bank". Because of gold's rarity and inability to be manufactured, this meant that the actual value of the dollar was fixed. Now inflation occurs anyway because it is a natural economic factors. Inflation is part of a cycle of increasing wages and increased money in the system. The best way to think of money over time is in relation to the perceived necessary purchasing power of a certain member of society. For instance a skilled worker in a fettered currency economy can assume to be able to own their own house (at least in modern times). Anyways I digress.

Now in the 70's for the US, the dollar became unpegged. Basically in modern society a dollar is backed up in value by another dollar. A dollar no longer has an intrinsic value. It is just a concept.

Now the simple version of the story is as follows. What basically happens is the central bank (the federal reserve in the US) has a license to "print" money. It can create it out of thin air. It no longer needs to be have a gold deposit for each dollar printed. Think about this one. This means the following.

When a main bank creates a mortgage (or any other loan), a common misconception is that it is loaning out money that it has in it's vaults from other people's deposits. This is no longer true. A bank literally creates the loan money out of thin air. The bank is allowed do this because of the security on the loan (ie the house) gives this money created intrinsic value. *But this loan money did not exist prior to the creation of the mortgage!*

Now this seems to be ok. Seems. Since by writing the mortgage check, the bank is introducing X amount of currency into the economy in response to the physical creation of a product (ie the house). So it appears like there still is a physically tangible value to this money. Thus the money created is tied to something physical so therefore it still has value. Now the problem is that now we have more money in circulation than we started with. Therefore we have more money in existence. But the purchasing power of this money has to compensate for this, so we have a higher rate of inflation in response to this creation of money.

*This is the first problem. Having a fiat currency system where banks can create money at will, results in increased inflation rates proportional to the creation of new money through the issuing of loans.*

But at this point it's not too bad. That is until you look at what happens next. Now if I'm loaned X dollars in a mortgage, I have to pay back (say for simplicities sake) 2X dollars over the term of the loan. Now X dollars was created and introduced to the system as new money when I got my loan, so that much is accounted for. But where do I get the other X dollars from?

The short answer is other people.

So, looking at this again now. A bank creates a loan out of nothing and receives in return twice that amount back from me over a period of time. So effectively the bank makes a profit from both my repaying of the principle AND the interest. Now because of inflation and the reduction in purchasing power due to the creation of new money, the bank doesn't really make as much of a profit as appears. Since by creating the loan it reduces the effective purchasing power of the currency, it's profits are worth less for it having got them. It will still always make a profit, the interest will ensure that.

Now lets look at the interesting part of this loan, the interest. The bank effectively creates the money for free and gives it to us, and we then pay for this via interest. Now take a step back from this a second. If by the creation of the loan the bank decreases the value of the currency, but because of the interest reduces the amount of money that is "out there in people's pockets", what's going to happen? We have a funneling of value. Effectively the wealth of society is funneled upwards from the lower section of the population up into the upper reaches. Lets look at a practical example.

What basically happened in this country was that the banks about 10 years ago changed their stance from one of granting mortgages that were small in relation to the wage of the worker, to a situation where they started granting huge mortgages to just about anybody. House prices obviously shot up in response to this, and now we have a situation where we have a hugely overvalued and overinflated property market. Owning your own house is not what it used to be, nowadays with house prices the way they are, you are looking at a mortgage being a potentially bankrupting situation if there is a high increase in the basic interest rate (and yes that is looking more and more likely as time goes on). What has happened was that the banks got greedy and have effectively shot themselves in the foot, but anyways I'm off on a tangent.

The interest repayments require a person to go out into the world and compete with other people and come back with some of their money. Now on one hand, yes if you work you get paid money and this is how you make it. But essentially what happens is a competition for the redistribution of wealth. Think of it like this, it's a chain

Person works and earns money -> Person spends said money for goods and services -> Said spent money is then used to pay other people

and the cycle continues like this unabated. UNTIL interest is brought into the equation. Then we have a slightly more complex cycle.

Bank creates money and loans it to someone -> Person spends said money for goods and services releasing it into the economic system -> Person works and earns back some money -> Person spends part of said money on repaying the principle loan -> Person spends more of said money repaying the interest of the loan -> Person spends whats left of goods and services -> Said spent money is then used to pay other people

Now think about this for a second.

The money the bank creates is a zero creation event. Over time as the loan is paid back, this money is returned to the bank and cancels out it's original introduction to society. So the amount of money in circulation over the period of time of the loan, is not effected by the creation of the loan. However, the interest results in more and more money NOT being returned to the economic cycle because it is funneled away to the bank. Now think about it, if money is constantly being taken out of the system by the bank, and the only way new money is added is through interest laded loans, what is the only logical result for this situation?

Continued in the next post.... (damn post size limit!!)

nesf

The bank gets richer and the people get poorer. More and more wealth is transferred up the food chain to the top. As society progresses with a fiat currency system that allows usury, the wealth of this society is funneled upwards at a constant rate. Now here comes the illusion which is very clever.

The reason that the banks aren't being burned down by angry mobs in Ireland, the US and elsewhere is as follows.

1) People don't understand money. People don't know what actually happens. People are generally not that bright and accept the status quo.
2) Wages increase. Person A earns more money now than they did 10 years ago. Now the actual value of their wage has decreased, they don't have the same purchasing power that they used to. But they don't notice that because they have more money. The fact that it's worth less doesn't occur to them.
3) Credit. Banks love credit and consumers do too. Every developed nation (as far as I know), has a credit debt problem. Basically everyone except the very well off, spend most of their lives in debt to someone. A mortgage is a lifetime commitment, and not taken lightly. But credit cards bills, small loans hire purchase etc are taken out with abandon. People live on credit, not realizing what they are doing. Every time credit is taken out, interest is generated. Money or more importantly wealth is taken out of society and funneled up into the usurers, ie the banks. In the next 20 years the credit bubble will burst, ie the banks won't be able to underwrite any more credit and will just sit back and wait for people to pay off their debts. It is not going to be pretty.

It's not a situation of "wake up people" it's a, "I really can't see anything but disaster looming in the future" type of situation.

Money is not inherently evil, nor is it inherently wrong. Usury is the problem (ie the loaning out of money for interest). Usury was banned upon pain of death until the 1600's. Can you see why now? Usury just reallocates wealth upwards.

This brings me onto the topic of the economic reality of the service economy, and the problems that come with it. But I think I've gone on about this for long enough.

Anyone have thoughts on the above?

growler

" In the next 20 years the credit bubble will burst, ie the banks won't be able to underwrite any more credit and will just sit back and wait for people to pay off their debts. It is not going to be pretty."


what do you think will cause this sudden change in banking policy ? it wouldn't be in the interest of the banks to withdraw credit , it is more likely that interest rates would make credit undesireable and have obvious knock on effects on. Banks (at high street level) are answerable to their shareholders , the devaluation of the asset securities that they hold in the event of spiralling interest rates would have immediate and negative profitability impacts.

At central bank level in the EU interest rate are under a certain amount of political influence which is designed to protect the consumers from wild fluctuations. I'm not saying that it won't happen but I would be interested to hear what factors you think might cause the banks to withhold credit.

antoinolachtnai

You guys have missed something, economic growth.

Let's start with a straightforward currency, like the dollar, or the sterling. (The Euro is subtly different.)

The dollars or sterling you have in your back pocket are essentially a loan, a loan from you to the government. True, if you aren't a civil servant or government supplier, you probably didn't make the loan, but someone else did, and then traded the loan with you. You took it off them because you knew that its value was recognised.

Like any lender, you expect there to be collateral. Collateral is what gives your loan note its value.

As was said, there is no 'hard' collateral now, like there used to be with the gold standard. So where is the collateral?

It is much more abstract, but the value of a pound sterling is rooted in two things:

- the strength of the economy and

- the prudent management of the currency.

If the economy continues to grow, your money will largely hold its value, at least relative to the economy.

The risk is that the growth in the value of your money is undermined by inflation. Inflation is when the perceived value of money reduces. It generally happens because there is an oversupply of money for some reason.

If the currency is prudently managed, inflation won't be too severe (although a certain level of inflation is inevitable, if you have a fiscal policy that stimulates economic growth). The Central Bank manages the currency by regulating the money supply, which is the speed at which new money is printed. The money supply is mainly regulated by setting the interest rate. If you raise the interest rate, the money supply is reduced.

Now, the obvious thing to do is to basically stop or severely curtail the supply of money. This would ensure that there was no inflation.

This is essentially what they did in Argentina, where they locked the Peso to a hard currency. You could only get new money by international trade, i.e., by bringing in hard currency from abroad.

It didn't work. The reason was that there was an insufficient money supply to support the high level of economic growth that was going on within the Argentinian economy. So value was being generated (for example, by people building nice houses) but there was no way to issue currency to match that freshly-created value. Remember, the economy isn't just external trade; internal activity also matters. This is the reason why pegged currencies work in export-oriented economies like Singapore.

It's also gets to the heart of why gold-standard currencies don't work anymore. Most of the economy nowadays is based on knowledge and services, not on trading a finite amount of 'stuff'.

So to get back to the story, if you don't have a sufficient money supply, bad things happen. Most importantly, there is no money to invest in new ventures, building, and so on. As a result, there is no growth. Then we have real trouble. Economies, and more importantly, communities stagnate. All the wealth stays with the people who have it already. There is no opportunity to raise capital and build new enterprises, so nobody bothers.

So this is why the interest rate is low in Europe. It has to be, to allow growth in the major European economies, i.e., France and Germany.

I'm sorry to say that a lot of what nesf and growler say above is just plain wrong. I appreciate where they're coming from, but they really haven't done the reading to understand how things work. Some of the greatest howlers are:

Fallacy: The assumption that the economy is a zero-sum game.

It isn't. For example, when you borrow money to build a house, you can create new value. The value of a house is (or at least can be) greater than the value of the site, materials and labour. This isn't just a neoliberal view of the world. As it happens, this is a core socialist belief. Economic development results in real, tangible fruits, which can be shared amongst the people. (There is a legitimate environmentalist view which tempers this optimism a little.)

Fallacy: Interest rates are going to go up, just you wait.

Of course they will go up. But that's more a result of the fact that the rates are so low already and are bound to go up sooner or later, rather than anything we can actually see on the horizon. So I think you are panic-mongering here.

There is no sign of interest rates going up very much in Europe. They aren't going up for three reasons. The economy still needs to be stimulated. The euro is very strong relative to the Dollar, and an interest rate increase would result in the currency growing even stronger (as the higher rate would attract investors to buy euros). If you go back through boards.ie I said the same thing at the start of the year.

Banks can't 'create money at will'. They have to maintain a liquidity ratio.

Also, there is no political pressure on the European Central Bank. They are essentially a free-standing bank, separate from the EU and the governments. This is based on the successful Bundesbank model. Their brief is to manage the currency prudently. Some people would say there is too much emphasis on prudence, and not enough emphasis on stimulating growth.

Fallacy: There is loads of inflation.

I don't know where this inflation you talk about is. Inflation is low in the eurozone. I accept that there is inflation in Ireland in regard to services. However, many goods are coming down in price. Most of the inflation problems in Ireland arise out of government policy (restriction on supply, restraints on competition in groceries, increases in government charges and taxes and so on) not out of something bad that the banks do.

There is also inflation in relation to houses, obviously, but there are again some clear factors behind this in terms of population patterns. The reality is that when there are 1.2 million people between 15 and 34 in the country, many of them in employment and all waiting to buy a home, the price will go up. There is no banking system you could design that would avoid this.

Fallacy: Banks control the price of houses

That banks are lending money according to a concerted policy which is designed to make prices go up and drive consumers into unsustainable debt. If the Irish banks knew a sure-fire way of getting house prices to go up, they would buy mortgages books abroad put that policy into operation in the UK and european markets. Banks are highly exposed to property. They have no interest in putting themselves in a position where they end up with negative equity.

Fallacy: banks are pushing money on people to get them into debt.

It is true that money is easier to get than before. This is partly because of low interest rates, but also because lending is run nowadays as a business, rather than as an old-boys club (which is what it basically was until the '90s).

Fallacy: The credit bubble 'will burst' and the western world has a 'debt problem' which will end in tears.

If the credit bubble is going to burst, why hasn't it burst already in the US? The country has been awash with soft credit since the sixties, when credit cards were first introduced. That economy has been through a couple of economic cycles, and it still hasn't hit the wall.

I'm not saying there aren't big issues to consider, but there are many positive aspects to credit. If you need a car so you can get to work, it's empowering to be able to get a loan to buy it, even if it's expensive. If you can buy a washing machine so you have more time to spend with your kids, that's great. If you can borrow money to go to college and increase your potential to support yourself and contribute to your community, that's fantastic.

Fallacy: Purchasing power is decreasing.

This is just not true. Have you been in Argos recently? You can now buy two electric drills for the price you would have paid for one, similar drill in 1983, and that's without taking into account the decrease in the value of money.

To take the housing issue, lower interest rates mean that payments on houses aren't really that much higher than they were in the 80's relative to salaries. Remember, interest rates were well over 10 percent for many years and the currency was flying all over the place. A lot of that was because of poor management of rates, currencies and reserves. Now we have a Central Bank which knows better what it is doing, and this stuff just doesn't seem to happen anymore.

The same story can be told in any area - clothes, services, meals, etc. On the surface, prices look higher, but with the standards people expect nowadays, and the spending power mean that you can't really compare the new prices with the old ones. Granted, there are some areas where there are serious inflation problems in Ireland, but this doesn't have much to do with the banking system.

I know there are other places where what you say might be a bit more true, and where it is truly the case that people now aren't as well off as their parents. But this is not the case in a growing economy like Ireland. And I don't know if it's fair to blame the banking system where it does happen. In Germany, for example, the ECB is clearly trying to stimulate the economy. The same thing is going on in Japan. But you need more than economics to get growth - you need innovation, together with hard work and appropriate demographics.

Fact: People don't know much about money. This is definitely true. In fact, some people have antiquated ideas about how the whole system works.

nesf

Good post, I'll respond to it in full and back my points with references tomorrow when I have the energy.

I'll ask you to just remember one thing

My purpose here is to get conversation going and get people talking about investing, the markets and money. Not everything I post here as mod of this board is necessarily my own opinion or in fact serving any purpose other than to get people talking.

Not everything I post up here is my pet little project.

MrThrifty

As Jedward might exclaim, OMG! I know this post is ancient and apologies for reopening it but if it was genuinely written back in 2005 then I wish I'd read it back then! Bang on the money! I suppose the whole pensions bubble is another day's lecture...

On a related note, watched an interesting doc on TV recently which touched on the whole consumer credit thing called 'planned obsolescence'. Scary stuff!

BuffyBot

Please see the charter, re: dragging up old threads.