Why interest-bearing loans do not create an ever-increasing demand of money

I sometimes hear it claimed that the practice of charging interest causes an ever-increasing demand for money. The argument goes, since principal plus interest is more than principal alone, money needs to be created (by taking on a new loan) in order to pay back the loan. It is then claimed that this creates a vicious circle of ever-mounting debt. The argument is fallacious and demonstrates a fundamental misunderstanding of the nature of money. If, as is indeed the case, money can be reused, there is no vicious circle. Consider the following gedanken experiment.

Suppose I loan you twelve twenty-euro notes for one year, with principal repayment every month and interest totalling twenty euros due at maturity (that is, at the end of the year).

For simplicity, let’s assume you do nothing with the money, just sit on it. Every month you come to me and give me one of the notes I loaned you.

Assume for simplicity again that I do not do anything with the notes I receive from you, I just sit on them.

At the end of the year, you have one twenty-euro note and an obligation to pay me fourty euros (the last installment of principal, plus the agreed interest). What do you do?

One thing you could do is come to me and ask for a further loan. That could be done, I could give you one of my hoarded twenty euro notes and you could then retire the original debt (albeit with a new twenty-euro debt). But this is not the only option.

Another option is that you mow my lawn a couple of times. The wage we agree on is fourty euros in total (assume for simplicity that there are no taxes etc). You do the work, I give you two of my hoarded twenty-euro notes; you now have sixthree of them, one left from my loan and two that I paid you with. Now you can pay the last installment of the principal and the interest. End result: you are no longer in debt, and you have a twenty-euro note that you can do whatever you want with.

Neither scenario required the creation of new money.

24 thoughts on “Why interest-bearing loans do not create an ever-increasing demand of money”

  1. At the end of the year, I have 1 note. The I mow your lawn, you give me two notes and I “now have six of them”. You meant three, right?

  2. Hold on, why did the bank have the original 240 euros? It was made from nothing. So how in the end, is the one who took the loan, still indebted to this banker. All the banker did was sit on his ass and wait for the loan to return, and then he commenced the other person as his slave to work his lawn? A slave for the sake of nothing. For pieces of paper, of imaginary value reinforced and regulated by the powers that be, who also happen to be under the influence of the bankers.

    So when was the last time you mowed the lawn of the European Central Bank anyhow?

    This is a critical problem of your thinking. You proclaim that as the central bank creates money and loans it, when the loan is paid back, the central bank could use this money to fund new projects, pay themselves bigger salaries etc. I’m sure they can do part of that because the books of a central bank are probably top secret indeed, but..

    No. Consider the multi-billion nature of loans, and you easily figure out this is false. If the central bank could use the returned money outright, we’d have hyperinflation from the use of that money. It wouldn’t make sense.

    When a loan is paid back to a bank, the loan money is extinguished from circulation.

    The question is, what happens to the interest? Part of it is paid as interest for those people who invested in the securities, which were given when the bank gave the money as a loan. But only a part of the money supply can go and buy those securities. So not all of the loans that comprise the money supply can be bought, but a fraction can be. And the buyers are those of the greatest wealth. And as we pay our taxes, the government pays public debt interest, and that interest must partially go to these already wealthy individuals, further reinforcing their wealth, where their interest compounds into ever greater numbers.

  3. Hold on, why did the bank have the original 240 euros?

    It doesn’t matter. The story works however the money was originally obtained.

    The “I” in the story was not a banker, by the way. But the story works even if the “I” had been. Notice that no account (deposit) money was involved; it was all physical (“base”) money which a banker (except for the central banker) cannot create.

    Even if the “I” was a banker and the money had been account money created by him, the story still works in all essential respects. It’s true that each payment would then decrease the money supply, but the money supply in the story never needs to exceed the original loan amount (which is the point of the story). Notice that the interest payment is, in the “mow lawn” version, made by using money which the mower is not in debt for.

    So when was the last time you mowed the lawn of the European Central Bank anyhow?

    I never did. Mowing lawns is not my specialty. I, however, am paid a salary by the University of Jyväskylä, which in turn is largely funded by the Finnish state, which in turn is partially funded by the ECB’s profit through the Bank of Finland. Thus, a portion of my salary comes indirectly from the ECB (not by debt, but by a dividend-like payout).

    Other ways the ECB provides money to others in a non-debt manner are direct salaries and wages paid to its employees (yes, including Jean-Claude Trichet) and payments to contractors (such as building constructors). And there’s one other manner: the ECB pays out interest on deposits.

    This is a critical problem of your thinking.

    There is no problem in the thinking. Your thinking, however, seems to be muddied by moral outrage. This is a technical issue, not a moral one, and your moral objections have no bearing on the issue.

    the books of a central bank are probably top secret

    I doubt they merit a Top Secret classification, but like the books of any corporate entity, access to the books is restricted. However, the ECB publishes annually an audited report, and weekly financial statements. They aren’t hard to locate.

    If the central bank could use the returned money outright, we’d have hyperinflation from the use of that money

    This statement is false, and since you did not provide any argument for it, I need not argue against it.

    Part of it is paid as interest for those people who invested in the securities, which were given when the bank gave the money as a loan.

    I cannot make sense of this statement, and of the stuff that follows it. Are you perhaps confusing loan security with securitized loan? They aren’t the same thing.

  4. It doesn’t matter. The story works however the money was originally obtained.

    Why doesn’t it matter? The euro is not backed by anything, and the central bank is not a government entity. It is a fraud.

    I never did. Mowing lawns is not my specialty. I, however, am paid a salary by the University of Jyväskylä, which in turn is largely funded by the Finnish state, which in turn is partially funded by the ECB’s profit through the Bank of Finland. Thus, a portion of my salary comes indirectly from the ECB (not by debt, but by a dividend-like payout).

    If we do get paid dividend, then why worry about national debt? Then why would all the nations be in debt at the same time? Shouldn’t most of the debt money come back as a dividend?

    Prove that ECB funds major projects in the economy, worth millions of euros, without any interest charged. Show me the dividend too, I have not heard of that before. Can you really prove this?

    If the central bank could use the returned money outright, we’d have hyperinflation from the use of that money

    This statement is false, and since you did not provide any argument for it, I need not argue against it.

    You just skipped my argument: the loan money is extinguished from circulation upon repayment. If the loan money was not extinguished, the banks would gather enormous amounts of money from just making new loans. This would mean the bank would have as much profit as it put out on loan. And there would be no limit to the ability of issuing loans, because of the 9:1 reserve requirement, + that with each loan being paid back, their reserves would just grow infinitely.

    For example, a bank had 10 euros. It could loan out 9 euros, that would be paid back, the bank would have 19 euros, it could now loan 17 euros, then after that it would have 36 euros reserves already + all the interest on those loans. Not gonna happen that way.

    And my final point was, that in this system, you can invest in the bonds that are issued by governments. The only way for government to acquire money is to issue a bond, or collect existing debt money from the system. Either way, someone is in debt to bankers. Now, those with existing debt money in quantity, whether by business, inheritance or whatever, can buy those bonds, which make a profit for them. They are now in a positive inflow of money and compounding interest. Meanwhile the state, now in debt, and the citizens and corporations also in debt, need to make more money. They can either work for the one who owns the bond to get some of his money, or they can issue new bonds to pay their existing debts among themselves. But this only allows for the previously rich outsider to buy more bonds. So not only does this system perpetuate growth, it perpetuates the gap between the rich and the poor. Or more historically, it is simply called usury.

    What’s more crazy is that the money-cycle expands and demands growth outside of the need of real things of value. So, everywhere people are working for things they don’t actually themselves need, but they simply have to work at something to live in this system, because of the chronic lack of money. They are attempting to make others consume more, to take more loans/work more, just so they themselves can pay their expenses and debts away. But the only ones who benefit are the bond owners, oligarchy. And you are telling me we get dividends from ECB? Holy shit.

    Hey, the quantitative easing means that the FED is actually buying back those bonds: inflating the money supply. It is actually the right thing to do. ECB has only done very little of that. But the basic truth is that the system sucks donkey balls no matter how you rotate it.

    http://issuu.com/scenix/docs/sistema_monetario

  5. Why doesn’t it matter? The euro is not backed by anything, and the central bank is not a government entity. It is a fraud.

    Because it doesn’t. If you want to pursue this, please demonstrate how it matters in the story.

    Show me the dividend

    I’m not here to do your homework for you (and it’s clear that you haven’t studied the ECB at all). But I’ll answer this question.

    http://www.ecb.int/press/pr/date/2010/html/pr100304_1.en.html: The ECB’s surplus (profit) for 2009 was 2,253 million euros, which was distributed to the national central banks in toto in early 2010.

    Under ECB rules, the distribution would have been based on a national central bank’s portion of the fully paid up ECB shares; Finland’s portion would have been 1,8 %, or about 40 million euros. I haven’t found an actual statement of Finland’s portion, but for the general rule, see http://www.ecb.int/ecb/orga/capital/html/index.en.html .

    The Bank of Finland receives most of its income from implementing ECB policies in Finland (such as offering central bank loans to Finnish banks according to ECB’s policy). It also receives its share of ECB’s surplus, as above.

    http://www.suomenpankki.fi/fi/suomen_pankki/ajankohtaista/tiedotteet/Pages/tiedote11_2010.aspx: In 2010, the Bank of Finland gave 260 million to the Finnish state in a dividend-like payment (“tuloutus valtiolle”). This was reported in the financial press; see for example http://www.taloussanomat.fi/rahoitus/2010/04/07/suomen-pankki-tulouttaa-valtiolle-260-miljoonaa/20104900/12 .

    You just skipped my argument: the loan money is extinguished from circulation upon repayment.

    Ah. I didn’t take it for your argument, because it doesn’t make any sense.

    In the story, the money was physical (it was actual banknotes), it wasn’t account money. That money is not extinguished when the loan is paid back. The loan-giver (whether a banker or not) is certainly able to use that money as he or she wishes without triggering a hyperinflation event.

    The rest goes beyond the topic of this blog post, and I’m not interested in pursuing it at this time. (I reserve the right to revisit it in a separate blog post, however, because the issues you raise are certainly worthy of consideration.)

  6. But I do think we are still paying vastly more interest on existing debt, than a few million in dividend can cover. If public debt is 70 billion, just 1% of that is already 700 million. The dividend is not 100%, and as such, as long as it continues, more debt has to be taken to keep the system liquid.

    The M1 figure is what the central bank has loaned to commercial banks.
    In 2009 this figure was: 3 718 billion euros
    https://stats.ecb.europa.eu/stats/download/bsi_t02_03_nsa/bsi_t02_03_nsa/bsi_t02_03_nsa.pdf

    Now the ecb essentially loans the banks money, which is then deposited at the central bank, for a small income. But the interest on the loan exceeds the income. The interest for the loan is now either 1% or 1.75% (strange for there to be 2 different rates posted on their site), while the interest for the deposit is 0.25%. So the ECB is collecting from the system 0.0075*3718 billion euros, which is 27.885 billion euros of… “profit” for the central bank.

    Considering it pays dividend of 2.253 billion, there is a very large gap here, and it can’t really all be just Trichet’s pay.

    Furthermore, even I don’t understand the system, and finding information on it is difficult, but I don’t have to understand the system, but rather think of it as a black box. If we stop taking loans, does more money flow into the bank than flows out of it, or are they in perfect balance? If they are in perfect balance, why does the economy have to grow every year in this system?

  7. But I do think we are still paying vastly more interest on existing debt, than a few million in dividend can cover.

    If by “we” you mean Finnish state debt, that’s true. As I wrote above, the state debt interest is about 2000 million. But I think 260 million is a bit more than “a few million” :-)

    The M1 figure is what the central bank has loaned to commercial banks.

    No, it’s not. What you are describing is “base money”, also called “monetary base” or “M0″. M1 is currency in circulation plus overnight deposits (in all MFIs, not just central banks), so it includes checking accounts (käyttötili).

    The interest for the loan is now either 1% or 1.75% (strange for there to be 2 different rates posted on their site)

    The 1% is for normal loans (with maturities of one week or three months, usually), the 1.75 % is for overnight emergency loans (a penalty rate, so to speak).

    So the ECB is collecting from the system 0.0075*3718 billion euros, which is 27.885 billion euros of… “profit” for the central bank. Considering it pays dividend of 2.253 billion, there is a very large gap here, and it can’t really all be just Trichet’s pay.

    Your numbers are wrong since you’re using M1 and not base money. But there’s a bigger problem with your calculation: the ECB doesn’t conduct most loan operations, the national central banks do. Thus most of the interest paid by Finnish banks accrues directly to the Bank of Finland.

    You may find the ECB Annual Report illuminating. The ECB financials are at the end of the document. See http://www.ecb.int/pub/annual/html/index.en.html

    I don’t have to understand the system, but rather think of it as a black box

    True, as long as you refrain from commenting on the insides of the system.

    why does the economy have to grow every year

    There are multiple answers to that question.

    At one level, it doesn’t. In fact, in the long run the economy only grows as a result of two things: population growth and innovation. The former explains economy growth in toto but not growth per capita. The latter explains growth per capita. In the short run, a post-recession economy grows for a while because unemployed people and capital are finding employment; but without population growth and innovation, the economy growth stops when everyone and everything is happily employed.

    At another level, it does. That’s because growth per capita creates opportunities. A per-capita stagnating economy means that there are no new opportunities, and one can get ahead only by waiting for others to retire (or die). A per-capita contracting economy is a game of musical chairs: opportunities (chairs) are being taken away, and someone must lose.

    Now, debt can cause one to wish for growth. The reason is, if your income grows, it’s easier to pay down the debt. But it’s a fallacy to think that debt would require growth: you can always pay off debt so long as you have more income after necessities to service interest and some pricipal, and that does not require growth.

  8. Ahh well I just couldn’t find the M0 figures, so I thought M1 is it.

    Anyways, you go and try find those M0 figures. I can’t find them anywhere.

    http://www.wikinvest.com/wiki/Money_supply
    According to that, the eurozone doesn’t even list M0. Pretty scary huh?

    And I think you are missing the bigger picture when you think that the loans don’t create more loans. As you can see, the dividend is not 100%. Additionally, at any one given time, there is more debt demanded back, than there is money in circulation. And if all debt was paid, there’d be no money.

    You should try watching some of the very indepth documents made on the subject: Money masters, Money as Debt, or the lectures of Gold Rush 21 conference. They can tell more than pdf-files from ECB, which are either plain numbers, or plain propaganda in text form.

  9. According to that, the eurozone doesn’t even list M0. Pretty scary huh?

    Not scary, boring. As in, nobody cares about M0. In any case, a rough number can be figured out from the latest weekly financials release at http://www.ecb.int/press/pr/wfs/2011/html/fs110222.en.html: adding together items 1 (banknotes in circulation) and 2 (monetary policy related nonphysical euros created by the ECB) yields 1.153 billion euros.

    Additionally, at any one given time, there is more debt demanded back, than there is money in circulation.

    The total value of all outstanding debt probably is much larger than money in circulation. I’m not sure if that’s what you mean, or the amount of interest and principal due at a particular day. In any case, ‘s not a big issue; there is no vicious circle of debt creation.

    if all debt was paid, there’d be no money

    True for fiat money such as what we have now. So what? The real issue is whether there is a vicious circle of ever-increasing debt creation; as my story demonstrates, no such vicious circle is created by the mere demand of interest.

    You should try watching some of the very indepth documents made on the subject: Money masters, Money as Debt, or the lectures of Gold Rush 21 conference. They can tell more than pdf-files from ECB, which are either plain numbers, or plain propaganda in text form.

    You know, I’d recommend that you read a good introductory economics textbook. You don’t have to buy its arguments, but please give it at least a chance.

    As to the documentaries, I don’t believe they’re useful. It’s much easier to brainwash a person via a documentary film than via a book.

    I’ve watched one (I believe it was Money as Debt, but I haven’t checked recently), after someone recommended it to me. I wouldn’t call it “in depth”. What it was was a propaganda piece which contained some good solid information and lots of indoctrination. I am fortunate that I had already examined the issues myself prior to watching it; if I hadn’t, the film probably would have succeeded brainwashing me into a conspiracy theorist.

  10. How about conspiracy fact? And I truly wonder who is the brainwashed one. I’m not one to buy claims without proper support for them. History is literally awash in what would today be called conspiracy theory. Do check the US early presidents’ opinions on central banks. Andrew Jackson or Abraham Lincoln or Thomas Jefferson. I suppose they never got their dividends. http://en.wikipedia.org/wiki/Andrew_Jackson#Opposition_to_the_National_Bank

    So you see, these things go wayyyy back.

    Btw, your M0 figure can’t be right. Only 1153 million? 1% of that is roughly 11 million. But the total dividend was over 2000 million. What?

    In your example the debt is paid back timely, and the interest worked off for the central bank. Your example ‘works’. But in reality, the national debt just keeps piling up on top of the old debt, and the interest becomes somewhat of an ever-increasing yearly burden. And because the interest is a pure leech in the supply of money, more money has to be loaned to satisfy the need for credit. The money is loaned either by private entities, who are then taxed, or by government.

    I think this is easy to see, because when times are bad and the people are not taking loans, the government steps in and starts taking those loans for them, and spends them in the economy. If what you said actually worked in real life, the government wouldn’t have to do this. But in all honesty, the whole system would collapse in a systemic shortage of credit due to the existing interest on existing debt. And because the trend of the national debt is up, and the amount of interest is up, then it is easy to conclude that overall, the amount of new debt has to rise to satisfy the interest when taxes aren’t enough. If the dividend was 100% none of this mattered. So, I don’t think the M0 is boring at all. Tracing the M0 interest and the dividend are pretty vital stuff:

    For as long as there is money in circulation, there is also debt that has an interest demand. Money supply is steadily shrunk by this interest. Dividend needs to be 100% the amount of the interest, or someone in the system has to loan more to keep the ponzi afloat.

    Our dividend isn’t 100% the interest. But more like 13%. So, where do the rest of the money go? Government loans the money from commercial banks. This is in law, can’t loan from ECB. So the interest goes to some JP Morgan first and its profit, and after that a little for ECB. So maybe the ECB does pay its dividends a-ok, that just isn’t what we loaned! Man in the middle attack!

    What makes the squeeze are the rich individuals, owning bonds which promise to pay a sum. These people collect interest on top of interest, and are not about to lose any wealth. When people stop taking loans, these bonds still apply, and all the rest of the money flows to these bond-holders. Because they expect a growth on their bonds of some x% that is more than the allowed inflation, this inevitably leads into the need to make more money, but because of the inflation requirement, to also grow in the real world of things as well. More wood needs to be cut etc. This would explain why such a small percentage of money is actual money in circulation. Whereas the M2 and M3 have grown rapidly, the M1 has been left proportinately behind. There is a lot of “mickey mouse” money on the books of some wealthy individuals.

    Bonds and leveraged debt packages and what have you are toxic. They are going to tank once there is no more oil, no more patience in the people to grow the economy and do whatever it takes for a fistful of euros to please some bums at the top. Party hard!

  11. How about conspiracy fact?

    If you know any, I’d be interested. However, do remember the old dictum, “one can keep a secret; so can two if one of them is dead”. A large conspiracy is nearly impossible to keep afloat for long, and thus such claims, to be taken seriously, require compelling evidence.

    Do check the US early presidents’ opinions on central banks. Andrew Jackson or Abraham Lincoln or Thomas Jefferson. I suppose they never got their dividends.

    First of all, a central bank dividend is a very old concept. It used to be called seignorage, back when governments were too disorganized for effective tax collection; kings would protect their privilege of issuing currency quite jealously because it was one of their few effective ways to raise revenue. In England as late as the 18th Century, counterfeiting coins (or even merely possessing equipment for it) was high treason, punishable by death.

    Of course, counterfeiting money is still a crime, but it’s not considered treason.

    Second, I’m aware, in general terms, of the monetary history of the United States of America.

    Btw, your M0 figure can’t be right. Only 1153 million?

    Check again. It says “billion” above (and no, I haven’t changed that).

    As to the rest, it is predicated on a faulty assumption (which we have discussed over and over again here) and thus requires no comment. But I will say this: I’m not saying – and I never have said – that debt is always and in all circumstances a good thing. Believing that debt can be harmful does not require one to believe in monetary fallacies.

  12. I didn’t read all the comments so I’m sorry if this has already been dealt with. The story is misleading because it doesn’t show the whole picture. Of course some individuals can pay their loans back because they can use money created by other peoples loans. Essentially all money is created by interest-bearing loans, so there is always more debt than money. If two persons both loan 1 and have to pay back 1,1, there is 2 money and 2,2 debt. One of them can work for the other and gain 0,1 so he can pay his debt. But the other one only has 0,9 now and can never pay back. It doesn’t help if he mows the banks lawn, because the original 1 of the lucky persons loan has been wiped out. The bank only has 0,1. It doesn’t matter how many people are involved. Someone always has to lose in this game of musical chairs.

  13. Your assumption that working for the bank does not help is faulty.

    In your scenario, there are three actors, A, B and C. A has 10 cash and owes B 11 cash. C has 10 cash and owes B 11 cash. B is owed 22 cash but has no cash (but being a bank could create it if it wished). The total of cash outstanding is 10, the total of loans outstanding is 22 cash.

    Let’s say the following sequence of events happens:

    A works for B, for a wage of 10 cash. Now A has 20 cash and owes B 11 cash. C has no cash and owes B 11 cash. B is owed 22 cash but has no cash. The totals are unaffected.

    A kills his debt. Now A has 9 cash and owes nothing. C has no cash and owes B 11 cash. B is owed 11 cash and has 11 cash.

    C works for A for a wage of 9 cash. Now A has no cash and owes nothing. C has 9 cash and owes B 11 cash. B is owed 11 cash and has 11 cash.

    C pays down his debt for 9 cash. Now A has no cash and owes nothing. C has no cash and owes B 2 cash. B is owed 2 cash and has 20 cash.

    Notice that until now, nobody has worked for the Bank. That changes:

    C works for B for a wage of 10 cash. Now A has no cash and owes nothing. C has 10 cash and owes B 2 cash. B is owed 2 cash and has 10 cash.

    C kills his debt. Now A has no cash and owes nothing. C has 8 cash and owes nothing. B is owed nothing and has 12 cash.

    There. It was your scenario, and I managed to kill all the debt of 22 cash without ever needing more than 20 cash in money at one time.

    I believe this disposes of your objection.

  14. “A works for B, for a wage of 10 cash. Now A has 20 cash and owes B 11 cash.”

    Wasn’t B supposed to be the bank, which had no cash? How can B pay A 10 cash if it doesn’t have it?

  15. “A kills his debt. Now A has 9 cash and owes nothing. C has no cash and owes B 11 cash. B is owed 11 cash and has 11 cash.”

    Bank loans don’t work that way. The bank only has 1 cash now. The principal is just wiped away when the loan is paid back. http://www.talousdemokratia.fi/sivut/suomen_pankin_vastaus “Kun pankille maksetaan laina takaisin, niin kyllä se raha katoaa. Aina, jos asiakas maksaa pankille eikä toiselle asiakkaalle, rahan määrä supistuu.” It’s in finnish, but I think you understand it.

  16. I originally did not respond to the previous comment, because I got fed up with responding to arguments already made and countered above. But I think I better make that explicit now, as this story is getting attention again.

    I already responded in another comment making essentially the same objection: “Even if the “I” was a banker and the money had been account money created by him, the story still works in all essential respects. It’s true that each payment would then decrease the money supply, but the money supply in the story never needs to exceed the original loan amount (which is the point of the story). Notice that the interest payment is, in the “mow lawn” version, made by using money which the mower is not in debt for.”

  17. You seem to miss the point. In the original story the “I” gets to keep the money the “you” pays back because it’s not a bank loan. If it was a bank loan, all the 20€ payments would just disappear and in the end the “you” would still be 20€ in debt. And if it was the first and the only loan in the world, there would be no money left to make the final payment.

    Correct me if I’m wrong but as far as I know there isn’t any debt free money in the world today. And even if there is, the amount is tiny in comparison to the amount of money created via interest bearing loans. Assuming there is some amount of debt free money, one could theoretically pay the vast interests using the tiny amount of debt free money over and over again.

  18. No, it’s you who is missing the point.

    “If it was a bank loan, all the 20€ payments would just disappear and in the end the “you” would still be 20€ in debt. ” – true enough. But since the bank was able to create the original 120 euro loan, it can certainlycome up with the 40 euros required to pay for the lawn mowing (or whatever), which the “you” can then use to kill the outstanding interest and keep the 20 euros of debt-free money.

    The point here is that so long as the lawn-mowing happens after at least 40 euros of the principal has been repaid (that is, after the first two months), the total outstanding money supply in the story never exceeds the original 120 euros required to make the original loan (regardless of whether the “I” is a bank or not, and regardless of whether we are dealing with bank-created money or base money). The interest does not *force* us to create money in addition to the original loan amount.

    After all, the claim I am here demonstrating false is that somehow interest compels the overall rise of the money supply over the level required to make the original loans. To disprove it, it is enough for me to show circumstances where interest does not compel a money supply rise. It seems to me that the story generalizes to most circumstances where the loan is amortized, or a number of bullet loans are staggered so that not all of them mature at the same time. And real life debt is overwhelmingly either amortized loans or a collection of staggered bullet loans.

    A further point that I’m trying to make with this story is that while a loan is a monetary phenomenon, its interest is not. Interest is a real phenomenon in the economic sense: it’s the voluntary obligation to provide goods or services in payment of the service rendered by the creditor. (It’s just that, since we do not live in a barter economy, the goods or services can be provided to someone else who thinks them valuable enough to pay for them.)

  19. Correct me if I’m wrong but as far as I know there isn’t any debt free money in the world today. And even if there is, the amount is tiny in comparison to the amount of money created via interest bearing loans

    There is debt-free money in the world today. Any payments rendered by a central bank for goods or services are generally made with debt-free money. That includes wages paid to employees, fees paid to construction companies and interest paid for deposits in the central bank. It also includes the central bank’s dividends (or equivalent).

    See earlier comments above for discussion about how much that is in real life.

    It is true that most of the money in circulation is money ultimately created by debt. (Of course, a lot of that debt is backed by collateral.) However, the important thing here is that it exists, and can be used to settle interest payments.

  20. Also, if it should happen for some strange reason that the bank is not able to come up with 40 euros to pay for the lawn-mowing, there’s still a way to settle the interest: the bank and the debtor agree that the lawn-mowing is worth 40 euros and the bank pays for it by cancelling the outstanding interest and by issuing its own promissory note, worth 20 euros, to the “you” in the story.

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