Financial news outlets occasionally discuss central banks’ decisions on interest rates. Economists claim markets determine interest rates based on the supply and demand of funds, but the actions of central banks affect interest rates and the available funds. The standard explanation is that central banks set short-term interest rates based on their estimates of the economy and inflation. By doing so, they influence long-term interest rates via financial markets.
It works as follows. Based on estimates of future short-term central bank interest rates, financial institutions borrow short-term money to buy longer-term government bonds. For instance, if traders expect the short-term interest rate will remain below 2% in the coming year and 1-year government bonds yield 3%, they may borrow short-term money from the central bank to buy these bonds, pay them back when they mature, and pocket the 1% difference.
This trade creates demand for these bonds, so their price rises and their yield drops. Perhaps traders stop buying the bond when the interest rate drops to 2.5% because there is always a risk that the central bank will raise interest rates. If 10-year bonds yield 4%, another trader might sell 1-year bonds and invest the proceeds in 10-year bonds, bringing down their yield, too. Usually, this happens in future markets, so traders often don’t own these bonds.
If traders in financial markets believe the central bank will raise interest rates, they sell bonds, so their prices go down, and their yields rise until bond yields reflect the expected interest rate hike. Central banks have stated goals concerning inflation and sometimes economic growth and unemployment. Inflation, GDP, and unemployment numbers tell traders much about what central banks will do. So, if unemployment rises, interest rates might fall.
The financial markets are supposed to discipline central banks. Traders in financial markets might believe a central bank is doing a poor job. If inflation increases while the government runs growing deficits and the central bank doesn’t sufficiently raise interest rates, the value of its currency could drop, and inflation could spiral out of control. To avoid that, the central bank may raise interest rates to protect the currency and prevent inflation.
Changing the markets
Some critics of central banks argue that they eliminate the market mechanism. Central banks’ interventions profoundly affect how financial markets operate. As a result, there is much more lending than there otherwise would have been. Central banks create liquidity in financial markets. It allows banks to buy and sell government bonds with different maturities to match their lending, making all types of lending and borrowing possible anytime.
In the past, the situation was different. Banks had to be careful not to run into trouble because they could not borrow easily from the central bank. For instance, if you applied for a mortgage, the bank tried to find matching term deposits. Perhaps you could get a 5-year mortgage if the bank had sufficient 5-year deposits. After five years, you had to renew your mortgage, and if the bank lacked deposits, you could not renew it and had to sell your home.
Central banks reduce the risk of bank failures. When borrowers pay back their debts, banks are solvent, but they may find themselves short of cash in their vaults when depositors take out their deposits. Central banks can create this money if needed, so banks need less cash. Central banks can also rescue banks and reduce the risk to the general economy. After all, a financial crisis can cause an economic crisis like the Great Depression. That nearly happened in 2008.
Central bank interventions in financial markets subsidise the financial sector in the following ways:
Central banks reduce the risk of systemic failure so financial institutions can take on more risk and lend more. Banks may make risky loans to profit from higher interest rates if they expect the central bank to help them if things go wrong.
Central banks signal their intentions to financial markets. If the central bank intends to change interest rates, it gives an advance notice so financial institutions are not caught off-guard and can adapt their bond portfolios and borrowing.
The supply and demand of funds in financial markets ultimately determine interest rates. However, these markets would operate differently without central banks, with far less borrowing and lending. Because central banks allow the financial system to function more smoothly and reduce the risk of systemic failure, interest rates might be lower than they would have been otherwise, which can benefit society.
Central banks are powerful, undemocratic, technocratic institutions. Since the 1970s, they have become independent from governments. Before that, governments often used their central banks to finance their deficits via money printing, leading to inflation and a growing distrust in currencies. Making the central bank independent from politicians with a mandate to keep inflation low was a move to instil confidence in fiat currencies after the gold standard ended in 1971.
Central banks may impede the functioning of financial markets by mispricing risk. Without central banks, financial institutions would have to be more careful. However, bank failures would occur more often, and banks would pay more interest to depositors to compensate for that risk. That would negatively affect economic growth and cause crises. That is why there are central banks.
Conclusion
Central banks set short-term interest rates and profoundly affect long-term interest rates. Their actions make lending and borrowing possible by providing liquidity to financial institutions via government bond trading. Ultimately, markets determine interest rates. When the central bank loses its credibility in fighting inflation, investors sell the currency, and the value of the currency will drop.
The need for central banks is also a consequence of interest charges on money and debts. Nowadays, most money is a debt. Banks loan money into existence, and debtors must repay it with interest. If the interest rate is 5%, and banks have loaned € 100, they expect € 105 in return. That money doesn’t exist. Others must take on additional debt if depositors don’t spend their balances. If that also doesn’t happen, central banks may need to print that money to prevent a crisis.
In the past, the banking sector consisted of different types of banks depending on their risk profile. The Glass-Steagall Act in the United States severed linkages between regular banking and investing activities that contributed to the 1929 stock market crash and the ensuing depression. Separating banking from investments can prevent banks from providing loans to corporations they have invested in.1
The separation of commercial and investment banking prevented securities firms and investment banks from taking deposits. The reason for the separation was the conflict of interest resulting from banks investing in securities with their assets, which were their account holder’s deposits. Banks were obliged to protect the account holder’s deposits and should not engage in speculative activities.2
The Glass-Steagall Act included the Federal Deposit Insurance Corporation (FDIC), which guaranteed bank deposits up to a specified limit. It also comprised Regulation Q, which prohibited banks from paying interest on demand deposits and capped interest rates on other deposit products. Maximising interest rates can help limit the risks banks are willing to take on loans.3
Until the 1980s, the legislation remained more or less the same. With the rise of neoliberalism, regulations became increasingly disapproved of. Hence, the Glass-Steagall Act became increasingly disregarded. It was, for the most part, dismantled in 1999. Regulation Q ceilings for all account types, except demand deposits, were phased out during the 1980s. After the 2008 financial crisis, a renewed interest in the Glass-Steagall Act emerged.
Natural Money distinguishes between regular banks that provide loans and investment banks that are partnerships investing in equity. Islamic banks also operate in this way. The maximum interest rate of zero works like Regulation Q. It aims to limit the risks banks are willing to take on deposits, as interest is a reward for taking risks. Banks could offer higher rates on deposits if they take more risk.
In the United States, money market funds found a way around the limits imposed on banks by Regulation Q. These funds offered higher rates than banks. They invested in collateralised debt obligations (CDOs) like mortgage-backed securities (MBS). The 2008 financial crisis started in money market funds, not traditional banks.
Banking with Natural Money operates as follows:
Regular banks make loans at a maximum interest rate of zero. They can invest in government securities.
Investment banks don’t lend money but participate in businesses, providing equity. They can also rent houses, lease cars, or purchase other items.
Regular banks can promise a fixed interest rate, and the central bank supports them. The government can offer a deposit guarantee.
Investment banks can’t guarantee returns. They pay dividends based on their profits. Depositors are investors who can face losses.
Regular banks give negative interest rates on deposits. Investment banks can offer higher returns.
Regular banks are always liquid. Investment banks can lock in deposits if they lack liquid funds.
Natural Money can improve financial stability by favouring equity investments over debt investments. The maximum interest rate on debt makes debt investments less attractive. There is no reward in the form of interest for engaging in high-risk lending, which can further improve the financial system’s stability. If banks are too big to fail, splitting them up can improve financial stability. The core problem is banks taking risks with deposits, not the size of banks.
Featured image: Deutsche Bank Towers in Frankfurt am Main, Germany. T. Gozdziewicz. CC BY-SA 2.0. Wikimedia Commons.
1. The Glass-Steagall Act. Will Kenton, reviewer (updated 5 December 2019). Investopedia. 2. Glass–Steagall legislation – Wikipedia. 3. Regulation Q. Will Kenton, reviewer (updated 1 November 2019). Investopedia.
When borrowers couldn’t repay their debts with interest in the past, they became the serfs of money lenders. That is why religions like Christianity and Islam forbade interest on money or debts and deemed it usury. Nowadays, most money is a debt on which debtors pay interest. That is why debt levels increase, inflation is permanent, and the financial system becomes unstable. We have central banks to manage these problems.
Incomes can fluctuate, but borrowers pay fixed interest charges, which can get them into trouble. The less a debtor can afford to pay interest, the higher the interest rate will be, while a lower rate would improve the borrower’s situation. The lender demands a higher interest rate to take risks, thereby increasing the risk and making the financial system less stable. And interest on top of interest causes trouble. An example shows why.
Suppose Jesus’ mother had opened a retirement account for Jesus just after he was born in 1 AD at a bank next to the Temple in Jerusalem. Suppose she had put a small gold coin weighing 3 grammes in Jesus’ retirement account at 4% interest. Jesus never retired, but he promised to return. Suppose now that the bank held the money for this eventuality. How much gold would there be in the account in the year 2020?
It is an amount of gold weighing 12 million times as much as the Earth. If Jesus returns, the gold will not be there. You don’t need to be a genius to see something is wrong. A few eventually own everything, and the rest are in debt. The only thing the rich have to do is keep the money in the account, making money while they sleep and reaping the fruits of the toil of others. People have already known this for over 3,000 years.
There isn’t enough gold to repay our debts, so gold isn’t money today. When interest charges cause trouble, central banks print money to cope with the shortfall and prevent the scheme from collapsing. And so, debts continue to increase. Inflation reduces the debt burden by lowering the value of money and debts. But if inflation is too high, we lose trust in our money. That is why central banks aim for some inflation but not too much.
How the financial system operates
Money and finance seem mysterious to us, but the basics are simple. When you go to a bank and take out a loan, for instance, a car loan, you get money and a debt. The bank creates this money together with the debt. This money becomes someone else’s deposit once you purchase the car. When you pay back the loan, the money disappears. It seems magic, but it is accounting. You must repay the loan with interest. If the interest rate is 5% and you have borrowed € 100 for a year, you must return € 105.
Nearly all the money we use are deposits created from loans that borrowers must return with interest. Banks might pay interest on these deposits, but the interest rate is lower than the rate on the debt. The bank pockets the difference. Borrowers must return more than they borrowed. If they have borrowed € 100 at 5% interest, they must return € 105 after a year. So, where does that money come from? Here are the options:
Borrowers borrow more.
Depositors spend some of their balance.
Borrowers don’t pay back their loans.
The government borrows the money.
The central bank prints the money.
That also happens in reality. Problems arise when borrowers don’t borrow and depositors don’t spend their money. In that case, borrowers are € 5 short, and some can’t repay their loans. If many borrowers can’t repay their debts, you have a financial crisis, and an economic crisis will follow. It is why governments have deficits and central banks print money. With interest on debts, these things are hard to avoid.
The financial crisis of 2008 nearly brought down our civilisation. If you were familiar with the problems caused by interest, the crisis didn’t come as a surprise. Central banks succeeded in ending the crisis by printing trillions of US dollars. The shortfall was as enormous as that. It demonstrated we are the usurers’ hostages.
It has not always been like that. In the nineteenth century, mortgages were hard to come by, and there were no car loans. People and businesses were less deeply in debt, so most money wasn’t in debt but gold coins or paper money backed by gold in a government or central bank vault. Nevertheless, there were financial crises and economic slumps caused by debtors who couldn’t repay their debts.
That is why there are central banks. They can halt or prevent financial crises, but in doing so, they allow banks to create far more debt because central banks can print money to fix the shortfalls caused by interest charges. And that is what has occurred. Now, we are trapped. Governments can’t balance their budgets, and central banks can’t stop printing money without collapsing the economy.
Ending interest on money and debts has been impossible until now because lenders didn’t lend without interest. Without interest, we wouldn’t have had a modern capitalist economy. Lenders demand interest because:
When you lend out money, you can’t use it yourself. That is inconvenient, so you desire compensation for the use of your money.
The borrower may not repay, so you desire compensation for that risk.
You can use your money to invest and earn a return. To lenders, the interest rate must be attractive compared to other investments.
Lending and borrowing are essential for the functioning of a modern capitalist economy. We take interest for granted. However, economic and financial system changes may make it possible to end interest on money and debts. Innovations in finance may make it feasible to stop charging interest on debts. And so, the end of usury might be at hand.
Ending usury
You can lend money to a bank and use it anytime. That is convenient. Banks lend your money and check the financial condition of their borrowers. They lend to many different people and businesses. If a few debtors run into trouble, the bank can still fulfil its obligations, reducing the risk of lending. Central banks can help out banks if needed, while governments guarantee bank deposits, reducing the risk of lending money, so bank deposits are often safer than cash.
So, what about the returns on investments? In the past, returns on investments, on average, have been higher than the economic growth rate. Investors have reinvested most of those returns, so the amount of capital has grown faster than the economy, and a growing share of total income was not for wage earners but investors. That cannot go on forever because who will buy the things the corporations make if wages keep on lagging? An example can demonstrate why that is so.
Figure 1: Interest versus total income
Figure 1 shows how total income, wages, and capital income develop with an economic growth rate of 2% and an interest rate of 5% when capital revenues start at 10% of total income and investors reinvest all their capital income. After 25 years, the economic pie has grown more than capital revenues, and wages have risen. At some point, capital income starts to increase more than total income, and wage income goes down. After 80 years, there is nothing left for wages.
Wealthy people reinvest most of their capital income. Saving and investing often made them rich in the first place. In recent decades, we have seen economic growth slowing in advanced economies. Several factors affect economic growth, such as population growth and technological innovation. One is available capital and profitability. If growing capital income comes at the expense of labour income, this capital’s products will have fewer buyers. As a result, capital returns decline, and as a result, interest rates.
We run into the planet’s boundaries. Economic growth in the future may be low, non-existent, or even negative, which poses new challenges. Wealth inequality becomes a greater problem once the general level of opulence declines, and it may lead to financial or economic collapse. The future needs a financial system that remains functional under stress, promotes equality, and rewards productive work. Two examples from history provide some insights into how we might do it.
The miracle of Wörgl
In the middle of the Great Depression, the Austrian town of Wörgl was in deep trouble and prepared to try anything. Of its population of 4,500, 1,500 people were without a job, and 200 families were penniless. Mayor Michael Unterguggenberger had a list of projects he wanted to accomplish, but there was not enough money to carry them out. These projects included paving roads, erecting street lights, extending water distribution across the whole town, and planting trees along the streets.1
Rather than spending the remaining 32,000 Austrian Schilling in the town’s coffers to start these projects, he deposited them in a local savings bank as a guarantee to back the issue of a currency known as stamp scrip. A crucial feature of this money was the holding fee. The Wörgl money required a monthly stamp on the circulating notes to keep them valid, amounting to 1% of the note’s value. The Argentine businessman Silvio Gesell had come up with this idea in his book The Natural Economic Order.2
Nobody wanted to pay for the monthly stamps, so everyone spent the notes they received. The 32,000 schilling deposit allowed anyone to exchange scrip for 98 per cent of its value in schillings. Hardly anyone did this because the scrip was worth one Austrian schilling after buying a new stamp. But people did not keep more scrip than they needed. Only 5,000 schillings circulated. The stamp fees financed a soup kitchen that fed 220 families.1
The municipality carried out the works, built new houses, a reservoir, a ski jump and a bridge. The key to this success was the fast circulation of the scrip money within the local economy, fourteen times higher than the schilling. It increased trade and employment. Unemployment in Wörgl dropped 25% while it rose in the rest of Austria. Six neighbouring villages copied the idea successfully. The French Prime Minister, Édouard Daladier, visited the town to witness the ‘miracle of Wörgl’ himself.
In January 1933, the neighbouring city of Kitzbühel copied the idea. In June 1933, Mayor Unterguggenberger addressed a meeting with representatives from 170 Austrian towns and villages. Two hundred Austrian townships were interested in introducing scrip money. At this point, the central bank decided to ban scrip money.
Since then, several groups issued local scrip currencies. None of them was as successful as the currency of Wörgl. In Wörgl, the payment of taxes in arrears generated additional revenues for the town council, which the town council spent on public projects. Once the townspeople had paid their taxes, they would have run out of spending options and might have exchanged their scrip for schillings to avoid paying for the stamps. That never happened because the central bank halted the project.
There are a few takeaways. The economy of Wörgl did well without issuing debt because the money kept circulating. A negative interest rate induces people to spend the money they have, so no new money has to be borrowed into existence to stimulate the economy. A holding fee makes negative interest rates possible as you do not have to pay it when lending money. For instance, lending out money at an interest rate of -2% is more attractive than paying 12% for the stamps. If we can uncover the conditions for it to work, remove any flaws, and plan for the consequences, we can end usury.
Joseph in Egypt
Money with a holding fee existed in ancient Egypt for over 1,500 years. There were state-operated granaries. Grain was the primary food source for the Egyptians. When farmers came with their harvest, they received a voucher telling them how much they had brought in and on what date. A baker could return that receipt and exchange it for grain after paying for the storage cost and loss due to degradation.
The Egyptians used these receipts as money. Grain was a commodity everyone needed, so these vouchers had value.1 Because of the storage costs, they gradually lost value. With this kind of money, you might have interest-free loans. If you save money, you make losses by keeping the money. Hence, lending it without interest can be attractive if the borrower is trustworthy. There is no evidence this happened.
The origins of the granaries are unclear. The Egyptian government collected a portion of the harvests as taxes and stored it in its facilities. The government storage probably proved convenient for farmers. They didn’t need to store and sell their grain themselves, and it made sense to have a public grain reserve in case of harvest failures.
A story in the Bible supposedly explains the Egyptian grain storage. As the tale goes, the Pharaoh had dreams his advisers couldn’t explain. He dreamt about seven lean cows eating seven fat cows and seven thin and blasted ears of grain devouring seven full ears of grain. A Jewish fellow named Joseph explained those dreams to the Pharaoh.
Joseph told the Pharaoh that seven years of good harvests would come, followed by seven years of crop failures. Joseph advised the Egyptians to store food for meagre times. They followed his advice and built storehouses for grain. In this way, Egypt survived seven years of scarcity.
The vouchers lost their value over time to cover the storage cost. It works like buying stamps to keep the money valid, like in Wörgl. Both are holding fees. The grain money circulated for over 1,500 years until the Romans conquered Egypt around 40 BC. It did not end in a debt crisis, which suggests that a holding fee on money or negative interest rates can create a stable financial system that lasts forever.
Storing food makes sense today, even when you make losses on the storage. Harvests become increasingly unpredictable due to global warming and intensive farming. We only have enough food in storage to feed humanity for a few months because it isn’t profitable to store more. We may think money can save us from famine, but we can’t eat money, so Joseph’s advice to the Pharaoh is as sensible now as it was back then.
Natural Money
The miracle of Wörgl demonstrates that money with a holding fee might have ended the Great Depression. The grain money in ancient Egypt provided a stable financial system for over 1,000 years. The holding fee can make it attractive to lend money at an interest rate of zero or even lower. Lending at an interest rate of -2% to a reliable borrower is better than paying a holding fee of 10%.
At present, cash has a zero interest rate. With negative interest rates, taking your money from the bank and storing it in a safe deposit box can be attractive. A steep holding fee, like in Wörgl, disadvantages people who use cash. That is not needed. An interest rate close to that of bank accounts will be sufficient to keep people from hoarding cash.
We can have cash with a negative interest rate, so banknotes and coins become separate from central bank currency. Short-term government loans could back it, and the interest rate on cash would be close to that on short-term government debt. If the cash interest rate is -3%, one euro cash will be worth 0.97 euro currency after a year. Cash thus stops being a currency and becomes government debt.
And now, we arrive at a definition of Natural Money:
Natural Money currencies carry a holding fee in the vicinity of 10% per year.
Loans, including bank loans, have negative interest rates. Zero is the maximum.
Cash becomes money with a negative interest rate backed by government debt.
Natural Money doesn’t change the nature of the business of banking. Banks borrow money from depositors at a lower rate to lend it at a higher rate. They may borrow money at -2% to lend it at 0% instead of borrowing it at 2% to lend it at 4%. A maximum interest rate of zero will favour equity financing over lending and borrowing at interest, and equity finance may often replace traditional banking. Thus:
Borrowing for consumption will be restricted. Car loans and credit card debt may disappear. Consumers will be better off because they don’t pay interest.
Leveraged financing will become constrained. Businesses need to reduce their debts and attract more equity.
The role of governments and central banks changes. Government and central bank interventions kept the usury scheme afloat. Without usury, these things would be unnecessary or even undesirable, as there would be no financial crises. The financial system would be stable, as the maximum interest rate promotes responsible lending, and there is no reward for taking excessive risks.
The miracle of Wörgl indicates that negative interest rates can lift the economy from a depression. If the economy does better with Natural Money, interest rates could rise. That probably is not a problem, as the currency’s value may increase, and yields on interest-free money could be better than on interest-bearing money. When the usury scheme collapses, Natural Money currencies might become a haven.
Research
Other local currencies with a holding fee weren’t as successful as the one in Wörgl. The payment of taxes in arrears inflated the success of Wörgl. It generated additional revenues for the town, which the council could spend. It provided a stimulus that might have petered out once the citizens had paid their taxes.3 Maybe it is too good to be true, but there are reasons to think otherwise. Once interest rates are near zero, the markets for money and capital cease to function, and central bank interventions become ineffective.
To prevent the 2008 financial crisis from escalating, central banks took extraordinary measures, like printing trillions of dollars, to keep the usury financial system afloat. A holding fee could have kept the markets functioning without such measures. A maximum interest rate of zero could have impeded irresponsible lending, preventing the financial crisis from occurring in the first place.
Implementing a usury-free global financial system is a profound change with far-reaching consequences. Is it possible? And under which circumstances? What are the benefits and drawbacks? What are the implications for individuals, businesses and governments? How does it affect banks and the financial system? These questions need answering. History provides us with few examples, but there are many economic theories.
This research uses available knowledge to (1) discover the prerequisites for a usury-free financial system, (2) uncover how it works best in practice, and (3) what the consequences are for individuals, businesses, governments and financial institutions. It seems feasible, and the design of Natural Money is more robust than the current financial system. Still, unanticipated issues may appear once a Natural Money financial system is operational.
Economists and central bankers believe low and negative interest rates will be temporary, but the graph above tells a different story. It shows the interest rates in the United States between 1961 and 2016. The green line is the real interest rate, which is the inflation-free interest rate. So if the interest rate of your mortgage is 5% and the inflation rate is 2%, the real interest rate on the mortgage is 3%. The rise in interest rates in the early 2020s is not a rise in the real interest rate. It merely tracks a pickup in inflation.
It could be a structural development. Once an economy matures, it has little room to grow, and interest rates remain low. And if we intend to live within the planet’s boundaries, we may even need negative growth. Low growth rates are a problem for the usury financial system as it only operates smoothly with high enough interest rates. And so, the future world might do well with a usury-free financial system.
1. The Future Of Money. Bernard Lietaer (2002). Cornerstone / Cornerstone Ras. 2. The Natural Economic Order. Silvio Gesell (1918). 3. A Free Money Miracle? Jonathan Goodwin (2013). Mises.org.
Liquidity in financial markets means you can buy or sell financial instruments like stocks and bonds at any time without delay. In other words, you can sell them in the financial markets for currency like euro or US dollar cash. During a financial crisis, liquidity evaporates, and you can’t sell stocks and bonds. Their price collapses because there are only sellers and no buyers. To prevent that, central banks inject liquidity into the financial system. They print new currency, so euros and US dollar cash are plentiful.
It can end the crisis. Since the stock market crash in 1987, money printing by central banks has become a frequently used solution for financial crises. If currency is plentiful, short-term interest rates drop, and stocks and bonds become more attractive investments, so there will be buyers for them. Once interest rates are near zero, and the central bank can’t lower them, a problem arises. Market participants will accumulate central bank currency because its zero interest rate is attractive.
They will not invest but hold on to their cash. With interest rates near zero, traditional methods of dealing with financial crises have become ineffective. That is why central banks adopted extraordinary measures like Quantitative Easing in the aftermath of the 2008 financial crisis and the 2012 euro crisis. Investors say, ‘Cash is king.’ It is the ultimate means of payment. If your bank goes bankrupt, your deposit might be gone. But you can still pay if you own banknotes, which are central bank currency.
During a financial crisis, people fret about whether their stocks might still have value in the future as the economy might collapse. That is why investors also prefer central bank currency. But that is only due to the interest rate on cash. Had there been a holding fee on the currency of 12% per year, investors would not prefer cash but anything else, and there would always be liquidity in the market. And the central bank doesn’t have to do anything. We may not even need a central bank.
In times of crisis, there is a flight into safe financial instruments, so investors may gobble up government bonds. Central bank currency is unattractive because of the holding fee. Holding on the currency will cost you 12% per year. A euro turns into 88 cents after a year. And so, interest rates on government debt may go as low as needed, like -5%, and bring liquidity by ensuring that other investments become attractive. And so, there will always be liquidity.
Who needs currency, then? No one wants to own it if it costs 12% per year to hold it. It will be the end of currency. At present, banks need currency for their reserve requirements. That is not necessary for financial stability. Equity requirements are more helpful than reserve requirements. Short-term government debt can do nicely as a reserve. Banknotes are also central bank currency. A 12% holding fee would make cash unattractive. Therefore, cash banknotes should not be central bank currency.
The 2008 financial crisis rekindled interest in Minsky’s Financial Instability Hypothesis. This hypothesis states that capitalist economies are inherently unstable due to the inner workings of the financial system. Minsky ignored interest as the underlying cause of instability and proposed that the government should manage the problem.
It is a critical public interest that the economy doesn’t suffer from financial instability in the private sector. That requires governments and central banks to manage and back the banking system, which can cause moral hazards and lead to private gains backed by public losses.
Financial instability is primarily caused by leverage and interest on debts. Incomes vary, while interest payments are fixed. Financial institutions are even more leveraged than other corporations, which can escalate into a financial crisis or economic downturn. Negative interest rates can, therefore, potentially benefit financial stability.
It may be time to introduce the Financial Stability Hypothesis. It states that once interest rates are below zero and rates above zero are not allowed, stabilising mechanisms make the economy inherently stable. As a result, governments and central banks may have fewer reasons to interfere, and fiscal and monetary policies may become obsolete.
Minsky argued that market participants become optimistic and complacent when the economy does well, increasing leverage and risk in the financial system. Debt defaults and interest payments can escalate into an economic crisis when the economy slows.
But what would happen when interest rates are always negative and positive interest rates on money and debt are not allowed? If there is a holding fee on currency, then lending at negative interest rates can be attractive. In that case, the economy could become inherently stable because of the following stabilising mechanisms:
Lenders require interest to compensate for risks. When interest rates are capped at zero, equity investments become more attractive than debt, which can reduce financial leverage.
Capping interest rates to zero eliminates high-risk debt from the financial system, as the funding of risky ventures will come from equity rather than debt.
Usurious lending practices like credit card debt will end. This can stabilise the financial system and increase disposable income, as consumers will no longer pay interest.
Negative interest rates require trust in the currency and debtors. That provides an incentive for governments to fix their finances. It isn’t austerity, as governments receive interest on their debts.
When inflation rises, interest rates go up, and there would be less credit at a maximum interest rate of zero. That constrains the amount of money in circulation, capping inflation.
When there is excess deflation, interest rates go deeper into negative territory. That causes a stimulus, so the economy improves, and deflation mitigates.
Negative interest rates and a ban on interest rates above zero on money and debts might stabilise and improve a debt-burdened economy. Inflation would be low, and there could be deflation. Governments and central banks don’t have to manage the economy actively using fiscal and monetary policies.
Some historical evidence suggests that negative interest rate currencies can be stable. Ancient Egypt had money backed by grain storage. Because of the storage cost, the money had a holding fee that worked like a negative interest rate. This money circulated for more than 1,500 years.
The key to making a usury-free financial system feasible is accepting that not every demand for a loan must be satisfied, most notably demand for loans that harm people or can destabilise the financial system. Loan requests must be discarded rather than fulfilled at a higher interest rate. That will also rein in inflation.
The Plan For The Future 