The Spider’s Web

The Spider’s Web is an informative documentary about the hidden world of offshore finance.

This is a documentary that everyone should watch to understand what is going on behind the scenes.

If you have Netflix, you can also watch it there.

Wörgl bank note with stamps. Public Domain.

Cash for negative interest rates

The problem with cash

Negative interest rates may be here to stay. Interest rates are the result of supply and demand for money and capital in financial markets. The factors that have caused interest rates to go down are still in place and may not go away. And so it may be better to allow interest rates to go down further and into negative territory. For that reason, we may need a holding fee on central bank money.

Most money is in bank accounts. It is loaned to banks by depositors. Central bank money is different. It is not a loan. The central bank money we all know is cash. But banks have accounts at the central bank. The balances in those accounts are central bank money too. So, if the central bank sets the interest rate, it is the interest rate on central bank accounts.

Cash comes with an interest rate of zero. Cash can be an attractive investment when interest rates on bank accounts are negative. Depositors may take their money from the bank and put their savings in cash. In Switzerland, where interest rates are the most negative, bank notes of 1,000 francs and safe deposit boxes are in short supply. Hence, interest rates can’t go further down as long as cash remains the way it is.

When people stop lending money and take their money from the bank, the economy runs into trouble. With a holding fee on central bank money of 10% per year, it can be attractive to lend out money at negative interest rates like -2% because you don’t pay the holding fee on money lent. That includes money in bank accounts. And so you may keep your money in the bank even when interest rates are negative.

Cash as a loan to the government

Only, a holding fee of 10% per year would make cash unattractive. And in Wörgl people had to buy stamps and glue them to the banknotes to keep them valid. This is cumersome. If the interest rate on cash would be a bit lower than interest rates on bank accounts, that might be enough to stop people from hoarding cash. And if we do not have to glue stamps on banknotes, cash would remain practical to use.

So if cash is a loan to the government rather than central bank money, the interest rate on short term loans to the government could be applied. That rate would be much better than the holding fee, for example -3%. There would be an exchange rate between cash and central bank money. The value of cash could gradually decrease at a rate of 3% per year so you don’t have to glue stamps on bank notes to keep them valid.

Human psychology

Negative interest rates reduce the balance in your account while inflation is stealthy. Wage changes are more visible than price changes as some prices go down while others go up. Even when negative interest rates and deflation are a better deal, people might not opt for it. Psychologists have found that for most people the pain of a loss outstrips the pleasure of a similar gain, which makes them risk-averse.

When interest rates are negative, money disappears so inflation will probably be lower. There might even be deflation, which means that prices on average go down. That could be a better deal than printing money to produce inflation as this money usually ends up in the hands of the rich while everyone else pays for the inflation. But most people simply do not like see their account balance go down because of a negative interest rate.

They prefer the illusion of a small gain that amounts to a loss in reality to the illusion of a small loss that is a gain in reality. And there is a risk that the expected benefits from negative interest rates do not materialise. It is not rational but human psychology is the way it is. There may be a fix for that by hiding negative interest rates and make them look like inflation. To explain how, we have to look at the characteristics of Natural Money:

  • Central bank money carries a holding fee of approximately 10% per year. If you own central bank currency then € 1,00 turns into € 0,88 after a year. This can make lending at negative interest rates attractive.
  • Interest rates on bank accounts might be around -2% per year in terms of central bank money, so people don’t pay the holding fee but the interest rate banks offer.
  • Cash is a short-term loan to the government and carries the interest rate of short-term government loans, which might be -3%.
  • Central bank money and cash are separate currencies. They have an exchange rate. Cash gradually loses value relative to central bank money.

Making cash the money in people’s mind

If balances of bank accounts are expressed in cash rather than central bank money, negative interest becomes hidden from the public. The interest rate on short-term government loans is one of the lowest. Banks must be able to offer at least this interest rate so people won’t see their money disappear because of negative interest. And if prices in shops are expressed in cash, cash will become the currency in people’s minds.

If the interest rate on cash is -3%, the value of cash goes down by 3% per year in terms of central bank money. So if a bank offers an interest rate of -2%, and the account is settled in cash, it appears as if the interest on the bank account is +1%. And if the deflation rate is 1%, prices go down by 1%. Meanwhile cash goes down 3% in value so that it appears there is an inflation rate of 2% as cash prices go up by 2%.

It is a trick to prevent people from acting against their best interest. Nowadays the interest rate on bank accounts is 0% and inflation is 2% so you would lose 2% in purchasing power per year by holding money in a bank account. In the example above the loss is 1%, which is a better deal. Natural Money can be a better deal for account holders. The economy is expected to do better so real interest rates can be higher.

Critics might argue that we could be fooled by this scheme, just like we were fooled before by inflation. We won’t notice the negative interest rate, just like we didn’t notice inflation previously. But separating cash from central bank money and expressing prices and the value of bank accounts in cash can clear the psychological barrier that stands in the way of adopting negative interest by the public.

Central bank money should remain the accounting unit in the financial system. Bank accounts should be accounted in central bank money, just like debts and interest rates as well as prices of financial assets like stocks and bonds. A similar situation existed in Europe between 1999 and 2002 when the digital euro was already introduced while cash was still the national currency.

A goldsmith in his shop. Peter Christus (1449).

How the financial system came to be

A goldsmith’s tale

Once upon a time, goldsmiths fabricated gold coins of standardised weight and purity. This made them a trusted source of gold coins. The goldsmiths also owned a safe where they stored their own gold. Other people wanted to store their gold there too because those safes were well-guarded. And so the goldsmiths began to rent out safe storage. People storing their gold with the goldsmith received a voucher certifying the amount of gold they brought in.

At first, these vouchers could only be collected by the original depositor. Later on, any holder of the voucher could collect the deposit. Another innovation was making standard vouchers representing 1, 2, 5 or 10 units. From then on people began to use them as money as paper money is more convenient than gold coins. And so depositors rarely came to collect their gold and it remained inside the vaults of the goldsmiths.

Modern banking

Some goldsmiths also lent out their own gold at interest. As depositors rarely came in to collect their gold, they discovered they could also lend out the gold brought in by the depositors. When the depositors found out about this, they demanded interest on their deposits too. At this point, modern banking took off and paper money became known as banknotes.

Credit note's holder, Stockholm's Banco sub no. 312
Credit note’s holder, Stockholm’s Banco sub no. 312

Borrowers preferred paper money too so the goldsmiths, who had become bankers, found out that they could lend out more money than they had gold in their vaults. They began to create money out of thin air. This is called fractional reserve banking as not all deposits were backed by gold reserves. The new money was spent on new businesses that hired new people so the economy boomed.

When depositors discovered that there were more bank notes circulating than there was gold in the vaults of the bank, the scheme could run into trouble if all depositors came in at the same time to demand their gold, but this rarely happened. Depositors received interest so they kept their deposits in the bank. They trusted their bank as long as they believed that debtors were paying back their loans.

Bank runs

But sometimes people began to doubt that the bank was safe and worried depositors came to the bank to exchange their banknotes and deposits for gold coins. This is called a bank run. If too many people came in at the same time, the bank could run out of gold and close down because not all the gold was there. As a result, the bank’s notes and deposits could become worthless.

Bank run
A crowd at New York’s American Union Bank during a bank run in the Great Depression

People who lost their money had less money to spend. This could hurt sales so that businesses could run into trouble and default on their debts. As a consequence, depositors at other banks sometimes feared that their bank could go bankrupt too, leading to more bank runs. This could escalate into a financial crisis and an economic depression. This happened in the United States during the Great Depression of the 1930s.

Regulations and central banks

To forestall financial crises and to deal with them if they occur, banks were required to have a minimum amount of gold available in order to pay back depositors. Central banks were created to support banks by supplying additional gold if too many depositors came in to collect their gold at the same time. Central banks could still run out of gold but this was solved by ending the gold backing of currencies. Nowadays central banks can print new dollars or euros to cope with any shortfall. Regulations limit the number of loans banks make and therefore the amount of money that exists.

But everyone can lend to everyone. There are ways to circumvent the regulations imposed on banks. For example, corporations can issue bonds or use crowdfunding. And a lot of lending nowadays happens outside the official banking sector in institutions that are not subject to these regulations. Human imagination is the only limit to the amount of debt that can exist. And as long as people expect that those debts will be repaid, even if it is with new debts, there can be trust in these debts. But the financial crisis of 2008 demonstrated that this trust can disappear very suddenly.

Featured image: A goldsmith in his shop. Peter Christus (1449). Metropolitan Museum of Art. Wikimedia Commons. Public Domain.

Amazon Blue Front Economist

Supply and demand

There is a saying, teach a parrot to say ‘supply and demand’ and you have an economist. Economics is about supply and demand. In order to understand how the invisible hand of a market economy operates, you should be familiar with the law of supply and demand. Not surprisingly, this is one of the most important laws in economics. This law states that the price is where supply and demand are equal. An example about the market for coffee can clarify the magic of the invisible hand.

If coffee would be free people might like to drink lots of coffee but producers can’t make coffee for free. Producers go bankrupt if the price is zero because they have costs, for instance employees and equipment. If the price of coffee is low, for instance € 3 per kilogram, that may not cover all the costs. Some producers can produce cheaper than others because they have more efficient production facilities, so when the price is € 5 a few producers might start producing coffee because they can make a profit.

That may not be enough to satisfy all the demand that is out there. The low-cost producers have a limited production capacity so they may be able to come up with 650 kilograms of coffee. Consumers might want to indulge themselves in 1,700 kilograms if the price is only € 5 per kilogram. In that case there would be a shortage of coffee of 1,050 kilograms. Consumers who fear that they are going to be left out of the action might then offer more money so that the price of coffee rises.

When coffee becomes more expensive some consumers might not be able to afford coffee. Others may buy less because they have other expenses like beer and milk. On the other hand, some producers might start making coffee because they can make a profit at these prices. So when the price goes up, supply goes up and demand goes down.

At € 10 per kilogram every producer may be able to make a profit, even those who have high costs, and producers may come up with 2,000 kilograms. However, consumers may only buy 600 kilograms if coffee costs € 10 per kilogram so there may be a surplus of 1,400 kilograms. Producers may then try to sell off their surplus at lower prices before it gets spoiled in order to recover some of their costs. When prices are lower, consumers are willing to buy more, but high-cost producers can’t make a profit and may stop making coffee. So when the price goes down, demand goes up and supply goes down.

The price may settle where supply equals demand. When the price is € 7 producers may make 1,200 kilograms and consumers may gobble up 1,200 kilograms. So € 7 per kilogram could be the price of coffee according to the law supply and demand. Of course, things in reality are a lot more complicated than that, but the law suffices for a basic understanding of markets. A graph can illuminate what has been discussed so far.

supplydemand2

The graph shows the quantities of coffee demanded and supplied at different prices. When the price goes up, demand goes down and supply goes up. The downward sloping black dashed line represents demand. The upward sloping black line represents supply. If the price is low the supplied quantity is low and the demanded quantity is high, leading to a shortage. At a price of € 5 there will be a shortage of 1,050 kilograms as demand is 1,700 kilograms while supply is only 650 kilograms.

If the price is high, demand is low and supply is high, leading to a surplus. If the price is € 10, there will be a surplus of 1,400 kilograms as supply is 2,000 kilograms and demand is only 600 kilograms. The lines of demand and supply cross at 1,200 kilograms and a price of € 7. Supply and demand are both 1,200 kilograms at a price of € 7, which must be the price according to the law of supply and demand.

In reality things often differ a lot from the simple model. There may be different qualities of coffee and each may have its own price. In some markets there is a lot of competition and corporations hardly make a profit. In other markets there is little or no competition and corporations make huge profits. And there hardly ever is an equilibrium as there are many factors that influence supply, demand and price, and they constantly change. Nevertheless, simple examples like this one are useful because they help to explain how a market economy works.

Featured image: Ara Economicus. Beverly Lussier (2004). Wikimedia Commons. Public Domain.

Slums in Jakarta

From scarcity to abundance

The road to prosperity

Until very recently nearly everyone lived in abject poverty. Most people had barely enough to survive. In 1651 Thomas Hobbes depicted the life of man as poor, nasty, brutish, and short. Yet a few centuries later a miracle had happened. Many people are still poor but more people suffer from obesity than from hunger while the life expectancy in the poorest countries exceeds that of the Netherlands in 1750, the richest country in the world in the wake of the Industrial Revolution.

In 1516 Thomas More wrote his famous novel about a fictional island named Utopia. Life in Utopia was nearly as good as in the Garden of Eden. The Utopians worked six hours per day and took whatever they needed. His book inspired writers and dreamers to think of a better world while leaving the hard work to entrepreneurs, labourers and engineers. Today many of us have more than they need but still we work hard and feel insecure about the future.

Why is that? The answer lies within the nature of capitalism. It is not enough that we just work to buy the things we need. We must work harder to buy more, otherwise businesses go bankrupt, investors lose money, and people will be unemployed and left without income. In other words, the economy must grow. That worked well in the last few centuries, and it brought us many good things, but it may be about to kill us now.

People in traditional cultures didn’t need much. They were easily satisfied. Many modern people in capitalist societies believe they never have enough. You can always go for a bigger house, a more expensive car, or more luxury items. Many of us do not need more but the advertisement industry makes us believe that we do. We believe in scarcity even when there is abundance. And so the economy must grow. That is what they tell us.

But what are the consequences of this belief? If you eat too much this is great for business profits. And if you become obese as a consequence and need drugs for that reason, you again contribute to business profits so this is even better. Meanwhile we are using the resources of this planet in a much faster pace than nature can replenish. Humanity is standing before the abyss. Civilisation as it is will not continue for much longer. The end is near.

What has this to do with interest? If we want more products and services, we need more businesses, so we need investments. To do investments, we need savings. And to make people save, we need interest to make saving attractive. Consequently investments need to be profitable to pay for the interest. But there can be too much of a good thing. If we don’t need more stuff, we don’t need more savings, and interest rates go down.

A sustainable and humane economy?

Is it possible for humanity to live in harmony with itself and nature? We work harder than ever before and in doing so we destroy life on this planet. It seems hard to change this. If you organise production differently then your products might not be sold at a price that covers the cost to make them. In a market economy the value of a product is the price it fetches in the market. Marketing often comes down to inflating the market price of a product or a service to make more profit.

In the past there have been two fundamentally different approaches to the economy. For instance, before Germany became united in 1990, there were a capitalist and a socialist Germany. Socialist Germany ensured that everyone was employed. People in socialist Germany had enough but they had little choice as to what products they could buy. For instance, in socialist Germany there were two kinds of yoghurt while there were sixty in capitalist Germany.

And there was little freedom in socialist Germany. The secret police were everywhere. When Germany became united the socialist economy collapsed. Socialist corporations suddenly were bankrupt because no-one wanted to buy the products they produced. The ensuing reorganisation of the economy led to mass lay-offs and a staggering rise in unemployment. Ultimately 60% of the jobs in the former socialist firms disappeared.

Many lives and communities in former socialist Germany were destroyed. And people suddenly felt insecure about their future as businesses had to compete and make a profit in order to survive. In a market economy efficiency considerations determine what is produced. These efficiency considerations are the result of customer preferences as well as the requirement to make a profit. Loss-making businesses usually can’t attract capital in a market economy.

The quest for efficiency results in fewer and fewer people producing the things we need. To keep everyone employed in a capitalist economy unnecessary products and services must be produced, causing a rapid depletion of scarce resources as well as lots of waste. At least in theory we work can a few hours per day so we have more time for our mobile phone and each other. It may also be possible to free up resources to address poverty and other social problems.

And what has this to do with interest? The profit a corporation is expected to make should be higher than the interest rate in the markets for money and capital. Because what’s the point in making the effort and taking the risk of running a business if you can get the same return on a savings account? And so it appears that with negative interest rates corporations with zero profits can survive and that the economy doesn’t need to grow.

Share of Labour Compensation in GDP at Current National Prices for United States

The road to inequality

Not so long ago an economist wrote a book that sent a shock-wave through the economic world because of stating a major cause of wealth inequality, which is that the return on capital usually is higher than the rate of economic growth. Capitalists reinvest most of their profits so capital usually grows faster than the economy most of the time. It can be proven beyond any doubt that capital can’t grow faster than the economy forever. Something will have to give at some point.

And what has this to do with interest? Interest is any return on capital. Interest income is the income of capitalists. That includes business profits and interest on bonds. The graph shows that labour income as part of the economy has diminished in recent decades in the United States. And that is because the capital share of national income has risen. In the past depressions and wars destroyed a lot of capital. Since 1945 there hasn’t been a serious depression or a world war.

The capitalist economy is like a game of monopoly. First everyone is doing great and capital is built in the form of housing and hotels. At some point some people can’t pay their bills anymore. To keep the game going, the winners can lend money to the losers. But at some point the losers can’t pay the interest any more. To keep the game going, interest rates must be lowered, so they can borrow more. But at some point some people can’t pay the interest again.

This happens in the real economy too. In a game of Monopoly we can start all over again. In the real economy that’s not an option. It would mean closing down factories in another great depression or destroying houses in another world war. So the game must continue. In Monopoly the rich can lend money at negative interest rates to the rest so that they can pay their bills. In the real economy this may be possible too.

Monopoly features a scheme that looks like a universal basic income. Every time you finish a round you get a fixed sum of money from the bank. At some point the bank may end up empty. The rich can then lend money to the bank at a negative interest rate to pay for it. It might seem a stupid thing to do because Monopoly is just a game. But the real economy is not. It may need an income guarantee for everyone financed by the rich.

An outline of the future economy

Can we have an economy that is humane and in harmony with nature? A few centuries ago no-one would have believed that we could live the way we do today and most people would have believed that it is more likely that unicorns do exist. If excess resource consuming consumption is to be curtailed, fewer options for consumers remain, for instance there may only be organic products, and supermarkets in the future might look a bit like those in former socialist Germany.

That may not be so bad. People in socialist Cuba live as long as people in the United States despite the United States spending more on healthcare than any other country in the world. Cubans eat no fast food so they live a healthier life style. And Cubans suffer less from a negative self image than people who are exposed to the advertisement industry. Advertisements aim to make us unhappy with ourselves and what we have in order to make us buy more products and services.

Like in former socialist Germany there isn’t much freedom in Cuba. If the government is to regulate the fat content in fast food or the sugar content in sodas then we lose our freedom to become obese. Alternatively, the government could even end our freedom to destroy life on this planet and kill our children. That may be oppression. But the alternative may be a collective suicide of humanity. Even though socialism failed we may have to pick the best parts out of it and integrate them into a market economy.

If the most resource consuming non-essential activities are to be axed, entire industries will be wiped out like in socialist Germany. One can think of making air travel sustainable and what that will with ticket prices. It is bad for economic growth. Many people would not like this. Still, life in a future sustainable market economy can be much more agreeable than life in Cuba or former socialist Germany.

So what has this to do with interest? A dramatic change to make the economy sustainable can cause a massive economic shock like the Great Depression. The economy can soon recover if interest rates can go negative. Before you say that it is more likely that unicorns exist, this has been tested during the Great Depression. The outcome is dubbed the Miracle of Wörgl. And evidence for the existence of unicorns has not yet been so forthcoming.

If interest rates are low then the creators of ideas and makers of things are rewarded more. They are the entrepreneurs and labourers rather than the owners of capital. It is in the spirit of Silvio Gesell who believed that labour and creativity should be rewarded and not the passive ownership of capital. Only when there is a shortage of capital or more demand for goods and services than there is supply, people need to be encouraged to save.

The economy is already constrained by a lack of demand rather than supply. That will be even more so when excessive consumption is to be curtailed and the rich have fewer options to spend their money on. And so it may become possible to fund an income guarantee with income taxes as well as negative interest on government debt. This can improve the bargaining position of labourers.

It is better to have an income guarantee rather than a universal basic income because that would be cheaper. There is little to gain from handing out money to people that already have enough. And the scheme should provide an incentive to work. A simple example can explain how that might work out. Assume there is an income guarantee of € 800 per month and a 50% income tax. The following table shows the consequences for different income groups.

Perhaps it doesn’t feel right that people are being paid for doing nothing. But nowadays people are paid for producing and selling things we do not really need and by doing so they endanger our future. Someone who does nothing at all can be worth much more for society than a travelling salesperson, a trader on Wall Street or a constructor who builds mansions for the rich. Of course it is better that people do something useful and useful people should be rewarded for their efforts, but doing nothing is always better than doing something stupid, and having zero value is always better than having negative value.

Another question is how this can be paid for? The Miracle of Wörgl shows us that the economy can flourish without growth when interest rates are negative so that most people will be employed. Money can still be a motivator to run a business or to go to work but less so than in the present. It doesn’t have to stop people from starting a business. Many entrepreneurs didn’t intend to become rich. They just wanted to be an entrepreneur or believed in the product they were making or selling. Still, there is no doubt whatsoever that a humane economy in harmony with nature will be very different from the economy of today.

Featured image: Slums built on swamp land near a garbage dump in East Cipinang, Jakarta Indonesia. Jonathan McIntosh (2004).

Other images: Share of Labour Compensation in GDP at Current National Prices for United States. FED. Public Domain