A currency is the money that is in use within a nation. US dollars, Chinese renminbi, Korean won and Brazilian real are all currency. A national currency promotes national self-determination. It allows a nation to pursue its own economic policies, although the options are limited by market forces.
Local or regional currencies can supplement national currencies, most notably when communities or regions are closely integrated and want to achieve some economic independence. A supranational currency like the euro reduces national economic independence. The issue of self-determination makes currency a political subject.
Reserve currencies facilitate international trade. In the past decades the US dollar was the most used reserve currency. This arrangement allowed the United States to enjoy a higher living standard and military paid for by foreign nations.
On the other hand foreign nations had a competitive advantage. This harmed US businesses. By buying US Dollars foreign competitors of the United States were able to suppress the exchange rate of their currency and sell their products cheaper.
Furthermore, the reserve status of the US Dollar made the FED responsible for the international banking system. The FED had to rescue foreign banks during the financial crisis of 2008 so that the US taxpayer backed up foreign banks.
International Currency Unit
An International Currency Unit can facilitate trade. It can be introduced alongside national currencies. The International Currency Unit can be a weighed average of national currencies. It may require an international central bank to guarantee stability in the international banking system. As long as central banks make political decisions, an international central bank would be a troublesome construct.
Only when central banks do not set interest rates and do not print currency, it might be feasible to introduce an international central bank. This might be possible when the International Currency Unit is a Natural Money currency. The underlying currencies may need to be Natural Money currencies too. With Natural Money interest rates are not set by central banks so the role of central banks is reduced.
The euro is a unique experiment. The nations of the euro zone are sovereign but have given up their national currencies. This produced political and economic tensions. Countries in Northern Europe feel that they have to pay for the debts of Southern Europe while countries in Southern Europe feel they are faced with austerity dictated by Northern Europe. The available options appear making the eurozone a federation like the United States or reverting to national currencies.
Returning to national currencies doesn’t have to end the euro. National currencies can be introduced alongside the euro. Alternatively, the euro can become a weighted average of the national currencies making up the euro zone. Existing balances in euro will remain in euro. In the latter case the future euro would look like the proposed International Currency Unit. It could be a step towards introducing an international currency and an international central bank.
Cryptocurrencies are debt-free and do not need a central bank. They promise an alternative payment system independent from governments and banks as well as an alternative way to issue stock. Proponents of private currencies believe that private currencies like cryptocurrencies can supplement or even replace existing currencies issued by governments and central banks.
Currency is important for political self-determination so governments have usurped the prerogative to issue currencies. Private currencies can undermine the power of governments. Cryptocurrencies also facilitate crime, scams and tax evasion, so they their use is likely to become regulated or even banned in the future. Governments may also start to issue cryptocurrencies themselves.
Until now cryptocurrencies have not been stable. Payments are cumbersome and prone to fraud. Regular currencies don’t have these disadvantages. Cryptocurrencies without a holding tax don’t allow for negative interest rates. As negative interest rates may be needed to ensure a stable economy without crises, these currencies may not be suitable as a means of payment.
Imagine that Jesus’ mother had put a small gold coin weighing 3 grammes in Jesus’ retirement account at 4% interest just after he was born in the year 1 AD. Jesus never retired but he promised to return. Suppose now that the account was kept for this eventuality. Imagine now that the end is near, and that Jesus is about to return. How much gold would there be in the account in 2018?
It is an amount of gold weighing 11 million times the mass of the Earth. The yearly interest would be a gold nugget weighing 440,000 times the mass of the Earth. There is a small problem, a fly in the ointment so to say. It would be impossible to pay out Jesus because there simply isn’t enough gold.
It might seem that the bank had to close long ago because of a lack of gold, but that isn’t true. As long as Jesus doesn’t show up it can remain open, at least if the borrowers are allowed to borrow more to pay for the interest. And it may not be such a big deal if the economy grows 4% as the interest can be paid out of growth. The interest on Jesus’ deposit can be created out of thin air by making new loans that allow borrowers to pay for the interest.
There is a limited amount of gold while compound interest is infinite. As long as bankers can create money out of thin air to pay for the interest and people accept bank deposits for payment, everything is fine. Problems only arise when people demand real gold. A bank can go bankrupt when depositors want to take out their deposits in gold.
Perhaps Jesus’ retirement account isn’t such a big problem after all. Our money isn’t gold but currencies central banks can print. Assume now that Jesus’ mother had put one euro in the account instead. One euro at 4% interest makes 22,000,000,000,000,000,000,000,000,000,000,000 euro after 2017 years. That may seem an intimidating figure, but the European Central Bank can take 22 pieces of paper and print 1,000,000,000,000,000,000,000,000,000,000,000 euro on each of them. And there you are. Something like this happened during the financial crisis of 2008. This is called quantitative easing. You may have heard that word before.
Central banks can print new dollars and euros to cope with a shortfall. In fact, this is what central banks often do. There is always a shortfall because of interest because most money is debt and interest on this debt needs to be paid. To make up for the shortfall, there are two options. First, people can borrow more. Second, central banks can print new currency. Both things can happen at the same time. Central bank decisions about interest rates are also about dealing with the shortfall caused by interest charges.
When central banks lower interest rates, people can borrow more because interest rates are lower. Central banks lower interest rates when people are borrowing less than is needed to cope with the shortfall. If central banks raise interest rates, people can borrow less because interest rates are higher. Central banks raise interest rates when people are borrowing more than is needed to cope with the shortfall and the extra money makes people want to buy more stuff than can be made. And if people don’t borrow at all, this is a crisis, and central banks may print more currency to cope with the shortfall.
Interest on capital versus economic growth
There is a problem central banks can’t fix by printing more currency. Interest is more than just interest on money. Interest is any return on investment. Throughout history returns on investments were mostly higher than the rate of economic growth. Most of these returns have been reinvested so a growing share of total income was for investors. This can’t go on forever because who is going to buy the stuff corporations make in order to keep these investments profitable? A simple example can illuminate that.
The graph above shows how total income and interest income (in red) develop with an economic growth rate of 2% and an interest rate of 5% when interest income starts out as 10% of total income and all interest income is reinvested. After 25 years the economic pie has grown faster than interest income and wages have risen. At some point interest income starts to rise faster than total income, and wages go down. After 80 years there’s nothing left for wages. This graph explains a lot about what is going on in reality.
In the short run it was possible to prop up business profits and interest rates by letting people go further into debt to buy more stuff. In the long run, the growth rate of capital income cannot exceed the rate of economic growth. Interest rates depend on the returns on capital so this can explain why interest rates went down in recent years. In the past interest rates below zero weren’t possible but from time to time there were economic crises and wars that destroyed a lot of capital. This created new room for growth.
Wealth inequality and income inequality
When interest rates go down, the value of investments tend to rise. If savings yield little this benefits the wealthy as most people have their money in savings while the wealthy own most investments. But it is important to know the cause otherwise you might think that interest rates should rise. The graph above shows that wealth inequality causes interest rates to go lower, hence redistributing income, for example via higher wages or taxes on the wealthy, can bring higher interest rates.
There is a difference between wealth inequality and income inequality. Your labour income and the returns on your investments are your income. If you are rich but make no money on your investments, your wealth doesn’t contribute to your income. In reality wealthy people make better returns on their investments than others because they have better information and can take more risk. Still, the graph shows that income and wealth inequality can’t increase indefinitely, and that returns on investments can’t exceed the reate of economic growth in the long run, hence interest rates need to go lower.
Most people pay more interest than they receive. The interest paid on mortgages and loans is the proverbial tip of the iceberg. Interest is hidden in rents, in taxes because governments pay interest on their debts, and the price of every product and service because investments have to be made to make these products and services. German research has shown that 80% of the people pay more in interest than they receive, while only the top 10% of richest people receive more in interest than they pay. Lower interest rates benefit most people despite some side-effects that work in the opposite direction.
Humans are herd animals. They buy stuff and even go into debt to buy stuff when others are going into debt to buy stuff too. Suddenly they may realise that they have bought too much or have gone too deeply into debt, and all at the same time. One day they may be borrowing money, queueing up before the shops, and bidding up prices. The next day, they may decide to pay off their debts, leaving the shop owners with unsold inventories they have to get rid of at fire sale prices. So prices may go up when people are in a buying frenzy and may go down when sales dry up.
When there is a buying frenzy business owners are optimistic and do a lot of investments, and often they go into debt to make those investments. But if suddenly customers disappear, they may be stuck with unsold inventory and debts they cannot repay. Businesses may then have to fire people. Those people are then left without income, and cannot repay their debts too, so sales will go down further. If their debts are not repaid, banks could get into trouble. In most cases the economy will recover. In the worst case banks go bankrupt, money disappears, the economy collapses, and an economic depression takes off.
Interest can make things worse. Assume that you have a business and expect to make a return of 8%. You have € 100,000 yourself and you borrow € 200,000 at 6%. You expect to make 8% so borrowing money at 6% seems a good idea. If you only invest your own € 100,000 you can make € 8,000, but if you borrow an additional € 200,000 you can make € 12,000 (8% of € 300,000 minus 6% of € 200,000, which is € 24,000 minus € 12,000). The balance sheet of your business might look like this:
cash, bank deposits
If sales disappoint and you only make a return of 2% on your invested capital of € 300,000, which is € 6,000, you make a loss because you pay € 12,000 in interest charges. You may have to fire workers. Businesses can go bankrupt because they have borrowed too much and have to pay interest, even when they are profitable overall. Sales often disappoint when the economy fares poorly. This means that more businesses face the same difficulties and make losses because of interest payments. They may have to fire workers and these workers lose their income. This can worsen the slump.
Interest, economic depressions and war
Silvio Gesell discovered that interest rates can’t go below a certain minimum because lending would then stop. Money would go on strike as he put it. Why is that? Low yields make investing and lending money unattractive because of the risks involved. Debtors may not repay and banks may go bankrupt. Depositors then prefer to take their money out of the bank and keep it with themselves.
This can cause economic crises and depressions. Silvio Gesell lived around 1900. Interest rates below zero weren’t possible because of the gold standard. Depositors could go to the bank and withdraw their deposits in gold so that they didn’t have to accept negative interest rates. From time to time there were bank runs, economic crises and wars that destroyed a lot of capital. And this created new room for growth.
There may be a relationship between interest, economic depressions and war. In 1910 the amount of capital income (the red circle in the graph) relative to total income (the two circles together) was close to what it was in 2010. This could have led to an economic depression. Before that could happen Word War I began. The war destroyed a lot of capital so that interest rates could remain positive.
A few decades later the Great Depression arrived. If interest rates could have gone below zero in the 1930s, the Great Depression might not have happened, Adolf Hitler would not have risen to power and World War II would not have occurred. The currency of Wörgl demonstrates that negative interest rates could have ended the depression. After World War II interest rates never came near zero again. Governments and central banks printed more money. This caused inflation, which eroded trust in money.
People feared that inflation would make their money worth less so interest rates rose. In the 1970s the link between money and gold was abandoned because there was a lot more money than there was gold to back it. In the 1980s governments and central banks started policies to bring down inflation and to promote trust in money. As of 1983 interest rates went down gradually as a consequence of a renewed trust in money and central banks. Debt levels rose and interest rates went near zero.
Promoting inflation might not be a good idea. The end result is unpredictable. The best one can hope for is a poor performing economy and a lot of inflation like in the 1970s. But if interest rates rise because lenders lose their trust in money and debts, people may not be able to repay their debts, and the financial system might get into serious trouble. This can cause another great depression or another great war. But if the alternative is negative interest rates, stability and prosperity, then why not opt for that?
There is a story in the Bible about a Pharaoh having some bad dreams he could not explain. He dreamt about seven fat cows being eaten by seven lean cows and seven full ears of grain being devoured by seven thin and blasted ears of grain. A fellow named Joseph was able to explain those dreams. He told the Pharaoh that seven good years would come and after that seven bad years would follow. Joseph advised the Egyptians to store food in large storehouses. The Egyptians followed his advice and built storehouses for food. In this way Egypt survived the seven years of scarcity.
What is less known, because it is not recorded in the Bible, is that the storing of food resulted in a financial system. The historian Friedrich Preisigke discovered that the Egyptians used grain receipts for money and had organised a banking system with the use of those grain receipts. Farmers bringing in the food received receipts for grain. Bakers who wanted to make bread, brought in the receipts which could be exchanged for grain. According to the Bible, Joseph took all the money from the Egyptians. This may have made them to look for an alternative.
In this way the grain receipts may have become money. The money unit was an amount of grain stored at a storehouse. The degradation of the grain and the storage cost caused the value of the receipts to decrease steadily over time. This was like a holding tax on money similar to the stamps in Wörgl. It stimulated the Egyptians to spend their money. It is unclear whether there were loans made with this money. The actions of Joseph may have helped to create this money as he allegedly proposed the grain storage and took all the money from the Egyptians.
A few centuries later, during the reign of Ramesses the Great, Egypt was again a leading power. Some historians claimed that the wealth of Egypt during the reign of Ramesses the Great was built upon the grain financial system. The grain money remained after the introduction of coins around 400 BC until it was finally replaced by Roman money. The money and banking system were stable and survived for more than a thousand years, probably because there weren’t financial crises caused by interest payments.
Featured image: Joseph interpreting the Pharaoh’s dream. Illustrations for La Grande Bible de Tours. Gustave Doré (1866). Public Domain.
In 1932, in the middle of the Great Depression, the Austrian town of Wörgl was in trouble and prepared to try anything. Of its population of 4,500, a total of 1,500 people were without a job and 200 families were penniless. The mayor Michael Unterguggenberger had a long list of projects he wanted to accomplish, but there was hardly any money to carry them out. These projects included paving roads, streetlights, extending water distribution across the whole town, and planting trees along the streets.
Rather than spending the 40,000 Austrian Schilling in the town’s coffers to start these projects off, he deposited them in a local savings bank as a guarantee to back the issue of a currency known as stamp scrip. The Wörgl money required a monthly stamp to be stuck on all the circulating notes for them to remain valid, amounting to 1% of the each note’s value. A businessman named Silvio Gesell came up with this idea in his book The Natural Economic Order.
Nobody wanted to pay for the monthly stamps so everyone receiving the notes would spend them. The 40,000 schilling deposit allowed anyone to exchange scrip for 98 per cent of its value in schillings but this offer was rarely taken up. That was because the scrip could be spent as one schilling after buying a new stamp. The money raised with the stamps was used to run a soup kitchen that fed 220 families.
Over the 13-month period the project ran, the council not only carried out all the intended works, but also built new houses, a reservoir, a ski jump and a bridge.
The key to its success was the fast circulation of the scrip money within the local economy, 14 times higher than the Schilling. This increased trade and created employment. Unemployment in Wörgl dropped while it rose in the rest of Austria. Six neighbouring villages copied the system successfully. The French Prime Minister, Édouard Daladier, made a special visit to see the ‘miracle of Wörgl’.
In January 1933, the project was copied in the neighbouring city of Kitzbühel. In June 1933 major Unterguggenberger addressed a meeting with representatives from 170 different Austrian towns and villages. Two hundred Austrian townships were interested in adopting the idea. At this point the central bank decided to assert its monopoly rights by banning scrip money.
One can only imagine what had happened if communities all over the world had been free to copy the idea. The Great Depression may have ended in 1936 and World War II may never have happened. It may be a lesson for the future. If another major economic crisis is about the plunge the world into another world war, this ‘miracle money’ can prevent that from happening. The reason is
1. The Future Of Money. Bernard Lietaer (2002). Cornerstone / Cornerstone Ras.
For a society to function, it needs a kind of order only a government can provide. Over time more and more people came to believe that a government should work in the interest of its citizens. That is quite a leap as traditionally governments were a kind of crime syndicate providing a protection racket. Citizens paid taxes to a lord or a king who provided them with security against other other lords, kings and ordinary criminals.
Even today many governments more or less resemble crime syndicates. They are oligarchies working in the interest of those in power. Government officials often take bribes too. Except for Northwest Europe, Switzerland, Canada and New Zealand, governments range from a bit corrupt to very corrupt. Even when the government isn’t corrupt, citizens often feel that it doesn’t work in their interest.
The above graph from Transparency International gives an indication of the corruption in each country. Poverty is seen as a cause of corruption but corruption is also a cause of poverty. If a country suffers from corruption, money is diverted to unproductive people. Investors will be wary of making investments so interest rates need to be higher to attract capital. This makes fewer investments profitable and the country will be poorer.
The Swiss have the most trust in their government.1 Probably that is because of some of the unique features of Swiss democracy. The Swiss combine representative democracy with direct democracy. The government and parliament administrate the country but if citizens feel the need to take matters in their own hand, this is always possible.
Switzerland uses direct democracy in the form of referendums more than any other country in the world. These referendums are binding, which means that the government must respect the outcome.2 The following types of referendums exist in Switzerland:
mandatory referendums on changes in the federal constitution
optional referendums on other federal laws that will be held when 50,000 eligible voters demand for it
similar rules exist on the state and communal levels, but the constitutions of the states deal with the specifics
citizens can propose a change in the constitution via a popular initiative, and the electorate can decide whether to accept the initiative, an alternative proposal from the government or parliament, or to keep things unchanged
Switzerland is a federation of 26 member states called cantons. The member states have a large degree of independence.
The Swiss constitution promotes making decisions at the lowest possible level and delegating power to a higher level if that is deemed beneficial.
The citizens of the Swiss states elect the Council of States (Senate) by majority vote. They can cast as many votes as there are vacant seats. Voters can propose representatives and influence the fractions of different political parties.
The Swiss elect their National Council (Congress) every four years by proportional representation. The people vote for a political party. Optionally they can vote for a specific person on the candidate list of the party.
Executive power has been distributed in Switzerland. The daily affairs of government are performed by the Federal Council consisting of seven members.
It is customary that all major political parties are represented in the Federal Council.
Constitutional changes need a double majority, which means that majority of the electorate as well as a majority of the cantons must support it.
Most Swiss communities use direct democracy to make decisions. In a few small cantons people can vote directly by the show of hands.
Combining representative democracy with direct democracy means that the citizens aren’t burdened with the daily affairs of government but still are in full control as they can vote on any issue when they feel that is needed.
Direct democracy allows for a more fine-grained alignment of government decisions with the wishes of the citizenry as on some issues the majority might be liberal and on some others it might be conservative.
Before laws are introduced, interest groups such as state governments, political parties and non-governmental organisations are consulted, and their concerns are taken into account. As referendums tend to come down to yes or no questions, this is important.
Proportional representation allows for multiple political parties that more closely match the preference of voters. New parties can emerge more easily. It also means that small shifts in voter preferences tend to have little effect on the political landscape.
Swiss voters can influence the make up of the political fractions of multiple political parties, which means that the people who are elected in parliament for a specific party are more likely to be acceptable to voters of other parties as well.
All major political parties work together in the Federal Council because there is little room to forward political agendas as citizens can always call for a referendum.
The use of direct democracy in Switzerland makes it less relevant who is in government so that political discussions tend to focus on issues and content rather than people and rhetoric. The Swiss tend to be well-informed about the issues that are at stake.
Proportional representation as opposed to win or lose elections foster cooperation between political parties as individual political parties mostly don’t have a majority so that they need to work with other parties to achieve their goals.
Proportional representation reduces the need to spend large amounts of money on political campaigns and other manipulations like gerrymandering, voter fraud and vote suppression as the effects of these actions tend to be limited.
Many countries have strict limits to political donations and campaign spending. Switzerland does not have these restrictions. This is not as harmful as it might be without proportional representation and referendums.
Direct democracy undermines the effects of lobbying for a law doesn’t pass if it is not supported by a majority of the voters. And so interest groups need to convince the citizenry rather than politicians in order to achieve their objectives.
In Switzerland the Congress represents the nation as a whole while the Senate represents the states. Hence, a decision needs the consent of a majority of the parliament of the nation as well as a majority of the cantons.
Most countries have a Congress and a Senate but many are unitary states and not federations like Switzerland. In unitary states the role of a Senate varies. For example, it can focus on protecting the constitution against laws that violate it.
Switzerland doesn’t have a Constitutional Court or Senate to protect the Constitution. There is no good safeguard of human rights. The majority can vote for stripping the rights of minorities. Switzerland is bound to the treaties it signed but better safeguards to protect human could be an improvement.
The Swiss are satisfied with their political system. And even though it has a few weak points, there is good reason to believe that other countries benefit from implementing a similar political system in which the citizens have the final say. Yet, different nations might opt for different versions of direct democracy.
Some people think that a better political system is possible. There are many ideas. The Swiss political system has proven to work in practise. It allows citizens to vote on proposals to alter and improve the political system. So even if a better system is possible, the Swiss political system may be the best way to get there.
The Swiss federation can be a model for the European Union and the United States. By delegating responsibilities to the state level it might be possible to reduce bureaucracy in the federation while increasing the legitimacy of the centralised institutions. Swiss democracy might also be a model for a world government if that ever comes to pass.
Featured image: The assembly of the canton Glarus. Democracy International (2014). [copyright info]
1. Government at a Glance Fact Sheet OECD. (2013). [link]
2. Switzerland’s Direct Democracy. http://direct-democracy.geschichte-schweiz.ch/ [link]