Keith's NO EMPIRE Blog

A radical dissident perspective on various topics. Comments welcome at

Thursday, September 01, 2011

Private Financial Control, Debt Money and Compound Interest: Inevitable System Collapse

“The study of money, above all other fields . . .is one in which complexity is used to disguise truth or to evade truth, not to reveal it . . .The process by which banks create money is so simple that the mind is repelled.” (John Kenneth Galbraith)

“(Money is) the fundamental principle of social organization in capitalism.” (Doug Henwood)

I have been reading a lot of radical critiques of our political economy lately and I am struck by the extent to which even radical critiques rely upon a certain conceptual orthodoxy which inhibits understanding. What is occurring is really rather simple, so much so that simply stating the facts sounds simplistic, particularly to those accustomed to technical economic jargon intended more to obfuscate than illuminate.
The three key features of our current system which are absolutely crucial to understand are that the financial system is privately controlled for private profit, it is a debt based money system in which new money is loaned into the system at interest, and there is no formal means for dealing with the long term unsustainability of compound interest accumulation.

The fact that our financial system is privately controlled for private profit means that the financial system will inevitably be gamed to serve the profit seeking motives of the financiers at the expense of the real economy. We live in a highly complex, highly monetized society absolutely dependent upon money and the financial system to function. Controlling the creation and distribution of money/credit-- who/what gets funded and who/what doesn’t -- provides the financiers with immense social power, currently close to de facto control of the global political economy. Much of the system consists of rules, regulations and procedures designed to impose a uniformity of behavior upon the various private individuals and organizations which make up the financial system, thereby promoting confidence in system soundness by constraining the financiers from blatantly pursuing private profit seeking by abusing their power to create money. However, these rules, regulations and procedures have been circumvented by the creation and use of exotic financial instruments and other machinations justified by economic sophistry to the detriment of the real economy and financial stability. Private control of the financial system is inherently dysfunctional and needs to be ended. Unfortunately, this seems unlikely to occur, at least in the short run.

Few people seem aware that our financial system creates new money by loaning it into existence at interest. Two important consequences of debt money are that it creates a de facto lean on future earnings since it must be paid back with interest, and that the paying back with interest requires that new money be loaned into the system to enable the interest to be paid. This, in effect, is an internal compounding dynamic which requires compounding growth of the financial system to avoid default and system collapse. In other words, the real economy runs on debt owed to the private financial institutions which created the money. Without this debt, there would be no money in our current system. This debt based money works to the advantage of the financiers and to the disadvantage of the political economy as a whole, and needs to be replaced by debt-free government created sovereign money. This would not eliminate either interest payments on borrowed money, nor interest income on saved money, rather, it would eliminate systemic indebtedness to private finance.

The final critically important point to understand is the consequence of having a financial system in which the driving force of private accumulation is unsustainable compound interest. In the real world, nothing increases geometrically for very long. Consequently, the geometric increase in debt obligations has historically been resolved in one of several ways. First, the economy needs to continually grow to provide a real physical base to support the growing financial system. This entails both a growth in population and growth in the formal monetary transaction economy at the expense of the informal economy, that is, social interactions need to be increasingly monetized. Secondly, price inflation has tended to ameliorate the interest burden by effectively lowering the real rate of interest. The final way of dealing with unsustainable compound interest in our private system is through debt default and the writing down of bad debts. This write down is usually accompanied by a seizure of real assets (foreclosure) which are usually liquidated. This has been the historical consequence of recessions and depressions, in which the breakdown in the financial system causes a crash in the cash starved real economy which, in turn, forces a bad debt write down to repair the financial system. Massive foreclosures during recessions/depressions represent a cannibalization of the real economy by the financial system. While it should be possible to deal with compound interest at the systemic level through progressive income and wealth taxation to interrupt the accumulation process and redistribute the money, this has not been done because our capitalist political economy is designed to facilitate the accumulation and concentration of wealth, and any procedures which interfere with this are resisted regardless of the systemic implications.

Our current situation is both dire and unprecedented. For starters, our population and real economy have more or less reached the physical limits of growth. Consequently, the real physical base which has historically supported the growth of the financial system needed to meet interest payments on the debt are no longer able to do so. One consequence is the de-linking of the financial system from the real economy in what is usually referred to as financialization. Secondly, the current financial policy is to restrict inflation as much as possible thereby eliminating the de facto lowering of the nominal interest rate. The consequences of this are currently being masked by very low nominal interest rates, a consequence of Federal Reserve policy. One consequence of this is to cause investors to make riskier investments and engage in financial gamesmanship to obtain higher yields. A truly unprecedented situation is the massive bailout of the financial sector by transferring bad debts from the financiers onto the public. As a consequence, bad debts are not eliminated from the system, only from the financiers’ books. In other words, the financiers profit from good investments and profit even more from bad investments insofar as they create the money to loan the government to purchase their bad debts from them. The consequence of all of this is to starve the real economy while providing the financial sector with vast money power, hence, social control. The final result may be a massive privatization of public wealth as the financial system devours the real economy and the polity as a whole.

Taken as a whole, our private financial system has miserably failed the real economy and the polity while simultaneously increasing its control over both. Financial warfare seems an appropriate description. It is difficult to predict the final outcome or even the game plan of the financial elites. It appears to be a sort of slash and burn philosophy whereby capital will milk an area for all it is worth, then move on to greener pastures in a globalized world. A world of interdependencies linked by the global financial system where the areas will compete against each other to obtain financing. Apparently, the accounting rules will be modified to accommodate world-wide debt servitude. It is difficult to imagine this scenario actually working, total system-wide financial collapse seems more likely. It is also difficult to imagine the consequences of a system-wide financial collapse, however, it appears that is precisely where we are headed.

A critically important point is that our current private financial system is inherently unstable. It is held together by self-serving rules, regulations and procedures, some designed to reassure the financiers that they won’t be cheated by their fellow financiers, others designed to ensure that the fruits of the real economy flow into the financial system. These rules, regulations and procedures (and their organizational manifestations) can, of course, be changed. The extent to which they can be changed is contingent upon the extent to which the more powerful global financial centers can agree upon new rules, regulations and procedures which serve to inhibit individual and organizational profit seeking in order to achieve systemic equilibrium and stability. Implementing rules, regulations and procedures to deal with the systemic implications of unsustainable compound interest has never been attempted, much less implemented. While progressive taxation on income and wealth could achieve the desired outcome, it is practically inconceivable that the rich and powerful capitalists would go along with this, much less initiate it. It is difficult to imagine private capital solving this problem in such a way as to maintain the current hierarchy of power and equally difficult to imagine private capital agreeing to any significant alteration of the current hierarchy in our capitalist society, therefore, systemic collapse seems likely. In other words, the inherent bias and self-interest of private financiers will likely preclude solving our current financial problems as long as the financial system is run by private capital for private profit.


Anonymous Anonymous said...

Excellent analysis! I think another and perhaps better way to create "formal means for dealing with the long term unsustainability of compound interest accumulation" would be limiting financial heritage. I mean, if you need to socialize (rob) wealth from an individual, it would be nicer to do it after the person is dead; place a cap on wealth accumulation at that point. Wealth distribution becomes twisted usually after a long period of time - interest needs its time to compound - and it usually needs several generations to happen.
Just some thoughts of mine...

12:36 AM  
Blogger Seattle Keith said...

@ Anonymous- Thanks for the kind words! However, I disagree with your statement that “…if you need to socialize (rob) wealth from an individual, it would be nicer to do it after the person is dead; place a cap on wealth accumulation at that point.”

First of all, the notion that money and wealth are private property is one of the great propaganda victories of the dominant elites. Money is power, economic power in fluid form, the primary instrument of social control. Concentrated economic power results in de facto social control by the wealthy and the corporations. Democracy absolutely requires a more equitable distribution of income which can only be achieved by progressive income and wealth taxation. Right now the rich and corporations are roughly equivalent to economic royalty. Did democracy “rob” royalty of its birthright? Right now, income and wealth levels are determined by relative power, not merit. No one “earns” a billion dollars. Income and wealth redistribution is essential to lessen both economic power concentration and economic powerlessness. Also, a radically imbalanced economy such as ours tends to starve consumption and promote financial speculation.

1:30 PM  

Post a Comment

<< Home