This looks suspiciously like a proposal to make something from nothing, to create real wealth from thin air, using only deception and force.

When you say 'zero interest loan', the loan can only be zero interest to the person borrowing. But we need to understand that interest on capital is a reflection of man's universal time-preference for satisfaction now, rather than the same satisfaction in the future. Interest cannot be made to go away. Government is not magic, and we should not attribute to it magic powers to change something that is embedded in the structure of reality.

The loans are not really zero interest. All it means is that the government is going to force *someone else* to pay the interest. The borrower won't need to care about it. Neither will government. The victims will be anonymous: they won't even know it themselves.

There are two basic problems with this proposal: ethical and practical.

The fundamental ethical problem is that this proposes using force or threats of force to take property from A without his consent to give it to B. If A doesn't agree, ultimately, a group of guys armed with weapons will come and if he resists, they will beat him into submission, and either way, he will be locked up in a cage where he is at risk of being further violated.

Obviously if you disregard A's property right, which you do, the proposal is ethically meaningless, or rather unethical. Even if a majority voted for it, that would make it *possible*, but it wouldn't and couldn't make it *ethical*.

I could make better use of your property, than you could, if I just take it by force. That's the level of your ethical argument.

As to the practical issue, the proposal assumes that the property taken from A to give to B, whether as interest or capital, will in practice be more productive of good when used in this way. But how could you possibly know that? You won't know whom it was taken from, nor what they could have done with it

Even if it were a justification to steal from one who has more, to give to one who has less, which it is not (otherwise theft would be legal), still, there is nothing in the system of governmental appropriation of money by taxation or inflation that would enable one to assume even that the person expropriated would be worse off than the one benefitted. For example, the governemnt taxes the homeless through the GST to fund bailouts for corporations, and taxes the kids who work at McDonalds to fund satellite internet for millionaire graziers.

There is neither reason nor evidence to think that the money expopriated would be more productive or more beneficial in the hands of the person who receives the handout, than in the hands of its proper, but forgotten owner.

The proposal is nothing but a superstition of omnipotent, all-knowing government doing magic tricks with smoke and mirrors. It assumes government can make something out of nothing. But in fact, the cost of what is destroyed is greater than the benefit, otherwise there would be no need to use force to compel the arrangement in the first place.

Peter,

The current method of creating new money is that banks lend money they do not have and interest is charged immediately on the money lent.

That is a fact and that is how fractional reserve banking works.

This new money has no assets backing it so why should it incur interest? The fact that banks require an asset as security against the loan is irrelevant. The asset is not backing the new money - it is backing the loan. The new money itself has no asset backing it. It is hoped that the money that is lent will create new assets but that is no forgone conclusion and often does not happen. We must break this link between debt and money being the same. Debt is different to money. Debt is a promise. Money is a representation of an asset. It is the mixing of the two that has lead to our problems.

As you rightly point out if you lend money that represents an asset you should charge interest because it is the asset that is being loaned and someone should pay for it. Paying no interest on "old money" is theft. I am not saying that we should not pay interest on money that represents assets - of course we should. What I do say is that we should not pay interest on money until represents an asset. You make the assumption that new money is already backed by an asset that is used as security against the loan. That is the case with "old money" but it is not the case with newly printed money.

We do not have to use fractional reserve banking. The linking of money to debt leads to the positive feedback mechanism between the creation of debt creating money which then allows the creation of more debt. Positive feedback leads inevitable to dysfunctional markets. Please read "The Origin of Financial Crises" by George Cooper to get a good description of how this occurs.

Our contribution is show a way to create new money AFTER it represents a productive asset.

Fickle Pickle

It might help if we adopt Mises' terminology:
'money' - money in specie - ie gold where gold is money, and government paper under a fiat regime
money substitutes, which comprise:
'money certificates' - claims redeemable in money eg cheques
'fiduciary media' - claims not redeemable in money - ie the amount which, under a fractional reserve regime, is not backed by money in specie.

Your question is good: why should fiduciary media attract interest?

It is the fiduciary media which are the source of all the mischief: inflation, massive systemic malinvestment, and recession.

However the solution is not more governmental intervention in money and credit.

Overwhelmingly the problem is caused by government manipulation of the money supply. Under a free market in money and banking, the tendency of banks to issue fiduciary media would be constrained within strict limits by the market disciplines of loss and bankruptcy. What enables it to grow to the stage of ruining entire economies is government, and government does it because it has an interest in endless inflation.

The solution to the problems caused by fractional reserve banking is to abolish governmental control of the money supply: no legal tender laws, no reserve bank, no governmental production or supply of money or credit, no cartelisation of the banking industry, no cozy deals by which government and the banks inflate the currency and take a cut for themselves at the expense of the entire population, no government backing of banks to shore up the whole fraudulent arrangement.

New ways for government to manipulate the supply of credit as a new way to try to manipulate people, to try to achieve more centrally-planned goals of government is contra-indicated. Once we add the cost of the intervention to the cost of the benefit, we are worse off than without any intervention in the first place

Wing Ah Ling

The proposal will remove the need for controls of the credit markets. The only thing the government will do is decide on the general areas where they want public investment to occur. It does not matter how many loans in any particular area are created because all that will happen will be that the loans will become devalued. That is, inflation caused by excessive production of loans will be restricted to the loans and will not flow through to the rest of the money supply.

The other critical thing is that the loan money is allocated via a free open market so that it will find the most efficient allocation. Provided the loan money on average is spent on assets that produce more wealth over some period of time than is loaned then society will be wealthier.

Another way of looking at the whole issue is that credit is an ownership issue while money is an asset issue and in principle should not be affected by ownership. It does not matter from an economic point of view to whom we issue the loans. The distribution of loans is a social equity issue.

We have put up with fractional reserve banking to create new money because it seems so reasonable. The movement of capital to areas where it is most needed through the use of a financial market works well for "old money".

Unfortunately it does not work for new money created as interest bearing debt. This creates a difficult (impossible) to control internal positive feedback mechanism that leads to instabilities. It is all explained very well in the literature on servo mechanisms, control and chaos theory.

Breaking the link between money and debt breaks the positive feedback loop and allows markets to work their magic.

We initially started with the idea of using restricted money in markets to spend government funds. Our contribution is to show a way to efficiently construct these markets which I am calling "Markets with a Purpose". The idea of using them to create money is a recent idea.

Privileging fractional reserve banks from bankruptcy where they would otherwise be unable to redeem claims in money, *is* control of the credit markets. It is the control of the credit markets that has caused the entire bubble and economic crisis.

Your proposal is in effect that government can issue fake money on condition that it spends it to ‘benefit’ the public. However, we should ask, since this money is not backed by assets, what is the source of its value? The source of its value is the custom of society in using money certificates as money. Government gets to pass off fiduciary media - unbacked money certificates – to be spent as if backed by money. In essence it is a fraud: the original fraud underlying fractional reserve banking where the bank does not disclose to the depositor the fact that his deposit is not backed by money. The dollars of everyone in society who uses money – everyone – are diluted to pay for the privileges the government confers on its political favourites by pretending to create real wealth by redistribution. The desire to engage in social engineering projects does not excuse it – on the contrary, it is the root of the evil that we should be condemning.

Secondly, just because the loans are interest free, why will that mean inflation will be restricted to the loans? The critical factor is the increase in the money supply. The loans will increase the money supply and therefore will cause inflation. There will be no dividing wall between unbacked money substitutes at zero interest, and backed money substitutes at market rates, in their circulation and effect as money substitutes.

Thirdly, the loan money will not be allocated via a free open market. Government will decide what areas the investment will occur in. If the proposals could cover their costs, they could attract capital on the open market without government subsidising them in the first place. The only possible reason for government deciding to subsidise them is because they do not stack up on the basis of profit and loss.

(cont.)

This is just a repeat of the rationale underlying the sub-prime bubble. It is more Keynesian ‘bread from stones’ cargo cult.

It does matter from an economic standpoint whom we lend the money to. The new fake money causes malinvestment in the sector where it enters the economy. That’s why the sub-prime bubble appeared in the housing sector. The new money makes investments appear profitable which, absent the new money and its inflation, would be seen to be loss-making. Capital and labour then flow in, inflating a bubble. But eventually reality kicks in. The market must wash out, must liquidate the malinvestments caused by inflation, and re-allocate the capital to productive, ie profitable purposes, in the process causing unemployment. We get the recession, based on government manipulation of the money supply, based on Keynesian errors.

The reason we have fractional reserve banking is not because it is reasonable or beneficial, it is because - ‘who shall guard the guards?’ – we have no way of stopping government from abusing its power over the supply of money, deceiving and defrauding the population, and playing Santa Claus.

The root cause of the entire problem is
a) government’s protection of fractional reserve banking from the ordinary market disciplines of loss and bankruptcy, in exchange for a cut of the loot,
and
b) Keynesian voodoo that we can get something for nothing by taking from A and giving to B, or by paying people to dig holes and fill them in again.

The equitable and practical solution is to abolish government’s self-interested, inflationary and abusive control of the money supply, not to extend it to new and more efficient methods of jiggery-pokery.


To understand why Keynes was wrong, see:
http://www.lewrockwell.com/rozeff259.html
and
http://mises.org/story/2492

Peter,

You make the statement

Your proposal is in effect that government can issue fake money on condition that it spends it to ‘benefit’ the public.

That is not what I am saying.

I am saying the government can issue zero interest contingent loans to people where the loans must be spent to the best advantage of the individual within a market place where the goods and services have an objective of reducing the amount of ghg emissions.

You say

"It is the control of the credit markets that has caused the entire bubble and economic crisis. "

I say - like George Soros - it is the internal operation of credit markets that has caused the entire bubble and economic crisis.

I say - like Minsky - that when you link money to credit you get Financial Instability.

The problem is that the way we create money today MUST result in unstable and hence inefficient markets.

I sometimes wonder why free market proponents are the ones that most attack the ideas in this article? I believe in the efficacy of free markets. What I am describing is a way to make markets work the way they should work. I am against regulation of market places because if a market needs regulating then is unstable market and almost impossible to stabilise through regulation.

Regulations to control unstable markets often fail because they cannot react quickly enough or the timing is wrong. We must build markets that are efficient. Because people can buy and sell things in a free and open market then that does not guarantee efficiency. Inefficient markets are everywhere and the inefficiency is normally caused by positive feedback mechanisms in the market itself - not from the vain attempts at control.

The stock market is an example of an unstable, unpredictable, chaotic market. This is caused by positive feedback between prices and demand. The more the price goes up the higher the demand and the less the supply. The more the price goes down the lower the demand and the greater the supply. This must lead to instability.

“I am saying the government can issue zero interest contingent loans…”

Are not the loans zero interest specifically because they are loans of money substitutes not backed by money in specie, in other words, fiduciary media, in other words, the fraction that is *not* held in reserve in FRB?

“it is the internal operation of credit markets that has caused the entire bubble and economic crisis.”

That is the issue. The Austrian school’s theory of money and credit is that government’s manipulation of the money supply, fiat money, easy money and FRB, are the original cause the following bubble and bust, and all the other market ructions we see are strictly secondary phenomena. I understand the theories that the problem is caused by the internal operation of the credit markets. May I ask, have you read and do you understand the Austrian theory of Ludwig von Mises, Friedrich Hayek and Murray Rothbard?

“I say - like Minsky - that when you link money to credit you get Financial Instability.”

Let’s say gold were money, and that all loans were backed 100% by gold. Don’t you agree that we would not then have such financial instability as we have now?

And don’t you agree that the source of the financial instability is fractional reserve banking, and specifically, the fact that banks can issue loans, unbacked by money, and then when there’s a run on the bank, the government bails them out with public money? Surely that is the origin of the mischief? You yourself seem to be pointing in that direction by identifying the ‘new money’ ie the amount lent over and above the amount redeemable in money on demand, as the source of the problem. Therefore it’s not the link of money to credit per se that is the problem, it’s FRB that is not subject to the market disciplines of loss and bankruptcy?

Thank you Wing ah Ling for your comments. You put the traditional arguments well. The Austrians, and you, would be correct if markets were efficient in the sense of seeking a stable state. The problem is most don't. Cooper's "Origin of the Financial Crises" explains it well for financial systems. Chaos theory explains it for dynamic evolving systems and Maxwell explains it for mechanical systems.

Where the Austrians go wrong is their belief that the financial stability hypothesis is correct. They assume financial systems are stable because any market will seek stability. If this is so and they observe that markets are not stable then what has gone wrong? They observe governments trying to regulate markets to stop the instability. They then draw the conclusion that the regulation is causing the instability.

If we take away the financial stability hypothesis and replace it with the financial instability hypothesis - financial systems are unstable because of their internal construction with positive feedback mechanisms - then the Austrian argument does not follow.

If markets are unstable then we can make them stable by regulations or by removing their internal positive feedback mechanisms. We can experiment with the later by building an "Energy Rewards" market whose purpose is to both create new money and to reduce ghg and see what happens.

Rudds stimulus package is using an unstable mechanism to create the money by the banks generating the money then loaning it to the government and so increasing the amount of credit. This will make make the problem worse as this feeds the positive feedback loop. Create money, pay interest, create more money to pay the interest. If they created the money through zero interest contingent loans then it would increase money without increasing loans on which we pay interest

Fickle Pickle

I have found the Austrian theory has enormous explaining power. I have never seen it refuted, only either ignored or misrepresented.

What you call the financial stability hypothesis: that markets are efficient in the sense of seeking a stable state, is not part of, and is not a correct representation of Austrian economic theory. Therefore it has not been refuted by anything you have said. I can only assume you must have gleaned it from second-hand sources.

I will try to show why the Austrian explanation should be preferred and I invite you to have an open and inquiring mind on the issues. Austrian theory also has a devastating critique of economic theory - theory of purposive human action - that is based on models taken from physics and engineering.

But first so’s I can understand where you’re coming from, could you please answer these questions for me:
1. What is the definition of a ‘stable’ as opposed to a not stable market?
2. What are the defining characteristics of an efficient as opposed to non-efficient market?
3. The money – the real wealth – that government throws at a given problem must come from somewhere. How do you know that the total cost of the money taken is not greater than the benefit of the intervention in any given case?
4. If gold were money, and if all loans were backed 100% by gold, in what sense would that be a system of money linked to credit that was unstable and therefore inefficient?

Here is an excellent, interesting, non-jargon explanation of the Austrian theory in a podcast nutshell:
http://www.lewrockwell.com/podcast/index.php?p=episode&name=2008-08-11_017_austrian_theory_of_the_business_cycle.mp3

I hope you will enjoy it

1. What is the definition of a ‘stable’ as opposed to a not stable market?

A stable state in any system where the value of state variables oscillate around fixed values in the absence of external influences. An unstable system is one where a small variation in a state variable causes large changes in later states in the absence of external influences. The so called "butterfly effect". A stable system is predictable. An unstable system is unpredictable. Planetary motion is predictable, weather patterns are unpredictable.

2. What are the defining characteristics of an efficient as opposed to non-efficient market?

A stable market is efficient because it is predictable. An unstable market can never be efficient because it is unpredictable. Market players in an unpredictable market are playing roulette not finding the best value.

3. The money – the real wealth – that government throws at a given problem must come from somewhere. How do you know that the total cost of the money taken is not greater than the benefit of the intervention in any given case?

The real wealth comes from the future return on investment of the productive assets built with the money "printed" by the government. If we create money and invest it in renewable energy infrastructure we get our money back many times over. Choose carefully the markets used to create money.

4. If gold were money, and if all loans were backed 100% by gold, in what sense would that be a system of money linked to credit that was unstable and therefore inefficient?

I did not say this will stop the debt market from being unstable. I said we would keep the money market stable. The approach is to try to isolate unstable markets from stable markets and to worry about one at a time.

The Austrians correctly describe positive feedback. Getting rid of central banks does not solve the money creation problem. That is why I have come up with a system to create money by creating a covering asset before the money can earn interest.

I see. So the basic value is stability in determining whether government intervention in a market is desirable.

However what I am trying to find out, is the criterion for government intervention. ‘Stable’ by itself is an arbitrary term, but when I ask what it is, your answer only takes me further back to needing to know what you mean by:
‘Internal’/’external’
‘Large scale’/’small scale’
‘Predictable’/’unpredictable’.

Let’s take the market for potatoes. Is super-phosphate an internal or external factor? Water in a drought? How about fuel? Truck tyres?

How would I, in advance of planting my potatoes, know whether you consider which variable affecting the market to be large as opposed to small scale? What if someone else thought differently? How could this be anything other than depending entirely on arbitrary subjective opinion, and therefore inimical to science?

As for predictability, all schools of economics - but one - have failed abysmally to predict the economic crisis. The Fed was saying as recently as a year ago that everything is fine. The Keynesians, the monetarists, institutionalists, the neo-classicals: they were the cheerleaders for this debacle: what credibility do they have?

The Austrian school is the one exception. It predicted this particular crisis *years* in advance, as well as the Great Depression years in advance: http://mises.org/story/3128 . Predicting the past is easy: did George Cooper predict this crisis five years in advance? In fact Ludwig von Mises predicted exactly this consequence from exactly this cause 97 years ago.

Earlier you said that not central bank policies of easy money but
“the internal operation of credit markets … has caused the entire bubble and economic crisis.”

So according to this theory, the supply of money is a factor external to the operation of credit markets? Surely not?

The only difference between your proposal, and the cheap-money policies behind Freddie Mac and Fannie Mae, is that they only aspired to *lower* the rate of interest: you aspire to abolish it for loans unbacked by money in specie for ‘public’ ie governmental purposes

To quote Mises: ‘Stability… is an empty and contradictory notion. The urge toward action, i.e. improvement of the conditions of life, is inborn in man. Man himself changes from moment to moment and his valuations, volitions, and acts change with him. In the realm of action there is nothing perpetual but change. There is no fixed point in this ceaseless fluctuation… It is vain to sever valuation and action from man’s unsteadiness and the changeability of his conduct and to argue as if there were in the universe eternal values independent of human value judgments and suitable to serve as a yardstick for the appraisal of real action.’

Even where the same prices are paid for the same quantity of potatoes, still each price datum stands for a different quality of potatoes, and a different valuation and value scale of the specific parties. “It would be manifestly wrong to let the prices of various commodities enter into the computation without taking into account the different roles they play in the total system of the individuals’ households. But the establishment of such proper weighting is again arbitrary.” The computation of averages would again yield different results, depending on the statistical method chosen. This in turn must be arbitrary.

Again, suppose we lived in a world that was unchangeable, everyone repeated the same actions, and one individual or group change here always had an equal and opposite individual or group change there, and so we lived in a world of stability. Then ‘the idea that in such a world money’s purchasing power could change is contradictory’.

‘In the actual world of change there are no fixed points, dimensions, or relations which could serve as a standard…. Where there is action, there is change.’

No measurement of purchasing power, and therefore of prices is or can be stable.

And there are more reasons I can give why the notion of stability of prices as a criterion for government intervention is neither morally nor intellectually defensible.

Wing Ah Ling

I did not say "So the basic value is stability in determining whether government intervention in a market is desirable" nor many of the other things you claim I say.

Let us say we have a market in potatoes where when we increase the price the supply decreases and when we decrease the price the supply increases. Let us not worry why this might happen - just assume it does.

The price of potatoes is at x. For some external reason the supply decreases by a small amount. A small decrease in supply in this market causes the price to increase. This in turn causes the supply to decrease. This in turn causes ..... How far the price will go up is unpredictable. Probably until an external event causes the supply to go up a little instead of going down. The same process is now repeated and we do not know how far it goes down. The market does not find a stable state because its internal mechanisms work to create instability. Small external events cause large changes from internal positive feedback.

We know when we have such markets by observing market behaviour. If we find that the market prices vary randomly and cannot be explained by external events then the market is unstable. We then look for the positive feedback within the market. We have two choices. We can try to control it by some from of regulator or we can eliminate the cause of the feedback. For money markets the method used by central banks is regulation but as the Austrians observe that makes it worse.

I make the claim that the cause of instability in the money market is the way we create money by creating debt that requires interest before the money represents an asset.
I claim we can fix this problem by creating zero interest money that must create a productive asset before it earns interest.

Contact me off line on skype at cscoxk or by email at cscoxk at gmail dot com.