NGO Another Way (Stichting Bakens
Verzet), 1018 AM
SELF-FINANCING, ECOLOGICAL, SUSTAINABLE, LOCAL INTEGRATED DEVELOPMENT PROJECTS FOR THE WORLD’S POOR.
Edition 02 : 08 August, 2011.
Edition 03 : 09 February, 2013.
Summaries of monetary reform papers by L.F. Manning published at http://www.integrateddevelopment.org
NEW Capital is debt.
General summary of all papers published.(Revised edition).
(The following items have not been revised. They show the historic development of the work. )
THE DNA OF THE DEBT-BASED ECONOMY.
The following three-dimensional diagram represents the DNA of the debt-based economy. It is tilted forward from the top to make its features easily understandable.
Click here to view a drawing showing the DNA of the debt-based economy.
Click here to view a schematic drawing of a debt model of the debt-based economy.
The diagram is made up of two mirrored helical strands of financial DNA. The blue strand represents the total accumulated GDP output for a given period while the red strand represents the total outstanding productive investment principal. The vertical axis of the helices represents time. The diagram shows a random period of four years.
On the blue helix,
Vy bases of production output My are added over the time
span needed to make one full turn of the blue helix (usually a year). On the
red helix, Vy bases of national saving Sy (net new
productive investment) are added over the time span needed to make one full
turn of the red helix (usually a year). For ease of consultation, the bases are
shown only for year three. The drawing shows nineteen of them, as this is the
approximate speed of circulation Vy of productive deposits My in
The helices replicate by extension. The blue helix showing GDP “dies off” at the end of each period. The helices grow exponentially by the transfer of National Saving Sy from the blue helix to the red one over each notional production cycle.
For each of the bases the national saving Sy is returned to the next production cycle on the blue helix in the form of net new capital investment Sy (Saving = Investment) as shown. Individual bases can vary in size (up or down) reflecting the state of the economy.
The annual length or growth ring Lz of the blue helix shows the GDP as it accumulates during that year. The nominal, usually annual, GDP growth in the blue DNA is the change in length Lz of the DNA spiral over the period z compared with the corresponding length L z-1 over the previous period. In the diagram, the length (and therefore the diameter) of the GDP spiral is shown to be increasing exponentially from year to year.
The annual increase in the length of the growth ring Lz of the red helix shows the annual increase in outstanding investment principal S which also equals the nominal GDP growth for that year. The total length of the red helix at any time is the sum of all outstanding investment principal. It equals the current (annual) GDP at any time.
At the end of each (annual) period z (and only then) the value of output represented by length Lz of the blue helix (the GDP for that year) equals the value represented by the whole of the red helix (its total length representing the sum of all outstanding investment principal).
The plan diameter of the helices typically expands exponentially. The helices vary together with the state of the economy. In the case of recessions they show up as changes in the annual rate of increase of the helix diameters, and therefore the length of the spiral loops. In the case of depressions they would show up as an actual annual decrease in the helix diameters.
Click here to view a drawing showing the DNA of the debt-based economy.
Click here to view a schematic drawing of a debt model of the debt-based economy.
"Money is not the key that opens the gates of the market but the bolt that bars them."
Gesell, Silvio, The Natural Economic Order, revised English edition,
“Poverty is created scarcity.”
Wahu Kaara, point 8 of the Global Call to Action Against Poverty, 58th
annual NGO Conference, United Nations,
“You shall not crucify mankind upon a cross of gold.”
William Jennings Bryan, Official Proceedings of the Democratic National Convention Held in Chicago, Illinois, July 7, 8, 9, 10, and 11, 1896, (Logansport, Indiana, 1896), pp.226–234.
“Where is the thicket? Gone. Where is the eagle? Gone. The end of living and the beginning of survival.”
This work is licensed under a Creative Commons Attribution-Non-commercial Share-Alike 3.0 Licence.
THE DNA OF THE DEBT-BASED ECONOMY
VERSION 3 31/7/2011
01. THE REVISED FISHER EQUATION.
02. DEBT AS MONEY.
03. INTEREST AND BANK SERVICES.
04. DEPOSIT INTEREST AND SYSTEMIC INFLATION.
05. THE CURRENT ACCOUNT.
06. SAVING AND INVESTMENT.
07. CREATION OF AND PAYMENT FOR CAPITAL GOODS.
08. THE DEBT MODEL.
09. DIFFERENTIAL ANALYSIS DEPRESSIONS AND RECESSIONS.
10. EQUITY IN SOCIETY.
11. THE RELATIONSHIP BETWEEN SAVING, INVESTMENT AND GROSS DOMESTIC PRODUCT.
01. THE FISHER EQUATION.
The basic mechanisms at the heart of the “modern” financial system have never successfully been put into a logical framework enabling the underlying relationships of its mechanical components to be quantified.
One effort to do so was provided by Irving Fisher in 1912
MV = PQ (1)
M = the amount of money in circulation.
V = the speed of circulation of that money; the number of times M is used over a given period T.
P = the price level of goods and services an economy produces during time T,
Q= the quantity of monetised goods and services an economy produces during time T.
The product PQ is what is known today as Gross Domestic Product or GDP.
At first sight, the Fisher equation seems to be self-evident. People have to be able to produce and exchange goods and services. To the extent money is used to do this, the total produced must bear a relationship to the amount of money and the frequency with which it is used.
In practice, very little money is needed if the speed of circulation V is high. In a very simple market economy all the money could be exchanged every weekly market day. This is shown in Figure 1.
Click here to view FIGURE 1 : THE SIMPLE DYNAMIC FISHER PRODUCTION CYCLE.
Figure 1 is cash-based. In it, factors M, P and Q have been assumed to be constant. The available money supply remains in circulation.
If, in Figure 1, PQ were greater than M, not all of the goods for sale could be sold. Either M would have to be higher or P lower.
Over a year, the money M in Figure 1 is circulated 52 times because there are 52 weekly markets, so V in the Fisher Equation would be 52.
The V in the Fisher equation refers to the speed of circulation of 100% of the money supply.
Humans are, by nature, hoarders. Ever since money was first used, and especially after durable metals like gold and silver were used for the money supply, people have “saved for a rainy day.” The money physically circulating at the market in Figure 1 was just a part of the total money supply, not all of it. The rest was “stored” 2. Instead of V in the Fisher equation being 52 as shown in the simple example in Figure 1, it was in fact much less because most of the money supply was hoarded. Despite that, the value of V seems to have been more or less stable over long historical time periods 3, suggesting the human tendency to hoard is psychological as much as functional.4
Where the speed of
circulation V is constant it becomes more a structural
than a dynamic component in the Fisher relationship. The immediate
response to a change in the money supply M will therefore tend to be a change
on the production side of the equation PQ.
If the change in M is rapid, the response will be a change in prices P
until production and demand adjust to compensate for the change in the money
supply. That’s different from what happens with fresh produce in the
supermarket after bad weather. In that case the money side of the equation
remains unchanged and prices rise because production falls. That happens in the
shops regularly and from season to season. Changing the speed of circulation V
would reflect either a change in people’s behaviour toward money, or changes in
the way the financial system works.
2. DEBT AS MONEY.
Structural changes in the money supply M began with the creation of new debt as money. When the Bank of England was established in 1694, the money supply, for the first time, became relatively independent of the supply of gold and silver.
When a bank issues a new loan the loan becomes an asset in the accounts of the bank. The new loan asset is offset by an equal bank liability in the form of a money deposit in favour of the borrower. Money has been created “out of nothing” by way of a bookkeeping entry. In the debt-based financial system, for every dollar of money M there is a dollar of debt. Every loan must be repaid over time. As it is repaid, the outstanding loan is reduced and the corresponding outstanding money deposit is also reduced by the same amount. When the loan has been repaid both the loan and the debt have been cancelled out of existence.
Unlike gold and
silver coins, debt cannot be hoarded. The debtor must repay the loan from
whatever deposits he or she can earn. That creates the production cycle shown
in Figure 2. For simplicity, the debt M
in Figure 2 is interest-free. Production and consumption are shown on the right
hand side of Figure
A fundamental structural change has taken place. Whereas in Figure 1, the money M remains in circulation, in the simple debt system shown in Figure 2 there is no money and no debt left at the end of each cycle because each cycle is self-cancelling.
Click here to view FIGURE 2 :THE BASIC DYNAMIC PRODUCTION CYCLE USING DEBT.
In aggregate, it is impossible to save debt. It is, therefore, impossible to hoard or “save” money issued in the form of debt in the debt system shown in Figure 2 without also increasing debt. The cash component of a given money supply can, however, be hoarded. 5
In the real world, production and consumption are going on all the time. There is always an amount of debt M and its corresponding “money” deposits in use in the
dynamic economic system. In this paper, the dynamic production debt will be called My and its speed of circulation Vy.
Vy has not been constant in the debt-based system because there have been structural changes to the financial system itself. In industrialised societies, the role of debt in the productive economy has increased over time. Cash transactions now contribute very little to the measured GDP. The proportion of employees paid weekly and the distribution of income among employees, businesses and taxation shown in the upper right hand side of Figure 2 have also changed 6. There are also shorter-term variations. During recessions, business bill payment time increases compared with the average while, during economic expansions, it tends to decrease 7.
3. INTEREST AND BANK SERVICES.
Interest has been paid on loans ever since the use of money became widespread thousands of years ago. People would loan their hoarded cash savings to someone else and expect their savings to increase by the amount of interest they received. The borrowers would usually borrow in the expectation that doing so would increase their productivity or their fortune in some other way. For example, buying an ox or workhorse might dramatically increase production from a farmer’s land.
The increased production created by using the ox or the workhorse would more than offset the interest on the loan. Both parties were better off as a result of the investment made by using the borrowed money.
The operative word
is “investment”. Investment is the use of money (originally cash, now mostly
debt) to increase production. The problem with the formation of the Bank of
England in 1694 was twofold. First, the
loans it made to the government of the day were not to increase production but
to help pay the war debts of the crown. Secondly the Ways and Means Act 8
that authorised the Bank of England provided for a perpetual fund of interest
charged on ships’ “tunnage” and liquor duties. Not only was the loan for
current spending instead of investment, it would never be repaid because the
Bank of England directors were happy to receive risk-free interest payments
forever. Since then, governments have found it very easy to borrow perpetual
debt in this way and its use has increased steadily over time.
The major change to the financial system brought by
the formation of the Bank of
In the basic dynamic cycle using interest-free production debt as shown in Figure 2, there is no residual debt after any individual production cycle, and no residual deposits.
The basic debt system incorporating bank interest as part of the productive economy is shown in Figure 3. There, the bank interest Is % is the bank spread 9. It does not include the funding interest If % banks pay on deposits. Bank interest Is % is part of the productive economy. Funding interest If % paid by banks on deposits (net after tax) held by their clients is not productive.
Banks provide goods and services just like any other business. Those goods and services are part of the gross domestic product (GDP). The bank spread is a large part of the “price” of banking. The only difference between Figure 2 and Figure 3 is that in figure 3 bank services become part of Q in the Fisher equation output PQ and the interest Is becomes part of the production debt My already referred to on page 8. The production cycle is therefore still self-cancelling as in Figure 2.
The interest Is banks charge to provide goods and services and the tax paid on funding interest If is part of productive economic activity and does not cause inflation.
4. DEPOSIT INTEREST AND SYSTEMIC INFLATION.
Figure 4 shows what happens when funding interest If % is paid on bank deposits. The dynamic production debt My is all repaid in full to the bank at the end of each cycle. The funding interest If % paid by a bank is a bank liability, not an asset. The deposits belong to deposit holders. The bank must transfer to them the deposit interest it receives when the production debt My is repaid. At first sight the bank would be losing money because it would be left in debt by the same amount as the deposit interest.
In practice, the production system does not “pulse” as shown for simplicity in Figure 4. Instead, there is an ongoing dynamic flow of production and consumption funded by the dynamic production debt My. The pool of residual debt (My in this paper) shown at the lower centre of Figure 4 is the accumulated interest component My*If % /(Vy*100) created through each nominal business cycle. 11 Since the price P itself is the sum of the price increases shown at the bottom right of Figure 4, price P must represent the total price inflation.
Assuming production Q is constant, the deposit interest If % (less tax) can be paid to depositors only if prices P increase as shown. Otherwise the production debt My
cannot be cleared when the economic production Pq 12 is sold. In this paper, the inflation caused by the deposit interest on the dynamic production debt My is called systemic inflation.
In an economy based on interest bearing debt, almost all price is inflation.
Figure 5 gives a historical
overview of inflation in
By the beginning of the 20th century prices had increased by just 6 times in 600 years, with nearly all the increases due to the “great debasement” of the mid-Tudor period and the Napoleonic wars around the turn of the 19th century. Prices fell by about one third between 1800 and 1900 during the industrial revolution due to vast improvements in productivity. Higher productivity means more goods and services are produced for the same input costs leading to lower prices P if money M and speed of circulation V remain constant.
The price change formula P=P*(1+ If % /(Vy *100)) shown at the bottom right of Figure 4 refers to a single production cycle producing the (constant) economic output q. Figure 6 shows that, assuming the deposit interest rate If and output Q are more or less constant, physical inflation is half of If %. The figure P* If % /(Vy *100) is the rate of change of P. It must be mathematically integrated to give the total change in P. This increase in price in called systemic inflation.
Click here to view FIGURE 6 : SYSTEMIC INFLATION.
Systemic inflation is a structural part of the debt-based financial system whenever interest is paid on deposits.
Figure 7 compares
systemic inflation with consumer price inflation (CPI) in
Click here to view FIGURE 7. SYSTEMIC INFLATION AND CPI INFLATION IN NEW ZEALAND..
increases increase the debt for production My faster than would
normally be the case. From the original Fisher Equation (1) MV=PQ, if M rises
while V and Q stay the same, P must rise in proportion to the rise in M. This is what happened before the debt-based financial
system became dominant after WWII as shown in Figure 5. It also seems to have
When economic productivity increases, more goods and services are produced using the same productive debt My because, in aggregate, the unit cost of each item produced is a little less than it was previously. In the original Fisher equation (MV=PQ), if M and V remain constant and Q increases then P must decrease.
The price of many
items has fallen dramatically over the years as shown, for example, in Figure 5
during the industrial revolution in
Productivity growth is inherently deflationary.
Labour productivity is often measured by dividing the value of total production, the gross domestic product (PQ), by the total number of paid hours worked. Capital productivity is often measured by dividing PQ by the total current productive investment.. Education and skill levels play a major in both measures because they allow new ideas and new technologies to be introduced. Caution needs to be used when applying productivity figures because the methods used to measure them can be inaccurate. Typically, employees with higher education and skill levels are paid more. That tends to increase some incomes at the expense of others, distorting the income distribution in most western economies. The most extreme form of this is the very high compensation packages now being paid to the executives of large corporations.
This paper assumes that, in aggregate, wages inflate at systemic inflation plus the rate of productivity growth to maintain overall price levels. One key reason why so many employees in modern industrial economies feel and are in fact worse off is because the benefits of productivity increases are skewed as discussed above 15. The increasing skew can be corrected only by income redistribution within the economy.
In a debt-based economy where interest is paid on deposits, systemic inflation is half the interest rate If paid on deposits provided adjusted incomes rise in line with inflation and productivity growth and there are no changes to indirect taxes.
Distributing the benefits of productivity increases throughout the economy by improving real wage levels and purchasing power requires socially mandated income redistribution.
countries have failed to redistribute the benefits of increased productivity,
with consequent loss of consumption capacity in the wider economy. The classic
case of this in recent years is the tax cuts made by recent republican
presidents in the
rates declined in
5. THE CURRENT ACCOUNT.
The current account
process is shown in Figure 8. The purple
box at the lower left shows how payments made on the current account in debtor
Click here to view FIGURE 8 : THE CURRENT ACCOUNT PROCESS.
Foreign ownership of a debtor nation’s economy drains its domestic economic growth through outgoing current account payments of interest on commercial paper and dividends and profits arising from the physical foreign ownership of its assets.
Foreign ownership of a debtor nation’s economy exposes it to high interest rates and the permanent risk of capital flight.
In a debt-based economy, it is not possible to both consume domestic production and pay for the remittances to foreign countries covering interest and profit because that would mean spending the same deposit twice. The cost of remittances for interest and profit payable abroad must therefore be borrowed within the domestic economy of the debtor country to enable the value of goods and services produced there to be consumed.
The surplus goods and services produced in a creditor country are part of its gross domestic product and are counted towards its economic growth. When they are exported, so is the growth.
A positive balance on external trade exports domestic growth in exchange for foreign assets.
The deposits from the sale of capital goods by a debtor country do not return to those who borrowed the debt to pay for the surplus goods and services and remittances sent offshore. They finish up, instead, in the hands of those in the debtor country that have sold assets (or an indirect claim on those assets) to settle the current account deficit. This means the debtor country’s capital account must be reduced accordingly.
Contrary to popular opinion, the direct borrowing of foreign currency by debtor country banks does not increase asset inflation in the debtor country. This is because the creation of the additional domestic debt used to fund the current account deficit precedes the banks’ offshore borrowing. The bank “borrowing” the foreign exchange simply “avoids” creating some of the deposits that would otherwise result in the direct sale of assets in the debtor country to settle its current account imbalance. If the creditor country banks chose not to lend their foreign currency to the debtor country, the additional domestic deposits that would necessarily arise from the sale of an equal amount of assets to foreigners would further inflate domestic asset values in the debtor country.
Many, if not most, of the debtor country deposits arising from the foreign “investment” as shown at the upper left of Figure 8 fail to qualify as productive investment as defined under the international System of National Account (SNA). They cause, however, additional structural inflation through the payment of deposit interest on the extra deposits. In that indirect sense, current account deficits are always inflationary in the debtor country. The amount of inflation depends on the interest rate paid on deposits in the debtor country and the tax rate on interest income there.
The main determinant of the exchange rate is the opportunity cost of capital in the debtor country. It has to be “worthwhile for the creditor to “invest” in the debtor country. When there is a free capital market the debtor must “match” other investment options around the world. Otherwise the debtor country’s exchange rate would need to fall until the investment prospect becomes “good” enough for the creditor to “invest”. The base-line opportunity cost of capital is the long-term bond rate in the debtor country. because bonds can be freely traded. Almost the only determinant of the bond rate is the deposit interest rate that must take foreign assessments of lending risk into account.
The main component
of the current account deficit in debtor countries is
by interest paid on the existing accumulated current account
At any point of time, the current account deficit in heavily indebted debtor countries is approximately the sum of the accumulated current account deficit x the average bond rate - the trade balance for the preceding period + the net profits of foreign-owned banks for the preceding period.
6. SAVING AND INVESTMENT.
The use of the term “saving” to describe a current account surplus is misleading. A creditor country uses the surplus deposits on its current account to buy foreign assets not because it has saved but because it has sold surplus production offshore and received remittances from offshore. It is a trading dynamic, not a conscious decision to forgo or defer consumption. It can be more a function of overproduction than under-consumption. The assets the creditor country buys mostly represent existing wealth like equities, businesses, property, and related loans, rather than new investment in bonds and business expansion in the debtor country that would be defined as productive investment in the SNA. They are not “saving” as defined in orthodox economic theory because most purchased foreign assets do not relate to new domestic production in the creditor country and do not alter its gross domestic product.
The purchase of offshore assets and the provision of loans to offshore banks is, from the point of view of the creditor country, income earning and “productive” at the price paid for them, otherwise the exchange would not take place. That “income” is not national income for the creditor country because it cannot be remitted there. It forms part of the creditor country’s current account surplus that is, in turn, swapped for more foreign assets, and so on as long as the current account surplus continues.
From the debtor country’s point of view, deposits arising from foreign capital inflows on the current account qualify as “saving” in the debtor country national accounts only when they are committed to new productive capacity. In reality, most capital inflows that appear as domestic deposits in the debtor country represent “investment” in the unproductive investment sector that serves to inflate the value of existing assets or “wealth” there. That “investment” neither adds to nor reduces production capacity in the debtor country. It does not qualify as investment under the System of National Accounts (SNA) and is therefore not “saving” as defined in orthodox economic theory. Any deposits from the capital inflows used to retire existing debt in the debtor country reduce debt and deposits by the same amount. They do not affect the domestic economy of the debtor country other than to reduce the systemic inflation caused by interest payments on the domestic deposits a little.
Taking the current account balance (CA) in creditor countries and debtor countries in turn the sequence of the exchange that takes place is:
Any gross fixed capital formation from return capital flows invested by a creditor country as foreign direct investment in new capital goods in the debtor country is automatically included in the GDP of the debtor country 19. The increase in the total capital value in the creditor country contributed by the capital goods it receives in payment of the debtor country’s CA deficit should be recorded in its capital account. If it is to be treated as income, it must also be shown in the creditor country’s income and outlay account.
In a debtor country, gross fixed capital formation arising from any return capital flows invested by the creditor country in new capital goods in the debtor country is automatically included in the GDP of the debtor country 20. The decrease in the total capital value of capital goods in the debtor country resulting from its sale of capital goods to the creditor country in payment of the debtor country’s CA deficit should be recorded in its capital account. If it is to be treated as negative income, it must also be shown in the debtor country’s National income and outlay account.
When the current account balance is included as income in the national income and outlay account of the SNA an entry of equal value entitled “purchase of capital assets on the current account” should be included on the “use of income” side of the national income and outlay account.
The National income and outlay account of the SNA needs to be restructured to reflect orthodox economic theory as follows:
Use of income side:
= Final consumption C
+ Purchase abroad of non-productive capital investment goods (=CA)
+ Saving for productive investment S. (2)
+ Current account balance (CA)
less the balance on external goods and services
less repayments of principal on outstanding productive investment. (3)
The National capital account of the SNA needs to be restructured.
There is no “saving” residual on the “use of income” side of the National income and outlay account because the items “Purchase abroad of non-productive capital investment goods (=CA)” and the Current Account Balance (CA) in equations (2) and (3) cancel each other out.
When Saving is
calculated as gross capital formation less principal repayments as shown in
equations (2) and (3) and used in Figure
Click here to view FIGURE 10. NATIONAL SAVING S, AND NATIONAL SAVING S AS A PERCENTAGE OF GDP* NEW ZEALAND 1962-1010. The GDP used in Figure 10 is GDP as presented in the national accounts. Saving is gross capital formation less the principal repayments calibrated as in Figure 9.
Saving in developed
countries, particularly debtor countries like
While higher depreciation may in part reflect technological innovation and “planned obsolescence”, its main effect has been to increase the ratio of principal repayments to productive investment. Higher repayment rates lead to a lower net operating surplus after debt servicing and therefore a lower saving rate 23.
Until now, there has been little or no mention in economics literature of this structural impact on saving.
National saving has been swapped for short-term business profit, typically boosting stock and existing property prices instead of longer-term investment.
Increased depreciation allowances speed up principal repayments and reduce Saving S and Investment I.
7. CREATION OF AND PAYMENT FOR CAPITAL GOODS.
Click here to view FIGURE 11 : INVESTMENT AND CAPITAL FORMATION.
Figure 11 shows how capital goods are created and funded. The basic economy without capital goods is shown in blue. The funding of capital goods and subsequent repayments are shown in orange. The fundamental orthodox investment equation (Savings= Investment) is shown in red.
The production of goods and services giving rise to new capital goods is included in the productive debt shown as My in Figure 11 24. Those new capital goods must be sold to clear the market. Since the income earners in the productive sector who want to buy the capital goods are not usually the same as those who produce the capital goods, they are exchanged through bank intermediation.
The buyers of the capital goods borrow part of the production incomes of employees (employee incomes) and businesses (gross operating surplus) Sy=S/Vy where Vy is the speed of circulation of Mv, as shown in the upper part of Figure 11. That enables the original producer loans My to be retired, thereby clearing the market.
In aggregate, some employees and businesses have notionally swapped their share of the sale price of the capital goods that they do not want to consume with others in the productive sector (the investors shown at the lower left of Figure 11) that do want to consume them. This creates lending within the productive sector. There is a debt created in favour of the “savers” in return for their deposit. After using the “savers’” deposits to repay the production debt the investor has a debt as a liability and a capital good as an asset, while the “savers” have an interest-bearing loan to the investor as an asset to replace the deposit they had in the bank.
Whatever bank intermediation takes place, in aggregate, the process shown in Figure 11 must always be true if the goods and services Q produced by the productive sector are all to be sold to clear the market. Where that does not happen, there will be consequential changes in inventory.
The main feature of the exchange discussed above is that the investor debt is interest-bearing and accumulates with each production cycle.
The investment and capital formation shown in Figure 11 is dynamic. The faster the rate at which investors repay their debt, the less Saving there will be, because Saving = New investment less repayment of outstanding capital.
Increased repayment of debt, including household debt, reduces Saving and reduces net new productive Investment.
Any attempt to withdraw any part of deposits S/Vy for non-productive investment purposes (“savings”) reduces purchasing power in the productive economy or leaves capital goods unsold, leading to increases in inventory, and subsequent unemployment and recession.
such as Kiwisaver in
It is impossible to increase GDP or Saving without increasing production loans My and new productive investment.
Increases in inventory, other than what is needed to allow for inflation and population growth, have very little, if any, value despite their being entered in the National Accounts as “investment” at cost. Added inventory and subsequent production must later be discounted to clear the build-up, otherwise inventory would continue to grow.
There is always an outstanding production debt My that is continually being recycled through the production system and there is always a corresponding flow of Saving Sy = S/Vy and investment Iy = I/Vy for the production of capital goods.
Economic policy planning and implementation must be based on a progressive dynamic supply of new productive debt My to make use of spare labour and resources in the economy or to increase the skills of, and re-employ existing resources.
Capital formation takes place by new debt formation within the productive sector itself and domestic productive investment in terms of the SNA can be viewed as the redistribution of production incomes to clear the capital goods market in the productive sector.
Capital formation as it is shown in Figure 11 of this paper follows the basic tenet of orthodox economics that Savings=Productive Investment.
Investment in new residential housing consumes
part of the Savings Sy=S/Vy
in Figure 11. As noted at the lower right of Figure 11, most housing investment
is, however, economically unproductive once it has been built. Furthermore,
the more new housing investment there is, the less is available from Sy
for other productive investment. Assume, for example, that in
Not only does housing construction slow the growth of economic consumption, it is very difficult for the buyers of new homes to repay their mortgage debt without decreasing their own existing consumption. As shown in Figure 4, incomes nominally increase at only the rate of systemic inflation. As discussed in section 4, systemic inflation is half the deposit interest rate. The increased income of homeowners is therefore not enough to repay the interest on their mortgages, let alone repay any principal. It follows that to own their new homes homeowners must consume less by an amount equal to their principal repayments plus their mortgage interest.
In the absence of productivity gains, new homeowners must reduce their domestic consumption by an amount equal to principal repayments plus their interest cost.
In the distant past, the income deficit could have been met by large labour productivity gains. Increasing labour productivity is deflationary because, unless extra incomes are injected into the economy to cover the purchase of the extra production, it makes available more goods and services for the same production cost.
Consumption could be maintained as long as the
productivity increase was enough to offset, in aggregate, the additional
interest and principal payments being made by households
More recently, indebted homeowners have instead been working longer hours, often by switching from single-income households to two-income households. While indebted households may manage to keep up their mortgage payments by working longer and/or with two members working instead of one, there is a corresponding structural decrease in consumer demand that cannot be satisfied within the productive economy. That structural decrease in consumer demand is the result of interest and capital payments homeowners must make to repay their household debt. Either consumers in aggregate must be induced to borrow outside of the productive economy to maintain demand (for example, by re-mortgaging their homes) or there will be growing structural unemployment as production is reduced because of the oversupply of consumption goods and services. The only other option is to export the surplus consumption goods and services.
In practice there is a combination of outcomes
with some productivity increase, perhaps 1% annually in New Zealand, developing
structural unemployment and some (extra) consumer debt to temporarily maintain
demand. There should also be an improvement in the balance of trade. Additional
debt can be generated using house price inflation as the security for new
loans. However, the additional consumer
debt cannot be repaid out of existing incomes any more than the indebted
homeowners can repay their loans from their incomes. In both cases the extra
debt makes the productive economy worse and not better off in the longer term
due to falling consumption capacity. The classic result of this was the
sub-prime crisis in the
In the long run, homeowners cannot repay their mortgage debt without causing increasing structural unemployment in the productive economy. They can export the surplus consumption goods and services they cannot themselves consume This will alter the balance of foreign ownership of the domestic economy but not the wellbeing of its people.
Residential housing investment that does not generate income is fundamentally incompatible with a financial system based on interest-bearing debt.
SECTION 8. THE DEBT MODEL.
The first version
of the debt model was published in the paper:
Manning, L “The Ripple Starts Here: 1694-2009 : Finishing the
Past”, presented at the 50th
Conference of the New Zealand Association of Economists (NZAE),
While the debt model is based on the volume of debt, it is unrelated to earlier volume-based reform proposals like those of Social Credit that failed to offer a viable theoretical basis to support them.
The premise in both the debt model and Figure 4 is that the circulating deposits and cash My = Prices P x output q where q is the quantum of domestic output produced by My over a single cycle. Taken over a whole year, the SNA definition of Gross Domestic Product GDP is given in the debt model by mathematically integrating the expression Pq* Vy, where Vy is the number of times the circulating deposits and cash My are used during the year 27.
The SNA should reflect an expression of the original Fisher Equation of Exchange as shown in Figure 2 28. The only difference is that the money supply M in the Fisher equation of exchange included hoarded cash, whereas in the debt system shown in Figure 2 for practical purposes there is now very little cash contributing to measured GDP.
In Figure 4 My cannot include hoarding of debt beyond the term of the production cycle because all the productive bank debt giving rise to My is conceptually repaid at the end of the cycle 29.
At any point in time there are five broad blocks of deposits in the domestic financial system.
Mt The transaction deposits representing the productive debt My - M0y so:
My = Mt + M0y (4)
Mca The accumulated domestic deposits representing the sale of assets to pay for the accumulated current account deficit (see section 5 of this paper for details).
M0y The cash in circulation included in Mv and used to contribute to productive output.
Ms The net after tax accumulated deposits arising from unearned deposit income on the total domestic banking system deposits M3 (excluding repos) 30.
(M0-M0y) Cash hoarded by the public and not used to generate measured GDP.
In this paper the total of these deposits, that is, Mt + Mca + M0y + Ms , is provisionally assumed to be the M3 (excluding repos) monetary aggregate published by most central banks monthly less the amount of cash in circulation M0 except for the part M0v that is included in My. In this paper M0y is assumed to have the same speed of circulation as My. In industrialised countries, the contribution of cash transactions to the measured output of goods and services (GDP) has been declining in recent decades and their contribution to the GDP has been provisionally calibrated for the purposes of this paper 31.
In this paper, the total debt in the domestic financial system is assumed to be the Domestic Credit, DC debt aggregate published by most central banks monthly.
At any point in time there are four broad blocks of domestic debt in the domestic financial system. Three of them together add up to DC such that:
DC = Dt + Dca 32 + Ds (5)
Dt The productive debt supporting the transaction deposits Mt.
Dca The whole of the debt created in the domestic banking system to satisfy the accumulated current account deficit 33.
Ds The residual debt to balance equation (5)
The fourth block of debt is :
Db, the virtual “bubble” debt, the excess credit expansion or contraction in the banking system such that Ds - Db = the debt supporting the accumulated deposit interest Ms defined above. Db can be positive or negative as discussed further below in relation to Figure 5.
There is also a fifth block of debt Is that is, conceptually, not bank debt .
Is, the total debt accumulated by investors arising from Saving Sy = S/Vy.
In Figure 11, the investor pays the investment Iy =I/Vy = Sy = S/Vy to the producer and the money is used to retire the outstanding part of My relating to the investment in question. Conceptually the investor borrows the purchase price from employee incomes and the business operating surplus as discussed in section 7. Except for households buying new homes discussed separately on pages 27-28, the investor then becomes a producer, and the interest on investment Iy is included as a production cost in the subsequent production cycle loans My.
The predicament of new homeowners is quite different. They cannot service their debt because they cannot, conceptually earn more than they were before they bought their new home, because the home itself is nearly always unproductive. There is no new income stream from their housing investment. If economic demand is to be maintained, homeowners must, in aggregate, rely upon increasing house prices and refinancing of their properties, creating an aggregate “pass the baton” systemic increase in debt.
When non-productive investment assets are traded there is typically a capital gain because of asset inflation on investment (Dca + Ms + the property component of Is). The new purchaser pays more for the asset because of asset inflation, allowing the seller to retire the outstanding mortgage debt on the property.
By definition in this paper :
My x Vy = GDP
Ms = Ds
The cash contribution to GDP = M0y * Vy. Therefore :
DC = (GDP)/Vy - M0y + Ms + Dca + Db (6)
Ms =Ds = (DC – Dca ) – GDP/Vy + M0y - Db (7)
GDP = Vy *(DC - (Ms +Dca +Db ) + M0y ) (8)
My = GDP/Vy = DC - (Ms +Dca + Db) + M0y (9)
Where the terms are as defined on pages 28-29.
Equations (6 ) to (9) are all forms of the debt model developed in previous papers 34.
Ms is the same format as Ms in the earlier forms of the model. It has been freshly calibrated. Unlike the previous forms of the model equations (6) to (9) are general and include the contribution made to the economy by cash transactions.
In equation (7), all the terms except GDP/Vy = My and Db are known or can be estimated with reasonable accuracy. For the purposes of equations (8) and (9) My can be approximated using trend-lines because it is small compared with Ms. Db is unknown but can be approximated through the calibration as in Figure 5. The calculations in equations (8) and (9) involve the subtraction of large numbers to get relatively small numbers, which leaves them sensitive to modelling and data error.
calculated as “the accumulated deposits arising from unearned deposit income on
the total domestic banking system deposits M3(excluding repos) ” as
defined on page 30, agrees more or less with that calculated in equation (7),
bearing in mind the value of Mb, the proposition that debt growth is
determined by deposit interest will be proven.
The model will require further calibration as further data becomes
available. Despite that, it is
self-evident Db will be positive during periods of rapid expansion,
particularly as bubbles form, and will become negative during periods of rapid
contraction, particularly as bubbles collapse. The classic case of this in
The dependence of the gross domestic product (GDP) on the Domestic Credit DC and the interest rate on bank deposits in the modern cash-free economy from which Ms is calculated has profound implications for economics.
In the light of the worldwide financial chaos of 2007-2009 the indicative debt model shown in Figure 12 provides a powerful argument in support of public control of a nation’s financial system.
Click here to view FIGURE 12 : THE SCHEMATIC DEBT MODEL OF A DEBT-BASED ECONOMY.
The vertical axis
in Figure 12 applies to the Domestic Credit for
It isn’t possible to have a simpler model of the economy than equation (8):
My =Nominal GDP/Vy equals domestic credit DC less (unearned net deposit income Ms + the accumulated current account Dca + the cash contribution to GDP M0y plus a correction for bubble activity Db (+/-))
Click here to view FIGURE 13 : EXPONENTIAL DEBT AND GDP NEW ZEALAND, 1993-2011.
It is theoretically impossible to maintain exponential debt expansion faster than GDP expansion over an extended period because the added debt servicing costs will always leave the productive sector insolvent.
To avoid national bankruptcy, each nation must maintain, in aggregate, a zero accumulated current account deficit.
approximation for the speed of circulation Vy of productive debt
plus cash transactions My is given in Figure 14. Vy varies with the change in the
payments systems. Minor secondary shorter-term cyclical variability also occurs
through changes in the average time taken to pay bills. When times are tough people take longer to
pay their bills, and each change of a day in the time taken to pay them can
alter Vy by perhaps 0.25%. The process is usually reversed in better
times. Otherwise Vy reached a constant value of about
Click here to view FIGURE 14 : SPEED OF CIRCULATION Vy NEW ZEALAND 1978-2011.
Note that in Figure 14, no correction has been applied to Vy for secondary increases in payment time during recessions or decreases in payment time during economic boom periods. The maximum correction in Vy appears to be in the order of +/- 0.3 or up to 1.5%. The series shown is less stable from 1978 to 1989. This is possibly due to distinctly different growth exponentials 1978-1989 arising from the very high interest rates that were typical during those years.
As shown in Figure 15, My in
Click here to view FIGURE 15 : ESTIMATED TRANSACTION FUNDING My NEW ZEALAND 1990-2011.
used to calculate Vy in Figure 15 is as follows. The GDP in
Businesses pay suppliers monthly, and indirect payments are usually made on a monthly basis too, so their speed of circulation is about 12 on average. Most workers get paid fortnightly (though some get paid weekly and some monthly) so an average speed of circulation of 26 has been assumed for that.
When the above figures are weighted the weighted average speed of circulation is (12x(42.7+12.3)+45 x 26)/100 = 18.3.
A similar estimate of payment trends and a separate Vy calculation was made for each of the other years, and a polynomial best fit curve was drawn as in Figure 15.
My was then obtained by dividing the official GDP figure by the speed of circulation taken off the best fit trend curve. This gives the data series shown in Figure 16 and used when applying the debt model discussed in section 8.
The methodology is easily replicable using better information about payment trends and is applicable to any country.
Figure 15 shows the
preliminary estimate for estimated production debt and cash My in
Figure 16 shows an
indicative comparison between the residual debt Ds for New Zealand
calculated from equation (5) and plotted against the model Ms
calculated as the accumulated after tax deposit interest on M3 (excluding
repos). The curve for Ms is a first approximation because
assumptions have been made on the average tax deducted from the gross payments
of unearned income (M3 (excluding repos x the average interest paid on
deposits). The tax is the average tax
paid by each income-earner on his or her total income. It is not the marginal
tax rate 36. The losses from
the 1987 share market crash in
Once the tax rates on Ms have been accurately calibrated, the size of any debt bubble Db can be immediately calculated. Measures can then be taken to eliminate the bubble without risking any economic downturn.
Click here to view FIGURE 16 : BUBBLE DEBT Db AND Ms NEW ZEALAND 1978-2011.
9. DIFFERENTIAL ANALYSIS DEPRESSIONS AND RECESSIONS.
Equations (6) to (9) can equally be applied in their differential form by calculating differences from one period to the next.
For example, over any small period of time dt, the change in the total debt DC = the change over the same time dt of ( GDP/Vy - M0y + Ms + Dca + Db ).
There is quite a lot more variability in the figures calculated this way compared with equations (6) to (9) because additional error is introduced by multiple subtractions of large numbers.
Using the differential approach (and Newtonian notation) allows the new debt model to show how the economy is performing in practice. With better data economic performance could be assessed monthly, or even, theoretically, in real time. The differential equations are:
d/dt DC = d/dt ( GDP/Vy - M0y + Ms + Dca + Db ) (10)
d/dt Ms =d/dt Ds = d/dt ((DC – Dca ) – GDP/Vy + M0y - Db ) (11)
d/dt GDP = d/dt (Vy *(DC - (Ms +Dca + Db ) + M0y )) (12)
d/dt My = d/dt GDP/Vy = d/dt (DC - (Ms +Dca + Db) + M0y (13)
DC = Domestic Credit debt aggregate published monthly by central banks.
GDP = Gross Domestic Product (the same as economic output PQ in the original Fisher Equation
Vy = The speed of circulation of the productive debt My
My = The dynamic productive debt used to generate output (see Figure s 3 and 4)
My is interchangeable with GDP/Vy in equations (10) to (13).
M0y = The cash in circulation included in Mv and used to contribute to productive output.
Mt = The transaction deposits representing the productive debt My - M0y so:
Ms = The net after tax accumulated deposits arising from unearned deposit income on the total domestic banking system deposits M3 (excluding repos) 37.
Dca = The whole of the debt created in the domestic banking system to satisfy the accumulated current account deficit 38.
Ds = The residual debt to balance equation (5)
Db =The virtual “bubble” debt, the excess credit expansion or contraction in the banking system such that Ds - Db = the debt supporting the accumulated deposit interest Ms.
For example, in
d/dt DC = d/dt (GDP/Vy - M0y + Ms + Dca + Db) (10)
NZ$ 26.4b = 0.73 + 0.02 + 10.01 + 13.34 + d/dtDb
= NZ$24.1b + d/dtDb .
This shows the credit bubble grew by about NZ$ 2.3b in the March 2008 year.
Figure 16 shows the bubble surplus Db growing in the March 2008 year (upward slope of Ds relative to Ms), accounting for the difference between the official figure and the derived one. The example above is within the statistical error of the official data even before taking Db into account. More calibration work is needed before using the differential method for predictive purposes, particularly in equation (12) that requires a small number to be multiplied by Vy to get the change in GDP 39.
An approximate check of the calibration is readily available because in Figure 16, Db should be zero where the model Ms curve intersects the Ds curve. Some obvious years to check are 1982, 1992, 2004 and 2009 though the two curves do not cross exactly at the data points.
In Figure 16 using the nearby data points the “error” between Ds and Ms in 1982 is -1.0% of GDP (Ds slightly larger than Ms). In 1992 the error is + 1.7%, in 2004 +1.4%, and in 2009 -1.8%. The error between the Ds curve and the Ms curve is within acceptable limits given the preliminary nature of the model calibration and the accuracy of the official data series.
A non-zero figure for Db in the debt model represents an imbalance between existing debt and economic performance, and it indicates unsatisfactory financial management.
When Db in the debt model is negative a credit bubble exists and when Db is positive an economic contraction is taking place. When the slope of the bubble is rising (upwards over time) the bubble is intensifying and when it is falling (downward over time) it is dissipating. The bubble is not fully dissipated until the Ds curve meets the Ms trendline and Db has returned to zero. When the slope of the recession is falling (downwards over time) the recession is intensifying and when it is rising (upward over time) the economy is in recovery. The recovery is not complete until the Ds curve meets the Ms trendline and Db has returned to zero.
Figure 16 shows
From equation (12), when d/dt GDP = 0
d/dt GDP = d/dt (Vy *(DC - (Ms +Dca + Db ) + M0y)) (13)
Since in a fully debt based financial system M0y is zero and d/dt Db is usually small,
d/dt DC = d/dt (Ms+Dca ) approximately (14)
In a debt-based financial system, if there is no increase in the total economic output, domestic credit must still increase by the amount of unearned income that has to be transferred to the investment sector Ms plus any current account deficit that has to added to Dca. Unless there is residual bubble debt Db in the financial system, failure to maintain sufficient domestic credit as in equation (14) would be accompanied by economic collapse because GDP would necessarily fall by any shortfall in domestic credit x Vy.
The provision of new debt for inflation in the debt model together with unearned income and the current account deficit can together be considered financial system costs. Economic growth occurs only when and to the extent that d/dt DC exceeds the financial system costs as shown in Figure 12.
A recession provides for inflation but not economic growth, while a depression provides for neither economic growth nor inflation.
A recession occurs when the change in the total debt over time is less than what is needed to service the financial system costs made up of the net unearned interest that has to be paid on all bank deposits plus any new current account deficit plus any increase in the productive debt used to generate new economic output. In that case, d/dt DC is less than d/dt (Ms+Dca ) plus provision for inflation.
A depression is a deep recession. It occurs when the change in the total debt over time is less than what is needed to service the unearned interest that has to be paid to the accumulated net deposit interest Ms plus any current account deficit that has to be added to the accumulated current account deficit Dca, that is, when there is no provision for either inflation or growth.
The model can be used to provide specific measurable monetary targets to avoid recessions and depressions. The targets can easily be identified in advance and new debt injected into the system to maintain growth limited only by the resources available and the productive capacity, education and knowledge of employees and businesses.
The amount of new
productive debt d/dt My needed to fully utilise the available
resources and the productive capacity, education and knowledge of employees and
businesses is very small. In
The collapse in the capitalist system is caused, in part, by its failure to recognise that production must, just by a little bit, lead consumption to provide the incomes that enable consumption to take place.
In recent decades it has been assumed that lower interest rates would be enough to restart a stalled economy. That is no longer true. The exponential growth of debt required by the debt-based system itself means that the increase in consumption capacity generated by an interest rate cut is no longer sufficient to allow an economy to recover.
For example, in
March 2011, domestic credit in
Interest rate reductions only work to stimulate an economic recovery when asset inflation remains high enough for the debt generated by refinancing and trading of existing assets to offset the systemic debt requirements of the financial system.
The logical outcome
of the existing debt system in creditor countries is zero deposit interest and
stable or falling asset prices (as in
In the absence of strong capital controls, the logical outcome of the existing debt system in debtor countries is bankruptcy because debtor countries must maintain high rates of interest to avoid capital flight. The debtor status of debtor countries can only be reduced if their exchange rates are reduced so their current accounts become positive enough to reverse the foreign ownership of their assets.
There is a powerful theoretical incentive for public investment in new production to assist a market economy out of recession or depression. That investment in the first instance needs to be in new means of production to provide incomes and employment to relieve the fiscal pressure on public social welfare expenditure. Once the market economy fails, as it does in recession, it cannot recover without a stimulus sufficient to encourage the private sector to invest and produce. Until the private sector does so, the production cycle is effectively broken.
Government has a fundamental role to stimulate an economy when it enters a recession by directly investing in new production. Infrastructure investment is too slow to be useful because there is a long lead-time before increased productivity exceeds the infrastructure costs.
10. EQUITY IN SOCIETY.
Figure 17 shows
compensation of employees plotted against the operating surplus for
The System of
National Accounts (SNA) version 68 (1968) did not include consumption of fixed
capital (depreciation) in the operating surplus. Version SNA 93, introduced in
One common way of
measuring income equality is by using the Gini coefficient
Over recent decades,
Since 2007, the
Gini coefficient for
distribution suppresses demand for domestically produced goods and services.
People with low incomes have relatively little to spend on domestic
consumption, especially on services, which make up the bulk of monetised
economic activity. Income concentration encourages relatively high demand for
imported “luxury” products adding to
There are just two ways to avoid large earned income imbalances. The first way is to increase lower end wages and salaries, especially minimum incomes. The second way is to reconsider taxation policy, not for political reasons but because the existing income distribution structure has not been working well. Both the debt model referred to Section 8 of this paper and the analysis in Section 4 show that inflation and growth must be reflected in incomes for the production cycle to clear. Heavily skewed income distributions make the process of clearing the market from each production cycle more difficult. Some people have “too much” (and growing) income in relation to domestic consumption and many others “too little” (and falling) income. “Ordinary” employment gets squeezed. That’s why the economies of social democracies have tended to perform better than the more capitalistic ones in recent times.
Every economy can be thought of as having its own physical shape. That shape reflects the degree of “reasonable self-sufficiency” the economy possesses. Reasonable self-sufficiency describes how well domestic production matches the consumption patterns of the population as a whole taking into account its income structure. The less of its own domestic product an economy can afford to consume and the more reliant that economy becomes on importing what it needs but does not produce, the more skewed the economy becomes. The more skewed the economy the more dependent it is likely to be on foreign trade, globalisation, and in some cases, on the foreign ownership that arises from large accumulated current account deficits.
Income distortions have become structural, especially in industrialised capitalist economies. According to the debt model, increased incomes are inflationary unless they are accompanied by corresponding increases in productive output. Since the employed workforce is already producing goods and services, the SHAPE of the economy, the basket of goods and services produced in relation to incomes and consumption patterns, will have to change if it is to improve the lot of the people as a whole so that everyone gets a “fair” share 45. Increasing incomes without increasing production would just increase prices.
Changing the shape of the economy means eliminating excessive debt, especially the domestic debt arising from current account deficits. It also suggests changing the tax structure.
Tax structures in
most parts of the world are confusing, antiquated and expensive to run. They are layered like an onion. New taxes
have been added over the centuries as the means to collect them have become
available. They are full of loopholes and exceptions granted to vested
interests of one kind or the other. Governments of all hues have tended to
weight tax law with an eye towards their own perceived constituencies and
re-election. This implies short-term goals have been adopted instead of
policies for the long-term benefit of the nation as a whole. Governments claim
to know the importance of goals such as economic efficiency, research and
development, the “knowledge” economy, investment and the reduction of welfare
dependency but they are unable to “walk the talk”. Systemic constraints have
made effective political action to adapt the existing financial architecture to
the needs of modern economies all but impossible. The current financial system
has become a straightjacket on the world’s economies as the recent debt “crises”
have demonstrated, with
The SHAPE of an economy is largely determined by its income distribution.
Skewed tax systems relatively benefit a small section of society at the expense of everyone else.
Skewed tax systems impair economic performance and economic growth potential by systemically transferring purchasing power from the productive sector to the unproductive sector through increased debt and debt servicing.
A flat tax to achieve tax universality is available to governments that choose to use it. It is called a Financial Transactions Tax (FTT) 47. FTT is very cheap to run. It could easily replace all other forms of taxation except social excise and environmental taxes such as those on tobacco, alcohol, fuel, pollutants, and perhaps source deductions on sugars and saturated fats that contribute heavily to obesity, diabetes 48 and heart disease. Most of the nations’ Revenue Departments could be dismantled. One version of FTT is to deduct the tax automatically every time money is transferred out of any deposit account unless the transfer is to another account held by the same account holder. Savings in downstream compliance costs (government, accountants, lawyers, business administration), would be substantial 49. The quality of economic output could be improved. The quantity of output would play a smaller role in the economy. FTT would considerably increase economic efficiency, releasing a pool of educated and experienced people for more productive and useful output 50.
The quality of output refers to the real benefit the economic activity contributes to national and environmental wellbeing. Reducing compliance costs and the demand for legal, taxation and policy advice, for example, would, over time, free more people to do more work that is more useful to society. The more complicated and controlled society becomes the less beneficial its economic output is.
The level of the FTT needed is easy to calculate. In New Zealand, for example, the 2010 budget proposes total tax revenues of NZ$ 70 billion out of a GDP of, say, NZ$190 billion. Suppose NZ$ 65 billion is to be raised from FTT. Based on total transactions in the New Zealand economy of about 1.8 times the GDP or, say, NZ$340 billion 51, the required FTT rate is then about 19% (65/340) 52. All income is kept until it leaves the bank account into which it has been placed.
Unlike GST, which is a “pass-the-parcel” tax on value added, FTT is a layered tax because it is charged every time money is transferred from a bank account. The more complex a product is, and the more packaging, transport and storage it needs the more expensive it will be because there are more payments made before the final product is consumed. FTT therefore favours local production and local consumption of local products. Local development will be stimulated. Typically, exports are sold exclusive of such domestic taxes 53. FTT would be added to imported goods and services when they are sold just as GST is at present.
A single Financial Transactions Tax (FTT) automatically collected on withdrawals from bank deposits can help correct the tax skew inherent in existing taxation systems that substantially exempts the investment sector from paying its “fair share” of tax.
Most ordinary people spend most of their income on basic needs. While those buying a house will pay FTT 54 on both the house and on loan repayments, a 19% FTT tax on the interest and repayments is still usually less than 1% of their outstanding loan. Their total household financing cost is still much less than the interest most people pay now.
11. THE RELATIONSHIP BETWEEN SAVING, INVESTMENT AND GROSS DOMESTIC PRODUCT.
As shown in Figure 11, some players in the productive sector “save” by not consuming their share of income from the production of capital goods. Others borrow those savings to invest in the purchase of capital goods, and by doing so, enable the market to clear. Over any given period, the total outstanding principal cost of the capital goods is added to the savings pool and the repayments made on the outstanding balance of all previous capital goods are deducted from it.
This helps show how the debt model works. As explained below, productive investment debt Is in the debt model must closely reflect the accumulated principle outstanding on capital assets at any given time. In the debt model, the productive debt My times its speed of circulation Vy equals the GDP. This means the accumulated productive investment Is provides an independent confirmation of the debt model because, subject to a stable employment structure and to stable per capita working hours, Saving S and its corresponding investment I in Figure 11 must reflect economic growth. This must be true because there is nowhere else for real economic growth to come from. The same physical and capital resources applied the same way will always produce the same output.
It may be possible to increase “efficiency” through economic restructuring, that is, by better utilising the same resources, but that offers a qualitative rather than a quantitative improvement. It doesn’t necessarily change the output measured as GDP. When restructuring results in unemployment as it usually does, the GDP will fall unless new investment, including education and retraining, is made to make the idle resources productive again.
Figure 18 shows the
accumulated outstanding principal and GDP for
Click here to view FIGURE 18 : OUTSTANDING PRINCIPAL ON PRODUCTIVE CAPITAL GOODS.
One reason for the
calibration is that the repayment factor of 1.23 x depreciation is an average.
It is not fixed and varies with the state of the economy. It will even vary a
little from one “ordinary” year to the next. 1990-93 was a time of severe
When (mostly new) businesses fail their assets are sold off and some of the debt gets repaid. That increases the outstanding principal repayments relative to the outstanding debt, particularly when banks are forced to write down debt to cover losses or when
they demand greater repayments
from businesses that have not failed. The reverse seems to have been the case
Figure 18 shows
that with just the two calibration corrections over 62 years, the model
outstanding principal Is fits the official GDP data like a glove.
There were not many failures or bankruptcies in
There cannot be any increase in production or GDP without an increase in productive investment I.
Increases in productivity affect prices rather than GDP.
The accumulated total I of productive Saving S equals the gross domestic product GDP.
National Saving S calculated as the gross capital formation less principal repayment over any period equals the nominal GDP increase over the same period.
Long-term business economic profit equals the opportunity cost of capital as required by orthodox economic theory.
A subsistence economy requires little investment. The most valuable possessions of tradesmen in medieval times were their (few) tools. Their tools were far more valuable than their house and were often inherited.
In a modern society, greater employment requires investment, in aggregate, for supervision, equipment, transport and the like, even when capacity utilisation is relatively low in the presence of unemployment. Orthodox economic theory insists that unemployment rises when there is insufficient investment and (re)training to provide the skills a developed economy needs. Figure 18 supports that view. It suggests that existing capital investment must not only be replenished as it is repaid, but must be extended if measured economic growth is to occur.
In the debt model derived in section 8, the money to pay for the capital goods an economy produces comes from incomes (compensation of employees and gross operating surplus of businesses) generated through the production cycle. These are reallocated for investment in capital goods as shown in Figure 11 of this paper. Once the loan to purchase the capital good is in place, the production loan is repaid as shown in Figure 11.
The entrepreneur who has bought a capital good conceptually has a corresponding debt not to the bank but to the rest of the productive sector. The loans are “real” but notionally they do not affect the supply of new bank debt.
In practice, most productive lending is now intermediated through the banking system as shown in Figure 11. Bank intermediation allows non-productive “saving” to take place outside the production system. Instead of “savers” borrowing to “save” as the debt system requires, entrepreneurs borrow from the banks while income earners and businesses “save” their share of the value of the capital goods they have produced. Conceptually, the net effect remains the same. Income earners and businesses lend to entrepreneurs and borrow to “save” for their non-productive investments.
The main historical reason non-productive saving is not equal to system deposits less the dynamic production deposits My is that a lot of productive investment in New Zealand used to be funded directly by borrowing the deposits of other deposit holders (such as through solicitors’ trust accounts, insurance companies, Masonic lodges, the Post Office Savings Bank, building societies, Stock and station agents, non-bank finance houses) rather than through the banks. That meant there were fewer deposits left over for unproductive “saving”. More recently, consumer finance in the form of credit cards and hire purchase has increased borrowing for consumption, allowing for some increase in unproductive “saving”.
Debt and interest payments covering new productive capital assets are repaid out of new income generated by their use. That is the only feasible way to repay them unless new debt is borrowed to repay existing debt and interest. Otherwise the production cycle could not remain self-clearing.
Growth arises directly from the additional production created using the new capital goods. The entrepreneur must repay the loan he has conceptually received from his co-producers and ALSO make a profit from the new investment to provide his own income (part of his operating surplus). Otherwise there would be no economic rationale in making the investment in the first place. That is why benefit to cost ratios are sometimes applied when deciding to invest in capital assets. A low benefit to cost ratio low indicates there will be insufficient profit from the investment to provide the entrepreneur a satisfactory income after all costs and repayments have been deducted.
Non-productive capital assets like housing, including new housing, provide a repayment challenge to those who buy them. Homeowners, for example, must often pay for their home out of their (future) income. To do so in aggregate, they must either increase their productivity over time in the hope their incomes rise in real terms or there must be an adequate redistribution of income from the business gross operating surplus to households through taxation.
The business sector
claims, with some justification, that redistributing entrepreneurial incomes
reduces productive investment. That would be the case if management salaries
and bonuses remained constant. In the debt model, using existing incomes for
debt repayment must result in loss of purchasing power, growing unemployment,
recession, and perhaps even deflation. In
To give a numerical
face to Figure
According to the
provisional model in Figure 18 the
The amount of
productive debt My used to actually produce the nation’s goods and
services is small. While My increases as the economy expands, it
remains at roughly just 5% of GDP because it reflects the nature of the payment
systems within the economy. It is “rollover” funding as set out in the debt
model (see Figure 14) and it presently has a speed of circulation in
As discussed above, the loans (and interest) relating to new productive capital assets must be paid from new GDP created by the new investment as shown in Figure 11, otherwise there would be no point in making the investment in the first place. The new production produces the additional employee and entrepreneurial (gross operating surplus) incomes to consume the new production.
The ONLY new earned purchasing power entering the productive system apart from utilisation of existing unused productive capacity arises from added production from new capital assets. Any other purchasing power would have to be borrowed as “consumer finance” and would be inflationary unless it is used to offset non-productive saving.
Since debt can be used only once 58, higher employee and entrepreneurial incomes must be a proxy for increased GDP.
If new capital goods did not increase output, entrepreneurs would quickly become bankrupt because there would be no income either to repay the loan they have taken out to purchase the capital good or to pay the interest on it. Further lending by the banks would then be withheld due to higher perceived lending risk. The system dynamics would then fail, as happens during recessions.
Except by utilising existing idle productive capacity, the only way to increase GDP is through new productive investment so that GDP cannot increase faster than investment.
To be able to make its debt repayments an economy must expand by at least the net amount of new productive debt coming into the system, that is, the gross capital formation less repayments 59.
The debt model confirms the orthodox economic principle that in a competitive market economy long-run economic profit is zero 60.
The debt-based economy does NOT provide any way to repay the loans used to buy non-productive capital goods such as residential housing using earned incomes because, by their nature, such capital goods are mostly non-productive. There are intangible benefits of good housing like better health, lower stress and proximity to work but those benefits are not measured in the gross domestic product (GDP).
In aggregate, in
the interest-bearing debt system, housing debt is repaid through the exchange
of existing property and consequential capital gains in much the same way
revaluation and refinancing must be used to fund other non-productive
investment such as Kiwisaver in
In the present debt-based economic system the housing market relies on investment sector inflation.
As long as the accumulated current account balance is zero, and debt is expanded according to the systemic needs of the productive economy described in the debt model set out in this paper, asset prices will inflate more or less in line with nominal GDP growth.
This can be
confirmed by considering equation (10) as it applies to a country like
d/dt DC = d/dt ( GDP/Vy - M0y + Ms + Dca + Db ) (10)
d/dt DC = d/dt (Ms + Dca )
If, as is the case
d/dt DC = d/dt (Dca ) approximately.
When d/dt Dca is
negative, d/dt DC is also negative, and this is what has been causing
Figure 19 shows the DNA of the debt-based economy. It shows how economic output (GDP) and Saving are irrevocably linked in a twin helical structure with the one dependent entirely on the other.
Figure 19 results directly from the debt model based on the revised Fisher Equation of exchange developed by the author and provided in this paper. Each conceptual production cycle uses transaction funding My to produce goods and services. My is a dynamic and continuously variable financial input that gives rise to an equal value of output that includes earned employee incomes, the gross operating surplus and indirect taxes. Conceptually, that input is always just sufficient to clear the market at current prices but changes to take into account inflation and increased production as more non-financial economic resources (labour and land) are utilised.
National Saving is the difference between gross capital formation and principal repayments. For the system to remain stable, Saving must be exactly enough to purchase the capital goods produced in any cycle. That is why saving, investment and economic growth are exactly linked as shown in the DNA diagram of the debt-based economy in Figure 19.
Non-productive “saving” occurs when National Saving is diverted to non-productive investment in pension funds, Kiwisaver and ordinary term bank deposits in New Zealand and replaced by new bank debt in the form of consumer debt or household revaluation and refinancing. To the extent that happens, bank debt increases. Instead of entrepreneurs borrowing the incomes of employees and businesses earned through the production of the new capital assets, those incomes are “invested” in non-productive investment and new bank debt is used to fund the entrepreneurs instead. There is nowhere else for the non-productive “saving” to come from, just as there is nowhere for the debt servicing and repayments of new non-productive debt to come from.
The economic system under the revised Fisher Equation is a closed system. With Vy now more or less constant in many countries (Figure 14) the only way to increase output at constant price is to increase My and, by and large, the only practical way to increase My at full employment (model Db = 0) is through productive capital investment. There may be a little leeway following a recession when capacity utilisation, of both capital goods and labour, is less than optimal, but even that will usually involve some investment and is temporary. It would appear as a correction to Db in the debt model.
The balance between incomes, output and purchasing power is absolute. The debt model does not allow for economic multipliers.
Economic growth and productivity can be improved by giving precedence to productive investment over non-productive investment, and to the production of capital goods over consumption goods. Moreover, there is ALWAYS a trade-off between non-productive consumption, including non-productive government expenditure, on the one hand and capital investment, including productive government investment, on the other hand.
Figure 19 is made up of two mirrored helical strands of DNA. The blue strand represents the total accumulated GDP output while the red strand represents the total outstanding investment principal. The vertical axis of the helices represents time.
On the blue helix, Vy bases of production output My are added over the time span needed to make one full turn of the blue helix (usually a year). On the red helix, Vy bases of national saving Sy (net new productive investment) are added over the time span needed to make one full turn of the red helix (usually a year).
The helices therefore replicate by extension. The blue helix “dies off” at the end of each period
The helices grow by the transfer of National Saving Sy from the blue helix to the red one over each notional production cycle. There are Vy such cycles during each period (usually a year)
For each of the bases, the national saving Sy is returned to the next production cycle on the blue helix in the form of net new capital investment Sy (Saving = Investment) as shown.
The bases can vary in size (up or down) according to the state of the economy.
The annual length or “growth ring” Lz of the blue helix is the GDP for that year.
The nominal GDP growth in the blue DNA is the change in length Lz of the DNA spiral over the period z compared with the corresponding length L z-1 over the previous period.
The annual length or “growth ring” Lz of the red helix is the increase in outstanding investment principal S which also equals the nominal GDP growth for that year.
The total length of the red helix is the sum of all outstanding investment principal and it equals the current nominal GDP at any time.
At the end of each (annual) period z (and only then) the value of output represented by length Lz of the blue helix (the GDP for that year) equals the value represented by the whole of the red helix (the sum of outstanding investment principal that also equals the GDP).
The plan diameter of the helices typically expands exponentially. The helices are three dimensional, so the diameter shown at the “crossing” points in the two-dimensional diagram on Figure 19 is similar to that at all other points on the curves after allowing for nominal GDP growth.
The helices vary together with the state of the economy. In the case of recessions they show up as a reduction in the rate of increase of the helix diameter. In the case of depressions they show up as an actual decrease in the helix diameter.
Increasing productive capacity means directly increasing My by directly putting spare productive resources to use or developing new ones, or by better using existing resources.
The mechanisms outlined in this paper show why economic policy has failed until now. To expand the economy, My needs to increase with little or no inflation so deposit interest rates need to be close to zero and the quantity of new deposits needs to constrained without raising interest rates. To expand My means increasing productive investment. To increase productive investment means the increase in My must be directed into new plant, factories, training and technology. At present, that means reducing consumption so as to increase national saving, S.
One key way to do this is to extend the repayment period for productive capital goods.
The combination of low or zero deposit interest and extended repayment periods for capital goods will transform national savings by drastically reducing debt servicing.
In addition to reducing the burden of debt servicing on capital goods, interest-free funding can injected to allow consumption to continue while using spare resources to increase production capacity. One way to do this is outlined in Paper 3 (link provided below). As that new productive capacity becomes operational it increases productive efficiency and consumption capacity.
For practical purposes, debt-based financial systems in modern industrialised countries are cashless. In industrialised (and most other) countries, privately owned banks create new debt and charge their clients for doing so. In the debt-based system the debt is created before its corresponding money deposit.
Except for residual cash transactions, in a debt-based financial system there is a unit (dollar) of debt for every unit (dollar) of “money”. For every unit (dollar) “saved” by one person there is a unit (dollar) of debt owed by another.
Debt can only be used once. Once debt is used it must eventually be repaid with interest. Unless it is written off by bank failure, existing debt can be repaid only by reducing the banking system deposits or net worth.
The debt based financial system is dynamic and independent of orthodox economic equilibrium theory. Orthodox economics offers no mechanism to achieve elimination of unsustainable debt growth. As the ratio of unearned income to GDP increases, the ability of the productive economy to fund the pool of unearned income decreases.
Net after-tax interest paid by banks on their clients’ deposits forms an exponentially increasing pool of non-productive unearned interest income that is never repaid and is a structural part of the debt-based financial system. The interest rate on deposits must be eliminated if the exponential growth of the pool of non-productive unearned income is to be stopped. Unless the deposit interest rate is zero, Domestic Credit, unearned deposit income and nominal GDP must all grow exponentially because, in the debt based financial system, they are all a function of the deposit interest rate.
In the absence of realised capital gains it is impossible to maintain exponential debt expansion greater than GDP expansion over an extended period because the added debt servicing costs will always leave the productive sector insolvent. The debt supporting the exponentially increasing pool of non-productive unearned income leads to an ongoing transfer of real wealth from the productive sector to the non-productive investment sector.
Credit bubbles, recessions and depressions result from the failure of the banking sector to properly align demand for credit with the productive capacity of the economy. Credit expansion in the banking system above what the debt system requires means there is a bubble in the economy while credit expansion below what the debt system requires means there is a recession or depression in the economy. A credit bubble or economic contraction is neutralised when credit expansion has been adjusted so that it just satisfies what the debt system requires taking into account the full productive capacity of the economy.
There is no “money” multiplier in the debt based financial system other than the (slightly) variable speed of circulation of the transaction deposits actually used to generate productive economic output.
Exponential debt growth can be eliminated by progressive credit monetisation of the existing debt and by permanently reducing the OCR (Official Cash Rate) towards zero, at which point systemic inflation caused by interest paid on deposits would be removed from the financial system.
Systemic inflation and exponential debt growth are caused by interest paid on bank deposits. Interest paid by banks on their clients’ deposits forms an exponentially increasing pool of non-productive unearned income that is a structural part of the debt- based financial system and cannot be repaid.
In a debt-based economy where interest is paid on deposits, systemic inflation is half the interest rate paid on deposits provided adjusted wage rates rise in line with that systemic inflation plus productivity growth and there are no changes to indirect taxes. Systemic inflation arising from deposit interest automatically reduces towards zero as deposit interest rates reduce towards zero. However, in the absence of quantity controls on the issue of new debt, low interest rates can lead to unproductive “bubble” lending, thereby increasing price inflation.
In an economy based on interest bearing debt, almost all price is inflation. Aggregate consumer prices inflate with the deposit interest rate so that deposit interest on existing productive investment can be paid into the unearned income pool without disrupting the productive economy. Increasing interest rates to manage inflation increases the flow of deposits from the productive sector to the investment sector by increasing the unearned income pool. It is no longer possible to combat inflation by substantially increasing interest rates (or to stimulate growth by reducing them) because modest increases in interest rates are now enough to drive the economy into recession.
Foreign ownership of a part of a debtor economy causes asset inflation there because there are more domestic deposits available to fund the exchange of assets remaining in domestic ownership.
The supply of new electronic cash (not debt) to businesses to fund virtual increases in minimum wages does not necessarily cause immediate increases in prices because the E-Note injections are not part of production costs and some of the extra wages will be used for private debt retirement.
In a debt-based system, the interest banks charge their clients to provide goods and services (the bank spread) is part of productive economic activity and does not cause inflation. When the bank spread and costs are constant, the larger the total debt of a nation the larger the turnover of the banks and the more profit they make.
Deposit interest paid by banks to their clients is not specifically beneficial to the banks but is the fundamental source of systemic inflation in the debt-based financial system. Public credit and money issue enables domestic banking systems to operate in high growth, low risk, low interest, low inflation economies while retaining their existing profit margins.
Gross domestic product (GDP).
The nominal increase in GDP over any period equals the increase in National Saving, which is the gross capital formation less principal repayments over the same period.
Productivity growth is inherently deflationary. It usually affects prices rather than GDP and declines as an economy becomes more service-based. Except by utilising existing idle productive capacity, the only way to increase GDP is through new productive investment through the supply of new transaction deposits to make use of spare labour and resources in the economy or to increase the skills of and re-employ existing resources, and by the relationship between the production of capital goods and goods and services for consumption
Interest rate reductions stimulate an economic recovery only when the capital gains from the exchange of existing capital assets produce enough new debt to satisfy the systemic debt requirements of the financial system.
In a cash-free debt based economy with zero interest rates on deposits the increase in GDP equals the speed of circulation of debt in the productive sector times
(a) the change in domestic credit, less
(b) the current account deficit, plus
(c) a correction for any imbalance between the change in domestic credit and what the debt system requires taking into account the full productive capacity of the economy
A recession provides for inflation but not economic growth, while a depression provides for neither economic growth nor inflation. A recession occurs when the change (increase) in the total debt (both public and private) over time is less than what is needed to service the financial system costs made up of the net unearned interest that has to be paid on all bank deposits plus any new current account deficit plus any increase in the productive debt used to generate new economic output. A depression is a deep recession that also fails to provide for inflation.
Apart from utilisation of existing unused productive capacity, the additional production from new capital assets is the ONLY way to increase earned purchasing power in a debt-based economy.
The SHAPE of an economy, which is the basket of goods and services produced in relation to incomes and consumption patterns, is largely determined by its income distribution. Poor income distribution suppresses demand for domestically produced goods and services. Since the employed workforce is already producing goods and services, the SHAPE of the economy must change to improve economic efficiency and promote domestic production.
Socially mandated income redistribution is necessary to distribute productivity increases throughout the economy and improve real wages and purchasing power. The application of a single flat financial transactions tax to all withdrawals from bank accounts changes the shape of the economy by redistributing income.
Skewed tax systems benefit a relatively small section of society at the expense of everyone else because they impair economic performance and economic growth potential by systemically transferring purchasing power from the productive sector to the unproductive sector through increased debt and debt servicing.
A uniform wealth tax on all net wealth from all sources is redistributive because it (gradually) reverses the accumulation of net wealth inherent in the presently dominant debt-based financial system. A single Financial Transactions Tax (FTT) automatically collected on withdrawals from bank deposits can help correct the tax skew inherent in existing taxation systems that substantially exempt the investment sector from paying its “fair share” of tax.
Consumption (with housing).
Most residential housing is economically unproductive once it has been built, thought its construction is part of the productive economy. Residential housing that does not generate income is incompatible with a financial system based on interest-bearing debt.
Assuming incomes are constant and there are no productivity gains or realisation of capital gains through asset inflation, homeowners must reduce their domestic consumption by an amount equal to the principal and interest payments they make on their non-productive capital assets. The reduction can be (partly) offset through capital gains. Realised values from the exchange of existing assets must in that case increase by an amount sufficient to cover both the interest and principal repayments. The reduction in domestic consumption must otherwise be matched by the export of the resulting surplus consumption goods and services if structural employment and recession are to be avoided
The process of production and consumption in the productive economy is self-cancelling wherever it takes place and however its phases of production and consumption are shared amongst nations. Export of surplus consumption goods and services to avoid structural unemployment and recession decreases foreign ownership of the domestic economy. It does not directly improve domestic wellbeing in the exporting country.
Inclusion of a housing provision in a tax-free guaranteed minimum income (GMI) system allows close matching of the GMI to existing government income transfer structures in many industrialised countries
Capital formation in a debt-based economy takes place in accordance with the basic tenet of orthodox economics that National Saving equals Productive Investment. It arises from the redistribution of employee income and gross operating surpluses of businesses to purchase the capital goods created by the productive economy. Production must always, but only just, lead consumption to provide the incomes that enable consumption to take place.
In the modern world, faster depreciation has swapped longer-term productive investment to boost existing stock and existing property prices. Saving for productive investment and real GDP growth as measured using the international System of National Accounts cannot be restored to modern developed economies unless the protocols around depreciation are altered, bank lending polices and regulations reviewed and the serious distortions in the System of National Accounts (SNA) records themselves are corrected.
In a debt-based
financial system and in the absence of a debt bubble it is impossible to
increase National Saving (and therefore GDP) without increasing production
loans and new productive investment. In the absence of asset inflation, any
attempt to withdraw any part of deposits for non-productive investment purposes
(“savings”) reduces purchasing power in the productive economy or leaves
capital goods unsold, leading to increases in inventory, and subsequent
unemployment and recession. Unproductive savings and pension schemes such as
The investment sector represented by the accumulated net after tax interest paid on bank deposits produces nothing itself and is paid for through inflation in the productive sector. Increased depreciation allowances speed up principal repayments and reduce national saving and productive investment. Increased repayment of debt, including household debt, reduces national saving and reduces net new productive Investment.
The accumulated net outstanding principal invested in productive capital goods is equal to the net accumulated national saving because in a competitive market economy the long-run economic profit of business tends toward zero as profit falls toward the opportunity cost of capital. Productive investment represents the redistribution of production incomes to clear the capital goods market in the productive sector.
Economies in recession must be stimulated by direct investment in new production because the lead-time before the benefits of increased productivity from infrastructure investment exceed the infrastructure costs is usually too long to be effective.
System of national accounts.
The use of depreciation for measuring economic success has been catastrophic for the world economy.
When the current account balance is included as income in the national income and outlay account of the SNA an entry of equal value entitled “purchase of capital assets on the current account” should be included on the other, “use of income”, side of the national income and outlay account.
The National income and outlay account of the SNA needs to be restructured and the National capital account consequentially adjusted to reflect orthodox economic theory as follows:
Use of income side:
= Final consumption C
+ Purchase abroad of non-productive capital investment goods (=CA)
+ Saving for productive investment S
+ Current account balance (CA)
less the balance on external goods and services
less repayments of principal on outstanding productive investment.
Current account transactions are exchange transactions, not production transactions. To avoid bankruptcy of the world economy in the long run, each nation must maintain, in aggregate, a zero accumulated current account.
There is no such thing as foreign debt; there is only foreign ownership by foreign creditors of part of a debtor’s nation’s economy either as physical ownership or ownership of commercial paper. An accumulated national current account deficit reduces national savings and increases the domestic debt of the debtor country, its domestic inflation and foreign ownership of its economy. Foreign ownership of a debtor nation’s economy drains its domestic economic growth through outgoing current account payments of interest on commercial paper and dividends and profits arising from the physical foreign ownership of its assets.
The debtor status of debtor countries can only be managed without affecting their domestic economies if their exchange rates are reduced so their current accounts become positive enough to reverse the foreign ownership of their assets. In the absence of effective management of capital flows and the exchange rate, the logical outcome of the existing debt system in heavily indebted debtor countries is national bankruptcy because debtor countries are condemned to paying high interest rates to avoid capital flight.
Exporting domestic production (“export-led recovery”) is an unsatisfactory method for reducing an accumulated current account deficit unless the accumulated deficit is small and the exchange rate is free to fluctuate independently of domestic interest rates.
At any point of time, the current account deficit in heavily indebted debtor countries is typically just a little more than:
a) the accumulated current account deficit of the debtor country, multiplied by the average bond rate in the debtor country, minus
b) the trade balance of the debtor country for the period, plus
c) the net repatriated profits of foreign-owned banks operating in the debtor country over the same period.
A positive balance on
external trade swaps domestic growth in the exporting country for foreign
assets in the debtor country and is a positive growth factor for the exporting country’s business
interests. The logical outcome of the existing debt system in creditor
countries is zero deposit interest and stable or falling asset prices (as in
A tax-neutral variable Foreign Transaction Surcharge (FTS) applied to all outward exchange transactions allows the progressive reduction in foreign ownership of the domestic economy (the so-called foreign debt) by enabling the exchange rate to fall towards a stable base level, increasing the value of exports and decreasing the quantity of imports, and providing a more even playing field for local manufacturers and producers.
Existing privately issued interest-bearing government debt can be progressively retired as it matures and replaced with publicly issued interest-free debt or E-notes spent into circulation by the Government. E-notes (electronic cash) perform exactly the same role as existing bank debt.
Zero or low interest credit and money issue enables economic growth to be tied to the productive economy instead of being inflated by deposit interest.
Local money systems.
Local money systems are co-operatively owned interest-free, self-cancelling monetary systems in which there is no systemic debt because the debt incurred during the production phase is cancelled when the product or service is sold. They can be organised nationwide and taxed in formal currency, promote domestic production, increase economic efficiency and reduce financial leakage from local economies.
THE REFERENCED PAPERS
The referenced papers :
NEW Capital is debt.
General summary of all papers published.(Revised edition).
(The following items have not been revised. They show the historic development of the work. )