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When did the interest/loan/debt based monetary system come into existence?

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  • 25-04-2014 2:16pm
    #1
    hatrickpatrick
    Registered Users Posts: 17,797 ✭✭✭✭


    The current monetary system, where every unit of new currency is issues by a bank with interest attached, has not obviously been around forever. When did it first come into existence? Which was the first country to use such a system of creating new money?


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    #2
    Sand
    Registered Users Posts: 12,580 ✭✭✭✭Sand


    The concept of debt has always been around - "Debt The first 5,000 years" by David Graeber explores it. It includes some intriguing discussion on how it has always been important to justify violence or coercion on the part of the creditor against the debtor, to the point where in some societies the borrower had to ritually "steal" the money from the lender so the borrower could be treated as a thief/debtor. A similar dynamic has been handed down to the present day with the creditor seen as virtuous and the debtor seen as malevolent, rather than them actually being two sides of a mutually agreed and beneficial contract with recognised risks.

    Credit notes have been around in Europe since the Renaissance. The concept of central banking, which I believe you are referring to depends on when the various laws creating central banks were completed. The gold standard was abandoned in the face of the Great Depression, briefly re-established and finally abandoned at Bretton Woods.


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    #3
    SupaNova2
    Registered Users Posts: 515 ✭✭✭SupaNova2


    I would echo Sand's recommendation of Graeber's book. Graeber argues that debt(promises to pay) have always been currency, a medium of exchange.


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    #4
    tim04750
    Closed Accounts Posts: 216 ✭✭tim04750


    I read up a bit on how new currency in the US is introduced by the federal reserve as a loan at interest, surely the euro doesn't work like that does it ?


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    #5
    sin_city
    Registered Users Posts: 899 ✭✭✭sin_city


    Have you seen the documentary by Bill Still called The Money Masters?

    It's 4 hours long but it goes back over the centuries and should be enough to give you the answer to what you're looking for


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    #6
    andrew
    Moderators, Science, Health & Environment Moderators, Society & Culture Moderators Posts: 3,372 Mod ✭✭✭✭andrew


    The Bank of England has two interesting papers on this:

    Money in the modern economy: an introduction

    Money creation in the modern economy


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    #7
    hatrickpatrick
    Registered Users Posts: 17,797 ✭✭✭✭hatrickpatrick


    tim04750 wrote: »
    I read up a bit on how new currency in the US is introduced by the federal reserve as a loan at interest, surely the euro doesn't work like that does it ?

    'Fraid so, and in my view that's the main reason for the boom and bust cycle. It guarantees inflation and a debt-loop when there's always more money oŵed back than there is in circulation.

    I'll have a look at that documentary, cheers for the tip.
    Does it address why this system was created, who thought it was a good idea, and why the hell it hasn't been changed by now?


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    #8
    SSD2014
    Registered Users Posts: 7 ✭SSD2014


    Priests. Sure who else would come up with something that destroys the world.


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    #9
    hatrickpatrick
    Registered Users Posts: 17,797 ✭✭✭✭hatrickpatrick


    Having an interesting discussion about this on AH and it's quite astounding how many people have simply never considered the origin of the currency we use, despite its fundamental involvement in the state of the economy.

    Seems to be one of those things people just accept as working without ever asking how it works, which strikes me as odd considering how important the mechanics of it are to economic health O_o


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    #10
    Geuze
    Registered Users Posts: 13,396 ✭✭✭✭Geuze


    Does this help?

    http://www.bankofengland.co.uk/banknotes/pages/about/history.aspx


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    #11
    Frank Lee Midere
    Closed Accounts Posts: 3,780 ✭✭✭Frank Lee Midere


    SSD2014 wrote: »
    Priests. Sure who else would come up with something that destroys the world.

    Link? Catholicism opposed usury.


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    #12
    Frank Lee Midere
    Closed Accounts Posts: 3,780 ✭✭✭Frank Lee Midere


    This isn't AH. There is nothing wrong with currency being issued as debt ( the alternatives are far worse), the problem is what it is used for. If money ends up in asset bubbles then it's problematic.

    And fractional reserve banking is banking. A non fractional reserve bank is one which doesn't loan anything.


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    #13
    recedite
    Closed Accounts Posts: 13,992 ✭✭✭✭recedite


    Frank Lee Midere wrote: »
    A non fractional reserve bank is one which doesn't loan anything.
    What if.... a bank could only operate according to the normal misconception; one person deposits cash and then the bank lends it out to another person at a higher rate of interest.
    Such a bank would loan existing money, but not create new money. It could never collapse, or help create an asset bubble. It would unfortunately be less profitable for its owners.

    The originator of all money would be a state investment bank, acting instead of a central bank. In a recession, or whenever it was desired to increase the money supply, that bank would commission new public infrastructure works. The work would be paid for with newly created money, fed directly into the economy as a stimulus. The amount allowed to be issued by the state bank could be limited to some multiple of the running 5 year average of annual tax take.


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    #14
    SupaNova2
    Registered Users Posts: 515 ✭✭✭SupaNova2


    recedite wrote: »
    What if.... a bank could only operate according to the normal misconception; one person deposits cash and then the bank lends it out to another person at a higher rate of interest.
    Such a bank would loan existing money, but not create new money. It could never collapse, or help create an asset bubble. It would unfortunately be less profitable for its owners.

    Such a bank would still collapse if loans it made can't be repaid. Though you are right to say that it would be far less profitable for banks, the system of fractional reserve banking emerged from goldsmith bankers wanting to do just that, make more profit. What is the value of gold to bankers who can lend the same ounce multiple times? Far more than its value in the marketplace. The gold fractional reserve system with its inflexible reserve lead to bank runs with those at the end of the line being left with nothing. Instead of seeing the pyramid expansion of credit on top of reserves as the problem, the inflexible supply of reserves was seen as the problem, gold was not flexible enough in supply to be a reserve so gold standards were suspended. National currencies took on the role of reserves in commercial banking systems, the dollar became the reserve currency on an international level. In a bank run today, instead of the 10% of people at the end of the line being left with nothing, everybody shares the pain, as government bailouts and monetary expansion save the day at the expense of the currency's value.

    I'm not aware of any good economic arguments defending the current system. At best the system works in that it keeps the show on the road, even if in a haphazard boom bust manner.


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    #15
    gctest50
    Registered Users Posts: 9,605 ✭✭✭gctest50


    recedite wrote: »
    What if.... a bank could only operate according to the normal misconception; one person deposits cash and then the bank lends it out to another person at a higher rate of interest.
    Such a bank would loan existing money, but not create new money. It could never collapse, or help create an asset bubble. It would unfortunately be less profitable for its owners.
    ..........

    That sort of bank would suck badly
    - wouldn't take many loans not to be repaid and it would be under pressure
    - word about that wouldn't be long getting out and more people would just stop paying back hoping it would go broke
    - word about it going broke would get out and you'd have a run on it - loads would just try withdraw their money all at once


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    #16
    Jim2007
    Moderators, Business & Finance Moderators Posts: 10,286 Mod ✭✭✭✭Jim2007


    gctest50 wrote: »
    That sort of bank would suck badly
    - wouldn't take many loans not to be repaid and it would be under pressure
    - word about that wouldn't be long getting out and more people would just stop paying back hoping it would go broke
    - word about it going broke would get out and you'd have a run on it - loads would just try withdraw their money all at once

    Imagine a bank where:
    - term loans are frowned upon and rearly granted
    - bank overdrafts are an unknown concept
    - the credit in credit card, is the period between the date you execute the purchase and the end of the month when the full amount is debited to the customer's account
    - HP financing is rearly undertaken
    - loans to industry and commerce are 100% backed by hard assets

    Well there is no need to imagine... That is how a typical Swiss domestic bank operates! In a typical Swiss bank assets under management, not the size or quality of the loan book, is the determining factor in profitability.


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    #17
    gctest50
    Registered Users Posts: 9,605 ✭✭✭gctest50


    Not really comparible to here money-wise ?

    And our banks aren't powered by nazi gold unlike some abroad in other places

    .


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    #18
    Manach
    Moderators, Society & Culture Moderators Posts: 9,713 Mod ✭✭✭✭Manach


    Fairly low-brow, but there is a chapter or two in the latest Undercover Economist book on the development of this. He also spends some time discussing the stone disc coins of Yap : http://en.wikipedia.org/wiki/Rai_stones


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    #19
    recedite
    Closed Accounts Posts: 13,992 ✭✭✭✭recedite


    SupaNova2 wrote: »
    Such a bank would still collapse if loans it made can't be repaid.
    Yes but each individual loan is isolated from the others. One or two bad loans would not trigger a run on the bank. It can never lose more than the total amount deposited. With fractional reserve, a bank can lose a multiple of its worth, far more than it ever had on deposit.
    Compare to a landlord who buys 50 properties, each on a buy to let basis, and rents them out. If the rental market has a downturn, and one or two properties are left vacant, that triggers a domino effect whereby he can never pay all the mortgages, and ends up losing all the properties. Even worse, he may end up in debt if they were all sold while in negative equity.

    The landlord who owned all the 50 properties at the start will only get rid of the underperforming ones.

    That is the difference between a system built on credit reserves, and one built only on debt. Stability.


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    #20
    Frank Lee Midere
    Closed Accounts Posts: 3,780 ✭✭✭Frank Lee Midere


    recedite wrote: »
    Yes but each individual loan is isolated from the others. One or two bad loans would not trigger a run on the bank. It can never lose more than the total amount deposited. With fractional reserve, a bank can lose a multiple of its worth, far more than it ever had on deposit.
    Compare to a landlord who buys 50 properties, each on a buy to let basis, and rents them out. If the rental market has a downturn, and one or two properties are left vacant, that triggers a domino effect whereby he can never pay all the mortgages, and ends up losing all the properties. Even worse, he may end up in debt if they were all sold while in negative equity.

    The landlord who owned all the 50 properties at the start will only get rid of the underperforming ones.

    That is the difference between a system built on credit reserves, and one built only on debt. Stability.

    This seems to be a definition of fractional reserve banking which merely wants a larger fraction of the reserves kept by the bank. If so it isn't earning any money. And the main point of banks is to lend.

    As I said before the problem isn't that banks lend - they are supposed to be middle men - but what they lend to. Banks should be designed to lend to businesses not housing. That's the change - which is fairly recent - which has destabilised the world economy.


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    #21
    recedite
    Closed Accounts Posts: 13,992 ✭✭✭✭recedite


    Frank Lee Midere wrote: »
    If so it isn't earning any money. And the main point of banks is to lend.
    But equally the bank would not be exposed to more risk than it can afford to cover.
    The same principle applies to the buy-to-let landlord, or someone betting on the horses. If you gamble more than your net worth, then either you make a huge profit when you win, or somebody else ends up picking up the tab when you lose.

    I agree that banks should not be allowed to get involved with property.
    Lets say I sign a mortgage deed for €200,000. My signature creates that money. The bank did not have €200,000 already sitting there as a deposit, just waiting to lend out. So why should I pay the bank 5 or 6% interest for 25 years, for something I created myself?
    The bank will say it carries the risk of my default, or of some downturn in the market. In practice we find that when things go bad, the State (ie the taxpayer) recapitalises the bank because it has insufficient reserves.
    We also find that the downturn is in fact caused by the bank creating too much money and pumping it into the property market.
    Therefore, take out this parasitic and destructive middleman. Let the State create and lend new money into the property market directly. Lend the money at 2% interest, one mortgage per person, per lifetime.


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    #22
    SupaNova2
    Registered Users Posts: 515 ✭✭✭SupaNova2


    recedite wrote: »
    Lets say I sign a mortgage deed for €200,000. My signature creates that money. The bank did not have €200,000 already sitting there as a deposit, just waiting to lend out. So why should I pay the bank 5 or 6% interest for 25 years, for something I created myself?
    The bank will say it carries the risk of my default, or of some downturn in the market. In practice we find that when things go bad, the State (ie the taxpayer) recapitalises the bank because it has insufficient reserves.
    We also find that the downturn is in fact caused by the bank creating too much money and pumping it into the property market.

    Therefore, take out this parasitic and destructive middleman. Let the State create and lend new money into the property market directly. Lend the money at 2% interest, one mortgage per person, per lifetime.

    A healthy banking system allocates scarce resources via a bidding process. If a bank has a 2 potential customers that have the same default risk, it will accept the customer willing to pay the most interest. The customer willing to pay more interest is willing to do so because they are confident of making enough profit to comfortably pay that interest rate and thus credit(scarce resources) get directed to that customer. In the current system both customers would be served as long as the banks sees both loans as profitable. The problem with extending credit in such a fashion is that projects that seem profitable may later become unprofitable due to the inflation caused by that looser credit expansion. Also as you point out it can fuel bubbles.

    But if you see the problem as loose credit expansion, how does assigning the government control of the mortgage market with even looser lending standards do anything to solve this problem? In fact this would be way more destructive, at least the way you have outlined. With a fixed 2% rate making no discrimination as to who the borrower is and the likelihood of repayment the taxpayer becomes a sup prime lender worse than any bank during the boom.


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    #23
    recedite
    Closed Accounts Posts: 13,992 ✭✭✭✭recedite


    SupaNova2 wrote: »
    how does assigning the government control of the mortgage market with even looser lending standards do anything to solve this problem? ....the taxpayer becomes a sup prime lender worse than any bank during the boom.
    It may seem "loose" on the face of it, but if a citizen became eligible for a mortgage at, say, 25 years old, there is no flexibility at all there. Also, by being tied to demographics, there is always an equivalent base of taxpayers in that demographic. The taxpayer bails out the defaulter, and both are always in balance. So there would be no "passing the bill on to the next generation" as we are doing now.


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    #24
    SupaNova2
    Registered Users Posts: 515 ✭✭✭SupaNova2


    recedite wrote: »
    It may seem "loose" on the face of it, but if a citizen became eligible for a mortgage at, say, 25 years old, there is no flexibility at all there. Also, by being tied to demographics, there is always an equivalent base of taxpayers in that demographic. The taxpayer bails out the defaulter, and both are always in balance. So there would be no "passing the bill on to the next generation" as we are doing now.

    Most people are not happy with current bailouts and you want to make it a bigger built in part of the system, it would not fly, thankfully. If the defaulter is bailed out by the taxpayer why would anyone repay loans?


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    #25
    recedite
    Closed Accounts Posts: 13,992 ✭✭✭✭recedite


    SupaNova2 wrote: »
    A healthy banking system allocates scarce resources via a bidding process...
    If the "resource" is credit itself, then banks do not merely allocate it, they are allowed to create it out of nothing, and then lend it out for profit. That is my point.

    If we go back to the Bank of England document linked to earlier, they admit this. Then they show the credit and debt in a diagram, laid out as a balance sheet. They also say that the consumer can choose to "destroy the money" by paying off the debt. But what they don't say is that this is one balance sheet that can never balance.

    Take my example of the €200,000 mortgage. When that amount is repaid, the original debt is repaid and the balance sheet is correct. However I am required to go on paying the compound interest, so I will repay say €300,000 (for simplicity's sake). Where does this extra €100,000 come from, and how does it fit into the balance sheet? Well, the bank has created that extra €100,000 out of nothing and demands that it be paid back to itself. The balance sheet can not add up; there is always a discrepancy comprised of that extra interest payment.

    In effect, this is the same as if I printed off €100,000 in forged banknotes in my back bedroom.The extra money adds to, and dilutes, the existing money supply. In other words, it creates price inflation. In a way it is a victimless crime, in that everyone using the currency gets fleeced a little bit, but nobody notices.

    So now we find that as well as causing asset bubbles, by creating money for themselves out of nothing commercial banks are also the root cause of inflation.


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    #26
    recedite
    Closed Accounts Posts: 13,992 ✭✭✭✭recedite


    SupaNova2 wrote: »
    why would anyone repay loans?
    Why would anyone pay property tax? If you have the money, they will find a way to get it from you.


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    #27
    SupaNova2
    Registered Users Posts: 515 ✭✭✭SupaNova2


    recedite wrote: »
    If the "resource" is credit itself, then banks do not merely allocate it, they are allowed to create it out of nothing, and then lend it out for profit. That is my point.

    I'm aware that is one point you are making and I agree with it, at least in part. When I said a healthy banking system should allocate scarce resources I was not referring to credit in itself, but the physical resources that credit will be used to acquire.


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    #28
    SupaNova2
    Registered Users Posts: 515 ✭✭✭SupaNova2


    recedite wrote: »
    Why would anyone pay property tax? If you have the money, they will find a way to get it from you.

    So they would be forced to pay to avoid a jail sentence. Again, I don't think your system would have any support.


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    #29
    recedite
    Closed Accounts Posts: 13,992 ✭✭✭✭recedite


    SupaNova2 wrote: »
    .. I was not referring to credit in itself, but the physical resources that credit will be used to acquire.
    Then allocating those is the function of "the market" and/or the currency as "a medium of exchange". Not "banking" per se.
    SupaNova2 wrote: »
    So they would be forced to pay to avoid a jail sentence. Again, I don't think your system would have any support.
    No, if they really could not pay, then the debt would be waived.
    Under the current system, if someone files for personal bankruptcy and gets a loan writen-off, or claims rent allowance, or lives in social housing, the state ends up paying anyway. By cutting out the middlemen (bankers and barristers) there is a net gain, if anything, for the exchequer.

    Its not a completely alien concept. Before the euro, there were times when interest rates were so high that an ordinary worker on the average industrial wage could not get a mortgage from a commercial bank. It was common for county councils to provide mortgages. Lots of today's middle class taxpayers grew up in a privately owned family home that was funded with a council mortgage, even though they may not be aware of it. The councils understood that if these workers could not get a mortgage, they would end up on the housing list anyway, looking for a council house.


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    #30
    recedite
    Closed Accounts Posts: 13,992 ✭✭✭✭recedite


    This new bank they are setting up is an interesting sort of bank. A State bank, not a commercial bank. KfW is set up "to provide loans for purposes prescribed by the KfW law at lower rates than commercial banks".


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    #31
    SupaNova2
    Registered Users Posts: 515 ✭✭✭SupaNova2


    recedite wrote: »
    Then allocating those is the function of "the market" and/or the currency as "a medium of exchange". Not "banking" per se.

    Well it has been the function of banks as long as they have existed. One person saves the medium of exchange, another borrows, banks co-ordinate the action. One person temporarily gives up claims on resources(currency) while the bank passes them on to someone else. The relationship of one person foregoing so another can have does get lost in a fractional reserve system and in part is the cause of price inflation and bubbles.


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