Saturday, February 07, 2009

Thoughts about the meaning of money and wealth

It seems to me that the money supply works like a sliding window.

On one hand, we have money being created at interest. This increases the distance between the edges of the sliding window because there is more money available.

On the other hand, money is being removed from the buffer to make interest payments on the money being added to the other side.

Of course this cannot possibly work, because eventually the vacuum edge will catch up with the creation edge. The when aspect of this is irrelevant, because it is unquestionable that it will happen.

How could this arrangement have a chance to function? One could say that charging (varying rates of nonzero) interest for money is actually a good thing because there are not enough resources for everybody's whims to become a reality. This allows us to separate what is a worthy investment (e.g.: a mortgage with a reasonable purchase price) from junk (e.g.: a defaulted credit card with a huge balance and a jobless cardholder).

The problem with this is that there is no money to ever pay back the interest. In other words, the vacuum edge always catches up with the creation edge. Let's define the rate at which the edges get closer together as the loss rate. For the sliding window approach to work, we must have that the loss rate is no more than zero.

This restriction on the loss rate prohibits charging interest within the money pool. In other words, you cannot run a bank with money in circulation and charge interest because then there is not enough money in circulation to pay the interest. Or, if you do allow banks within the system, they must always experience losses to the tune of the amount of interest they charge. In other words, what they collectively win on one side, they must collectively lose on the other.

One could imagine a banking regulation entity, or a bank of banks, that sums up the balance sheets of all banks and makes sure that the result stays close to some level that corresponds to the amount of money in circulation. When (not if) a bank blows up because of lending practices that are suboptimal for the environment in which they are made, then the others get its assets and so the system is always balanced.

However, this is not all that comes from constraining the loss rate. This requirement prohibits charging interest to create money. Or, to be more precise, the interest payments for the money in circulation cannot be made with money in circulation.

The only reason why this arrangement has been possible all these years is that we have always had a continent to take over, new resources to deplete, and room to increase the population of Earth. In other words, charging interest for new money makes sense in that it serves to prioritize strategies that foster growth and development instead of financing stagnation and laissez faire. Well, the issue is that now we have nowhere else to run, and so this approach is obsolete. What are we going to replace that with?

In coming years, it is clear that our population will have to go down and stabilize around some value. We know this value is greater than 1 and less than 1 trillion, and so although we do not know the precise number, we do know talking about some reasonable figure makes sense. We also know that this value will be bound by the amount of renewable resources Earth can produce to sustain our population. In other words, our wealth is defined by the resources we have to our disposal in order to survive in a (better or worse) sustainable manner.

If we follow the bank of banks approach, then we would come up with a money supply mechanism that calculates what is our wealth expressed in some denomination, and then creates the corresponding amount of money. In other words, since for the most part we use resources by spending money, this ensures that we will not outspend our wealth because there will not be enough money to do so. What is more, the money would be a representation for other tangible things that do not require our work to exist, like sunlight, and therefore interest cannot be charged for money to be created.

It's not that easy, of course. Clearly, the value of a barrel of oil that will be used in low efficiency gas engines is not equal to the value of the same barrel of oil if it will be used in high efficiency gas engines instead. Being able to obtain more miles per gallon increases our wealth because we can do more with the same resources. Thus, we can use the efficiency with which we will use our wealth to drive the money creation process.

In other words: want more things than we have? Then let go of something you do not want anymore in exchange. Want a higher standard of living in which we can add new things to our inventory without letting go of others? Sure, but that requires more money in circulation. Want more money in circulation? Make more efficient use of our wealth, or create wealth by developing new technologies that enable us to raise our standard of sustainable living.

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