Where does interest come from?

Economics Economics Questions
21

I have no idea why you went through all that first part. Again, Griffin is not saying that interest is the problem. He’s saying the Federal Reserve and it’s powers and mode of operation are the problem. And yes, new money in and of itself is a problem. It’s certainly not the only one. Obviously since every new dollar created is not just printed and spent, but printed and lent (at interest) the problems of the fiat money are compounded. Take your thought experiment further…you’re imagining a central bank printing money and spending it out into the real economy.

That steals wealth by essentially trading nothing for something. Now picture the new money being lent at interest. Now it’s not just the initial printed money’s worth of resources being stolen…it’s that plus interest, as it all must be paid back. Sure, the more money that is printed, the less value each dollar has, so it is therefore easier for the debtor to pay off his interest…but depending on the terms of the loan, I guarantee you there are almost no circumstances in which the bank doesn’t make out even better than if it had just went out and bought real goods with the new money.

Interest in and of itself is not a problem…but interest on newly printed money is more of a problem than just newly printed money.

22

John, that whole post wasn’t about Griffin. I meant it as a reply to ouchris. Sorry bout that.

23

So, is it fair to say, that in a true free market (i.e. no fed) that interest is NOT created from nothing but in a market in which a FED prints it’s own money and lends it at interest then the interest payments can never be paid back and thus make it part of the ponzi scheme?

24

I don’t want to be rude, but did you actually read any of this thread? The entire first page explains in about 5 different ways why the notion of “the interest cannot be paid back” is a total myth.

25

I think the island economies make interest harder to understand, not easier. An entrepreneur borrows $1M with the expectation that he can pay it back, plus interest, at a profit. Let’s say Eddie Entrepreneur realizes that he could double the productivity of his factory if he purchased a $1M piece of equipment. His current revenue is $10M per year which will go to $20M per year after purchasing the needed equipment. However, Eddie doesn’t have $1M of spare cash on hand so he goes to the bank to borrow it. He explains to the bank how he intends to use the money to increase his revenues and puts up a portion of the factory as collateral against the loan. The bank signs over $1M to be repaid in one year’s time at 10% interest ($1.1M repayment). Eddie buys the equipment and his profits nearly double as the productivity of his factory has doubled virtually overnight. With the extra profits, Eddie easily repays the $1.1M at the end of the year.

Interest is no different than any other rent, it is the price of using the money for the duration. There’s nothing special about interest in this regard. Where does the money to pay for the light bill or your rent or car payment come from? It comes from the earnings you generate through selling your labor or, in the case of capital investment, through the profits you earn on successful speculation less your losses on unsuccessful speculation.

Clayton -

26

So, is it fair to say, that in a true free market (i.e. no fed) that interest is NOT created from nothing

Agreed.

but in a market in which a FED prints it’s own money and lends it at interest then the interest payments can never be paid back

I disagree with that.

Going back to the two part understanding of economics, we will have a hard time imagining what increasing the money supply does in a world without money. Here is how I see it:

In a world without money, trade is usually done in the following sequence. A produces something that B wants. B also produces something that A wants. A and B then exchange things and walk away happy.

Now what if A owns a cow, which makes milk every day, and B owns land, which produces wheat once a year? B needs his milk every day, but cannot repay in wheat for a long time. What he does is, if A agrees, set up a receipt system. A will give B milk, B gives A a note saying “This note proves that A produced milk and gave me a quart of it. I will exchange this note in the exact same way as I would for milk itself.”

Thus the notes are a proof that A produced something, and give him the right to buy things with the notes. just as he could with the milk he produced. One can see how this system will make it easier for A to work and sell milk to B, who gives him a note, which, if everyone in town agrees, can be used by A to buy anything he could buy with a quart of milk from persons C, D, and E.

Those notes are, of course, money. They are proof that A has produced and thus that he deserves to get something in return.

Now suppose that A locks his doors at night and starts printing up forged notes. He can then go to town in the morning and buy whatever he wants, but having produced nothing in return.

That is what the Fed does when it prints money. It takes away whatever it chooses to, and gives nothing in return.

In our little story about the banker, it would be like the banker breaking in at night to the farmer’s barn and stealing his tools. The unsuspecting farmer sees he has no tools now, and so he goes to the banker to borrow the banker’s tools, promising him a cut of the crop, as always [=paying interest].

So that the interest CAN be paid back. The problem is the theft of the tools. There is also the added gall of demanding that interest be paid to use them, in addition to never getting the tools back. It is all a tremendous unfair highway robbery of the farmer, yes. But the farmer CAN raise his crops and give the banker a cut. Meaning he CAN pay back the loan and the interest.

BTW, a ponzi scheme is something else. It is borrowing money and promising to pay back with interest. But instead of using the money to produce something, it is all snorted away on cocaine. When the lender comes to ask for his money plus interest, the crook looks for a new sucker willing to lend him the full sum, in return for a promise of getting it back in the future with interest. Obviously, this cannot go on forever.

27

Thanks for the replies (even the person who said “not to be rude” :wink: ).

One final thing. I found this doing some research. Please explain how this either is false or does not pertain to what we are talking about.

“It is critical to understand that the entire structure of this system can only produce one thing in the long run: DEBT. [a] It doesn’t take a lot of ingenuity to figure this scam out. For, nearly every single dollar produced by both the central bank and its regulated commercial banks is loaned at interest. That means every dollar produced is actually the dollar plus a certain percentage of debt based on that dollar. [b] And since the banking system has the monopoly of the production of the currency, and they loan each dollar out with an immediate debt attached to it, where does the money to pay for the debt come from? It can only come from the banks again. Which means the banking system has to perpetually increase its money supply to temporarily cover the outstanding debt created which, in turn, since that new money is loaned out at interest as well - creates even more debt. [c] The end result of this system, is essentially slavery for it is technically impossible for the government and thus the public to ever come out of the self-generating debt.”

thanks

28

It certainly pertains, and is certainly false.

Here too, the question has to be examined from two points of view. From the money-less point of view, the debt can be repaid with interest by giving back the tools and a share of the extra product.

So the whole problem, it seems to me, is when we are looking at the green pieces of paper. The argument of that quote seems to be as follows:

  1. Suppose I print new money on Jan 1, 2011, and lend all that new money to someone with interest, payable Dec 31, 2011. Where will the little green pieces of paper come from to pay that interest?

  2. All the money already in the system from 2010 and earlier cannot be used, because it will have to be used for something else, to repay previous loans.

  3. The money I printed on Jan 1, 2011 cannot be used to pay the interest, because it has to be used to pay the principal.

  4. Thus the only choice left to the poor sucker is to come begging before Dec 31, 2011, say on Dec 1, 2011, and ask me to print new money for him. I twirl my evil mustache and agree, on condition he pay interest on that new money as well. So the only way he can pay his interest is to borrow more, thus increasing instead of decreasing his debt.

There are two flaws with this argument. First, say I borrowed $1,000 on Jan 1, 2011, at 10%. I have the green paper to repay the thousand. I only need $100 of new paper, which is the interset. When he prints new money on Dec 1, 2011, he only prints $100, not $1,000 like on Jan 1, 2011. The next time I come hat in hand, I only need $10, the time after that only $1, then a dime, a penny, a tenth of a cent etc etc.

So that the problem is eventually solved.

Second flaw is that the bankers have to eat, and I’m the one selling food. Where will they have money to pay for the food they want to buy? One could equally well have proven that all bankers will starve to death, naked and homeless. Because the only money the have they lend to someone. That’s how all money is created, right?

Obviously, they get some of the pre-existing supply of money, created before Jan 1, 2011. They will buy some of my food, thus I have it, and use it to pay the interest.

In other words, the answer lies in the pre-existing money supply, the money in the system before Jan 1, 2011. It is not all in the hands of the bankers on Dec 31, 2011, or at any other date. It circulates. When I need some to pay the interest, I get some and give it to the bank. It does not disappear there, either. The bankers will put it right back into circulation, either buying things or lending it again.

29

Here is an example I found online. Can someone tell me what is wrong with it? My guess is it’s too simplified.

No money has to be created to pay interest.

Its difficult to use such a simplified version of an economy when trying to understand why. In the context of this example money is pointless, it has no purpose. What would the borrower use the money to do? Do they each produce something that the other wants? Do they trade these things? If so why do they need money? Why not just barter?

No to understand you need to have a reasonablely realistic economy. One that has a need for money. One that produces a wide array of goods and services that people trade on a daily basis. Then you can begin to understand money and interest.

Look at my example above. It shows how the paying of interest without the expansion of the money supply is possible. It is possible because the people who borrow the money earn an income from others. That income is the source of money to pay interest, it comes from the rest of the people in an economy through the trade of goods and services.

If the borrower fails to earn enough income to cover the interest by trading his labor in an economy then he will be in default and the loan will not be repaid.

30

Fiat based currencies are ponzi schemes and on top of that you have fractional reserve, so not only is there not enough money to pay back the interest. There is also not enough reserves to finance the loans in the first place.

31

The real Austrian answer is originary interest and time preference

Every individual chooses how he wishes to live and attempts to make this so, in economics this involves the buying and selling of goods and services, this, by definition has to extend to points in time as well. It is a universal trait that man will prefer things sooner to later if all the conditions for the wanting of that thing is met. For instance if I will want water because I am thirsty, so I can give it a miss now, but in two hours from now when I am thirsty and I will want the water as soon as I am thirsty, if it were between waiting and drinking then I would choose to drink immediately, I would not want to wait. However, If it were between a cup of water when I first became thirsty and two cups of water ten minutes from that time then I might choose to wait ten minutes.

This principle of time preference also extends to money. An individual who values money in the now will not want to part with it. So there is only one way to convince a man who wishes to spend now to lend to you, and that is by offering him interest. This is deemed originary interest, or how many of tomorrows dollars is worth one of today’s. I will not save a thousand dollars just to receive a thousand dollars and one cent a year from now, perhaps I will if I’d get a thousand one hundred dollars. Additional interest is added to loans based upon how insecure they are, if I can’t be sure of even getting back everything that I loan you then I better be getting a lot of money if your venture does succeed, otherwise if it were the same amount of interest then I would just go and give out a loan to a less risky venture.

As the interest rate becomes lower then more people are prone to withdraw their savings and spend today, however in an unhampered market this is because for two factors, the interest rate became lower either because loans are less profitable (Businesses know that they will not be able to make enough to pay back the loan so they stop taking out loans) or because people are more inclined to save their money, so the rate of interest goes down because people are starting to value money tomorrow more, a lower rate of interest tomorrow is still worth more than the principle is today.