A saving driven economy vs A loan driven economy

[johnyj]

On a small island there are 3 people: A capture fish, B pick fruits, C collect shells and work as a merchant

Everyday, A catch 3 fish,  eat one fish, sell 2 to C and exchange for 2 shells, 1 shell used to buy a basket of fruit from C and he save 1 shell

B pick 3 baskets of fruits, eat one basket, sell the other 2 and get 2 shells, spend 1 shell to buy 1 fish from C , and save 1 shell

C collects 4 shells, all of them used to purchase 2 fishes and 2 baskets of fruits, sell 1 fish and 1 basket of fruit to get 2 shells back, he eat 1 basket of fruit and 1 fish, and left with 2 shells. From second day he only need to collect 2 shells to make the system work, if he collect 3 shells then he could save 1 shell for himself

In order for C To live, he must continuously collect shells to buy products from A and B, the shells work as a medium of exchange and are regarded as a store of value too

Over time, the saved shells on the island will get more and more, their savings increased and some more investment could happen. (In fact, these savings do not correspond to real consumable wealth, but since each shell contains certain amount of labor from C, and they seldom degrade, people tends to regard shells as wealth token, e.g. the shells have value).


This is a saving driven economy, investment happend after a saving has been made, it is not mandatory to do investment, everyone can have a lot of saving while the society can still have a low GDP

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Population and economy expands, there are not enough shell for trading, so C stops shell production and issue the shell notes instead, there is no essential difference in transaction as long as shell notes keep their value stable

But now for C, he does not need to work, which is very strange, why it does not matter if C is working? The reason is: Shell can not be consumed,  the end user only consider shell's exchange value. A and B only care about if shells can be used to exchange other things with a good and stable face value

In modern banking system, any person except central bank must use their valuables/labor to exchange currency, including commercial banks and the government, they can sell their own assets to central bank to get currency, or borrow currency from the central bank, but only central bank have the origianl ownership of the new issued currency

This generated some difference:

In the original system, A and B work and sell the products to C to get currency, their income generated from C's purchasing and consumption. C also work to generate currency, this process is sustainable, everyone is working, everyone can have their saving

In the new system, the central bank produce currency, but he do not buy products from A and B, he only lend to a commercial bank C, but C also do not buy products directly from A and B, he loan to a big wholesaler D and D make a living by trading A/B's products


Back to the island:


A capture 3 fish, eat one, sell the other two to D for 2 shells, 1.5 shells are used to purchase a basket of fruit from D, and he save the rest 0.5 shell

B pick 3 baskets of fruit, eat one basket, sell the other two baskets for 2 shells, and then spend 1.5 shell to buy a fish from D, and save up 0.5 shell

D borrowed 4 shells to purchase 2 fish and 2 baskets of fruits, he sold 1 fish and 1 basket of fruit to get back 3 shells, eat a basket of fruit and a fish, and at the day end he have only 3 shells at hand (the other shell has become A and B's saving)

It is clear to see, if A and B want to have some saving, then D will not have enough currency to pay back his loan, not even mention the interest

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In the first system, there is a steady stream of currency flow into market and become ABC's saving, everyone can have more and more saving. In the second system, all the currency flow into the market as some kind of loan, A and B's saving will become D's debt, the overall saving of all the people on the island will always be 0

Why such difference?

In the first system, C produce money and use them to buy products from A and B and consume them, money flow into the economy, becomes A and B's saving, everyone's saving is positive, and it will increase over time

In the second system, the money produced by central bank eventually become some kind of loan, so the society as a whole can not have a net increase of saving, because the central bank never consumes anything

In one word: If the money producer do not consume, the society as a whole could not have net saving in money's form

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[bullioner]

In the first scenario, it's not necessarily true that a large amount of saving is possible.  C is basically unproductive.  It is likely that the market value of a shell would decrease as more shells entered the system in total, so C would no longer be able to survive just by finding a couple of shells a day.  This is inflation.

In the second scenario, yeah, shells would need to enter the economy in ways other than lending for them to continue to be a viable medium of exchange.  If a debtor goes bust, having traded the shells they borrowed with other market participants, that would make extra shells available.  Or if some entity, a central government say, is given shells to spend by the central bank.

[johnyj]

In the first scenario, it's not necessarily true that a large amount of saving is possible.  C is basically unproductive.  It is likely that the market value of a shell would decrease as more shells entered the system in total, so C would no longer be able to survive just by finding a couple of shells a day.  This is inflation.

In the second scenario, yeah, shells would need to enter the economy in ways other than lending for them to continue to be a viable medium of exchange.  If a debtor goes bust, having traded the shells they borrowed with other market participants, that would make extra shells available.  Or if some entity, a central government say, is given shells to spend by the central bank.

What I want to explain in the first scenario is exactly what you discovered: Although the amount of shell could get more and more, it does not necessary cause inflation, since people regard them as a medium of saving

Imagine that every gold owner, especially large gold owner like government start to spend their gold to buy things in the world, what you can expect? The gold price will drop like a falling knife! But that won't happen, simply because they treat gold as a store of value and they even want to transfer that value to their next generation and next generation etc...

In the second scenario, if government really were given shells to spend, then there will be much less problem, but those politicians are fighting at house for lifting the debt limit, they are not in better shape than any average business, they can only borrow from FED

You had a good point, if some of the borrower default, some of the others could have some saving, but that default eventually will impact the loan issuer, which normally is not central bank (for example Lehman Brothers), so those financial institutions are all suffering when the normal people in society are trying to save more after financial crisis

[johnyj]

I added some correction to the previous conclusion, although the society as a whole can not have saving in money's form, that do not stop people from generating saving in other form

Of course in a money driven society, most of the products are produced to be sold, e.g. exchange for money, there might be some small amount of saving in other form, but they are not significant

[Etlase2]

In the second scenario, if government really were given shells to spend, then there will be much less problem, but those politicians are fighting at house for lifting the debt limit, they are not in better shape than any average business, they can only borrow from FED

It sure seems like the monetary system would be a lot simpler if the politicians just printed the money they wanted to spend, as you suggest. From the taxation in general/taxation via inflation standpoint, the results are probably the same. However, then new money only enters society via government spending, and that seems to me to be a dangerous proposition. The theoretical benefit of the "Bretton Woods II"/fiat system of money is that, when it is not abused, new money should be getting into the hands of people who are creating and innovating...

But the system has been grossly distorted into one where new money gets into the hands of people who are finding ways to create and innovate themselves into more money (aka wall street and london). Was that an intended consequence? It's easy for hindsight to be 20/20, but I have some faith that the system had good intentions. The rapid advancement of technology has also made it much better for the banks and much worse for the rest of us. It is all too easily to manipulate the money supply nowadays.

[Mike Christ]

I'm really bad at economics so I'm still trying to wrap my head around this

In scenario one, everyone is saving and becoming more prosperous together by making their prices fair and wages fair.  So the shells they earn translate evenly into the products they buy.  The shell actually corresponds with the work effort.

In scenario two, people are selling their goods evenly, one good for one shell, yet buying at 50% higher than normal from islander D who is attempting to make a profit.  However, because islander D is a glutton/couldn't find business, he wound up keeping more than he could sell, couldn't make ends meet, and wound up owing islander C a shell plus interest.  So unless islander D makes some better business, and gets his ass in gear, he's going to be islander C's bitch forever, who will continue to earn shells from islander D's bad business.

Is that right?

[johnyj]

I'm really bad at economics so I'm still trying to wrap my head around this

In scenario one, everyone is saving and becoming more prosperous together by making their prices fair and wages fair.  So the shells they earn translate evenly into the products they buy.  The shell actually corresponds with the work effort.

In scenario two, people are selling their goods evenly, one good for one shell, yet buying at 50% higher than normal from islander D who is attempting to make a profit.  However, because islander D is a glutton/couldn't find business, he wound up keeping more than he could sell, couldn't make ends meet, and wound up owing islander C a shell plus interest.  So unless islander D makes some better business, and gets his ass in gear, he's going to be islander C's bitch forever, who will continue to earn shells from islander D's bad business.

Is that right?

Sorry, I have a little bit jump in the second scenario, where I also want to describe a profit making person D by buying at lower price and selling at higher price. If you can not follow, you can just use all the same numbers from scenario one, like this:

A capture 3 fish, eat one, sell the other two to D for 2 shells, 1 shells are used to purchase a basket of fruit from D, and he save the rest 1 shell

B pick 3 baskets of fruit, eat one basket, sell the other two baskets for 2 shells, and then spend 1 shell to buy a fish from D, and save up 1 shell

D borrowed 4 shells to purchase 2 fish and 2 baskets of fruits, he sold 1 fish and 1 basket of fruit to get back 2 shells, eat a basket of fruit and a fish, and at the day end he have only 2 shells at hand (the other 2 shells have become A and B's saving)

So you can see, if D do not raise price, A and B will get more saving, then D will lack 2 shells to pay back his loan.

And if D raise the price to 2 shells per sold fish/fruit, he will be able to get back all the investment while A and B won't have any saving

The point is to illustrate, in an closed system (without import/export), if the money supplied is coming from a loan, the system as a whole could not have net saving in money's form

[Mike Christ]

Okay, I think I got it.  So you're basically saying, profit doesn't come from nothing, and loans generate something that isn't there.  If you have 10 shells to ever exist (silly but it's manageable for me), Islander C has to keep making up shell-dollars for D to continue being in debt.  So if you had 10 shells and 20 shell-dollars, each shell-dollar is only actually worth .5 shells, and will continue to devalue as long as loans (which have to come with interest, else it's not a loan--I think that's right) are given out.  Islander C keeps pumping out shell-dollars that eventually wind up back in his pocket.  Eventually he realizes the other three are figuring out his plot, so he seizes all the shells and makes everyone use his shell-dollars.

After so long, people have trillions of shell-dollars which are worth extremely small amounts, and islander C still keeps all 10 shells to ever exist anyway, keeping him King of the island.  The more their island develops, the more powerful he becomes, until he starts attacking other islands and taking their resources once they finally hit the wall and nobody can tolerate islander C anymore.  Islanders D are so broken that they can't even figure out what's up or down because they're working to the bone to repay their ever growing interest to Islander C.  Finally, after every island is conquered, and every resource is gone/polluted, everyone dies the end!

Maybe I'm overthinking this

[johnyj]

In the second scenario, if government really were given shells to spend, then there will be much less problem, but those politicians are fighting at house for lifting the debt limit, they are not in better shape than any average business, they can only borrow from FED

It sure seems like the monetary system would be a lot simpler if the politicians just printed the money they wanted to spend, as you suggest. From the taxation in general/taxation via inflation standpoint, the results are probably the same. However, then new money only enters society via government spending, and that seems to me to be a dangerous proposition. The theoretical benefit of the "Bretton Woods II"/fiat system of money is that, when it is not abused, new money should be getting into the hands of people who are creating and innovating...

But the system has been grossly distorted into one where new money gets into the hands of people who are finding ways to create and innovate themselves into more money (aka wall street and london). Was that an intended consequence? It's easy for hindsight to be 20/20, but I have some faith that the system had good intentions. The rapid advancement of technology has also made it much better for the banks and much worse for the rest of us. It is all too easily to manipulate the money supply nowadays.

I have not looked from this aspect, but my point is that debt free money and debt money are very different

When you earn money from a person, if that money is borrowed, the amount of your earning equals to the amount of debt he will have, he will get more debt. But if that money is his saving, the amount of your earning will just equals to the amount of saving he spent, he won't get debt. And since debt always incur an interest charge, the difference will become big after a long time

So, if government are spending debt free money, then your earning will only equal to the amount of saving they spent, but if they are spending borrowed money, then your earning will add to their debt and interest burden, eventually fire back towards you

But unfortunately, in today's system, government can never have debt free money, unless FED write off their debt.

[Etlase2]

I have not looked from this aspect, but my point is that debt free money and debt money are very different

That depends. In the US at least, it really wouldn't make that much difference.

When you earn money from a person, if that money is borrowed, the amount of your earning equals to the amount of debt he will have, he will get more debt. But if that money is his saving, the amount of your earning will just equals to the amount of saving he spent, he won't get debt. And since debt always incur an interest charge, the difference will become big after a long time

So, if government are spending debt free money, then your earning will only equal to the amount of saving they spent, but if they are spending borrowed money, then your earning will add to their debt and interest burden, eventually fire back towards you

But unfortunately, in today's system, government can never have debt free money, unless FED write off their debt.

Government debt and personal debt are two very different things. Government debt is fairly meaningless--it is more of just an account of how much the government has spent beyond what it has taxed. Sure, they owe "interest" on it, but any interest owed to the Fed (in the US example) is paid back to the treasury for a net of zero. In the case of interest owed to China, for example, China can do one of two things: spend that money buying US products and services, or buy US debt with its US dollars. It does earn interest on the latter and causes the US government to print more money to pay the interest, but using the money to buy products and services would likely cause the same inflation of the money supply as chinese US dollars are coming back in to the country. Buying products and services would probably boost the US economy, but it's likely only a temporary effect until price inflation kicks in.

One way or another, the US government has made the US dependent on the good of the rest of the world to keep using it as a reserve currency while allowing the US government to spend wantonly. But this situation goes far beyond monetary policy. It's not really a matter of debt vs not-debt currency, it's more a matter of government-controlled money and a bunch of wicked games being played with it.

[johnyj]

I have not looked from this aspect, but my point is that debt free money and debt money are very different

That depends. In the US at least, it really wouldn't make that much difference.

When you earn money from a person, if that money is borrowed, the amount of your earning equals to the amount of debt he will have, he will get more debt. But if that money is his saving, the amount of your earning will just equals to the amount of saving he spent, he won't get debt. And since debt always incur an interest charge, the difference will become big after a long time

So, if government are spending debt free money, then your earning will only equal to the amount of saving they spent, but if they are spending borrowed money, then your earning will add to their debt and interest burden, eventually fire back towards you

But unfortunately, in today's system, government can never have debt free money, unless FED write off their debt.

Government debt and personal debt are two very different things. Government debt is fairly meaningless--it is more of just an account of how much the government has spent beyond what it has taxed. Sure, they owe "interest" on it, but any interest owed to the Fed (in the US example) is paid back to the treasury for a net of zero. In the case of interest owed to China, for example, China can do one of two things: spend that money buying US products and services, or buy US debt with its US dollars. It does earn interest on the latter and causes the US government to print more money to pay the interest, but using the money to buy products and services would likely cause the same inflation of the money supply as chinese US dollars are coming back in to the country. Buying products and services would probably boost the US economy, but it's likely only a temporary effect until price inflation kicks in.

One way or another, the US government has made the US dependent on the good of the rest of the world to keep using it as a reserve currency while allowing the US government to spend wantonly. But this situation goes far beyond monetary policy. It's not really a matter of debt vs not-debt currency, it's more a matter of government-controlled money and a bunch of wicked games being played with it.

Thanks, you brought in some other variables that currently my model still can not analyze, I will try to make another model when it comes to import/export

At least in my current model stated above, you will see there is a big difference, debt free money like gold can permanently become saving, since itself is the result of work, holding that money do not incur anyone else's debt, while debt money could never become saving, since it does not contain any work, holding that money always incur someone's debt, so it can only be used as a token of exchange

[Etlase2]

At least in my current model stated above, you will see there is a big difference, debt free money like gold can permanently become saving, since itself is the result of work, holding that money do not incur anyone else's debt, while debt money could never become saving, since it does not contain any work, holding that money always incur someone's debt, so it can only be used as a token of exchange

Unless there is no fractional reserve, gold is not debt free money. It functions very similarly. Without fractional reserve, a gold money supply cannot expand and contract as necessary for smooth economic operations. "Hard" currency may slow down government largesse, but it will also slow down innovation when new ventures cannot find capital.

[johnyj]

At least in my current model stated above, you will see there is a big difference, debt free money like gold can permanently become saving, since itself is the result of work, holding that money do not incur anyone else's debt, while debt money could never become saving, since it does not contain any work, holding that money always incur someone's debt, so it can only be used as a token of exchange

Unless there is no fractional reserve, gold is not debt free money. It functions very similarly. Without fractional reserve, a gold money supply cannot expand and contract as necessary for smooth economic operations. "Hard" currency may slow down government largesse, but it will also slow down innovation when new ventures cannot find capital.

I think FRB has nothing to do with this, it is more like insurance, commercial banks hedge the withdraw risk by combining lot's of savings together. They can never loan out more gold than they have, that so called "money multiplier" concept is just an accounting trick

And what you said is true when the economy needs to EXPAND continuously. Like human body, when an economy has become more mature, the growth will eventually slow down, the reason that an economy has to grow continuously is because all the money are debt driven

You can hold lots of gold while have a decent but low living standard and no innovation, it's totally fine (Just like old China and India) But you can not hold lots of USD while doing the same, because someone else in the society must be heavy debt laiden because of your saving, they have to work hard to payback that debt, and those guys will try to earn your USD to pay back their debt

[Etlase2]

I think FRB has nothing to do with this, it is more like insurance, commercial banks hedge the withdraw risk by combining lot's of savings together. They can never loan out more gold than they have, that so called "money multiplier" concept is just an accounting trick

It may be an accounting trick, but it absolutely expands the money supply when two or more people can claim the same gold. Gold just puts the brakes on government spending, it doesn't solve personal debt that you worry so much about.

And what you said is true when the economy needs to EXPAND continuously. Like human body, when an economy has become more mature, the growth will eventually slow down, the reason that an economy has to grow continuously is because all the money are debt driven

Not expand continuously, expand ever. If you ever want innovation from someone other than the rich, you need to expand the money supply when the need arises, or there will be no class movement at all. The "continuous growth" of modern economies is primarily a fiction that is encouraged due to the nature of fiat and governments. That doesn't mean that there are not periods where growth is real, and the money supply needs to respond to it.

You can hold lots of gold while have a decent but low living standard and no innovation, it's totally fine (Just like old China and India) But you can not hold lots of USD while doing the same, because someone else in the society must be heavy debt laiden because of your saving, they have to work hard to payback that debt, and those guys will try to earn your USD to pay back their debt

It is a system that works reasonably well as long money flows, and flows to reasonable areas, something banks are supposed to be good judges of. That is, after all, why we are supposed to be giving them the privilege of holding all of our money and earning interest. It is the banks abusing that privilege that causes the system to shock, not the fact that debt exists. And it is the politicians that are so easily bribed into doing things that are favorable to the banks. This again is not an issue of debt, it is an issue of corruption of the monetary system. The fact that the system is corruptible is a big problem, but what do you expect when you give that sort of control to a few people?

[johnyj]

It may be an accounting trick, but it absolutely expands the money supply when two or more people can claim the same gold. Gold just puts the brakes on government spending, it doesn't solve personal debt that you worry so much about.

If more than one people claim the same piece of gold at the same time, banks go bankrupt, that is what is happening after financial crisis

Not expand continuously, expand ever. If you ever want innovation from someone other than the rich, you need to expand the money supply when the need arises, or there will be no class movement at all. The "continuous growth" of modern economies is primarily a fiction that is encouraged due to the nature of fiat and governments. That doesn't mean that there are not periods where growth is real, and the money supply needs to respond to it.

The growth are all true, but not sustainable. For average people, the biggest spending (and hence the growth for society) comes from housing, then their spending will decrease, unless you could find an even bigger spending after housing, that is the problem now

It is a system that works reasonably well as long money flows, and flows to reasonable areas, something banks are supposed to be good judges of. That is, after all, why we are supposed to be giving them the privilege of holding all of our money and earning interest. It is the banks abusing that privilege that causes the system to shock, not the fact that debt exists. And it is the politicians that are so easily bribed into doing things that are favorable to the banks. This again is not an issue of debt, it is an issue of corruption of the monetary system. The fact that the system is corruptible is a big problem, but what do you expect when you give that sort of control to a few people?

Yes, those aspects all affect efficiency, but my model just showed that no matter how smart/efficient the banks/policy maker are, that debt based money creation will always lead to insolvency

In my second model desribed in the OP, you can try all different productivity/pricing combination to generate saving for both A,B and D, you will find out that is simply impossible, their combined net worth in currency's form is always 0, just because none of them have the original ownership of the currency

[Etlase2]

If more than one people claim the same piece of gold at the same time, banks go bankrupt, that is what is happening after financial crisis

And that is what I said and you denied it as if gold is any different. It's not.

The growth are all true, but not sustainable. For average people, the biggest spending (and hence the growth for society) comes from housing, then their spending will decrease, unless you could find an even bigger spending after housing, that is the problem now

No, the problem now is that banks lent recklessly. Housing does not lead to real growth, housing bubbles caused by the all too easy flow of money from the banks into housing leads to a monetary growth bubble and collapse. There's a reason why I used the word innovation several times. Stop thinking so narrowly. While the internet bubble and burst was a bubble, it still changed the world as we know it for the better. The sting was mild, and the innovative players shone through. The housing bubble was nothing but a wealth transfer.

Yes, those aspects all affect efficiency, but my model just showed that no matter how smart/efficient the banks/policy maker are, that debt based money creation will always lead to insolvency

It's an oversimplification and doesn't prove anything. You seemed to have missed the whole point I mentioned where government spending is putting "loan-only" money into society with a loan it pays interest on mostly to itself. Keeping this out of the equation makes your scenarios flawed. If the creditors get frightened, the government can always (well, almost, as long as the money is sovereign, lol europe) spend more to ease credit crises. Yes the cycle continues, but politicians are essentially paid to keep it that way by the powerful.

[johnyj]

It's an oversimplification and doesn't prove anything. You seemed to have missed the whole point I mentioned where government spending is putting "loan-only" money into society with a loan it pays interest on mostly to itself. Keeping this out of the equation makes your scenarios flawed. If the creditors get frightened, the government can always (well, almost, as long as the money is sovereign, lol europe) spend more to ease credit crises. Yes the cycle continues, but politicians are essentially paid to keep it that way by the powerful.

Government and FED are different organization, FED buy bonds from government, and government has to pay interest to FED. That's my understanding, if you have better source please share it

And you can even remove the interest element in this discussion (As I did in my model), anyway interest is almost 0 now.

[Etlase2]

Government and FED are different organization, FED buy bonds from government, and government has to pay interest to FED.

Fed pays profit to treasury.

That's my understanding, if you have better source please share it

I'm sure you can figure out something worthwhile to google. When all else fails, wikipedia:

"The U.S. Government receives all of the system's annual profits, after a statutory dividend of 6% on member banks' capital investment is paid, and an account surplus is maintained. In 2010, the Federal Reserve made a profit of $82 billion and transferred $79 billion to the U.S. Treasury.[22] This was followed at the end of 2011 with a transfer of $77 billion in profits to the U.S. Treasury Department.[23]"

And you can even remove the interest element in this discussion (As I did in my model), anyway interest is almost 0 now.

But you can't remove the government spending element. When the economy goes bad, governments spend money like it's going out of style. Even if 50% goes to the top 20% and 50% goes to the bottom 80%, that bottom 80% received a much larger boost to its bottom line. Economies can't function well when the rich have too much money, but the rich seem to keep forgetting that. If the government wants to stay in power, it won't forget for too long.