When to Not Use Money – and Why

Let us imagine a fictitious mountain village — or, for that matter, any other close-knit community — that has a high degree of economic independence at the community rather than individual level. Within this community, there is an on-going active exchange of favours, including goods and services. Naturally, there will be some sort of accounting mechanism that ensures everybody is providing roughly as much to the village as he is drawing from the village economy. Keeping a purely mental record of the entire history of such exchanges in mind may be too challenging, so let’s assume our villagers write little notes to keep track of exchanged favours. There is no intrinsic reason why some such approach should not work quite well.

Let us now assume that our villagers change their strategy, and decide to use legal tender money for this ‘bookkeeping of favours’ instead. In that case, they first have to obtain some of that money. But how? Evidently, one or more people from the village would have to climb down the mountain, visit the national bank, and take up credit. How does this work? Credit contracts come in many different flavours, but the basic rule of the game is that the credit taker has to promise to the bank to return a certain economic value to the bank in the future, plus added interest.

The bank then takes the written promise to hand over future economic productivity, which itself has some value, and uses its privilege (granted by the state) to pawn this contract with the central bank in exchange for legal tender bank notes. Before the exchange, the credit taker had in his hands an economically valuable pledge to provide a certain quantity of goods and services in the future. After the exchange, the value he holds in his hands is none other than that of his original pledge — but anonymized and split into small denomination bills (figuratively speaking).

But in addition to this, the credit taker now also has an obligation to hand over extra economic value to the bank — this is the interest.

Note that the credit taker made the decision to take up the credit so that he could pay someone in legal tender money. Had he been able to directly pay with his pledge to hand over some of his future economic productivity, without the detour via legal tender, he would be better off.

This holds in particular if, in a trade, there is a corresponding equivalent counter-trade and both parties use trade as a battery-like store for available time — along the lines of "I am occupied on Mondays and Tuesdays, but free on Wednesdays and Thursdays, and it’s just the opposite with you — so I will take care of your and my children on Wednesdays and Thursdays, and you will take care of them on Mondays and Tuesdays." Or: "I am very busy right now with a very rewarding project, but the garden has to be dug and planted now — if you do this now for me, then in summer I will take care of weeding and slug control in your garden, as I have fewer obligations then."

Such agreements can be negotiated without there ever being a need to use legal tender, and intuitively one would expect that in a functioning culture, such promises are regarded as a matter of honor and therefore strictly fulfilled. No one would get the idea of asymmetrically charging interest on the favour that is farther in the future.

If, in contradistinction, such agreements are being made in such a way that legal tender money changes hands, this money must at some point have entered the economy — i.e. someone must have taken up a credit.

Let us come back to the previous gardening example and assume that ten hours of gardening work have an economic value of 200 dollars. You work ten hours for me now and I pay you 200 dollars. In summer, I work ten hours for you and you pay me 200 dollars. In between, these 200 dollars will be in somebody’s pocket, but as they have been obtained from the bank via taking up a credit, there is someone somewhere who will have to dig the banker’s garden for an additional hour.

What additional value has the banker given to society to earn this privilege? Not much more than applying his state-granted privilege of basically re-writing a contractual promise to future economic productivity. Beforehand, it was written on contract paper, afterwards it comes on uniform colorful slips of paper. The banker "earns" his claim on economic activity by exchanging white paper for that other mesmerizingly colorful paper. When did the banker take a spade and sweat? Not at all — he only applied his funny, state-granted privilege.

Had the banker instead said: "Look, instead of writing your promise to hand over some of your future economic productivity on ordinary white paper, you can alternatively write your promise on my great colored paper, but in exchange for that favour, I would like to have an extra 10% of the pledged economic value" — well, quite likely everyone would have replied "try to find a bigger idiot than me for that scheme".

But still — and this is quite strange — just because the colorful paper is called "money", everyone falls for that scam. Those who see through it will instead try to make money-less mutual agreements wherever they can. But still, they will grudgingly have to obtain legal tender money for some tasks — in particular for paying taxes — and hence have to obtain some of the the colorful paper.

From the perspective of the bank this is very clever. A comparison with German church tax is perhaps enlightening here. In Germany, all members of a major Christian church will for every 100 Euros of payable income tax also have to pay an extra 7 Euros of additional tax to the church. If these 100 Euros entered the economy via someone taking up a credit at 7% interest rate from the bank, then the need to pay 100 Euros of income tax to the state creates an additional need to pay 7 Euros to the bank — the same as the church tax. But the church has the problem that their agreement with the ministry of finance makes it very visible how they fleece people, and correspondingly there is a considerable drive for people to cancel their memberships. The banks achieve precisely the same objective of getting an extra 7 Euros for every 100 Euros of taxes paid to the state in a much more clever way — so clever indeed that people normally do not notice.

Of course, one could claim that interest is an insurance against a debtor not being able to meet his obligations. But if it were just like that, why then does, for example, the bank want to see the house and have it as security when someone tries to take up a mortgage? Advocates of the prevailing economic theory would of course reason out that having the house as an additional security lowers the risk and hence just makes the mortgage cheaper — and in the end, it is the market that ensures that competition between banks to offer the best conditions to borrowers that makes sure interest rates track risk. But is this really the case? If it were so, I actually wonder why the British wind energy company Ecotricity sent a letter to all its customers offering them an opportunity to bank with them at 7.5% interest to get a better deal for itself and its customers by cutting out the banks. (Of course, there is some risk involved in such direct investment in a company. But normally, there also would be a risk in allowing a bank to manage one’s money. The real difference is that — as we have seen — the state will bend the rules when necessary to provide a bailout to banks but might be less inclined to do so for what is currently a non-major energy supplier.)

Finally, it really gets absurd if we consider the situation that the state, which granted the incredible privilege of expanding the money supply to the banks in the first place, then borrows money from the banks at conditions to its disadvantage and to the advantage of the bank. Suppose the state wants to finance the construction of a bridge. Couldn’t it then directly take the value of the bridge to back the paper money handed out to pay for its construction?

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