Borrowed Money As A Medium Of Exchange
Let us suppose we live in an isolated community where only ten families live. They are engaged in the usual occupations of a small community. Everything is going smoothly in the community, everyone is making a living and the peoples needs are being met. Due to some unexplainable reason, they wake up one morning and find all of their money is gone. There is absolutely not even one cent in the bank or in the community. Nothing else is disturbed. Now what are the people to do for money?
The next day a gentleman named Mr. Goldsmith, with $10,000 in gold coins comes into the community and tells the people he has heard of their problem and he offers to loan to each family $1000 in gold coins for one year at six percent interest. Of course he requires some collateral as security for the loan. That seems fair to the people; gold is considered to be the best kind of money.
So the village official borrows his $1000 and he officially signs a note and also a statement that he will levy a tax sufficient to pay the principal and interest when due. The farmer borrows his $1000 and keeps in his granary $1000 worth of grain as his collateral. The electric power producer signs a note pledging the income from people who pay their electric bills. The church official promises to pay from dues he will collect from his members. The post office will sell stamps for its income. All the others borrow their $1000 of gold coins and pledge either their goods or services as collateral. [p. 53]
Business is again normal. The people are working, buying and selling and taking care of the needs of each other. Most of them are thankful that Mr. Goldsmith helped them out. But as the end of the year approaches the people start to save their money so they can repay their loan. There is less buying; business is getting slow. No one wants to part with his gold coins because he has to pay back his loan.
When the day arrives on which the payments for the loan are due, they all go to pay Mr. Goldsmith. Some have enough money to pay the principal and interest; some can pay only the principal; some only the interest, but all pay him all the money they have. He counts the money he receives and it is exactly $10,000. That is the amount he loaned to them. However, they had agreed to pay him 6% interest. Six percent interest on $10,000 equals $600, but there is no $600 of extra gold coins in the whole community. They have goods and services with which they could pay the $600 interest, but gold coins they do not produce and therefore do not have. They cannot sell their goods or services for gold because no one has that necessary extra $600 in gold.
Mr. Goldsmith says he is compelled to take what is due him from the collateral that was pledged as security. He sets a date when he will auction off as much of the goods as is necessary to pay what is due him.
The auction is held. The local people attend, but they cannot bid for the goods because they have no money. They used all their money to pay off their loans and have none left. Two strangers are present who have money but they bid very low when the goods are offered. The necessary amount of goods is sold to the highest bidder, but the highest bidder buys the goods at about one third of their real value. Mr. Goldsmith gets his interest money. Note, however, that the people who borrowed from him paid the $600 interest with goods that they produced.
Now their debts are paid off but they again have no money. They are in the same position as they were one year earlier, except they are out the $600 worth of goods used to pay the interest charges. But the goods that were [p. 54] sold for $600 were really worth about $1500. It seems evident that borrowing gold coins, with interest, for the purpose of using them as a medium of exchange was not satisfactory. What did they do that was wrong?
- They borrowed money for the purpose of exchanging goods and services.
- They borrowed an item (gold), with interest, as money, an item they did not possess and that they themselves could not produce.
- They agreed to pay the interest with gold. They could not pay with gold because they did not produce gold. (People should agree to pay for their wants only with things they produce.)
Now let us see how it would work if the people in that community tried to use bank credit as a medium of exchange. The local banker was studying the problem during the past year. He told them how bank credit works. Each person who needs money goes to the bank and borrows as much as he needs. He signs a note and pledges the same security as he would if he borrowed gold coins. The banker then gives him a checkbook and enters the amount, say $1000, as a deposit in his account. The borrower can then write out checks as he needs them, up to $1000. The interest will be six percent per year.
Let us say each of the same ten families borrows $1000 of bank credit. They write checks for all of their purchases of goods and services. Everyone accepts the checks because the bank accepts the checks. So business again goes on in a normal manner. Some produce goods and some perform services. The needs of the community are taken care of. They are pleasantly surprised that the checks work just as well as Mr. Goldsmiths gold coins.
However, as the months pass and the time approaches when the loans and interest are to be paid, the people start to buy less. They begin to save what checks they can get, or deposit them in their bank account, so they will have [p. 55] enough to pay off their loans. Soon people completely stop buying. Those who try to sell cannot because people cannot write out any more checks. They each need $ 1000 plus $60 for interest of checkbook money to pay off their loan.
When the due date comes, some again cannot pay their note and interest in full. They have goods to be sold but there are no buyers. The reason is that they (all the borrowers together) have borrowed $10,000 worth of to bank credit and have promised to pay back $10,600 in bank credit, the extra $600 being the interest on the $10,000 loan. That extra $600 of bank credit did not exist in the entire community. The bank only created $10,000 worth of bank credit, and it could not create any more, unless someone borrowed some more.
We now see that it is impossible to pay back such a loan, with interest. This is easy to understand when everyone is required to repay his loan at the same date. But when the loans come due at different dates and many of the loans are renewed and increased in size, and there is enough bank credit created to satisfy the needs of the community, then the fact of the impossibility of paying back the loans with interest is concealed.
This means that in order to have enough money (medium of exchange) in circulation so the business of producing and exchanging goods and services continues in a normal manner, the total debts in the country must continually increase. If some individuals and corporations pay off their debts, others will have to increase their debts.
Therefore, when the medium of exchange is bank credit borrowed at interest, the total debt in the country must increase. If an attempt is made to reduce the total debt, prices and wages must also be reduced otherwise goods and services will go unsold and some unemployment will take place. As long as people continue to borrow and increase their debt, business will continue because there will be enough of the medium of [p. 56] exchange in circulation to buy the goods and services produced; however, the burden of interest payments will become greater and greater. If some of the debts of private individuals [p. 57] and corporations are reduced, then the debt of governmental bodies has to be increased. If the debt of government is to be reduced, then the debts of private people must be increased. But the total debt in the nation must be continually increased (at least enough to pay the interest charges on the debts made as the bank credit money is increased) in order to keep people producing. That is the situation when the medium of exchange is borrowed, with interest; that is the situation as it exists in the United States in 1969.
We have learned so far that the community that found itself without money tried borrowing gold coins from Mr. Goldsmith and also tried borrowing bank credit from their local bank for the purpose of having a medium of exchange. Both plans failed: What would the results have been if they had borrowed money (coins or currency) from the national government? Well, the federal government officials cannot, with justice and honesty, loan out any money. They have no money to loan out. They cannot, with honesty and justice, issue money to loan out. The only bona fide money they can issue, with justice and honesty, are tax credit certificates. United States notes or coins, when issued with honesty and justice, can be issued as if they were tax credit certificates. And tax credit certificates are paid out for goods and services, not loaned out.
An honest merchant who issues a certificate of credit pays it out or sells it, but never loans it out. He never issues certificates of credit to loan out. Likewise, honest and informed government officials will never issue tax credit certificates (United States notes or coins) to be loaned out. But if the officials would issue United States notes, coins, or certificates to be loaned out, such money would not be bona fide money.
So let us solve the problem for the people in the community without money in the right way. The right way is for those people to create their own medium of exchange by issuing their own credit certificates. We see from what has been said that a medium of exchange is necessary for the convenient exchange of goods and services. We have learned that there is more than one type of medium of exchange to be used for the buying and selling of goods and services. We have also learned that when people borrow their medium of exchange, with interest, they cannot get out of debt. They must continue to borrow more and more, or stop producing for each other.
Another important thing to remember is that when the medium of exchange is borrowed, there exists a serious handicap to the normal activities relating to the production and exchange of goods and services, because those who have the money or credit to loan also have the power to refuse loans and thereby reduce the amount of the money in circulation which in turn results in prices going down and workers being laid off. In other words, they have the power to cause business to slow down. (One method used to reduce loans is to charge high interest rates.)
However, by themselves, those who loan money or credit do not have the power to make business pick up. They, by themselves, do not have the power to put money (medium of exchange) in circulation. They can offer people loans, even with low interest rates, but they cannot make people borrow. If people do not borrow money, then there will not be enough money in circulation to maintain prosperity. A well-informed people will not depend on borrowed money for their medium of exchange. The ups (booms) and downs (busts) in business activity in the past have nearly always occurred when the amount of the medium of exchange was increased or decreased. When the medium of exchange was increased, business activity increased. When the medium of exchange was decreased (by less borrowing) business activity decreased.
That is how prosperity and depressions are made. That is how inflation or deflation is made. Banks can make deflation by refusing to loan their bank credit (medium of exchange), but they cannot increase the supply of money (bank credit) unless some producers or distributors of goods or services are willing to borrow. They can encourage [p. 58] people to borrow by lowering interest rates, but they cannot make people or governments borrow. That is why they, by themselves, cannot put more money into circulation even if it is needed to restore or maintain employment and production.
Many people believe that wars make prosperity. That is not true. What happens when a nation gets into a war is that the government borrows money (bank credit) from the banks thus more money is put in circulation. That is what causes an increase in business activity.
The same increase in business activity would take place if the money supply were increased for any other purpose. It could be increased without borrowing, but because it is for a war, everybody thinks it is all right to borrow. The same amount of money can be created by the government for war or for any other purpose without borrowing, by the issuing of United States tax credit certificates or by notes or coins issued as tax credit certificates. Prosperity will exist as long as people are willing to produce goods and services, and if enough of a bona fide medium of exchange exists so that the people can share those goods and services with others, in justice.
SOLUTION FOR THE NATION OR COMMUNITY WITHOUT MONEY
The right way for a nation, a state, a county, a city, or a community to provide a sufficient amount of a bona fide medium of exchange is for each or all of them to create it, themselves. They should not borrow it.
The governmental bodies-federal, state, and local- should each issue all the tax credit certificates it needs for its necessary expenditures. It must levy a tax equal to the amount of the tax credit certificates it issues.
If there still is need for more of the medium of exchange, then private corporations and persons should issue as many certificates of credit as are necessary to sell all the wanted goods and services produced. In that way there will always be enough of a bona fide medium of exchange in circulation and it will not be a borrowed medium of exchange. [p. 59]