The Interest Process; Money Flow
Interest is only an artifact of top down money. In a mutual money system, credit; a large claim on the community, is a matter of community commitment recorded directly in the user community asset-liability account. There is no interest charged in these transactions.
Interest is charged in the process of issuing top down loans. The interest commitment and claim on commitment are between a user (borrower) and an authority (lender). Payments on loan interest are mediated through the user current account and the money authority equity account just as are payments on principal.
The interest bearing loan process works as follows. A lender and a borrower meet through our connections in the money user and money authority communities, now acknowledging that interest is a part of our loan agreement. We come to agreement on the terms of the loan, just as before, however interest is added as a new complication.
Interest is a debit-credit transaction, linked to the principal of a loan. It involves a credit, a claim on commitment for the lender/creditor charged to the borrower/debtor, at the end of each time period agreed upon . No new money is created for this transaction; it uses money already created and in the user's account.
In paying this debt, at the end of each payment period, the borrower authorizes the user community account to debit their personal account, and credit the community current account an amount equal to principal plus interest. From this point principal and interest have to be treated separately.
As noted in chapter 6, in the case of money creator loans, as loan payments are made, principal goes from the borrower to the user community current account, to the money authority equity account and thence back to the user community equity account, zeroing out a portion of the debit there from the money creation process. In money manager loans, the principal goes from the user community current account through the money authority equity account to the lender.
In both money creator and money manager loans, interest goes from the user community current account to the lender's user community current account to the extent that the lender has legitimate expenses in creating and managing the loan. The remainder goes through the money authority equity account to the equity account of the lender. This division occurs whether they are a money creator or a money manager. This equity is by definition unearned income-profit.
Because this part of the transaction puts a debit in the user community current account with the credit going to a party that functions outside the user community, the user community money supply which again consists of the sum of all user positive balances is decreased by the amount of interest that goes to the lender's equity account.
The user community money supply consists of the principal that we borrowed from the money authority sub-community. However we owe principal plus interest. The result is scarcity of money in the user community. The money authority equity account and its users now have a surplus equal to the equity payment. The result for the user community is that there is less money in our money supply than is due to the money authority sub-community to pay off all loans.
Again, what we are left with as a user community is a deficit in our community money supply equal to the equity paid to the money authority community by members of our user community. As a result, our community money supply is insufficient to pay the total of what we community members owe to members of the money authority community.
However this effect is somewhat moderated by another kind of transaction.
To the extent that the money received by the lender/money authority for equity in the loan payback process is transferred to their user community account and spent in the productive user community in return for goods or services, the lender is also acting as a member of the user community. They can use money numbers in their earned user community current account as well as transfer money numbers from their individual money authority equity account to their user community current account, to pay for goods/services they want from a seller of value in the productive community.
This somewhat decreases the scarcity of money in the user community money supply as well as the surplus in the money authority money supply.
And it must be added that when equity is spent in the user community it is a 'freebie' for the money manager, as they provided no goods/services when they received it. In other words equity can be seen as a private tax on the user community, payable to the owner of equity.
The larger and longer the term of the loan and the greater the interest rate, the smaller the portion of it is returned to the user community by money authority spending here, and the larger is the portion that is accumulated in the money authority money supply.
The money in the money authority member's equity accounts, money which was created by members of the money user community as a result of our loans, is never extinguished. This money stays in existence. The debit attributable to that credit in the money authority member's equity account remains in the user community asset/liability account. The credit remains with the money authority.
The balance in the user community current account is no longer zero. It is now negative. The user community money supply has been diminished. On the other side, a permanent surplus for the members of the money authority community is created. This a major way that equity is created. The other way is through other forms of profit/unearned income.
As a historical note, according to the Oxford English Dictionary, the first use of the term 'equity' to refer to the unencumbered assets of a corporation was in 19041. Before that, profits were listed as a positive number in the profit-loss account. At a time when the profits of the major corporations were being questioned, someone thought up the idea of calling profits equity, in other words fair.
In order to cover the exponentially growing deficit in the money user money supply, created by the exponentially growing interest load, the total money supply (which is the current sum of our outstanding user loans plus the money authority's money surplus) must grow at an exponential rate to prevent system breakdown. This is the underlying reason why growth in the economy is seen by Economists as necessary in money systems that include interest in their definitions.
The effects of the necessary growth in the money supply can to some extent be mitigated by inflation in the short to medium term, allowing the money supply to grow exponentially with lower exponential growth in the economy; the function of controlled inflation. However in the longer term, the need for exponential money supply growth has its limits. Constant exponential growth of money numbers is not feasible in the long term in a finite economy.
All of this is a result of a system structure that includes interest and other forms of unearned income in its operation.
Dealing with scarcity
There are two major ways that the scarcity in the productive user community is dealt with in order to prevent system breakdown. The first way to deal with scarcity, noted earlier, is for the user community members to constantly take out more and bigger loans to produce and sell more and more services and stuff in order to replenish and add to the user community money supply at an exponential rate, so that everyone can pay back both principal and interest.
Over time there is insufficient money in the user community to buy more stuff, because demand can not continue to increase exponentially forever in an economy that is finite and money is scarce. This sets the stage for the down side of a business cycle, the second method of dealing with the deficit in the user community money supply created by interest and other unearned income.
The money authority community slows lending because it sees some users are unable to repay their loans; the risk of making loans has increased. This accentuates the scarcity of money numbers in the user economy which depends on a constant increase in loans for an adequate money supply to repay all loans.
Because of the lack of money in the user community money supply created by the payment of interest to the money authority, a number of users have to go bankrupt or default on our loans. This creates competition and a fight between users to see who can pay all of our debts, and who will loose what physical assets we have. Community is destroyed in this "each one for ourself" process.
As a result of defaults, the remaining money debts of those who lost our assets are written off; canceled. Cancellation of the debt for principal cancels the remaining claim on commitment for principal of the lender. This is balanced by cancellation of the remaining debt due to the principal of the loan in the user community money supply. Cancellation of interest cancels the remaining debt due to the interest that would be due in the future in the user community money supply.
Payments already made by the borrower for principal and interest are forfeited, as well as property claimed by the lender. Canceling the remaining principal and interest lowers the liability against the user money supply, bringing the balance in the user community current account back to zero. This makes it possible for the remaining debtors to pay our debts with the money in our money supply.
Money managers loose the remaining money they had lent, as well as continuing interest income. A money creator only looses the continued interest income as they had no out of pocket expense for the principal. Remember, they had 'created' the principal 'out of nothing' as a functional loan from the user asset-liability account. However under present rules they can go bankrupt, as they hold the liability on their books.
Meanwhile, major money authorities are able to buy the assets pledged against defaulted loans in the government managed foreclosure auctions, at bargain basement prices, using the surplus of money that they have accumulated through the money authority equity account.
The result is greater concentration of ownership and power in the hands of the major money authorities with the passage of each business cycle. Henry George called receivers of this money and assets rentiers. That term is again being used in some circles.
Thus, for-profit bank authority created interest bearing fiat money sets up a two tier economy, with the lower tier consisting of the productive user community, and the upper tier consisting of the money authority community and especially the major money authorities. Any such system also has a finite life, unlike mutual money systems which do not practice the use of interest and unearned income/profit.
1 Oxford English Dictionary, 1989 Ed, Equity, definition 5.c.
