Brown Web of Debt The Shocking Truth about our Money System (3rd ed)

Chapter 41 - Restoring Natonal Soverignty

create is eventually paid back and zeroes out. But that result is skewed by the charging of interest, and by the fact that the burgeoning federal debt never gets repaid but just keeps growing. The money supply expands because government securities (or debt) are sold to the Federal Reserve and to commercial banks, which buy them with money created out of thin air; and it is this unchecked source of expansion that has to be regulated by artificial means. In a system without a federal debt and without interest, consumer debt should be able to regulate itself. That sort of model is found in the LETS system, in which “money” is created when someone pays someone else with “credits,” and it is liquidated when the credits are used up. Here is a simple example:

Jane bakes cookies for Sam. Sam pays Jane one LETS credit by crediting her account and debiting his. “Money” has just been created. Sam washes Sue’s car, for which Sue gives Sam one LETS credit, extinguishing the debit in his account and creating one in hers. Sue babysits for Jane, who pays with the LETS credit Sam gave her. The books are now balanced, and no inflation has resulted. There is no longer any “money” in the system, but there is still plenty of “credit,” which can be created by anyone just by doing work for someone else.

The LETS system is a community currency system in which no gold or other commodity is needed to make it work. “Money” (or “credit”) is generated by the participants themselves. Projecting this account-tallying model onto the larger community known as a nation, money would come into existence when it was borrowed from the community-owned bank, and it would be extinguished as the loans were repaid. That is actually how money is generated now; but the creators of this public credit are not the community at large but are private bankers who distort the circular flow of the medium of exchange by siphoning off a windfall profit in the form of interest. The charging of interest, in turn, creates the “impossible contract” problem – the spiral of inflation and unrepayable debt resulting when more money must be paid back than is created in the form of loans. In community LETS systems, this problem is avoided because interest is not charged. But an interest-free national system is unlikely any time soon, and interest serves some useful functions. It encourages borrowers to repay their debts quickly, discourages speculation, compensates lenders for foregoing the use of their money for a period of time, and provides retired people with a reliable income. How could these benefits be retained without triggering the “impossible contract” problem? As Benjamin Franklin might have said, “That is simple” . . . .

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Chapter 42

THE QUESTION OF INTEREST: BEN FRANKLIN SOLVES THE IMPOSSIBLE CONTRACT PROBLEM

“Back where I come from, we have universities, seats of great learning, where men go to become great thinkers, and when they come out, they think deep thoughts, and with no more brains than you have. But they have one thing that you haven’t got, a diploma.”

– The Wizard of Oz to the Scarecrow

Like Andrew Jackson and Abraham Lincoln, Benjamin Franklin was a self-taught genius. He invented bifocals, the Franklin stove, the odometer, and the lightning rod. He was also called “the

father of paper money.” He did not actually devise the banking system used in colonial Pennsylvania, but he wrote about it, promoted it, and understood its superiority over the private British gold-based system. When the directors of the Bank of England asked what was responsible for the booming economy of the young colonies, Franklin explained that the colonial governments issued their own money, which they both lent and spent into the economy. He is reported to have said:

[A] legitimate government can both spend and lend money into circulation, while banks can only lend significant amounts of their promissory bank notes . . . . Thus, when your bankers here in England place money in circulation, there is always a debt principal to be returned and usury to be paid. The result is that you have always too little credit in circulation . . . and that which circulates, all bears the endless burden of unpayable debt and usury.

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A money supply created by banks was never sufficient, because the bankers created only the principal and not the interest needed to pay back their loans. A government, on the other hand, could not only lend but spend money into the economy, covering the interest shortfall and keeping the money supply in balance. In an article titled “A Monetary System for the New Millennium,” Canadian money reform advocate Roger Langrick explains this concept in contemporary terms. He begins by illustrating the mathematical impossibility inherent in a system of bank-created money lent at interest:

[I]magine the first bank which prints and lends out $100. For its efforts it asks for the borrower to return $110 in one year; that is it asks for 10% interest. Unwittingly, or maybe wittingly, the bank has created a mathematically impossible situation. The only way in which the borrower can return 110 of the bank’s notes is if the bank prints, and lends, $10 more at 10% interest. . . .

The result of creating 100 and demanding 110 in return, is that the collective borrowers of a nation are forever chasing a phantom which can never be caught; the mythical $10 that were never created. The debt in fact is unrepayable. Each time $100 is created for the nation, the nation’s overall indebtedness to the system is increased by $110. The only solution at present is increased borrowing to cover the principal plus the interest of what has been borrowed.1

The better solution, says Langrick, is to allow the government to issue enough new debt-free Greenbacks to cover the interest charges not created by the banks as loans:

Instead of taxes, government would be empowered to create money for its own expenses up to the balance of the debt shortfall. Thus, if the banking industry created $100 in a year, the government would create $10 which it would use for its own expenses. Abraham Lincoln used this successfully when he created $500 million of “greenbacks” to fight the Civil War.

In Langrick’s example, a private banking industry pockets the interest, which must be replaced every year by a 10 percent issue of new Greenbacks; but there is another possibility. The loans could be advanced by the government itself. The interest would then return to the government and could be spent back into the economy in a circular flow, without the need to continually issue more money to cover the

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interest shortfall. Government as the only interest-charging lender might not be a practical solution today, but it is a theoretical extreme that can be contrasted with the existing system to clarify the issues. Compare these two hypothetical models:

Bad Witch/Good Witch Scenarios

The Wicked Witch of the West rules over a dark fiefdom with a single private bank owned by the Witch. The bank issues and lends all the money in the realm, charging an interest rate of 10 percent. The Witch prints 100 witch-dollars, lends them to her constituents, and demands 110 back. The people don’t have the extra 10, so the Witch creates 10 more on her books and lends them as well. The money supply must continually increase to cover the interest, which winds up in the Witch’s private coffers. She gets progressively richer, as the people slip further into debt. She uses her accumulated profits to buy things she wants. She is particularly fond of little thatched houses and shops, of which she has an increasingly large collection. To fund the operations of her fiefdom, she taxes the people heavily, adding to their financial burdens.

Glinda the Good Witch of the South runs her realm in a more people-friendly way. All of the money in the land is issued and lent by a “people’s bank” operated for their benefit. She begins by creating 110 people’s-dollars. She lends 100 of these dollars at 10 percent interest and spends the extra 10 dollars into the community on programs designed to improve the general welfare – things such as pensions for retirees, social services, infrastructure, education, research and development. The $110 circulates in the community and comes back to the people’s bank as principal and interest on its loans. Glinda again lends $100 of this money into the community and spends the other $10 on public programs, supplying the interest for the next round of loans while providing the people with jobs and benefits.

For many years, she just recycles the same $110, without creating new money. Then one year, a cyclone comes up that destroys many of the charming little thatched houses. The people ask for extra money to rebuild. No problem, says Glinda; she will just print more people’s- dollars and use them to pay for the necessary labor and materials. Inflation is avoided, because supply increases along with demand. Best of all, taxes are unknown in the realm.

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A Practical Real-world Model

It sounds good in a fairytale, in a land with a benevolent queen and only one bank; but things are a bit different in the real world. For one thing, enlightened benevolent queens are hard to come by. For another thing, returning all the interest collected on loans to the government would require nationalizing not only the whole banking system but every other form of private lending at interest, an alternative that is too radical for current Western thinking. A more realistic model would be a dual lending system, semi-private and semi-public. The government would be the initial issuer and lender of funds, and private financial institutions would recycle this money as loans. Private lenders would still be siphoning interest into their own coffers, just not as much. The money supply would therefore still need to expand to cover interest charges, just not by as much. The actual amount by which it would need to expand and how this could be achieved without creating dangerous price inflation are addressed in Chapter 44.

Interest and Islam

Instituting a system of government-owned banks may sound radical in the United States, but some countries have already done it; and some other countries are ripe for radical reform. Rodney Shakespeare, author of The Modern Universal Paradigm (2007), suggests that significant monetary reform may come first in the Islamic community. Islamic reformers are keenly aware of the limitations of the current Western system and are actively seeking change, and oilrich Islamic countries may have the clout to pull it off.

As noted earlier, Western lenders got around the religious proscription against “usury” (taking a fee for the use of money) by redefining the term to mean taking “excessive” interest; but Islamic purists still hold to the older interpretation. The Islamic Republic of Iran has a state-owned central bank and has led the way in adopting the principles of the Koran as state government policy, including interest-free lending. In September 2007, Iran’s President advocated returning to an interest-free system and appointed a new central bank governor who would further those objectives. The governor said that banks should generate income by charging fees for their services rather than making a profit by receiving interest on loans.2

That could be a covert factor in the persistent drumbeats for war against Iran, despite a December 2007 National Intelligence Estimate

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finding that the country was not developing nuclear weapons, the asserted justification for a very aggressive stance against it. We’ve seen that a global web of debt spun from compound interest is key to maintaining the “full-spectrum dominance” of the private banking monopoly currently controlling international markets. A paper titled “Rebuilding America’s Defenses,” released in September 2000 by a politically influential neoconservative think tank called the Project for the New American Century, linked America’s “national defense” to suppressing economic rivals. The policy goals it urged included “ensuring economic domination of the world, while strangling any potential ‘rival’ or viable alternative to America’s vision of a ‘free market’ economy.”3 We’ve seen that alternative models threatening the dominance of the prevailing financial establishment have consistently been targeted for takedown, either by speculative attack, economic sanctions or war.4 Iran has repeatedly been hit with economic sanctions that could strangle it economically.

How a Truly Interest-free Banking System Might Work

While the threat of a viable interest-free banking system could be a covert factor in the continual war-posturing against Iran, today that threat remains largely hypothetical. Islamic banks typically charge “fees” on loans that are little different from interest. A common arrangement is to finance real estate purchases by buying property and selling it to clients at a higher price, to be paid in installments over time. Skeptical Islamic scholars maintain that these arrangements merely amount to interest-bearing loans by other names. They use terms such as “the usury of deception” and “the jurisprudence of legal tricks.”5

One problem for banks attempting to follow an interest-free model is that they are normally private institutions that have to compete with other private banks, and they have little incentive to engage in commercial lending if they are taking risks without earning a corresponding profit. In Sweden and Denmark, however, interestfree savings and loan associations have been operating successfully for decades. These banks are cooperatively owned and are not designed to return a profit to their owners. They merely provide a service, facilitating borrowing and lending among their members. Costs are covered by service charges and fees.6

Interest-free lending would be particularly feasible if it were done by banks owned by a government with the power to create money,

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since credit could be extended without the need to make a profit or the risk of bankruptcy from bad loans. Like in China, a government that did not need to worry about carrying a $9 trillion federal debt could afford to carry a few private bad debts on its books without upsetting the economy. A community or government banking service providing interest-free credit would just be a credit clearing agency, an intermediary that allowed people to “monetize” their own promises to repay. People would become sovereign issuers of their own money, not just collectively but individually, with each person determining for himself how much “money” he wanted to create by drawing it from the online service where credit transactions were recorded.

That is what actually happens today when purchases are made with a credit card. Your signature turns the credit slip into a negotiable instrument, which the merchant accepts because the credit card company stands behind it and will pursue legal remedies if you don’t pay. But the bank doesn’t actually lend you anything. It just facilitates and guarantees the deal. (See Chapter 29.) You create the “money” yourself; and if you pay your bill in full every month, you are creating money interest-free. Credit could be extended interest-free for longer periods on the same model. To assure that advances of the national credit got repaid, national banks would have the same remedies lenders have now, including foreclosure on real estate and other collateral, garnishment of wages, and the threat of a bad credit rating for defaulters; while borrowers would still have the safety net of filing for bankruptcy if they could not pay. But they would have an easier time meeting their obligations, since their interest-free loans would be far less onerous than the 18 percent credit card charges prevalent today.

Interest charges are incorporated into every stage of producing a product, from pulling raw materials out of the earth to putting the goods on store shelves. These cumulative charges have been estimated to compose about half the cost of everything we buy.7 That means that if interest charges were eliminated, prices might be slashed in half. Interest-free loans would be particularly appropriate for funding state and local infrastructure projects. (See Chapter 44.) Among other happy results, taxes could be reduced; infrastructure and sustainable energy development might pay for themselves; affordable housing for everyone would be a real possibility; and the inflation resulting from the spiral of ever-increasing debt might be eliminated.8

On the downside, interest-free loans could create another massive housing bubble if not properly monitored. The current housing bubble resulted when monthly house payments were artificially lowered to

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the point where nearly anyone could get a mortgage, regardless of assets. This problem could be avoided by reinstating substantial downpayment and income requirements, and by shortening payout periods. A home that formerly cost $3,000 per month would still cost $3,000 per month; the mortgage would just be shorter.

Another hazard of unregulated interest-free lending is that it could produce the sort of speculative carry trade that developed in Japan after it made interest-free or nearly interest-free loans available to all. Investors borrowing at zero or very low interest have used the money to buy bonds paying higher interest, pocketing the difference; and these trades have often been highly leveraged, hugely inflating the money supply and magnifying risk. As the dollar has lost value relative to the yen, investors have had to scramble to repay their yen loans in an increasingly illiquid credit market, forcing them to sell other assets and contributing to systemic market failure. One solution to this problem might be a version of the “real bills” doctrine: interest-free credit would be available only for real things traded in the economy -- no speculation, investing on margin, or shorting. (See Chapter 37.)

What would prudent savers rely on for their retirement years if interest were eliminated from the financial scheme? As in Islamic and Old English systems, money could still be invested for a profit. It would just need to be done as “profit-sharing” -- sharing not only in the profits but in the losses. In a compound-interest arrangement, the lender gets his interest no matter what. In fact, he does better if the borrower fails, since the strapped borrower provides him with a steady income stream at higher rates of interest than otherwise. In today’s market, profit-sharing basically means that savers would move their money out of bonds and into stocks. Alternatives for taking the risk out of retirement are explored in Chapter 44.

A Financial System in Which Bankers Are Public Servants

The religious objection to charging interest is that people who have not labored for the money take it from those who have earned it by the sweat of their brows. This result could be avoided, however, without actually banning interest. In ancient Sumer, interest was collected but went to the temple, which then disbursed it to the community for the common good. (See Chapter 5.) A similar model was created by Mohammad Yunus, the Muslim professor who founded the Grameen Bank of Bangladesh. The Grameen Bank

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charges interest, but at a significantly lower rate than would otherwise be available to poor women lacking collateral; and the interest is returned to the bank for their benefit as its shareholders. (See Chapter 35.) That was also the system successfully employed in colonial Pennsylvania, where a public land bank collected interest and returned it to the provincial government to be used in place of taxes.

Whether loans are extended interest-free or interest is returned to the community, community-oriented models would work best if the banks were publicly-owned institutions that did not need to return a profit. Today government-owned banks are associated with socialism, but they would not have raised the eyebrows of our forefathers. The Pennsylvania land bank was a provincially-owned institution that generated sufficient profits to fund the local government without taxes, and in this it was quite different from the modern socialist scheme. Even the most successful modern Western democratic socialist countries, including Sweden and Australia, do not eliminate taxes. Rather than funding their governments with profits from publiclyowned ventures, they rely on heavy taxes imposed on the private sector. Sweden developed one of the largest welfare states in Europe after 1945, but it had few government-run industries.9 India was off to a good start, but it got sucked into massive foreign debts by the engineered oil crisis of 1974 and a banker-manipulated Congress that took on unnecessary IMF debt.10 The Australian Labor Party, while holding public ownership of infrastructure out as an ideal, has not had enough political power to put that ideal into practice, at least not lately. At the turn of the twentieth century, Australia did have a very successful publicly-owned bank, one of which Ben Franklin would have approved. Australia’s Commonwealth Bank was a “people’s bank” that not only issued paper money but made loans and collected interest on them. When private banks were demanding 6 percent interest, Commonwealth Bank financed the Australian government’s First World War effort at an interest rate of a fraction of 1 percent. The result was to save Australians some $12 million in bank charges. After the First World War, the bank’s governor used the bank’s credit power to save Australians from the depression conditions in other countries. It financed production and home-building, and lent funds to local governments for the construction of roads, tramways, harbors, gasworks, and electric power plants. The bank’s profits were paid to the national government and were available for the redemption of debt. This prosperity lasted until the bank fell to the twentieth century global drive for privatization. At the beginning of the twentieth century, Australia had a standard of living that was among the highest

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in the world; but after its bank was privatized, the country fell heavily into debt. By the end of the century, its standard of living had dropped to twenty-third.11

New Zealand in the 1930s and 1940s also had a government-owned central bank that successfully funded public projects, keeping the economy robust at a time when the rest of the world was languishing in depression.12 In the United States during the same period, Franklin Roosevelt reshaped the U.S. Reconstruction Finance Corporation (RFC) into a source of cheap and abundant credit for developing the national infrastructure and putting the country back to work.13 Besides the RFC and colonial land banks, other ventures in U.S. government banking have included Lincoln’s Greenback system, the U.S. Postal Savings System, Frannie Mae, Freddie Mac, and the Small Business Administration (SBA), which oversees loans to small businesses in an economic climate in which credit may be denied by private banks because there is not enough profit in the loans to warrant the risks.

The Myth of Government Inefficiency

A common objection to getting the government involved in business is that it is notoriously inefficient at those pursuits; but Betty Reid Mandell, author of Selling Uncle Sam, maintains that this reputation is undeserved. She says it has resulted largely because the only enterprises left to government are those from which private enterprise can’t make a profit. She cites surveys showing that in-house operation of publicly-provided services is generally more efficient than contracting them out, while privatizing public infrastructure for private profit has typically led to increased costs, inefficiency, and corruption.14 A case in point is the deregulation and privatization of electricity in California, which met with heavy criticism as an economic disaster for the state.15 Complex publicly-provided services tend to break down with privatization, just from the complexity of contracting and supervising the contract. Privatization of the British rail system caused rate increases, rail accidents, and system breakdown, to the point that a majority of the British public now favors returning to government ownership and operation. Catherine Austin Fitts concurs, drawing on her experience as Assistant Secretary of HUD. She writes:

The public policy “solution” has been to outsource government functions to make them more productive. In fact, this jump in overhead is simply a subsidy provided to private companies and organisations that receive thereby a guaranteed return regardless

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