SAVINGS CRISIS – THE IDEAL MONETARY SYSTEM, PART 4

Assume that the idea I explained in the previous part also occurred to one of my ancestors in Ancient Egypt five thousand years ago. Being affluent, he did save some money for the future generation. Generation after generation, his descendants used magical skills to preserve the estate, safeguarding it in the face of collapsing empires, wars, nationalisation and hyperinflation, so that one day I may inherit it all. They were always keen to avoid risk, aiming at modest but certain returns, and were content with an average annual 1 percent in real terms. Having come into the estate, I should do something with it.

Now, how much money do I really have? Last time I calculated that I have 300 million times the world’s current GDP. That’s what should earn me some more. As I want to play safe, I need to find a low-risk investment. My options are a bank deposit, and the bonds of well-managed, stable companies or of reliable countries. Unfortunately, this is obviously impossible, as no-one is capable of producing the interests on such an amount of money.

Few reliable debtors
In any case, it sounds highly improbable that such an amount could have been amassed, and not only because it would have been impossible to make those clever manoeuvres through the mazes of history. Ages ago, one of my ancestors would have hit the wall I’ve just mentioned: indeed, is there anyone that would borrow this fortune and then repay it and its interests? Simply put, there’s not enough potential reliable debtors on Earth.

Modern money is credit money, as we learned on our first finance lessons, or even long before that. That is, the vast majority of the money in the economy is in effect debt. My savings in my bank is actually the bank’s liability to me. The money I paid into the bank has left its cash desk a long time ago, because it’s been loaned out to someone, who owes it to the bank. That person also keeps the amount borrowed in a bank, which is his bank’s liability to them, and so on. Yet everyone thinks that they have disposal of the money they see on their internet bank balance.

Why do we pay our money into banks?
Consequently, a part of savings is channelled by banks to borrowers. Some people pay their money into banks because they specifically expect to earn interest on it, while others are simply forced to do so, as they can only arrange payments through banks. For whatever reason, a significant part of the money circulating in the economy will end up in a bank sooner or later. And those banks can only pay the promised interest if they loan out the funds collected. Another part of savings is channelled directly to borrowers and is transformed into debt without the intermediation of banks, e.g. by means of bond issues.

Savings are therefore continuously accumulated in the system, and are channelled to increasingly bad debtors. Sooner or later, the question to arise at the systemic level is the same as I’d be concerned about if I had a few sextillion dollars: who should I lend this huge amount of money to on interest? The answer will also be the same at the systemic level: above a certain amount, which is, as experience suggests, a few times the GDP at maximum, money can’t be loaned out sensibly.

A savings crisis?!
To ensure that the argument can be followed more easily, so far I havn’t pointed out the fact that there’s no problem with the stock of money (and debt) growing proportionally with the GDP. When someone’s debt increases but so does, proportionally, their income, they will not become a worse debtor. There’s trouble when money supply (and thus the stock of debt) grows faster than the GDP. One the one hand, this is exactly the case (see here or here), on the other hand, the GDP is not likely to grow forever either.

Recently there’s been a lot of talk about the excessive indebtedness of the world and the need to deleverage. However, debt is the mirror image of savings; that’s what our monetary system is built upon. If debt has become too high, this also means that the amount of savings has reached an unsustainable level too. The landslide hitting the world economy in 2007/2008 is termed ‘credit crisis’, while it could reasonably be called a savings crisis as well.

An unsustainable system
Meanwhile, we’re continuously warned how extremely important self-provision is, and that everyone had better save up for their retired years. Taken together with attempts to deleverage debt, this seems to be a contradiction that can’t be resolved.

From time to time, the unsustainable nature of the system may be concealed. Good methods include wars and nationalisation, in the course of which savings will disappear. A less drastic solution is where a large number of debtors go bankrupt as part of a credit (savings) crisis, and liabilities are never repaid. People can then start saving again.

The need for printing money
When we’re finally fed up with this rat race, we can start thinking about where our monetary system went fundamentally wrong. The point is therefore to find a place in the system for the increasing amount of savings so that they aren’t transformed into debt. To avoid the need to lend to bad debtors and risk repayment, while allowing the amount of savings to grow. This means simply that money should be printed. Base money is no-one’s debt, and there’s no need to worry about whether or not it’s going to be repaid (in theory, it’s the central bank’s debt, but a better debtor can’t be named anyway). If we take a look around the world, we see that money is being diligently printed everywhere. At the moment, centrals banks are printing the amount of money by which the value of savings exceeds the sustainable value of debt. Whether they’re doing it right is highly questionable, but they have no other choice. They’re forced to do this unless they want additional waves of bankruptcies, wars or nationalisation.

However, this is merely symptomatic treatment and will not remedy the fundamental flaws of our monetary system. What’s more, the treatment may have side effects, because there’s another way for our savings to become nothing even if we never let go of them for a single moment, and that’s what we’re risking by cranking up the money press: inflation. I’ll write about that in the next part.

 

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Original date of Hungarian publication: 08 july 2014