Friday, September 11, 2009

To demurrage or not to demurrage, that is the question.

What’s demurrage, alias negative interest?
Miguel Yasuyuki Hirota
May 4, 2006 ·

It’s now a clear-cut fact that today’s positive-interest-based monetary system is a huge hurdle against our sustainable lifestyle as well as our economic activities. Silvio Gesell(1862-1930), a German-Argentinean merchant and economist, is a remarkable figure who suggested how to reform this paradigm on his masterpiece “The Natural Economic Order.”

He starts his argument with the fact that money is at a privileged position in comparison with other goods. In general commodities are depreciated as the time passes by and you can’t sell yesterday’s newspaper or one-year-old apples while you can hoard your money as long as you like without suffering from any loss at all(in case of no inflation: note that Germany adopted the gold standard when he wrote that book), which allows bearers of notes to charge the compound interest on lending them to somebody in need. The more money you have the more profit you can earn by this financing, enabling the superrich to live solely on such income while most of the poor are asked to contribute to them.

So what was Gesell’s idea?: “To abolish the privilege of money.” People prefer money to goods on storing economic value because money remains the same, so he came up with charging bearers of paper notes a certain amount of “demurrage fee” regularly to prevent them from hoarding(for instance, to put the stamp of one-hundredth of the face value each month: to be depicted more next time).

This will give a fundamental shift to the financial system as it’s quite helpful for borrowers: lenders see their act as a means rather to get rid of suffering from the monetary loss triggered by the demurrage fee than to increase their asset and even negative-interest loans will be possible when the demurrage fee is high enough: In case the fee is 1% per month = roughly 11.4% per year, it’s better to lend US$1000 to receive only US$950 next year than hoarding it at home and losing more than US$100. The negative interest rate will give more chances to those businesses which haven’t been financed so far due to their low profitability, more people will have access to credits = more freedom to run the business they want and consequently our economy will be more democratically managed.

Although Gesell died in 1930 without witnessing any case at all where his theory is applied, the subsequent history proves that he was right. Next time I’ll deal with a historical success.

Interest rate and long-term projects
May 1, 2006

The current compound interest is liable not only for what I depicted in the last article but also for pouring money arbitrarily into short-term projects while those with a longer time span find it quite difficult to be sufficiently financed. Stefan Brunnhuber, another German who has been tacking this issue, gives a clear picture on all about it on his book “Wie wir wirtschaften werden”(to be published in English as “Our Future Economy”).

Let’s say that you have two projects to choose from: which project would you invest to?

a) a €10 pine tree which will grow to €100 in 10 years

b) a €10 oak tree which will grow to €1000 in 100 years

The interest rate plays an essential role on your choice although most of you aren’t aware of it: the positive interest rate is synonym of the depreciation of future assets because what will be bigger in the future is smaller in the past. Provided that the interest rate is fixed at 5% per year your € 1000 in 2006 is equivalent to €1628.89(1000×1.05^10) in 2016, but this means that your € 1000 in 2016 is reduced to only €613.91(1000/1.05^10) in 2006. From this viewpoint the pine tree is worth now € 61.39 while the oak tree is only worth € 7.60(1000/1.05^100) and everybody is therefore inclined to plant a pine tree while nobody is interested in oak.

This explains why entrepreneurs rush into China to set up new factories because profits are expected to be brought soon. Long-term projects such as reforestation and education are unlikely to call the attention of the business world because they aren’t profitable in this framework.

But this paradigm will see a fundamental shift as the interest rate changes: future assets can be appreciated instead of being depreciated in case there should be a negative interest rate. The pine tree will be worth €162.89 instead of € 61.39 and the oak tree €131,501.26 instead of € 7.60 with 5% of negative interest rate. This will favor long-term projects or those which will churn out profit constantly, enabling more projects to be financed.

But how can we make a negative interest rate possible? Next time I’d like to deal with this issue.

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