According to political consensus, it's because of the wrong incentives that we have arrived at the current financial crisis. Too many excessive bonuses have been given to bankers, to reward huge short term profits, causing huge long term losses. Naturally, these bonuses are perverse incentives, which despite all discussion we still have.
Yet, there is a much more perverse
incentive in our current banking system. It's a deeply anchored
incentive, which costs not just many millions, but it actually
devours all of our money. Does this sound strange? I'm talking about
the way our bank balance sheets now are organised. The problem forces
us to go into debt continuously, just to keep the economy going.
How?
Suppose, I get a mortgage to pay for my
house. I'd like to borrow three hundred thousand, but I have thirty
thousand of my own. Fine, the bank tells me, because the bank can
lend out more than ten times its cash reserves. My thirty thousand
will be a reserve, and with the flick of a computer keyboard my
thirty thousand is inflated to three hundred thousand of bank credit.
That's ten times as much as I had. It's just bank credit, but it's as
good as money – or in fact, it currently is our money.
On one side of the balance sheet it now
says “credit to lender: 300,000”. On the other, nicely balanced,
it says “to be repaid by lender: 300,000”. To be repaid with
interest, by the way, but that's another thing. My autograph, and my
promise to pay have enabled the bank to create 270,000 of new money.
That's 270,000 to be used in the economy to invest or speculate, buy
things, hire people, and pay taxes.
Virtually all our money is continuously
being created this way. Once someone promises the bank to pay back
the money, and the bank wants to believe it, then the money can be
created. It's rather bizarre when you think about it, but that's what
our money is now: bank debt tokens.
But what happens when I pay back my
mortgage? In that case the loan is extinguished, and not only the
debt, but also the money disappears! On one side of the balance
sheet my debt to the bank is crossed out, but on the other side the
money I used to pay back is also crossed out. The two hundred seventy
thousand I borrowed are taken out of circulation. We cannot use this
money any longer, and nobody has it any longer. It's taken out of
existence, and can't be used for investing, nor for buying stuff, nor
for paying interest.
So our economy loses out, when we pay
back (too much) of our debts, at least in the sense that we'll have
less money to go around with. That's a rather strange and counter-intuitive incentive. It
also means that in this system some kinds of austerity will be
deadly to our economy.
The bankers also do not really want me
to pay back my loans. They don't get the money that I pay back,
because it's crossed out against the debt. At the most my paying off
unburdens their balance sheets a bit. Instead, the bank makes its
money from the interest I pay on my loans. Interest does not have to
be extinguished on the balance sheet. Interest is much more “real”
to the bank, as they can keep it as their profit. It's much more
interesting – pun intended.
If the bank could choose, we would pay
interest for eternity. If we want to keep our money in the economy,
we'd never pay off our debts. If we would, we would shrink the money
supply – which we are currently doing. So, if we want to keep the
economy going we will have to borrow money forever. Yet we can't.
Even if we learn not to worry about insane debt levels, we can't.
The way our bank balance sheets work
now, we have to borrow until the system bursts. One day the interest
we have to pay, just to be able to use our money, will be more than
what we can collectively earn.
That day may already have arrived.