Rethinking Money

by Bernard Lietaer

  Clearly, it’s almost impossible to break from the shackles of debt obligation, given the effect of compound interest on a loan.

  Growth by itself, even exponential growth, it should be emphasized, is not necessarily problematic. For instance, there is no reason to worry if one’s knowledge base increases exponentially. Healthy growth is facilitated by the influences of innovations and inventions, the expansion of markets into new geographic areas or through internal growth in the labor force, and by rising standards of education and training. The growth induced by compound interest money, however, does not discern. Rather, compounded interest unchecked by countervailing forces blindly pushes the real economy to grow, regardless of the form of growth or its consequences. This mandatory growth obligates everyone to be on an economic treadmill, no matter what the long-term impact may be.

  SHORT-TERMISM

  “The time horizon for the financial planning for my family is easily 20 to 25 years into the future. There are provisions made for my children’s well-being, their education, and once they’re out of the house and on their own two feet, I suppose I will be looking at my wife’s and my retirement,” answered the CEO of a major German corporation spontaneously. He didn’t have to think about it or carefully evaluate his reply, it was so spontaneous.

  “And what is the time horizon for decisions in your company?” The second question hung in the air for a moment.

  “Well, usually there’s a three- to five-year horizon in a business plan. But what is really critical is the next quarter and possibly the one after that,” came the reply rather matter-of-factly. “If I don’t deliver profits each quarter, I’ll be quickly replaced by someone else who will.”

  His response would be typical for most businesspersons who are being candid, particularly in publicly owned companies. In the business and financial world, the importance of the immediate future totally outweighs the long-term future. The upshot is that financial rewards are strongly skewed toward immediacy. Subsequently, there is not enough long-term planning. This has serious consequences. For one, to conserve and protect Earth’s finite resources requires long time horizons, even intergenerational thinking. Therefore, whenever decisions are made on a short-term basis, sustainability—whether financial or ecological from local to planetary—tends to be overlooked. For instance, British Petroleum’s or Ford’s decisions and choices in energy and transport strategies would clearly be different if they were based on a 100-year time line, instead of on a few quarterly results.

  Part of this short-termism is independent of the monetary system: The further in the future that events are located, the more difficult it is to make accurate predictions about them, meaning there is increased risk. Hence the old saying, “a bird in the hand is worth two in the bush.”

  There is, however, a second key impetus toward short-termism that is entrenched firmly in the conventional money system. Today’s money is created through bank debt, as explained in the last chapter, and it requires the payment of interest. In other words, every dollar, peso, or euro that exists today is someone’s debt, whether incurred by a state, corporation, or individual. This means that interest is a built-in feature of the monetary system. Furthermore, as known to anyone familiar with the discounted cash flow (DCF) technique used in financial decision making, the readiness to make long-term investments depends, to a significant extent, on the current and anticipated interest rates.

  Discounted cash flow analysts know that interest is one of the three factors in discounting any future cash flow. (The other two factors are the intrinsic risk of the investment project and the cost of equity capital.) With the issue of interest, however, an entrepreneur, for example, can put her capital in a bank instead of investing it. If she deposits $61 in the bank at an interest rate of 5 percent, she will have $100 after 10 years.5 Thus, any investment of $61 today that will have a value of $100 in 10 years is only worthwhile if the money market interest rate is lower than 5 percent. Otherwise, she can make the same amount of money with less risk by leaving it in the bank.

  To put it another way, say the same entrepreneur has a choice between two different forestry investments: planting a pine or an oak. With the same interest rate, the short-term thinking process becomes clear when one compares the two. To keep the numbers simple, it is assumed that all numbers are inflation adjusted and that the risk of specific investment projects is independent of the time frame. A pine tree can be felled in 10 years and would then bring a yield of $100. An oak, on the other hand, cannot be harvested until it is 100 years old, and it would then be valued at $1,000 per tree. With these assumptions, and if one doesn’t have to take interest into account, the two investments could be seen as equivalent, as one could harvest and replant the pines every 10 years, ending up with the same $1,000 in 100 years.

  Now, the investor asks: “What are these two investments worth as seen from today?” We saw that with an interest rate of 5 percent, the investment in a pine that will produce a yield of $100 in 10 years is equivalent to $61 today. Similarly calculated, with the same interest rate of 5 percent, the value today of the $1,000 oak tree in 100 years is only $7.60! This difference in value of $61 versus $7.60 is due only to the interest feature of the money used. This demonstrates that, while there is a lot of commercial interest in harvesting old-growth forest, there is none in planting trees that will take a long time to mature and be harvested.

  More generally, this difference also describes why, in a society using an interest-bearing currency, financial investments are focusing mainly on the short term.

  EROSION OF SOCIAL CAPITAL

  Social capital is a buzz term related to an individual’s goodwill, camaraderie, and favorable social status within his or her community. Perhaps one measure of someone’s social capital is the number of people who turn up for someone’s funeral and the caliber of their eulogies. This attribute is not trivial. It is the glue that transforms a collection of individuals into a human—or perhaps better still—a humane society.

  Essentially, social capital is a proven precondition for rendering a democracy functional6 and for securing economic prosperity.7 These are possible only when a society has a sufficient sense of responsibility, mutual trust, solidarity, and cooperation. Responsibility and trust are essential for business and the market system to operate effectively. Increasing crime rates,8 poverty, and the exclusion9 of ever-growing numbers of a given population10 are the first indications of the erosion of societal adhesion. Studies show that, at present, social capital is not only undergoing a change in nature but also dwindling quickly.

  An entire field of economics is based on the assumption that something in human nature (and not the kind of money used) predetermines certain behavior patterns. Money is deemed value neutral; therefore, it is thought to have no effect on one’s conduct. What happened with the !Kung tribe over half a century ago, however, clearly illustrates just the opposite: It is the type of money used in a transaction that encourages competition or collaboration, stinginess or generosity.

  The !Kung are considered one of the very last societies on Earth whose ways of living have remained fundamentally unchanged since prehistoric times. They live in the high plateau of the Kalahari Desert, an area that occupies most of the country of Botswana and parts of Namibia and South Africa. This Iron Age clan remained largely isolated for over 40,000 years. Whatever outside contact they had did not alter the !Kung way of life. This was proven in archaeological digs,11 which found a range of stone and bone tools and a specific camp layout, excavated from three ancient !Kung sites.

  In the 1960s and 1970s, anthropologist John Yellen studied the !Kung lifestyle. This time period happened to be just before and after these people became acquainted with conventional money, which brought about unprecedented change in the !Kung culture in a remarkably short period of time.12

  Traditionally, the !Kung adhered to a rich set of social values and rules, which regulated the distribution of food and other goods. The practice of shar
ing formed the core of the !Kung system of values.

  Families were expected to welcome relatives who showed up at their camps. Moreover, etiquette dictated that meat from large kills be shared outside the immediate family. By distributing his bounty, a hunter ensured that the recipients of his largess would be obliged to return the favor sometime in the future. In the traditional !Kung view of the world, security was obtained by giving rather than hoarding, that is, by accumulating obligations that could be called upon in times of need.

  The layout of a traditional !Kung camp reflected their norms of sharing and reciprocity. Huts were arranged in a circle, with the doorways facing inward, allowing members to directly look into each other’s huts. The hearths were placed outside the huts, and each person could see what food everyone else was preparing and, therefore, whether there was any food to share. Individuals also established formal relationships with nonrelatives in which two people gave each other gifts, such as knives or iron spears, at irregular intervals. Reciprocity was delayed, so that one person would always be in debt to the other.

  During the 1970s, the Botswana government started to stimulate trade with the !Kung people. This development, as well as more contact with South Africa, introduced conventional money into the !Kung tribe. With this newfound cash, the !Kung people purchased such goods as glass beads, clothing, and extra blankets, which they hoarded in metal trunks, locked for the first time, inside their huts.

  Many times, the items procured far exceeded the needs of an individual family and could best be viewed as a form of savings. As the !Kung hoarded, they stopped depending on others to give them gifts and retreated from their traditional interdependence. At the same time, perhaps because they were ashamed of not sharing, they sought privacy. The layout of the camps suddenly changed significantly, after having remained unchanged for 40,000 years! Hut openings no longer faced inward, distances between the huts increased, and hearths were moved inside. Privacy played a much greater role than before, and reciprocal exchanges lost their importance.

  This example confirms that conventional money doesn’t simply facilitate exchanges, as generally assumed, but rather actually creates very specific social behaviors. The !Kung, who had a culture of unusual generosity and consideration for the well-being of the group, a culture that had survived practically unchanged for millennia, was altered dramatically in less than one generation with the introduction of money. The tribe’s emotional signature devolved into selfishness and parsimony, characteristics far more prevalent in the modern developed world than in their own traditions.

  A national survey of Americans found that some 93 percent said that people are too focused on working and making money, and 87 percent responded that we’re living in a materialistic world that makes it difficult to teach children ethics and morals. At the same time, several other studies have shown that the key to building communities and social capital is gift exchanges, such as helping a neighbor or mentoring a student.13 These findings further attest to the unfortunate reality that, as monetized market mechanisms are introduced into ever-greater areas of society, social capital begins to erode.

  International financier George Soros concluded, “International trade and global financial markets are very good at generating wealth, but they cannot take care of other social needs, such as the preservation of peace, alleviation of poverty, protection of the environment, labor conditions, or human rights—what are generally called ‘public goods.’ “14

  UNRELENTING CONCENTRATION OF WEALTH

  It is generally not understood that an interest-based monetary system is also one of the key underlying mechanisms for concentrating wealth in increasingly fewer hands, fueling the growing disparity between rich and poor. This concentration process has been accelerating in most countries, regardless of whether the nation is categorized as developed or developing.

  A recent German study on the transfer of wealth via interest from one economic group to another was conducted by Helmut Creutz, a monetary analyst and author. In his 2007 survey of German families, he grouped the entire sample into 10 income categories of approximately 3.5 million households each.

  Because of the upward concentration of wealth caused by interest, there was a transfer of wealth from the bottom 80 percent of the population to the top 20 percent, especially the top 10 percent, due exclusively to the interest feature of the monetary system used. This transfer of wealth occurred independently of the cleverness or industriousness of the participants, attributes often assumed to account for differences in income.

  The first eight groups of households are in the negative, which means that they have paid out more in interest than they received. In the ninth group, interest gained and paid roughly cancel each other out. However, in the tenth group, the total gains add up to the total losses of the first eight groups.

  The highest transfers of interest were from the middle classes to the top 10 percent of the households. Even the lowest-income households transferred a substantial amount of interest in that year to the wealthiest group.

  Nobel Prize–winning economist Joseph E. Stiglitz writes: “Economists long ago tried to justify the vast inequalities that seemed so troubling in the mid-19th century—inequalities that are but a pale shadow of what we are seeing in America today. The justification they came up with was called ‘marginal-productivity theory.’ In a nutshell, this theory associated higher incomes with higher productivity and a greater contribution to society. It is a theory that has always been cherished by the rich. Evidence for its validity, however, remains thin. The corporate executives who helped bring on the recession of the past three years—whose contribution to our society, and to their own companies, has been massively negative—went on to receive large bonuses. In some cases, companies were so embarrassed about calling such rewards ‘performance bonuses’ that they felt compelled to change the name to ‘retention bonuses’ (even if the only thing being retained was bad performance). Those who have contributed great positive innovations to our society, from the pioneers of genetic understanding to the pioneers of the Information Age, have received a pittance compared with those responsible for the financial innovations that brought our global economy to the brink of ruin.”15

  Creutz, reflecting on the current euro crisis, remarks, “Thanks to the blindness of our economical experts there is also the danger that after a collapse, which could be worse than that of 1929, the same systemic errors will be put in place again.”16

  Although no equivalently extensive study isolating the effects of interest payments on the concentration of wealth is available for the United States, data indicate an even more dramatic economic disparity, especially in recent decades.

  A comparison of real after-tax household incomes between 1979 and 2007 revealed that the income of the richest 1 percent in the United States soared 275 percent, but the bottom 20 percent grew by just 18 percent. The income of the richest 1 percent nearly tripled, while increases were smaller down the economic ladder. After the 1 percent, income for the next highest 20 percent grew by 65 percent, much faster than it did for the remaining 80 percent of the population but still lagging well behind the top group. This study illustrates how the better-off have captured the bulk of income gains over the past three decades. The top fifth has seen its share of income increase, while the other four quintiles have suffered declines in their shares.17

  The renowned historian Arnold Toynbee18 concluded that the collapse of 21 different civilizations is explainable using only two reasons: excessive concentration of wealth in the hands of the few and the inability of the elite to introduce significant changes in the face of shifting sociopolitical or socioeconomic circumstances.

  Excessive concentration of wealth isn’t just an economic issue. Zbigniew Brzezinski, President Carter’s national security advisor, sees it also as a geopolitical one: “Not to focus on [this issue] is to ignore a central reality of our times: the massive worldwide political awakening of mankind and its intensifying.”19 Awarene
ss about money and its uses may be the change agent that shifts our society away from collapse and toward renewal.

  THE PROCYCLICAL MONEY CREATION PROCESS

  The economy grows or contracts in a series of repetitive expansions (booms) and contractions (busts). Referred to as the business cycle, this pattern comprises an interlude of escalation of above-average economic growth, reaching a peak, followed by a contraction to below-average economic growth, potentially all the way to a depression at the low point. Then a new business cycle begins with a new swell of growth, and the pattern repeats itself. While business cycles are recurrent, each is unique in longevity, depth of dip, and height of peak.

  The way money is created, by bank debt, tends to amplify both the ups and the downs of the business cycle. Banks tend to have a herd instinct when making credit available or restricting it for particular countries or industries. When business is good, banks tend to be generous in terms of credit availability, thereby amplifying a good period into a potentially inflationary boom period. But as soon as the business horizon darkens even just a bit, banks reduce credit availability, which, if not counteracted, can easily lead to a full-blown recession.

  Central banks attempt to offset these fluctuations by giving countercyclical interest rate signals, meaning that in a downturning economy, interest rates are cut. The counteractions, however, usually are not very effective. Furthermore, the capacity of central banks to intervene in monetary markets has been significantly reduced in deregulated financial markets. Consequently, despite their efforts, the collective actions of the banking system tend to exacerbate the business cycle in both boom and bust directions.