- Published on Sunday, 20 April 2014 11:58
Critical Thinking's economic analysis revealed three fundamental flaws in the global economic system. Two days ago Daily Pickings focused on land value. Today's issue is interest on money and its perverse consequences, particularly in the context of sustainability.
Interest on money allows those who have more money than they need to exploit those who need it; consequently interest is a major driver of inequality. It is also the basis of fractional reserve banking, the mechanism by which banks create money from nothing. In the long term, interest is the primary driver of inflation because exponential debt growth leads to the money supply outstripping the supply of goods and services, driving up prices. (See Interest, Inequality and Sustainability) What is less well understood is how interest on money discounts the future.
A famous critique of ‘pure time preference’ came from the Cambridge economist Frank Ramsey in 1928, who observed that discounting later enjoyments in comparison with earlier ones is ‘a practice which is ethically indefensible and arises merely from the weakness of the imagination’.
Interest on money and the paradox of discounting the future is a circular argument. Interest on money drives exponential debt (money) growth which in turn demands exponential economic growth that is the justification for applying a discount rate to future value.
Bernard Lietaer, who has written extensively on alternative currencies, illustrates in Money and Sustainability - The Missing Link (extract below) the effect of positive and negative (demurrage) interest rates on the perception of value. Using the discounted cash flow (DCF) model to calculate future returns shows the perversity of outcomes depending on interest rates. Negative interest rates (demurrage) put a premium, rather than a discount on the future.
DCF is applied to investment decisions and for valuing oil reserves, forestry and other resources. Exponential growth implies infinite growth - clearly nonsense in the context of a finite planet. If environmentalists are serious about sustainability, they need to campaign to abolish interest on money - it is the only effective, durable solution.
Discounting the Future: Economics and Ethics by Timothty J. Brennan