21 Apr 2013

How can we owe twice as much as there is money in the system?

My last blog provided clear numbers that demonstrate that the total amount of public sector and private sector debt is twice the amount of money in the system. In other words, it is physically impossible to pay off the debt in the system. It doesn't matter how much austerity you impose. You could abolish all public sector jobs, abolish pensions, end state education, end state health systems, completely eliminate any remains of a welfare state, and there still wouldn't be enough money to pay off all that debt.

How on earth did we get here?

How is it possible to owe more money than there is in the system?

Well, let's think about it a bit.

Let's imagine that there was a day when the money supply was created in one day. Someone waves a wand, and the banks have the $68.3 trillion that is currently in the system. They then start lending the money into the economy. They lend the money to individuals to buy houses and that money gets used to pay the builders to build houses. They lend the money to businesses who invest in new plant and distribution networks. They lend the money to governments who use the money to build schools, hospitals, transport systems etc etc. All the money that goes to individuals, businesses and governments gets into the economy. All is happiness and light.

On day one, the  size of the money supply (lets call it M3 for the sake of argument) is exactly equal to the amount of debt that individuals, businesses and governemnts have taken on. No problem with that. After all, when some people have money that they are not actually using, it is normal that they lend that money to those that need it. And the banks are just trying to do their job of making sure that the money goes to the places where it is needed, right?

Yes, but there is a slight problem. The banks that lend the money into the system feel that they should be able to charge interest for making the loans.  Thus, while there is $68.3 trillion in the system on day one, after one year, the amount of debt is no longer equal to $68.3 trillion. It is equal to $68.3 trillion plus the interest. Let's assume that the banks are charging 5% interest per year - very reasonable compared with the rates charged by credit card companies, or payday loan outfits. After one year, the amount of debt has now increased to $71.7 trillion.

With compound interest at 5% per annum, it is not difficult to see that after a 14 years and 11 weeks,  the total amount of debt in the system will have more than doubled.

So, hopefully you can now see how it is possible that with €68.3 trillion of money creation, you only need to wait a bit, and the amount debt will be double that amount. And it's not going to stop. Assuming 5% interest, we can safely conclude that in another 14 years or so, the amount of debt will have doubled again.

Of course, the banks won't let that happen - if that continued, there soon would be four times as much debt as money in the system. Then 8 times, then 16 times.

Fortunately, the banks are there to help. They will be happy to create yet more money (read debt) to keep the system going. I think we can confidently predict that by 2027, the money supply will have doubled to $136 trillion. But the amount of debt will have reached twice that - namely, $272 trillion.

I'm pretty confident about that because when I looked at how the ratio of debt to money supply in the Eurozone has changed over the last decade or so, I was intrigued to see that the 2.5:1 ratio has stayed constant.  Here are the actual figures.

Remarkable, eh? For some reason, the commercial banking system manages to create enough new debt each year to keep the system at the same ratio of debt to money, despite the effects of compound interest. I guess that there must be some very bright people running the show.

The net result of this is exactly what we currently have. A situation in which we collectively owe twice as much money to the banking system than there is money in the entire system.

So what needs to be done?

Actually, lots of things. But one would be to make money creation with debt associated a criminal offense. In a sense it is the worst form of usuary. Lending money with a high interest rate is bad enough. But lending money that you don't have and charging a high interest rate can not be described as anything other than a criminal racket - at least as bad as Madoff's famous Ponzi scheme.

And that's precisely what commercial banks are currently allowed to do.

But Bernie Madoff only ripped off his clients for $50 billion. The current banking system has allowed us to be ripped off to the tune of $68.3 trillion.

We need 100% reserve banking. And we need it now....


  1. One reason why debts can exceed the total amount of “debt based money” is that debts can arise completely independent of money or anything to do with money. E.g. in simple barter economies where there is no money, debts still arise.

    E.g. person A on desert island supplies person B with coconuts, but does not demand anything in return IMMEDIATELY. In that case, a debt arises.

    Re the popular idea that interest gives rise to perpetually rising indebtedness, that is not true and for the simple reason that money paid by way of interest payments gets recycled. That is, money paid to banks by way of interest is then spent on bank staff costs, plus it’s paid to those who have deposited money at the bank, and to bank shareholders, etc etc.

    Of course there are specific INDIVIDUALS, and indeed individual countries which can get themselves into an unsustainable debt situation, i.e. their income does not cover what they have to pay in interest. But that is the exception.

  2. Hi Ralph,

    So, are you saying that interest accumulation has nothing to do with it? It's all people that have generously provided large quantities of coconuts and are waiting to be paid?

    Do you agree that banks can create money? Do you agree that if they make a loan and the loan doesn't get paid off, then the borrower owes not just the loan, but also the interest on the loan? How do you get rid of the extra debt caused by the interest?

    Finally, if you agree with my numbers, the fact is that the situations where individuals, businesses and governments are in an unsustainable debt situation is almost universal. You haven't convinced me at all that there is not a major problem here. As I say, there is simply not enough money in the system to pay off the debt.

  3. I don't know the answer, but if you haven't already, it would be interesting if you were to watch one of Steve Keen's lectures on Youtube where he shows his model or models working, and I've heard him say more than once that he disagrees with money-reformers who say there isn't enough money in the system to pay the interest as well as the principal. Which is not to say that he doesn't think debt is a big problem - quite the opposite. But, I think he is saying, under certain circumstances anyway, the system can be sustainable. But when it gets out of control it will inevitably lead to a crash.

  4. Do you really think the 2.5 (approx) ratio figure is really engineered by smart people in the finance sector, or could it be an inevitable consequence of the maths?

    (That's a genuine question, by the way).

  5. it is engineered by smart people for the simple reason that it has been going on for centuries and the results have been pretty much the same. So if these group of people that know history well decide that they want certain private assets, they can conspire. Also Nicholas Biddle threatened Andrew Jackson with a recession, and then it happened.

  6. The real problem. So far we have just looked at numbers. But have you seen the effects of those numbers? I believe the banks are gaining control of most homes in America by way of mortgages. There are 150 million homes in America. Of the 150 million homes, the banks hold mortgages on 105 million homes. There are 19 million homes vacant, yet there are 8 million people homeless. Banks are also demolishing homes they cannot sell. This is a huge problem. Imagine that banks continue with their control of the government. Imagine that in the future if you want to own a home and borrow money from the banks you are going to have to give up certain rights.

  7. it does not matter if the money gets recycled because it, nevertheless, comes from the same pool of money. The money in the pool just gets shifted, but there is still only the principal and not the interest. The way that the interest comes about is by the creation of new money by way of credit. This markedly different than a company who earns a profit. Merely earning profit does not require additional money but merely shifting the same resources.