On the face of it, something along these lines could be the cause of the fact that today, the levels of combined public and private sector debt exceed the total money supply by a factor of 2 to 1. This ratio is even higher in the Eurozone (2.5:1) and higher still in the US economy (3.55:1).
Since discovering this enormous hole in the economy, I've been asking lots of people what they think. Some people have told me that the problem is that measures such as M3 don't include everything. For example, apparently when banks make loans over much longer periods than a few years, this doesn't get included in the standard money supply measures. Thus if a bank was to make a loan that only had to be paid back after 30 years, this would not show up. So, perhaps the missing money is in the form of these really long term loans.
If that really is the explanation, then it is a major problem. It means that banks can make loans that don't appear anywhere, and that we can never know how much lending goes on. Surely, at the very least we need another measure (let's call it M5) that includes even these very long term loans?
So, what about Jacques Jaikaran's Debt Virus hypothesis? Could that be the explanation? It's worth noting that Jaikaran himself is not an economist. He is in fact a plastic surgeon, and a number of economists tried to argue that he simply did know what he was talking about. Indeed, there have been a number of attempts to debunk his propositions.
In an attempt to see whether the debt accumulation idea could be behind the huge gap between debt levels and the amount of money in the system, I've been looking at some of those attempts to prove that he was mistaken. And, for the moment, I'm not at all convinced.
For example, Ardeshir Mehta has a site called 'Debunking the "Debt-Virus Hypothesis"' in which he shows how you could repay a $14 trillion loan (equivalent to the total cost of housing in the USA) by progressively paying back a sum that includes both the interest payments and a part of the principle loan. At the end of 30 years, and with an annual interest rate of 5.3%, he shows that the debt will in fact have been paid off. He notes that banks will have received the original $14 trillion, plus an additional $14.3 trillion in interest payments.
OK. Yes. That does work. But it also means that $14.3 trillion has been handed to the bankers in "fees", money that Mehta assumes the bankers will have spent back into the economy. Of course they may have done that, and in that case they will no doubt have had a wonderful 30 years having the rest of the population working largely to keep them supplied with Rolls Royces, Yachts and Private Jets. I'm not sure that the $14.3 trillion that the bankers got in "fees" for all their hard work could be considered a reasonable return, given that the banks didn't even have the money that they created for the original loans. But that's another question.
However, Mehta's debunking method makes a couple of other questionable assumptions. What guarantee is there that the bankers will actually spend their money back into the economy. They could, if they wish, move their gains to some off shore tax haven. In that case, the money that the population need to pay off the interest payments will not be there. Given that there are indeed estimates that there is something like $21 trillion stashed away in tax havens, I would say that the evidence that the bankers have been returning all their gains back into the economy is questionable to say the least.
The other assumption is that the population is indeed paying off the debt. It's true that when you take out a mortgage and you pay off the loan over a fixed period, the amounts you pay will typically be calculated so that the entire loan plus the interest gets paid off at the end of the loan period. Unfortunately, that's not what most governments are currently doing. Instead, governments go to the markets, borrow €10 billion over a fixed term of say 10 years, and then do nothing during that period. At the end of the 10 years, the governments then go to the markets and try a borrow the €10 billion again, but this time they need to borrow even more to cover the interest charges. With an interest charge of 7.2% per annum, they will need to find €20 billion.
Thus the so-called "Debunking" only applies to the case where there is (a) a preset plan to repay the entire debt over a fixed period, and (b) the banks reinject their interest fees back into the economy. Any situation where the loan is left untouched for a long period is guaranteed to end up with a massive difference between the amount of money in the system and the amount of debt.
Another attempt to "Debunk" the Debt-Virus Hypothesis argues that when you have a given amount of debt, you don't need that amount of money to pay off the debt. For example, there is a website called "Why the Debt Virus Hypothesis is False" which says that "one dollar circulating in the economy can pay off a million dollars of interest if it passes through a million people’s hands and each one uses it to pay a dollar’s worth of interest on their loans". Another place you can find the same argument is in a Youtube video called "The compound interest paradox mistake".
The idea is that you could have 5 people, lets call them A, B, C, D and E. Suppose that A owes B $1, B owes C $1, C owes D $1 and D owes E $1. That means that total debt is $4. But then suppose that A pays off his debt to B with a $1 bill, and that B then passes the bill on to C, then to D, then to E. Thus, a single $1 bill can indeed be used to cancel $4 of debt (and even $1 million, if needed).
OK. Yes. But suppose that A, B, C and D all owe $1 to just one person, namely E. In that case you really do need $4 to get everyone out of debt. Let's call E the bank. It's clear that when everyone owes money to the bank, this attempt to get out of the problem will not work. And since, under the current system, money creation is almost all done by commercial banks, in the end you really do need that money.
And as I have been arguing, it really does look like there is simply not enough money in the system to pay off the accumulated debt. And yes, I think that Jacques Jaikaran hit the nail on the head back in 1992. Debt and Compound Interest is indeed like a virus that you can never get out of the system.
The solution, in case you didn't know, is (a) to take money creation out of the hands of the commercial banking system, (b) make all money creation debt free, and (c) create enough debt free money to allow the system to get out of debt.