The Ponzi scheme of creating money

The first time I used “Ponzi scheme” to describe the fractional reserve process of creating money I feared I was skating on thin ice. It’s a rather strong term with which to describe a process which most of the people who don’t understand how it works (and those who do) consider to be motherhood.  However, it has in the past (the depression of the 1930s)and almost certainly will in the future cause a great deal of human suffering.

Therefore it was with some relief that I discovered that Richard Heinberg says the same thing in his book The End of Growth: Adapting to Our New Economic Reality (P. 33)

I like his way of explaining the problem.  because all of our money is created by the making of loans, if all the outstanding debt were to be paid off at one time there would not be enough money to repay it all because of the interest.  The charging of interest on the debt/money means there is never enough money available to repay all outstanding debt.

The system works only so long as there is continued economic growth and a continuously increasing supply of money which means more and more debt.  The problems come when economic growth slows or stops and some of that debt has to be reduced.  As there is not enough money to repay it the purchasing power of the debt is reduced  by  the failure of financial institutions or the drop in prices of assets such as housing.  (The purchasing power of money can also be lost to inflation.)

Heinberg sees a need for a new way to create money and directs our attention to  local currencies such as a Local Exchange Trading System. (LETS).  That too made me feel good as my own proposal for money is to expand the LETS into a National Exchange Trading System.  For more on this and an explanation of fractional reserve banking see my essay “LETS go to market: Dealing with the Economic Crisis” on this web log.


One Response

  1. Don’t follow this at all. There are strange thoeries going round.

    As every monetary economist knows the quantity of money at any pont of time is not “fixed” at its previous level. If the demand for money goes down the quantity of money can go down or “evaporate”.

    Also people, not banks, create the value of money, and also the quantity through disintemediation.

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