WORDS AND PICTURES

Professor Adrian Kuzminski discusses the money theory of Edward Kellog, the subject of his book The Ecology of Money.

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ORIGINALLY PUBLISHED 23 April 2014

RF: The subject of your book is the structure of money; money as a utility. I think your headline is that the money supply today is controlled privately by national monopolies and that they are mired in moral hazard; they can’t keep their hands out of the cookie jar and the device they use to syphon off cash is compound interest.

ADRIAN: That’s the headline. I think that’s exactly right and I think what’s interesting is that although it’s easy to say that, this is a story that’s really not been told, especially the historical depth and dimension of it has not been told and even the most highly educated people don’t get this, don’t understand it. They don’t realise that our financial system is privately controlled. There is a sense in the popular media of how corrupt it is, for sure. But the conclusion is; “Well, we can fix this; we can reform it.” I’m sceptical about the prospects of reform.

RF: Your story starts with the particular structure of the Bank of England. Private institutions issue debt backed by government taxes. You say this has been the driver of growth for 300 years including essentially underwriting the Industrial Revolution.

ADRIAN: That’s right. There was a financial revolution that occurred in Holland and which was completed in England. Before that, we lived under subsistence economies. People had no choice but to live ‘renewably’ as we would say today. They had to use animal power, they had to use muscle power their wind power, water power; that was it.

So the prospects for growth were very limited and technological innovations that occurred were small, they were incremental, they didn’t lead to a big explosion. This was a steady state world which had existed for thousands of years. The world in 1800 was not very much different from the world in say 2000BC; you’re still relying on a kind of subsistence, and renewable resources. So; what happened? If I ask you; “What do you think caused the Industrial Revolution?” What would you say?

RF: Well I always thought it was the Black Death, altering the balance of power between landowners and artisans and creating the beginnings of a middle class. That’s what I was taught at school anyway!

ADRIAN: Not bad! That’s certainly part of the story. The Black Death allowed peasants to charge more for their labour, in fact allowed them to turn themselves into wage labourers. They could go into the cities and they could get jobs. That shook things up and eroded the feudal structure. But that was not the actual trigger for the economic explosion that occurred.

Most people say technology; the steam engine, that’s the image in a lot of people’s minds.

But if you’re running a business in a pre-industrial economy, in a subsistence economy, the exchanges you’re engaging in are by and large, equivalent exchanges.

If I make a deal with you; if I go to the market I have some gold coins in my pocket I buy something from you, you’re getting an equivalent value and everybody goes home, the transaction is closed. But when we start dealing in debt, there is not an equivalent exchange. I’m giving you a promise, you’re giving me the product and hopefully that promise will be cashed in; so far so good.

Insofar as an economy depends on these kind of equivalent exchanges even with credit of this sort, there aren’t many reasons to grow; next year is not going to be that different from last year. Your prospects aren’t going to be that different. But, if you borrow money to run your business; to run your estate; this goes for agriculture as well. If you are borrowing money, at usurious rates of interest; if you have to pay back more than you borrowed you have a built-in incentive to grow. So therefore you have got to make more money than you made last year. The economy of Eighteenth-century Britain was increasingly driven by usurious debt.

RF: People have always had an awareness that debt and usury is morally hazardous because of the implications for the individual succumbing to debt. But what you’re highlighting is that it also bakes into society what is described as The Red Queen Syndrome; having to run faster and faster to stay in the same place; at a macro-level.

ADRIAN: Well you had to run faster and faster not just to stay in the same place, you had to run faster to get to a new place and then to another new place and to another new place. That was fine as long as we had abundant global resources. As long as we had energy, agricultural lands, fisheries, forests, minerals that to extract. The system could run; it ran beautifully and made us all rich. It gave us; you know; think about what it would be like to live 250 years ago. No antibiotics, no electricity. Life was nasty, brutish and short as somebody said.

RF: Dentistry is the only word you need to say to me. I want to come on to the energy issue but first, to go back to the Bank of England and exactly what they did that was structurally different to what had happened before. I think one of the key changes was the establishment of a secondary market for debt; and the potential that created for debt never to be extinguished; for debt to be continually rolled over.

ADRIAN: That’s right. The beauty of a national debt is that it’s rolled over constantly and the secondary market is vital; but it created a flaw. The Consols; the famous bonds of the Bank of England; were issued for a long time, and created a market for debt that didn’t exist before. So everybody could peg other kinds of loans to a public interest rate and the secondary market stabilised the whole system.

Before that if you wanted to borrow money, you had to go find some private bank somewhere, you have to go to the local Lord or the local money lender, whoever it was, and maybe they would lend to you, maybe they wouldn’t lend to you. It was a one-to-one situation; it was not institutionalised. It was kind chaotic and archaic and not at the centre of the economy but at the periphery of the economy. That’s a huge difference.

RF: Now, you say, that we can no longer kick the can down the road. We are reaching the limits of our natural resources. Can you explain exactly what that means because the planet is not shrinking. Every rock you pick up is 100% mineral, so…

ADRIAN: Well it’s an energy in, energy out situation. 100 years ago, when Spindletop in Texas came in; you know the gusher that started the oil boom in the US; you had to invest one barrel of oil to get maybe a hundred barrels of oil out. So you were getting a 99% return on that investment. As oil became more and more difficult to extract; as you needed to go deeper or offshore; now you need to go into things like shale; now it’s down to maybe ten to one and this has is a declining ratio. It’s getting more and more expensive.

I’m using oil as one example but this applies to many other resources as well. So it’s getting more and more expensive to get the same amount of energy out. And if you look at the fisheries of the world, the forests and so forth, I think you are coming up against the same problem. I’m making a Malthusian argument; that population growth has accompanied all of this; there are many more mouths to feed. Yes, there are minerals in any rock you pick up but what good are they? I mean how can you translate that rock in your hand into some kind of consumer item that is affordable, that’s the problem.

RF: There are analysts who suggest fracking is an energy net loss; that the energy expenditure involved in extracting shale oil when you include all of the capital expenditure of new roads and so on is actually less than the energy output. So it has reached the point of being a fraudulent business model; that exists purely to originate debt. This suggests debt is the product; which is essentially what you’re saying; we are willing to burn two units getting one back if it means we can synthesise more debt.

ADRIAN: That’s right, I think that’s Deborah Rogers making a very good case about fracking being exactly that. So it’s a Wall Street scheme, like collateralised debt obligations. You are using borrowed money to make more money but you’re not efficient enough to contribute to real wealth. There are enough little hot spots, where drillers can point and say, “Look at this gusher here, look at this great well.” But those are small compared to the big fields of supposed reserves which are not economical if these analysts are right.

RF: We have enjoyed 300 years of growth as you say the population expanded with that growth. It has been a policy objective to dramatically expand populations because that was what the Industrial Revolution required; it required manual labour. It is not that earlier societies didn’t have the ambitions to expand, but they didn’t have the rocket fuel of debt; and indeed rocket fuel. So a future society that is capable of driving short term growth and can capture the short term benefits; is there any way it can be expected to stay its hand? How do policy makers make those sacrifices when the technology does exist?

ADRIAN: Well that’s a $64,000 question; how realistic is it? But the bright side is that we do have incredible technologies and presumably we can apply that to renewable resources so that we can do things with renewable resources that we had no clue about 250 or 1,000 years ago. We can probably be a hell of a lot more efficient with renewable resources.

There’s a big drive now in Germany and in the United States as well, to, to transition from fossil fuels to renewables and I’m actually surprised at how successful the Germans in particular have been with this. I would have thought a few years ago that this was going to be a tougher road to adoptionbut they are doing remarkably well. So I think if the technology is applied to the right subjects, maybe it cushion this blow. But otherwise it’s going to be hard, because the population is too big, the resources are too limited. We’re drawing down our bank account; our natural bank account so to speak.

RF: Let’s return to the subject of money. Money is credit, credit is trust, trust is predictability; why are we letting intermediaries like governments and financial institutions muscle in on what should be a simple handshake between two people?

ADRIAN: Well, it’s got to be more than a simple handshake doesn’t it? You have to have a reliable system where your transactions will clear to the point where you can depend on them. In a society where the moral culture is strong enough maybe in a kinship society you can do exactly that, you can do it on a handshake. But in a society of anonymous individuals in a mass society I don’t think you can.

RF: So there has to be some kind of central authority verifying transactions. But we talked about fracking as an example of how the central issuance of debt results in the misallocation of resources; the use of credit to mask failed business models. So, credit distorts our perceptions. Debt is like a drug in that we become hooked on it. But it’s also like a drug because it is hallucinatory; it brings another dimension of possible futures into our life and we start seeing things that aren’t there.

The alternative system that you are proposing, that Edward Kellogg proposed, is still based on credit that is centrally administrated; so how does it escape that wishing well mind-set among hopeful buyers of credit; and the potential for them to be abused by issuers of credit?

ADRIAN: Kellogg’s credit is non-usurious; if you go to the bank today and you get a mortgage, or you get a student loan as you have to in the United States, you look at the payback on a loan and you see there’s a tremendous cost. A $100,000 mortgage over a typical term; you’re going to pay twice as much money back. With Kellogg’s system that is eliminated. The burden of having to produce goods and services; to labour for the creditor; is eliminated in his system. That freedom goes back to the borrower.

RF: Kellogg’s model is based on a fixed 1% interest rate irrespective of who the counterparty is; is that right?

ADRIAN: Yes it is a 1% interest rate and it is a curious thing; in the book I talk about the rule of 72, which is an accounting principle, which is essentially a way of calculating how long it takes for the debt on the principle to equal the principle. And at 1% it takes 72 years; which is roughly a human lifetime. So if you borrow X amount of money you have a lifetime to meet interest obligations. Whereas interest rates that are higher than that; if it’s 2% it’s 35 years, if it’s 3% it’s twenty some years and it goes down so that very high interest rates; we’ve had 20% interest rates in 1980 or so; the debt burden becomes astronomical and unbearable so it becomes debt servitude. Kellogg’s 1% dovetails nicely with a human scale; an economy really should be aligned with our lives rather than the abstraction of compound interest.

RF: A 5% mortgage holder is going to pay double the amount she borrowed. This highlights an abuse of risk management when the institution lending money is protected. That interest rate of for arguments sake 5% is justified by banks on a couple of criteria.

One is the opportunity costs i.e. they could be lending the money elsewhere but that’s based on what you highlight in your book and has been highlighted elsewhere, the false assumption that lending comes from savings and that there is a limited amount of money that can be lent. But the way that money is loaned into creation in our system there’s no real opportunity cost there. But I think that is the same in Kellogg’s model? Money is loaned into existence on demand; but there is a regulatory limit on the lender preventing them from lending at more than 1% and the 1% return that the lender accrues exists in the public domain; it is not paid out as a dividend to shareholders either.

ADRIAN: Yes; we are talking about public banking. There is a movement for public banking in this country and I think maybe in Britain as well and other places, but the public banking people would like to see the private banking system made public and therefore in some way made accountable and be run for public benefit. But that is I think a dubious proposition if you don’t have an accountable government.

The government could still charge usurious rates, in fact a proposal has been made that you substitute the interest rate for taxation as a selling point. But you still have the burden of usury if you do it that way. So what Kellogg is saying is that 1% is a fundamental principle; something that could be written into the Constitution; that it has to be 1%.

The other thing is that his proposal is decentralised. There is no central bank; there is no authority at the top issuing money through the big banks, the ‘too big to fail’ banks that pump out the money for the economy as a whole via the trickledown theory; eventually it gets down to your local bank and you try go get a mortgage.

So Kellogg is saying forget about all that; no central bank, you don’t need central banking. You just have no local banks, in your community and the whole point is if you have good collateral; if you have a plausible promise of paying back the loan; it could be your own labour power, it could be your youth, your education or it could be hard collateral like property. Then the bank would have to lend you money.

RF: This brings me to the other criteria banks use to justify higher rates; an assessment of counterparty risk. If every counterparty gets a 1% interest rate, it undermines the principle that some counterparties are safer bets than others. Today, when banks can borrow at close to 0% they can just rush out and gamble in the derivatives market. Wouldn’t we all do the same thing if there is no sliding scale attached to the risk of individual borrowers then you’re just going to have a massive pile of bad debt aren’t you?

ADRIAN: Well no, I think the risk mitigation is attached to the collateral you bring to the table. If I go to my local bank and I have a job or the prospect of a job and I borrow some money, the standards should be the same as they are now. You have got to be able to demonstrate you can pay back the loan, so I don’t see that there’s any difference there. There will be a failure rate, some people will not be able to pay back their debts just the way they do now, but it will be much easier for them to do so in this system.

If you have good collateral, or if you’re a good prospect for a loan that’s what determines whether a loan is agreed or not. Kellogg thought that the central administration; he placed it in the bureau of weights and measures. In other words it’s not a financial institution it’s a regular charging institution in the narrowest sense of the term. It’s job is to oversee all of these local public, community banks and make sure that they’re all operating on the same playing field.

In his vision as I understand it, they are community banks. They are run by elected people; we elect trustees of the local community bank, so they’re not privately owned; that’s very important, they are public banks and they are publicly accountable. Whereas today the higher up the chain you go, the less accountability; there is no accountability with Wall Street or the big commercial banks. But your local bank, like your credit union, can be accountable.

RF: I want to touch on the 1% again because you describe it as being the mechanism that results in the individual borrower replacing the resources they consume; the credit borrowed is extinguished over the lifetime of the borrower by a new tranche of credit amassed from the interest payment it raises. It is an elegant model but it raises a question about what you could argue is a major driver of demand for fixed income products today which is retired people who are no longer working.

ADRIAN: Yes, living off of investment income is the principle model of retirement and that’s basically living off of interest and this would have to change; I mean current obligations would need to be honoured but no new ones could be instituted.

Instead as a younger person borrowing money under his system you can put more money aside as you are not in debt servitude so society would approach retirement in a more traditional way.

RF: One last thought about the context of this model in our contemporary society or in a future society. Have you got any thoughts about how it works internationally? How this currency would float against international currencies or what the consequence of international derivatives trading and that kind of thing might be? That is obviously another big driver of distortions in a currency that has an impact on individuals and is out of community policy-making hands.

ADRIAN: Well, that’s a challenge I think. Something like this might start most effectively in a small country, Iceland for example. As you know they resisted the IMF and various pressures to make them take on austerity and pay off those debts. A country like that might try something like this to stabilise their domestic economy. But once they did I think the question of what the unit of currency would be and how would it function in the exchange markets; I don’t have an answer to that, but if it was a stable unit of currency it should have value, it might have a very high value internationally.