Forum Post: Natural Economic Theory (The Problem of Interest)

Compound interest is infinite in the long run. It is an important cause of economic cycles and the expansion of debt, but for some reason the elephant in the room has been ignored until now. The issue is not difficult to understand. Assume that a 1/10 oz gold coin was put in the bank on interest in the year 1 AD on 4% interest. How much gold would there be in the account by the year 2000? The answer is: 3.6 * 10^31 kilogramme of gold weighing 6,000,000 times the complete mass of the Earth. Compound interest must be paid from debts. This is unsustainable and produces economic crises from time to time.

The lure of having more money in the future is at the basis of the expansion of debt. The borrower promises to repay more units out of a limited pool of money, which will become increasingly difficult unless savers spend their money or new debts are made. Insofar those promises can be exchanged for money, which is the case with savings accounts and bonds, they are inflationary. From time to time interest payments cannot be met because there is a limited amount of real money in circulation. At that moment the scheme collapses and a bust cycle sets in. Insofar those promises could be exchanged for money, their destruction is deflationary.

During a boom phase interest rates rise. Promises are made that cannot be kept because the pool of money is limited. Borrowing against demand deposits or fractional reserve banking has made it possible to issue loans without the need for savings. In this way interest rates are suppressed when investments exceed savings during the boom phase. This fuels the boom as higher interest rates would have curbed the boom sooner. Because interest rates cannot go negative, they are propped up when savings exceed investments during the bust phase. This extends the bust phase because lower interest rates would have ended the bust sooner.

If banks can only lend against savings and nominal interest rates can be negative then an active management of money supply, interest rates and aggregate demand by governments and central banks is not needed. It is likely that in mature economies of stable societies with political freedom and respect for property rights, the natural rate of interest set by the market that matches savings and investments and guides the economy on the maximum sustainable growth path without booms and busts, is in nominal terms at or below the rate of money supply increase. This can still be a positive real rate when there is economic growth.

It goes on here, including a disussion of all major economic views and their hiding of the problem of interest in their 'solutions'.

http://www.naturalmoney.org/naturaleconomy.html