The Financial system is an extraordinary machine humans invented to move value between people. Value itself is an invention that depends on what it is, what it is used for, and who is sending and receiving it. Money can move the difficult ever-changing concept of value easily and quickly and for little cost.
It can be “good” or “bad”, like all technologies. Today, it is bad because it is trashing our earth and making it unsuitable for humans. We know it isn’t good because the climate change we have caused through the use of money is heating the part of the earth on which we live. With extra heat comes extreme weather events and the destruction of other life on which we depend.
In this world, the financial system of moving value has become our means of individual survival. Unfortunately, it also leads to wars and mass migration as people seek places of safety and the resources to maintain life.
A Sharing and Caring Economy
The good news is that we can change the financial system so it stops leading us to extinction. We can change it because we created it. It is not a natural phenomenon constrained by the laws of physics.
We created it, and we can improve it. We do this by keeping the profit motive and following a complementary path that starts with creating money. Money provides a way for people to share resources. It doesn’t create resources. When banks create a new loan, they expect the borrower to repay it and provide extra to the bank to cover its costs, risks of non-repayment, and profit. The extra is created with interest. With regular loans, the bank keeps all the interest and expects the borrower to pay the interest with no extra effort on the part of the Bank.
It means that the cost to the borrower is uncertain because interest rates vary, and the value of money changes with inflation and its relative value of other currencies and money exchange.
Two easily made improvements to the system are:
- The Bank agrees to share the profit included in interest payments.
- The Bank lends existing depositors money, the borrower shares the profit they make with the depositor, and the Bank takes a fee for helping arrange the loan.
Both these approaches share profits and reduce the cost of loans by speeding up the transfer of value and reducing the amount of money at risk.
This contrasts with regular loans, where banks try to increase the amount of interest they collect and keep all the profit. Banks are regulated industries, and governments try to make banking fairer by taxing profits and redistributing it back to the population that pays it. Governments can also encourage banks to use 1 and 2 above.
The essential difference between “Capital that Cares and Shares” and the existing “Capital that earns the maximum profit then tries to make amends with taxes and redistribution of profits” is the misunderstanding that the cost represents the value of a product. Rather the value of an exchange of value is best represented by the least amount of money exchanging hands to satisfy both the buyer and the seller. That occurs when the profit is shared according to the effort the seller expends to produce the profit, and it is about equal to the effort the buyer required to obtain the money to pay for the profit.
To illustrate the principle, the current system of selling a house is to sell it to the person who will pay the most for the property. In a sharing and caring economy, the house is sold to the person with enough money and the greatest need for the house. In a sharing economy, a cheaper home in an expensive suburb will go to a lower-paid worker who lives in the area rather than a property speculator who will seek a capital gain. The value to the lower-paid worker is greater than the value of the property to a speculator.
Economic Models of the Economy.
The science of economics uses models of the economy to predict and control the movement of money under human-created rules. The following illustrates the difference between the traditional and sharing models by modelling three ways to transfer house ownership from one person to another.
In the traditional banking model, banks lend money to buyers and create new money with a license from the government. The borrower is charged interest, which covers the bank's costs, risks, and profits. Regarding existing home loans, banks take little risk as they always take a mortgage on the property. If the borrower cannot repay on time, the bank takes the property.
However, the interest cost over the loan's life often exceeds the amount borrowed. The borrower takes on most of the risk and must work hard to generate extra cash to pay off the loan and interest. In contrast, the bank takes relatively little risk and effort. Regrettably, the profit from bank loans is not shared with the borrowers who contribute the most to the profit.
The second model is one where the risk and effort expended are shared according to the risk of the borrower and the bank. Here it is called Fair Banking. The bank still gets the same profit but does not continue to get it after it has no risk or costs.
The third model is where existing money is used within a community where the risk is shared between the lender (which may be a bank acting as an agent to lend depositors money) and the borrower by both keeping their share of the property that they purchased. This removes the cost of creating new money entirely and hence requires less money to make the transfer. Less money means less cost, and less cost for the same goods means more profit.
A Netlogo Simulation of the Three Approaches
A Netlogo simulation is available on request to verify the results. You can see the simulation in action in this YouTube video. The following shows the simulation and shows the cost of loans. The cost is the amount of extra money, beyond the house’s value, needed to transfer it. The results show that regular loans cost at least double the cost of fair banking, which in turn, costs double using existing money.
Using existing money to transfer existing assets will result in lower housing costs and release immense amounts of capital for other investments. We can use that capital to address issues, such as replacing energy from fossil fuels with energy from renewable sources. The change can start quickly by replacing regular loans with fair loans while moving towards using existing money to transfer existing assets.
The Simulation
Simulations are models that closely reflect the real world and allow us to investigate the effect of chance present in all complex systems.
Figure 1 shows the simulation of the same 100 loan applications after one year, where the prospective buyer had a randomly generated income, deposit, and house value. The buyer asked three different organisations for a loan. The organisations offered
- A Regular Bank Loan
- A Fair Bank Loan with 80% of the interest paid each month deducted from the loan amount outstanding.
- A Community Loan uses existing money borrowed from other community members where there is no need to create new money.
Different shapes of triangles (1), squares (2), and pentagons (3) represent the different loan types. The colours represent the loan situation.
- Green is given a loan.
- Cyan is rejected for lack of income.
- Violet is rejected for lack of an adequate deposit.
- Pink is rejected for both income and inadequate deposit.
- Yellow is the loan repaid in full.
If the prospective buyer has an income greater than $10,000, they will always be offered a dwelling or a shared place in a Community. A deposit and an income sufficient to cover monthly repayments are needed for both regular and fair loans.
As the buyer makes a payment, they acquire equity in the property. The payments are monthly, and after one year, the average cost of $1 of equity of a 30-year loan was
- Regular 4.07
- Fair 1.16
- Community 0.4
The increased cost meant that, on average, buyers saved $29853 in the first year. This makes housing affordable.
As the payments continued, the cost of the regular loans dropped, the fair loans dropped a little, and the community loans increased a little.
However, about 50% of the houses could not be purchased with regular and fair loans. 100% of the houses could be purchased under the rules of community loans.
The Advantages of Simulations
Simulations allow for changes to various parameters. For example, what difference does a change in interest rate make? How important are deposits? What is the change in Bank profits if interest and sharing rates change? What happens if loans default? What happens if we change the bank rules on repayments?
The following shows what happens when every person has enough deposit and enough income to get a regular Bank loan.
A Simulation where all households have the income and deposit to purchase a home.
In this simulation, all the buyers are given enough income and deposit to qualify for Bank loans. The income and deposits were the same for community loans, as the buyers could all purchase the occupied house.
The simulation was triggered by the switch “All-People-Can-Buy”. The difference is that there was a 140% increase in the average income and a 93% increase in the deposit required to obtain loans. This result can inform public policy by showing the effort and cost required to address housing affordability through grants to first homeowners and rental assistance.
It also shows the effect Fair Banking would have on inflation. It would immediately reduce the cost of housing with Fair Bank loans by about 25%. As Housing makes up about 20% of the CPI, regular Bank Loans contribute about 5% to inflation and removing this may allow us to have an economy without inflation. However, further detailed simulations covering the whole economy must confirm this.
Another interesting result is that Fair Banking and Regular Banking receive the same income until the houses are purchased. Fair Banking loans are paid off in 1/3 less time, while Community Loans are not paid as rapidly because the amount of money transferred is less.
Community Loans are highly productive as they achieve the same result of a transfer of assets with much less money. It explains why economies today show slow economic growth because we use more money to transfer assets than is needed. Production and labour productivity grow, but how we create money through unfair loans means there is too much money in an economy sitting in unproductive bank accounts and over-priced assets.
Banks and the Creation of Money
Banks are an essential public utility. They should be owned by the depositors, borrowers, and the people who use their payment systems. The critical factor with ownership is that the people who use the banks and operate the banks should get a say in how the bank operates.
The Reserve Bank can set the scene and share its profits and losses with the regulated banks. Everyone who uses a bank should be a partial owner of the bank, and the banks should not be owned and controlled by people outside the community they serve.
Fortunately, we have such banks in Australia today — like Bank Australia and Beyond Bank.
These banks could work with their communities and offer localised Community Banking services and Fair Bank loans while using their centralised systems to provide economies of scale.
