Predictable economics discards the concept of the time value of money by reforming banking practices that unfairly benefit those with capital. It will lead to a predictable, efficient, and productive economy. In doing so, the economy could reduce the damage to the natural environment while creating more value for less money. Because of human actions, the current economic system is leading to an environment unsuitable for humans. We need to try different approaches to economics. Making reliable economic predictions would be a good start.
Economic models are unpredictable because economic theory and models are built on the idea that capital increases with time. The models say some money, called capital, can generate more money. Giving capital a time value makes it a commodity, allowing capital markets to determine how to distribute capital. However, capital is money and is indistinguishable from any other money. Money cannot change in value as it is a measure of value. Measures define changes in another entity’s value and cannot measure a property it does not have.
An analogy is with temperature and heat. Temperature measures heat. When there is more heat, the temperature rises. A rising temperature did not create heat. Similarly, a rising capital value is not the cause of the increase. What has happened is that something other than money has caused a rise in the capital value or the cost of goods and services made with the capital. When we make predictions based on the untruth that money today is worth more than money tomorrow, the predictions will almost always be wrong.
To make economics predictable, we can eliminate the time value of money in our modelling. One existing idea allows commodity markets to adjust the values of goods and services. Markets are a method of gauging and projecting future demands, but consumers' perception of value changes as they grow. Open and free small markets work reasonably well but poorly when there are few buyers, sellers or both. They fail when, like capital, the market tries to set a price on a measure.
Money Creation
When a company makes a profit, it does not create more money. It receives more money than it spends, but the total amount in the community stays the same. More money is introduced into the community when a bank makes a loan by debiting a loan account. Profits do not make money. They increase the money possessed by one party at the expense of another.
In today's economy, most new money is created by giving loans to people with money. This new money is known as capital, and the profit generated from the loan repays the loan and covers the cost of operating the loan system. Unfortunately, banks create new money and profit from it by prolonging the loan repayment process. By extending the loan repayment period, more money is generated from a set amount over a longer period, which adds value to it over time. This is the mechanism to make some money, we call capital, to make more money, and it is easy to stop.
When banks extend loans with new money, they make an accounting mistake. The loan money itself has not generated more money. The banks extend the loan's repayment time by not including interest and fee payments created by the loan extension. They do not give the money created by the extension to the borrower. This gives some money, called capital, the ability to generate more by not giving the money to the borrower to use. Instead, the bank gives the money directly to itself.
When a loan is created, its value is deposited into another account, and if the loan is extended, the extension value should also be deposited in the borrower’s account or used by the borrower. This happens with a credit card loan when a person buys goods and services from a third party. The loan is extended, and the goods and services are paid for from the loan extension.
The accounting error occurs when the bank is the service provider to the borrower and the owner of the money. If the bank charges interest or some other fee, it pays itself the amount of money but does not recognise that the borrower has paid the interest or the fee. The bank asserts that the fee, be it interest or some other fee, is a return on capital because money in the loan has generated more money by extending the loan. The existing loan has not created the money. It has been created by the bank acting as a government agent.
This means that a borrower pays interest and other fees twice: once as a return on money and once as a fee for service. The bank should treat itself like any other service provider and recognise that the borrower has paid the interest fee. It is, at best, an accounting error and should be stopped.
The Flow on Effects of the Accounting Error
The accounting error means people who can get loans from banks have a great advantage over those who borrow existing money as the lender has to provide the money to extend the loan when lending existing money. Banks that create new money have lower costs. Banks do not pay interest twice to another bank when they borrow money from another bank, including the Reserve Bank. It means that money for investment costs rich people half as much as it does to people who cannot get bank loans for new money.
The banking system is designed so that those with existing money accumulate twice as much from the same investment as those who have to get money for investment elsewhere. They do this because they can get bank loans while those without money cannot get a bank loan, and those with the most money can get the biggest loans.
This accounting advantage makes for a dysfunctional finance system, as human society flourishes when we share surpluses and work with others to create them. Giving capital a value for slowing down its use and then giving all the surplus to the lender and the intermediary bank increases the inequity of surplus division. It leads to conflict, resentment, and, ultimately, retaliation, which makes an economy increasingly dysfunctional.
An Australian Financial Experiment
From 1960 to 1980, credit unions and mutual associations used members' savings of existing money to provide 70% of Australian housing loans. In 2024, the Big Four banks, credit unions, and mutual associations that became banks will provide almost 100% home loans using new money.
Around 1980, banks were limited in how much new money they could create. The banking changes around 1980 allowed banks to lend new money with fewer deposits. At the same time more household savings went into superannuation. This caused a massive slowdown in the movement of capital and the corresponding increase in the amount of money in the economy, an increase in the wealth of the top 10%, and the impoverishment of the bottom 10%, with little benefit to the remaining 80%.
The current cost-of-living crisis, inflation in house prices, and low productivity in Australian industry and businesses are all direct results of using newly created money to change the ownership of existing assets, especially housing assets. These issues can be tackled by implementing more productive uses of the newly created money by the banks working with the government to establish different rules for loan repayments.
Productive Use of New Money
Using new money to transfer existing assets, including houses, is unnecessary and reduces productivity. The economy has more than enough old money to transfer home ownership. The government should require the banks to use existing money to transfer assets.
New money is valuable because no one has to work to use it. Successful societies need many things, and the main ones are the basics for human survival. Today, the basics are available if a human has access to money and a store of money to get them through crises. Unfortunately, in Australia, most people's stores of money are tied up in superannuation or housing inaccessible to people—most live paycheck to paycheck or pension payment to pension payment.
Innovation and investment are only accessible to the already very wealthy, including overseas investors. Governments are the main suppliers of investment money for all our infrastructure. They raise money by taxing the profits of those who can borrow new money from the banks. Creating new money is expensive as the borrower has to pay interest twice and repay the loan.
A much simpler and more productive method is for governments to pay for new community assets through local communities that use the assets. Local communities borrow money from banks with a set of different repayment rules. They do not pay double interest but pay interest once and do not repay the total loan amount, providing they invest any profits in new community assets as agreed by the government and the community. If community members repay the loan, the profits do not go to the government but to those who pay to use the community assets. Over time, the community members become the owners of the assets, and they, in turn, sell the assets they own to the people who use the assets using existing money.
This saves the cost of creating money and then destroying it when it is repaid. Importantly it makes all users partial owners and sellers of the assets that serve them. Groups of users in the same area can work together to change the cost of using the assets and deciding on the price of using the assets. Groups of groups can decide on intergroup usage and prices are automatically adjusted. The approach will drop the cost of any product or service that uses the approach as money moves quickly and it is not wasted or stored unnecessarily and it continues to circulate rather than be destroyed.
The approach creates a more equal and cooperative society as it is always cheaper to work together to solve a problem and it is always less costly to share improvements and new knowledge than it is to hide improvements and knowledge.
The system becomes one that produces more for the same amount of money and ensures the profits are distributed equitably. It transforms economies from engines that produce money to economies that produce more goods and services for less money and fewer natural resources.
What you can do to Make a More Productive Economy.
If you have a loan with a bank that debits your loan account with fees and interest, you can request that they send you an invoice for their services and NOT debit your loan account. If they refuse, you can file a complaint with your local consumer protection agency, claiming the bank is charging you twice for the same service. In Australia, it is the Australian Financial Complaints Authority.
References
The ideas here have been explored in more detail in medium articles at Kevin Cox
