2
$\begingroup$

Let me apologize if my questions sound stupid to experts. I have no training in economics. I am just curious and puzzled. I couldn't find any answer to the questions below.

As far as I have understood, broadly speaking, money is created by central banks and landed to governments with interest and creating debt.

Now, let's take a simple example. Let's imagine a world with 10 countries and 1 central bank. The central bank gives 10B (billions) to each country (100B in total) at a 1% interest rate. At the end of the year, the world owes 101B.

  • Where is this extra 1B coming from?
  • Since 1B was never created in the first place, how can the 1B be paid back?
  • If it turns out that the world cannot actually ever pay back the full debt, then why do we care? What is the use of the 1B in debt?

Of course, the countries are in business with each other. During the year some will gain money, some will lose money. The countries that managed to gain that 1% can pay back the interest, but hardly the full debt. In general, for each 1% gained by some country, others must have lost that money.

So it appears to me that with such a design 1) the debt cannot ever be paid back, 2) someone must go bankrupt in the long run and 3) the debt can only grow over time (since it cannot be fully paid back). Is that true or am I missing something?

Just to be clear, I get why we need money. I don’t get why we need debt. Wouldn’t capitalism work as well if central banks could just distribute money around as needed without asking them back?

I don't think this question duplicates this one. While the linked question does explain the mechanism of money and debt creation, it doesn't shine light on WHY we care about debt, nor whether it is possible to ever pay back the world debt if it is destined to steadily increase over time.

Improve this question
$\endgroup$
14
  • 2
    $\begingroup$ Possible duplicate of How is the interest on fractional reserve money creation paid? $\endgroup$
    – 410 gone
    May 7, 2019 at 14:35
  • 1
    $\begingroup$ Why the downvote? $\endgroup$
    – alec_djinn
    May 7, 2019 at 14:35
  • $\begingroup$ @EnergyNumbers It is not the same question even if the topic partially overlaps. $\endgroup$
    – alec_djinn
    May 7, 2019 at 14:37
  • $\begingroup$ It's a duplicate because the answers there, answer your question here. $\endgroup$
    – 410 gone
    May 7, 2019 at 22:09
  • $\begingroup$ The WHY DO WE CARE part is fully missing. $\endgroup$
    – alec_djinn
    May 8, 2019 at 5:48

2 Answers 2

Reset to default
4
$\begingroup$

So there are a couple of things you want to consider:

1st: It is not true that if some country gains 1% some other country must have lost that 1% of economic growth. The economy is not a zero-sum game where the gains of one person are the losses of another one. In fact, usually, it is the opposite. Think about it this way, if the US grows by a lot it also means that they will buy more things from other countries so these countries will probably also grow faster.

2nd: Money is just the means by which we keep track of, and do transactions. At the end, what really matters is how much stuff is produced (goods or services). That is why if some country produces more things, everyone can benefit from it.

I do understand your logic that if the Bank produces 100B of coins how can they expect to get back 101B? Once you think of it in terms of stuff, the puzzle is resolved as follows:

  • The bank lends you the money so you can buy and plant seeds (these are the 10B), they expect to get back some of the benefits from this productive project after you produce apples (they could directly ask to pay back in apples, but this would be impractical, that's one of the reasons we use money, so instead they ask you for the 10.1B). Of course, if the bank does not print more money where will the .1B come from? Well, indeed the bank will never ask for 1% interest if they know there is no physical way to actually pay it back.
  • What really happens is that the bank understands that if an economy is growing, she needs to constantly be printing money, so people can easily do and keep track of all the transactions they do. Therefore, when they ask for the 1% interest, first this is possible, because there is more money out there in the economy, and second, they choose how much interest to charge in order to reflect that they expect you to do something productive with the money (interest also depend, of course, on how risky is your project, and other factors).

I am over-looking the whole issue of inflation to keep things simple and explain the main logic of why banks (including the central bank) charges interests. Whenever you think about whether a debt can be paid or not; the relevant question is not if there is enough money out there to pay it. Rather the relevant question is if the money loaned is being used in a productive way so that it can later pay the interests. And if the answer is no, we care because that means that the money loaned is being wasted, instead.

Improve this answer
$\endgroup$
12
  • $\begingroup$ In the sample I made, the extra 1B is not there jet. So you say that the bank will print more money to allow the countries to pay have that extra 1B? Won’t that 1B have also an interest? How to cover that? Why do we even need interest if we need extra money to be printed to pay it back? $\endgroup$
    – alec_djinn
    May 8, 2019 at 6:06
  • $\begingroup$ Also, mathematically I don’t get your first point. Given a fixed amount of money, if one gains, another must lose. Else you continue to print money but then is the same, if one gains, another must ask for more debt. Am I wrong? Is there any scenario in which all the parties have more money they started with and no debt? $\endgroup$
    – alec_djinn
    May 8, 2019 at 6:12
  • $\begingroup$ I understand your confusion, money is really tricky, and you can spend a full semester thinking and understanding why we need money in the first place, why do we need to print more money constantly, etc. My point is that interests are not about the actual coins you get back, but rather about the extra value (measured in terms of stuff, not money) that you get as a reward from lending someone money). $\endgroup$
    – Regio
    May 8, 2019 at 15:38
  • $\begingroup$ Probably the easiest is to assume there is no money in the economy, even in this barter economy, if I were to lend you some resources, say a piece of my land for a couple of years, not only would I want that piece of land back at the end of those years, but also some of the benefits from what you produced on it. This is the interest. Why do I want this interest, because otherwise I could have done something productive with that land, so I won't lend it to you unless you compensate me. Printing money is not what motivates interest, nor is necessary to have interest. $\endgroup$
    – Regio
    May 8, 2019 at 15:41
  • 1
    $\begingroup$ I don't know why you refuse to see money and stuff as interchangeable. @Giskard 's point is that interest rates are not there in order to receive more coins (whether this is mathematically possible or not. In your example if no more money is created - though there are multiple ways it can be created- then it cannot be repaid), but rather interest if there in order to receive more stuff from the resources you lent. If money had no counterpart with real stuff, we wouldn't even need money. So interest are there to provide good incentives for borrowing and lending in terms of real stuff not coins $\endgroup$
    – Regio
    May 9, 2019 at 15:09
-1
$\begingroup$

Money can circulate multiple times. If you borrow \$100B (all the money in the world) and spend it on new factories (all the factories in the world), you are giving the money to the workers (all the workers in the world) to set up the factory and then to make things. Since your factories are producing all the stuff in the world, all the stuff they buy comes from you and they give you money. Some of that money goes back to the bank. But what does the bank do with it? One thing that the bank does with its money is to pay its employees, who buy stuff (from your factories) and thereby give you money... which you can pay back to the bank.

In fact, the bank can even lend you \$150B when there is \$100B in the world. Your factory doesn't just magically appear one day - you pay workers to build it. So you pay the workers \$1000 per week per worker, and what do they do with the money? They put it in the bank (because there is nothing to buy because you are still building your factory). Even if there was something to buy, where do you think the shop would keep the money that the worker paid to the shop? That's right, in the bank. So the bank still has \$100B at all times. Even after you've paid \$100B to the workers, the bank still has \$100B left and it can let you pay another \$50B.

Improve this answer
$\endgroup$
6
  • $\begingroup$ That comes back to the point that to make more money you need more debd. So debt, at last, can't be repaid. In the current system, there will always be more debt than money in circulation. $\endgroup$
    – alec_djinn
    Oct 28, 2021 at 15:14
  • $\begingroup$ @alec_djinn Why does it need more debt? You make iPhones and don't have any money. The bank pays the bank worker. The bank worker buys an iPhone. You pay the money to the bank. Now you still have no money and no money or debt has been created but you have paid off some of the debt. $\endgroup$
    – user253751
    Oct 28, 2021 at 15:39
  • $\begingroup$ In your example, it seems that the worker's salary doesn't have an interest rate, but in reality, it has. What the worker receives as a salary got generated as a bank loan in the first place, the money to cover the salary wouldn't exist otherwise. The same is for the money used to build the factory, the phone, and the rest. At the very beginning of their existence, that cash was given as a loan from a central bank. The cash can circulate indefinitely in the economy, but it will always be less than enough to repay the loan debt. $\endgroup$
    – alec_djinn
    Oct 29, 2021 at 6:03
  • $\begingroup$ So, following your example, this is what happens in reality. 1) A central bank loans 1000 to the local bank, at say 1% interest. The local bank pays the worker the same 1000. The worker buys an iPhone with that money. There are 1000 circulating in the economy, but 1010 are needed to repay the full debt to the central bank. That extra 10 does not actually exist. The local bank can get enough money to repay the debt by making a profit, for example. But that profit is still money that was circulating in the economy. They are also attached to some debt. $\endgroup$
    – alec_djinn
    Oct 29, 2021 at 6:10
  • $\begingroup$ So, in the end, if you sum all the money in existence, it will be less than the total debt. The debt is going to exist and grow over time, there is no way to get rid of it. This is happening in practice, indeed the debt ceiling is pushed further up regularly by most of the world's nations. So, my question is WHY DO WE CARE about repaying the debt if ultimately it cannot be zeroed away? $\endgroup$
    – alec_djinn
    Oct 29, 2021 at 6:13

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge that you have read and understand our privacy policy and code of conduct.

Not the answer you're looking for? Browse other questions tagged or ask your own question.