free html hit counter Peak Oil Debunked: 147. THE DEBT VIRUS HYPOTHESIS

Monday, October 31, 2005

147. THE DEBT VIRUS HYPOTHESIS

Many peak oilers are opposed to the current economic system because it must grow to function, and they fear growth. In their view, human beings are yeast in a petri dish, and if we keep growing, we will overshoot and die-off, suffocating in our own waste. Therefore growth must be stopped, and the only way to do that is to somehow restructure the economy.

It is true that the economy must grow, but the economic system is a complex thing, so let's take it one step at a time. Why is it that the economy must grow? Heinberg blames it on the monetary system, more specifically, "debt money" and interest:
The mania for growth is not merely a personal pathology, or even a problem of economic ideology; it is structurally embedded in most national monetary systems. Currently, most money is loaned into existence by banks and is thus based on debt and implies a commitment to pay interest on that debt. If the economy does not grow, new money will not be created to pay interest on existing loans; those loans will thus be defaulted upon, and a crash will occur. It is essentially impossible to achieve a static or controllably contracting economy with a debt-based currency. Therefore, if we are to achieve a reduced-scale, steady-state society, we will need to change our monetary system to one that is not based on debt and interest.Source
This theory -- that new money must be loaned into existence in order to pay interest on existing loans -- is called the "Debt Virus Hypothesis" (DVH). It was popularized by Jacques Jaikaran in his 1995 book Debt Virus: A Compelling Solution to the World's Debt Problems. (As a point of human interest, we should probably note that Jaikaran is not an economist or a banker. He's a plastic surgeon from Texas, who was involved in the right-wing "Republic of Texas" movement and arrested for tax fraud. Source.)

Succinctly put, the DVH says this: When bankers create new money by issuing a loan, they only create the amount loaned, not the interest. So where does the new money to pay the interest come from? It can only come into existence through a new loan being made, and therefore the monetary system requires endless growth to avoid collapse.

But something is fishy here: Why does the money to pay the interest have to be "new" money? Suppose the bank loans out $100 and wants $110 back ($100 + $10 interest) . Why can't the $10 be "old" money -- i.e. money which is already in the economy and is idle at the moment?

The fallacy of the "Debt Virus" hypothesis is that it assumes, nonsensically, that all of the billions upon billions of dollars already existing in the economy cannot be used to pay a newly created interest obligation. It says that money for paying a particular interest obligation must be specially created. It sets up a false 1-to-1 correspondence between particular sums of money and particular debts. The fact is, the self-same $10 bill can be used to pay off any number of debts; today it pays my interest, 15 minutes later it pays yours. It's not a zero-sum game where me paying my interest somehow shuts you out from paying yours.

At this point, a defender of the DVH might say: "But you can't pay interest with money that's already been created! It was loaned into existence!" This is just a red herring.

The fact that money was loaned into existence doesn't prevent anybody, in any way, from using it to pay interest. It's simple really; I'll show you how it's done. My buddy Earl calls me up and says: "Hey, you remember that $100 you owe me?" I write him a check off my account, it clears, and he uses it to pay interest on his mortgage. Voila. Earl just paid off interest with money which was loaned into existence -- i.e. the money I took out of my checking account. Earl paid off the interest with "old" money, and no new money needed to be created. Kind of mind-boggling, ain't it?

Even more amazing is the fact that that $100 just keeps on going... The bank uses it to pay interest on one of their loans from another bank, and that bank in turn pays it out to Grandma Peasoup as interest on a CD, and she uses the $100 to pay interest on her mortgage.

For an even more astounding demonstration of this magic, suppose we have a billion broke hobos lined up, starting with Abe, Bob, Cliff.... and ending with Yordo and Zeke (there's a lot of Mikes in the middle). Abe takes $10 out of his pocket and loans it to Bob, provided that he pays back the $10 plus $1 in interest. Bob says okay, and makes the same loan to Cliff, and of course Cliff makes the same loan to Dave etc. etc. until Yordo loans the money to Zeke.

Total indebtedness at this point: $10 billion
Total interest due: $1 billion

Wow! Where in the hell are these guys going to come up with that kind of cash? Between them they've only got a couple thousand, and there's no way a bank is going to loan a bunch of penniless hobos billions of dollars. But some bank has to. Right? According to Heinberg, somebody somewhere has to loan a whole new $1 billion into existence to pay the hobo interest. Is all hope lost?

Nah... Zeke just takes a swig off his flask, pulls a buck out of his wallet and pays off the 11$ he owes to Yordo, Yordo does the same with Xavier etc. etc. until Bob pays off Abe. It's like a big zipper. Isn't that fucking incredible? We just paid off $1 billion in interest with 1 measly buck.

More info on the DVH
--by JD

21 Comments:

At Monday, October 31, 2005 at 6:33:00 AM PST, Anonymous wankerness said...

Interesting...I don't quite understand the implications of this. Does this refute the claim that the monetary system/economy will be utterly destroyed once consumption starts declining? Many people (Heinberg, Simmons, Montequest) always use it as a given that massive oil price increases will slow the economy (which is true, I'm sure) which will lead to a complete implosion and depression because our economy "requires growth." Others describe this as "a non-existant paper crisis." Where do you stand here?

 
At Monday, October 31, 2005 at 7:29:00 AM PST, Blogger Quantoken said...

JD:
First do not discredit some one just because he is not an economist, it applies to yourself, too that you are not an economist. An economist is just a profession to make a living. Being one or not being one may not have too much correlation to whether you actually know economy or not. You can cook a better meal than a cooker does, but that doesn't necessarily mean you have to make a living as a cooker.

Now, your example doesn't work logically. Why some one wants to loan $100 and pay interest, when he already have $100 extra to loan someone else and collect interest. Besides all the huzzle, at the end of one round every one has exactly the same amount of money as beginning so nothing is gained. No one is getting richer.

People get involved in real economic activity because they can profit from it. When they go home at the end of each day they have slightly more money than they have in the morning, the extra money they earned in the day, which is real money, allow they to buy butter and bread and all the life's essential to live on. So the monetary fortune CAN be converted to material fortune. That is the whole basis that money has value and people have insentive to engage in economic activity.

Now this can not grow exponentially, because the material fortune, which the monetary fortune is associated with, has a physical limit and can not grow expotentially.

A growth of the amount of money, if without the corresponding growth of the material fortune, is meaningless and worthless, and is called inflation by economic term. I am willing to leave my money in the bank because I know with confidence that I can withdraw the cash at any time and buy the equivalent amount of mechant goods or gold, and that any one with money in the bank can do the same, too. If that confidence is begin to shake for any reason people will want to be the first one rush to the bank and convert their money to gold, the "real" money.

Quantoken

 
At Monday, October 31, 2005 at 8:04:00 AM PST, Anonymous Adenosine said...

Not so sure about this post. Deflation and inflations are real problems with the current monetary systems we have: look at Japan (1990s, deflation)! When people say 'the economy must grow' they really mean that the economy must grow in order to prevent large amounts of inflation because of the interest that's due, and also that the money supply must grow to prevent deflation (which can create a liquidity trap).

This whole 'debt based money' doesn't work too well if your economy tanks, or if people were highly speculative with your currency.... but during 'normal operations' it works out fine.
nd have consistent prices.

 
At Monday, October 31, 2005 at 8:09:00 AM PST, Anonymous wankerness said...

Well, one thing that I've never seen is an economist talking like the financial system is about to collapse us into a massive permanent depression when oil peaks, but I don't read much from economists (unless you count Lynch). The ones I've seen stuff from all seem to assume that we'll be able to transition into other forms of energy without a depression, but I'd like to know what would actually happen if we were unable to do that immediately and had to deal with at least a temporary (like, for a few years) decrease in energy.

According to alarmists the 70s oil shocks won't be anything compared to what will happen with this, but I don't know if I buy that. If there was an instant 10% drop in oil then and the economy didn't implode, why would it now with a 3-5% decrease per year? Cause of a huge price increase? I'm just really unclear on this and it seems that only non-economists that discuss peak oil ever predict a great depression, but this fact is countered that most economists don't seem to understand the geologic situation and how many things depend on oil.

If the doomers are running off this model proposed by a non-economist when predicting a crash, that is good to hear for the less alarmist crowd, but I'm not sure if that is the hypothesis they're all referencing.

 
At Monday, October 31, 2005 at 8:10:00 AM PST, Anonymous Anonymous said...

There is a fatal flaw in your analysis. Money is seldom idle (which is really the problem). When A asks for a loan from B, they aren't asking for money so they can hold on to it and pay B back at a later date with interest. That would be absurd. A intends to use the money for something, pushing it into the economy. Either A thinks he can invest it with enough interest to outweigh the interest he owes B, or that he will gain something valuable enough, and that he will make enough via other means, to justify paying the interest. It's usually the latter.

In the Hobo example, the second guy in line wants the money for something--it's not his intention to borrow the money with interest only to loan all that money to the third guy. He needs the money to eat, to get some coffee or some whiskey or something. So if he needs five dollars for his hoboing supplies for a given week, he's asking for a loan that will cover him for two weeks. But if the third guy asks for a loan for two weeks from the second guy, the second guy will have nothing left to supply himself with.

This is why money must constantly grow to feed the economy. As more people appear (via the usual route), they eat more, they use more energy, etc. etc. They need more money to buy the things they need. Hence, money supply must grow, as must the supply of useable things. If it doesn't, then there will begin to be a degradation of the economy.

Anyway, see David Korten's work called "When Corporations Rule the World" for an excellent introduction to this issue.

 
At Monday, October 31, 2005 at 8:25:00 AM PST, Anonymous wankerness said...

Re: the last comment, most of the developed countries are experiencing extremely limited population growth (I think I heard that the USA and the EU are actually declining in population apart from immigration), and if the money is being spent on food it's not like it gets burned, is it? Would the metaphor work better if each hobo ran a business in which they provided goods or services that the other ones required? Or would it still be a fatally flawed model? I suppose the fact that we buy so many imports makes this difficult, but we also export a ton of stuff...if the two are balanced would it result in the metaphor being valid?

I obviously know little or nothing about economics and am just trying to get my head around all this.

 
At Monday, October 31, 2005 at 11:15:00 AM PST, Anonymous Anonymous said...

The fact is even economists don't entirely agree with each other on what makes the economy keep going, which mechanisms cause depression and to what extent, and what the best thing to do during a depression is.

What I do know is that doomsayers probably know significantly less about economic processes than said economists, and if people who make their entire careers around it can't entirely wrap their heads around it, how can some armchair doomsday prophet?

 
At Monday, October 31, 2005 at 1:04:00 PM PST, Anonymous Anonymous said...

It works just as well if each person consumes more than they used to. Twenty people each consuming ten units of resource x is the same as ten people each consuming 20 units.

 
At Monday, October 31, 2005 at 1:05:00 PM PST, Blogger eltonwilson said...

I would just like to make the point that in the hobo example, $1 was created out of thin air (if this is a closed analogy). This $1 was used to pay $1 billion in debt. The only one who made any money on this transaction was Abe, who profitted a $1. So this analogy seems to go against the main argument of the article, that money doesn't have to be created to pay the debt. Did I misunderstand something?

"Besides all the huzzle, at the end of one round every one has exactly the same amount of money as beginning so nothing is gained. No one is getting richer."

"Zeke just takes a swig off his flask, pulls a buck out of his wallet and pays off the 11$ he owes to Yordo, Yordo does the same with Xavier etc. etc. until Bob pays off Abe."

 
At Monday, October 31, 2005 at 1:58:00 PM PST, Anonymous JW said...

JD you really have to study how “Fractional Reserve Banking (FRB)” works and the current makeup of “money” (M0 to M3) in many economies around the world. Money created in FRB in a debt-based economy is destroyed when the loan is paid in full, but not the interest, the interest is kept in the banks books as profits. Unless all banks collectively consume all economic productions, in which the interest could be paid off by the debtors by providing goods or services directly to the banks (remember only banks can create money), e.g. Company A borrows $1000 from Bank A with an interest of 10%, if Company A charges Bank A $1100 for goods and services supplied to Bank A and repay the loan with interest in full, then the money would have been kept static yet enabled economic activities. However, in the real world banks do not consume all goods and services of the economies but they do create all money. That’s why in order to keep these debt-based economies of the world from severe disruptions, continuous growth in consumption and production is required. The problem is that we live in a world where many resources are finite. Or otherwise, significant corrections will happen from time to time, remember the 1989 Black Friday, the 1997 Asian economic crisis.

 
At Wednesday, November 2, 2005 at 10:51:00 PM PST, Anonymous p said...

JD, if you are about to debunk something you better cover your own ass first. In other words: You better make sure that your own theories and examples will stand the test. The "hobo example" you present here is highly flawed though. I'll explain.

Even if your example would resemble the way current household debt is working, which it doesn't as I will explain further on, it would be flawed. What if Zeke would actually use the $10 to buy a bottle of scotch and drink that? No one in the chain would have a prospect of regaining it's $10 if Zeke didn't go out and find an other $10. An other flaw in the example would be that interest isn't a ontime pay. One pays interest every year. So what if Zeke decides not to pay back? Every person in the chain needs to keep paying interest..

But those flaws are nothing compared to the major flaw in your example: Did you borrow your mortgage from your neighbour, only to lend it further to another neighbour? Offcourse you didn't. You, and your neighbours all went to third parties to borrow money.

 
At Thursday, November 3, 2005 at 5:52:00 PM PST, Anonymous Anonymous said...

JD,

You so completely botched this one it's almost painful to read.

 
At Tuesday, August 8, 2006 at 10:16:00 PM PDT, Blogger fatcam00 said...

The thing to probably work through here is that it is the central bank who loans the money into existance. Another entity will print the money, but only under instruction from the central bank. From my understanding of this there is only a handful of ways that the money paid back to the central bank for interest can be re-injected back into the economy for paying off of further interest.

1. The central bank uses the equity created by the repaid interest to loan more money
2. The central bank pays it's employees and those employees spend that money back into the economy, allowing it to be used to pay off interest.
3. The central bank pays dividends to it's shareholders who might elect to re-invest and buy more shares in the central bank, or they may elect to take the dividend as cash which could then lead to that money being re-injected into the economy (allowing it to be used to repay interest).

I agree that the money repaid as interest doesn't just disappear out of circulation.

 
At Sunday, October 21, 2007 at 11:12:00 PM PDT, Blogger Pearl said...

The real deep spiritual issue is that we consume/degrade natural complexity in order to have experiences. Experience is what Buddhists mean by Samsara. Desire for mundane experience is the root of all the ills of a person and the human world. In this, almost everyone is implicated.

We are trading the ancient for the transient. Enlightenment and Bliss for entertainment and sensation.

 
At Thursday, December 13, 2007 at 9:21:00 AM PST, Blogger redpillguy said...

There's a very important piece of the puzzle you are missing.

Every time a bank loans money, they create it out of nothing. And every time they create money, they loan it. The 2 go hand in hand; you don't get one without the other. The Federal Reserve creates money out of nothing, and banks do the same via the magic of fractional reserve banking.

So every time new money is created and loaned, the interest payment for this loan needs to come from money already in existence. Therefore each time there is a loan repaid, it shrinks the money supply in circulation. The system needs constant money creation (new loans) at a faster rate than old loans are being repaid (thus the spiralling debt).

The Nobel prize winning economist, Milton Friedman, has shown that every recession has been accompanied by a contraction of the money supply, and vice versa.

If the Federal Reserve raises interest rates (prices of loans) and thus greatly reduces new loan activity, servicing all the existing debt requires that the money is shrunk. Voila, engineered recession.

All the money in circulation has already been replaced by debt-based money. Therefore, all the money in circulation cannot repay all the debt. Meaning, the banks own all the money.

The last paragraph is explained well using statistics (the Fed's M2 and M3) by this blogger (you need to reconstruct it):
http://
fskrealityguide.blogspot.com
/2007/11/
ron-paul-federal-reserve-and-gold
.html

Your hobo example doesn't invalidate it, because the hobos don't have the power to create money out of nothing.

Bank expenses cancel it out partially, but do you believe that their sum total administrative cost is equal to 5 to 10% of GDP of the entire economy? (5 to 10% is the range of loan interest rates). Is 5 - 10% of the population employed by banks? If the sum total of all bank's expenses are less than the sum total of all interest payments made, then the "debt virus" aka "Compound Interest Paradox", exists, and the banks have us all by the balls.

 
At Monday, December 17, 2007 at 9:35:00 PM PST, Anonymous milkdude said...

your initial question - why cant the interest due be from "old" money?
answer - there is no old money. all money created into the system is debt, even the old money. every dollar in circulation has interest due on it, somewhere, sometime. the only way to pay off the accumulated debt is through new loans of principal. which again has more interest due. the picture is bigger than you can see

the author of this blog is retarded.

 
At Thursday, December 20, 2007 at 7:12:00 PM PST, Anonymous Anonymous said...

JD appears to be confusing velocity of money (his $100 example paying off everyone's debts) with his zipper analogy. As someone said earlier, the zipper has nothing to do with money creation by a bank. The analogy of the zipper is really describing nonbank lending, in which case each nonbank lending entity would be looking to make a profit, not break even, and the interest would still have to come from bank-created money lent into existence to begin with. People lending money to their friends is similar to nonbank lending in that it uses money already created by bank lending.

Old money? I assume his definition is money created by earlier lending, which is all money in existence. Using money not yet created in order to pay off a debt would defy the principle of causality.

The argument that comes closest to discrediting the debt virus hypothesis is that the banking system pays its expenses, interest to account holders and dividends to shareholders out of its revenues, among which is interest income from loans. These factors, interest to account holders, dividends and expenses, would recirculate into the economy but retained earnings would not. In 2006, all domestic commercial banks took in revenues of $597B including $381B in commercial loans, and made total profits of $128B before dividends (FDIC). This out of M3 equivalent of about $11.5B. This is quite a bit less than even reported inflation of about 2%. So the DVH really should refer to banking system's retained earnings instead of interest.

Still, there is the matter of coming up with the $50-100B or so to pay these retained earnings - the money supply would shrink by this amount. So the DVH is not completely discredited. But JD, know your facts before pontificating.

By the way, another thing commonly claimed is that the Treasury pays the FED interest on Treasuries bought by the FED. Actually, this interest is rebated by the FED after deductions for expenses including dividends to the FED Bank owners (the banks in the regions) of 6% per share. It's all pretty messy so making any generalizations can be dangerous.

 
At Saturday, March 15, 2008 at 12:47:00 PM PDT, Anonymous The smart creature said...

The exchange mechanisms between the components of the present economic system rest on the existence of a financial bubble maintained under pressure as long as expanding markets allow investors to make profits re-injected into the bubble. In order to remain viable, such a system is therefore compelled to increase year after year the annual energy production needed to sustain its growth. When this production ceases to increase and starts to decline, the expansion will be reversed into contraction, the bubble pressure will vanish and the markets will collapse. When will this production ceases to increase ? At some point during the following decades. For more details, look at the March 2008 Newsletter in the multilingual blog (English, French, Spanisc)

http://thesmartcreature.blogspot.com

 
At Wednesday, August 20, 2008 at 2:10:00 AM PDT, Anonymous Anonymous said...

My understanding is that the debt virus is a real and harmful process but it is true that the total interest is not the amount that needs to be loaned out in the next wave of debt. The interest minus whatever is spent back into the economy by the banks is the amount the next wave of loans would need to cover. Figuring out how much of the interest is spent back into the economy would be no small feat. The costs of administration and operations would not be that hard to figure out but the rest of it would be. Even though stockholders get dividends alot of them would probably have enough money where it would just sit in their bank accounts and be used as a new source of fractional reserves creating more inflation. The only 2 things I can think of that would actually mitigate this problem are defaults on unsecured loans where the money from the loan would be basically "free money" given to the economy and trade surpluses. Trade surpluses that were equivalent to the amount of interest owed or more would essentially cancel out the debt interest but it would only serve to shift the problem to other countries.

The idea of "old money" paying of the debt is ludicrous since all money old or new was loaned into existence with the exception of unsecured loan defaults and trade surpluses which would be no where near enough to offset the cost of the interest debt. The central premise of this theory is that at any given point in time more money is owed to the bank than exists at that time. If right now the total amount of money in existence is 1 trillion dollars (all of it lent into existence) and 1 trillion plus interest is owed there is no way to pay it back without future loans that cover the interest. The problem is that once that loan is made there is interest on it too so in effect the loan can never be repaid without spending the interest into the economy which at this point in time is not the case. It is actually worse then this because the interest compounds upon itself behind the scenes while it is hidden in inflation.
Examples which use islands to simplify this process bring much more clarity to the idea of the debt virus by removing many complexities that only serve to cloud the issue and bring the problem into sharper focus. If this type of process was tried on an island it would become readily apparent what was happening and would be quickly rectified by the inhabitants.
It is such a colossal fraud that most people recoil at the idea that this is how our economy works but it sure seems to be the case.

 
At Monday, October 20, 2008 at 5:54:00 AM PDT, Anonymous Anonymous said...

I don't think peak oilers hate growth. But debt will work backwards in peak oil.

The more money you make the further into debt you will go.

The less you make, the more you will make.

This is because growth is impossible in peak oil.

 
At Thursday, September 24, 2009 at 10:15:00 AM PDT, Anonymous Anonymous said...

I'm no economist by any stretch and this may seem simplistic but it makes sense to me. Ever since the "Banking Industry" came into existence it has been possible to create wealth without producing or providing a damned thing! Were we to eliminate the "Value of Money" (interest) and re-implement ONLY its true purpose of allowing the exchange of goods and services without having to revert to the "Barter System" we wouldn't be burdened with having to continually "Grow" to survive.

I know... I know... TOO LATE!

 

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