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  • Writer's pictureMartin Schmalzried

Supply and demand in a debt based monetary system: why we have it backwards

In economics, supply and demand are two foundational concepts. Together, they form the “market”, which ideally, should be “free”, and most if not all economic models include supply and demand mechanisms in their projections and theories. But what if I told you that within a debt based system, supply and demand have been wildly misrepresented? We tend to think of the “supply” as economic actors who have goods and services to sell, and “demand” as economic actors who want to buy said goods and services. They get together in a “virtual” market place, and in ideal conditions, where there are no external pressures or distortions, prices fluctuate and settle at a level where both the supply and demand agree for an exchange to happen.

But that is completely leaving aside the crucial question of how the demand side acquires the money to pay for goods and services in the first place. Most economic models assume that money is a neutral medium of exchange, but in a debt based system, that is very far from the truth as we will see in this article.

Another way to analyse exchanges in a debt based economy is to start with the premise that money is a good or a commodity like any other. This is not new, of course, and some economists have created models which take that into consideration, but what is most interesting, is that since money is a commodity created via a debt, it has very interesting properties which doesn’t make it neutral at all as a medium of exchange.

Let’s examine this closer and reversing the demand and supply side. The consumers do not represent the “demand”, in this case, they represent the “supply”, since they are the ones who accumulate the money via their work and so are "suppliers" of money. The businesses represent the “demand”, since they are in demand of money. And in order to convince consumers to part with their money supply, they will pay them with goods and services in exchange for their money. So in this case, I start from the premise that the payment is goods and services, and the “good” or commodity that is sought after is money. Why would this analysis hold? Because money is the only commodity with a “forced spending” clause. In other words, any person in debt is forced to spend his goods/services in exchange for money to repay private banks according to a set and agreed schedule. To put it into perspective, it is as if you received your salary, as a worker, and then you were forced to spend part of that salary on buying certain goods from businesses. For instance, it's as if you had a contract with a candy company to mandatorily buy 100€ worth of candy each month for 15 years. If that’s not a market distortion then I don’t know what is.

In other words, each and every single economic actor in debt is forced to sell either his labour/time (in the case of a worker) or his goods/services in exchange for money. This creates an inherent or natural demand for money which has no equivalent in the economy, and conversely, an inherent pressure on selling goods/services/labour in exchange for money. Even for “basic” goods and services like food, the demand can fluctuate somewhat in the real world. During “bad” times, people can compress their spending and consume less food or less services. But people in debt cannot “compress” their “spending” on repaying their debt. Doing so is simply called “defaulting on a loan” and carries certain dire consequences like forcing you to “spend” your house to “buy” your loan with money.

Let me give you a practical example of how a debt based monetary system can "grip". Let's take the example of a consumer loan. Consumer credit is very beneficial for the economy simply because it is directly associated to spending. No one borrow money from the bank to put it on a savings account. That is only done by speculators, and is actually detrimental to the economy, since its about making money with money, creating no "real" tangible good/service. So a consumer takes out a loan, spends that loan instantly on a good/service.

The consumer is forced to sell his/her labour at least to cover for the reimbursement of the loan, the economy is chugging along. Then the business pays out part of the revenue from the sales of the goods/services in the form of salaries. The people receiving the salary are scared about the future and decide to cut their spending. The money stops flowing, businesses cut expenses, and the person who took out the consumer loan cannot find a job to repay his/her loan, and defaults on the loan repayments. The bank has to move in on his/her assets to recover the outstanding loan repayments. If this happens on a massive scale, banks cannot recover enough money, they can also initiate a collapse in the prices of certain assets (like in 2008 in real estate when banks tried to sell homes all at once to cover for defaulted subprime borrowers). Then banks risk going bankrupt, the state has to move in, and cover for the outstanding debts, which then become a burden on the entire economy through public debt and future taxation. A socialisation of losses at the service of a system.

The same can play out if a business takes out a loan to invest in more production. There is no guarantee that the money paid in the form of salaries will return in the form of stable consumption, which will allow it to service the loan. Thus plenty of strategies were designed to address that problem, among others: advertising. Since the only way, in a free market economy, to get people to consume is to make sure that they want to, you have to make them want to consume, and what better way than advertising to make sure they want something they otherwise may not need. Other strategies were used in the past (and still exist) like giving workers rebates if they shopped or bought products from the company they work, all to encourage spending and prevent the economic machine from gripping...

You might wonder why I’m going through all that trouble to reverse the relationship of supply and demand and making it so complicated, and that’s for a very timely reason: the current economic and financial crisis is directly linked to this new way of viewing supply and demand. This “forced spending” of money on debt can only work if exchanges keep on going. When the economy comes to a halt, then all those in debt cannot honor their “promise” to pay because they cannot find any supply to satisfy their demand of money in exchange for their goods/services. This prompts governments to borrow even more, with a promise to repay with tax payers’ money sometime in a hypothetical future where we have double digit growth again, and the debt burden will become sustainable (like that’s ever going to happen), just in order to prevent the debt based system to implode.

The big problem, is that in a period when there is heightened uncertainty, consumers, savers refuse to “sell” their money in exchange for goods and services which exacerbates the problem, making it near impossible for economic actors in debt to honor their promises to repay their debt. The only solution, which I believe policy makers are considering, knowingly or not, is to find a way to match the forced selling of goods/services to a forced spending of money. In other words, because indebted economic actors are forced to sell their labour or their goods/services in exchange for money to honor their forced agreement to purchase their loan, you need to also force economic actors sitting on huge piles of money to spend it. And because the economy is incredibly complex, states cannot force people to buy fixed portions of goods and services in a detailed way. Instead, they will use the following strategies:

  • Forced spending via taxation: by guaranteeing the loans to companies, up to 80% in case of default, it is as if the state was directly taking money from consumers and giving it those companies, even if they don’t provide any good in exchange. Another way to do forced spending via taxation is to issue special “coupons” for various activities, like a coupon for going to the zoo or to the museum, or a special voucher for free trips on public transport. These only appear to be free, because ultimately, they are paid via taxation, one way or another. The same goes for helicopter money, in the end, because the “extra” money available in the economy through stimulus checks will have to exit the economy one way or another, or it might cause high to hyper inflation. A last measure is also possible, but will never be implemented in practice: tax the ultra-rich and put an end to trickle up economics which sucks money out of the hands of the people who actually spend it, in order to put purchasing power back in the hands of workers and therefore give them the necessary confidence to spend more money in the economy, thereby allowing indebted economic actors to honor their debt. That will never happen for many reasons: either because of corruption and the close links between politicians and the ultra rich, or simply the difficulty of implementing such a tax in a way which would work. The ultra-rich have won the game of regulatory whack-a-mole and have become masters at avoiding taxation for the last few decades.

  • Forced spending via money with an expiration date: converting “real” money into lunch vouchers or green vouchers to consume food or green products, which expire after a set period of time, is a way to force people to spend them and provides some guarantee that businesses will always have a “minimum” supply of money available to them because consumers will spend these vouchers before they expire. The same applies to car leasing, which is a “forced” spending on automobiles. Instead of receiving more money, you part with some of your salary, and get a benefit “in kind” which props up artificially a part of the economy. These measures will likely be increased in the future, where states will propose converting more of people’s salaries into forced spending either in kind (paying for your utility bills directly, or your phone bills…) or via vouchers with an expiration date.

  • Forced spending via negative interest rates: now here is the real danger. If the two previous strategies fail to “jump start” spending, or making sure that people start “offering” their money again in exchange for goods and services, the states might be tempted to resort to negative interest rates which essentially means, confiscating part of the money sitting on your bank accounts, in order to encourage you to spend it into the economy. Taking such a decision is risky. There is a risk that consumers might seek refuge either in cash, or in other assets. In the past, cash and gold were the only two “go to” assets to protect your wealth from negative interest rates. Other assets like real estate can also be used, but they are not as fungible (you can’t pay for your bread with your house) and thus are only used to invest for people who have a lot of wealth to protect. But nowadays, we have seen the emergence of decentralized crypto-assets. These, and especially stablecoins, could be a real alternative to cash or gold, in the event states and central banks try to micro-manage the economy just to prop up an outdated system (a debt based system, which cannot handle abrupt fluctuations in demand). This is why, in my mind, central banks are rushing to create a “digital” central bank controlled version of their currencies (which can be subject to negative interest rates), as opposed to private stablecoins, which would be harder to control (impose negative interest rates on them). The same for other crypto-assets like Bitcoin. Regulators from all over the world are scrambling to curtail the use of decentralized crypto-assets under the guise of “money laundering”, “terrorist financing” and “other illicit activities”, or also to “protect consumers” from harm, but the reality is that they want to shut the door to as many alternatives to debt money as possible in order to impose their “forced spending” measures without any major impediments. What is ironic, is that even the fattest rats, the ultra-rich, seem to be leaving the debt based monetary system boat, by starting to invest into Bitcoin and the likes as well… It will be interesting to see how this plays out and whom public authorities will choose to serve: willingly let the debt based system collapse because they bought a ticket out via a decentralized crypto-asset or another, and because their rich buddies have jumped ship, or blindly attempt at clinging on to a failing system to save face.

The debt based system is outdated and doomed to fail in the long term anyways. But how long will we stand and watch as states and central banks give the financial system a mouth to mouth and cardiac massage all the while the “real economy” is dying? In the next article I will explain why the debt based system is simply completely incompatible with a new circular economy. In the meantime, I hope this article gave you a broader understanding of the problems caused by a debt based system, the distortions it creates on “free” markets, and the implications for savers and consumers.

Personally, I have already been advocating for a while to shift from a debt based monetary system to a system based on the Relative Theory of Money, which in my mind, is the only viable alternative both in terms of positive societal outcomes and economic outcomes such as price stability.

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