July 30th, 2011

There is a tale in Greek mythology about the daughter of a Phoenician king who was seduced by Zeus in the disguise of a bull. Her name was Europa. A whole continent inherited this name. Yet this is just a symbol for the rich heritage of arts, science, philosophy, drama, which shaped the culture of this continent from its cradle onwards. More than 2500 years ago the Greeks invented the phonetic alphabet, from which the Latin and Cyrillic letters were derived. At around that time a cultural revolution happened, which is associated with the names of outstanding personalities still well known: Pythagoras, Euclid, Archimedes for mathematics and natural science, Socrates, Plato, Aristotle for philosophy, in order to mention just a few examples. The Greek dramas dealt with themes of universal relevance and are still an inspiration in our time. The theme of Sophokles’ “Antigone”, for instance, is the conflict between the law of a ruler and individual human dignity and conscience. Another of his dramas is the famous “Oedipus”, which deals with the seemingly inescapable consequences of a self-fulfilling prophecy. The modern French multi-talent Jean Cocteau elaborated this theme in his adaptation of the Oedipus saga and gave it the title “La machine infernale” (The Infernal Machine). And last but not least, the ideas for the shaping of a peaceful human society – democracy – originated in ancient Greece. The contribution of Greece’s most excellent minds to the making of this continent and their influence far beyond cannot be over-estimated. And there can be no doubt that Greece is an indispensable part of Europe.

Today, Greece is in serious troubles. Moneywise. It’s staggering along the brim of insolvency and needs urgent help. The rest of the euro-zone is alarmed, because it sees the euro-currency at stake. This goes even so far, that Ben Bernanke, President of the Federal Reserve Board, paints a gloomy picture: if Greece’s problem is not solved, this might have devastating effects on the world’s economy as a whole. The flap of a butterfly that triggers a storm. Greece’s administration may be somewhat inefficient and maybe even corrupt to some extent, but this is a minor part of the problem. The concern of the affected neighbours in the euro-zone is the stability of the euro. Their dilemma is quite aptly described in the satirical YouTube-video:

Clarke and Dawe – European Debt Crisis


Although this is quite a funny dialogue, one’s laughter might get stuck in the throat by the end. The crucial question in this video was: how do broke economies get the money for the bailout of other broke economies? And there was no answer to this question. Are all European states broke? How about Germany, which has taken the lead in negotiating the Greek problem within the triad involved: the European Central Bank, International Monetary Fund and European Commission? After all, Germany is still enjoying an AAA from rating agencies. Can this be called a broke economy? Well, we have to differentiate between the real economy and the state represented by its administration. The rating agencies evaluate only financial instruments like treasury bonds issued by the state. In the case of these treasury bonds (a rather euphemistic term, more appropriate would be: debenture bond) the condition of the real economy plays a role in rating, too. At the moment Germany’s economy booms, the state will collect high tax revenues and is therefore deemed capable of servicing its debts. That seemingly justifies a triple A rating.

The thing looks different if we consider the stock of debts. Within 60 years the German state has been piling up debts amounting to 2 trillion or 2,000 billion euros. The servicing of these debts, i.e. interest payments, swallows about one fourth of the annual federal tax revenues. It’s the second largest item in the budget, tendency rising. A few months ago – the state’s debts amounted to 1.8 trillion euros – I have then tried to find out how long it would take and how much it would have to pay, in case Germany would seriously consider to get rid of its debts. I applied the annuity calculation at a fixed repayment rate. The monthly amount for servicing the debts is 4.5 billion euros at an assumed interest rate of 3% (actually it is 3.4%). Since this amount only services the debts, the monthly rate must be higher if the debt is to be reduced, let’s say, 4.6 billion euros. It would then take 125 years to clear the debts and the repaid amount would be about 3.5 times as large as the actual debt sum. Until today the tax-payer was not charged with the servicing costs, because the state made its payments by taking on new debts. That’s how the indebtedness has accrued during the past 6 decades. But this time the tax-payer would have to be directly charged with additional 4.6 bn. per month apart from the normal tax load. Alas, in the meantime the monthly rate for merely servicing the debts has gone up to 5.7 bn. And the state is taking on new loans in order to hide the fact, that it is bankrupt since decades and to make the tax-payer feel as if everything was fine.

Over-indebtedness is a worldwide phenomenon, virtually all states are suffering from this predicament. And even though governments know that this problem has to be solved, no one has a solid plan for getting rid of debts much less is anything effectively done about it. A similar predicament arises from the same structural mismanagement in nuclear power plants. Since 30 years they are producing thousands of tons of radioactive waste without having solid plans for its treatment. And while a sensible solution for the problem is postponed and postponed and postponed the piles of radioactive waste are growing bigger and bigger and increase the danger of accidental or deliberate (e.g. by terrorists) pollution. The same structural pattern of behaviour applies to the financial sector of national economies.

The mechanism for the accelerated growth of indebtedness and corresponding monetary assets – a veritable infernal machine – is described in full detail in “The Money Syndrome” by Helmut Creutz.

Now, Wolfgang Schäuble, Germany’s Minister of Finance, tries to involve private creditors for tinkering an emergency parachute (“Rettungsschirm”*) for Greece. At first glance it seems a sound idea to have creditors waive a part of their claims. After all, some of these creditors have made good profits at the cost of the Greek state. The trouble is, they can’t be made to do so, because there is no law to compel them. They can only be asked to give some of their profits back on a voluntary basis. So, who should ask the creditors and who of the creditors should be asked? Private banks may be among the profiteers, but their main task is to administer the funds of their clients and to play a role as mediators between creditors and debtors. They are obliged to their clients, in particular to the creditors. But they know who the big winners are and they could ask them. Would they? I don’t know, but let’s have a look where the big winners could be found.

Firstly, in contrast to a widespread misconception, we must understand that as consumers we all pay interest even though we have not taken a loan at all. Loans are an important tool for investment and for overcoming temporary liquidity shortages in the economy. The state is not the only debtor in the economy but the largest debtor and the only one who pays interest by taking on new debts and ne­ver repays its debt. Private entrepreneurs repay their debts and calculate all arising expenses into the price for their produce including accruing interest. Therefore all consumer prices contain an interest share that may vary within a broad range between 10 to 70 per cent depending on the amount of capital employed for production. On average today’s consumer prices include an interest share of at least 40 per cent.

The following graph is taken from the book “The Money Syndrome“. It shows the market participants divided into 10 groups according to their disposable income and the amount they are using for consumption per year (the green columns). The orange columns indicate the interest payments hidden in consumer prices and the blue columns show average interest returns that the members of the respective groups receive from owning an interest bearing asset.

The following graph is an extraction of the above figure and shows the balance of interest payments and interest yields. The balance of group 9 is almost even. The members of this group own interest bearing assets worth at least 450,000 euros, which yield as much interest returns as they pay while annually spending 50,000 euros for consumption. All lower groups have smaller assets the returns from which don’t suffice to compensate for the losses in consumption. Therefore, their balance is negative. Only group 10 has a positive balance and collects what the majority of market participants (groups 1 to 9) lose in this game. The growing gap between rich and poor is often referred to in the public discussion, but no one ever asks how it is caused. At any rate, primarily the creditors in group 10 should be asked to contribute to the emergency parachute for Greece, because they are the winners in the game.

This system of compound interest is the basic mechanism for redistributing wealth from the poor to the rich. Mathematically, compound interest is an exponential function, which inexorably leads to a crash of the financial system. Nothing can be done to prevent this crash. All measures that had been taken in the current financial crisis only served and still serves to uphold the existing system. It’s not a matter of doubting the willingness of responsible politicians to try their hardest for finding a solution to the Greek dilemma. They are trying to do so on the premises of current economic thinking. And whatever measures they may come up with on these premises will not prevent a devastating outcome, because it is based on the ignorance of a systemic flaw. The thinking of the majority of economists is conditioned in an obsolete view of how the economy works and they cultivate a blindness for the fundamental flaw in the system. This led Dr. A. Bartlett, a physicist, to the conclusion: “The greatest shortcoming of the human race is our inability to understand the exponential function.”

I found at least the statement of a well-known German banker, Josef Ackermann, chairman of the board of the Deutsche Bank. In an interview with the Frankfurter Allgemeine Zeitung (FAZ, June 30, 2009) he made a statement, which may give a hint as to the direction in which to look for a better system.

Ackermann: Conventional theories are essentially based on a static model of equilibrium, in which all transactions occur simultaneously – i.e. time does not play a role. Money only appears as a kind of veil over the real economic activity, but doesn’t have a relevant impact. Similar things can be said about portfolio-theoretical and monetaristic approaches…

FAZ: These theories make a bet without considering time, so to speak.

Ackermann: If processes are considered in time – e.g. money can be spent only after being earned -, this leads to different conclusions. Then money and the creation of money play a central role. Until today this has been neglected in conventional models. Not at last the current financial crisis has shown, that the effects of the money sphere on the real economy are still insufficiently investigated.

Hans Eichel, a former Minister of Finance in Germany, was once asked by a pupil: „How does money come into existence?“ His concise answer is in perfect accordance with the established practice: „We borrow money from ourselves and we pay it back to ourselves.“ This doesn’t really answer the question, though, because the one, from whom I borrow money, should have it already, otherwise borrowing would be futile. So, where does money really come from?

The established conception of money rests upon the belief, that the market participants of a national economy have a potential to create values out of nothing by performing labour. That’s the state’s treasure. In order to excavate this treasure, the state issues “treasury bonds”, whereupon the central bank issues money, which starts and supports the economic process, i.e. the seizure of the treasure. However, treasury bonds of the state are only backed by a promise for future actualization. While the market participants incessantly create values and sustain the economic process, the state (i.e. its administration) goes on issuing promise after promise and fails to fulfil its promises until it finally loses trustworthiness and goes bankrupt. Usually, the state is blamed then of having lived beyond its means. But that’s not true, the normal citizens are not to be blamed for the bad job of their repre­sentatives, the politicians. This is what happened in Greece now. In this respect Greece’s economic fate maybe considered as an omen and sooner or later all states which are based on this monetary conception, i.e. virtually all states of the world, are going to run into the same trap. Ben Bernanke might be right. But it’s not Greece which causes a disaster of such a dimension. Instead, a tremendous worldwide tension has built up from the inherent systemic flaw of the system as never before in history, which only needs to be triggered by a butterfly’s flap in order to crash.

Let’s have a closer look now at Ackermann’s suggested alternative: “money can be spent only after being earned”. This is fully compliant with the everyday experience of the vast majority of market participants, who accept money as remuneration for accomplished work, which in turn entitles them to purchase equivalent services or goods that are offered in the market. The conception does away with promises, it has nothing to do with credit or debenture bonds, but acknowledges and documents what actually exists, here and now. And Eichel’s answer to the pupil’s question would sound quite differently, too: “We acknowledge each other’s performances, document them with the useful tool called money and exchange goods and services with it.” This ties money to actual processes, while Eichel’s original answer is a circular argument which ignores any link to the real economy. In contrast to the established practice where money is “backed” by debts, money would then be backed by actual goods and services that are offered in the market for sale.

Ackermann’s complaint about neglected investigations into the impact of the financial sphere on the real economy concerns the credit and interest system. In a situation, when the economy is in a boom cycle, banks generously grant credits to companies and consumers, because it’s quite likely that credits get repaid inclusive interest payments, although in such a situation the demand for credits is lower. But the granting of credits and engaging in investments is their main business and of course they are trying to partake in the situation. In bust cycles, however, banks become parsimonious and meticulously investigate the applicants’ ability to repay. The banks’ behaviour is pro-cyclic, i.e. they support a booming economy and they obstruct it in a bust cycle. This is not in favour of a sustainable economy and has a lot to do with the interest system and also with the state’s indebtedness. Interest has to be paid, no matter in what a condition the economy is. After all, this is the law and it’s a man-made law. And interest rates are always positive, even if the economy cannot earn enough to pay for them. Therefore, in a recession, the state is required to take over the idle capital by taking on debts in order to boost the economy. After all, the state enjoys a high degree of creditworthiness and is (was) deemed unable to go bankrupt. This keeps interest rates in a positive range, even though and particularly in a saturated economy they should be allowed to decline in market conformity to zero or temporarily even below zero. Thus, the state itself gets under pressure for increasingly being unable in the long run to reduce its debts in an orderly way. A state at the brim of insolvency like Greece, being classified as C by rating agencies would have to pay interest at an usurious rate of around 20% which would eventually destroy not only the state but the economy as well.

This is the special feature of our established capitalist system, which Heiner Geißler, social politician of the Christian Democrats, has concisely characterized: “Capitalism is theft endorsed by the state.” His associate of the CDU, Angela Merkel, in negotiating the “emergency parachute” for Greece and possible other members of the EU with experts of the IMF, ECB and European Commission, did so with the declared intent to go to the roots of the problem. That was a slightly immoderate statement, though, considering the outcome of these negotiations. The “emergency parachute” or by its official term “European Financial Stability Facility (EFSF)” is still far away from the roots of the problem. Thorough investigations into the impact of the financial sphere on the real economy are still badly needed and long overdue.

The Greeks cannot be blamed for having invented the interest system. They can even refer to one of their outstanding ancestors, Aristotle, who clearly described the nature of interest:

“Money was intended to be used in exchange, but not to increase at interest. And this term interest, which means the birth of money from money, is applied to the breeding of money because the offspring resembles the parent. Wherefore of all modes of getting wealth this is the most unnatural.” (I.1258b4 – Wikiquote: Aristotle)

I have met Cassandra the other day and she, being a well-known figure in Greek mythology, too, said with a gloomy look in her eyes and a voice pregnant with meaning: “Capitalism is doomed!”

I know. But who would listen to her and give birth to an insight?

By Robert Mittelstaedt