Seminar für freiheitliche Ordnung
der Kultur, der Wirtschaft und des Staates e.V.
Zeitschrift/journal
Fragen der Freiheit
(questions of liberty)

 

 published in No  228 - page 32 - 64 (1)

Prof. Dr. Dieter Suhr ()

University of Augsburg

1990

The Neutral Money Network

(NeuMoNe)

A Critical Analysis of Traditional Money

and the Financial Innovation "Neutral Money"


German-Version


 
     

    CONTENTS 

    1. Introduction
    1.1. Points of Departure 
    1.2. Difficulties in Understanding 
    1.3. Getting at the Problem 

    2. From the Self-Supply Economy to the Money Economy
    2.1. Lack of Transactions in the Robinsons' Economic Community
    2.2. Transaction Costs in the Barter Economy 
    2.3. Transaction Costs in the Money Economy 
    2.3.1. Money as a Social Relation Good 
    2.3.2. Saving of Transaction Costs
    2.3.3. Money as Prerequisite for Transactions 
    2.3.4. Novel Transaction Impediments
    2.3.5. Money Interest as Novel Transaction Costs 
    2.3.6. Transaction Costs of Freshly Issued Money 
    2.3.7. Interest as Constraint on Transactions
    2.3.8. Incongruencies of Money's Costs and Benefits 
    2.3.9. Creation and Destruction of Money 

    3. Traditional "Saving and Investment"
    3.1. "Money" versus "Capital"
    3.2. Overcoming the Resistance in our Minds
    3.3. "Saving" as Quasi-Destruction of Money
    3.4. "Lending" as Quasi-Issuance of Money

    4. The Structural Nonneutrality of Money
    4.1. "Lending instead of spending" versus "Borrowing instead of selling"
    4.2. Timing Freedom of Money versus Timing Uncertainty of Transactors
    4.3. Production of and Profits from Money's Liquidity 

    5. Interest Free Money: The Neutral Money Network
    5.1. The Theoretical Carrying Cost Concept
    5.2. Competition between Current and Neutral Money
    5.3. Some Technical Details
    5.3.1. Neutral Bank Money and Neutral Paper Money
    5.3.2. The N-money account
    5.3.3. Refinancing N-money Credits
    5.3.4. Charging the Costs of N-money Services in Traditional Money
    5.3.5. Symmetric Liquidity Costs for Positive and Negative N-money Balances
    5.3.6. Avoiding Liquidity Costs
    5.3.7. Switching from Traditional Money to NeuMoNe and vice versa 

    6. Three Objections concerning the Neutral Money Economy
    6.1. Saving without Interest
    6.2. Enough "Capital" without Interest
    6.3. Pricing and Allocation without Interest 

    References


 

1. Introduction

1.1. Points of Departure

Our thesis is: in spite of their formidable efficiency, current Western free market economies still suffer from significant deficiencies in their monetary transaction system. Abolishing these insufficiencies of traditional money would increase not only the economic efficiency of the free market exchange system but also its fairness and its social justice.

The insights that clear up both issues, that is, the monetary deficiencies as well as how to improve money's exchange services, are very simple. Above all, they are quite in line with modern monetary economics which says that money saves information and transaction costs and thus economizes economic communication: money extends the frontiers of profitable transactions and through that it also widens the frontiers of production as well as of consumption and increases welfare.
 

1.2. Difficulties in Understanding

In spite of their simplicity, the following concepts meet with resistance in our minds. This difficulty, however, lies "not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds" (Keynes, 1936, p. VIII, regarding very similar intellectual endeavours). For instance, practically all economists are still convinced that our current money, with very few exceptions, is already as efficient as it can be and, hence, does not require any substantial change or improvement.

To steer clear of the hindrances associated with traditional thinking, we shall start from some very elementary observations and proceed step by step from Robinson Crusoe to the money economy and, finally, to our monetary pilot project. This financial innovation, namely the Neutral Money Network, is designed to compete with traditional money. Since the transaction services in this new network are cheaper than those of its traditional rival, our Neutral Money Network is destined to win out.
 

1.3. Getting at the Problem

Modern monetary economics says that money saves information and transaction costs. One can easily visualize that: without money, individuals would have to look for exchange possibilities, that is, to gather information about potential exchange partners and their goods. In addition, it is very complicated to estimate the value of the goods if there is no monetary unit suitable for valuing and pricing them. Hence, barter exchange is cumbersome and costly requiring a tremendous amount of transaction endeavour. Employing money, however, one simply sells and buys goods on the markets. Thus, selling and buying, intermediated by money, is convenient and cost saving.

But money does not merely save information and transaction costs. It also gives rise to a new kind of monetary transaction cost, unknown in a barter economy and virtually ignored in economic theory up to now. My aim is to visualize and to develop an awareness of these novel transaction costs, which burden individuals in our economy and which reduce money's cost saving efficiency. For this purpose we shall first look at an economy without exchange, then at a barter economy and, at last, at the costs (and the profits) that arise when money is introduced into the economy.
 

2. From the Self-Supply Economy to the Money Economy

2.1. Lack of Transactions in the Robinsons' Economic Community

Let us first assume an economy with individuals that are all living in complete self-sufficiency. These Robinsons do not exchange goods at all. Thus, there are no transaction costs. Everybody is dealing only with himself. One might think of transferring goods from one place to another, i.e. of transport through space, or of transferring goods from the present into the future, i.e. of storing them. But these are merely real procedures by way of which the goods are shifted to oneself, not transactions in the economic sence of socio-economic transfer between individuals.

Living self-sufficiently, our Robinsons are quite limited in many respects. They can only consume what they themselves produce. They are unable to make use of one another and to profit from socio-economic interaction. Rather they subsist on their personal ability and capacity to work. Hence, they are lacking nearly all the conveniences we are accustomed to.

For instance, superfluous goods which Robinson can dispense with today and of which he expects to have need of at a later date must be stored personally, causing storage costs. For Robinson lacks the opportunity to substitute his storage activities by simply giving the goods to somebody who needs them today and who would provide them at the date at which Robinson expects to need them himself.

Today, we can substitute the storage of real goods by claims to future goods or even by claims to future money. Robinson, however, must do without these freedoms. Or, in other words, Robinson not only misses out on the advantages from the division of labour but also on those arising from division of consumption between individuals along the time axis. He suffers losses from being forced to hold and store all the real goods he wants to "save" for consumption at a later date.
 

2.2. Transaction Costs in the Barter Economy

Second, let us look at transactions in a barter economy where individuals can make use of other individuals reciprocally. Since exchange will not be performed voluntarily unless every partner receives more than he gives, exchange involves a mutual increase in utility. Having the chance to exchange their goods, individuals can take the first steps to profiting from the division of both labour and consumption.

If, however, the performance of an exchange causes a partner to expect efforts and endeavours which exceed his expected gain then the exchange gets stuck in transaction costs. Indeed, as has been said above, barter is troublesome. In addition, individuals who produce for exchange run the risk not finding takers for their goods who will supply what they demand. The high transaction costs severely limit the range of exchange and through that also the frontiers of production and consumption.

Of course, exchange does not produce "costs" in the sense of pecuniary expenditures, because money does not yet exist. However, exchange is connected with real costs in the form of search work, communication efforts, bargaining energy, etc. It is this kind of cost that functions as a barrier which deters individuals from exchange. Customs have similar effects.

Hence, in a barter economy individuals soon reach a level of transaction costs that makes marginal exchange unprofitable and holds them back in the realm of self-supply. When producing goods for their own use, individuals at least know that they are serving their own needs.
 

2.3. Transaction Costs in the Money Economy

If money is introduced into the economy, then a new artificial good with characteristic properties appears on the markets.
 

2.3.1. Money as a Social Relation Good

With regard to self-supply, this new good is completely barren, that is, worthless: Robinson can not eat money, nor build a house with it, nor can he economize his costly storing by using money as a substitute for storing his real goods.

However, money is outfitted with properties which predestine it to be used in socio-economic situations either as a means of exchange or as a "store of value". In the latter case, money is useful in that it is a kind of claim or legal expectation which relates the money holder to the other individuals' supplies. Now money can be used as a substitute for the storage of real goods because there are others who have (or produce or store) and supply the goods in question and because money bestows on its owner the option to have access to those goods held by the others. This is why money is sometimes distinguished from usual goods by defining it as a "social relation good".
 

2.3.2. Saving of Transaction Costs

Money intermediates exchange and replaces it by selling and buying. Both, selling and buying, are economic transactions. Thus, we can still speak of "transaction costs" when the costs of the whole two-stage procedure of selling and buying or the costs of each half-stage exchange are concerned. Similarly we may, in general, talk of "transactors" instead of "sellers" and "buyers". Although transactors in the money economy have to perform two transactions instead of one exchange to reach their transaction goal, namely selling and buying, there is no doubt among economists that these two-stage transactions are much more efficient than one-stage exchange, and this advantage is because money saves information and transaction costs (above 1.3.).

With money as a socio-economic institution transactors can simply send the goods offered by them and call for the goods they desire through the channels of specialized markets. Money is the admission ticket to these institutionalized transaction channels of the money economy. The efficiency of the monetary institutions extends the range of profitable transactions substantially. Economic communications and transactions are increased significantly, and the frontiers of production and consumption are widened correspondingly. In addition, welfare grows greatly through the extended division of labour and consumption.

Note that this rise in welfare is due to the increase in profitable communications and transactions. It is the productivity of a more efficient system of information and transaction which brings forth more wealth. Productive or consumptive goods and services, supplied by others, are simply achievable at lower cost. We have not yet spoken of "capital" and its "productivity". There has been no need to use this term up to now because the phenomena could be grasped and described sufficiently in terms of individuals, goods, information, transactions and, most important, information and transaction costs.
 

2.3.3. Money as Prerequisite for Transactions

In a money economy with advanced division of labour and consumption, we may state that self-supply becomes nearly impossible. Individuals depend on one another. They are not only consumers and not only producers but practically always also transactors. Before they can obtain the goods desired for consumption or production they must transact. Transaction goes before consumption and also before production that is based on goods produced by others. The roles of the consumer as well as that of the producer who uses goods from others are preceded by the role of a transactor. And the role of the transactor always encompasses the role of an acquirer and spender of money. Money in the money economy becomes the very prerequisite for transactions and, consequently, of production and consumption.

Hence, individuals who, for whatever reason, are unable to play the role of an acquirer of money also can never assume the role of a money spender and will never succeed in buying goods or services. Moreover, it can be shown that the lack of money in the hands of needy individuals can virtually prevent them from otherwise feasible and mutually profitable transactions. Assume, for this purpose, a potential seller who struggles to acquire money by offering commodities, useful services or labour. Assume also that he finds a potential buyer who desperately needs the goods offered. Even then, the former will not sell his goods to the latter and receive money unless his potential buyer has money or is able to acquire it, for instance, by selling goods himself or by taking out a loan. Assume, again, that this potential buyer also knows another potential taker who needs his goods. Once again, even then he also will not be able to sell his goods and to receive money unless his potential taker has, or can get hold of, money ... etc.
 

2.3.4. Novel Transaction Impediments

Potential suppliers and producers, on the one hand, and potential demanders and consumers on the other are prevented from performing transactions that were readily feasible if only the potential transactors involved could employ the transaction lubricant "money". In other words, even if potential exchange partners are not veiled by the fog of ignorance, transactions can still get stuck due to a lack of money. One single individual without money can stop whole series of transactions, and, correspondingly, one single holder of money who does not spend or lend his money can make a whole series of transactors suffer from the same effect. Hence in the money economy individuals experience novel transaction impediments which are not existent in a barter economy.

Being unable to acquire money means being prevented from transacting. And not to transact means to be hindered from producing or consuming. He whose transactions get stuck because he can not acquire money is virtually excluded from the economic community.
 

2.3.5. Money Interest as Novel Transaction Costs

As we have seen above, exchange in the barter economy is cumbersome and costly. It becomes soon stuck in the impenetratable information deficits which veil the other individuals' needs, demands and supplies. Money, then, has proved its efficiency as a catalyst in creating communication channels which allow the penetration of the opacity of the sphere of economic interaction. However, we have also just observed novel difficulties for individuals who need to transact, namely the difficulty to acquire the money without which the transaction channels remain closed for them, and their planned transactions cannot be executed.

These novel difficulties concern the acquisition of transaction money by the potential transactor:

  • either, in the role of a seller, he fails to find a buyer (in which case the potential buyers often lack money too, because they cannot sell their goods ... etc.)
  • or, in the role of a buyer, he is prevented from borrowing money because he can not afford the interest cost of that loan money: the interest cost that makes the goods more expensive for him than they are for others.
Let us now focus our attention on these interest costs by which potential transactors are hindered from performing otherwise feasible transactions: here interest paid for loan money functions as a prohibitive cost constraint for executing transactions though they would be profitable "in real terms". Since transactions are practically impossible without money and since interest is paid for money used to intermediate transactions, money interest possibly must be seen as a novel form of transaction cost which does not exist in a barter economy.

Note that in these cases interest does not at all figure as cost of "capital". The transactors pay their money interest not for "financial capital" but for being enabled to employ money in their transactions regardless of what the money is used for afterwards. Interest has not only to be paid for "financial capital" which is used to buy investment goods but also for loan money that is spent on consumption and even for money to convert debts or to finance a burial. Once again, it was not necessary to use the term "capital" to grasp und describe the economic phenomena in question.
 

2.3.6. Transaction Costs of Freshly Issued Money

Apparently, money not only saves costs, but it also gives rise to a novel form of transaction costs, namely to interest for loan money. These novel costs can be visualized best by observing the cost of freshly issued money to its users in the economy.

Assume an exchange economy where a central bank is created to print and issue money. As money usually is not given to individuals for nothing, assume also that the new money is issued by lending it to individuals who have need of money to save information and transaction costs. (This idealized method or model of issuing money conforms to the modern reality of money in both, first, that the banking system also creates fresh money by some form of credit and, second, that fresh money earns interest just as well as credit money from private money holders.) Assume also that consumers and producers, being informed about the advantages, plan to employ money to economize their transactions, and that the authorities have taken care of limiting the total amount of money.

Now the consumers and producers who take out loan money to be spent on goods have to take into account both,

  • first, the advantage of buying goods with money instead of burdensome exchange and,
  • second, the interest cost of the newly issued money.
By employing money, they can transact more economically. But the benefits from that are reduced by the cost which arises from acquiring the transaction catalyst "money". Hence, on the one hand, money makes goods cheaper in that they can be obtained with less efforts. On the other hand, however, money makes goods more expensive in that one has to add to the goods' prices the interest expenditure caused by the transaction instrument. Hence individuals who employ money save net transaction costs only if the gain from saving physical exchange endeavour is not balanced or outweighed by the novel pecuniary transaction expenditures called "interest".

These novel transaction costs were unknown in the barter world. Unknown were also the bank that issues the money and the yield to that bank from its issuance of money. As the costs of printing and issuing money are relatively low whereas the interest paid for it is relatively high, the bank profits from its money issuing services: "seigniorage" in the form of "return over cost" from issued money. In the end, thus, we have in the money economy not only novel transaction costs but also a new kind of profit which nearly exactly corresponds to the novel costs. The bank simply profits from the fact that the individuals have transaction needs and that money saves more costs in the course of their transactions than its own production burdens the bank with.
 

2.3.7. Interest as Constraint on Transactions

Interest paid for credit money increases transaction costs and thus functions as a cost constraint on transactions. While money as such widens the opportunity range of individuals and the transaction frontier in general, interest costs reduce that range and restrain that frontier. Even if the bank transfers its profits to the treasury to be spent on state expenses, these additional expenditures cannot compensate for all the other transactions that get stuck in all those cases where individuals find it unprofitable to transact on the basis of loan money, the interest on which makes prices higher for them than they are for others.

And here our introductory hypothesis concerning the inefficiency of current money is confirmed: because money does not only save costs but also gives rise to transaction costs which reduce the transaction frontier, our monetary system is suboptimal. It suffers from inefficiencies in that it causes novel costs.
 

2.3.8. Incongruencies of Money's Costs and Benefits

When the borrower spends his money he profits from spending and getting the desired goods. But the sellers of those goods now get money, too, and can act as buyers of other goods; and, again, there are second phase sellers who receive money that enables them to buy still other goods ... etc. Thus the money which is acquired by the first transactor in the series of transactions sets whole transaction chains into train. He enables all the others who are involved in those chains to profit from using money for transacting efficiently. Or, more fashionably worded, he produces "positive externalities" with the money for which he alone is bearing the original acquisition costs. While he incurs the interest cost, originating from the acquisition of newly issued money, and while he profits from that money just in one single transaction, the others enjoy the benefits from that money without being burdened with similar costs. This is an incongruency concerning the allocation of that money's costs and benefits.
 

2.3.9. Creation and Destruction of Money

When the loan falls due and the lender must pay back the credit, he then has to use some of his money for that purpose and is prevented from spending it on goods. In the same way in which he previously brought into motion a series of transactions by acquiring and spending money, he now interrupts a series that reaches him. The money which he refunds to the bank disappears from the markets. The transaction series which would go on if he spent the money instead of refunding it remains stuck due to the lack of money.

In monetary economics, issuance of money is also called "creation" of money. Correspondingly the disappearance of money from the markets and the secure keeping of it in a bank safe is named "destruction" of money, because money which is taken from the market no longer functions as a medium that saves transaction costs.
 

3. Traditional "Saving and Investment"

3.1. "Money" versus "Capital"

Note, again, that the interest paid for newly issued money has nothing to do with "capital", nor with "saving". The bank does not "save" anything. In particular, it does not sacrifice present consumption for future consumption, but just prints and issues its money. Nor do the borrowers get anything like "capital" from the bank. They simply acquire money for transaction purposes and pay interest exactly for that. If they spend the money afterwards on investment goods, i.e. on "physical capital", to increase the productivity of their enterprise, once again, the increment in efficiency comes from their being enabled by money to get hold of those goods. Hence the costs incurred to increase efficiency and productivity by employing newly issued money are costs, not of "capital", but of the transaction which leads to that (physical) "capital".

Of course, in the eyes of the "investor" who spends the money borrowed on productive instruments, the money acquisition costs are somehow connected with what he plans to do with that money. And afterwards, in his eyes, the costs seemingly adhere to the good that was purchased. But it confuses cause and effect and leads to fatal intellectual confusion in economics if one disguises through one's terminology as special "capital" cost what is actually general money acquisition cost and, thus, transaction cost.
 

3.2. Overcoming the Resistance in our Minds

Here one is inclined to admit that interest for newly issued money might, indeed, have to be understood in the way described. But one is also inclined to object that interest, which is received by private individuals who "save" money and which is paid by others who "invest" that money, must be seen as a "premium for saving" and as a "cost of (financial) capital". For, in these cases, funds which are not consumed apparently make production more effective. In this traditional view, interest is the price that equilibrates the savers' abstinence from consumption and the "productivity of capital".

However, even in these cases, we must be aware that the physical investment goods which make production more effective are not created by that "financial capital" at all. What happens is just that the borrowed money enables the "investor" to perform the transactions required to obtain the "productive" production goods needed. We have to see that there is an investor who needs investment goods and that there is also somebody who already has and offers these very same goods and that they have no chance to contract and transact unless the bank or somebody else supplies them with money. Here, too, money is the transaction catalyst that brings together the buyer and the seller of the investment goods in question, while a lack of money means that their transactions, which ideally (in "real terms") would be quite feasible, get stuck because of the inefficiencies of the monetary transaction system.

And, correspondingly, we must be aware that "saving" in our minds may be seen as something which it generally is not, and that we are led astray by the terminology used and by the associations induced by that terminology. And, in fact, at this stage in our investigation we encounter the most severe form of what we have called "resistance in our minds", namely that "the difficulty lies, not in the new ideas, but in escaping from the old ones" (Keynes). So we must make tabula rasa in its literally and original, Aristotelian sense, that is, we must try to think regardless of what we have been accustomed to think. To free ourselves we even have to go against the current of what has traditionally been seen as given in the realm of "saving and investment". For, if there really is an intellectual delusion that veils our sight and hinders us from understanding the inefficiencies of our money, then we do not have a chance to break free and clear up our vision unless we succeed in thinking anew, regardless of habitual concepts of "saving and investment".

In our case, "thinking elementarily" means applying the concepts and terminology of the modern transaction economics: "transactions" and "money" as the very means to economize on "transaction costs". The time-honored phrase, that interest equilibrates the "abstinence" of consumers and the "productivity" of physical "capital" is bound to the less precise ideas which also relate the psychology of individuals to physical properties of goods instead of dealing with the economic interactions influenced by those psychological and physical factors. In addition, it is not at all clear who the "investor" is: the saver when he lends his money (or buys nonfinancial assets), or the entrepreneur when he spends the borrowed money (or uses productive goods owned by others)? Above all, the traditional wording only relates to a special case. Not spending one's money has often other grounds than merely "abstinence" from consumption. For instance, it can be profitable to hold money or claims to money instead of holding goods the (marginal) costs of which exceed their (marginal) benefits. And borrowed money is not only employed for productive investment goods but also for consumption purposes. Interest, in the latter case, would be the price that equilibrates abstinence from present consumption and the very opposite, namely the proclivity for present consumption. Though this, indeed, would be a very inspiring variant of the traditional wording, it would raise doubts regarding the generality of the traditional concepts of "saving for investment".

Lending and, reciprocally, borrowing is the common procedure (or "point of intersection") of various series of economic interactions that can have very different motives on the side of the lender and on that of the borrower. We must be aware that interest on loan money has to be paid regardless of the lenders' different motives for "not spending" and "lending" their money and regardless of the borrowers' different purposes for acquiring money. In any case the lender abstains from using his money for present transactions and the borrower acquires that money, because he needs it for his present transactions.
 

3.3. "Saving" as Quasi-Destruction of Money

Lending one's money is preceeded by "not spending" it. Traditionally, to "save" means both, first, the procedure of "not spending" one's money and, second, one of the possible motives for that, namely "sacrificing" present consumption for an even greater amount of future consumption. The latter essential of traditional "saving" is of psychological character: it presupposes an unsatiable proclivity for present consumption, professionally called "time preference", which is dominated only by an even greater psychological preference for more future consumption. Here, however, we are not predominantly dealing with these psychological incentives, which, "at the margin", influence the individual's choice to "save" and "lend". We are concentrating on money and transactions.

Regardless of his psychological motives, the traditional "saver" does not spend his money on real goods but holds it back. In terms of transaction economics, he abstains from present transactions. Since, however, all transactions involve at least two people, abstaining from transactions by the one of them who does not spend his money simultaneously means that another potential transactor also abstains, or rather is prevented, from transacting. The money, which was originally acquired by somebody from the money issuing bank and which incurred costs burdening that acquirer, now rests quietly in the cash box or safe of someone else who "saves" the money.

In the barter economy a person who abstains from exchange also possibly hinders someone else from exchanging. However, to hold back simple goods of the kind exchanged in that economy affects only those potential partners whose supply reciprocally meets the demand of the first individual who holds back his goods. In the money economy, however, one potential buyer who does not spend his money interrupts the whole series of transactions that would be set in motion by him if only he would continue to buy goods from potential sellers.

Thus, we have to state that the traditional "saver", during the time he holds instead of spends his money, blocks the series of transactions that would go on if he spent his money. Or, in more fashionable terms, this saver produces "negative externalities" to others who suffer from not selling, that is, from being prevented from acquiring money. The "saver" in his role as a "non-spender" who keeps his money securely in the safe or stores it elsewhere makes the money disappear from the markets.

Remember, now, that the disappearance of money from the markets and the keeping of it elsewhere is called "destruction" of money when it is done by the bank that issues money and then gets it back (above 2.3.9.). Here, where it is done by private "savers" the effects are the same. The "saver" behaves like a small private quasi-bank that destroys money for a period of time.
 

3.4. "Lending" as Quasi-Issuance of Money

Usually, traditional "savers" do not hold abundant amounts of cash. Rather they lend their money to others. By doing so their money reappears on the markets. Of course, they do not "spend" it: they do not initiate a new series of transactions by themselves. But they enable somebody else to do that. And, again, we must remember that introducing money into the realm of transactions is called "creation" of money when it is done by the bank. Here, where it is done by private lenders of money the effects are the same. The "lender" behaves like a small private quasi-bank that issues money for a period of time. And just like the bank, which profits from the interest that substantially exceeds the cost of its money issuance, now the lender in his role as quasi-issuer of money profits from the fact that the interest earnings substantially exceed the cost of the procedure of "not spending" and "lending" the money. He earns a quasi-seigniorage from his quasi-issuance of his quasi-destroyed money.

Thus, the procedure "lending instead of spending" one's money is profitable as such and functions, on its own, as an artificial incentive for individuals to postpone spending because of the profits from doing so. This also explains where the increment of prospective consumption comes from which makes individuals save more than they would without the profit mechanisms of "lending instead of spending". Hence interest does not come from an original sacrifice of present for future consumption but, the other way round: the money economy offers to individuals the profitable seigniorage from "lending instead of spending" and in this way it intices them artificially to sacrifice present for more future consumption.
 

4. The Structural Nonneutrality of Money

4.1. "Lending instead of spending" versus "Borrowing instead of selling"

Traditionally money has two essential functions, namely as a means of saving transaction costs and as a "store of value" (above 2.3.1.). Meanwhile, we have learned that holding (in the sense of "not spending") one's money means to withdraw that money from the market and to block a series of transactions: "private quasi-destruction of money". We have also learned that "lending" money means to profit from that blockage and to burden transactors with novel transaction costs each time the profit mechanism of "lending instead of spending" is applied: private quasi-issuance of money with private quasi-seigniorage.

However, the option to profit from "lending instead of spending" presupposes that the individuals involved do not personally use their money for actual transactions. This is the case when they are satisfied that they have, at the margin, dispensable money. This is not the case with needy individuals who require money for purchasing goods nor for needy individuals who plan to produce goods in order to sell them for money to live on. Hence, the current money system gives to the satisfied individuals the option to blockage the transactions of the others and to profit from this blockage.

The current monetary system endows the rich, who are outfitted with wealth already, with the additional option to profit from the game of "lending instead of spending". And the option to lend and not to spend is completely free to the wealth holders. They decide voluntarily, calculating only in terms of more or less profit ("opportunity costs").

The others, who still have substantial physical needs and, thus, also transaction needs, are endowed with the reciprocal role in that game, namely with the role of the borrower in the game "borrowing instead of selling". The needy do not decide to borrow voluntarily. They are forced by their needs to do so, and they calculate in terms of the real costs with which they burden themselves.

The reciprocal structure of profitable "lending instead of spending" on the side of capital and expensive "borrowing instead of selling" on the side of consumers and producers represents in nuce the asymmetry or, in professional terms, nonneutrality of money. The lender exploits the transaction needs and, by that, also the physical needs and the economic activity of borrowers: not, once again, by "supplying financial capital" but by giving up their blockage of transactions for a period of time. This is exactly how our money makes the poor, the needy and the active pay for the superfluity of the rich, the satisfied and the idle ones. And this is exactly how our current money's inefficiencies are accompanied by injustice and unfairness.
 

4.2. Timing Freedom of Money versus Timing Uncertainty of Transactors

In the barter economy, transactors, in their exchange contract, have to decide about the date at which each partner is to receive the other's supply. So the receiver of the first partner's good is sure also to have his own good exchanged at the contracted time. However, the seller who contracts in the money economy must not decide about the time of his demand for certain goods, not even about the time at which he wishes to decide about the spending of the expected money. From this freedom of the money holder to decide freely about goods, partners, places and timing of his own demand originates uncertainty for the other suppliers about their supply. The money holder's freedom of timing is strictly associated with the supplying transactors' uncertainty of timing. The money holder's opportunities and benefits are the transactors' risks and costs.

This, again, shows that money imposes on the economy an asymmetric distribution structure: individuals who can already afford to hold money instead of being forced to consume their income are given the valuable freedoms of money while the others, who are less satisfied, are burdened with risks and costs. This is a kind of steady stream or transfer from the active and the industrious who have the costs to the idle who have the benefits.
 

4.3. Production of and Profits from Money's Liquidity

If nobody accepts money, it is without any value in transactions. Money only functions as money, if everybody can reliably expect the others to spend and accept that money as the medium of economic transactions. Hence it is not sufficient for an authority or bank to issue the technical instruments of money. Bank notes and coins only become liquid money by being generally used as money. One may say that money receives its liquidity not from the issuing bank but from all the transactors who make use of it. It is the transaction activity of the individuals themselves that produces the moneyness of money.

The production of money's liquidity, however, is interrupted when individuals do not accept the others' money or when they do not spend their own money. And here, again, he who interrupts and disturbs the process of producing money's liquidity profits from doing so, namely in that he enjoys the "freedom of timing" and has the option of "lending instead of spending", while the others suffer from being forced to "borrow instead of sell". Hence the money holder profits from the liquidity of money which is produced by the others.
 

5. Interest Free Money: The Neutral Money Network

5.1. The Theoretical Carrying Cost Concept

We had to analyse traditional money and its effects thoroughly and vividly to see that it really brings with it inefficiencies and injustice. Now the time has come to show that traditional money need no longer be accepted as some kind of invariable fate. There are many ways to explain the practical concept of neutral money. An instructive one is to start from the freedoms which money grants to the money holder. In economics the valuable conveniences of money have borne names suitable to bring to our minds, from different points of view, the phenomenon we are dealing with: "conveniences", "liquidity premium", "money services", "yield from money held", "grant of money", "productive services of money", "money stock utility".

These benefits of money at hand are constituted by the genuine ability of money to serve as a means of economic transaction. However, the transaction function of money is undermined in that money yields its services for free even, and in particular, when it is held back and prevented from functioning as it should. It is this power to sabotage the transaction series, and to profit from that, that makes money suboptimal with regard to its efficiency. The valuable services of money intice individuals to hold money or to lend it instead of spending it. So, if we plan to reduce money's dysfunctions and to improve its efficiency we have to remove or neutralize the distribution effects of money by which the money holder has the benefits and the pecuniary returns and the others have the costs, risks and expenditures.

Since the cause of the distribution effect, namely money's liquidity services, can not be eliminated without abolishing money itself, the strategy must focus on neutralizing the effect. This can be done in a way which is extremely simple, at least, as far as its theoretical foundation is concerned. For, if the problem is that money yields its money services for free, then the positive psychological effect of these services can be compensated for simply by attaching to money disutilities in the form of costs so that their negative psychological effect counterbalances the positive one.

Thus, the concept is simply that money held must incur "carrying costs" or "storage costs" to compensate for money's liquidity premium. Or, in more professional and general words: liquid real-M balances must be connected with symmetric costs such that these costs, at the margin, equalize the benefits from being liquid. The elementary formulae that underly these ideas can be found in John Maynard Keynes' General Theory (1936, pp. 225­229). Keynes considered in detail the effects of such "carrying costs". He even incorporated modest liquidity costs of this kind into the so called Keynes Proposals for the International Clearing Union.
 

5.2. Competition between Current and Neutral Money

Current money is suboptimal because it triggers dysfunctional transaction costs in the form of money interest which either burdens transactors with pecuniary expenditures or totally deters them from feasible transactions. Hence, the appeal of our project lies in offering transactors a financial innovation which readily performs the usual transaction functions of money, but does this at lower costs. By offering to the potential transactors monetary transaction services that are cheaper than those of current money one can expect that through this service the Neutral Money Network (NeuMoNe) financial innovation will win the competition against current money.

However, current money has the superior starting position because everybody accepts, spends and uses this traditional medium of payment whereas NeuMoNe still has to be implemented and propagated. Moreover, in monetary affairs, people usually are extremely careful, reserved and conservative. Nevertheless, the spreading of barter clubs shows that financial markets leave an opening for transaction techniques that are even less effective during the introductory phase than neutral money will be. In particular, NeuMoNe is very flexible in that it offers facilities to use one's neutral money as a basis for current money and vice versa.

Of course, the starting phase is the hardest because neutral money cannot yet prove its efficiency as long as participants of NeuMoNe are still so rare that they have search costs to find partners, and costs of frustration if they can not find them at all. But these starting impediments can be reduced substantially if, for instance, local authority treasuries declare their participation. The pilot projects which were launched in Schwanenkirchen in Germany and Wörgl in Austria during the depression of the Thirties give evidence that it is not impossible to introduce cost-bearing money. On the contrary; these projects apparently worked so well and threatened to spread over the country so fast that they could only be stopped by the authorities' prohibition and suppression of them. They could be prohibited because they used notes as the technical instrument for payments and this was illegal. They attached liquidity costs to these notes, the reverse side of them was divided into 12 spaces (for every month) or 50 resp. 52 spaces (for the weeks of a year) with the provision that the notes only maintained their face value if they were stamped periodically.
 

5.3. Some Technical Details

5.3.1. Neutral Bank Money and Neutral Paper Money

NeuMoNe makes use of the legal competence of banks to create or issue bank money. It works on the basis of giro or checking accounts. Hence, the concept has also no technical problems with charging the participants the liquidity costs. In this, NeuMoNe also differs significantly from Irving Fisher's famous Stamp Scrip proposal to provide unemployment relief and to stimulate trade in the USA 1933 (Fisher, 1933). The Stamp Scrip concept, like the projects of Schwanenkirchen and Wörgl, was also based on special notes. In spite of that, Fisher's and Cohrssen's compelling plea for cost bearing money as well as their popular and vivid description of practical recommendations for the implementation of Stamp Scrip suggest themselves as inspiring and helpful models for our NeuMoNe project. Thus, whoever begins with the practical work and then has a desire for more ideas and stimulation should consult Stamp Scrip. Moreover, if NeuMoNe is supported by the state government so that legal provisions even for the issuance of NeuMoNe notes can be arranged, then Stamp Scrip will offer still more information and instructions directly for the implementation of that financial innovation.
 

5.3.2. The N-money account

The initial group which launches NeuMoNe could or should be joined by local businessmen, enterprises, consumers' associations, unions etc., including, in particular, municipalities and local authority treasuries, the more the better. Most important, of course, is the participation of a bank (or banks) which should be deeply rooted in the local checking and giro accounting procedures. It is not necessary that the participants declare an unlimited readiness to accept NeuMoNe as payment in all their transaction activities. It is sufficient that they participate by opening an account for NeuMoNe and are willing to decide about whether and to what extent NeuMoNe will be accepted from case to case or by declaring general conditions. The broader the acceptance, of course, the better it is for the launching of the NeuMoNe pilot project. The bank (let us call it "N-Bank") has the chance to attract new clients who expect to profit from the NeuMoNe banking services. Municipalities and entrepreneurs have the chance to finance additional projects without incurring additional interest cost. Individuals can profit, for instance, by gradually substituting debts in traditional money, burdened with interest costs, by debts in NeuMoNe, freeing them from interest ... etc.

The central idea is that N-Bank credits to its clients N-money balances at an interest rate near zero but with liquidity costs for the time of holding that liquid N-money balance. (Conventional interest also includes a premium or price for the default risk. In the NeuMoNe system this risk premium or price can be charged as if it were interest or, for instance, through a single charge at the beginning of the whole credit period.) If a client disposes of his liquid N-money balance so that the next N-money client receives that money on his N-money account the former frees himself from those liquidity costs by shifting the N-money, together with its costs, to the next participant in NeuMoNe. In this way every participant bears liquidity costs only for the exact time, and for the extent to which, he is actually liquid. N-Bank, however, continues to receive its liquidity costs since the money which is debited to one client is simultaneously credited to the next one. As N-money migrates from account to account, it is accompanied by N-money's liquidity costs.
 

5.3.3. Refinancing N-money Credits

However, before N-Bank can credit N-money balances for the first time it has to refinance the funds in some way or other by selling bonds on the financial markets or by canvassing saving or other deposits. (Of course, the initial endowment with money to launch NeuMoNe can also be supplied by the members of the NeuMoNe pilot group who, in this case, would not even have to do without interest.) For this conventional outside money N-Bank has to pay traditional interest. Consequently, N-Bank has to charge its N-money clients costs high enough to pay that interest, to cover expenses and to make a profit. N-Bank will provide for that by calculating an adequate margin between the interest paid and the liquidity and other costs charged to its N-money clients.
 

5.3.4. Charging the Costs of N-money Services in Traditional Money

Instead of charging its N-money clients conventional interest for loans, N-Bank charges them liquidity costs for holding liquid N-money balances. In this way N-Bank transposes conventional interest cost into novel liquidity costs and transforms the traditional money into neutral money. However, there is one difficulty regarding the liquidity and other costs of the NeuMoNe services: during the starting phase of NeuMoNe and as long as NeuMoNe has not yet superseded traditional money, N-Bank has to meet its own liabilities in traditional money. Thus, N-Bank has to charge its NeuMoNe clients costs which are accounted in traditional money. The result is, that NeuMoNe payments are made by checking or giro orders using the N-accounts with N-Bank while the cost of that, for the time being, must be paid for in traditional money. Hence, it would be convenient for N-Bank and its NeuMoNe clients to have a conventional banking account with N-Bank besides their NeuMoNe account.
 

5.3.5. Symmetric Liquidity Costs for Positive and Negative N-money Balances

Another unusual measure must be dealt with here, namely why will the NeuMoNe-accounts be charged with symmetric liquidity costs, regardless of whether the NeuMoNe liquid balance is positive or negative.

The Stamp Scrip project and the other predecessors of neutral money were based on paper notes. The notes always represented a positive money balance. NeuMoNe accounts, however, are suited to represent positive as well as negative liquid neutral money balances:

  • Positive liquid balances, like paper money, represent monetary expectancies to transact (to spend money) at an undetermined future date. Herein appears the "freedom of timing" considered above (4.2.): a freedom which is accompanied by the uncertainty of others to transact (to acquire money). Under neutral money this freedom is no longer cost-free. It is connected with liquidity costs.
  • Negative liquid balances, unlike paper money, represent the negative monetary expectancies that reciprocally correspond to the positive ones, namely the expectancies to transact (to acquire money) at an uncertain future date to compensate for one's liquid debt.
Under neutral money it must not matter whether uncertainties originate from individuals who are free to decide about spending or from individuals who are free to decide about acquiring money. Hence, negative balances are to be charged with liquidity costs, too, in a way which is symmetric to the liquidity costs imposed on positive N-money balances. Keynes, in the Keynes Proposals for the International Clearing Union, also suggested such symmetric charges for liquid balances with the Union.
 

5.3.6. Avoiding Liquidity Costs

Clients can escape the liquidity costs of neutral money in different ways which are very instructive with regard to the characteristic differences between traditional and NeuMoNe financial theory and practice:

To reduce costly positive balances, they alienate N-Money by buying goods or by lending it either to someone else or to N-Bank itself. For instance, they transfer it to N-money saving accounts with N-Bank. This means that they are giving up their irresolution (rather than that they "save"!) and that they are rewarded for their decisive behavior by being relieved of liquidity costs (not by interest earnings).

To reduce costly negative balances, they acquire money by selling goods or by borrowing N-money from someone else or from N-bank itself. For instance, they take out a term loan in N-money from N-Bank to equalize their liquid N-money debt. This means, again, that they are giving up an irresolution (rather than that they acquire "financial capital"!) and that they are rewarded for their decisive behavior by being relieved of liquidity costs (instead of being burdened with interest for "financial capital").
 

5.3.7. Switching from Traditional Money to NeuMoNe and vice versa

NeuMoNe is flexible in that it enables clients to transform traditional into N-money balances and vice versa.

Of course, a positive N-money balance cannot be directly exchanged for the same amount of traditional money. This would ruin the system. However, clients can deposit their N-money on N-money saving accounts or buy N-money bonds so that they avoid liquidity costs and create securities with the bank which can be used as a basis for taking out a conventional loan. For this loan money the client must pay interest as usual.

A client who has to pay a liability in N-money and who disposes of the required amount in traditional money will not deposit this money on his N-money account to carry out the payment because he would sacrifice the costless benefits of traditional money for nothing. The bank will suggest that he deposits that money on a traditional money savings account or to buy bonds that yield interest and, then, to take out a loan in N-money for his payment purposes. Here we see that clients can profit from the margins between traditional and new money without endangering the NeuMoNe system. This option for clients to profit from the margins between old and new money is one of the ways NeuMoNe can win the competition with traditional money because even transactors with traditional money at hand have an incentive to persuade their partners to participate in the NeuMoNe accounting system. And by taking this chance they contribute, in the long run, to reducing the very same margins from which their profits come: they cause NeuMoNe to spread at the cost of traditional money.

The more NeuMoNe spreads the greater the chances of all participating banks to refinance NeuMoNe not in the traditional financial markets but in the markets in N-money financial instruments. Then, at last, N-money will be exchanged into traditional money and vice versa. The price of traditional money in N-money will exceed its face value because traditonal money will serve as the ideal liquid reserve asset which is worthwhile to pay a surplus price for. But the surplus properties of traditional money, then, will no longer give rise either to inefficiencies in the money economy or to social injustice and unfairness.
 

6. Three Objections concerning the Neutral Money Economy

In discussions concerning neutral money people regularly have certain objections which are quite convincing as long as one thinks within the patterns of practical behavior and within the corresponding theoretical concepts of the traditional money economy. It is, and it was for me, impossible to switch one's whole thinking from the world of traditional money over to the new world of the neutral money economy at once. As has been said above, it is difficult to cast doubts on current money's efficiency. It is even more difficult to understand the inefficiencies of current money and to construct theoretically a monetary transaction technique which avoids those inefficiencies. However, even then one is not yet at home in the new world of neutral money. The traditional modes of seeing, expecting and behaving are still at work inducing doubts upon doubts about the new concepts based on single experiences or theories which have originated in the environment of the traditional money economy.
 

6.1. Saving without Interest

One of these familiar objections is: "Who is going to save if he does not earn interest anymore?"

The answer is simple: everybody who cares minimally for his future has the incentive to distribute his life-time income optimally in a way so that he can maintain his expected standard of living also in times when he is no longer gainfully employed. If, however, these careful individuals receive interest rewards for postponing consumption, then they are motivated and induced to consume less in the present and more in the future than is actually optimal according to their own "real" preference schedules, not to speak of the others who have to finance that increment of future income by being forced to consume less at that time. "Interest" does not push forward production by rewarding "saving"; rather it counteracts present activities because it rewards the present inactivity of the "saver" and, at the same time, punishes the entrepreneur with costs for his transaction and, thus, for his production activities. Moreover, all investments which are modestly profitable "in real terms" but which do not render returns that match the value of money's yield are blocked because of too high pecuniary transaction costs called "interest for financial capital".

Borrowers who no longer give away money to meet their interest liabilites will use it for other purposes. They can "save" it and buy claims to future money. They can spend it on present or future goods. Since individuals who take out loans usually need that money for goods, they will predominantly use their saved interest to purchase goods. Consumers will demand more consumptive and producers will demand more productive goods than today. On the other hand, wealth holders who do no longer earn interest can spend less money. They will reduce their demand either for real goods or for assets. Since lenders typically dispose of dispensable money they will still intend to "save": more real goods would render to them shrinking marginal utility but burden them with rising marginal cost. Therefore it can be quite profitable for them to avoid the cost of additional riches by holding costfree bonds, even if the bonds yield not interest.
 

6.2. Enough "Capital" without Interest

Another objection, closely related to the first, is: "There will be a lack of financial capital and, hence, less productivity if capital does not earn interest any longer."

As has just been said, "capital" stands for returns on loan money which do not increase but disturb and decrease the efficiency of money as the transaction catalyst in our economy. (The same is true for "capital" in so far as this term stands for returns on real goods which are let out or leased or used by others in even other ways: the active users will not be able to bring to life these goods' efficiency unless they finance returns that, roughly speaking, correspond to the interest which they would have to pay if they bought the goods instead of being allowed in other ways to use the goods of the others.)

It is part of the "resistance in our minds" that we believe in the "productivity of capital" whereas, in fact, this alleged productivity of financial or other "capital" exhausts itself in incentives for abstaining from real activities on the supply side and in punishments for engaging in activities on the demand side of "capital". Hence "financial capital" is virtually nothing but, first, the term which is given to the embodiment of a conceptual self-deceit and, second, the term for the ideological legitimation of present money's inefficiency and of the social injustice springing from it. We suffer from a fatal capitalistic delusion which lets counterproductive "capital" be considered something productive!
 

6.3. Pricing and Allocation without Interest

Another objection is: "When credit incurs no interest costs, then individuals can acquire infinite amounts of money. This is absurd and shows the absurdity of the idea of neutral money. Interest is, and must always be, the price which allocates financial resources." The answers, again, are simple, though I admit that it might require some exercise in elementary economics to understand them:

If the present demand for transactions is no longer constrained for needy borrowers by interest costs, then the prices to be paid in the course of these transactions respond more adequately to the real present demand of these transactors. And, correspondingly, if the present demand for transactions is no longer subsidized for wealthy lenders by interest income, then, once more, the real needs of both lenders and borrowers are more adequately reflected in the spot prices, and this holds true, in particular, regarding the present prices of future goods. Hence, instead of the price of money falsifying the price of goods, making them cheaper for the rich and more expensive for the poor, neutral money is transparent and reflects the real needs in an unfalsified way, giving the poor a chance to acquire goods at costs similar to those at which rich people can acquire them and giving the rich the chance to experience a life without being artificially subsidized. With the prices reflecting the real needs more adequately, allocation of funds will be improved. Prices will respond to these changes in demand. Therefore the counterproductive allocation by the price of money (interest) will be substituted for by the more efficient allocation by the prices of the goods themselves.

With the subsidies for the wealth holders tending to zero, the accumulation of real goods becomes costly instead of being profitable because the increasing marginal cost of goods overcompensates their declining marginal utility. Hence, the real costs of goods limit the mass of goods which are worthwhile holding. Then, individuals will not be so irrational to take out unlimited amounts of neutral money credits (which must be spent to avoid liquidity costs!) if additional goods only bring to them more (marginal) cost than benefit. The absurdity, thus, is not with neutral money, but with the present system which motivates and induces wealth holders to hold goods which they do not need and, at the same time, to prevent others, who need the goods, from using them. Neutral money is both destined and suited to abolish these deficiencies in the allocation of goods.

Besides, who or which bank will be ready to credit to a borrower more than he is able ro repay? Even today, loans are limited not only by their (pure) interest cost but also by the costs of the default risk. Indeed, this should be the "real" limit on credits.
 

References

Fisher, Irving, 1933, assisted by Hans R. L Cohrssen and Herbert W. Fisher, Stamp Scrip. New York: Adelphy Company.

Gesell, Silvio, 1929. The Natural Economic Order. Berlin: Neo-Verlag.

Keynes, John Maynard, 1936. The General Theory of Employment, Interest, and Money.London: Macmillan, (1961).

Suhr, Dieter, 1983. Geld ohne Mehrwert. Frankfurt: Fritz Knapp.

Suhr, Dieter, 1989. The Capitalistic Cost-Benefit Structure of Money. Berlin, Heidelberg, New York: Springer.

Suhr, Dieter, and Hugo Godschalk, 1986. Optimale Liquidität. Frankfurt: Fritz Knapp.

 

1. Der Artikel von Professor Dr. Dieter Suhr ist veröffentlicht in der Zeitschrift "Fragen der Freiheit" Nr. 228, S. 32 ff., und zu beziehen beim Seminar für freiheitliche Ordnung, Badstr. 35, D-73087 Bad Boll, Tel. 07164/3573.

This article of Professor Dr. Dieter Suhr is published in the Journal "Fragen der Freiheit (Questions of Liberty)" No. 228, page 32 till page 64, and can be ordered at Seminar fuer freiheitliche Ordnung, Badstr. 35, D-73087 Bad Boll, Deutschland, Tel. +49-7164-3573.



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