Apple Economics

At the RO Studio one Friday night, five of us sat down to understand two opinion articles written by Darius Guppy for the Independent and the Telegraph, two British newspapers. The articles argue that our banking system is a fraud, because it creates a virtual economy of such runaway inflation that we are forced to produce beyond the means of the resources on this planet.

As we began to read the article, we realized that we didn't really know what inflation was. Fortunately, Fanny, who works in finance, had an example story for us. "If there were five apples on this table," she said, "and each of us at the table had a coin, each apple would cost one coin."

Slide 1

"Now, if each person at this table had two coins," said Fanny, "each apple would then cost two coins."

The amount of money in a system divided by the amount of product in that system equals the price of what is produced. This is a basic principle of economics. The more money you have in the system, the higher the cost of products.

Slide 2

Now we were ready to attempt the articles before us. The first article began by describing banking as it was first conceived:

When value was represented by gold, people wanted to store it securely. So they gave it to a person with a safe room, or bank, to hold for them. Some other people asked if they could borrow the gold, since it was just sitting around, and it was agreed to lend it out. To make the risk of lending it worth it, it was agreed that the person would pay something for the ability to borrow it. This became known as interest. In our illustration here, a 20% interest is shown. If the bank lent out 5 gold bars at 20% interest, to be paid back at the end of the year, the bank owner would receive a whole new gold bar by New Year's. This image is our classic image of how a bank works.

Slide 3

Now of course, gold is not that convenient to carry around, it's bulky and heavy. So around the time of the Crusades, the Knights Templar came up with a unique solution: the note. Gold became represented by paper. The idea was that you could go get the gold represented by the paper note in your hand from the bank at any time. You trusted the bank to hold the money, and used the representation instead.*

Under this new system, bankers soon learned that people rarely cashed in the bank note in exhange for the actual gold bar. So someone had the bright idea to lend out more than one note on the same gold bar. The probablility of even five people coming in to claim the gold bar at the same time was really low, so there really was no risk.
So banks began lending out more money than they actually possessed.

Nobody had a problem with this, for some reason. The banks especially did not have a problem with this, because they quickly realized an enormous increase in profit. This practice even has an official economic name, "Fractional Reserve Banking," so it must just be another perfectly sound economic practice, right?

Slide 4

Each gold bar in the bank is lent out to five people, who each have the use of an entire virtual gold bar. Each of these people pays 20% interest back to the bank. With 25 people paying 20% interest, the bank realizes a profit of five gold bars. The bank has literally doubled its money in a year.

Now, for those who feel that 20% interest is highly unrealistic, I invite you to consider two points. First, that some American credit card companies begin charging a 33% interest on their credit card once a payer falls behind on their monthly payments. Second, that even when we consider a 5% rate of interest, the vastly speeded-up** level of wealth creation still becomes apparent, it just takes a little bit longer than a year.

The image in slide 4 is much closer to the reality of how banks work than slide 3. And we begin to see where the deception about the value of a note is creating a problem.

But what exactly is the problem? Let us consider slide 5.

Slide 5

If our friend the banker is doubling his money every year with his practice of fractional reserve banking and 20% interest, that means at the end of four years, he has realized 80 gold bars. Eighty. He started with five. That is an increase of 1600%.

So this is our problem. Now, the notes that are lent out and return to the bank don't really figure in the virtual economy. As they return to the bank, they cancel out. Essentially they never existed to begin with. But the interest that returns to the bank persists in the system. This income from these virtual notes create a virtual money economy expanding at an enormous rate that has only a tenuous link to our real economy of old-fashioned goods and services.

You might be thinking, well, good for our banker. In our meeting at the RO Studio, Amy said, "Well, obviously the smart thing to do is invest in the bank!"

But let us return to our apple model, and consider the effect of a bank upon our apple economy.

Slide 6

Five people with one gold bar each, and one bank with ten gold bars. That's 15 gold bars. Fifteen gold bars is the total amount of money in the system this year. Yet we still only have five apples on the table, that's the sum total of our economy this year. Well, guess what? Fifteen gold bars divided by five apples means that each apple costs three gold bars. Apart from the bank, everybody only has one gold bar. They cannot afford an apple.

So a very interesting principle has emerged. The very act of growing wealth through interest automatically creates a have-not class. Accruing capital automatically creates poverty. The 'M-shaped economy' is not happening because we're doing capitalism wrong. It's happening because we're doing capitalism right.

Now, you know how you're always reading in the newspaper that the government wants our economy to grow? How everybody seems to want the economy to grow? "Growth" is on everyone's lips. I've often wondered why growth is so dang important.

Well. Here's a reason why. If you wish to bring down the price of apples, and you have too much money sloshing around your system, there's only one thing to do: you have to increase the number of apples.

Slide 7

Voila! We worked super hard, we worked overtime and weekends, we polluted super hard, and we produced many shiny new apples. They're a little fake, not exactly as good as the real thing, but heck, they're apples, so they count.

Check out our system now. Fifteen gold bars, fifteen apples. Hurray! One apple again costs one gold bar. Everyone can relax now, because it's all in balance again; we can all afford to buy what we like. And look at all the lovely shiny things we have! Economically, this is where Taiwan is now. Everything's looking really rosy for us at the moment.

But I have some bad news for you, because this was just this year. Remember slide 4?


The bank is doubling its money every year.

Remember slide 5?


This year the bank only has 10 apples. But 4 years down the road? The bank will have 80 apples. Which means...

Slide 8

Exactly. We worked our butts off, pulled overtime like you wouldn't believe, we sourced all the available alternatives to produce our apples, but we still could only produce 17 apples. And yet look at the bank! It has 80 gold bars!

So here's the accounting: The bank's 80 gold bars plus the 5 gold bars of the regular citizens equals 85 gold bars. Eighty five gold bars divided by seventeen apples equals a cost of five gold bars an apple.

When you have only one gold bar, five gold bars is wildly unaffordable. If you want to know how the story goes from here, this tumblr illustrates it pretty well.

The moral*** of the story is: Fractional reserve banking creates an incredible exponential build-up of value, which creates a virtual economy that is not remotely related to our real economy. In order to avoid an inflation that leaves most of the population living in a cardboard box, we're forced to grow the real economy at an unsupportable pace. Our planet is one of finite resources, and yet the virtual economy keeps expanding infinitely. A radical overhaul of how we do banking is definitely in order.

I would even go so far as to argue that the concept of interest itself represents an instability over time that cannot be supported in a truly balanced economy. Interest is a fundamental mechanism in concentrating capital. If capital concentration creates poverty, then the very act of charging interest creates poverty. A well balanced economy needs a level-playing field. A truly level playing field requires that no one has an outsize pile of concentrated wealth.

Let's state it another way: Lending out money interest-free is a radical act of social justice.
Or even more clearly: A society run on the principles of social justice would ban the practice of charging interest.

If we are interested in creating a society that works well for all its members, one of the most important conversations we can be having is, "How do we best exchange value?"




*Now, the point of our story here is NOT that gold is somehow better than paper. Any system representing value has its problems, and can be subject to inflation and deflation by various means. New cowrie shells can be found on the beach. Gold can be found in a river, and may cease to be currency when it's turned into jewelry. Cows or goats have to be fed, and can die. Paper can be burned or ripped. Zeros can be added to computer systems. Creative accounting can count new investment as profit. The point of our story is not that one representation of value is somehow better. This is not a shill for a return to the gold standard.
The point here is that fractional reserve banking counts value at inconsistent rates, creating an inconsistent (virtual) economy. Banks are allowed to say they have 25 bars of gold when they really only have 5. It's just "a 20% capitalization rate!" Imagine if a private person pulled that. You'd be called a counterfeiter, or worse. But when you're a bank, and call it a "capitalization rate", it's okay. And if you follow our story to slide 5, it turns out that being allowed to count your lendable reserves at five times or whatever their value is comparable to being given a license to print money.

**Speeded up in comparison to the old fashioned way of making profit, i.e. creating a product and selling it.

***The other moral of the story is this: I was able to write these slides and create this story because we five women sat down together to discuss an article. After reading the article, I sort of understood, but it was actually discussing the article and trying to answer the questions we asked each other that allowed me to understand the concepts at a level where I can now explain them to other people. If five ordinary women can sit down with an opinion article and figure out what's going on with our economy, then nothing is stopping you, either, from taking a good hard look at what's going on around you, and discussing it with other people. When you are clear about what's going on, you have half a chance of doing something about it, or at least can make better decisions in relation to it.

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