Sustainability, growth, degrowth and debt-based money

In a previous article (The (un?) sustainability of growth) I had concluded that "sustainable growth" is a contradiction in terms. The argument, very succinctly, went as follows:

1) Growth is defined as the increase of the GDP (Gross Domestic Product) of a given country or economic zone (or as Arthur Lewis put it "the growth of output per head of population").

2) GDP reflects the products made (and consumed) and services rendered (and consumed) within that zone, therefore it also reflects the resources consumed during the production process; raw materials, energy, clean air, clean water etc.

3) Resources are neither infinite within our ecosystem, nor entirely renewable within our timescale, even allowing for partial recycling and partial use of renewable energy sources (and discounting space travel!).

So, 1+2+3 lead us to conclude that overall production and consumption cannot continue to increase in output indefinitely. So neither can the GDP, hence, the unsustainability of growth. Of course, they cannot even continue indefinitely above a specific rate, which we may have already surpassed (the issue of de-growth, see below).



A little Terminology

More recently, this quantitative term has started being replaced by the more qualitative one "sustainable development". Development encompasses growth but also social, political and other parameters. According to Michael P. Todaro and Stephen C. Smith, "development must be conceived of as a multidimensional process involving major changes in social structures, popular attitudes and national institutions, as well as the acceleration of economic growth, the reduction of inequality, and the eradication of poverty". But in any analysis of economists, it seems that development requires growth, although usually this is only implied. In any case, it seems that most models proposed by economists to combat poverty, illiteracy, environmental decline, climate change etc, are growth models. "Sustainable" growth, but growth nonetheless.


An even more recent trend is the use of colors. Instead of the quantitative term "sustainable", politicians, journalists and NGO’s have employed the qualitative term "green". Thus, the fully quantitative (though self-contradictory) term "sustainable growth" has been conveniently replaced with the fully qualitative (though vague) term "green development" and its offshoots ("green economy", "green capitalism", "green jobs", etc). What does "green" mean? How does one measure it? Why would one employ such a term?


My personal answer to this last question is that this term is vague enough to allow for a complacent lifestyle, but carefully defined as to allow for an environmental political correctness. It does not compel us to change our lifestyle in measurable ways (drive less, use public transport, travel less, eat less meat, buy less clothes, create less waste), but it rids us of guilt: if we can afford it, we can drive a hybrid motor car (but drive the same distance), we can eat organically farmed meat (but eat the same quantity), we can recycle our waste (but produce the same amount of it) and feel good about ourselves.


"Green" is not so much how much you consume, but how you consume. It is more of a fashion statement. As long as you remember to flush the toilet, it doesn’t matter what waste you left behind.



Degrowth – Blessing or curse?

Considering a viable alternative, I considered a decrease in consumption, which amounts to de-growth, but keeping some crucial realities in mind: "It should be clear that at the present state of things, a reduction of the consumption rates, and hence of growth, is the only viable alternative for a sustainable economy. Of course, something of the kind should not be considered without a prior redistribution of wealth; limiting consumption for a country of the developed West, might mean taking the bus to work, instead of a car, or buying fewer new clothes per year. Limiting consumption in a developing country might make the difference between life and death for people living on a few dollars per month."


Of course, the idea of degrowth is definitely not mine. Nicolas Georgescu-Roegen (1971) [1], the Club of Rome (1972) [2] and Ernst-Friedrich Shumacher (1973) [3] had realized that growth is not sustainable in a closed system like the Earth and had advocated that decrease of consumption is the only sustainable practice. The term degrowth first appeared in French. An early appearance was by André Amar, in 1973 [4], but it was due to Georgescu-Roegen that it gained a wider popularity with the 1979 French translation of his book, Demain la decroissance. Entropie, écologie, économie (Tomorrow degrowth. Entropy, ecology, economy).


However, I also raised the issue of wealth distribution: if for people in the developed West a decrease in their consumption may mean travelling less and commuting to work, for people in the developing world it can mean death by starvation. Such "degrowth exercises" have been carried out in the past with catastrophic consequences for human societies. In many instances, production and consumption dropped for various reasons and people suffered. Let’s take carbon dioxide emissions as a "marker" for economic and industrial activity. Data for Global Fossil-Fuel Carbon Emissions [5] are plotted below:


Figure 1. Yearly carbon emissions from the 18th century to this day


Major "dips" coincide with the period after the 1929 crash and the 1979 oil crisis, while smaller ones coincide with other economic adversities (crippled economy after WWII, 1973 oil crisis, 1991 US recession and 1st Gulf war, Asian financial crisis). Let’s discount wars and stick to strictly economic events, e.g. the 1929 credit-crunch and the 1973 and 1979 oil shortages. Environmentally speaking, these were good things. CO2 emissions dropped and the economy slowed down causing less depletion of natural resources. In fact, in each case a  degrowth occurred!


But what is it about our economy that makes this so painful? Why is growth necessary just to keep things going? Why is it catastrophic when people decide, or are forced, to consume less? Why does that lead to unemployment and even famine?


Is there an economic arrangement that makes environmental policies truly painless?

[Note: For each of these events that marked 20th century history and ruined millions of lives, a small "dip" is the only evidence. Imagine the size of devastation for a continuous decrease of consumption to sustainable levels, under the current economic system]



The issuance of money

How is money created an by whom? Let’s examine the case of the USA and the dollar.


After 1913 the Federal Reserve was founded as a private company, with main missions to control the quantity (and value) of the US currency and act as lender of last resort (banks’ banker) in cases. The congress voted a charter, relinquishing to the Fed the privilege to issue paper money. Its shareholders are the banks, which are obliged to buy 3% of their value in Fed shares. They get a steady 6% dividend per year from the Fed’s earnings. It is not a public institution, and government control over the Fed is practically very small.


How does that money come to be? Either by virtue of a printing press, or by the strokes of a few keys on a computer.

And how does it enter the economy? By lending.

Let’s see it in steps:


1) US currency (Federal Reserve Notes) is printed by the US Bureau of Engraving and Printing and sold to the Fed for roughly the cost of production (paper and ink).


2) The Fed declares these notes "dollars"  and then uses them to buy public debt (e.g. T-bills). In other words, it lends that money to the Federal government, which uses them to finance its policies. This is a loan because, since the government bought these dollars with bonds, it has to repay them with interest.

The Fed may also lend money to commercial banks as paper money (which they need to do business with their customers in cash), or as electronic money (created on a computer). This is also a loan and the discount rate set by the Fed is one of its tools to control liquidity and inflation. The higher the rate, the more expensive money becomes.


3) Now the government has paper or electronic money that it can spend on salaries of federal employees, contractors of public works, military spending (above all in the US), etc. This is one way the money enters the economy.

The other way is through the commercial banks. It is a common misconception that when a bank makes a loan to a customer, it loans the money of its depositors. Wrong! Through the magic of fractional reserve banking, a bank can loan several times its customers’ deposits, thereby creating new money.


Fractional reserve banking

How does fractional reserve banking work and how does it create new money?

A) Imagine that the Fed issues $100, which a commercial bank borrows (like the government, the commercial bank borrows the money and has to repay it with interest). These $100 are entered as liabilities in its balance sheet, because it owes them to the Fed. A 10% fractional reserve requirement means that it is obliged to keep $10 of that amount as reserves and it may lend the remaining 90$. Now, these $90 are new money, written as assets in its balance sheet, because someone owes it to the bank. The existing money now is the original $100 plus the new $90, a total of $190!


Therefore, banks can do with money what Jesus did with fish and loafs of bread. But it’s no longer a miracle.


B) Now imagine that the borrower opens a bank account to store his money (in the same bank or a different one, makes no difference). The 2nd bank receives these $90 and from that it is obliged to keep 10% ($9) and may lend 90% ($81).

New money = $81.

Total money = $100 + $90 + $81 = $271.


A simple spreadsheet can tell us that after 10 loans, $586.19 of new money has been created on top of the initial $100. After a large number of loans, the amount of new money in circulation tends to 10 × $100 = $1000. It has increased by 10-fold. This is the money multiplier (e.g. for a 5% fractional reserve requirement the money multiplier would be 1/0.05 = 20).


When a borrower repays his loan plus interest, the bank erases the entry in its assets, thereby destroying that amount of money. Then the bank will in turn repay the Fed for the money it initially borrowed from it, and this money will also be destroyed in the Fed’s balance sheet.


So, it is not the Fed, but commercial banks which are the main creators of money (~95% of its amount). All of it (including the Fed’s) is debt-based money, because it has been lent and has to be repaid.



1) Borrowing from a bank = creating money. Repaying debt to a bank = destroying money. The same does not apply for debts between people, it’s the banks’ "privilege".

2) For every dollar issued this way, debt is created from the interest. This debt is an extra amount of money that has to be paid. And who will issue that extra amount of money for us to pay our interest with? You guessed it, the Fed and the banks, creating a vicious cycle of debt. The amount of total debt accumulated by the US government is calculated to $65.5 trillion, exceeding the world GDP! [6]

3) If the Fed and the banks fail to create more money (either by stopping the lending process, or by calling in mature loans) some of the borrowers will default.


This process (credit-boom and credit crunch) is what leads to the so called "business cycles", or "boom-bust cycles". By means of boom-bust cycles, banks end up owning more and more real wealth through foreclosures. Money is not important, because they create it themselves in the first place. But real wealth is created by nature and by working people.


[Note: The European Central Bank (it issues Euros) works in roughly the same way. Its shares are owned by the Central Banks of the countries in the eurozone, plus some Central Banks of countries outside the eurozone (e.g. UK, Denmark, Sweden, etc). These Central Banks are in turn private institutions, generally speaking, with certain exceptions. The ECB has a guaranteed independence from national governments, the European Commission and the European Parliament, so it sets its own policies. It is therefore, to a great extent, exempt from democratic control.]


[Note: Two excellent "primers" on the subject are the films "Money as debt" and "The money masters"]




Doesn’t the constant creation of money create inflation? In principle yes, but not necessarily.


Inflation (or deflation) can occur when supply (production) and demand  (consumption) are not at par. Increased demand or limited supply of a certain product (demand-pull/cost-push) will cause inflation, but that may be the case for particular goods in abundance or scarcity (e.g. 1973 and 1979 oil crises). However, what causes inflation in an economy as a whole is a disparity between production (real wealth) and money supply.

When the production of an economy is stable and the money supply is suddenly increased, the value of the currency will drop (e.g. hyperinflation during war periods from money printed to fund war efforts). Everyone has more of these "rectangular papers" to buy things with. So the prices of goods will increase with respect to a relatively worthless currency. Inversely, a sudden decrease of the money supply will bring deflation, because fewer money will circulate (e.g. during the 1929-31 recession). People will have less money to spend and the prices of the goods will fall, although the productive infrastructures may be intact and fully functional.


When an economy needs to expand, more money is needed for its increased needs (e.g. 16th century colonial expansion). More products have to be bought and sold, so more money needs to exist and change hands. The increase in GDP will balance the increased money supply.


This money can be base money issued by the Central Bank, or credit money issued by the commercial banks, which means that both these actors can influence inflation, with the Central Bank usually being in a position of regulatory power.


But today, base-money and credit money alike bear interest. They both bear debt. And consequently, more money needs to be created to repay the interest. So under the current monetary system both these money supplies need to constantly expand so that not too many borrowers default. The proof is in the monetary supplies of various currencies. In the figures below I give the monetary supplies of dollars (1917-2009) [7] and euros (1997-2009) [8] and their respective money multipliers, i.e. how much money has been created on top of the base currency. Ever since the Fed and the European Central Bank undertook the issuance of money (1913 and 1998, respectively), they have been increasing the supply of base money (denoted M0). Banks on their turn have multiplied this base money through various processes (measured by M1, M2 and M3 [9]), keeping a minimum money multiplier of 12-13, and allowing it to climb up to 19-22.


To understand these figures, it suffices to note that M0 is base money (banknotes and coins). The difference M3-M0 corresponds to all the layers of money created on top of base money, through what the economists refer to, with a dose of linguistic distortion and , as financial "products".




Figure 2. Monetary supply of dollars (monthly averages) and money multiplier




Figure 3. Monetary supply of euros (monthly averages) and money multiplier



-But if the production of the real economy does not increase at par with money supply, defaults will occur by borrowers.

-So the GDP needs to expand.

-So growth is an inescapable consequence of our monetary system.



A monetary system for degrowth

As has been pointed out, degrowth is a direction that we will have to follow sooner or later. Sooner by choice, later by need.

Sudden degrowth under the current monetary system means extreme social hardships and suffering. So our best choice is to plan a degrowth economy, if we want to avoid a sudden and painful mandatory degrowth.

One of the parameters, probably even the first, that will have to be redefined in such an economy is its monetary system. A monetary reform is desperately needed.


Let’s accept the premise that modern economies, i.e. those beyond the level of barter, need money to function. Nevertheless, there are many types of money and we may choose the one that best serves our needs. A type of money that will allow us reduce our consumption and GDP growth requirements, without causing huge inflation or deflation. And a type of money that will not bear debt, obliging us to produce more and more simply to repay that debt and stay afloat.


Thankfully, such a monetary reform has been proposed and worked out in detail (see for example the The American Monetary Act proposed by the American Monetary Institute).  Since others have taken the trouble to work out such a system in detail, I will not go into its detailed description. I will only outline some of its main features.


In such a system the control of money issuance passes to the State. The State will issue debt-free money and it will use it to make the economy run, to create and conserve public infrastructures and to set the production output to sustainable levels, also taking into account the fluctuations of the population of the country.


To avoid inflation, the commercial banks will be obliged to gradually buy up that money, thereby increasing their reserves to at least 100%. They will then be obliged to abandon the fractional reserve system for lending money, thereby ceasing to act as money creators.


To conclude with, a debt-free currency is a prerequisite to a sustainable economy. It is not the goal per se, but it most certainly is one of the most useful tools to achieve that goal.



A final note on the economic system

I should make a clear distinction, closing this article. What I just mentioned, mostly concerns our monetary systems, not so much our economic systems. Economic systems have to be modeled and decided upon, taking into consideration the needs of individual countries and the traditions of individual nations.


A developed country of the West may indeed need to decrease its per capita consumption, thereby undergoing a degrowth process. The monetary system will facilitate such a process, so that it is not accompanied by misery, but simply by a decrease of waste. However, an underdeveloped country may still need an increase in its per capita consumption before it attains decent levels. The monetary system will facilitate this process by offering increased monetary supplies for the economy to grow.


In addition, the monetary system does not imply a certain political system, or a specific type of ownership of the means of production. Debt-free money has been issued in capitalist countries (e.g. the US by Andrew Jackson and later by Abraham Lincoln) while debt-bearing currency has been issued by socialist countries (e.g. the USSR and China today).


A debt-free monetary system only implies a shift in our concept of money; from having the intrinsic value of real wealth (seeds and cattle can multiply, hence the interest) to becoming a legally ascribed value that measures real wealth but can afford no interest. A glass jug measures volume, but volume is not glass. It is an abstract concept. Similarly, under this scheme, money measures wealth, but it is not wealth itself. It is also an abstract concept defined by law. This legally ascribed value entails a stronger governmental role in the monetary system, since a democratically elected government usually personifies popular will.


For those who fear such a development, I may only note that a bad President or a bad Prime Minister you can vote down. A bad Banker, never.


Who would you fear the most?



[1] Nicolas Georgescu-Roegen, The Entropy Law and the Economic Process, Harvard University Press, 1971

[2] Donella H. Meadows, Dennis L. Meadows, Jørgen Randers William W. Behrens III, The Limits to Growth, Universe Books, 1972

[3] Ernst-Friedrich Shumacher, Small is beautiful:Economics as if People Mattered. New York: Perennial Library, 1973.

[4] André Amar, La croissance et le problème moral, Les cahiers de la Nef, Vol 52:les objecteurs de croissance, 1973

[5] Carbon Dioxide Information Analysis Center

[6] Federal obligations exceed world GDP. Does $65.5 trillion terrify anyone yet?

[7] US M0 monetary base data between 1917-2002 and 1959-2009 have been taken from the St. Louis Federal Reserve.

M0-M3 data have also been collected from the Federal Reserve statistical release Money Stock Measures of October 22, 2009.

There is a disparity between the M0 data from the St. Louis Fed and the Federal Reserve, both of which are given in the figure below:


-The data from the St. Louis Fed indicate a doubling of the base money supply between August and December 2008 (~ $800 bn).

-On November 10, 2005, the Federal Reserve System announced that, as of March 23, 2006 they will be ceasing the publication of the M3 monetary aggregate.

-Data after that date were taken from the article M3 b, repos & Fed watching, taking into account the introduction of three new programs used by the Fed to increase liquidity (Primary Dealer Credit Facility, Term Securities Lending Facility and Term Auction Facility).

[8] From the ECB website. M0 euro data up till September 2007 were found at the "statistics pocket book" zipped file here (spb027.csv file) and subsequent data up till August 2009 as separate monthly releases at the "statistics pocket book" here (chapter "Monetary policy", Table 8.3 of each pdf file). M1-M3 statistics were found here.

[9] M1 = M0 + Negotiable Order of Withdrawal (NOW) Accounts, travelers’ checks, demand deposits.

M2 = M1 + time-related deposits, savings deposits, and non-institutional money-market funds.

M3 = M2 + large time deposits, institutional money-market funds, short-term repurchase agreements, along with other larger liquid assets

Leave a comment