The Four Basic Misconceptions

Money is one of our most ingenious inventions. It helps the exchange of goods and services and overcomes the limitations of barter, thereby creating the possibility of specialisation, which
is the basis of civilisation.

However, throughout most of history, the circulation of money has been based on the payment of interest. Interest leads to compound interest. Compound interest leads to exponential growth. And exponential growth in turn is unsustainable. Therefore, in order to understand how our monetary system works as an ‘invisible wrecking machine’, we must first understand four basic misconceptions about money which almost everybody holds.

The Growth Misconception: ‘Money based on interest can grow forever.’

The graph below shows three generically different growth patterns.



Curve A represents an idealised form of the normal physical growth pattern in nature, which our bodies as well as those of plants and animals follow. We grow fairly quickly during the early stages of our lives, then begin to slow down in our teens, and usually stop growing physically when we are about twenty-one. This, however, does not preclude us from growing further ‘qualitatively’ instead of ‘quantitatively’.

Curve B represents a mechanical or linear growth pattern, e.g. more machines produce more goods, more coal produces more energy, etc. This growth pattern is not so important for our analysis. It should be clear, however, that in a finite universe even this pattern will eventually create problems.

Curve C represents exponential growth, the most important and generally least understood growth pattern which may be described as the exact opposite to curve A in that it grows very slowly in the beginning, then accelerates continually faster and finally grows in an almost vertical fashion. In the physical realm, this growth pattern usually occurs where things are out of order, where there is sickness, often leading to death. Cancer, for instance, follows an exponential growth pattern, and, using this analogy, interest may be seen as the cancer on
our social and economic system.

Based on interest and compound interest, our money doubles at regular intervals, i.e. follows an exponential growth pattern.

Since through our bodies we have only experienced the physical growth pattern of nature, which stops at an optimal size (curve A) it is difficult for human beings to understand the full impact of the exponential growth pattern in the material realm.

This phenomenon can best be demonstrated by the famous story of Joseph’s penny: If Joseph the father of Jesus had invested one penny at his birth at 5% interest and Jesus returned to the same bank in 1990 - with the money accrued in the meantime he would have been able to buy 134 billion balls of gold of the weight of the Earth based on the official price of gold at this time. This shows mathematically that the continual payment of interest and compound interest over a longer period of time is practically impossible and explains why - at regular intervals - we have economic and social breakdowns, social revolutions or war.

The Transparency Misconception: ‘Interest is paid only when we borrow money.’

A further reason why it is difficult for us to understand the full impact of the interest mechanism on our economic system is that most people think all they have to do is to avoid borrowing money.

What few understand is that every price we pay includes a certain amount of interest. The exact proportion varies according to the labour versus the capital costs of the goods and services we buy. This ranges from a 12 % interest component for rubbish collection, (because here the share of capital costs is relatively low and the share of physical labour is particularly high) to 38% for drinking water and up to 77% for public housing.

On the average we pay about 40% interest in all the prices of our goods and services. In medieval times people paid ‘the tenth’ of their income or produce to the feudal landlord. In this respect they were better off than we are nowadays, where almost one half of each dollar goes to the people who own capital.

The Fairness Misconception: ‘Everybody is treated equally in the system.’

A third misconception concerning our monetary system may be formulated as follows: Since everyone has to pay interest when borrowing money, we are all equally well off within our present money system.

On the contrary there are huge differences as to who profits and who pays in this system. Comparing the interest payments and income from interest in ten equal parts of 2.5 million households in West Germany, this figure shows that 80% of the population pay more than they receive, 10% receive slightly more than they pay, and the remaining 10% receive about twice as much interest as they pay (i.e 34,200 DM per household per year in 1985). That is the share that the first 80% lost.

When 80% of the population who pay more than their fair share start to understand that they have almost no chance of ever belonging to the group of the last 10% who profit, when they consciously identify this hope as an illusion, only then can the system be changed. This illustrates the least understood reason why the rich get richer and the poor get poorer. In absolute figures, this amounts in Germany in the year 2000 to a transfer of about 1 billion DM every day from those who work for their money to those can make their ‘money work for them’. But have you ever seen money work?

The same principle holds true for any other country. In fact, in most countries the percentage of those who profit from the present system is even smaller. In the year 2000 in the United States 1% of the population owned more wealth than the lowest 95%.

Though we have not completed our research for New Zealand yet, it looks as though it
may be only the top 5% who receive more interest than they pay out.

In other words, within our monetary system we allow the operation of a hidden redistribution mechanism which constantly transfers money from those who are net borrowers to those who are net lenders. Thus, on the one hand, large amounts of money concentrate in the hands of fewer individuals and multi-national corporations and, on the other, ‘Third World Countries’ will never be able to get out of debt in the current system, as they always have to pay back several times the amount loaned to them.

From another point of view the interest and compound interest mechanism not only creates an impetus for pathological economic growth, but also works against the constitutional rights of the individual in most democracies. If a constitution guarantees equal access for every individual to public services like the provision of the money supply - then it should be illegal to have a system in which 20% of the people continually receive more than they pay for that service and 80% of the people receive less than they pay.

The Balance Misconception: ‘Interest is needed to counter inflation.’

The fourth misconception relates to the role of inflation in our economic system. For most people, inflation seems like an integral part of any money system, almost ‘natural’ since there is no country in the world without inflation. Few realise this is just another form of taxation by which governments try to overcome the worst problems of increasing debt and interest burdens.

Only as long as public and private debts increase exponentially can the economy keep growing.. If the debt stopped increasing or even if its rate of increase declined, then the economy would collapse. In the present money system we are faced with a dire choice: either economic growth or ecological collapse. Ecological collapse happens because we are forced to bring more and more natural resources into the money economy and make it grow exponentially, following the pathological growth of the money system.

Because inflation is perceived as a given, economists and most people believe interest is needed to counteract inflation, while in fact interest is the major cause of inflation. And if we can abolish interest we can also abolish inflation. (In addition we certainly need to take measures to prevent speculation in land and other resources as well.)

Economic historian, John L King, links inflation to the interest paid for the ‘credit balloon’. In 1988 he stated, ‘I have written extensively about interest being the major cause of rising prices now, since it is buried in the price of all that we buy. But this idea, though true, is not well accepted. $9 trillion in domestic US debt at 10 % interest is $900 billion paid in rising prices and this equates to the current 4% rise in prices experts perceive to be inflation. I have always believed the compounding of interest to be an invisible wrecking machine and it is hard at work right now. So we must get rid of this mindless financial obsession.’

The corporatisation and privatisation of large parts of formerly state owned services (hospitals, telecommunications, electricity, railways, airlines etc) is at the same time reducing government debt and increasing the listed private debt, thus masking the economic burden of debt servicing. Every New Zealander therefore pays interest on not just Government borrowing but also on all private borrowing through the prices we pay. We even have to pay extra if a private but essential corporation suffers from too much debt. In 2001 the New Zealand Government paid $1 billion to prevent Air New Zealand from collapsing.

With most of our banks being owned overseas, a large part of the interest New Zealanders pay now goes overseas. In the year ended June 2001 we sent $5.2 billion overseas, and now more and more of our debts are denominated in US dollars, so we earn in New Zealand dollars and pay in US dollars. This makes our currency vulnerable to attack from financial speculators.

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External Links:

• Interest and Inflation Free Money (Book), by Margarit Kennedy

Money is one of humankind's most ingenious inventions - and also one its most dangerous. Interest and Inflation Free Money offers a clear, simple explanation of how financial policies shape the global markets - and how interest wrecks cultures, ecosystems, and economic systems.

This book can also be ordered through this website!

• Margrit Kennedy's personal site

Margrit Kennedy, on the subject of money.