JULY 2013

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Why interest free banking doesn’t work

There is no such a thing as a free lunch. Everybody has to work for theirs, whatever it is.

Recently, we met someone online who was adamant in debating the feasibility of a free interest banking. Even though he/she couldn’t answer a simple question such as “How a business is to operate without profit?” or to demonstrate mathematical calculations on how can a business operate without charging any kind of fees or profit element, this person would continue to debate, regardless. He/she even suggested that the bank should be allowed to print money on their own and use that to pay their own salaries and profits (banks are not allowed to print their own money at the moment). Apparently they are so determined to destroy existing financial systems, whatever it is, so that they can implement theirs, even if they could not answer simple and very basic questions about their proposed system. Therefore we decided that this month’s article would be dedicated to answer or rebuke his/her premise, again, once and for all.

In Book 1 of the series we have explained how the first or the seed money would come about and into the system and in Book 2, we have shown why debt is needed in order to issue the money. We have explained in detail why our current monetary system which is in reality, an asset based system requires proper distribution into the economy via debt instruments. Then we explained further why fractional reserve banking is the most efficient way to distribute money and the mathematics behind it in detail and with full illustrations (with free video presentation) and we also showed the calculations of where money to pay for the interest for the loans would come from. However, we guess people who think they knew it all, would not read any of it before rebutting everything. Thus, we hope those who follow this blog would read these books first before forming any opinion. Nearly 45% of Book 1 is available at its mini site for free reading and Book 2 preview is available at its mini-site HERE. Once you understand these simple concepts of money, you can then move on to the interesting part of the series which is paying of the national debt and many other interesting topics.

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Now, once again, we reiterate that money we currently used is “Asset-backed Money issued via Debt instrument” and that money is issued by the government (not private corporations) and money is to facilitate trade and is NEVER the permanent store of anything (human sweat, blood etc.) and it only exists to store value temporarily until a trade is completed. So instead of explaining further why our current system is working fairly for everyone, we will show instead why “interest free banking does not work” (we already explained and showed proofs why existing system is the best in our three books series).

What is interest?

Interest is actually a cost and profit element paid to a lender for enabling a borrower to acquire and use a (large) piece of asset such as a home, a business property, a factory machine, cars, trucks and any other asset for personal or business use. Without a willing lender who is willing to part ways with his or her hard-earned capital, only to be given to an unknown borrower, the borrower could never make these (large) purchases or start any businesses to generate new usable assets in the economy in the first place. These profits are needed by the lender to cover his or her costs as well as the costs of foregoing use of such assets. [If you have a house and you lend it out to others, where would you stay then? Surely you will need to be compensated fairly for your trouble.] The interest is used to pay rents, salaries, equipment, taxes and so forth, and the little that remained is the profit for the lender. Since banks cannot print their own money or create money out of thin air, they must ensure that their borrowers pay them back their lent capital. A single bad borrower could theoretically wipe out a large portion of their potential profit (if you don’t believe us, open up your spreadsheet software and start calculating!). More than one bad borrowers could theoretically cause enough damage that the lender may lose all of his money, and more. As for banks, they took in depositors’ money and use it to lend. In case a borrower fails to pay, the bank must use its own personal money to cover the depositor’s money lost through that lending. All these hard work and risk taking require profits to be paid alas, nobody would give away ALL of their hard earned money for NOTHING.

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If you buy a $300,000 house with no money down, the moment your loan is approved, you are “enabled” to live in a house that is 100% OWNED BY OTHERS. You have 0% stake in the house.

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Do you think you could live in other people’s house without paying any rent? If it is not your house, no matter what, you will need to pay rent on it. In the case of mortgages, the interest paid is in fact, the rental payments. Surely the lender can’t let you stay, and only be paid the principal after a long 25 years! Where would the lender stay then? Thus, you are paying rentals plus the principal of the house (detail explanation is in Book 3). As you pay more and more toward the principal, your share of ownership of the house increases, and thus you will pay less and less rental, which resulted in lower interest payments. And when you owe 100% of the house, you would not need to pay any more interest since you no longer have to pay rent on that house.

Do understand, that at the beginning of the loan, you initially have zero ownership of the house and you should be aware of this very fact and should be careful when uttering the word– “This is my house and it is not fair for the lender to take it from me”. The ownership remains with the bank (lender) who is the representative of many ‘mini lenders’. They are the depositors alright. So, these depositors have the right to the house, as long as their money is used. The same goes with any type of loans. Anyone who wanted an interest free loan, should not borrow. Then there is no need to pay any interest.

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Where does money for paying interest came from?

If you still think that the government or the central bank has to print more and more money due to interest payments, then you are far mistaken. Do download this bonus presentation “Does Bank Loans Interest Payments Sucks Money Out of the Economy”  which shows where interest money came from and refer to Book 2 for a more detailed calculations.

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To put it simply, some interest money came from within the economy and others from new assets generated in the economy. That is why, only good type of loans should be given, such as for the creation of new businesses, new factory for manufacturing, or for creating other usable assets that add value to the economy. Loans that are not used to generate new productive assets such as for gambling and for other speculative uses, would really and actually suck money from other areas of the economy. A gambling loan you incurred would require you to divert money from other intended use, compared to a factory loan where the factory generate products which naturally would cover the loan on its own. When the interest-is-bad proponent showed their calculations, they never shows that money paid to the bank would enter the economy ONCE again via rental payments, salaries to their workers, profits paid to depositors and investors and taxes to the government plus myriads of other ways. They would always show that money become less and less since interest is paid out and forgot to show that interest payments would re-enter the economy once again, just like the payments for capital do.

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Be smart and understand this fact by watching the video presentation on our web.

Why interest is paid over a long period of time?

Interest is not paid up front. You usually have to fork the interest over a long period of time. For example, for a $300,000 house with a fixed mortgage of 5% for 25 years, the interest would be $226,131. It seems a large amount but if you have to pay rents of $800 for 25 years, that would be about $240,000! So, as you can see, the interest is usually around what you have to pay for rent. Is it ok to pay rentals, but not interest? Aren’t they the same in this instance? So, where does the money for paying rent comes from? Will rent suck money out of the economy? Of course not and so are interest payments on mortgages. Would they say rental payment is also evil and we should give everybody a FREE house?

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The growth in the money supply, has nothing to do with interest payments! We proved this fact via our calculations and presented them in the book series. We even showed the real reasons as to why the money supply grew (regularly). We explained this so thoroughly, there is no room for any more confusion on it (it is due to population growth and efficiency advances). As long as issued money is less than the total assets in the economy, then everything is fine and dandy. When Book 3 of the series was published, the current asset of the United States was way more than the total government debt which includes money in circulation. To know how much, do read Book 3. And by the way, the problem of Zimbabwe is not due to paper money, it is something else altogether!

Debt Free Alternative Currencies?

The person also pointed out one Mr. Bernard Lietaer who in his lecture, “Money Diversity” suggested that the financial crisis was the result of one dominant currency and proposed alternative currencies for a more resilient financial system. After listening to his lecture, we could point out many things that were left out by Mr. Lietaer.

  • He mentioned that money should be issued interest free and without debt. The alternative currencies he proposed in his lecture were all based on debt, and surely not interest free. For example a Swiss Business to Business currency (WIR) is clearly a form based on IOU for businesses. This is debt based money.
  • He also mentioned the use of Doras, a form of points based system issued for a “job” done. A person can accumulate Doras and once the target amount is achieved, could redeem it for something valuable, such as a trip to Burma. Dora currency is based on debt, because it is a promise to pay sometime in the future. In fact Dora is worse than the US Dollar, which is payable for any goods and services out there, whereby Doras can only be exchanged for the already contracted “dream” such as a trip to Burma, with a sole party (i.e. the government). Mr. Lietaer mentioned that Doras is not based on debt or interest, however this is not true. He clearly mentioned that the use of Doras does not cost the government any money, which is absolutely not true. When the time comes, sometime in the future, and the Doras is cashed out, the Government has to fork out “real cash” to send this person on his “dream”. The Government could not use Doras to pay for the airlines ticket, accommodation and food! Also, in the case of Doras, what if the person that made the contract wishes to change his dream or dies? Doras is clearly a debt based money and a poor one at that.
  • Mr. Lietaer also mentioned the use of airline miles as a form of currency which is debt free and interest free. He could not be more wrong. Again, airline points are debt based money, it is issued with the promise to pay in the future. The value of each unit of airline miles are not the same. For example 3000 points nearing expiry date have little value, or 5000 points (but short of 500) to allow for redemption also have different value than 5,500 points, ready for redemption. Therefore the value of points changes according to time, and conditions stated.
  • Mr. Lietaer mentioned that since 1970, IMF had identified 145 banking crashes, 204 monetary collapses and 72 sovereign debt crises, plus 48 massive meltdowns between 1637 and 1929. He attributed the low diversity of our monetary system due to just a few currencies in use. This is an oversight in our opinion. In reality, we have almost two hundred currencies in a giant globalized, interconnected economy. A shortfall of wheat supply in Russia, would be immediately transmitted to the rest of the world, and the shortfall would be shared (by changing supply routes and prices). Attributing crises to the low diversity of issued currencies, while forgetting the real root causes of such crises that usually are caused by excessive human greed and human stupidity, plus the herd mentality, is a typical tactic of the doom and gloom club. People cut corners, or followed blindly, buying useless things or for governments to issue more money than they should, forgetting the asset level. The solution is better education. We made an explanation within Book 2 of the series regarding banking failures and who is responsible.
  • The US Dollar is certainly better than the list of alternative currencies he mentioned because it is issued based on Asset. The debt is created on the other side of the ledger. The US Dollar is essentially “Asset Backed Money Issued via Debt Instrument” (this is written in our book 2).
  •  All money even those mentioned by Mr. Lietaer himself, are debt backed, however the Dollar is actually asset backed.

People do not like to hear the truth. They love sensationalism, and put blame on other simple things. They like to blame and single out one person for a failure for instance. One person causing a whole mess is actually never the case however. The causes of monetary crashes or banking failures may be simply due to corrupt governments, led by dictators or just an outright plain war. Of course, there is an uncontrolled greed there somewhere with plenty of stupid people following behind.

Nothing is stopping free interest and debt free money people from creating their own currencies and their own banks. But why won’t they go on and create one? They gave too many excuses, but no concrete actions. When we pressed for answers, they cited reasons which are not relevant; just plain excuses. So far, all alternative currencies out there is just debt based; even the system that use no currency such as the LETS, where when you give services or products to a person and earns LETS to be exchanged with other people who accepts it. They consider the system as barter and with no money involve. However, when you receive nothing for your services and products but rather accept the “ability” to receive some kind of services and products in the future, it is still debt.

Now for a case study. Can an interest-free bank exist?

We search high and low for an interest-free bank and found one in Sweden. So is it truly “interest” free?

Enter JAK Bank Sweden.

Read HERE for the full detail on how this bank operates.

To summarize,

  • JAK is a coop Bank which means member has to pay fees to become a customer of the bank. This is a yearly fee and goes towards “administration” or day to day operations of the bank. So instead of getting paid for someone to use your surplus money, you now have to pay for the bank to hold your surplus money. In 2001, to join would require SEK200 with a yearly membership fee of SEK200 (regardless of your deposits, and is unfair in our opinion)
  • To borrow money, you must first deposit money within the bank. If you want to borrow money because you have none, how could you “deposit” first? This is a serious issue with this system. Once deposited, you would earn “POINTS”. The points enable you to borrow money in the future. Thus in essence, you are paying interest in the form of POINTS. There is no mistake about it. In a conventional bank, your deposit would earn “profit or interest” and in this JAK Bank, you would earn points (from the article the points are in paid in the range of 0.6 to 0.9 depending on deposit type (fixed deposit or savings). Can you see the similarities here? You forgo the profit in a conventional bank which is paid in currency which could be used to pay your conventional loan and opt for points to pay for your borrowings later. The only bad thing here is if you do not borrow anything in the future, what good are your accumulated points?
  •  JAK Bank has no physical presence. This mean, this Bank only exists virtually and does not require premises (branches) to operate. Customers deposit their money via online transactions through other, conventional banks. Thus, JAK Bank does not need to pay a lot of money for building leases, office supplies, computer systems, office refurbishing etc. as would other conventional banks.
  • JAK Bank operated by volunteers and thus require no salaries which of course in the real world would be hard to find. Where are we going to find people who do volunteer work and do not need any salaries for the rest of their lives? Can we ask you to work for free forever?
  •  If surplus money is not available, approved loan must wait in queue until funds is available. So, don’t hope for a quick loan, even with enough points.
  • Almost all loans must be collateralized (have asset to back) or must have a guarantor. And certainly don’t forget the borrower must have accumulated enough points in the first place to qualify.
  • JAK Bank Points
    • If you have $100 and put it in the highest paid accounts, you are given let say a 0.9 Point Factor, which means you earn 90 points. Do be aware that the points can be lowered or raised depending on the need of the bank. So, with a PF of 0.9, your $100 after 6 long months would have accumulated 540 points
    • To borrow, as the article suggested, you would have to pay 1 point for every dollar you would want to borrow, each month. So, if you want to borrow $240 and pay it within 6 months, you must have about 840 points. So you would still not qualify for a $240 loan after six months, and would need for more months to accumulate enough points. Oh, by the way, for each loan you take, you would have to pay a fix administration fee to process the loan.

As we have said at the beginning of our writings, there is no free lunch!

BTW, can you calculate how much you will need to save and how long you need to save to qualify to borrow interest free money to buy a house?

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Thus, using the JAK system, interest in the form of points existed. The only thing good about the system develop by JAK is that, members will be prudent about money, as they will need to save constantly in order to be able to borrow a larger amount in the future, which encourages frugality. However, one need to remember, if one can save constantly, then that person would not need to borrow for its purchase. A bank’s role should be connecting people with surplus capital to those that in need of it. If anything should happen to a JAK borrower, such as the person loses his or her job, the principal would still need to be paid, similar to conventional loans and collateral could be lost. So how is this any different from conventional banks?

Other than this bank, we cannot find any interest free banks except for the microfinance site, which enable direct lenders to give his or her money at no cost or expectation of their seed money to be returned. These loans are usually small and are considered as donations to enable people from very poor countries to start their small businesses. We consider this type of lending as charity as the money given is usually low and can be written off in a heartbeat.

The online debater also pointed out that with our current system, interest free bank cannot exist and proposes we do away with the system. This is just an excuse, because mathematically (and fundamentally) we found no problems to initiate such a system within our existing interest based system. What is so difficult anyway? Just lend out your money without collecting interest, is that impossible to do? (It is impossible if profit is the objective). And ask ordinary folks out there to deposit their money into the interest free bank, expecting no interest whatsoever as well. Worse, they could be charged fees for depositing money into the bank. These are the fundamental problems faced by free interest banking, and they are not due to the restrictions placed by the existing interest based system. In fact, anybody can start their own interest free monetary system. Just put your money under the mattress so that it does not earn any interest. Second, don’t borrow money from anyone, especially a bank, so you don’t have to pay any interest whatsoever. The credit card? You cannot use it because it is on credit. Now, in an instance, you are already living an interest free life. Is that so hard to do? Many people kept giving excuses, saying we need a house to stay on, or a car to use to go to work. Of course you do, that’s why you should borrow and pay the lender some profits or just rent a house and rent a car and be debt-free.

Nothing is free indeed.

Interest free banking is not fair

Everyone is under the impression that interest free banking is extremely fair, or perhaps the fairest of all. However this is certainly not the case at all. Just think for an instance, you lend your so hard-earned $300,000 money to someone else, who goes on and made a profit of $600,000 on top of your $300,000 in just 20 years. Is it fair if he just keep all of the profits for himself, not sharing with you a single cent, while you languish day and night waiting for all of your money to be repaid, and forego the chance of generating your own profit? You could have made $600,000 too, perhaps more. But you decided to give the guy a chance, and forego yours. Therefore, it is only fair if the guy pay you some of his profits. This is extremely fair and therefore, charging interest is extremely fair to both parties. We described this part in further detail in our book series, showing every step of the way how fair the process is. We always have to look at both parties, lenders and borrowers. It must be fair for both, at the same time. No other party should profit from the other, unfairly. We can assure you, our current system did this job exceptionally well.

Some people would say that it is unethical for money to create money. How is it different when Person A used his $300,000 money and build a house and then rent it out with the intention of getting back all the principal plus some profit than when Person A lends his $300,000 to Person B who then builds a house and pays Person A the principal and rent (as the house actually belongs to Person A)?

So our current monetary system is indeed the best and fairest system to distribute money. Anyone who could not show or demonstrate a better and viable system that can replace the current system, then he or she should stop yapping about change and figure out what to change first. People always want the “ideal” life according to their “wants”, but forgets that the world is not “ideal” and that human being is not “ideal” with most people guided by self-preservation and greed. Even the earth is not ideal as you can never predict disasters and so forth. We even get the weather prediction wrong, regularly. Why should we destroy an existing system for something that we don’t even know about? A full and detail explanation must be made, together with its computer simulation and calculations. In short, much like what we did for the current system and published them in the three books series.

When the time comes, the monetary system would evolve because human civilization is always evolving (hopefully for the better). We might remove all forms of money and replaces them with other ‘forms’ of currencies. It might be based on the pursuit of knowledge, or anything imaginable. However to achieve these new ideals, humans must upgrade their level of civility. Read the book by Michio Kaku once in a while, not just the doom and gloom prophets. Look to the future, and move on. Bartering was proven not to work a long time ago, and so was gold based money. Stop looking for these types of monetary system, and work to understand and then improve what we already have.

Sharif Rahman & Amy Norwood

July 2013



Article Snapshot July 2013