Tag Archives: Economy

Making money from money: is this a needed feature of our society?

Ripple is an attempt to (re)design society: our interactions will no more based on the fact we all agree money (generated by banks and governments) exist but on how much we trust other people. Each participant indicates which other participants he or she trusts, by offering to accept their IOUs up to a certain amount, like a line of credit: your peers become the generators of currency. In short, Ripple lets everyone act like a bank.

Now, in such a society, is interest needed? Do we want to implement as a feature of the system the fact you can make money from money? This was the question posed in the Ripple-users mailing list.

The answer by Daniel Reeves is illuminating. I copy a portion of it below but I suggest you to read the entire thread, it is really worth your minutes.

There was some google video circulating a while back that started out very informative and then spun off into batshit insanity, claiming that it’s mathematically impossible to pay off debts with compound interest, etc..
A thought experiment that has helped me is to pretend there is no money and just look at movement of wealth. Remember the distinction: wealth is the actual stuff we want, money is just a way to transfer it. So the question “how can I repay a loan with interest; where does the extra money come from?” becomes “how can someone give back more wealth than they were loaned; where does the extra wealth come from?”.
Well that’s easy to answer. The same place all wealth comes from: people make it. They build things, do work, cough up valuable property.

Say you have a beautiful painting (= wealth) that I want and I have nothing to offer you for it except the promise to return it to you later. That’s a big favor I’m asking you. To keep things fair, I might offer you a small thing of my own in return (say, doing your dishes). So there you have it, I borrowed the painting and paid it back, plus interest (doing your dishes). Everyone’s happy.

It really is, fundamentally, as simple as that.

And, by the way, there’s nothing magical or mathematically insidious about compound interest either. In fact, the concept is already implicit in this “extra favor” conception of interest.

On why we accept worthless pieces of paper and what happens when we stop.

Exercise for the reader: Let suppose you are the chief of Saudi Arabia, you sell most of the oil in the world. Why would you ask to be paid in a currency that is not your currency? Think why Saudi Arabia asks to be paid in dollars and not directly in its own currency (Riyal).

Did it?
Ok, so now the news from Reuters: some OPEC countries are considering/threatening stopping asking dollars in exchange for oil. The precise sentence uttered by Iranian President Ahmadinejad was “They get our oil and give us a worthless piece of paper”. For now it is just a threat. And both Ahmadinejad and Chavez announced it for political reason (“crashing the empire of dollar”, as Chavez put it). But in reality also because with a weaker and weaker dollar, they get less and less buying power in the international markets and so keeping accepting dollars simply is a stupid economic decision.
But we know what this means, right? Iraq wanted to dump the dollar and sell oil in euros and we all know what happened to Iraq. But now somehow the situation is different, but not too different.
Anyway, going back to the sentence “They get our oil and give us a worthless piece of paper”, the symbolism is powerful.
A piece of paper has zero value, a piece of paper has value only because we recognize a value in it and we accept it based on this “somehow commonly agreed” value. But what happens when enough people stop assigning value to a certain piece of paper? I fear we will all see it together.