Are interest rates a neutral policy variable? Or are they a tool for class warfare? It turns out that the evidence speaks for itself. Here are three ways that higher interest rates redistribute income.

Blair Fix

Download: PDF | EPUB [I]nterest rates are, first and foremost, a distributional variable that affects the income shares of various social groups. — Louis-Philippe Rochon &amp; Mark Setterfield (2007) When I read about monetary policy, I have a rule of thumb. Every time I see the phrase

 interest rate

, I replace it with the term

 wage rate

. Then I ask myself whether the discussion still makes sense. Often, it does not.

How Interest Rates Redistribute Income

Frederick Soddy looms large in the field of ecological economics. Here’s a short dive into his ideas.

In the field of ecological economics, [Frederick
Soddy](https://en.wikipedia.org/wiki/Frederick_Soddy){target="_blank"
rel="noopener"} looms large. Born in 1877, Soddy became a chemist and
eventually won a Nobel prize for work on radioactive decay. Then he
turned his attention to *economics*.

Between 1921 and 1934, Soddy wrote four books that looked at how money
relates to the physical economy. For his ground-breaking work, Soddy was
rewarded with deafening silence. Here's how ecological economist [Eric
Zencey](https://en.wikipedia.org/wiki/Eric_Zencey){target="_blank"
rel="noopener"} puts it:

> ... Soddy carried on a quixotic campaign for a radical restructuring
> of global monetary relationships. He was roundly dismissed as a crank.
>
> ::: {style="text-align: right" target="_blank"}
> (Eric Zencey in [*Mr. Soddy's Ecological
> Economy*](http://www.nytimes.com/2009/04/12/opinion/12zencey.html){target="_blank"
> rel="noopener"})
> :::

Although ignored during his life, Soddy's work would become a central
part of [ecological
economics](https://en.wikipedia.org/wiki/Ecological_economics){target="_blank"
rel="noopener"}. Let's have a look at Soddy's thinking.

### Wealth vs. virtual wealth {#wealth-vs.-virtual-wealth target="_blank"}

Like a good natural scientist, Soddy insisted that human society is
constrained by the laws of physics. Humans survive, he noted, by
consuming natural resources. Exhaust these resources and we're done for.

Think of humans (and our economy), says Soddy, like a machine. We
transform energy into physical work. Like all machines, we're bound by
the laws of thermodynamics, which say that you can't get something for
nothing. Energy output requires energy input. That means humans are
[forever dependent on natural
resources](https://economicsfromthetopdown.com/2020/06/18/can-the-world-get-along-without-natural-resources/){target="_blank"
rel="noopener"}.

Now comes the problem. Our biophysical stock of resources --- what Soddy
called 'wealth' --- is bound by the laws of *thermodynamics*. But money
--- which Soddy called 'virtual wealth' --- is bound only by the laws of
*mathematics*. Money can grow forever. Natural resource extraction
cannot. This mismatch, Soddy claimed, is the root of most economic
problems.

### Cows and virtual cows {#cows-and-virtual-cows target="_blank"}

Here's an example of Soddy's thinking. Suppose that Alice is a would-be
cattle farmer. She inherited some land and wants to use it to farm
cattle. The problem is she has no money.

Not to worry. Alice goes to the bank and gets a \$100,000 loan. With
this money, Alice buys 100 cows. She's now a cattle farmer --- her dream
is fulfilled!

Wait, says Soddy. Alice has a problem. She's invested her 'virtual
wealth' (money) in 'real wealth' (cows). But her 'virtual wealth' came
from interest-bearing debt. That means the amount she owes the bank
grows with time. Let's have a look at this dynamic.

Banks usually require that you make regular payments on your debt. But
to simplify the math, let's assume Alice's bank operates differently. It
requires no regular payments. Instead, after *t* years, the bank demands
full repayment (with interest). The amount Alice owes depends on three
things:

1. The size of her loan (the principal, *P*)
2. The interest rate (*r*)
3. The time (*t*, in years) since her initial loan

Assuming interest accrues annually, here's the formula for the amount
(*A*) that Alice owes:

::: {style="text-align: center" target="_blank"}
[*A* = *P*(1+*r*)^*t*^]{.math .display target="_blank"}
:::

Suppose the bank charges 5% interest (*r* = 0.05). Here's how much Alice
will owe for various call-in times:

::: {style="text-align: center" target="_blank"}
| Call-in time | Amount owed |
|--------------|-------------|
| 5 years | \$127,628 |
| 10 years | \$162,889 |
| 20 years | \$265,330 |
| 30 years | \$432,194 |
:::

What's important are the dynamics of Alice's loan. As the call-in time
increases, the amount she owes grows *exponentially*. This exponential
dynamic, says Soddy, is a problem. Here's why.

Alice used her \$100,000 loan to buy 100 cows. If the bank calls in her
loan after 10 years, she owes \$163,000. That's the equivalent of *163
cows*. If Alice wants to avoid bankruptcy it seems she has only one
choice. To repay her loan, Alice must breed more cows.

So here is the problem with interest-bearing debt. It comes with a
baked-in need for *economic growth*. Or so it seems ...

### Inflating away debt {#inflating-away-debt target="_blank"}

Repaying interest-bearing debt doesn't necessarily require economic
growth. There's a second option. Interest-bearing debt can be paid back
with *inflation*.

To see how, let's return to farmer Alice. With her \$100,000 loan, Alice
bought 100 cows. After 10 years, the bank calls in her loan at
\$163,000. If cow prices don't change, Alice needs to sell 163 cows to
pay her debt. At first glance, it seems like her only option is to breed
more cows. But there is an alternative. She could *raise the price of
cows*.

Alice *bought* her cows at \$1,000 per head. If she *sells* them for
\$1,630 per head, she can repay her loan without breeding more cows. So
repaying interest-bearing debt doesn't necessarily require economic
growth. It can also be financed with inflation.

### Breadth and depth {#breadth-and-depth target="_blank"}

Our toy model of debt (based on Soddy's reasoning) leads to a simple
conclusion. If interest-bearing debt is to be repaid (en masse), there
are only two options:

1. The economy must grow
2. Prices must grow

Jonathan Nitzan and Shimshon Bichler call these two scenarios
[*breadth*](https://blairfix.github.io/capital_as_power/breadth.html){target="_blank"
rel="noopener"} (economic growth) and
[*depth*](https://blairfix.github.io/capital_as_power/depth.html){target="_blank"
rel="noopener"} (inflation). Although it's theoretically possible to
pursue both strategies at once, Nitzan and Bichler find that real-world
societies tend to be single minded. They cycle between rapid growth with
slow inflation (breadth), and slow growth with rapid inflation (depth).
(For details, see Chapters 15 and 16 of [*Capital as
Power*](http://bnarchives.yorku.ca/259/){target="_blank"
rel="noopener"}.)

Both scenarios allow societies to pay off debt en masse. Yet both have
problems. Let's start with *breadth*. It's simply suicidal (and
impossible) to pursue economic growth forever. At some point we'll
either exhaust our resources and/or pollute the environment so badly
that growth will cease. So paying off debt with perpetual growth is not
an option.

What about *depth*? At first glance, it seems like inflating prices is a
sustainable way to deal with debt. After all, the environment doesn't
care if prices grow exponentially. But humans *do* seem to care. Few
people want inflation. Why?

The answer can't be found on paper. That's because in theory, inflation
is a *uniform* increase in prices. But in practice, it never works this
way. Real-world inflation is always *differential*. Some people are able
to raise prices faster than others. This means that inflation always
*redistributes income*. Unfortunately, the winners tend to be the
powerful. (For details, see Jonathan Nitzan's thesis [*Inflation As
Restructuring*](http://bnarchives.yorku.ca/207/){target="_blank"
rel="noopener"}.)

So based on Soddy's reasoning, we find that interest-bearing debt comes
with a fundamental problem. There is no fool-proof way to pay it back.
Perpetually economic growth isn't an option. And if we try to inflate
away debt, the accompanying income redistribution creates instability.
It seems there's no way out of debt.

### Debt default {#debt-default target="_blank"}

Actually, there is a way out of debt, and it's surprisingly simple. We
wipe the slate clean. We *debt default*.

In his book [*Debt: The First 5,000
Years*](https://www.goodreads.com/book/show/6617037-debt){target="_blank"
rel="noopener"}, David Graeber argues that throughout history, default
was the most common way of dealing with debt. Often this happened on a
large scale in something called a 'debt jubilee'. Unpayable debts were
wiped off the books, allowing debtors to start fresh. Of course, this
wasn't a long-term solution. Eventually debts would accrue again,
requiring another jubilee. But as long as debt loads remained reasonably
small, the cycle could repeat without too much trauma.

This debt cycle is a good example of a wider phenomenon found everywhere
in nature --- *stability through fluctuation*. Natural systems are
stable not through stasis, but through small-scale fluctuations. These
fluctuations are a way of mitigating the exponential dynamics that would
otherwise be catastrophic.

As an example of such fluctuation, take population growth. If left
unchecked, populations (of any organism) tend to grow exponentially. But
they never grow forever. Eventually resources are depleted and the
population declines. When the population is again small enough that
resources are plentiful, exponential growth resumes. The result is a
boom-bust cycle --- stability through fluctuation.

Of course, if the fluctuations are huge, we can hardly call this
'stability'. But in most healthy ecosystems, population fluctuations are
small. The key to dampening boom-bust cycles appears to be *diversity*.
When there are many species in an ecosystem, each keeps the population
of others in check. Prolonged exponential growth never gets a foothold.

### Debt monoculture {#debt-monoculture target="_blank"}

In nature, the surest way to provoke exponential growth is to destroy
diversity. This is something that industrial farmers know well. Here's
their recipe. Cut down a forest, plant a single crop, and wait ... for
the exponential growth of pests. In nature, *monoculture* is the enemy
of stability. The same is probably true among humans.

Back to Soddy's debt dynamics. Soddy thought that the exponential
dynamics of interest-bearing debt were a problem. Looking at nature,
however, and we realize that exponential dynamics are everywhere. So
it's not the *dynamics* themselves that are the problem. The trouble
starts when these dynamics go *unchecked*. In nature, exponential growth
goes unchecked when we plant monoculture crops. In human societies,
exponential growth goes unchecked when we have *debt monoculture*.

The term 'monoculture' is especially apt, because debt is literally a
*culture*. Debt is an idea --- a convention of quantifying property
rights, and then applying exponential dynamics to these rights. The
dynamics themselves are not the problem. The trouble starts when the
idea of interest-bearing debt becomes a monoculture.

Interestingly, throughout most of human history the use of debt was
limited. And when it was used, many people were skeptical that debt
should accrue interest. Hence the ban, in many medieval societies, on
interest-bearing debt (dubbed *usury*). Think of this skepticism of debt
as a sign of cultural diversity.

Debt, anthropologist David Graeber argues, is just one particular way of
solving a fundamental social problem. All societies function by keeping
track of a web of social obligations. Throughout most of human history,
these obligations were tracked loosely and qualitatively. Alice helps
Bob catch a fish. Bob returns the favor by helping Alice cook. Different
cultures (and even different sub-cultures) had different ways of
conceiving and tracking these obligations. Cultural diversity.

Then came *capitalism*.

There are many ways that capitalism is different from other forms of
culture. But perhaps the most important is the use of *quantification*.
In capitalism, the web of social obligations (that have always existed)
suddenly became *quantitative*. Bob doesn't owe Alice a favor. He owes
Alice \$10. And if he doesn't pay, that amount grows exponentially with
time.

The idea of interest-bearing debt is an old one. But it's only with
capitalism that this idea became widespread. In other words, capitalism
is the first *debt monoculture*. Capitalism takes the diverse ways of
thinking about social obligations and replaces them with one.
Interest-bearing debt.

As with any monoculture, we expect boom-bust dynamics to be amplified.
And so they have been. But here's the terrifying truth. For the last 200
years we've been riding one long *boom*. For two centuries, debt has
grown continuously. We've achieved this by perpetually consuming more
resources and by perpetually raising prices.

Eventually there will be a reckoning. Societies like the United States
are now plumbing the depths of income inequality (i.e. income
redistribution). And humans are pushing the limits of the Earth's
carrying capacity. So what's worked for the past 200 years won't work
for the next 200.

It seems clear that debt monoculture is doomed to fail. So in a way,
Frederick Soddy was right. The dynamics of interest-bearing debt are a
problem. But only because we've allowed them to become the dominant
human culture.

------------------------------------------------------------------------

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\[[Cover image: Linda Hall
Library](https://www.lindahall.org/frederick-soddy/){target="_blank"
rel="noopener"}\]

### Further reading

::::::::: {#refs .references}
::: {#ref-graeber_debt:_2010}
Graeber, D. (2010). *Debt: The first 5,000 years*. New York: Melville
House Pub.
:::

::: {#ref-nitzan_inflation_1992}
Nitzan, J. (1992). *Inflation as restructuring. A theoretical and
empirical account of the US experience* (PhD thesis). McGill University.
:::

::: {#ref-nitzan_capital_2009}
Nitzan, J., & Bichler, S. (2009). *Capital as power: A study of order
and creorder*. New York: Routledge.
:::

::: {#ref-soddy_virtual_1926}
Soddy, F. (1926). *Virtual wealth and debt: The solution of the economic
paradox*. London: George Allen & Unwin.
:::

::: {#ref-soddy_role_1934}
Soddy, F. (1934). *The role of money: What it should be, contrasted with
what it has become*. London: George Routledge & Sons.
:::

::: {#ref-zencey_mr._2009}
Zencey, E. (2009). Mr. Soddy's ecological economy. *The New York Times*.
<http://www.nytimes.com/2009/04/12/opinion/12zencey.html>
:::
:::::::::

In the field of ecological economics, Frederick Soddy looms large. Born in 1877, Soddy became a chemist and eventually won a Nobel prize for work on radioactive decay. Then he turned his attention to

 economics

. Between 1921 and 1934, Soddy wrote four books that looked at how money relates to the physical economy. For his ground-breaking work, Soddy was rewarded with deafening silence.

Frederick Soddy’s Debt Dynamics

I've always been baffled why 'modern monetary theory' is called a
*theory*. I don't mean this in a disparaging way. As far as theories of
money go, I think modern monetary theory (MMT for short) is the correct
one. But having a correct theory of money is a bit like having a correct
theory of traffic lights.

Traffic lights (like money) are a social convention. We agree that red
means stop and green means go. Why we've chosen these particular colors
is an interesting question, as is why we choose to put traffic lights
where we do. But the fact that red means stop and green means go just
*is*. It's something we've defined to be true. The workings of money are
similar. True, money is more complex than a traffic light --- but only
in application. In conceptual terms, money is equally simple. It's a
social convention that we've defined into existence.

To frame our discussion of money, let's begin with what it *isn't*.
Money isn't a *thing*. True, money can have concrete forms like dollar
bills and metal coins. But it needn't. It can be as abstract as digits
in a bank account, or tallies on a stick. Money is an *idea*. It's an
agreement to tie our social relations to a unit of account. To
understand money creation, we need only look at the principles of
double-entry bookkeeping. Debt goes on one side, credit goes on the
other. The two sides carry opposite signs and so cancel out. This allows
us to create money while simultaneously balancing our accounts.

Here's a simple example. Suppose that a friend does a favor for me. I
want to return the favor, but don't have the time to do so immediately.
So I give my friend a note that says "Blair owes you one favor". This
note is *money*. It is created from nothing using the principles of
bookkeeping. On one side is a *debt*: I owe my friend a favor. On the
other side is a *credit*: my friend is due a favor. And that's all there
is to it. My friend can now exchange my IOU with other people. It
becomes money in circulation.

Understanding this act of money creation is trivial --- much like
understanding the creation of a traffic light. Just like we define the
rules of traffic, we define the rules of double-entry bookkeeping. We
then use these rules to regulate our behavior, creating money as we
please.

What's interesting, though, is that few people misunderstand traffic
lights. We all know that traffic lights can be put anywhere we want
them, and that they're based on an arbitrary social convention. Yet when
it comes to money, the same is not true. Many people fundamentally
misunderstand money. To them, it's not an arbitrary social convention
that can be created/destroyed at will. Instead, they perceive money as a
scarce commodity --- something that, like water in a desert, must be
guarded and conserved.

What we really need, then, is not so much a theory of money, but a
theory of why people *misunderstand* money.

### The quantified obligation

To think about why people misunderstand money, let's keep the definition
of money in our heads. The anthropologist David Graeber defines it best.
Money, he argues, is a *quantified obligation*. The holder of money is
entitled to receive things from other people. (See his book [*Debt: The
First 5000
Years*](https://www.goodreads.com/book/show/6617037-debt){target="_blank"
rel="noopener"} for a detailed exposition.)

We can see from this definition that money is a powerful tool. In fact,
it's a tool for power. If I have a lot of money, I can get other people
to do my bidding. This fact is hardly controversial. We all know the
adage that 'money is power'. But somehow we forget this adage when we
think about money creation. Money is nothing but a quantified
obligation, so in principle anyone can create it. But in practice, few
people have this power. The problem is that for money to circulate,
people must trust that they can use it to receive an obligation. I could
*try* to circulate a note that says 'Blair owes you one hug'. But other
than my wife and daughter, few people want that IOU. So it will never
circulate as money.

In practice, money creation is done almost exclusively by the powerful.
Textbooks on money will use the word 'trust'. They'll say that money can
circulate as long as we *trust* the issuer. This is true, but neglects
the flip side of trust. When you trust someone, you endow them with
*power*. When soldiers trust their commanding officer, they're likely to
obey orders. That gives the commander power. Trust, in many ways, is the
basis of power. You can't have stable power relations without it.

So while I could *try* to create money, few people would be interested.
I lack the trust of the public, which is another way of saying that I
have little power. But if *government* wants to create money, many
people are interested. Many people trust the government, which is why
governments have power.

### Legitimate violence

The sociologist [Max
Weber](https://en.wikipedia.org/wiki/Max_Weber){target="_blank"
rel="noopener"} famously defined the 'state' (i.e. government) as having
a 'monopoly on the legitimate use of violence'. I think we could equally
define the 'state' as having a monopoly on the legitimate creation of
money.[^1^](#fn1){#fnref1 .footnote-ref} There are interesting
parallels, in fact, between violence and money.

Just like anyone can create money, anyone can do violence. You could
walk onto the street right now and shoot someone. But most of us don't.
Why? First, because we think it's wrong. Second, because the state
punishes murderers. In other words, violence in modern societies is
highly regulated. The same is true of money. Technically, anyone can
create money. But few of us do. Your personal IOU will never circulate
widely. And if you try to create state-backed money, the government will
punish you. Like violence, the creation of money is tightly regulated.
To see this fact, we need only look at language. We have a name for
taboo violence (*murder*) and we have a name for taboo money creation
(*counterfeiting*).

Those of us raised in stable societies take for granted both the
regulation of violence and of money. This regulation begins to feel like
a 'natural order'. But if you were raised in a war-torn country, I
suspect you'd feel differently. You'd understand that anyone can do
violence --- with devastating results. And if you lived through a period
of hyper-inflation, you'd probably better understand that anyone can
create money. (People tend to make their own money when government
currency breaks down.)

### Limits to government power

One of the main thrusts of modern monetary theory is to point out that
government spending has no limits. If governments control their own
currency, they can spend as much money as they want by creating money
out of thin air. The interesting question is not whether this is true.
It's *trivially true* --- much like it's trivially true that a green
traffic light means go. Any currency issuer (government or otherwise)
can create as much money as they want. The interesting question is why
governments *don't* spend unlimited amounts of money.

Many economists will trumpet inflation as the boogeyman. Create too much
money, they say, and you'll have hyperinflation. Just look at what
happened in the [Weimar
Republic](https://en.wikipedia.org/wiki/Hyperinflation_in_the_Weimar_Republic){target="_blank"
rel="noopener"}. It's true that money creation can lead to inflation.
But MMT proponents point out that this has an easy solution. Government
can *destroy* money just as easily as it can create it. Government
spending creates money. Government taxation destroys it. Again, this is
trivially true. And yet few (if any) governments accept this truism. In
fact, most governments behave as if money, like water, is a scarce
commodity. Why?

The answer, I believe, has to do with *power*. The creation of money is
inseparable from the accumulation of power. Here's an example. Suppose
that I'm a king who claims the sole authority to create money. And
suppose that everyone in my kingdom accepts this right. I create hordes
of money and use it to buy all the land in my kingdom. I put the landed
aristocracy out of business. And in so doing, I put all the citizens
under my command. Everyone, in effect, becomes a state employee. It's
the totalitarian dream --- an entire society unified under a single
hierarchy.

This tale is, of course, a fantasy. The problem for a real king is that
his subjects probably won't accept his right to create unlimited amounts
of money. There will be pushback, largely from other powerful people.
The landed aristocracy, for instance, won't want to give up their land.
So they'll oppose the king's right to create money (and to tax it out of
existence). History shows that rather than being sovereign money
creators, feudal kings were in perpetual need of finance. This is just
another way of saying that kings were relatively *weak*. They lacked the
power to finance themselves.

What is true for the feudal king is true for modern governments. Like
the king, governments can *in principle* create as much money as they
want. But *in practice* they don't, because there are limits to their
power. When governments create money, they accumulate power, which
implicitly means taking power away from other (powerful) people. The
landed aristocracy didn't want to cede control of their land to the
king. And modern corporations don't want to cede power to the
government. And so these corporations act continuously to oppose
government money creation.

### The arbitrariness of power

I'm hardly the first to connect money creation with power. It's been
done countless times before. And yet many (most?) people still
misunderstand money. Why? A good theory of money should explain this
misunderstanding. Why --- despite it being plainly true --- do we recoil
at the idea that anyone can create money, and as much of it as they
want?

My suspicion is that accepting this fact is difficult because it means
accepting that our existing social order is *arbitrary*. Those who
create money do so not out of any natural right, but because of power
that has been arbitrarily given to them. Nothing makes the human mind
recoil like learning that the things we hold dear --- the patterns and
behaviors that dominate our lives --- are arbitrary.

This points to a deep truth about human behavior. Our social conventions
are, by definition, arbitrary. And yet the existence of these
conventions is predicated on us believing that they are *not* arbitrary.
One of the worst things you can say about a law is that it is
'arbitrary'. Convince enough people of this fact and the law will soon
change. Similarly, one of the worst things you can say about money
creation is that it is 'arbitrary'. Our social order depends on us
forgetting (or refusing to see) this fact. The flip side is that
*changing* the social order means *remembering* this arbitrariness.

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You can use/share it anyway you want, provided you attribute it to me
(Blair Fix) and link to [Economics from the Top
Down](https://economicsfromthetopdown.com/).

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### Notes

::: {.footnotes}
1.  [I can hear your objections. Private banks create money --- so how
    can government have a monopoly on the legitimate creation of money?
    I think of banks as the equivalent of military subcontractors. The
    latter are private-sector institutions that have been given the
    right to do violence. The same is true with banks, only with money.
    Banks are private-sector institutions that have been given the right
    to create money. Just as easily as it was given, government could
    take this right away.[↩](#fnref1){.footnote-back}]{#fn1}
:::

### Further reading

::::::: {#refs .references}
::: {#ref-galbraith_money_1975}
Galbraith, J. (1975). *Money: Whence it came, where it went*. London:
Deutsch.
:::

::: {#ref-graeber_debt:_2010}
Graeber, D. (2010). *Debt: The first 5,000 years*. New York: Melville
House Pub.
:::

::: {#ref-robbins_debt_2016}
Robbins, R. H., & Di Muzio, T. (2016). *Debt as power*. Manchester
University Press.
:::

::: {#ref-rowbotham_grip_1998}
Rowbotham, M. (1998). *The grip of death: A study of modern money, debt
slavery and destructive economics*. Jon Carpenter Publishing.
:::
:::::::


I’ve always been baffled why ‘modern monetary theory’ is called a

 theory

. I don’t mean this in a disparaging way. As far as theories of money go, I think modern monetary theory (MMT for short) is the correct one. But having a correct theory of money is a bit like having a correct theory of traffic lights. Traffic lights (like money) are a social convention.

Messaggi di Rogue Scholar

How Interest Rates Redistribute Income

Frederick Soddy’s Debt Dynamics

Why Isn’t Modern Monetary Theory Common Knowledge?