Positive Money make a mistake.

While I support the Sovereign Money idea promoted by Positive Money (an idea supported by numerous leading economists) it’s sad to see Positive Money falling for a popular myth, which runs as follows.

Commercial banks lend, and they obtain the money they lend by creating it out of thin air (which is true).  But those banks supply the non-bank sector with relevant capital sums, but no enough to pay the interest. Thus (allegedly) borrowers and the non-bank sector in general does not have enough money to pay the interest.

To explain the flaw in that idea, take a nice simple example: an barter economy decides to introduce money for the first time. So let’s assume banks set up, and lend out money to a variety of borrowers.

Since money is useful stuff, people are prepared to hold a stock of it just to do daily transactions even if they get no interest (which is pretty much the case with current accounts at UK high street banks right now).

Clearly the higher the rate of interest offered to money holders, the more they’ll be prepared to hold. But let’s say the average rate paid (including the rate on deposit / term accounts) is 1% - which is roughly the average at the moment in the UK.

Those who have borrowed will in most cases start repaying capital and will pay interest soon after obtaining their loans. As to capital repayments, that will not reduce the total amount of loans because old loans being repaid will be replaced by new loans being taken out, which is very much what happens in the real world.

As for the so called interest charged by banks, a significant proportion of that is not what might be called “genuine interest”: it’s actually a charge to cover the numerous costs that banks incur: staff salaries, costs of maintaining bank branch buildings etc. So that element of the so called interest charge goes straight into the pockets of staff, plus those who maintain said buildings etc. And those people in turn spend the money purchasing, among other things, the stuff made by those who pay so called interest to banks. So that money just goes round in circles!

As for GENUINE interest (which gets paid to bank depositors, shareholders and bond-holders) that too goes round in circles.

The fact that borrowers pay interest no more means they run out of money than does the fact that some people rent their accommodation means THEY run out of money.  And the fact that some people periodically buy a new car does not mean they run out of money either.