Consequences of low-cost storable money
Money’s durability, liquidity and ability to preserve purchasing power provide important benefits. They allow people to transfer value through time, prepare for future expenses and respond to uncertainty.
Silvio Gesell nevertheless argued that conventional money combines these useful qualities with comparatively low carrying costs. Its owner can often postpone spending, lending or investing without experiencing the same immediate losses faced by people holding goods or offering labour.
In Gesell’s theory, this initial monetary asymmetry creates a chain of effects involving interest, productive investment, employment and wages, production and competition, monetary circulation, inflation and deflation, economic crises and the distribution of income and wealth.
These effects should not be understood as automatic or as the only forces operating in an economy. Investment, employment, prices and inequality are influenced by many institutional, technological, political and social conditions. Gesell’s narrower claim was that the ability to retain money at comparatively little cost creates an additional monetary influence across each of these areas.
Effects on investment and productive capital
Interest establishes an investment threshold
Using terminology later associated with John Maynard Keynes, Gesell’s argument can be expressed by saying that the monetary rate of interest establishes a threshold that the expected return on productive investment must exceed.
The expected marginal efficiency of capital is the anticipated return from creating or acquiring an additional productive asset. Examples could include purchasing machinery, building a factory, constructing housing, developing new technology or expanding productive capacity. An investor compares the expected return from a project with the returns available from alternative uses of the same funds.
Suppose comparatively secure and liquid financial assets offer a return of 3 per cent. A productive project that is risky, uncertain and difficult to exit would generally need to offer more than 3 per cent before an investor would consider it worthwhile.
The required return would also need to compensate for the possibility that the project will fail, uncertainty about future revenue, the period for which funds will be committed, the difficulty of recovering the investment and the administrative and management costs involved.
The relevant investment threshold is therefore not simply a basic interest rate. It is the risk-adjusted opportunity cost of committing funds to the project.
Money itself should not be confused with an interest-bearing financial asset. Physical cash does not ordinarily pay nominal interest. Bank accounts, bonds and other financial assets produce returns because of the arrangements attached to them.
Gesell nevertheless believed that the liquidity of money provides the foundation for basic interest. The owner’s ability to retain money establishes the conditions under which a return can be demanded before liquidity is surrendered. That return then becomes part of the benchmark against which productive investments are assessed.
Reduced capital formation
Projects whose expected risk-adjusted returns fall below the available financial threshold will ordinarily not proceed.
A factory may remain unbuilt, machinery may not be purchased and a potentially useful innovation may not be developed even though it is technically feasible. The project may be capable of producing additional goods and services, but it will not attract private investment if its expected return is considered insufficient.
Capital formation is also constrained by real conditions, including the availability of labour, access to land and resources, technical knowledge, energy requirements, regulation, consumer demand, managerial capacity and physical depreciation.
Gesell’s claim was not that interest is the only limit on investment. It was that monetary interest adds a separate financial constraint.
By allowing wealth holders to retain liquidity or choose relatively secure financial assets, conventional money may prevent some productive projects with low but positive expected real returns from proceeding.
If basic interest were absent, the financial threshold might be lower. Some projects that are currently considered insufficiently profitable might then become viable.
This would not mean investment would continue without limit. Risk, resource scarcity, expected demand, labour availability and depreciation would still constrain capital formation. The narrower claim is that removing basic interest would allow investment to continue beyond the point at which it presently stops.
The scarcity of productive capital can become self-perpetuating
Gesell argued that returns on productive capital tend to decline as that capital becomes more abundant. Factories, machinery, housing and other productive assets can command high returns when they are scarce. As additional assets are created; productive capacity expands; competition between owners increases; more goods and services become available and scarcity returns begin to decline.
However, if the expected return approaches the threshold established by monetary interest, further private investment becomes less attractive. Investors may prefer to retain liquidity or select a safer financial asset. Capital formation can therefore stop before productive capital becomes abundant enough to eliminate its scarcity return.
The process may become self-perpetuating:
Productive capital is relatively scarce.
Scarce capital earns a comparatively high return.
New investment increases the supply of capital.
The expected return begins to decline.
Investment slows when the return approaches the monetary threshold.
Productive capital remains scarce enough to continue generating income for its owners.
This is a theoretical tendency rather than an uncontested economic law. Returns on capital can also persist because of genuine risk, innovation, entrepreneurial skill, monopoly power, ownership of scarce resources, intellectual property and continuing technological change.
Gesell’s specific contention was that basic monetary interest creates a floor beneath which expected returns on newly created productive assets cannot ordinarily fall without discouraging further private investment.
Effects on labour
Labour demand
If the monetary investment threshold prevents otherwise viable productive projects from proceeding, fewer businesses, facilities and employment opportunities may be created.
Gesell expected this to leave the demand for labour lower than it would be in a more capital-abundant economy. Fewer productive projects can mean fewer employers, fewer available jobs, less competition for workers, lower productive capacity and slower development of new industries.
The relationship between investment and employment is not automatic. Some investments complement workers and increase the demand for labour, while others automate tasks and replace particular forms of work.
Productive investment may nevertheless support employment indirectly by expanding total output, creating new industries, increasing income, reducing production costs or generating additional demand elsewhere in the economy.
Gesell therefore associated restricted capital formation with lower employment and productivity than might otherwise have existed.
Labour bargaining power
Workers may have less bargaining power when employment opportunities are scarce.
When many workers compete for a limited number of jobs, employers can generally offer less favourable wages and conditions than they would have to offer if businesses were competing intensely for labour.
Workers also face a temporal constraint. A person’s capacity to work today cannot usually be stored and sold at a later date. Workers who depend on wages to meet rent, food and other living expenses may be unable to wait for more favourable employment terms.
Owners of liquid monetary wealth may have a greater capacity to postpone hiring, investing or entering an agreement.
In this qualified sense, Gesell associated restricted capital formation and monetary withholding power with unemployment, economic dependence, weaker labour bargaining power and a smaller share of production going to workers.
Other factors, including labour law, trade unions, skills, education, technology and market concentration, also influence wages and bargaining power. Gesell’s argument concerns the additional effect of a monetary system in which access to purchasing power can be withheld.
Effects on production, competition and real prices
Restricted capital formation can leave productive capacity lower than it otherwise would be. Additional productive investment may introduce more efficient machinery, improved technology, greater production capacity, new businesses, increased competition and better infrastructure. These changes can reduce the real resources required to produce each unit of output. They may increase the quantity and quality of goods available to consumers.
If monetary interest prevents some productive investments from proceeding, consumers may face higher production costs, reduced output, less competition, fewer choices and slower improvements in quality.
This outcome is not guaranteed. Additional investment may strengthen dominant firms, increase market concentration or flow into existing land and financial assets rather than new productive capacity.
Automation may also increase returns for owners without increasing employment proportionately. Even when production costs decline, firms with substantial market power may retain the gains as profit instead of passing them to consumers.
Gesell’s argument is therefore strongest when stated conditionally: to the extent that monetary interest restricts productive investment and effective competition, consumers may face higher real costs or fewer available goods and services than they would in a more capital-abundant economy.
The benefit of greater capital formation would not necessarily appear as a fall in the overall nominal price level. If monetary policy kept average prices stable, the benefits might instead appear as higher real wages, increased output, improved products, shorter working hours and lower relative prices in the affected industries.
Effects on monetary circulation
Velocity depends on confidence and expectations
The level of monetary expenditure depends on both the quantity of money and the frequency with which it is used.
The rate at which money changes hands is commonly described as its velocity. If people retain money for longer periods, velocity declines. A decline in velocity can have an effect similar to a contraction in the actively circulating money supply. Businesses receive less revenue, inventories accumulate and production may be reduced. Employment and household income may then decline.
If people begin using the same quantity of money more rapidly, an increase in velocity can have an effect similar to monetary expansion. Depending on the productive capacity of the economy, this may increase output, prices or both.
The willingness to retain money varies with confidence, expectations, interest rates, perceptions of risk, debt obligations, income security and expectations about future prices.
During prosperous periods, households and businesses may feel secure enough to spend and invest readily. During periods of uncertainty, households, businesses, banks and investors may all try to increase their monetary reserves. This may be prudent for each participant individually. Collectively, however, the attempt to obtain more liquidity can reduce expenditure precisely when businesses and workers most need demand.
The same nominal quantity of money can consequently support very different levels of economic activity at different times.
Financial intermediation does not guarantee circulation
Savings held through banks and financial markets may be lent to others. This can make retained income available for consumption or productive investment.
However, financial intermediation does not guarantee that this will happen. Banks may become more cautious, reject loan applications, retain additional reserves or reduce lending during periods of uncertainty. Households and businesses may become unwilling to borrow, repay existing debts, delay investment or increase precautionary balances. Even when money is lent, its next recipient may also decide to retain it.
Gesell’s criticism was that the circulation of conventional money depends on the changing confidence and preferences of successive holders. The quantity of money can remain unchanged while its contribution to current expenditure varies substantially.
Effects on aggregate demand
Aggregate demand refers to total expenditure on goods and services across the economy.
Expectations about money’s future purchasing power can influence both the amount and timing of expenditure. If people expect deflation, they may postpone purchases because the same money is expected to buy more in the future. Businesses may delay investment because they anticipate receiving lower prices for future output.
If people expect inflation, they may bring purchases forward or exchange monetary balances for goods, property, securities, commodities or foreign currency.
Purchases of existing assets do not necessarily create demand for newly produced goods and services. They may instead increase asset prices or transfer existing ownership claims. Expectations can therefore change the composition of expenditure as well as its total level.
Moderate and predictable inflation may discourage the passive holding of cash, but it should not be said to prevent saving in general. People can continue saving through financial assets, property and other forms of wealth.
High and unpredictable inflation can eventually undermine economic activity by disrupting contracts, making calculation difficult, reducing confidence, shortening planning horizons and encouraging movement into alternative currencies or assets. Neither inflation nor deflation is automatically self-reinforcing in every case. Monetary policy, fiscal policy, credit conditions, production, wages and public expectations can interrupt either process.
The broader Gesellian criticism is that conventional money makes current demand unusually sensitive to expectations about future purchasing power.
Deflation and monetary retention
When the general price level falls, a fixed quantity of money gains purchasing power. Even if cash pays no nominal interest, it produces a positive real return because it will purchase more goods and services in the future.
Holding money may consequently appear more attractive than spending it or committing it to an uncertain long-term investment.
This creates the possibility of a reinforcing contraction:
An initial decline in expenditure reduces demand.
Businesses respond by lowering prices.
Falling prices increase the purchasing power of money.
Monetary retention becomes more attractive.
Additional expenditure is postponed.
Demand declines further.
Businesses expecting lower future prices may reduce production and investment because they anticipate receiving less revenue for their products. Reduced production can then lower employment and income, placing further pressure on demand.
Deflation also increases the real burden of debt. A borrower must repay a fixed nominal obligation using money that has become more valuable. This can increase defaults and weaken financial institutions.
Deflation does not mean that every person will postpone every purchase. Essential consumption must continue, and some buyers may respond to lower prices by buying more.
The strength of the effect depends on whether the decline is expected to continue, household and business debt, income security, access to credit and the ability of public policy to restore confidence.
Gesell’s argument concerns the additional incentive deflation creates to retain money, not an absolute cessation of exchange.
Economic crises and cumulative contraction
The effects of monetary retention can combine during periods of economic uncertainty.
Households, businesses and banks may all attempt to increase liquidity at the same time. Their collective actions reduce velocity and aggregate expenditure.
Lower expenditure reduces business revenue. Businesses may then respond by reducing production, delaying investment, dismissing workers, lowering wages or cancelling orders. These responses reduce income elsewhere in the economy, producing a further decline in demand.
Falling prices may then increase the real return from holding money and increase the real burden of debt. Defaults and declining collateral values can weaken banks and other financial institutions, causing credit conditions to tighten further.
The cumulative process can be represented as follows:
Confidence deteriorates.
Participants increase liquid balances.
Monetary velocity declines.
Business revenue falls.
Production, investment and employment decline.
Household income declines.
Aggregate demand falls further.
Prices and collateral values may fall.
Debt burdens and defaults increase.
Financial conditions tighten.
During periods of optimism, the opposite dynamic can occur. Rising income and asset prices may strengthen confidence, encourage borrowing and accelerate investment. Credit expansion can support further expenditure and rising asset values. If expectations later reverse, the movement back towards liquidity can be sudden and destabilising.
Gesell treated money’s ability to be withheld as a fundamental source of this instability. A more qualified interpretation is that low-cost monetary storability and liquidity preference provide mechanisms through which an initial disturbance can spread and intensify.
Economic crises can also be caused or worsened by supply disruptions, excessive leverage, banking failures, asset bubbles, policy errors, wars, natural disasters or technological changes.
The Gesellian claim is not that storable money is the sole cause of every crisis. It is that widespread monetary retention can allow an initial shock to become a broader contraction of circulation, demand and employment.
Distributional consequences
Interest and the transfer of income
Interest transfers income from borrowers and users of capital to creditors and owners of interest-bearing assets.
People and organisations possessing net monetary wealth can receive continuing income from loans, bonds and other financial claims. Borrowers must generate enough income to repay both principal and the additional financing charges attached to their obligations.
Gesell believed basic interest could therefore contribute to the concentration of income and property.
The distributional effect is not as simple as a direct transfer from poor borrowers to rich lenders. Borrowers can include wealthy households, profitable corporations, governments or property investors. Creditors can include ordinary savers, pension funds, insurance schemes and public institutions. Taxes, defaults, inflation, consumption and investment losses can also prevent wealth from compounding indefinitely.
Gesell’s objection concerned basic interest specifically. It did not concern compensation for risk, administration or genuine financial services.
Nevertheless, ownership of net interest-bearing assets is generally concentrated among households and institutions possessing greater financial wealth. People with few assets may receive interest through savings or pensions while simultaneously paying it through mortgages, consumer debts, rent, taxation and the prices charged by indebted businesses.
Gesell’s structural claim was that basic interest tends to favour participants who possess more financial assets than debt.
Cumulative inequality
When interest income is reinvested, an initial inequality of wealth can become self-reinforcing.
Greater monetary wealth allows its owner to acquire more income-producing assets. The income generated by those assets can then be used to purchase additional assets.
The process can be represented as follows:
Existing wealth produces income.
Part of that income is reinvested.
Reinvestment increases the stock of wealth.
The larger stock produces more income.
Further accumulation becomes possible.
People without substantial assets remain dependent primarily on income from labour. They may need to borrow to acquire housing, education, business equipment or other productive assets.
Debt payments can limit their ability to accumulate financial wealth, while existing asset owners continue receiving income.
In Gesell’s account, the monetary system can therefore transform an initial inequality in wealth into a persistent inequality of income and economic power.
This tendency is affected by taxation, inheritance rules, public services, labour institutions and patterns of ownership. Basic interest is not the only cause of inequality, but Gesell regarded it as an important reinforcing mechanism.
Political consequences
Economic inequality can also produce differences in political influence.
Workers, debtors and producers may face immediate financial obligations, while holders of liquid wealth may be able to wait for more favourable terms. Transactions can therefore be legally voluntary without taking place between participants possessing equal economic freedom.
If liquid wealth becomes concentrated, its owners may gain disproportionate influence over which businesses receive finance, which projects proceed, where investment takes place, which workers obtain employment and which technologies are developed.
Concentrated economic resources can also be converted into political influence through ownership of institutions, lobbying, campaign finance, control over public communication and influence over research and policy.
These political effects are not caused by monetary storability alone. They can nevertheless reinforce the economic inequalities associated with concentrated financial wealth and basic interest.
Why legal restrictions on interest are insufficient
If basic interest arises from the ability to withhold money, a legal ceiling on interest does not remove its underlying cause.
When the permitted return is considered insufficient, lenders may refuse to lend, move funds into other markets, impose additional fees, demand more collateral and conceal interest in other contractual terms.
Riskier borrowers may then be excluded from formal credit and forced to use less regulated alternatives.
This does not mean restrictions on lending rates are always ineffective or undesirable. Well-designed regulations can protect borrowers from exploitation, improve transparency, prevent extreme charges and reduce abusive lending practices.
Gesell’s narrower point was that regulating the visible interest rate does not change the monetary conditions from which he believed basic interest arose. If the money holder retains the option not to lend, the underlying bargaining advantage remains.
Interest-rate controls can regulate lending practices without eliminating the incentive to withhold money.
Why creating more money is insufficient
Increasing the quantity of money does not guarantee that the additional money will circulate through consumption or productive investment.
Recipients may retain the money as liquidity, repay debts, purchase existing financial assets, purchase property or move the money into another currency.
Banks may hold additional reserves rather than increase lending. Businesses may remain unwilling to borrow or invest if they expect weak demand. Households may continue building precautionary balances.
During a contraction, additional money can satisfy an increased desire for liquidity without restoring expenditure. The actively circulating money supply may remain weak even though the total nominal quantity has increased.
If confidence later returns and retained balances begin circulating more rapidly, the enlarged money supply can place upward pressure on output, asset values or consumer prices.
Gesell therefore believed that monetary expansion alone leaves the option to retain money unchanged. Increasing the quantity of money does not directly change the incentive facing its holders.
His proposed alternative combined management of the money supply with a carrying charge intended to encourage circulation. The monetary authority would adjust the quantity of money to support price stability, while the carrying charge would discourage prolonged retention.
Whether such a system would achieve its intended outcomes remains disputed. However, it follows directly from Gesell’s diagnosis: if the underlying problem is the ability to withhold money at comparatively little cost, changing the quantity of money without changing that incentive does not remove the problem.
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