Demurrage

The previous sections have helped to highlight the problems that arise due to the adoption of hoardable money, such as it being a root cause for interest, which then contributes towards growing wealth inequality. Demurrage represents a promising solution to these problems.

Removing the store of value property

By designing money to perform the store of value function in addition to the medium of exchange function, we inadvertently made money superior to real goods & services as a form in which to hold wealth. As a consequence of this superiority, money does not meet with goods & services on a level playing field when it mediates their exchange.

When considering the direct exchange of goods & services as a baseline scenario, it can be observed that it is universally true that tangible wealth imposes costs on its holders. Whether that is due to physical decay, costs of storage and maintenance or technological obsolescence. The physical nature of goods & services compels their sale sooner rather than later.

When exchange takes place between producers of goods & services, there is pressure to transact on both sides of every negotiation. Therefore, if money is to be a neutral medium to facilitate exchange without changing the terms of those exchanges, it must meet goods & services on a level playing field as well.

If it does not, the terms of exchange will be affected by money and it will therefore not be a neutral medium. The goal of Silvio Gesell’s proposal is to simply make money neutral.

Treating money as a public resource

Treating money as a form of private wealth is harmful to society. A proper understanding of money can help with recognising it as a creation of society, a public utility designed to enable everyone to reap the enormous rewards of the division of labour.

Water, air, public airwaves, public parks and the internet are all examples of resources that belong to everyone. These resources are not owned by any single individual. People rely on these resources for society to function properly. Money is also a vital public resource. Everyone depends on money to exchange goods and services and for investing or donating towards impactful initiatives.

Money could be thought of as a public road. Public roads are not forms of private property. They are public utilities created by society to improve the living standards of all of its members. The charging of interest is like allowing people to park their cars on public roads and then allowing those people to charge others to move their cars so traffic can flow. Permitting the extraction of interest is allowing private parties to treat a vital public resource as a form of private property and charge for its use. We wouldn’t tolerate such a situation on our roads, but we have tolerated an analogous situation when it comes to the vital public resource of money. Our systems of money should belong to The Commons and not be considered as a form of private wealth that can be hoarded.

Demurrage as the solution

On the topic of fixing the problems with money, Silvio Gesell writes:

“Only money that goes out of date like a newspaper, rots like potatoes, rusts like iron, evaporates like ether, is capable of standing the test as an instrument for the exchange of potatoes, newspapers, iron and ether… So we must make money worse as a commodity if we wish to make it better as a medium of exchange. As the owners of goods are always in a hurry for exchange, it is only just and fair that the owners of money, which is the medium of exchange, should also be in a hurry… Supply is something detached from the will of owners of goods, so demand must become something detached from the will of owners of money… As the law of gravity knows no moods, so the law of demand will know none.”

“Supply is under a direct compulsion inherent in the nature of wares, and for this reason I propose a similar compulsion for demand. In the process of settling the price, supply would then no longer be at a disadvantage in comparison with demand.”

Demurrage money is money that constantly loses value over time. Demurrage money would create a level playing field between money and goods and services. It would lead to a mutually shared incentive for buyers and sellers to transact rather than creating situations where demand can be easily withdrawn due to the will of the holders of money.

Demurrage would have a negligible effect on anyone using money as a medium of exchange. If you receive your pay in demurrage money and use it during the following days and weeks to purchase goods & services, the cost of holding that money due to demurrage would be almost imperceptible. Even if you wait a month to spend your money, the loss due to demurrage would be minor. Demurrage would only have a meaningful impact on those who hold money for long periods of time.

This one monetary change, of putting money on a level playing field with the goods & services, would eliminate the privileges of money and thereby solve all of the problems that result from those privileges.

Unhoardable goods & services would meet with unhoardable money to negotiate exchanges, and the universal compulsion to circulate that applies to both sides of every barter transaction would then also apply to both sides of every exchange intermediated by money. Money would then no longer be able to exact “tribute”. This in turn would result in the gradual disappearance of interest and the removal of the artificial limit on the production of capital.

Inflation vs demurrage

Why is demurrage needed when we already have inflation? This is a reasonable question, since it’s a well-established fact that over any long period of time inflation erodes the purchasing power of our modern form of fiat money, which means that it is not well suited for use as a long-term store of value. Doesn’t that solve the problem? No, it doesn’t.

While it is true that inflation makes money a bad store of value on average, it does not do so under all economic conditions. Modern fiat money can have the same problem as gold-backed money, even in spite of the fact that inflation erodes its value over time.

One of the key differences between demurrage and inflation is that demurrage is consistent and predictable. It is always the same. In good times and in bad times, demurrage reduces the purchasing power of money by the same amount each and every day or week. Inflation, on the other hand, is inconsistent, unpredictable and constantly changing. Sometimes inflation is high, sometimes it’s low, and sometimes it reverses itself and becomes negative.

Inflation is not a solution to the problem of the reduction in commerce due to falling prices. This is because, by definition, if prices are falling there’s no inflation. Falling prices means deflation, which is the opposite. Regardless of whether it is gold-backed money or unbacked fiat money, any time prices fall, the purchasing power of money increases. And that rewards those who withhold money from circulation. So the disincentive of hoarding, which is sometimes provided by inflation, disappears completely and becomes its opposite, a reward to hoarding, precisely at the times when society most needs money to circulate. While inflation means that on average money is not a feather bed, it becomes a feather bed exactly when we need it not to.

Demurrage money, on the other hand, provides the same incentive to keep money circulating in all economic environments. This is the most important difference between demurrage and inflation. When it matters most, demurrage money and conventional fiat money behave exactly opposite to one another. The effect of inflation on modern fiat money is not just not the same as demurrage. It is directly opposite demurrage when it matters most.

Another important difference between demurrage and inflation is that inflation affects both existing currency and future cash flows. Demurrage only affects currently existing, outstanding units of currency. It has no effect on future cash flows. So it incentivises people to put the money they currently have back into circulation, but it does not affect the future purchasing power of salaries, pensions and other fixed income streams. Demurrage is actually one of the best ways to avoid inflation and preserve the purchasing power of future cash flows. Despite their apparent similarities, in some very important respects, demurrage and inflation actually work in exactly opposite ways.

Money velocity & supply

In response to the turbulence following the collapses of Bear Stearns and Lehman Brothers, the world’s central banks created unprecedented amounts of new money, but they were powerless to make that money circulate. Under the currently adopted systems of money, central banks have the power to influence the total supply of money in circulation. However they have little influence over how that money circulates. According to Gesell, this situation is a consequence of the irrational design of the existing forms of money.

Let’s discuss a related aspect of the differences between modern fiat money and demurrage money, specifically how they affect prices. The general price level in the economy is a function of two things, the amount of money in existence and the velocity with which that money circulates. So if one wishes to adjust the price level, there are two levers one can use, the money supply and the velocity of money. This is a crucial difference between conventional approaches to monetary policy. The currently adopted systems use the lever that changes the quantity of money. Gesell advocates for the lever that will influence the velocity of money. This is a critical difference.

Let’s think about the differences between attempting to regulate the price level via the money supply versus the velocity of money. If we attempt to support prices during periods of economic weakness by increasing the quantity of money, we risk falling into the situation where a large increase in supply has little actual impact on prices due to a lack of money velocity. Under our existing system, the monetary authorities can create unlimited quantities of new money, but they cannot force that money to circulate. A case study of such a situation was demonstrated following the financial crisis of 2008. For a decade-plus, the world’s central banks created massive, unprecedented sums of new monetary reserves and cut interest rates to zero (or even below zero), but they were still unable to compel that money to flow into the productive economy, thereby stimulating production and employment. Instead, for the most part this new money just served to inflate massive asset bubbles.

When things finally did turn around, and prices began to rise, the economy was like a flooded engine with huge amounts of fuel pooled throughout the system. What happens with pooled fuel once the engine finally starts to fire? It ignites all at once and causes an explosion. This is why the current monetary system can go very quickly from one extreme to the other, from having to fend off deflation by whatever means necessary to suddenly seeing inflation get out of hand.

It’s obvious why demurrage is a solution to the problem of deflation, but what’s less obvious is the fact that it’s also the solution to inflation as well. The purpose of demurrage is to maximise the velocity of money under all economic conditions. If money is always circulating at the maximum possible velocity, where could inflation possibly come from if the quantity of money remains the same? Since demurrage money would always remain in motion, there would be fewer piles of idle money sitting on the sidelines which might be suddenly mobilised. There would be no pools of fuel waiting to ignite and explode. And there would also be little possibility of increased monetary velocity, since money would always be circulating near the maximum velocity possible given the existing state of commercial organisation. So it would not be mathematically possible to cause a sudden rise of prices in that environment due to demurrage money. Not only are demurrage and inflation not the same things, demurrage is actually the cure for inflation.

Regulating money supply vs velocity

Let’s compare the differences between attempting to regulate the price level via the lever of the money supply versus the lever of the velocity of money. Money is the chain that transmits force from the pedals to the wheels. Our existing form of money is like a chain with a bunch of slack in it. Because it is not well fitted to the gears of the real economy, it moves in a jerky fashion. It sometimes moves too fast and other times too slow.

The conventional Keynesian approach to avoiding deflation, unemployment and economic crises is that every time the chain seizes up we add links to it. Sometimes this alleviates the immediate problem (sometimes it doesn’t), but by continuously adding more links, we create more and more slack in the chain. This creates bigger and bigger problems in the future, since the increasing slack weakens the connection between the pedals and the wheels. With more and more slack in the chain, there is an increasing need to execute more and more extreme manoeuvres in order to achieve the desired results. Eventually we get to a point where it becomes essentially impossible to control the bicycle.

Continuing with the analogy, the Gesellian solution is essentially the opposite of the Keynesian approach. Whereas the latter requires more and more links to be added to the chain, resulting in more and more slack over time, the Gesellian approach aims to have no slack in the chain whatsoever. If there’s no slack, small adjustments in the quantity of money become powerful and precise tools for adjusting the speed of the wheels. Under such a system, the monetary authorities would no longer be “pushing on a string”. They would be pushing on a ramrod. As Gesell writes, “If money were under compulsion to circulate, minute changes in the quantity of money would suffice to make demand fit like a glove the natural variations of production.”

Only minute changes in the quantity of money would be necessary to adjust to the natural variations of the real economy because rapidly and consistently circulating money would be a precise and reliable mechanism for the transmission of energy from the pedals to the wheels.

And this further illustrates how demurrage is not only the solution to deflation, it is also the solution to inflation. So this is another illustration of the fact that modern fiat money is not similar to demurrage money just because it loses purchasing power on average over time. Conventional fiat money does not stabilise the velocity of money. It does the opposite. When prices begin to fall conventional money behaves exactly like gold-backed money and exacerbates the downward movement in prices by incentivising holders of money to postpone their purchases. And conversely, when prices start to rise, conventional money incentivises holders to spend it as soon as possible. In other words, far from being “self-adjusting” and restoring balance when disturbances occur, modern fiat money does the opposite and exaggerates those disturbances in both directions.

Hard money

Another question to answer is around whether demurrage money should have backing. Proponents of “hard money” see rampant money creation in our modern fiat system and conclude that what’s needed is a return to the gold standard. According to this view, backed money is the way to avoid out of control money creation and thus stabilise prices. This is a superficially appealing argument, because it starts from the completely valid perspective of objecting to the endless expansion of the money supply that is necessary with our current form of money. But “hard money” never has and never will produce enduring price stability.

Supporters of the gold standard tend to consider the terms “hard money” and “sound money” as synonyms. But from a Gesellian perspective, the terms “hard money” and “sound money” are actually antonyms. Gesell’s states: “The power of money to effect exchanges, its technical quality from the mercantile standpoint, is in inverse proportion to its technical quality from the banking standpoint.”

“Hard money” or backed money is good if you want money to be a store of value, but as covered already elsewhere in these resources, making money a good store of value means making it a bad medium of exchange. “Hard money” ensures that prices will not be stable. Because hoardability means that velocity will always fall when prices are already falling and always rise when prices are already rising. “Hard money” not only doesn’t achieve price stability, it actually causes price instability. Backing is not only unnecessary for a medium of exchange, it is in fact counterproductive.

Saving under demurrage

How would people save under a demurrage money system? There are at least two irrational, preconceived notions underlying the question. The first is that we should use a public utility, our legal tender medium of exchange, upon the circulation of which all our lives depend on, as a vehicle for saving. Silvio Gesell wrote: “All the commodities of the world are at the disposal of those who wish to save, so why should they make their savings in the form of money? Money was not made to be saved!”

The second irrational preconceived notion underlying the question “how will we save?” is the idea that saving money entitles us to receive additional wealth through the growth of those savings. This idea is arguably deeply irrational. If you receive income without creating wealth, someone else is creating wealth without receiving income. In other words, if you gain wealth by saving money, where does that wealth come from? Obviously someone else is creating it, but you’re receiving it!

Money can be invested and put to productive use. Keeping money in circulation by putting it at the disposal of someone who can use it would be one of the best ways of saving under a demurrage money system.