How to free society of debt

When doubts started to emerge

In my professional career as banker, asset manager, risk manager and economist, I have been closely involved in about 100 financial systemic crises and transitions, predominantly in emerging markets. Such experiences leave impressions, and made me skeptical about what I was taught in university: “in the end, everything moves towards equilibrium states”.

My experiences in real life appeared diametrically opposed. In the end, everything always seemed to move away from equilibrium, resulting in the apparently unavoidable systemic crashes. My doubts grew stronger, feeling I had history on my side, as all financial-monetary systems crashed in the end (typically within a timeframe of less than a century).

Optimal debt is zero

In 2013, when I was Head of Strategy of a systemic bank, I wrestled with the strategic question about the optimal level of indebtedness for society. Getting an answer to that question, I reasoned, would help to design a society-serving strategy for the bank I worked for.

The more I pondered about debt, the more I realised that the optimal level of debt in society, is zero. Always being intrigued by nature's workings, I noticed that nature doesn't seem to apply the concepts of debt, debit, credit, its legal cousins of rights, obligations, claims and liabilities and of course interest (rates) as a derivative of debt. In an economic sense, nature seems to make use of 'values' and in a legal sense, nature seems to apply concepts of 'abilities' and 'possibilities'.

Debtless society versus indebted society in theory

Born with a stubborn curiosity, I tried to imagine a financial-monetary system that didn't use debt. The first thing I realised, is that debt wasn't maliciously invented, it was just practical in commerce, when within a transaction, goods and money couldn't be exchanged simultaneously. Most frequently, physical constraints made such mutual simultaneous exchange of goods and payments impractical, if not impossible. However, with the arrival of the virtual age, the need for debt in transactions no longer needs to occur, as in the virtual world, everything becomes omnipresent and can be exchanged and managed simultaneously.

Also in terms of finance, we can replace debt with some new asset class, which I coined “active and passive equity”. If someone wants to buy a house, but only has 20% of means, one could become 20% active equity holder of that house, with full abilities to use the house. An investor, a pension-insurance company for instance, could (through a liquid investment fund) invest in the remaining 80% of the value of the house as a passive equity holder.

The active equity holder can pay out the passive equity holder with one percent per quarter, so that after 80 quarters, or 20 years, the active equity holder would have become full home owner without ever having to go into debt. Meanwhile, the active equity holder would pay rent to the passive equity holder for its economic share in the house. The passive equity holder would have natural inflation protection, being exposed to the real economy with a positive rental return on top. The financial solution provider would lose interest income, but also a lot of risk and wouldn't need own capital commitments. Moreover, fee income in structuring, mediation and contract management would be a lot higher than with existing mortgage solutions.

I studied the subject in more detail and came to the conclusion that if markets could organise themselves efficiently, at scale, all financial solutions that use debt, can be made debtless with the use of active and passive equity.

Even more importantly, our monetary systems are based on debt. We use money in the form of credits (banknotes and coins as credits on the balance sheet of a central bank and current account and deposit holdings with commercial banks). The vast majority of those credits are created and co-exist with debits. Only a fraction of those credits are covered by reserves, like gold in the vaults of a central bank, hence the name of our financial-monetary system being a “fractional reserve banking system”. Practically, give or take 95% of our money is debit or debt based. Systemically, you cannot see money separated from debt. If we want more money, we need more debt. If we want less money, we need less debt.

This basic “credits equals debits” system, induces destructive competitive forces upon society, because everyone intends to grow their “credits minus debits” position. So if one is successful, it is at the cost of at least someone else that witnesses a deterioration in its “credits minus debits”.

In addition, the current debt-based money system is not-circular, because net-debtors pay more interest to net creditors than the other way around, resulting in dwindling credit (read money) holdings of the group of net debtors as time progresses. This induces monetary policy of central banks to grow balance sheets faster than productivity growth (read pursue inflation) in order to meaningfully replenish the dwindling credit holdings of net-debtors. But because the intricate link between credit and debit in the system, if credits rise faster than productivity, so must debits rise faster than productivity. In other words, central banks inflation policies, are debt spiral policies.

Debt based systems versus value based systems

What struck me most in these explorations, is that a value-based monetary system would outcompete the current debt-based monetary system and whilst in competition, implode the current system, as it would take away funding commitments.

Fortunately, it is possible to launch a value based systems by introducing multiple stand alone initiatives that re-enforce each other and migrate the current system into a value-based system rather seamlessly. If we would do so, we could maintain the value of our money and get rid of our monetary debts at once.

Scenario for a restarts of the euro currency system

Last week, I presented the above research results at a conference celebrating the 30th Anniversary of the Maastricht Treaty, which treaty laid out the foundations for the establishment of the euro currency system. Of course, these solutions can be used for any currency system.

If you want to know more, the pre-published research paper can be found here.

The presentation can be found here.

Happy to think about financial-monetary reform, as the need for it, is imminent.