Tuesday, December 15, 2009

Addicted to Growth

Do you know what fractional reserve banking is? If you don't, you really should.

If you do understand fractional reserve banking - and its consequences - then you understand that our civilization is hooked on an economic growth cycle that can't be broken without destroying the very economy that our comfy, greedy civilization is built upon.

We, as a civilization, are addicted to debt. We're also addicted to debt's alter ego: economic growth.

You can't repay debt without economic growth, and you can't grow the economy on thin air. Economic growth is based on having more stuff to sell, and more (or wealthier) people to sell it to - which is achieved via all kinds of activities, ranging from pulling energy and minerals out of the ground, to importing new consumers from foreign countries. Unfortunately, most of the things we "make money" from are unsustainable in the long term.

Anyone who sits down and really thinks about it can understand that perpetual growth on a finite planet simply isn't possible. If your body kept growing and growing and growing, it would eventually collapse and die. Similarly, if the human population keeps growing, eventually the ecosystems that sustain us will collapse and die. (Whether the planet can sustainably support 1 billion people or 1 trillion people is beside the point. The point is: there are physical limits to growth, beyond which life-supporting systems cannot survive). Obviously, the growth has to stop at some point in time - and when it does, it's going to be very, very ugly.

Fractional reserve banking is a form of black magic: it is the system that conveniently allows banks to reach into thin air and bring previously non-existent money into existence. The banks then lend that money to their customers, with a handsome interest rate attached to the loan. That debt is paid back via economic growth.

If you've ever borrowed a 5- or 6-figure sum of money (to buy something like a new car or a house), I'll bet you 50 magic bucks that you never saw that money as cash. You never held that money in your hands, did you? Why not? Because, thanks to the magic of fractional reserve banking, most of that money doesn't really exist.

Do you know what a "cash reserve ratio" is? It's the minimum reserve of cash that each bank must physically hold in relation to customer deposits and notes. So, if you deposit your hard-earned pay of $1,000 into a bank with a cash reserve ratio of 10%, then the bank is only obliged to keep $100 of cold hard cash on hand to cover your deposit. It's free to lend the remaining $900 (your $900) to whomsoever it pleases - and, at a much higher interest rate than you receive on your deposit.

Do you know what the cash reserve ratio for Australian banks is? It's 0%. Yes: zero percent. In other words, an Australian bank is not obliged to hang onto a single dollar in cash to cover your deposit.

The really tricky part comes next. When you transfer your borrowed money to the seller of your new house or car, the money almost inevitably goes into the seller's bank account, which means the bank can lend that same money out again ... and again ... and again. That is the magic of fractional reserve banking! And that is why we can't collectively choose to simply hop off the debt/growth merry-go-round. If we did, the banks would collapse, and they'd take our economy down with them.

But if we don't remove ourselves from the debt/growth cycle, then sooner or later, our life-supporting ecosystems will collapse. Hence, we find ourselves in a sticky Catch-22 situation: stuffed if we do, and even more stuffed if we don't.

If everyone went to the bank today to convert their money into cash, the banks would all collapse before morning tea time. When that happens, it's called a run on the bank, and a run on the bank is a scary prospect for anyone who cares about their money. The current global financial crisis has witnessed numerous runs on banks, including the one that sent Bear Stearns down the toilet.

I'm taking steps to reduce my debt, and to make my life as sustainable and self-sufficient as possible.

What are you doing?

1 comment:

  1. I'm largely free of debt, which is lucky. I have the cursed student loan hanging over me, and car payments to make each month, but unlike a lot of people I know I don't owe anything on credit cards or bank loans. One day I'll move the Kingdom of Bhutan and work to increase the happiness, not the wealth.

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