Mutual agreement

9 February 2015

In brief

The basic misunderstanding of MPE-people and others is they think money can only be exchanged for goods and services.

They fail to see that money can also be exchanged for money. That makes sense if the mutual conditions are different.

It’s what happens in a bank loan and it warrants interest.

Longer

MPE

MPE means “Mathematically Perfected Economy”, a money reform proposal by Mike Montagne. I wrote several other articles in response to it, see menu.

Buying and selling

Of course I too agree that money can be exchanged for goods or services:

Selling means one party provides the other with goods or services, and gets money in return.
Buying means one party gives the other party money, and gets goods or services in return.

Money for money

A somewhat less obvious transaction is exchanging money for money: one party gives money to the other party, and gets money in return. (And then I don’t mean exchanging money for a different currency.)

(Note that I am now using the notion of money as ‘financial value’ or ‘an amount’, not in the special monetary sense of ‘claim on a bank, by a member of the public’.)

Exchanging money for money seems useless. Why would you do that, the net effect is zero! Simple answer: it does make sense if the conditions are different.

Bank credit

And exactly that is the situation when taking out a bank loan.

The borrower promises to pay back the loan (debit side of bank balance sheet).

The bank promises to make the loan amount available to the borrower (credit side of balance sheet) and to transfer it, or part of it, whenever the borrower wants to make a payment.

The net effect, when just looking at the amounts, is zero: debit offsets credit. Yet it makes sense because the conditions for the two parties are so vastly different:

The borrower need not pay back right away, but only later, usually in installments.
The bank must be prepared to make the amount available for payment at any time, in any combination of smaller amounts.

This unbalance in mutual repayment conditions is exactly the reason why the bank asks – and in my view deserves – interest for this service.

It also clarifies why banks are good at granting credit, better than individuals or small firms: banks are big enough and have enough diversity in their client pool so they can sustain agreements with such unequal conditions as is the case in a lending agreement.

An earlier mention of this idea or at least a similar thought is here.