The Debt Brake

Chancellor Angela Merkel confronts growing criticism for her one-sided emphasis on cutting expenditures of the state as a recipe for the troubled situation in Greece and other Southern countries of the Euro-zone. The most successful blogger in France on contemporary economic processes, Paul Jorion, called her fiscal pact, vulgo “debt brake” a “blague de potache” or “schoolboy prank” (and here again in German) and the Nobel laureate Joseph Stiglitz calls it suicidal for Europe.

Every now and then Mrs Merkel refers to the example of a Swabian housewife who reliably and responsibly keeps her house in order. A clue for the rationale behind might be found in the “Song of the Bell” by the poet Friedrich Schiller (being born in Swabia himself) more than 200 years ago:

… And inside rules
The prudent housewife,
The mother of children,
And wisely reigns
In the domestic circle,
And teaches the girls,
And guides the boys,
And stirs without end
The industrious hands,
And multiplies the gains
With orderly mind…

By the way, Mrs Merkel here also follows her mentor, the former Chancellor Helmut Kohl, who expressed his basic understanding of economics with words like: “What is right for an individual household, can not be wrong for the state’s budget.” Of course, he is right, this is pretty well applicable to the state’s administration and to any individual business, but it cannot serve as a guideline when facing the complex interplay in a national economy with millions of individual enterprises and households. This requires a more profound knowledge of how to harmonize the millionfold different wishes and aspirations on a basis of fairness and justice. But as a business economist doesn’t see the forest because of the many trees, the national economist sees the forest but cannot distinguish individual trees. They are living on different planets.

Dirk Müller, an investment consultant and stock broker, managed to break a taboo in the public discussion in Germany by introducing the problem of compound interest in mainstream media. He gives a neat explanation why the restricted view of a Swabian housewife, i.e. the managerial-economics of entrepreneurs, of the state or any other individual participant in the economy, cannot account for macroeconomic interrelations. He points at the total indebtedness and its root cause in national economies.

Business Management vs. Macroeconomy


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The trouble is, that debtors, who manage to repay their loans, repay it to the bank where they got it from. The banks in turn credit the repayment plus interest to the accounts of the owners. Multi-millionaires and billionaires, even if they wanted to use their money for consumption, would simply be unable to spend it all. Thus, the monetary assets remain in the system and the banks have to find new debtors who are creditworthy enough to earn the interest, which the banks owe to the owners of monetary assets. In the long run, this becomes more and more difficult as monetary assets and the respective debts grow. Therefore, the banks increasingly turned to speculation in order to gain the necessary means for servicing the monetary assets. For that purpose they have also invented obscure new financial instruments. To put it short: the total indebtedness remains in the system and increases, regardless of individual debtors repaying their debt. Banks which suffered from losses in speculation, called for bailouts only in order to maintain liability towards their obligees.

The following graph is taken from The Money Syndrome. The figures here are a bit more accurate than the ones Dirk gave in his talk. The orange column represents the average annual income of an employee or household, while the greenish column represents the per capita share of the total indebtedness.

Relation of Income and Indebtedness

In the fifties an average citizen had to pay 6% for interest in prices and taxes and for private loans. This share of his income went on top of the monetary assets of some creditors. And at the same time it increased the total of indebtedness, because the banks which collected these interest payments had to find new creditworthy debtors. In the mid-seventies the debt share had already doubled and so did the interest burden which then amounted to 13% of an average household income. In 2000 the interest share doubled again to 28% and today the share amounts to over 40%. Note, that all interest payments only increase the indebtedness which again leads to an increase of interest demands. This happens with accelerated speed. It’s a vicious circle, which finally and inexorably leads to a collapse of the whole system. Ask the economic experts what this system is good for! And the Swabian housewife may “wisely reign in the domestic circle” but she doesn’t know what’s going on outside and how her inside reign is getting affected despite her diligent care.

Every Homogeneous Region Needs a Suitable Currency

In the following video Dirk Müller points at another important factor, which the Euro doesn’t account for and more or less cripples the members of the Euro-zone because of a basic flaw in the Euro system.


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It is a fact, that nations dispose of different economic capacities. The reasons for that are manifold. It depends on disposable resources, developed infrastructure, communication and traffic facilities, efficient administration, skilled craftsmen, social structure, education, culture a.s.o. Such differences cannot only be observed between nations, but also in various regions within a nation. Germany for instance is a federation of 16 states. Dirk Müller’s example referred to the difference between the poor Saarland and the rich Baden-Württemberg. In larger states like Bavaria such a difference can also be observed between the poorer North and the richer South of Bavaria. The established practice to deal with these differences is a transfer of payment from the richer states to the poorer ones. This is feasible because these more or less autonomous 16 states are politically united and the differences are bearable. And yet, these transfers are a constant source of conflicts between states, which have to be negotiated once and again to find a compromise. Just recently the chief minister of Bavaria moaned about “too high” transfer payments to other states. The effect of these transfers is quite similar to the effect of development aid to Third World countries, where these financial infusions create a dependency on the helper and often keep them in a persistent state of vegetating and doesn’t allow them to achieve real autonomy. Besides, the existing money system has a strong tendency to concentrate in hotspots and the subsidies soon flow off again to those concentration spots – via industrial conglomerates, large international corporations, international trade chains a.s.o. Countries, which have to deal with this predicament again and again, are often referred to as a bottomless pit. Particularly rural areas everywhere in the world are suffering from money drainage, which commonly is blamed upon “globalisation”. But that’s a misunderstanding. The world’s money system is outdated. It was devised at a time when our ancestors wanted to explore and conquer a world, the size and extension of which they had no idea. The age-old core of the money system remained unchanged, although we know the limits of our world today. We have to acknowledge these limits in order to get beyond them and find a sustainable way of life. This is impossible with an obsolete money system and a stubborn belief that this system could go on for ever.

Marek Belka, the Governor of the Polish Central Bank just recently came up with a proposal for Greece’s dilemma (Financial Times Germany). Greece’s problem with the Euro is: it cannot be adjusted to its economic capacity, i.e. devaluated. He therefore suggests a dual currency system for Greece: the savings of citizens would be deposited in banks with the stable Euro, while the internal currency, issued by the state, would be used in the real economy. Wages and salaries would then be paid with a heavily devaluated special “Euro”(?). The proposal of Chief Macroeconomist Thomas Mayer of the Deutsche Bank (in English). goes in a similar direction: a heavily devaluated parallel currency (“Geuro”) as a temporary measure. These two proposals and some others imply, that, after a transitory period, Greece could go back to “normal”, resume the Euro and the compound interest system… and everything would be fine then?

A Europe of Autonomous Currency Regions…

Greece may be blamed for a chaotic administration of its economy, but it is not responsible for the weak design of the Euro system, which can not integrate heterogeneous economies unless they converge in a set of economic parameters. It is designed for a homogenous economy and may well serve for a country like Germany, but it cannot account for the special features of a multitude of European economies. Even the Deutschmark could not account for the different conditions in all regions and required transfer payments from the stronger parts to the weaker ones. Germany’s “transfer union” is a patchwork solution and cannot serve as a model on a European level, because the differences between nations are much greater.

Christian Gelleri and Thomas Mayer are the initiators of the “Chiemgauer” (please note: the Chief Macroeconomist of the Deutsche Bank and the “Chiemgauer” initiator Thomas Mayer incidentally share the same name but not the same identity), a regional currency in Southern Bavaria. It was founded in 2003 and so far it’s the most successful Regio project in Germany, which will celebrate its tenth anniversary in 2013. The initiators submitted a proposal that could not only Greece’s economy get back to work, but could be a first step to overcome the outdated money system and open the perspective of an economic order that meets the needs of today and a long future. They have elaborated their proposal in a working paper which can be downloaded as a PDF-file in English, German, French, Portuguese and last not least in Greek from (translations in more languages are planned). The original idea of the Regio was to strengthen the regional economy and to protect it against the drainage of Euros. The Chiemgauer is therefore endowed with a circulation incentive as most other Regio initiatives in Germany which keeps it running and sustains the robustness of the regional economy. The Regios are devised as complementary currencies which do not aim at replacing the Euro, but as an additional instrument which allows more autonomy to homogeneous regions. These homogeneous regions may be of different size, roughly speaking within a range of 3 to 15 million or so households. As a complementary currency Regios could everywhere in Europe (or the world) enhance the autonomy and robustness of the respective region. And a Europe of economically robust regions would result in a robust European economy.

… and the Euro as a Supraregional Currency

By no means should the Euro be abandoned! No one in the Euro-zone wants to get rid of the advantages it offers, the Greeks don’t want it and no one else. Currently, the Euro has dramatically lost attractivity and at present no one would like to join the Euro-zone. The Euro system might regain attractivity, if it opened perspectives for overcoming an outdated currency design. Provided the Regio idea spreads all over Europe, the Euro might become the roof over all these currency regions. The Euro would then become a stable supranational or rather supraregional currency unit defined as a standard of reference.

John Maynard Keynes submitted such a proposal for an international clearing union at the legendary international conference in Bretton Woods 1944. It was turned down, though, by the US-American White plan, which favoured the US Dollar as an international key or reference currency. But a national currency is not a good idea for a reference currency. In a way it was advantageous for the USA, if a huge foreign trade deficit can be called an advantage.

Keynes devised the “Bancor” as a supranational currency and one of its major tasks should have been to watch the trade balance between nations and, if necessary, to impose pressure on those whose foreign trade accounts are seriously imbalanced or for too long a time. The advantage of a supraregional currency unit is, that imbalances don’t have to be cleared (although it is possible) on a bilateral basis between peer regions but only between each member with the clearing union. Some of the tasks Keynes had described for the international clearing union, have been realised by the IMF.

If the Euro assumed the role of a reference currency, then each member region would have a suitable exchange rate to the Euro. In the case of changing economic conditions, the exchange rate of the Regio could easily be adjusted accordingly, while the Euro remained stable. This would give the regions a cushion, a certain flexibility and they wouldn’t be compelled to comply with an externally predetermined economic standard of performance. Enterprises which export their products to other regions and travelers through Europe could use the Euro as a means of payment as they do today without having to worry about regional exchange rates.

Mainstream Economics – an Outdated System

Economics is not a natural science, but is usually understood as a part of social sciences. Although social sciences focus on different phenomena or take a different point of view, they also have to account for relevant natural laws and cannot simply ignore them. An apt metaphor for the complex economic processes in a live community might be the metabolism of living beings. Metabolism describes the biochemical changes of matter for building the body’s own components, for gaining thermal and kinetic energy, for abandoning faecal matter and by coordinating these cyclic processes through information feedback via the nervous system. Economy might be seen as an extension of individual metabolism to regional, national or even global size, the possible performance of which surpasses the capacity of an individual.

Alas, today’s economic science cannot provide a basis for the organisation of a sound economy. A conspicuous example for the incompetence of economics is the LTCM (Long-Term Capital Management), founded in 1994. The hedge fund worked with theories that were elaborated by two professors, Robert C. Merton and Myron Scholes, who received the Nobel Prize 1997 “… for a new method to determine the value of derivatives.” In its heydays the hedge fund commanded more than 100 billion USD in assets and showed a return on investments of over 40%(!) per annum. Then the Russian Financial Crisis occurred, and Russian Government Bonds, which the LTCM held as security, lost their value. At the end of 1998, the Fed organised a bailout with a number of business partners of LTCM in order to avoid a wider collapse of financial institutions in the US and beyond. Some time later the French Nobel laureate Maurice Allais was asked, what was going wrong, where had Merton and Scholes made a mistake in their calculations? And Allais answered: “The mathematic equations were perfect, there was no mistake. Reality was wrong!” Note the irony in the statement: reality should submit to economists’ fancies?

Many years ago, Congressman Ron Paul once asked Alan Greenspan, then Chairman of the Federal Reserve Bank, “What is money?” Greenspan quite frankly admitted, “I don’t know. But we are working on it.” Money, which we are using today, is primarily issued on the security of the state’s treasury bonds, i.e. on the promise to repay it some time in the future. But that day may never come, as John Kenneth Galbraith pointed out:

“In numerous years following the war, the Federal Government ran a heavy surplus. It could not, however, pay off its debt, retire its securities, because to do so meant there would be no bonds to back the national bank notes. To pay off the debt was to destroy the money supply.”

What information does a money carry, that is issued on a vage promise which will never be delivered? It invites all sorts of speculations about its value and this is happening as long as idle money is roaming around on the globe with the effect, that Keynes so aptly described:

“Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation.”

The information of money at the moment of issuance is in direct contradistinction to the money that is circulating in the realm of real economy. Someone who accepts money for a work done is then entitled to claim equivalent goods or services that are offered in the market. This is the comprehensible information of money circulating in the real economy and it is maintained at every change of hands. However, the circulating money, too, does not account for the loss in the market, as long as it is held idle. This is where thermodynamics comes into play to compensate for this loss and keep the economy running.

Thermodynamics is a special branch of physics. Historically, it emerged in the beginning of the 19th century as a new approach to deal with energy conditions, transformation from one kind of energy to another or changes of energy states. At the beginning of the 20th century it gained increased relevance in fundamental scientific research, quantum physics, chemistry and biology. Entropy is also applied in information theory and social sciences.

Silvio Gesell, Rudolf Steiner and J.M. Keynes probably had not studied thermodynamics, but they must have had an intuitive insight when talking about “rusting money” (Gesell), “ageing money” (Steiner) or “demurrage fee on liquidity” (Keynes). The circulation incentive in today’s regional currencies accounts for a natural law described in thermodynamics and could therefore become a feasible and smooth transition from an outdated money system to one that can really meet the global challenge. A more detailed explanation of the 2nd Law of Thermodynamics and its application in economics would go beyond the scope of this article. But it will come in one of the next articles.

A New Europe?


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Robert Mittelstaedt