What is the Debt Virus and Why is it Wrong?
People are often surprised to hear that when banks lend money, they actually create it out of thin air. They transfer the balance of the loan to your bank account and hold a record of the debt. When the loan is paid back, the money is extinguished and vanishes from the economy.
This really is how money is created and added to the economy. The banks make a profit, and generate money for themselves by charging interest on the debt, and this is what has given rise to the theory called “the debt virus hypothesis”.
The debt virus hypothesis runs like this:
Let’s say that Patty wants to borrow $1 million to build a pen factory. Greedo Bank lends her the money by creating it out of thin air and transferring the balance to her account.
Greedo Bank charges high interest. To borrow $1 million for a year will cost Patty another $1 million in interest, so if Patty only borrows the money for a year, she has to pay back 2 million dollars.
But Greedo Bank has only created 1 million dollars of money. So where does the other million dollars come from?
Presumably, at some point it has to be created by another bank and fed into the economy. But this bank will also need to charge interest – let’s say another million dollars. This million dollars has to be paid back by another interest bearing loan, meaning that yet another million dollars has to be created somewhere, and so the spiral goes on.
The debt virus hypothesis says that this means that the banks have trapped us into a cycle of dangerous expansion, having to create more and more money just to pay off this increasing spiral of interest, never mind the original loans. It says that we can only get away with this when the economy is growing fast, but it all has to stop somewhere.
If the economy ever stops growing fast enough, then there won’t be enough money to pay back all the debt and the whole system will come crashing down in a debt meltdown. They say it’s simple math.
It’s scary stuff that makes the credit crunch look like a walk in the park.
People who believe in the debt virus say that it spells the inevitable doom of the financial system.
In fact, these people are mistaken. No extra money is needed to pay off the interest because of the way that money circulates in the economy.
Here is an example of a miniature economy that shows how it works:
Let’s say that Patty has borrowed her million dollars from Greedo Bank and built her factory: Patty’s pens. She has made mountains of pens, but owes the bank a million dollars of debt and a million dollars of interest.
Let’s also say that Patty spent the whole of her million dollar loan with a businessman: Bill Billionaire. Bill built her factory and sold her all the raw materials she needed and therefore has a million dollars burning a hole in his pocket.
Keen to invest his gains, Bill buys a million dollars worth of pens from Patty, hoping to sell them on for a profit.
Patty now has enough money to pay off the interest on her loan. She skips down to the bank and hands it over.
Now, when it gets the interest, Greedo Bank has made a million dollars profit on the loan it made to Patty. Being a huge bank, it needs a lot of pens, and Bill sees his chance. He sells some of his pens to the bank for a million dollars.
Excited by his quick sale, he uses the money to buy another million dollars worth of pens from Patty.
Patty now has enough money to pay off the original loan. She does this and the loan is gone and the money is extinguished.
But wait! Now the interest and the loan have both been paid off, and no extra money had to be created to do it!
And that’s why the debt virus hypothesis is false.
In fact, one dollar circulating in the economy can pay off a million dollars of interest if it passes through a million people’s hands and each one uses it to pay a dollar’s worth of interest on their loans.