Interest charges are a strongly regressive tax that the poor pay to the rich. A public banking system could realize savings up to 40 percent – allowing taxes to be cut, services increased and market stability created – with banks feeding the economy rather than feeding off it.
In the 2012 edition of Occupy Money released last week, Professor Margrit Kennedy writes that a stunning 35 percent to 40 percent of everything we buy goes to interest. This interest goes to bankers, financiers, and bondholders, who take a 35 percent to 40 percent cut of our GDP. That helps explain how wealth is systematically transferred from Main Street to Wall Street. The rich get progressively richer at the expense of the poor, not just because of “Wall Street greed,” but because of the inexorable mathematics of our private banking system.
This hidden tribute to the banks will come as a surprise to most people, who think that if they pay their credit card bills on time and don’t take out loans, they aren’t paying interest. This, says Dr. Kennedy, is not true.
Tradesmen, suppliers, wholesalers and retailers all along the chain of production rely on credit to pay their bills. They must pay for labor and materials before they have a product to sell, and before the end-buyer pays for the product 90 days later. Each supplier in the chain adds interest to its production costs, which are passed on to the ultimate consumer. Dr. Kennedy cites interest charges ranging from 12 percent for garbage collection, to 38 percent for drinking water, to 77 percent for rent in public housing in her native Germany.
Her figures are drawn from the research of economist Helmut Creutz, writing in German and interpreting Bundesbank publications. They apply to the expenditures of German households for everyday goods and services in 2006; but similar figures are seen in financial sector profits in the United States, where they composed a whopping 40 percent of US business profits in 2006. That’s more than five times the 7 percent made by the banking sector in 1980. Bank assets, financial profits, interest and debt have all been growing exponentially.
Exponential growth in financial sector profits has occurred at the expense of the non-financial sectors, where incomes have at best grown linearly.
By 2010, 1 percent of the population owned 42 percent of financial wealth, while 80 percent of the population owned only 5 percent of financial wealth. Dr. Kennedy observes that the bottom 80 percent pay the hidden interest charges that the top 10 percent collect, making interest a strongly regressive tax that the poor pay to the rich.
Exponential growth is unsustainable. In nature, sustainable growth progresses in a logarithmic curve that grows increasingly more slowly until it levels off (the red line in the first chart above). Exponential growth does the reverse: It begins slowly and increases over time, until the curve shoots up vertically (the chart below). Exponential growth is seen in parasites, cancers – and compound interest. When the parasite runs out of its food source, the growth curve suddenly collapses.
People generally assume that if they pay their bills on time, they aren’t paying compound interest; but again, this isn’t true. Compound interest is baked into the formula for most mortgages, which comprises 80 percent of US loans.
If credit cards aren’t paid within the one-month grace period, interest charges are compounded daily; and even if you pay within the grace period, you are paying 2 percent to 3 percent for the use of the card, since merchants pass their merchant fees on to the consumer. Debit cards, which are the equivalent of writing checks, also involve fees. Visa-MasterCard and the banks at both ends of these interchange transactions charge an average fee of 44 cents per transaction – though the cost to them is about 4 cents.
Even if you pay cash, you are liable to be paying an additional 2 percent to 3 percent, since, until recently, merchants were not allowed to give discounts for cash payments. A July 2012 settlement with Visa and MasterCard, however, allowed merchants in the settlement to add a surcharge for credit card use.
How to Recapture the Interest: Own the Bank
The implications of all this are stunning. If we had a financial system that returned the interest collected from the public directly to the public, 35 percent could be lopped off the price of everything we buy. That means we could buy three items for the current price of two, and that our paychecks could go 50 percent farther than they go today.
Direct reimbursement to the people is a hard system to work out, but there is a way we could collectively recover the interest paid to banks. We could do it by turning the banks into public utilities and their profits into public assets. Profits would return to the public, either reducing taxes or increasing the availability of public services and infrastructure.
By borrowing from their own publicly-owned banks, governments could eliminate their interest burden altogether. This has been demonstrated elsewhere with stellar results, including in Canada, Australia, and Argentina, among other countries.
In 2011, the US federal government paid $454 billion in interest on the federal debt – nearly one-third the total $1.1 trillion ($1,100 billion) paid in personal income taxes that year. If the government had been borrowing directly from the Federal Reserve – which has the power to create credit on its books and now rebates its profits directly to the government – personal income taxes could have been cut by a third.
Borrowing from its own central bank interest-free might allow a government to eliminate its national debt altogether. In Money and Sustainability: The Missing Link, Bernard Lietaer and Christian Asperger, et al., cite the example of France. The treasury borrowed interest-free from the nationalized Banque de France from 1946 to 1973. The law then changed to forbid this practice, requiring the treasury to borrow instead from the private sector. The authors include a chart showing what would have happened if the French government had continued to borrow interest-free, versus what did happen. Rather than dropping from 21 percent to 8.6 percent of GDP, the debt shot up from 21 percent to 78 percent of GDP.
“No ‘spendthrift government’ can be blamed in this case,” write the authors. “Compound interest explains it all!”
More than Just a Federal Solution
It is not just federal governments that could eliminate their interest charges in this way. State and local governments could do it too.
Consider California. At the end of 2010, it had general obligation and revenue bond debt of $158 billion. Of this, $70 billion, or 44 percent, was owed for interest. If the state had incurred that debt to its own bank – which then returned the profits to the state – California could be $70 billion richer today. Instead of slashing services, selling off public assets, and laying off employees, it could be adding services and repairing its decaying infrastructure.
The only US state to own its own depository bank today is North Dakota. North Dakota is also the only state to have escaped the 2008 banking crisis, sporting a sizable budget surplus every year since then. It has the lowest unemployment rate in the country, the lowest foreclosure rate, and the lowest default rate on credit card debt.
Globally, 40 percent of banks are publicly owned, and they are concentrated in countries that also escaped the 2008 banking crisis. These are the BRIC countries – Brazil, Russia, India, and China – which are home to 40 percent of the global population. The BRICs grew economically by 92 percent in the last decade, while Western economies were floundering.
Cities and counties could also set up their own banks; but in the US, this model has yet to be developed. In North Dakota, meanwhile, the Bank of North Dakota underwrites the bond issues of municipal governments, saving them from the vagaries of the “bond vigilantes” and speculators, as well as from the high fees of Wall Street underwriters and the risk of coming out on the wrong side of interest rate swaps required by the underwriters as “insurance.”
One of many cities crushed by this Wall Street “insurance” scheme is Philadelphia, which has lost $500 million on interest swaps alone. The complicated way in which the swaps work was explained in an earlier article here. Last week, the Philadelphia City Council held hearings on what to do about these lost revenues, which have gone directly into the coffers of Wall Street banks. In an October 30 article titled “Can Public Banks End Wall Street Hegemony?” Willie Osterweil discussed a solution presented at the hearings in a fiery speech by Mike Krauss, a director of the Public Banking Institute.
Krauss’ solution was to do as Iceland did: Just walk away. He proposed “a strategic default until the bank negotiates at better terms.” Osterweil called it “radical,” since the city would lose it favorable credit rating. But Krauss had a solution to that problem: the city could form its own bank, and use it to generate credit from public revenues just as Wall Street banks do now.
“The crux of Krauss’ argument, and most radical of all, is for the creation of a public bank,” wrote Osterweil, which “will keep the taxes and other financial assets of the people … circulating in the city, by leveraging them to provide the sustainable and affordable credit required in a modern economy to power locally directed economic development and jobs creation.” It is a radical solution whose time has come.
Public banking may be a radical solution, but it is also an obvious one. This is not rocket science. By developing a public banking system, governments can keep the interest and reinvest it locally. According to Kennedy and Creutz, that means public savings of 35 percent to 40 percent. Costs can be reduced across the board; taxes can be cut or services can be increased; and market stability can be created for governments, borrowers and consumers. Banking and credit can become public utilities, feeding the economy rather than feeding off it.