The Compound Interest Paradox Revisited - Examples

Table of Contents

Overview
The Federal Reserve
Free Market Banking
A List of Monetary Systems
Examples
Edward Flaherty is a Troll
Summary

There are some propaganda artists on the Internet who say "There's no such thing as the Debt Virus." Another name for the Compound Interest Paradox is "The Debt Virus".

If you construct an example looking at just a single bank, you do not see the Paradox. If you construct an example of society as a whole, the Paradox is obvious.

That is one of the rules of Mathematics. In order to understand something better, give an example.

In Reader Mail #4 and Reader Mail #4a, I gave examples of how debt-based money works. I repeat those examples here.

A Detailed Example

Let's look at a detailed example of the debt-based money system in action.

To simplify things, I will only have the Federal Reserve, one bank, and 10 citizens.

The Federal Reserve sets interest rates at 8% initially. The bank, who has a monopoly, decides to charge 10% for loans. In reality, there are multiple banks that act as a cartel, and the effect is the same. The bank can borrow from the Federal Reserve at 8%, so it offers depositors 7% interest. The bank will never offer depositors a higher interest rate than the Fed Funds Rate.

Let's ignore the effect of the bank's operating expenses and profits for now; this example is complicated enough as-is.

Each citizen owns property worth $1 million. This may be his current actual property, or he may be pledging his future earnings. Since there is no money in circulation at the start of the simulation, it's silly to say "their property is worth $1 million". That's the value the bank assigns to the property, which is good as any other number in a debt based fiat monetary system.

At the start, there is no money in circulation.

The balance sheet is:
Federal Reserve: $0
Bank: $0
10 Citizens: $0 and $1 million in property

Each citizen borrows $1 million, pledging his $1 million property as collateral.
The bank borrows $1 million from the Federal Reserve at 8% interest.
The reserve ratio is 10x, so this $1 million borrowed from the Federal Reserve is used to create $10 million in actual money. Each citizen immediately deposits his money back in the bank.

The balance sheet is:
Federal Reserve: -$1 million (money it created)
$1 million (owed by bank)
Bank: $10 million in deposits (owing 7% interest)
$1 million owed to Federal Reserve (owing 8% interest)
$10 million in loans (earning 10% interest)
$1 million in cash
10 Citizens: $1 million in their bank account
$1 million in debt
$1 million property

Let's add in the interest now.

The balance sheet is:
Federal Reserve: -$1 million (money it created)
$1.08 million (owed by bank)
Bank: $10.7 million in deposits (owing 7% interest)
$1.08 million owed to Federal Reserve (owing 8% interest)
$11 million in loans (earning 10% interest)
$1 million in cash
10 Citizens: $1.07 million in their bank account
$1.1 million in debt
$1 million property

At this step, you can already see the Compound Interest Paradox. The Federal Reserve created $1 million and loaned it out at 8% interest. However, the Federal Reserve never created the $80,000 required to make the interest payments. Later, when the Federal Reserve receives its $80,000 interest payment, it pays it out to the government or for its own expenses. This is the mistake that Flaherty and Griffin make. The Federal Reserve, when it does collect the $80,000 interest, pays it out as expenses and profits. There still is a permanent $80,000 money supply shortfall. Even though the Federal Reserve and the bank will pay out their profits, the Compound Interest Paradox still exists. The books of the Federal Reserve and the bank will balance, but the books of "society as a whole" do not balance.

It is only at this step, where the Federal Reserve creates new bank reserves, that the Compound Interest Paradox occurs with the full force of law. When the bank makes a fractional reserve loan with customer deposits, it pays out all its interest income as expenses or profits.

The citizens trade with each other. Nine of them are the most skilled workers, and they have $1.1 million, enough to repay their loans. The last citizen is left with only $0.8 million and he declares bankruptcy.

9 Citizens: $1.1 million in their bank account
$1.1 million in debt
$1 million property
each repays his loan, left with $0

1 Citizen: $0.8 million in his bank account
$1.1 million in debt
$1 million property
declares bankruptcy

The bank collects the $1.1 million from each of the 9 solvent debtors. The bank seizes $0.8 million from the 1 bankrupt citizen and seizes his $1 million property.

The balance sheet is:
Federal Reserve: -$1 million (money it created)
$1.08 million (owed by bank)
Bank: $1 million in cash
$1 million in property (confiscated from one citizen)
9 Citizens: $0 in their bank account
$0 debt
$1 million property
1 Citizen: $0.3 million unpayable debt
His $1 million property is in foreclosure by the bank.

The bank says "Let's auction off the $1 million property to pay this $0.3 million debt." Any bids? No! Nobody has any money right now except for the bank. We're in the bust phase of the business cycle. The bank writes off the $0.3 million unpaid debt and takes possession of the $1 million property, planning to sell it later.

Now the bank has to repay its loan to the Federal Reserve. The bank only has $1 million in cash, but it owes the Federal Reserve $1.08 million! This is a serious crisis.

The balance sheet is:
Federal Reserve: $0.08 million (owed by bank)
Bank: $0 cash
$0.08 million (owed to Federal Reserve)
$1 million in property (confiscated from one citizen)
9 Citizens: $0 in their bank account
$0 debt
$1 million property
1 Citizen: $0.3 million unpayable debt
His $1 million property is in foreclosure by the bank.
This citizen has a bad credit rating and can no longer borrow.
1 new citizen: $1 million property, representing the work of the other 10 citizens in the past year.

Look at the above balance sheet snapshot. All outstanding loans have been repaid, but there's still a $0.08 million debt that the bank owes the Federal Reserve that cannot be repaid. This is a demonstration of the Compound Interest Paradox in action.

However, this bank is the only bank. It is "too big to fail". The Federal Reserve doesn't demand immediate payment of the remaining $0.08 million. The Federal Reserve cuts interest rates to 3%. The bank lowers the interest rates it charges to 5%. The bank now offers 2% on deposits.

Besides, the bank isn't insolvent yet. It still owns a property valued at $1 million. That's another loophole in the financial system. The current market price of the property is $0, but it was valued at $1 million a year ago. Banks are allowed to value their assets as the purchase price or current market value, WHICHEVER IS GREATER. The bank is allowed to carry the property on its books at a value of $1 million, because that was the value when it issued the loan. The bank is not required to mark to market. In this case, if the bank did "mark to market", it would be insolvent and the economic system will have collapsed; that is never allowed to happen. This is the "Level 3 Assets Scam".

To keep the total number of citizens at 10, suppose that one of the 9 citizens had a child and he inherited $1 million of property. This represents the wealth created by those 10 workers in a year.

Interest rates have been slashed from 10% to 5%. The citizens say "Interest rates are half as much now; we can borrow twice as much!" Each citizen borrows $2 million at 5% interest for a year. The bank borrows $2 million from the Federal Reserve at 3%.

The balance sheet is:
Federal Reserve: $0.08 million. (owed by bank from before, now charged 3% interest)
-$2 million (money it just created)
$2 million. (owed by bank, newly issued loan, charged 3% interest)
Bank: $2 million cash
$20 million in loans, earning 5%
$20 million in deposits, earning 2%
$1 million in property (confiscated from one citizen)
10 Citizens: $2 million in their bank account
$2 million in debt
$1 million property
[citizen count includes one new citizen]

The bank says: "Let's auction off the $1 million property now!" The money supply is twice as big as it was before, so the property is sold for $2 million even though it was worth $1 million before, and worth $0 at the bottom of the recession.

The balance sheet is:
Federal Reserve: $0.08 million. (owed by bank from before, now charged 3% interest)
-$2 million (money it just created)
$2 million. (owed by bank, newly issued loan, charged 3% interest)
Bank: $2 million cash (just borrowed from Federal Reserve)
$2 million cash (sale of confiscated property)
$2 million (owed to Federal Reserve, just borrowed)
$0.08 million (owed to Federal Reserve, old balance)
$20 million in loans, earning 5%
$20 million in deposits, earning 2%
9 Citizens: $2 million in their bank account
$2 million in debt
$2 million property [formerly valued at $1 million]
1 Citizen: $0 million in his bank account
$2 million in debt
$4 million property [formerly valued at $2 million, includes property confiscated and sold]

The bank now pays back its $0.08 million loan to the Federal Reserve, which the Federal Reserve spends on its own expenses and turns over the rest to the Federal Government. The bank has $1.92 million in profit, which it retains for further investment or pays out to its owners.

Almost 10% of the wealth of society, in one year, has been transferred to the banks. This is the 10% interest rate the bank was charging on its loans, which is no surprise.

There was an aggregate money supply deficit of 10% on the part of the "rest of society". They lost 10% of their wealth to the banking cartel. This money is paid out to the banks' owners, so their books balance. In the meantime, the rest of society still is in a debt hole. There has been a huge transfer of wealth from the "rest of society" to the banks. The bank did not do any work to earn its profit. It was merely an accounting trick. The bank's profits are built into the rules of the monetary system.

The bank's operating expenses are probably much less than $1.92 million, so there's a huge unearned profit for the banks. You can correct this example to adjust for the bank's operating expenses. You can adjust the extremity of the boom/bust cycles. The principle is the same.

Maybe the bank's management will pay themselves a salary of $1.8 million, leaving $0.12 million as dividend payments for shareholders. For this reason, an investment in a bank isn't necessary a great investment, even though banks are guaranteed a profit built into the rules of the monetary system.

The Federal Reserve showed a profit of $0.08 million, which it turned over to the Federal Government or uses to pay its own expenses. This is negligible compared to the $1.92 million profit earned by the bank.

The person who lost his $1 million property wasn't stupid or lazy. He was the least efficient worker. There was a fundamental structural flaw in the monetary system. It was guaranteed that at least one person would be unable to pay his debts. The media will say "That person lost his property because he was stupid or lazy." They will never say "There's a fundamental structural flaw in the monetary system."

The actual reality is even worse than the example I gave above. For example, suppose Federal income tax rates are 25%. In that case, as people trade, 25% of the money supply is drained and goes to the government. This makes it even harder for people to pay back their debts.

The income tax is a fundamental part of this scam. The people can't get together and say "We're going to trade with silver; forget about the Federal Reserve and banks." The government demands that people pay income taxes whenever they work, and income taxes must be paid in Federal Reserve Notes. It is impossible to obey the law and live a morally just life. I can't work, trade with Federal Reserve Notes, and pay income taxes without supporting the Federal Reserve and other things I find objectionable. The current economic and political system is one of absolute perfect enslavement. That isn't an accident. It was designed that way on purpose by the Supreme Leader of Humanity.

Also notice that, by adjusting interest rates, the Federal Reserve can adjust the rate at which the Compound Interest Paradox enslaves the rest of society. The Federal Reserve can adjust the rate at which the financial industry confiscates the wealth of everyone else. By calibrating the wealth confiscation rate, the Federal Reserve ensures that the average person has enough wealth that they don't revolt, but not so much spare time that they can figure out what's going on.

The above example is a simplification of what actually happens. However, even that simplified example was very long. It illustrates the Compound Interest Paradox exactly as it occurs in the real world. You can adjust that example to correct for all the variables I omitted: the Federal Government, Treasury Bonds, Federal deficit spending, Federal Reserve "monetizing the debt", bank expenses and profits paid to shareholders, new wealth created by workers, the Federal Reserve raising/lowering interest rates, boom/bust cycles, and expansion/contraction of the money supply. If you want an example with all of those factors, and you understand my example, you should be able to create it.

Summarizing, to understand the Compound Interest Paradox, you can't just look at the balance sheet of banks and the Federal Reserve. From the point of view of an individual bank, its books balance and you don't see the Compound Interest Paradox. You also need to look at the balance sheet of the "rest of society" (i.e., everyone who isn't a bank).

A Simpler Example

Here, there will be only 1 citizen, the Federal Reserve, and the government.

At the start, no money is in circulation. In this example, the citizen is allowed to borrow directly from the Federal Reserve at the Fed Funds rate of 5%.

The citizen borrows $1M from the Federal Reserve at 5% interest.

Government: $0
Federal Reserve: -$1 million, money it created
$1 million debt, owed by citizen (earning 5%)
Citizen: $1 million debt (charged 5%)
$1 million cash

A year later, let's add in the interest.

Government: $0
Federal Reserve: -$1 million, money it created
$1.05 million debt, owed by citizen
Citizen: $1.05 million debt
$1 million cash

Already, you can see the Compound Interest Paradox. The Federal Reserve should have paid a credit of $0.05 million to the government when it created the money. In that case, the government could have paid the $0.05 million as its own expenses and the money supply would balance.

The citizen repays the $1 million.

Government: $0
Federal Reserve: $0.05 million debt, owed by citizen
Citizen: $0.05 million unpayable debt

The Federal Reserve says "We'll loan you another $1M so you can repay your debt."

Government: $0
Federal Reserve: -$1 million, money it created
$0.05 million, owed by citizen, in default
$1.0 million, owed by citizen, new debt
Citzen: $1.05 million debt
$1 million cash

The citizen now pays the extra $0.05 million he still owes.

Government: $0
Federal Reserve: -$1 million, money it created
$0.05 million, paid by citizen
$1 million, owed by citizen
Citizen: $1.05 million debt
$0.95 million cash

The Federal Reserve now has a profit of $0.05 million. The Federal Reserve has a bookkeeping surplus of $0.05 million, which it can spend or turn over to the Federal government.

The Federal Reserve's books balance. The citizen is in a deeper and deeper debt hole.

The citizen can't say "This is a stupid game; I'm not playing anymore." The government only recognizes Federal Reserve Points as valid money. The government demands that taxes be paid in Federal Reserve Points, although I didn't include taxes in this example. Government violence forces people to use Federal Reserve Points, even though they're intrinsically worthless.

The Compound Interest Paradox is a structural flaw in the monetary system, put there on purpose to enslave everyone under a crushing debt burden. Legally, there is no escape.

The Compound Interest Paradox is pretty complicated. The original authors of the Federal Reserve Act knew what they were doing. A few Congressmen were smart enough to figure out the scam and complain. They were killed, blackmailed, discredited, or silenced. Nowadays, it's easy to make sure that very few people smart enough to understand the Federal Reserve are elected to Congress. For example, Ron Paul was allowed to be elected to Congress, but as a single Representative he has no real power.

The mainstream media doesn't complain about the Federal Reserve and the Compound Interest Paradox. They are controlled by the international banking cartel insiders, who purchased all the newspapers and TV stations to cover up their misdeeds. University economics professors can't write papers on the evils of the Federal Reserve and the Compound Interest Paradox, because they are dependent on government subsidies/grants.

Many people have tried to explain the flaws in the monetary system and taxation system to the people who think they're the political and economic leaders. They had their chance to fix the current economic system, and neglected their responsibility. The only fair solution is a complete collapse of the current economic system. Hopefully, the collapse can be organized in an orderly fashion.