"There was probably no other person in the whole country who had meditated so much on the question of interest. Maragaya's mind was full of it. Night and day he sat and brooded over it. The more he thought of it the more it seemed to him the greatest wonder of creation. It combined in it the mystery of birth and multiplication. Otherwise how could you account for the fact that a hundred rupees in a savings bank became one hundred and twenty in course of time? It was something like the ripening corn. Every rupee, Maragaya felt, contained in it the seed of another rupee, and that seed in it another seed and so on and on to infinity. It was something like the firmament, endless stars and within each star an endless firmament and within each an further endless... It bordered on mystic perception. It gave him the feeling of being part of an infinite existence."
R. K. Narayan, The Financial Expert.
An exchange system may utilize any of a number of instruments and protocols. It may utilize physical objects which circulate from hand-to-hand, such as paper notes, coins or tokens; it may be comprised of accounts and ledgers using debits and credits; or it may involve some combination of these. Whatever form the exchange media may take, whether paper notes or account balances, the same basic principles apply. In general, from this point on, when we speak of "currency," it should be understood that the term also includes credits in a ledger (bookkeeping) system.
Anyone familiar with the LETS system already has a basic understanding of what mutual credit (MC) looks like. Mutual credit is the generic term which includes ledger systems like LETS but isn't limited to the particular procedures and protocols which LETS uses. It might, like LETS, use a ledger or system of accounts for recording the initial obligations of its members, while also providing its members with circulating notes. These notes would be issued to members against their credit lines, in effect, providing a physical representation of that credit. Just as a cash withdrawal is debited against (subtracted from) a bank account, the amount of any notes thus issued would be debited against the member's Mutual Credit account.
A mutual credit (MC) system is designed to surmount the limitations of barter. Like money, it provides an intermediary device which allows two parties to trade even though one of them may have nothing the other wants. For example, suppose Martha knits sweaters, and John wants to buy one but has nothing that Martha presently needs. Using mutual credit (MC), he can still get the sweater, giving Martha "credits" for the agreed price. Where does John get the credits to give to Martha? He creates them. Just as banks create dollars to give to someone who requests a loan, John creates the credits to pay Martha for the sweater. Martha can then spend her credits when she buys something from anyone else in the system. When John creates credits to pay Martha, he obligates himself to accept credits from someone in the system at some future time in payment for his own goods or services. In this way, by making a sale, he "redeems" the credits which he originally issued. This is shown pictorially in Figure 12.1. It can be seen that the process is essentially identical to that of the ideal money circuit which we described in Chapter 2, and the LETS trading circuit described in Chapter 10.
In a mutual credit system, the people empower themselves to do the same thing that banks have done for years, essentially creating their own money in the form of credit, but saving the cost of interest, while distributing the money themselves according to their own needs. In such a system, holding credits is evidence that so much value has been delivered to the community, while a debit balance represents that person's commitment to deliver value to the community sometime in the near future.
Mutual Credit can be viewed as an extension of the long-established practice of trade credit which businesses offer to one another in the normal course of business. They simply sell to their customers on what is called "open account," which means that they deliver the merchandise and bill their customer for the amount due. A certain amount of time is allowed for payment to be made. It may be 15, 30, or 60 days, or more, depending on the customs of that particular line of business. Often, a discount may be given for prompt payment. In the terminology of business, an example of typical trade terms might be "2%/10; net 30 days," which means that payment is due within 30 days of the billing date, but a 2% discount may be taken if payment is made within 10 days.
The basic idea of a Mutual Credit system is to extend the practice of trade credit to a wider group of participants, each of whom has the power to buy without cash, and, at the same time, to lengthen the duration within which balances may be outstanding. The ideal, at least with respect to empowerment of the participants and local control of the local economy, is to eliminate completely the requirement of payment in official currency.
Over the long-run individual account balances will move up and down, some months ending with a credit balance and some months ending with a debit balance, but averaging out around a balance of zero. As long as debit balances do not become chronic or extreme, the system can handle these situations readily; indeed, since the total of credits must be balanced by an equal amount of total debits, outstanding debit balances are a necessary feature of the system and will have no adverse effect upon its operation. If a particular participant develops a chronic debit balance, steps can be taken by the group to help him/her to increase sales and/or reduce purchases. This issue will be considered in more detail later on.
The following are the essential steps in starting a Mutual Credit trading system:
As the MC system develops, members will likely find that they are supporting one another in a variety of ways -- as friends, confidants, counselors, etc.. Some direct barter and informal trading will occur. This should be encouraged rather than discouraged. Even though private and informal transactions by-pass the system and avoid paying fees into it, they also reduce the work load. The primary objective, after all, is to foster the development of mutually supportive relationships. If the system works for people, they will help to maintain it through donations and volunteer labor. Sometimes, it's better not to keep score.
The above steps and suggestions are based on limited experience and are by no means the final word on the matter. Each group will have to work out for itself many of the answers to the recurrent problems of exchange. The questions and issues that need to be addressed in establishing and operating a mutual credit system are essentially the same as those which exist in any system of money and banking, and if not properly handled can lead to disastrous consequences. Various groups have dealt with them in different ways, but some approaches are superior to others. These issues are summarized as follows:
One problem which may arise in any system of exchange, and which is worthy of special attention, is stagnation of circulation. In a mutual credit system, stagnation takes the form of idle balances, either debit or credit. Those
holding debit balances have bought more than they've sold. If such an account is idle, that member, in effect, is not honoring her/his commitment to the members of the system in a timely manner. Having received value, s/he is "committed" to deliver like value. Although there may be no specified time limit for honoring such a commitment, there is the expectation that efforts will be made to move the account balance back toward zero. Some activity in earning credits shows "good faith" and indicates that a member is willing and able to provide something the community needs or wants. If a member does develop a chronic debit balance, however, it needs to be handled in some way.
In keeping with the basic principles of a local, limited, personal and convivial system, chronic debit balances should not be dealt with in a punitive fashion. A mutual credit system is designed to be friendly and helpful rather than dominating and manipulative. A chronic debit balance may be indicative that a member is having some kind of personal trouble, in which case fellow members would probably want to help in some way. Perhaps that member needs to improve the quality of the products or services s/he provides, or perhaps s/he needs to acquire some new skill to provide something the community needs. In a personal, local system, these matters can be handled in a helpful way, by those closest to the problem, rather than impersonally and coercively by distant and unresponsive bureaucracies.
Those holding credit balances in a mutual credit system, have sold more than they've bought. If an account with a credit balance is idle, that member, in effect, is not demanding from the system value which is due him/her. Having delivered value, s/he is entitled to receive like value. Although there may be no specified time limit within which credits must be spent, the expectation is that credits will be spent, not saved. Saving credits has the effect of preventing, to some extent, those with debit balances from selling enough to get back to zero.
The primary problem to be overcome in facilitating trade is the "barter limitation," i.e. the fact that the buyer may not have anything the seller wants. By creating an intermediary "medium of exchange," e.g. trade credits, there is a "space" created within which the seller may supply the buyer's need anyway, and then proceed to find a supplier for his/her own need. This "space" is only partially temporal; mostly it is interpersonal, a matter of matching up specific needs or wants with appropriate supplies in the market. In other words, it allows some slack in which people can find one another so that each can have his/her needs satisfied.
Another necessary function in finance is the storage of value. When economists speak of money as being also a "store of value," they are speaking metaphorically. Since value is an abstract concept and not a physical quantity, it cannot really be stored. Cabbages can be stored, wheat can be stored, building materials can be stored, metals can be stored, but each, of course, is subject to some degree of spoilage or deterioration over time. The primary problem to be solved by storage is the asynchronicity of supply and demand.
The very idea of storage is based on the desire to match present supplies with future needs. We put aside the extra food from the garden in summer to satisfy our hunger next winter when the garden will not be producing. Similarly, we save during our productive years so that we can have the means of livelihood during our retirement years. But unlike our storage of food from the garden, which we do directly, our saving for retirement we do socially. Saving, in financial terms, must involve other people.
Ultimately, at any point in time, non-producers, such as young children and retirees, are dependent upon then current producers for the satisfaction of their material needs and desires. The mechanisms by which non-producer needs are met are varied and often complex and are based on such factors as cultural values, ethics, social norms, legal statutes and financial agreements. In our retirement years for example, we are mainly dependent upon two basic arrangements: (1) legislated, involuntary redistribution of wealth by governments in the form of such programs as FICA taxes (Social Security) and Welfare and, (2) contractual agreements of a form usually called "investments" which consist of such financial instruments as pensions, insurance, annuities, stocks, bonds, mutual fund shares, bank deposits, etc..
Both legislated programs and investments provide the recipient with a "claim" against current and/or future production. The question as to which claims may or may not be "legitimate" is, of course, always open to debate and disagreement, and the questions of which claims may or may not be honored is always a matter of concern. The satisfaction of any claim is always dependent upon the ability and willingness of those who are asked to bear its burden.
Given our cultural conditioning and the prevailing practice within the conventional systems of money and finance, there is a tendency to want to impose a levy or charge upon debit balances, these balances being thought of as loans to the "debitor," and the levy representing an interest charge. Considering what has been said above, it should be clear that such attitudes and practices need to be reconsidered.
In accordance with the rationale put forth by Silvio Gesell, some have argued that, in order to keep an exchange system vital, a periodic levy should be made upon credit (positive) balances. This kind of charge is known as "demurrage."  The argument is that demurrage would encourage the spending and discourage the holding, or saving, of currency or credit balances, and insure the lively flow of "money" (credits) through the system. That is not to say that saving is "bad," but that it should be accomplished using some medium other than the exchange medium. 
The imposition of levies upon either debit or credit balances, or both, will undoubtedly promote their use as an exchange medium, deter their use as a savings/investment medium, and prevent stagnation. However, such levies may have a negative effect upon another primary objective, that of "reciprocity."
The idea of reciprocity is that the value received by a trader should be equivalent to the value which he/she delivered. The discriminatory imposition of a levy upon only one or the other type of balance upsets this ideal. The case for imposing levies upon balances is a strong one. However, since everyone benefits from the operation of the system, if a levy is imposed upon balances, both debit balances and credit balances should be charged equally.
Another possible approach to dealing with the problem of idle balances would be to limit both the amount of debit and credit which could be carried over from one period to the next. Any amount in excess of the limit would be "cleared" to a capital account. Anyone who cannot clear his/her debit at the end of the current period, or who wants long-term financing for any purpose, would have to find someone willing to assign his/her credits for a specified period of time. This is a capital market function. Likewise, anyone who desires to "save" his/her credits, must find some suitable investment medium for accomplishing the storage of his/her value. In other words, side-by-side with the exchange system, there would exist a capital market which would provide for capital formation (investment) and savings (storage of value).
As an example, suppose that at the end of the quarter, Betty has a credit balance of 900, but the maximum that may be carried over is 500. She must then find someone who needs the remaining 400 credits and make a private deal with him/her, or she might "deposit" her excess credits in a savings coop which would invest them for her.
Suppose too that Gary wants to acquire enough credits to hire George to help him build a house. They agree on a price of 2,000 credits. But since the debit limit on all current accounts is, say, 500, Gary must "borrow" the remaining 1,500. He could make a deal with Betty, and maybe two or three other members, to use their excess credits for some specified period of time. During that time, of course, Betty would not be able to use those credits herself. Alternatively, Gary could go to the savings cooperative and request a loan of 1,500 credits.
Capital formation is the process of creating the means of production, including the creation of new businesses or the expansion and improvement of existing ones. It includes construction of buildings, improvement of land, production of tools and equipment, and other expenditures which are expected to be recovered over a long period of time through the sale of products or services. The creation of exchange media should be based upon the exchange of current supplies of goods and services. It is a well-established principle of sound banking that long-term assets should not be used as the basis for creating new money, but should be financed out of "savings," i.e. money which has already been created but not spent on current consumption.
Having both a "current" account and a "capital" account is a way of separating the "medium of exchange" from the "store of value." It is as easy as transferring deposits from your checking account to your savings account, or writing a check to buy shares of stock or a mutual fund. Indeed, along with empowering people by allowing them to create their own exchange medium, it is still important to follow sound banking practices. Since these practices have been largely forgotten and abandoned by the established monetary and financial institutions, new systems must be built from the ground up. These systems should be based upon the principles of equity (just), conviviality (open to all) and reciprocity (mutual/cooperative), and a clear understanding of the effects of various financial practices.
In either case, whether in a current account or a capital account, a credit balance represents a "claim," and the activity which gives rise to the claim should determine whether it is "current" or "capital." In the current account, a credit is a short-term claim upon the market, which is intended only to facilitate trade. It is a "demand" deposit which the market should be able to satisfy at any time. In the capital account, a credit is a claim against long-lived assets which are not liquid, but will produce benefits over a long period of time. For example, if the claim has resulted from activity which has produced a building or equipment, it will take time for the cost of these to be recovered. This recovery takes place in the normal course of their use in the production and sale of consumable goods.
One of the "sins" of the present banking establishment is that it has blurred this distinction between savings deposits (time deposits) and demand (checking account) deposits, and has issued money on the basis of, not only goods on the way to market, but also goods being taken from the market.  Properly, demand deposits represent goods (and services) presently in the market, available for purchase, and savings deposits represent investments in capital goods and durables. Formerly, banks paid no interest on demand deposits because such deposits had to be kept available for payment of checks drawn upon the account. Thus, they could not be invested in longer-term, interest-earning assets. Now, banks are paying interest on demand deposits and giving some savings deposits much the same liquidity as demand deposits.
A STORY OF ROBINSON CRUSOE: An Introduction to the Theory of Interest by Silvio Gesell 
Robinson Crusoe, as is well known, built his house, from motives of health, on the south side of the mountain, whereas his crops grew on the damp but fruitful northern slopes. He was therefore obliged to carry his harvests over the mountain. To eliminate this labor he decided to construct a canal around the mountain. The time required for this enterprise, to avoid silting, would have to be carried out without interruption, he estimated at three years.
He slaughtered some pigs, and cured their flesh with salt; he filled a deep trench with wheat, covering it carefully with earth. He tanned a dozen buckskins for suits and nailed them up in a chest, enclosing also the stink-glands of a skunk as a precaution against moths. In short, he provided amply, and as he thought, wisely, for the coming three years.
As he sat calculating for the last time whether his "capital" was sufficient for the projected undertaking, he was startled by the approach of a stranger, obviously the survivor of a shipwreck.
"Hallo, Crusoe!" shouted the stranger as he approached, "my ship has gone down, but I like your island and intend to settle here. Will you help me with some provisions until I have brought a field into cultivation and harvested my first crops?"
At these words, Crusoe's thoughts flew from his provisions to the possibility of interest and the attractions of life as a gentleman of independent means. He hastened to answer "yes."
"That's splendid!" replied the stranger, "but I must say at once that I shall pay no interest. I would prefer to keep myself alive by hunting and fishing, for my religion forbids me to pay, or to receive, interest."
Robinson Crusoe: An admirable religion! But from what motive do you
expect me to advance you provisions from my stores if you pay me no
Stranger: From pure egoism, my dear fellow, from your self-interest rightly understood. Because you gain, and gain enormously.
R.C.: That, stranger, you have yet to prove. I confess that I can see no
advantage in lending you my provisions free of interest.
S.: I shall prove it in black and white, and if you can follow my proof, you will agree to loan without interest, and thank me into the bargain. I need, first of all, clothes, for, as you see, I am naked. Have you a supply of clothes?
R.C.: That chest is packed with buckskin suits.
S.: My dear Crusoe! I had more respect for your intelligence. Just fancy nailing up clothes for three years in a chest -- buckskins, the favorite diet of moths! And buckskins must be kept aired and rubbed with grease, otherwise they become hard and brittle.
R.C.: That is true, but I have no choice in the matter. They would be no
safer in my clothes cupboard -- less safe, indeed, for it is infested by
rats and mice as well as by moths.
S.: The mice will get them in any case. Look how they have already started to gnaw their way in!
R.C.: Confound the brutes! I am helpless against them.
S.: What! A human being helpless against mice! I will show you how to protect yourself against rats and mice and moths, against thieves and brittleness, dust and mildew. Lend me those clothes for one, two or three years, and I will agree to make you new clothes as soon as you require them. You will receive as many suits as you have lent me, and the new suits will be far superior to those you would have taken from this chest. Nor will you regret the absence of the particular perfume you have employed! Do you agree?
R.C.: Yes, stranger, I agree to lend you the chest of clothes; I see that
in this case, the loan, even without interest, is to my advantage.
S.: Now show me your wheat; I need some for bread and seed.
R.C.: It is buried in this mound.
S.: Wheat buried for three years! What about mildew and beetles?
R.C.: I have thought about them and considered every other possibility,
but this is the best I can do.
S.: Just bend down a moment. Observe the beetle crawling on the surface of the mound. Note the garbage and the spreading patch of mildew. It is high time to take out and air the wheat.
R.C.: This capital will be my ruin! If I only could find some method of
protecting myself against the thousand destructive forces of nature!
S.: Let me tell you, Crusoe, how we manage at home. We build a dry and airy shed and shake out the wheat on a boarded floor. Every three weeks the whole mass is turned over with wooden shovels. We also keep a number of cats; we set mouse traps and insure against fire. In this way we keep the annual depreciation down to ten percent.
R.C.: But the labor and expense!
S.: Exactly! You shrink from the labor and expense. In that case you have another course. Lend me your wheat and I shall replace it pound for pound, sack for sack, with fresh wheat from my harvest. You thus save the labor of building a shed and turning over the wheat; you need feed no cats, you avoid the loss of weight, and instead of mouldy rubbish, you will have fresh nutritious wheat.
R.C.: With all my heart, I accept your proposal.
S.: That is you will lend me your wheat free of interest?
R.C.: Certainly; without interest and with my best thanks.
S.: But I can only use part of the wheat, I do not need it all.
R.C.: Suppose I give you the whole store with the understanding that for
every ten sacks lent you give me back nine sacks?
S.: I must decline your offer, for it would mean interest - not indeed positive, but negative interest. The receiver, not the giver of the loan would be a capitalist, and my religion does not permit usury; even negative interest is forbidden. I propose therefore the following agreement. Entrust me with the supervision of your wheat, the construction of the shed, and whatever else is necessary. In return, you can pay me, annually, from every ten sacks two sacks as wages.
R.C.: It makes no difference to me whether your service comes under the
heading of usury or labor. The agreement is, then, that I give you ten
sacks and you give me back eight sacks?
S.: But I need other articles, a plough, a cart and tools. Do you consent to lend them, also, without interest? I promise to return everything in perfect order, a new spade for a new spade, a new, unrusted, chain for a new chain, and so forth.
R.C.: Of course I consent. All I have at present from my stores is work.
Lately the river overflowed and flooded the shed, covering everything
with mud. Then a storm blew off the roof and everything was damaged by
rain. Now we have drought, and the wind is blowing in sand and dust.
Rust, decay, breakage, drought, light, darkness, dry-rot, ants, keep up a
never-ending attack. We can congratulate ourselves here upon having, at
least, no thieves and incendiaries. I am delighted that, by means of a
loan, I can now store my belongings without expense, labor, loss or
vexation, until I need them later.
S.: That is, you now see the advantage you gain by lending me your provisions free of interest?
R.C.: Of course I do. But the question now occurs to me, why do similar
stores of provisions at home bring their possessors interest?
S.: The explanation lies in money which is there the medium of such transactions.
R.C.: What? The cause of interest lies in money? That is impossible,
S.: .... From their nature and destination your goods are the purest form of what is usually called capital. I challenge you to take up the position of a capitalist towards me. I need your stuff. No worker ever appeared before a capitalist as naked as I stand before you. Never has there been so clear an illustration of the relation between the owner of capital and the individual in need of capital. And now make the attempt to exact interest! Shall we begin our bargaining again from the beginning?
R.C.: I surrender! Rats, moths and rust have broken my power as a
capitalist. But tell me, what is your explanation of interest?
S.: The explanation is simple enough. If there were a monetary system on this island and I, as a shipwrecked traveller, needed a loan, I would have to apply to a money-lender for money to buy the things which you have just lent me without interest. But a money-lender has not to worry about rats, moths, rust and roof-repairing, so I could not have taken up the position towards him that I have taken up towards you. The loss inseparable from the ownership of goods (there is a dog running off with one of your -- or rather my -- buckskins!) is borne, not by money-lenders, but by those who have to store the goods. The money-lender is free from such cares and is unmoved by the ingenious arguments which found the joints in your armor. You did not nail up your chest of buckskins when I refused to pay interest; the nature of your capital made you willing to continue the negotiations. Not so the money-capitalist; he would bang the door of his strong-room before my face if I announced that I would pay no interest. Yet, I do not need the money itself, I only need money to buy buckskins. The buckskins you give me without interest; but upon the money to buy buckskins I must pay interest!
R.C.: Then the cause of interest is to be sought in money? And Marx is
S.: Of course Marx is wrong. He underestimated the importance of money, the nervous system of economic life, so it is not surprising that he went wrong on other things of fundamental importance. Like all his disciples he made the mistake of excluding money from the scope of his inquiry. He was fascinated by the shining metal disks, otherwise he could never have used the following words: "Gold and silver are not by nature money, but money is by nature gold and silver, witness the coincidence of their natural properties with its functions."
R.C.: Practice certainly does not agree with Marx's theory -- that has
been clearly proved by our negotiations. Money is for Marx only a medium
of exchange; but money does more, it seems, than "merely pay the price of
the goods it purchases." When the borrower refuses to pay interest, the
banker can bang the door of his safe without experiencing any of the
cares which beset the owner of goods (capital) -- that is the root of the
S.: Rats, moths and rust are powerful logicians! A single hour of economic practice has taught you more than years of study of the text-books.
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