Richard Glover – September 2019
Abridged from article published in Land and Liberty (1238) with the kind permission.
Interest is at the heart of today’s economy, affecting savings, investments, pensions, mortgages, the macroeconomy, and even international flows of finance. Lending money at interest has historically been prohibited and remains so today in the Islamic world. Perhaps commercial pragmatism has finally vanquished ancient dogma, and the Islamic world just needs to catch up. But then again, perhaps a last look at past understandings of interest, our modern practices, those questions of morality, could be a useful investment for our time.
Interest and usury are used interchangeably here. Usury often suggests an excess, as in translations of Aristotle and Deuteronomy which have influenced millennia.
Aristotle considered retail trade as comprising commerce, service and usury, viewing these as distinctly less noble than household management and wealth creation:
“There are two sorts of wealth-getting, as I have said; one is a part of household management, the other is retail trade: the former necessary and honourable, while that which consists in exchange is justly censured; for it is unnatural, and a mode by which men gain from one another.
The most hated sort, and with the greatest reason, is usury, which makes a gain out of money itself, and not from the natural object of it.
For money was intended to be used in exchange, but not to increase at interest.
And this term interest, which means the birth of money from money, is applied to the breeding of money because the offspring resembles the parent.
Wherefore of all modes of getting wealth this is the most unnatural.”
Aristotle, Politics Book 1 Part X
Aristotle’s household management represented new wealth creation. His retail trading of wealth changing hands involves money lending and monopolistic trade, the poor supporting the rich. He emphasizes money as a medium of exchange and not an end. Money is sterile with no real power of growth; hence interest, money’s apparent power to reproduce, is unnatural and to be avoided. He also described wealth creation having natural limits; we only work until needs and desires are satisfied. Extracting wealth from others expends little effort and has almost limitless possibility.
Deuteronomy 23: 19-20 gives guidance on usury for the Judaic and Christian worlds:
“Thou shalt not lend upon usury to thy brother; usury of money, usury of victuals, usury of any thing that is lent upon usury:
Unto a stranger thou mayest lend upon usury; but unto thy brother thou shalt not lend upon usury: that the LORD thy God may bless thee in all that thou settest thine hand to in the land whither thou goest to possess it.”
Usury here applies to commodities such as wheat, as well as to money loans. However, it may or may not be a sin, depending on some distinction between brothers or strangers. Perhaps brother represents family, and family bonds are be better served by giving and receiving than usury. Nevertheless, the brotherhood of all Jews could lend without sin to Christians at usury.
This influence remained strong for many centuries; usury was sinful, and you didn’t want to get caught. This presented difficulties in the post-Roman world with its trade and commerce flourishing again. Each ship’s voyage needed financing yet involved risk; Popes and Kings often ran short of money. Fortunately, Jews could step in, with others helping during their periods of banishment.
Financial innovation also created solutions to ensure money transactions could not be mistaken for usury, finding ways to hide actual practice from the authorities.
One “interest-free” solution channelled lending and repayment through reciprocal foreign-exchange transactions; obscured were the different exchange rates ensuring lender’s profit. Some, “dry exchanges”, involved no foreign exchanges at all.
An ingenious scheme used written interest-free loan-contracts with defined default penalties. If a principal of £100 was to be repaid after ten months, a default payment could be £130 two months later. An unwritten agreement to default ensured 30% “non-usurious” return for the year’s loan.
Annuities were also used for financing public or private projects for profit without usury. Money was advanced in exchange for future income in the form of rent, generally not related to the investment.
Bills of exchange used discounting to obscure usury in transactions involving a merchant bank. The principal is repaid without interest but less than the principal had been received to start with.
Pressures of expanding commerce generated many arguments in favour of usury. St Thomas Aquinas (1225-74) gathered these into four general areas and formulated counterarguments with frequent reference to Aristotle. These extracts convey something of his argument:
“To take usury for money lent is unjust in itself, because this is to sell what does not exist, and this evidently leads to inequality which is contrary to justice.”
“… just as it is a sin against justice, to take money, by tacit or express agreement, in return for lending money or anything else that is consumed by being used, so also is it a like sin, by tacit or express agreement to receive anything whose price can be measured by money.”
“A lender may without sin enter an agreement with the borrower for compensation for the loss he incurs of something he ought to have, for this is not to sell the use of money but to avoid a loss.”
“It is by no means lawful to induce a man to sin, yet it is lawful to make use of another’s sin for a good end, since even God uses all sin for some good…”
Thomas Aquinas – Summa Theologica part 2 Q78
Aquinas reaffirmed money’s sterility making usury a sin against justice itself as it charged for something that did not exist. He allowed lenders to charge for real costs or losses arising from the loan, and reasoned that borrowing at usury was permitted if used for a good purpose.
Just how sinful is it? Dante positioned usurers a long way down in hell’s inferno of his Divine Comedy. Seven descending steps are Limbo, Lust, Greed, Heresy, Violence, Fraud and Treachery. Usury is an aspect of violence which has three targets of people and property, life (through suicides or profligates), and lastly God or nature. Usury is the worst, against God and nature. More sinful than blasphemers or sodomites, you really did not want to get caught.
Islam also forbad usury at this time, and still does. The word for interest is riba meaning increase; it is forbidden and manifests in two ways. Riba-alfadl is where one party gains at the expense of the other in like-for-like transactions:
“Gold for gold, silver for silver, wheat for wheat, barley for barley, date for date, salt for salt, must be equal on both sides and hand to hand. Whoever pays more or demands more (on either side) indulges in Riba.”
Riba-al-nasiah covers transactions or trades involving time with four characteristics:
- Fixed and guaranteed
- Increases with time
- Secures lender; exposes borrower
- Does not increase with Allah; invites his anger and wrath
Fixing a deal amidst life’s uncertainty loads risk onto a borrower, who may already be in pressured circumstance. Charging more for longer periods is charging for God’s gift of time. If a purer heart is closer to Allah, an impure heart that charges excessively is further away; Allah does not grow with usury and his wrath is drawn. To avoid Riba-al-nasiah, avoid all of these. Islamic banking aspires to do just that, principally through sharing profit and risk.
Life continued and its costs and enterprise were supported through loans, despite general prohibition. Jews lent and Christians borrowed. In England when not outlawed, Jews were only allowed to practice as doctors or moneylenders. The attraction of avoiding repayment possibly encouraged their expulsion in 1290, not freely returning until 1829.
Italian merchant families and their banks offered finance for a time, notwithstanding some English kings’ defaults taking down a bank or two. Wealthy merchant families were able to facilitate financial transactions across Europe using bills of exchange. Trust within an extended and well-placed family was an important factor, and such merchants could become very wealthy.
Pragmatism rather than scriptural or moral argument arrived with Francis Bacon (1561-1626). He compared usury’s problems (discommodities) with benefits (commodities). Discommodities included increased inequity and poverty, whilst commodities included encouraging commerce and easing life’s ups and downs through occasional loans. Deciding in favour of usury, he suggested a maximum 5% rate for household lending, and licensed lending for the riskier needs of merchants. He hoped to “grind the teeth of usury” yet use its benefits. The suggestion was not taken up, but his pragmatism remained.
New usury laws gradually made lending at interest easier. The Netherlands permitted 12% on commercial loans in 1540. Henry VIII permitted 10% on all loans in 1545, and after many revisions, all restrictions were removed in 1854. The United States lagged in removing usury restrictions, especially with national banks; this helped London command the Euro/Dollar trade and grow into leading currency market today. Difference in usury restrictions between US states guided financial organisations to their most profitable location.
Today, banks have no inhibitions to charging the highest possible rates, it being understood as merely the law of supply and demand.
As economics developed as a discipline, economists offered their understandings of what was observed, including interest. Could it be a natural phenomenon obeying some natural law, rather than being a human device for money extraction?
One of the earlier economists seeking the answer was Frederic Bastiat (1801–1850) who suggested interest arises naturally from the power in tools and other physical capital to increase labour productivity. This attractive idea faulters on considering how free-market competition would increase supply, reducing any such premium. Only monopoly power such as market restrictions and property-rights could maintain such charges of interest.
Eugen Böhm von Bawerk (1851–1914) suggested interest arose from a natural time preference for using goods today rather later. The borrower’s preference is clearly to spend today, but this argument assumes a lender also wanting to spend today. Any lender with more money than needed today is playing the market rather than weighing up to spend or not to spend.
For Alfred Marshall (1842–1924), interest was the reward for frugality in deferring consumption. This widely held notion needs to be put into the context. Society at large is impoverished if starved of innovation or development; it is also poorer when money is piled high for some and absent for others. In this light, sitting on spare cash should be penalised rather than rewarded.
John Maynard-Keynes (1883–1946) related interest to future uncertainty. Money in the hand is both a safe bet and useful in case a speculative opportunity arises. Bonds must offer enough return to attract this money, which determines the prevailing rate of interest. Although uncertainty or risk is important when considering the future, this relates more to spare cash for gambling on financial assets than to money in exchange for goods and services.
More Bits of Interest
Once simple, compounding interest crept in as a mysterious art until calculation tables published in the 16th century revealed the secrets. Compounding still confuses today as with linking it to ever-increasing spirals of money and debt. Let us imagine three loans of 1p at 1% annual interest at the time of on Aristotle’s death, each under different terms and conditions; their debt positions today, 2341 years later, can be compared.
|Years||Simple||Compound||Compound + repayments|
Table 1 – long term debt under different borrowing schemes
The difference in today’s debt position between these is staggering, with compounding multiplying debt ten-fold every 232 years to reach £131M; simple interest’s debt today would be 24p. As staggering is the effect of 0.01p annual payments on the compounded loan, leaving a debt of only 1p. This illustrates the need for clarity; but clarity is also needed to debunk the near-universal belief that compound interest is the natural basis for loan charges.
Commercial banks have created nearly all the UK’s money through lending; are ever increasing loans needed to cover interest? Not necessarily. The money can never leave their computers; they have to attract deposits to balance the loans, sometimes paying interest. Banks live off the difference in interest rates and fees. Where profits are spent into the economy, the money supply remains stable. This does not address any oligopolistic power of banks charging more than the costs involved.
Calls to nationalise money creation and credit through the central bank need to heed history’s examples of rulers causing inflation through mismanagement or abuse of their powers. Avoiding both private and public abuse of the nation’s money supply will always remain a challenge.
Interest rates are sensitive to inflation; lending £1,000 for a year with 10% inflation only returns the same purchasing power at 10% interest. This is a nominal interest rate of 10% but a net interest rate of 0%. The rate of inflation (or the more feared deflation) is normally expressed as a number such as 2% per year. This headline figure is based on a large basket of goods and services and is a good measure of inflation where the whole population shops with the same basket. In practice, rising costs for many are often rising charges by a few, such as rents, rather than strictly inflation.
Microcredit is an alternative lending model instigated by Mohamed Yunis and the Grameen bank in 1970’s Bangladesh. He sidestepped the viscous grip of moneylenders and market controllers by evolving a system of small loans, typically for a year with weekly repayments. It relies on integrity of strength of village’s women community, rather than written contract or collateral. The scheme has mushroomed, raising countless numbers from abject poverty to some level of prosperity. For us, the main relevance is that loans are typically around 20% interest, and yet borrowers thrive. Savings are typically deposited with Grameen and earn interest. The not-for-profit Grameen’s earnings support its helping village communities use the money wisely. Moneylenders and Grameen both charge interest; but one breeds poverty, the other brings prosperity.
Loans are always for a purpose, and have consequences; targeting more consumption, more enterprise or more asset purchases yield very different results.
Dissatisfaction or deprivation can encourage borrowing to support or stimulate consumption. Attractive credit opportunities, advertising onslaughts, overzealous landlords and creditors, all conspire to increase consumption and debt; resistance requires almost super-human self-restraint. Consumption-stimulating borrowing ultimately balances through reduced consumption to support repayments and interest.
Dominant lending today is for asset purchases, ownership changes rather than creation of new wealth. Mainly mortgages, of which most goes on title changes on freehold or leasehold interests rather than new buildings. This stimulates land prices and the money supply, and give banks a share in the economic rent of the nation’s land.
Most beneficial to the community are loans for new wealth creation and enterprise; bringing new opportunities, these typically fund the repayments. Banks can lend pre-existing money or create new money; it is wise to restrain introducing new money to periods of rising economic activity to avoid inflationary tendencies.
Banks and other financial institutions make lending choices, sometimes guided by more central institutions; wisdom rarely prevails. For example, the Basle accords aim at financial stability and encourage lending against land assets rather than enterprise; this leads to instability. Banks are also guided by shareholders’ appetite for dividends and capital gains. Reform of banking, money and interest needs to rebalance the interplay between market and non-market forces.
Summary and Conclusions
This brief review exposes differing views on interest and usury. Deuteronomy implies usury is only sometimes sinful; Aristotle was adamant it was unhealthy; interest helps commerce prosper and benefit communities; Aquinas permitted charges for real loaning costs but not opportunity costs; Grameen displaced moneylenders but maintained interest; economists searched in vain for natural causes of interest; debtors have been more often imprisoned than forgiven.
The lack of clear answers to the rights and wrongs of interest demands our looking elsewhere. Why does anyone accept onerous loan conditions? Yunis saw clearly a lack of freedom leads to abject poverty, whilst real credit and a few dollars leads to prosperity. Those moneylenders had power and used it to inflict poverty. How can the same power serve the common good?
Economics has become almost the science of acquiring resources and ameliorating the resulting scarcities. Might has become right, property-rights separate the haves and have-nots, and common interest has become divergent interests. Unchecked privileges ensure private command of devastating debts, oceans of money, considerable land and other rents, as well as access to the means of tax avoidance and influence on tax policy. The resulting impoverishment encourages desperation and loans under onerous terms.
Governments have the power but little inclination to ensure privilege is less the expense of others and more the support of shared prosperity. Education rarely aspires to explain the effects of privilege without responsibility.
Education and government need to encourage privileges being balanced by responsibilities; less might being right for some and more justice and prosperity for all. Aristotle’s strange assertion of “interest being against nature” may hold a clue. Perhaps today he would observe the strong’s exploitation of the many as being against the highest aspects of what it is to be human.
In economic terms, the power of privilege can often be expressed as an economic rent, such as of location. Fiscal reform to secure manifestations of economic rent for public benefit would greatly reduce exploitation leading to impoverishment.
The wider interest of society necessarily conforms with the more noble aspects of being human. Morality of loans at interest centre on their leading to more or less harmony and prosperity. Those inner intentions of both Yunis and moneylenders can guide us; education can convey such guidance; government can encourage our finest qualities by restraining injustice.