Usury & Interest

The word “usury” has crept back into public view over the past decade. It is interesting that the current Pope, in 2014, greeted the National Council of Anti-Usury Foundation by saying “When a family has nothing to eat, because it has to make payments to usurers, this is not Christian, it is not human!” Usury, a word once buried under the prosperity of the latter half of the last century has come back into the public mind since the great recession of 2007, and the sovereign debt crisis in 2011 which still rumbles on in the Eurozone.

In Barren Metal: A History of Capitalism as the Conflict between Labor and Usury, E. Michael Jones identifies two views on economy that have appeared dialectically throughout history. The first being an economy based on labour, the second being an economy based on usury. The society of the ancients was a labour economy, a slave economy. The economies of the feudal princes were also labour economies. Even Classical and Pysiocratic economists in the 18th century generally assumed wealth was found in the land, and was exploited by labour. Malthus understood real incomes as being entirely determined by labour scarcity. High populations of agricultural labourers working a fixed amount of land will decrease output per capita. Real wages will naturally fall causing populations to fall. This decline in the population of agricultural labourers increases output per capita, raises wages, and so increases population. The cycle will continue and wages will cycle around the subsistence wage, where birth rates are equal to death rates. Lassalle would later describe this observation, made by Ricardo, Malthus, and Turgot before them, as the “Iron Law of Wages”.

A Classical utopian like Adam Smith would be rebuked for believing a technology that increases output per capita would also increase long-term real wages because the natural effect would be to simply raise the population to a greater stable level, so that more people were living on the subsistence wage. Smith was also rebuked in chapter XIV of Malthus’ An Essay on the Principle of Population. Smith imagined that increasing industrial output would permanently raise the wages of industrial labourers. Malthus disagreed, writing that without the complimentary increase in agricultural output, or “provisions”, the wage increase for industrial labourers would simply be inflationary, drawing them back into the subsistence wage. This was accurate for most of human history until the first Industrial Revolution, and the “Demographic Transition” which I will not explain here, overcame the so-called “Malthusian trap”; however, as world growth slows I can feel the parson’s icy hand on my shoulder. Pride goeth before destruction, and an haughty spirit before a fall.

The societies of the industrial and post-industrial period have been based on usury. Ecclesiastical law from the 9th century to the 13th century defined usury as simply lending at interest; however, as commercial loans became ubiquitous across the Italian city states the definition of usury was shaken. Pope Innocent IV agreed with Henry of Susa‘s assertion made in 1271 that “If some merchant, who is accustomed to peruse trade, and the commerce of fairs, and there profit much, has lent money with which he would have done business, I remain obliged from this to his interesse to recompense him for the profit he would have made had he engaged in the business himself.” This developed further in the writings of Bernardino of Siena who described money as a form of “capital”, the renting of which being no different to that of a plough. Aquinas argued that the ownership of the money was transferred to the borrower from the lender and therefore the lender had no right to charge interest on the loan. It is true that the ownership of money, or a plough, transfers to the borrower to use how he desires or within the agreements of a contract (a bank lender may demand that the money lent to a business is spent in certain ways, and has the right to demand repayment at any time if the contract is broken); however, the terms of that transfer of ownership determines the interest payed to the lender. The lender is being compensated for time and risk, to be payed on an agreed date.

During the high middle ages, commercial enterprises received lower interest rates than loans for individuals. The former was an investment, the interest a compensation for risk; the latter was generally used for short-term consumption, and individuals were less likely to repay their loans. Given that minor conquests and family squabbles were not at all intended as investments, kings and princes were perhaps the most risky, paying rates of almost 40% at times; however, in Venice interest rates for shopkeepers and blacksmiths dropped from around 20% to 8% between 1230 and 1330. The Church during this period described usury as lending above a rate of 12%. Naturally, those usurious loans would mostly be the loans to individuals, and this is the most problematic form of lending in the public eye.

Jews were exempt from ecclesiastical law and Jewish loan sharks would provide short term loans at high rates of interest to private individuals. It is certainly interesting that many today evoke Shakespeare’s Shylock in the Merchant of Venice to decry companies that lure desperate people into short-term, high-cost credit agreements. It is more interesting still that the founder of the infamous Wonga.com, Errol Damelin, is a Jew. A quick search of the word “Wonga” leads to pages of complaints from desperate people that feel cheated and robbed. One man describes Wonga.com as “a bunch of blood-sucking evil b****ards who need taking round the back of the bike-sheds for a good kickin”, not a dissimilar sentiment from that of Shakespeare’s time, I’m sure. The definition of usury has varied across the centuries and gradually came to mean excessive or unfair interest.

The arguments against usury have been made since the ancients, Xenophon in his Oeconomicus, Aristotle in his Politics, extended through to Aquinas and into the 17th century. The foundation of Aristotle’s thinking was the sterility of money. Since money does not yield more money from itself, as say a tree yields fruit, it is sterile. The idea that money could beget money was then absurd, and indeed to Aristotle, unnatural.

However Aristotle, in his infinite wisdom, did not consider that a tree does not yield fruit strictly by itself, since a tree needs sunlight, water, air, and often a temperate climate to yield fruit. A tree combines its potential to yield fruit (natura naturans) with external inputs in order to actually yield fruit; likewise, money generates profit using a combination of its potential to yield profit (money begetting money) with the external input of the investor’s business acumen. Just as orchards need a favorable climate to yield fruit, markets need a favorable economic climate to yield profit: sunlight, private property, water, contract law, etc.

What damns Aristotle’s theory, and that of Scholastics after him, is that it fails to incorporate time. A sapling doesn’t produce fruit immediately, and neither does a loan produce immediate money. When a man takes out a loan he is buying the use of money for a period of time, and he is compensating the lender for the risk of default. A contract is drawn and the interest repaid after an agreed amount of time. The nonexponential interest is effectively a rent charged for the use of the principle; however, compound interest accounts for time to a greater degree than simple interest. The rate is proportional to the length of time the borrower rents the money. Rather than drawing out a contract whereby the loan must be returned, the borrower can extend the duration of the loan in exchange for greater levels of interest.

The obvious problem with this is that those unable to pay will need more time in order to repay the interest, but during this time the interest is increasing exponentially. The very people that need the loans extended or rolled over are the people the least likely to pay, and when the rates are exponential it quickly becomes impossible to pay. Indeed, that is largely the point of short term lending companies. They encourage borrowers to take out more than they can repay in order for the borrower to default. After the default the company, say Wonga.com, can seize assets equal to the value of the principle and interest.

Compound interest catches people out. A man is used to the idea of renting a DVD for £5 and returning the DVD (principle) with the rental free (interest). One day the DVD rental shop proposes the seemingly reasonable contract that the man will now be charged 50p if he returns the DVD that day, £2 if he returns it the next day, and so on, and the man happily accepts. He returns to the shop after two weeks finding that to his astonishment that he owes them almost £34,000,000. Compound interest makes men and destroys them, as Einstein once remarked: “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”

A borrower does not actually have to invest the money he borrows, he can keep it under his bed until he has agreed to return it to the lender, but he will have to return what he has borrowed and compensate the borrower for the time he has rented the money. There is an opportunity cost at play. The lender could invest his money in a venture returning 4% per year above his investment, or he could lend the money to someone. Unless the interest on the loan is above 4% per year he will invest the money rather than lend it. If the borrower is particularly risky, the lender may raise the rate to 10%.

One of the other Aristotelian and religious arguments against interest is that loaning money undermines charity. If a government denied a lender the right to charge interest on his loan, the government would also have to deny the loaning of cars, bicycles, DVDs,  tools, and a whole range of other goods. It would have to force car rentals to lend cars without demanding a fee lest they undermine charity. So those hardliners that decry any lending at interest would also then have to deny all rent. This regressive and nonsensical view, which was thoroughly refuted by Bernardino of Siena in the early 15th century, persisted into the early-modern world, and still lingers. Turgot lamented at the usury policy of the ancien régime in his Paper on Lending at Interest written in 1770. He identified that the word usury at that time was only used in reference to loan sharks charging high levels of interest to the poor. This type of lending was immoral to Turgot “not because they charge interest, because they take advantage of the pressing needs of others”.

Axes are not wicked themselves because some wicked people chop wood. An axe-murder is harmful to society because he murders, not because he murders with an axe. Interest is not wicked in and of itself.

Tags: adam smith anne turgot aristotle bernardino of siena e. michael jones ferdinand lassalle henry of susa interest oeconomicus (book) paper on lending at interest (book) politics (book) thomas aquinas thomas malthus usury