Wednesday, April 1, 2015

A (Very) Short Discourse on Interest

It’s appropriate that we take a look at interest today, because the way interest rates have been manipulated in modern times is one of the biggest April Fool pranks in history.  Since the invention of central banking in 1694 with the institution of the Bank of England, the public has been mulcted by having to pay interest on the loan of “pure credit” (i.e., not based on past savings) money.

Adam Smith: wages to labor, rent to landlords, interest to capital owners.
Before we get into the benefits of a two-tiered interest rate system that would solve this problem, however, we should know what interest is — and what it isn’t.  “Interest” comes from “ownership interest.”  In classical economics, “wages” are the return to labor, “rent” is the return to land, and “interest” is the return to capital.  Interest is also known as “profit,” which is the residual due to the capital owner after all costs are met.

Now for the fun part.  Most people, including virtually every economist and wannabe, confuse “money” and “capital.”  Capital, however, is “productive wealth,” wealth that produces other wealth, while money is “token wealth,” a symbol for actual wealth, which can be either consumer or capital goods.  Yes, money can also be capital in a sense if it is used to purchase capital.  In that case, however, because money is a financial asset, it’s probably better to call it “financial capital” to distinguish it from “true” capital.

Moneylending: distant second to bills and notes in commerce.
Even in the Middle Ages interest was legitimate IF it was charged on money used to purchase capital or lent to purchase capital.  Someone lending out of his accumulation of savings was (and still is) entitled to a just return on his money — assuming that the money was used to finance a productive project that made a profit.  The market would determine what a fair division of profits would be between lender and borrower involved in a productive project.

Benedict XIV: "Dudes, usury is dishonest profit, not all profit!"
Problems came in when lenders wanted a return in excess of the market rate or that exceeded a fair share of the profits (they can be different, depending) or, worse, when the money was lent for a purpose that didn’t generate a profit at all, such as to purchase food, clothing, or shelter.  That’s usury: taking a profit when no profit is due — note the real title of Pope Benedict XIV’s 1746 discourse Vix Pervenit: “On Usury and Other DISHONEST Profit.”

We won’t get into the legitimacy of “interest” on a home mortgage: that’s considered “quasi-rent” and is legitimate; a similar justification can be made for interest on consumer loans for goods that are not “consumed by their use,” i.e., “durables” for which rent would otherwise be due.  And then there’s Aquinas’s really weird exception to charging for the use (usufruct) of money: if you borrow bags of gold from the local moneylender to display at a wedding feast or something to show off your wealth, you owe rent for the use of that money to the moneylender because you didn’t consume (i.e., spend) the money.  And you thought today’s wedding customs, with bridezilla and such, were strange.

"But, George, this IS the future!"
That covers loans out of past savings.  What about loans out of future savings, i.e., money creation based on accepting a contract to be repaid out of future profits?  There are no past savings to lend, although we might want to discuss “renting money” for collateral to secure the ownership interest of whoever accepts our contract.  (Like the money borrowed to display at a party, collateral is not intended for consumption.  It is therefore legitimate to charge a fee for the use of collateral if you don’t have your own.  A capital credit insurance policy fills the collateralization requirement perfectly, and the insurance premium qualifies as the fee for the “rent” of the collateral — i.e., the insurance pool.)

Properly speaking, then, a loan of “future savings” should not involve any payment of interest.  That doesn’t mean it’s free, however.  Whoever accepts your contract trusts you to meet your obligation when it falls due, and in return either gives you goods and services now, or allows you to use his good name to obtain goods and services now.  The other party is on the hook twice: 1) he trusts you to meet the obligation in full in the future, and 2) a dollar today is worth more than a dollar a year from now.

"This was worth HOW much a century ago? Shut up and take my money!"
Thus, if you get a dollar today and repay a dollar a year from now, you have gotten the lender off Hook Number One, but you’ve screwed him on Hook Number Two.  That’s why commercial notes and bills almost always pass at a discount off the face.  Another merchant or a banker will accept your $100,000 note only on condition that you get goods, or he creates money, respectively, less than the face of the note, say, 2% (which seems to be the favorite example in all the textbooks).  Thus, you agree to repay $100,000 for a loan of $98,000.

With Capital Homesteading, everybody can be in the money.
(Of course, when the Capital Homesteading monetary and tax reforms pass, and the increase in the value of the currency over time offsets the time value of money, you could actually start to see long term bills and notes passing at a substantial premium!  Whoever accepted your $100,000 note would immediately rediscount it at a premium, and the final holder in due course would make a profit by being repaid in dollars that were worth more than what he paid for the note.)

A lot of people call the $2,000 difference interest, and the 2% an interest rate.  That is not, however, strictly speaking, correct.  It’s not interest, it’s a discount.  It’s the fee to the other merchant or banker to compensate him for risk and the time value of money, and is also legitimate IF (that word again) if it is used ONLY for capital projects.  You’re using the other person’s credit or goods for your own profit, and you should expect to pay for it.

Tomorrow we have even more fun: we look at the specifics of a two-tier interest structure.


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