On Usury and Other Dishonest Profit, Part XVII

At its simplest, banking consists of people making deposits, and the bank lending out the deposits. People making deposits are called (obviously) "depositors," while the people to whom the bank lends the deposited funds are called "borrowers." This most basic form of bank is called a deposit bank or a "bank of deposit," to use three words when two will do.

Clearly a deposit bank cannot lend out more than is deposited. The only way for a bank of deposit to get into trouble (aside from the ever-present danger that borrowers will not repay their loans) is for depositors to demand back more money than the bank has on hand, the balance having been loaned to borrowers.

As viewers of the Frank Capra film It's a Wonderful Life (1946) know, a deposit bank can't make any money for itself or its depositors if it doesn't make loans — but at the same time, that means that the depositors cannot demand all their money. The funds are (presumably) invested in the community, and are not "liquid." In order to allow depositors to withdraw all their funds, the bank would have to call all the loans (probably bankrupting all its borrowers in the process), pay out the depositors, and shut its doors. . . just as the evil Mr. Potter planned when he caused a run on the Savings and Loan.

The funds loaned out by deposit banks represent accumulations of savings, that is, unconsumed income from prior periods. Given that the purpose of production is consumption, the existence of savings means that goods and services were produced that were not consumed, and the purchasing power that (per Say's Law of Markets) came into being with that production was — in an ideal world — set aside to meet future anticipated consumption needs. This keeps the economy in balance, the bank of deposit serving a valuable and necessary service. The proper role of a bank of deposit, therefore, is to provide a secure place for people to accumulate savings to meet future anticipated consumption needs, and lend them out to other people in the interim to allow them to meet current consumption needs.

There are two problems with deposit banking, however, both related to our subject. One, if a deposit bank charges a borrower more than a just fee for providing a loan for consumption purposes, the bank is engaging in usury. A loan of money spent on consumption obviously does not generate a profit by its nature. Taking a profit in the form of an interest rate on a consumption loan is therefore unjust — the bank is taking a profit when no profit was made. This is a form of theft.

Even the calculation of a just fee is problematical. If the amount of the fee is based on what the money would have generated in the way of profits had it been invested in a productive project, it constitutes usury. You can't morally take a profit from one individual or group on the grounds that you might have made an equal or greater amount of profit by lending to someone else. In essence, this is to make one individual or group pay for the opportunity cost of your not taking the moral (and productive) alternative.

Basing the fee charged on a loan for consumption purposes on the time value of money, while it makes a better case, is still usury. The time value of money is based on what a current sum of money will be worth in the future, or what a future sum of money is worth at the present time. Often this is calculated based on some expected or anticipated rate of return, that is, on what the sum of money would generate if it were invested in a productive project. Paradoxically, this is usually the "riskless" rate of return, typically determined by the rate paid by the government on its borrowings, one of the most obvious forms of usury in any economy, government by its nature being non-productive.

Basing the fee on the rate of inflation (if any) is more sound. A lender has the right in justice to have the full value of what was borrowed restored to him or her. A unit of currency that buys a one pound loaf of bread this year, yet only half a one pound loaf of bread next year has clearly lost half its purchasing power. In justice, the borrower should then restore to the lender two units of currency for every one unit borrowed, or the lender has incurred a loss through the transfer of purchasing power from the lender to the borrower.

The problem is that inflation is itself usurious by its nature. Inflation allows a debtor to make a profit from the decreasing value of the currency. This has the effect of transferring purchasing power from savers to debtors, without the debtors having produced anything or having provided any service to the lender. In times of inflation, debtors make a profit by consuming, and benefit by being wasteful and spendthrift. Effectively, during inflation, debtors steal purchasing power from lenders by paying back debts with "cheaper" units of currency. Keynesian monetary policy is based in large measure on these principles, redistributing purchasing power through the "hidden tax" of inflation.

The seemingly unavoidable plunge into usury by banks of deposit is obviously not good for society. The seemingly moral alternative, however — banks of deposit lending only for productive investment — while individually moral (and thus permissible), actually causes more harm to the economy than charging interest on consumer or government loans made out of existing accumulations of savings. Why this is so we will cover in the next posting.