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Monday, August 2, 2010

Interest-Free Money, Part VIII: Good Credit v. Bad Credit

As we saw in the previous posting, a basic shift in the understanding of money and credit early on had a significant influence on how we understand the proper use of these uniquely social institutions and the role of existing accumulations of savings in financing new capital formation. As a result of the idea that "saving" consists exclusively of cutting consumption, the belief grew that money as money is somehow productive, and that interest is somehow the charge for the use of money, rather than a sharing in the profits of a productive enterprise. In consequence, lenders began asserting that, regardless whether the loan of money is put to a productive or non-productive use, the lender is due a fee for the use of the money.

Good Credit v. Bad Credit

This blurring of the distinction between different types of loans has led to the failure to distinguish between "bad" uses of credit and "good" uses of credit. To those with accumulated savings, all uses of credit are "good" because all yield a profit. To those without accumulated savings, naturally enough, all profit therefore tends to become bad.

This did not happen overnight. During the Middle Ages the idea had grown up that "good" doesn't consist of what we can figure out about God's Nature (Intellect) by observing humanity, but in the carrying out of what we believe to be God's commands revealed to us in some fashion. The basis of the natural law thereby shifted from God's Nature or "Intellect" (which by definition is unchanging) to whatever people believe to be an expression of God's Will, usually the Bible — and people's interpretations of anything, but especially the Bible, tend to experience a very high degree of change, as ministers, psychiatrists, and politicians are well aware.

Prior to the Reformation, with varying degrees of success, the three great Abrahamic faiths had uniformly and consistently condemned something called "usury." In Christendom, the authority of the pope backed up by the Magisterium (as the body of official Church teachings is called) supported the ancient ban on usury, which began at least as far back as Aristotle. As late as 1745, Pope Benedict XIV, the head of the Catholic Church, issued an encyclical titled "On Usury and Other Dishonest Profit."

What is "usury"? The easiest (and most correct) way to understand usury is in terms of "good credit" versus "bad credit." Aristotle's definition of usury, which is the systematized basis of the ban on usury in the three Abrahamic faiths (although not restricted to them, as we shall soon see), is straightforward. Usury is the taking of a profit from something that does not, by its nature, generate a profit:
Now money-making, as we say, being twofold, it may be applied to two purposes, the service of the house or retail trade; of which the first is necessary and commendable, the other justly censurable; for it has not its origin in nature, but by it men gain from each other; for usury is most reasonably detested, as it is increasing our fortune by money itself, and not employing it for the purpose it was originally intended, namely exchange. And this is the explanation of the name, which means the breeding of money. For as offspring resemble their parents, so usury is money bred of money. Whence of all forms of money-making it is most against nature. (The Politics, I.x)
As a result of the "usury war" we are about to relate, many translations substitute "interest" for "usury." The Medieval interpretation of what Aristotle said, however, was not that interest is wrong (for interest consists of taking a share of real profits), or that retail trading in goods in which a merchant sells for more than he or she paid is wrong (for that is providing a necessary and valuable service, and should, in justice, be compensated). What is wrong is dealing in money as a commodity or charging rent for it, or buying and selling goods in the hope of gaining by a change in the price (speculation). Charging for the use of money as money is what Aristotle condemned, not taking a share of the profits from a productive project financed by money that is lent by its owner.

Productive v. Non-Productive

Thus, lending money to finance capital formation is "good credit." Lending money to spend on consumption, speculation, or to cover government deficits is "bad credit." Taking interest on a loan of money used to finance capital formation is legitimate, as the interest represents the lender's just share of profits. This is due him or her in justice for contributing to the financing of the project out of his or her existing accumulation of wealth. As long as it is not excessive, that is, constitutes more than what the lender is due as his or her fair share, taking interest does not constitute usury or any other form of unjust profit.

Every culture oriented in accordance with the natural law has condemned usury, although this has been most strongly expressed in Hinduism, Buddhism, and the three Abrahamic faiths: Judaism, Christianity, and Islam. Ancient Vedic (Hindu) texts from India dating back 3,500-4000 years make several references to the Kusidin, or "interest taker," (Lakshmi Chandra Jain, Indigenous Banking in India. New York: Macmillan and Company, 1929.) although it seems clear that by "interest" is meant usury, for lending for a productive project was virtually unknown in the ancient world, east or west; "interest" is a poor translation.

Hindu Sutras from around 700-100 BC, and Buddhist Jatakas from 600-400 BC go into more detail and make it clear that the usurer was universally excoriated. The Hindu priestly and warrior castes were forbidden to engage in usury. The Laws of Manu from the second century AD refine the concept in a way that suggests that there can be legitimate interest taking, though not in excess, describing anyone who takes excessive interest as partaking of "pus and urine." (The Laws of Manu. London: Penguin Books, 1991.)

Monotheism and Usury

Judaism was strict on usury, at least in its teachings. The fact that there are so many prohibitions expressed against the practice suggests that it was as widespread as it was condemned. (Exodus 22:25; Leviticus 25:36-37; Deuteronomy 23:19-20.) Again, however, this is not a condemnation of profit, but of unjust profit, that is, taking a profit when no profit is generated.

The Islamic prohibitions against usury are very clear on the distinction between good credit and bad credit. Still, the Islamic attitude toward interest and usury puzzles people today unfamiliar with economic and philosophical history. There is a general refusal to take usury, or "riba," but usury is clearly distinguished from interest.

This requires a little explanation, for Islamic thought in this area is advanced and rather sophisticated, although fundamentalists have tended to obscure the Prophet's common sense teachings on the matter. There are two types of riba. The first is prohibited in the Qu'ran, and consists of an increase in financial capital without any services being provided. The second is prohibited in the Sunnah, and consists of commodity exchanges in unequal quantities. Both are obviously instances of taking a profit when no profit has been generated. Yet again, it is unjust profit-taking that is forbidden, not a just profit:
Those who charge usury are in the same position as those controlled by the devil's influence. This is because they claim that usury is the same as commerce. However, God permits commerce, and prohibits usury. Thus, whoever heeds this commandment from his Lord, and refrains from usury, he may keep his past earnings, and his judgment rests with God. As for those who persist in usury, they incur Hell, wherein they abide forever. (Al-Baqarah 2:275.)
Condemnations against riba (as distinct from interest) are manifold in the Qu'ran:
God condemns usury, and blesses charities. God dislikes every disbeliever, guilty. Lo! those who believe and do good works and establish worship and pay the poor-due, their reward is with their Lord and there shall no fear come upon them neither shall they grieve. O you who believe, you shall observe God and refrain from all kinds of usury, if you are believers. If you do not, then expect a war from God and His messenger. But if you repent, you may keep your capitals, without inflicting injustice, or incurring injustice. If the debtor is unable to pay, wait for a better time. If you give up the loan as a charity, it would be better for you, if you only knew. (Al-Baqarah 2:276-280.)
O you who believe, you shall not take usury, compounded over and over. Observe God, that you may succeed. (Al-'Imran 3:130)

And for practicing usury, which was forbidden, and for consuming the people's money illicitly. We have prepared for the disbelievers among them painful retribution. (Al-Nisa 4:161)

The usury that is practiced to increase some people's wealth, does not gain anything at God. But if people give to charity, seeking God's pleasure, these are the ones who receive their reward many fold. (Ar-Rum 30:39)
Clearly, just as in Judaism, the problem of usury in Islam was widespread, but was nevertheless looked upon as vile, being universally condemned. Nor were matters any different in Christendom, and, before that, in Paganism. (See, e.g., Plutarch's essay, "Against Borrowing Money," available in Selected Essays and Dialogues. Oxford, U.K.: Oxford University Press, 1993.) The urge to take a risk-free profit, whether or not it is due in justice, is evidently very strong, regardless of your religious beliefs or lack thereof.

The problem is that nobody likes to be told he is doing wrong . . . especially when the wrongdoing is extremely profitable. In common with the modern urge to get rid of the guilt instead of the reason for the guilt, the Medieval proto-capitalist and usurer didn't want somebody sitting on a throne a thousand miles away in Rome condemning him.

The Effect of the Reformation

There were thus two very good economic reasons for "throwing off the yoke of Rome" in the 16th century. One, the Catholic Church's insistence on the personal sovereignty of each individual person prevented, or at least inhibited or ameliorated the drive to centralized, totalitarian rule by the political elite. Two, the Catholic Church's prohibition against taking a profit when no profit is generated interfered with the power of the rising moneyed classes to make as much of it as possible while risking as little as possible. Due to the false assumption that existing accumulations of savings are necessary to finance capital formation, combined with the demand for collateral in the form of existing wealth, the "new men" already had a virtual monopoly on all future ownership of the means of production.

Even before the Reformation the new doctrines of divine right and the incapacity of ordinary people to look after their own interests had resulted in an increasing concentration of ownership of land, the chief productive asset of the time. In Utopia (1516), Thomas More's biting satire on the abuses of the natural law prevalent in Tudor England, mocked the increasing trend toward concentration of ownership.

In several places in the first and second books of Utopia, More declared that the Utopians had carried Tudor policy to its logical conclusion and abolished private property. This has weirdly been reinterpreted by modern academics as advocating the very thing that More was satirizing! (Paul Turner, "Introduction" to the Penguin Books edition of Utopia. London, 1965, 11-12, 13.) Significantly, More put the whole story in the mouth of the "narrator" Raphael (One of the great philosophical problems of the Middle Ages was Raphael the Archangel, a patron of travelers, who tells a lie and deceives Tobit as to his origin and identity.) Hythloday, whose name signifies "Lying Traveler Who Speaks Nonsense." (Turner, op. cit., "Hythlodaeus means 'dispenser of nonsense." 8.)

As a lawyer as well as a student of the "new learning," More (as well as his readers) was fully aware that private property is the basis of civil society. To abolish private property was, as far as the people of that time were concerned, raving insanity. More's point, of course, was that the Tudor policy of concentrating ownership of the means of production was effectively the same as abolishing private property for the great mass of people, and, by destroying their livelihood by clearing agricultural land to raise sheep for the staple, destroying them. This was not only by giving people a justification for theft out of necessity, turning ordinarily honest people into thieves, but by taking away their means of making a living:
"But I do not think that this necessity of stealing arises only from hence; there is another cause of it, more peculiar to England." "What is that?" said the Cardinal: "The increase of pasture," said I, "by which your sheep, which are naturally mild, and easily kept in order, may be said now to devour men and unpeople, not only villages, but towns." (Thomas More, Utopia. New York: Alfred Knoph, Inc., 1992, 26.)
Today's interpretation of what may be one of the most important points in More's book would, in all probability (and taking into account his well-known love of a good joke) have reduced him to helpless, if wondering, laughter. (See the Lives of Saint Thomas More by William Roper and Nicholas Harpsfield, published in a single volume in Everyman's Library, London: J. M. Dent and Sons, Ltd., 1963.)

Usury, of course, is closely related to private property, but represents a serious distortion of the concept. The Catholic Church carefully distinguished between loans for consumption and investment in productive endeavors, the latter being legitimate and a positive good for individuals and the social order. This, however, did not satisfy the greed of those supporting the reformers. As one authority noted,
The denial of the legitimacy of interest was a natural evolution from conditions of the time. The rigors of the church were directed primarily against loans for consumption to persons in need. When saved capital was the exception, and opportunities for organized industry were rare, loans for productive purposes were the exception. When the time came for escaping the restrictions of the canonical laws, several ways were found of doing so. Already, as early as the thirteenth century, Albert le Grand conceded that "if usury is against the perfection of Christian law, it is at least not contrary to civic interests." Even St. Thomas admitted the loss resulting (damnum emergens) to the lender who was kept out of his money, and the interval of time and the value lost (quantum ejus intererat) gave birth to the word interest as a substitute for usury (usura). (Charles A. Conant, A History of Modern Banks of Issue. New York: G. P. Putnam's Sons, 1927, 14-15.)
Risk Sharing v. Risk Elimination

Getting out from under the censuring eye of Rome, the political and economic powers that backed the reformers were now free to demand a profit on a loan of money, regardless of the purpose of the loan. Just as is the case today, a loan of money for consumption was often preferred over a loan for productive purposes. A loan for a productive project was, being construed as a type of partnership, frequently non-recourse in effect, even if such was not specified in the loan agreement. This was because if a loan made for a capital project went into default, it was due to the fact that the project turned out to be worthless along with the collateral, or at least not quite as profitable as projected. Consequently, the lender shared in the loss just as he or she would have shared in the gain.

A loan for consumption purposes, on the other hand, left a borrower's collateral intact, as it was not at risk in a business. Further, a borrower for consumption purposes intended and generally had to prove that he or she could repay the loan out of his or her other resources, making it indifferent for what purpose the loan was made. Thus, a loan made for consumption purposes was, paradoxically, considered more certain than a loan made for a capital project that was intended to generate its own repayment and be subject to the risks of the market.

Consequently, both the political and the economic elites had good reasons for supporting the religious changes of the Reformation. There was sufficient flexibility in the new religious doctrines, especially those rooted in personal interpretation of Scripture, to allow anyone with a plausible argument to force through a desired change, especially if the change happened to be politically or economically to the advantage of the one pushing for the change. The eventual effect was that divine right theory undermined the idea of personal sovereignty and human dignity directly, while the new acceptance of usury undermined private property for the great mass of people, further eroding personal sovereignty and human dignity.

This was in spite of the fact that, by and large, the first generation of reformers made no essential changes in traditional moral philosophy, especially with respect to usury. (See, e.g., Martin Luther's A Treatise on Usury (1520) and On Trading and Usury (1524)) Instead, the changes in such areas as political philosophy and economics only began to make their appearance after people like Luther, Melancthon, and Zwingli, even Henry VIII Tudor, had passed from the scene. These men were, if anything, much more stringent and narrow in their interpretations of traditional moral philosophy than Rome had ever been, if only to allow them to demonstrate the alleged "laxity" of Rome in these matters and justify their break with the body of the Church.

Bending to Presumed Economic and Political Necessity

The problem, however, was that subsequent generations of reformers were in large measure far more dependent on the political and economic powers than their predecessors or Rome had ever been. At the start of the Reformation, the political and economic elite needed the support of the religious reformers to justify their political and economic break with the Empire and the Church. Afterwards, however, the reformers needed the politicians and the rich far more than the politicians and the rich needed the reformers.

There were reformers of the reformed churches, of course, who sought to return to the purity and faith of the original reformers, which they believed to be more consistent with primitive Christianity. The effect of these later reformers, however, was to foster the growth of non-conformist groups at odds with the new legally-established churches under the official control of the head of State, which then created their own conformity, and their own reformers, and so on.

Consequently, not only were there more political theories floating around than you could shake a stick at, views on finance, especially usury, were all over the map. Which view was accepted depended on who had the power to force his or her views on the rest of society — and that meant the political and economic elite, who could (as might be expected) be counted on to promote and maintain whatever theory gave them the most political and economic power over others.

It comes as no surprise that Sir Robert Filmer, who so avidly supported the divine right of kings, also came out strongly in favor of the idea that usury — bad credit — was no longer wrong, unless it exceeded just bounds . . . ignoring the question as to how taking a profit when there had been no profit generated could ever be just, regardless of the amount. That is, it is permissible to take interest on a loan of money as money, only don't exact too much. (Sir Robert Filmer, Quaestio Quodlibetica, or a Discourse, whether it may be lawfull to take Use for Money (1653).) Filmer was harshly criticizing a tract by Roger Fenton, a Bachelor of Divinity, who published A Treatise of Usurie in 1611. Reverend Fenton's treatise accurately defined usury in Aristotelian terms, demonstrating a much more thorough grasp of the subject than Filmer:
In the loane of money (of which principallie it is my purpose to write, being the most usuall and proper for these parts) be it thus concluded out of the premises; That gain or lucre which commeth not merely for loane; (such loane, which is before described) is no usurie. For the object of usurie is mutuum. It is no usurie, I say, if it be for other respective considerations, and not meerely for loane.

A man unskilfull in trading hath a stock of money, which he delivereth to a merchant or tradesman to imploy: receiveth part of gaine, and beareth part of hazard proportionably. This is no usurie, but partnership. No usury, because his money is not lent by mutuation, so long as he reserveth a propertie in it himselfe, in contracta societatis cessat obiectum usurae mutuum. In like manner the stocke of a widow or an orphant is in trust committed to a friend to imploy and use it in charitie, onely to their use: they have the benefit of the increase; which is no usurie; because the money is still theirs, it prospereth or perisheth to them, as to the right owners. (Robert Fenton, A Treatise of Usurie (1611), I.iiii.3.)
There were also commentators claiming that all interest is usury (Philippus Caesar (Philippus Caesar, A General Discourse Against the Damnable Sect of Usurers (1578). Also Sir Thomas Culpeper, A Tract Against Usurie (1621).)), and that no interest is usury (John Dormer (John Dormer, Usury Explain'd, or, Conscience Quieted in the Case of Putting out Mony at Interest (1695). Also Sir Francis Bacon, On Usury (1625).)). In the end, though, it didn't matter what the divines and philosophers said. Having the power (which, as Daniel Webster was to state a few centuries later, naturally and necessarily follows property (Massachusetts Convention of 1820.)), the rich were in the position to be able to dictate whatever truth was most expedient for them.

In this they were helped immensely by the fixed idea that capital formation cannot be financed without first cutting consumption and saving, or (better) having far more income than can be consumed. When their capital produces far more income than they can consume, the rich are "forced" to reinvest the excess in yet more capital, or, more accurately, leave retained earnings in a business. This provides a greater store of collateral that can be used to secure the financing for more capital, and so on, at an accelerating rate. This, in turn, creates yet more income that cannot be consumed, concentrating ownership ever more closely in fewer and fewer hands. As Karl Marx observed, capital breeds capital:
Capital is money: Capital is commodities. [Capital is only money or commodities in the sense that money is a derivative of production and consists of anything that can be used in settlement of a debt, or (to put it another way) can be used to purchase goods and services, that is, "financial capital." Properly speaking, capital means assets that produce a good or service, and thus "brings forth living offspring" in the sense that it generates its own repayment, and provides the collateral for further capital expansion.] In truth, however, value is here the active factor in a process, in which, while constantly assuming the form in turn of money and commodities, it at the same time changes in magnitude, differentiates itself by throwing off surplus-value from itself; the original value, in other words, expands spontaneously. For the movement, in the course of which it adds surplus value, is its own movement, its expansion, therefore, is automatic expansion. Because it is value, it has acquired the occult quality of being able to add value to itself. It brings forth living offspring, or, at the least, lays golden eggs. (Karl Marx, Das Kapital (1867), I.iv.)