THE Global Justice Movement Website

THE Global Justice Movement Website
This is the "Global Justice Movement" (dot org) we refer to in the title of this blog.

Tuesday, December 20, 2011

"On Usury and Other Dishonest Profit"

Last week or so (it might have been two weeks ago) we came across a posting in a LinkedIn group to the effect that Pope Benedict XIV's 1746 teaching, Vix Pervenit ("On Usury and Other Dishonest Profit") "proved" — consistent with the poster's interpretation of the vaguely cited work of the solidarist Father Heinrich Pesch, S.J. — that all interest is forbidden by Catholic social teaching. Since the posting verged at times on the incoherent, we ignored it, although we were briefly tempted to respond.

Yesterday, however, we got a request from the "owner" of the Catholic Financial Professionals LinkedIn group (not where the posting appeared) to give our opinion on this understanding of Vix Pervenit. He had evidently come across the same or a similar posting, and thought that some discussion on the subject in a group that at least knew the fundamentals of money, credit, banking and finance might be more useful than the broad condemnation issued by people unfamiliar with the subject.

The main problem with condemnation is that Father Pesch's economics — and the social teachings of the Catholic Church, as well as Judaism and Islam — is based on Aristotelian philosophy . . . and Aristotle did not condemn all interest as usury.

Here's the thing. Discussion on Vix Pervenit pops up every couple of years, especially when economic conditions take a downturn. The problem is that most people lack the framework to understand what the document says. This is due to the general decline in understanding of Aristotelian/Thomism, especially with respect to private property, contract, and thus money and credit.

We have the claim that Vix Pervenit "proved" that all interest is usury, and therefore dishonest. On the contrary, "interest" — which comes from "ownership interest" — is, in classical economics, the profit due to the owner of capital. Consistent with the classical division of the factors of production into land, labor, and capital, "rent" is the profit for the use of land, and "wages" are the profits accruing to labor.

Consequently, to claim that all interest is usury and therefore dishonest is the same as saying that all profit from capital is dishonest — which we know is not the case, or the natural right of private property would be completely meaningless. "Property" is not the thing owned, but the natural right to be an owner, absolute and inherent in each human person, and the bundle of socially determined and necessarily limited rights that define the exercise of property within a specific society.

An important right of property is the right to receive the fruits of ownership — the "use" or the "usufruct." This means that the owner of a thing has a right to control the use of the thing, and to receive the benefit of its use, whether directly in the form of whatever the thing is used to produce, or indirectly by receiving the income generated by what is produced. If an owner lends a thing to be used by another, the owner is entitled to a share of the profits that result from the use of the thing — though not all, just a market-determined rate representing the owner's pro rata contribution to production by allowing the use of his or her capital.

Thus (avoiding the long argument showing the linkage between money and property), if someone has accumulated savings in the form of money, and lends the money to another to purchase capital or otherwise engage in an activity designed to produce a marketable good or service, the owner of the savings is, in moral philosophy, a partner of the borrower, and is entitled to share in the profits — and suffer the losses — resulting from the investment. This share is called "interest," and is a legitimate right of property.

It happens all too frequently, however, that investments do not pay off. Also, before the reinvention of commercial banking in the 16th century and the ability to monetize the present value of future production, which financed the Industrial Revolution, borrowing for investment (i.e., capital formation) was relatively rare. Most borrowing was for consumption, not investment.

Neither failed investments nor borrowing for consumption generate a profit. In that case, no profit is due to the lender. More, for a failed investment, the lender may even lose the principal lent, while for a loan for consumption, the lender is due in justice only what was lent. If the lender still insists on taking a profit in that case, he or she commits an injustice. This taking of a profit when no profit has been justly earned is called "usury," for by means of it, a lender of money exacts what he or she has not earned — because nothing has been earned. The profit taken is dishonestly gained.

Vix Pervenit was issued in the mid-18th century soon after the invention of central banking made commercial banking more sound, and thus an important factor in the economic growth that characterized the period and stimulated invention and expansion of commerce and industry. Unfortunately, the human tendency to try and get something for nothing led many people to manipulate the new financial institutions and contracts to circumvent traditional teachings on usury and take a profit at every opportunity, whether or not a profit was made.

Vix Pervenit was issued to clarify Church teaching on the difference between honest interest (profit) and dishonest interest in light of the advances that had been made in finance. This accounts, in part, for the extreme complexity, even confusing nature of the document for the modern reader.

Adding to the difficulty of understanding it is the fact that the document assumed as a given that all investment and spending is financed out of existing accumulations of savings. That is not, in fact, the case. Commercial banking — the oldest type of banking, dating back to the dawn of civilization — has a special function. A commercial bank is defined as a financial institution that takes deposits, makes loans, and issues promissory notes. A promissory note is an obligation that the bank issues when accepting a "bill of exchange." A bill of exchange is an offer of the present value of future marketable goods and services. It becomes "money" — a contract — when accepted.

Because a bill of exchange is not based on past savings (that is, savings already accumulated by cutting consumption), but on future savings (increases in production in the future), a lender, be it a bank or another business or individual who accepts a bill of exchange, is not due interest. Instead, the lender is due a fee for accepting the bill, based on the present value of whatever is to be delivered in the future, and a risk premium based on the creditworthiness of the drawer of the bill. This "discount rate" — which usually includes the risk premium — is the difference between the face value of the bill and its present value — again, not an interest rate because it is not based on a share of profits.

Thus, Vix Pervenit tried to address a system based on both past and future savings, but from within a framework that assumed that all loans came out of past savings. Nevertheless, the principles hold true, even if understanding them and applying them properly calls for a deeper analysis and understanding than the teaching is usually accorded by the simplistic modern commentator.