But what will an ounce of silver or gold generate? Once interest was applied to money, a fundamental debate arose that has continued to this very day. One of the central areas of concern is how much interest should be applied to a loan.
Interest and Usury
While usury is today considered an excessive interest rate, it was formerly defined as charging any interest on money. The practice of charging interest on money was not officially sanctioned in the West until the reign of England’s King Henry VIII. He legalized interest in 1545 following his break with the Roman Church. Up until that schism, all three “religions of the Book” (Judaism, Christianity, and Islam) prohibited usury (see insert).79
Usury and Religion
It is written in the Hebrew Scriptures: “Unto thy brother thou shalt not lend upon usury, that the Lord thy God may bless thee in all that thou settest thine hands to” (Deuteronomy 23:20). Islam is even more universal in its condemnation: “What ye put out as usury to increase it with the substance of others, shall have no increase from God” (Koran Sura 30:38).
Since the modern monetary system evolved predominantly under Christian influence, it is this religion’s changing views of usury over time that merits particular attention. The denunciation of usury as a mortal sin was one of the most persistent dogmas of the Catholic Church. Clement of Alexandria, an early church father, specified in his Stromata, Chapter XVIII, “The law prohibits a brother from taking usury; designating as a brother not only him who is born of these same parents, but also one of the same race and sentiments.”80
The First Council of Carthage (345 CE) and the Council of Aix (789 CE) declared it to be reprehensible even for laymen to make money by lending at interest. The Canonical Laws of the Middle Ages absolutely forbade the practice.81 The Council of Vienne (1311 CE) went so far as to declare that those who maintained that there was no sin in demanding usury, should themselves be punished as heretics.
The original doctrine against usury was finally questioned within the Catholic Church itself in 1822. The case involved a woman from Lyons, France, who was refused absolution unless she returned the interest she had earned. Clarification was requested from Rome, which responded: “Let the petitioner be informed that a reply will be given [to] her question when the proper time comes…Meanwhile she may receive sacramental absolution, if she is fully prepared to submit to the instructions of the Holy See.” A forthcoming resolution was promised again in 1830 and for a third time in 1873. This promised clarification never came.
Thus, the sin of usury, which was never officially repealed by the Church, was simply forgotten.82
Interest and Lending
Interest serves key functions during the lending process. Researcher Andrew Lowd points to three factors for reasonable interest rates: default protection, inflation, and opportunity cost.83
Default Protection. Interest protects lenders from potential loan defaults. Known as “risk premium,” the interest in such cases acts as a fair precaution to ensure that the lender receives back at least the amount lent out to borrowers.
If, for example, 105 loans of $1,000 each are made, but only 100 are repaid, $5,000 is, in effect, lost. Not knowing which of the borrowers will default, the lender spreads the risk out over all the loans by charging a five percent interest charge to each borrower. The interest serves as a small borrower’s fee for the convenience of making additional funds available as a loan.
Inflation. Defined here as a sustained increase in the general level of prices, inflation necessarily decreases the purchasing power or value of money over time. If a lender makes a loan with the inflation rate at three percent annually, the money automatically loses three percent of its value per year, even if the borrower is perfectly reliable and trustworthy. By charging an interest rate equal to the prevailing rate of inflation, lenders act to ensure that their money maintains its value.
Opportunity Cost. Money can be used as a means to make more money. By loaning money to a borrower, lenders forgo their own opportunity to make a profit. Charging interest compensates for the lender’s missed opportunity.
What is of particular relevance here with regard to money’s value-nonneutrality is the impact of interest on our behaviors.
Behavioral Effects of Interest
Though the full implication of interest is seldom understood, its behavioral effects are pervasive and powerful. Three patterns directly related to this built-in feature of our monetary system include:
encouraging competition;
fueling economic growth;
concentrating wealth.
1. Encouraging Competition
Charging interest—one effect of money created as bank debt—forces competition beyond that which would occur naturally.
Consider bank loans. When a bank creates money, say by providing a $100,000 mortgage, it only creates the principal for that loan. The bank does not create the interest on that loan, but expects a return of some $200,000 over the next 20 years or so. The bank requires the borrower to earn this second $100,000.
The following story illustrates how interest is woven into the fabric of the monetary system and how it stimulates competition.
The Eleventh Round
Once upon a time, there was a small village where people knew nothing about money or interest. Each market day, people would bring their chickens, eggs, hams, and breads to the marketplace. There they entered into the time-honored ritual of negotiations and exchange for what they needed.
One market day, a stranger with shiny shoes and an elegant hat came by and observed the process with a smile. When one farmer ran around to corral six chickens needed in exchange for a ham, the stranger could not refrain from laughing.
“Poor people,” he said. “So primitive.”
Overhearing this, the farmer’s wife challenged him: “Do you think you can do a better job handling chickens?”
The stranger replied: “Chickens, no. But I do have a much better way to eliminate the hassles. Bring me one large cowhide and gather the families. I will then explain this better way.”
As requested, the families gathered, and the stranger took the cowhide, cut perfect rounds in it, and put an elaborate stamp on each. He then gave ten rounds to each family, stating that each round represented the value of one chicken. “Now you can trade and bargain with the rounds instead of those unwieldy chickens,” he said.
It seemed sensible. All were impressed by the stranger.
“One more thing,” added the stranger. “I will return in one year’s time, and as a token of appreciation for the improvement I made possible in your lives, I want each of you to bring me an extra round, an eleventh round.”
The wife was concerned. The eleventh round was never created; it was never cut from the cowhide. She then asked, “But where will that round come from?”
“You’ll see,” replied the stranger with a sardonic smile.
As the stranger suggested, it was far more convenient to exchange rounds instead of chickens on market days. But this convenience had a hidden cost: the eleventh round generated a systemic undertow of competition among the participants. One out of every 11 families would have to lose the equivalent of all its rounds in order to pay the stranger, even if every villager managed their affairs responsibly.
The eleventh round and the competition it generated impacted another age-old tradition as well. During harvests, or when someone’s barn needed repairs after a storm, the villagers simply helped one another, knowing that if they themselves should one day have a problem, others would in turn come to their aid.
When a storm threatened a few of the farmers the year following, there was an uncharacteristic reluctance to assist neighbors. Families were now wrestling one another over that eleventh round. The introduction of interest-bearing money actively discouraged the long-held tradition of spontaneous cooperation among the villagers.
The “Eleventh Round” is a simplified story for non-economists. The impact of interest was isolated fro
m other variables by making the assumption of a zero-growth society: no population increase, no production increases, and no increases in the money supply. In practice, all three variables (population, output, and money supplies) do change over time, further obscuring the impact of interest. The point of the Eleventh Round is that, all other things being equal, the artificial competition to obtain the money necessary to pay the interest is structurally embedded into the current system.
So how does a loan whose interest is never created get repaid? Interest repayment requires the use of someone else’s principal. Scarcity is generated by not creating the money required to pay interest. It forces people to compete with each other for money that was never created, and penalizes them with bankruptcy should they not succeed. When a bank checks credit worthiness, it is really verifying a customer’s ability to compete successfully in the marketplace to obtain the money required to reimburse both the principal and interest. Ultimately, someone must always lose. Scarcity is the hidden engine that drives our bank-debt monetary system.
In the current national currency paradigm, one reason why so much attention is paid to central bank decisions is that increased interest rates necessitate more bankruptcies in the future. The economic pie must grow that much faster just to break even. The monetary system therefore obliges us to incur debt and then compete with others through our exchanges to pay the resulting interest to the banks or lenders. No wonder “it is a tough world out there,” and those who live within a competitive monetary system readily accept Darwin’s supposed “survival of the fittest.”
An ever-mounting body of evidence, however, supports a less harsh and even wholly contrary interpretation of the natural world.
Kinji Imanishi, the late professor of biosociology from Kyoto University, challenged the stereotypical Darwinian vision of nature as a struggle for life. The survival-of-the-fittest model is completely blind to the many frequent cases of symbiosis, joint development, and harmonious coexistence that prevail in all domains of evolution. Even our own bodies would not be able to survive long without the symbiotic collaboration of billions of microorganisms in the digestive tract.84
Evolutionary biologist Elisabet Sahtouris points out that predominantly competitive behavior is a characteristic of a young species during its first forays into the world. In contrast, in a mature system like an old-growth forest, the competition for light, for instance, is balanced by intense cooperation among species. Species that do not learn to cooperate with others with whom they are codependent invariably disappear.85
Although the theories of Social Darwinism—a 19th century movement that advocated “survival of the fittest” as applicable to human society—have long been debunked, some of their tenets still linger. Many people maintain that competition and cruelty are natural and inevitable tools for survival, and are inherent to human nature. Yet, contrary to popular belief, Charles Darwin himself did not see competition as the foremost tool for continued existence in the evolution of humankind (see insert).
Darwin, Loye, and Survival of the Fittest
Evolutionary systems scientist David Loye, in his books The Great Adventure and Darwin’s Lost Theory of Love, points us back to the very source of Darwinism itself: Charles Darwin. After On the Origin of Species (1859), Darwin wrote another book, The Descent of Man (1871), in which he points out that the brutal and bloody theory in Origin pertains only to prehuman evolution.
Loye explains that in The Descent of Man, which deals primarily with human evolution, “Darwin actually writes only twice of survival of the fittest—and one of these times is to apologize for exaggerating the importance of this idea in Origin of Species!”86
Furthermore, “in this book of 848 pages in fine print, he [Darwin] writes only 12 times about selfishness, which by now hordes of sociobiologists, evolutionary psychologists, and best-selling books have assured us is the central survivalist motivation for human evolution high and low.”87 The misunderstood theory of evolution simply does not apply to the evolution of human society, because once human consciousness comes into play everything changes. As Loye points out, what Darwin is actually writing about in Descent can be clearly inferred by the word count:
survival of the fittest, 2 times
selfishness, 12 times
moral sensitivity, 92 times
love, 95 times
habit, 108 times
More surprising still, as Loye uncovers, Darwin wrote in Descent more than a century ago:
As important as the struggle for existence has been and even still is, yet as far as the highest part of our nature is concerned there are other agencies, which are more important. For the moral qualities are advanced, either directly or indirectly, much more through the effects of habit, by our reasoning powers, by instruction, by religion, etc., than through natural selection.88
Descent was completely overlooked, not because it was less valid than Origin, but rather because it contradicted the bias of the age in which Darwin lived. That competitive bias is still reinforced in the world today by the monetary system, especially through the built-in feature of interest.
2. Fueling Economic Growth
The key assumption of the Eleventh Round is that everything remains the same, one year to the next. In reality, we do not live in a world of zero growth. Population, production, and the money supply all grow at varying rates, making it more difficult than in the Eleventh Round to notice what is taking place.
Perpetual growth is not just another fact of life. The monetary system acts like a treadmill requiring sustained economic growth, even if the average real standard of living remains stagnant. The interest rate determines the average rate of economic growth needed just to remain at the same place.
Presently, the monetary system takes the first slice of the ongoing growth to pay for interest. Agrarian societies customarily sacrificed the first fruits of the harvest to their gods, while we instead now give the first yields of our toils to the institutions that manage our money.
3. Concentrating Wealth
A third effect of interest is the continual transfer of wealth from the vast majority to a small minority. The wealthiest receive an uninterrupted profit from whoever needs to borrow money. A revealing study on the transfer of wealth via interest from one economic group to another was performed in West Germany in 1982 (Figure 5.1).89
Germans were grouped into ten income categories of about 2.5 million households each. During that year, transfers between these ten groups involved a total of DM 270 billion in interest payments (approximately $120 billion at the time). A stark way to present the process is to graph the net interest transfers (interest earned minus interest paid) for each of these ten household categories.
The net effect is that the top ten percent of households received a net transfer of DM 34.2 billion in interest from the remaining 90 percent of society during the year in question. The greatest sums of interest were transferred from the middle classes (categories three to eight), each of which transferred about DM 5 billion to the top ten percent of the households (category ten). Even the poorest households transferred a substantial DM 1.8 billion of interest each year to the wealthiest group.
The graph illustrates this systemic transfer of wealth from the bottom 80 percent of the population to the top 20 percent, and especially to the top ten percent. This transfer occurs independently of the cleverness or industriousness of the participants—a classical argument often used to justify differences in income—and is instead a direct result of the type of money in use.
Is it mere coincidence that once interest became legal, all democratic countries created income taxes and income redistribution schemes to counteract at least part of this wealth transfer process?
No equivalent study isolating the effects of interest payments on the concentration of wealth yet exists for other countries. This process is, however, occurring everywhere, because by definition interest payments transfer weatlh from those who have to borrow to those who can afford to
lend money out. Available data suggests that economic disparity is, for example, even more dramatic in America than in Germany, with the U.S. middle class particularly adversely affected. The share of wage income earned by those in the 20–80 percentiles fell by one-fifth between 1966 and 2001. Those in the 80–90 percentile income group instead maintained their percentage of earned income, while those in the 95–99, 99–99.9, and 99.9–100 percentiles earned 29 percent, 73 percent, and 291 percent more, respectively.90
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