The History and Ethics of Interest

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of Interest by ARTHUR[ene

The principle of private property has never yet

had a fair trial in any country. The laws of property have never yet conformed to the principles on which the justification of private property rests. They have made property of things which never ought to be property. . —]Joun Stuart MILL.

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The author is Senior Lecturer in Economic History in the University of Edinburgh and has published a number of books on Economic History and Economics as follows: — Economics in Outline

An Economic History of the British Isles An Economic History of Europe, 1760-1939 Single-Tax George: A Biography of Henry George The Art of War: An Outline of Military History A New Liberalism for the New Age

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INTRODUCTION.

The writer of this pamphlet is an individualist who believes that no genuine system of individualism can exist so long as the

taking of interest is permitted by law. Economic competition, which is the necessary basis of any individualist system, only

operates beneficially when it is free and equal, ie., when it is untainted by monopoly. Interest, by making capital a quasimonopoly, effectually prevents the establishment of a true competitive system. In 1047,I published a pamphlet 4 New Liberalism for the New Age, in which I put forward this thesis, and tried to sketch a plan for the elimination of the capital monopoly (and of other monopolies) and the transformation of all businesses into producers’ co-operative associations, owned and managed by the workers, black-coated and manual. I presented this scheme as an alternative to collectivism—in my opinion, the only alternative—and the one effective way of arresting the steady drift of modern society towards socialism, communism, economic planning, state capitalism; all of them forms of totalitarianism, between which, as I think, there is not much to choose. The main obstacle to the acceptance of my ideas, I found, was the unfamiliarity of the proposal to abolish interest. The modern man has become so accustomed to the paying and taking of interest ‘that he simply cannot visualize a society in which interest does not exist. To make this conception appear a little less strange is the purpose of the present pamphlet. I have written, first, a short history of interest, in order to show that until about three hundred years ago, interest was universally condemned by the best social,

moral and religious opinion. Next, I have surveyed the chief economic theories put forward in defence of interest, in order to show that not only are they inconsistent with each other, but that, taken singly, not one of them can stand up to serious examination. I

2

,

INTRODUCTION

Finally, I have given a short restatement of the scheme for the establishment of a genuine individualist system, contained in my earlier pamphlet, in the hope that having demonstrated the comparative novelty of the idea that interest is right,

and the feebleness

of the economic arguments put forward in its support, my ideas may obtain

easier access to the minds

of my readers, and may,

perhaps, win their assent.!

1 The two chapters which follow arc taken almgst verbatim from. a larger work; still awaiting publication, which I have called Economic Radicalism; the Alternative

so Socialism.

CHAPTER A Short History

L

of Interest®

THE ANCIENT WORLD,

Usury, as an economic phenomenon, appeared at a very early stage in human development. It existed, for example, in the natural economies described in the Irish Brehon laws. But, for obvious reasons, it was the appearance of money as a medium of exchange and still more as a store of values that gave it its first notable extension. Almost from the beginning, the taking of usury or interest was regarded as an offence against morals. Among ancient philosophers who condemned it may be mentioned Plato, Aristotle, the two Catos, Cicero, Seneca and Plutarch. It was disallowed by most of the old religions, including the Jewish, the Christian and the Mohammedan. Both the Bible and the Koran’ denounce it as sinful.’ This general moral disapprobation was reflected in civil legislation. Most of the ancient codes contain provisions to restrain the activities of the usurer. Solon’s reform of the Athenian constitution (504 B.c.) included a cancellation of public and private debts. In Republican Rome, the Lex Genucia (340 8.c.) prohibited the taking of interest altogether. But the patricians found means to evade the law, and usury wrought fearful havoc during the last period of the Republic, both in Italy and the provinces. The Democratic party in Rome took up the cause of the oppressed debtors, and Julius Cesar, a Democratic politician who had “arrived,” limited the rate of interest, probably to 12 per cent. Under Justinian, this maximum rate was lowered to 8 per cent. for merchants and manufacturers, 4 per cent. for the nobility and 6 per cent. for others. 2 In what follows, I shall use the words usury and.interest as identical, Usury,

i.e., payment for the use of a thing, was the original word for interest. To-day it

has come to mean excessive interest only. We shall see how the distinction arose.

But until comparatively recent times, usury meant interest of any kind, and I shail use the word in this sense.

3Among Bible texts referring to usury are Leviticus XXX, 35-37; Exodus XXII, 25; Deuteronomy, XXII, 19; Ps. XX, 5; Ezekiel, XVIII, 8; Luke, VI, 35. For the chief references in the Koran, sce The Qur'an, wanslated by Dr, Richard Bell, Vol. 1, pp. 40, 41, 57. 3 LY

4

THE HISTORY AND ETHICS OF INTEREST THe CHRISTIAN ATTACK oN Usury,

When the RomanEmpire became Christianised, the war on usury assumed a new intensity. In the fourth century a.p.,, the Church forbade the taking of interest to the clergy, and in the fifth century to the laity. In the eighth century, Charlemagne made usury a criminal offence. During the early Middle Ages,Popes and Councils ‘continued to fulminate against it, and civil governments passed laws

forbidding it.

The anti-usury movement may be said to have

reached its height in 1311, when Pope Clement V. made the prohibition of usury absolute and declared all secular legislation in its

favour null and void. Moneylending became a monopoly of the Jews, and the unpopularity of Jewish usurers helped to swell the

tide of anti-Semitic feeling in Christian countries, leading fo such incidents as the expulsion of the whole Jewish community from

England in 1290. The Lateran Council of 1515 defined usury as follows:

This is the proper interpretation of usury when gain is sought to be acquired from the use of a thing, not in itself fruitful (such as a flock or a field) without labour, expense or risk on the part of the lender.* The root of the Church’s objection to usury was that it was a form of unearned income. To live without labour was denounced as

unnatural, and so Dante put usurers in the same circle of hell as the inhabitants of Sodom and other practisers of unnatural vice. Even to-day, the official opinion of the Roman Catholic Church stigmatises usury as against nature.

The Church’s standpoint is made clear in the following two

authoritative quotations: Land was the ultimate source of wealth, but it needed human labour to win from it what it was able to’ provide. Labour, therefore, as the one element in production which depended on the human will, became the centre of their doctrine. All wealth was due to the employment of labour

on the materials furnished by nature, and only by proving that labour had been engaged in bringing about the result

could the acquisition of wealth by individuals be justified.’ 4 Ashley, Economic History of England, Pt. 1, p. 451. 5 Ashley, op. cit., Pr. II, p. 393.

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Ey A

SHORT

If t h e borrower

HISTORY

OF

INTEREST:

did not derive any profit

5

from the loan, the

sum lent had in fact been sterile and obviously the just price of the loan was the return of the amount lent; if on the

contrary, the borrower had made a profit from it, it was *.

the reward of his labour, not the fruit of the loan itself. To repay more than the sum lent would therefore be to make payment to one person for the labour of another. The exaction of usury was therefore the exploitation of another man’s

exertion.®

The Church’s teaching on this point was indeed only one branch of its general doctrine of Just Price, according to which the price of

an article should never exceed its cost of production, including a .

fair reward to the producer, i.c., the reward which would enable him to maintain the standard of life suitable to his social position.

(The Church recognised different standards of life for different classes.) Profiteering in all its forms was thus excluded. A seller

had no right to take advantage of the ignorance or special need of a buyer, as Jacob did when he purchased Esau’s birthright for a mess of pottage. On this point, Christian teaching flatly contradicted the egoistic spirit of the Roman Civil Law, which recognised a natural right in each man to get the better of his neighbour if he could. “In purchase and sale” it declared “it is naturally allowed to the contracting parties to try to overreach each other.” The Church, it is true, did not always apply this simple principle consistently. It sanctioned certain forms of unearned income, particularly land-rents, rent-charges and profit from sleeping partnerships. In the case of land-rents, it might be argued that the beneficiaries, chiefly barons and the higher clergy, rendered public " services to the community in return for their revenues. In the case of the other two forms of income, there were special circumstances which might be held to justify them. A rentcharge was derived ultimately from something fruitful, namely the land, and therefore did not violate the accepted definition of usury (see p. 4). A sleeping partner, if he contributed no labour to the partnership, at least shared in the risk of the enterprise, and acceptance of risk was

one of the conditions which relieved a transaction from the charge .

O'Brien, An Essay on Medieval Economic Teaching, pp. 181-2. 7 Ashley, op. cit., Pt. 1, p. 133. 8 But this definition ignores the patent fact that fruitful things only produce fruit when labour is applied to them.

:

6

THE HISTORY AND ETHICS OF INTEREST

of being usurious.

Nevertheless, it i s significant

that the stricter

canonists condemned both these forms of income. [J

Tue CuurceH’s THEORY OF USURY.

I t would

have been well if the Church

had remained

content

with the simple and straightforward argument against interest, that it was the exploitation of another man’s labour. But the

Schoolmen could not resist the temptation to support their doctrine by an elaborate and oversubtle theory, which was not only divorced from reality but opened up the ‘way to all sorts of evasions. They based i t o n a finespun

distinction

o f the Roman

or Civil

Law.

In the Middle Ages, the Civil Law was to some extent the rival of the Canon Law.. Their teachings diverged on a number of

points, notably on interest, which the Civil Law allowed but the Canon Law condemned. It seemed therefore a clever move of the canonists to borrow a weapon from the armoury o f their opponents, just as Marx thought he was stealing a march on his

enemies by basing his exploitation theory on the incomplete Ricardian law of value. But, in both cases, the departure from the path of realism and common sense brought

its own nemesis.

The legal distinction referred to was that drawn by the civilians

between a commodatum—that is, the loan of something not destroyed by use like ahouse or a horse, and a mutuum, the loan of something consumed in use like a loaf of bread or a bottle of wine (what the civilians termed a fungible). In the case of

a mutuum, the ownership of the thing transferred passed to the borrower, and the transaction was regarded as equivalent to a sale. Now the civilians reckoned money as a fungible and the is (money, so far as the individual loan of i t as a mutuum concerned, being destroyed in use, though not from the point

of view of society). The Church took over both these conceptions. I n the case of a loan of money—that

is, of a fungible—what,

it

was asked, is the just price? The canonists answered—the exact amount of the money advanced. To ask more was like selling a loaf of bread and then charging in addition for the use of it. I f it was objected that the element of time comes in somehow and has to be accounted for, the canonists replied nobly or perhaps

disingenuously, that time was common property, the gift of God, and therefore could not be charged for.

A SHORT HISTORY OF INTEREST

7

. Perhaps there is more to be said for the Church’s theory than might appear from this summary account of it, but i t can hardly be absolved from the charge of unreality. Whatever a loan of money is, it is certainly not a sale, and it does not help in the

least to regard it as such. An unreal theory always comes, sooner or later, into violent contradiction with the facts, as Marx discovered with

his

conception

of surplus

value,

based o n the

Ricardian economics. In the case of the canonists, their artificial theory opened the door to a series of evasions, which threatened to reduce the Church’s veto to an empty form.

Evasions

or

THE

CHurcH’s

THEORY.

Among the exceptions to the Church’s prohibition, which were justified by the canonist theory, may be reckoned the profit from sleeping partnerships. The sleeping partner could draw a share in profits which he did not help to make, because, the canonists alleged, he retained the ownership of the capital which he invested in the business—that is, the transaction was not a muruum.

It

is curious that this consideration should have been allowed to outweigh the obvious objection that the sleeping partner was drawing an income without labour or effort. But so it was. The Church, however, insisted that the sleeping partner must share fully

in the risks of the business.

I f the enterprise failed,

he

could not ask his money back like an ordinary creditor. This arose from the fact that he had not parted with the ownership of his invested capital. It is doubtful, however, if this restriction made much

difference in actual practice.

When

a business fails,

and the liquidation shows few or no available assets, the ordinary creditor

has not much

settlement.

advantage over the investor

in the final

©

More serious were two other exceptions or evasions known as damnum emergens and lucrum cessans. Suppose a debtor did not repay his loan on the stipulated day, the creditor might suffer loss (damnum emergens, “loss emerging”). In that case, the just price of the loan must include some compensation for this loss.

This additional payment was called interest as opposed to usury— that which is “between” (interesse) the present position of the creditor and what it would have been i f he had received back the loan at the date fixed.

8

THE HISTORY AND ETHICS OF INTEREST

Interest might also be claimed on the ground of lucrum cessans

(“gain ceasing™). Suppose, through the delay in repayment, the lender lost an opportunity for making profit. The Church was a little more reluctant to admit this claim, since opportunities for profitable investment in the Middle Ages were not numerous. Yet, on the whole it did admit it, though some churchmen held that positive proof of the lost opportunity of gain must be provided.

‘The result was, that taking these two exceptions together, a creditor could now lawfully draw usury under the name of interest, provided he granted the loan gratuitously for a certain period,

which might be made very short. In the later Middle Ages, Christian usurers like the Lombards and the Caursines,® were quick to take advantage of this loophole. A further refinement of theory seemed likely to make the gratuitous period unnecessary. The keen minds of some scholastics discovered that the kind of loan which the Church condemned—

a loan in which the ‘creditor claimed interest from the beginhing of the loan and stipulated for the return of his principal whether the enterprise was successful or not—could be analysed into three separate contracts, each of which was lawful if regarded singly, namely; (1) a sleeping partnership; (2) an insurance contract against the loss of the principal; and (3) an insurance contract against

fluctuations in the rate of profit. Now, if it was lawful for A to make these three contracts separately with X, Y, Z , why was it not possible for A to make all three of them with X? But in that case, the three contracts fused into the kind of loan which the Church condemned. This was the theory of the Triple Contract, as ‘it was called. It landed the Church in a dilemma, from which the only escape seemed to be an abandonment of the ecclesiastical condemnation of usury. To this pass, then, had come the Church’s teaching, largely because the canonists had forsaken common sense in favour of a hair-splitting theory. The Triple Contract, if accepted, robbed the Church’s doctrine of all meaning, and naturally the ecclesiastical authorities hesitated to recognise it. While the question was still under discussion, the Reformation broke out. 9 The Caursines, inhabitants

of Cahors in France, or more probably

Italy, are classed by Dante with the Sodomites. (Inferno, XI, 53.)

of Caorsa in

A SHORT HISTORY OF INTEREST

’

9

Tue RerormaTiON AND Usury.

. Contrary to a belief at one time sedulously spread by Catholic

controversialists, the Reformation did not lead immediately to a relaxation of the restrictions on usury. On the contrary, the Reformers, professing to restore primitive Christianity, returned to the earlier and more rigid precepts of the Canon Law. Luther, in particular, a peasant’s son with all a peasant’s hatred of usurers, distinguished himself by his invectives against professional moneylenders. The Roman Catholics could not afford to lag behind their opponents on this question, and during the Counter-Reformation period, the old restraints on usury were applied with something like the old strictness. One result of this more rigorous attitude was the condemnation by Pope Sixtus V of the theory of the Triple Contract (1585). To this day it has never been officially sanctioned by the Church. Nevertheless, the check imposed on the victorious progress of usury was only temporary. By the end of the sixteenth century, the

movement towards relaxation’ was in full swing again. The growing strength of the monied interest everywhere accounts for the increasing laxity in the interpretation of Christian teaching on economics. The clergy, both Catholic and Protestant, found it more and more difficult to restrain wealthy members of their flocks from

exploiting to the full the advantageous position which their wealth conferred upon them. Capitalists desired to add to their riches by putting out their money at interest; merchants wished to borrow in order to seize opportunities of making monopoly profit. In the dialogue entitled A Discourse upon Usury, 1572, written by Dr. Thomas Wilson, a strong upholder of the old restrictions, a lawyer is made to say—

There is a shipwreck and goods are to be sold where I may

get twenty in the hundred if I may borrow after ten. Who would not give less to have more?? It is sometimes asserted that the usury restrictions broke down because borrowers desired their removal. This paradoxical explanation could not be true of ordinary debtors. If true at all, it could 1 He preached a famous sermon on Usury and published a Tract on Trade and Usury.

2 Scc Tawncy's edition of the Discourse, p. 247.

10

THE

HISTORY

AND

ETHICS

OF

INTEREST

only apply to those who meant to use their borrowed wealth, as in the case quoted above, to exploit their neighbour.

Against the new tendencies, the clergy Catholic and Protestant struggled gallantly, but they were fighting a losing battle. Gradually, official opinion changed. The old doctrines were thrown overboard. The thousand year period during which interest had been held in leash by Christianity came to an end. It was succeeded by a shorter period of about two hundred and fifty years (1600-1850),

during which interest was permitted, provided it was not excessive. A maximum rate was fixed by law in most countries. In England, the maximum was established at 10 per cent. in 1571. It was reduced by successive stages to 5 per cent. in 1714.

Mopern

CarsoLicisM

The controversy, having

AND Usury.

thus been settled so far as practice was

concerned, let us.sece how the point of theory was dealt with. In the Roman Catholic Church, the Jesuits were the chief defenders of usury. They found means to explain away Pope Sixtus’s bull, and they made full use of all the other exceptions allowed by the Church—damnum emergens, lucrum cessans, &c. The result of their efforts was that within a comparatively short time, the ordinary Catholic layman ceased to feel any compunction in drawing interest, provided it was not extortionate, which meant in practice, provided i t was not above the maximum rate fixed by the state. But, it is important to note, in principle, the Church never went back on its original teaching. The theoretical prohibition of interest still held

and still holds. The last formal pronouncement on the subject is contained in Benedict XIV’s Encyclical Vix Pervenit, issued in 1745.

In this document, the Pope reaffirms that intrinsically (i.c. inherently) an interest-bearing loan is sinful. But, he adds, there are certain extrinsic (i.e. external) circumstances which may be held to justify a loan, such as damnum emergens, &c. On these, the Pope pronounces no judgment. He does not approve, but neither does he disapprove. And he takes up the same non-committal attitude with regard to the lawfulness of unearned i income from interest, or profit from investment in productive property. This is still the official attitude of the Church. It was restated in the revised code of Canon Law promulgated by Benedict X V in 1917. Canon1543 runs—

A

SHORT

HISTORY

OF

INTEREST

II

If a fungible thing be given to someone in such a way that it becomes his and that later he is to return its equivalent in

* quantity and kind, no profit can be taken merely by reason of this contract; but when handing over a fungible thing, a stipulation for legal interest is not in itself wrong, unless it is

clear that this interest is excessive, or even for a higher return, if there is a just and proportionate title to justify it. ‘To understand the significance of this statement, it should be understood that money is still regarded by Catholic theologians as a fungible thing, and that therefore by a “just and proportionate title,” an Sotriasiel title is meant. The Church’s position would appear to be this; that while it condemns interest in principle, it suspends its judgment on certain practical evasions of the principle. This leaves Catholics free to

draw interest in the meantime, but subject to the condition that should the Church revise its attitude, should the Pope’pronounce against the lawfulness of the evasions in question, then the taking

of interest would become sinful. ‘This half-hearted approval or rather toleration of interest is very significant.

I have drawn my account of the Church’s present position with regard to interest from Father J. A. Ryan’s book,Distributive Justice (2nd edition, 1927). The author was Professor of Moral Theology and Industrial Ethics in the Catholic University of America, and an influential representative of Catholic thought in the United States. He sums up the situation as follows— At present, the majority of Catholic writers seem to think that a formal defence of interest on capital is unnecessary. Apparently they assume that interest is justified -by the mere productivity of capital. However, this view has never been explicitly approved by thé Church. While she permits and authorises interest, she does not define its precise.moral basis.

(p. 155.) Father

Ryan’s personal views are interesting.

He rejects the pro-

ductivity theory of interest (pp. 156-159) and considers that the abstinence theory applies to only a small number of savers (pp. 161164).* In these circumstances, he admits that the validity of interest 3 These theories are examined in the following chapter,

12

THE

HISTORY

AND

ETHICS

OF

INTEREST

is doubtful; but, he argues, the capitalist, even if a “non-sacrificing

saver,” is entitled to give himself the benefit of the doubt. His claim to interest is uncertain, but so is the claim of his only possible rivals, the consumer or the worker. He has at least a presumptive

title based on the fact of possession. This title stands till it is overthrown by a better claim. Not a very convincing justification of interest, surely.

Not all Catholic theologians are so cautious as Professor Ryan.

A number take up a bolder and more positive attitude in defence of interest.* Some maintain that money is now, what it was not in the Middle Ages, quasi-fruitful, that is, a profit can always be made for the loss of the opportunity of gain. Others argue that in the Middle Ages, money had only one value—exchange value. Now,

owing to the opportunities of using it profitably, it has an additional value, arising from its power of earning a revenue. Interest is the equivalent of this additional value. Of these justifications, it need

only be said; (a) that they travel far from the Church’s original argument against usury—that it was wealth obtained without labour or effort; (b) that their upholders tend to argue in a circle, e.g., interest is justified because money earns profit, but could it earn

~ profit, if interest were not permitted?; (c) though they may not openly contradict the Church’s official teaching, they find no direct sanction in it.

Father Watt's

verdict is decisive—

To the present writer, it seems evident, taking the Canon and its footnotes together, that by “just and proportionate title” an extrinsic title is. meant, and that the nineteenth century theories

about the modern “quasi-fruitfulness” or “virtual productivity” of money as an instrument of commerce (or as capital) are

ignored in favour of the old theory that money is always something fungible®.

This amounts in practice to what was stated before. The Church 4 For an account of these and also for an up-to-date statement of the Catholic

Rev. Lewis Watt, S.J., Usury in position on interest, see the pamphlet by the “Catholic Theology, published by the Catholic Social Guide;1945. The translation of Canon,1543, on p. 11, is taken from this pamphlet, 5 Watt, Usury in Catholic Theology, pp. 39-40.

A

SHORT

HISTORY

OF

13

INTEREST

condemns interest in principle, but leaves the question of the evasion open.® MODERN

PROTESTANTISM

AND U s u r y .

In the Protestant Churches, much the same practical position has been reached by a slightly different route. Under pressure from the mornied interests, which were particularly strong in Protestant countries, the Protestant preachers h a d gradually

to abandon their

unqualified opposition to usury. Calvin’s pronouncement on the subject—in a private letter written in 1545—marks an important stage in the process. The statement was wrung from him with

great difficulty, and he rightly prophesied that it would be misused. In it, he made a notable concession. He admitted

that interest could

. not be unreservedly condemned. The special circumstances in each case must be considered. Calvin’s logical mind perceived the close analogy between interest and rent. Both were forms of unearned income. If the one was justified, then so was the other. It was - foolish

to forbid

a man to draw interest from his capital, and at

the same time permit him to buy land with i t and ‘draw rent.

Interest per se then could not be condemned. But it might be sinful in particular instances. Calvin enumerated seven such cases. Two

of them are significant. Interest must not be taken from men in need; and in the case of investment in productive enterprises, the borrower must make equal or greater gain than the lender. If Calvin’s conditions had been strictly observed, the progress of usury would have been at least slowed down. But what he foresaw came to pass. His general approval of interest was emphasised; his reservations were ignored. In the next generation, several Protestant polemists enlisted openly under the usurer’s banner. Salmasius, the controversial opponent of Milton, produced a crude vindication of

interest based on a blend of the productive and the use theories,’ 6 That the consciences of some Catholics are a little uneasy on this question: might be inferred from an anonymous article which appeared in the Catholic Herald, 23rd November, 1935, entitled *‘Should Money Make Money?’ The writer asks

“"Arc we Catholics really afraid to tackle the problem of usury? Are we trying wo smother the light of the Church in case 100 many awkward questions might arise? Are we not suffering from the consciousness of a guilty conscience in so far as i t

was our Catholic forebears who first let the Church down on the question of usury and made the Reformation possible?'’ And he concludes “If therefore we are goin, to assist in the solution of the social problem, we must . . . face the difficult and awkward task of discovering the ‘guises’ under which usury is still practised; . . . and the question to be answered is not ‘Does Money Make Moneyr® but ‘Should Money Make Money?® ** . 7 These theories are examined in the next chapter.

14

THE

HISTORY

AND

ETHICS

OF

INTEREST

which to contemporaries seemed conclusive. Salmasius had the good fortune to preach to the converted, that is, to the monied men,

who alone were articulate on this question. In Holland, where financial interests were especially powerful, usurers were at last admitted to the sacrament in the Dutch €alvinist Church (1657), partly as a result of Salmasius’s writings. Since the middle of the seventeenth century, the usury question has ceased to stir controversy among Protestants, The thesis has been tacitly accepted that only excessive interest is sinful, and the question of what is excessive is left to the individual conscience, which means that in practice it is never considered at all. Richard Baxter was perhaps the last English divine to repeat the old prohibitions, but his teachings flew over the heads of his contemporaries. From the beginning of the eighteenth century, the subject ceased to be referred to in Protestant pulpits. In the recent pronouncements of Protestant churchmen on social questions, from the Copec Conference of 1924 to the Malvern Con-. ference of 1941, the question is likewise practically ignored. The only distant reference to it I have come across is contained in Archbishop Temple’s little book, Christianity and she Social Order, (Penguin edition, 1942). On p. 82 he states—

Above all, we should seek to end the right to bequeath from generation to generation a power to levy private taxes on industry in the form of dividends, thus placing on industry a burden disproportionate to the benefit received and maintaining a distinct “shareholding” class in the community.

And discussing measures to bring this about, he says on the same page—

’

I should myself prefer the principle of “withering” capital, in accordance with which so soon as the interest paid on the original investment is equal to the sum invested, the principal should be reduced by a specified amount each year until the claim of the investor to interest or dividends was extinguished. The rate of annual reduction would be fixed specially for each enterprise in accordance with the relevant factors involved.

This

proposal bears some resemblance to the method I have

A

SHORT

HISTORY

OF

INTEREST

15

suggested (see p. 39) for the redemption of the principal of loans and the capital value of land.? ’

Tue DeconrtroL

oF Usury.

In the late eighteenth and early nineteenth centuries, a campaign was launched to get rid of all the remaining restrictions on usury. It was supported mainly by economic liberals—inconsistently, as I believe. Their facile assumption that, interest being the price of money, it should no more be regulated than the prices of other commodities, overlooked vital elements in the problem. Among the controversial literature on the subject, a conspicuous place is

occupied by Bentham’s Defense of Usury (1787), which has received extravagant praise. Mill speaks of “the triumphant onslaught made

upon it (the maximum rate of interest) by Bentham in his Letters on Usury which may still be referred to as the best extant writing on the subject”; and Dicey declares that it “supplied every argument

which is available against the laws which check the freedom of trade ~ in moneylending.’! Anyone who approaches the reading of the book with these culogies in his mind will be astonished to find it a short, scrappy production, exhibiting to the full the mingled weakness and strength, the shrewdness and simplicity, the realism and fantasy, of the founder of utilitarianism. Benthain’s position is summarised in

his opening statement (p. 2).— No man of ripe years and of sound mind, acting freely and with his eyes open, ought to be hindered with a view to his advantage, from making such a bargain in the way of obtaining money, as he thinks fit, nor (what is a necessary conse8 The following report from the Glasgow Herald of 8th Pebruary,1945, secrits

10 indicate that there are some faint stirrings of conscience over the quéstion of

interest among Protestants as well as among Catholics.— The question of usury and interest was raised in a motion submitted at the

annual meeting of the Glasgow and Galloway Djocesan Council of the Episcopal

Church in Scotland held yesterday in Glasgow. The motion, which was

defeatcd by a large majority, was proposed by the Rev. T. E. Pickering, of St. Stephen's Episcopal Church, Rutherglen, and was in the following terms: — *“That this Diocesan Council urges the Bishops and the Representative Church Council to take steps to free the whole Church from income derived from various forms of usury and interest banned by Christ and Church Canon Law,

and unhelpful to fellowship and peace.’

Y Principles of Political Economy (Ashley’s edition), p. 927. L Law and Public Opinion in England, p. 33.

16

THE HISTORY AND ETHICS OF INTEREST

quence) anybody hindered from supplying him upon any terms he thinks proper to accede to. Of the fallacies with which this apparently simple statement is so thickly strewn, Bentham was totally unconscious. That a bargain

might be legally “free” and yet economically “unfree” never seems to have entered his mind. A wealthy man himself, he could not be expected to enter into the situation

when indigence bargains with

opulence. All lenders, he argues, are thrifty persons; all borrowers, prodigals; and he remarks sententiously (p. roz)— Those who have resolution to sacrifice the present to the

future are natural objects of .envy to those who have sacrificed the future to the present. The children who have eaten their cake are natural enemies of the children who have theirs. What a travesty of the relations between the average debtor and creditor! Bentham himself was a creditor. Did he ever ask himself * how much of the present he had sacrificed to the future? Did it never strike him as curious that when a child postpones eating his cake, he merely has the pleasure of eating it when others have finished theirs; but that when a creditor postpones consumption, he not only gets his whole cake to eat but an extra slice as well? Bentham was not a profound thinker,

His favourite mental

pabulum consisted of the half-truths which are often more dangerous than complete falsehoods. The fundamental question of the rightness or wrongness of interest, he never really considered. He assumed that interest was right. All he was concerned with was to get rid of the legal maximum rate. And he thought he had found a crushing argument against it by asserting, not proving, that the Usury Laws injured the very class they were intended to benefit. Creditors, he maintained, will only lend above the legal rate, and

to indemnify themselves for the risk they run in breaking the law, they add an extra percentage. This is a beautiful example of Benthamite reasoning—taking the far-fetched exception for the general rule. Bentham was a rationalist run to sced—a standing warning to all who have to use their brains. He respected reason,

but he had no conception of how the rational faculties should be used. Of him, it may truly be said that when he was not arguing

A

SHORT

HISTORY

OF

INTEREST

17

in a vacuum, he was reasoning inerrantly from principles that are absurd.?

Despite its patent faults, the Defense of Usury acquired an amazing literary reputation. This is explained not by any intrinsic merit it possesses, for it possesses very little, but by the circumstances of the time when it was published. Like Salmasius, Bentham had the advantage of preaching to the converted. His book expressed the sentiments of monied men in the chief financial centres of Europe, and therefore its success was assured. The monied men did not neccessarily read it, but they brandished it in the face of the opponents of usury, much as later Das Kapital was hurled at the heads of the opponents of socialism. The first half of the nineteenth century saw the gradual abolition of the Usury Laws in most European countries.

In Britain,

a House of Commons

Committee,

before

which Ricardo gave evidence, recommended their repeal in 1818. Not till 1833, however, was any step taken to put this recommendation into force. In that year, the Bank of England secured the suspension of the maximum interest rate for its promissory notes. This was followed in 1839 by the suppression of the maximum on all loans over f1o—with some exceptions, notably mortgages on, land. Finally, in 1854, the remaining restrictions on interest were swept away (except in the case of pawnbroker’s interest which was limited by an Act of 1872 to a maximum of 25 per cent). The repealing measure was piloted through the House of Commons by the Chancellor of the Exchequer, Gladstone (not as yet a Liberal), who made the astounding statement that “the superstition which formerly prevailed on the subject” (of interest) was “partly Judaical and partly Mohammedan’ — pretty good that for a Christian statesman when we recall the war which the Christian Church waged for centuries against usury! 2 This is perhaps strong language to usc about a man whose reputation till stands high and who played so important a part in the liberal movement. Bur i v

is difficult to keep one's temper with a existed. It is this mixture of

person like Bentham. A wiser fool never

qualitics that irritates. If he had been a complete

fool, one could despise him. If he had been a perfect sage, one could respect him.

But the combination of wisdom and folly is more than the ordinary sensible man can stand. Bentham was not a favourite with many of his liberal contemporaries, See Hazlit’s essay on him in The Spirit of the Age (*‘He turns wooden utensils in a lathe for exercise, and fancies he can turn men in the same manner''); also the young Macaulay's ambiguous treatment of him in his essay Westminster Reviewer's Defence of Mill (Works, Vol. V , pp. 272-300). 3 Hansard,

CXXXIV,

p . 930.

18

THE HISTORY AND ETHICS OF INTEREST THE ReconTrOL OF Usury.

Towards the end of the nineteenth century, there was a general revulsion of opinion in all European countries against the unlimited freedom which had been so unwisely granted to the usurer. In

connection with one type of loan—the consumption loan—experience had shown that the moneylender could not be allowed a free hand. A consumption loan is contracted by a poor debtor to meet an immediate need, not to finance a productive enterprise. The interest on such loans is always extortionate, as the helpless debtor has no option but to accept the lender’s terms. The excuse usually

given for this high interest—that the creditor risks the loss of his money—is- groundless. No professional usurer ever lends without being practically certain of getting his money back: He may lend without security—on note of hand—but only to persons who from their social position and fear o f exposure will be compelled to repay

him even if they ruin themselves in the process. If they cannot pay themselves, their friends or relations will pay to avoid scandal. ‘The usurer always knows how to select his victims. And not only is he repaid. He is generally repaid two or three times over. With a consumption loan, a debtor has usually great difficulty in repaying at the stipulated date, In that case, he has to renew on harsher ‘and harsher terms. ‘This process will continue, until either the debtor is sucked dry or by a desperate effort succeeds in liberating himself from the stranglehold of his creditor. Consumption loans represent economic exploitation in its most criminal form; and it is now universally accepted that some restraint must be placed on the activities of the professional moneylender. In Britain a Select Committee reported on the subject in 1897. Among the many cases of victimisation mentioned in its report, one may be cited as typical. A moneylender, Isaac Gordon, lent a debtor £5178. Within pine months, he had received back £10,274; and when the debtor went bankrupt, the moneylender proved for another £3809. Following on the Committee’s report, the Moneylenders Act of 1900 gave the courts power to cancel “unconscionable” loan bargains.. It had been intended to reimpose a maximum rate of interest, but the opposition

in Parliament

proved

too strong—an

opposition

supported, surprisingly, by many prominent liberals. Indeed, the most conspicuous defender of the usurers was the well-known literary essayist, Augustine Birrell, a future Liberal Cabinet Minister.

A SHORT HISTORY OF INTEREST

19

Birrell’s witty speech against the Bill shines like an oasis in the dreary desert of Hansard. But seldom have brilliant talents been prostituted to a more ignoble use. Birrell’s eulogy of professional

moneylenders, and his audacious claim that the working-classes would suffer from any curtailment of their activities, are in the best tradition of the Benthamite dialectic; but it was lamentable to

associate a great and historic political party with so sordid a cause. On a vital amendment, Birrell was followed into the division lobby

by a bunch of Liberal paladins, future members of Liberal Govern-~ ments, Asquith, Grey, M‘Kenna, Herbert Gladstone, Lawson Walton. In 1925, another Select Committee investigated the subject.

Tts proceedings were chiefly notable for the boldness with which several moneylenders appeared before it and justified their trade— also by the claim of some of them that no moneylender could escape bankruptcy unless he were allowed to charge interest at the rate of 60 per cent. Despite this appeal, a hardhearted legislature

passed the Moneylenders Act of i927 which limited interest to 48 ‘per cent. ‘The relevant portion of the statute (section10 (1)) states—

Where . . . it is found that the interest charged exceeds the rate of 48 per cent. per annum . . . the court shall, unless the contrary is proved, presume for the purposes of section one of the Moneylenders Act, 1900, that the interest charged is excessive

and that the transaction is harsh and unconscionable, The cautious wording of the provision will be noted. It leaves opportunity on occasion for the charging of a higher rare than 48 per cent. Nevertheless,in practice this has come to be the maximum rate, moneylenders, with their usual circumspection, preferring to be on the safe side. Despite the statements made before the Select

Committee about the absolute necessity of a 60 per cent. rate, it does not appear that the Act has driven many moneylenders out of

business. This is as far as the control of moneylending has proceeded in Britain. In other countries; the position is much the same. A maximum rate of interest is fixed by law, but generally so high that it applies only to consumption loans. Nevertheless the acceptance

of the principle that the rate of interest must be limited is a significant reversal of the nineteenth century doctrine and suggests that

the public attitude on the question may one day: be revised in an even more drastic fashion.

CHAPTER

IL

Theories in Defence of Interest.

On the question of the justification of interest, the trumpet of the economist gives forth an uncertain sound. The average text

book tends to ignore this aspect of the subject.It takes the rightness of interest for granted. But surely we are entitled to ask for some proof of this. Has the capitalist a claim to his interest on the same ground that the labourer has a claim to his wages? Does he earn it by any service or sacrifice? Or is he a non-producer whom the law permits to deprive genuine producers of part of the wealth they create? "To these and similar questions the economists have returned contradictory and unsatisfactory answers—that is, when they have returned any answers at all. Let us examine the main theories they have advanced in defence of interest.

Tue Propuctivity

THEORY.

The exponents of this theory visualise capital as consisting of producer goods, which are “productive.” It is only fair, they argue, that those who lend productive goods should receive a share of the extra wealth these goods produce. If it is pointed out that most interest-bearing loans take the form of a transfer of money, the reply is that this money can always be turned into producer goods and must therefore be regarded as their equivalent, The same applies to a loan of consumer goods.

Now in what sense are producer goods productive? Not in any direct sense. Tools and machines consist of inert matter. They can produce nothing until they are vitalised by labour. Labour (including the labour of organisation) is the only direct productive “4

There

is an excellent history

of interest theories down to about 18go i n Bshm-

Bawerk’s Capital and Interest.

20

THEORIES IN DEFENCE OF INTEREST

agent. All we mean when we say capital is productive is that labour can produce more wealth with it than without it.? We have still, however, to decide whether the “productiveness” of capital in this restricted sense either creates interest or else gives the lender a justifiable claim to it. The supporters of the theory generally begin by imagining a primitive community—say a tribe of Red Indians who live by trapping buffaloes. Each Indian, we shall say, traps an average of five buffaloes a month. Then some genius invents the hunting bow. With a bow, an Indian can now kill 20 buffaloes a month. Supposing, for simplicity’s sake, that both trap and bow wear out in a month, then the superior productivity of the bow might be said to equal 205 or 15 buffaloes. Therefore, say the defenders of the theory, if one Indian lends another his bow for a month, he is entitled to get back not merely his bow or a new one (the principle of the loan) but some of the extra buffaloes which the borrower killed with it (as interest); because, if he had kept his bow, the lender could have killed these buffaloes himself. This argument sounds extremely plausible but it can be refuted very simply. Let u s compare two transactions—the sale of a bow and the loan of the same bow. Suppose the price of a bow has

become fixed at 10 buffaloes; the bow lasts for a month: and the . prevailing rate of interest is 10 per cent. per month. Then the Indian who can pay “cash” for his bow gets it for 10 buffaloes. The Indian who borrows will have to return a bow at the end of the month, which will cost him 10 buffaloes, plus one buffalo as interest —in all 11 buffaloes. You might speak of this as a credit transaction —a sale with deferred payment. The “cash” price is 10 buffaloes; the credit price, 11 buffaloes; that is, the cash price plus the interest. 3 As the statement that labour alone is productive may sound heterodox, 1 adduce the following quotations in support of it.— Adam Smith, Wealth of Nations, the opening sentence:

The annual labour of every nation is the fund which originally supplies it

with all the necessaries and conveniences of life which i t annually consumes. Taussig, Principles of Economics, Vol. 11, p. II:

Capital as such is not an independent factor in production, and there is no separate productiveness of capital.

Keynes, General Theory of Employment, Interest and Money, pp. 213-4: “ I t is much preferable to speak of capital as having 2 yicld over the course

of its life in excess. of its original cost, than as being productive. . . . It is preferable to regard labour, including, of course, the personal services of the

entreprencur and his assistants as the sole factor in production, operating in

a given environment of technique, natural resources, capital equipment and effective demand.

22

THE HISTORY AND ETHICS OF INTEREST

Now contrast these two transactions. In the second, there is interest; in the first, there is no interest. Therefore, there must be some

factor present in the second, which is not present in the first. Is: this factor the “productivity” of the capital lent? No, because it is the same bow and the same *productivity’ which is involvedin both transactions. ‘The purchaser of a bow enjoys its “productivity” for a month, But the same would be true if he borrowed it. And yet he pays interest. For what? Certainly not for the “productivity” of the bow, because the purchaser of the bow gets that and yet pays no interest. This is decisive. We must reject the Productivity

Theory. If there is a justification for interest, it is certainly not the: so-called “productivity”

of capital. Tue Use THEORY.

Let us try in another direction. The Use Theory is really a variant of the Productive Theory. It states that interest is the: payment made for the “use” of a borrowed tool or machine. The lender might

have used it himself.

He lets the borrower

use it.

Therefore the borrower must pay for this permissoin. For the sake of variety, let us consider Bastiit’s account of this: theory in his essay on Capital and Interest.® As his manner was, Bastiat relates a little apologue. He imagines a carpenter, James, who makes himself a plane. As soon as it is finished along comes another carpenter, William, and asks to borrow the plane for a year. Thereupon an edifying dialogue takes place. James points out that the plane will be worn out in a year. William offers to supply a new one in its place. “But,” says James, “this is not enough. I have made the plane for the sake of improving my work and condition; if you merely return it to me in a year it is you who will gain profit by i t during the whole of that time. I am not bound to do you such a service without receiving anything from you in return.” After some haggling, William admits the reasonableness of this argument and agrees to pay one plank as interest. On this reasoning, there are two comments to be made. First, it presupposes an entirely impossible situation. Did Bastiat really believe that James, having made a plane for his own use, would immediately hand it over to William, and himself go on working 6 Bastiat, Ocuwres, Vol. V , p. 43. There is an English translation in Bastiat's: Essays in Political Economy (1872).

THEORIES

IN

DEFENCE

OF

INTEREST

with inferior tools? ‘The supposition is absurd. James will part with his plane only if he cannot or does not wish to use it himself— if for example he is ill, or has more planes than he can use, or is setting up as a professional manufacturer of planes. He is not making a one-sided sacrifice. He is making a bargain for his own convenience. We shall have to allude to this point again. Second, would i t not be more natural for James to sell his plane rather than to lend it?

A n d i f he does not sell but lends, will the

‘reason not be that William cannot pay “cash” but must buy on credit? ‘This brings us up against the same difficulty as in the case of the Productivity Theory. If William can pay “cash,” he can have the plane for the current price—say 20 planks. But if he delays payment for a year he must pay the current price plus interest; that is, 20 + 1 = 2 1 planks. Why the difference in price? Has the “use” of the plane anything to do with it? Again, no; because it is the same plane and the same “use” which is involved in both transactions. The borrower, it is true, has the use of the plane for a year. But so has the purchaser and yet he pays no interest. “Use” therefore cannot be the cause of interest, and we must send the Use

Theory to keep company with the Productivity Theory in the limbo reserved for exploded economic fallacies. T u e AssTINENCE THEORY,

In this theory, generally associated with the name of the English economist, Nassau Senior (1790-1864), the defenders of interest shift their ground. They transfer their attention to another feature of capital—not its “productivity,” but the fact that its creation presupposes saving. Saving by itself, of course, does not create capital. I t is a purely negative act, meaning the non-consumption of goods or services. Capital goods can only be produced by the positive act of labour. But saving is a condition of their production, because while labourers are at work on them, they (the labourers) must be fed and clothed. Therefore there must be already in existence a supply of necessaries ‘accumulated for this purpose, the 1esult of previous saving, or at any rate of non-consumption. And this saving, it is alleged, must be rewarded by interest, otherwise it will not take place, and society will suffer through shortage of capital. The weakness in this reasoning is the assumption that saving always involves sacrifice and must be stimulated by a money payment. This is not true, except possibly in a few cases which we will discuss later. Savers may be divided broadly into three classes.

23

24

THE HISTORY AND ETHICS OF INTEREST

(x) The class of very rich savers, whose incomes are so large that they cannot by any possibility consume them all, These people simply cannot help saving. No question of abstinence is involved,

and the abolition of interest would not affect this kind of saving in the least.

(2) Then there is the large class of savers with moderate incomes, which they could consume if they pleased, but who prefer to defer consumption of part of them till a later date. The saving of this class seems to be sacrificial, because it means preferring the future to the present, and present desires are generally more vivid and urgent than future ones. But it is an immediate sacrifice for the

sake of an ultimate gain. The members of this class save because by postponing consumption, they make a gain in “utility.” And this gain in utility is sufficient to induce them to save without any additional stimulus in the way of interest.

The matter can be simply explained. By “utility” the economist means the capacity of a commodity to satisfy a human desire or

serve a human purpose. It is a well-known psychological fact

that, the greater the quantity of a commodity one has, the less satisfaction one obtains from additional units of it; or, in the

language of the economists, “the marginal utility of a thing to anyone diminishes with every increase in the amount of it he already

has.”* Take, therefore, the case of a man with £500 a year. The utility of £1 is less to him than if he had only £200 a year. But a time may come when he will have only £200 a year—when he

retires, for instance. Therefore, it will pay him in utility to keep back each year a few pounds from his present income and spend them later when he has retired. They will bring him more utility then. This is the great motive that inspires the saving of these people, the fact that the future utility of the money saved is greater

than its present utility. It is not interest that induces them to save, They would save even if no interest were paid. Why then do some people with moderate incomes spend them all? Because the present utility of money to them is greater than its

future utlity. Utility is something psychological.It depends on the mental make-up of the person concerned, his disposition, his tastes, To some people, the utility of present goods appears so enormous that no future utility can outweigh it. Therefore, they 7 Marshall, Principles of Economics, p. 92.

THEORIES

IN

DEFENCE

OF INTEREST

25

consume all their incomes as they earn them. But the point is that both the saver and the spendthrift are pursuing their own interest; they are following the line of conduct which they think will give them the greatest utility. They are each sacrificing someThe saver sacrifices the present; the spendthrift, the future. thing. But each does so because he believes that, by so doing, he is reaping

or will reap a harvest of utility which outweighs the sacrifice. Therefore, in the case of the small saver, no additional inducement is needed to make him save. The payment of interest to him is as superfluous as it is to the millionaire.

(3) Then lastly, if we are to believe the economists, there is a class of people so situated that they will not save unless interest is paid. Whether it is a large or a small class, it is difficult to say. Let each one appeal to his own experience. Has he ever been in a position where he had £100, and the only thing that prevented him from immediately spending it was the prospect of having £105 to spend, a year later? I should not imagine that this would happen very often. Indeed, I can scarcely imagine

it happening at all. But, as the economists assure us that it «does happen, we must assume that there is a class of savers who would spend and not save if interest were not paid. Even the economists, however, generally assume that this is a small class, but they maintain that, without the savings of this class, society would not have the amount of capital that it needs; and as it is impossible in practice to distinguish between the savers of the different classes, all savers must receive interest whether they require it as a stimulus or not. This last argument is a little difficult to meet owing to our ignorance about the facts. Is there a class of savers corresponding . to the third class described above? There may be, but it is almost impossible to prove. On the other hand, the defenders of the theory can say that the non-existence of this third class cannot be proved

either.

Until this point is definitely settled, the abstinence theory

cannot be unreservedly accepted or rejected. But there are three comments we can make: (a) Supposing the theory were true, and yet interest was abolished, would the amount of capital saved by society be less? Not necessarily. The savings of the third class would disappear, but this might be made good by increased saving amongst the second class. If for example, a man is aiming at saving enough capital to give him a certain income during his retirement, he will have to save more if this income has to be drawn from his

26

THE

HISTORY

AND

ETHICS

OF

INTEREST

capital without any additional subsidy in the way of interest; (b) Another point is this. The theory assumes that in modern societies there is always a tendency to shortage of capital. After two destruc‘live world wars we are inclined to accept this statement without question. But it is not necessarily true. Indeed, an economist like J. A . Hobson maintains that, in normal times, our economic troubles

arise from the fact that we save, not too little, but too much. We are like the French peasant who starved himself to death in order

to provide for his old age. We fail to strike a proper balance between saving and consumption; (c) And lastly, if-the abstinence theory is true, then interest is paid not on the ground of justice but for reasons of expediency, and it is a wasteful payment because the vast majority of those who receive it do not need it as an economic stimulus. We must, therefore, reject the abstinence theory though not so decisively perhaps as the two previous theories we have discussed.

We reject it on the ground that the economic advantage which it attributes to interest is so small and doubtful that it cannot weigh against the decisive counter-balancing advantages which would accrue to society from its abolition.®

Tae PsycuoLoGICAL THEORY.

Allied to some extent with the abstinence theory is the psychological theory of the Austrian economist, Bohm-Bawerk (1851-1914).°

According to Bohm-Bawerk, a loan is merely an exchange of present wealth for future wealth. But as men tend naturally to put a higher value on the present than the future, the exchange would not be equal, unléss the borrower paid back more nominal wealth than he received. If, for instance, he received L100 (present wealth), he must promise to pay back [ios (future wealth). The extra [5 js interest. In B6hm-Bawerk’s own words— The loan is a real exchange of present goods against future

goods. . . . Present goods invariably possess greater value than

future goods of the same number and kind, and therefore a 8 To get rid of some of the unfortunate implications of the term abstinence, Marshall substitutes the colourless term: waiting. Principles of Economics, p. 234.

But this does not help us. If waiting involves no sacrifice, why should it be paid for? 9 See his Positive Theory of Capital, translated Smart, 1891.

THEORIES

IN

DEFENCE

OF

INTEREST

27

definite sum of present goods can, as a rule, only be purchased by a larger sum of future goods. Present goods possess an agio in future goods, This agio is interest.

This theory is open to the same objection that we have seen can be brought against the abstinence theory. It is simply not true to say that in every case men estimate present wealth more highly than future. Even Bohm-Bawerk himself was ultimately compelled to

admit this. He had said that the two great factors that normally disposemen to prefer present goods to future are the pressure of ‘present want, and the inability

to imagine the future.

But he had

to admit that relatively only a small number of people are affected by these factors, and in particular, they do not affect the investing class which is the ‘class that lends.

Therefore,

in order to save his

theory, he had to introduce a third factor, which he held would operate in practically every instance—‘‘the technical superiority of present goods.” What he meant was this. There is always an advantage in turning

wealth into capital, consumer goods into pro-

ducer goods; because producer goods increase output and create a surplus (profit). But the making of producer goods takes time. Therefore there is an advantage in setting about their manufacture as soon as possible. If I have £100 and invest it in 1945 in a machine

which will take a year to build, I get a return in 1946. But if I delay making the machine tll 1946,I do not get a return till 1947. Now if in. 1945,I am asked to lend my £100, this means that I am sacrificing the year’s profit which I would get if I turned my money immediately into a machine. Because I lend my money, I cannot

make the machine till 1946 and I get no profit till 1947. Therefore, the borrower must compensate me for this loss and the compensation I receive is interest.

In regard to this argument, I think we must feel the same difficulty as about Bastiat’s account of the loan of the plane. We wondered why James lent his plane instead of using i t himself. Similarly, in the case imagined above, we ask why should I lend my £100 instead of turning it straight away into a machine. In the second case,I get profit. In the first case,I only get interest, which is generally less. Why do I make this sacrifice? Obviously, not

for the borrower’s advantage. There must be some convenience to me in transferring my capital to another. Perhaps I cannot use it 1 1bid, p. 259.

28

THE

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AND

ETHICS

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INTEREST

myself. Perhaps it will be more convenient to me to use it twelve months hence. In that case the borrower is really rendering me a service. He is keeping my capital intact for me till I am ready to use it. Or if I have not the skill to use it under any circumstances, he is making it “produce” wealth. Who then should get paid? Why should it be the creditor and not the debtor?

I shall take this point up again later, and try to show that contrary to the general belief, the services of creditor and debtor are’ reciprocal, and not all on the side of the creditor. But in the meantime I shall content myself with asserting that this second form of Bohm-Bawerk’s theory proves nothing. Any plausibility it has is due to the fact that it is really a disguised form of the productivity theory, which B6hm-Bawerk himself rejects. It is because my £100 can be turned into a machine, and because the machine enables the labourer to turn out more goods and make profit, that apparently interest is due to me. But we have already seen the groundlessness of this claim. In its first form, the psychological theory did put forward a fresh defence of interest which we may or may not accept.

But in its second form, the theory does not advance the question one inch. It brings us not a step nearer the solution of our problem why a man who does not choose to use his capital to produce wealth with, should nevertheless be able to draw an income from the mere ownership of it. There may be an answer to this question but as "yet we have not found it. +

If any reader has a lingering doubt about the first form of the psychological theory, he may perhaps have it dispelled by the ingenious argument of the French economist, Charles Gide.? If present goods are more valuable than future goods, then, it follows, Gide argues, that they are more valuable than past goods also. Consider how this conception ‘might be applied. I have received a loan of £100 a year ago, and the creditor calls on me to pay back £105. But on the analogy of Bohm-Bawerk’s reasoning, I might argue that the bargain is not equal. I am being asked to pay back £105 for wealth which, certainly when it was present seemed equal to £100 but which now that it is past, seems equal to only fos. 2 Cours d’economie Politique, Vol. 1, p. 29s.

THEORIES

IN

DEFENCE

OF

INTEREST

29

Why then should £o5 not be a fair repayment of the loan, in which case interest would be negative?* Tue KeynNesiaN THEORY.

In 1936 the publication of The General Theory of Employment,

Interest and Money, by J. M. Keynes (afterwards Lord Keynes), fluttered the dovecotes of the economists and kindled controversies which are still in progress. Keynes’s main purpose was to reveal the deficiencies of the classical political economy, especially its assumption, so much at variance with the facts, that the economic resources of a country in labour and capital are normally in full employment. But i n the course of his investigations, he was led to enunciate some new and startling propositions about interest and saving which are of great importance for our present inquiry. Keynes did not set out either to criticise or defend interest. Nor in the end did he expressly condemn it. But his conclusions placed it in a new, and on the

whole, a very unfavourable light.* Keynes rejects the old view that interest is the regulator of saving; that saving increases or diminishes as interest rises and falls; and that the rate of interest is fixed by the demand for capital compared with the supply of it. He points out that people save even when they receive no interest—when, for instance, they place their money on deposit receipt in a bank or when they hoard it in the form of cash. This in his opinion is conclusive that saving does not depend on interest (except indirectly as we shall explain later, and in a way quite opposite to that which is generally supposed). What then does saving primarily depend on? On two things:

(a) the habits of individuals and communities as regards thriftiness; (b) the level of income which individuals and communities enjoy. Given fixed incomes, thrifty individuals and communities will save more than unthrifty; given fixed habits of thriftiness, the bigger the 3 The conception of negative interest is in no way absurd, In fact, it is more

rational than positive interest. It seems much more reasonable that we should pa: the banker for looking after our money than that he should pay us. Marshall in his

Principles, p. 232, considers the circumstances under which **by handing over his

means to another to be taken care of, a person could only expect to get a sure promise of something less and not of something more than that which he lent: the rate of interest would be negative.”

4 The General Theory is not always easy reading, but there is a popular account

of the Keynesian theory in Joan Robinson's Introduction to the Theory of Employ.

ment, to which the general reader may be recommended. I have sometimes found it convenient to quote from this book in preference to the larger work.

|

30

THE

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AND

ETHICS

OF

INTEREST

income enjoyed by individuals and communities, the more will be. saved. These propositions are indisputable. But the next conclusion wears an air of paradox. It is that a community can never save more

money than it can invest.

By investment,

Keynes means

using savings in capital production, “making an addition to real capital such as occurs when a new house or a new factory is built, a railway line constructed or a store of raw materials accumulated.”? The relation

between saving and investment

is a curious one.

To

begin with, these two factors are independent of each other; they are determined by different causes. We have just seen what determines saving. Investment depends on something quite different— the decisions of entrepreneurs or business men to produce or buy goods. These decisions in turn depend on the view taken by entrepreneurs of the prospects of making profit. If the prospects seem good, business men will produce or buy. Otherwise, they : will sit tight. From this it follows that saving does not, of itself, provoke

investment. Society can save as much capital as it likes. Unless entrepreneurs think they can make profit by using it, they will not invest it. Suppose then a community saves too much; saves, that is, more than entrepreneurs choose to invest; what happens to the surplus capital? It melts away. But how? ‘Through unemployment. This is what happens. The people who saved will have

reduced their consumption on consumer goods. This is what saving generally means. The consumer goods ‘industries will have to turn off some of their workers. These unemployed men will have to subsist partly at least on their small savings. This dissaving will eat up capital and balance the surplus saved by the other people. Dissaving will work against saving unfil from the social point of view, all the surplus capital is gone, and the community has just the amount of capital that it can use—that is, that its entrepreneurs will invest. If, however, the entrepreneurs had decided to invest the additional capital, there would have been no unemployment or cnly temporary unemployment, because the boom in the producer

goods industries would have balanced any dullness in the consumer goods industries. This implies, of course, that labour is sufficiently mobile to make it easy to shift unemployed workers from one group of industries to the other. [X

3 Joan Robinson, Theory of Employment, p. 10

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31

The following sentences from Miss Robinson's book summarise the preceding argument. “The rate of investment determines the rate of saving . . . the level of income is always such as to equate

the rate of saving to the rate of investment . . . whatever the rate of investment may be, incomes will always be such that people save at whatever rate provides the capital which entrepreneurs are investing.”® . This is in one respect a most unsatisfactory state of affairs. It means that the resources of the.community in labour and capital

are seldom if ever fully employed. Entrepreneurs cannot or will not employ all the capital that the community can save. And in order to keep incomes down to the level at which only that amount of capital will be saved which entrepreneurs will use, unemployment must be maintained at a certain level. Therefore, a substantial part of the community’s resources both in labour and capital must ©

remain unutilised, and unemployment is a chronic evil of modern societies; sometimes more acute, sometimes less severe, but never totally disappearing.

The cause of chronic unemployment is interest. If the rate of profit is lower than the rate of interest, the entrepreneur will cease

to produce. If he has to borrow, he cannot afford to pay interest at a higher rate than he is making profit. If he is working with. his own capital, it will pay him to cease producing for a low rate of profit and lend out his capital at a high rate of interest. In practice,

there is a law of diminishingprofit just as thereis a law of diminishing return to land. Up to a certain point, every additional dose of

capital put into a business brings a higher rate of profit. ‘After this |

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point, the rate of profit diminishes with every additional dose. Suppose a producer has £50,000 invested in his business. Up to the first £30,000 say, every addition to his capital has brought him an increasing rate of profit. After this point, the rate declines with every additional dose until for the last dose it is say 3 per cent. If he adds another £5000, the rate will drop to 2% per cent. Now if the current rate of interest is 3 per cent., he will not make this further addition. Obviously, if he had to borrow the -£5000 at 3 per cent., he would make a losing bargain. And if he had £5000 of his own, it would pay him better to lend out the money rather than put it into his business. This is the way in which the rate of interest holds up economic development. If the rate of interest had 8 Theory of Employment, pp. 41, 83,

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32

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been 214 per cent., the entrepreneur would have put £55,000 into his business instead of [50,000. If the rate of interest were zero, he might have invested £100,000. But since the rate is 3 per cent., he invests only £50,000, and his brother entrepreneurs proportionately. This means that the community could have saved far more capital than is actually invested, but owing to the rate of interest, the entrepreneurs cannot avail themselves of it. And to keep down

the community’s savings to just the amount which the entrepreneurs. can invest, a certain level of unemployment must be permanently maintained. It is clearly the interest of the community that the rate of interest should fall to zero. In that way alone, can the community’s capital and labour be fully employed. Why then does the rate of interest not fall to zero? Because in that case, capitalists would refuse to. lend their capital. They would prefer to hoard it in the form of cash. Cash has certain advantages over invested capital in the shape of securities, bonds, shares, mortgages, &c. Cash is kquid. It is. legal tender. It can be used at once to pay debts or to make purchases. Securities, on the other hand, have first to be realised, to be sold. This causes delay, and when the securities are sold they may not fetch their original price. During a commercial crisis, when there is a famine of ready money and an insatiable demand for cash, securities may even prove utterly

unsaleable, and their

owners may be driven into bankruptcy. Some inducement therefore is necessary to make a man invest his money, that is turn his cash into securities. The inducement is the payment of interest. According to Keynes, interest is a liquidity premium. As such, it renders an important service. For hoarding is a bad thing for the community. It withdraws currency from circulation and causes a shortage of the medium of exchange. It creates unemployment. Money which is. hoarded is not spent. Producers find themselves short of orders and are left with stocks on their hands. The economic machine slows down and may come to a complete standstill. From this, in passing, we learn an important lesson. In a society where no interest is allowed, special measures must be taken to prevent hoarding. 1 shall refer to this point later, when 1 hope to suggest a feasible method of overcoming this difficulty. In the meantime, we note that according to Keynes, interest is both good and bad. It is good so far as it discourages hoarding. It is very bad so far as it discourages investment and creates unem-

I

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ployment. In fact it makes full employment a sheer impossibility. Every trade boom has a slump lying in wait for it due to the influence of the interest rate. As employment increases, and wages rise, there is a bigger demand for cash. This sends up the interest rate, as

capitalists now require a greater inducement to turn their cash into securities. With the rise in interest, investment falls off and unemployment

develops again.

A s Miss Robinson puts it, “ a revival

in

trade is always in danger of cutting its own throat.” Keynes's practical remedy for all this is to keep interest rates low— It is to our best advantage to reduce the rate of interest to a point relatively to the schedule of the marginal efficiency of There can be no capital at which there is full employment. doubt that this criterion will lead to a much lower rate of interest than has ruled hitherto.?

Now, though this state of affairs would be quite compatible with

some measure of individualism,

yet it would

mean the

euthanasia of the rentier, and consequently the euthanasia of the cumulative oppressive power of the capitalist to exploit the scarcity value of capital.’ This is perfectly true; but my suggestion is that the euthanasia of

the rentier and of the oppressive power of capital would be more effectually promoted by the abolition of interest, coupled with special measures (which I shall indicate later) to prevent the hoarding of cash. ’ THE TRUE EXPLANATION OF INTEREST.

In considering these different theories of interest, the reader must have been struck by the profound disagreement which exists on this subject amongst economists. From this discordance, he will have drawn his own conclusions. But meanwhile all that concerns us is to ask i f out of this welter of confused opinions we can obtain some

7 Theory of Bmployment, p. 78. This is what I meant when [ said carlier that

interest regulates saving only indirectly and in the opposite direction to what fs commonly believed. According to the old theory, high interest encouraged saving. According to the new theory, high interest discourages investment, causes unemployment, reduces incomes and therefore diminishes saving, ) 8 General Theory of Employment, ¢oc., p. 375. Y 1bid, pp. 375-6.

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glimmering of the truth. I think we can. There is a passage in Keynes which contains a precious hint. According to the Keynesian theory, interest is primarily a liquidity premium. But that it is more than this is suggested in the significant statement on p. 376 of the General Theory of Employment—

Interest to-day rewards no genuine sacrifice any more than does the rent of land. The owner of capital obtains interest because capital is scarce, just as the owner of land can obtain rent because land is scarce. In other words, interest is a scarcity or monopoly charge; the owner of a relatively scarce article, the capitalist, takes advantage ~ of the purchaser’s needs to. charge a non-competitive price. If interest were merely a liquidity premium, it could hardly exist

outside of monetary economies. But history reveals it as a familiar phenomenon in the earliest natural economies where exchange proceeded by barter. The primary cause of interest is simply the unequal distribution of wealth, the concentration of capital in a few

hands. © This concentration and inequality have proceeded far beyond what could possibly have taken place in a truly competitive economy. To begin with, they were probably due to uneconomic causes—to war, conquest, enslavement of vanquished peoples. But afterwards, they were maintained and accentuated by monopoly

ractices like the levying of rent, the takingof interest and unscrupufou ous profiteering. Whenever, in any community, a broad gulf opens. out between the rich and the poor, then interest makes its appearance. The rich man has superfluous commodities which the poor man needs, either to relieve his immediate wants, or as raw materials

of his industry. But he cannot pay for them on the spot. Therefore, he buys them on credit, and the seller takes advantage of the

purchaser's impecuniosity to charge an extortionate price. This is the essence of all loans, even when, at a later date, the wealth lent is transferred not in kind but in money. The principal of a loan is

the competitive price of the commodities transferred (or of the commodities which the borrower buys with the money advanced); the interest is the extra charge imposed by the seller on credit.

Is this. extra charge just? Prima facie, according to the economic principle, that a claim to wealth must be based on labour, it is clearly not. The wealth represented by interest is produced by the debtor, not by the creditor. But perhaps the creditor makes some

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sacrifice in lending the money? This is ‘generally assumed in . theories in defence of interest. But it is not true. If a man has wealth and wishes to consume it, he consumes i t ; if he wishes to use it in the production of more wealth, he does so. He only lends

when he has superfluous wealth, which he wishes neither to consume or use. There is a tendency always to regard the typical creditor as a man who gives away his dinner to another man. He goes hungry to-day, and though he will get his dinner back to-morrow, it seems just that he should get some compensation for fasting to-day. But actually, the typical creditor is a man with two dinners. He cannot eat both. The one he keeps will be cold and stale the following day. But suppose he finds another man who will consume his superfluous dinner to-day, and supply him with a fresh one to-morrow.

This would

seem an excellent bargain

for

him, and it would strike us as exceedingly odd if he insisted that the other man should give him back a dinner and a half, But this is what happens with a loan. The creditor gives away superfluous wealth; the debtor looks after it till he wants it again; and instead of. being paid for this service, he has to pay. The explanation, of course, is that the debtor’s need is so great. The creditor can wait; the debtor cannot. In our illustration above, if the second man was in such a state of undernourishment, that he

would die if he did not get a dinner immediately, the first man might be able to drive an advantageous bargain with him. He might insist on getting back a dinner and a half or two dinners, but the transaction would be no more just than Jacob’s exchange of a mess of pottage for Esau’s birthright. I said earlier that the services of debtor and creditor were

reciprocal. The service of the creditor is that he lets the debtor use his wealth. I have suggested that this involves no great sacrifice, if sacrifice at all, because if the creditor could have used his wealth himself, he would have done so. It is only his superfluous wealth that he lends. But the debtor renders a service too. Suppose the creditor could find no one to lend his wealth to. What would happen? He would have to look after it. Now wealth, in the form of commodities, deteriorates rapidly. Food rots, clothing becomes moth-eaten, iron rusts, wood warps, animals die, buildings crumble into ruin, and machines get out of repair. Wealth has to be kept “alive”

so to speak; what is more, i t has to be continually

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. reproduced. The money measure of wealth gives a false idea of its permanency. Mill brings this out in a striking passage—

The greater part in value of the wealth now existing in England has been produced by human hands within the last twelve months. A very small proportion indeed of that large aggregate was in existence ten years ago; of the present productive capital of the country scarcely any part, except farm

houses and manufactories, and a few ships and machines; and even these would not in most cases have survived so long if fresh labour had not been employed within that period in putting them into repair. . . . Capital is kept in existence from age to age, not by preservation but by perpetual reproduction.’ In other words, wealth has “carrying costs.” It can only be kept in existence by the expenditure of labour. From this standpoint, a

loan appears in a new light. The creditor gets back his wealth intact, with its value undiminished. This means that the debtor has borne the carrying costs. And, in addition, he pays interest. So that the creditor is doubly paid. Such a leonine bargain implies that the transaction is not equal. The creditor has an extra pull which can

cnly spring from some kind of monopoly. It is true that in a monetary economy there is another way in which a capitalist can preserve his wealth without incurring carrying costs. If thecurrency is a stable one he can hoatd it in the form of cash. . But this does not mean that carrying costs are not incurréd. It only means that they are not incurred by the capitalist. The cash he hoards is only representativewealth. Somewhere the real wealth which his cash represents is being looked after by someone. This

is one of the injustices of hoarding. The hoarder gets a service for whichhe makes no payment; another reason for taking measures to prevent it. The primary functions of money are to act as a medium of exchange and a méasure of value. When it is also used as what the economist calls “a store of values” it leads to abuse. We shall indicate later how this misuse of money can be avoided.

(See p. 38.)

Summing up, then, we see that as an economic institution, interest is open to- the following objections. It is not the recompense of labour;

the wealth which it represents is created by the debtor, not

by the creditor. It is not the reward of sacrifice; the creditor lends 1 Mill,

Principles of Political Economy (Ashley’s edition), p. 74.

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superfluous wealth, which he does not wish to consume, and which he cannot or will not use in the production of more wealth. If it is maintained that the creditor renders a service to the debtor by permitting him to use his wealth, then this service is more than out-

weighed by the service which the debtor renders to the creditor by I'

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keeping his wealth intact for him. If it is alleged that interest encourages saving and thereby promotes economic welfare, it can be replied that this has never been satisfactorily proved. On the contrary, if the Keynesian theory is true, then interest discourages production, curtails saving and creates chronic unemployment. Lastly, interest is the result of a monopoly; not a natural monopoly like land, because capital can be indefinitely multiplied, but an artificial monopoly due to the human laws and customs which have concentrated ownership of capital in a relatively small number of | " hands. On all these counts, then, interest stands convicted. It violates the right of private property; it impedes the working of free competition; i t retards economic progress; it helps to perpetuate and aggravate the conditions of monopoly and inequality out of which it sprang. It follows then that the abolition of interest is an essential preliminary to the establishment of a genuine individualist © economy.

APPENDIX. AY

An Economic System Without Interest. To the policy which would lead up to a system of this kind I have given the name Economic Radicalism, on the ground that it is a continuation and completion of the older Economic Liberalism, applying its methods more logically and consistently, but having the same end in view—the creation of a free competitive economy without exploitation. It would necessitate the following measures.

1. The taking of interest must be made a legal offence with appropriate penalties.

)

2. Steps must be taken to prevent hoarding. In my earlier pamphlet I suggested that this might be achieved through the adoption of Silvio Gesell’s plan of a shrinking currency, i.e., a currency of dated notes, the value of which would shrink with the

‘passage of time. To benefit by their full value, the holder would have to spend or invest them within a certain period. But I find this proposal excites so much misunderstanding and alarm, that a simpler plan would be preferable. I suggest the issue of a currency of dated notes, which would be recalled at intervals and exchanged for a new dated currency. The necessity of exchanging the old currency for the new should be sufficient to catch the hoarder, who could be penalized by fine or by the forfeiture of a substantial portion of his hoard. At the same time, under the system which I propose,I do not think there would be much temptation to hoard. After the initial stages, capital would pass into the possession of people who wished to use it in production, and such people would see no advantage in hoarding. It is different to-day when, with certain exceptions, those who produce have no capital, and those who have capital do not produce.

3. Shareholders’ dividends, as forms of unearned income, must

be placed in the same category as interest and declared illegal. 4. This would involve the reconstruction of joint stock enterprises. 38

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The shareholders would cease to be the owners of the business and become its creditors. The ownership would pass to the workers of all grades, who would form a producers’ co-operative association.

5. The shareholders, though no longer entitled to interest or dividends, would remain the owners of their capital, which would be repaid to them in instalments. A simple plan would be for the co-operative association to continue paying dividends at the old rate until the total dividends paid to each shareholder equalled the capital value of his shares. 6. The same system would be applied to partnerships and single owner businesses. 47. The producers’ co-operative associations would compete against each other. A Monopolies Commission with extensive powers would have to be set up to crush any attempt at monopolistic combination amongst the associations. 8. The Commission would prevent the creation of artificial monopolies like cartels and trusts. But natural monopolies like the land would remain. These are indestructible. To make the tenants the owners of the land would simply transfer the land monopoly from one set of people to another. The only way to deal with such monopolies is to nationalise them. This is a regrettable but inescapable conclusion. However, the state need not attempt directly to manage the land. It would be sufficient if the government took the place of the landowners and drew the rents from the actual cult-

vators, with some provision for good cultivation. Farming enterprises would be organised cooperatively in the same way as industrial businesses. The landowners would be compensated by continuing to receive their rents until the total rents paid over equalled the capital value of the land.

From such a system, I believe, the following salutary consequences would result. Individualism would be substituted for the collectivism which is establishing itself all over the world; the wage system would be abolished; labour and capital, united in the same hands, would no longer represent antagonistic forces; by the abolition of unearned income, the producer would receive the full product of his labour, and would be able to provide for himself the benefits which he now receives from the Welfare State, a much

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more satisfactory arrangement; through the maintenance of the competitive principle, economic progress would be assured; by reducing the functions, and, consequently, the overgrown powers of the state, the liberty and independence of the individual would be safeguarded; democracy would cease to be a pious hope and become

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a reality; the danger of war, the fundamental cause of which is

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the divergency of aim and ambition amongst irresponsible or only partially responsible governments would be enormously diminished. In short, an approach would be made to a stable form of society which would ensure to the common man something like a tolerable existence. The two agelong problems of the human race—the problem of war and the problem of poverty—would at last find their solution.?

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2 For a fuller explanation of my scheme,I refer readers to my earlicr pamphlet, A New Liberalism for the New Age (Hodge: 1s.).