Now that the Reserve Bank has intervened in the credit market to raise interest rates in New Zealand, and has signalled a phase of rising interest rates that may last from 2-4 years, we need to examine what this really means.
The concept of savers’ entitlement to interest has become so ingrained in our thinking that very few of us – whether on the political right or political left, whether economists or taxi‑drivers – can see any way of questioning this entitlement. It hasn’t always been so.
In Northern European languages the words for ‘debt’ tend to be closely associated with the concept of ‘sin’. Yet in Islam and classical Catholicism, it is usury that is sinful. And usury properly means the act of lending for the purpose of extracting interest.
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Before further consideration of the concept of interest, I would like to note some comments arising from my dailyblog on ‘miserliness’ (14 February 2014).
Contrary to one reader’s claim, I made no attempt to define ‘political miserliness’, but I did define miserliness as the intent to “make money but only spend a portion of it”. This means that misers are not necessarily like Dickens’ character ‘Scrooge’, or Shakespeare’s ‘Shylock’. Many misers appear quite affluent.
Misers are people who, through neither purchasing consumer goods nor investment goods, frustrate the circular flow of income and spending that is the essence of an operative economy. Further, misers’ life‑principle is to save – which means to ‘own’ ever-more debt. Thus for misers to permanently own increasing amounts of debt, then the rest of society must permanently ‘owe’ increasing amounts of debt. Owning debt is the counterpart of owing debt. Every dollar of debt that creditors’ own is owed by debtors.
Political miserliness is not quite the same as being a persistent net saver. While few governments seek to run perpetual surpluses – miserly Singapore would appear to be an exception – governments that refuse to accommodate (ie borrow) big private sector surpluses can be accused of political miserliness. Thus public miserliness is the failure to offset private miserliness. Further, miserly governments tend to recommend private miserly behaviour, even though private miserliness is the direct cause of public indebtedness. Globally, the private sector can only own more debt if the public sector owes more debt.
The same reader says: “Perhaps you don’t understand what it is to be poor? My point is that you have failed to acknowledge that the poor borrow of necessity, not of choice.” I certainly would never dispute that quite obvious fact. We might note that the “necessity” of the poor to borrow from the misers is a direct consequence of the misers’ failure to spend. As Paul Krugman said: “Your spending is my income, my spending is your income”. The poor lack income because too many people don’t spend theirs.
Another reader says “‘misers’ do spend money. Both every day, and in the longer term acquisition of assets”. I’m not sure what she means by ‘assets’. But it’s only spending if it is a purchase of a new asset such as a building or a computer system. Such spending is called investment, and misers by definition save more than they invest. (The public discussion is hampered by the ubiquitous misuse of the word ‘invest’ by most journalists and financial professionals. Investment is an antonym of saving, not a synonym.)
Another reader says: “Are you arguing modern monetary theory, crudely that private (dis)spending plus public spending equals zero?” The answer is ‘yes’, in the sense that the relationship given is true by definition, just as X-X=0 by definition. But that does not mean that I would concur with every policy conclusion of modern monetary theoreticians.
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So what is interest? It’s actually a conflation of two ancient concepts: ‘yield’ and ‘compensation’. In ancient societies the word ‘interest’ was commonly linked to the concept of reproduction. For example, the interest on a flock of sheep would be the lambs born each year. This is an example of the ‘yield’ concept. Likewise, in the modern context, GDP (gross domestic product) is the yield on a society’s productive assets.
It would appear that this kind of interest can never be negative. But if you properly account for depreciation of society’s productive assets, it can be negative. Just ask Marilyn Waring.
Nevertheless, interest as we usually understand it is better regarded as a compensation price. It is in part compensation for risk (especially borrowing rates). It is commonly (but wrongly) understood as compensation for abstinence; the problem here is that true abstinence is an end in itself that does not require compensation. It is compensation – however, and under certain conditions – for delayed consumption.
At its core, interest is a scarcity price. If lenders are scarce and borrowers are many, then borrowers must compensate lenders, in order that the credit-debt market should clear. (Note that ‘credit’ is debt owned; debt is ‘debt owed’. Credit is an asset; debt is a liability.)
Our problem is that we tacitly assume that borrowers are always abundant and that saver-lenders are always scarce, and therefore interest rates should always be positive; that is, we assume that borrowers should always compensate lenders. Essentially we assume, without realising it, that credit-debt transactions are always initiated by borrowers, and that prospective lenders play an accommodating role, essentially doing borrowers a favour. The interest rate represents the price charged for that favour.
It was not always like that, as pre-Protestant Christian theology taught. In that view, rich misers could exploit the poor and vulnerable by lending them money at interest. Charging any rate of interest was understood as a form of exploitation of the vulnerable; it was usury, it was Robin Hood in reverse. Indeed much historical anti‑Semitism arose because Jewish culture regarded usury as an acceptable commercial practice, whereas Christians and Muslims did not.
Clearly the issue of saver-lenders exploiting the poor and vulnerable has never gone away. The main difference is the intermediation of finance companies. You don’t have to walk far along the main street of Avondale (where I live) and New Lynn to see the finance companies and pawn shops who specialise in lending to the poor. (None of these companies went broke in the late 2000s; it was the Hanovers and Lombards, which provided leveraged debt to the rich, that failed.) These companies are just intermediaries; their creditors are, indirectly, the middle class Mums and Dads of New Zealand.
Dollar Dealers of Henderson and Avondale have been offering “free” pay day loans of $50. You just pay a $20 fee, otherwise it’s interest free! Instant Finance offers a 0% interest three month loan of $500. You just pay a $99 “establishment fee”! Who’s kidding who? Many of the good people of Avondale, New Lynn and Henderson are desperate. They can only gain income from selling stuff, either directly or by working for an employer who survives by selling stuff. There are also many misers who are successfully selling stuff, but who are not reciprocating by buying anything like as much stuff in return. So, in the absence of sufficient incomes, the poor of West Auckland borrow, either through sheer desperation, or because they are bombarded with the easy‑free‑cheap credit messages from these conduits of the creditor interest.
What if lenders are abundant and people wanting to borrow are few? The rules of the marketplace dictate that, in these circumstances, borrowers not lenders should be compensated. Given these underlying conditions so far this century, therefore true market interest rates have been negative. And actions by central banks to raise interest rates can only be understood as unwitting attempts to defy market forces and support creditors at the expense of debtors. Such attempts, in the mid-late 2000s, by central banks to raise interest rates in the face of a global savings glut played a large part in creating the global financial crisis.
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Today the mystique of finance and compound interest is as strong as ever. In the Western Leader, just before the advertisements for the likes of Dollar Dealers, we get Rob Stock (for example “Boot camp on spending”, 13 March) promoting the message of ‘Simple Savings’, a group that advocates almost complete avoidance of spending. While we are exhorted by the financial literacy industry into miserly behaviour, central banks are constantly looking for excuses to raise interest rates above the rate of inflation. It’s a doomed enterprise that began, worldwide in the 1980s, in response to widespread erosion of savings in the inflationary 1970s.
Compound interest is conceived as a legitimate form of extortion. For everyone who receives it, someone else must pay it. That is unsustainable. It can only be accompanied by intermittent financial collapse (as in the 19th century), offsetting inflation (as in the 20th century), or unsustainable economic growth.
An interesting example of the marketing of the ‘financial literacy’ industry was broadcast in Radio New Zealand’s parenting segment of Kathryn Ryan’s ‘Nine to Noon’ show, on 20 March 2014. Stuart Locke, a finance professor from Hamilton, gave listeners a set of popular homilies about “money not growing on trees”, the demise of school savings schemes, and the miracle of compound interest. He advocates for a self-serving industry that tells us nothing about the nature of money as a constructed social technology, nor about the obvious reality that every dollar worth of stuff saved (ie advanced as credit) represents a dollar worth of stuff that someone else owes.
Nobody should ever be able to get away with insinuating that lending is good but borrowing is bad, because lending and borrowing are precisely the same thing. The lender owns the debt; the borrower owes the self‑same debt. Locke also advocated that everyone should join Kiwisaver because of the associated government freebies; he said this not long after having said that money is not free! And if we all take the advice, to save but not to borrow, then market-clearing interest rates would be hugely negative. We would have to pay for the privilege of being savers if hardly anybody was prepared to pay interest to savers.
If compound interest is so wonderful, then what has happened in the past to people who put a bit of money aside when they were young? If, 75 years ago (in 1939), you saved $100, about half of a typical person’s annual income, and lent it for 75 years at 7% interest compounded per annum, in the absence of debtor default you would collect $16,000 today (ignoring the matter of income tax).
Basically you would have lost. $16,000 today would pay a year’s rent on a small house in Whanganui. $100 (£50) in 1939 would have paid a year’s rent on a house in Auckland.
Inflation makes low interest rates negative in practice. In the modern capitalist world in which the supply of loanable funds exceeds the normal demand for such funds, underlying interest rates are negative. We however are used to thinking of interest as a savers’ entitlement, a no‑questions‑asked reward for abstinence. So we try to create an artificial world in which interest rates consistently exceed the inflation rate, creating Shangri-La rewards from compound interest. It doesn’t work. The only people who increased their standard of living through compound interest are the lucky ones who took big risks that paid off.
A policy of ensuring the right of saver-lenders to a positive risk-free real rate of interest – that is, a policy of setting the Official Cash Rate above the inflation rate – is nothing less than a policy of usury.
We should abandon the witch-doctors’ brew that passes for contemporary monetary policy. We should act to ensure that interest rates serve their correct compensatory purpose, to clear the credit-debt market. I know it’s difficult for banks to administer negative interest rates; for example there’s the matter of people preferring to stash wodges of cash at home than to pay bank fees. But managing negative interest rates is something we are going to have to learn to do, given the underlying savings glut in our globalised capitalist world. After-all, squirrels like to save acorns and other nuts, but they don’t expect to receive interest.
Behind my concept of the government creating money which it then spends directly into the economy to provide government services is the idea that it’s balanced by taxes. The government takes in exactly what it spends. Under this scenario there isn’t enough money to allow anyone to save and, even if there was, due to the fact that the government also makes loans available at 0% interest savers would not be able to get any unearned income.
You can see why the capitalists don’t like the idea of government creating money.
Gawd that is so laughable. Of course it is all predicated on your so called “independent” closed economy where we all make everything we need here. As soon as you require any goods or services from external sources it all breaks down. The amount of control you would have to exert over society as well would be incredible. Ah well, at least it has a snowball’s chance of being enacted by anybody outside Pyongyang.
Nope, international trade still works.
No more than what the private banks exert. Of course, the private banks would lose that control which would really upset them but society would be more democratic.
On a barter basis I presume as under your system any money leakage out of the system will slowly undermine it.
Troll alert!!!
I don’t see why it makes a difference. We use NZ dollars, whether these are created out of nothing or pre-exist, to purchase the currencies we need for overseas purchases. The only thing affected is the exchange rate, but that is as it should be.
The reason some don’t like the idea of Govt’s creating money is that it is inflationary, and therefore depletes the value of savings, and makes goods and services more expensive (particularly penalising those on fixed incomes).
“The government takes in exactly what it spends. Under this scenario there isn’t enough money to allow anyone to save”
Only in a closed economy, such as a socialist or communist led economy.
In a market economy there will be savings because wealth is generated by the private sector, which will generate income from sources outside of solely Govt. activities.
No it’s not. in fact, it’s far less inflationary than the private banks creating money as they do ATM. In fact, it’s been estimated that between 50% and 80% of inflation today is directly attributable to the private banks creating money. This is especially true in regards to the unsustainable inflation of house prices.
Bollocks. We’re talking about the creation and destruction of money here not about the creation of wealth. Two completely different things.
It’s actually the opposite. Instead of the Reserve Bank only indirectly and non-exclusively affecting inflation through changing the OCR it would directly be able to change the inflation rate through controlling exactly how much money is in the economy. The target could then be set at 0% inflation. Money is created or destroyed by the RB as the size of the economy increases or contracts.
Let’s discuss the many, many issues with this idea of Draco’s.
How is the pricing of risk managed in this brave new world? This is something many hard core leftist never truly comprehend. Interest is in a large part reflective of the risk associated with a certain economic activity that capital is associated with. It is why riskier ventures generally have higher associated interest costs. If you are offering 0% loans to all and sundry how can you ensure it is not used for overly risky activities?
How will international trade be carried out if your currency is essentially worthless in the eyes of the rest of the world because the Government can destroy or create it at will? The only way around this would be to keep a stash of hard currency made via export sales and then use this to purchase imports. The access to this central fund of real money would become incredibly lucrative to certain people and be open to abuse and a likely source of corruption.
How do the authorities decide who gets access to these 0% loans and what activities would they deem not necessary? This was always the problem with the old Soviet style command and control economies as the centralized bureaucracy could never keep up with the demands of the economy.
You win some, you lose some. Same as always.
Bollocks. It’s nothing more than capitalists desire to get money for nothing. It is the basis for the destruction of society.
Why would it be worthless? Oh, that’s right – it wouldn’t be as it can still be used to buy goods and services.
By taking a look at the business plan and other relevant information. Pretty much the same as the banks do now in fact.
The banks usually charge fees for the service they provide. Where that service includes a loan the fee should probably include an insurance component commensurate with the risk.
You assume that “risk” is necessary. Why? If your assumption is plucked out of thin air, then the argument predicated on that belief falls apart.
Remember that the economy is not constructed via immutable laws of physics. It is a human construct designed to serve our needs – not the other way around.
You seem to be labouring under the mistaken belierf that the current economic model has always existed. That is rubbish. Economic models evolve over time to meet the needs of society as it changes.
There is no reason – aside from blind ideology – why economic models will not further evolve.
By the way, Gosman;
You referred to “Soviet”. I invoke Godwins Law (v.2). You’ve lost the argument.
Everything has a degree of risk Frank. If you can’t see that then you are living in a fantasy land.
Godwin’s law is about Nazi’s not Communists.
Godwin’s law is about simplistic reductive arguments. Nazis was the example given, but it applies to other pathetic comparisons such as Soviet Communism.
The law is more about poor logic than it is about Hitler. You failed to pick up on that for obvious reasons
No. Godwin’s law is specifically related to Nazi comparisons. Additionally we are discussing economic systems so therefore it is apt to discuss the nature of centralized command and control systems as exemplified by the Soviet Union.
Oh good lord, this has to rank as the Crap of the Week;
Bullshit, bullshit, bullshit! IV, your ignorance is unbelievable.
How on Earth can “wealth [be] generated by the private sector, which will generate income from sources outside of solely Govt. activities”, when all wealth creation is predicated on a stable society; legislation; regulated/managed economy; and social services such as education, healthcare; law enforcement; etc, – all government (State) activities?!
You are so intoxicated by your bizarre ideology that you’ve conveniently forgotten who educates the workers, managers, bureaucrats, technocrats, engineers, etc, who actually make societies/economies function.
If it weren’t for the activities of the State – which is nothing more than people acting collectively, for collective benefit – you simply wouldn’t have “wealth […] generated by the private sector”, because the first rag-tag bunch of bandits happening along and steal whatever you’ve produced.
You couldn’t have “wealth […] generated by the private sector” because you wouldn’t have an educated workforce.
The evidence of this is the lack of skilled tradespeople for the Christchurch rebuild. You solution, if you recall, IV, was to simply import more skilled workers from offshore.
The stupidity of your suggestions was breathtaking, and you simply couldn’t understand how your circular “logic” would eventually break down.
If no one educated and trained workers, there’d be no tradespeople to import, from anywhere. But you were so engrossed in pushing your debunked “free ” market stupidity, that you couldn’t see it.
You couldn’t even transport your goods. Bugger-all roads.
This is why neoliberalism is fatally flawed, IV, and sycophants like you should take take note; it fails to understand that without the power of the State to organise, the “free” market has no basis on which to operate.
So take your blinkers off, IV, Gosman, et al. It really is time for you RWNJs to grow up.
Even places like Somalia (which you erroneously attempt to use as an example of a libertarian paradise) has wealth. Wealth is not predicated on having a stable functioning society with a strong central authority. This can facilitate wealth generation it is true but wealth doesn’t depend on it.
People who don’t like to be slaves don’t like the idea of government creating money. The system you advocate just steals wealth from workers and those in the productive sector and transfers it to those close to the issuer of the government the parasitic sector.
It does nothing of the kind. It’s the private banks creating money ex nihilo and then charging interest on it that turns people into slaves.
So who would you suggest would be custodians of the currency? Politicians?
Rules, regulations, transparency and the people.
What? It’s the parasitic sector that gets the wealth now. What else would you call a currency speculator?
No agreements with you there, I am in no way defending the current system. However I would suggest a banker is lower life form than a currency speculator.
Shouldn’t be able to speculate on currency because the exchange value between currencies should be a function of the import/export amounts between the two countries.
I’m not that keen on ‘slavery’, as such.
I don’t like it when banks create money/debt from the collective belief in money as a medium of exchange. Especially when they turn turtle and have to be bailed out by taxpayers to keep the fiction going. (‘Too big to fail…’)
Through that trusting belief, they create people who are in thrall to them because of the debt they share. Twenty or thirty years a wage slave to pay off a mortgage while the interest and obligations fluctuate relentlessly. And the paper value of the property wanders hither and yon. (But that’s private enterprise for you…)
How is this any different from a government of any political bent creating money and managing indebtedness? Is the slavery any worse?
I would have liked K Rankine to further discuss the Muslim banking system where there are fees but not interest.
If you believe that the various administrative arms of the government are ‘parasites’, fine. Yet those same parasites are also customers and clients and buyers from the ‘productive’ sector. They are. Either as buyers on behalf of government, or of themselves. It’s a way of distributing resources, among other goods.
And, to share a belief: I don’t believe that the private/productive sector is any more innovative, adventurous, creative, or efficient and effective than the public sector, based on results. The evidence to the contrary abounds.
I am not sure if Keith is intentionally evading the real inherent problem with usury or he is ignorant to it.
Our banks are not intermediaries between borrowers and lenders.
The problem with our monetary system is that our banks charge interest on money that they create out of thin air. This creates an impossible situation were there is more debt in existence than there is money to pay it back, requiring exponentially more and more loans to come into existence just for the system to remain constant. That is debt slavery, and always ends badly.
Lending ones money at interest is no more of a problem collectively than a shop keeper buying a good for one price and adding a margin and selling that good for a profit.
“This creates an impossible situation were there is more debt in existence than there is money to pay it back, requiring exponentially more and more loans to come into existence just for the system to remain constant. That is debt slavery, and always ends badly.”
This isn’t necessarily true, since the bank can put the interest it receives back into circulation through the payment of staff salaries, office expenses, dividends, etc. Though in practice it is probably true to some extent because, like any other business, a bank will probably retain some of its earnings.
“Lending ones money at interest is no more of a problem collectively than a shop keeper buying a good for one price and adding a margin and selling that good for a profit.”
Except that interest is a non-productive expense. The shopkeeper on the other hand provides a service inasmuch as he provides his customers with a single venue to which they can come to purchase a diversity of goods. This is deemed to add value to the goods he sells.
Like this eh?
https://www.youtube.com/watch?v=TGdm1k836zE
Money creation out of debt (usury) is the problem, not interest in itself.
The word “usury” refers to the charging of interest, not the lending of money. But this is just a technicality, I guess. However, money is not created out of debt, it is created out of nothing and then lent.
Creating money out of nothing is not a problem provided that creation is done by the government rather than the banks. The trouble with banks creating money is that the seigniorage (ie the difference between the face value of a monetary unit and the cost of producing it) is pocketed by private interests, viz the banks. Since money is a community mechanism it is better the seigniorage goes to the crown and used for the benefit of everybody. How would it be if, whenever I wanted to buy something, I could simply print the money that I needed to make the purchase. But is more or less precisely what the bank does when it wishes to make a loan.
Indeed much historical anti‑Semitism arose because Jewish culture regarded usury as an acceptable commercial practice, whereas Christians and Muslims did not.
I think that this bit may be wrong, the reason Jewish people did get into money lending in European countries was things like-
they were not allowed to own land
they did not allow usury except to non jews- ie jewish people did not approve of usury either. This makes sense as all three are Abrahamic Faiths.
The role of money lending in warfare in feudal societies was not trivial. Prior to Wallenstein’s taxation system the influence of money lenders was disproportionate, and resented by the enemies of those they supported. As allegiances shifted, former borrowers sometimes found it convenient to repudiate their loans, and more prudent to disguise this repudiation as a religious issue.
A modern instance is the German resentment of the Rothschild gift – a large sum of money given to the allies to accelerate the conclusion of World War One. This resentment was later exploited by the Nazis.
Nobody seems to mention the cost of opportunity lost.
Mr Filthy Capitalist Moneybags has money he can use to create goods/service but instead he loans it to another.
Mr Moneybags forgoes the earning potential of his money until it is repaid.
Can a smarty pants in here tell me why the interest is not the cost of opportunity lost to lender over the term of loan?
Because the capitalist wasn’t going to do anything with it anyway. That’s the nature of capitalists.
Opportunity cost is a hypothetical concept useful in comparing different uses of an asset such as money, but it is not a real cost. Try claiming it as a tax deduction sometime.
Thanks but both answers seem insufficient.
Draco simply assumes something without any evidence at all. Funny yes, but even though my prejudices would like me to believe it true, it is not helpful . I’m sure many in possession of capital do plan to use the it for productive endeavour (manufacturing, services etc)
Mikesh the opportunity lost cost is very real to the lender the second they forgo the earnings possible from productively using the money themselves. It is effectively the same as ceasing to operate whatever enterprise is under consideration.
Try reading The Entrepreneurial State. The only time the capitalists turn up is when they can make windfall profits without actually doing anything.
The only thing that removing interest does is make it so that accumulating money is worthless – just as it should be.
Nobody is denying that the payment of interest will encourage some to lend who might not otherwise do so, but the claim that there is some “cost” to the lender that justifies the practice of charging interest is rubbish.
@ Richard Christie . Please define the ‘opportunity’ that’s lost ?
Excellent Post Kieth Rankin
Hi Countryboy, a straightfoward example. You have 50,000. You plan to trade with it or set up a small manufacturing business and expect the either to return 20% over next 6 months. If instead, you loaned it to me at no interest you will have incurred an opportunity loss of $10,000 over the six months.
No interest = no motivation to lend.
That’s my understanding of the term, some pointy-head* may correct me on my terminology, maybe it applies to something else. Anyway the example illustrates a serious justificaion for the borrower offering a rate of interest to the lender.
*please make any correction straightforward. Although I can solve 2nd order differential equations and do Laplace transforms I often find economist-speak and it’s own peculiar brand of math almost incomprehensible.
Not a problem. The government can lend at 0% interest quite happily.
Takes the need for capitalists out of the equation and thus gets rid of the massive dead-weight loss that they represent.
Perhaps that is well and good in your proposed alternative system.
But I’m trying to explore the validity of this justification for interest (compensation for lost opportunity or return) in the current set up.
Why would we even bother? The current set up is a failure and trying to fix it won’t help.
“No interest = no motivation to lend.”
Lending is a service for which a bank can no doubt charge a fee.
OK. Seems to me that interest is a fee, one that is dependant on a variety of factors, the most dominant being the sum loaned and the term.
Interest is definitely not a fee. A fee is based on the administrative effort needed process and supervise the loan. This effort doesn’t change whereas interest rates do. How can a particular rate of interest be an appropriate reward for effort at one point in time, and a different rate appropriate for the same effort applied at a different point in time.
Nope, interest is nothing more than a scam. It allows people to get more without doing any actual work or, in fact, any production of wealth at all. Same goes for shareholders.
Many capitalists are parasites in drag just look at a number of NZ Businessman who purchased State Assets, they have never done an honest days work in their lives. The money was made by the stroke of the pen and we the taxpayers were the losers. MSM will tell you otherwise.
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