Tuesday, 22 February 2011

The Injustice of Usury

Since the union between David Cameron and Nick Clegg was formed last year, we have had a series of austerity measures forced upon us, including reforms to the funding of Higher Education in the UK in an attempt to tackle our huge national debt. Despite the angry protests of student bodies, MPs voted in favour of such reforms. With much of the dust now settled from the initial uproar, Aaron Porter has promised a further wave of demonstrations.[1] My previous articles have called for students to be holistic in their approach to protesting. They should avoid focussing solely on the issue of student debt and instead initiate a debate on our current debt-based economic system, which has not only caused great distress to students and the wider British public, but has also been the source of immense suffering throughout the less-economically developed World. 

The Evolution of Interest
By examining the historical perspectives of usury, it becomes apparent that usury was traditionally viewed as an evil act. Plato regarded it as a way in which the rich could exploit the poor, whilst Aristotle taught that money should only ‘be used in exchange and not increased through interest’.  
The practice of usury has also been condemned by all three of the Abrahamic faiths. During the Council of Nicea in 325 AD the Church was pressurised into compromising on many key principles, however the one issue they remained united on was the sinful nature of usury.[2] As history progressed, a continual struggle ensued between the merchants who wanted to profit from usury and the Church. Key developments in the ‘legalisation’ of usury include the development of the contractum trinius, which consisted of three contracts, each of which when taken alone bypass the usury provisions, but when taken together give the net result of a usurious transaction.[3] Later on, Hispanus created the idea of a lender charging the borrower a fee for any late repayments on a usury-free loan as a means of compensation to the lender. This charge later became known as ‘inter esse’[4] (from the Latin for ‘that which is in between’), and it is from this term that we derive the term ‘interest’. As ‘inter esse’ gained popularity, it was later argued that it should be charged from the outset of a loan, and not just when a late repayment was made. By the 15th Century, King Henry VIII had set a cap on interest at a rate of 10%; anything greater than this was deemed to be usury. The Church remained silent on the practice, and by the early 20th century, interest was finally accepted by the Church.[5]
The prohibitions of usury can also be found in the faiths of Judaism and Islam. 
‘If you advance money to any poor man amongst my people, you are not to act like a money lender; you must not exact usury from him.’[6]
‘O you who believe, fear God and give up what remains of your claims of usury if you are truly believers. If you do not, then take notice of war from God and His apostle.’[7]
It is apparent that practicing usury has been despised throughout the ages and great efforts have been made to legalise a process which many believed to be wicked. Philosophers and religious leaders alike saw the harms of charging interest and were outspoken in their condemnation of such a practice. Despite this, we seem to have reached a situation where charging interest is deemed to be perfectly acceptable. Perhaps this is due to a combination of our unawareness of the severity of evil with which it was once perceived, along with the lack of knowledge on the alternatives. 
Is charging Interest really fair?
In order to examine the fairness of charging interest, let us take the example of a person who wishes to start a small business but doesn’t have the capital to do so. He approaches a rich merchant who offers to lend him the capital at a given rate of interest. The lender naturally will have some concern as to whether or not his loan can eventually be repaid in full, due to the uncertainty of whether the business will make a net profit or loss. Therefore the lender will also look to ‘secure’ the loan prior to dispensing it. This is done through the existing assets of the borrower, otherwise known as ‘collateral’, which the lender can take possession of should the borrower default on the loan. 
The above example is a basic transaction which would be familiar to most of us as a perfectly acceptable way of doing business. However, how can it possibly be fair that the rich merchant profits regardless of whether the small business makes a profit or a loss? Surely if the merchant is providing capital to the business, it can only be termed a wholly fair system if the merchant too shared any profits or losses that might result? Furthermore, by setting a requirement for ‘collateral’, only those who have a reasonable level of assets will qualify for such a loan. In other words, the rich have the opportunity to become richer, whilst the poorer individuals who lack assets struggle to demonstrate collateral, are left with fewer opportunities to build on their wealth. From the lender’s perspective, he is essentially more concerned with finding ways of ensuring he does not lose his money, and whilst this is perfectly acceptable, he uses the abundance of his wealth as a means to exploit the borrower by placing conditions on the loan which only work in the lender’s favour.
Perhaps one might argue that in this particular example the merchant is well within his right to charge interest on his loan, as he is giving up the ‘pleasure’ he could have had with his money. There are a couple of issues with this argument. Firstly, how much ‘pleasure’ would a billionaire really sacrifice if he were to lend a few thousand pounds? Would charging interest on this really ‘compensate’ him for the ‘pleasure’ he is losing out on with that money? Secondly, let us look away from the example of the merchant, and examine the situation today where banks lend money to small businesses. My previous article demonstrated how banks operate on a fractional reserve, giving them the ability to create money out of nothing. Therefore, is it really ethical practice for banks to charge interest on money as a compensation for ‘pleasure’ when in reality the lent money doesn’t tangibly exist?
A potentially more robust justification for the charging of interest lies in the argument that the lender is ‘protecting’ the purchasing power of his money. The purchasing power of £100 in the 1970s was far greater than what it would be today as a result of inflation, and based upon this, lenders charge a fee (interest) to protect against this. However, this still doesn’t explain why banks should be allowed to charge such a ‘protection fee’ on money which they have created out of thin air. In addition, suppose one accepts the charging of interest as a protection against inflation, how does this justify banks charging an interest rate which exceeds the expected level of inflation? If banks charge interest as a protection against inflation, perhaps it is worth examining the causes of inflation. 
Inflation of the price of goods will usually occur when there is abundance in the supply of money, e.g. if the government were to print and distribute a huge number of bank notes into circulation, the price of goods would rise accordingly. An extreme example of this can be seen in the history of Germany between the two world wars, where the price of goods often doubled within a matter of a few hours due to hyperinflation. By 1923, the cost of a loaf of bread had risen to 200 billion deutschmarks, and a principle contributory factor to this hyperinflation was the wreckless printing of state money.[8]
However, the printing press alone cannot be blamed for inflation. My previous article gave a brief insight into the way banks have the ability to create money out of nothing. The graph below, taken from the IMF statistics yearbook in 2000[9], demonstrates that the proportion of money in circulation which is created by the banks through fractional reserve banking(Proxy M2) is far greater than the proportion of state money, and this proportion seems to rise at an exponential rate. Therefore, the principle cause of the inflation we see today is as a result of money created by the bank. If one considers the interest repayments on this created money, we then begin to get an understanding on the reasons why we have such a huge collective national debt.     
On closer inspection of the above graph, a sharp rise in the proportion of bank money is seen to occur during the 1980s. This reflects some key changes in the UK banking sector, where banks which previously had operated on a reserve ratio 10% were now able to work on a ratio as low as 0.5%. Operating on lower reserves allowed the banks to produce more money for the purpose of lending, and thus, it seeks to explain the huge boom seen in house prices during this period. Whilst homeowners at the time were rejoicing at their gains, we have now reached a situation today where one has no option but to submerge themselves into vast amounts of debt if they want to be a homeowner, making the task of getting onto the property ladder a huge challenge.
Comparing the parallels from the previous generation of to that of the upcoming generation today; the preceding generation were paid to go university and had the opportunity to make huge returns in their acquisition of property on graduating, however today students are not only being asked to pay for their education, but in addition they do not have the ability to get onto the property ladder upon graduation let alone benefit from it. It is no surprise therefore, that Aaron Porter talks about generation inequality. However, what Mr Porter must realise is that it isn’t the previous generation who are to blame at large, but rather the people who tinkered with economic policy primarily for their own benefit. 
The Effects of Leverage
Our current system encourages people to borrow as much as they possibly can. If one can make £20 pounds of profit through borrowing £100, then why not borrow £100,000,000 so that he can make £20,000,000of profit? 
Such a mentality once again illustrates why it is only those with huge amounts of collateral who are capable of profiting from such an interest based system. The small businesses are simply being wiped away by the huge multinational corporations. 
A trip down the local high street might include visiting clothing shops such as Burton, Dorothy Perkins, Topshop and Miss Selfridge. At first glance it all appears to be healthy competition within the clothing retail industry, however on closer examination it becomes apparent that all these chains are actually owned by the same group, Arcadia Group Ltd.
The resulting effect of this is that the small business has no other option but to join hands with the large multinational companies as they simply cannot compete with them. Therefore we have now lost the variety and fairness which once existed in the local high street. In addition, the nature of such an economic system means large firms must always factor in the cost of borrowing to their total income, and so in maximising profit the firm is likely to sacrifice on quality, which eventually affects the consumer. 
A prime example can be found in the building industry, where the trend has become for huge building firms to acquire large amounts of land and erect poor quality housing on them purely for the sake of profit. The shoddy construction of these new homes made from plasterboard make no comparison to the quality of solid brick Victorian and Edwardian houses in the property market. 
Yet another tactic used by the large multinational companies to maximise their profits is to shift the production of their goods to poorer countries, where goods can be produced incredibly cheaply due to the cost of labour and also without the constraints on health and safety of workers. The goods produced can then be sold at high prices in more affluent countries, with the company taking the vast majority of profits. 
A principle failure in our economic system is illustrated here; that the multiple opportunities to create profit only exist to a small minority of the population, frequently at the expense of those who are less fortunate.  

The Effects of Debt on the Less Economically Developed Countries
The current economic crisis and continual talk about the level of our national debt has led to much anger amongst the people of Britain. This anger stems from the fact that the public at large are being asked to take the burden of this debt through austerity measures, such as the significant increases in tuition fees. 
Perhaps this realisation should put us in a place where we can empathise with the people of those countries which are less economically developed and have much higher levels of debt than we do. The effects of debt in those countries however, are far more profound than what we face:
“Relieved of their annual debt repayments, the severely indebted countries could use the funds for investments that in Africa alone would save the lives of about 21 million children by 2000 and provide 90 million girls and women with access to basic education”[10]
The poorer nations are coerced into debt, as they are told that by taking huge loans and investing wisely, they will be able to repay debts and make profit which they can use in bettering their economy. The reality is far from this idealistic view, and the information provided to us by the UNDP development report shows the profound effect that debt repayment alone has had in poorer countries. 
Perhaps one may argue that it is the failure and corruption of the leaders of these countries to use the loans from the IMF and the World Bank in a shrewd manner, which has lead to spiralling levels of debt in the less economically developed nations. Whilst there may be an element of truth to this, the sole blame cannot be placed on this factor alone. Surely one cannot simply label every single poor country as ‘corrupt’, and even if this were the case, why would the World Bank and IMF supply loans to people who are known for corruption? There is no doubt that large sums of money are required by these nations to bring them to a position where they can be self sustainable, and the resulting interest repayments will always be huge as a result. Before accusing the leaders of poorer countries of corruption, perhaps one should also look at the terms upon which loans are issued to these countries:
‘There is a very broad consensus among African governments that the IMF and World Bank terms are often harsh and unsuitable, generating severely adverse effects on the overall economies of these countries especially with regard to agriculture, manufacture and foreign trade’[11]
Some of us may wonder why these countries remain in such a poor economic state, despite the efforts of the public in richer countries, ranging from ‘Live Aid’ concerts and annual television appeals. The unfortunate reality is that the money given to these poorer nations in charity primarily goes to servicing their debts. 
‘When charity pop concerts for Africa are held in London or New York, the tens of millions raised are typically enough to pay the continent’s interest bill for a few hours. In 1999, the developing countries excluding the Eastern block were more than $2,030 billion in debt to the developed world’[12]
‘The development institutions trumpet their aid to the world, to show that something is being done. But what is given with one hand, is taken back many times over with the other. According to the World Bank, in 1999 Angola received $261m in aid but paid $1144m in debt service, Cameroon received $190m in aid but paid $549m in debt service, Kenya received $195m in aid but paid $716m in debt service, and Vietnam received 257m in aid but paid 1410m in debt service’[13]
The reality of the situation is that the vast majority of revenue which the governments of poorer nations receive goes towards the repayment of its debt. Governments of these countries will look for any means possible to try and gain revenue to repay their debts. Frequently, this is done at the expense of the environment. The table below[14] illustrates the ranking of some countries for their rate of deforestation, and compares this to their ranking for foreign debt during the period from 1990-2005:
Ranking for Deforestation
Ranking for foreign debt
In addition to this, the governments of these countries are forced to divert the revenue they make away from areas of need such as health and education, and towards the servicing of foreign loans. When taking all these factors together one must question whether the World Bank and IMF really has the interests of these countries at heart, or whether they are looking at their own interests first. Upon reflection, the words of Plato describing interest as a vehicle for the rich to exploit the poor resonate. 
In conclusion, our current banking method is not wholly fair; it is a system which favours the rich and denies the poor, with the poorest experiencing the worst of its effects. Earlier in the week, Mr Porter promised that he ‘wants to push the arguments beyond tuition fees’ and that ‘protests must be about wider issues’. One hopes that the student community has now realised that the issues we face are far deeper than one merely of tuition fee hikes.

1] Sean Coughlin, BBC News Website, http://www.bbc.co.uk/news/education-12266765, viewed on 26/1/2011
[2] Tarek El-Diwany. The Problem With Interest. Second Edition. Kreatoc Ltd, London 2003. p23. 
[3] J.F Chown. A History of Money 1994. p121
[4] John Noonan. The Scholastic Enquiry into Usury. Harvard University Press 1957. 
[5] Tarek El-Diwany. The Problem With Interest. Second Edition. Kreatoc Ltd, London 2003. p24. 
[6] Exodus 22:25
[7]Quran 2:278
[8] The Nightmare German Inflation. USA Gold. http://www.usagold.com/germannightmare.html. Viewed on 26/11/2011
[9] Tarek El Diwany, Bank Lending and Property Prices, http://www.islamic-finance.com/item105_f.htm. Viewed on 26/1/2011
[10] UNDP Human Development Report 1997, p. 93
[11] Conference of the Institute for African Alternatives, Onimode, B. [ed.], The IMF, the World Bank and African Debt, Zed Books, 1989.
[12] Global Development Finance, 2001
[13] Global Development Finance, 2001
[14] Adapted from: Tarek El-Diwany. Why We Are All In Debt. http://www.youtube.com/watch?v=57CRUjOSuDo&feature=related. Viewed on 26/11/2011

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