Wednesday, October 17, 2007

Usury Vs Just Interest

Most religions and many old-timey social theorists condemn "Usury" in one form or another. Most people believe that Usury entails any charging of interest on loans. If this practice were ended, there would probably be no loans at all, given that the value of money today is greater than the value of money tomorrow.
Of course as an anarchist, I believe that any voluntary agreement between two people is acceptable, provided that violence and deception is not involved. But I think I see a difference between Usury and a free market conception of interest.
The difference is in what is being loaned.
Rather than go into the details of what I consider Usury myself, I'll point out FSK's pretty thorough analysis of the compound interest trap here.
The money shot:
Each loan has the effect of decreasing the number of dollars in circulation, because the payments always are more than the principal*. What would happen if all the banks got together and said "let's collude and offer no more new loans"**? As loans were repaid, there would be fewer and fewer dollars in circulation. Prices would drop. Some people would be unable to pay off their loans. The banks would foreclose, taking possession of real assets, even though the dollars they loaned out cost nothing to print.
* Though his case is not as apodictic as he makes it out to be, because the banks themselves need to circulate currency (through paying their employees and other business expenses). However, if they can make loans from thin air, they don't need to recirculate that much of the currency they receive in payments in order to stay in business.
** (this actually happened with a large number of farm loans at the beginning of the "Great Depression" - there was a literal memorandum sent telling banks to stop loaning and start liquidating after a certain date)

How would this be different in a free market? Whatever was loaned would have to exist as saved money... that is to say money already removed from circulation. It would not be entering and then leaving circulation. The interest rate would have to be less than the loanee thought they could gain through some sort of wealth production in the intervening time period, or they wouldn't take out the loan (precisely because they couldn't count on new money entering circulation and deflating their payments).
On top of this, banks(and other loaners) would be competing with each other to offer the lowest interest rate loans, there being no Federal Reserve to set interest rate floors or ceilings.

All of the interest paid back would come from money they earned somehow; even if they defaulted, the asset would merely be "bought" by the bank indirectly, with the use of the asset being what was loaned temporarily to the loanee.
All of the transactions that the loanee made to earn the money they are using to pay off the loan have increased the total supply of wealth in society... so even though money has technically been shifted around, the total purchasing power of money in circulation has increased, because otherwise people would stop taking loans out. There may be less dollars circulating, but each one would buy a lot more stuff. Denominations could be split infinitely, into cents, mills, micros, as necessary. (Imagine a world where steak dinners were priced in pico-dollars!)
To put it concisely, banks would not be able to funnel money/assets into their own pockets, because all loaned money would have to come from savings, directly or indirectly. Even though a form of fractional reserve banking would be possible, the rate at which it could occur would be severely limited by the risk of bank runs. It would probably fall to a rate equal to a warehousing fee for other items. At that rate, there wouldn't be any banks solvent enough to destroy each other, and the odds of everyone demanding their money at once would be almost nil, because they wouldn't have put their money in the bank in the first place then.

Why couldn't free market banks "create" their own fiat money? Well, they could, but why would anyone use it? If moneys freely compete, eventually a certain money would be chosen as "sound" enough to be acceptable at most places. Most austrian economists agree that would be gold-based, but it really doesn't matter. What matters is that that would become the reserve, and if it inflated too much, something else would replace it.

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