Saturday, January 26, 2013

Ban Interest!

One of the monetary ideas that regularly pops up in discussions is the idea that the charging of interest is destabilizing to the economy, and therefore interest should be banned.

Through my post regarding Wörgl at Mises, I was contacted via email by Bart Klein Ikink.  After sharing one or two emails, I asked him if I could use his emails in a post, to which he agreed.

I have wanted to explore this for similar reasons that I have explored Wörgl.  This is another monetary theory that seems to fly in the face of the nature of man, one that likely cannot be sustained without the introduction of force by a state actor.  It also seems faulty from a standpoint of economic efficiency.

With this in mind, I begin to explore this theory.  I don’t know how far I will dive into this subject beyond this one post.  I will caveat that I am following Mr. Ikink’s use of the term “money” although in most cases I believe his intent is “currency.”

I believe some of Mr. Ikink’s concerns to be legitimate in the context of the current system under central banking and the compounding of leverage this allows – in other words, in a system where far more credit is extended than would occur in a free market.  However, I disagree with his solutions (this shouldn’t be a surprise to regular readers).  I address his points in the context of a free-market – no government enforced central banking, and no government subsidies to banks in any form.  In other words, I do not intend to use the current system as the measuring stick, but a free-market system.

I have highlighted specific questions and criticisms I have of Mr. Ikink’s statements.  For there to truly be a productive dialogue I will expect specific replies to these, in the context of the highlighted text.  Most fundamentally, many of the highlights regard the issue of how such a system is to be implemented.  Will it be by force?  If so, this proposal fails on its face as centrally planned solutions can never be justified – neither for the means nor the ends.  If not implemented by force, how will human behavior be made to conform to this unnatural act?

From his email:

Under normal conditions the borrower is servant to the lender.

It is inappropriate to speak of a “servant” (with a negative connotation) when the relationship is voluntary.  Both the borrower and the lender are receiving some benefit in such a situation.

I think free money is more efficient if applied in the right way. If this is true then any argument is useless and Natural Money, which is a specific type of free money that includes a ban on charging interest, will become the dominant type of money in the future.

If your concept is truly more efficient, the market will discover this if left free.  But you don’t seem to advocate that this can come about in a market left free.  Who is to define “the right way”?  How would you propose to enforce “a ban on charging interest”? What if some choose to use a different way?

There are a few things to consider regarding Natural Money:

1. There is a holding fee on the money at a rate of 0.5% to 1.0% per month.

This is consistent with the theory of Silvio Gesell.

7. Because banks can only lend at 0% or lower, and because banks cannot create money, all loans must be made out of savings, and banks will choose the best borrowers with lowest risk profiles.

What if a borrower is willing to pay interest because he believes it is the best option in the given circumstance?  What if a bank will only lend to some borrowers with interest?  Would you stop the willing borrower and the willing lender?  By what means?

8. Corporations and projects that are risky will be financed with equity and not with loans… 

Why must such projects be financed with equity?  What if management and shareholders believe it is preferable to finance such a project with debt?  What if a bank is willing to lend?  How would you stop this?

…so business risks will be taken out of the financial system, and consequently there will be no financial crises.

There is nothing that can be done to take “business risks…out of the financial system,” unless you somehow plan to outlaw “loss” from “profit and loss.”  Do you plan to outlaw “loss”?  How?

As to “no financial crises,” I will come to this later.

There are two ways [to implement this system]:
1.       The public option: maybe there is a region, for example a small country or state in the US, that will make this type of money legal tender.

I made the point in my article regarding Wörgl, and will do so again here for completeness: I am supportive of decentralization, therefore am in favor of various experiments regarding money and credit.  However, if you lean on legal tender, you reintroduce the first steps of allowing force into the system.  Once this is allowed, be certain that those with political power will use it to their advantage.  In other words, back to the current system.  Will you lean on legal tender?

2. The private option: maybe it is possible to create a business proposal that is attractive to a group of corporations.

Absent the force of the state, this would be acceptable. 

From the blog post:

Capitalists call our roadmap to destruction freedom of choice.

Define what you mean by “capitalist.”  Is it what passes for corporate leaders today, making money at the trough of government subsidies and captured regulation?  Or is it entrepreneurs earning income in a free-market environment by providing goods and services desired by others?  If the former, it is not in an environment of “freedom of choice.”  If the latter, you are incorrect as freedom of choice can only occur in an environment without coercion, therefore without government subsidies and favoritism.  Therefore you must define your term.

Within the Capitalist economy we are free to choose which products to consume, but we are not free to choose for our own survival.

Again, you must define your use of the term “Capitalist.” 

It is absolutely the case that virtually all rational individuals choose their own survival and take actions that they believe to be consistent with this choice.  Explain how it is that individuals are not free to do so.  Get at the root.

Those who take measures to save the Earth will be outcompeted by others who do not take these measures.

What “measures to save the Earth” are you referring to?  Prices freely arrived at and profit and loss are the best tools available to man to ensure resources are used in the most efficient manner possible.  In other words, a truly free market is the best tool for those who advocate some form of environmental conservationism.  It is basic economics.  Can you explain why I might believe this, even if you disagree?

Money dictates our choices and this can be called a dictatorship of money.

Money is an inanimate object, unable to dictate anything.  It is a servant, not a master.  There can be no “dictatorship of money” and certainly so absent the force introduced by state power.  Individuals make choices.  Money is used to facilitate those choices and make possible the division of labor, upon which society as we know it rests.

Interest causes wealth to concentrate as the poor pay interest to the rich. Interest can be seen as a tax on poverty to the benefit of the rich.

Interest doesn’t cause wealth to concentrate.  Borrowing with interest (a voluntary action) might or might not – at the time the loan is made, it isn’t certain in which direction wealth will transfer, nor is it a given that one party will lose wealth to the other.  Both parties expect to benefit – to increase wealth – else they wouldn’t have entered into the transaction. 

No one forces another to borrow.  The poor are not obligated to pay interest if they do not borrow.  Therefore it cannot be called a tax.  Please explain your statement in this context, or explain why you reject these points.

Interest disrupts the flow of money in the economy and causes economic crises.

Interest does not “disrupt” the flow of money; it facilitates the flow of money.  Interest provides those with capital an incentive to lend it – unless you want to force a specific form of money (depreciating scrip) on everyone.  Are you suggesting force and no choice?

Therefore an interest based economy is inefficient. The following example demonstrates this and also that interest on money is unsustainable in the long run:

If something is “unsustainable” it will not be sustained.  If a borrower is unable to pay interest, the lender will not be paid.  It is this simple.  It is not complex.  Explain why the consequence of unpaid debt is any more traumatic than what I have described.

If someone brought a 1/10 oz gold coin to the bank in the year 1 AD, and the money remained there until the year 2000 AD, collecting a yearly interest of 4%, the amount of gold in the account would have been 3.6 * 10^31 kilogramme of gold weighing 6,000,000 times the complete mass of the Earth.

But this represents nothing other than your ability to compound numbers over an extended period of time.  It is a useless example for the real world.  You said yourself that this is not sustainable – it cannot happen – so what is your point?  Explain why you suggest that something that is unsustainable is sustainable.

If interest is charged on a limited scale or over a short timeframe then those problems do not surface.

Interest is charged over the period of a loan.  This could be from one day to several years, perhaps a few decades.  In the end, the borrower will either repay the lender or not.  If the borrower is unable to pay it becomes an ownership question (who has claim to what assets, based on the debt contract), not a fate-of-the-world question.  Explain why you see this otherwise.

Over time it is inescapable that it reduces large numbers of people to a state of servitude to the money lenders. This is a long term development that transcends the life span of a human.

Debt normally doesn’t transcend.  Most personal debts are discharged upon death – the heirs of someone who dies in debt are typically not obligated to repay those debts beyond the value of the assets in the estate. 

Interest is the main reason why a number of civilisations have failed and why Western civilisation is about to fail. Therefore all interest is usury and the current financial system is a usury financial system [+].

I think more civilizations have “failed” (to use your term) because the government-monopoly on money, credit and currency finally failed after decades or centuries of being abused. 

The reasons western civilizations are failing (to the extent this is true) are likely many and complex.  However, in the economic realm, I can point to one – central banking and the abandonment of at least some form of discipline provided by gold.

The superior efficiency of Natural Money can end the current world order that is based on usury banking. Natural Money is money with a holding fee (scrip money) combined with a ban on charging interest.

Who will enforce the ban?  How?

After the initial set up phase, the interest free currency should float against the national interest based currency in a free market.

A floating currency will be an improvement over the experiment at Wörgl.  And it will also prove the downfall of the depreciating currency.

Lending at 0% has not been tried. The free money currencies have not floated so their value could not rise.

You are fooling yourself if you think money that comes with a charge and cannot earn interest will appreciate against money that comes with no charge and in fact earns interest.  Would you value depreciating currency more than currency that held its nominal value? 

Try to imagine that the economy is a system like the human body [+]. All parts of the system need each other to operate properly. Try to imagine that money flowing in the economy is like blood flowing in the body. In this case it would not make sense that a kidney is saying to the liver: "This is my blood you may borrow it at interest." It also does not make sense for parts of the body to hoard blood because there might be no blood flowing in the future. Strangely enough economists think that this makes sense.

Your example does not describe in any way the functioning of a free-market economy or human action.  People are not automatons.  But to use your example, the kidney and liver have a common incentive to share blood.  Each organ does this out of self-interest, just as individual humans choose to cooperate with others out of individual self-interest.  By banning interest, do you propose to ban self-interest?  If not, then how will you ban interest?  

When interest on money is charged, money in the future is valued less than money now.

Money in the future will almost always be valued less than money in the present – in any economic world you can imagine.  This has nothing to do with interest being charged.

The following example demonstrates this [+]:

Suppose that a cheap house will last 33 years and that it will cost 200,000 Euro to build. The yearly cost will be 6,060 Euro (200,000 divided by 33). A more expensive house costs twice as much (400,000 Euro) but will last a hundred years. This house will cost only 4,000 Euro per year. For two thousand Euros per year less, it is possible to build a house that is not only more pleasant to live in, but will also cost less in energy use.

After going to the bank for a mortgage application the math changes, because the bank calculates interest. If the interest rate is 10% then the expensive house will not only cost 4,000 Euro per year on write-offs, but during the first year there will be an additional interest charge of 40,000.00 Euro (10% of 400,000.00 Euro).

The long lasting house now costs 44,000.00 Euro in the first year. The cheaper house now appears less expensive again. There is the yearly write off of 6,060.00 Euro but during the first year there is only 20,000.00 Euro in interest charges. Total costs for the first year are only 26,060 Euro. During the following years, lower interest charges still make the less durable house cheaper.

This example shows that without interest charges there is a tendency to select long-term solutions while with interest charges short-term solutions will be preferred.

The example is faulty.  Your example implies that resources are unlimited.  The question isn’t one of investing 400,000 currency units as opposed to investing 200,000 units.  The question is the resources that those units will acquire.  Very few people have enough currency units, no matter what invention of money you derive, to store up assets into the indefinite future.  Have enough resources been saved to spend twice as much on a house that will last three times as long?  Is tripling the life of the house the best choice one might have for his incremental 200,000 units?  This is the question.  You are stuck on currency units, when the issue is resources and the balancing of subjective needs.

Interest is an allowance for risk and therefore interest introduces risk in the financial system [+].

You have it backwards.  Interest is an allowance for risk” because there already is risk.  The risk exists before the interest, not because of it.

If there was no interest on money, debtors cannot borrow more than they are able to repay.

There is nothing about your theory that will disallow someone from borrowing more than he can pay.  What if his purpose for borrowing goes awry?  What if his income stream proves to be insufficient to pay?  Can you really say this is possible after you used as an example a 100 year interest-free loan for a house?  Can you be so certain of the future – for 100 years?

With Natural Money there will be less systemic risk in the financial system for the following reasons:

- A ban on charging interest will reduce the risk that lenders are willing to take.

True.  Because those with capital will hold their money more dear.  In fact, they likely won’t lend at all – unless you force them to use only depreciating currency.

- Debts cannot grow out of control because of interest charges.

This is false.  You are suggesting no-cost money.  Draw a simple supply and demand curve and see the conflicts inherent in your statement.  This is basic economics.  Are you suggesting that you have developed a theory that bypasses the most basic and almost universally accepted assumption of economics?

- The balance sheets of corporations and individuals will become less leveraged.

False.  See above.

- Risky projects will be financed with equity instead of loans.

Only if you introduce this requirement by force.

- The constant flow of money within the economy caused by the holding fee will reduce the risk of economic downturns.

Economic downturns are brought on by the cleansing of the mal-investments brought on by the prior expansionary money and credit schemes made possible by central banks.  Arguing for even cheaper credit does nothing to resolve this, and in fact it can easily be shown to exacerbate this. 

If you truly want to reduce the risk of economic downturns, advocate for a complete free-market in money, credit and banking, without government force and coercion.  No government support for any one scheme, no government regulations, no taxes on currency exchanges, taxes can be satisfied in any currency unit, etc.  From this, let a thousand experiments be tried and propose yours as one of them.  Find others of a like mind who will voluntarily cooperate with you.

That is my proposal!


  1. 1. There is a holding fee on the money at a rate of 0.5% to 1.0% per month.

    gpond: Who receives this fee? Is placing a holding fee on money held, not equivalent to making ALL money usurious? Instead of a fee (interest) on borrowed money, we are to prefer a periodic fee (interest) on ALL cash balances?

    Furthermore, maintaining a cash balance is prudence itself, because the future is inherently uncertain. The size of this cash balance will vary depending upon the upcoming needs that are perceived by the individual, as well as the perception that not all upcoming needs are perceivable (uncertainty).

    If this prudence is punished, will not imprudence be encouraged? Will this imprudence make the "system" less risky; less prone to crisis?

    BM, I will enjoy reading all that you write on this subject, but I am struck with the idea that each of us will be wasting our time…

    1. "Who receives this fee? Is placing a holding fee on money held, not equivalent to making ALL money usurious? Instead of a fee (interest) on borrowed money, we are to prefer a periodic fee (interest) on ALL cash balances?"

      Yes, this is one of the inconsistencies. I recall someone once promoting the JAK bank where interest is neither given or received. But there were bank fees that ended in the same result (not demurrage, but just straight bank fees).

      I decided to pursue this because I want to make my understanding and critique more precise. I find that a good way to do it is to write out my thoughts.

      Beyond this, I am virtually certain of the outcome. But this will be fully dependent on the ability of Mr. Ikink to respond directly to my questions and concerns.

      As you know, advocates of such a system could not do this at DB when probed by DB or any number of the feed backers. I hold higher hope for Mr. Ikink.

    2. gpond

      I re-read your comment in the context of the text you quoted. This really is a good point and I wish I thought to make it myself in the article.

      Basically, instead of those who borrow paying interest, it will be those who save that pay interest (in another form, but the end result is the same).

      It truly is upside down, especially when considering that wealth increases from savings, not from spending.

      Thank you for this.

  2. I have answered most questions asked and you can find the answers here:

    Jonatan intends to reply on those answers within a few days.

    1. Here is my reply: