An issue that has to be resolved in any discussion of money, is whether it is legitimate for Christians to charge interest. For many centuries prior to the Reformation, Christians considered that charging interest was wrong; it was referred to as usury. This was the result of a misunderstanding of the Old Testament teaching on interest. John Calvin resolved this problem by clarifying the difference between poor loans and business loans.
The Old Testament prohibits interest on loans to the poor, because they are a form of charity (Ex 22:24; Lev 25: 35-37). The poor person will have to use the money borrowed for consumption goods so there will be no profit, which can be used to pay interest. This prohibition on interest was erroneously extended by Christians to business loans (Matt 25:27). Interest on commercial loans for use in trade or business is not forbidden.
The legitimacy of interest is an important principle to establish because interest is essential to economic growth. Economic growth can only take place if the economy's capital (stock of productive plant and equipment) is built up. This can only happen if someone in the economy saves, and interest is essential for saving to occur.
Consider a subsistence fisherman. He has no equipment, but he catches enough fish with his bare hands to survive, by working most of the day. He could improve his fishing by making some nets or a boat, but while he was doing this he would not have time to fish so he would go hungry. If he can save a little bit of fish each day, he can build up a stock of fish. Then he can live on saved fish while he builds a net and boat. With the net and boat (his capital) he can catch enough fish to live on in half a day. This means that he will only need to fish every second day. He can use the other day to make better equipment or other things that will improve his lifestyle. Or he could fish every day, and trade the surplus with other people for other things that he needs. Getting some capital equipment improves the quality of his life. However to obtain the capital equipment, he had to make some saving first. The reward for saving was the stream of extra income he was able to produce with his capital. This is the equivalent of interest.
The same principle applies in any economy. If all money is spent on consumption goods, there will be no money available to buy capital goods. For money to be available to buy capital goods some people have to forgo consumption. They can either buy capital goods themselves and start a business, or they can deposit the money in a bank. The bank can lend the money to a business to buy capital goods. The reward for forgoing consumption is the profit that the business makes, or the interest that will be earned on the savings account.
If it is not possible to pay interest on a loan, there will be no incentive to save. The only people who would save are those who can start business themselves. Most others would just consume all they earn. The resulting shortage of capital would limit the growth that takes place in the economy.
The price of capital goods will adjust so that their supply is equal to the value of savings available for purchasing them. For example if people decide to save more, some of the consumer goods being produced will no longer be required. The price of consumer goods will fall. This will encourage producers to produce capital goods. These can be purchased with loans that will be made available through the additional deposits in savings accounts.
The interest rate will also rise and fall to clear the markets. Interest has three components
- inflation premium
- risk premium
- time preference factor
Each of these will be explained separately in the following sections.
1. Inflation premium
Part of the interest rate is an inflation premium to compensate the lender for any future inflation. If there is inflation in the economy, then the borrower will pay back the loan in dollars that are now worth less than the dollars that were originally lent. To compensate for this the interest rate charged will include an inflation premium. The higher the rate of inflation, the greater the inflation premium will be.
In New Zealand, the inflation premium has been quite large because of very high inflation rates in the recent past. In a Christian society with sound money, the inflation will be rare so the inflation premium will be very small.
2. Risk Premium
When a person lends money through a bank there is a risk that the loan will go sour. The business venture may fail. The borrower may prove to be dishonest. A premium will be built into the interest rate to compensate the lender for this risk. In a Christian society, the risk premium will be quite small. Dishonesty should be rare. If borrowers have prayed about their ventures, they should not go wrong. However, there will always be some situations that go wrong, so there will always be a small risk premium.
3. Time Preference
The time preference factor is the most important component of the interest rate. Interest is the price that is paid to people who postpone the purchase of goods and services to which they have an entitlement. We live in the present, so people will always prefer something in the present to something in the future. The present is always more certain than the future. Goods available in the present will be worth more than those available in the future. The interest rate reflects this difference. Interest is the compensation that savers get for postponing their purchases until a later date.
Looking at it the other way round, it is the price borrowers pay for being able to make purchases sooner than they would normally be able.
The level of interest rates will depend on the value that people place on the future. If people have confidence in the future, they will not need much compensation for saving, so interest rates will be low. On the other hand if people have no hope for the future, the interest rates will be high. A future orientation will reduce interest rates; a present orientation will cause high interest rates.
Real Interest Rates
The main cause of fluctuation in interest rates is the inflation premium. The real interest rate is the nominal interest rate after excluding the inflation premium. From the 17th century through until about 1980, real interest rates in the large industrial economics of the world hovered around 3 percent with very little variation. This was reflected in the interest rate on Post Office Savings Bank accounts, which remained at 3 percent for year after year. Fixed interest rate mortgages were available for 6 percent interest for many years.
High interest rates have been observed in earlier times. In medieval times real interest rates in England reached 10 percent. Studies of ancient Rome, ancient Greece and medieval India have uncovered evidence of real rates of between 6 to 12 percent. These were times when confidence in the future was low, so naturally interest rates were high.
The reasons for the long period of low interest rates during the last four centuries are not widely understood. The development of legal systems and security were important in reducing the risk premium. However the main reason was the change in values that was brought about by the reformation. The reformation, largely through the influence of Calvin, turned people to task of building the Kingdom of God. They believed that God was working out his purpose and that his Kingdom would be established through time. This led to a radical change in the prevailing attitude to time. Time became an instrument by which dominion over the world could be established. Faith in God produced a tremendous hope for the future.
Wherever, Calvinism and Puritanism took root, Christian hope and a vision of the Kingdom of God produced a future orientation, which brought about a sharp fall in interest rates. The low interest rates allowed a rapid accumulation of capital goods, which produced the longest period of economic growth, that the world has known. The changing concept of time allowed western civilisation to break a millennium-old barrier and begin a period of exponential economic growth.
In the 16th century, Spain and Portugal became the wealthiest of nations through an inflow of gold from the Americas. However, within a hundred years, it was dissipated, as a result of the present orientation of these countries. The imports of gold caused inflation, which pushed up interest rates. The wealth moved to Holland, Scotland, England, and later the United States, where a future orientation made the capital more productive.
The future orientation, which had its origins in Calvin's theology, was later secularised during the enlightenment. The development of science and technology, which the Reformation fostered, produced a humanistic hope in the future. This humanistic hope helped maintain the future orientation that began with the reformation and helped it spread to non-Christian nations like Japan. However, during the 1960's and 1970s this humanistic hope finally collapsed, overcome by the despair of war, famine and environmental disaster. Without Christian faith to sustain it, this hope was unrealistic anyway
In the last two decades there has been a radical change in the world view of the western world. One aspect of this has been a change from a future to a present orientation. The focus now is on instant gratification in sex, drugs and consumption of goods and services. Hope has died and the future is now a source of fear and dread. Music, literature, television and films have become a way of escaping from the future rather than a tool for establishing the Kingdom.
Without faith in God there can be no hope, so the humanistic hope was an aberration. It was inconsistent with the humanistic world view. Sinful man cannot be a source of hope. Society is now living in a way that is more consistent with its presuppositions. As the Apostle Paul says, if there is no resurrection, "Let us eat, drink and be merry because tomorrow we die". This present orientation has to be the attitude of any non-Christian society, so saving for the future will not be very popular. Very high interest rates will be needed to persuade people to save.
Another factor, which has contributed to this present orientation, has been the social welfare state. In earlier times people had to save to provide for themselves in there old age or times of sickness or accidents. The modern state promises to take care of people from the cradle to the grave so there is no need to worry or save about the future. This has added to the present orientation, which will destroy a nations wealth, and undermine the ability of the state to provide the security it promised.
Since about 1980, real interest rates have increased throughout the world to 5 or 6 percent (in New Zealand they are seven or eight percent). This is consistent with the present orientation that has spread throughout the world. Nominal interest rates are currently, the lowest that they have been years. However, low inflation (sometimes negative), means that real interest rates are still very high.
I expect that real interest rates will rise further as the present orientation takes hold further. High interest rates make capital accumulation difficult. We will see capital being destroyed to finance consumption. This will cause a decrease in wealth and end to economic growth. The risk premium will also increase, as dishonesty becomes more common at all levels of society.
The long term economic growth experienced by Western civilisation since the Reformation was unique. Although it was copied in many modern cultures, it was rooted in a particular set of values, which had their source in Christianity. The conditions necessary for economic growth will not return, until there is a Return to faith in God as a result of a revival of Christianity.
Controlling Interest Rates
The responsibility of governments to set interest rates is just taken for granted in the modern world. All modern countries have a central bank that sets the base rate of interest. What most people do not realise is that this is a very modern practice. For most of history, central banks did not exist, so do we need them now? (During medieval times, the church tried to control interest rates by prohibiting usury, but that was a disaster).
The more important question (normative economics) is whether it is morally right for the government to set interest rates. The answer to this question is obvious, if we think about other things we own. If the government tried to make me sell my house for $70,000, I would be very upset. If they set the price at which I could sell my car at $1000, I would be sure that was wrong.
Most people would prefer to put their house or car on the market and see what they could get. By forcing me to sell at a set price, the government is robbing me of the difference between that price and what I could get on the market. By setting the price higher than I could get on the market, it is robbing the purchaser of the difference between the set price and what I would be prepared to sell it for.
The ability to set prices, allows the government to rob one person for the benefit of another. Setting prices is a form of theft.
By setting the price of money, the government is stealing from some people, for the benefit of others. By setting the price of the future, the government is robbing some people of part of their future to benefit others. Those who benefit are the bankers and financiers who get access to cheap money. Those who suffer are the people on fixed incomes who cannot adjust for the resulting inflation. Government controlled interest rates are just another form of theft.
The modern practice of authorising a central bank to set interests is morally wrong, so it should be opposed by Christians.
All loans should be short term. A Christian should not borrow more than they can repay in seven years (Deut. 15:1-3; Ps 37:21). The future is the Lords. He will not allow us to commit ourselves beyond seven years.
The reason for this principle is that no one except God knows the future. Since we do not know the future we should not make contracts which bind our future. God says the maximum time that we can bind ourselves for is seven years (Deut 15:1). Beyond that length of time, we do not know what our situation will be. Therefore, we cannot be certain that we would be able to repay a loan. We should not make commitments that we may not be able to keep. We do not know if we will be living or what our situation will be in thirty years time. God has decreed that seven years is the maximum length of commitment that we should make. All loans and deposits should have a term of less than seven years.
Even if the seven year limit on loans is not accepted, this will still come about, because the matching rule will push long-term interest rates up to high for people to risk taking long term loans.
The use of long term mortgages to buy homes is wrong. In recent years it has become possible and common for people to borrow up to ninety percent of the purchase price of a home on a mortgage. This has the effect of pushing up the price of dwellings dramatically. The result is that households in total are no better off. They still hold the same stock of housing, but they now have tremendous debt. The consequence is that they will pay for their houses two or three times over in interest. This shifts tremendous wealth to the banks. If borrowing such large amounts were unacceptable, the price of houses would fall dramatically. Households would be better of, and they would still have the same total number of dwellings.
In a Christian society most loans should be taken out for business purposes. Christians should be discouraged from borrowing to buy consumption goods. Christians should always stay out of debt. They should only go into debt as a last desperate solution to poverty. The reason is that a borrower is a slave of the lender (Prov 22:7). A lender is able to control those who are in debt to them. God wants his people to be free to obey him. If they are in debt they do not have that freedom.
Borrowing to buy capital goods, which are productive, is legitimate for Christian businesses. These will produce a Return to the borrower, which will cover the cost of the interest. Christians should only borrow to get started. As God blesses them they should quickly get debt free, so that they are free to serve God. Further development of the business should be done out of retained profits. No debt should remain outstanding except the continuing debt of loving one another (Rom 13:8). If they are obeying God, then Christians should be in a position where they can lend to others. They will be the head and not the tail (Deut 28:11-13).
International Capital Flows
Large flows of capital can be a cause of serious instability in the modern economy. Foreign investors will often buy up a particular national currency forcing it to appreciate. When they sell out, the currency depreciates quickly. This instability can undermine the local economy.
There is a simple solution to this problem. Capital can only flow out of a country if it has already flowed in. It can only flow into a country, if people in that country are willing to sell assets or to borrow from overseas. If the laws of a country enforce the matching principle for loans, then these foreign speculators will not be interested making loans to that country. If there is a strong future orientation, short-interest rates will very low. There would not be much demand for short-term loans. Foreign speculators will not be interested in long-term investments, as it would be too hard to get their money out again.
The best protection for a local economy is to have a high level of savings. If there is plenty of capital within a country, there will be no need for foreign investors. Interest rates will be low, so the country will not be appealing for them. God has promised the nation that obeys him that they will lend to many nations and borrow from none. "The Lord will make you the head, not the tail (Deut 28:12,13). This is the key to independence from destabilising capital flows.
Short Term Loans
During the Credit Crunch, credit markets are dried up all over the world. One of the worst problem areas was the commercial paper market, which is the source of operating funding for many banks and large corporation. The important question is seldom asked. Why were so many businesses, so dependent on commercial paper? The reason is very illuminating.
Short term interest rates are generally lower than longer term rates, because lenders demand higher returns to compensate them for the greater risk involved in tying up their money for a long time. Businesses and banks have taken advantage by substituting towards raising a considerable part of their funding on a short-term basis.
Banks raised funding on the 90-day bill market to fund 15 year mortgages. Businesses raised funding using short-term commercial paper to fund equipment with a productive life of up to ten years. This was profitable while short-term funding was abundant, but it was very risky. Short term funding is cheaper, but it is risky to use it to fund long-term liabilities.
Borrowing short term to fund long-term liabilities is quite risky. If the short-term credit market dries up, the business or bank will be in trouble. They might be unable to roll over the credit, or they might have to pay very high interest rates to do it. That is what has happened in recent years. Many businesses and banks borrowed short term to get lower interest rates suddenly found that they could not roll over their short term loans.
Security for Loans
When a loan is made something can be taken as collateral for the loan (Ex 22:25,26). It may be a mortgage over land or a lien over other goods. The collateral increases the security of the lender. It also limits the amount of borrowing, by preventing multiple indebtedness.
A poor person may give the lender a good to hold as a pledge that the loan will be repaid. However, capital goods, which are needed to produce a living, must not be taken as a pledge (Deut.24:6).
Christians should be thrifty. They should build up their capital (productive assets). The person who consumes all that he earns become poor (Prov 14:4; 21:29). Ideally, Christians should not be in debt at all (Deut 15:4-6). As God blesses them they should be quickly able to repay all loans. Normally, they will be debt free. Long term indebtedness is a sign that God's blessing has been lost, through failure to trust him or obey his Word.
Keynes said savings are bad, as they remove aggregate demand. He was seriously wrong. The problem was that during the depression, people did not want to spend their money. Due to the insecurity of the banking system and inflation there was no mechanism for putting savings into productive investments. So people had to put their money under their mattresses.
In a Christian society, the main source of funds for lending would be people saving for retirement. Savings for unforeseen circumstances, such as sickness, accident, and death, etc., would also be important. Some type of insurance where the risk is spread may also develop to provide better protection, by sharing the risk of this type of disaster.
For Christians lending at interest is a second-best option, as they have no control over what the banker does with their money. It could be used to build a brewery or a brothel. Christians should put their surplus funds into enterprises that will be productive for the Kingdom of God. They will then have control over what is done with their money (II Cor 6:14-15). They can ensure it is used for the glory of the Kingdom.
Storing wealth for a long time in a place where it will be safe is very difficult.
Do not store up for yourselves treasures on earth, where moth and rust destroy, and where thieves break in and steal (Matt 6:19).
Most forms of wealth can be destroyed by moths and rust. Gold is quite safe, as it does not rust, but it is easily stolen buy thieves.
A person who stores his wealth in gold for several years gets back what he started with. No interest is earned.
Many people need to save for their future. Young people save to buy a house. Older people save for their old age. They will be more concerned about security than interest. Most savers will be happy, if they can get their savings back when they need them, with none being lost. These people do not need interest to make them save.
They will need insurance in some form, to deal with the risk of the bank failing or the borrower defaulting. This insurance could be paid for with a fixed fee, or by adding to a risk premium to the interest rate.
In a well functioning economy, inflation might fall to zero. A sound banking system would eliminate inflation, so savers would not need an inflation premium to compensate them for the rampages of rising prices. If investment in capital makes business more efficient, then prices should gradually fall over time. Money in a savings account will be worth more when it is withdrawn than it was when first saved. The real interest rate will be positive, even if the nominal interest rate is zero. Savings will bring a return without positive interest.
We should allow interest rates to be decided by the free market. If funding is scarce, interest rates will rise. If funds are abundant, interest rates will decline. If society has a positive attitude to the future, interest rates should decline to zero.
High interest rates are the sign of a sick culture.
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