The philosophy of debt – is interest ‘rational’?


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The philosophy of debt – is interest ‘rational’?

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We invited philosopher Alexander X. Douglas, lecturer in philosophy at the University of St. Andrews, to write about debt. The article below outlines his views on the philosophy of debt, not (necessarily) ours – please enjoy it as the interesting and fascinating read that it is.

The device that most frightened medieval and early modern debt-phobics was interest. Richard Price warned that if the national debt of Britain was allowed to grow at the standard rate of compound interest, its repayment would, within his lifetime, require a lump of gold many times larger than the Earth. The anti-usury homilies of St Gregory and St Basil (usury is lending at interest) tell stories of poor debtors losing any hope of bettering themselves to impossible interest bills. Gregory went as far as to call usury a form of murder, since somebody who has to turn over all her income in interest payments has nothing left to spend on herself and loses all ‘opportunity of life’.

Interest payments can help explain why the ancient author, Plutarch, reasoned as follows: ‘Have you money? Do not borrow, for you are not in need. Have you no money? Do not borrow, for you will not be able to pay.’ To the second part we might be tempted to reply: what if you invest the money you borrow? Then you might make more than you invested, and it isn’t true that you won’t be able to pay. But we should remember that interest rates in the ancient world were typically far beyond any reasonable return on investment.

Aristotle's argument

One of the earliest arguments against usury in the Western tradition is found in Aristotle’s Politics. The argument sounds strange to modern ears. The Greek word for interest is tokos, which means ‘offspring’. Aristotle argues that usury is unnatural because money doesn’t give birth. Start with ten rabbits and you might soon have eleven, since rabbits have a way of multiplying themselves. But lending ten gold pieces and asking for eleven in repayment expects of nature what it can’t provide. In the nineteenth century Jeremy Bentham’s Defence of Usury accused Aristotle of missing an obvious fact:

“A consideration that did not happen to present itself to that great philosopher, but which had it happened to present itself, might not have been altogether unworthy of his notice, is, that though a daric (the currency of the age) would not beget another daric, any more than it would a ram, or an ewe, yet for a daric which a man borrowed, he might get a ram and a couple of ewes, and that the ewes, were the ram left with them a certain time, would probably not be barren.”

It is uncharitable to suppose that Aristotle had not realised this. Possibly his criticism of usury was more metaphorical. Or, as I argued in my book, Aristotle’s point was really that the interest rates generally charged on money-loans vastly exceeded the productive powers of nature. No seeds purchased in the ancient world could generate crop yields worth ten of times their initial value. Thus no farmer who borrowed to buy seeds could hope to service the debt. But this means that much of the ancient literature against usury only applies to lending at high interest rates. Is there anything wrong with lending or borrowing at more reasonable rates?

The concept of ‘use’

In the medieval period we find attacks on the idea of lending at any rate of interest. An interesting argument is found in St Thomas Aquinas. ‘Usury’ literally means charging for the use of something. Thomas’ argument is that the most you can possibly use of anything is 100%, so the most you should ever be asked to repay is the whole amount that you borrowed. To borrow at 5% interest is to promise to repay 105% of the value of the loan. That is 5% more than you can possibly have used. The borrower who agrees to this is irrational and the lender who demands it is immoral.

The philosophical weakness of the argument lies in the slipperiness of the concept of ‘use’. What is the use of something? If I use £100, borrowed from you, to bet on the horses and then win £1,000, did I not get £1000 worth of use from your £100? Should I not at least share some of my winnings? Or if I start a business with a loan and then make a killing, did I not get more use out of the loan than its primary face-value? These questions are what people sometimes disparagingly call ‘metaphysical’. The loan, we might say, played some role in my winning on the races, but so did my knowledge of the race, and so did Lady Luck (who charges no fee). How much of the winning was contributed by each of these factors? How could we ever know? Likewise with the business loan: how much of the success was down to what I bought with the loan, how much was down to my hard work, how much, again, to luck?

Economists in the so-called ‘Post-Keynesian’ tradition – Joan Robinson for example – turned these metaphysical questions into a weapon against the standard economic theory of lending. That theory tells us that a rational credit market will charge an interest rate on loans roughly equal to the average rate of return on investment. But what, Robinson asked, is the rate of return on investment? Suppose I spend my own money building a factory and then hire workers. The factory generates gross profits of 12%, say, half of which I pay to the workers and half of which I keep as net profit for myself. So my rate of return is 6%.

In this case I’ve decided that half of the gross profit was contributed by the workers and half by my factory itself. But how do I know that? I presumably pay my workers the ‘going rate’, but that’s a matter of what other people in the industry pay, not of the workers’ actual contribution. And what determines how much others in the industry pay? One factor is the interest rate on loans: other businesses have loans to pay off and must net enough profit to service these. So rather than the rate of return on investment determining the rate of interest, the rate of interest seems to be determining the rate of return. Or, worse, there’s a circle: each seems to be determining the other at the same time!

What is the ‘right’ interest rate?

The Post-Keynesians argued that this paradoxical result shows that the whole standard analysis starts on the wrong foot. In fact the ‘right’ interest rate can’t be determined rationally in the way that economic theory proposes. The rate is a matter of pure convention, and the convention isn’t justified by anything. The answer to St Thomas' question – how much can you charge for the use of something – has no objective answer. It’s a matter of pure convention. When a business borrows money to invest and then makes a return, the return has to be split among the business, the lender, and the workers – capital, rent, and labour. But the split is somewhat arbitrary. Whether a rate of interest is reasonable or ‘usurious’ in the old condemned sense is a matter of moral feeling.


The marshmallow trick

Economists have, however, one more trick up their sleeve for claiming interest charges as objectively rational. This is the theory of ‘time-preference’. Humans are naturally impatient, so the theory goes, so that having something now is worth more than having the same thing in the future. A famous experiment involving children and marshmallows is said to have verified this result. The economist’s trick is to propose a measurable rate of time-preference: how many marshmallows tomorrow is worth one marshmallow today? If one marshmallow today is worth 1.05 tomorrow, then borrowing at 5% per day is rational.

Joan Robinson also took apart this trick. Is one present marshmallow worth 1.05 future ones? It depends on who you ask. I today might say so. But suppose you asked my future self, ‘If you could change the past, how many marshmallows would you not have eaten in order to have one today?’ The answer could plausibly be ‘several’. In that case the ‘rational’ interest rate is negative. Economists sometimes define ‘rational’ behaviour as behaviour that an agent won’t regret. The definition becomes circular when we realise that we have to qualify this to: won’t rationally regret (people often regret silly things). But in any case the fact that people give different rates of ‘time-preference’ depending on whether they’re looking backwards or forwards throws doubt on this whole theory of ‘rational’ interest payments.

In the end people borrow at the rates they do because those are the rates charged, and those rates are charged because people borrow at them. The attempts by economists to find a deeper reason than mere convention for this have not clearly succeeded. There is, however, an obvious objective constraint on interest rates. The conventional rates have to be low enough for the whole system to remain solvent. It is a surprising fact of history that this was not normally the case.

The work of Michael Hudson and others has shown that the interest rates on agricultural lending in much of the ancient world were much too high to be reasonably paid. Agricultural debtors fell often into debt slavery: sending their children to work as servants at the houses of their creditors in order to service their unpayable loans. The Biblical book of Nehemiah includes a lament about this – ‘We have borrowed money to pay the king’s tax … yet here we are subjecting our sons and daughters to slavery’ (NJPS translation, 5:4-5). The only way this system could be sustained was through periodic mass cancellations of debt – jubilees. David Graeber’s book, Debt: The First 5000 Years, notes that the Sumerian word for freedom – amargi – means ‘returning to mother’ and refers to the release of debt-servants on the day of the jubilee. The credit systems of the ancient world, to put it bluntly, only worked by breaking down.

It is not impossible for credit systems today to work likewise. It seems increasingly likely that student debt in the United States will eventually be subject to something like a jubilee. A vast proportion of it is never repaid, meanwhile the debtors work their whole lives in service to it. A credit framework that systematically generates unpayable debts either collapses or develops some sort of periodic jubilee mechanism. That mechanism was applied to Third World debt, due in part to the work of the Jubilee 2000 campaign.

But not every credit system works this way. While it is increasingly difficult for businesses to get loans at all, the conventional rates in business lending are not such as to make default the norm. In my next article I will present a birds-eye view of the sustainability of credit systems as a whole.

Article updated on:
April 1, 2020

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