In Whose Interest?

by Bernard A. Lietaer and Stephen M. Belgin

“Money is like an iron ring we put through our nose.
It is now leading us wherever it wants.
We just forgot that we are the ones who designed it.”
Mark Kinney

Interest

Though loans and interest likely date back to pre-urban societies, the first written evidence of interest goes back to ancient Sumer where it was known as más, which also meant “a lamb.” Allowing a flock of sheep to graze on one’s land gave the landowner the right to choose a lamb born from that flock. This denotes the original relationship between loans, interest, and rural produce.¹ According to Stephen Zarlenga, Director of the American Monetary Institute, “Loans were made in seed grains, animals, and tools to farmers. Since one grain of seed could generate a plant with over 100 new grain seeds, after the harvest farmers could easily repay the grain with ‘interest’ in grain.”² However, what will an ounce of silver give rise to? Once interest was applied to money, debate and confusion arose that has continued to this very day. One of the central issues of this debate was how much interest should be applied.

Interest and Usury

While usury is today considered an excessive interest rate, it was formerly defined as charging any interest on money. In Western Civilization the practice of charging interest on money would not become officially acceptable until the reign of King Henry VIII of England, who, after his break with Rome, first legalized interest in 1545. Up until that schism, all three “religions of the Book” (Judaism, Christianity, and Islam) prohibited usury. ³

Though historically a source of lively debate, interest continues to function as a necessary component of our national currencies.

Interest and Lending

Interest provides important incentives and protection during the lending process. Researcher Andrew Lowd points to three factors for the necessity of reasonable interest rates attached to national currencies: protection against default, inflation, and time preference.⁴

Protection against default. Interest protects the lender from potential loan defaults. In this situation, interest is known as “risk premium,” and works as a fair precaution by the lender to ensure that he receives back at least the amount he loaned out. For example, if a lender engages in 105 transactions of $1,000 each, and only 100 of the loans are paid back, he has in effect lost $5,000. Not knowing which of the borrowers will default, the lender spreads his risk over all of his loans, equating to a 5% interest charge for each borrower. The interest serves as a small borrower’s fee for the convenience of having additional funds temporarily available.

Inflation. Inflation is another economic factor that justifies the charge of reasonable interest. Inflation—a sustained increase in the general level of prices—necessarily decreases the purchasing power or value of money over time. If a lender makes a loan with inflation at 3%, the money automatically loses 3% of its value over time, even if the borrower is perfectly reliable and trustworthy. The lender, predicting the rate of inflation, can ensure his money maintains its value by charging an interest rate equal to the rate of inflation.

Opportunity Cost. Money can be used as a tool to make more money. By providing a borrower with money, the lender forgoes his own opportunity to make profit for himself. A lender charges interest as compensation for his missed opportunity to make a profit.

The functions discussed above pertain to some of the many functional considerations regarding interest. Another aspect of interest is the impact it has on our behavioral patterns.

Behavioral Effects of Interest

Though the full implication of interest is seldom understood, its effect upon society is pervasive and powerful. Three behavioral patterns directly related to this built-in feature of our monetary system include:

• Encouraging competition
• Fueling economic growth
• Concentrating wealth

Encouraging Competition

When a bank creates money by providing you with, say, a $100,000 mortgage loan, it creates only the principal when it credits your account. It expects a return, however, of some $200,000 over the next 20 years or so. The bank does not create the interest; it requires you to earn this second $100,000 through your interactions with others.

The following story, “The Eleventh Round,” illustrates the way interest is woven into the fabric of our monetary system and how it stimulates competition among its users.

The Eleventh Round

Once upon a time, there was a small village where people knew nothing about money or interest. Each market day, people would bring their chickens, eggs, hams, and breads to the marketplace and enter into the time-honored ritual of negotiations and exchange for what they needed. At harvests, or whenever someone’s barn needed repairs after a storm, the villagers simply exercised another age-old tradition of helping one another, knowing that if they themselves had a problem one day, others would surely come to their aid in turn.

One market day, a stranger with shiny black shoes and an elegant white hat came by and observed the whole process with a knowing smile. When one farmer who wanted a big ham ran around to corral the six chickens needed in exchange, the stranger could not refrain from laughing. “Poor people,” he said, “so primitive.”

Overhearing this, the farmer’s wife challenged him: “Do you think you can do a better job handling chickens?”

The stranger responded: “Chickens, no. But I do know a much better way to eliminate all the hassles. Bring me one large cowhide and gather the families. I’ll explain this better way.”

As requested, the families gathered, and the stranger took the cowhide, cut perfect leather rounds in it and put an elaborate and graceful little stamp on each round. He then gave ten rounds to each family, stating that each round represented the value of one chicken. “Now you can trade and bargain with the rounds instead of those unwieldy chickens,” He said. It seemed to make sense and everybody was quite impressed with the stranger.

“One more thing,” the stranger added. “In one year’s time, I will return and I want each of you to bring me back an extra round, an eleventh round. That eleventh round is a token of appreciation for the improvement I made possible in your lives.”

“But where will that round come from?” asked the wife.

“You’ll see,” replied the stranger, with a knowing look.

Assuming that the population and its annual production remained exactly the same during that year, what do you think happened? Remember, that eleventh round was never created; it was never cut from the cowhide.

As the stranger had suggested, it was far more convenient to exchange rounds instead of chickens on market days. But this convenience had a hidden cost: the demanded eleventh round generated a systemic undertow of competition among all the participants. One out of every 11 families would have to lose the equivalent of all its rounds, even if everybody managed their affairs well, in order to provide the eleventh round to the stranger.

The following year, when a storm threatened some of the farmers, there was an uncharacteristic reluctance to assist neighbors. The families were now in a wrestling match for that eleventh round. The introduction of interest-bearing money actively discouraged the spontaneous cooperation that had long been the tradition of the village.

The Eleventh Round is a simplified illustration of an important principle regarding money for non-economists. The impact of interest on a closed community was isolated from other variables by making the assumption of a zero growth society: no population increase and no production or increases in the money supply. In practice, of course, all three of these variables grow over time, further obscuring the impact of interest. The point of the Eleventh Round is that, all other things being equal, the competition to obtain the money necessary to pay the interest is structurally embedded in the current system.

So how does a loan, whose interest is never created, get repaid? Essentially, to pay back interest on a loan, someone else’s principal must be used. In other words, not creating the money to pay interest is the device used to generate the scarcity necessary for a bank-debt monetary system to function. It forces people to compete with each other for money that was never created, and penalizes them with bankruptcy should they not succeed. When your bank checks your creditworthiness, it is really verifying your ability to compete successfully against the other players—that is to say, managing to get out of them the money that you require to reimburse your interest. Ultimately, someone must always lose.

In our national currency paradigm, one important reason so much attention is paid to decisions made by central banks is that increased interest rates automatically imply a larger proportion of bankruptcies in the future. Our monetary system obliges us to incur debt and compete with others in order to perform exchanges and pay the resulting interest to the banks or lenders. No wonder “it is a tough world out there,” and that those who live within our competitive monetary system so readily accept Darwin’s supposed “survival of the fittest.”

There is, however, an ever-mounting body of evidence to support significantly less harsh and even wholly contrary interpretations of the natural world.

Kinji Imanishi, the late professor of biosociology from Kyoto University, challenged the stereotypical Darwinian vision of nature as a struggle for life. The “survival of the fittest” model is completely blind to the many frequent cases of symbiosis, joint development, and harmonious coexistence that prevail in all domains of evolution. Even our own bodies would not be able to survive long without the symbiotic collaboration of billions of microorganisms in our digestive tract, for example.⁵

Evolutionary biologist Elisabet Sahtouris points out that predominantly competitive behavior is a characteristic of a young species during its first forays into the world. In contrast, in a mature system like an old-growth forest, the competition for light, for instance, is balanced by intense cooperation among species. Species that do not learn to cooperate with others with whom they are codependent invariably disappear.⁶

Although the theories of Social Darwinism—a nineteenth century movement that advocated that the idea of “survival of the fittest” should be applied to human society—have long been debunked, some of the tenets linger. Many people still maintain that competition and cruelty are natural and inevitable tools for survival.

Yet Charles Darwin did not himself see competition as the foremost tool of survival in the evolution of humankind. Evolutionary systems scientist David Loye, in his books The Great Adventure and Darwin’s Lost Theory of Love, points us right back to the very source of Darwinism itself: Charles Darwin. After the Origin of the Species (1859), Darwin wrote another book, The Descent of Man (1871), in which the author points out that the brutal and bloody theory in Origin pertains only to pre-human evolution. Loye explains that in The Descent of Man, which deals primarily with human evolution, “Darwin actually writes only twice of survival of the fittest—and one of these times is to apologize for exaggerating the importance of this idea in Origin of the Species!”⁷ Furthermore, “In this book of 848 pages in fine print, he [Darwin] writes only 12 times about selfishness, which by now hordes of sociobiologists, evolutionary psychologists, and best-selling books have assured us is the central survivalist motivation for human evolution high and low.”⁸

The misunderstood theory of evolution simply does not apply to human evolution, because once human consciousness comes into play everything changes. As Loye points out, what Darwin is actually writing about in Descent can be clearly inferred by the word count:

• Survival of the fittest, 2 times
• Selfishness, 12 times
• Moral sensitivity, 92 times
• Love, 95 times
• Habit, 108 times

More surprising still, as Loye uncovers, Darwin wrote in Descent more than a century ago, “As important as the struggle for existence has been and even still is, yet as far as the highest part of our nature is concerned there are other agencies which are more important. For the moral qualities are advanced, either directly or indirectly, much more through the effects of habit, by our reasoning powers, by instruction, by religion, etc., than through natural selection.”⁹

Descent was completely overlooked, not because it was less valid than Origin, but rather, because it contradicted the bias of the age in which Darwin lived. That competitive bias is still reinforced in our world today by our monetary system, especially through the built-in feature of interest.

Continual Economic Growth

The principle assumption of the Eleventh Round is that everything remains the same from one year to the next. In reality, we do not live in a world of zero growth in population, output, or money supply. The real process involves the growth of all three. The monetary system just takes the first slice of that growth to pay for interest. Agrarian societies customarily sacrificed the first fruits of the harvest to their gods; we now give the first fruits of our toils to the institutions that manage our money.

In real life population, production, and money supply all grow at different rates from year to year, making it much more difficult than in our Eleventh Round story to notice what is actually happening. Our monetary system acts like a treadmill requiring continuous economic growth, even if the average real standard of living remains stagnant. In this story, the interest rate determines the average rate of economic growth needed to remain at the same place.

Perpetual growth is another fact of life in our modern societies, the social and environmental impacts of which are being experienced worldwide. It should be remembered that this monetary system was created during a time when the ecological or social costs of indefinite and compulsory growth were not known.

Concentration of Wealth

A third behavioral effect of interest is the continual transfer of wealth from the vast majority to a small minority. The wealthiest receive an uninterrupted profit from whoever needs to borrow money.

A revealing study on the transfer of wealth via interest from one economic group to another was performed in West Germany in 1982 (Figure 3.1).¹⁰ Germans were grouped into ten income categories of about 2.5 million households each. During that year, transfers between these ten groups involved a total of DM270 billion in interest payments (approximately $120 billion at the time). A stark way to present the process is to graph the net interest transfers (interest gained minus interest paid) for each of these ten household categories.

The highest transfers of interest were from the middle classes (categories three to eight), each of which transferred about DM5 billion to the top 10% of the households (category ten). Even the poorest income households transferred a substantial DM1.8 billion of interest each year to the wealthiest group.

The effect was that the top 10% of households received a net transfer of DM34.2 billion in interest from the rest of society during that year. The graph illustrates this systemic transfer of wealth from the bottom 80% of the population to the top 20%, especially the top 10%, due exclusively to the monetary system used. This transfer of wealth occurs independently of the cleverness or industriousness of the participants—a classical argument presented to justify differences in income. Is it a coincidence that after interest officially became legal, all democratic countries have felt the need to create income taxes and income redistribution schemes to counteract at least part of this process?

© Excerpt from Of Human Wealth: New Money for a New World by Bernard Lietaer and Stephen Belgin, Citerra Press, 2008 All Rights Reserved. This is an Advance Reader’s Copy of Manuscript. For more information contact

As a senior central bank executive in Belgium, Bernard Lietaer was one of the principal architects of the “ECU,” the convergence mechanism that developed into the euro. In recognition of his leadership as General Manager of one of the world’s most successful offshore currency funds, he was identified by Business Week as the world’s top currency trader in 1991. He was also a professional consultant for over a decade to multinational corporations on four continents.

Stephen Belgin is co-founder of Entrepreneurs Without Borders, which promotes sustainable business practices and new work opportunities using innovative monetary solutions. He has dedicated his life to searching for and communicating solutions to the pressing issues that face our world.

Endnotes

1. Marc van de Mieroop “The Invention of Interest” in William N. Goetzman and K. Geert Rouwenhorst, The Origins of Value: The Financial Innovations that Created Modern Capital Markets (Oxford: Oxford University Press, 2005), p. 24.

2. www.appropriate-economics.org/materials/Brief_History_of_interest.html (15 August 2006).

3. In Islam, for example see: Gillian Tett, “Banks Create Muslim ‘Windows’ as Islamic Banking Expands its Niche,” The Financial Times (2 June 2006), p. 6: “The central religious precept driving the Islamic finance industry is the idea that riba (a word that can be translated either as “interest” or “usury”) is haram (“forbidden” or “sinful”)…At first glance, this appears to rule out most aspects of modern finance. But although the Koran bans the creation of money, by money, it does allow money to be used for trading tangible assets and businesses—that can generate a profit…Ironically, some of [the] structures and techniques [of modern Islamic banking] echo those that flourished in Christendom in Europe between the 12th and 15th centuries. The Christian Council of Nicea (in 325) banned the practice of usury among the clergy and in 1140 this principle was extended to church members.”

4. Andrew Lowd in his thesis Alternative Currencies in Theory and Practice.

5. Pierre Thuillier, “Darwin Chez les Samourai,” La Recherche, no. 181 (1986), p. 1276-80.

6. Elisabet Sahtouris, Earth Dance: Living Systems in Evolution (Alameda: Metalog Books, 1996).

7. David Loye, personal email to Stephen Belgin (2005).

8. Ibid.

9. Ibid.

10. Margrit Kennedy, et.al., Interest and Inflation Free Money: Creating an Exchange Medium that Works for Everybody and Protects the Earth (Okemos: Sava International, 1995), p. 26.

Bernard Lietaer will be co-leading a module with Victoria Castle, Shifting the Money Paradigm: Embodying a Culture of Sufficiency, at the Authentic Leadership in Action Summer Institute, June 22-28, 2008, in Halifax, Nova Scotia, Canada.