The Morality of Moneylending: A Short History (Part 2) – New Ideal

The start of the sixteenth century broughtabout a commercial boom in Europe. It was the Golden Age of Exploration. Traderoutes opened to the New World and expanded to the East, bringing unprecedentedtrade and wealth to Europe. To fund this trade, to supply credit for commerceand the beginnings of industry, banks were established throughout Europe.Genoese and German bankers funded Spanish and Portuguese exploration and theimportation of New World gold and silver. Part of what made this financialactivity possible was the new tolerance, in some cities, of usury.

The Italian city of Genoa, for example, had arelatively relaxed attitude toward usury, and moneylenders created many ways tocircumvent the existing prohibitions. It was clear to the citys leaders thatthe financial activities of its merchants were crucial to Genoas prosperity,and the local courts regularly turned a blind eye to the usurious activities ofits merchants and bankers. Although the Church often complained about theseactivities, Genoas political importance prevented the Church from actingagainst the city.

The Catholic Churchs official view toward usury remained unchanged until the nineteenth century, but the Reformation which occurred principally in northern Europe brought about a mild acceptance of usury. (This is likely one reason why southern Europe, which was heavily Catholic, lagged behind the rest of Europe economically from the seventeenth century onward.) Martin Luther (14831546), a leader of the Reformation, believed that usury was inevitable and should be permitted to some extent by civil law. Luther believed in the separation of civil law and Christian ethics. This view, however, resulted not from a belief in the separation of state and religion, but from his belief that the world and man were too corrupt to be guided by Christianity. Christian ethics and the Old Testament commandments, he argued, are utopian dreams, unconnected with political or economic reality. He deemed usury unpreventable and thus a matter for the secular authorities, who should permit the practice and control it.

However, Luther still considered usury a grave sin, and in his later years wrote:

In other words, usury should be allowed bycivil authorities (as in Genoa) because it is inevitable (men will be men), butit should be condemned in the harshest terms by the moral authority. This isthe moral-practical dichotomy in action, sanctioned by an extremely malevolentview of man and the universe.

John Calvin, (15091564), another Reformation theologian, had a more lenient view than Luther. He rejected the notion that usury is actually banned in the Bible. Since Jews are allowed to charge interest from strangers, God cannot be against usury. It would be fantastic, Calvin thought, to imagine that by strangers God meant the enemies of the Jews; and it would be most unchristian to legalize discrimination. According to Calvin, usury does not always conflict with Gods law, so not all usurers need to be damned. There is a difference, he believed, between taking usury in the course of business and setting up business as a usurer. If a person collects interest on only one occasion, he is not a usurer. The crucial issue, Calvin thought, is the motive. If the motive is to help others, usury is good, but if the motive is personal profit, usury is evil.

Calvin claimed that the moral status of usury should be determined by the golden rule. It should be allowed only insofar as it does not run counter to Christian fairness and charity. Interest should never be charged to a man in urgent need, or to a poor man; the welfare of the state should always be considered. But it could be charged in cases where the borrower is wealthy and the interest will be used for Christian good. Thus he concluded that interest could neither be universally condemned nor universally permitted but that, to protect the poor, a maximum rate should be set by law and never exceeded.2

Although the religious authorities did little to free usury from the taint of immorality, other thinkers were significantly furthering the economic understanding of the practice. In a book titled Treatise on Contracts and Usury, Molinaeus, a French jurist, made important contributions to liberate usury from Scholastic rationalism.3 By this time, there was sufficient evidence for a logical thinker to see the merits of moneylending. Against the argument that money is barren, Molinaeus (15001566) observed that everyday experience of business life showed that the use of any considerable sum of money yields a service of importance. He argued, by reference to observation and logic, that money, assisted by human effort, does bear fruit in the form of new wealth; the money enables the borrower to create goods that he otherwise would not have been able to create. Just as Galileo would later apply Aristotles method of observation and logic in refuting Aristotles specific ideas in physics, so Molinaeus used Aristotles method in refuting Aristotles basic objection to usury. Unfortunately, like Galileo, Molinaeus was to suffer for his ideas: The Church forced him into exile and banned his book. Nevertheless, his ideas on usury spread throughout Europe and had a significant impact on future discussions of moneylending.4

The prevailing view that emerged in the latesixteenth century (and that, to a large extent, is still with us today) is thatmoney is not barren and that usury plays a productive role in the economy.Usury, however, is unchristian; it is motivated by a desire for profit and canbe used to exploit the poor. It can be practical, but it is not moral;therefore, it should be controlled by the state and subjected to regulation inorder to restrain the rich and protect the poor.

This Christian view has influenced almostall attitudes about usury since. In a sense, Luther and Calvin areresponsible for todays so-called capitalism. They are responsible for theguilt many people feel from making money and the guilt that causes people toeagerly regulate the functions of capitalists. Moreover, the Protestants werethe first to explicitly assert and sanction the moral-practical dichotomy theidea that the moral and the practical are necessarily at odds. Because oforiginal sin, the Protestants argued, men are incapable of being good, and thusconcessions must be made in accordance with their wicked nature. Men must bepermitted to some extent to engage in practical matters such as usury, eventhough such practices are immoral.

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In spite of its horrific view of man, life,and reality, Luther and Calvins brand of Christianity allowed individuals whowere not intimidated by Christian theology to practice moneylending to someextent without legal persecution. Although still limited by governmentconstraints, the chains were loosened, and this enabled economic progressthrough the periodic establishment of legal rates of interest.

The first country to establish a legal rate of interest was England in 1545 during the reign of Henry VIII. The rate was set at 10 percent. However, seven years later it was repealed, and usury was again completely banned. In an argument in 1571 to reinstate the bill, Mr. Molley, a lawyer representing the business interests in London, said before the House of Commons:

Since to take reasonably, or so that both parties might do good, was not hurtful; . . . God did not so hate it, that he did utterly forbid it, but to the Jews amongst themselves only, for that he willed they should lend as Brethren together; for unto all others they were at large; and therefore to this day they are the greatest Usurers in the World. But be it, as indeed it is, evil, and that men are men, no Saints, to do all these things perfectly, uprightly and Brotherly; . . . and better may it be born to permit a little, than utterly to take away and prohibit Traffick; which hardly may be maintained generally without this.

But it may be said, it is contrary to the direct word of God, and therefore an ill Law; if it were to appoint men to take Usury, it were to be disliked; but the difference is great between that and permitting or allowing, or suffering a matter to be unpunished.5

Observe that while pleading for a bill permitting usury on the grounds that it is necessary (Traffick . . . hardly may be maintained generally without [it]) Molley concedes that it is evil. This is the moral-practical dichotomy stated openly and in black-and-white terms, and it illustrates the general attitude of the era. The practice was now widely accepted as practical but still regarded as immoral, and the thinkers of the day grappled with this new context.

One of Englands most significant seventeenth-century intellectuals, Francis Bacon (15611626), realized the benefits that moneylending offered to merchants and traders by providing them with capital. He also recognized the usurers value in providing liquidity to consumers and businesses. And, although Bacon believed that the moral ideal would be lending at 0 percent interest, as the Bible requires, he, like Luther, saw this as utopian and held that it is better to mitigate usury by declaration than suffer it to rage by connivance. Bacon therefore proposed two rates of usury: one set at a maximum of 5 percent and allowable to everyone; and a second rate, higher than 5 percent, allowable only to certain licensed persons and lent only to known merchants. The license was to be sold by the state for a fee.6

Again, interest and usury were pitted against morality. But Bacon saw moneylending as so important to commerce that the legal rate of interest had to offer sufficient incentive to attract lenders. Bacon recognized that a higher rate of interest is economically justified by the nature of certain loans.7

The economic debate had shifted from whether usury should be legal to whether and at what level government should set the interest rate (a debate that, of course, continues to this day, with the Fed setting certain interest rates). As one scholar put it: The legal toleration of interest marked a revolutionary change in public opinion and gave a clear indication of the divorce of ethics from economics under the pressure of an expanding economic system.8

In spite of this progress, artists continued to compare usurers to idle drones, spiders, and bloodsuckers, and playwrights personified the moneygrubbing usurers in characters such as Sir Giles Overreach, Messrs. Mammon, Lucre, Hoard, Gripe, and Bloodhound. Probably the greatest work of art vilifying the usurer was written during this period The Merchant of Venice by Shakespeare (15641616), which immortalized the character of the evil Jewish usurer, Shylock.

In The Merchant of Venice, Bassanio, a poor nobleman, needs cash in order to court the heiress, Portia. Bassanio goes to a Jewish moneylender, Shylock, for a loan, bringing his wealthy friend, Antonio, to stand as surety for it. Shylock, who has suffered great rudeness from Antonio in business, demands as security for the loan not Antonios property, which he identifies as being at risk, but a pound of his flesh.9

The conflict between Shylock and Antonio incorporates all the elements of the arguments against usury. Antonio, the Christian, lends money and demands no interest. As Shylock describes him:

Shylock: [Aside.] How like a fawning publican he looks!

I hate him for he is a Christian;

But more for that in low simplicity

He lends out money gratis, and brings down

The rate of usance here with us in Venice.

If I can catch him once upon the hip,

I will feed fat the ancient grudge I bear him.

He hates our sacred nation, and he rails,

Even there where merchants most do congregate,

On me, my bargains, and my well-won thrift,

Which he calls interest. Cursed be my tribe,

If I forgive him!10

Shylock takes usury. He is portrayed as the lowly, angry, vengeful, and greedy Jew. When his daughter elopes and takes her fathers money with her, he cries, My daughter! O my ducats! O my daughter!11 not sure for which he cares more.

It is clear that Shakespeare understood the issues involved in usury. Note Shylocks (legitimate) hostility toward Antonio because Antonio loaned money without charging interest and thus brought down the market rate of interest in Venice. Even Aristotles barren money argument is present. Antonio, provoking Shylock, says:

If thou wilt lend this money, lend it not

As to thy friends, for when did friendship take

A breed for barren metal of his friend?

But lend it rather to thine enemy:

Who if he break, thou mayst with better face

Exact the penalty.12

Friends do not take breed for barren metal from friends; usury is something one takes only from an enemy.

Great art plays a crucial role in shapingpopular attitudes, and Shakespeares depiction of Shylock, like Dantesdepiction of usurers, concretized for generations the dichotomous view ofmoneylending and thus helped entrench the alleged link between usury and evil.As late as 1600, medieval moral and economic theories were alive and well, evenif they were increasingly out of step with the economic practice of the time.

During the Enlightenment, the Europeaneconomy continued to grow, culminating with the Industrial Revolution. Thisgrowth involved increased activity in every sector of the economy. Bankinghouses were established to provide credit to a wide array of economicendeavors. The Baring Brothers and the House of Rothschild were just thelargest of the many banks that would ultimately help fuel the IndustrialRevolution, funding railroads, factories, ports, and industry in general.

Economic understanding of the important productive role of usury continued to improve over the next four hundred years. Yet, the moral evaluation of usury would change very little. The morality of altruism the notion that self-sacrifice is moral and that self-interest is evil was embraced and defended by many Enlightenment intellectuals and continued to hamper the acceptability of usury. After all, usury is a naked example of the pursuit of profit which is patently self-interested. Further, it still seemed to the thinkers of the time that usury could be a zero-sum transaction that a rich lender might profit at the expense of a poor borrower. Even a better conception of usury let alone the misconception of it being a zero-sum transaction is anathema to altruism, which demands the opposite of personal profit: self-sacrifice for the sake of others. In the mid-seventeenth century, northern Europe was home to a new generation of scholars who recognized that usury served an essential economic purpose, and that it should be allowed freely. Three men made significant contributions in this regard.

Claudius Salmasius (15881653), a French scholar teaching in Holland, thoroughly refuted the claims about the barrenness of moneylending; he showed the important productive function of usury and even suggested that there should be more usurers, since competition between them would reduce the rate of interest. Other Dutch scholars agreed with him, and, partially as a result of this, Holland became especially tolerant of usury, making it legal at times. Consequently, the leading banks of the era were found in Holland, and it became the worlds commercial and financial center, the wealthiest state in Europe, and the envy of the world.13

Anne-Robert-Jacques Turgot (17271781), a French economist, was the first to identify usurys connection to property rights. He argued that a creditor has the right to dispose of his money in any way he wishes and at whatever rate the market will bear, because it is his property. Turgot was also the first economist to fully understand that the passing of time changes the value of money. He saw the difference between the present value and the future value of money concepts that are at the heart of any modern financial analysis. According to Turgot: If . . . two gentlemen suppose that a sum of 1000 Francs and a promise of 1000 Francs possess exactly the same value, they put forward a still more absurd supposition; for if these two things were of equal value, why should any one borrow at all?14 Turgot even repudiated the medieval notion that time belonged to God. Time, he argued, belongs to the individual who uses it and therefore time could be sold.15

During the same period, the Britishphilosopher Jeremy Bentham (17481832) wrote a treatise entitled A Defenseof Usury. Bentham argued that any restrictions on interest rates wereeconomically harmful because they restricted an innovators ability to raisecapital. Since innovative trades inherently involved high risk, they could onlybe funded at high interest rates. Limits on permissible interest rates, he argued,would kill innovation the engine of growth. Correcting another medievalerror, Bentham also showed that restrictive usury laws actually harmed theborrowers. Such restrictions cause the credit markets to shrink while demandfor credit remains the same or goes up; thus, potential borrowers have to seekloans in an illegal market where they would have to pay a premium for theadditional risk of illegal trading.

Benthams most important contribution was his advocacy of contractual freedom:

My neighbours, being at liberty, have happened to concur among themselves in dealing at a certain rate of interest. I, who have money to lend, and Titus, who wants to borrow it of me, would be glad, the one of us to accept, the other to give, an interest somewhat higher than theirs: Why is the liberty they exercise to be made a pretence for depriving me and Titus of ours.16

This was perhaps the first attempt at a moral defense of usury.

Unfortunately, Bentham and his followers undercut this effort with their philosophy of utilitarianism, according to which rights, liberty, and therefore moneylending, were valuable only insofar as they increased social utility: the greatest good for the greatest number. Bentham famously dismissed individual rights the idea that each person should be free to act on his own judgment as nonsense upon stilts.17 He embraced the idea that the individual has a duty to serve the well-being of the collective, or, as he put it, the general mass of felicity.18 Thus, in addition to undercutting Turgots major achievement, Bentham also doomed the first effort at a moral defense of usury which he himself had proposed.

An explicitly utilitarian attempt at a moral defense of usury was launched in 1774 in the anonymously published Letters on Usury and Interest. The goal of the book was to explain why usury should be accepted in England of the eighteenth century, and why this acceptance did not contradict the Churchs teachings. The ultimate reason, the author argued, is one of utility:

Here, then, is a sure and infallible rule to judge of the lawfulness of a practice. Is it useful to the State? Is it beneficial to the individuals that compose it? Either of these is sufficient to obtain a tolerance; but both together vest it with a character of justice and equity. . . . In fact, if we look into the laws of different nations concerning usury, we shall find that they are all formed on the principle of public utility. In those states where usury was found hurtful to society, it was prohibited. In those where it was neither hurtful nor very beneficial, it was tolerated. In those where it was useful, it was authorized. In ours, it is absolutely necessary.19

And:

Although the utilitarian argument in defense of usury contains some economic truth, it is morally bankrupt. Utilitarian moral reasoning for the propriety of usury depends on the perceived benefits of the practice to the collective or the nation. But what happens, for example, when usury in the form of subprime mortgage loans creates distress for a significant number of people and financial turmoil in some markets? How can it be justified? Indeed, it cannot. The utilitarian argument collapses in the face of any such economic problem, leaving moneylenders exposed to the wrath of the public and to the whips and chains of politicians seeking a scapegoat for the crisis.

Although Salmasius, Turgot, and Bentham made significant progress in understanding the economic and political value of usury, not all their fellow intellectuals followed suit. The father of economics, Adam Smith (17231790), wrote: As something can everywhere be made by the use of money, something ought everywhere to be paid for the use of it.21 Simple and elegant. Yet, Smith also believed that the government must control the rate of interest. He believed that unfettered markets would create excessively high interest rates, which would hurt the economy which, in turn, would harm society.22 Because Smith thought that societys welfare was the only justification for usury, he held that the government must intervene to correct the errors of the invisible hand.

Although Smith was a great innovator ineconomics, philosophically, he was a follower. He accepted the commonphilosophical ideas of his time, including altruism, of which utilitarianism isa form. Like Bentham, he justified capitalism only through its social benefits.If his projections of what would come to pass in a fully free market amountedto a less-than-optimal solution for society, then he advocated governmentintervention. Government intervention is the logical outcome of any utilitariandefense of usury.

(Smiths idea that there need be a perfectlegal interest rate remains with us to this day. His notion of such a rate wasthat it should be slightly higher than the market rate what he called thegolden mean. The chairman of the Federal Reserve is todays very visiblehand, constantly searching for the perfect rate or golden mean byalternately establishing artificially low and artificially high rates.)

Following Bentham and Smith, all significant nineteenth-century economists such as David Ricardo, Jean Baptiste Say, and John Stuart Mill considered the economic importance of usury to be obvious and argued that interest rates should be determined by freely contracting individuals. These economists, followed later by the Austrians especially Carl Menger, Eugen von Bhm-Bawerk, and Ludwig von Mises developed sound theories of the productivity of interest and gained a significant economic understanding of its practical role. But the moral-practical dichotomy inherent in their altruistic, utilitarian, social justification for usury remained in play, and the practice continued to be morally condemned and thus heavily regulated if not outlawed.

End of Part 2.

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The Morality of Moneylending: A Short History (Part 2) - New Ideal