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Compound interest is the root of banks' evil



It is not that bankers are bad people. Well, perhaps they are a little, although everybody has to make a living I suppose. But there is an overwhelming case that banks are bad.That was why lending was called usury. There was also apparently a line somewhere about: 'forgive us our debts as we forgive the debts of others', although this was, for reasons not entirely clear, changed to 'forgive us our trespasses' in later versions. Maybe bankers were involved in the rewrite.

Jars of coins getting progressively fullerSome of this quintessential wickedness has been exposed in the royal commission into the banks, which has at least alerted most Australians to the folly of thinking that bankers ever operate in the interests of their customers. But the problem goes much deeper than a few crooked operatives and it will not be fixed by changing the corporate 'culture' (whatever that means exactly). The fundamental evil is the arithmetic of compound interest.

Interest on debt rises exponentially, while economic activity is linear. That means that sooner or later those in a weaker position are unable to pay. This familiar pattern is now being played out globally. In effect, we are seeing the first world-wide crisis of usury. Global debt is $US260 trillion dollars, or 320 per cent of GDP, a level it has never reached before and proportionally about twice what it was in the 1980s. The only reason it is not failing spectacularly is that interest rates are being kept extremely low, at least for now.

The physicist Albert Einstein, apparently a bit of a whiz with numbers, described compound interest as the eighth wonder of the world. 'He who understands it, earns it ... he who doesn't ... pays it,' the great man observed, apparently thinking he had uncovered another universal principle of nature.

What Einstein should have said is that it is the source of much of the evil of the world. For thousands of years it has been the means by which elite few have exploited, impoverished and enslaved the many. The Great Depression, for example, was not the result of the 1928 stock market crash, but the behaviour of the banks.

The economic historian Michael Hudson has shown that forgiving debts has been critical to maintaining a civilised society for thousands of years, as far back as the Mesopotamians. Unless the ruling class is able to strongarm the banking class into forgiving debts, there is an inevitable impoverishment of the population.

We now have that debt problem almost everywhere. There are two ways to deal with it: one unlikely, the other very achievable. The first is to have government create most money, a role which the economist Nicholas Gruen has plausibly proposed for the Australian central bank. Or, at the very least, any banks that have to be bailed out should be nationalised.


"This is just a devious way for lenders to avoid taking responsibility for their own actions by appearing to capture the moral high ground."


Instead, in 2008, trillions of dollars of tax payers' money in America and Europe was gifted to the very people who had created the problem in the first place. Predictably, they gleefully put the funds into their own pockets, all the while shamelessly criticising the very government that had gifted it to them.

A second option, which is more achievable, is a world-wide effort to create more equity capital to balance the debt capital. Where debt is usury, equity is not, because the provider of the capital takes the risk.

Why, for example, do developing countries get loans, which routinely cripple their economies? Why not give them equity? It could be listed on their stock exchanges, adding depth to their financial systems. Equity markets are also less vulnerable than debt markets because they can reprice without creating chaos. If a country's debt markets collapse, it takes the banking system with it. But if the stock market collapses, it acts like a shock absorber because nobody loses unless they sell.

Two pieces of populist neoliberal nonsense need to be jettisoned if these measures are to be taken up. One is the claim that the problems are caused by 'fiat' money (money created by government dictate). The proposed alternatives are usually a return to the gold standard, or the use of crypto-currencies.

The analysis is inaccurate. Governments do create physical cash, but that is a small proportion of the overall amount. Most money is issued by banks, or other private actors. Of that global debt of $US260 trillion, 61 per cent is private. Plus, on top of that, there is the Dr Strangelove world of derivatives 'money' that leads to more than $US4 trillion a day of cross-border capital flows. These private financial markets are largely, or completely, independent of national governments — no fiat involved.

Another ridiculous notion is the idea of 'moral hazard': that if debt is forgiven, then people will just take advantage, lose their moral compass. This is just a devious way for lenders to avoid taking responsibility for their own actions by appearing to capture the moral high ground.

As Hudson notes, the moral hazard is the other way round: 'The basic moral financial principal should be that creditors should bear the hazard for making bad loans that the debtor couldn't pay — like the IMF loans to Argentina and Greece. The moral hazard is their putting creditor demands over the economy's survival.'



David JamesDavid James is the managing editor of businessadvantagepng.com. He has a PhD in English literature and is author of the musical comedy The Bard Bites Back, which is about Shakespeare's ghost.

Topic tags: David James, banks, royal commission



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Existing comments

David, we have nothing to worry about. We just continue to go along with the sellout of Australian infrastructure to China and there will be money to burn. Ask Daniel Andrews. The fact that he's hitherto kept it secret doesn't mean its not squarely on his political agenda. And he has the mandate and who cares what Canberra thinks? Short term gain. Long term pain. Print more money? That's what the USA does. Jobs? Utilise the Australian invention of the Direct Fuel Cell to replace coal fired turbines worldwide. Utilise Coal. The DFC has a 2% CO2 emission rate with no combustion. Its entirely scale able. Stop the spending cuts. Stimulate the economy. Let the Liberals show some moral responsibility for a change. Usury is not the problem. Politicians are the problem as they refuse to take job creation seriously in this unlucky country where cities like Cairns and Toowoomba face 20% unemployment. If wealth was a value in heaven it would not be given to bastards on earth. (Swift) Men are like bank accounts. Without a lot of money they dont generate a lot of interest. (Anon) Expect the worst. Prepare for the worst. Capitalise on what comes. (Zig Ziglar).

Frank Armstrong | 04 December 2018  

David , What an enlightening account . I recall there was a practice in the Old Testament that every seven years all debt was forgiven and people started afresh. Maybe that might be the circuit breaker we all need. But I am not going to loose any sleep waiting for it to happen!

Gavin O'Brien | 05 December 2018  

Both the French and the Russians had a pretty good crack at sorting out greed and usury amongst the upper ruling elite. I wonder how far we are from resorting to the same methods the aforementioned used? Unfortunately, revolutionaries, when intoxicated by the fragrances of power, seem to impose far more injustices on the people than those whom they have overthrown. Its a pity really, because sometimes it seems that there is no way other than open rebellion to rid the world of the bastards who believe that God made them to make money and enjoy the fruits of the world regardless of the cost to others.

john frawley | 05 December 2018  

¨. . . lending was (once) called usury¨ David tells us. Really? When and by whom? Given that David’s essay is published in a Jesuit publication claiming to be ‘informed by . . . the principles of Catholic Social Teaching’ among other things, readers are entitled to assume that the Catholic Church might be the one responsible. But nothing could be further from the truth and readers who wish to know exactly what Catholic teaching is on usury will find it in John P. Kelley’s Aquinas Lecture of 1944, ‘Aquinas and Modern Practices of Interest Taking’ which can be found in the Australian Catholic University’s collection of Aquinas Memorial Lectures at https://library.acu.edu.au/find/special-collections/aquinas Kelly clearly explains the difference between lending and investing, usury and interesting taking and his essay, one of the most lucid explanations of this matter that I know of, is well worth readers’ attention. David’s criticism of the particular evil of compound interest is also worth deeper study by readers and a good place to go to is Margrit Kennedy’s book, available in pdf form, ‘Interest and Inflation Free Money’, at http://userpage.fu-berlin.de/~roehrigw/kennedy/english/Interest-and-inflation-free-money.pdf Kennedy, a German academic, was particularly interested in the way public policy is obstructed by compound interest but as David has pointed out, much, much more than that is under threat.

Paul | 06 December 2018  

This is an excellent, incisive article with a very simple, realistic and practical solution to the problem. Islam still regards the taking of interest on a loan, any rate of interest, simple or compound, as being Riba or Usury. I believe the Catholic Church was against the levying of interest well into Renaissance times. Interest, in a simple, mainly agricultural society can lead to economic ruin and slavery. As part of the Belt and Road Initiative it could do terrible damage to poorer nations. In Islam Riba is regarded as one of the worst possible sins which will lead its practitioner to Hell. The current international practice of unaffordable compound interest loans will certainly create as much of a Hell on Earth as Global Warming. Sadly, the originators of these loans seem to have no real religious or ethical beliefs. They are utter materialists. I do not think any society based on utter materialism will last. You only have to look at the Soviet Union. All three Abrahamic faiths see tyrannical nations being ultimately ground into dust by divine justice. There will be no exception for economic tyrants.

Edward Fido | 06 December 2018  

The calculation of interest is an algebraic process, not arithmetic as you suggest David. A factor in the difficulties some customers find themselves in is the failure of our education system to develop a basic understanding of mathematics, and hence risk, in most of the population. It is a far simpler proposition to correct educational deficiencies, rather than attempt to modify behaviour of the population by government fiat.

Peter | 06 December 2018  

"Interest on debt rises exponentially, while economic activity is linear. That means that sooner or later those in a weaker position are unable to pay." This doesn’t make sense. Why would a bona fide profit-seeking capitalist contract with a party they are certain will be unable to honour the contract? Would a capitalist lend a million dollars to a pauper who plans to blow it all on a spectacular fireworks display and have nothing left to repay the loan? The narrative is plainly dodgy. Supposedly, capitalists are on the one hand penny pinching Scrooges; on the other hand they gleefully lend out when they know there's not the remotest hope their loans will be repaid! What's the gain from their palpable monetary loss? The sadistic pleasure of imagining their paupered borrowers languishing in debtors' prison?( In which case, they’re not really profit-seeking capitalists in the monetary sense anyway, are they?) Well, such characters may exist even now beyond the pages of Dickens. But debtors' prisons don't, so heaven knows how they get their non-monetary recompense these days. Of course, when you have governments leaping in and honouring debts with taxpayers money, then capitalists will lend to all and sundry, regardless of the borrower’s personal ability to pay. They don’t care where the return comes from any more than the government cares about who it fleeces to keep the system going. But that’s not the capitalist system. It’s “crony” capitalism – ie, a type of socialism.

HH | 10 December 2018  

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