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Charging Interest Isn’t Immoral, It’s a Matter of Timing

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Ronald Preston once referred to a ‘persistent Christian undercurrent, which refuses to take economics seriously.’ One important manifestation of that refusal is that people of good will often suppose that it is inherently wrong to engage in lending and borrowing at a positive rate of interest, that the lender must inevitably be taking advantage of the borrower. Worse, people who suppose this will often imagine that they are adopting a morally superior position, when in fact they are simply making an intellectual error. It is just not true that the lender is ʻgetting something for nothing’, or is ʻdoing nothing for the borrower’.

Consider a poor Asian rice farmer and his family who are in desperate straits. They have almost no rice left to eat, let alone to plant in order to produce a new crop. Early one morning before the heat becomes unbearable, a dust cloud appears far down the dirt track. It becomes larger and nearer, until it is seen to envelop an expensive, chauffeur-driven car. When the car halts near the family’s hut, a well-dressed man emerges from the rear door and approaches the hut. ʻGood morning’, he says, ʻI am your distant cousin and I’ve heard of your great distress. I have come to give you, if you will kindly accept, ten tons of good quality rice, to be delivered tomorrow.’ The farmer and his family are naturally overcome with relief and gratitude. Politely declining their offer of simple refreshments, the cousin gets back in the car to leave. But just before the driver accelerates away, the cousin winds down the window and calls out, ʻOn second thoughts, the ten tons of rice will be delivered not tomorrow but one year from today. After all, a ton of rice is just a ton of rice, so what difference can the delivery date make?’

We can well imagine that as the car speeds away, the now distraught farmer is shaking his fist and cursing his cousin. The delivery date makes an enormous difference, probably a difference of life or death, to the farmer and his family and only the stupid or the disingenuous can make out that a ton of rice tomorrow is ʻjust the same thing’ as a ton of rice in a year’s time. It often matters to people – and sometimes matters greatly – when something is available to them. That people have such preferences concerning the timing of availability is the fundamental reason why interest is paid.

To take the issue a little further, consider two individuals, P and Q, who are both quite well- off, well informed and have no form of power over each other. (This is to emphasize that lending and borrowing at interest need not necessarily turn on poverty, or ignorance or coercion.) Suppose that, in the absence of a loan, Q would have £1000 this year and £1205 next year. But if P leads Q £100 at an annual interest rate of 5%, Q will have £1100 this year and £1100 next year (i.e. £1205 minus the £105 to be paid to P). If Q prefers the income stream (£1100, £1100) to the income stream (£1000, £1205) then the loan at 5% has made Q better off. (In Q’s own estimation, that is.) It would then be tendentious nonsense to claim that P has ʻexploited’ Q, or ʻtaken advantage’ of Q, or ʻgained at Q’s expense’. To the contrary, P has helped Q, by making it possible for Q to have a preferred income stream. Indeed, since Q was always perfectly free not to take the loan, it is obvious that it was taken only because, far from harming Q, it benefited Q (in Q’s own judgement). Likewise, presumably, P made the loan (being free not to do so) only because that benefited P (in P’s own judgement). Thus the lending and borrowing, at a positive rate of interest, made both parties better off. On what grounds, then, could anyone reasonably assert that it was wrong for P and Q to enter into their transaction?

The above example is most straightforward in the absence of inflation, for then increases or decreases in amounts of money correspond in a simple way to increases and decreases in command over real goods and services. Suppose now, however, that over the period of the loan from P to Q, all money prices unexpectedly rise by more than 5%. Then the money P receives from Q (repayment plus interest) gives P less real purchasing power than was lent to Q. The lender, P, has earned a negative ʻreal’ rate of interest. So much for the lender ʻexploiting’ the borrower! More generally, anyone who claims that lending and borrowing ʻought’ to take place at a zero rate of interest has a strong obligation to make it clear whether it is a zero money rate or a zero real rate that is being commended. If the former, they must explain why a negative real rate is fair; if the latter then they must acknowledge that, in the presence of inflation, a zero real rate requires a positive money rate. (This is an issue that has exercised some Muslims in their discussions of lending and borrowing at a positive rate of interest.)

Nothing said above denies that poverty, ignorance and the wielding of power, etc. may influence lending, borrowing and rates of interest. But if they do, then it is the poverty, the ignorance and the power, etc. that need to be tackled– and that is where religious people should focus their attention when discussing, say, pay-day- loan firms and Justin Welby’s idea of competing them out of existence. Nothing is to be gained by ignorant ignoring of the possible mutual benefits of lending and borrowing and the fundamental source of those possible benefits must always be borne in mind – it lies in the fact that people often care when something will be available to them.

Ian Steedman is an Associate Research Fellow of William Temple Foundation

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