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August 15, 2005

New Economics: The Scourge of Interest Rates

Interest is steering us towards non-sustainability, argues Jeremy Wakeford, writing for the South African New Economics Network, a group described on their site as an independent network for the creation of a humane, just, sustainable and culturally appropriate economic system in South Africa.

Not only does interest act as a constantly active mechanism for the transfer of value from the poor to the rich, it is also an incentive for wasteful consumption. The result is the thoughtless use of resources which by rights should not only be left in place but should be lovingly cared for, to ensure the survival of future generations.

The debate about interest has been carefully kept from public view and the great confusion over the necessity and the effects of interest taking is generally not ever resolved by economists.

In the early part of the 20th century, some socioeconomic thinkers and reform advocates have made proposals to overcome the practice - most visibly Silvio Gesell, a German businessman who lived in Argentina and proposed in his work "The Natural Economic Order" that money should rightly be issued by and for the people, not by and for the banks, and that it should be proofed against the practice of taking interest by an alternate mechanism - a periodic decurtation of its value or negative interest rate. Such negative interest, according to Gesell, would serve two purposes: It would ensure that money circulates, improving economic conditions, and it would also move taxation from income to the money mass itself for a more equitable distribution of the tax burden. The proceeds from the negative interest would provide a constant flow of value to be distributed to the grassroots in the form of a guaranteed "citizens' income".

I summarized Gesell's views in some earlier articles here. Gesell was one of the first to successfully pilot a "local economy" scheme in the Tyrolian town of Worgl, in Austria.

Thanks to Tom J. Kennedy, also known as 'Tommy UsuryFree', who is based in Canada and is a prolific money reform activist, for forwarding this article of Jeremy Wakeford.

Tommy's sites:

- - -

SANE Views
Vol.5, No.16, 11 August 2005

The Scourge of Interest Rates

by Jeremy Wakeford

Jeremy Wakeford is a lecturer in the School of Economics, University of Cape Town, and a member of the SANE Board. The views expressed here are his, and should not necessarily be attributed to either of these organisations. 

This week the South African Reserve Bank's monetary policy committee (MPC) meets to determine short term interest rates. Their decision carries significant consequences for just about every aspect of the macro-economy (investment, consumption, savings, the rand exchange rate, inflation, economic growth and employment). Many people - not just financial speculators - await the MPC's decision with bated breath. But the role of interest rates in our individual and collective lives is far more fundamental and insidious than merely influencing monthly budget allocations. It goes to the core of whether humanity will achieve sustainability.

Most of us take for granted the current monetary system and the existence of interest. Commercial banks create money each time they advance a loan (say for an individual wanting to purchase a new home or car, or a business wanting to expand its operations). Contrary to popular perception, government creates only a tiny fraction (around 3%) of the money supply - the physical notes and coins in circulation. The remaining 97% of bank-created money is virtual: it exists merely as numbers on computers. And while notes and coins are non-interest bearing, bank loans and deposits both come with interest attached - albeit at differential rates which suit the banks.

The present money system, and the widespread levying of interest on loans, actually has a short history relative to human civilisation. From Aristotle's time (circa 300 B.C.) until the eighteenth century, charging interest on money loans was considered morally unacceptable usury. Indeed, some cultures and religions - notably Islam - still outlaw usury today. As money guru Bernard Lietaer points out, it was only when the Catholic Church's assets shifted from land to financial capital that it declared charging interest to be no longer sinful.[1]

Setting aside the moral issue for now, we can ask whether interest is really necessary for the functioning of economies? Mainstream economists have several justifications for interest (rates).

First and foremost, they say the only effective way to combat inflation is by manipulating interest rates so as to dampen money supply growth. But only in recent decades have interest rates been the primary tool of monetary policy in most countries (when Monetarist ideology came to prominence). Before then, governments used various liquidity controls to affect directly the amount of money commercial banks created, and up till 1972 all currencies were backed by a real commodity - gold. An in-depth discussion of inflation is beyond the present scope, but suffice it to say that there are other money systems which have historically not relied on interest rates for price control.

Second, economists point out that at least one section of society - the elderly - relies on interest payments on savings for their daily consumption. True, but only because we live in a highly individualistic society where we all have to compete for money which is in perpetually scarce supply. Strong communities take care of their elderly in other ways, rather than pensioning them off.

A third justification for interest rates is that human beings are innately short-sighted and impatient; they prefer to consume today rather than in a year's time. This is undoubtedly true to some extent, but let's consider the effect of the system on the people. If I live within a system over which I have no control, then I had better do the best I can within that system, i.e. respond to the incentives. So if the interest rate is high, I should cut down and sell all my trees and deposit the money with a bank so as to earn interest. This simple example illustrates a general principle: positive interest rates on money incentivise the unsustainable draw-down of natural resources. Furthermore, interest encourages production and consumption of short-lived goods. For example, buying a new R50,000 short-lived car every four years makes more sense than buying one R250,000 car that lasts for 20 years, even if you have the larger amount of cash now - because the balance can be invested at interest.[2] On a global scale this massively contributes to unnecessary resource exhaustion and pollution.

Aside from being an immediate threat to the environment, interest rates have several damaging consequences for society. One is the discounting of future generations. When economists evaluate an investment prospect, they implicitly downgrade the importance of long-term costs and benefits (e.g. environmental and social) because future streams of benefits and costs are discounted, i.e. divided by an annually compounding interest rate. An interest rate of 10% effectively means that any costs or benefits that accrue in more than 20 years' time are considered irrelevant to the decision taken today. So much for consideration for our progeny, which is the hallmark of sustainable development.

Not only intergenerational equity, but also current equity is undermined by interest. Interest transfers wealth from the poor (generally debtors) to the rich (generally creditors) - and especially to the commercial financial institutions and their shareholders. This applies to nations as well as individuals.

Moreover, the widespread indebtedness of consumers in the modern economy locks them into wage dependency to pay off the interest on loans and credit. The majority of people have to work increasingly hard for less as they compete with others for scarce currency to repay loans and interest. On the other side of the equation, interest encourages creditors to hoard money in bank accounts, thereby depriving others of the crucial medium of exchange and allowing real resources (like labour) to remain needlessly idle.

Finally, and perhaps most importantly, interest-bearing, debt-based money requires continuous economic growth to avert financial collapse. This is because real economic activity must always expand to finance interest payments on loans - more has to be paid back than was originally borrowed.

In sum, a financial system based on debt and interest is completely at odds with the key principles of sustainable development: sustainable economic livelihoods, social equity and environmental sustainability. Sadly, given the astronomical vested interest in the current setup, probably the only way human society will progress to a sustainable economy is via a major collapse of the current global and national financial systems - which an increasing number of informed people regard as inevitable and rapidly approaching. This will bring pain and suffering to many in the short to medium term, but is vital for the sustainability of human society in the long term.

Are there alternatives? Yes, community-based, local currencies such as Local Economic Trading Systems (LETS), which usually charge zero interest, and sometimes even include a negative interest rate or booster to encourage circulation and long-term real investment. There are currently over 7000 such LETS worldwide, albeit mainly in rich countries. Similarly, in previous economic downturns such as the Great Depression, local currencies have sprung up spontaneously as the limitations of national currencies became manifest. And in case you think such local schemes are irrelevant in today's globalised world economy, think again: SANE's Internet-based Community Exchange System now has several trading groups operating in various parts of the country as well as in Australia and New Zealand. Such systems provide hope for the future.

[1][1] Bernard Lietaer, "Community Currencies"; see also his book The Future of Money.

[2] Ibid.

This issue, and all previous issues of SANE Views, is available from the SANE web site


Community Currencies: A New Tool for the 21st Century

Tailoring New Economics to South African Realities Economy and social organisation

Internet-based exchange: P2P Can Cut Banks Out Of The Picture: Ripple


Bernard Lietaer
The Future of Money: Creating New Wealth, Work, and a Wiser World

See also:

SOCIOECONOMIC DEMOCRACY: An Advanced Socioeconomic System

Money As Debt
An excellent introduction to some of the major problems with our current economic system. Want to know what is at the root of the current breakdown of banking? It seems that what's happening today is only a logical consequence of the way our money is created.

Our whole economy is hostage to those issuing money (the banks) and a necessary consequence of today's system is that money tends to end up in just a few hands, leading to exquisite and varied problems for the rest of us ... we need some smart changes here. The video identifies the problem and proposes one possible solution. There may be others.


posted by Sepp Hasslberger on Monday August 15 2005
updated on Friday October 15 2010

URL of this article:


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