A significant cause of the unjust inequalities of wealth found in our society is a simple mechanism which keeps it all going: the state-chartered monopoly power held by private banks to create money as debt, and to profit from it through the interest charged on their loans. Their ability to set interest rates (coordinated through central banks like the Fed) is a form of monopoly pricing; in this case, the pricing of money. The banking system–through its power to charge interest–is able to control the credit markets to its own benefit.
Since the banking system has the power not just to set but to vary the interest rate, it has the power to adjust the value of money to maximize the return it gets from borrowers. HIgher rates make money scarcer and more valuable; lower rates make it more common and less valuable. Dollars which can be loaned out at a real 6% per year, for instance, are twice as valuable as dollars which can be loaned out at only a real 3% per year.
As a result of this power, a relatively small number of creditors are able to rely on the banking system as it’s structured for creditors to steadily extract wealth from the mass of debtors. Creditors are able to skim off and reinvest the interest, while borrowers labor under varying degrees of debt peonage. This all happens every day as a matter of routine legal business contracts.
Once upon a time, this kind of debt burden was called usury, and was widely condemned; it is still outlawed in many Muslim countries under Sharia law. Conflicts between debtors and creditors were common in the ancient Western world, and reappeared with the revival of commerce in feudal and early modern times. In spite of all the difficulties it raises, however, some degree of credit, or debt, remains necessary to facilitate production and exchange in anything more than a local subsistence economy.
Early modern creditors, such as Renaissance bankers, were private creditors. They pushed back against the charge of usury. Increasing commerce, they argued, demanded more credit, not less. Without some kind of compensation for putting their assets at greater risk by lending them out, they not unreasonably demanded some kind of reliable consideration–for which the most convenient mechanism available was to charge what interest they could.
The question became what is and is not a usurious rate of interest. As long as no satisfactory answer to this question was offered, as it was not for centuries, then any rate of interest might as well be justified as not. Its critics failed to outlaw usury because they could not define it. In the end, what most Western countries once regarded as usurious lending practices came to be accepted as natural, and were finally legitimized in law.
In what follows here, the problem of interest and usury is reassessed, and an alternative solution for a fair and just distribution of assets throughout society through a new system of public credit is outlined.
The struggle over credit, debt, and interest was originally an Old World struggle. It was fought out in European history, ancient and modern, in response to marked economic and social inequalities attributed to these practices. In the ancient and medieval worlds, there was no point of reference outside the tension between already established social orders over the distribution of wealth: kings and subjects, citizens and slaves, lords and peasants, and so on. Inequality was all anyone ever knew. A fair distribution of wealth could only be imagined abstractly by reformers, who had no direct experience of it.
America was different. North America in particular provided access to resources by ordinary people not available, or even imaginable, in the Old World. Once its indigenous peoples were ravaged by disease from initial European contact, and then overcome and marginalized by the occupying colonists, the continent became open to new settlers, justly or unjustly, for the mere effort of claiming its lands and appropriating its resources. Many immigrants, in spite of indentured servitude and slavery, actually had the experience of appropriating for themselves resources largely available for the taking in an open continent, something not possible in Europe or anywhere else.
This unique American experience didn’t make America wholly exceptional. The Euro-Americans brought with them all the vices and evils of the Old World, including the intolerances of patriarchy, racism, slavery, and the rest. What was exceptional in America, however, was the essentially free access to resources on open land on the frontier. That allowed ordinary citizens, who were propertyless in Europe, to acquire property in America. They had the opportunity to become independent producers–farmers, artisans, mechanics, teamsters, builders, shopkeepers, and other small business entrepreneurs–and they forged in the process an identity arguably unique to America, though never shared by all Americans, an identity of independent ownership epitomized in the farmer and small business person.
Frederick Jackson Turner famously derived this uniquely American identity from the role of the frontier in American life down to its closing in 1890. The frontier offered accessibility to property and resources which made possible a broad middle class of citizens who owned and operated the means of production for their own profit. They could compete or cooperate, but they remained independent players in a common economic game of small-scale capitalism. They hired help as needed, but they did not work for anyone else, but only for themselves and their families. They were not proletarians but small business people. Theirs was not the pseudo-exceptionalism of 20th century American global empire building, but the real exceptionalism of early America as a society marked by widespread private ownership of property and the democratic governance it sustained.
The introduction of socialist ideas from Europe, which there fit into preexisting norms of chronic class struggle, obscured this American exceptionalism, which socialists have never understood. European-inspired socialists presumed that the power of capitalism would be as concentrated as the power of feudalism had been. Just as there had been lords and peasants, so there would be capitalists and workers. American exceptionalism–forged most sharply in the Western frontier, and memorialized in countless Western movies–represented and defended a capitalism which was decentralized and democratized, not centralized and monopolized. This sensibility–based on property and assets widely distributed among roughly egalitarian citizens–was a development perhaps unprecedented in modern history.
This identity was articulated most clearly in populist movements defending democracy and property and self-rule in colonial and ante-bellum America, and it remained a central force in American life down to the 1890s. Populism–the dual demand for property and democracy–is arguably the original and unique American identity. It presumes a norm of widely distributed ownership of resources underwriting the relative economic and political independence of individuals. The American exceptionalism embedded in populism is distinguished by its understanding that the relative economic independence of citizens is a necessary condition of their ability to participate freely and honestly in democratic decision-making.
The basic struggle of populist Americans was to preserve the decentralized capitalistic democracy they created against the forces conspiring against it. The biggest threat, as they saw it, came from monopoly power, not from capitalism, and the most powerful monopoly draining middle class wealth in their view was the banking system, where the rules of engagement were those between debtors and creditors, not capitalists and workers. This struggle was won by the banking monopolists by the end of the nineteenth century. The populists, divided over strategy, were outfoxed and overwhelmed by the legal extension of monopolistic powers to corporations, including banks, which gradually displaced the independent business owning middle classes with the economic dependency of wage labor.
In our day, the practice of largely unregulated private credit at unearned rates of interest has been normalized to the point of being almost entirely taken for granted. Credit, debt, and interest, are usually presumed to be necessary and settled features of economic life, along with the concentration of wealth in the hands of creditors at the expense of debtors. This is how things work, we are told, as if it was a natural evolution of social practices.
We forget, however, that modern finance is not the result of natural processes resulting in current practices, but was in fact a peculiar human invention–an intentional financial revolution which occurred in Holland and England in the seventeenth and eighteenth centuries. This revolution created a new financial system by inventing novel rules and institutions which made modern economic and financial practices possible. It allowed investors, for the first time in human history, to borrow on a large scale against future earnings, and invest in and vastly increase current production.
The key event in this revolution was the establishment of the Bank of England in 1694 by a consortium of private creditors under an act of Parliament. The Bank agreed to assume the personal debt of the monarch, which parliament agreed to transform into a national debt secured by government bonds. The Bank issued notes (which became British pounds) to purchase those bonds. The security of the debt, and the bank notes issued to buy it, rested on the ability of the government to tax the public to ensure repayment of its bonds. As part of the deal, the Bank, as creditor for the debt, got to charge interest on the bonds to its profit, and its notes circulated through the economy as the currency known as British pounds.
Alexander Hamilton later called this the ‘English system,’ and it was unprecedented in world history. For the first time ever, the taxing power of the state was used as a reserve fund for a national debt held by private investors for their profit. Seventeenth century goldsmiths had already discovered that they could lend out their notes in excess of their gold reserves. With British pounds now backed by a national debt, the banks, like the goldsmiths before them, were able to confidently lend out far more pounds than they had on deposit. The result was an enormous expansion of credit, now institutionalized as never before. This expanded credit was central to the British victories over the French in the eighteenth century, the rise of the British colonial empire, and the funding of what turned out to be the industrial revolution.
This British financial revolution may be the most underappreciated event in modern history. The unprecedented economic productivity it unleashed transformed the planet. Along the way, it suppressed long-standing objections to usury. Interest was defended by bankers as the price of risk, and its fluctuating rate, they claimed, was naturally set according to the shifting desires of creditors and the varying demands of debtors. They invoked Jeremy Bentham, whose pivotal essay, “In Defense of Usury,” argued that interest rates ought to be settled by a free market of supply and demand.
The rate of interest determines how the surplus of future production made possible by a loan is to be divided between creditors and debtors, with the former now able to demand a share commensurate with the rate of interest they can charge. The higher the rate of interest the greater the portion of productive surplus which goes to creditors, and the less the portion which goes to debtors. It also adds to the costs of goods and service which increases pressure on producers to keep down wages.
The private banking system–effectively a cartel run by the largest banks–currently exercises monopoly control over the interest rate. Banks are officially chartered institutions given the sole right to take deposits, make loans, provide accounting services, and set interest rates on their loans, all for a profit. A bank brings money into existence every time it makes a loan, and the notes it issues are legal tender. Because it holds a monopoly over the money system, it can charge a monopoly priced interest rate for its product.
One measure of the rate of return on investment is how long it takes for the interest collected to equal the principle lent out, or how long it takes for a loan to be doubled in repayment. The following table illustrates the correlation between interest rates and time needed to double the principle:
15 percent = 4.8 years
10 percent = 7.2 years
5 percent = 14.4 years
3 percent = 24 years
2 percent = 36 years
1 percent = 72 years
Consider a thought experiment. Without credit no economy can function. Even in a simple economy, the merchant advances materials to the artisan or farmer, on the promises of the latter to produce the goods and harvest the crops. The economy as a whole runs on credit, its essential lubricant. Old loans are constantly being paid off and new ones are constantly being taken out. The economy as a whole carries some perpetual debt, as it should be to function. But debt can quickly become onerous.
An entire economy which carried a perpetual 15% real debt load, for instance, would have to double in size every 4.8 years to produce enough new goods and services to sustain repaying that level of debt without selling assets to do so. The highest US economic growth ever achieved was 19% during World War II, never before or since approached. In recent decades, the annual economic growth rate of the US economy has been in the range of 3% or so, and gradually declining. Very high interest rates, such as 15%, presume an astronomical growth rate impossible except in brief and rare circumstances. Paul Volcker as Federal Reserve head famously spiked interest rates to 20% in 1981, another record, to bring rampant inflation under control, but that too was exceptional.
Even at a 3% perpetual debt load, other things being equal, the economy would not only have to double to keep up every 24 years, but would have to continue to double after that indefinitely every 24 years. A $1 million dollar loan for the creditor turns into $2 million in 24 years, and, if relent, $4 million in 48 years, $8 million in 72 years, $16 million in 96 years, and so on. The borrower, by contrast, must pay back the $2 million in 24 years, and $4 million in 48 years, and so on, to keep this process going. They have, of course, the use of the money they borrowed in the meantime. But the creditor has what the borrower lacks: a legally enforceable contract demanding a specified rate of profit–a protection of state power in addition to the backing of the borrower’s collateral. The borrower has no such guarantees and simply takes their chances.
What justifies the interest rates charged by the private banking monopoly? The conventional answer is risk of default. But the creditor already has (or should have) as backing for the loan good collateral put up by the borrower (property, equipment, inventory, etc.). This should cover most if not all risk of default. The idea that a rate of interest is established to cover risk in addition to collateral adds a secondary guarantee to the creditor, while insurance and loan guarantees add a tertiary guarantee, together creating a kind of triple indemnity, a comfort to creditors, but an onerous reality for borrowers.
The borrower is put in a position to labor excessively, like an indentured servant, to satisfy the demands of a creditor master. Given their monopoly power, banks are able to charge for loans not just the costs of doing business (offices, equipment, personnel) but any amount of interest the credit markets will bear. This extra cost is an extortion, a private tax by creditors on borrowers due solely to their monopoly power. Instead of maintaining a right to the full fruits of their labor, the borrower is forced to give up the difference between the moderate existence permitted under conditions of major debt at interest, and the much fuller life which would be possible if the borrower could retain the profits of their own labor, and not have to turn a large share of them over to the creditor for no other reason than bankers can extort a monopoly price for the credit they control.
Is there a just rate of interest? Credit, after all, is necessary to any functioning economy. A just interest rate could be calculated at what must be earned, at a minimum, to keep the economy at a steady state of net zero growth. A perpetual rate of zero-interest loans, would require borrowers to produce enough to pay for the resources they have consumed in spending down their loans, but it would not be enough to replenish those resources.
When loans are repaid, the money they created is extinguished, as it must be to avoid an ever-ballooning money supply created by ongoing lending. When lent money is spent into circulation, it is passed on to someone else in return for goods and services they supply. They in turn can save rather than spend the money, which withdraws it from the economy (putting it in a mattress), at least temporarily. The saver can resume spending, however, or they can lend it to someone else, who presumably needs to borrow in order to spend for some purpose.
When money is spent, resources are consumed. Money, after all, is a valid public claim against some measure of resources. It is a license to consume resources. The holder of money is entitled to spend it, that is, to cash it in for goods and services, which diminishes the amount of available resources. Those resources must somehow be replenished if the economy is to be perpetuated. One way to do that is to incentivize borrowers to produce more than they consume.
In a zero-interest economy, proposed by some modern theorists, there would be no incentive for private holders of money to lend, and no incentive for borrowers to replenish any of the resources the money they borrowed allowed them to consume. By contrast, if the borrower must pay some rate of interest, they (or someone on their behalf) will necessarily have to produce in proportion to the rate of interest more than they need to produce in order to consume for themselves. That extra production can then be sold to repay the interest. In this way, interest drives economic growth–at least as long as they are willing borrowers.
Ideally, borrowers paying interest would, at a minimum, need to produce enough extra in products and services to make sure that the resources are there for the next generation of borrowers to be able to produce and consume in turn. Such a steady state of production would provide for the continuous replenishment of goods and services as they are consumed or depreciated. The individual portion we each owe to that ongoing replenishment is the sum of what we consume and wear out over the course of our own lifetimes. We should have to pay not only for what we consume, but for the cost of replacing it. The minimum rate of steady state economic activity can be understood as the rate of natural replacement rate required by economic entropy, that is, by the depreciation of the resources (materials and labor power) for which we must compensate to maintain our current economic infrastructure of goods and services.
It is a curious coincidence that the time for 1% interest to equal the principle in payment, or 72 years, is about a traditional human lifetime. The interest charged on public credit loans, the amount necessary to reinvest to keep a steady state economy going, would naturally come out at about 1% if we took our own lives as the measure of replenishment. Fixing public credit interest at 1% would ensure the minimal responsibility needed by borrowers to keep things going, while also reserving to them all the remaining productive income the loan makes possible. The principle would be extinguished as it was repaid, like all loans, but the accrued 1% interest would automatically guarantee that the funds needed for ongoing borrowing would be replenished.
This vision of a self-regulating steady-state economy governed by a 1% rate of interest on debt was the deepest vision of classic nineteenth century American populists. It was developed most fully by the monetary theorist Edward Kellogg. Kellogg was an antebellum businessman in New York City who suffered the crash of 1837 and became a writer and advocate of monetary reform. His main works are Labor and Other Capital (1849), and a revised version, A New Monetary System (1861), posthumously edited by his daughter, Mary Kellogg Putnam. [This writer has discussed Kellogg at some length in two works: The Ecology of Money: Debt, Growth, and Sustainability (2013) and Fixing the System: A History of Populism, Ancient and Modern (2008).]
American populists like Kellogg were in the Jeffersonian tradition. They were distrustful of concentrations of power either in big business or in big government. In the Jacksoian era, many populists, like the New York editorialist William Leggitt, supported market-dependent free private banking, with little or no state regulation. Kellogg and other populists, however, opposed any form of private banking, even decentralized free banking. They saw the lack of interoperability among thousands of local, independent banks whose notes, lacking adequate coordination or a uniform standard of issue, were variable and unstable in value. Their for-profit private basis for lending usurped what Kellogg regarded as a public function. He developed instead a system of decentralized public banking, regulated but not managed by the federal government.
Public banks would be locally run, perhaps one in every county, and locally accountable. Access to public banking would be entirely local and decentralized. Most bank lending, after all, is already decentralized. We might imagine public bank trustees to be locally elected (much as we elect school boards or town or village boards or city councils) to ensure accountable, democratic community management and oversight. The central regulating national agency–Kellogg called it The Safety Fund–was not a central bank. It purchased no assets and issued no loans and set no interest rates. Instead it distributed uniform public credit dollars to local public credit banks which alone were empowered to issue them to the public, in return for debt-backed securities, such as mortgages, or other good collateral.
The federal regulation Kellogg proposed would be akin to what is already done to maintain national standards of weights and measures, and no more. It would define a dollar just as the National Bureau of Standards defines our current measures of value, such as length, weight, volume, time and date, and so on, by fixing the rate of interest and thereby ending fluctuations in the value of money. The Bureau of Standards would be charged with the enforcement of a fixed rate of interest and other credit protocols, established by Congress, not a central bank issuing currency to the banking system in any amount, or raising and lowering interest rates as it sees fit.
The value of a dollar, Kellogg argued, is determined by the interest rate it can command. A dollar which can be lent out at 6% real interest, as we’ve noted, is worth twice as much as one which can be lent out at only 3% real interest. The stability of the dollar, or any currency, can be guaranteed only if it is lent out at a fixed rate of interest established by law. I have suggested that the cost of running a steady-state economy can be understood as the rate of entropy calculated by the human consumption of resources over a lifetime, and that the interest rate appropriate to maintaining steady-state consumption is 1% per year. This is in fact the rate Kellogg determined should be the fixed rate on all public credit loans. In paying back 1% on their loans, the borrowing public would be both replenishing the principle which is being extinguished as it is paid off, while also reserving for debtors the remaining full value of the use of their loans.
Interest at 1% is legitimate interest because it is a mechanism able to compel the borrowing public to produce in their lifetimes at least as much as is necessary to replenish the resources they consume in the ordinary course of events. We have an arguable moral obligation for our own survival as a species to replenish what we consume, and if so we are justified in paying an interest rate of 1% to ensure that end. Any production beyond the obligation to maintain a steady state or status quo society is production rightfully belonging to the producers actually carrying out that production, not to their creditors.
Any rate above 1% compels the appropriation of resources beyond that of a steady state economy. It forces any economy to depart from a steady state and enter a growth path, no matter what, even at the cost of depleting resources. A 1% rate, on the other hand, does not preclude growth any more than it commands it. Any growth which loans at 1% are able to stimulate will be entirely in response to the conditions and opportunities available, and not be forced beyond their means by the external compulsion of satisfying a higher rate of interest.
How would public credit work? Any citizen could apply for a loan for any purpose to his or her local public credit bank on the basis of national criteria for good collateral at a rate of 1%. These would be secured loans. Kellogg presumed hard collateral, such as land, to be required, but modern definitions of collateral might include earning potential or other reliable factors to broaden access to loans as much as possible while avoiding moral hazard. Setting the terms of uniform national standards of collateral would be the business of The Safety Fund. The borrower would be guaranteed that, by paying only 1%, they would retain income that would otherwise go to bankers or the state or other creditors.
Anyone with some collateral would have an enhanced opportunity to finance their own lives and families and businesses. Debt at 1% interest would be far more affordable than at higher rates. Those without adequate collateral would benefit indirectly from the services a democratic state could be expected to provide for its citizens (such as social security, universal health care, public education, family assistance, etc.), as well from as new employment and other opportunities which a broader-based prosperity would promise.
The first financial revolution in England put the new and enhanced power of credit arbitrarily and unnecessarily into private hands. The sheer scale of credit it made possible revolutionized the world. But the benefits of that credit went into the hands of a small private financial elite of creditors, who accumulated vast wealth and power, leaving the mass of the population deeply indebted and financially insecure.
Monetary reformers today also claim to put the power of credit into public hands. Unlike the populists, however, they advocate a centralized form of public credit as an antidote to the abuses of private credit. The most popular alternative proposals today for public monetary reform are progressive fiat money schemes, usually some version of Modern Monetary Theory, associated with figures such as Warren Mosley, L. Randall Wray, and Stephanie Kelton.
These theorists imagine the government ending the monopoly of currency creation by private banks by itself issuing money directly in various ways: in payment for government contracts, for infrastructure projects, for the military, as a universal basic income, as funding for education, health care, and so on to subsidize any other desired ends.
Many of these proposals involve some form of direct fiat money creation by the government. They would largely if not wholly replace the private money system with public money created by the government. The main historical precedent for this in the United States is the issuance of Greenbacks during the Civil War. The government was desperately in need of money to pay for the war, and it printed over $450 million in Greenbacks as payment to military suppliers and other government contractors. These Greenbacks circulated generally in the population as a public tender currency, and were used to pay taxes. After a short time, the private banking interests were able to lobby for legislation phasing out Greenbacks and reinstating their private monopoly over money.
Unfortunately, direct-issue, single-source fiat money schemes substitute one centralized monopoly with another–the system of privately run state chartered banks is replaced with a public system run by the government. The centralized distribution of money is presented as a vehicle for social justice, which it could be, but it seems as likely, with the government today lacking effective public accountability, to become just as well a recipe for favoritism, special interests, inequality, and further corruption. It would be a managed, top-down financial system, and like any top-down system it will be a bureaucracy which ends up being run by the few. In the end, the sociologist Robert Michel’s famous “iron law of oligarchy” is likely to prevail, where in any hierarchical organization, power is inevitably concentrated at the top.
More problematically, a fiat system of direct issuance of money by the government is a system for redistributing income, not the production of assets. Direct issuance does not provide credit at nominal interest. It leaves its subjects dependent upon one or another government check determined through a complex and distant process with minimal, infrequent, and mostly symbolic public oversight (elections, the courts). The decentralized system of public credit, by providing loans, enables citizens to invest the money they borrow in order to realize their own productive potential and independence. A government fiat check only sustains consumption, like the free ‘bread and circuses’ offered to the people in ancient Rome. The prospect of a loan not only makes economic independence possible, the obligation of repayment fosters a social responsibility which direct government payments only undermine.
Moreover, there is no clear mechanism in a public fiat money plan to maintain a stable currency and prices. Money needs to be systematically extinguished as well as created, and it’s not clear how that could happen in a fiat system, apart from the heavy taxes which might be required to extinguish any large amount of fiat money. Modern monetary theorists argue that some kind of special agency or commission could calculate the rate of inflation and adjust lending and taxes accordingly to offset any undesirable increase. But the uncertainty of economic calculations, the divergent views of economists, the power of a central government agency, political polarization, corruption, and the lack of political accountability, all undermine confidence such an agency could ever hope to control inflation, or even be objective in attempting to do so.
The demand for money (once people see it’s a free creation) would be enormous, and inflationary, and the endless funding of one and another deserving group of recipients would favor those who have the most political influence, likely leading to a maldistribution of wealth that could be as bad as the one we have now. And it’s not clear that the private bankers couldn’t live with fiat money, and eventually game the public system, as long as they can continue to make loans and charge interest and control the credit markets. Many monetary theorists embrace the Chicago Plan of the 1930s, which would require banks to lend only money on deposit, but then the credit necessary to fund the economy would seemingly dry up.
Kellogg’s public credit dollars are not fiat money simply issued by the government with no clear backing except the monopoly of the sovereign. They are dollars issued as loans with clear collateral and a schedule for repayment. The effect of populist public credit promises to reverse and stabilize the flow of money. Instead of money distributed top down by monopolists (private or public) as a privilege for which borrowers have to pay usurious interest, or as a funded payment to ensure a minimal level of dependency, decentralized populist public credit becomes a right exercised locally and individually to retain for themselves what creditors historically have been able to appropriate from borrowers, that is, anything over 1%, which the borrower now gets to keep. There would be no shortage of credit, as all credit would be available on equal terms at only 1% interest to all qualified borrowers. It would, finally, guarantee a path to ownership of assets to all citizens, for the first time in history.
For early Americans, and populists in particular, the measure of wealth was not income, but rather assets which could be put to work to produce income. The frontier vision promoted the idea of a right to ownership of productive assets, and to the benefits which can be realized from them. With the triumph of centralized private banking, and its credit and debt monopoly grip over the economy, the idea of a right to assets gradually vanished. The struggle shifted ground and became one over the distribution of income, while the accumulation of higher value assets to the few continued unabated.
The populist claim of a right to productive property in our time means the right to credit, since credit remains indispensable to the acquisition and utilization of assets. The frontier is long gone, but the right to credit remains as the instrument to secure the right to assets. We can no longer find empty land to homestead, but we can claim a right to credit, and to its full benefit. As a public right, credit should not be monopolized and controlled by private interests. It should instead be guaranteed by the government equally to all citizens at a uniform and stable, non-usurious interest rate.
This is not the place to speculate over how a decentralized system of public credit at 1% could be institutionalized under current conditions, or what role private banks might play in a world of 1% public credit, or many other related issues. The purpose here is only to outline the plausibility of a just monetary system which ensures the widespread ownership of assets and wealth. It ought to be an option in the minds of those who, someday, may be brought by circumstances to the responsibility of being in a position to design and implement such a system.