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- The Second Greatest Story Ever Told, Chapter 12 -
- The Interest/Discount Spread -
- Non-Disclosure, Misrepresentation, Lack of Transparency -
- Self-Liquidating Loans -
- In Praise of Scholasticism –
Chapter 12
in which the gentle reader learns why the miller and the baker
did not succeed to commit the perfect crime
Having burnt their fingers once before, the
miller and the baker proceeded very cautiously. They understood very well the
inherent danger that the bill market may reject their anticipation and
accommodation bills. Therefore they insisted that their customers post
collateral security.
"We can now print our own money" gloated the miller. "When we accept accommodation
bills, we borrow at the lower discount rate in order to lend at the higher
interest rate. We simply pocket the difference between the two. It's manna
from heaven." The baker added gleefully: "And if our customers fall
upon hard times and can't pay their debt, no harm done.
We shall pay on their behalf out of the proceeds of their collateral."
The miller and the baker went on creating
bills merely for the sake of discounting them, and so to provide their
customers with ready cash, and themselves with an income. In order to make
these accommodation bills more attractive to the prospective buyer, they
invented goods and sent them on imaginary trips around the globe. They
thought that chances of exposure of the fraud were nil. They would never ever
allow their customers to default. Should they be unable to pay, the
Acceptance House would routinely pay off their debt at maturity without
demur, and get compensated by selling the collateral. Whenever the market
value of the collateral fell, the Acceptance House would issue a 'margin call',
that is, a call to restore market value to the original level by posting more
collateral.
For a time it looked as if the baker and the
miller have indeed succeeded in inventing the 'perfect fraud'. The sky was
the limit to the profits to be made in the acceptance business, as only human
imagination could limit the type of goods to be invented for the purpose of
discounting. Alas, there was a fly in the ointment. What the baker and the
miller forgot to consider was that their profit depended on a positive spread
between the interest rate and the discount rate. But their activities were
undermining exactly this foundation. As more and more fictitious bills were
put into circulation, the spread narrowed. The Acceptance House was forced to
accept ever more fictitious bills in order to maintain its customary profit
margin. This, of course, made the spread to narrow further. Clients were
caught up in the squeeze and were forced to forfeit their collateral. The
burden of the fraud was shifted to the mortgage market and, ultimately, to
the real estate market.
One day the miller came home with bad news:
"You can buy real estate as cheap as stinking mackerel", he said to
the baker. "We had better liquidate all the mortgages in our portfolio
before the owners walk away from their properties." But it was too late.
There were no more takers for first mortgage on prime commercial real estate
than for a third mortgage on a farm in the moon.
The Acceptance House, too, was forced into
liquidation. The conspiracy of the miller and the baker collapsed once more. The
worst aspect of the disaster was that it victimized a lot of innocent
bystanders, owners of real estate who had nothing to do with the fraud and
the conspiracy, but who nevertheless suffered real losses because of it.
It is clear that accepting anticipation or
accommodation bills amounts to illicit interest arbitrage. The drawers of
these bills should properly go to the bond (i.e., loan) market and borrow at
the prevailing rate of interest, making full disclosure to the lenders about
the nature of their enterprise. Instead, they went to the Acceptance House
where full disclosure was not a requirement. In this way they could keep
their cards closer to their chest and escape scrutiny as to the nature of
their business, as well as control that lenders would normally want to
exercise over the activities of their borrowers. For its part, the Acceptance
House welcomed this business because of its great profitability. It pocketed
the spread between the rate of interest and the discount rate without
assuming any risk, indeed, without rendering any useful service to society
(such as the Discount House does).
Borrowing Short
to Lend Long
More generally, it is illegitimate to borrow short
in order to lend long. To do so is tantamount to making unwarranted
assumptions about future market and credit conditions. There is no way to
predict what the consumer will demand most urgently in the future, nor to predict what items will fall out of his favor. There is no way to predict how tight credit
conditions will be.
There are those 'free market economists' who call
the denounciation of borrowing short to lend long a
witch-hunt. They say that the practice cannot be condemned on economic
grounds, any more than risk-taking can. "Let competition prevail",
they argue, "and let the smartest guy win the jackpot!" They call
our criticism, at best, a moral judgment; at worst, an effort to stifle
competition. It is not for the economist to make moral judgments on what is
and what is not an acceptable level of risk-taking.
There is no need to quarrel with the last statement.
But to say that the case against borrowing short to lend long has nothing to
do with economics shows a profound lack of understanding of the market
process. It should be clear that the dispute is not about risk-taking. The
proposition that borrowing short to lend long ought to be outlawed does not
aim at stifling competition, any more than the proposition that
misrepresenting the quantity or quality of goods offered for sale ought to be
outlawed does. Economics does not criticize speculation and other forms of
risk-taking as long as risk-takers use their own funds, or they persuaded
someone else to advance funds for this purpose.
Social circulating capital is not owned by any
individual, nor by any group of individuals. It is
communal property, as it were. It is property 'socialized' in the best sense
of the word. The flip-side of social circulating capital is the bill market. To
dip into the bill market in order to raise funds without contributing
anything in return is the same as stealing communal property. Just what is a
valid contribution to social circulating capital and what isn't, is a
question that is decided by the bill market. If the bill, making full
disclosure without misrepresentation, can be discounted at the going rate,
then the underlying good belongs to the social circulating capital; otherwise
it doesn't. Bills that can be so discounted are capable of monetary
circulation; others aren't. This is an objective criterion setting apart
self-liquidating bills from anticipation, accommodation, and other fiduciary
bills. There is no appeal against the verdict of the market. There is no
scientific argument that could overrule it. We may assume that according to the
most authoritative scientific research "miracle product X" ought to
have a place in everybody's household. But, unless this opinion can convince
consumers, product X will not be part of the social circulating capital, and
bills drawn against it just won't circulate. The bill market is the final
arbiter on that matter. However, all statements on the face of the bill must
be true to fact and to intention. Otherwise the bill is disqualified and
becomes phony, and the drawer and acceptor become
impostors and counterfeiters. They should be subject to the same punishment
reserved for the conspirators in coin-clipping and forgery of bank notes.
Baring Brothers
The textbook example of the fate of the Acceptance
House guilty of illicit interest arbitrage is the collapse of the House of
Baring in 1890. The firm Baring Brothers & Co. was established in 1763 in London by John and Francis Baring. They
were the sons of John Baring (1697-1748), a successful German cloth
manufacturer who in 1717 started a small business in Devon.
At first the partners were import and export commission agents for other
merchants, but they soon began to lend their credit in the form of trade
acceptances. They were involved in financing the British war effort against
revolutionary France and,
later, that of the Union against the Confederacy in North
America. In 1890 the firm was still controlled by the Baring
family when it got involved in Argentinean and Russian government finances
and collapsed. Baring Brothers & Co. was bailed out by the Bank of
England. However, as an Acceptance House, the firm's credit was effectively
ruined. See The House of Baring by R.W. Hidy
published in 1949.
The
Interest/Discount Spread
If the market knowingly discounted undisguised
anticipation and accommodation bills at the same discount rate as that
applicable to real bills, then there would be no basis for objecting against these fiduciary bills. But clearly this is not the
case. Undisguised accommodation bills would never circulate. Disguised
accommodation bills may circulate for a time, thanks to the conspiracy of the
Acceptance House and its clients but, as a rule, the fraud will come to light
sooner or later. The charge of non-disclosure, fraud, and misrepresentation
concerning the nature and the status of goods on the face of the bill stands.
The positive spread between the interest and the
discount rate is not there for the picking. It is there to support social
circulating capital. Supplying the consumer with urgently needed goods on the
shortest possible notice and in the most efficient manner would become
prohibitively expensive, were it not for the presence of the spread. Bread
and milk would have to be supplied on the same harsh terms as the surgeon's
knife and the watchmaker's precision instruments. The publisher of newspapers
would have to apply the same mark-up as that of a Sanskrit grammar. Indeed,
milk, bread, and newspapers are perishable. Incentives to produce and
distribute them for the benefit of society are absolutely essential. Of
course, we don't mean subsidies. We mean the spontaneous incentive embodied
in the undistorted spread between the interest and discount rates.
Damages caused by natural disasters, for example,
would be far harder to heal (and, hence, far more devastating) in the absence
of a positive spread. The productive apparatus of society would be less
efficient, more wasteful, and less responsive to changes in the absence of a
positive spread between the interest and discount rates. It should be evident
that the market needs safeguards against illicit interest arbitrage causing
the spread to vanish, much the same as it needs safeguards to prevent any
other form of fraud. Alas, it was not done in the heyday of bill-trading and
of the gold standard, before the outbreak of World War I. Illicit interest
arbitrage should have been outlawed, and fraud in bill-drawing punished. It
should have been enshrined in legislation governing the bill market that
drawing anticipation and accommodation bills is tantamount to falsifying
public documents and, as such, constituted fraud. This would have put the
Discount House in a stronger position to detect and expose fraudulent bills. The
Acceptance House could no longer safely accept bills known to carry false
statements on their face. This is not just a legal and moral problem. It is
also one of economics. It is most unfortunate that the economists' profession
contributed nothing to its solution. It took the 'see no evil, hear no evil'
attitude, leaving the problem to solve itself 'through competition'. It
ignored the fact that fraud lends an unfair advantage to its practitioners,
and it was futile to expect that competition could purge business of crooked
practices.
The position of the Austrian School,
inspired by Mises, suggests that credit expansion by
the banks (which we could identify with the acceptance of anticipation and
accommodation bills) would be forestalled by the institution of 'free
banking': the best-managed banks would survive. It is a
strange way to handle fraud in letting competition take care of it. The
Austrian School must recognize the presence of
fraud in credit expansion. The reason that it has failed to do so is its
superstitious adherence to the Quantity Theory of Money, and its mindless
rejection of the Real Bills Doctrine of Adam Smith.
Non-Disclosure,
Misrepresentation, and Lack of Transparency
We should realize that the problem has become worse,
exposure of the conspiracy made more difficult, and the watershed between
upright and fraudulent business conduct further obscured when the banks
started emulating practices of the Acceptance House. As we know, earlier the
banks emulated the practices of the Discount House. So long as they confined
their activities to discounting self-liquidating bills only (or lent against
business transactions moving salable merchandise to
the ultimate cash-paying consumer only), they were merely supplementing the
efforts of the Discount House, and no fraud would be involved. Fraud appeared
when they started emulating the Acceptance House.
The banks, no less than the Discount House, cannot
create credit. They negotiate it. The credit already exists by virtue of the
underlying merchandise moving apace to the ultimate cash-paying consumer. In
discounting only self-liquidating bills, or in lending only against such
collateral, the banks merely make the credit more convenient and more
negotiable. This is legitimate business, it is a
healthy form of using credit. The Austrian
School is mistaken in
bundling it together with other forms of credit expansion causing economic
harm, such as discounting anticipation, accommodation, and any other types of
fiduciary bills, or in lending against such collateral, emulating the harmful
practices of the Acceptance House. In doing so the banks practice illicit
interest arbitrage. No longer are they engaged in legitimate business, but in
a form of credit-abuse. Just like the Acceptance House, the banks
fraudulently raise funds in the bill market at the discount rate and peddle
them in the bond market at the rate of interest. In the process they
appropriate the spread between the higher interest rate and the lower
discount rate, to which they are not entitled.
Notice non-disclosure, misrepresentation, and lack
of transparency in the banks' procedure. The fraudulently drafted paper and
other dubious or illiquid assets are now sheltered in the banks' portfolio. They
are no longer available for public examination, as they have been earlier
when the Acceptance House was trading them in the bill market. It is true
that bank examiners could scrutinize these assets but, to the extent that
they are paid by the government, they will follow norms adopted by their
paymaster. It is clear that government wants to classify Treasury bills as
paper eligible for discounting, or to be used for collateralizing loans. Therefore
the stage is set for subverting the system of bank inspection. The problem of
money and credit is thereby reduced to that of non-disclosure,
misrepresentation of banking assets, and lack of transparency. The fictitious
bills are withdrawn from circulation where they could be recognized and
rejected by the public, and buried in the bank's portfolio where they could
not. Exposure of fraud and conspiracy has become more difficult,
and illicit interest arbitrage harder to detect.
This raises questions of responsibility. Accounting
standards and the agenda for bank examiners are set by the government. Inclined
to favor a minority at the expense of the majority,
the government has succumbed to the temptation, allowed compromising accounting
standard and covering up fraud and conspiracy. Moreover, the government has
embarked upon the path of promoting its own Treasury Bills as money. This is
the worst kind of government incursion in the banking business, short of
nationalizing it. The practice of the government furnishing illiquid assets
for bank portfolios, while maintaining the pretense
of liquidity, has been greatly expanded in the twentieth century, and is now
more wide-spread than ever. It is further reinforced by distorting the theory
of banking. The government is charged with the task of managing the nation's
economy as well as its money supply. By allowing its debt to be used for the
purposes of monetization by the banks, the government has appointed itself as
dictator of the economy. It can order economic participants to obey its
orders, punishing those who resist, with the carrot of the money supply and
the stick of high taxation.
Another way of describing what has happened is this.
By overtaking the bill market, the banks have hijacked the social circulating
capital. They have put all the producers and distributors as well as a large
part of the consuming public permanently in debt to themselves. We may recall
that the social circulating capital used to possess a great momentum of its
own, so that lending could be replaced by clearing. The banking fraternity,
under leave from the government, has reversed this. The spontaneity of bill
circulation has now been replaced by the duress of bank lending. In other
words the banks, through their control of the social circulating capital,
hold society to ransom.
Self-Liquidating
Loans
According to Ludwig von Mises
all the note and deposit liabilities of the banks in excess of capital
accounts and vault cash are inflationary and contribute to credit expansion. They
tend to suppress the rate of interest below the level that would obtain in
the absence of bank lending. Mises does not
recognize the idea of self-liquidating loans that finance the movement of
merchandise and are to be repaid in 91 days or less from the proceeds of the
sale of that merchandise to the ultimate cash-paying consumer. Nor does he
recognize the essential difference between the interest rate and the discount
rate. Yet these two rates are entirely independent of one another as their
changes are autonomous. Either may be stationary while the other moves. If
both move, they may move in the same or in the opposite direction. The very
forces governing changes of either are different. The discount rate is
governed by the propensity to consume, while the rate of interest is governed
by the propensity to save. As other quantity theorists, Mises
holds that lower propensity to consume necessarily means higher propensity to
save. Yet this is a palpably false proposition: it is possible that people
decide to withhold gold from both the bill and bond markets. The only
connection between the two rates is that the discount rate is not supposed to
rise above the rate of interest. It is true that illicit interest arbitrage
may drive the discount rate above the rate of interest temporarily. It will
take a separate course of this University to investigate the consequences of
this. We refer to the great topic of the business cycle.
Short-term self-liquidating loans by the banks are
loans in form only. In substance they are instances of clearing, in exactly
the same way as bills of exchange are. In effect, the bank discounts bills of
the producers and distributors. The resulting 'loans' are definitely
non-inflationary. The reason is that those bills could in fact circulate on their own. The bank has to withdraw them from
circulation (or to preempt them from entering
circulation) when making a self-liquidating loan. There is no net increase in
the volume of purchasing media. The underlying credit exists on its own
merit. It would exist even in the complete absence of banks. To put
this differently, self-liquidating loans represent not lending but clearing
activity. Only by abuse of language can they be called loans. This is most
unfortunate, as the functions of lending and clearing ought to be kept
separate, and should under no circumstance be confused. Only then can one see
that there is no increase in the volume of purchasing media as a result of
the bank extending a self-liquidating loan. I repeat: the bank is not issuing
credit; it is merely negotiating it. The credit already exists on the
strength of the urgent demand for the underlying consumer good. The bank
merely substitutes its own credit (which is more convenient and more
negotiable, and recognized more widely) for the credit of the producers and
distributors (which may be less convenient and less negotiable, and
recognized less widely). Whether the credit is in the form of a bill of
exchange, or in the form of a self-liquidating bank loan, its circulation simpky mirrors that of the underlying merchandise in
urgent demand.
Mises and the Social
Circulating Capital
Of course, not every consumer good is such that its
movement can be financed by self-liquidating bank loans. Slow-moving
merchandise, durable goods sold on installment
plans as opposed to cash payments in full are some of the examples that don't
qualify. Such goods are no part of the social circulating capital, as Adam
Smith characterized the mass of fast-moving goods on their way from the
producers to the ultimate cash-paying consumers that will reach its
destination in 91 days or sooner. Certain merchandise may at one point in
time belong to the social circulating capital only to fall out of it later as
a result of changing consumer tastes and habits. Other merchandise may
regularly enter in and out of the social circulating capital following the
seasons. Heating fuel and seasonal clothing are examples. This highlights the
rationale for limiting the terms of self-liquidating loans to 91 days. Under
no circumstances must the term for such loans be extended by the bank. Financing
the movement of merchandise that may take longer than 91 days to reach the
consumer is not the task of the commercial bank that 'lends' at the discount
rate. It is the task of the investment bank that lends at the higher rate of
interest.
Mises recognizes
neither the bill of exchange nor the self-liquidating loan as a
non-inflationary source of credit. Neither does he make a distinction between
the discount and interest rates. Most glaring is the failure of Mises to accept the existence of social circulating
capital. Although Mises often talks about the
importance of urgent consumer demand and the significance of consumer's
choice, he fails to draw the necessary consequence which is as follows. The
most urgently demanded consumer goods are distinguished by the market in
being given preferential treatment: their movement to the consumer need not
be financed through lending. Items in the social circulating capital finance
their own movement through clearing. It is indeed most unfortunate that Mises and other sound-money economists have failed to
make the important distinction between self-liquidating loans of the
commercial banks and other loans that investment banks may make. As a
consequence of this failure they have to condemn all bank
lending in excess of capital accounts and vault cash as inflationary, which
is a grave error.
100 Percent Gold
Reserve Banking
Some sound-money theorists such as Murray Rothbard see the solution to the problem of credit abuse
in the so-called 100 percent gold reserve banking. They suggest that banks
should maintain 100 percent gold reserves against all their outstanding
credit. No bank is supposed to lend in excess of capital accounts and vault
cash. However, this dogmatic approach throws the baby out with the bath
water. The prescription has been made on the wrong diagnosis of the problem. The
problem is not that banks lend against assets other than gold. The problem is
that banks borrow short in order to lend long. In their lending practices
banks make commitments not justified by the quality and maturity of the
assets they hold. Advocates of 100 percent gold reserve banking are barking
up on the wrong tree. They have missed the real culprit, illicit interest
arbitrage. The problem of bank illiquidity is not going to be solved by the
100 percent gold reserve requirement, but by prescribing that banks discount
eligible paper only. Consumer demand is seasonal as well as unpredictable.
Accordingly, the supply of purchasing media must be elastic. It must flow and
ebb with consumer demand. It must vary with the seasons. Without an elastic
supply of purchasing media the distribution of consumer goods may seize up
amidst plenty. In addition, one must also face the problem of financing the
production and distribution of consumer goods most efficiently, and without
hindering technological progress. This progress can be illustrated in terms
of refinements in the division of labor. 100
percent gold reserve banking would imply that every new refinement must mean
another invasion of the pool of circulating gold coins. Under these condition the gold standard would be a fetter upon
technological progress.
Do Banks Create
Credit out of Thin Air?
Banks do not create credit out of thin air, as
suggested by Mises in his Theory of Money and
Credit (op.cit., p 279, p 390). To the extent they restrict their
portfolio to self-liquidating loans, they do not
contribute to credit expansion. They merely make credit that already exists
by virtue of the very movement of merchandise to the consumer more
negotiable. This is certainly a legitimate activity of the banks. To the
extent the banks lend against assets other than self-liquidating paper, they
borrow short to lend long. They raise funds in the bill market to place them
in the bond market. Although this is an extremely lucrative business, it is
illegitimate nevertheless. The banks pocket the spread between the higher
interest rate and the lower discount rate to which they are not entitled:
they make no contribution to the production process. In
this case, no less than in the previous, bank credit is not created out of
thin air. Borrowing short to lend long is no prestidigitation. It
is fraud. It is fraudulent to arbitrage funds from the bill to the bond
market. The way to see that the bank is guilty of illicit interest arbitrage
is to examine the maturity dates in the bank's portfolio of assets, including
the maturity of the collateral. If the bank is willing to extend the maturity
of its loans beyond 91 days, or if it lends against assets that are not
self-liquidating, or if it buys such assets for its own account, then the
bank is engaging in illicit interest arbitrage. Through non-disclosure and
misrepresentation these illicit transactions are disguised so that they can
no longer be detected by the public. Illiquid assets are buried deep in the
portfolio and start to metastasize in the banking system. No longer is there
a limit to the size of bank assets. (In the absence of illicit interest
arbitrage social circulating capital set the limit.) Now that the limit has
been removed, the pressure is on for the banks to increase their assets in
order to maintain profit-levels. One bank drops an innocuous snow ball on the
mountain slope, unmindful of the danger that the size and momentum of the
innocuous snow ball could increase rapidly, eventually destroying entire
villages down below in the valley. The dropping of the snow ball is the
beginning of the business cycle; the avalanche is the depression into which
it may degenerate. As detection of credit abuse becomes harder, the business
cycle started by the banks is even more devastating than that started by the
Acceptance House.
Banks are guilty of usurping power over the social
circulating capital. They are guilty of extortion: they pocket the spread
between the rate of interest and the discount rate to which they are not
entitled. The banks are guilty of conspiring against the public interest,
just as the miller and the baker were in accepting anticipation and
accommodation bills in the hope of illicit gains. The conspiracy of the banks
is far more ominous: distortions and misallocations caused by the banks'
illicit interest arbitrage are cumulative and potentially very damaging. Ultimately,
they must lead to a credit collapse.
We must conclude that the banks are not creating
credit out of thin air. It must be made clear for once and all that nobody
can do that. The banks, aided and abetted by the
government and its bank examiners, arbitrage funds from the bill to the bond
market illegitimately. In doing so they are committing a serious crime
against the public.
In Praise of
Scholasticism
Revisionist economic historiography, largely due to
the efforts of Murray Rothbard, has rehabilitated
scholasticism. No longer are the scholastic philosophers described as amateur
economists with a hidden agenda. On the contrary, they are rightly considered
as the most original, most penetrating, and most sophisticated economic
thinkers of their day. The scholastic fathers were way ahead in economic
thought of their contemporaries. It is a pity that with the secularization of
the institutions of higher learning their intellectual merit has been largely
forgotten.
There is one area, however, in which the judgment of
the schoolmen is seriously questioned. This is their alleged intransigence of
their condemnation of interest. Their denunciation of the usurer, their
branding of usury as 'crime worse than murder', may sound strangely
irrational to modern ears. It is true that the scholastic philosophers
condemned usury using violent language. "The murderer kills one victim
at a time, and kills him but once. The usurer, by contrast, is more like a
vampire sucking the life-blood of society as a whole under the cover of
darkness, and stops just short of killing the victim, so that he could
continue his parasitic behavior indefinitely."
The thundering of the schoolmen against usury
appears irrational to us only because of a semantic confusion. Substitute
'discount rate' for the rate of interest, and 'illicit interest arbitrage'
for usury, and the mystery disappears, and the
pieces of the jigsaw puzzle fall into place. Scholastic philosophy was far
deeper than we have ever admitted. Its diagnosis and prognosis of the social
consequences of economic forces, both the benevolent and the malevolent kind,
were far keener than our own. Scholasticism perceived a deadly danger, one
inherent in illicit interest arbitrage, to which we are not alive. Contrary
to conventional wisdom, the scholastic fathers did not consider the exchange
of income and wealth as an instance of usury, and they did not object to
interest payments involved in them. They explicitly recognized the legitimacy
of mortgages and rent-charges, together with interest.
But the scholastic philosophers also knew that in
the absence of war and natural disasters the discount rate must be very low,
thanks to the increasing consumer demand and to a lively bill market, such as
the one that developed in Italy
during the Renaissance. The great momentum represented by the movement of
merchandise from the producer to the market, driven by high consumer demand,
was not lost upon the keen analytic mind of these remarkable economic
thinkers, as it was lost upon their contemporaries as well as on their
successors, including our latter-day economists. The scholastic fathers
understood that if the discount rate was unreasonably high, then it was due
to evil forces. It was due to illicit interest arbitrage trying to slow down
the flow, and cut down the size, of social circulating capital. Merchants
guilty of 'usury' (read: illicit interest arbitrage) have betrayed their
trust, just like the miller and the baker in our Second Greatest Story
Ever Told. Their job was to facilitate, not to obstruct, the flow of
goods to the ultimate consumer. Those of them who did obstruct it for private
gain were guilty of one of the most heinous crimes against society. Not only
have they betrayed their trust, they have set out to destroy the peaceful and
voluntary cooperation of individuals in the market economy. They have
undermined the system of division of labor. They
are guilty of vampirism.
St. Thomas of Aquinas (1225-1274) made a distinction
between the rate of interest and the discount rate, if only indirectly, and
considered the discounting of short-term bills of exchange an admissible
commercial practice. This is further proof that the ire of the canonists in
condemning usury was not directed against interest-taking in general, but
against illicit interest-taking, that is, against the practice of
illicit interest arbitrage carried on under the disguise of bill trading. The
scholastic fathers were the first to point out that many of these bills had
been fraudulently drawn. Seen in this light, and with the necessary semantic
adjustments, the whole controversy surrounding the usury problem becomes a
rational and highly sophisticated attempt on the part of the scholastic
philosophers, who had the best training in economics and finance of their
days, to root out unaccepted commercial behavior. They
were trying to fend off a great danger threatening society that, unknown even
to them, might not deliver its final blow for hundreds of years, but when it
ultimately did, it would cause damage of Apocalyptic dimensions. The
scholastic fathers had an Apocalyptic vision something that we, in the
twenty-first century, tend to ridicule.
Illicit interest arbitrage is economically
equivalent to counterfeiting money. Dante assigned a special hell for
counterfeiters and money-clippers, be they princes or paupers. In the Divine
Comedy, Canto xxx, he described the punishment awaiting all currency
debasers. The fact that Dante reserved one of the most terrible punishments -
the eight of nine circles of hell - to debasers of coin, impostors, and
deceivers under false pretenses, is indicative of
the general attitude towards such people in his days. The verdict of the
scholastic fathers was merely a reflection of the general attitude.
Neither Dante nor the scholastic fathers had an
opportunity to examine the wholesale betrayal of public trust reaching its
pinnacle under the regime of irredeemable currency making, as it has, the
massive disenfranchisement and exploitation of the working classes, and the
saving and producing public, possible. We may well wonder what words the
scholastic fathers would have chosen to condemn, and what circle of hell
Dante would have assigned to, the perpetrators of these crimes against
society after having exhausted the most damning words in the dictionary and
having filled the uppermost circles of hell with small-time crooks - in order
to demonstrate their abhorrence of the ultimate fraud and betrayal of trust
involved in the regime of irredeemable currency!
Illicit interest arbitrage is responsible for the
ongoing decay of the international monetary system, and for the coming credit
collapse: the Apocalypse which the scholastic fathers saw coming. Looking at
the ruins of the once proud edifice, the international trading system, can we
blame the scholastic fathers for being so
uncompromising in their fulminations against illicit interest arbitrage as to
call it economic vampirism? Can we blame them for being able to foresee the
future and realize its dangers more clearly than their contemporaries, or the
generations to follow - including our own?
References
Borrowing
Short and Lending Long: Illiquidity and Credit Collapse, by A. E. Fekete, CMRE Monograph Series No. 38, 1984. Committee for
Monetary Research and Education, 10004 Greenwood Court, Charlotte, NC 28215-9621, United
States, FAX: (704) 599-7037
The
Theory of Money and Credit, by Ludwig von Mises,
Indianapolis:
Liberty Classics, 1980 (first German language edition in 1912)
October 7, 2002
Antal E. Fekete
Professor Emeritus
Memorial University
of Newfoundland
St.John's, CANADA A1C5S7
e-mail: aefekete@hotmail.com
GOLD UNIVERSITY
SUMMER SEMESTER, 2002
Monetary
Economics 101: The Real Bills Doctrine of Adam Smith
Lecture
1: Ayn Rand's Hymn to Money
Lecture 2: Don't Fix the Dollar Price of Gold
Lecture 3: Credit Unions
Lecture 4: The Two Sources of Credit
Lecture 5: The Second Greatest Story Ever
Told (Chapters 1 - 3)
Lecture 6: The Invention of
Discounting (Chapters 4 - 6)
Lecture 7: The Mystery of the Discount
Rate (Chapters 7 - 8)
Lecture 8: Bills Drawn on the
Goldsmith (Chapter 9)
Lecture 9: Legal Tender. Bank Notes of Small Denomination
Lecture 10: Revolution of
Quality (Chapter 10)
Lecture 11: Acceptance House (Chapter
11)
Lecture 12: Borrowing Short to Lend
Long (Chapter 12)
Lecture 13: Illicit Interest Arbitrage
FALL SEMESTER, 2002
Monetary
Economics 201: Gold and Interest
Lecture
1: The Nature and Sources of Interest
Lecture 2: The Dichotomy of Income versus Wealth
Lecture 3: The Janus-Face of
Marketability
Lecture 4: The Principle of Capitalizing Incomes
Lecture 5: The Pentagonal Structure of the Capital Market
Lecture 6: The Definition of the Rate of Interest
Lecture 7: The Gold Bond
Lecture 8: The Bond Equation
Lecture 9: The Hexagonal Structure of the Capital Market
Lecture 10: Lessons of Bimetallism
Lecture 11: Aristotle and Check-Kiting
Lecture 12: Bond Speculation
Lecture 13: The Blackhole of Zero
Interest
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