I would like to make a deal with the Right Rev Peter Selby, Bishop of Worcester from 1997 to 2007. I promise not to make public statements about the merits of the Trinitarian doctrine (a form of higher theological mathematics asserting that 3 = 1). In return I would like the Bishop not to write any more nonsense about credit and debt.
In today’s Credo column on the Faith page of the Times of London (“It’s time to stop giving credit to our culture of debt”, The Times, Saturday October 13, 2007, p. 83) the Bishop produces a number of canards about debt. Unencumbered by logic or facts, the Bishop makes a slew of assertions that are, at best, unproven and at worst plain wrong.
Assertion 1: The Jubilee 2000 campaign, advocating debt relief for the poorest nations of the world, "was a remarkable achievement". Case unproven. The Bishop makes the common mistake of confusing poor countries and poor people. The debt relief in question is the forgiving of debt owed by the governments of the poorest nations. It is quite possible, and in a many cases indeed likely, that the vast majority of the citizens of these poorest nations may have been made worse off by the cancellation of part or all of the debt owed by their governments. Most of the poorest countries have appalling governments - repressive, corrupt, incompetent and inefficient. Unlike the vast majority of the population, the rulers of the poorest countries often are rich – their wealth stolen from the people. Debt forgiveness consolidates the hold of these disastrous governments on power and postpones the day that they can be held to account. When trying to help the poor ‘do no harm’ should be an overriding concern. Jubilee 2000 violated the ‘do no harm’ maxim.
Assertion 2: The need to get across “a systemic analysis of the nature of runaway debt, its roots in the creation of money by lending and borrowing, and the potential dangers for the world of both domestic and international debt.” Here the Bishop makes a factual statement about runaway debt. Where is (was) this runaway debt? The
? The UK ? Everywhere in the world? Clearly, one can point to specific instances of excessive borrowing. Some households in the US and the US have undoubtedly engaged in this. Elsewhere there is too little debt and borrowing. In the People’s Republic of UK , for instance, it would probably be welfare-enhancing for the government to raise spending on education, health and environmental investment, and to finance at least part of this by borrowing, thus absorbing the excessive saving of Chinese households and public enterprises. Apart from his factual errors, the Bishop also confuses money creation with credit and borrowing. One can have lending and borrowing without money creation and money creation without lending or borrowing. The Bishop is confused about what money is, how it is created and what it does. He is in good company. Most people haven’t got a clue about the meaning and modalities of money. But fortunately, most monetary ignoramuses don’t display their ignorance by writing about it in the Times. China
Assertion 3. “It is obvious that if you allow financial institutions to make huge profits by lending large multiples of the deposits they hold, you are allowing them to create money”. This is complete gobbledegook. For those who care, there are many operational definitions of money, ranging from narrow money (coin and currency plus commercial bank deposits with the central bank) to broader monetary aggregates, typically the sum of coin and currency in circulation, plus some subset of the deposits of certain deposit-taking institutions, plus some of the close substitutes for these deposits. ‘Creating money’ – an unfortunate and imprecise phrase that appears to attribute divine powers to the ‘money creating’ institutions – does not require financial institutions to make huge profits; neither do financial institutions that make huge profits necessarily create money. If financial institutions lend huge multiples of the deposits they hold, they must be financing that lending out of non-deposit resources (the wholesale markets, for instance, as Northern Rock did). This may have been reckless, but has nothing to do with money creation.
Assertion 4. “This failure of understanding has led to the use of debt as an instrument not just for uncontrolled personal consumption but also for building hospitals, schools and even prisons. The disciplines of living within your means, of allowing public functions to be provided by democratically accountable institutions, and of not using tomorrow’s resources today are forgotten as the young are trained in indebtedness as a condition of obtaining their tertiary education”. This is complete nonsense. The institutions and financial instruments that permit borrowing and debt (the cumulative total of all past net borrowing), represent a wonderful manifestation of human ingenuity – the Bishop might even call it a gift from God; I certainly would. Without borrowing and debt, each household, each firm and each government could only invest what it saves itself. That would lead to gross inefficiency and a colossal waste of resources. The financial means for financing investment are not necessarily distributed in the same way as the capacity to come up with productive and profitable investment projects. Without debt and borrowing, each family, enterprise and government would have to be financially self-sufficient. The creation of enterprises on a scale larger than cottage industries would have been extremely difficult. Material standards of living would be at the level of
and India before the 1980s. China
Consider the state of
infrastructure (social overhead capital). Transportation infrastructure is sub-standard and clapped-out. Many hospitals are a disgrace; many primary and secondary schools are in need of further capital investment; there is prison overcrowding. Clearly, there is a strong case for large-scale catch-up investment in infrastructure. To finance all of this temporary investment boom with a balanced budget would be inefficient, as it would require large temporary increases in average and marginal tax rates. It would also be unfair, because the benefits from the improved infrastructure will benefit future generations as well as current ones. These future beneficiaries should contribute towards the cost of the investment. UK
There is another reason why borrowing by governments may be fair. Government borrowing tends to shift the burden of financing the government from the old to the young and from current to future generations. If the pattern of the past 225 years persists, future generations are likely to be better off than us. Shifting the tax burden to future generations that are likely to be better off than ourselves, is something even the Bishop might not object to.
The same holds for student loans to finance tertiary education. It is efficient and can be made fair. The returns to investing in a tertiary education accrue overwhelmingly to the student in the form of higher future income and greater job satisfaction. It is only fair that those who benefit should pay. Taxing the average Briton to subsidize the tertiary education of persons who, after completing their tertiary education, may well be richer than the average Briton, is unfair. Clearly, the risk of failing to complete the tertiary education programme or of failing to achieve a higher income for some other reason should not be a deterrent to enter tertiary education for students from poor backgrounds. That’s why repayment of the student loans should only begin once the income of the former student is above some appropriate threshold level. Requiring students to pay for their own tertiary education, if necessary by borrowing, is both efficient and fair if income-contingent debt service is built into the programme.
Finally, as regards “…not using tomorrow’s resources today..”, the only way to shift physical resources from tomorrow to today is by reducing investment and, in the limit, consuming capital. Investing in tertiary education, likely all investment, shifts resources from today to tomorrow, regardless of how it is financed. A closed economic system has to reduce current consumption (and possibly also early future consumption) temporarily in order to increase investment today and thus achieve higher future consumption in the longer run. By borrowing, it may be possible, in an open economic system, to avoid any absolute decline in consumption, today and tomorrow, provided the return on the investment is sufficient. Borrowing and then repaying principal and interest is a wonderful mechanism for achieving a more even, smooth consumption profile over the life cycle.
Assertion 5. “Most serious of all, we fail to notice where the resources are coming from: all the talk in the world about climate change and the depletion of the resources of the planet will be fruitless if we do not limit our appetite for eating up tomorrow’s bread and burning tomorrow’s oil today.” The Bishop may well be correct that were are depleting exhaustible natural resources too fast. However, excessive resource depletion and destruction of the environment have nothing to do with the culture of credit and debt. The former
Soviet Union had very little credit and debt. Its financial system consisted of a single monobank that provided virtually no consumer credit. Its government debt was low. Other communist countries, like , paid off all their public debt (at great cost to the population alive at the time). Yet despite being as far removed from the culture of credit and debt as one could get, the communist countries depleted scarce natural resources and vandalised the environment on a scale never seen before or since (except for China today). Romania
Assertion 6. “The communities of faith – Jewish, Christian and Islamic - have a proud history of criticising the institutions of credit and debt”. Fortunately, that is not true now and never has been. There is a tradition in the Abrahamic faiths of periodic limited debt forgiveness. In the Old Testament, this takes the form of the Sabbatical year and the Jubilee year. A creditor could, following a borrower’s inability to service his debt, take possession of the debtor’s land and cultivate it in order to be paid. Sometimes the debtor had to sell his own and his family
's labour to the creditor - a form of slavery known as bondage. Every 7th year was a sabbatical year in which the debt would be erased. The sabbatical also applied to the land itself, which was to be left fallow every 7th year. Every 7th Sabbatical, that is, every 49 years, was a Jubilee year. Debtors were released from both debt and bondage, and the land was restored to the debtor. The Sabbatical and Jubilee tradition limited the extent and duration of indebtedness. It did not do away with the institutions of debt, bondage (or other forms of slavery), or declare them ungodly.
There is also, in the Abrahamic tradition (and in even older traditions on the Indian subcontinent), a prohibition of interest, or usury – making money just by lending money. Today, only the literalist, fundamentalist followers of Judaism, Christianity and Islam consider the charging of interest to be sinful and ungodly per se. The best-financed and most vocal forms of Islam today come from the oil- and gas-rich theocracies of the
Middle East (often taking the fundamentalist and literalist Wahabbite form of Islam found in and exported from ). Today, therefore, the prohibition of interest (riba) is only an economically significant issue for Islamic finance. Sharia permits financial contracts, including securities, that involve the sharing of profit and loss. A stream of payments must be associated with an underlying real asset with risky returns or with an underlying risky productive activity. Collateral is also allowed. Saudi Arabia
From an economic point of view, interest (strictly the nominal interest factor), is just an intertemporal relative price - the price today of borrowing money. Prohibiting interest, or setting caps on interest rates to avoid ‘excessive’ interest rates is a constraint on exchange that limits intertemporal trade and therefore will tend to be inefficient and welfare-decreasing. It is true that in an economy where there also many other distortions in credit markets and insurance markets, and where the scope for targeted redistribution is limited by informational and administrative constraints, caps on interest rates can sometimes be rationalised as a second-best policy. However, I have yet to encounter a problem to which the prohibition of interest is the solution. The prohibition of interest, a constraint on voluntary exchange and on the right to determine the terms of a contract freely, makes no economic sense.
Religious fundamentalism and literalism, in economic and financial affairs as in all others, is obscurantism, based on a perverse mixture of fear and muddled thinking. Fortunately, the more enlightened Christianity that has evolved since Thomas Aquinas condemned usury, recognises the social value of the institutions of debt and credit and the welfare-enhancing potential of borrowing and lending. The Bishop is more than 700 years behind his church.
The explosion of wealth, much of it held in financial form, among oil- and gas-exporting nations, many of which adhere, at least notionally, to fundamentalist-literalist forms of Islam, has led to an explosion of financial engineering aimed at circumventing the Quranic ban on riba. Considerable ingenuity and vast amounts of resources are devoted to the construction of financial products that are economically equivalent to interest-bearing loans or interest-bearing bonds, but theologically equivalent to permissible Islamic risk-sharing instruments. The process of certifying financial products as Sharia-compliant is time-consuming and costly; those with the religious authority to provide the desired certification (typically Islamic scholar-jurists) often don’t understand finance. Financial experts tend not to be well-versed in Sharia law and its application to financial structures. Those with the power of certification can extract significant rents from the issuers and buyers of Sharia-compliant problems.
From an economic point of view, it is costly theological window-dressing, in the sense that no Sharia-compliant product I have ever studied passed the interest rate ‘duck test’: if it looks like interest, compounds like interest, imposes on both parties to the contract obligations equivalent to those associated with interest, and – the bottom-line test – provides the parties to the contract with equivalent contingent payment streams, then it is interest, even if it is stamped “profit sharing”.
Take a car loan as an example. Under Islamic banking a conventional car loan is reproduced by the bank buying the car from the dealer, selling the vehicle at a higher-than-market price to the buyer of the car (with the buyer often paying in instalments), and with the bank retaining ownership of the vehicle until the car (i.e. the loan) is paid in full. This is functionally equivalent to a car loan with interest where the car is the collateral for the loan. An Islamic mortgage loan would have the bank buying the property from the seller and reselling it at a profit to the buyer, allowing the buyer to pay the purchase price in instalments. In order to protect itself against default, the bank asks for the property as collateral until the ‘purchase price’ (loan) is paid in full. The property is registered to the name of the buyer from the start of the transaction.
In sum: debt and credit are good. Borrowing and lending are good. Abuses and misuses are certainly possible. They ought to be addressed through legislation and regulation if the benefit from so doing exceeds the cost of the intervention. Ranting against the culture of debt and credit from a position of matching moral authority and ignorance is not good.
The Bishop’s column is unmitigated twaddle. It is a disgrace that such manifestly uninformed nonsense is put out on a ‘Faith page’. One of God’s great gifts to humanity was the brain. It behoves us to use it.