An issue that
has to be resolved in any discussion of money, is whether it is
legitimate for Christians to charge interest. For many centuries
prior to the Reformation, Christians considered that charging
interest was wrong; it was referred to as usury. This was the result
of a misunderstanding of the Old Testament teaching on interest.
John Calvin resolved this problem by clarifying the difference
between poor loans and business loans.
The Old Testament prohibits interest on
loans to the poor, because they are a form of charity (Ex 22:24; Lev
25: 35-37). The poor person will have to use the money borrowed for
consumption goods so there will be no profit, which can be used to
pay interest. This prohibition on interest was erroneously extended
by Christians to business loans (Matt 25:27). Interest on commercial
loans for use in trade or business is not forbidden.
The legitimacy of interest is an important
principle to establish because interest is essential to economic
growth. Economic growth can only take place if the economyís
capital (stock of productive plant and equipment) is built up. This
can only happen if someone in the economy saves, and interest is
essential for saving to occur.
Consider a subsistence fisherman. He has no
equipment, but he catches enough fish with his bare hands to
survive, by working most of the day. He could improve his fishing by
making some nets or a boat, but while he was doing this he would not
have time to fish so he would go hungry. If he can save a little bit
of fish each day, he can build up a stock of fish. Then he can live
on saved fish while he builds a net and boat. With the net and boat
(his capital) he can catch enough fish to live on in half a day.
This means that he will only need to fish every second day. He can
use the other day to make better equipment or other things that will
improve his lifestyle. Or he could fish every day, and trade the
surplus with other people for other things that he needs. Getting
some capital equipment improves the quality of his life. However to
obtain the capital equipment, he had to make some saving first. The
reward for saving was the stream of extra income he was able to
produce with his capital. This is the equivalent of interest.
The same principle applies in any economy.
If all money is spent on consumption goods, there will be no money
available to buy capital goods. For money to be available to buy
capital goods some people have to forgo consumption. They can either
buy capital goods themselves and start a business, or they can
deposit the money in a bank. The bank can lend the money to a
business to buy capital goods. The reward for forgoing consumption
is the profit that the business makes, or the interest that will be
earned on the savings account.
If it is not possible to pay interest on a
loan, there will be no incentive to save. The only people who would
save are those who can start business themselves. Most others would
just consume all they earn. The resulting shortage of capital would
limit the growth that takes place in the economy.
The price of capital goods will adjust so
that their supply is equal to the value of savings available for
purchasing them. For example if people decide to save more, some of
the consumer goods being produced will no longer be required. The
price of consumer goods will fall. This will encourage producers to
produce capital goods. These can be purchased with loans that will
be made available through the additional deposits in savings
The interest rate will also rise and fall to
clear the markets. Interest has three components
- inflation premium
- risk premium
- time preference factor
Each of these will be explained separately
in the following sections.
1. Inflation premium
Part of the interest rate is an inflation
premium to compensate the lender for any future inflation. If there
is inflation in the economy, then the borrower will pay back the
loan in dollars that are now worth less than the dollars that were
originally lent. To compensate for this the interest rate charged
will include an inflation premium. The higher the rate of inflation,
the greater the inflation premium will be.
In New Zealand, the inflation premium has
been quite large because of very high inflation rates in the recent
past. In a Christian society with sound money, the inflation will be
rare so the inflation premium will be very small.
2. Risk Premium
When a person lends money through a bank
there is a risk that the loan will go sour. The business venture may
fail. The borrower may prove to be dishonest. A premium will be
built into the interest rate to compensate the lender for this risk.
In a Christian society, the risk premium will be quite small.
Dishonesty should be rare. If borrowers have prayed about their
ventures, they should not go wrong. However, there will always be
some situations that go wrong, so there will always be a small risk
3. Time Preference
The time preference factor is the most
important component of the interest rate. Interest is the price that
is paid to people who postpone the purchase of goods and services to
which they have an entitlement. We live in the present, so people
will always prefer something in the present to something in the
future. The present is always more certain than the future. Goods
available in the present will be worth more than those available in
the future. The interest rate reflects this difference. Interest is
the compensation that savers get for postponing their purchases
until a later date.
Looking at it the other way round, it is the
price borrowers pay for being able to make purchases sooner than
they would normally be able.
The level of interest rates will depend on
the value that people place on the future. If people have confidence
in the future, they will not need much compensation for saving, so
interest rates will be low. On the other hand if people have no hope
for the future, the interest rates will be high. A future
orientation will reduce interest rates; a present orientation will
cause high interest rates.
Real Interest Rates
The main cause of fluctuation in interest
rates is the inflation premium. The real interest rate is the
nominal interest rate after excluding the inflation premium. From
the 17th century through until about 1980, real interest rates in
the large industrial economics of the world hovered around 3 percent
with very little variation. This was reflected in the interest rate
on Post Office Savings Bank accounts, which remained at 3 percent
for year after year. Fixed interest rate mortgages were available
for 6 percent interest for many years.
High interest rates have been observed in
earlier times. In medieval times real interest rates in England
reached 10 percent. Studies of ancient Rome, ancient Greece and
medieval India have uncovered evidence of real rates of between 6 to
12 percent. These were times when confidence in the future was low,
so naturally interest rates were high.
The reasons for the long period of low
interest rates during the last four centuries are not widely
understood. The development of legal systems and security were
important in reducing the risk premium. However the main reason was
the change in values that was brought about by the reformation. The
reformation, largely through the influence of Calvin, turned people
to task of building the Kingdom of God. They believed that God was
working out his purpose and that his Kingdom would be established
through time. This led to a radical change in the prevailing
attitude to time. Time became an instrument by which dominion over
the world could be established. Faith in God produced a tremendous
hope for the future.
Wherever, Calvinism and Puritanism took
root, Christian hope and a vision of the Kingdom of God produced a
future orientation, which brought about a sharp fall in interest
rates. The low interest rates allowed a rapid accumulation of
capital goods, which produced the longest period of economic growth,
that the world has known. The changing concept of time allowed
western civilisation to break a millennium-old barrier and begin a
period of exponential economic growth.
In the 16th century, Spain and Portugal
became the wealthiest of nations through an inflow of gold from the
Americas. However, within a hundred years, it was dissipated, as a
result of the present orientation of these countries. The imports of
gold caused inflation, which pushed up interest rates. The wealth
moved to Holland, Scotland, England, and later the United States,
where a future orientation made the capital more productive.
The future orientation, which had its
origins in Calvinís theology, was later secularised during the
enlightenment. The development of science and technology, which the
Reformation fostered, produced a humanistic hope in the future. This
humanistic hope helped maintain the future orientation that began
with the reformation and helped it spread to non-Christian nations
like Japan. However, during the 1960ís and 1970s this humanistic
hope finally collapsed, overcome by the despair of war, famine and
environmental disaster. Without Christian faith to sustain it, this
hope was unrealistic anyway
In the last two decades there has been a
radical change in the world view of the western world. One aspect of
this has been a change from a future to a present orientation. The
focus now is on instant gratification in sex, drugs and consumption
of goods and services. Hope has died and the future is now a source
of fear and dread. Music, literature, television and films have
become a way of escaping from the future rather than a tool for
establishing the Kingdom.
Without faith in God there can be no hope,
so the humanistic hope was an aberration. It was inconsistent with
the humanistic world view. Sinful man cannot be a source of hope.
Society is now living in a way that is more consistent with its
presuppositions. As the Apostle Paul says, if there is no
resurrection, "Let us eat, drink and be merry because tomorrow
we die". This present orientation has to be the attitude of any
non-Christian society, so saving for the future will not be very
popular. Very high interest rates will be needed to persuade people
Another factor, which has contributed to
this present orientation, has been the social welfare state. In
earlier times people had to save to provide for themselves in there
old age or times of sickness or accidents. The modern state promises
to take care of people from the cradle to the grave so there is no
need to worry or save about the future. This has added to the
present orientation, which will destroy a nations wealth, and
undermine the ability of the state to provide the security it
Since about 1980, real interest rates have
increased throughout the world to 5 or 6 percent (in New Zealand
they are seven or eight percent). This is consistent with the
present orientation that has spread throughout the world. Nominal
interest rates are currently, the lowest that they have been years.
However, low inflation (sometimes negative), means that real
interest rates are still very high.
I expect that real interest rates will rise
further as the present orientation takes hold further. High interest
rates make capital accumulation difficult. We will see capital being
destroyed to finance consumption. This will cause a decrease in
wealth and end to economic growth. The risk premium will also
increase, as dishonesty becomes more common at all levels of
The long term economic growth experienced by
Western civilisation since the Reformation was unique. Although it
was copied in many modern cultures, it was rooted in a particular
set of values, which had their source in Christianity. The
conditions necessary for economic growth will not return, until
there is a return to faith in God as a result of a revival of
Controlling Interest Rates
The responsibility of governments to set interest rates is just
taken for granted in the modern world. All modern countries have a
central bank that sets the base rate of interest. What most people
do not realise is that this is a very modern practice. For most of
history, central banks did not exist, so do we need them now?
(During medieval times, the church tried to control interest rates
by prohibiting usury, but that was a disaster).
The more important question (normative economics) is whether it
is morally right for the government to set interest rates. The
answer to this question is obvious, if we think about other things
we own. If the government tried to make me sell my house for
$70,000, I would be very upset. If they set the price at which I
could sell my car at $1000, I would be sure that was wrong.
Most people would prefer to put their house or car on the market
and see what they could get. By forcing me to sell at a set price,
the government is robbing me of the difference between that price
and what I could get on the market. By setting the price higher than
I could get on the market, it is robbing the purchaser of the
difference between the set price and what I would be prepared to
sell it for.
The ability to set prices, allows the government to rob one
person for the benefit of another. Setting prices is a form of
By setting the price of money, the government is stealing from
some people, for the benefit of others. By setting the price of the
future, the government is robbing some people of part of their
future to benefit others. Those who benefit are the bankers and
financiers who get access to cheap money. Those who suffer are the
people on fixed incomes who cannot adjust for the resulting
inflation. Government controlled interest rates are just another
form of theft.
The modern practice of authorising a central bank to set
interests is morally wrong, so it should be opposed by Christians.
All loans should be short term. A Christian should not borrow
more than they can repay in seven years (Deut. 15:1-3; Ps 37:21).
The future is the Lords. He will not allow us to commit ourselves
beyond seven years.
The reason for this principle is that no one except God knows the
future. Since we do not know the future we should not make contracts
which bind our future. God says the maximum time that we can bind
ourselves for is seven years (Deut 15:1). Beyond that length of
time, we do not know what our situation will be. Therefore, we
cannot be certain that we would be able to repay a loan. We should
not make commitments that we may not be able to keep. We do not know
if we will be living or what our situation will be in thirty years
time. God has decreed that seven years is the maximum length of
commitment that we should make. All loans and deposits should have a
term of less than seven years.
Even if the seven year limit on loans is not accepted, this will
still come about, because the matching rule will push long-term
interest rates up to high for people to risk taking long term loans.
The use of long term mortgages to buy homes is wrong. In recent
years it has become possible and common for people to borrow up to
ninety percent of the purchase price of a home on a mortgage. This
has the effect of pushing up the price of dwellings dramatically.
The result is that households in total are no better off. They still
hold the same stock of housing, but they now have tremendous debt.
The consequence is that they will pay for their houses two or three
times over in interest. This shifts tremendous wealth to the banks.
If borrowing such large amounts were unacceptable, the price of
houses would fall dramatically. Households would be better of, and
they would still have the same total number of dwellings.
In a Christian society most loans should be taken out for
business purposes. Christians should be discouraged from borrowing
to buy consumption goods. Christians should always stay out of debt.
They should only go into debt as a last desperate solution to
poverty. The reason is that a borrower is a slave of the lender
(Prov 22:7). A lender is able to control those who are in debt to
them. God wants his people to be free to obey him. If they are in
debt they do not have that freedom.
Borrowing to buy capital goods, which are productive, is
legitimate for Christian businesses. These will produce a return to
the borrower, which will cover the cost of the interest. Christians
should only borrow to get started. As God blesses them they should
quickly get debt free, so that they are free to serve God. Further
development of the business should be done out of retained profits.
No debt should remain outstanding except the continuing debt of
loving one another (Rom 13:8). If they are obeying God, then
Christians should be in a position where they can lend to others.
They will be the head and not the tail (Deut 28:11-13).
International Capital Flows
Large flows of capital can be a cause of serious instability in
the modern economy. Foreign investors will often buy up a particular
national currency forcing it to appreciate. When they sell out, the
currency depreciates quickly. This instability can undermine the
There is a simple solution to this problem. Capital can only flow
out of a country if it has already flowed in. It can only flow into
a country, if people in that country are willing to sell assets or
to borrow from overseas. If the laws of a country enforce the
matching principle for loans, then these foreign speculators will
not be interested making loans to that country. If there is a strong
future orientation, short-interest rates will very low. There would
not be much demand for short-term loans. Foreign speculators will
not be interested in long-term investments, as it would be too hard
to get their money out again.
The best protection for a local economy is to have a high level
of savings. If there is plenty of capital within a country, there
will be no need for foreign investors. Interest rates will be low,
so the country will not be appealing for them. God has promised the
nation that obeys him that they will lend to many nations and borrow
from none. ďThe Lord will make you the head, not the tail (Deut
28:12,13). This is the key to independence from destabilising
Short Term Loans
During the Credit Crunch, credit markets are dried up all over
the world. One of the worst problem areas was the commercial paper
market, which is the source of operating funding for many banks and
large corporation. The important question is seldom asked. Why were
so many businesses, so dependent on commercial paper? The reason is
Short term interest rates are generally lower than longer term
rates, because lenders demand higher returns to compensate them for
the greater risk involved in tying up their money for a long time.
Businesses and banks have taken advantage by substituting towards
raising a considerable part of their funding on a short-term basis.
Banks raised funding on the 90-day bill market to fund 15 year
mortgages. Businesses raised funding using short-term commercial
paper to fund equipment with a productive life of up to ten years.
This was profitable while short-term funding was abundant, but it
was very risky. Short term funding is cheaper, but it is risky to
use it to fund long-term liabilities.
Borrowing short term to fund long-term liabilities is quite
risky. If the short-term credit market dries up, the business or
bank will be in trouble. They might be unable to roll over the
credit, or they might have to pay very high interest rates to do it.
That is what has happened in recent years. Many businesses and banks
borrowed short term to get lower interest rates suddenly found that
they could not roll over their short term loans.
Security for Loans
When a loan is made something can be taken as collateral for the
loan (Ex 22:25,26). It may be a mortgage over land or a lien over
other goods. The collateral increases the security of the lender. It
also limits the amount of borrowing, by preventing multiple
A poor person may give the lender a good to hold as a pledge that
the loan will be repaid. However, capital goods, which are needed to
produce a living, must not be taken as a pledge (Deut.24:6).
Christians should be thrifty. They should build up their capital
(productive assets). The person who consumes all that he earns
become poor (Prov 14:4; 21:29). Ideally, Christians should not be in
debt at all (Deut 15:4-6). As God blesses them they should be
quickly able to repay all loans. Normally, they will be debt free.
Long term indebtedness is a sign that Godís blessing has been
lost, through failure to trust him or obey his Word.
Keynes said savings are bad, as they remove aggregate demand. He
was seriously wrong. The problem was that during the depression,
people did not want to spend their money. Due to the insecurity of
the banking system and inflation there was no mechanism for putting
savings into productive investments. So people had to put their
money under their mattresses.
In a Christian society, the main source of funds for lending
would be people saving for retirement. Savings for unforeseen
circumstances, such as sickness, accident, and death, etc., would
also be important. Some type of insurance where the risk is spread
may also develop to provide better protection, by sharing the risk
of this type of disaster.
For Christians lending at interest is a second-best option, as
they have no control over what the banker does with their money. It
could be used to build a brewery or a brothel. Christians should put
their surplus funds into enterprises that will be productive for the
Kingdom of God. They will then have control over what is done with
their money (II Cor 6:14-15). They can ensure it is used for the
glory of the Kingdom.
Storing wealth for a long time in a place where it will be safe
is very difficult.
Do not store up for yourselves treasures on earth, where moth and
rust destroy, and where thieves break in and steal (Matt 6:19).
Most forms of wealth can be destroyed by moths and rust. Gold is
quite safe, as it does not rust, but it is easily stolen buy
A person who stores his wealth in gold for several years gets
back what he started with. No interest is earned.
Many people need to save for their future. Young people save to
buy a house. Older people save for their old age. They will be more
concerned about security than interest. Most savers will be happy,
if they can get their savings back when they need them, with none
being lost. These people do not need interest to make them save.
They will need insurance in some form, to deal with the risk of
the bank failing or the borrower defaulting. This insurance could be
paid for with a fixed fee, or by adding to a risk premium to the
In a well functioning economy, inflation might fall to zero. A
sound banking system would eliminate inflation, so savers would not
need an inflation premium to compensate them for the rampages of
rising prices. If investment in capital makes business more
efficient, then prices should gradually fall over time. Money in a
savings account will be worth more when it is withdrawn than it was
when first saved. The real interest rate will be positive, even if
the nominal interest rate is zero. Savings will bring a return
without positive interest.
We should allow interest rates to be decided by the free market.
If funding is scarce, interest rates will rise. If funds are
abundant, interest rates will decline. If society has a positive
attitude to the future, interest rates should decline to zero.
High interest rates are the sign of a sick culture.