I hope I’m not merely harvesting lower lying fruit:
Well no, it wouldn’t destroy it:
If all credit ratings were lowered a notch, Wall St would laugh. A AAA bond becomes a AA bond. A BBB bond becomes BB bond. And so on. The only adjustment would be by investment committees who would take about 10 seconds to deem old BBBs (and new BBs) “prudent”.
Ok, now the government says that ALL bonds are AAA, and everyone must have prizes. No wait, why stop there?: all bonds are AAAAA.
It’s not insidious, but it does mean that the official raters have lost much of their business and that portfolio managers must now rely on official reports.
How long would it take for Moody’s to (with free speech protection) offer a 10 point rating scale on the top of their report? Maybe 30 seconds. Ok, an hour: their lawyers would have to type up the appropriate disclaimers.
Actually, it’s the opposite. Boneheaded policy decisions are a boon for researchers. In order to measure the effect of a certain phenomenon, one must consider what would have happened if the phenomenon did not occur. It’s easier to do that if policy makers surprise markets with a sudden change in regime.
Although, thinking it over you do have a point. Much of the US (and UK) form of capitalism is equity-based (was Germany, in contrast, is or was bank-based). I’m not sure about Canada. Is that due to common law? Maybe, but some researchers have noted that the US has tough state by state regulation of insurance companies and a banking system fragmented by the (now overturned) Glass Stegall rules dating to the 1930s. Our equity-based system may have developed due to regulatory fiat.
With regrets, I’m not going to have the time to keep up with this debate. I will point out only one thing, which is the reason I bothered to post in the first place. “What if?” questions (also known as counterfactual history) interest me (so to speak). What I’ve noticed is that the overwhelming majority of scenarios proposed are pessimistic. The Allies lose WW2, the Mongols successfully conquer Europe, the South successfully secedes and never abolishes slavery, etc. Hardly anyone posits positive scenarios. I guess Dr Pangloss was right. We do live in the best of all possible worlds.
I have no idea what you mean. Interest (or something that serves the same function) is a critical cog in the machinery.
If you remove the lugnuts from the wheels on your car, what are the good outcomes?
And I’m not sure what’s so pessimistic about saying that interest is good and necessary. Or are we just supposed to stick our heads in the sand and pretend that if interest went away, we’d magically turn into the land of sharing and caring and everyone would start giving away their money for free?
I think PBear42 was saying something about counterfactuals in general.
It may interest him to know that one of the earliest papers in economic history that used the counterfactual approach had a non-disasterous outcome.
The conventional wisdom had been that railroads were incredibly important for economic growth in the US. Robert Fogal argued otherwise: he noted that if the railroad was not invented, the US would have continued its program of canal building. The end result would have been lower economic growth, but it wasn’t like economic development would have been brought to a halt. For example, crops from the Ohio Valley could have been brought to market.
Where there is strong underlying demand, a market economy, credible rule of law and transparent governance, removing one linchpin typically doesn’t cause the whole edifice to collapse. The development of substitutes (canals in Fogal’s case, interest payments in all-but-name in mine) builds in a measure of redundancy.
Sure people find a way, but it is terribly inefficient. For those of you who remember pre-web days, I used to wander from store to store looking for books or other merchandise, using time and footpower (and sometimes gasoline) to find something for Christmas at the lowest price. Now we do it on line. We all save time and money, and are more satisfied. Society is more efficient.
Like Sam said, it is all about information. In fact I agree with everything Sam wrote in this thread, which really sucks.
Yes, I was speaking of counterfactuals in general. Indeed, interesting to hear about Fogels thesis (with which I wasn’t previously familiar). And, no, I didn’t suggest anything remotely like that people with wealth would give it away.
Agreed, except perhaps for the “terribly” part. This isn’t Darfur we’re talking about. (Not that you claimed it was. Just saying.)
Still, my posts here smack of Pollyanna, which makes me a little nervous. Policy can go horribly wrong. For example, mix a liquidity trap and a nonexistant national safety net with experts as yet ignorant of macroeconomics and the US great depression results.
Yet some of the most blatant violations of free markets (I’m thinking of tarriffs) can have small direct effects (that is, the big disadvantages of protectionism have little to do with welfare loss triangles, IMHO).
msmith537 in much of post 35 sounded almost like a basic economics teacher, verbatim. But all that goes to why the present system self-sustains, in that it answers the question, “Why should I lend money at interest, & expect to pay interest when I borrow money, in the system as it is?”
What at least some of us are getting at is a radically different economic theory, where interest would be unnecessary to economic health. And that might be possible, but it almost certainly would involve more than just abolishing “interest” strictly speaking.
It might mean the redefinition of property. It very probably would mean a different definition of economic health. And that could be a good or bad thing.
At the very least, with money today you will be able to buy something and get benefit from it that you won’t have if you save the money until tomorrow. The discount rate has to at least make up for this. It’s true even for periods short enough that inflation is not an issue.
Of course it is, as the tiniest bit of thought would reveal.
OK, suppose I offer to give you $1000, either today, or ten years from now. Even if there were no inflation (which could happen) and no legal interest (which is unreasonable), $1000 today is worth more than $1000 ten years from now, because that money can be used to purchase things which produce income.
Suppose I were a tailor. I buy raw materials and tools and pay rent on my shop, and sell finished clothing. If I had $1000 today, I could buy better tools (capital goods) and better cloth, and therefore sell more finished goods at a higher price. Imagine I buy a steam press for $1000 to iron my clothing, now what I used to have to do laboriously by hand I can do in seconds. So for the next ten years I make more money because I had that steam press. The total amount of extra money I make over the next ten years because I had that steam press is the extra value that $1000 had today rather than ten years from now.
Think of all the economic opportunities that people have to pass up because they don’t have enough money today to exploit them…they couldn’t get that job because they didn’t have a car to go to the interview, they didn’t get the job because they didn’t have a nice suit at the interview, they couldn’t go to the interview because they didn’t have the money for a babysitter, they couldn’t afford the take the class that would give them the training to perform the job. And on and on. If they had the money TODAY, they’d be able to overcome those obstacles and get the job and easily afford to pay the money back with the new income.
Of course some people will piss the money away, or they’ll buy some capital equipment that breaks, or the expected increase in sales never happens, but money today is always better than money tomorrow, and the difference between that value is what we call the interest rate…meaning the amount of money someone who HAS the money today would demand before they give you the money today. And the amount they demand before they give you the money today is variable, depending on how likely they think you are to pay back the money. There’s always some way to make money by investing your money, even if it’s buying property and charging rent to live and/or work there, which is the way most people in pre-industrial times invested their money.
:dubious: I’m not sure you understand what it is to be very poor. At some point high interest rates become mathematically impossible to pay off, & no net worth accrues. Even before that point, high-interest loans become simply destructive.
Information & efficiency, huh? It seems like you’re advocating for lubricating the efforts of those who see everyone else’s labor & equity as something to be exploited.
Don’t presume. I’m fully aware of what it’s like to be poor, and to be under a large debt load.
Not at all. Where you do get exploitation from? Better information benefits EVERYONE. For example, poor people disproportionately buy used cars. It can be shown mathematically that the used car market is flawed, because of asymmetrical information (the seller has information the buyer doesn’t have). This is a bigger disadvantage for poor people who have to deal in this market than for rich people, who can buy new cars.
The market tends to correct for this. The used car market, for example, has evolved through the addition of an industry of auto inspectors, ‘certified’ used car programs, Consumer Reports magazines, etc.
When you cut off the flow of information, it hurts everyone. It’s not about exploitation or rich vs poor. It’s about ensuring that transactions are made in the most efficient way possible, and that everyone has a good understanding of the tradeoffs inherent in every market transaction so they can make the best decisions.
Not at all. For the schoolteacher or bricklayer who wants to buy a house, money today is more valuable than money tomorrow. Sure, they could save until they possess sufficient funds for a purchase in, say, 15-20 years. But life is short, and many are willing to pay for the privilege of owning their own home (built with the sweat of others) before they’ve amassed sufficient wealth.
Sam and Voyager: I suspect that the key issue here isn’t information, it’s contracting. Within an Islamic society, one can still calculate a “shadow” interest rate, probably with a high degree of accuracy. Similarly, it wasn’t hard to calculate a “shadow” 30-year T-Bond rate: the Bush admin could therefore suspend issuance without controversy.
Stopping 2 parties from engaging in a well-considered contract is another matter. If the benefits of such contracting are massive and legal barriers trivial they will find a workaround. But the higher the barriers, the greater the costs incurred.
Similarly in a world where bankruptcy is a criminal violation rather than a civil procedure, a regime permitting interest contracting will punish the imprudent as well as their family. This is inevitable: just as any human population has a distribution of wealth, so there will be a distribution of prudence.* It is in society’s interest to ban (or simply not enforce) contracts where the result is wholly predictable harm and there are superior alternatives. You can’t sell yourself into slavery and you can’t pledge your fingers as collateral for a bank loan. Viewing interest as a form of contract permits us to isolate cases of exploitation and address them.
All the same, banning an ordinary interest contract because there is a power imbalance between some parties within a society seems both costly and ineffective. I prefer using bankruptcy law as a policy tool, as well as the usual safety nets of the welfare state.
Not that imprudence is the only driver of bad outcomes, or even the main one. Ill health and economic necessity also come to mind.
I just talked to one of the guys I work with. It is similar here. The bank buys the car for you and you make regular payments for it until at a set point the title of the car passes to you. You need a guaranteeor to sign for you in case you don’t pay.
So, what happens if you want to sell the car before you have paid it off? Apparently, you don’t. Any potential buyer gives you cash which you then pay to the bank for them. At the end of the term you get title and transfer it to the person you are selling the car to.
Do you just give up the equity you have put into the car? No, the buyer pays you cash and then continues the monthly payment until it is paid and you transfer the title to him.
What guarantee does the potential buyer have that when car is finally paid you will transfer the title to him? Well, you sign a deal with him. But, you are not allowed to sell the car until you have title to it. The bank has title until you finish payments.
Obviously sales are between friends and family for the most part. Who would trust that a stranger would hand over title at the end of the payments? The same applies to property. If the value of the property goes up and you want to sell beforehand to take advantage of this, the bank won’t refinance until the original ‘loan’ is paid for. Someone has to come up with a bunch of cash to make up the difference and then take the chance that the original person will transfer the deed at the end.
I have no idea how long the above would take to accomplish, but it looks high risk for all concerned and very time consuming.
Vs.
I have a line of credit. I want that car, I write a cheque (maybe get it certified), they give me title, I drive away with my car, they have their money. Little hassle or risk for either of us and most likely I won’t see the seller again. This could be done in as little time as a few minutes.
In that situation, how is the interest calculated? How is the buyer made aware of how much of the purchase price is the equivalent of interest, and how much represents the real value of the car?
It’s important that interest rates be published and widely known. It’s important that interest rates vary depending on the risk of losing capital. It’s important that they be allowed to float with the demand for money. It’s important that there be some form of futures market in interest rates, so that people can decide whether to buy now at today’s rates, or wait for rates to come down. Or if they should lock in a higher rate, or accept a lower rate that is ‘floating’. And how much risk they have that if they engage in long-term debt, interest rates in the future will climb and change the real cost of what they want to buy on credit today.
If the alternative to interest lacks any of these features, it would not be as efficient a mechanism.
I can believe that the Islamic world has an ‘alternative’ to interest rates that is functaionally the same because their reasoning is religious. In other words, if they can have interest but just not call it that, fine. But if the objection to interest voiced in this forum is simply that it’s wrong to make people pay a premium for borrowing money, then there’s a real problem. Because any alternative we come up with will by necessity incorporate the same thing. Buy it today, you pay more than if you wait and buy it next year.
Bond markets are contintually recomputing the interest rates of both government and corporate bonds. I agree that interest rates are parts of contracts, but any contract will have additional terms. But I agree that limiting contract terms by banning interest is a mistake.
It was done in the middle ages. Usury is a sin…
No interest, but they had late payment penalties charges.
So, you better pay your loans late if you wanted any chance of getting a loan in the future.
