Wednesday, October 16, 2002

Interest-An interesting ramble on interest from the Hokie Pundit. He has a better post on his testimony, but that speaks for itself. He has an open offer to "feel free to tear this to shreds where it deserves it," so here's my critique
I think the concept of usury is misunderstood, especially in regards to bank interest and the stock market. It seems straightforward enough from one angle: you lend money to someone, and they pay the amount you gave back plus a little more for your inconvenience. However, there are flaws in that logic. Money is a measurement of value. Five dollars now isn't the same as it was in 1800, nor is it likely to be the same as it will be in 2525. Currently, $5 is roughly equal to four gallons of gas.
The basic theory of interest rates has rates including three basic components (1) A "real" rate of return above and beyond inflation; usually that's about 2-3% (2) Expected inflation during the length of the loan (3) Various risk premiums; default risk and maturity risk (insecurity about future inflation) are the two biggies You add the three factors to come up with an interest rate for a loan. If you have a risk-free short-term government loan, if you had a 2% real rate and 3% expected inflation, Treasury Bills would be running at 5%. A corporate short-term loan might run 6%, implying a 1% default risk premium. 30-year Treasury bonds might be running 7%, implying a 2% maturity risk factor over the T-bills.
When people speak of usury, they're condemning two evils. The first is not loving your neighbor, since you're requiring something in return for helping him. The second is taking something that you haven't earned. In modern dictionaries, usury is usually defined not simply as "interest," but as "exorbitant interest," and this seems to be nearer the original intent. It's implied when you make a loan that you want the same amount back.
If you are helping a friend or family member make ends meet, such a loan should be treated as more of a gift; if you get it back, fine, but don't lend stuff to friends and family you can't afford to like without. Any interest that is actually paid should be treated as a bonus. However, loaning to a stranger or to a friend on a non-emergency basis might have a cost of capital factored into the loan and a fair interest rate would be appropriate. Usury laws are on the books in most state protecting consumers from overly-high rates from loan sharks and/or merchants. One problem that cropped up in the late 70s is that everyday interest rates were close to 20%, bumping into usury laws that thought that 20% was Lenny the Loan Shark rates; this cut off some financing options until the laws were amended.
A small interest rate should be enough to keep up with inflation, and though a perfect accounting is impossible to predict, the spirit is right.
Note that the algorithm listed above has estimated inflation. You can't predict inflation perfectly, but you make an estimate.
With stocks, you're buying part of a company. When you bought it, it was worth one amount, and when you sell it, it's worth another, but that's okay, since you didn't make a loan. You're under no obligation to ever sell your shares. With your aid, the company has either increased or decreased in value, and whatever the market value for your shares is when you decide to sell is what they're worth. It would only be wrong if you bought stocks at a certain price and then sold them for higher to someone else by preventing them from using the market value.
I'm not sure what to make of the last sentence, but stocks are designed to go up and down in value, while loans will have a fixed principal value that is expected to be repaid.

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