The Problem with Interest

“The most powerful force in the universe is compound interest.” — Albert Einstein

“Zero nominal interest rates are necessary for efficient resource allocation.” — Friedman Rule

No country could experience severe economic problems if there were a deep understanding of money, interest, and speculation. This is neither an exaggeration nor a naïve assertion. If interest were necessary and useful, or even simply harmless, it would not have attracted so much debate and controversy. History provides abundant evidence of the harm that it has inflicted over the centuries

No country has ever implemented a full-fledged interest-free financing system to supply a plumb-line through which almost all deviations would be directly associated with economic justice and is, in my view, nothing more than the abolition of interest. If properly implemented, it would relieve millions of households that currently lie under its fatal heaviness. In short, we need a theory of money free from the anomaly of interest.

It has been asserted again and again that we need speculative demand for and supply of money in order for the rate of interest to develop. The rate of interest developed in the money market may or may not have an impact on saving and investment.

An interest-based loan involves the transfer of ownership of a sum of money from the lender to the borrower, for a pre-specified agreed period and the addition to the principal. It is based fundamentally on the individualistic behavior upon which capitalism has been constructed. Since it is based on the mutual consent of the lender and borrower, a naïve person may view it as a contract, which benefits both parties. While this may be true in some cases for the individuals involved, it is not true for society as a whole. In most cases, the borrowers are experiencing some degree of hardship, to relieve which they accept all the consequences, which may result in compounding that hardship in a way that has an adverse effect on their whole lives. This quite often happens in the case of consumption loans. The production loan is quite different in both its analysis and consequences. Unlike the consumption loan, in which borrowers have no choice other than to put their family life in hardship, the production loan quite often provides an opportunity for the borrower to pass the interest costs on to consumers since, in the capitalist system, these are accepted as part of the costs of production and, hence, tax deductible.

Heinrich Haussmann produced an interesting and amusing attempt to show the evils of interest in Germany, using statistics from Bundesbank. To show how interest income accumulates exponentially, he quotes the example of a calculation of the increase in value of one pfennig (one-hundredth of a Deutschmark) at 5 percent compound interest from the birth of Christ to 1990. The number was huge, amoun ng to 135 billion balls of gold, each the size of the earth!

To obtain a better understanding of the accumulated figure at different times, the time span was divided into different periods. In the first period, consis ng of 296 years, only one kilogram of gold was obtained. In year 1499, the first gold ball was formed; in 1749, there were one million gold balls; in 1890, one billion gold balls were obtained. Interes ngly enough in the final 100 years to 1990, 134 billion gold balls the size of the earth had been obtained. (Creutz 1999: 25-6).

The simple rule of the compound interest shows that the principal amount would double every 14 years, which would produce 268 billion balls by 2004 and 536 billion in 2018.

Source: Prof. Iraj Toutounchian, Thoughts from Iraj Toutounchian’s Islamic Money & Banking: Narrated by Camille Paldi. Republished with permission.