A moral economy: interest, usury and Islam

8 April, 2010

This is a piece written for a conference on Islamic finance to be held on 29th April in Edinburgh.

The notion of the moral economy is intrinsic to all the major faiths, each of which has placed ethical boundaries on the behaviour of those active in the market.

The ten commandments of the Jewish Torah or Christian Old Testament laid down an ethical boundary – or regulation – for work:

“for six days you shall labour and do all your work. But the seventh day is a Sabbath to the Lord your God; you shall not do any work – you, your son or your daughter, your male or female slave, your livestock, or the alien resident in your towns.

The Qu’ran lays down clear ethical boundaries for lending and borrowing, and for trade.

These boundaries have been vital in the maintenance of great civilisations. As  Karl Polanyi, the great economic historian argued (in his 1944 book “The Great Transformation”) – the regulation of the conduct of human affairs by law  is vital to the maintenance of civilised society, and to the market, because

“robbed of the protective covering of cultural institutions, human beings would perish from the effects of social exposure; they would die as the victims of acute social dislocation through vice, perversion, crime and starvation….neighbourhoods and landscapes defiled, rivers polluted, military safety jeopardized, the power to produce food and raw materials destroyed”.

So one of the great contradictions we in the West face today is this: law – or regulation –  needs boundaries, in particular ethical boundaries; but also geographical and political boundaries.

However markets, in particular financial markets, abhor boundaries.

How do we reconcile therefore, the ethical boundaries/regulation advocated by the world’s great religions with the resistance of, in particular financial markets, to these boundaries?
That is the great challenge faced today by  those who would promote the notion of a moral economy.

One of the most important ethical boundaries set by the Prophet1 in the Qu’ran has to do with the ‘price’ paid for a loan: the rate of interest. While many would regard the Qu’ran’s strictures on interest rates as antiquated, I would like to argue that they are acutely relevant to today’s financial crisis.

This is because one of the economic characteristics of the period from 1980 to the present day is high real rates of interest (i.e. adjusted for inflation/deflation) paid by borrowers.  By this we mean interest rates in the broadest sense: those for short, long, real, risky as well as safe loans.  While the Federal Funds or Bank of England rate might seem low, the real rate paid by credit card holders or entrepreneurs taking risks, has for a long period, been much, much higher.
Indeed it is these high rates of interest, that I contend, led to the ‘debtonation’ of the financial system in August, 2007, and the most severe financial crisis in history.  For it is high real rates of interest that ultimately made debts unpayable – for sub-prime mortgage borrowers in the US, for the millions that have defaulted on their mortgages and had their homes ‘foreclosed’; for thousands of companies that have been bankrupted by a heavy burden of debt; by semi-states such as Dubai, and now by states such as Iceland, Ireland and perhaps Greece.

Historically the average rate of return on investment has  been in the range of 3-5%. Any borrowing above that rate presents repayment difficulties for most entrepreneurs and investors.  The post 1977 rates of interest can be described as usurious.

Sidney Homer’s A History of Interest Rates, has been the definitive analysis of the subject since its first edition in 1967.  He published a second edition ten years later.  Homer died in 1983, and his pupil Richard Sylla was entrusted with the production of a third edition of his work. On the opening page, Sylla warned:

“The spectacular rise in interest rates during the 1970s and early 1980s pushed many long-term market rates on prime credits up to levels never before approached, much less reached, in modern history. A long view, provided by this history, shows that recent peak yields were far above the highest prime long-term rates reported in the United States since 1800, in England since 1700, or in Holland since 1600. In other words, since modern capital markets came into existence, there have never been such high long-term rates as we recently have had all over the world.”  (Homer and Sylla, 1991, p. 1)

High rates across the whole architecture of rates – for short and long, safe and risky loans – have prevailed ever since.
Tremendous capital gains have effortlessly been made by those who held assets, lent them on to governments, corporations or individuals, and thereby extracted even greater wealth. This is what has always been understood as usury.

Islam and interest-bearing money

‘Those who consume interest shall not rise, except as he rises whom Satan by his touch prostrates [i.e. one who is misled]; that is because they say:  “Trade is like interest”; whereas, Allah [God] has permitted trading but forbidden  interest. ……whosoever reverts (to devouring interest) those, they are the inhabitants of the fire, therein dwelling forever.’   Qu’ran 2:275

Islam prohibits the taking or giving of interest or riba, regardless of the purpose of the loan, or the rates at which interest is charged.  “Riba” includes the whole concept of effortless profit or earnings that comes without work or value added production.

In Islam money can only be used for facilitating trade and commerce – a crucial difference with the world’s major Christian religions. This was because Islamic scholars were fully aware that debt-creating money can stratify wealth, and exacerbate exploitation, oppression and the enslavement of those who do not own assets.

The Qur’anic ban on interest does not imply that capital or savings are without cost in an Islamic system. While Islam recognises capital as a factor of production, it does not allow capital to make a claim on the productive surplus in the form of interest.  Instead Islam views profit-sharing as permissible, and a viable alternative.  The owner of capital can legitimately share in the gains made by the entrepreneur. That implies that the owner of capital will also share in the losses.

Investors in the Islamic order have no right to demand a fixed rate of return.  No one is entitled to any addition to the principal sum if he does not share in the risks involved.  Another legitimate mode of financing recognized in Islam is based on equity participation (musharaka) in which partners use their capital jointly to generate a surplus. Profits or losses are shared between partners depending on the equity ratio.

Islamic banking is a risky business compared with conventional banking, for risk-sharing forms the very basis of all Islamic financial transactions.

Global finance, in the shape of un-regulated and unethical capitalism, poses a profound threat to Islam. Because Islam expressly prohibits the concentration of wealth in the hands of the few, i.e. hoarding (kenz) waste (tabthir) extravagant consumption (israf) and miserliness (bukhl) – the excesses of global financial liberalisation are in deep conflict with Muslim values.

Not only Muslim values, but the values of Jews and Christians too.
If we are to return to our roots; if we are to protect both our civilisation, but also our ecosystem,  then it is vital that we, as people of faith, once again assert the centrality to society of the moral economy.


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9 comments to A moral economy: interest, usury and Islam

  • Thanks for the clear summary as ever.

    I would love to know your thoughts on Clay Shirky’s latest post.

    http://www.shirky.com/weblog/2010/04/the-collapse-of-complex-business-models/

  • Talton Embry

    I have been going through your writings. I love the moral tone of your writings. I believe that you are totally correct in your prescription as described by “Step one: personal transformation” as outlined in your book. However, I believe your premise is fundamentally flawed in that you do not consider the “storehouse of value” function of money to be valid. Neither do our governments and therein lies the basis of our problems. I believe that even the Qu’ran allows for “top-ups” to be made on the repayment of loans where the lender’s value has been impaired by wrongful currency depreciation. It is therefore, unfair to juxtaposition the Homer and Sylla quote concerning interest rates during a period of ruinous inflation with a statement that “High interest rates…have prevailed ever since.” In fact, rates have declined by 85% and more for the safest investments and 70% for riskier ones.

    In “The Coming First World Debt Crisis” you assert that;
    “there is a great problem with this notion of money as a store of value. Why? Because the token in her pocket is a static, barren asset. It remains a small, cold metal token. The hen, a live procreative animal, is, in contrast, probably already laying eggs for her new mistress, from which chickens are hatching – thereby adding considerable interest or value to the newly-acquired asset that is the hen.
    In other words, the live hen, is multiplying itself. Money, also an asset, is barren and cannot multiply itself. Instead, for money to be multiplied, interest must be added. A hen can generate a form of interest, i.e. can increase itself, by laying eggs and producing chickens. But money cannot increase itself. Interest on money must come from some other source or process.
    So for example, if, in our mythical village of the past, a villager borrowed a hen for a week, he would expect to pay interest on the loan of the hen by offering a few of the eggs she lays or perhaps one of the ten chickens that she hatches. That would represent payment (interest) for the loan of the hen.”

    If a person lends a chicken, the lender expects back the chicken, the eggs laid, the chicks hatched and something extra for the risk of lending the chicken. The chicken and its future production are a single item of value that the lender owns. The lent chicken cannot produce “interest” in excess of itself. A borrower cannot use the chicken for a week, keep most of its eggs and chicks and then return it for payment-in-full.

    The metal token and the chicken are both “storehouses of value” for their holders. The chicken should be a more productive storehouse of value than the metal token. It should be because it is riskier (it dies), less convenient (it needs to be fed and cared for), and less portable, and less easily secured.

    When currency ceases to be a storehouse of value, people become speculators. In 1918 my grandfather ran the Berlin branch of the Guaranty Trust Company. The bank’s staff was paid four times a day because the currency was depreciating so rapidly. When he went to his clerks apartment for dinner, he was surprised to find the guest bedroom stuffed with light bulbs. His clerk explained that whatever currency he had left after each pay period, he used it to purchase light bulbs as they were easily stored, retained utility and, therefore value, and were easily exchanged. For him, the light bulbs were money where the German currency was not.

    Governments around the world have made vast promises to their citizens in order to win elections. To assist them in winning the elections, they have purposefully neglected to presently tax their citizens for the cost of these benefits. Voters have been given false choices. As a result, the benefits will either not be delivered at all, will not be delivered at the full expected value. This represents the theft of votes. In other countries, governmental theft is outright.

    I read your July 4th, 2002 report on the Malawi grain sale and the subsequent resulting famine in that country. While the details are still murky, it would seem that the IMF was less to blame than you reported. It appears that President Muluzi sold off a great deal of the grain supplies to associates at cheap prices who then profited greatly when they resold it at higher prices. Some reports indicate that debtors received no money from any grain sales. Recently, Mr, Muluzi was charged with stealing $11 million of donor money. The new government of Malawi continues to attract criticism for its corruption. “Debt is still the lynchpin” is incorrect, corruption is the lynchpin.

    On the matter of interest, I think your emphasis misplaced. Debt is the problem, interest only a symptom of the problem. If we needed and wanted less than we have, we would all be rich. If we were governed in an honest and prudent fashion, our wealth would be better distributed, and the needs of all better satisfied. However, we cannot depend upon our politicians for such a result, which is why I like your writings so.

    From Oliver Goldsmith’s “The Deserted Village”:
    “Teach erring man to spurn the rage of gain;
    Teach him, that states of native strength possessed,
    Though very poor, may still be very blest;
    That trade’s proud empire hastes to swift decay,
    As ocean sweeps the laboured mole away;
    While self-dependent power can time defy,
    As rocks resist the billows and the sky.”

    Sorry to be so long. I am really very taken with your spirit if not all of your thoughts.

  • Where is the morality in this from the 10 commandments: “…you shall not do any work – you, … your male or female slave…”? Surely the entitlement to the ‘fruits of your own labour’ is the fundamental economic moral imperative.

  • I do not see anything immoral in the principles of a mutual building society or a credit union, or even a small local bank. Savers seek only to maintain the purchasing power of their savings via interest and borrowers pay this interest.

    This simple model provides a far better basis for financing capital goods than shareholdings, private equity, etc. which extort surplus labour from those who worked it.

  • Ann

    Carol, we do not disagree.

  • Ann

    Carol the morality is in the regulation. Everyone is entitled to the fruits of their own labour, but not all are able to gather these entitlements. Especially if they are enslaved. This regulation would not provide entitlements for the slave; but it would provide regular release from 24/7-type slavery. The morality is in the periodic, regular, guaranteed regulation of work, so as to bar excessive exploitation of the labourer.

  • Ann

    Talton, thank you for your kind words and comment, and for the book. Much appreciated.

    On store of value: am not sure that my analogy in the book works. I was trying to illustrate and explain Aristotle’s opposition to metal money, and do not think I succeeded.

    But on the bigger points: “if a person lends a chicken, the lender expects back the chicken, the eggs laid, the chicks hatched and something extra for the risk of lending the chicken.” I have a problem with that; why so much ‘capital gain’ for the mere loan of a chicken, when that chicken produces ‘interest’ or repayment for the loan (i.e. eggs and chicks) naturally – and as a result of having been fed and cared for by the borrower?

    Aristotle (if may be so rash as to speak for him) would probably have argued that the ‘interest’ on this loan – the eggs and the chicks – is the ‘natural’ interest on the loan – making the loan repayable. And that is the key issue: does the loan itself, contain within itself, the means of repayment by the borrower? Or does the loan contain within itself the threat of non-repayment? Will it bankrupt the borrower? Will it require the generation of additional (over and above the ‘natural interest’) economic activity/exploitation of assets/labour – which rather than enabling repayment, makes the debt unrepayable? (Because there are limits to the exploitation of labour (no more than 24 hours a day 7 days a week), and to the exploitation of assets.)

    So when lenders/the bond market start charging Greece 7% interest, are the bond markets building into that rate the inability of Greece to repay – or even more worrying, the threat of Greece’s insolvency? Of course bond holders would argue that they are simply ‘pricing the risk’ of a Greek default, but they may also be precipitating it – hurting both Greece and the bond market in the process.

    Islam does not allow lenders to make the additional gain on a loan, if the lender does not have a stake in the loan. Because lenders are required to share the risk of the loan/investment, they are probably more cautious about precipitating the bankruptcy of the business in which they are investing. Not so the bond markets, who can rely on government-backed bailouts by e.g. the IMF/Eurozone. Knowing this moral hazard, the bond markets seek to maximise their short-term returns, and care less about bankruptcy ultimately, because the state subsidises/protects their interests in the event of bankruptcy. The IMF for example, is a preferred creditor, and as such was rather careless about lending to Argentina/the Philippines/Rwanda/Zambia…to name but a few.

    On inflation. I completely understand your concern about inflation, and the horror of your grandfather’s experience. Germany’s intransigence in relation to Greece can also be explained by this ferocious preoccupation with inflation, albeit somewhat contradictory as the Eurozone is about to fall into a Japan-style deflation.

    However: you simply make my point about regulation. The creation of credit is an effortless activity carried out by the central bank (quantitative easing) and the banking sector. The banking system can ‘magic’ credit in ways that you and I cannot. This is why it must be regulated. Because if the banking system creates too much credit (as it did in 1918) and this credit exceeds the capacity of the economy for economic activity – then we will have inflation. If it restricts credit (as it is doing now) below the level of economic activity the economy is capable of – then we get deflation. Which is why the creation of credit must be regulated – and why it is better this is done by a non-profit-seeking, public-interest institution, like the Federal Reserve. (I am of course critical of the Fed for its capture by Wall St. but that does not mean that public servants like Greenspan et al are just that: public servants. The private sector does not exist to serve the public, but rather to make capital gains from the public. )

    Finally, I disagree with you on interest. Debt is not a problem, if, and this is the point, the repayment of the debt is in line with the ability of the borrower to repay, with the ability of the ecosystem to generate resources for repayment (I think of Brazilian rainforests, stripped to raise the hard currency needed to repay Brazil’s foreign debts) and if the interest is in line, or less than the historic levels of profit made by companies.

    When Argentina defaulted on her debt, lenders simply compounded the interest on the unpaid debts – and demanded repayment. Argentina could not repay, and so carried on defaulting, eventually forcing bond holders to take a 70% haircut.

    So, sadly, we disagree on these major matters. But I do appreciate your interest, and your comments.

  • Ann

    Jo, thanks for this link. I read it and found it chilling, as he says. Noticed that Niall Ferguson has a piece in Foreign Affairs, titled something like ‘America’s collapse could be sudden’. http://www.foreignaffairs.com/articles/65987/niall-ferguson/complexity-and-collapse.

    Can’t say I take Ferguson seriously, but it looks as if he draws on Tainter who, as this short summary shows, is much more impressive…yet another book to read!

  • Peter Hogwood

    Unfortunately, this essay is yet another example of the negative side of the Internet, in the endless multiplication of nonsense, in which Websites copy from one another.

    This is a very inept translation from the Qu’ran:

    “Those who consume interest shall not rise, except as he rises whom Satan by his touch prostrates [i.e. one who is misled]; that is because they say: ‘Trade is like interest’; whereas, Allah [God] has permitted trading but forbidden interest…whosoever reverts (to devouring interest) those, they are the inhabitants of the fire, therein dwelling forever.” Qu’ran 2:275

    Modern scholarship has informed us that the ancient Semitic languages each had two words that had been translated (or mistranslated) as usury, by non-native speakers, both from the Aramaic of the Bible, and the Arabic of the Qu’ran.

    “John Calvin’s letter on usury of 1545 made it clear that when Christ said ‘lend hoping for nothing in return,’ He meant that we should help the poor freely. Following the rule of equity, we should judge people by their circumstances, not by legal definitions. Humanist that he was, Calvin knew there were two Hebrew words translated as ‘usury.’ One, neshek, meant ‘to bite’; the other, tarbit, meant ‘to take legitimate increase.’ Based on these distinctions, Calvin argued that only ‘biting’ loans were forbidden. Thus, one could lend at interest to business people who would make a profit using the money. To the working poor one could lend without interest, but expect the loan to be repaid. To the impoverished one should give without expecting repayment.”
    http://eh.net/encyclopedia/article/jones.usury

    “The Quran forbids usury, not interest. Quite a few states in USA have laws against usury. Usury is defined as excessive interest. A Dictionary defines usury as ‘an excessive or inordinate premium for the use of money borrowed’, ‘extortionate interest’, or ‘the practice of taking exorbitant or excessive interest.’ The Arabic language also makes distinction between interest (Fa’eda) and usury (Reba). The Quran forbids Reba or usury.”
    http://www.submission.org/islam/interest-usury.html

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