Economics Questions

Re: Why not ban usury?

ToxicAssets — Thu, 07 Mar 2013 15:32:35 GMT

Clayton:

@Meistro: That's beside the point. The point is that what began as a $100 obligation balloons into absurd numbers, not because "that's what was agreed to" - of course people are free to negotiate any price they like between themselves - but because humans are extraordinarily bad at exponential arithmetic. Most people pay close to 2x the sticker price for an automobile because they buy it on credit... by the time you add up all the interest, the total purchase price comes out to nearly 2x. But they don't think it through, they just say "Oh, 8% isn't that much". But it isn't just 8%... it's 8% on 8% on 8% on 8% on 8% on $25,000 (annuitized over 5 years or however many years the loan is). Some States have laws to try to rectify this by giving the consumer the total package price, etc. but the fact is that that's like putting your finger in the crack of a leaking dam... the point is that everybody buys cars for that price, so of course, that's what the Joneses will pay to have a car. In other words, my view is that it's not an accident that things like car loans are the way they are. It's an interlocking, interconnected system. It's pure evil.

Clayton -

But that's why few debts are structured as zero coupons contracts.

Most real world contracts have a stream of coupons payed on pre-assigned intervals (usually of the same length) where the accrued interest since the previous coupon payment is payed, thus leaving only the principal. So you pay 8% over the principal every year and in the last year you pay the principal + 8%, and you have no exponential explosion. And this can go on for an infinite amount of time. Or you can structure so you pay the interest plus a part of the principal so that in a number of years all is payed.

This mode of payment seems to have worked well since the middle ages and perhaps contributed to the prosperity of the judeo-christian world, which lagged far behind the Islamic world before the Reinassance.

Even though this is a very complex process, the relative freedom to practice usury many relocated spanish jews encountered in the prostestant electorates of the Holy Roman Empire, as well as in the Habsbourg Netherlands and London, contributed to the advancement of these regions.

Re: Why not ban usury?

Johnny Doe — Thu, 07 Mar 2013 08:16:11 GMT

Clayton:
I'm actually coming to the view that contracts that are based on compound interest per se are ill-formed contractual arrangements in that there is not actually a single, agreed price.

Isn't 5 % per annum a single, agreed price?

Clayton:
The cascading scale of defaulting prices upon non-payment implied in compound interest contracts are exploitative because a) they result in absurd sums very rapidly[1] and b) the terms of such instruments are invariably favorable to the wealthy, a sure sign that they are a symptom of the parasitic social order, not the natural social order.

It depends on the interest rate.

Clayton:
The underlying presumption of compound interest - that money is exponentially valuable in time - is actually false.

Is a commodity you can't use, exponentially less valuable in time as you can't use/invest it when someone else is borrowing it from you?

Clayton:
@Meistro: That's beside the point. The point is that what began as a $100 obligation balloons into absurd numbers, not because "that's what was agreed to" - of course people are free to negotiate any price they like between themselves - but because humans are extraordinarily bad at exponential arithmetic. Most people pay close to 2x the sticker price for an automobile because they buy it on credit... by the time you add up all the interest, the total purchase price comes out to nearly 2x.

But they do so in a society where the fiat-money is inflated, so if that car is an investment that enables them to be more productive immediately, that might not be so stupid, as the loan decreases relatively to their growing income as money is being inflated.

Clayton:
It may be true that people don't grasp the math of compound interest. But that just means they are signing up for a Darwin Award when they voluntarily agree to a complicated contract without sitting down to figure out what it actually says,
But how does it happen that such stupidity is so common? I'm not asking a question about population traits (why are so many people stupid) but, rather, how is it that this trait is so often expressed? For example, the willingness to commit petty theft is appallingly common. Yet there is actually not a lot of petty theft in absolute terms, compared to what there could be.

How do you know?

Clayton:
This is because petty theft is punishable. So would-be petty thieves are induced to calculate - in their own terms - the costs of indulging the urge to commit a petty theft.

Yet, somehow, stupid people are not being induced to calculate the true costs of compound interest loans which they are taking out for literally everything from houses

...with enough regulation to curtail supply in a given area, real estate prices will increase in value, so borrowing to invest in real estate might be profitable in a fiat-monetary system.

Clayton:
to cars, to boats, to televisions, to dental work, to breast implants, etc. Let me put it this way and let you ponder it: the modern system of consumer credit is subtly redistributive.

Clayton -

Re: Why not ban usury?

Clayton — Wed, 06 Mar 2013 22:54:55 GMT

@eliotn: You can put it that way but I want to underscore that I think older moral/legal philosophers were well aware of these issues and the prohibitions on "usury" (that is, lending at interest, even simple interest) were actually based on these considerations. This is very clear from Sharia law regarding banking. It is permitted to effectively lend money, and it is even permitted to make money lending money, but the instruments are structured such that there are no open-ended obligations. It's a gross and irresponsible over-simplification to simply say "Islam prohibits lending at interest". Yes, it does, but it also effectively permits credit when the arrangement is properly structured. I guess what I'm trying to say is that I see a historical correlation between the rise of positive legal theory in the West and the explosion of credit-based, Western economies. When you throw "justice" out the window, it's all just a big math equation.

Clayton -

Re: Why not ban usury?

eliotn — Wed, 06 Mar 2013 21:21:20 GMT

Clayton, it looks like the key issue isn't all about interest, its the fact that courts don't enforce the tool of the performance bond, as described by Rothbard in Ethics of Liberty. So they have to use other vague measures, such as including interest.

And it looks like the issue is a problem with the "innocent until proven guilty", that the debtor is "guilty until proven innocent". Am I right?

Re: Why not ban usury?

Clayton — Wed, 06 Mar 2013 18:34:48 GMT

The issues in question are unlimited liability and weather or not people understand the agreement, not the mathematics behind the agreement.

That was my point - I'm trying to underscore that the current system does accept compound interest in calculating liability in certain cases. Since mathematics really has nothing to do with the question of justice, I'm arguing that this should be dispensed with. And, as a prediction, I think that once this is dispensed with, it will have a massive impact on the nature of the loan market. I think the loan market would massively shrink in size, I think that simple interest, fixed-term loans would become more common and I think that interest rates would go up quite a bit, especially in the low-end lending market.

Clayton -

Re: Why not ban usury?

dude6935 — Wed, 06 Mar 2013 18:30:33 GMT

That has nothing to do with simple vs compound interest. Like I just said, the issue is ultimately about unlimited liability.

Weather or not defaulting on a loan is theft is neither here nor there. Even if it is theft, what are we to do, make the borrower a slave? Let the contract state these things. We have no business interfering in voluntary agreements (assuming there truly is agreement).

Clayton:
In other words, all we have really done is reworded the contract. It is no different than an ordinary mortgage contract except that all the squishiness has been discarded - there is no room for the judge's discretion, or for either party to argue about prevailing prices, abusive interest rates, and so on. The contract is just a simple marker of the terms of a conditional exchange of property.

Yes exactly. The issues in question are unlimited liability and weather or not people understand the agreement, not the mathematics behind the agreement. If X then Y. What takes place within the calculation is irrelevant once a defined value is agreed to.

So, if a "usurer" uses clear contracts with defined values, we should have no problem with that activity.

Re: Why not ban usury?

gotlucky — Wed, 06 Mar 2013 04:58:23 GMT

dude6935:

I know all that. But if you engage in many separate simple interest contracts, you can just as easily run out of property to fulfill your contracts. You are bankrupt. Just because the numbers become large at some arbitrary point in time is irrelevant.

If we enter into a compound interest contract that matures to a maximum defined benefit, the objection falls away. Compound vs simple is not the question. The question is about unlimited liability.

The fact remains that if you believe that bankruptcy is legitimate, then you believe that it is legimate to reneg on these so called contracts. If you believe these are legitimate contracts, then you believe that theft is legitimate. Let the cognitive dissonance commence!

Re: Why not ban usury?

Clayton — Tue, 05 Mar 2013 23:19:48 GMT

By this I mean that two loan contracts for 1 month, when naturally combined, result in one contract for 2 months using compound interest, not simple one.

I understand and accept that a professional creditor may combine contracts in this way, and do so to both the advantage of creditor and debtor. It is clear that interest is in some sense "exponential" with respect to time, just from looking at the market outcomes.

That said, this has nothing to do with the question of justice, which is really the question that law is seeking to answer. "What is the just outcome in this situation?" You can't just reach for the first industry-standard calculation method you come across and declare that to be just. The word justice is as literal as it gets: justification. That is just what can be justified. Just saying "there are loan houses who combine and refinance loans using such-and-such equations" is no more relevant to a particular debt dispute than arguing over the true price of oranges in the case of a missed orange shipment. Contracts that are wide-open and refer to things like "going price" or what-not, are ill-formed contracts and lead to increased, not decreased conflict. This doesn't mean that such contracts will not be made anyway, however, the idea is that in an unhampered market in law, we should expect the settlement of disputes over such messy contracts to be expensive vis-a-vis better-crafted contracts, thus, we should expect the market to impel people to write clearer, more cost-effective contracts. IOW, this isn't about taking anyone's "freedoms" away, it's about understanding a) where does justice fit into this and b) what are the various cost impacts of structuring and enforcing contracts?

Insisting on limiting the loan contract liability is just asking for arbitrage - A can borrow $100 from B to be returned in 1 year as $110, with some additional fees if returned later, but never more than $120. Then A can lend these $100 for one year term indefinitely, first to C, then to D, then to E (let's say, undercutting the going rate of 10%, so earning only 9% a year). After 3 years, A finally decides to return $120 to B, keeping the positive balance for himself. I do not see this model as sustainable.

The point is that the chain of contracts should always be in the form of a simple "if then" model, or perhaps a couple, clearly cascaded and precedented conditionals and should conform as closely as possible to the Rothbardian view of a contract as a conditional transfer-of-title... the more clearly the language corresponds to this view, the more cost-effectively disputes arising from violation or perceived-violation of the contract can be settled.

How loan terms are calculated should not be in view. For example, let's say I go to the bank and ask for a 10 year loan of $100K. They come back and tell me they will loan me $100K in exchange for an IOU contract that I will pay $916.66 per month for 120 months; if I miss payment for 30 days, I agree to a $100 fee, if I miss payment for 60 days, I agree to a $250 fee, and if I miss payment for 90 days, I agree that double the outstanding balance is owed to the creditor, i.e. conditional title transfer. This is a perfectly enforceable contract, and the amount of interest on the loan is calculated using compounding (10% APR, compounded monthly). The fees act as a grace period, and the defaulting value acts as an incentive to meet the original terms. The instrument does not "accrue interest" over time once defaulted on, any more than a stolen bicycle "accrues interest". The doubling also serves to take into account enforcement, collection, legal, etc. costs on the anticipation that arguments like "you cost me money by forcing me to have to secure my own property" are invalid.

In other words, all we have really done is reworded the contract. It is no different than an ordinary mortgage contract except that all the squishiness has been discarded - there is no room for the judge's discretion, or for either party to argue about prevailing prices, abusive interest rates, and so on. The contract is just a simple marker of the terms of a conditional exchange of property. Nothing more. Rothbard quotes Hobbes in EoL who points out that, when it comes to law, words matter, so being nit-picky about contract wording is just part of the territory.

Clayton -

Re: Why not ban usury?

dude6935 — Tue, 05 Mar 2013 23:10:10 GMT

I know all that. But if you engage in many separate simple interest contracts, you can just as easily run out of property to fulfill your contracts. You are bankrupt. Just because the numbers become large at some arbitrary point in time is irrelevant.

If we enter into a compound interest contract that matures to a maximum defined benefit, the objection falls away. Compound vs simple is not the question. The question is about unlimited liability.

Re: Why not ban usury?

gotlucky — Tue, 05 Mar 2013 22:24:10 GMT

You are highly mistaken as to what Clayton is saying.

EDIT: Here is one of his statements from earlier:

Clayton:

But what, exactly, is the agreement? That's the point. Being "held to terms of agreement" is, as Rothbard notes in EoL, an anti-liberal conception of what a contract is. A contract is, at root, a conditional property title. "Terms of the agreement" is a squishy and ill-defined concept... and, ultimately, it leads to unlimited liability. Any agreement, however tiny - even if such an agreement was never actually made! - can balloon into astronomical liability.

I fully agree that people should be able to create voluntary agreements with each other, but not just any old agreement is considered a valid libertarian contract. The fact that you think bankruptcy is a legitimate method of reneging on these agreements should be a hint that they are not as legitimate as they might seem.

Re: Why not ban usury?

dude6935 — Tue, 05 Mar 2013 22:19:48 GMT

I understand that the mortgage market is heavily regulated and probably a lot of these regulations are actually good things as far as they go.

They say everyone (and every AnCap) has a blind spot. I guess this is Clayton's. I could understand saying that laws against murder are good as far as they go, but the prevention of voluntary transactions, com'on man... If both parties know what they are agreeing to, I don't see a problem. And bankruptcy is always an option if things get out of hand.

Re: Why not ban usury?

Andris Birkmanis — Tue, 05 Mar 2013 21:57:20 GMT

BTW, Clayton, I think that using the compound interest for contracts is far from being artificial - it is in fact the natural one.

By this I mean that two loan contracts for 1 month, when naturally combined, result in one contract for 2 months using compound interest, not simple one.

Insisting on limiting the loan contract liability is just asking for arbitrage - A can borrow $100 from B to be returned in 1 year as $110, with some additional fees if returned later, but never more than $120. Then A can lend these $100 for one year term indefinitely, first to C, then to D, then to E (let's say, undercutting the going rate of 10%, so earning only 9% a year). After 3 years, A finally decides to return $120 to B, keeping the positive balance for himself. I do not see this model as sustainable.

Re: Why not ban usury?

Southern — Tue, 05 Mar 2013 21:25:13 GMT

Jones can file suit, claiming that Smith owes him money... and if Smith doesn't show up to court and answer Jones' challenge, Jones wins by default. That's the meaning of default. The party who shows up to court wins by default, supposing the other party is a no-show.

I'm not sure this is entirely accurate. If I sue you and you dont show the court is still going to ask me to make my case that you owe me money. If I have no evidence the court would certainly not award me a judgement.

At any time, I can send you a "notice" in the mail that you owe me money. The threat implied in this notice, is that if you don't respond to me, I will file a suit against you. And should I choose to do that, you must respond regardless of whether you can afford a lawyer, etc. or else I will win by default.

You have to respond because the court commands you to. But you wont lose by default because you dont show up. You lose because evidence is presented that you do indeed owe the money and you are not present to dispute the evidence.

This sounds entirely resonable to me. If it was any other way I could avoid all legal action by simply refusing to show up for court.

I can't send a letter to my mortgage company: "I hereby declare I owe you no money." They'll just laugh and throw it in the garbage... because there's no way I can follow up and file a suit along those lines... "Show up to court to defend yourself against my claim that I owe you no money."

This makes no sense. When I claim you own me money that you have refused to pay back, I am in essence claiming that you have stolen money from me. You are telling me that an individual who has not been allegedly stolen from should be the one to initiate the law suit?

Law suits are initiated by those who are claiming to have wronged in some way. Not the other way around.

Re: Why not ban usury?

Southern — Tue, 05 Mar 2013 21:04:58 GMT

I guess what I'm trying to say is that it's mathematically identical.

Its not mathematically identical: Lets assume we have a 10 day loan of $100,000 at 1% per day. In the first example you have the interest compounded by adding it to the principal where the next days calculation for interest is based on the new principal balance. In example two the interest is not compounded and is only calculated based on only the original principal. There is a $462 difference in the amount of interest owed.

	Begin Principal	Interest	End Principal	Total Owed		Begin Principal	Interest	End Principal	Total Owed
Day 1	100000	1000	101000	101000	Day 1	100000	1000	100000	101000
Day 2	101000	1010	102010	102010	Day 2	100000	1000	100000	102000
Day 3	102010	1020	103030	103030	Day 3	100000	1000	100000	103000
Day 4	103030	1030	104060	104060	Day 4	100000	1000	100000	104000
Day 5	104060	1041	105101	105101	Day 5	100000	1000	100000	105000
Day 6	105101	1051	106152	106152	Day 6	100000	1000	100000	106000
Day 7	106152	1062	107214	107214	Day 7	100000	1000	100000	107000
Day 8	107214	1072	108286	108286	Day 8	100000	1000	100000	108000
Day 9	108286	1083	109369	109369	Day 9	100000	1000	100000	109000
Day 10	109369	1094	110462	110462	Day 10	100000	1000	100000	110000

Interest Accrued		10462			Interest Accrued		10000

Total Repayment		110462			Total Repayment		110000

There is no legal action whereby you can tell someone "put up or shut up."

This is not true. When you file for bankruptcy arrangements are made where some creditors are paid and others legally have to eat the bad debt. Once the bankruptcy is discharged creditors have no legal recourse to recover money from you.

if you believe someone owes you money, you may file a legal action to force that person to prove they don't owe you... it's completely one-sided.

This is also not true. If someone takes you to court because they claim you owe them money.... they are the ones who have to prove it. They have to provide evidence that they gave you money and you agreed to repay under certain terms. If a creditor decides to take you to court and they cannot produce evidence the case will simply be dismissed. To claim other wise is just untrue.

Re: Why not ban usury?

Andris Birkmanis — Tue, 05 Mar 2013 11:16:55 GMT

because when everyone borrows 10 chips and everyone owes 11 chips in the mort-gage death-gamble contract, someone gets morted, knocked out of the game into starvation by lack of life-support tickets.

Care to elaborate what you meant?

Oh, and suggesting your own post as an answer is uncool, IMO.