Titles to interest

This blog post is meant to define a new extrinsic title to legitimate taking of interest, in view of the Catholic doctrine on usury. I begin with some quotations that are helpful to my purpose. If you are not familiar enough with the doctrine to follow what is said, try checking the Catholic Encyclopedia on usury and interest.

6. Leo X, in the Fifth Council of Lateran, 1515, ruled that – “usury is properly interpreted to be the attempt to draw profit and increment, without labour, without cost, and without risk, out of the use of a thing that does not fructify.” In 1745, Benedict XIV wrote in the same sense to the Bishops of Italy: “That kind of sin which is called usury, and which has its proper seat and place in the contract of mutuum, consists in turning that contract, which of its own nature requires the amount returned exactly to balance the amount received, into a ground for demanding a return in excess of the amount received.” Mutuum, be it observed, is a loan for a definite period, of some article, the use of which lies in its consumption, as matches, fuel, food, and, in one respect, money. We shall prove this to be properly a gratuitous contract. (s. iv., n. 4, p. 254.)

7. Usury then is no mere taking of exorbitant interest. There is no question of more or less, but it is usury to take any interest at all upon the loan of a piece of property, which

(a) is of no use except to be used up, spent, consumed:

(b) is not wanted for the lender’s own consumption within the period of the loan:

(c) is lent upon security that obviates risk:

(d) is so lent that the lender foregoes no occasion of lawful gain by lending it.

8. When all these four conditions are fulfilled, and yet interest is exacted upon a loan, such interest is usurious and unjust. And why? Simply by reason of the principle that we laid down before, speaking of private exchange (n. 3), a principle that is thus stated by St. Thomas:

“If one party is much benefited by the commodity which he receives of the other, while the other, the seller, is not a loser by going without the article, no extra price must be put on. The reason is, because the benefit that accrues to one party is not from the seller, but from the condition of the buyer. Now no one ought to sell to another that which is not his, though he may sell the loss that he suffers. He, however, who is much benefited by the commodity he receives of another, may spontaneously bestow some extra recompense on the seller: that is the part of one who has the feelings of a gentleman.” (2a 2ae, q. 77, art. 1, in corp.)

— Joseph Rickaby, S.J., Moral Philosophy, 2.5, §5

It is in view of the conditions laid out by Leo and by Fr. Rickaby that moralists have often explicitly recognized certain legitimate “extrinsic titles” to interest, as explained below:

“Loss occurring (damnum emergens) and profit ceasing (lucrum cessans) are the two great titles to interest, as interest is understood today, a return owed without fault of the debtor.” If one could have made a profit with one’s money instead of loaning it (and can prove it!) then this becomes a legitimate title for interest. If I were going to purchase an orchard, but made the loan instead, the lender might also owe me the profit I lost from not owning the orchard. This title would become much more important as commercial centers and opportunities for investment became prevalent. Much later, it might even come to include the cost of one’s labor in making the loan (a just wage for bankers). “In the eyes of the Church, the most important and legitimate one [excuse], held that usury could be considered a salary, a remuneration for labor (stipendium laboris).”

— Fr. Gary L Coulter, The Church and Usury, ch. 3

Less commonly, some people have recognized inflation as a legitimate title to interest, so that a lender could lawfully charge an interest rate to cover the rate of inflation. Germain Grisez mentions this, in passing, in a passage quoted by Fr. Coulter:

Those who deposit or lend can fairly charge for various other factors: costs incurred in making and administering the loan, the risk of non-payment, probable inflation, taxes, the foregoing of other legitimate uses to which the money otherwise would be put, and so on.

— Germain Grisez, Living a Christian Life, vol. 2 of The Way of the Lord Jesus (Quincy, IL: Franciscan Press, 1993), 834

If someone were only familiar with the three titles just mentioned before – damnum emergens, lucrum cessans and stipendium laboris –, allowing for inflation could seem strange. It certainly did in the (rather extreme) opinion of the late Zippy Catholic. As my friend Calvin Engime once told me:

I used to accept inflation as a title to interest because Germain Grisez said it is one, but I don’t see the reason for this. It comes back to: what would have happened if you hadn’t made the loan? The money would still have declined in value while sitting in your pocket, and why should the borrower have to compensate you for that?

If someone were to object to Cal’s opinion by saying that the money could be invested to prevent its decline in value, Cal would certainly point out, correctly, that this fact could not be a reason for inflation as a title to interest, but only for lucrum cessans, which he does not dispute. So, is there any reason for Grisez’s statement?

I think there is, and I submit that it lies in the second condition laid out by Fr. Rickaby in the first quote from above, that the property loaned, being something consumed in use, “is not wanted for the lender’s own consumption within the period of the loan.” The difference between inflation, as a title to interest, and lucrum cessans, is that the inflation title represents foregone consumption, in an economic sense, as opposed to production, which is represented by lucrum cessans.

The inflation-title is the compensation for the decline in your power to consume, because you could have chosen to buy something instead of making the loan, and by making the loan you have delayed this consumption to a time when your money is worth less; it is only right that you be compensated for doing this, since it lowers your quality of life to some extent, and you do it only for the sake of making the loan.

This is fair enough, and certainly correct, but it is not usually seen because loans are usually made out of stored “savings”, which the lender did not mean to spend consumptively (as opposed to productively) any time soon. If the money was unlikely to be spent, anyway, why should there be compensation for the decline in value that it would have suffered while not being spent?

The answer is that, regardless of whether the money will be spent or not, it remains that, in a fundamentally uncertain world, there is always some usefulness to having cash holdings, because the probability that some desire to use it consumptively will arise is never zero. While holding cash, the saver enjoys the potential to consume whenever he wants, if he happens to want it, and this potential is itself useful. If it were not, then he would, of course, spend his cash instead of holding it, either productively or consumptively.

The service that money renders does not consist in its turnover. It consists in its being ready in cash holdings for any future use.

Money is never “idle.” It always renders to somebody the only service that it can render, namely being a part of a man’s cash holdings.

Cash holdings are sometimes greater and sometimes smaller with the same individual. But nobody ever has cash holdings greater than he wants to have. If he thinks that his cash holdings are excessive, he invests the surplus either by buying (producers’ or consumers’ goods) or by lending it. (Time deposits are one method of lending money.) [...]

— Ludwig von Mises, On the Velocity of Circulation

Now, once we acknowledge the usefulness of this potential to consume, which is undeniable, we have done more than explain the title of inflation. This is where my new legitimate title to interest comes in; I shall call it the potentiality title, or title of potentiality, after the potential to consume. I will explain it next.

There is no reason why only the decrease in the potential to consume due to inflation should be admitted as a legitimate title to interest. The potential itself, being useful, is of different usefulness to different persons, according to how they rate their probability of desiring to consume in the future. This can only be evaluated according to the lender’s foresight regarding opportunities to consume.

So, plainly, it is legitimate that the lender charge interest on a loan in order to be compensated for his loss of potential to consume, since this loss lowers his quality of life to some extent, and he incurs it only for the sake of making the loan. Because of the nature of the usefulness of the potential, the precise just rate of this interest can only be determined with knowledge of the lender’s mind. Which should allow almost any numerical rate to be justified, effectively; the exception would be when there are reasons to suspect the lender of allowing his estimation to be influenced by unjust motives.

To some people, this may seem like a rash conclusion. It may ease their minds to consider these facts which Cal told me about before, in an earlier conversation:

Up to the 19th Century, the burden was on anyone who had collected interest on a loan to affirmatively demonstrate that it was justified, or else he could not be absolved unless he made reparation of what he had taken. Then some theologians advanced the theory of “title of civil law,” according to which the fact that the civil law permitted a certain rate of interest was sufficient title to it, independent of any other claim. The Holy See ruled that, pending a definitive judgement on the legitimacy of this opinion, those who put it into practice were not to be disturbed, at least as long as the rate of interest is not flagrantly excessive, and there the matter has pretty much stood ever since.

Now, not only does this other theory also allow almost any effective rate of interest to be morally justified – at least in most countries, which tend to permit almost any interest – it is also much less reasonable. For it claims that a lawmaker can turn a natural injustice into a just act with the mere stroke of a pen; whereas my opinion of the title of potentiality does no such thing, but explains the justice of the act on the basis of the undeniable fact that it is useful to hold cash for the reason that it gives someone the potential to consume in the future. So, if the conclusion regarding the “title of civil law” was not too rash to be put into practice, then much less so is my conclusion, which is a much more reasonable one.

Addendum, 2023-11-05

I have recently been reading Rothbard’s Austrian Perspective on the History of Economic Thought, volume 1, where §4.8, on Lessius and de Lugo, points out that the former had a similar theory, the title which he called “carentia pecuniae” (charging for lack of money). As Rothbard describes it, having cited Lessius’s work De Justitia et Jure (1605) as his source:

But that is not all. For Leonard Lessius contributed his own, new and powerful, weapon against the usury ban: a new ‘title’ or justification for interest. The new justification – prefigured only by the neglected Summenhart – was carentia pecuniae: charging for lack of money. Lessius pointed out quite cogently that the lender suffers the lack of his money, the lack of his liquidity, during the term of the loan, and therefore he is entitled to charge interest for this economic loss. In short, Lessius saw perceptively that everyone derives utility from liquidity, from the possession of money, and that being deprived of this utility is a lack for which the lender may and will demand compensation. Lessius pointed out that unexpected situations can and do arise which could be met far more effectively if one's money were in one's possession and not absent for a period of time. Time, in short, can and should be charged for, for that reason, ‘for it can never be obtained that the merchants do not value a long-term concession higher than a short-term one’. And those who are deprived of their money ‘value more the lack of their money for five months than the lack of it for four, and the lack of it for four more than three, and this is partly because they lack the opportunity of gaining with that money, partly because their principle is longer in danger...’.

Furthermore, Lessius points out that bills of exchange, or rights to future money, are always at a discount compared to cash. This discount is, of course, the rate of interest. Lessius explains: ‘This is a matter of common experience in that money provides the means to a multitude of things which those rights do not provide. Therefore they may be bought at a lower price’. Lessius also notes that merchants and exchangers daily determine the ‘price of the lack of money’ on the Antwerp Bourse, averaging about 10 per cent; and foreign exchanges, of inestimable value to the economy, would perish if such prices could not be charged.

Thus, for Lessius, the price for a lack of money is established on organized loan markets. But to the extent that a loan market exists, there is no need to justify each merchant's loan on the basis of his particular opportunity cost or deprivation of funds. That price, which becomes the just price, is set on the loan market. As Lessius puts it:

Moreover, any merchant seems able to demand this price... even though there is no gain of his that stops because of his loan. This is the just price for the privation of money among merchants; for the just price of an article or obligation in any community is that which is put upon it by that community in good faith for the sake of the common good in view of all the circumstances... Therefore, even if through the privation of money for a year there is no gain of mine that stops and no risk of capital, because such a price for just causes has been put upon this privation, I may demand it just as the rest do.

With carentia pecuniae, therefore, Leonard Lessius delivered the final blow to smash the usury prohibition, while unfortunately still retaining the prohibition in a formal sense. It is no wonder that Professor Noonan, the great scholar of the scholastics on usury, holds Lessius to be ‘the theologian whose views on usury most decidedly mark the arrival of a new era. More than any predecessor he would probably have felt completely at ease in the modern financial world.’ [John T. Noonan, Jr, The Scholastic Analysis of Usury (Cambridge, Mass.: Harvard University Press, 1957), p. 222.]