The interesting thing about interest...

As Australians patiently wait for the leading economists of the RBA to announce whether or not interest rates will change, a curious mind cannot help but think about why we even have interest rates.

 

Interest rates are an integral part of our economy. Lower interest rates mean that it is cheaper to borrow money which entices people and businesses to spend more. This can spur economic growth as well as inflation. Needless to say, falling interest rates will do the exact opposite and as such are a good way for the RBA to stop the economy from overheating.

 

For most ordinary people, the most obvious effect of interest rates is felt when they make mortgage repayments. With house prices in Australia at record highs, mortgages have become an assumed part of life for the average Australian (unless you have a cool half a million dollars stashed away underneath your bed, in which case please mail me your address). When you borrow money from the bank, you have to repay that money as well as a fee for borrowing it. This fee is known as interest and it recognises that a dollar today is worth more than a dollar tomorrow (the time value of money).

 

Say you wanted to buy the average house in Dandenong which costs $427,000[1], you would most likely need to borrow money from the bank to do so. Assuming you take out a 30 year variable loan from Westpac at the going interest rate of 5.7%, you will be paying the bank $2,478.31 monthly. Over the life of the loan this means that you will have paid the bank $465,191 in interest on top of the $427,000 you borrowed. Yep, you paid $892,191 for a $427,000 house (and this doesn’t even include all of the other associated fees and costs).[2]

 

Now I know what you’re thinking, ‘these guys are criminals!’ but let me play the devil’s advocate for a moment; would you have been able to afford the home in the first place were it not for the loan that the bank offered? What incentive would the bank have to lend you money if they did not make a profit from it?

 

Paying interest has become a widely accepted part of the global financial system but this wasn’t always the case. How would you feel if you borrowed $5 from your friend for lunch money one day and the following week he asked you to return the $5 with an additional $1 of interest? Ripped off? Used? Well that’s how the people of Venice felt when they first came across the concept of interest being charged on borrowed money. Although the Jewish Torah forbade charging interest to a ‘brother’ or fellow Jew it didn’t prevent them from charging interest to non-Jews. When the Jews charged interest on money borrowed by Catholics in Venice, the outraged Catholics felt betrayed and angry at the Jews who they labelled money hungry and greedy for such doings. They forced them into a part of town which they called the ‘ghetto’ where they were persecuted for centuries. Although this occurred in the 16th century, those characteristics form part of a negative stereotype given Jewish people even to this day, and the concept of ghettos was used to isolate and persecute Jews in places like Nazi Germany.

 

While the Catholic Church initially called it ‘usury’ and labelled it illegal. The sheer amount of money and influence that came from effectively charging interest meant that the wealthy and powerful Christians of the time began to commonly practise it and in turn the church softened its stance on the matter.

 

While interest is still forbidden in the Islamic faith, the Islamic banking system has found different methods of ensuring that banks can earn a profit from loans. This is done mainly through the charging of other fees and going into a joint venture with the investor in which the bank is entitled to a share of the investor’s profits.

 

While each of these Abrahamic faiths has clearly shown a great deal of apprehension towards the idea of interest over the centuries, it has become a commonly accepted part of our money centred financial system. I guess that’s part of what makes interest so interesting!

 

What are your thoughts on the matter?

The image titled 'Christ drives the usurers out of the temple' depicts the early Christian view of 'usury' or charging interest.


By English: Lucas Cranach the Elder Русский: Лукас КранахEpiphyllumlover at en.wikipedia [Public domain], from Wikimedia Commons



Write a comment

Comments: 4
  • #1

    Allan Ali (Wednesday, 08 April 2015 03:40)

    An interesting read and no doubt an accurate synopsis of where we're at today. Two questions that I'd like to throw back at you :

    1. How'd we get to where we are today? (In terms of economic markets/socio-economics)
    2. What measures could we put into place to make sure we don't get here again?

  • #2

    Vladimir Dumovic (Wednesday, 08 April 2015 03:57)

    Excellent questions Allan!
    In many ways where we are now has been a natural progression of an economic system based on private ownership and profit motive. If society sets the goal of accumulating massive amounts of material wealth then that is exactly what people will do. The most important factor in how much wealth you can accumulate is how much wealth you begin with and as such we see an ever increasing gap between rich and poor.
    To avoid this we as a society would have to change the rules completely. The most distinct alternatives to our capitalist system are the anarachist and communist models which promote the collective rather than the individual, and whereby most things are shared in common. I recommend a read of chapter 10 of the textbook 'My Economics, Our Economics' for some more depth on the alternative models.

  • #3

    Vefki (Monday, 13 April 2015 00:18)

    they help you find a way to earn money and become independent

  • #4

    Ash (Monday, 13 April 2015 00:21)

    I believe that interest rates are ethical as everyone needs to make money in some way, it would be wrong if the bank did not money it would be basically an organisation that gets 0 profit although I believe that the Islamic way is more ethical as they don't rip you off in my opinion.