The Mathematical Economics of Compound Rates of Interest: A Four-Thousand Year Overview Part I

January 24, 2004 By Michael Hudson Whoever enters here must know mathematics. That was the motto of Platos Academy. Emphasizing such abstract ratios as the Pythagorean proportions of musical temperament and the calendrical regularities of the sun, moon and planets, its philosophy used the mathematics of nature to reveal an underlying harmony and order in the universe and hence, in an ideal society. But there was little quantitative analysis of economic relations. Although the Greek and Roman economies were increasingly wracked by debt, there was no measurement of this phenomenon, or of overall production, distribution and other macroeconomic measures. The education of modern economists still consists largely of higher mathematics whose use remains more metaphysical than empirically measuring the most important trends. Over a century ago John Shield Nicholson (1893:122) remarked that The traditional method of English political economy was more recently attacked, or rather warped, by pushing the hypothetical or deductive side . . . to an extreme by the adoption of mathematical devices. . . . less able mathematicians have had less restraint and less insight; they have mistaken form for substance, and the expansion of a series of hypotheses for the linking together of a series of facts. This appears to me to be especially true of the mathematical theory of utility. I venture to think that a large part of it will have to be abandoned. It savors too much of the domestic hearth and the desert island. To contemporary economists, mathematics has become the badge of scientific method. But are the right things being mathematized? Do todays models correlate the appropriate phenomena, or do they confuse cause and effect while omitting key dynamics? Is the use of mathematics scientific ipso facto, regardless of how it is applied? The preferred method of mathematical economics is general equilibrium analysis in an environment in which only small marginal disturbances are envisioned, not major structural problems or legal changes in the economic environment. Marginal analysis avoids dealing with quantum leaps. It selects and correlates a rather narrow set of phenomena (supply, labor and materials costs, the interest rate, income and the pattern of demand) to produce models that show how economies might settle at an equilibrium point if left free from outside political interference. Many economists are trained in calculus and higher mathematics without feeling much need to test their theories quantitatively. They tend to use mathematics less as an empirical measuring tool than as an expository language or simply as a decoration to give a seemingly scientific veneer to their policy prescriptions. Mathematical economics rarely is used to statistically analyze the inherent tendencies at work to polarize wealth and income. In fact, the mathematical badge of science has distracted attention from the tendency for economies to veer out of balance.[1] The problem is that to achieve a single determinate, stable solution to any given problem (always posed as a disturbance to a pre-existing balance), general equilibrium theorists are driven to assume diminishing returns and diminishing marginal utility in order to close the system. A narrow set of variables is selected that all but ignore the economys growing debt overhead relative to its assets, and the associated flow of interest. Economies change their shape as they grow. This shape is distorted by the inherent tendency for financial claims bonds, bank loans and other financial securities to grow more rapidly than the economys ability to carry them, much less to pay them off. The volume of such claims tends to grow by purely mathematical

principles of self-expansion, independently from underlying economic trends in wealth and income, and hence from the ability of debtors to pay. The task of economic regulation is reduced to setting an appropriate interest rate to keep all the economys moving parts in equilibrium. This interest rate is supposed to be controlled by the money supply. An array of measures is selected from the overall credit supply (or what is the same thing, debt securities) to represent money. This measure then is correlated with changes in goods and service prices, but not with prices for capital assets bonds, stocks and real estate. Indeed, no adequate statistics presently exist to trace the value of land and other real estate. The resulting economic models foster an illusion that economies can carry any given volume of debt without having to change their structure, e.g., their pattern of wealth ownership. Self-equilibrating shifts in incomes and prices are assumed to enable a debt overhead of any given size to be paid. This approach reduces the debt problem to one of the degree to which taxes must be raised to carry the national debt, and to which businesses and consumers must cut back their investment and consumption to service their own debts and to pay these taxes. Excluded from the analysis is the finding that many debts are not repayable except by transferring ownership to creditors. This transfer changes the shape of the economys legal and political environment, as creditors act as rentiers to subordinate labor and capital to the economys financial dynamics. Rent-seeking exploitation and the proverbial free lunch are all but ignored, yet real-world economics is all about obtaining a free lunch. That is why one seeks to become a political insider, after all, yet such considerations are deemed to transcend the narrow boundaries of economics. These boundaries have been narrowed precisely so as to limit the recognized problems only that limited part of economic life that can be mathematized, and indeed, mathematized without involving any changes in social structure (the environment). A particular kind of mathematical methodology thus has come to determine what is selected for study, recognizing only problems that have a single determinate mathematical solution reached by or what systems analysts call negative feedback. As noted above, such entropic behavior is based on the assumption of a falling marginal utility of income: The more one earns, the less one feels a need to earn more. This is fortunate, because most models also assume diminishing returns to capital, which is assumed to be invested at falling profit rates. Income and wealth thus are portrayed as tapering off, not as soaring and polarizing until a financial collapse point, ecological limit or other kind of crisis is reached. A model acknowledging that positive feedback occurs when the rich get richer at the expense of the poorer, and when the real economy is dominated by an expanding overhead of financial capital, will depict an economic polarization that has an indeterminate number of possible resolutions. The economic problem becomes essentially political in the sense that conflicting trends will intersect, forcing something to give. This is how the real world operates. But to analyze it would drive economists out of their hypothetical entropic universe into an unstable one in which the future is up for grabs. Such a body of study is deemed unscientific (or at least, uneconomic) precisely because it cannot be mathematized without becoming political. The mathematical universe of modern economics was not created without some degree of protest. A generation ago F. J. Dyson (1964:132f.) commented that Mathematical intuition is more often conservative than revolutionary, more often hampering than liberating. Citing Ernst Machs observation that The power of mathematics rests on its evasion of all unnecessary thought and on its wonderful saving of mental operations, he worried that too much real-world complexity might be discarded. Nowhere is this problem more pronounced than in the treatment (or lack of recognition) of the economic role played by money and debt. The exponential growth of debt

Dramatists and novelists often have paid more attention to debt than do modern economists. The novels of Dickens, Balzac and their contemporaries, as well as earlier British drama, are filled with debt imagery. In fact, one of the earliest applications of Napiers logarithms, developed in the late 1500s, occurs at the outset of Shakespeares A Winters Tale. Floridly expressing gratitude for the nine months of hospitality he has received, the character Polyxenes jokingly uses the metaphor of a burdensome debt that can never be repaid. The idea is that to take the time to thank his host properly would consume yet more time, using up yet more hospitality for which yet more thanks would be due, creating a never-ending obligation. Nine changes of the watery star [the moon] hath been The shepherds note since we have left our throne Without a burden: time as long again Would be filld up, my brother, with our thanks; And yet we should for perpetuity, Go hence in debt: and therefore like a cipher, yet standing in rich place, I multiply With one we-thank-you many thousands more That go before it. Without a burden means without debt. The cipher . . . standing in a rich place is the language used in the early 1600s to indicate the logarithmic exponential. The imagery was that of a debt mounting up unpaid at compound interest, multiplying to the point where it engulfs the kingdom. Economic writers in earlier times were more ready than their modern counterparts to confront the problem of debts growing so large as to be unpayable. In The Wealth of Nations (V, iii), Adam Smith observed that Bankruptcy is always the end of great accumulation of debt. The liberation of the public revenue, if it has ever been brought about at all, has always been brought about by a bankruptcy; sometimes by an avowed one, but always by a real one, though frequently by a pretended payment. The tendency of debts to accumulate at compound rates of interest explains why Smiths axiom applies so universally. The principle was described graphically by one of Smiths contemporaries, the dissenting Anglican minister and actuarial mathematician Richard Price. It was Price who first popularized the distinction between compound and simple interest that later came to be associated mainly with Malthusian population theory. In the 1770s when Price and Smith wrote, Britains war in America had forced the nation deeply into debt. It was largely out of their opposition to such debt that they urged Britain to grant freedom to its colonies. As for the debts that already had mounted up, Price proposed an idea that had been anticipated a half century earlier by Nathaniel Gould, a director of the Bank of England. Parliament would pay off the national debt by setting aside a million pounds sterling in a sinking fund, to accumulate at compound interest by reinvesting the dividends annually until the fund grew large enough to pay off the entire debt. Prices 1772 Appeal to the Public on the Subject of the National Debt described the seeming magic of how money could grow at compound interest: Money bearing compound interest increases at first slowly. But, the rate of increase being continually accelerated, it becomes in some time so rapid, as to mock all the powers of the imagination. One penny, put out at our Saviours birth at 5% compound interest, would, before this time, have increased to a greater sum than would be obtained in a 150 millions of Earths, all solid gold. But if put out to simple interest, it would, in the same time, have amounted to no more than 7 shillings 4d. Price elaborated this idea in his Observations on Reversionary Payments, first published in 1769 and running through six editions by 1803. A shilling put out at 6% compound interest at our Saviours birth would . . . have increased to a greater sum than the whole solar system could hold, supposing it a sphere equal in diameter to the diameter of Saturns orbit. He concluded that A state need never, therefore, be under any difficulties, for, with the smallest savings, it may, in as little time as its interest can require, pay off the largest debts.

What Price had discovered was the exponential growth of money invested at interest, multiplying the original principal by plowing back the dividends into new saving. What he failed to appreciate was that never in history has any economy been able to turn a penny or any other sum into a surplus large enough to pay creditors a solid sphere of gold reaching out to Saturns orbit. Marx accordingly poked fun at Prices calculations in his Grundrisse notebooks (1973:842f.) on the ground that no societys productive powers are able to support such compound rates of growth in interest claims. The good Price was simply dazzled by the enormous quantities resulting from geometrical progression of numbers. . . . he regards capital as a self-acting thing, without any regard to the conditions of reproduction of labour, as a mere self-increasing number, subject to the growth formula Surplus = Capital (1 + interest rate)n Economists estimate that during the two thousand years since the birth of Christ the European economy has grown at a compound annual rate of 0.2 percent, far less than the level at which interest rates have stood. No wonder Adam Smith found that no nation in history had paid off its public debt. As he observed in The Wealth of Nations (loc. cit.) Englands tax revenues had become a fund for paying, not the capital, but the interest only, of the money which had been borrowed . . . Sinking funds established ostensibly to pay off this debt were not effective, as governments invariably reborrowed the money. Smith concluded that the availability of such funds merely facilitates the contraction of new debts. It is a subsidiary fund always at hand to be mortgaged in aid of any other doubtful fund, upon which money is proposed to be raised in any exigency of the state. The contrast between geometric and arithmetic rates of growth has long been established in the popular mind not by reference to the interest rate at which savings and debts double and redouble, but by Thomas Robert Malthus with regard to the growth of population relative to the food supply. Malthus first published his theory in 1798, a generation after Price put forth his argument for a sinking fund. Picking up his fellow ministers mathematical imagery, Malthus asserted that population tended to grow geometrically at compound rates, but was held back by the fact that the means of subsistence could only grow at an arithmetic rate, that is, at simple interest. Malthus did not foresee that fertility rates historically have tapered off as incomes have risen. Over time, breakthroughs in agricultural and mining technology have increased productivity in these sectors even more rapidly than has occurred in manufacturing, so that food and other consumption goods have increased even more rapidly than has population. Although Malthuss demographic ideas have been disproved, the financial analysis drawn by Price remains apt. What indeed grow geometrically are the economys financial claims its bonded debt, mortgages and bank loans, whose interest charges have tended throughout history to accrue in excess of societys wealthcreating powers. It was inevitable that private individuals would attempt to make use of the compound interest principle by leaving savings to accumulate over a protracted span of time. In 1800 a Mr. Thelluson set up a trust that was to accumulate its income for a hundred years. At the expiration of that time the trust was to be divided among his descendants. His estate of 600,000 was estimated to yield 4500 per year (at 7 percent), producing a final value of 19,000,000, some thirty times the original legacy. As matters turned out, Thellusons will was contested in a litigation that lasted some 62 years, from his death in 1797 through 1859. By the time the lawyers were paid, the property was found to be so much encroached on by legal expenses that the actual sum inherited was not much beyond the amount originally bequeathed by the testator.[2] Meanwhile, under the leadership of William Pitt, the government calculated that at four per cent compound interest the trust would own the entire public debt by the time a century had elapsed. Some legislation known at the time as Thellusons Act was speedily passed, limiting such trusts to twenty-one years duration.

Orthodox academic models rarely acknowledge the problems posed by the exponential growth of debt overhead. Such models typically make government policies appear unnecessary to cope with this problem, by focusing on the kind of world that might exist if the financial overgrowth of savings and debts did not double every decade or so, having multiplied again and again over the past century. It thus has been left mainly to non-mainstream writers to address the structural problems created by an accumulation of interestbearing debt. The socialist Proudhon (What is Property, quoted in Flrscheim 1902:326), for instance, observed that If men, united in equality, gave to one of their number the exclusive right of property, and if this single proprietor placed with humanity a sum of 100 francs at compound interest, repayable to his successors of the twenty-fourth generation after the lapse of 600 years this sum of 100 francs would, if invested at 5 per cent., amount to the sum of 107,854,010,777,600 francs, a sum 2,696 times as large as the capital of France, estimated at 4,000 millions (50 years ago), or 20 times as large as the value of the whole globe with all movable and unmovable wealth. Marxs analysis of the financial dynamics of debt The most sophisticated analysis of financial capital in the 19th century was that of Marx. In Volume III of Capital (ch. xxx) and Vol. III of Theories of Surplus Value (both published posthumously) he referred to high finance as being based on imaginary or fictitious capital. It was fictitious because it consisted of claims on tangible wealth rather than constituting the direct means of production. These financial claims took the form of bonds, mortgages, bank loans and commercial paper. Marx (Capital, III.461) called these financial claims a void form of capital inasmuch as they represented a financial overhead whose interest charges ate into industrial profits. Such profits were earned actively by employing labor to produce goods and services for sale a process Marx summarized by the formula M-C-M, spending money to produce commodities that would sell for yet more money. But the growth of interest-bearing financial capital was characterized by the disembodied M-M, making money simply from money itself, i.e. in an essentially sterile way. Marx spelled out how financial capital tended to assert its domination over tangible capital above all in monetary crises and the foreclosures that followed in their wake. To illustrate how the inexorable force of such usury capital and its stipulated debt service tended to exceed debtors ability to pay, Marx (Capital, III: 463) cited Martin Luthers imagery likening it to the beast Cacus, and Dr. Prices calculations about the power of compound interest. The volume of financial claims grew willy-nilly as a result of this mathematical principle, inexorably surpassing the ability of the economys tangible productive powers to keep pace. Yet after analyzing finance capitals tendency to grow geometrically at compound interest, Marx abruptly dropped the subject. He believed that finance capital was becoming thoroughly subordinated to the dynamics of industrial capital. In the course of its evolution, industrial capital must therefore subjugate these forms and transform them into derived or special functions of itself, he speculated (1971:468). It encounters these older forms in the epoch of its formation and development. It encounters them as antecedents, but not as antecedents established by itself, not as forms of its own life-process. It was the destiny of industrial capitalism to mobilize finance capital to fund its own economic expansion. Where capitalist production has developed all its manifold forms and has become the dominant mode of production, Marx concluded, interest-bearing capital is dominated by industrial capital, and commercial capital becomes merely a form of industrial capital, derived from the circulation process. If this were true, the economys means of payment would be able to keep up with the exponential growth of interest-bearing debt claims. Alternatively, the overhang of financial capital savings and their counterpart debts would be wiped out by monetary crises. More than any other economist, Marx drew attention to this problem, but he nonetheless viewed finance capital as playing a subordinate role. He thus shared the 19thcentury optimism of the French utopian socialist Fourier and of the St. Simonians that industrial progress might solve the debt problem by mobilizing savings more productively than ever before had been the case. German historical economists such as Roscher pointed to the fact that interest rates tended to fall steadily with the progress of civilization; at least, rates had been falling since medieval times. Credit laws were

becoming more humanitarian, and debtors prisons were being phased out throughout Europe as more lenient bankruptcy laws were freeing debtors to start afresh with clean slates. Most important, European and North American public debts were on their way to being paid off during the relatively war-free century 1815-1914. Lending was mobilized to fund heavy transport, industry, mining and construction. For awhile, the economys debt burden seemed likely to become self-amortizing. The broad consensus was that the debt problem was curing itself by being co-opted into a more socially productive credit system. Modern observers can trace how these salutary trends gave way to the overgrowth of debt experienced in recent decades. The drives of finance capital have tended to overshadow those of industrial development. Indeed, finance capital was absorbing industrial capital even in the Victorian era as emperors of finance surpassed captains of industry. Flrscheims financial critique Marx and his socialist followers directed their invective mainly against industry and its profits, not financiers collecting interest. Henry George attracted many followers by focusing on the rentier income taken by landowners reaping rents that enriched them at societys expense, while their rent takings slowed economic progress. Georges major European follower, Michael Flrscheim, wrote one of the few books focusing primary attention on the problems caused by interest-bearing debt. It is true that the employer is the sponge which sucks up the profit, the greater value (Mehrwerth, as Marx calls it) of labors product, he wrote (A Clue to the Economic Labyrinth, 1902:116), but only to yield it to the rent and interest lords, as well as to the middlemen, who together press it out of him as quick as he gets it, barely leaving him on the average the hard earnings of his own work, and, what is worse, taking the power from him of increasing production to its full potentiality. He accordingly recommended that labor and capital combine to attack the real enemy, the rentiers. To do this in an informed way, finance capital had to be distinguished from physical capital. Pointing out (p. 347) that Tribute Claim Capital constitutes the Bulk of the Worlds Capital, Flrscheim explained that When an orator or writer has to reply to a socialists attack upon capital as the oppressor of labor, he points to what orthodox economy calls capital, and speaks of our wonderful progress due to our improved means of production and distribution, whereas his antagonist thinks of Government bonds, of land monopoly, of mining rights, of all kinds of tribute claims selling at Exchange for certain amounts, and not at all falling under the orthodox definition of capital, though representing that capital which people principally have in view when they use the term. But he was almost alone in focusing on this target. Flrscheim elaborated that All exertions, all improvements in the methods and tools of labor, the strictest economy, the severest self-denial, are all powerless to compete with the rapidity of self-increase possessed by capital placed at compound interest, and they cannot keep up with its demands. To illustrate this point he composed the following allegory to illustrate the dynamic at work. Many ages after man was driven from Paradise and told by the Lord to earn his bread by the sweat of his brow, mercy began to prevail. A loving angel was sent down by the Great Master, charged with the task of lightening the burden. The angels name was Spirit of Invention. He began his work by teaching man to make useful tools, to tame animals, mobilize water power, air and wind power, fire and steam power to drive machinery. It seemed that at last the golden era had come of which men had dreamed for ages past, without ever hoping to attain it. Without trouble, with almost no exertion, except that of wealth for the satisfaction of wants which, in former times, even the richest did not know or dream of. But that envious spirit, that fallen angel, Satan, who once before, in the shape of the serpent, had driven man from Paradise by seducing him to sin, was jealous and angry that his own empire would soon be over for ever. Among the follies of man, one little imp, called Interest, managed to attract Satans attention. What is the matter with you, Interest? he asked the saucy imp. You dont seem to be so dejected as your comrades are?

Why should I be dejected, master? replied the spirit, Am I not one of your favorite soldiers? Havent I always been victorious under your august guidance? But Satan answered sadly, Alas, You are no match for the Spirit of Invention. The imp, however, volunteered to demonstrate his prowess in a dual. You little imp! Fight the powerful angel who is defeating all my army? laughed Satan. Yes, I alone; provided, of course, you allow my son, Compound Interest, to help me. He explained with regard to the goblins of technology, that Instead of their being a source of blessing to mankind, I shall make them the producers of untold misery worse than ever man suffered from thy hands. So Satan let him have his way. The battle of giants began. In the beginning the angel laughed, for, though twenty squares were passed, no noticeable diminution of his forces was perceptible. Demon Interest said nothing, but attended to business, quietly doubling his army on every succeeding square. At the thirtieth square the angel ceased to laugh, and soon saw he was lost. I despised you, little fellow, he signed despairingly, and I am punished for my vanity. I see there is no use fighting against you. Demon Interest is more powerful than the Spirit of Invention. I am your slave. Command your servant! I am the only servant of my great master, dryly replied the demon. Here I see him coming. He will give you his orders. And Satan gave his orders. He commanded that the angel was to continue in his work with all his troops, which were to be increased with all possible exertion, so that humanity which did not know the nature of the antagonist it had to fight against would always keep in fresh hope of final success when the new troops were forthcoming. But as fast as they appeared, Demon Interest was to send forth a larger army to capture the new forces, to enslave them, and instead of their benefiting man make them increase the slave-chains which weigh him down. To the surprise of the king, this series of doublings produced an amount larger than the treasures of his whole kingdom could buy. It is this kind of chess-game which capital is continually playing with labor. The remarkable growth of compound interest would soon swallow products, capital, the earth and even the workers. Flrscheim concluded (1902:333f.) by asking, What is compound interest? Is it anything else than the fresh investment of earnings of capital? He added the story that Napoleon Bonaparte, when shown an interest table, said, after some reflection: The deadly facts herein lead me to wonder that this monster Interest has not devoured the whole human race. It would have done so long ago if bankruptcy and revolution had not been counter-poisons. This problem has a pedigree dating back some four thousand years. What is surprising is the clarity with which ancient economies dealt with it in a more straightforward way than is favored today. What the Babylonians recognized that modern economists dont At past Heilbronn symposia I have discussed the importance of tracing civilizations economic trends back to Sumer and Babylonia.[3] It was in this epoch, over two thousand years prior to classical antiquity, that the basic elements of modern economic relations first appear. These elements included interest-bearing debt and ways of coping with the problems caused by its spread. Mathematics played a major role in the training of scribes. This hardly is surprising, as cuneiform writings first application (c. 3200 BC) was to economic account keeping. Already in the 3rd millennium BC, scribes were trained in mathematical procedures such as manpower allocation problems (e.g., how many men were

needed to dig canals of a given size or to produce a given amount of bricks), the surveying techniques needed to calculate surface measurements (including the geometric analysis of squares and circular shapes), astronomical computations and even quadratic equations. Scribes also were trained to calculate the expected growth of herds and the exponential growth of interest-bearing investments.[4] Rather than reflecting economic productivity, profitability or the general ability to pay, the accrual of interest was essentially a mathematical phenomenon. For ease of computation, the normal commercial rate had been built into the system of sexagesimal weights and measures. Interest accrued at the rate of one shekel per mina per month, that is, the unit fraction, 1/60th. This rate remained constant over many centuries (indeed, millennia), and worked out to 12/60ths per year, 60/60ths in five years. Compounding occurred quinquennially, once the initial principal had reproduced itself in five years.[5] Interest rates in Greece, Rome and the Byzantine Empire likewise were based on ease of computation in their local systems of weights, measures and arithmetic.[6] The fact that these interest rates were not economically based or responsive to changing economic conditions made repayment problems inevitable. Debt problems also develop today, of course, but contemporary theory insists that economies can adjust to any given level of debt charges. The Babylonians made no such assumption. Their student exercises show that they recognized that herds, for instance, increased at a slower pace than did the growth of debts mounting up at 20 percent per year, to say nothing of agrarian rates typically around 33 1/3 percent. In light of these exercises I would like to make a suggestion that initially may seem outrageous. Mesopotamian economic thought c. 2000 BC rested on a more realistic mathematical foundation than does todays orthodoxy. At least the Babylonians appear to have recognized that over time the debt overhead became more and more intrusive as it tended to exceed the ability to pay, culminating in a concentration of property ownership in the hands of creditors. Scribal students (nearly all of whom were employed in temple and palace bookkeeping) were taught to calculate how rapidly investments doubled when lent out at interest. A model exercise appears in a Berlin cuneiform text (VAT 8528): How long does it take a mina of silver to double at the normal commercial rate of interest of 1/60th (that is, one shekel per mina) per month? (This often is expressed a 20 percent annual interest, inasmuch as 12/60ths = 1/5 = 20 percent.) The solution involves calculating powers of 2 (22 = 4, 23 = 8 and so forth).[7] The answer is five years at simple interest, as compounding began only once the principal sum had entirely reproduced itself after 60 months had passed. At this rate a mina multiplies fourfold in 10 years, eightfold in 15 years, sixteenfold in 20 years, and so forth. A related problem (VAT 8525) asks how long it will take for one mina to become 64, that is, 26. The answer is 30 years, six times the basic five-year doubling period (Illustration 1). The basic idea of interest-bearing debt is one of doubling times. An ancient Egyptian saying that If wealth is placed where it bears interest, it comes back to you redoubled.[8] Babylonian agricultural debts at the typical 33 1/3% rate doubled in three years. The Laws of Hammurapi appear to reflect the view that held that when creditors had received interest equal to their original principal after three years of service the debt should be deemed to be paid off and the debt bondservants freed. Babylonians recognized that while debts grew exponentially, the rest of the economy (what today is called the real economy) grows less rapidly. Todays economists have not come to terms with this problem with such clarity. Instead of a conceptual view that calls for a strong ruler or state to maintain equity and to restore economic balance when it is disturbed, todays general equilibrium models reflect the play of supply and demand in debt-free economies that do not tend to polarize or to generate other structural problems. Adam Smith grounded such ideology in a Deist religious view of the Lord as having started up the universe and then let it proceed harmoniously by its own laws of motion. But in Babylonia the earning capacity of subsistence rural producers hardly could be reconciled with creditor claims mounting up at the typical 33 1/3

percent rate of interest for agricultural loans (or even at the commercial 20 percent rate). Such charges were unsustainable for economies as a whole. At no time in history has agricultural output grown at sustained rates approaching these levels. In situations where the loan proceeds were used for basic consumption needs, interest charges ate into the cultivators modest resources and finally absorbed them in toto. Once the usury process got underway and debtors were called on to pay sums beyond their ability to produce, creditors were enabled to draw the land and other wealth into their own hands. Economic relations were put back in balance by Babylonian rulers acting from outside the economic system. They cancelled agrarian barley debts no less frequently than every thirty years, proclaiming clean slates on the occasion of their ascending to the throne, or as military or economic conditions dictated.[9] Modern economies would rely on income and price adjustments. But prices for most essentials, and most noncommercial incomes in Mesopotamia, were administered or set by custom. There was no idea that the economy by itself might automatically provide such balance. Todays economists have a problem analyzing the relationship between the debt overhead and the capacity to pay. Academic orthodoxy holds that economies can adjust to any volume of debt, given sufficient price and income flexibility to facilitate the transfer of revenue and assets to creditors. What is not recognized is that the resulting economic polarization reduces the economys ability to function well. In addition to missing this negative feedback (the proverbial vicious circle), modern economists tend to overlook the fact that interest-bearing debt grows according to its own exponential laws of increase. The economy rarely can keep up. If Sumerian and Babylonian students could learn the mathematics of compound interest and the associated exponential growth of debts, it should not be out of reach for modern economists to do so. But todays economic ideology does not encourage mathematical models based on intersecting financial and physical trends. For it is at such points of intersection that something has to give, that is, a political solution must be imposed from outside the system. The mathematics of wealth addiction and hubris Ancient economic thought did not endorse the ideal of accumulating wealth and riches. Rather than praising ambition as the mainspring of progress, Mesopotamian religion condemned the amassing of property. Excess was held to be the primary cause of injustice, and it was characteristic above all of creditors abusing the weak and poor and foreclosing on their lands. It was to avenge the economic injustice done by the rich and strong against the weak that the Sumerian goddess Nanshe moved, as would the Greek goddess Nemesis in classical antiquity. Nearly every ancient society recognized that physical consumption might bring satiety, but that financial riches and property did not. The biblical prophets described how the selfish principle of insatiability led to hubris, a form of wealth addiction whose exponential upsweep in greed was akin to the growth of money at compound interest. When Isaiah declaimed Woe to you who add house to house and join field to field till no space is left and you live alone in the land, he was condemning not only the greed of creditors but the inexorability of interest-bearing debt that gave them the power to amass property at the expense of the society around them. The Greek reaction against the insatiable desire for property found its counterpart in the Delphi Oracles motto, Nothing in excess, and in the political poetry of Solon (frag. 13.71-73): No manifest limit of ploutos wealth exists for men; whoever of us has now the greatest substance for life, they are eager for twice that. Who will satiate everyone? Hesiods Theogony (596) bore the same message: there is satiety of everything except ploutos, for (1157-58) you cannot satiate your spirit with ploutos.[10] Addictive egoism was epitomized by the table manners of drinking wine at symposia. Eating and drinking represented a daily social exercise in equity and moderation or immoderation, as the case might be. Economically, wealth addiction was epitomized by the drives of creditors to amass more and more wealth

without limit. Such uncontrolled appetites were held to reflect a lack of proper philosophical training, a less civilized mode of behavior. The worlds major religions are replete with this attitude.[11] Proverbs 30:8 asks Give me neither poverty nor riches. The Confucian (Analects XI, 15) advise that Excess and deprivation are equally at fault, each causing problems. The Tao Te Ching announces that He who knows that he has enough is rich. The Hindu (Bhagavad-Gita II, 71) teaches that That person who lives completely free from desires, without longing . . . attains peace. And Buddhisms Dharmapada 336 advises that Whoever in this world overcomes his selfish cravings, his sorrows fall away from him like drops of water from a lotus flower. The hubristic spirit of evil was that of insatiability, a wealth addiction that led its prey to victimize the rest of society what Martin Luther depicted the drive for usury as the all-consuming monster, Cacus. Todays world seems to be embracing this spirit, viewing moderation as uneconomic behavior. In its place is being put a self-referential economics of moral obesity. Ivan Boesky is reported to have announced in 1986 to a seminar convened at Stanford University that There is nothing wrong with greed. If the fictional corporate raider Gordon Gekko elaborated this passage more overtly in the 1987 movie Wall Street Greed is good it was a theme that ancient Greek poets and dramatists dealt with as hubris, the drunken arrogance of wealth and power. The very word greed was coined to describe something sinful. It was a word of condemnation, not praise of the sort found in such recent texts as C. B. McConnells Economics (1984:16): The principal task of the economy is to attain the maximum fulfillment of societys unlimited material wants. Utilitarianism since Jeremy Bentham and Stanley Jevons has deemed satiety to be the guiding principle of human psychology. Schoolbook economic models assume that each added unit of consumption goods yields less and less pleasure (utility). This theory of diminishing marginal utility holds that people tend to reduce their economic drives as they grow richer. Instead of wanting to consume more and more, they save more of their income or simply choose leisure. Left out of account is the insatiable drive on which ancient societies placed such great emphasis the drive to accumulate property, most typically through the dynamics of usury. Modern utilitarian theory views wealth is ultimately as something to be consumed, much like food or clothing an amassing of the means of consumption rather than as the means of production or, ultimately, a social power relationship. A repertory of mathematical economic functions, real and imaginary Four types of mathematical curves describe how economies grow and, sometimes, collapse (Illustration 2). Straight-line growth (y = bx) represents constant returns to scale, as in Mesopotamian exercises in calculating the amount of labor needed to perform everyday tasks, including the cultivation of land. It is short-term and microeconomic in that it relates to an economic context in which factor proportions and productivity remain unchanged. An exponential curve (y = erx) describes growth with time x of a sum starting with a value of 1 at compound interest r. When plotted on log paper, this growth appears as a straight line. When the growth due to compound interest is modeled by y = erx, this describes the growth when accrued interest is added continually to the loan. But the typical way of compounding interest is to add accrued interest after a fixed interval, for example a year, as already discussed. Then the growth equation changes to y = (1+r)x. This is also exponential growth, just as dramatic as in the continuous case. In this case with discrete and equal time intervals, exponential growth is also called geometric growth. Rates of growth are often expressed in terms of doubling times. The doubling time is ln2 / ln(1+r). Here ln is the natural logarithm. An S-curve describes most biological growth. It is characterized by an accelerating upswing that tapers off as it reaches an asymptotic limit. Economies tend to grow exponentially as they recover, as long as underutilized capital or land is available to employ labor. The typical business cycle, for instance, tapers off as capacity and debt-servicing limits are reached. Business upswings are brought to an end suddenly, by

financial tightness caused by over-borrowing, that is, over-indebtedness. Defaults occur, and a crash follows. The ensuing business downturn occurs much more quickly than the upswing. The characteristic shape of most business cycles is thus scalloped and ratchet-like. An upsweeping log curve encounters financial constraints and collapses rapidly. Actually, this shape represents a combination of two curves intersecting. The upswing (y = a + bx + cx2) is intersected by the exponential growth in debt (y = x2). Something has to give at the point of intersection. A financial collapse ensues, often with political overtones and institutional changes. Most economists seek to explain the economy in terms of a single curve. Joseph Schumpeter used a smooth sine curve (y = sine x) as an analogy to describe the business cycle. This is especially attractive to theorists who postulate automatic stabilizers, such as Wesley Clair Mitchell and the program of leading and lagging indicators he pioneered in America at the National Bureau of Economic Research. Yet this does not acknowledge the extent to which the worlds financial overhead has multiplied over the past century. How compound interest shapes business behavior The next millennium is likely to see the Thelluson principle operate on an economy-wide scale. Saving will take the form largely of creditors earning interest, which will be plowed back increasingly into new lending rather than new tangible capital formation. This will increase the economys debt overhead rather than its capacity to carry its debts. Nearly all sectors are now seeking to use the principle of compound interest for their own gain at the expense of the rest of society. It has become normal for insurance companies, for instance, to stall in paying the claims of their customers, so that they can continue to invest their money (while charging off their taxable income by placing it in a reserve fund as if they actually paid the money out). By the time five years or so have elapsed, the money built up in the companies reserve funds is able to cover nearly the entire sum due their policy holders. Real estate speculators benefit by not having to pay taxes on their land as it appreciates in price, but only at the point of sale when their capital gains are taken (Gaffney 19:19): The basic preference for land gains is tax deferral. Land gains are not recognized and taxed as income when they accrue, but only later upon sale for cash. A puts $1 in a savings account paying 7.2% compounded annually. (That is the rate at which money doubles every 10 years.) He gets 3.6% after taxes [assuming a 50 percent tax rate], and plows it back, at which rate it takes twice as long, 20 years, for money to double. After 60 years his wealth has grown to $8. B puts his $1 into land whose value rises at 7.2% per year. After 60 years its value has doubled 6 times to $64. He sells it and pays taxes of 50% on the gain of $63. He thus clears $32.50 after taxes. Bs wealth has grown to over 4 times As wealth, although both made the same rate of return, and both paid taxes at the same rate. The difference is timing. To tax capital gains as they accrue thus would produce a very different result from taxing these gains only at the point they pass through the market. In view of these practical applications, why has mainstream economics dropped this understanding, so important in earlier epochs and still of central importance? The hypothetical parallel universe approach to economics Marx (Capital, I:14) defined political economys task as being to lay bare the economic laws of motion of modern society. By contrast, equilibrium theory describes how market relations might settle at a stable resting point if only the world were something other than it is. A world is envisioned that is characterized by

automatic self-adjusting mechanisms, so that active government policies appear unnecessary to ensure economic balance. It is a world free of the financial dynamics of debt growing at compound rates of interest. One must suspect a political reason for the aversion felt by economic model-builders to these financial dynamics. To acknowledge their tendency to create structural problems would imply just what it did in Sumerian and Babylonian times: the restoration of economic balance by public fiat, that is, from outside the economic system. Neglect of the debt overhead therefore is a prerequisite for economic models to generate laissez faire conclusions. A what if universe is postulated the kind of world that might exist if finance capital were not a problem. After all, what is not perceived or quantified is less likely to be regulated. Economies are supposed to be able to pay their debts simply by saving more. The working assumption is that sufficient saving and investment will to enable any societys growth in debt to proceed ad infinitum. Monetarist theory in particular assumes that creditors will invest their earnings to further expand output and raise living standards. This logic treats investment in an ambiguous way. Any increase in saving is deemed to be good, regardless of whether it is invested productively or parasitically, physically or financially. Yet such saving in reality consists not only of direct investment in tangible capital formation. It also takes the form of stock market investment and real estate speculation in the ownership of assets already in existence, merely bidding up their price. What is neglected especially is todays most characteristic pattern of lending: the investment of savings to extract interest charges that are recycled into new loans rather than financing new means of production to help economies grow their way out of debt. Such a pattern of recycling savings serves to enlarge the volume of financial claims attached to existing productive assets. These financial claims on wealth bonds, mortgages and bank loans are lent out to become somebody elses debts in an exponentially expanding process. In recent decades such claims have grown more rapidly than tangible investment in factories and farms, buildings and homes, transport and power facilities, communications and other infrastructure. For the past two decades, economies have been obliged to pay their debts by cutting back new research, development and new physical reinvestment. This is the essence of IMF austerity plans, in which the currency is stabilized by further international borrowing on terms that destabilize the economy at large. Such cutbacks in long-term investment also are the product of corporate raids financed by high-interest junk bonds. The debts created by businesses, consumers and national economies cutting back their long-term direct investment leaves these entities even less able to carry their mounting debt burden. They are forced to live even more in the short run. Interest rates rise as debt-strapped economies become riskier, for as Adam Smith observed, interest rates usually are highest in countries going fastest to ruin. And as interest rates rise, yet more money is shifted away from direct investment into lending at interest, until the system is torn apart from within. Capital flees abroad, the currency falls and unemployment rises. No doubt a point must come at which the burden shakes the public out of its hope that matters somehow will return to normal. In the end the global economy must be obliged to do what Adam Smith said every debtor economy historically has been obliged to do: let its debts go. (Now that global debts are becoming dollarized, it is less possible for a national economy simply to inflate its way out of debt and make Smiths less costly pretended payment.) But it has become academic fashion to imagine alternative virtual realities in which no such debt problems exist. The effect is to turn economics into something akin to science fiction. The literary critic Colin Wilson has observed that in evaluating such fiction, the proper question to be asked is, what if the world were really like this? What does such speculation teach us? Let us ask this question of todays monetarist economic fantasies. Fearing governments to be corrosive, monetarism warns that they should not act to shape the economic environment. In particular they should not seek to steer or otherwise regulate financial markets, for that will kill the proverbial goose that lays the

golden eggs. Society has no reason to be disturbed by interest-bearing debt accruing more rapidly than the means to pay. But is this really Planet Earth? Or is it a hypothetical world in which the charging of interest either was never invented, or was banned by Judeo-Christian-Islamic-Communist anti-usury laws winning rather than losing out? Such theorizing may be useful as an amusing exercise in alternative history, that is, history as it might have evolved in some other way in some parallel universe. But the monetarist mathematics are not those of earthly reality. As in science fiction, the main criterion for success in modern economics is its ability to maintain internal consistency in the assumptions being made. The trick is to convince readers to suspend their disbelief in these assumptions. The audience is asked to take seriously problems posed in terms of a universe in which money is not lent out at interest or spent on stocks, bonds, real estate and other financial claims on wealth, but is spent only on the production of current goods and services. The student is asked to believe that debts will not tend to grow beyond the means to pay, and that any disturbance in the economic balance will be met by automatic stabilizing responses rather than requiring action from outside the market economy. According to equilibrium theory, the growth in debt overhead in recent decades should not have developed into a serious problem. All that is necessary is for us to suspend our natural disbelief in the fiction that shifting the money supply can steer interest rates to a particular level that will keep the economy in balance. In sum, rather than tracing the incompatibility between the growth in debt claims and the economys ability to pay, most economists have simply ignored the problem. Not being amenable to the usual mathematical solution, the problem itself is deemed unscientific, rather than theory being rejected as such. Economics vs. the Natural Sciences: The airy methodology of as if What is even more remarkable is the idea that economic assumptions need not have any relationship to reality at all. This attitude is largely responsible for having turned economics into a mock-science, and explains its rather odd use of mathematics. Typical of the modern attitude is the textbook Microeconomics (1964:5) by William Vickery, long-time chairman of Columbia Universitys economics department, 199293 chairman of the American Economic Association and winner of the 1997 Nobel Economics Prize. Prof. Vickery informs his students that pure theory need be nothing more than a string of tautologies: Economic theory proper, indeed, is nothing more than a system of logical relations between certain sets of assumptions and the conclusions derived from them. The propositions of economic theory are derived by logical reasoning from these assumptions in exactly the same way as the theorems of geometry are derived from the axioms upon which the system is built. The validity of a theory proper does not depend on the correspondence or lack of it between the assumptions of the theory or its conclusions and observations in the real world. A theory as an internally consistent system is valid if the conclusions follow logically from its premises, and the fact that neither the premises nor the conclusions correspond to reality may show that the theory is not very useful, but does not invalidate it. In any pure theory, all propositions are essentially tautological, in the sense that the results are implicit in the assumptions made. [Italics added.] This disdain for empirical validity differs from the method found in the physical sciences. Why strive to be logically consistent if ones working hypotheses and axioms are misleading in the first place? Ptolemaic astronomers were able to mathematize models of a solar system revolving around the earth rather than the sun. The phlogiston theory of combustion was logical and even internally consistent, as is astrology, former queen of the medieval sciences. But these theories no longer are taught, because they are seen to have been built on erroneous assumptions. The sophistical tendency can be traced back to John Stuart Mills 1844 essay On the Definition of Political Economy; and on the Method of Investigation Proper to it:

In the definition which we have attempted to frame of the science of Political Economy, we have characterized it as essentially an abstract science, and its method as the method a priori. . . . Political Economy, therefore, reasons from assumed premises from premises which might be totally without foundation in fact, and which are not pretended to be universally in accordance with it. The conclusions of Political Economy, consequently, like those of geometry, are only true, as the common phrase is, in the abstract; that is, they are only true under certain suppositions, in which none but general causes causes common to the whole class of cases under consideration are taken into account. But lacking empirical testing and measurement, economics narrows into a mock-science of abstract assumptions without much regard as to whether its axioms are historically grounded. The self-congratulatory language used by economists euphemizes the resulting contrast between economics and science. Pure theorists are depicted as drawing heroic generalities, that is, banal simplicities presented in a mathematical mode called elegant rather than simply air-headed. To the extent that the discipline uses mathematics, the spirit is closer to numerology than to the natural sciences. The problems inherent in this approach are typified by Nobel Prizewinner Paul Samuelsons article on The Gains from Trade (1939:205): In pointing out the consequences of a set of abstract assumptions, one need not be committed unduly as to the relation between reality and these assumptions. This statement did not deter him from drawing policy conclusions affecting the material world in which real people live. For instance, he wrote concerning his Factor-Price Equalization Theorem (which claims that under a regime of free trade, wages and profits will tend to equalize throughout the global economy): Our problem is . . . a purely logical one. Is If H, then inevitably C a correct statement? The issue is not whether C (factor-price equalization) will actually hold; nor even whether H (the hypothesis) is a valid empirical generalization. It is whether C can fail to be true when H is assumed to be true. Being a logical question, it admits of only one answer, either the theorem is true or false (reprinted in Caves and Johnson 1968:59). Contrasting this theorem with the real-world tendency of international incomes and wages to polarize rather than equalize, Gerald Meier (1968:227) observes that It need not . . . come with any surprise that factor returns have been so different . . . when in short, the restrictive conditions of the theorem have been so clearly violated in reality. But is it not sophistical to speak of reality violating a theory? Theory violates reality, not the other way around. If one must be logical, why not start with realistic rather than merely hypothetical assumptions? The answer, I am afraid, is that realistic assumptions do not lead to the policy conclusions pre-selected by economic ideologues. This explains why Samuelson-type trade theories continue to treat the international economy as a thermodynamic system to be analyzed by entropy theory, whereas the real-life world economy is an expanding system, in which labor migrates and capital flows from low-income cold economies to highincome hot ones. Wrong-headedness rarely is accidental; there usually is a self-interested policy motive. In his essay on How Scientific are the Social Sciences, the Swedish economist Gunnar Myrdal (1956:336) observes that Facts do not organize themselves into systematic knowledge, except from a point of view. This point of view amounts to a theory. He emphasizes that contrary to widely held opinions, not only the practical conclusions from a scientific analysis, but this analysis itself depends necessarily on value premises. We therefore are entitled to ask whose interests are served when economists claim that their assumptions need have no connection with reality, yet then proceed to give policy recommendations. Why have they settled on the particular assumptions of, say, the Heckscher-Ohlin-Samuelson theory of international equilibrium rather than starting from more realistic assumptions capable of explaining the real worlds financial and economic polarization between debtor and creditor nations? The products of poor-labor countries exchange for those of better-paid labor not only because of productivity differences, but because the currencies of poor-labor countries depreciate as a result of the

capital transfers they make in a vain attempt to service their foreign debts. In the end these debts will prove unrepayable, and must face default, as they mount up at interest beyond the economic means to pay. But in an attempt to conceal this mathematical inevitability, creditor-oriented model builders in the IMF and other such institutions design austerity programs which deprive debtor economies of capital, educational programs and other basic infrastructure. Such programs make it even harder for poor countries to catch up. And matters are further aggravated by attempts are made to encourage such countries to stave off their mathematical fate by undertaking privatization programs, that is, a voluntary and self-imposed forfeitures of national assets to foreign and domestic creditors. Creating a statistical picture of this phenomenon is impaired by the fact that wealthy domestic families operate out of offshore banking centers nominally as foreigners in their own countries. Another statistical black hole consists of land statistics and other asset values. The blame rests mainly on economists themselves, for constructing models in which foreign debt, offshore banking centers, land values, and the composition of savings and debt do not seem to be necessary at all. Even the existing statistics suffice to show that just as poor countries have become dependent on richer ones, so domestic economies polarize as debtors (including the government itself) become increasingly dependent on creditors. Such phenomena nowhere appear in the polite world of orthodox economic model building in the service of this untenable status quo. In these fairy tales everyone ends up in a more or less equitable equilibrium. To date, mathematics has been used in a way that does not admit a discussion of institutional and structural transformation. This is not the fault of economics as such. What needs to be done is to project the point at which trends intersect, that is, the point at which something must give. At these crises the solution is not inherently economic, but political. Of course, it is axiomatic that wealth tends to be turned into political power, forcing solutions to crises that increasingly favor vested interests as the economy polarizes. But the analysis of such phenomena is dismissed by general equilibrium theorizing that assumes a constant and unchanging political environment, on the logic that changes in laws are exogenous to the subject matter of economics proper. The word exogenous is heard so often these days that one wonders just what is left to be relevant in economics proper. Another way in which mathematics has been abused by the economics profession is in the failure to pinpoint what has become a universal economic problem: the impossibility of the worlds financial savings continuing to grow at compound interest ad infinitum. A striking analogy of the inherent mathematical problem was pointed out recently by Edward O. Wilson, in Consilience (New York: 1998:313), citing the arithmetical riddle of the lily pond. A lily pod is placed in a pond. Each day thereafter the pod and then all its descendants double. On the thirtieth day the pond is covered completely by lily pods, which can grow no more. He then asks, On which day was the pond half full and half empty? The twenty-ninth day. This provides a helpful answer to financial optimists who insist that there are two sides to every question, and that what one person sees as a glass half empty, another will realize is a glass half full. Growth the economys savings is, simultaneously, growth its debt overhead, except as such saving is recycled into equity ownership and tangible direct investment. By the time people feel obliged to argue over whether the economic glass if half empty or half full, we probably are on the brink of the Last Days. Are some debts productive? Certainly they are. Ancient societies drew the distinction (which was made down through the classical economists) between productive and unproductive credit, that is, between commercial loans which provided the business borrower with the resources to earn the money to repay his debt with interest; and consumer or government loans on which the interest had to be paid out of the debtors remaining resources. The Bronze Age core economies coped with the debt problem simply by canceling societys unproductive debts when they grew too large. However, the Sumerians and Babylonians only annulled consumer barley-debts; they left commercial silver-debts intact. (This implicit distinction between productive and unproductive debt represents a third way in which Babylonian economics may be

deemed more sophisticated than modern economics (in addition to the afore-mentioned focus on the destabilizing role of debts multiplying at compound interest, and the phenomenon of wealth addiction.) But the modern failure to distinguish between productive and unproductive credit shows the adverse effects of building internally consistent logical models on the basis of unreal or irrelevant economic assumptions. At issue is not the individualistic economics of Robinson Crusoe on his desert island, but the long dynamics of social history. The economic historian is struck by the great wealth that has been accumulated again and again by the richest families throughout history. But as this wealth has grown, the harder it has been to keep it viable. This is because purely financial wealth (that is, financial claims on resources that find no counterpart in a corresponding growth in tangible investment and the means to pay) tends to be invested in ways that impoverish the surrounding society. This blocks the circular flow that is necessary for a viable economy. For this reason, the great monied fortunes tend to be lost. They tend to be plowed back into yet new loans, which become especially riskier. At a point the government itself becomes the debtor of last resort (as in modern financial bailouts), and we are brought back to Adam Smiths maxim that no government has ever repaid its debts. The great 12th-century accumulation of wealth of the Templars was seized by Philip the Fair, who dissipated it in warfare. The wealth of the great Italian banking families was lost in loans to Britains kings, who dissipated the proceeds in waging the Anglo-French wars. Most early debts were wiped out by wars, and increasingly by their inflationary aftermath. Others financial fortunes were lost through bad judgment such as risky foreign investments. Some fortunes were dissipated by ones heirs. The relevant point for the social analyst is that financial fortunes cannot continue to accumulate in the aggregate, precisely because of the inexorable mathematics of compound interest. So obviously, there are different kinds of mathematical economics. What the Cornell philosopher E. A. Burtt referred to the metaphysical foundation of modern physical science has become a politically tinged metaphysics in the hands of monetarists and neoclassical economists. Just how far their non-quantitative mathematical spirit diverges from the origins of economics is reflected in the closing words of David Humes Enquiry Concerning Human Understanding: When we run over libraries, persuaded of these principles, what havoc must we make? If we take in our hand any volume; of divinity or school metaphysics, for instance, let us ask, Does it contain any abstract reasoning concerning quantity or number? No. Does it contain any experimental reasoning concerning matter of fact and existence? No. Commit it then to the flames: for it can contain nothing but sophistry and illusion. It is impossible to keep aggrandizing wealth at compound interest. [1] I discuss this problem in Trade, Development and Foreign Debt: A History of Theories of Convergence and Polarization in the World Economy (London: Pluto Press, 2 vols., 1993). [2] Palgraves Dictionary of Political Economy, citing the Annual Register (1797) and Chamberss Encyclopaedia (vols. 8 and 10). Geoffrey Gardiner (Towards True Monetarism, London 1993:135) observes that in the late 1970s, the burgeoning oil revenues of the producers were further gilded by the addition of high interest earnings. At their highest British interest rates had the effect of doubling the cash deposits of the oil-producers in only five years, or 16.3 times in twenty years! . . . The wisdom of an earlier age, which had led to the passing of Thellusons Act to discourage the establishment of funds which compounded interest indefinitely, had been forgotten. [3] Roschers Victorian Views on Financial Development, Journal of Economic Studies 22 (Spring 1995), and Karl Bchers Role in the Evolution of Economic Anthropology, in press. [4] Karen Rhea Nemet-Nejat, Cuneiform Mathematical Texts as a Reflection of Everyday Life in Mesopotamia (New Haven 1993 = AOS Series Vol. 75) provides a bibliography. For the growth of herds, see Ignace Gelb, Growth of a Herd of Cattle, Journal of Cuneiform Studies 21 (1967).

[5] The Babylonians were well aware of the phenomenon of compound interest, but did not apply it in practice. Assyrian long-distance trade investments typically ran for five years (Larsen 1976), the time it took for the investment to double at the rate of 1/60th per month. The money typically was re-invested in a new contract. From the Old Babylonian period (2000-1600 BC) to the neo-Babylonian epoch (c. 600-333 BC), no compound interest is found in agricultural or commercial practice. When loans were not paid off, interest was calculated and a new loan document was drawn up. [6] I explain the details briefly in Why did interest rates in the ancient world consistently decline over the millennia, Archaeological Odyssey, July 1999. A more thorough discussion will appear in JESHO early in 2000. [7] Hildagard Lewy, Marginal Notes on a Recent Volume of Babylonian Mathematical Texts, JAOS 67 (1947):308 and Nemet-Nejat, op. cit.: 59f. [8] Miriam Lichtheim (Ancient Egyptian Literature, II:135). [9] My forthcoming Bronze Age Finance reviews this practice, as does the forthcoming ISLET colloquium on Debt in the Ancient Near East, ed. Michael Hudson and Marc Van Der Mieroop (Harvard: Peabody Museum Press). For the time being see my article Proclaim Liberty Throughout the Land, Bible Review 15 (Feb. 1999). [10] Thomas J. Figuera, KHREMATA: Acquisition and Possession in Archaic Greece, in K. D. Irani and Morris Silver, eds., Social Justice in the Ancient World (Westport, Conn.: Greenwood Press, 1995):41-60. [11] Alan Durning, Asking How Much is Enough, in Linda Starke, ed., State of the World 1991 (New York: 1991):166. Humanist Economics: From Homo economicus to Homo sapiens, (1995), collects relevant quotations from modern economics textbooks. _______________________________________________________________________________________

The Mathematical Economics of Compound Rates of Interest: A Four-Thousand Year Overview Part II
April 24, 2001 By Michael Hudson 2. Why Economies Develop Debt Crises: The Mathematics of Compound Interest The past centurys economic schoolbooks have described a universe running down from entropy. Production is assumed to be plagued by diminishing returns, so that each additional unit of input produces less and less output. Even if technology were recognized to raise the productivity of labor, capital and land over time, neoclassical models hold that each additional unit of consumption or wealth yields diminishing psychological utility.[1] Not only will economies grow less rapidly, they will feel poorer. Large parts of the population in many countries are indeed becoming poorer and forced into debt, but the pessimistic assumptions cited above make no reference to debt. Their seeming independence from finance and from social policies to deal with debt problems and wealth distribution is supposed to make economics scientific. And if the subject is to be a science, of course, it must adopt the scientific hallmark, mathematics. Unfortunately, the only way for economic models to produce a mathematically solvable equilibrium is to use physical production functions that slow down and psychological wealth-seeking utility functions that dissipate rather than become addictive. Economic technocrats thus are taught to use mathematics in a wrongheaded way at the outset, while ignoring the exponential mathematics of debt and the asset-price inflation it feeds.

This blind spot of learned ignorance has created economic devastation from Russia and Japan to third world debtor countries. Todays academic curriculum teaches models that fail to recognize how the economys debt overhead mounts up to produce financial shocks. Also ignored is the degree to which wageearners and industrial investors find a rising share of their incomes diverted to pay debt service. The way to get rich today is not by earning wages and profits, but to benefit passively from the inflation of real estate and other asset prices as interest is credited and other new savings are recycled into mortgage and stock market loans. But even if economic theory recognized these dynamics, the national income and product accounts (NIPA) do not include capital gains, so there is no clear basis for giving a quantitative sense of proportion to the financial, insurance and real estate (FIRE) sector vis--vis the rest of the economy. The neglect of debt is curious, for the subject was placed at the center of economic and indeed, religious policy for most of civilizations past four thousand years. The mercantile debts and rural usury of Bronze Age Babylonia and classical Greece and Rome saw the accrual of interest double and redouble the sums due, leading to expropriation of indebted families and forcing them into bondage. From feudal Europes papal bankers to the emergence of large-scale Dutch, English and French finance capital, the expansion path of public as well as private debts has soared off the charts toward infinity. Money is saved and reinvested to grow without end, regardless of the economys ability to pay. Yet the mathematics describing the growth of interest-bearing debt on an economy-wide basis are missing from todays macroeconomic policy models. What the Babylonians recognized that modern economists dont Mathematics played a major role in training the scribes of Sumer and Babylonia. Most of them were employed in palace and temple bookkeeping, so their schoolbook exercises included manpower allocation problems such as calculations of how many men were needed to produce a given amount of bricks or dig canals of a given size, the expected growth of herds and the doubling times of investments lent out at interest.[2] Surprising as it may seem to modern readers, this mathematical training four thousand years ago was more relevant for dealing with societys debt overhead than is that given to economics graduates today, for it dealt with exponential functions (as well as astronomical computations and even quadratic equations). When U.S. bank lending rates peaked at 20 percent in 1980, they reached what had been the normal commercial interest rate from Sumer c. 2500 BC through the Neo-Babylonian epoch in the first millennium. In fact, when Alexander the Great conquered the Near East in 331 BC, the rate had remained remarkably stable at the equivalent of 20 percent for more than two thousand years. It had not been set with any particular reference to profit levels or the ability to pay, but was a matter of mathematical convenience, reflecting the Mesopotamian way of computing fractions by division into 60ths. A bushel of barley was divided into 60 quarts, and a mina-weight was composed of 60 shekels. Paying interest at the rate of 1/60th each month added up to 12/60ths per year, or 20 percent in modern decimal notation. A mina lent out at this rate would produce 60 shekels in five years, doubling the original principal. A model Babylonian scribal exercise from around 2000 BC appears in the Berlin cuneiform text (VAT 8528). It asks the student to calculate how long it will take for a mina of silver to double at the normal rate of one shekel per mina per month. The answer is five years at simple interest. And in fact, the common practice was to lend long-distance traders money for this five-year period. Assyrian trade contracts c. 1900 BC, for instance, typically called for investors to advance 2 minas of gold, getting back 4 in five years. Elsewhere in Mesopotamia commercial contracts normally were denominated in silver, but the interest rate was the same. This idea that doubling times were determined by the rate of interest was well enough understood to be given a popular imagery. If wealth is placed where it bears interest, it comes back to you redoubled,[3] an Egyptian proverb observes. Another compares making a loan to having a baby, viewing the reproduction of numbers in sexual terms. The word for interest in every ancient language meant a newborn, either a goatkind (mash) in Sumerian and the Akkadian language used by the Babylonians, or a young calf tokos in Greek or foenus in Latin. The kid or calf was born of silver or gold, not by borrowed cattle as some economists once believed, missing the metaphor at work. What was born was the baby fraction of the principal, 1/60th. And only when these accruals of interest had grown to be as large as their parent, after the

fifth year, were they deemed adult enough begin having new interest babies on their own, for everyone knows that only adults can reproduce themselves. Thus, compounding began only after the principal had reproduced itself by the time 60 months had passed. Investors who wanted to keep their loans growing had to draw up new loan contracts. How long could the process go on at these rates? A relevant scribal problem (VAT 8525) asks how long it will take for one mina to become 64, that is, 26. The solution involves calculating powers of 2 (22 = 4, 23 = 8 and so forth).[4] A mina multiplies fourfold in 10 years, eightfold in 15 years, sixteenfold in 20 years, and 64 times in 30 years, that is, six times the basic five-year doubling period, expressed in modern notation as 26. Traders and merchants were able to pay such rates out of their business gains, but serious problems occurred in the agricultural sphere, especially when crops failed or military hostilities interrupted the harvest. Matters were aggravated by the fact that interest rates were higher and more extortionate in the rural sector. The most typical rate was 33 1/3 percent, evidently reflecting the normal sharecropping rate of a third of the crop. Rates of 50 or even 100 percent might be charged, often for only short periods of time. Creditors (mainly palace collectors or other officials) demanded whatever they could get when they found cultivators in distress conditions. Sharecroppers or other individuals who were unable to break even or pay their stipulated rents or fees to the palace were forced to borrow out of need found that once they ran into debt, it was difficult to extricate themselves. The problem was that rural loans were made to pay taxes or get by hard times, not to acquire property or finance investment. Thus, instead of financing the acquisition of property, rural usury led to its forfeiture. At the interest rate of 33 1/3 percent, Babylonian agricultural debts doubled in three years. Probably reflecting this fact, 117 of Hammurapis laws (c. 1750 BC) stipulates that after three years of service, by which time the creditor had received interest equal to the original debt, it should be deemed to have been paid and the bondservant liberated to rejoin the debtors family. The implication is that doubling the debt principal represented a moral and indeed, practical limit, largely because it was recognized how quickly debts grew to exceed the rural economys ability to pay. Indeed, at no time in history has output grown at sustained rates approaching the typical 33 1/3 percent rate of interest charged for agricultural loans, or even the commercial 20 percent rate. When the loan proceeds were used for consumption or to pay tax arrears, interest charges ate into the needy cultivators modest resources, obliging him to pay sums growing exponentially beyond his ability to produce. Under these conditions, creditors were enabled to draw into their own hands the debtors family members as bondservants, followed by the land and other assets. This threatened to polarize society self-destructively by expropriating the citizen-army that traditionally supported itself on the land. The charging of interest is found in classical Greece some time around 750 BC, probably being introduced by Syrian (Phoenician) traders. (Hudson 1992 provides a scenario for how this occurred.) Following Egyptian mathematical practice, Greek interest rates were decimalized at 10 percent, half the Mesopotamian rate. This made the doubling time for loans ten years. But despite this fact, along with sharecropping rates and related crop payments being set at a lower proportion of the yield than in Mesopotamias richer lands, this did not save cultivators from running into such serious problems that rural debt revolts occurred. Spartas Lycurgan reforms went so far as to ban the use of precious metals as money, and made the land inalienable and hence safe from forfeiture for debt arrears. By the 7th century BC the oligarchies in Corinth and other Greek cities were overthrown and driven into exile by popular leaders (tyrants) who cancelled the debts of their rural supporters and redistributed the lands of the exiled families. One of the last cities to experience a debtors revolt was Athens, where Solon laid the foundations for economic democracy by banning debt bondage in 594 BC. But subsequent Greek regimes drew the line, often obliging civic administrators to pledge not to cancel the populations debts. By the third century BC even Spartas formerly egalitarian economy was polarizing between landowners and families who had lost their property through debt foreclosure. Toward the end of the century Spartas kings Agis and Cleomenes tried to save matters by cancelling the populations debts, but they were exiled and Cleomenes was murdered. Spartas final reformer, Nabis, was overthrown by local oligarchies with the aid of Rome.

The Romans and other Italians seem to have adopted the practice of charging debt around 750 BC from Greek and Near Eastern traders, but used the duodecimal system of fractions based on dozens, probably reflecting the division of the year into twelve months. The pound was divided into twelve troy ounces, and the legal rate of interest was set at 1/12th (8 1/3 percent). This was the lowest major regional rate in antiquity, but it also proved often to be beyond the ability of cultivators to pay, especially in times of war when they were called away from their land to fight. (For a while the rate was cut in half, but in due course reverted to 1/12th.) The decline in interest rates as civilizations center moved westward from the Near East to Greece and then to Italy resulted from technical mathematical causes, not from declining productivity, profit rates or monetary deflation. And despite this decline (and hence the length of time it took for a debt principal to double), the debt burden became increasingly serious as debt cancellations became a thing of the past. Livy, Diodorus and Plutarch described how debt pressures were aggravated as the economy polarized and the wealthiest landed families shifting taxes onto the less prosperous classes, impoverishing Roman society. The money economy was destroyed, bringing on the Dark Ages and a reversion to local subsistence production. In his Politics (I.10 at 1256, written c. 330 BC) Aristotle pointed out how inappropriate was the metaphor of debts reproducing themselves, for silver was sterile. The taking of interest is contrary to nature because money by nature cannot produce anything and is intended only to serve the purpose of exchange, that is, as a means of payment and common measure of value. Its proper function was simply to be a catalyst, not to intrude into exchange relations, yet interest-bearing debt had a financial expansion path that diverged from that of the underlying tangible economy. This is why rural usurers were so hated. The contrast between moneys sterility and the reproductive power of animals explains the frequent depiction of usurers as old homosexuals, incapable of reproducing themselves. When Livy (VIII.28) wrote his history of Rome he probably knew only the bare fact that in 326 BC the Papirian law had abolished the right of creditors to keep their debtors literally in bonds. In the popular Stoic fashion of his day, he drew on an established literary archetype to compose a dramatic scenario for the events leading up to Romes debt revolt. He portrayed the Roman crowd rioting to protest a lustful usurer, Lucius Papirius, abusing a boy left in his charge as a debt pledge, regarding the boys youthful bloom as added interest on his loan. When the boy rejected the creditors advances, Lucius ordered him to be stripped and beaten. Mangled by the blows, the boy rushed into the street and complained loudly of the usurers lust and brutality. A vast crowd gathered, inflamed with pity for his youth and outrage for the wrong, and considering too the conditions under which they and their children were living, and they ran into the Forum and from there in a compact body to the senate house. Forced by this sudden outbreak, the consuls convened a meeting of the senate, and as the members entered the senate house the crowd exhibited the lacerated back of the youth and flung themselves at the feet of the senators. The strong bond of credit was on that day overthrown through the mad excesses of one individual. The consuls were instructed by the senate to lay before the people a proposal that no man be kept in shackled or in the stocks, except such as, having been guilty of some crime, were waiting to pay the penalty; and that the goods but not the person of the debtor should be the security for money lent. Usury was personified as sterility, the antithesis of fecundity and participation in the normal social reproductive process. Rather than creating families, creditors broke them up by seizing their members as bondservants and foreclosing on their subsistence lands, thus depriving them of their means of support. Some usurers consumed splendidly to gain the approval of others, as in the narrative of Sodom and Gomorrah, but more often they acted miserly and did not consume much, sacrificing their own worldly enjoyment to an addictive, increasingly compulsive property acquisition for its own sake. The soaring curve of wealth addiction became the natural counterpart to the exponential growth of debt. As individuals obtained more money and property, they desired yet more, becoming insatiable. The way to acquire property most quickly was through usury, causing social polarization. Woe to you who add house to house and join field to field till no space is left and you live alone in the land, declaimed Isaiah. Greek dramatists would portray the limitless greed for money as a disease of the psyche. In Aristophanes last play,

Ploutos (388 BC), the character Karion remarks that a person may become over-satiated with food bread, sweets, cakes, figs and barley but no one ever has enough wealth. His friend Chremelos agrees: Give a man a sum of thirteen talents, and all the more he hungers for sixteen. Give him sixteen, and he must needs have forty, or lifes not worth living, so he says. (lines 189-93) As the French classicist Jean-Pierre Vernant (1982:82) paraphrases this thought: Ultimately, wealth has no object but itself. Created to satisfy the needs of life, as a mere means of subsistence, it becomes its own end, a universal, insatiable, boundless craving that nothing will ever be able to assuage. At the root of wealth one therefore discovers a corrupted disposition, a perverse will, a pleonexia the desire to have more than others, more than ones share, to have everything. In Greek eyes, ploutos (wealth) was bound up with a kind of disaster, headed by hubristic behavior, whose defining characteristic was not just the egoism of wealth but the injury its holders did to their victims, above all through usury. The exponential doubling and redoubling of debt For thousands of years religion paid more attention to the problems inherent in the exponential growth of debt than do modern economists. Martin Luther depicted the growing mass of usurious claims on the poor and the rest of society as the great huge monster . . . who lays waste all . . . Cacus, who would eat up the world in a few years as usurers scheme to amass wealth and get rich, to be lazy and idle and live in luxury on the labor of others. Once Cacus got hold of a man and imbued him with the insatiable desire for moneywealth, he turned him into a usurer and money-glutton who would have the whole world perish of hunger and thirst, misery and want, so far as in him lies, so that he may have all to himself, and every one may receive from him as from a God, and be his serf for ever. . . . For Cacus means the villain that is a pious usurer, and steals, robs, eats everything.[5] Napiers 1614 book on logarithms juxtaposed exponential or geometrical series of numbers to their simple arithmetic expansion. A poetic application of this mathematical idea appears at the outset of Shakespeares A Winters Tale, which actually was published a few years earlier. The metaphor of a cipher . . . standing in a rich place is used to indicate the logarithmic exponential by which a debt multiplied as it mounted up unpaid at compound interest.[6] This passage has caused speculation on how and when Shakespeare might have known Napier or his circle, but the most striking cultural point is how dramatists and novelists often have paid more attention to debt than do modern economists. The novels of Dickens, Balzac and their contemporaries, as well as earlier British drama, are filled with debt imagery, reflecting the major role it played in nearly everyones life. In antiquity no governments had gone bankrupt, as public debts did not arise until medieval Europe. The process started with Italian bankers lending money to enable rulers to pay Peters Pence and related tribute to the Roman papacy. In short order the continents territorial wars pushed realms deeply into debt, headed by the almost constant fighting between England and France. As the previous chapter has noted, it was largely to avoid further war borrowing that Britain granted liberty to its colonies, just as it finally would dismantle its colonial system after 1945, being too broke to continue the game. It was in reference to Britains war debts that one of Adam Smiths contemporaries, the Anglican minister and actuarial mathematician Richard Price, graphically explained the seeming magic of how debts multiplied exponentially. His 1772 Appeal to the Public on the Subject of the National Debt described how Money bearing compound interest increases at first slowly. But, the rate of increase being continually accelerated, it becomes in some time so rapid, as to mock all the powers of the imagination. One penny, put out at our Saviours birth at 5% compound interest, would, before this time, have increased to a greater sum

than would be obtained in a 150 millions of Earths, all solid gold. But if put out to simple interest, it would, in the same time, have amounted to no more than 7 shillings 4d. In his Observations on Reversionary Payments, first published in 1769 and running through six editions by 1803, Price elaborated how the rate of multiplication would be even higher at 6 percent: A shilling put out at 6% compound interest at our Saviours birth would . . . have increased to a greater sum than the whole solar system could hold, supposing it a sphere equal in diameter to the diameter of Saturns orbit. Price suggested rather naively that Britains government should try to make use of this exponential principle to pay off the public debt by creating a sinking fund that itself would grow at compound interest. The idea had been proposed a half century earlier by Nathaniel Gould, a director of the Bank of England. Parliament would set aside a million pounds sterling to invest at interest in a sinking fund, where it would build up the principal by reinvesting the dividends annually. In a surprisingly short period of time, Price promised, the fund would grow large enough to pay off the entire debt. The government thus would extricate itself from debt by establishing financial claims on the rest of the economy! A state need never, therefore, be under any difficulties, for, with the smallest savings, it may, in as little time as its interest can require, pay off the largest debts. What Price had discovered was how the exponential growth of money invested at interest multiplied the original principal by plowing back the dividends into new saving. Here was the explanation for how savings snowballed in the hands of bankers, bondholders and other savers who kept on reinvesting their dividends. It is the same principle the Babylonian scribes had been taught four thousand years earlier, when the compound interest phenomenon was just really getting underway on a large scale. What Price failed to appreciate was that never in history has any economy been able to turn a penny or any other sum into a surplus large enough to pay creditors a solid sphere of gold reaching out to Saturns orbit. Economists estimate that during the two thousand years since the birth of Christ the European economy has grown at a compound annual rate of 0.2 percent, far less than the level at which interest rates have stood. No doubt many people saved pennies back in Roman times, and indeed, hundreds of talents of silver and gold were lent out at high rates of interest. Yet nobody had accumulated a vast volume of gold nearly as large as the earth itself, or even as large as a city block. The entire volume of gold in the world today is enough to fit into a single large fortress an estimated million tons, worth about $- billion at the price of $280 an ounce. (fn) The inference is that the interest that savers intend to obtain will not and cannot materialize in practice. Financial claims on income and head wealth run ahead of the economys non-financial or physical ability to produce (and hence, to pay), culminating in crises that wipe out savings along with the bad debts. The accrual of savings (that is, other parties debts) thus are not inherently linked to the economys ability to carry these debts. Recognizing that no societys productive powers could long support interest-bearing debt growing at compound rates, Marx poked fun at Prices calculations in his Grundrisse notebooks (1973:842f.) that were incorporated into Capital (III:xxiv). The good Price was simply dazzled by the enormous quantities resulting from geometrical progression of numbers. . . . he regards capital as a self-acting thing, without any regard to the conditions of reproduction of labour, as a mere self-increasing number, subject to the growth formula Surplus = Capital (1 + interest rate)n No wonder Adam Smith found that no nation in history had paid off its public debt, and that Britains tax revenues had become a fund for paying, not the capital, but the interest only, of the money which had been borrowed . . . As for the idea of a sinking fund, governments simply turned around and reborrowed an equivalent sum for whatever was set aside to pay off the debt, or indeed whatever was needed to finance yet new wars. Such a fund is a subsidiary fund always at hand to be mortgaged in aid of any other doubtful fund, upon which money is proposed to be raised in any exigency of the state. To ambitious monarchs or parliamentary leaders, the fund would be an irresistible temptation.

In 1798, a generation after Price put forth his argument for a sinking fund, the Rev. Thomas Robert Malthus drew the contrast between geometric and arithmetic rates of growth in the way that most economic students recognize today. Picking up his fellow ministers imagery, Malthus asserted that populations tended to grow geometrically unless checked by natural forces such as famine, disease or war, while the means of subsistence the populations of animals and plants consumed by humans could grow only arithmetically, that is, at simple interest. It followed that social programs to provide more money for the poor would be self-defeating, because they would have more children (multiply their numbers), pressing against the limits of subsistence and forcing their living standards back down to minimum survival levels. [7] The original financial context that made readers familiar with Malthuss contrast is all but forgotten today. Few economists remember that the mathematical idea was first applied to the rates at which savings and debts double and redouble at compound as contrasted to simple interest. What is ironic is that although Malthuss idea that fertility rates would increase in response to rising income levels has not materialized, the financial principle emphasized by Price remains apt. What do indeed rise with income levels are savings. These grow geometrically as interest charges on the economys financial claims its debt overhead in the form of, bonds, mortgages and other bank loans are recycled into yet new lending until the overall volume of debt claims exceeds societys ability to pay out of its income-generating powers. Private individuals did not fare better than governments in attempting to make use of the compound interest principle by bequeathing savings to accumulate over a protracted span of time. In 1800 a Mr. Thelluson set up a trust that was to accumulate its income for a hundred years. At the expiration of that time the trust was to be divided among his descendants. His estate of 600,000 was estimated to yield 4500 per year at 7 percent interest, producing a final value of 19,000,000, some thirty times the original legacy. As matters turned out, Thellusons will was contested in litigation that lasted 62 years, from his death in 1797 to 1859. By the time the lawyers were paid, the property was found to be so much encroached on by legal expenses that the actual sum inherited was not much beyond the amount originally bequeathed by the testator.[8] Meanwhile, under William Pitt the government calculated that at four per cent compound interest the trust would own the entire public debt by the time a century had elapsed. Legislation known as Thellusons Act accordingly was passed, limiting such trusts to twenty-one years duration. Socialist analyses of the dynamics of compound interest, and its consequences By failing to place proper emphasis on the degree to which new savings find their counterpart in new debts, todays academic models have promoted a false sense of security on the part of savers who believe indeed, insist that the loans which back their savings not be written off. Since the early 1990s the reluctance to write off the real estate debts, stock market debts, third world debts and other bad debts in which bank deposits, insurance policies and money-market funds have been invested has led to public bailouts to U.S. S&L depositors in the late 1980s, along with IMF bailouts from governments (that is, their taxpayers) to institutional investors. The reluctance to write off bad debts and the bad savings that have lost their backing is largely responsible not only for keeping debtor countries and debtor sectors on the hook, but also debt-ridden (one might equally well say savings-ridden) economies insolvent. The most notorious example is Japan, which has remained mired in a deep recession since the early 1990s. In Volume III of Capital (ch. xxx) and Vol. III of Theories of Surplus Value (both of which were published posthumously from notes made in the early 1850s) Marx described high finance as being based on imaginary or fictitious capital. Money lent out at interest was a void form of capital[9] consisting of financial claims on the means of production in the form of bonds, mortgages, bank loans and commercial paper. This view understandably emerged mainly from the ranks of economic reformers. Indeed, It has been left almost entirely to non-mainstream writers to explain how economies are sacrificed to their creditors. In 1840 the French socialist Proudhon voiced what had become widely recognized among his St. Simonian contemporaries when he proposed as a basic axiom that the financial power of Accumulation is infinite, and is exercised only over finite quantities: If men, living in equality, should grant to one of their number

the exclusive right of property; and this sole proprietor should lend one hundred francs to the human race at compound interest, payable to his descendants twenty-four generations hence, at the end of 600 years this sum of one hundred francs, at five per cent., would amount to 107,854,010,777,600 francs; two thousand six hundred and ninety-six times the capital of France (supposing her capital to be 40,000,000,000, or more than twenty times the value of the terrestrial globe![10] If this financial power were not checked by radical new policies to abolish financial fortunes and replace debt with equity investment, hopes to increase human welfare through higher industrial productivity would be stifled. Marx described the debt burden as corrosive to the extent that interest charges ate into profits, deterring investment in plant and equipment to employ labor to produce goods and services for sale. Marx summarized this process by the formula M-C-M, signifying the investment of money (M) to produce commodities (C) that would sell for yet more money (M). By contrast, the growth of interest-bearing capital classical usury consisted of the disembodied M-M, making money simply from money itself in an essentially sterile operation. Although sterile, however, financial capital asserted its domination over tangible capital, above all in the foreclosures that followed in the wake of such crashes. A transfer of ownership ensued from debtors to creditors was inevitable as the self-expanding growth of financial claims surpassed the ability of the economys productive powers and earning power to keep pace. This inherent asymmetry is what made financial claims fictitious, as their demands for payment ultimately could not be met. Attempts to carry the economys debt overhead deflated the market for the commodities being produced, causing gluts that led to crises in which everyone scrambled for money and the banks themselves were caught short and failed. Yet having analyzed finance capitals tendency to grow geometrically at compound interest, Marx dropped the subject, anticipating that finance capital would be subordinated thoroughly to the dynamics of industrial capital. Despite his compendium of historical citations recognizing the exponential growth of money-capital, he did not incorporate this idea into his long-term system. Rather, he judged this phenomenon usury to be survival from antiquity that the dynamics of industrial capitalism would render obsolete. In the course of its evolution, industrial capital must therefore subjugate these forms and transform them into derived or special functions of itself, he wrote with an optimistic Victorian ring. The destiny of industrial capitalism was to mobilize finance capital to fund its own economic expansion. Where capitalist production has developed all its manifold forms and has become the dominant mode of production, Marx concluded (1971:468), interest-bearing capital is dominated by industrial capital, and commercial capital becomes merely a form of industrial capital, derived from the circulation process. The financial problem would take care of itself as industrial capitalism mobilized savings more productively than ever before had been the case. For this to be true, the economys means of payment would have to keep up with the exponential growth of interest-bearing claims. This actually seemed to be the case as European and North American public debts seemed to be on their way to being paid off during the relatively war-free century 1815-1914. As lending was being mobilized to fund heavy transport, industry, construction and mining, the economys debt burden actually seemed likely to be self-amortizing by being linked to industrial capital formation. As the Technocracy Study Course (New York: 1934:136f.) published by Technocracy, Inc. one of the typically cultish movements that emphasized the importance of compound interest put matters (italics in original): The physical expansion of industry was, in a period from the Civil War to the World War, a straight compound interest rate of growth at about 7 per cent per annum. During that period, the debt structure was also extending at a similar rate of increment. Since the World War . . . the rate of physical expansion has been declining, and physical production has been progressively leveling off. Thus, for the period prior to the World War there was a close correspondence between the rate of growth of the debt structure, and of the physical industrial structure. Since the World War, while the physical structure has been leveling off in its growth, the debt structure, not being subject to the laws of physics and chemistry, has continued to expand until now the total long- and short-term debts are only slightly less than the entire wealth, or monetary value of all the physical equipment. As time progresses this discrepancy between the rate of growth of the physical

equipment and that of debt must become greater, instead of less. The implications of this will be interesting to consider. The Technocracy movement of the 1930s based its view of economics on the Compound Interest Property of Debt, according to which debt is expected to generate more debt, or to increase at a certain increment of itself per annum, around 5 percent over the long term. But though the Technocrats drew attention to this dynamic, the matter was dropped there without a positive policy conclusion. While Marx directed his invective against industrialists squeezing surplus value out of wage labor, Henry Georges Progress and Poverty (1879) accused landowners of taking the fruits of progress in the form of rents and rising land prices. His solution was to fully tax the lands rent (along with the kindred monopoly returns taken by the railroads and emerging trusts). Marxs own analysis had emphasized how labor had been driven off the land into the cities and reduced to a state of dependency on the owners of capital for its livelihood, but he accused George of ignoring the problems caused by industrialization. What socialists and rent taxers shared common was the recognition that despite the vast growth in productive powers resulting from power-driven production and other technological breakthroughs, the lot of workers hardly had risen. The statistics compiled by Thorold Rogers in Six Centuries of Work and Wages (1885:539ff.) indicated that English labor had lived as well on the eve of the discovery of America in the mid-15th century as in the late 19th-century factory towns. The surplus rather was accruing to the owners of wealth. Flrscheim, Bennett and others attempt to put compound interest at the center of economic analysis A number of financial writers in the 1890s found the cause of poverty to lie ultimately not in profit and rent but in interest-bearing debt. Thanks mainly to Keynes, the best remembered is the Swiss-German Silvio Gesell. He was influenced by the German-American iron-maker Michael Flrscheim, who had been Georges major European collaborator. It is significant, however, that Flrscheims Clue to the Economic Labyrinth was published by Swan Sonnenschein, Marxs British publisher. The tracts on debt reform by J. W. Bennett (1895) and John Brown (1898) were printed by the U.S. publishers of Marx, Charles H. Kerr & Co. These financial reformers agreed with land reformers that the economys surplus was being siphoned off in the form of rentier income, but pointed out that land rents ended up being taken by creditors in the form of interest, as were industrial and monopoly profits. Indeed, mortgage charges were bankrupting U.S. farmers as the interest burden was made more costly by the monetary deflation that rolled back prices for crops to the point where gold prices had stood before the Civil War, making it harder to pay outstanding debts. Bennetts Breed of Barren Metal (1895:87) described a hereditary rentier caste threatening to draw all the worlds wealth into its hands as the inventive powers of industrial enterprise were outrun by the inexorable mathematics of compound interest, the foundation stone on which our industrial system is built. . . . It is the principle which asserts that a dollar will grow into two dollars in a number of years, and keep on multiplying until it represents all of the wealth on earth. The problem was that under the laws of interest and rent the capitalists of the country . . . each year receive an amount of wealth so large that they are able to save from it a sum greater than the yearly net increase of the wealth of the nation (p. 151). In contrast to Keynes, Bennett (p. 49) emphasized that the problem with saving was not merely that money saved was not spent on current goods and services that is, hoarded in the usual understanding of the term but that they were lent out at interest, creating an inverted pyramid, the misplaced base of which becomes more unwieldy day by day. The interest-bearing wealth increases in a ratio which is ever growing more and more rapid. Economies became unstable as liabilities rose at an accelerating tempo while fewer assets were left unattached by debt. Spelling out what Bennetts analysis meant, John Brown (1898:81f.) explained: At ten per cent the principal is doubled every seven years, so that in less than a century the interest is 16,384 times the principal, and after that the principal increases at such a stupendous rate that the figures soon become unmanageable. At five percent the principal doubles every fourteen years, just half as rapidly as at ten per cent. Interest accumulates in a geometric ratio, while savings increase arithmetically. Thus if $10 is saved

up, say every seven years, in 140 years the principal will amount to $200. If, however, ten dollars is put into a bank at ten per cent interest every seven years, at the end of 140 years the principal will have become over twenty millions of dollars! Here, he concluded, is the subtle principle which makes wealth parasitic in the body of industry the potent influence which takes from the weak and gives to the strong; which makes the rich richer and the poor poorer; which builds palaces for the idle and hovels for the diligent. These dynamics explained the periodic trade depressions and financial crises as economies whose financial systems are founded on rent and interest-taking experienced a scallop-shaped upswing followed by sharp crash as creditors called in their loans when they saw how risky business conditions were growing as a result of the growth of debt. The process produced a trade depression every ten years or oftener and a panic every twenty years, Bennett explained (1895:93), as there are not available assets to meet [creditor] demands and at the same time keep business moving. The mathematics of compound interest also explained the extremely rapid accumulation of wealth in the hands of a comparatively few non-producers, as well as the abject poverty of a large percentage of the producing masses (p. 80). As Bennett elaborated (p. 102): The financial group becomes rich more rapidly than the nation at large; and national increase in wealth may not mean prosperity of the producing masses. The accrual of interest-bearing debt was responsible for the failure of improved machinery to better the conditions of the producing masses in a degree at all commensurate with the increased producing power which it has given to the laborer. Non-producers received much the largest salaries, for ones income is often in inverse ratio to the service which he does his fellow men (p. 111). This perception countered Frederick Bastiats banal claim that everyone was paid according to the economic service performed. The accrual of financial fortunes or more to the point, their failure to find their counterpart in new tangible capital investment threatened to undermine the nations economy and lead to its decay and final destruction, as had occurred in Rome and other ancient civilizations that had succumbed to usury. There is not enough wealth produced to meet all of these obligations. Either the current expenses of production cannot be paid or the fixed charges of rent and interest cannot be met. If current expenses are not paid, manufacturing plants deteriorate, fixed capital is encroached upon, wages are reduced and laborers thrown out of employment. Current obligations are not met. The business man finally becomes bankrupt, or the wage-workers become bankrupts and outcasts depending on charity for support. If interest is not paid, then the wealth hypothecated for the loan is appropriated by the lender, and the borrower, failing to meet his obligations, becomes a bankrupt (p. 85). If these writers are forgotten today, it is because urban poverty, the oppressive conditions of factory and slum life, and anti-trust policies were the most readily reformable problems. Little popular momentum to restructure the financial system could arise until a more acceptable alternative could be found than banning interest (Bennett and Brown) or depreciating moneys value (Gesell and the subsequent Social Credit movement). Rather than seeing finance in a symbiotic relationship to tangible activity, Bennett and Brown wanted economies to operate without it altogether. If interest-taking is right, claimed Bennett (p. 47), then compound interest-taking is right. The principle of compound interest is, that a dollar, or the wealth represented by it, without any exertion on the owners part will grow into two dollars in a given number of years, four dollars in twice that period, eight dollars in three times the original period, and that it will keep on increasing in a geometrical ratio until that one dollar, with its interest, would, in time, represent all of the wealth on the earth. The rate makes no difference as to the principle of the thing. . . . And what makes matters worse, it is not one dollar that is assumed to have the power of indefinitely increasing, but several billions of dollars. A syndicate of less than one hundred American capitalists, if allowed to collect interest on their capital at a low rate and re-invest for 150 years or less, would at the end of that time own the earth and all real and personal property thereon. This is a simple mathematical proposition, capable of exact demonstration, and any one who doubts the truth of this statement may set all doubts at rest by computing compound interest on one and one-half billions of dollars for one hundred and fifty years, at five per cent per annum.

It seemed that in the long run economies would have to succumb, but how could they get by without credit? These financial critics went beyond orthodox economists by pointing to the problems created by debts mounting up at interest and showing that interest-bearing debt grew by its own mathematical laws rather than economic laws. But they were unable to propose a way in which the two expansion paths physical production and interest-bearing claims might co-exist despite their inherent disequilibrium in the short run. Hence, their reforms were not pragmatic. The idea of a credit-free (or at least, interest-free) system simply was too radical for most people to contemplate. It was easier to think of general strikes and even outright revolution to seize the means of production and expropriate the proprietors or at least to tax them than to set about designing a financial system that, in theory, could avoid credit crises even in the short run. One of the most popular expositions of compound interest was developed by Flrscheim, who criticized George for refusing to address the issue. It is true that the employer is the sponge which sucks up the profit, the greater value (Mehrwerth, as Marx calls it) of labors product, he wrote (A Clue to the Economic Labyrinth [1902]:116), but only to yield it to the rent and interest lords, as well as to the middlemen, who together press it out of him as quick as he gets it, barely leaving him on the average the hard earnings of his own work, and, what is worse, taking the power from him of increasing production to its full potentiality. Contrasting finance capital to physical capital, he called on labor and industry together to attack the real enemy, the financial rentiers who ended up with most industrial profit as well as the rent collected by landlords. Pointing out that claims for financial tribute constituted the bulk of the worlds capital (p. 347), Flrscheim explained that, When an orator or writer has to reply to a socialists attack upon capital as the oppressor of labor, he points to what orthodox economy calls capital, and speaks of our wonderful progress due to our improved means of production and distribution, whereas his antagonist thinks of Government bonds, of land monopoly, of mining rights, of all kinds of tribute claims selling at Exchange for certain amounts, and not at all falling under the orthodox definition of capital, though representing that capital which people principally have in view when they use the term. Flrscheim elaborated that All exertions, all improvements in the methods and tools of labor, the strictest economy, the severest self-denial, are powerless to compete with the rapidity of self-increase possessed by capital placed at compound interest, and they cannot keep up with its demands. To illustrate the dynamic at work, he composed an allegory (pp. 327ff.). Many ages after man was driven from Paradise and told to earn his bread by the sweat of his brow, mercy began to prevail. A loving angel was sent down by the Great Master, charged with the task of lightening the burden. The angels name was Spirit of Invention. He began his work by teaching man to make useful tools and tame animals, and in time to mobilize water power, air and wind power, fire and steam power to drive machinery. It seemed that at last the golden era had come of which men had dreamed for ages past, but that envious spirit, that fallen angel, Satan, was jealous that his own empire would soon be over for ever. Among the follies of man, one little imp, called Interest, managed to attract his attention. What is the matter with you, Interest? he asked the saucy imp. You dont seem to be so dejected as your comrades are? Why should I be dejected, master? replied the spirit, Am I not one of your favorite soldiers? Havent I always been victorious under your august guidance? But Satan answered sadly, Alas, You are no match for the Spirit of Invention. The Interest imp, however, volunteered to demonstrate his prowess in a dual, helped by his son, Compound Interest. At this point, Flrscheim introduced an image that Napier had suggested at the outset of his second book on logarithms in 1617, the Robdologia, likening the principle of geometric increase to that of a chess-board on which each square doubled the number assigned to the preceding one. An old Persian proverb told of a Shah who wished to reward the inventor of chess, a subject, and asked what he would like. To the Shahs surprise, the man asked as his only reward that the Shah would give him a single grain of corn, which was to be put on the first square of the chess-board, and to be doubled on each successive square; which, to the surprise of the king, produced an amount larger than the treasures of his whole kingdom could buy. It is this kind of

chess-game which capital is continually playing with labor. The remarkable growth of compound interest soon swallowed products, capital, the earth and even the workers. This was in essence the ploy that Flrscheims Compound Interest demon used. Look at this chess-board, he told the angel against whom Satan had pitted him. It seems just like any other chess-board, with sixtyfour squares, but it had the peculiar quality of extending the dimensions of the squares, so as always to be large enough to hold whatever was placed on them. Instead of asking for grains of wheat to be placed on them, the Interest Imp asked for soldiers. Now, listen well to what I propose, he said to the angel, pointing to the latters huge army. I enter the first square with my son, and you match one of your warriors against us. We enter the second square doubled in number; you send two more warriors and so on every succeeding square. . . . When we arrive at the last square, and you have a single soldier left after occupying the same, we shall declare ourselves vanquished, and Satan with all his troops will leave this world for ever. If I win, you and your army are to be at the commands of my master. Are you agreed? The angel agreed, expecting his horde of soldiers to easily exceed the number that the Interest Imp and his son, Compound Interest, seemed likely to accrue. In the beginning the angel laughed, for, though twenty squares were passed, no noticeable diminution of his forces was perceptible. Demon Interest said nothing, but attended to business, quietly doubling his army on every succeeding square. At the thirtieth square the angel ceased to laugh, and soon saw he was lost. I despised you, little fellow, he signed despairingly, and I am punished for my vanity. I see there is no use fighting against you. Demon Interest is more powerful than the Spirit of Invention. I am your slave. Command your servant! I am the only servant of my great master, dryly replied the demon. Here I see him coming. He will give you his orders. And Satan gave his orders. He commanded that the angel was to continue in his work with all his troops, which were to be increased with all possible exertion, so that humanity which did not know the nature of the antagonist it had to fight against would always keep in fresh hope of final successwhen the new troops were forthcoming. But as fast as they appeared, Demon Interest was to send forth a larger army to capture the new forces, to enslave them, and instead of their benefiting man make them increase the slave-chains which weigh him down. Flrscheim concluded (p. 333) by asking, What is compound interest? Is it anything else than the fresh investment of earnings of capital? He added that Napoleon Bonaparte, when shown an interest table, said, after some reflection: The deadly facts herein lead me to wonder that this monster Interest has not devoured the whole human race. It would have done so long ago if bankruptcy and revolution had not been counterpoisons. But that is just the point, of course. The fact that mathematics of debts mounting up at compound interest tend to overwhelm the economys ability to pay means that something must give. For awhile the growing debt burden may be met by a sell-off or forfeiture of property from debtors to creditors. This problem, which should be the starting point of financial analysis, calls for public policy to resolve matters. Market resolutions violate societys norms of equity, as they did in the epochs of Hammurapi and Isaiah. Conclusion On the microeconomic level, every economy needs short-term credit to bridge the gap between income and outgo. Merchants need it to trade, and producers need it to carry inventories and undertake work in progress. Governments need to borrow in wartime or other national emergencies, and consumers borrow in the face of adversity, or simply in the expectation that they can repay the debt out of rising incomes in years to come. The rate of interest acts as a mediator between these borrowers and their creditors.

Financial optimists anticipate that debt service may be defrayed out of the borrowers rising earning power or profits, but a growing proportion of loans must be paid out of other sources of revenue than projects in which the loan proceeds are invested. Government debt stems from unproductive war spending or, more recently, from cutting taxes on the wealthy and on the finance, insurance and real estate sectors. Just as problematic are business and personal debts. Their aim should be that the interest rate is less than the profit rate or the rate at which consumers can earn the money to repay the debt with its stipulated interest. But even if this condition is met, the debt can be carried only at the cost of building interest charges into the economys cost structure. At the macroeconomic level, the inherent tendency is for the volume of debt to exceed the economys means to pay without a massive and drastic change in resource ownership. Financial systems will be malstructured if they steer the economys savings more into bonds and loans that is, into interest-bearing claims on the economys income and, ultimately, property than into equities or direct investment. To formulate a better policy it is necessary to distinguish between productive and unproductive debt. This distinction was implicit already in Bronze Age Mesopotamia, whose rulers cancelled agrarian barley debts but left commercial silver debts intact. In medieval Europe, the Thomist idea of interest was an equity-type interest in mercantile activities, as opposed to straight usury (an idea also found in Islam). What makes todays debt problem so intractable is the degree to which debt and savings are linked. In earlier ages most people saved by accumulating gold and silver coinage or bullion, but most savings today (and money itself) take the form of assets that represent the liabilities of other parties, enterprises or public agencies. Such debts represent the savings of everyday people, bank depositors, pensioners and governments, making it politically harder to let debts be wiped out by a financial crash or debt moratorium. Even if debts are wiped out by bankruptcy, savers are bailed out by the government, increasing public debt proportionally. The coming millennium may see the Thelluson principle operate on an economy-wide scale as each sector seeks to use the principle of compound interest for its own gain. It has become normal for insurance companies, for instance, to stall payment of customer claims, and for businesses in general to pay their bills later so as to leave their money earning interest. For the economy as a whole, new saving is taking the form largely of creditors accruing interest and plowing it back into new loans rather than tangible capital formation. This increases the debt overhead without building up the economys capacity to carry debt. Edward O. Wilsons Consilience (New York: 1998:313) points out how impossible it is for the worlds financial savings to grow at compound interest ad infinitum. He cites the arithmetical riddle of the lily pond. A lily pod is placed in a pond. Each day thereafter the pod and then all its descendants double. On the thirtieth day the pond is covered completely by lily pods, which can grow no more. He then asks, On which day was the pond half full and half empty? The twenty-ninth day. By the time people feel obliged to argue over whether the financial glass if half empty or half full, we are on the brink of the Last Days. Growth in savings is simultaneously growth the economys debt overhead. As debts grow, less saving is recycled into tangible direct investment; more takes the form simply of paying off debt. The growth in credit (that is, debt) may be used to inflate the stock market and real estate bubble, but in the end it must shrink the economy precisely because it is faux wealth, fictitious capital that draws savings away from new direct investment in tangible capital formation. It trivializes the problem to say that a debt-ridden economy owes the money to itself. For a century, American farmers and industries in the western states owed debts to bankers and bondholders in the east. Today, the poor throughout the world, and increasingly business and government bodies as well, owe a rising proportion of their income to wealthy institutional creditors (including pension funds nominally owned by workers, for whom these retirement savings are not available to pay off their own current debts). At some point the trends of debt must rise so high as to exceed the economys ability to pay, namely, the entire available economic surplus. There is no inherently mathematical solution at this crisis point. The response must be political, as it always has been.

Attempts to restore equilibrium by reducing wages and profits in indebted economies are counterproductive, in addition to being socially intolerable. Austerity aggravates the debt problem. Higher interest rates or taxes to pay creditors reduce the revenue available to invest in new productive capacity to enable the economy to earn its way out of debt. The market for output shrinks, making new direct investment less remunerative, leading yet more savings are invested in bonds and loans. Employment declines, wage levels stagnate and many families borrow money to make ends meet. Tax revenues fall, forcing governments to borrow to pay unemployment insurance and undertake counter-cyclical spending to make up part of the private sectors slack. But matters are aggravated as rents fall and real estate prices decline. Property owners default on their mortgages, threatening the ability of the banking systems loan portfolios to cover its deposit liabilities. The government is called upon to bail out savers (if not the banks themselves) by raising taxes or going deeper into debt by issuing more bonds, whose interest charges must be paid out of future tax levies. Some governments try to inflate their way out of debt by creating new money and credit, but such credit takes the form of yet more debt! Inflation pushes up interest rates, prompting businesses to borrow for shorter periods of time, hoping to refinance their loans when interest rates recede. This exacerbates the debt burden as more debt falls due each year. As loan maturities shorten, some companies and individuals default. Capital leaves the country as domestic and foreign investors jump ship. The exchange rate falls, making debts denominated in other currencies more expensive to service. In the end, debt cancellations are made inevitable. What is interesting to the economic historian is the degree to which the need for this resolution was perceived more readily over four thousand years ago in Sumer and Babylonia than is the case today. Part of the problem is that nearly all classes are now savers in one way or another, even indebted workers via their pension funds and Social Security. To wipe out debts is to annul the savings that are their counterpart. Whereas past financial crises wiped out savings along with the economys bad debts, matters have changed in todays era of federal deposit insurance. Governments have increased taxes or borrowed to bail out savers (as the FSLIC did in the late 1980s, and as Japan has done since the late 1990s), in the belief that the value of savings can be guaranteed in perpetuity, even when they are reinvested each year to mount up at compound interest. Such public guarantees ultimately must yield to a realization that, in the end, the game must be given up as the debt overhead tends to exceed the means to pay. If debts rise beyond the economys ability to pay, then the savings that form their counterpart cannot be made good. Not only must governments default, as Adam Smith noted, but private-sector debtors also must default. Heading the list is the economys most highly indebted sector, real estate. Property owners usually default at the point where the stipulated interest and amortization comes to exceed the rental cash flow. Commerce and industry likewise become insolvent at the point where their earnings and cash flow (and available reserve funds) threaten to be absorbed totally by debt service. Consumers become are confronted with bankruptcy at the point where debt service fully absorbs their take-home income (that is, wages net of tax deductions, social security and pension fund withholding and debt service) remaining over and above their basic subsistence needs. States and municipalities become insolvent at the point where they are unable to raise taxes or borrow yet more money. To increase property taxes would induce abandonment. Indeed, as the debt burden grows and something has to give, it is not savings and their counterpart debts. Pressure mounts to cut real estate taxes so as to save the federal government from having to bail out banks that have invested their checking and savings deposits in mortgage loans collateralized by real estate that has fallen in price. The tax burden is shifted onto labor in the form of income and sales taxes, including value-added taxes. The economy shrinks all the more in a debt deflation, the modern version of incipient financial insolvency. The result is something much like ecological pollution. We might think of it as debt pollution, and its overheats the financial environment while stifling normal growth.

What then are the alternatives? Attempts have risen throughout the ages to ban the charging of interest outright. This is what the laws of Exodus (the Covenant Code) urged, as well as Islamic law and the Christian Churchs laws against usury. Yet Canon law permitted mercantile lending and ended up endorsing the mountains of piety to lower interest rates on loans to the poor as it became apparent that credit is a necessary fact of life, and that it inevitably must bear a charge. To deny this is ill-tempered utopianism. Once this is acknowledged, questions arise regarding how and on what terms is it proper to charge interest. The most simple and basic reform is to direct credit into the most productive lines where it can be paid off out of an enhanced capacity to produce and earn money. This St. Simonian ideal was followed up most effectively in Bismarckian Germany and other Central European countries in the late 19th century, and more recently in Japan. The creation of an industrial credit system involved much closer links between banking, heavy industry and government than had been forged under Dutch and British banking. (These steps are described in the next chapter.) But todays deregulatory philosophy is moving in just the opposite direction. In an attempt to collect interest along with land rent for the community as a whole, numerous writers have urged government banks. Bennett (1895:172), for instance, pleaded for this St. Simonian socialist ideal: A real national banking system must be under the direct control of the government. All past experience has demonstrated that where individuals were given irresponsible power, they used it to advance their own ends, regardless of others. Interest still would be paid, to be sure, but it would be paid to the government or its financial agencies. More often, however, governments have created depository institutions such as Postal Savings systems and savings banks. But today, these are being privatized in every economy. When France nationalized its banks a few decades ago, it found that the problems were largely administrative, involving corruption and crony dealing of much the same sort found in Russia and other socialist economies, as well as Latin America. The most successful banking has occurred in mixed economies that provide the requisite sets of mutual checks and balances. But such balances are now being pulled out in todays deregulatory free banking environment. One must acknowledge in any event that permitting interest opens the gates for savers to compound their money by making new loans with the interest they receive. Over time it is inevitable that their financial claims will mount up beyond the economys ability to pay. There can be no long-term equilibrium between the financial rentier sector and the rest of the economy. That always has been recognized. What has not been agreed upon is what should be done when debt problems become economy-wide. Ancient rulers were not reluctant to cancel the most problematic, rural debts. Modern governments do nothing so straightforward, but as Adam Smith noted, they often pretend to pay their debt in the time-honored fashion of inflating their way out. Gesells variant of this approach would reduce the value of money steadily at a rate offsetting the rate of interest. However, his proposal dealt only with money itself. In his plan, prices themselves would not rise, but the bank notes or other monetary means of payment would have their face value reduced. Both the inflationary and shrinking money approaches would wipe out the value of savings as well as that of debt. But matters are just the reverse under todays IMF-Washington Consensus. Economies are subjected to deflationary austerity programs that make the debt burden heavier rather than lighter. Tax codes throughout the world now encourage loans at interest rather than equity investment. Permitting interest to be credited as a tax-exempt cost of doing business makes it less expensive for companies to issue bonds than stock. The result is that bondholders and other creditors get the business revenue that otherwise would be paid to the government tax collector if it were distributed out as dividends on equity. Yet equity investment minimizes the debt burden. Todays tax system this promotes and even accelerates the channeling of saving into interest-bearing debt, compounding over time. In the early centuries of public debt that is, in medieval Europe governments simply defaulted or repudiated their debts. This ruined the early Italian bankers; today it threatens the solvency of global banks and institutional investors. The political problem lies in the fact that to cancel debts involves canceling savings, as one partys debt is the backing for another partys saving. Todays international diplomacy

pressures governments not to declare bankruptcy, but to sell off their national patrimony and sacrifice their domestic economies to pay their creditors. Never before in history have private interests been placed so highly above those of government. All classical economists, including Marx, focused on profits as the economys motive force, but this has not turned out to be the case in recent decades. Seek profits involves risk, ties up capital, and requires entrepreneurial effort. It is easier, less risky and even minimizes taxes to lend out ones savings to others to manage, collecting interest for the service of providing this wealth. What is remarkable is that unearned revenue is now being encouraged in preference to earned profit, above all in the form of asset-price inflation. Until quite recently, nobody dreamed that it might be possible to carry an exponentially rising debt burden by using loans to fuel a matching asset-price inflation. Speculative borrowing may be made remunerative (if not economically productive) buys control of real estate, common stocks, hard assets and other property (MA-M, with A standing for real estate, enterprises or financial claims on these assets). Such a strategy has been able to work for about a generation only because rent (including monopoly profits) were large enough to pay interest charges, while indebted governments have raised the money to pay their creditors by selling off the public domain, that is, the national patrimony historically used to provide societys basic services at a price considered equitable and designed to promote long-term economic development. But this is not a process that enhances the power to produce goods and services. It is essentially sterile in terms of the classical definition of productive investment. Worst of all, it encourages debt compounding that only can culminate in the problems cited above. [1] I have treated the topic of this chapter in my articles on The Mathematical Economics of Compound Interest: A 4,000 Year Overview, Journal of Economic Studies 27 (2000):344-363, and The Use and Abuse of Mathematical Economics, ibid.:292-315. [2] Karen Rhea Nemet-Nejat, Cuneiform Mathematical Texts as a Reflection of Everyday Life in Mesopotamia (New Haven 1993 = AOS Series Vol. 75) provides a bibliography. [3] Miriam Lichtheim, Ancient Egyptian Literature, II:135. [4] Hildagard Lewy, Marginal Notes on a Recent Volume of Babylonian Mathematical Texts, Journal of the American Oriental Society 67 (1947):308 and Nemet-Nejat, op. cit.: 59f. [5] The passage occurs in Luthers 1540 Wittenberg pamphlet, An die Pfarrherren wider den Wucher zu predigen [That the priests should preach against interest]. Curiously, although Marx footnoted this passage in Capital (Vol. I, London 1887:604, and Vol. III, ch. xxiv:463f.), it is missing from Volume 45 of Luthers works (Fortress Press, 1962) dealing ostensibly with his economic writings published. That so important a denunciation of interest would be omitted attests to the cognitive dissonance with which denunciations of interest strike modern secular and religious minds alike. Yet from the Bronze Age onward, such denunciations have been in the forefront of all religions in societies where interest has been charged to needy debtors. [6] Expressing gratitude for the nine months of hospitality he has received, the character Polyxenes uses the florid metaphor of a burdensome debt that can never be repaid. The idea is that to take the time to thank his host properly would consume yet more time, using up yet more hospitality for which yet more thanks would be due in a never-ending series. (In this passage the words without a burden mean without debt.) Nine changes of the watery star [the moon] hath been The shepherds note since we have left our throne Without a burden: time as long again

Would be filld up, my brother, with our thanks; And yet we should for perpetuity, Go hence in debt: and therefore like a cipher, yet standing in rich place, I multiply With one we-thank-you many thousands more that go before it. [7] The reality is that instead of increasing as incomes rise, fertility rates taper off. And over time, breakthroughs in agricultural and mining technology have increased productivity in these sectors more rapidly than has occurred in manufacturing, so that food and other consumption goods have grown faster rather than more slowly than population. [8] Palgraves Dictionary of Political Economy, citing the Annual Register (1797) and Chamberss Encyclopaedia (vols. 8 and 10). Geoffrey Gardiner (Towards True Monetarism, London 1993:135) observes that in the late 1970s, the burgeoning oil revenues of the producers were further gilded by the addition of high interest earnings. At their highest British interest rates had the effect of doubling the cash deposits of the oil-producers in only five years, or 16.3 times in twenty years! . . . The wisdom of an earlier age, which had led to the passing of Thellusons Act to discourage the establishment of funds which compounded interest indefinitely, had been forgotten. [9] Capital III (Chicago 1909):461. [10] P. J. Proudhon, What is Property, First Memoir, Eighth Proposition (New York, n.d.:215).