Today, with great fanfare, Alan Greenspan and the Federal Reserve Board announced that interest rates would be raised. Greenspan’s role in the world would have seemed remarkable to any number of past generations. Thirty years ago, Greenspan’s visibility might have been surprising, but Paul Volcker’s importance in breaking the back of inflation in the Seventies (and Greenspan’s near-deification during the Nineties boom) vastly improved the Fed Chairman’s visibility. Eighty years ago, it might have shocked government officials that interest rates would be used as a tool of economic policy to manage growth, but we’re all Keynesians now. Two hundred years ago, the very idea of a national bank — a series of federal reserve banks, in fact — was a controversial one; Andrew Jackson fulfilled his election promise to decharter the Second National Bank (the first’s charter having expired in 1811), and the reserve bank system was not established until the twentieth century. And a thousand years, the mere act of charging interest could have gotten Alan Greenspan excommunicated or worse; following the various dictums of Aristotle, Leviticus, and the Koran, usury was prohibited. Usury today means interest rates charged on loans above some legal limit; if your local loan shark is making the vig on a loan too high, he can go to jail. (These rules, curiously, tend not to apply to credit card companies and payday loan operations.) For centuries, however, the term applied to any interest-bearing loan. Early civilizations understood bartering livestock; today Heifer International carries on the tradition of paying for today’s cows with tomorrow’s calves. But money was not livestock, and thinkers like Aristotle found the concept of interest deeply unsettling:
The most hated sort [of wealth-getting], and with the greatest reason, is usury, which makes a gain out of money itself, and not from the natural object of it. For money was intended to be used in exchange, but not to increase at interest. And this term interest, which means the birth of money from money, is applied to the breeding of money because the offspring resembles the parent. Wherefore of all modes of getting wealth this is the most unnatural.
The early Church didn’t need much more than a Biblical prohibition on usury and a sense that money breeding money like a living thing to feel the same way. As fifth century pope Leo the Great put it, "[U]sury of money is the death of the soul."
And there matters stood for hundreds of years; later pontiffs determined that usurious moneylenders could be excommunicated. But Jews weren’t concerned with that, and they considered religious injunctions against charging interest to apply only to their coreligionists. Jews were initially the only legal moneylenders in Europe, leading some religious and political authorities to court their presence as a spur to commerce. Where there’s a florin, shilling, or sou to be made, someone will eventually figure how to make it; Christians in Genoa learned to disguise interest-earning transactions as partnerships, fictitious sales, land transfers, and "dry transfers". The latter were ostensibly currency exchanges, as in one 1292 transaction which masked a 25% interest rate by specifying an exchange rate by which a debt incurred in Genoese coin could be paid in Provisine money. The Genoese became the merchant kings of western Europe because they knew how to skirt usury laws.
Although the Genoese pioneered such techniques as making profits through reasonably complex financial derivatives, competitors rose up. The real power of the Templars lay not in their idolotrous severed heads or their knowledge of the Merovingian bloodline of Christ but in their extensive network of moneychangers in Europe and the Holy Lands; the thirteenth century saw the order’s rise as an economic power equal to many of the actual nations in which they resided. Backlash was inevitable. But by the time of the Reformation, things were becoming unsustainable; the religious wars engulfing Europe threatened to bankrupt nations, leading to the issuance of the first government bonds. States needed usury as much as usurers needed states. And when John Calvin rose to power in Geneva, he declared the prohibition against usury to be part of a rural society’s belief system. Cosmopolitan, Protestant Geneva would allow moneylenders to charge whatever interest they chose.
Many still saw fundamental problems with interest. The Rule of 72 suggested ridiculous results; as an American lawyer named John Whipple argued (against Jeremy Bentham’s In Defense of Usury), "If 5 English pennies … had been … at 5 per cent compound interest from the beginning of the Christian era until the present time, it would amount in gold of standard fineness to 32,366,648,157 spheres of gold each eight thousand miles in diameter, or as large as the earth." Harry Stephen Keeler, the noted bad author, takes the idea to extremes in his story "John Jones’ Dollar", in which a single dollar’s interest compounded over hundreds of years ends up representing all the money in the universe. But that assumes uninterrupted growth. Science writer Charles Sheffield notes that population growth resembles compounding, but there are Malthusian restrictions and moderating social factors that will slow growth eventually (it’s already happened in Europe). Charles Ponzi‘s great invention only works as long as there are new suckers to find who can be convinced to feed the machine. Emails that urge recipients to pass them on to all their friends are effective only as long as people don’t read Snopes; sadly, this can give them a long lifetime indeed, as one hoax email writer discovered to his dismay (link via Waxy). And when the self-replicating nanotech von Neumann machines threaten to take spare atoms from every single object on the planet to create more nanotechnological von Neumann machines, using the power of compounding to reduce the earth to grey goo, our rapidly disintegrating descendants can take comfort in the fact that there are limits there, too. For instance, even grey goo won’t stop the credit card bills. Start saving those eight thousand mile gold spheres.