Economics Paradox: Banning Compound Interest Leads To A Higher Nationwide Return On Total Assets.

Modified from elsewhere:

Great work you are doing. I’ve been putting in a lot of thought in to how superior capital allocation would be, in practice, if it were a fees-only arrangement and compound interest were banned.

With both Usury and fractional reserve the bankers get lazy. Unless you had absolutely perfect policy settings (including “growth-deflation”) and unless your starting point is the best of all competitive situations, without one group of oligarchs controlling the system ….. Well what will happen is the banks will create new money (ie they will pyramid more on the available cash) on the basis of SURE THINGS.
And on top of this there will be interest-rate Apartheid when it comes to these sure things. Punitive rates of interest on small amounts of personal, non-tax-deductible debt will sit besides the lowest rates of interest on the sure thing of Bain capital trashing a manufacturing outfit and sending most of the jobs overseas.

This is entirely different from the assumptions of the Austrian-British Classical integration. I mention these two schools because; though they are one-eyed with regards with the concerns of you and I, they are the only two rational schools of economic thought. But like the neo-classicals; these two schools blandly assume that the banks will lend for capital creation, and allocate resources to the very best areas on that basis. I want to make the argument, as paradoxical as it may seem, that excellence in capital allocation will only come when compound interest is banned and when the rate of payback is, for the most part, voluntary.
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Well we know what the banks lend for right? They lend for debt-peonage, land value inflation, for firms that have achieved some form of monopoly ….. they will lend with their best interest rate, which will be a subsidy given inflation and at the right time of the cycle …. they will lend for sure things.

Personal debt that is non-tax deductible they will lend up to a certain limit and at exploitive interest rates. This may even be to the advantage of a minority of those who get sucked into this. But since this lending destroys rather then creates wealth …….. it would be right to outlaw it, and design social welfare partly around compensating for this reduction in liberty. Because on a society-wide level, lending for consumption is a massively negative-sum game.

So if we outlawed lending at interest for consumption, and had welfare such that no-one really got in the worst of trouble …. this done properly could be a net gain. We ought to outlaw lending (at interest or with high fees) for take-overs, for buying land (in most cases), for buying derivatives including shares …… And so forth until we have all loanable funds going for wealth-creation.

Now how about a world without compound interest? Done well this could be absolutely superior. Because in general, wealth-creating loans are loans that increase the cash-flow of the borrower NET OF REPAYMENTS TO THAT SAME LOAN.

So if the banker makes a loan and the persons cash-flow massively increases (net of repayments) its because he has bought some sort of capital goods which have reduced his costs or increased his revenues. But if he borrows to buy land in the hope of land appreciation …. If companies borrow for takeovers, or to buy shares (except those shares where high dividends are assured) or derivatives, or all sorts of Jive …………. then these are wealth-destroying loans because they either divert loanable funds away from wealth-creation, or they pump up the interest (or competitive fees) on the remaining loans.

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Now supposing if compound interest were banned, fees were allowable in many cases, and the borrower could fundamentally pay back at a rate of his choosing (within reason). Like payback was more or less voluntary over 5% of ones net income? Or something of this sort. Or perhaps even if payback were ENTIRELY voluntary mandating that the loan was made only to gain on another loan (here I go too far but I’m trying to emphasise a point.)

This would ensure excellence in resources allocation. Because think about it? The financier can only get a good rate of return if he is paid back quickly. This is the big point and I’m sure you’ll grasp it. He’s got to get paid back quickly. But if the borrower isn’t legally required to pay him back quickly then what is the incentive to the borrower?

Its to get another loan on good terms.

And so the lender MUST make wealth-creation loans, in order to get fast-payback, such that he makes a high notional interest rate, and then he must send more resources to the fellow who has used societies funds wisely and chosen to forego consumption and pay back quickly.

So its a real paradox. Because you would think that excellence in resource allocation would go hand in hand with a competitive interest rate. But this isn’t the case. As I think I have successfully explained, resource allocation excellence goes with banning the interest rate and inducing fast payback with the reward of a second loan. Because then fast payback must come as a result of the excellence of both the banker and the borrower allocating the funds to improve cash-flow (net of repayments).

Another point can be made in favour of an egalitarian society. If interest …… (or in this case FEES) are NOT tax deductible ……

Supposing if you have a tax free threshold of 50,000 dollars and 20,000 more for each registered dependent. And suppose taxable income is 50%( here I may be going to far again to make the point). And suppose also that fees and interest are NOT tax deductible.

Where will all these funds go? They’ll go down to the lower levels of society to capitalise those with productive virtue at the lower levels.

So I believe this is a genuine economics paradox. Whereas we think intuitively that the compound interest rate will be matched with excellence in resource allocation, I think it turns out that only perfection in policy would allow this. Whereas a pretty easy to design FEES-ONLY system would almost ensure this excellence.