Was the Usury Prohibition an Insurmountable Obstacle to the Development of Commerce and Finance - Essay Example

Was the usury prohibition an insurmountable obstacle to the development of commerce and finance? October 16, Table of Contents Introduction 51. Introduction 5 2. The practice of Usury and if it was an obstacle for commerce 7 2. The practice of Usury and if it was an obstacle for commerce 7 2.1. Usury and the Golden Age of the Dutch 9 2.2. Usury and Trade and Commerce in UK 15 2.3. Trade and commerce in Netherlands 21 3. Discussions 25 3. Discussions 25 4. Conclusions 29 4. Conclusions 29 References 33 References 33 1. Introduction Usury is the term used to describe unethical and immoral money lending at high interest rates. A loan, either in coins, or in kind such as grains, meat, ale, was considered usurious if the lender charged excessive interest1. The term excessive interest is often contentious, and the exact rate of interest that was termed usurious is often debated. All religions condemned usury, from the Hindu Vedas that date to 5000 BC, to Christianity, Islam, Judaism, Buddhism, and other religions2. The interest charged was 3-4 percent per month, and it often increased to 15-16 percent, 24 percent, or even 48 percent3. Many cities and cultures in ancient times, particularly Mesopotamia, Egypt and Phoenix, fixed an official rate of interest. However, a very high interest rate pushed the poor farmer, the trader, and the artisan into serfdom or into indentured services, where the borrower served the lender for life, and had his assets seized after one year and one day if the debt was not repaid, after the period of loan was over4. In medieval times, formal banks did not exist and the only people who had sufficient money were the Jews, landlords, and the church5. With this background, this paper examines the thesis question Was the usury prohibition an insurmountable obstacle to the development of commerce and finance? 2. The practice of Usury and if it was an obstacle for commerce Organised manufacturing, as seen in todays economy was not present until the industrial revolution. The society was mainly agriculture based with trading in food items, clothes and other such items. It was logical for a lender to expect adequate returns when he lent funds, and the borrower had no other means but to borrow from moneylenders who were often Jews6. Without funds, the trader or farmer did not have any means to continue his trade. This created a paradox since funds could be obtained only through loans, and if the lender did not obtain sufficient returns on the loans, there was little incentive to lend. Without funds, the trader and farmer could not continue their business7. At the same time, the government levied heavy taxes, and the additional burden of repaying the loans often turned the tenant farmer or the trader, into a vassal of the moneylender. Interestingly, while the government, the church, and other religious bodies forbade usury, they did not make funds available to the borrower. Moneylenders were regarded as outcastes, excommunicated, murdered, and persecuted8. A clear understanding is now developed on the perceptions and feelings about money lending. In the next sections, the development of commerce and economy of important nations in Europe is evaluated. The findings are then discussed to find out the relation between usury laws and the growth of commerce. 2.1. Usury and the Golden Age of the Dutch Denmark, one of the Scandinavian countries and isolated from mainland Europe, experienced the Dutch Golden Age in 1580-1650. Christianity was the main religion, and as with practices around the world, the church banned usury9. However, in this period, the Dutch economy grew rapidly and Denmark became a major force in international trade, agriculture, fisheries, manufacturing, dairy farming, and it developed a strong commercial and naval shipping infrastructure10. Most of the players in this field were individuals, and while the state supported commercial activities, it did not lend funds to private enterprises. The main question examined in this section is that in spite of the ban on usury, how did the Dutch fund the commercial activities?11 In Denmark and other European countries of the middle ages, an entrepreneur could only depend on friends, and the extended family for funds. Accordingly, large families of brothers, uncles, and cousins, worked together at various ventures, often borrowing funds from relatives, and repaying a fixed amount at specified intervals12. The problem was that the amount of funds available with friends was limited and usury laws prevented money lending13. The Dutch found a way out of this problem by developing partnerships with wealthy individuals, who were willing to invest funds in return for a share of profits14. The main issue that arose was of trust, and this lead to the development of debt and equity contracts that allowed lenders to give loans15. Some instruments that were developed include company contracts with limited liability and the development of the partenrederij16. This instrument was a contractual arrangement for the joint ownership of assets such as vessels for fishing vessels, manufacturing, transportation, or trade. The partenrederij was extended to other sectors such as paper mills, sawmills, peat exploitations, and to fund exploratory voyages to West Africa and Asia17. Shares of 2, 4, 6, and more percentages were given to investors18. Entrepreneurs also used the help of guarantors and pledged their property and business as collateral. Several firms specialised in offering guarantee and this helped to start the business of underwriting19. These developments brought in a huge infusion of funds, and helped the Dutch to move beyond their borders through trade voyages20. Since these commercial activities took a few years to yield profits, the borrowers often paid a fixed amount called annuities for each share that the lender held21. The Dutch government allowed the lenders, who held a share in a business to sell them to other investors, often at a premium, and under controlled conditions. These practices, helped in the development of the government recognised share market22. It becomes apparent that the ban on usury helped in the development of an alternative financial system, which was much more powerful than traditional money lending. The author of this paper would like to assert that the prohibition against usury actually helped in developing an alternative commerce and economic system. 2.2. Usury and Trade and Commerce in UK Medieval England was a difficult place to live, with very little commerce and trade, and the main businesses available were agriculture, fishing, weaving, and black smithy. Lords of various boroughs owned almost all the available land, forests, rivers, and lakes, forcing the farmer to perish in serfdom23. Money was available only with the Lords, and usury laws prevented them from lending funds to others. Protestant England levied very heavy taxes on tradesmen, and the paupers prison was the only recourse for the poor24. With renaissance, the situation changed, the rich started construction activities such as building manors, roads, and they opened up new areas for settlement. They paid farmers and tradesmen in coins, thus infusing some liquidity into the market25. Craftsmen soon started developing patents and selling their wares in other counties. However, for the majority of Britons, funding was scarce and they managed with funds, loaned by friends, relatives, and from Jewish underground moneylenders26. By the late 15th century, it became obvious that some workaround was essential to overcome usury laws27. In 1571, Queen Elizabeth passed a statute that allowed charging of interest rates of 8 percent, and this was reduced to 5 percent by 1713 before usury laws were abolished in 185428. By the 14th century, British traders started using Bills of Exchange as credit instruments, and traders could purchase these bills, obtain cash in exchange by paying a certain premium, sell and purchase foreign currency. An important theory that was developed during this time was that money was a commodity, whose value changed over time, depending on the demand, supply, metallic ingredients in the coins, and reputation of the nation the issued the coins. Several theories on trading, supply demand, exchange theory, and several other models, that helped to explain anomalies in profits, loss, and commerce, were developed29. By this time, the Dutch ruled the trade network, and enjoyed vast riches, and Dutch ships entered UK ports, exchanged goods, traded, and made huge profits. The British copied Dutch ship designs, their trading practices, and the concept of partnership firms, to overcome usury rules. By 1650, the 80 years wars had weakened the Dutch, and Britain stepped into the ready market, captured Dutch ships, and used the partnership instrument to form trading firms such as the East India Company30. The privately funded voyages helped in the discovery of new continents such as Americas, and new trade routes to India and the West Indies were established. New instruments called IOUs, which allowed loans for a time until the investments would yield profits, were drawn up. New practices such as companies acts, tax-free markets, income based taxation emerged and the government played a constructive role in managing the market31. Individual creativity, innovation, and inventions were encouraged, and this helped to pave the way for the industrial revolution. The industrial revolution helped in the launch of formal banks, which were allowed to charge fixed rates of interest and accept deposits from investors in return for profits32. The above discussions indicate that the ban on usury, and private money lending forced traders, shippers, and the investors to develop new financial systems. It is doubtful that if usury were allowed, these alternative systems would have developed. 2.3. Trade and commerce in Netherlands Netherlands, one of the Scandinavian countries, saw a huge rise in trade and commerce in the late 1500 along with a shift from feudalism to capitalism. While Christianity was the official religion, the rules and punishment against usury were harsh, and money lending for interest was discouraged strongly. Until 1400, the economy was mainly agriculture based33. However, with constant flooding of the countryside, the soil soon became less fertile, and it was clear that agriculture could not sustain its people. Small farmers, owned almost 80 percent of the lands, while big farmers, owned the rest34. With the usury laws in force, the small farmers could not borrow funds to till the lands, and a large number of labourers faced certain death and starvation. With the change in the agricultural patterns, and difficulty in paying labourers, several new industries were developed35. These included large-scale fishing, peat digging and dyking, shipping, textile, and breweries. Large traders supported these industries, and gradually they purchased the now vacant and infertile land. By the end of the 16th century, Netherlands had a very strong trade in non-agricultural products that contributed about 70 percent to the GDP36. The main argument proposed in this section is about the impact of usury laws on the agricultural society. It becomes obvious that while these laws prevented the farmer to access loans, the usury laws forced the development of alternative industries. 3. Discussions The previous sections have discussed the role of usury laws in three countries, Netherlands, Britain, and Denmark. A number of negative impacts about usury were evaluated. It is evident that usury laws thwarted growth of industry and commerce. However, human enterprise and the spirit of innovation helped to develop alternate systems that allowed lenders and borrowers to transact business. Funds were needed for trade to grow; therefore, traders, and investors, devised workarounds to overcome the usury rules. The workarounds included devising partnerships, creating complex investment instruments, selling shares in the firm, and developing alternative financial systems, which overcame usury rules. These alternative systems helped to fund and finance trade, ship voyages, and helped in the development of new theories and models on international finance. It is clear from the analysis in chapter 2, that law prohibited private lending of funds. Therefore, the trader, the craftsmen, and the ship builder needed funds from external sources. The only way possible was by forming partnerships with investors, who used collaterals, underwriting, bills of exchange, guarantors, and other instruments to ensure that their investment was protected when they lent funds. It is also obvious that some of these investors would have taken an active interest in the activities, to ensure that their funds were being used in the desired manner. Some investors even joined the board of directors, and played an active role in the business. Traditional moneylenders would not have shown an interest in running the company affairs, since they lent against collateral, which was seized, if the borrower defaulted. Therefore, the negative impact of usury laws in fact had a positive effect on the growth of trade and commerce. The link between usury laws and development of alternative economic systems, appear to have a clear cause and effect relation. If usury laws were not present, then borrowers would have turned to traditional moneylenders, borrowed funds at high rates, and the majority of them would have failed, and landed in debtors prisons. Another possibility is the finite amount of funds available with moneylenders and the percentage of their wealth, which they would be willing to lend on speculative undertaking. This is a hypothetical question, but it is clear that lenders would have limited their lending, and Europe would have remained in the dark ages for a much longer time. The author of this paper has attempted to link usury laws with the development of these alternative economic systems that led to the growth of international trade. The main question is if it can be claimed that these systems were developed only because usury laws prevented giving loans while charging interest. Another question that arises is that if the usury laws were not present, then would the world have never developed these economic systems? These are very important questions, but they are not the focus of this paper, and they would be answered in other papers. 4. Conclusions The thesis question that was answered in this paper is Was the usury prohibition an insurmountable obstacle to the development of commerce and finance? It is clear from the discussion in section 1 that usury was a despicable practice, associated with murder, and theft, and all religions forbade this practice. However, in a growing market, with a number of opportunities available, the innovative trader and shipper refused to sit silent and accept what the powerful church banned through canonical rules. Any attempt to break the rules would lead to excommunication, imprisonment, and seizure of the lenders property. Therefore, it is obvious that usury rules did present insurmountable obstacles to the development of commerce and finance. However, the spirit of human enterprise is strong, and has often led to improvisation, and workarounds. This is seen in the development of alternative financial systems and a parallel economy, where investors purchased a percentage of shares in a venture, thus providing funds to the enterprise. Several financial instruments such as bills of exchange were also developed, and these improvisations, allowed the investor and borrower to transact business while observing usury laws. These were the nascent beginnings of company laws, international trade, and the modern banking system. These systems were developed out of necessity, first in Denmark, where the system helped the Dutch to become market leaders, a position they lost because of wars that weakened their nation. Netherlands and Britain followed the financial structures, further refining them by creating bills of exchange, and within a couple of centuries, the money lender lost relevance, since private funds, income, equity, and prosperity among businesspersons grew. The economic scene was therefore ripe for the industrial revolution, and finally, the archaic usury laws were repealed. The answer to the research question therefore is that while usury presented obstacles to the development of commerce and finance, the barriers were not insurmountable. The business community developed alternative systems that allowed them to borrow and lend funds. The conclusion is that the negative impact of usury rules helped and encouraged the development of alternate economic and commerce systems. References Ashtor E A Social and Economic History of the Near East in the Middle Ages (OUP) [1976] 132-157. Bavel B "The Medieval Origins of Capitalism in the Netherlands" (BMGN LCHR 125 2-3) [2010] 45 Bland A English Economic History: Select Documents ( G. Bell) [1914 reprinted 1986] 17. Bon B "The jump-start of the Holland economy during the late medieval crisis, c. 1350-c.1550" (Economic History Review 57 3)[2004] 503-532. Boone M; Davids K; Janssens P Urban Public debts from the 14th to the 18th century. A new Approach, in: Urban Public Debts. 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