Adam Smith On Usury  

Past Peak has some interesting notes on Adam Smith, free markets and the cause of the credit crunch - Adam Smith On Usury.

Conservatives love to invoke Adam Smith — most of them, I'm guessing, without ever having read him. They've heard the phrases "invisible hand" and "division of labor" and that's about it. They imagine an Adam Smith who would endorse their idea of unrestricted and unregulated capitalism. Not so.

Yves Smith at nakedcapitalism has an excellent Adam Smith quote that is the perfect companion piece to the Infinite Debt post from last week. Old Adam nails it:

Adam Smith, in The Wealth of Nations, advocated usury laws (limits on interest rates) because they would promote lending to prudent borrowers and productive projects, which was better for society as a whole:

The legal rate...ought not be much above the lowest market rate. If the legal rate of interest in Great Britain, for example, was fixed so high as eight or ten per cent, the greater part of the money which was to be lent would be lent to prodigals and projectors [promoters of fraudulent schemes], who alone would be willing to give this high interest....A great part of the capital of the country would thus be kept out of the hands which were most likely to make a profitable and advantageous use of it, and thrown into those which were most likely to waste and destroy it.

When the legal rate of interest, on the contrary is fixed but a very little above the lowest market rate, sober people are universally preferred, as borrowers, to prodigals and projectors. The person who lends money gets nearly as much interest from the former as he dares to take from the latter, and his money is much safer in the hands of the one set of people than in those of the other. A great part of the capital of the country is thus thrown in the hands in which it is most likely to be employed with advantage.

Now before you say this approach discriminates against the poor, banks like ShoreBank of Chicago, and not for profit mortgage lenders extend credit to lower income individuals with loss rates in line with prime borrowers, It takes (gasp) borrower education and in person screening, something most banks eschew.

Mortgage lenders didn't pump out subprime mortgages out of the kindness of their hearts or because someone made them do it. They did it because that's where the high interest rates were. The same way that credit card companies handed out credit cards to anyone with a pulse. If you were someone who'd have a hard time paying off your balance, so much the better. That's where the high interest rates were.

And now the rest of us are left to pick up the pieces. Which is one reason why usury laws have existed for centuries — until very recently — and why we need them again.

But before we leave Adam Smith, here are some comments Noam Chomsky made in an interview:

[Adam Smith is] pre-capitalist, a figure of the Enlightenment. What we would call capitalism he despised. People read snippets of Adam Smith, the few phrases they teach in school. Everybody reads the first paragraph of The Wealth of Nations where he talks about how wonderful the division of labor is. But not many people get to the point hundreds of pages later, where he says that division of labor will destroy human beings and turn people into creatures as stupid and ignorant as it is possible for a human being to be. And therefore in any civilized society the government is going to have to take some measures to prevent division of labor from proceeding to its limits.

He did give an argument for markets, but the argument was that under conditions of perfect liberty, markets will lead to perfect equality. That’s the argument for them, because he thought that equality of condition (not just opportunity) is what you should be aiming at. It goes on and on. He gave a devastating critique of what we would call North-South policies. He was talking about England and India. He bitterly condemned the British experiments they were carrying out which were devastating India.

He also made remarks which ought to be truisms about the way states work. He pointed out that its totally senseless to talk about a nation and what we would nowadays call “national interests.” He simply observed in passing, because it’s so obvious, that in England, which is what he’s discussing — and it was the most democratic society of the day — the principal architects of policy are the “merchants and manufacturers,” and they make certain that their own interests are, in his words, “most peculiarly attended to,” no matter what the effect on others, including the people of England who, he argued, suffered from their policies. He didn’t have the data to prove it at the time, but he was probably right.

This truism was, a century later, called class analysis, but you don’t have to go to Marx to find it. It’s very explicit in Adam Smith. It’s so obvious that any ten-year-old can see it. So he didn’t make a big point of it. He just mentioned it. But that’s correct. If you read through his work, he’s intelligent. He’s a person who was from the Enlightenment. His driving motives were the assumption that people were guided by sympathy and feelings of solidarity and the need for control of their own work, much like other Enlightenment and early Romantic thinkers. He’s part of that period, the Scottish Enlightenment.

The version of him that’s given today is just ridiculous.