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04 Lending and Borrowing

Commodities and Capital

The difference between 03 Utility and Exchange Value has already been discussed. But utility value may be analysed further. There can be utility value from the consumption of a thing and utility value from the possession of a thing;
  • Utility value in the consumption of a thing, i.e. a bowl of rice.
  • Utility value in the possession of a thing because the thing performs a process that increases value or it prevents a process that decreases value, i.e. a factory or an umbrella.
  • Utility value in the possession of a thing because possession confers social advantage or prevents social disadvantage i.e. a royal seal or a passport.
  • Utility value in the possession of a thing because the thing provides pleasure or prevents pain i.e. a necklace or a sun hat.
Things that have primarily consumptive utility value I shall define as primarily commodity items and things that have primarily possessive utility value I shall define as primarily capital items. i.e. There is little value in the possession of rice, the value is primarily in its consumption, and there is little value in the consumption of a factory, the value is primarily in its possession. 
Gold is an interesting case because its exchange value is so high yet its utility value is so low. So by the above definition, if there is use value in its consumption then it is a commodity and if there is use value in its possession then it is capital. The decision I leave to you!
Of course utility value will effect exchange value also.

Products and Services

Some capital items return products that can be used at any time now or in the future, but some capital items return services which must be used immediately and cannot be preserved for the future. i.e. a factory produces goods which last but a house provides shelter which is consumed immediately by the occupants.

Off Market and On Market

Some products and services produced by capital, will be sold on the market, these I call on market products and services. Those that are never put on the market are off market products and services, i.e. when we own a house that we live in then the service provided by the house is off market. If we rent out the house then the service it provides is on market. This distinction is important because what is brought to market effects the market price.
One may examine the total price of all on market products and services from the capital of a given economic body or domain. One may also consider an estimated total price for all off market products and services from the capital of a given economic body or domain to get some idea of the value of the benefit that body or domain enjoys. (There is some disagreement about the use of Gross Domestic Product of a country as an indicator of living standard as a result of difficulty in considering off market products and services in the country.)

Lending and Borrowing

There is no value in lending/borrowing a commodity, i.e. why would one want a sack of rice only to return it the next week. But there is value in lending/borrowing capital, i.e. borrowing an umbrella for the week will be useful because there is a risk it might rain.

(The above is not strictly true. As short sellers often borrow commodities in order to trade with them but this isn't strictly borrowing.)
Capital has a return of value for the possessor of it. Because of this there is a market for lending and borrowing capital, i.e. for ten chickens I will borrow a plough for a week. Essentially one is selling or buying the return on the capital that is lent or borrowed, respectively. Loan contracts can vary widely in terms of the rights and responsibilities of the lender and borrower.
When a capital item is lent there can be a direct return to the lender such as when a field is lent and a fraction of the crop is returned to the lender, or there can be an indirect return such as when chickens or money are given in return for the loan of a plough.
In an economy money its self can be borrowed. Money is not capital or a commodity as I have defined it but it confers a right on the barer to obtain capital or commodity. Money is a second order valuable which confers a right on the bearer to obtain a first order valuable i.e. an item that has value in its own right. 

This creates a number of cases;

  • First order direct return loan - A capital item is loaned for a share in the return from that capital item. i.e. Lending a field for a share in the crop.
  • First order indirect return loan - A capital item is loaned for a return that is not related to the return from that capital item. i.e. lending a plough for a number of chickens.
  • Second order direct return loan - A sum of money is loaned for purchase of a capital item for a share in the return from that capital item. i.e. I cannot think of any case of this.
  • Second order indirect return loan - A sum of money is loaned for purchase of a capital item for a return that is not related to the return from that capital item. i.e. A sum lent for a house purchase the return being interest paid for out of a salary. Here the borrower is exposed to changes in the price of the capital item.
When money is loaned the use of that money is left up to the borrower, there is no guarantee that the borrower has even purchased a capital item, they may purchase a consumable commodity intending to repay the debt by other means. It is because of this that for a great part of history, lending money for interest was illegal and was a sin known as usury. See Wikipedia: Usury, and Lombard bankers.

The Lending Market

In modern economies probably the most important form of lending/borrowing is of money for money. The amount of money lent is called the "principle" and the additional money returned is called the "interest". The interest divided by the principle for a given period is the interest rate, normally defined as a percentage per year.

The Interest Rate

The interest rate should be determined by the lending/borrowing market. The interest rate on loans with a significant risk of default will be significantly higher than the base interest rate.

Money lenders will seek out borrowers bidding the highest interest rate while borrowers will seek out lenders offering the lowest interest rate. What interest rate borrowers can bid should be determined by what capital items they can buy and what returns those capital items will bring. However in practice the understanding of lenders of the lending risks will severely restrict what capital they can invest in i.e. it is hard for a non-technologist to make good investment decisions in relation to technology, uncertainty leads to many variations in , for example, technical share prices. Banks have specialists who only deal in shares within particular sectors.

In a free market the interest rate would be the result of the return on capital but in the modern economies it is the central banks that determine interest rates. The result is that they can distort the market for better or worse.

Temporary imbalance and the restorative force of interest

In exchange transactions there is always a balance in the flow of things, in that all parties to the exchange must contribute something and in return receive something.

However where loans are involved the balance of flow is offset by the loan. While a debt exists the debtor must maintain a flow of value to the creditor as interest for the debt, until the debt is repaid.

This means there is an incentive for the borrower to repay the debt, a restorative social force, however there can also be an incentive for the lender to maintain the debt or to try to get others in debt!

The Effects of Investment/Debt

Lending may provide vital liquidity to allow some body to make a profitable transaction that they otherwise could not make, or it may provide liquidity to allow some body to make an unprofitable transaction leading them further into debt.

Lending may provide vital liquidity for trade rings that otherwise could not complete. See Liquidity Problems

Money facilitates, what should be only temporary, imbalance in the economy to allow the execution of trades that otherwise would not execute and thus allowing trade ring fragments to grow and eventually complete.

The danger is where what should be temporary becomes permanent and trade ring fragments grow that have no hope of completion making the final crisis worse when it comes.


Debt can finance bubbles that may grow far bigger than they might otherwise have done. See The Housing Bubble Since the year 2000 Housing bubbles have been promoted in Peru and Romania and we have watched as prices multiplied by 5 to 10 times. This leads to servitude to the money lenders. Please note that there are also more positive forms of money lending to finance the building of genuinely productive capital items.

The promotion of bubbles financed by loans is good for other banks as they are in the business of lending money and the more they can lend the better their business. Efforts are always afoot to lend money to those that will never pay it back but will not default either.


Borrowing should only happen when the increases in productivity are sufficient to pay the interest and the debt, or subordination of the debtor to the creditor will result.

Some bodies deliberately set out to subordinate others through manipulation. Lending can be a means of subordinating bodies from people to nations. The only risk is default. More about this under the heading Economic Health.

Bad as opposed to good money lending has been around a long time. Matthew of Paris wrote in The Usury of the Cahorsins in 1235;

 "In these days prevailed the horrible nuisance of the Caursines, to such a degree that there was hardly any one in all England, especially among the bishops, who was not caught in their net. Even the king himself was held indebted to them in an incalculable sum of money. For they circumvented the needy in their necessities, cloaking their usury under the show of trade, and pretending not to know that whatever is added to the principal is usury, under whatever name it may be called.... "

The real Caursines were capitalist Christian bankers whose clients were the rich and powerful in society. In England their unpopularity was due to their officiating as papal brokers, and to the heavy rates of interest they charged.

Islamic Banking

Islamic banking which has expanded since the 1940s does not agree with the charging of interest on monetary loans.

Where as with a conventional mortgage a sum of money is borrowed and the house belongs to the buyer, with an Islamic mortgage the bank buys the house from the seller outright for a price. The bank then sells the house to the buyer for a higher price but to be paid for over a number of years, the buyer only owns as much of the house as they have paid for while the bank owns the rest (or rather investors in the bank). Thus if the house price changes or interest rates change it has no effect on the contract between the buyer and the bank. The buyer continues to pay the fixed instalments for the fixed duration.

If the buyer defaults i.e. fails to pay with an Islamic mortgage then the property will be sold and the buyer will get the money for the share they have paid for while the bank will get the rest.

The following links give more information on Islamic banking;
Islamic banking stops bubble lending by insuring that the lender shares the risk of the capital item with the borrower. Western banking has promoted housing bubbles across the world simply in order to lend and get interest. I recall an airport business magazine in about 2003 talking about expanding the mortgage market in Romania. Since then property prices multiplied 800% but have subsequently halved due to the credit crunch. Of course banks that lent recklessly i.e. without consideration of the capital items they were lending for, have now been left with a significant default risk and also devalued collateral. From Wikipedia - Islamic Banking;

Shariah-compliant assets reached about $400 billion throughout the world in 2009, according to Standard & Poor’s Ratings Services, and the potential market is $4 trillion.Iran, Saudi Arabia and Malaysia have the biggest sharia-compliant assets. In 2009 Iranian banks accounted for about 40 percent of total assets of the world's top 100 Islamic banks. Bank Melli Iran, with assets of $45.5 billion came first, followed by Saudi Arabia's Al Rajhi Bank, Bank Mellat with $39.7 billion and Bank Saderat Iran with $39.3 billion. Iran holds the world's largest level of Islamic finance assets valued at $235.3bn which is more than double the next country in the ranking with $92bn. Six out of ten top Islamic banks in the world are Iranian. In November 2010, The Banker published its latest authoritative list of the Top 500 Islamic Finance Institutions.

Islamic banking may be considered a threat to western banking and this would be another reason to target Iran!

Price, Offers and Bids

The market for borrowing and lending is much like the market for buying and selling, so readers may want to skim this section.

In the selling and buying market;

Given a market in a particular type of valuable typically there will be bodies offering to sell at or above certain prices and bodies bidding to buy at or bellow certain prices.

There will also be those who are selling or buying at the market price. In other words they are selling by accepting a given bid to buy or buying by accepting a given offer to sell.

In the lending and borrowing market;

Given a market in lending and borrowing typically there will be bodies offering to lend at or above certain prices and bodies bidding to borrow at or bellow certain prices.

There will also be those who are lending or borrowing at the market price. In other words they are lending by accepting a given bid to borrow or borrowing by accepting a given offer to lend.

In the lending and borrowing market the price might be a fixed based on a fixed amount of money borrowed for a fixed period, or it might be expressed as an interest rate, but otherwise what is said below is repeated

So a market generally consists of offers to lend, bids to borrow with others who choose to accept and thus fulfil the bids to borrow and offers to lend. So the market lending price is set by the lowest offer, while the market borrowing price is set by the highest bidder. The difference is the spread.

Once the lowest offer for lend has fulfilled then the next lowest offer becomes the new market lending price. The lending price has risen.

Once the highest bid to borrow has been fulfilled then the next highest bid becomes the new borrowing price. The borrowing price has dropped.

So the market lending and borrowing price change. Also of course new offers to lend and bids to borrow are put on the market, often trying to undercut the market lending price or better the market borrowing price.

In theory at least...

The reality of this market are more complex as there are many ways money can be lend and attached to different types of loan are different probabilities of default.

(C)2010 Tom de Havas. The information under this section is my own work it may be reproduced without modification but must include this notice.

Subpages (1): The Housing Bubble