So world leaders (note: 20 of them) have agreed to come together in a first ever meeting of the G20 to discuss a restructuring of global financial market systems. Finally, economic and politically minded people everywhere are revisiting the decisions that have shaped our global economy into the fertile soil for crisis that it has become.

Milton Friedman's legacy is under attack. The concepts of nationalism and socialism in the state are not only being reconsidered, they are being re-instituted as we speak (the nationalization of big banks globally). Hayek is turning in his grave, Ronnie and Maggie appear to have missed something. John Galbraith's name has been brought out from behind the dusty shelf, the dust washed off, his name placed high on the wall. We are wondering if Keynes was right about the entire market economy thing. Adam Smith's invisible hand seems to get slapped more often than not, ya?

What I want to know is how does the concept of (interest) fit into this. Why interest, why do I care? Well, I like to look at every angle and it seems to me the role of interest in economics is an issue debated from time immoral. What exactly is its role in our economy? How does it achieve that role? Does it come with any side effects? Are there alternatives to an interest system? Do they work? How can we improve our system to make it more efficient, less volatile and, in as much, balanced?

Fortunately, while looking with interest into interest I found it right interesting and flat out easy to find information on. Here's what I found. The Romans outlawed it, the Muslims hate it, Keynes recognized its place in economics, but warned against certain side effects.

The general arguments against interest are that it redefines the role of money from a currency to a product. Money, having the capacity to earn when saved, gets saved and, in such has multiple effects, a) it tends to pool in the coiffures of the wealthy, decreasing the velocity with which it moves through the economy, decreasing the money supply and in many ways stifling economic activity, b) by acting as a store of value it creates a new class of earner, the so-called (functionless) earner and c) as a store of value it drives up the demand for itself and creates inflation.

In addition, interest-free bankers in Northern Europe (the founders of the modern day credit union) point out that interest promotes the movement of capital from areas where it's sorely needed to areas where it's more safely put to use, causing the erosion of environment and marginalization of society. (see: Jak and: Jak on Wiki)

Further, Muslim economists declare that interest creates inequality and injustice while undermining liberty, by rewarding the lender with an increase in wealth without his/her participation in the risk. They also believe that lending to money to large pools of money is naturally less risky than lending to small pools of money, tilting the ability to access credit in favor of big business.

Okay, so what is exactly is the purpose of interest? Why does it exist? For an answer to this one I returned John Maynard Keynes, the father of modern economics. Keynes it turns out was quoted and leaned on by both fascist and socialist, the two extremes of conservative and liberal thought (please correct me if I'm wrong.)

Keynes noted that interest created an initiative for investment and acted as a reward to commercial banks for creating a media of payment. And in as much when we look at the Islamic banks that sprang up in the 70's, many of which still survive to today we see that they avoided the use of interest by replacing it with a myriad of financial (tricks,) discounting, trading and profit and loss sharing, which, in the end, could be said to have simply renamed interest and caused only a nominal difference in the political economy.

What's more, Islamic banks have well known difficulties participating in long-term low yield projects, financing the small businessman, granting non-participating loans to running businesses and financing government borrowing.

So it seems that interest has a key place in the political economy, it encourages investment, rewards commercial banks for managing our media of payment (without the need for their nationalization, which may breed its own set of problems,) and, through a central banking system that can lower and raise rates, allows for increases and decreases in money supply. However, it clearly comes at the cost of marginalizing society, creating a (functionless) class of taxpayer, driving up the value of money and, as we are all now aware, causing volatility in our economic environment.

So before I get to the point of this note, let me make one last, hopefully interesting, observation: we are not going suddenly up and do away with interest. So how can we fine tune its place in the economy?

For this one I found myself looking at another aspect of the interest system, primarily the introduction of money supply into the economy. As most of us are likely aware, money is created when banks award loans. As banks are called upon by legislation to keep reserves which they lend against, each loan created becomes a deposit in another bank which can then increase its loaning capabilities, creating another deposit in yet another bank and so on and so forth. (Note: The Peoples Bank of China alternates their reserve ratio requirements as a means of managing money supply.)

I found a link to an article on a New Zealand interest-free banking site about this function:

(Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the change in excess reserves of $90 into a maximum of $1,000 of money ($100+$90+81+$72.90+...=$1,000), e.g.$100/0.10=$1,000. In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of ($100+$80+$64+$51.20+...=$500), e.g.$100/0.20=$500. Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity.)

The above function has been toted to, with the help of the propensity for interest systems to concentrate wealth, create an inherent instability in our economy.

It might be noted that our Canadian banks have a higher reserve requirement (with respect to M1 and M2 classifications) than American or even British banks (again please correct me if I'm wrong.) This, and our more conservative appetite for risky investing in dodgy bundle mortgages, is undoubtedly a contributor to our, shrinking dollar aside, strong economic position today.

To the point! We looked at has a function and its alternatives don't appear much better. Now how do we reel in the side-effects? Can we add more stability to our economy by insisting on higher global reserve ratios? What about increasing our money supply directly, like Roosevelt did with his (New Deal?) Would putting money directly into socially beneficial construction projects stimulate the economy without marginalizing society, overly concentrating wealth and hampering economic stability?

How about capping the big dollars at the top of the food chain? Do we take action to reduce corporate bonus packages that increase the concentration of wealth to unhealthy economic proportions? Do we, as peoples of the North American continent, support the creation of interest-free banks, who allow the benefits of credit to improve those portions of the economy (important portions) that are marginalized? Please feel free to comment if you have any thoughts about this interesting topic.