On Deducing Faith and Redemption from Usury with the Help of Automata

"That every man is desirous to obtain, with as little sacrifice as possible, as much as possible of the articles of wealth." -- Nassau Senior, 1827

In "Expectation and Rational Conduct" (1937) Terence Hutchison argued that Senior's "first fundamental proposition" shared "one remarkable characteristic" with "almost all" formulations of the utilitarian doctrine: "they appear further to postulate, and only are applicable if the further postulate is made, that all expectations are perfectly correct."

Now, this perfect expectation postulate can be -- and has been -- shrugged off as a merely heuristic "convenient approximation" that enables the economist "to study in isolation, tendencies which in the world of reality operate with many others" (Robbins, 1935). But, as Hutchison emphasized, the consequences of such a "simplification" are not so easily waved aside. He cited Frank Knight:

"With uncertainty absent, man's energies are devoted altogether to doing things; it is doubtful whether intelligence itself would exist in such a situation; in a world so built that perfect knowledge was theoretically possible, it seems likely that all organic readjustment would become mechanical, all organisms automata."

Hutchison followed this quotation with the observation that it is misleading to attribute rationality to "this sort of conceptual marionette" because the decision process becomes superfluous when results are known beforehand. In one example, he compared the logical impossibility of perfect expectation to the liar's paradox: "A person's conduct cannot both be given to someone else who may adjust his own accordingly, and still be adjustable by the person."

1937 was a banner year for economic articles addressing uncertainty. In addition to Hutchison's article, the following were published: Coase's "The Nature of the Firm," Hayek's "Economics and Knowledge" and Keynes's response to critiques of his General Theory in The Quarterly Journal of Economics. In his article, Keynes observed that uncertainty about the indefinitely distant future renders the accumulation of wealth "a peculiarly unsuitable subject for the methods of the classical economic theory." Of course that "peculiarly unsuitable subject" happened to be none other than the very one the classical theory purported to illuminate -- with, as Senior put it, "certainty and universality."

"Exactly a year before Nassau W. Senior discovered at Manchester, that the profit (including interest) of capital is the product of the last hour of the twelve, he had announced to the world another discovery. 'I substitute,' he proudly says, 'for the word capital, considered as an instrument of production, the word abstinence.'" -- Karl Marx

Abstinence was the basis of Senior's theory of interest. Interest is a payment to the lender of money for the service of abstaining, for the time being, from consumption. According to Waterman, Senior "was the most important writer on scope and method among the classical economists, and the one whose work was most influential for the twentieth century development of economic methodology."

Some 26 years after Senior delivered his inaugural lecture at Oxford, Cardinal Newman, in his inaugural lectures at the Catholic University of Ireland, rebuked Senior for the presumptuousness of the claims he had made on behalf of political economy. Newman characterized Senior's argument as "just so far true, as to be able to instil what is false."

Newman quoted Senior's assertion that "The endeavour to accumulate the means of future subsistence and enjoyment, is to the mass of mankind, the great source of moral improvement." Newman interjected to exclaim that Senior had rated the pursuit of wealth as "not merely a source, but the great source" of not merely "social and political progress—such an answer would have been more within the limits of his art,—no, but of something individual and personal, 'of moral improvement.'"

That was only the warm up. To Senior's claim that "No institution could be more beneficial to the morals of the lower orders... than one which should increase their power and their wish to accumulate..."  Newman observed that this excluded Christianity, "for it expressly says, 'Lay not up to yourselves treasures on earth... for where thy treasure is, there is thy heart also."

"But it is not enough that morals and happiness are made to depend on gain and accumulation," Newman exclaimed, continuing:

"...the practice of Religion is ascribed to these causes also, and in the following way. Wealth depends upon the pursuit of wealth; education depends upon wealth; knowledge depends on education; and Religion depends on knowledge; therefore Religion depends on ‘the pursuit of wealth.'"

Thus did Nassau W. Senior deduce faith and redemption from usury, while redefining usury as "abstinence." Medieval canon law strictly condemned usury and prescribed excommunication as the punishment for usurers, excluding them from the sacraments of the church and the from society of other Christians. How did such a remarkable doctrinal reversal, from sin to sacrament, come about?

The history of double-entry bookkeeping offers a clue. Surely one of the motivations for early modern merchants to adopt the novel and challenging technique was to "prove an alibi" against suspicions of usury. Some of the financial instruments for evading the prohibition were complicated, to say the least:

"The canonist doctrine on usury had a profound influence on business practices, since interest could not be charged openly but had to be concealed under some form or other. As a result of the usury prohibition, bills were never discounted but were bought at a rate of exchange which fluctuated up and down according to the conditions prevailing in the money market. There is no doubt that interest was received by the banker who invested his money in the purchase of bills, for a hidden interest was included in the rate of exchange. Because of this subterfuge, the structure of the money market was such that exchange fluctuations were caused either by a change in the rate of interest or by a change in the terms of international trade."

... 

"The ledgers of medieval bankers do not contain any account called Interest Income. Nor is there any account for Interest Expense. It is true that the Italian merchant-bankers often paid interest on time deposits, but it was called deposit, discrezione, dono (gift), guadagno (gain), or provedigione (commission). The use of the word 'interest' itself was avoided like the plague. 

True, interest was concealed in the exchange rates, but the presence of the interest factor was boldly denied. The merchants argued -- and the canonists agreed -- that exchange transactions did not involve a mutuum or a loan of money for certain gain. It is quite true that the profit on individual exchange transactions was uncertain.

And so, we return at last to uncertainty, this time as an alibi for the certain gain of usury. But I have interrupted de Roover's narrative. There is more:

"As the analysis of our data reveals, it did happen that occasionally the lender lost. Nevertheless, the reasoning of the canonists was fallacious: they overlooked an essential point, namely, that the presence of the time factor tipped the scales in favor of the banker. While he suffered a few losses, the banker was bound to gain on most transactions, if he was a clever and cautious manager. Losses occurred only when the exchange rates were not in a position of equilibrium. Such a condition could not persist over a long period of time, for the economic forces of the money market automatically tended toward the restoration of equilibrium."

de Roover possibly overstated the case for the automatic restoration of equilibrium. But his point remains valid that the usual tendency toward equilibrium in the foreign exchange market favored the banker "if he was a clever and cautious manager."

Sections 5 and 6 of Hutchison's article address, respectively, "Perfect Expectation and Equilibrium" and "The Assumption of a 'Tendency' Towards Equilibrium." "The position of equilibrium," he argued at the beginning of section 6, "has always been the very central concept of economic analysis." In section 5 he had cited Oscar Morgenstern's argument that the postulate of perfect expectations "may give a nonsensical indeterminate situation the very reverse of equilibrium." Conversely, Knight, Hicks and Pigou argued that the postulate of perfect expectation is necessary for equilibrium theory.

Leaving aside some ostensively universal political economy and thinking instead in terms of Venetian merchant-bankers' interest on loans -- interest concealed within rates of exchange -- uncertainty, perfect expectation and the tendency toward equilibrium all play their roles in assuring both probable profit and usurious deniability to the bankers. The probability of gain is a qualitative one and thus not calculable. All the better to allay suspicion.

This just in: At the end of an appendix to Significance and Basic Postulates of Economic Theory, Hutchison remarked, "It must always be remembered that laissez faire and equilibrium doctrines had their origin in rationalistic Utopia-building." In the footnote to that comment, he cited the 1931 article by S. Bauer, "Origine utopique et métaphorique de la théorie du “laissez faire” et de l’équilibre naturel." Below is an abstract of that article:

9538. BAUER, STEPHANE. Origine utopique et métaphorique de la théorie du “laissez faire” et de l’équilibre naturel. [Utopian and metaphoric origin of the theory of 'laissez faire' and of natural equilibrium.] Rev. d’Êcon. Pol. 45(6) Nov.-Dec 1931: 1589-1602.

A re-examination of the origins of laissez faire gives rise to three observations: (1) the theory of laissez faire was originally conceived as a utopia; (2) it developed as an abuse of a metaphor; (3) this utopian metaphor has perpetuated itself into the 19th century in the guise of a theory of equilibrium. Economic laissez faire was utopian, i.e. far from the facts, and purely intellectual in origin, since both in France and England the corn markets of the 18th century were regulated. The metaphoric use of laissez faire carried over from the Pyrrhonean theory of medicine was current not only in Boisguillebert, d'Argenson, Gournay, and the Marquis of Casaux but is found in and old Spanish book by Balthasar Gracian, Oraculo Manual (1647) which was translated into French and was very popular in the 18th century. Indeed the whole concept of the sovereign and perfect character of nature can be traced through the Renaissance back to the Stoics. The medical analogy marks the work of the Physiocrats, of Adam Smith and of Cournot. Rodbertus protested against this point of view by setting "anthropocracy" in opposition to "physiocracy." Further protests are coming from those who explain economic phenomena in terms of economic institutions rather than in terms of deviation from a rigid system of equilibrium.