"It is not from the benevolence of the butcher, the brewer or the baker, that we expect our dinner, but from their regard to their own interest." - Adam Smith
Adam Smith's simple observation is very difficult to understand given human tendency to ascribe morals to every action. We are indoctrinated from an early age. For example, sharing is "good", shouting is "bad". These moral undertones, although helpful in preserving the social fabric, ensure that any economic discussion generates more heat than light. To understand how difficult it is to grasp and apply Smith's principle, consider the object of almost universal opprobrium, the village moneylender. He also acts from regard to his own interest but is reviled whereas the butcher, brewer and baker are considered to be upstanding members of village society performing useful "social" service. But doesn't the moneylender charge an usurious (an adjective which aptly demonstrates the point about actions being bestowed with moral connotations) rate of interest to the poor (another adjective with moral connotations) farmer? This question presumes moral failure even before an answer is made.
Morals ascribed to an activity are transient. What was unacceptable a hundred years ago is commonplace now and vice versa. However, the poor moneylender has been vilified throughout history. In our current modern society he has transformed into the reviled banker. The "good" butcher, brewer and baker have become the the industrial sector. This is apparent from the nostalgic romanticism of politicians as they wax eloquent about "making stuff" rather than "moving money" as a way to generate "fair" economic growth. These moral judgements conveniently forget the image of Victorian industry, from whose excesses rose Marxism. Quite ironic in light of Charles Dickens' 200th birthday celebrations. Forgotten too is the nostalgia and hankering for a simpler agrarian life which accompanied the rise of industrialisation.
The intrusion of morality into the economic sphere is partly explained by the human tendency to latch on to the certain past and believe it to be better than the uncertain present. This is especially acute in times of crisis. Witness the nostalgia of people living in tumultuous ex-communist countries about erstwhile hated communist regimes. However, it does not explain the enduring hate towards the moneylender or his modern equivalent, the banker.
This hate and the implied assertion of moral failure is due to three main characteristics of money which make a dealer in money (moneylender/banker) unique. The first is its infinite life. The second is its status as medium of exchange. The third, which proceeds from the first two, is the fact that it acts as a store of value. (Standard economics defines money only in terms of the second and third characteristic as infinite life greatly complicates academics).
These characteristics are more easily understood through considering a simple village economy where there is only one person for each job, i.e. one baker, one butcher, one farmer and so on. In this economy, money is the only commodity which can be stored to last forever. The produce of the farmer, butcher, baker decay after a short period of time. In contrast, gold bars last forever. In addition, as a medium of exchange, money confers on everyone the ability to exchange their produce, whether labour or goods, for money. Thus the moneylender can easily be repaid by all for his moneylending services. In contrast, everyone else has to convert their produce to money and then use that to pay for goods and services they consume. Therefore, the moneylender is in a position to accumulate his produce while the others are not. They can only store their surplus produce by converting it to money (with the exception of labour which cannot be stored). And they will store this surplus as money due to its durability and status as medium of exchange. This leads to money becoming a store of value. Assuming there is no inflation, the farmer knows how much wheat to set aside and sell for gold now to buy seeds for the next planting season.
To see how these three characteristics favour the moneylender, one has to look at the accumulation of money in the economy. Assuming a fixed quantity of money circulating in the economy, any producers which generate a surplus over their consumption will be matched by those who generate a deficit. Those producers who generate surpluses will store them as money. Unless they lend this money, and become moneylenders themselves, their accumulation of money will be solely dependent on their surplus produce from one time period to the next. Those who generate a deficit will borrow from the moneylender and repay him a larger sum of money (interest) from their surplus in future. To simplify greatly, assume that over time surpluses and deficits largely cancel out at the individual level. The result is a net accumulation of money by the moneylender due to charging of interest.
For a more modern capitalist economy, the assumption of surpluses and deficits cancelling out can be dropped. This leads to a situation where there is a rise of the wealthy at one end and indentured labourers at the other. Further assume that the wealthy lend their surplus money to the moneylender who then lends them out at a higher rate to those who need it. Voila, the village moneylender has become the modern banker. Even now, a part of the future produce of borrowers is taken by the bankers. As long as there are borrowers (and there always are) the banker accumulates money.
This net accumulation which comes about with little physical exertion leads to moralising about the "evil" of charging interest. If borrowed money is repaid in future then why should there be a charge? Why doesn't the moneylender perform physical labour to earn his daily bread like everyone else in the village? This line of thought not only ignores repayment risk but also assumes that the moneylender is not providing a service. What if the baker borrows money and then leaves the village or dies or his bakery burns down making him unable to repay the moneylender? Also the butcher, brewer or baker don't give their produce free of charge. Then why should the moneylender do such a thing?
Even if the argument is accepted that interest is a charge for risk and for services rendered, the rate of interest becomes a moral bone of contention. However, interest rate is simply a function of the characteristics of money and the market in money in the village. The price of money, i.e. the interest rate, is limited by the number of suppliers (moneylenders) and what people are willing to pay rather than make alternative arrangements (eg. a farmer may promise wheat in future for bread now rather than borrow money to pay for it if the moneylender's rate of interest is too high). As there is a monopolistic supplier in the village the rate will be as high as the market can bear. Similarly, the farmer is also free to increase wheat prices. But the price limit for the farmer is much lower since there are no alternatives to food consumption (therefore increasing the price too much will lead to social breakdown as villagers seize the wheat forcibly). The moneylender may be bypassed, the farmer cannot be.
Thus the unique characteristics of money lead to a moral veil being cast on an economic activity. The moneylender or the banker is serving his own interest similar to other people. Therefore, singling this one profession out for moral outrage and sanction is uncalled for.
This does not mean that banks and bankers can be absolved of all blame for the recent and present crises. However, rather than vilifying bankers and snatching their bonuses and honours, thought must be given to reforming the incentive system for the entire economy. We confront a systemic problem which is yet to be tackled. Short-termism led politicians to buy votes through supercharging economic growth by ensuring freely available cheap credit. A bid to keep up with the Joneses led to dishonest behaviour. Ayn Randian dogma ensured speculative excesses continued and regulators looked the other way. Finally it all culminated in large private gains and commensurate public losses. Scapegoating is not the solution for this. And if we are being so morally judgemental, let he who has not sinned cast the first stone.