CHAPTER IX.

Interest and Nett Profit identical—Circumstances which occasion Variations in the Rate of Interest—Impolicy of Usury Laws.

When an individual, instead of employing his own capital, lends it to another, he stipulates for a certain annual premium or return, which has been denominated interest.

In the preceding chapter we have considered profits as they are usually considered—that is, as consisting of the produce, or its equivalent, remaining to the undertaker of any sort of work, after his various outgoings have been replaced. But to ascertain the relation of profits and interest, this residue must be further analysed. Now it is obvious, that it consists of two portions, whereof one is the return to the capital employed, and the other the wages or remuneration of the capitalist for his skill and trouble in superintending its employment, with a compensation for such risks as it may not have been possible to provide against by insurance. Hence the distinction between gross and nett profits. The first comprises the wages of the capitalist, the return to his capital, and the compensation now alluded to, while the second consists of the return to capital only. In laying it down, when treating of the “Accumulation and Employment of Capital,” that high profits are the best criterion of national prosperity, we had gross profits only in view. And it is, indeed, evident, that the condition of those engaged in industrial undertakings depends on the magnitude of the produce or sum remaining to them, after their various expenses are deducted, without being in any degree influenced by the names they may give to portions thereof.

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When the parties to a loan are left, without any sort of interference, to adjust its terms, and when the security offered by the borrower is unexceptionable, and payment may be had on the shortest notice, the interest that will, under such circumstances, be stipulated for the capital or money advanced, will be identical with the rate of nett profit at the time. The lender having nothing to do with the employment of the loan, is not entitled to any compensation on that head; but he is entitled to all that can fairly be considered as the return to it after the risks, wages, and necessary emoluments of those who undertake its employment, are deducted; and this much he will get, and no more. Whatever else may be realised by the investment of the loan in an industrial undertaking or otherwise, will belong to the borrower, and will form the wages or compensation due for his skill and trouble in superintendence, &c. “The rate of interest,” says Mr. Tooke, “is the measure of the nett profit on capital. All returns beyond this on the employment of capital, are resolvable into compensations under distinct heads for risk, trouble, or skill, or for advantages of situation or connexion.”1

Whatever, therefore, may at any time occasion a brisk demand for capital, without also occasioning an increase in the productiveness of industry, or a fall of wages or taxes, may raise the rate of interest, or of nett profit, without affecting gross profits, or profits in the customary acceptation of the term. And this, as has been already observed, is most commonly the immediate effect of government loans. They raise the rate of interest without affecting profits; the rise merely diminishing that part of the total produce falling to the employers of capital which is to be considered as wages, and making a corresponding addition to the other part, or that which is to be considered as the nett return or interest of capital.

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Hence the advantage of a loan to the moneyed interest or to those who have capital to lend; and hence, also, its universally remarked injurious operation upon those who are employing borrowed capital.

The rate of interest is not, therefore, as has sometimes been supposed, always a correct test of the rate of profit. When, however, allowance is made for the disturbing effects of government loans, and other accidental causes of variation, the rate of interest or nett profit varies, speaking generally, directly as the rate of gross profit. Whenever interest is low during a period of peace, it is found that profits are also low, and conversely.

There are but few species of loans in which there is no risk, either of the repayment of the loans themselves, or of the interest at the stipulated periods. And as the trustees of many public bodies, as well as those of many private individuals, are obliged to invest in public securities only, the rate of interest which they bring is frequently depressed below what may be considered as the common and average rate of interest at the time. Government securities are liable to be deeply affected by political considerations, by the greater or less latitude for a rise or fall in the capital sum invested, and by a variety of circumstances which it is always very difficult, or rather perhaps impossible, even for those most experienced in such matters, to distinguish and appreciate. Mercantile bills of unquestionable credit, and having two or three months to run, are generally discounted at a lower rate of interest than may be obtained for sums lent upon mortgage, on account of the facility they afford of repossessing the principal, and applying it in some more profitable manner. Other things being equal, the rate of interest must of course vary according to the supposed risk incurred by the lender of either not receiving payment at all, or not receiving it at the stipulated term. No person of sound mind would lend on the personal security of an individual of doubtful character and solvency, and on mortgage Edition: current; Page: [485] over a valuable estate, at the same rate of interest. Wherever there is risk, it must be compensated by a higher premium or interest.

And yet, obvious as this principle may appear, all governments have interfered with the terms of loans—some to prohibit interest altogether, and others to fix a certain rate which it should be deemed legal to exact and illegal to exceed. It is needless, however, to waste the reader’s time by entering into lengthened arguments to show the mischievous effect of such interferences. This has been done over and over again. It is plainly in no respect more desirable to limit or reduce the rate of interest than it would be to limit or reduce the rate of insurance, or the prices of commodities; and though it were desirable, it cannot be accomplished. Legislative enactments for such an object invariably increase the rate of interest. When the rate fixed by law is less than the market or customary rate, lenders and borrowers are obliged to resort to circuitous devices to evade the law; and as these devices are always attended with more or less trouble and risk, the rate of interest is proportionally enhanced. During the late French war it was not uncommon for persons to pay ten or twelve per cent. for loans, which, had there been no usury laws, they might have got for six or seven per cent. It is singular that an enactment which contradicted the most obvious principles, and had been repeatedly condemned by committees of the legislature, should have been allowed to preserve a place in the statute-book for so long a period; but at length it was substantially repealed by the Act 2 & 3 Victoria, cap. 37, which exempts bills of exchange, having not more than twelve months to run, and contracts for loans of money above £10, from its operation.1

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