IX. Classes of Options

Options of the first group do not concern the theory of interest so much as the theory of prices, unless, as in the example of the mining, farmhlg, and forestry uses of land, the optional incomes differ in time-shape as well as in the kind of service rendered. This group may be designated as options of versatility. They are most striking in the case of tools and human beings. Options of the second class may be called options of chance. They concern the theory of insurance and spec ulation rather than the theory of interest, and, under the hypothesis which has thus far been maintained, that risk is absent, have no need as yet to be considered. This group of options is, however, of great practical importance. Under this head, when the options relate to contractual 178 SEC. 1] CLASSES OF OPTIONS 179 services, comes the special case of trade options. It is to this class that the term "option" is ordinarily applied by business men, and it has been with some hesitation that it has been given a broader meaning in this book.

But no better term seems available; and there is to be said, in favor of the broader use of the word, that it cor responds closely to its popular and untechnical meaning. The third group of options is the one which specially concerns us here, and will alone engage our attention through the remainder of this chapter. ~ When, in Chapter VII, we explicitly excluded optional em ployments of capital, we thereby assumed that the income stream was fixed both in amount and in the times when it accrued. We may pass from this case of perfect rigidity to the simplest form of option by introducing at first only one degree of flexibility. Let us suppose that the income stream from any capital is relatively fixed in amount, and that only the time of obtaining it is controllable at will. This species of choice occurs in the case of durable goods for consumption, which neither improve nor deteriorate with time. Wheat and other grains, for instance, may be used at almost any time, with little difference in the efficiency of the use and little cost except for storage.

The same is true of coal, cloth, iron, and, other durable raw materials, as well as, to some extent, of finished prod ucts such as tools and machinery, though usually de terioration from rust or other injury by the elements will set in if the use is too long deferred. "There such a range of choice exists, the possibility of obtaining an income from the capital in the future instead· of in the present will have the effect of preventing the rate of interest from sinking as far as it otherwise would; for if the rate of interest is low, the tendency on the part of the investor will be to defer the use of durable goods,- wheat, for instance, - and such a decision, by increasing future income and diminishing immediate income, will tend to raise the rate of interest, or at least to check its fall. Re180 THE RATE OF INTEREST [CHAP. IX versely, the possibility of using such articles at the present time instead of later has the effect of preventing the rate of interest from rising as far as it otherwise would; for, should interest rise, the telldencyon the part of the investor will be to more immediate employment of such durable goods as he had set apart for future use, and this decision, by relatively increasing present income and diminishing future income, will tend to reduce the rate of interest, or, at any rate, to check its rise. This is illustrated by wheat speculation. A rise in the rate of interest will check " bull" operations, since the speculator will be less will ing to "lose the interest on his money." Reversely, when the rate of interest falls, wheat holding will be encouraged.

Likewise land speculation is relatively easy when interest is low and difficult when interest is high. § 2 Under the group of options applying to durable in struments, there are many special cases. One of the most instructive is that which we might suppose if the quantity of income obtainable from an instrument or num ber of instruments were definitely fixed, but the time at which those services might be obtained were entirely optional. To illustrate this, uncomplicated by the pres ence of instruments of different types and the consequent necessity to translate the rate of interest into a common monetary standard, let us imagine a community in which the income frOIrl all capital is of the character just de scribed. This society would then be endowed witll a quantum of income as fixed as the quantity of money in a strong box. It could obtain all the income at once, or spread it over any number of years, but could not alter its amount either by increase or decrease, just as the owner of a strong box could take the contents all out at once, or at such times as he pleased, but could not increase or diminish the total amount. Every dollar's worth of income SEC. 2] CLASSES OF OPTIONS 181 s~crificed from this year's income would eke out next year's i:p.come by a dollar and no more; and reversely, every dollar's worth indulged in this year· would reduce by a dollar and no more the possibility of future indulgence.

Let us suppose this case realized on a desert island on which some sailors are shipwrecked and left each with 1000, pounds of hardtack and no prospect of ever improving their lot. We will suppose the use of this hardtack to be the only" real income" open to these ca"Staways,and that they have given up hope of ever adding to it by accessions from outside or by cultivating the island (which, by our hypothe sis, must be barren), the only possible variation of their income-stream- consisting of hardtack - being that pro duced by varying the time of its consumption. They have the option of consuming their entire store during the first year, or of spreading its use over two or more years, but in any case they will have the same total income, measured in hardtack." A little reflection will show that in such a community the rate of interest in terms of hard tack would necessarily be zero.! For, by hypothesis, the sacrifice of one pound of hardtack unconsumed from this year's income can only result in an equal increase in the income of future years. Therefore the rate of returnon sac rifice is zero. Since this rate must equal the rates of preference and the rate of interest, these rates must all be zero also.

To illustrate this case by a diagram, we see, as one op tion, that the entire consumption of hardtack may take place at an even rate 0 A within the time 0 B (Fig. 22). The total income will then be represented by the area OACB. An other option is that it shall be spread over DB', double the above-mentioned time, and consumed at the rate 0.t1', half the rate first mentioned, so that the same total amount will be represent~d by the area OA'C'B'. The choice of the second use rather. than the first implies 1 Cf. Adolphe Landry, L'Interet du Capital, p. 49; Carver,-The Distributionol Wealth, p. 2,32. .

182 THE RATE OF INTEREST [CHAP. IX the sacrifice of that part of the immediate income repre sented by the rectangle AD, but the addition of equal future income represented by the rectangle DB'. If the At1---------.; 0 e ..- ...D_·. ........ Of o---- ......-----....,;".;.. ........-.-..----- ........---a B'B FIG. 22. hardtack is not consumed at a uniform rate, the optional income-streams will not be represented by rectangles, but B' B I FIG. 23. by sloping curved figures, as ADB and A'DB' (Fig. 23), which have the same area. The substitution of the alterSEC. 2] CLASSES OF OPTIONS 183 native A'DB' for ADB increases immediate income by ADA' and decreases subsequent 'income by the exactly equal. amount BD8"" The coaelUJionthat the rate of interest under such con ditions must be zero, is at first startling; but it is easy to convince ourselves of its correctness if we reflect that the sailors will modifythe time-shape of their respective income stream until any possible rate of preference for a present over a future allowance of hardtack disappears. It would be impossible for any wouldbe lender to obtain interest on his loan, for the only way in which a borrower could repay a loan would be to pay it out of his originalstock of hard tack. He would not be fool enough to borrow100 pounds to consume to-day and pay back,105 pounds at the end of a year, when he had the option to consume the 100 pounds of his own hardtack, by sacrificing only 100 pounds out of his own stock kept for next year. Consequently there could be no interest payable in any exchange of present for future hardtack. It is equally impossible that there should be a negative rate of interest. Noone would lend 100 pounds of hardtack to-day for 95 receivable a year later, when he had the option of simply storing away his 100 pounds to-day and taking it out undiminished a year later. Hence, exchanges of present for future hardtack could not exist, except at par. There could be no premium or discount in such exchange.

Nor could there be any rate of preference for present over future hardtack. A pound of this year's hardtack and a pound of next year's hardtack would be equally balanced in present estimation; for, should a man prefer one·rathe:r than the other, he would take a pound for the preferred use away from the unpreferred, and this process would be continued until the desirability (in the present) of a pound of immediate hardtack and that of a pound of future hard tack were brought into equilibrium. Thus, if, through insufficient selfcontrol, he foolishly prefers to use his store freely in the present and to cut down his reserve for the 184 THE RATE OF INTEREST [CHAP. IX future to a minimum, the very scantiness of the provision for the future will enhance his appreciation of its claims, and the very abundance of his provision for the present will diminish the urgency of his desire to indulge so freely in the present. Provided there is some hardtack for both uses, the present desire for a pound of each will necessarily be the same. Failure of such equilibrium of desire can only occur when, as in starvation, the desire for the present use is so intense as to outweigh the desire for even the very last pound for future use, in which case there will be none whatever reserved for the future. But whether the hard tack tis at first abundant - for instance, enough to insure a long life-or whether starvation will necessarily follow after a year or two, the needs of the present and future will be adjusted on a basis of par price up to a point of time when the income-stream will cease. It is evident that some of the sailors, with a keen appreciation of the future, would plan to consume their stores sparingly. Others would prefer generous rations, even with the full knowl edge that starvation would thereby ensue earlier; but none of them would consume all of their stock immediately, for to do so would unduly rob the future, already poorly provisioned. They would, generally speaking, prefer to save, out of such reckless waste, at least something to satisfy the more urgent needs of the future. In other words, a certain amount of saving (if such an operation can be called saving) would take place without any interest at all. This coincides with conclusions expressed by Professor Carver in his Distribution of Wealth.1 It shows also that the preference for present over future goods of like kind and number is not, as some writers seem to assume, a neces sary attribute of human nature, but that it depends always on the relative provisioning of the present and the 'future.

1 p. 232. .See also It The Place of Abstinence in the Theory of In terest," Quarterly Journal 0/ Economics, July, 1894, and Fetter's Principles of Political Economy, New York (Century), 1904, p. 160.

SEC. 3] CLASSES OF OPTIONS § 3 185 The fact that interest was bound to be zero in the case of the sailors just discussed, was due to the extreme adjust ability of the time of receiving the given income. To see this clearly, let us next consider the case of an income~stream which, as before, is of a fixed amount, and the times of receiving which, though capable of being postponed as far as desired, are not capable of being hastened beyond a cer tain limit; the income, in other words, is fixed and sure, but comes ·slowly. Approximately such a case is found in mining. 1 The total yield ofa mine is practically fixed by the ore deposits which it contains. It is like the chest of money; just so much as it contains can be taken from it, and no more. But it is unlik:e the chest of money in that its contents cannot be extracted as fast as desired. The ore at the top must be removed before that beneath can be reached. Time for mining operations is required. Nature is slow in yielding up her treasures. This slowness of Nature, in view of man's impatience to exploit her, will give rise to a rate of interest.

It is as though the hardtack of our· shipwrecked sailors had'in some way been stored in a series of storehouses, each provided with a time lock arranged to open at a certain date. There is a definite amount of income, but it is only available at intervals. Under these circumstances, unless the time locks are timed to open as fast as the castaways would have chosen of thems~lves to eat their stores, the hardtack of to-day and of next year will no longer exchange at par. There:will be _a premium ~on present hardtac~ as ( compared_with future hardtack, the amount of the premium depending on the rehitlve provisioning of the various storehouses, - in short, on the size and time-shape of the 1 Strictly speaking,.of course the total product and total expense of exploiting a mfne will vary somewhat with the rate of extraction. An animated discussion of the most profitable rate of extraction was carried on in The Engineering and Mining Journal, New York, 1904.

186 THE RATE OF INTEREST [CHAP. IX income~stream as made available by the time locks. The case will be practically the same as though the income stream were rigid,as in Chapter VII; for the only option is to postpone the consumption of these provisions, and this option would not, under the circumstances, be exercised. We see, therefore, that in order that a positive rate of interest shall emerge, it is only necessary that .incomeshall sufficiently hold hack its flow. It is not necessary that Nature should be reproductive, as Del Mar and George maintain. Interest would exist even if there were no growing animals and plants, but only a world of minerals and other fixed stores to be extracted by man, provided only Nature were slower than we could wish in admitting us to her stores. In fact, if we were asked to state in a ""ord why there is interest, we should reply, because Nature is slow and keeps man waiting.

§ 4 But while the slowness of Nature is a sufficient cause for interest, her productivity is an additional cause. This brings us to our next class of options, the class, namely, in which, if present income is sacrificed for the sake of future income, the amount of the latter secured thereby is greater than that of the former sacrificed. The income which we can extract from our planet is not, in the aggregate, a fixed quantum, as is that part of it which comes from mines, but is obtainable in larger amounts for the remote future than for the present. Nature is reproductive and tends to multiply. Growing crops and animals make it possible to endow the future more richly than the present. By waiting, man can obtain from the forest or the farm more than he can by premature cutting or the exhaustion of the soil. In other words, not only the slowness of Nature, but also her productivity or growth, has a strong tendency to keep up the rate of interest. Nature offers man, as one of her optional income-streams, the possibility of great future SEC. 5] CLASSES OF OPTIONS 187 abundance at trifling present sacrifice. This option acts as a bribe to man to sacrifice present income for future, and this tends to make present income scarce and future income abundant and hence also to create in his mind a prefer ence for a unit of present over,s unit of future income.

§ 5 We next consider the case of an option the exact reverse of the preceding, - the case in which, if present income is sacrificed, the amount of future income obtained thereby is less than the amount sacrificed to obtain it. This is true of the incomefrom perishablegoods. Suppose our sailors were left, not with a stock of hard tack, but with a stock of figs which deteriorate at the fore known rate of 50 per cent. per annum. In this case the rate of interest would be necessarily minus 50 per cent. per annum, as may be shown by the same reasoning that es tablished the zero rate in the former case. The possibility of such negative interest has been discussed in a previous chapter. 1 When goods are perishable the tendency is to preserve them by cold storage, preservatives, etc., so as to extend their use into the future. This is an effort to create a new optional employment for those goods.

Some goods, then, like grain for food, and cloth, may be indiscriminately applied to the present or future without either loss or gain; others, like grain for seed, breeding animals and plants, gain in income power with time; and still others, like meat and fruit, lose. The resultant is that, for income as a whole, taking man and Nature as they are, it is impossible to sacrifice future in come for present very far without selling one's birthright for a mess of pottage, or, to make use of another phrase ology, without killing the goose that lays the golden egg. Thus Nature, by her productivity, stimulates man to self denial, and by her slowness she conlpels it. Were the 1 Chap. V, § 5.

188 THE RATE' OF INTEREST [CHAP. IX world in which we live neither slow nor reproductive, but simply an open storehouse of wealth, two things would happen which we saw in the case of the shipwrecked sailors. One is that the rate of interest would he zero, and the other is that man, however frugally he consumed his stores, must ultimately perish. § 6 In the foregohlg cases the options consisted of different employments of instruments of capital which were assumed to retain their physical identities throughout the period of t110se employments. If now we regard an instrumen.t or group of instruments of capital as retaining its identity through renewals or repairs, we introduce another large and important class of options; namely, the options of making those renewals and repairs, or not making them, or making them in anyone of many different degrees. If the repairs are just sufficient for the up-keep they may be called r~ newals; if more than sufficient, they may be called better ments. We shall include all these alterations wrought upon an instrument in the same category. They are alterations in the form, position, or condition of an instrument or group of instruments which affect the stream of services which that instrument or group will yield.

This class of optional employments, when the employment of the capital involves sales, merges imperceptibly into the special case which we originally called the method of modi fying an income-stream by buying ~r selling. Thus, consider a merchant who buys and sells rugs. His stock of rugs is conveniently regarded as retaining its identity, although the particular rugs in it are continually changing. This stock yields its owner a net income equal to the dif ference between the gross income, consisting of the pro ceeds of sales, and the outgo, consisting chiefly of the cost of purchases, but including also cost of warehousing, in: surance, wages of salesmen, etc. If the merchant buys SEC. 6] CLASSES OF OPTIONS 189 and sells equal amounts of rugs and at a uniform rate, his stock of rugs will remain constant and its income to .. be credited to that stock will normally be equal to the in terest upon its value. It will be standard income.1 But the owner has many options. He may choose to enlarge his business as fast as he makes money from it, in which case his net income will be zero for a time, but his stock will increase and his ultimate in come will be larger. In this option, therefore, his income stream is not constant,but ascendsfrom zero tO,somefigure above the "standard income" of the first option. A third option is gradually to go out of business, by buying less rugs than are sold, or none at all. In this case the income at first is very large, as it is relieved of the burden of pur chases; but it declines gradually to zero. In the inter stices between these three options there are, of course, endless intermediate options. The merchant thus has a very flexible income-stream. If the expenses and receipts for each rug bought and sold are the same whichever option is chosen, and if the time of turnover is also the same, it will follow that all of the options possess the same present value and differ only in desirability. We should then be dealing with that special class of options which we found open even in the case of rigid income-streams, - what we then called modifications of the income-stream through buying and selling. The reason for placing optional employments of capital on a different footing is that they do not all possess the same present value. In actual fact, the rug merchant, and merchants in general, would not find that all the optional methods of proportion ing sales and purchases of merchandise possessed equal present values; for if he attempted to enlarge his business too fast he would find that his time of turnover would be lengthened, and if he reduced it too fast he would find that 1 The case of evenly reconstituted capital is emph~sized in J. B:.

Clark's writings, e.g. The Distribution of Wealth. New York (Mac millan), 1899; see The Nature 0/ Capital and Income, Chap. XIV, § 4.

190 THE RATE OF INTEREST [CHAP. IX his selling expenses per unit of merchandise would be in creased. There is for each merchant, at any time, one particular line of business policy which is the best; namely, that which will yield him the income-stream having the maximum present value. It is his interest to choose this policy and to relieve himself of any resulting inconvenience in the time-shape of his income-stream by borrowing and lending or by buying and selling. Since, therefore, the various methods of renewing one's capital usually yield income-streams differing in present value, they resemble what we have called optional employments of capital and may be properly classed as such. § 7 The propriety of such a classification becomes still more evident when, instead of renewals, we consider repairs and betterments; for it is clear that the income from a farm has a very different present value according as it is tilled or untilled, or tilled in different degrees of intensity; that the income from a house so neglected that a leak in the roof or a broken window pane results in injuring the in terior is less valuable than the income it would yield if properly kept up; and that real estate may be under-improved or overimproved as compared with that degree of improvement which secures the best results.

In all cases the best results are secured when that series of renewals, repairs, or improvements is chosen which renders the present value of the prospective income-stream a maxi mum. This, as we have seen, is tantamount to saying that the renewals, repairs, or improvements are carried up to the point at which the return which they bring is equal to the rate of interest. The owner of a carriage, for instance, will replace a broken spoke, because the cost of doing so will pro long the life of his carriage so far as to earn much more than the interest upon the trifling cost of the spoke. This repair may cost him $1 and may save him $20. But so high a SEC. 8] CLASSES OF OPTIONS 191 rate of return as these figures imply cannot be expected from every repair, and after the really necessary repairs are made, it soon becomes a question to what extent it is worth while to keep a carriage in repair. Repainting, re varnishing, and resetting the tires are all costly, and though in every case the service of the carriage is increased in quan tity and improved in quality, the return grows less and less as the owner strives after increased efficiency. He will spend money on his carriage in repairs and renewals up to that point where the last increment of repairs will secure a return which will just cover the cost with interest; beyond this he will not go.

§ 8 , Another case of optional income-streams is found in the choice between different methods of production, especially between different degrees of what has been called" capital istic" production. It is always open to the prospective housebuilder to build of stone, wood, or brick; to the pro spective railroad builder to use steel or iron rails; to the maker of roads to use macadam, asphalt, wood, cobble, brick, etc., or to leave the earth unchanged except for a little hardening and rolling. The choice will in all cases depend on the principles which have been already explained. For another example, the services of a house which has a durability of 60 years will, compared with one which has a durability of 30 years, be equivalent to the services of two ,houses, one built to-day'and lasting 30 years, and the other built at the expiration of that period and lasting 30 years more. The' difference between the one long-lived house and the two short-lived houses is thus not in the services, but in the cost of construction. 'fhe cost of con structing the 60-year house occurs in the present; that of the two successive 30-year houses occurs half in the present and half at the end of 30 years. In order that the more durable house may have the advantage as to 192 THE RATE OF INTEREST [CHAP. IX cost, the excess of its cost over the cost of the first of the less durable ones must be less than the present value of the cost of the second, deferred 30 years.

The choice between different instruments for effecting the same purpose may, of course, depend on their relative efficiency,- the rate of flow of income, or upon their relative durability, - the time of the flow. It is true, however, as John Rae has pointed out,! that efficiency and durability usually go hand in hand. A house which will endure longer than another is usually more comfort able also; a tool which will cut better will wear out more slowly; a machine which does the fastest work will gen erally need to be strong and therefore lasting. The alternatives constantly presented to most business men are between policies which may be distinguished as temporary and permanent. The temporary involves the use of easily constructed instruments which soon wear out, and the permanent policy involves the construction at great cost of instruments of great durability. When one method of production requires a greater cost at first anD. yields a greater return afterward, it may, conformably to popular usage, be called the more "capitalistic" of the two. In other words, "capitalistic" methods of employing capital are those which tend toward an ascending income-stream.

The title" capitalistic" is not a happy one, although it has some justification in the fact that an ascending income stream means the accumulation of capital, or "saving," and still more in the fact that only a capitalist can afford to choose a method of production which at first yields little or no income, or even costs some outgo; for without cap ital no one could subsist, or at any rate subsist with comfort, in the interim. It is clear that the capitalist who thus subsists on his accumulations does so by possessing, or be coming possessed of, a descending income-stream. It is therefore as a possessor of income that he is enabled to subsist while waiting for the returns from his new venture. 1 The Sociological Theory of Capital, p. 47.

SEC. 9] I CLASSES OF OPTIONS 193 He is enabled to invest in an ascending or slowly return ing income-stream by having at command a descending or quickly returning income-stream. We may say, therefore, that a "capitalistic" method is a method requiring an ascending income-stream, and, it is so called because it is open only to those who have cOffilnand of other and descending income-streams, such persons being necessarily capitalists. § 9 The best example of the choice between those uses of capital affording immediate and tHose, affording remote returns is found in the case of human capital, commonly called labor. Man is the most versatile of all forms of ~.and among the wide range of choioosasto'''tlie'''oosl disposition of his energies is the choice between using them for immediate or for remote returns. This choice usually carries with it a choice between corresponding uses of other instruments than man. To choose to plant a tree for the sake of fruit ten years hence, rather than to plant corn for the sake of next year's crop, is to make choic~ of differ ent uses of land as well as of labor. But the existence of optional employments of labor, however inextricably bound up with optional employments of other instruments, deserves mention both because of its importance and be cause it usually supplies the basis for the optional employ ments of other forms of.. capital.

It is, in fact, almost exclusively through varying the employment of labor that the income-stream of society as a whole is capable of changing it.s time-shape. The individual may modify the time-shape of his particular income-stream through exchange,but in this case the person who exchanges with him must modify his income-stream in the opposite manner, and the two modifications cancel each other in the total of the world's income. But if an income is modified in time-shape through a change in the exertions o I I (: 194 THE RATE OF INTEREST [CHAP. IX of laborers, there is no such offset, since the total social income is actually modified also. The labor of a community is exerted in numerous ways, some of which bring about enjoyable income quickly, others slowly. The labor of domestic servants is of the former variety. The cook's and waitress's efforts result in the enjoyment of food within a day. Within almost as short a time, the chambermaid and the laundress promote the enjoyment of house, furniture, and clothing. The baker, the grocer, the tailor, are but one step behind the cook and laundress; their efforts mature in enjoyments within a few days or weeks. And so we may pass back to labor increasingly more remote from enjoyable income, until we reach the miner whose work comes to fruition years later, or the laborer on the Panama Canal, whose work is in the \ service of coming generations.

The proportions in which these various kinds of labor may be assorted vary greatly, and it is through this variation that the income-stream of the community changes its time shape. If there are at any time relatively few persons em ployed as cooks, bakers, and tailors, and more as builders, miners, and canal diggers, there will tend to be less im mediately enjoyable income and correspondingly more enjoyable income several years later. By withdrawing labor from one employment to another it is in the power of society to determine the character of its income..,streamnot only in time-shape, but also in size, composition, and uncer tainty. This power is exerted through the entrepreneur or "enterpriser" 1 according to his estimate of what return will come from each particular employment taken in connec tion with the sacrifice involved and the ruling rate of interest. Upon his judgment depends the future of society's income, and - since capital merely represents expected income - its future capital. If his judgment is good and he diverts labor from domestic service and the production 1 See Fetter, The Principles of Economics, New York (Century), 1904, Chap. XXIX.

Smc.10] CLASSES Oll' OPTIONS 195 of commodities for immediate service to the construction of great engineering projects such as the tunnels to connect Manhattan Island with the mainland, he is increasing future income at the sacrifice of immediate income, and at the same time accumulating capital. If, on the contrary, he makes opposite choice of the employment of labor, the opposite results will follow. Should his judg ment be at fault in either case, to that extent will the results stated fail to be achieved. His task is one of much responsibility and great moment for the welfare of the world. The great majority whose interests he sup posedly serves are almost as much dependent on his good judgment as are the passengers in a railway train de pendent for their safety on the good judgment of the engineer. § 10 Since the choice,for an individual, among different options, depends on the rate of interest in the manner described in Chapter VIII, it is clear that a low rate favors the choice of ascending income-streams, but also that the choice of such income-streams reacts to raise the rate of interest.

j~' on tne contrary, the rate is high, the opposites of both these propositions hold true. Thus, applying these prin ciples to the question of repairs, renewals,and improve ments, it is evident that the lower the rate of interest, the better can the owner afford to keep his carriage in repair, and the higher the state of efficiency in which it and all other instruments will be kept. But it is equally clear that the very attempt to keep instruments up to the highest level of efficiencytends, in turn, to increase the rate of in terest; for every repair means a reduction in present in come for the sake of future - a shifting forward in time of the income-stream-and this will cause a rise in the rate of interest. Thus, any fall in the rate of interest, by stimu lating repairs, renewals, and betterments, will bring its 196 THE RATE OF INTEREST [CHAP. IX own correction through oversupplying future income at the expense of immediate income.

Again, it is evident that a choice of the more durable instruments, as compared with those less durable, will be favored by a low rate of interest, and a choice of short-lived instruments will be favored by a high rate of interest. If the rate of interest should fall, there would be a greater tendency to build stone houses as compared with wooden. The present value of the prospective services and disser vices of stone houses as compared with wooden would be increased; for although stone houses are more expensive at the start, they endure longer, and their extra future uses, which constitute their advantage, will have a higher present value if the rate of interest is low than if it is high. We find, therefore, as John Rae has so well pointed out, that where the rate of interest is low, instruments are substantial and durable, and where the rate of interest is high they are unsubstantial and perishable. In this case, as in the preceding cases, the low rate of interest leads to a choice which shifts the income-stream forward in time, and thus tends to raise the rate of interest, and vice versa.

In general, then, a low rate favors the choice of "capital istic" methods of production. The construction of a sub stantial bridge which will never wear out is more likely to pay if the rate of interest is low than if it is high; for the lower the rate of interest, the higher will be the present value of the remote income which the permanent structure commands. Reciprocally, the more "capitalistic" the production, the greater the tendency to raise the rate of interest; so that the existence of numerous options has a regulative effect. Beyond the margin of choice there always lie untouched options ready to be exploited the in stant the rate of interest falls. Among these, as Cassell has pointed out, are waterworks of various kinds. Not only the canals of stupendous size but hundreds of less conI The Nature and Necessity 01 Interest, London (Macmillan), 1903, p. 122.

SEC. 10] CLASSES OF OPTIONS 197 spicuous waterways are subjects of possible investment; among the lesser ones are the Elbe and the Erie canals; and there might be built numerous others as soon as the rate of interest falls low enough to make the return upon . cost equal to the rate of interest. The same is true of the improving, dredging, and deepening of harbors and rivers, the use of dikes and, jetties, and the construction of irri gation works for arid lands. There is still room for much improvement in our railway systems by making them more efficient and more durable, by making the roads straighter, the roadbeds more secure, the rolling stock heavier, the bridges larger and stronger, etc. In a new country where the rate of interest is high and the return on sacrifice precarious or small, the cheapest and most primitive form of railway is first con structed. Very often it is a narrow-gauge road with many curves, costing little to construct, but much to operate.

Later, when the rate of interest falls, or the traffic so in creases that the rate of'retJIrn on sacrifice is greater, the broad-gauge comes into use and the curves are eliminated. This is the kind of change which ,has been proceeding in this country with great rapidity during recent years. There is a transition from relatively small first cost and large running expenses to precisely the opposite type of plant, in which the cost is almost all initial and the ex pense of operation relatively insignificant.