XV. Inductive Verfication (Economic)

CHAPTER XV INDUCTIVE VERIFICATION (ECONOMIC) § 1 IN the last chapter we found statistical evidence of-the influence· of· changes in the monetary standard upon the rate of interest. We now proceed to a similar inductive study of the economic - as distinct from the monetary - influencesupon.the rate of interest. In a study so broad, .it would be useless to attempt any exhaustive verification by statistics; the facts at hand , are too meager, and not such as to ep.able us to isolate the , separate causes at work. It will usually happen in any given case that some of the economic causes tending to make interest high are combined with others which tend to make it low. The fact, therefore, that interest is either high ·or low in such a case will not, of itself, be decisive in favor of any theory. "The best that we 'can expect is to show that the facts as we find them are at any rate consist ent with the theory maintained. For practical purposes, such a showing is enough, both because the theory should stand on· its own merits as an analysis, without the bolster ing of statistical verification; and because, if the analysis were really incorrect, a very cursory examination of the facts would probably suffice to refute it.

In our study of facts it is well to remember that the causes tendingto make interest high or low sometimes work out their effects, partly or wholly, in other ways. For instance, the economic causes which, in the United States, have tended to make interest high, have also tended to bring in loans from other countries, such as Great Britain, where the rate of interest "was low. The introduction of the loans prevented interest from being as hi~ as it otherwise would. ,u 289 290 THE RATE OF INTEREST [CHAP. XV In general it is true that a cause which would tend to make interest high in a community may simply result in increasing the loans contracted by that community, pro vided there exists another community in which the rate of interest is lower. If recourse to borrowing is not prac ticable, other methods of adding to present at the ex pense of future income - of "tipping forward" the income curve -may be found. If this" tipping forward" goes far enough it will show itself in a dissipation of capital; if not, in a slower accumulation. Contrariwise, the causes which work toward lending may, if lending is impracticable, result in some other form of " tipping back" the income curve and may show itself in a more rapid accumulation of capital or a less rapid dissipation. Finally, the same economiccauses which tend to make interest high will tend also to encourage the production of the less substantial and durable instru ments, whereas those causes which tend to make interest low will favor the production of instruments of the more durable and substantial types.

In short, in our collection of facts we should ascribe very similar significance to the four sets of phenomena high interest, borrowing, dissipation of capital, and perish abilityof instruments,. any causes back of these phenomena, which, according to our theory, should produce anyone of the four, will tend also to produce the other three. Like wise we should ascribe similar significance to the fOUf op posing phenomena -low interest, lending, accumulation, and durability of instruments. § 2 Briefly stated, the ~ry we are testing is that the -rate ,~ ~ J~ Qf interest expresses human preferenc~ for present over ~j~" future goods...as that preference works itself out from the I nature of the individual and the character of his income stream. We shall begin by considering the manner in which the nature of the individual influences the rate of interest.

SEC. 2] INDUCTIVE VERIFICATION (ECONOMIC) 291 In a previous chapter we enumerated the causes which, in the nature of man, tend to make interest high or low. It was there maintained that foresight, selfcontrol, and regard for posterity tend to make interest low. We may there fore expect to find, in a community possessing these quali ties, one or more or' the four interequivalent phenomena already mentioned -low interest, lending to other com munities, accumulation of capital, and construction of sub-:: stantial instruments; and to find, in a community lacking these qualities, one or more of the four opposite conditions. No extended study is needed to show that precisely these opposing sets of phenomena are actually found in the two opposite conditions mentioned. The communities and nationalities which are most noted for the qualities men tioned -foresight, selfcontrol, and regard for posterity are probably Holland, Scotland, England, France, and the"

Jews, and among these peoples interest has been low. More ove~, they have been money lenders, they have the habit of thrift or accumulation, and their instruments of wealth are in general of the substantial variety. The durability of their instruments is especially,obvious in their buildings, both public and private, and in their ways of transportation - carriage roads, tramways, and railroads. Thus in Eng-' land the railways have expended an average of $165,000 per mile, which is from two to three times the corresponding expenditure in most countries} The difference, though partly explainable by a difference in methods of account ing, seems largely due to the lower rate of timepreference: in England. John Rae observes of Holland:"The Dutch seem, of aU-European nations, hitherto to have been inclined to carry instruments to the most slowly returning orders.' The durability given. to all the instruments constructed by them; 1 See Dorsey, Engli8h and American Railroads Compared, New\ York (Wiley),- 1887; Price Howell, Journal 01 the Royal Statistical Society, Vol. LXII, p. 83; Commercial anclFinancial Chronicle,' Vol. LXXIV,p. 1224.

292 THE RATE OF INTEREST [CHAP. XV the care with which they are finished, and the attention paid to preserving and repairing them, have been often noticed by travel ers. In the days when their industry and frugality were most remarkable, interest was very low, government borrowing at 2 per cent., and private people at 3." 1 On the other hand, among communities and peoples noted l ~'for lack of foresight and for negligence with respect to the future are China, India, Java,2 the negro communities in li:the Southern states, the peasant communities of Russia,3 yand the North and South American Indians, both before !and after they had been pushed to the wall by the white man. In all of these communities we find that interest is high, that there is a tendency to run into debt and to dissi pate rather than accumulate capital, and that their dwell ings and other instruments are of a very flimsy and perish..

able character. It may well be that there are other causes at work to produce these results. We are here merely noting the fact that lack of foresight is one factor present. Of China, Rae states:"The testimony of travelers ascribes to the instruments formed by the Chinese a durability very inferior to similar instruments con structed by Europeans. The walls of houses, we are told, unless of the higher ranks, are in general of unbumt bricks of clay, or of hurdles plastered with earth; the roofs, of reeds fastened to laths. We can scarcely conceive more unsubstantial, or temporary fabrics. Their partitions are of paper, requiring to be renewed every year. A sim~ar observation may be made concerning their imple ments of husbandry and other utensils. They are almost entirely 1 The Sociological Theory 01 Capital, pp. 128-129. Z My colleague, Professor Clive Day, informs me that the rate. of interest in Java is often 40 per cent.

S See Bloch, The Future 01 War, p. 205. It appears that the peas ant will sell a promise to labor a short time in the future at one third the current wages! See also E. B. Lanin (pseud.), "Russian Finance," Fortnightly Review, February, 1891, Vol. LV, pp. 188, 190, 196, for typical and extreme cases. Inostranietz," L'Usure en Russie," Jo~l des Economiste, 1893, Sere 5, Vol. XVI, pp. 233-243, states that the rates paid by poor peasants to well-to-do peasants are fre quently 5 per cent. per week!

SEC. 2] INDUCTIVE VERIFICATION (ECONOMIC) 293 of wood, the metals entering but very sparingly into their construc tion; consequently they soon wear out, and require frequent renewals."1 . "European travelers are surprised at meeting ... little' float Ing farms, by the side of swamps· which; only require draining to render them tillable. It seems to them strange that labor should not rather be bestowed on the solid earth, where its fruits might endure, than on structures that must decay and perish in a few years. The people they are among think not so much of future years as of the present time." 2 "The Father Parennin, indeed, asserts, that it is their great de ficiency in forethought and frugality in. this respect, which is the' cause of the scarcities and famines that frequently occur. 'I be lieve,' he says, 'that, notwithstanding its great number of inhabit ants, China would furnish enough grain for all, but that there is not sufficient economy observed in its consumption, and that they employ an astonishing quantity of it in the manufacture of the wine of the country, and of raque.'" 3 "In China, we are told by Barrow, that the legal rate of interest i~ 12 per cent., but that, in reality, it varies from 18 to 36." 4 Simcox writes of China as follows:"The legal maximum is 3 per cent. per mensem, and the usual rate, as already mentioned, 30 per cent., per annum." 6 .Even on the seacoast where Englishmen have settled, the rate of. interest is high, and its reduction, such as has occurred, is only because of the equivalent economic phenomenon, loans from abroad. These facts are seen in the Appendix,6 where the rates of interest in China are given.

It is interesting to observe how the economic conditions in China which at first produced high interest afterward led gradually to loans from England and a fall in the rate of interest. The bank rate in Shanghai as given in the table was at first (1866) 13 per cent., and gradually fell to 6 per cent. as investments of English capitalists were made. 1 The Sociological Theory 01 Capital, pp. 88-89. 2 Loc. cit.,·p. 92. 8 Loc. cit., pp. 89-90. 4 Loc. cit., p. 128. 6 Primitive Civilization8~ London (Swan Sonnenschein), 1894, Vol. II, p. 327. G See Appendix to Chap. XIV,§ 1.

294 THE RATE OF INTEREST [CHAP. XV Of the North American Indians, Rae observed:"Upon the banks of the St. Lawrence, there are several little Indian villages. They are surrounded, in general, by a good deal of land from which the wood seems to have been long extirpated and have, besides, attached to them, extensive tracts of forest. The cleared land is rarely, I may almost say never, cultivated, nor are any inroads made in the forest for such a purpose. The soil is, nevertheless, fertile, and were it not, manure lies in heaps by their houses. Were every family to inclose half an acre of ground, till it, and plant in it potatoes and maize, it would yield a sufficiency to support them one half the year. They suffer too, every now and then, extreme want, insomuch that, joined to occasional intem perance, it is rapidly reducing their numbers. This, to us, so strange apathy proceeds not, in any great degree, from repugnance t.o labor; on the cont.rary, they apply very diligently to it, when its reward is immediate." 1 Of the South American Indians in Paraguay Rae tells of the difficulties which the Jesuits found in persuading the natives to provide for the future: " ••.if these [the Jesuits] gave up to them the care of the oxen with which they plowed, their indolent thoughtlessness would probably leave them at evening still yoked to the implement.

Worse than this, instances occurred where they cut them up for supper, thinking, when reprehended, that they sufficiently excused themselves by saying they were hungry." 2 In regard to the negro and the Russian we may cite the statistics of George K. Holmes 3 and the observations of N. T. Bacon.4 § 3 In many if not all of the cases which have been cited there are, of course, other elements which would tend to explain the facts besides mere mental characteristics. Thus, the high rate of interest among the negroes and the Russian peasants is undoubtedly due in part to their pov1 The Sociological Theory of Capital, pp. 71-72. 2 Loc. cit., p. 76. 3 Census of 1890. 4 Yale Review, Vol. XII, pp. 141, 239; Vol. XIII, p. 51.

SEC. 3] INDUCTIVE VERIFICATION (ECONOMIC) 295 erty, though their poverty is in turn largely due to the men tal.characteristics. There is here in operation the vicious circlewhich.has·been noted in Chapter XII. Where there is too little appreciation of the needs of the future, capital tends to disappear; and the pressure of poverty tends to enhance still further the demands of the' present and to press down its victims from bad to worse. But there are not wanting cases in which even persons who have wealth, but who nevertheless lack foresight and self control, exhibit the same facts, especially by running into debt. This is characteristic of a considerablenumber of the spoiledsonsof rich Englishnoblemen. The type is well described in some of Stevenson's novels. These persons are found living in Australia and elsewhere in virtual exile on a stipend provided by their families at stated intervals. This s~ipend is sometimes provided on condition that they remain away from their original environment with J its temptations to extravagance. One such individual known to the writer had inherited a large fortune. The precaution had been taken to leave i·t in trust so that he could draw only the income. Yet this man. contrived to contract large debts on chattel mortgages at high rates of interest, and was noted for his wasteful, shortsighted erection of temporary dwellings in the various communities among which he continually flitted. The same character istics are often found among wealthy students at univer sities, who have acquired, through improper home training, an exaggerated idea of the needs of the moment and little appreciation of those of the future. These men become the victims of money lenders, and are frequent patrons of the pawn shops.

Not only do we find examples of a high rate of preference for present, over future goods among the prodigally rich, but we often find the opposite example of a low rate of preference for present over future goods among the thrifty poor. Examples are especially frequent among the Jews, whose propensity to accumulate and to lend money even 296 THE RATE OF INTEREST [CHAP. XV in the face of misfortune and social ostracism, is too well known to require extended COIIlment. § 4 The factor which has been designated as "regard for pos terity" deserves special attention. Perhaps the most con spicuous example of extreme disregard for posterity is found in Rome during the time of its decline and fall. The following quotations from Rae contain important testi mony:"It were needless," he says, "to enlarge on a subject so well known as that of the general corruption of Roman manners, from the time of the first Cresar. Venality and licentiousness may be said to have been universal. I shall confine myself to one particu lar, as marking sufficiently the declension of those principles on which the strength of the effective desire of accumulation mainly depends. I allude to the decay of the family affections, of which evidence everywhere meets us. The men did not wish to be fathers, scarcely did the women wish to be mothers. . .. They lived, not in others, or for others, but for themselves, and sought their good in enjoyments altogether selfish. It was their aim to expend on their own personal pleasures whatever they possibly could. It would seem as if the majority, could they have foreknown the exact limits of their lives, would have made their fortunes and them terminate together. As they 'could not do so, the fortunes of many ended before their lives, as the fortunes of others held out beyond their lives. To reap, however, themselves, while alive, all possible benefit from what they might chance to leave others to enjoy after their death, they encouraged some of the members of a despicable class who seem to have constituted no inconsider able part of Roman society. Parasites ready to minister to every pleasure, and to perform every possible service, waited on the man of wealth, in the hope and expectation of enjoying a portion of it after his death. They were more desirable than children, both because they were able to give something more than mere unsub stantial affection and esteem, and because they were willing to give it. . .. It gave occasion to the law compelling parents to leave their children a certain part, a fourth, of their property.

Its prevalence may be judged of by the wording of the enactments increasing the children's share. . .. The general selfishness of the principles guiding the conduct of individuals; may be gathered SJJC. 5] INDUCTIVE VERIFICATION (ECONOMIC) 297 from the prevailing proverb, "When I die let the world burn." .•• Pasture took place of tillage; corn was brought from the provinces; and when the supply failed famine ensued. Even the construc tion of ships for the transport of-this, and other merchandise,. would seem to have been an effort _to which the accumulative principle was scarcely equal. It was found necessary to encourage it by rewarding those who prosecuted that branch of industry. Some times land formerly cultivated was allowed to lie entirely waste, and' passed altogether out of the class of instruments. The forest and wilderness gained on the Romans, as they would now, for similar reasons, on an Indian population, were some of these tribes put in possession of the domains, anciently the property of their race, at present yielding abundantly to the provident industry of the whites. Had there been no interruption of the barbarians, the Empire must have perished, more slowly perhaps,but as certainly, from the operation alone of these internal causes of decay"

They were occasioning a progressive diminution of the capacity which materials formerly possessed. Thus, it is to the Romans themselves as much as to the barbarians, that the destruction of the public edifices is to be ascribed. The stones were applied to private purposes." 1 "Thus, among the Roman writers, the heir is always represented in an invidious light, and to save for him is represented as a folly. The writings of Horace, and the contemporary poets, throughout, exemplify the prevalence of this feeling." 3 "In ancient Rome, interest was in reality exceedingly high, from 12 to 50 per cent." 3 These rates doubtless ,refer to the degenerate days. Previously, at the time of the end of the republic, the rate was as low as 4 to 6 per cent.4 § 5 The characteristics of foresight, selfcontrol, and regard f for posterity seem to be partly natural and partly acquired I within the lifetime of the individual. Among the casesI 1 Loc. cit., pp. 95-99. 2 Loc. cit., p. 64.

3 Loc. cit.,p. 129. Rae's authority is Boucher's Histoirede L' Usure, Paris, 1819, p. 25. 4 'See Seligman's Principles of Economics, New York (Longmans), 1905, p. 404.

298 THE RATE OF INTEREST [CHAP. XV which have been given are conspicuous examples of both, although it is difficult here, as always, to disentangle the' influence of nature from that of environment. We are accustomed, for instance, to ascribe to the Jews a natural racial tendency to accumulate, though this characteristic is certainly reenforced by, if not entirely due to, the ex traordinary influence of Jewish tradition. Of the Scotch, it would be difficult to say how much of their thrift is due to nature and how much to training handed down from _father to son. The American negro is regarded by nature 1\'as a happy-go-lucky creature; but recent experience with industrial schools has demonstrated the fact that these ' characteristics can be largely reversed by training, if in fact they have not been entirely created by the lack of !;training under conditions of slavery. There is now ac cumulating much testimony 1 to show that there is more error than truth in the common opinion as to the relatively great importance of heredity as compared with environ ment.

When postal savings banks were first introduced in Eng land, it was objected that the habits of the English poor, for whom they were intended, were such that they would never make use of them. But Gladstone insisted that habits were an arbitrary matter, and that the fashion of spending could be displaced by the fashion of saving as soon as the principle of imitation had had time to operate. The ex perience with English postal savings banks has justified his prediction. 2 In fact, it would be a serious mistake to assume that the ~ (lharacteristicsOf man as to foresight,selfcontro,l, a,nd regard .: for his own and his children's future are fixed racial or ". national qualities. The part which nature· may play in 1 For instance, the reports of the Children's Aid Society of New York; the child-saving work of Dr. and Mrs. J. H. Kellogg at Battle Creek; the evidence of the British Interdepartmental Committee on School Children, etc.

2 See The Development 01 Thrilt, by Mary W. Brown, New York (Macmillan) , 1900.

SEe. 6] INDUCTIVE VERIFICATION (ECONOMIC) 299 these matters is as yet far from being understood; but I however great that part may be, it is certainly true that the influence of training is also great, and therein lies the possibility and hope of social reform in these matters. It should be one of the distinct aims of any intelligent modem education, whether in the home or the school, to inculcate: foresight, selfcontrol, and a due regard for the needs of future years and, even of future generations. It goes with out saying that individuals and nations with these char acteristics have therein a more secure and permanent claim" for success in all directions. § 6 But, as has been emphasized in previous chapters, the rate of preference for present over future goods is not a ques tion of mere personal characteristics, but depends also upon the character of one's income-stream; namely, on its size, shape, composition, and probability. In respect to size,our theory maintains that the larger the income, otherthingssuch as foresightand self-controlbeing equal,the lower the rate of preference for present over future goods. If this is true, we should expect to find poverty and riches associated re spectively with a high and a low rate of interest, or with borrowing and lending, or with spending and saving, or with perishable and durable instruments. That this char acterization is in general correct is not likely to be denied.

It is true of course that the amount loaned to the poor is small because each individual loan is necessarily small; but the numberof these loans is very great, and the desire of the poor to borrow, when it exists, is very intense. \The many Qonspicuous exceptions to these rules are explainable on other grounds. It not infrequently happens that the poor, instead of being borrowers, are lenders;' but in this case either they have unusual foresight, selfcontrol, regard for their children, and other qualities tending in the same direc tion, or else their income-stream has such a time-shape 300 THE RATE OF INTEREST [CHAP. XV as to encourage lending rather than borrowing. Reverse conditions apply likewise to the case of many wealthy men, viz. those who are borrowers rather than lenders. Whether from wrong training or other causes, they lack foresight, self control, regard for posterity, etc. But disregarding these factors and confining our view to the direct influence of the size of income, it is true, in a general way, that the poor are more eager borrowers than the rich, and will often pat ronize pawn shops and other agencies in which the rate of interest is inordinately high; also that their dwellings or other structures are often of a very unsubstantial char acter, such as would not It pay" except to those who put a very high estimate on present as compared with future goods. The deeper the poverty, the higher the rates which the borrowers are compelled to accept. Even pawn broking is not available for the extremely poor, but is patronized rather by the moderately poor. Those who are extremely poor cannot give the kind of security which the pawnbroker requires. On this account they become the victims of even higher rates of interest, pledging their stoves, tables, beds, and other household furniture for the loans they contract. These loans are repaid in installments such that the rate of interest is seldom lower than 100 per cent. per annum. 1 Turning from classes to countries, it is noteworthy that in the countries in which there are large incomes we find low interest, a tendency to lend rather than borrow, accumulate rather than spend, and to form durable rather than perish able instruments, whereas in countries where incomes are low the opposite conditions prevail. Thus, incomes are large and interest is low in Holland, France, and England, whereas the reverse conditions hold in Ireland, China, India, and the Philippines. In Ireland, for instance, especially 1 For details as to thirteen typical loans of this character, see U. S. Bureau of Labor Bulletin, No. 64, May, 1906, pp. 622-633.

Thus, "loan 1," 143 per cent., "loan 3," 224 per cent., "'loan 7," 156 per cent.

SEC. 7] INPUCTIVE VERIFICATION (ECONOMIC) 301 in the early part of the nineteenth century, the rate of interest was high. The cottier was always in debt, and his hut and other instruments· were of the most unsubstantial variety.1 Again in the Philippin~s the rates of interest on good security are often 2, 5, and even 10 per cent. a month. "The Chinese money lender frequently takes advantage of the Filipino's poverty." 2 Many of these cases may be wholly or partly explained by other causes such as have been mentioned in the last section. The possibility of more than one explanation shows that in this field we can scarcely hope to adduce any complete proof of an inductive nature. But since any of the possible explanations fit in with our theory, ·we are safe in saying that the facts do not at any rate contradict that theory. § 7 As to the influence of the compositionof income, it is even more difficult to obtain any statistical confirmation of value. 'Ill a previous chapter it was shown that varia~ions in the amount of that income which takes the form of food would have an effect on the rate of interest similar to the effect. of .variations in the total income itself. Scarcity of food should therefore cause high interest, and abun dance of food, low interest. Certain presumptive evidence is found in the observation of Jevons on the relation be..

tween the price of wheat and the rate of discount.s Wheat being the most typical food in England, it may be·assumed with considerable probability that its price varies inversely with the amount of food consume,d. Jevons found that a 1 See Longfield, "The Tenure of Land in Ireland," in Proloyn's Systems of Land Culture, London (Cassell, Petter, and Galpin), 1876, p.16. 2 From a letter to the author from Professor E. W. Kemmerer; see also his article in The Busines8 Monthly, Pittsburg, April, 1907, p. 2. 3 See Investigatiofl,8 in Currency. and Finance, 1884, p. xiv; also, Robert Goodbody, in Byron W.lIolt's Gold Supply and Prosperity, p.166.

302 THE RATE OF INTEREST [CHAP. XV high price of wheat corresponded to high rates of interest, and vice versa. This would almost amount to saying that a relative scarcity of food was associated with high interest, and vice versa. During the siege of Paris the rate of inter est was high, although other causes than the scarcity of bread were doubtless accountable for the fact. § 8 As to the influence of risk, we encounter similar diffi culties. But evidence as to our main contention, namely, that in general risk tends to raise the commercial rate of interest but to lower pure interest, is forthcoming. The first part of this proposition is a matter of so common ob servation that no special collection of facts is necessary_ Every lender or borrower knows that the rate of interest varies directly with risk. A bird in the hand is worth two in the bush. The principle applies not only to the explicit interest in loan contracts, but to the implicit interest which goes with the possession of all capital.

Where there is uncertainty whether capital saved for the future will ever be of service, but there is certainty that it can be of service if used immediately, the possessor needs the possibility of a very high future return in order to induce him to save the capital for future use. It is note worthy that in time of war there is a ruthless destruction of crops and a tendency among the possessorsof consumable wealth to enjoy it while they may_ The same conditions are characteristic of communities which are in a perpetual state of uncertainty.1 "The rate of interest is everywhere proportional to the safety of investment. For this reason we find in Korea that a loan ordinarily brings from 2 to 5 per cent. per month. Good security is generally forth coming, and one may well ask why it is so precarious to 1 On the uncertainties of Indian life, see The Sociological Theory 01 Capital, pp. 69, 70.

SEC. 8] INDUCTIVE VERIFICATION (ECONOMIC) 303 lend. The answer is not creditable to Korean justice. In a land where bribery is almost second nature, and private rights are of small account unless backed up by some sort of influence, the best apparent security may prove a broken reed when the creditor comes to lean upon it." 1 There remains the second part of the proposition in re gard to risk; namely, tha~risk tends to increase the rate of interest on risky loans it tends at the same time to.... decrease -- an T4is proposition is not familiar to most persons. It has usually caused surprise when, during a time of political stress and danger, the rates of interest on perfectly safe loans were found to be so small. Many such instances may be cited. At certain periQds during the Civil War, when the greatest uncertainty prevailed, loans with good ·security were contracted at nominal rates, and bank deposits tended to accumulate for lack of sufficient outlet in secure investments. Times when public confidence is shaken are characterized not only by high rates on unsafe loans, but by efforts on the part of timid investors to find a safe place for their savings, even if they have to sacrifice some or all of the interest upon it~ They will even hoard it in stockings and safe deposit vaults, or,leave it idle on deposit in bank. "... In 1903 ...

'the public took alarm and began to hoard their capital in the form of banking credits, instead of bidding with it for securities. In the meantime, the scarcity of free capital in the market enabled the banks, which held the JIloney of the public, to exact 5 and 6 per cent." 2 We may even occasionally find cases in which the desire to obtain a safe method of using capital is so keen and so difficult to satisfy that the rate of interest is negative. The investor is then in the position of the user of a safe deposit vault, thankful enough to receive the assurance that his capital,by being 1 H. B. Hurlbert, ThePaMing oj Korea, New York, 1906, p. 283. 2 Charles A. Conant, "How the Stock Market reflects Values," North American Review, March, 1905, pp. 346-359.

304 THE RATE OF INTEREST [CHAP. XV intrusted to another, will not be diminished, to say noth ing of being increased.1 § 9 ; We still need to verify the most essential part of our theory; namely, that the rate of interest depends upon the time-shapeof the income...stream. If the theory is correct, we should find, other things being equal, that when, in any community, the income-streams of its inhabitants are in creasing, the rate of interest will be high; that when they are decreasing, the rate of interest will be low; and that when they alternate from one condition to the other, the rate of interest will also alternate according to the period of the loan. The most striking examples of increasing income-streams are found in new countries. It may be said that the United States has almost always belonged to this category. Were it possible to express by exact statistics or diagrams the size of American incomes, they would undoubtedly show a steady increase since colonial days. Statistics almost equiv alent to these desidorata are available (though not veryaccu rate) in the form of the United States Census figures of "per capita wealth," as well as statistics of production and.

consumption of staple commodities and of exports and im ports. 'rhese, combined with common observation and the statements of historians, lead to the conclusion that American incomes have been on the increase for two hun dred years. It is also true that during this period of rising incomes, the rate of interest has been high. The simplest interpretation of these facts is that Americans, being constantly under the influence of great expectations, have been always ready to promise a relatively large part of their abundant future income for a relatively small ad dition to their present, just as he who expects soon to 1 See Bagehot, Lombard Street, Chap. VI; also, Macaulay, History of England, Chap. XIX. .

SEC. 9] INDUCTIVE VERIFICATION (ECONOMIC) 305 come into a fortune wishes to anticipate its realization by contracting a loan. Not only has the rate of interest been·high in America as compared with other countries during this period of as cending incomes, but some of the other conditions equiva lent to a high rate of interest have also been in evidence. Thus, the country has been conspicuously a borrowing country, indebt to other countries. The proceeds of such loans have shown themselves in increased imports and diminished exports, creating a so-called unfavorable balance of trade. These phenomena have usually been expressed as a "demand for capital"; but, while it is quite true that the exploitation of our natural resources required the construction of railways and other forms of capital, this fact is better and more fully expressed in terms of in come. We wanted, not the railways and machinery them selves, but the future enjoyable products to which this apparatus led. The construction of these instruments necessarily diminished the immediate enjoyable income of the country and added to that of the expected future.

It was to even up this disparity of immediate and remote income that loans were contracted. It does not matter whether the loans from the foreigner were received in the form of machinery and other instruments of production, or in the form of the comforts of life to support us while we ourselves constructed the instruments. In either case the essential fact is the transformation of the income-stream, and not the U need of capital," which is merely one of the means thereto. Import statistics show that, as a matter of fact, we received our loans from the foreigner in both forms. Not only have we witnessed the phenomena of high rates of interest and of borrowing during this period of American development, but it is also true that the character of the instruments created was for the most part of the unsub stantial and "quickly returning" kinds. Our highways, as John Rae pointed out, were little more than the natural x 306 THE RATE OF INTEREST [CHAP. XV surface of the earth-after the removal of trees and rocks; our railways were lightly ballasted, often "narrow gauge,"

and crooked to avoid the necessity of excavations and tun nels; our earliest buildings were rude and unsubstantial. Everything was done, not in a permanent manner with reference to the remote future, but in order to save a large first cost. During the last two decades these conditions have been reversed. The rates of interest in America have fallen greatly, as the statistics in the Appendix will show.1 We l1ave ceased to be a borrowing nation, and are buying back our securities from abroad. This repayment of debts is accomplished through the export of our now abundant products, and creates a so-called favorable balance of trade. Again, the character of the instruments which have been now for some time in process of construction is of the most substantial kind. Steel rails have long since taken the place of iron rails, "broad gauge" of "narrow gauge" ; railways have been straightened by expensive tunnels, by bridges, and by excavations; 2 dwellings and other buildings have been made more substantial; macadamized roads are gradually coming into vogue; and in every direction industrial, agricultural, and domestic - there is an evident tendency to invest a large first cost in order to reduce future running expenses.

§ 10 Thus in America we see exemplified on a very large scale the truth of the theory that a rising income-stream raises and a falling income-stream depr;ses the rate of int~.r~, or that these conformations of the income-stream work out their effects in other equivalent forms. A similar causation may be seen in particular localities in the United States, est See Appendix to Chap. XIV, § 1. 2 It is estimated that Western railways in the United States have actually under way or in contemplation improvements amounting to $1,000,000,000. Wall Street Journal, December 19, 1905.

SEC. 10] INDUCTIVE VERIFICATION (EOONOMIC) 307 pecially where changes have been rapid, as in mining com munities. In California, in the two decades between 1850 and 1870,followingthe discovery of gold, the income-stream of that state was increasing at a prodigious rate, while the state was isolated from the world, railroad connection with the East not being completed until 1869. During this period of isolation and ascending income, ". · · 21WJt: tuniti or investment were innumerable. Hence e / ates of interest were abnormally high. The current rates in the' early days' were quoted at I! to 2 per cent. a month. . .. The thrifty MichaelReese is said to have half repented of a generous gift to the University of California, with the exclamation,'Ah, but I lose the interest,' a very natural regret when interest was 24 per cent. per annum." 1 Mter railway connection in 1869, Eastern loans began to flow in.

The decade, 1870-1880,was one of transition during which the phenomenon of high interest was gradually replaced by the phenomenon of borrowing from outside. The rate of interest consequently dropped from 11 per cent. to 6 per cent.2 "Since 1880 the economic history of California, or at least of San Francisco and vicinity, has not differed so very much from that of the rest of the country."·3 During recent years the rate on mortgages in San Francisco, up to the time of the earthquake and fire, has been 4 to 41 per cent. exclusive of the state tax. The same phenomena of enormous interest rates were also exemplified in Colorado and the Klondike. There were many instances in both these places during the tran sition period from poverty to affluence, when loans were contracted at over 50 per cent. per annum, and the bor:. rowers regarded themselves as lucky to get rates so "low." It. was also conspicuously true .that the first buildings and apparatus constructed in these regions were very unsub1 Carl C. Plehn, " Notes concerning the Rates of Interest in Cali fornia," Quarterly Publications 01 theA merican Statistical A.ssocia tion, September, 1899, pp. 351-352.

2 Ibid., p. 353. 8 Ibid., p. 353 308 THE RATE OF INTEREST [CHAP. XV stantial. Rude board cabins were put up in a day. Thus, high interest, borrowing, and unsubstantial capital were the phenomena which attended these communities when under going their rapid expansion. In Nevada in the seventies, when the mines were in creasing their product and the income of its inhabitants was tending upwards, the rate of interest was high and the people in debt. The bonded state debt itself amounted to $500,000 and drew 15 per cent. interest. 1 In the next dec ade all these conditions were reversed. The mines were on the decline,2 the rate of interest fell, and the state and territorial debts were largely paid off.3 The fall of the rate of interest in this case could not have been due to the in troduction of loans from outside, except so far as old debts were refunded at lower rates; fresh loans were seldom made, as the state had ceased to be a good place for new investments. In the last few years new Nevada mines in the gold-fieldregion have been opened. Loans are again entering the state, and the same cycle of history as above described is about to be repeated.

Lumbering communities often go through a somewhat similar cycle. The virgin forests when first attacked tend to increase rapidly the income-streams of those who exploit them. Then comes a period of decrease. Thus in Michigan two or three decades ago the lumber companies found a profitable investment, and borrowed in order to exploit the ~fichigan forests. Mter the exploitation was co~plete and the forests had been (often unwisely) exhausted, those regions ceased to be a desirable place for investment, and their owners came into the position, not of receiving, but of seeking, investments. Mter the trunk lines of railway were completed, connect ing the Mississippi Valley with the East, there arose a great demand for loans to exploit the rich farming lands in that 1 See "Message of the Governor of the State of Nevada," 1879. % Mines and Quarries, 1902. Special Report U. S. Census, p. 255.

8 See later, "Messages of the Governor of the State of Nevada."

SEC. 11] INDUCTIVE VERIFICATION (ECONOMIC) 309 section of the country. The rate of interest frequently was 10 and 12 per cent., and even higher. During much of this time the Northwestern Mutual Life Insurance Company, up to 1880, made an average rate on all its mortgage loans, $10,000,000 in amount, of nearly 10 per cent. Another striking proof of the demand for loans in the Middle West is shown in the experience of the New York and Connecticut life insurance companies. New York, up to 1880, had a law prohibiting the life insurance com panies in that state from loaning on real estate outside of New York. Connecticut had no restriction in this regard, and her companies loaned extensively in the West. The result is seen in the rates of interestrealized on mortgage loans of companies in the two states. Taking the period 1860 to 1880 as a whole, the Connecticut companies realized 11\ per cent. more than did the New York companies.

Since 1880, the Middle West has developed rapidly, and loans on farming lands are now made at low rates. During the past two years, certain of the insurance companies have been making mortgage loans in Illinois at 4t per cent.1 A similar history has recently been enacting itself in the northwest region of the United States. During the period of exploitation while the Great Northern and other railways were developing this territory, the phenomena of high interest and borrowing were almost universal. But lat terly, much to the surprise of many Easterners, it has been found that the rates of interest in these states have been at times lower even than in most American cities, and that the inhabitants have actually been seeking to lend to the East instead of to borrow from it. § 11 Australia furnishes another. example of a country which, through improvement in the means· of transportation, 1 See Zartman, The Investments· 0/ Life Insurance Companies, New York (Holt), 1906, pp. 89-91.

310 THE RATE OF INTEREST [CHAP. XV created a great demand for loans. The rate during the fifties on safe securities was rather low. This rate increased until, during the seventies, 7, 8, and 9 per cent. were usual. Since 1880 the rates have declined.1 England may perhaps be cited as exemplifying the same phenomena which we have seen in the case of Nevada, though in a less degree. Thus, as Nevada has exhausted its mines of precious metals, so England Is on the road toward. exhaustion of its coal and iron supplies. This fact has been noted with considerable alarm by many econo mists, especially Jevons. It does not necessarily indicate that the economic power of Englishmen will be greatly or even at all lessened. Its significance shows itself in the tendency of England to become an investing country. It is the part of those who have property in mines not to use all of the product as income, but to reinvest in order to maintain the capital. This the Englishmen have done and are doing; and being unable to make satisfactory invest ments at home, they have placed their loans allover the world. The income-stream produced for them by their native island is destined, perhaps, to decline, certainly not greatly to increase; but by saving from this declining income and investing in South America, Australia, South Mrica, and other regions where the natural resources are on the increase instead of on the wane, the Englishmen may still maintain their capital intact or even increase it. It is said, with how much accuracy I do not know, that Englishmen own an area in the United States as large as Ireland. The figures given by Giffen show that the na tional income increased for several decades, but that the rate of increase slackened 2 for the decade 1875-1885 com~ pared with 1865-1875; that whereas in the earlier decades there was a general increase in all directions, in the later 1 Zartman, The Investments oj LiJe Insurance Companies, p. 103.

:I Giffen, Growth 0/ Oapital, London (Bell), 1889. See also articles by Giffen in continuation of the same subject in Journal 0/ Royal Sta tistical Society.

SEC. 12] INDUCTIVE VERIFICATION (ECONOMIC) 311 decade there were many items of decrease,l the most nota ble being of mines and ironworks; 2 and finally, that among the greatest increases was that of foreign investments. 3 We thus see that the rate of preference for present over future goods, in its various manifestations - such as a high or low rate of interest, more or less lending and accumu lation of capital, and the character of the instruments formed - depends upon the time-shape of the income-stream of a community, as determined by its natural resources; that in virgin countries like the United States in the last two centuries,Australiaand South Africa, rich.in timber, untouched ore, and raw materials generally, the income stream is of the ascending type and produces a high rate of preference, whereas in older countries like England and Holland, in which the natural resources have been fully developed, and are even declining, the rate of preference tends to be low; such a country either uses up its income and thereby reduces its capital, or seeks economic salvation in foreign investment.

§ 12 The time-shape of an income-stream is, however, deter-J mined in part by other causes than natural resD.W:Ce_S. , Among these causes, misfortune holds a h'igh place in causing temporary depressions in the income-stream, that is, giving to it a time-shape which is first descending and afterwards ascending. The effect of such temporary depression is to produce a high valuation of immediate income during the depression period as compared with the valuation of the income expected after· the .depression is over. It is a matter of common observation in private life that loans often find their source in personal misfortune. The above-mentioned investigation of the conditions of borrowing among the poor 4 shows that the chief causes 1 Ibid., p. 44. 2 Ibid., p. 35. 3 Ibid., pp. 40-42. c U. S. Bureau of Labor Bulletin, No. 64, May, 1906, pp. 622 ff.

312 THE RATE OF INTEREST [CHAP. XV for borrowing are a death or birth in the family, or pro tracted illness, the expense of which, even when amount .. ing to only $10 or $20, would, without the loan, make serious inroads on the daily necessities. We may see the operation of the same principle on a larger scale in the case of tIle San Francisco earthquake, which, had it not been for tIle succor rendered by the whole country, would have cut down the income-stream of the city to the starvation point. In addition to the aid of many millions of dollars of gifts, there were needed also heavy loans. Whether these loans were used to produce sus tenance, which is direct income, or to offset the cost of rebuilding the city, which is outgo, the effect is the same, -they were for the purpose of salving over a temporary injury to the income-stream. The effect on the rate of interest was slight, because of the opportunity to borrow heavily from outside. Had the city not had this opportu nity, the depression in its income-stream could not have been mitigated, and the rate of hlterest would inevitably have risen to a level comparable with that which prevailed in the same region a half century ago during the gold fever.

In much the same way is the income-stream of a nation affected by war. The effects in this case, however, are more complex, owing, first, to the element of uncertainty which the war introduces until peace is declared; and, secondly, to the fact that wars are apt to be more pro tracted than most other misfortunes. The effect, accord ing to previous explanations, should be that at the ~eginning of the war the rates of inter~t on risky loans would be high. This would be especially true of the loans the periods of which are short, or not long enough to outlast the war. On the other hand, the rate of interest on safe loans would be lowered for short-term loans, and raised for long-term loans. A short-term loan relates to a descent in the income curve if repayable at a time when the income-stream is apt to be still further reduced. This descent in the income..,stream, together with the element of uncertainty, tends, as has been SEC. 12] INDUCTIVE VERIFICATION (ECONOMIC) 313, seen, to lower the rate of interest on safe loans. On the other hand, for long-term loans intended to outlast the war, the rate of interest is apt to be high, for the income stream at the time of repayment may be expected to exceed the income-stream at the time of contract.

At the close of the war, after peace is declared and the element of uncertainty introduced by it 'has disappeared, the rate of interest, even on short-term loans, will be high; for then the country is, as it were, beginning anew, and the same causes operate to make interest high as apply in the case of all new countries. The situation at this period is exemplified by the recent peace loan for Japan. When the effects of the war include the issue of depre ciated paper money, the rate of interest is affected in a som,ewhat more complex manner, being then sllbject to the influence of depreciation, according to the princi ples explained in Chapter V, and statistically verified in Chapter XIV. Among the most powerful causes which affect the time shape of income-streams has been noted the effect of inven tion. That the claims which have been made for the effect of invention are verified in fact can scarcely be doubted when we consider the history of railway transportation.

The very fact that during the last half century the chief outlet for investors' savings has been in the creation of new railways, is sufficient testimony. What is tnle in the case of this'single invention or group of inventions is more sig nally true when a large number of inventions is being made. The effect of the activity of the inventive faculty must have materially contribtlted to keep up the rate of interest in the. United States, and during the last generation in Ger many. The striking way in which the rate of interest in Germany has been maintained during the past century is shown by the experience of the Gotha Mutual Life Insurance Company, the largest in Germany. From 1829 to 1838, this company made an average rate of 3.9 per cent. During the years 314 THE RATE OF INTEREST [CHAP. XV 1850-1852, the rate realized was 3.9 per cent. In 1874, the rate had risen to 4.8, influenced partly by the same causes that had affected the interest rate allover the world, and partly by the great industrial progress which Germany was making. In 1885, the rate had fallen to 4.2 per cent., and in 1902 to 3'!9 pE:,J.~ cent., a rate the same as that which had been realized three quarters of a century before! 1 § 13 We have considered the effect on the rate of preference of those changes in the income-stream due to the growth or waning of natural resources and to the temporary in fluence of misfortunes and inventions. There remain to be considered those regular changes in the income..,stream of a rhythmic or seasonal character. Though most persons are not aware of the fact, it can scarcely be doubted that the annual succession of seasons produces an annual cycle in the income-stream of the community. This is especially true of agriculture. Grains, fruits, vegetables, cotton, wool, and almost all the organic products flow from the earth at an uneven rate, and require for their production also an uneven expenditure of labor from man during dif ferent seasons of the year. Statistics of consumption show that the income enjoyed conforms in general to a cycle.

Food products are usually made available in the warm months when crops ripen; logs are hauled out of the woods in winter, floated to mills in spring, and made into lumber in summer. But the tendency to a cycle is modified by the existence of stocks of commodities to tide over the periods of scarcity. The ice of winter is stored for summer, and the fruits of summer are canned and preserved for winter. Only so far as such storage and preservation are difficult and ex pensive, or impair the quality of the goods thus held over, or, because of the perishable nature of the goods, are im1 See Zartman, The Investment8 0/ Life Insurance Companie8 J pp. 105-106.

SEC. 13] INDUCTIVE VERIFICATION (ECONOMIC) 315 practicable, does there remain any cyclic change in enjoyed income. The cycle is different for different industries and for different classes of the population. The farmer is perhaps the most typical for the country as a whole. For him the lowest ebb is in the fall, when gathering and market ing his crops cause hi~la sudden expenditure of labor, or of money for the labor of others. To tide him over this period he may need to borrow. A whole group of other industries, particularly those connected with transporta tion, experience a sympathetic fluctuation in the income... stream. In the parlance of Wall Street, "money is needed to move the crops." The rate of interest tends upward, as the following table shows:1_ MONTHLY DISCOUNT RATES FOR PRIME TWO-NAME 60 TO 90 DAYS' PAPER IN NEW YORK CITY (Average for 10 years, 1896-1905) January.. ...••.. 4.3 February . . . . . • 4.1 March. . . . • . . . . . . . 4.4 April . . . 4.4 May . . . . . . 4.1 June . 3.9 July . . 4.2 August . . . . . . . . 4.7 September . 5.2 October . . . . 5.2 November . . 4.8 December . 4.8 In a community dominated by some other industry than farming the cycle would be different. Even in the above table the rates are of course a composite in which the cycles of the manufacturer and of other elements are superimposed upon the cycle of the farmer. The manufacturer's cycle is a little later than the farmer's and shifts the high rates from fall toward winter.

Accordingly in England, which is more dominated by the manufacturer,thecycle,though similar to that just observed 1 Compiled from daily rates given in The Financial Review.

316 THE RATE OF INTEREST [CHAP. XV for the United States, is shifted forward, as the following table shows: 1 MONTHLY AVERAGES OF MINIMUM RATE OF DISCOUNT OF BANK OF ENGLAND FOR YEARS 1845-1900 January · · 4.0 February · 3.6 March . 3.5 April . · 3.4 May . . · · · · · 3.6 June · 3.4 July . · · 3.3 August · · · · . . . · 3.4 September 3.4 October · 3.9 November · 4.2 December 4.1 § 14 The facts as presented in this chapter harmonize with the theory as presented in previous chapters. Accord ing to the theory, if there is a high degree of foresight, selfcontrol, and regard for posterity, or if income-streams are large or plentiful in the food-element, or have a descend ing time-shape, then, other things being equal, the rate of interest will be low, or capital will be accumulated, or the community will lend to other communities, or the instru ments it creates will be durable. We find these results present in actual fact where the antecedent conditions enumerated are also present. Reversing the conditions, we find reversed results. Of course this inductive veri fication is very rough, since we never can assert that It other things are equal," and thus isolate and measure anyone particular factor, as in the more exact inductions of physical science. Yet the inductive study is worth something, even if it be only in the fact that it does noi contradict the theory; for a false theory usually encounters facts with which it cannot be reconciled.

1 See Palgrave's Bank Rate and the Money Market, New York (Dut ton), 1903, p. 97.