XVIII. Summary

CHAPTER XVII SUMMARY § 1 WE have seen that the rate of interest is subject to both a nominal and a real variation, the nominal variation being that connected with changes in the standard of value, and the real variation being that connected with the other and deeper economic causes. As to the nominal variation in the rate of interest, we found that, theoretically, an ap preciation of 1 per cent. of the standard of value in which the rate of interest is expressed, compared with some other standard, will reduce the rate of interest in the former standard, compared with the latter, by about 1 per cent. ; and that, contrariwise, a depreciation of 1 per cent. will raise the rate by that amount. Such a change in the rate of interest, however, is merely a change in the number expressing it, and not in any sense a real change. Yet the. appreciation or depreciation of the monetary standard does produce a real effect on the rate of interest, and that a most vicious one. This effect is due to the fact that the rate of interest does not change enough to fully compensate for the appreciation or depreciation. Thus, if the monetary standard is appreciating at the rate of 3 per cent. per annum and the rate of interest falls only 2 per cent., the deficiency of 1 per cent. shows that the rate of interest has not really fallen, but risen. This rise of 1 per cent. is abnormal, being the result of an error in prediction. Had the debtors and creditors concerned foreseen fully the change in the monetary standard, they would have forestalled it fully.

Their failure so to do results in an unexpected loss to the debtor, and an unexpected gain to the creditor. What 327 THE RATE OF INTEREST [CHAP. XVII usually happens, therefore, as a consequence of an appre eiation in the monetary standard, is that the rate of interest nominally falls, but really rises, whereas in the contrary case, if the monetary standard is depreciating, the rate of interest nominally rises, but really falls. It is conse quentlyof the utmost importance, in interpreting the rate of interest statistically, to ascertain in each case in which direction the monetary standard is moving, and to re member that the direction in which the rate apparently moves is apt to be precisely the opposite of that in which it really moves. § 2 Turning from the nominal to the real variation in the rate of interest, we see that the rate of interest, considered in dependently of fluctuations in the monetary standard, is determined by six causes, namely: (1) The extent of the effective range of choice of different incomes which are open to each individual; (2) the dependence of "timepref erence" upon prospective income - its size, shape, com position, and probability; (3) the tendency of the rates of timepreference for different individuals to become equal to each other and to the rate of interest, through the loan market, or through buying and selling property; (4) the tendency of the various "rates of return on sacrifice"to·be come equal to each other and to the rate of interest, through the operation of free choice among available options; (5) the fact that supply and demand are equal, that the modifications in the income-streams of individuals through buying and selling or borrowing and lending mutually offset each other for each interval of time considered, that what is lent must equal what is borrowed, and what is gained by one in each year's income, by buying and sell ing, is lost by some one else; (6) the fact that, for the same individual, the estimated present values of the changes he elects to make in his prospective income-stream SEC. 3] SUMMARY 329 mutually offset each other; that is, the estimated present value of what he borrows is equal to the estimated present value of what he, returns, or, more generally, the estimated present value of an addition to his immediate income is equal to the present value of the consequent reduction in his future income.

Of these six conditions, many are so inflexible that they have little influence"onany variation in the rate of interest. The last four are of this relatively fixed type. We have remaining the first two as the only causes subject to im portant variations. The fluctuations in these causesexplain for the most part the changes in the rate of interest, as actually experienced. We shall now concentrate attention upon these two, - the range of known choice and the law of timepreference. § 3 As to the range of choice,each individual may, as assumed in our" first approximation," be possessed of one given in come which is rigid (except as it may be altered by borrow ing and lending); or, as assumed in the other approxima tions and as found in actual fact, he may be possessed of a given range of choice of many different income-streams. The range of choice actually open to any individual will depend principally upon the amount and character of the capital-property which he possesses. It follows that; for society as a whole, the range of choice of incomes will depend upon, first, the existing capital of the country; that is, its "resources," or the amount and character of the different capital-instruments existing within it at the in stant of time considered; and, secondly, the distribution of ownership of these capital-instruments throughout the community. 'In this statement 'it is intended, of course, to include under capital-instruments the individuals them selves who constitute the community, for they are the source, through" their personal exertions, of much of the 330 THE RATE OF INTEREST [CHAP. XVII income which they enjoy. In short, then, the available range of choice will depend upon capital and its distribution.

If the capital-instruments of the community are of such a nature as to offer a wide range of choice, we have seen that the rate of interest will tend to be steady. If the range of choice is narrow, the rate of interest will be comparatively variable. If the range of choice is relatively rich in the remotelyfuture income as compared with the more immediate income, the rate of interest will be high. If the range of choice tends to favor immediate income as compared with remote future income, the rate of interest will be low. Thus, for the United States during the last century, its resources were of such a character as to favor a remote future income. This is true, for a time at least, in every undeveloped country, and, as we have seen, gives the chief explanation of the fact that the rate of interest in such localities is usually high. The range of choice in any community is subject to many changes as time goes on, due chiefly to one of three causes.

First, a progressive increase or decrease in resources; second, the discovery of new resources or means of develop ing old ones; and third, change in political conditions. The impending exhaustion of the coal supply in England which has been noted by Jevons and other writers will tend to make the incomes~ream from that island decrease, at least in the remote future, and this in turn will tend to keep the rate of interest there low. The constant stream of new inventions, on the other hand, by making the available income-streams rich in the remote future, tends to make the rate of interest high. This effect, however, is confined to the period of exploitation of the new invention, and is suc ceeded later by an opposite tendency. During the last half century the exploitation of Stephenson's invention of the locomotive, by presenting the possibility of a relatively large future income at the cost of comparatively little sacrifice in the present, has tended to keep the rate of interest high.

As the period of railroad building is drawing to a close, this SEC. 4] SUMMARY 331 effect is becoming exhausted, and the tendency of the rate of interest, so far as this influence is concerned, is to fall. As to the political conditions which affect the rate of interest, insecurity of property rights such as occurs during politi cal upheaval tends to make the pure or "riskless" rate of interest low. At the same time it adds an element of risk to most loans, thereby diminishing the number of safe and increasing the number of unsafe loans. Hence the "com mercial " rate of interest in ordinary loans during periods of lawlessness is apt to be high. Reversely, during times of peace and security, the "riskless" rate of interest is comparatively high while the "commercial" rate tends to be low. § 4 We turn now to the second factor determining interest; namely, the dependence of timepreference of each in dividual on his selected income-stream. We have seen that the rate of preference for immediate as compared with remote income will depend upon the character of the in~ come-stream selected; but the manner of this dependence is subject to great variation and change. The manner in which.a spendthrift will react to an income-stream is very different from the manner in which the shrewd accumulator of capital will react to the same income-stream. We have seen that the manner in which the timepreference of an individual depends upon his· income will vary with five different factors: (1) His foresight and selfcontrol; (2) his love of offspring or regard for posterity; (3) the pro spective length and certainty of his life; (4) habit; (5) fashion. It is evident that each of these circumstances may change. The causes most.likely to effect such changes are, first, education and training in thrift, whether accom plished through the home, the school, charitable organi zations, or banks for small savings, building and loan as sociations, and other similar institutions calculated to have an educational influence; second, the tendency toward or 332 THE RATE OF INTEREST [CHAP. XVII away from a spirit of extravagance and ostentation through social rivalry; 1 third, the changes in the char acter of the institutions of marriage and the family which, in one direction or the other, will profoundly affect the love of offspring and regard for the welfare of posterity; fourth, the development of the science of hygiene which may tend to make human life longer and more certain; fifth, the causes which tend to make the distribution of wealth either more concentrated or diffused, and also those which tend to make the existing economic stratification of classes fixed and stereotyped or elastic and variable. These vari ous factors will act and react upon each other, and will affect profoundly the rate of preference for present over future income, and thereby influence greatly the rate of interest. Where, as in Scotland, there are educational tendencies which instill the habit of thrift from childhood, the rate of interest tends to be low. Where, as in ancient Rome, there is a tendency toward reckless luxury and com petition in ostentation, and a degeneration in the bonds of family life, there is a consequent absence of any desire to pro long income beyond one's own term of life, and the rate of interest tends to be high. Where, as in Russia, wealth tends to be concentrated and social stratification to be rigid, the great majority of the community on the one hand, through .poverty and the recklessness which poverty begets, tends to have a high rate of preference for present over future income; whereas, at the opposite end of the ladder, the inherited habit of luxurious living tends, though in a different way, in the same direction. In such a community the rate of interest is apt to be unduly high.

§ 5 From the foregoing enumeration, it is clear that the rate of interest is dependent upon very unstable influences, 1 See Rae, The Sociological Theory of Capital. Cf. the writer's II Why has the Doctrine of Larssez Faire been Abandoned?" Science, Jan. 4, 1907.

SEC. 5] SUMMARY 333 many of which have their origin deep down in the social fabric and involve considerations not strictly economic. Any causes tending to affect intelligence, for~sight, self control,habits, the longevity of man, and family affection, will have their influence upon the rate of interest. The most fitful of the causes at work is probably fashion. This at the present time acts, on the one hand, to stimulate men to save and become millionaires, and, on the other hand, to stimulate millionaires to live in ang§1~tatious manner. Fashion is one of those potent yet ·llusor. social forces which follow the laws of imitation so mue empha sized by Tarde,t Le Bon/ Baldwin,s and other writers. In whatever direction the leaders of fashion first chance to move, the crowd will follow in mad pursuit until the whole social bo4y will be moving in that direction. Sometimes the fashion becomes rigid, as in China, a fact emphasized by Bagehot; 4 and. sometimes the effect·of a too universal following is to stimulate the leaders to throw off their pur suers by taking some novel direction - which explains the constant vagaries of fashion in dress. Economic fashions may belong to either of these two groups, - the fixed or the erratic. Examples of both are given by John Rae. 5 It is of vast importance to a community, in its influence both on the rate of interest and on the distribution of wealth itself, what direction fashion happens to take. For in stance, should it become an established custom for million aires to c~!lsider it "disgraceful to die rich," and believe it de rigli;i)to give the bulk of their fortunes for endowing univers~s, libraries, or other public instituti9ns, the effect would be, through diffusion of benefits, to lessen the ·dis1 Social Law8, by G. Tarde, English translation, New York (Mac millan), 1899. Also Les Lois de l'Imitation.

2 The Psychology 01 Socialism, English translation, London (T. Fisher Unwin), 1899. Also The Orowd. S Social and Ethical Interpretations in Mental Development, New York (Macmillan), 4th ed., 1906. 4 Physics and Politica, Chap. III. I SeeThe Sociological Theory of Capital.

334 THE RATE OF INTEREST [CHAP. XVII parities in the distribution of wealth, and also to lower the rate of interest. § 6 From what has been said it is clear that in order to esti mate the possible variation in the rate of interest, we may, broadly speaking, take account of the following three groups of causes: (1) The thrift, foresight, selfcontrol, and love of offspring which exist in a community; (2) the progress of inventions; (3) the changes in the purchasing power of money. The first cause tends to lower the rate of in terest; the second, to raise it; and the third to affect only the nominal rate of interest, though practically it usually produces also a dislocation in the real rate of interest. Were it possible to estimate the strength of the various forces thus summarized, we could base upon them a pre diction as to the rate of interest in the future. Such a prediction, however, to be of much value, would require more painstaking attention than has ever been given to existing historical conditions. Without such a careful in vestigation, any prediction is hazardous. We can say, however, that the immediate prospects for a change in the monetary standard are toward its gradual depreciation; that a change in thrift, foresight, selfcontrol, and benevo lence, if it occurs, is for the most part likely to intensify these factors and thus to lower the rate of interest; and that the progress of discovery and invention seems apt to slacken in speed, both so far as industrial processes are concerned, and, what has hitherto been of more conse quence, so far as the discovery of exploitable areas is con cerned. It is true that the new chemical agriculture has the same effect as the discovery of new land. It is con ceivable, perhaps, that the future developnlent of these methods may be as potent as was t4e discovery and ex ploitation of the American, Australian, and African conti nents, which has tended to keep the rate of interest high.

SEC. 6] SUMMARY 335 Yet this result can scarcely be.regarded at present as prob able. America and Allstralia have been already exploited to a large degree, and within another generation almost the same degree of exploitation is apt to occur in Mrica. If we look forward, then, beyond the present lifetime, unless some invention or set of inventions comparable to those of steam and electricity are still in store for us, we see that the probable improvement in thrift, foresight, self control, family affection,. etc., and the slackening in the activity or economic importance of inventive processes, are all in the direction of lowering the rate of interest. It may of course happen that counter currents will prove the stronger. There is certainly danger that the spirit of ex travagance and display, a spirit which we have seen leads to reckless loans and high interest, will become a national disease as it did during the decline of the Roman Em pire. Only time can tell us whether or not we shall escape this danger.

So far as the effect of the monetary standard on the rate of interest is concerned, the prospect of depreciation of gold tends, on the one hand, nominally to raise the rate of interest, but practically to make the rate of interest really not only low, but lower than it otherwise would be. With the influx of gold from Colorado, Alaska, California, Australia, and latterly Nevada, and with the resllmption of mining in South Africa, there cannot be much question that gold will depreciate.1 This result will tend to be intensified by the fact that there are few if any large nations left which have not already adopted the gold standard or which are at all likely to do so, and thereby mitigate the fall of gold. The rate of interest is now, on ordinarily safe loans in civilized communities, in the neighborhood of 4 per cent., expressed in money. We may surmise that 1 See "Symposium," Moody'8 Magazine., December, 1905; Byron W. Holt, The Gold Supply and Pro8perity,N. Y. (Moody), 1907; also "The Depreciation of Gold," by Professor J. P. Norton, Yale Review,November, 1906.

336 THE RATE OF INTEREST [CHAP. XVII through much of the present century this rate will nomi nally continue, but that the rate of interest in terms of " com modities" will be 1 or 2 points lower. The effect of these conditions on trade and on the relative fortunes of stock holders and bondholders has been stated in Chapter XIV. The rate will not remain perfectly constant but will tend gradually to rise until the stringency thus produced cul minates in a commercial crisis. After such a period of liquidation, the same process of rising prices with high nominal but low real interest will begin anew. A discrepancy of 1 or 2 points between the rate of in terest as it is and as it should be is therefore of no trifling importance. Its cumulative effects, although seldom realized, are serious. It is commonly assumed that the rate of interest is a phenomenon confined to money markets and trade centers, and the public approval or disapproval of the rate usually takes its cue from the sentiments of the borrower. If "money is easy," he is content.

The truth is that the rate of interest is not a narrow phenomenon applying only to a few' business contracts, but permeates all economic relations. It is the link which binds man to the future and by which he makes all his far-reaching decisions. It enters into the price of securi ties, land, and capital goods generally, as well as into rent, wages, and the value of all U interactions." It affects profoundly the distribution of wealth. In short, upon its accurate adjustment depend the equitable terms of all exchange and distribution.