§17. Confusions to be Avoided

The very first effort of the beginner in this subject should be to rid his mind of all prepossessions as to the nature of income and capital. My grandchild of six recently asked the cashier of a savings bank, "Show me the money I am going to get when I grow up." The cashier gravely took him into a back room and held up a bag of coins. The vision of that bagful will doubtless persist into adult life as a picture of a savings bank account, even after he has learned in college that the total deposits of a bank far exceed the cash on hand, and that the depositor's capital is not actual cash but the right, measured in terms of cash, to the services or benefits flowing from the bank's assets, real estate, mortgages on real estate, stocks and bonds, and all the rest of its resources. Both capital and income seem to be simply money. We can always show a money sample, as did the cashier, and where one's capital is liquid so that it may readily be turned from one form to another via money—or rather Edition: current; Page: [32] credit—it is most simply and lazily pictured to the mind's eye as being itself money.

The student should also try to forget all former notions concerning the so-called supply and demand of capital as the causes of interest. Since capital is merely the translation of future expected income into present cash value, whatever supply and demand we have to deal with are rather the supply and demand of future income.

It will further help the student if he will, from the outset, divest himself of any preconception he may have acquired as to the rôle of the rate of interest in the distribution of income. This subject will be dealt with in Chapter XV; but it may be well here to point out that interest is not, as traditional doctrine would have it, a separate branch of income in addition to rent, wages and profits.

The income stream is the most fundamental fact of economic life. It is the joint product of many agencies which may be classified under many heads, such as human beings, land, and (other) capital. The hire of human beings is wages; the hire of land is land rent. What, then, is the hire of (other) capital—houses, pianos, typewriters, and so forth? Is it interest? Certainly not. Their hire is obviously house rent, piano rent, typewriter rent, and so forth, just as the man in the street calls them. Rent is the ratio of the payment to the physical object—land, houses, pianos, typewriters, and so forth—so many dollars per piano, per acre, per room. Interest, on the other hand, is the ratio of payment to the money value of these things—so many dollars per hundred dollars (or per cent). It is, in each case, the ratio of the net rent to the capitalized value of that rent. It applies to all the categories—to land quite as truly as to houses, pianos, type Edition: current; Page: [33] writers. The income from land is thus both rent and interest just as truly as the income from a typewriter or a bond. We can and do capitalize land rent just as truly as we do house rent. For example, land worth "20 years purchase" yields 5 per cent interest. All this is true quite irrespective of the question of distinctions between land rent, on the one hand, and house rent, piano rent, typewriter rent, and so forth on the other.13 It is a question of that sort of price which links one point of time with another point of time in the markets of the world. And it is a question concerning every branch of economic theory in which the time element enters. The rate of interest is the most pervasive price in the whole price structure.

As to profits, I believe the most fruitful concept is also that of the man in the street. When risk attaches to any one of the aforementioned forms of capital—human beings, land, houses, pianos, typewriters and so forth—the man in the street calls the net income profits. And profits, likewise, may be measured either (as rent) in relation to the physical units producing them, or (as interest) in relation to the values of these profits; that is, either as dollars per acre, per room, per piano and so forth; or dollars per $100 worth of land (houses, pianos, and so forth); or as dollars per share of ownership in any of these; or dollars per $100 worth of such shares. To pretend that either interest or profits is the income solely from capital goods other than land and that these two concepts are inapplicable to land—to pretend, in short, that wages, rent, interest and profits are four mutually Edition: current; Page: [34]exclusive divisions of the income stream of society is to treat different classifications of one thing as if they were themselves different things. It is as if we should speak of a certain total space as consisting partly of acres of land, partly of tons of soil, and partly of bushels of ore. Or again, it is like classifying a pack of cards into aces, clubs and red suits and pretending that these three classes are mutually exclusive.

The simple fact is that any or all income may be capitalized, including that credited to human beings, thus giving the resultant economic value of a man. William Farr, J. Shield Nicholson, Louis I. Dublin, and others have made such computations.14 However, we so seldom capitalize wages that we have no practical need to call wages or any portion of them interest. Nor where risk is a dominant factor, as in profits, is there real need to call the income interest. For instance, hoped-for dividends, according as the hope varies, are daily and automatically capitalized in the stock market and need not themselves be called interest. Much less would it be worth while to call enterpriser's profits interest. No one ever attempted to capitalize them. But in meticulous theory, all may be capitalized and so become interest.